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Edited Transcript of BRC earnings conference call or presentation 22-Feb-18 3:30pm GMT

Q2 2018 Brady Corp Earnings Call

MILWAUKEE Feb 23, 2018 (Thomson StreetEvents) -- Edited Transcript of Brady Corp earnings conference call or presentation Thursday, February 22, 2018 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aaron James Pearce

Brady Corporation - CFO & Treasurer

* Ann E. Thornton

Brady Corporation - CAO & Corporate Controller

* J. Michael Nauman

Brady Corporation - President, CEO & Director

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Conference Call Participants

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* Charles Damien Brady

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Keith Michael Housum

Northcoast Research Partners, LLC - MD & Equity Research Analyst

* Molly Rose Baum

BofA Merrill Lynch, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Q2 2018 Brady Corporation's Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded for replay purposes.

It is now my pleasure to hand the conference over to Ms. Ann Thornton, Chief Accounting Officer. Ma'am, the floor is yours.

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Ann E. Thornton, Brady Corporation - CAO & Corporate Controller [2]

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Thank you, Brian. Good morning, and welcome to the Brady Corporation Fiscal 2018 Second Quarter Earnings Conference Call. The slides for this morning's call are located on our website at www.bradycorp.com. We will begin our prepared remarks on Slide #3.

Please note that during this call, we may make comments about forward-looking information. Words such as expect, will, may, believe, forecast and anticipate are just 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 fiscal 2017 Form 10-K, which was filed with the SEC in September of last year.

Also, please note that this teleconference is copyrighted by Brady Corporation and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the Internet. As such, your participation in the Q&A session will constitute your consent to being recorded.

I'll now turn the call over to Brady's President and Chief Executive Officer, Michael Nauman.

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J. Michael Nauman, Brady Corporation - President, CEO & Director [3]

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Thank you, Ann. Good morning, and thank you all for joining us.

This morning, we released our fiscal 2018 second quarter financial results, and I'm proud to report our 10th consecutive quarter of improved year-on-year profitability. We increased pretax earnings by 20.4% compared to the second quarter of last year.

Total sales growth was 7.4% in the quarter, which was made up of 3.2% organic growth and an increase of 4.2% from foreign currency. These positive trends are direct results of the focus and dedication of the entire Brady team on the execution of our strategy.

This is Brady's strongest quarter of organic sales growth since the first quarter of fiscal 2012, which was 25 quarters ago. As we've stated previously, our first priority was to strengthen the foundation of our business to improve profitability and cash flow in order to invest more significantly in R&D to generate sustained, long-term sales growth.

Having turned our overall business around from negative growth to flat and now to growth above U.S. GDP rates, we are now pushing to make sure that we drive consistent and strong profitable growth.

Our priorities remain the same, which are to develop high-quality innovative products, to serve our customers extremely well, to drive efficiencies throughout our manufacturing facilities and to streamline our SG&A structure. Maintaining focus on these key priorities is working as this quarter marks 2.5 straight years of year-on-year pretax profit growth.

We've made a great deal of progress on operating efficiencies, and we continue to identify new opportunities from our manufacturing facilities to our back-office activities. We are building momentum as an entire organization.

We continue to invest in research and development, for our expenses were up another 19% this quarter. I'm really excited about the work we're doing in R&D. We have a team of creative engineers, who in conjunction with our product management team, sales force and most importantly, our customers, are constantly challenging themselves to develop better solutions for our end users.

Our Identification Solutions business continues to be strong, posting its third consecutive quarter of organic sales growth. We're growing in all 3 regions, and we're gaining positive momentum throughout this business. Although the health care segment of this business is still challenging, this portion of the business is expected to improve in the second half of the year.

The team is executing extremely well, capturing new sales opportunities and ensuring that we're providing the highest level of customer service.

Our Workplace Safety business reported a strong profit improvement of 16.4% compared to the second quarter of last year. Our European WPS business continues to be leading this division's results. This leadership team is effective and efficient and consistently drives our strategy and delivers organic sales and profit growth.

Pricing pressures continue to be a challenge, primarily in the WPS business in the Americas, and we don't expect that to change anytime soon. We're addressing these challenges by providing additional value to our customers with our industry-leading safety and compliance expertise by offering customized and proprietary products in Identification and Workplace Safety spaces by delivering excellent customer service, by improving our customer experience through advanced digital platforms and by upgrading our manufacturing capabilities. This strategy and our approach of providing significant value to our customers has been working as our turnaround of the WPS business is progressing. This quarter's profit and sales improvement is an important milestone in our turnaround.

We remain focused on the long term by taking action today that will result in sustained process improvement. Our focus for this fiscal year is consistent, which is to continue to serve our customers, drive efficiency through every function of our business and improve our underperforming businesses. We're driving organic sales growth every single day, and we believe we're making the right investments today to deliver consistent organic sales growth in both of our divisions.

The results of our efforts is the achievement of our financial goals and delivering long-term value to our shareholders. And I'm proud to report 2.5 years of quarterly profit improvement.

Now I'll turn the call over to Aaron to discuss our financial results for the second quarter, then I'll be back to provide specific commentary about our Identification Solutions and Workplace Safety businesses. Aaron?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [4]

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Thank you, Michael, and good morning, everyone. The financial review starts on Slide #3.

Sales increased 7.4% to $287.8 million in the second quarter, which consisted of organic sales growth of 3.2% and an increase of 4.2% from foreign currency translation.

We remain committed to R&D, and this quarter, we once again increased our investments in new product development. R&D expense was $11.3 million, which is an increase of 19.3% over the second quarter of last year.

We continued our trend of increased earnings this quarter, as pretax earnings were up 20.4% to $35 million compared to $29.1 million in last year's second quarter.

This profit improvement was primarily driven by organic sales growth in IDS and profitability improvements in both our IDS and WPS businesses, along with our constant focus on driving efficiencies throughout our G&A structure.

Net earnings finished at $4.3 million this quarter compared to $25.3 million last year. In last year's second quarter, we benefited from a lower-than-normal income tax rate of 13%, which was caused by certain onetime tax benefits from a large cash repatriation. This year, we recognized additional tax expense of $21.1 million or approximately $0.40 of EPS as a result of the U.S. tax legislation that was enacted in December. Without this tax charge, our EPS would have been $0.48 this quarter.

Lastly, cash flow from operating activities was $7.7 million this quarter compared to $19.3 million in last year's second quarter, and free cash flow was $3 million this quarter compared to $16 million in last year's second quarter.

Slide #4 details our quarterly sales trends. Again, total sales grew 7.4% and organic sales grew 3.2% versus the second quarter of last year. This quarter marks our third consecutive quarter of total company organic sales growth. We're gaining momentum, and we're focused on executing our strategy to continue this trend of growth for the rest of the fiscal year.

On Slide #5, you'll find an overview of our gross profit margin trending. Our gross profit margin was 49.9% this quarter, which is a decrease of 20 basis points compared to last year's gross profit margin of 50.1%.

We're continuing to identify and execute efficiency opportunities throughout our global operations, which is effectively offsetting pricing challenges in certain product categories.

Moving along to Slide #6, you'll find our SG&A expense trending. SG&A was $97.6 million this quarter compared to $94.7 million in the second quarter of last year. This increase was entirely due to foreign currency translation. In fact, in constant currencies, our SG&A expense was down approximately $1 million or 1%.

We remain focused on improving our processes and driving our waste throughout our SG&A structure. We're reinvesting a portion of these savings back into direct sales and marketing resources that will help drive future sales, while the remainder of the efficiency gains are helping deliver accelerated bottom line growth.

Slide #7 details our increased investment in R&D. We've increased our R&D expenditures both in absolute dollars and as a percent of sales again this quarter. Our commitment to growing organic sales over the long term involves a steady introduction of highly innovative proprietary products. We believe that investing back in Brady to the development of innovative new products that add significant value to our customers are the investments that will have the highest rate of return and are essential to our long-term success.

R&D expense was up 19.3% this quarter, and we expect this trend to continue with our full fiscal year 2018 expense expected to be up approximately 15% when compared to last year.

Turning to Slide #8, you'll see the trending of our earnings per share and our net earnings. As I mentioned, our results were significantly impacted by tax reform that was enacted during the quarter, which reduced diluted EPS by approximately $0.40.

In last year's second quarter, we realized a lower-than-normal tax rate of 13%, primarily from a cash repatriation of over $125 million to the U.S. This transaction benefited our diluted EPS by $0.09 last year. So if you exclude the 2 tax-related items, our EPS would have been $0.48 this quarter compared to $0.40 in last year's second quarter.

To move beyond the noise in our tax rate and see Brady's true earning trends that makes much more sense to look at earnings before income tax, which is the chart in the lower left-hand corner of this page, specifically, you can see that our pretax earnings have shown an impressive run as well, with our streak of year-over-year pretax earnings growth reaching 10 quarters, with growth of 20.4% this quarter, all of which while increasing our investments in R&D.

This brings us to Slide #9, which provides a summary of our cash generation. We generated $7.7 million of cash flow from operating activities this quarter compared to $19.3 million in last year's second quarter.

Contributing to the lower free cash flow this quarter was a slight increase in CapEx, combined with cash outflows for the payments of our annual incentive-based compensation and an increase in accounts receivable as a result of our stronger organic sales this quarter.

Looking at this chart, you can see the cash flow from operating activities typically runs well above net earnings, and we expect this to continue into the future. We consistently approach every decision with a cash-focused mindset and expect to continue generating free cash flow in excess of net earnings over the long term.

Moving along to Slide #10, you'll find the trending of our net cash position as well as a summary of our debt structure at the end of the quarter. At January 31, we were in a net cash position of $44.1 million compared to a net debt position of $37.7 million at this time last year. This is an improvement of over $80 million in the last 12 months.

As we look at deploying our cash, our approach to capital allocation is disciplined and patient. First, we use our cash to fund organic growth opportunities throughout the cycle, which includes funding investments in new product development, IT improvements, capability enhancing capital expenditures, et cetera.

Second, we focus on returning cash to our shareholders in the form of dividends, which we've consistently increased every year since going public.

After funding organic growth investments and dividends, we then patiently deploy our cash in a disciplined manner for acquisitions where we believe we have strong synergistic opportunities. And we use our cash to improve shareholder returns through opportunistic share repurchases.

At January 31, 2018, we had 2 million shares authorized for purchase. Overall, our cash generation has been strong, our balance sheet is strong, and we're focused on driving long-term value to our shareholders through our disciplined allocation of capital.

Before getting to our updated guidance, let me provide some comments on our income tax rate and what we expect the impact of the new U.S. tax legislation to be on our future financials, which is outlined on Slide #11.

In total, we took a noncash tax charge of $21.1 million this quarter. The key phrase is that these are noncash charges for Brady. Although the legislation is quite complicated and there are numerous items that will impact our future tax rates, there are 3 main items to point out.

First, a major part of the U.S. tax bill passed in December is a onetime tax on deemed repatriations. Brady's cash outlay from this provision is expected to be 0. Again, we won't have any out-of-pocket cash or expense from this provision.

Second, we need to revalue our U.S. deferred tax assets and liabilities and our current earnings to reflect the new lower U.S. tax rates.

And third, we need to assess the recoverability of the remaining deferred tax assets, primarily our foreign tax credit carryforwards.

The summary of the impact of all of these items, along with the reassessment of our search in related to permanently invested foreign earnings, makes up our tax charge of $21.1 million.

As we look at our future tax rates, there are also a few items to point out. First, the way that the tax bill was written is such that there are certain aspects that could phase in for a non-calendar year-end company such as Brady. This includes the reduction in tax rates.

As such, our U.S. federal tax rate this year will drop from the statutory rate of 35% to 26.9%. Then, on August 1, 2018, our U.S. federal tax rate will further drop to the headline rate of 21%.

The impacts of this rate reduction and the provisional expense that we booked this quarter may also require further refinance to our tax expense later this fiscal year. Also, there are numerous pieces of tax legislation that don't become effective for Brady until August 1, 2018.

As such, the tax rate that we'll see in our third and fourth quarters of this year will not necessarily be indicative of our ongoing future tax rates.

Excluding the impact of the tax charges recorded this quarter and any further noncash adjustments in Q3 or Q4 related to this legislation, we expect that our tax rate will be approximately 27% to 29% for the full year ending July 31, 2018. And then, beyond this fiscal year, we expect that our longer-term tax rates will decline from our historical ranges of 27% to 29% to a new range of 25% to 27%.

Slide #12 summarizes our guidance for the full fiscal year ending July 31, 2018. We're updating our full year diluted EPS guidance range from our current range of $1.85 to $1.95 to our new fiscal 2018 guidance range of $1.90 to $2 per share, exclusive of the tax charge that I just mentioned.

Our increased guidance is a result of 2 primary factors. First, is to reflect our stronger operating results, as our organic sales have improved and we continue to make strides in driving efficiencies throughout our business. Embedded in these improved operating results are further increases in our R&D spend as we now anticipate R&D cost to be up approximately 15% this year.

Second, we anticipate benefiting from the weakened dollar against certain other major currencies, including the euro. Although weaker dollar versus currencies such as the Chinese yuan can be a negative for us, in general, Brady benefits from a weaker dollar.

Included in our F '18 guidance is low-single-digit organic sales growth, which will be driven by continued strength in our ID Solutions business. Our guidance is based on foreign currency exchange rates as of January 31, 2018, and includes other key operating assumptions, including depreciation and amortization expense of approximately $26 million and capital expenditures of approximately $20 million.

Our capital expenditure plan decreased as we no longer expect that the purchase of certain strategic facilities will occur this year. We're not anticipating any restructuring charges, and we're not excluding any onetime item from this guidance other than the $21 million of tax charges that I just mentioned.

I'll now turn the call back to Michael to cover our divisional results. Michael?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [5]

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Thank you, Aaron. Slide #13 summarizes the Identification Solutions' second quarter financial results. IDS sales increased by 8.1% this quarter, finishing at $206.4 million, with organic sales improving 4.7% and with foreign currency translation increasing sales by another 3.4%.

Organic sales growth was led by EMEA and Asia, with both regions posting growth in the high single digits, while organic sales increased in the Americas in the low single digits in the quarter.

Sales growth in Europe was strongest in Western Europe and in our product ID, Wire ID and Safety and Facility ID product lines. The team is focused and dedicated and continues to win new business while growing sales with our existing customer base.

Organic sales grew throughout the IDS Americas region, with the strongest growth in our Wire product and Product ID product lines. We're gaining momentum and growing both sales and profit within most of our key product lines in this region.

Mid-single-digit sales growth within our U.S. industrial customers was partially offset by a decline in organic sales in our health care product line. We continue to face pricing pressures due to factors specific to the health care market, which includes consolidation of food purchasing organizations and large health care organizations and the uncertainty presented in the legislative direction of health care in the U.S.

We're addressing these pricing pressures through our continued investment in R&D. In fact, we've increased our investment in health care R&D projects by 28% in the second quarter compared to the same quarter last year.

Our new product development process remains a key area of focus for us. We're partnering with our customers to better understand their needs, and we're incorporating their feedback into our planned new product launches and updates. I'm excited about the work that we're doing in R&D, and I'm looking forward to new product releases in the upcoming quarters.

IDS finished the second quarter with $34.1 million of segment profit, which is an increase of 17.7% over the second quarter of last year. This is a direct result of the team's focus on growing organic sales while identifying efficiencies throughout our manufacturing facilities and SG&A.

As a percentage of sales, segment profit improved to 16.5% this quarter compared to 15.2% last year. Our expectation for this business for the full fiscal year of 2018 remain unchanged, which is low single-digit organic sales growth and segment profit in the mid- to high teens as a percentage of sales. We expect to continue to invest in R&D, and our efficiency activities in our facilities and throughout our SG&A structure should continue to provide benefits that will more than offset our investment in innovation.

Moving along to Slide #14, you'll find our Workplace Safety review. Sales increased by 5.6%, which consisted of organic sales decline of 0.5% and an increase from foreign currency translation of 6.1%.

In fact, if you exclude the impact of our small local business that we sold in June of 2017, organic sales would have been slightly positive for the Workplace Safety division in Q2.

Sales growth continued to be led by our European business, which makes up 50% of total WPS revenue. This business continued streak of organic sales growth by posting low single-digit growth in the quarter. Online sales continues to be the driver of growth in the region, and we saw high single-digit growth again this quarter. The European team is identifying new sales opportunities while expertly managing the catalog to digital shift that's been underway for several years.

Pricing pressures impact the European business just as it did to the U.S. business, but these challenges are more than offset by efficiency and improvements in our SG&A cost structure in this business.

Our Australian business increased organic sales on low single digits while adding solid profit improvements as well. The team is identifying new sales opportunities and growing sales with existing customers. We're gaining momentum in Australia, we're executing our strategy, and we're delivering consistently improved financial results.

Our North American business is turning the corner as the rate of sales decline is low -- in the low single digits compared to last year. Our average order size continues to increase. We're gaining momentum that we expect to continue throughout the back half of this fiscal year. We continue to face pricing pressures, which are compressing margins in our less proprietary product offerings, but our strategy in this business is to focus our energy on our proprietary product offerings and our custom capability, both of which are our strengths.

We believe this will help to further stabilize margins and return the business to consistent profitable growth. We're continuing to take action to improve the WPS business' organic sales growth through 3 priorities. First, we're working to improve the buying experience for our customers so that it is simple as possible, reaching our customers in a way they would like to be reached, whether it's online, mobile, catalog or in person, is essential to gain market share and grow this business.

Second, we're increasing our customer interaction to provide more value than simply filling orders. This allows us to understand what our customers are dealing with from a safety and identification standpoint, and to better serve those needs by offering our compliance expertise and complete solutions.

Third, one of our strengths is our ability to customize and quickly turn orders around to our customers. So we're improving our portfolio of products by introducing more customized and proprietary products that our customers need while providing them with our extensive safety and compliance expertise.

Segment profit in the WPS business was $7.1 million compared to $6.1 million in last year's second quarter, an increase of 16.4%.

As a percentage of sales, segment profit was 8.7% this quarter compared to 7.9% in last year's second quarter. We continue to address our cost structure throughout the global WPS segment, and we're investing in sales-generating resources while streamlining processes and reducing the cost of previous orders at the same time. These are the drivers of our improved financial results this quarter.

Our expectations for WPS financial performance for the full year are unchanged. We expect organic sales to be approximately flat, and that segment profit will continue to be in the high single digits as a percentage of sales.

I'm proud of what we've accomplished halfway through fiscal 2018. We're off to a good start, and we're gaining momentum. We've delivered 3 straight quarters of organic sales growth and 10 straight quarters of pretax profit growth, and we're capitalizing on new opportunities every single day. That's a trend.

But we have more work to do. We need to keep improving on underperforming businesses, and we need to invest in selling and R&D resources, while at the same time driving operational excellence throughout Brady. We believe we will continue to face pricing pressures in both our WPS and our health care product lines in IDS, which makes our investments in innovation and new products all more important to our long-term success.

We continue to push decision-making further into the company, and the impact of this culture shift is apparent in our financial results, reducing complexity in our global structure, and we're moving barriers so that our local managers can think, decide and act on their feet on a daily basis has been empowering and motivating for the team.

We're constantly working to identify and eliminate nonvalue activities that are not part of designing a product, making a product or serving our customers. We're directly in support of those efforts.

I'm proud of our results halfway through fiscal 2018, but we're not letting up as an organization. I'm motivated to push for more, and I know that the entire Brady team is motivated and excited for what the future will bring. I know that we can exceed our goals and continue to deliver what we've promised to our customers, our employees and our shareholders.

I'd now like to start the Q&A. Operator, would you please provide instructions to our listeners?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from the line of George Staphos of Bank of America Merrill Lynch.

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Molly Rose Baum, BofA Merrill Lynch, Research Division - Research Analyst [2]

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This is actually Molly Baum sitting in for George. My first question, could you just provide a little bit more detail on the digital growth in both -- in WPS in both Europe and the United States? Have trends been accelerating here?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [3]

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Although we don't get into very deep details on the call on this, we actually haven't seen very positive trends in that regard. And particularly in Europe WPS, we're seeing very strong strength across the board. As you know, that's actually made up of a number of markets, and we're seeing all of those markets do very well. And really, a lot of the strength of their growth there is in that area.

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Molly Rose Baum, BofA Merrill Lynch, Research Division - Research Analyst [4]

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My next question, WPS organic sales, looks like they accelerated as trends were down 0.5% in fiscal second quarter versus a 1% decline for the first 6 months. Could you just provide a little bit more color on what's been going well here?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [5]

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As I stated in the commentary, we've really been doing a much better job of customizing our products to our customers' needs, and we're developing new products and taking advantage of our new innovative products to accelerate focus in that market. We've also really been getting a lot closer to our customers than we had in the past, and that's generating both large order sizes and also stronger order patterns, both in actual sales and in backlog, which is a trend for WPS that is new and we haven't seen in a long time. So absolutely, the difference makers for us are our ability to quickly provide unique and customized products, introducing of new products into the marketplace and focusing more directly on making a significant impact in our customers' ability to provide safety solutions.

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Molly Rose Baum, BofA Merrill Lynch, Research Division - Research Analyst [6]

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And I actually have one last question on IDS, could you remind us which products would particularly benefit from a pickup in infrastructure facilities and capital spending? And what are the implications for your product innovation and for mix?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [7]

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Well, our -- any of our IDS safety facilities identification products are going to do very well with infrastructure changes. Anything that's involving literally taking a look at either changing the configuration of a manufacturing space to make it leaner, we do quite well with. In addition, any time that we actually build everything from our pipe marker capabilities to our sorbent abilities across the board, we tend to pick up quite well.

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Operator [8]

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And our next question will come from the line of Joe Mondillo with Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [9]

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Just wondering on the IDS segment. So you continue to guide towards this low single-digit growth. We're sort of in the mid-single digits for the first half of the year and seems like end markets are trending well. And you've always talked about how that sort of segment and sort of maybe a GDP x2 type of a business which would sort of trend at sort of a mid-single digit. So I'm just wondering, is there any reason to be cautious heading into the back half of the year regarding organic growth to IDS?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [10]

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We are optimistic about our IDS business. We definitely feel strongly that we are putting in place the right type of new product development to continue our growth curve. I believe that we've actually spoken about GDP plus 2, not x2, rates of growth in that business. But that doesn't mean that we aren't optimistic at all. To the contrary, we believe that the economy is getting stronger and that we have the products to take advantage of that and continue to grow at a rate above GDP.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [11]

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Okay. And I asked the question regarding the balance sheet last quarter. You guys continue to sort of maintain sort of this discipline/patient mentality. Just wondering, the balance sheet continues to improve, cash flow, as you noted in your commentary, it looks like it's going to continue to trend really well, so the balance sheet should continue to improve. Your operating have sort of an insufficient -- or inefficient capital structure. Just wondering if there's any update regarding your thinking on the balance sheet?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [12]

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We fundamentally believe that our approach to capital allocation is a strong one for the long term. We take a look at, first and primarily, reinvesting in the business. And as you can see, we've been reinvesting in the business, and we will continue to do that, whether it's R&D, which -- although a large portion does hit our bottom line, includes capital and strong capital. Whether it's in our facilities to making it more efficient, whether it's in purchasing facilities that we believe are key to our long-term future, we are doing more and more of that as we are able, not from a cash perspective, but to make sure that we have the bandwidth and are making wise decisions. In addition, our dividend payouts remain strong, and we remain willing to acquire stock as it makes sense for the company. As far as using cash in other ways such as acquisitions, although we absolutely have a strong analysis of this, we are patient. We need to make sure that we're not buying businesses that don't add significantly to the company. I've always said that we will keep our commitments. One of the commitments that I stated unequivocally about is if we acquire, we will acquire for synergistic, technological reasons. In other words, a company must have a technology that we cannot develop in a timely and cost-effective way. We must help that company when we acquire them and they must help us. So we are patient and that does not mean that we don't think that we'll deploy the capital, we do feel strongly we will. Timing is not one that we will stake because we believe that, that's actually negative to our shareholders' best interest.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [13]

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Okay. And then, Michael, last question for me. It's been a few years now since you've been working on improving the productivity of the company, efficiencies, trying to get SG&A as a percent of sales down. Just wondering, looking back to what you've done and looking at the company today, how much room do you think that there's improvement? I mean, SG&A still in a fairly high as a percent of sales, so just wondering, looking 1 year or 2 ahead, in terms of productivity and sort of just the overall cost structure of the company, how much more improvement do you think there's possible?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [14]

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Well, I'd like to say, intrinsically, we do have a business that does require more SG&A, and that we are small volume, high mix, proprietary niches. That said, I feel strongly that we have excellent opportunities to continue to improve our SG&A structure. One of the mantras I've always used is lower the water, you'll see the rocks. And really, the entire corporation has bought into that as they see more opportunities. I'll just -- I'll give you a great example that isn't directly related to SG&A, but it is a very visual. I went to one of our major facilities and challenge them with an audacious amount of space that they would have to open up. And the head of the operations literally said 6 months later that he thought I was insane. However, 6 months later, he'd already been able to open up half that amount of space so as well to 3 quarters and admitted he could do 3 quarters. And then when I challenged him, he said yes, he actually had plans to do all that space. If we literally just take a look at what we see today, our people often aren't seeing all of the opportunities, but if we continue to improve, we're seeing more and more opportunities. There are a lot of things that we're working on today. I know our organization never even thought it was possible just a year-plus ago. So I'm very confident we can continue to do it. I have line of sight. Our team leaders have line of sight. Our managers have line of sight on specific actions we're taking to continue the path. So I definitely feel as good about that as I did when we started it.

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Operator [15]

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(Operator Instructions) And our next question will come from the line of Charley Brady with SunTrust Robinson.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [16]

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I just want to clarify something. You commented on the FX impact on SG&A. Was there an impact on the -- at the segment level on the operating income of those segments or at the gross margin level for the Corporation?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [17]

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Charley, this is Aaron. I can answer that question. From a gross margin percentage perspective, it was very negligible. So we're still at the 49.9%. And if you start -- if you break it down further and you look at it by each of the 2 divisions, ID Solutions as a percentage, it was relatively negligible as well. Now our Workplace Safety business does have a much higher percentage of overseas business than ID Solutions, so they did see a slight improvement in their operating profit as a percent of sales, but it was very slight.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [18]

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That's helpful. Can you quantify -- I guess what I'm trying to understand what the headwind is on pricing? And does the new product development -- is that helping you counteract some of that -- from legacy products? Or is it just -- the pricing as a whole across the board is just pretty tough, even with the new product.

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J. Michael Nauman, Brady Corporation - President, CEO & Director [19]

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Well, we can -- we need to bifurcate that between the 2 areas that we're seeing the biggest challenge, Charley. One is WPS Americas and the other is our health care portion of IDS. And the drivers for those are different. In WPS Americas, you're effectively looking at a less opaque pricing structure in the marketplace. And so that does create more challenges. That said, by driving more proprietary products, by really providing complete solutions, we're giving our customers things that other companies really aren't and can't do. That result means we can overcome that. But obviously, on the one-off in the more commoditized space, that pricing pressure is stronger. Now let's flip over to IDS and the health care space, what you're looking up there is a consolidation of buying groups. you're looking at consolidation of health care providers. Whenever you see that, the leverage that they can maintain over pricing is higher than before. And as a result of that, with our less proprietary products, we, once again, are facing more of a challenge. In this case, once again, by creating unique proprietary products that we're pretty excited about, that actually not only add value but often create a price point that's exciting for the hospital in addition, and yet give us greater total revenue at better margins. It's a win-win for both our customer base, the buying groups and Brady overall. So yes, developing these proprietary products and the type of products we're doing does have a definite positive impact in overcoming that.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [20]

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I wonder if you could give us an example, when stated about more customization or complete solutions, just to help us better understand exactly kind of what that means and examples of stuff you've done?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [21]

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Sure, so, if you give an example and somebody wants a stop sign, that has definitely a more commodity feel to it. However, if somebody comes in and he's putting together an entire new building, and we can work with them on their safety needs and their identification needs and their total package, we end up being very uniquely suited to doing that. And that total package adds tremendous value to them, and also adds significantly more value to us.

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Operator [22]

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And our next question will come from the line of Keith Housum with Northcoast Research.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [23]

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My question for you in terms of the WPS segment and the move more towards proprietary products. Can you speak about the level of proprietary products versus commodity products now and perhaps where it was a year ago? And I guess, where we anticipate the mix being a year from now?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [24]

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Although we don't -- good morning, Keith, by the way. Although we don't break out the actual mix, I will tell you that we've spoken about the percentage, I believe, Aaron, of manufacturing, which is about 50%. We are planning to move that up. We see, in the longer term, being able to get another 20% out of that. We, obviously, do want to maintain a healthy portfolio of products that we don't necessarily have expertise to develop and manufacture to provide complete solutions, but we are uniquely positioned in our space to really provide most of the solutions ourself. It has been fascinating as we've been really working on both new products and looking at the products we make at the ability of the group to see differently how they should be positioned and how that -- what they should manufacture and what they shown. So we're confident we're going to move ahead, as I said, to those numbers. And more importantly though, as we add that percentage, more of those products will be ones that are truly differentiating to the Brady organization and WPS specifically.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [25]

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In view of the capacity and the equipment to do -- to increase that manufacturing? Or that will be included in traditional CapEx increases?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [26]

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As far as specific equipment, that is a case-by-case basis. But as I mentioned in my earlier statement about challenging one of our larger facilities to open up audacious amounts of space, one of the things that the leader of that group has done is in the middle of that space, which is significant, put signs and said, this space reserved for future manufacturing and sales. So yes, we have the capacity, we have, in many cases, the equipment, and so we can leverage this quite effectively, I believe. Now as we manufacture new products, we are investing in significant equipment, automated equipment, state-of-the-art capabilities as well, to manufacture those products that we weren't manufacturing before but are clearly within our technology wheelhouse I know we should have been.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [27]

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Okay. If I could sneak one more in here. Michael, you referenced that the second of the year you'll see some new health care products out there. The R&D efforts on the yield have been stepped up for several years now. Are we seeing new products that as -- when born from your recent R&D efforts are hitting the markets? Are they contributing to growth now? Or is that still a few quarters away outside of health care?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [28]

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Well, overall, I would tell you that we are achieving our targets on all of our new products, and that's a big change over just a few years ago. Significantly, a few years ago, we had a minority of our products that were hitting their numbers. Now, we are literally seeing our numbers plus in all of our products that we're developing. So we have a much more robust process in bringing to market. And our pipeline is much stronger for the future. So you will be seeing in this year and coming forward more products executing more effectively and driving more sales, yes. I don't believe I had made an actual statement related to health care products coming out, but we do have health care products coming out as well. So you are correct, but I just want to clarify I don't believe I actually made that statement, but they are definitely coming out.

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Operator [29]

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And our next questions will come from the line of Joe Mondillo with Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [30]

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Just to have a couple of follow-up questions. When you look at your commodity-like product offering at WPS, specifically in the U.S., have you started to see any sort of slowdown in the headwinds that you've seen in the trends there? Or is that just sort of consistently continuing at a certain rate?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [31]

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Well, I'd like to say a couple of things. One in our commodity products, in many cases, we've eliminated some that just don't make sense in our portfolio, actually, to the extent, over the last couple of years, of tens of millions of dollars in revenue. So what you're seeing as results are net of us eliminating a lot of products that absolutely didn't make any sense. So to that point, without question, we're seeing less headwinds. If there was a product that was commoditized that we really shouldn't have been selling, we aren't selling it anymore. And therefore, we're not literally trying to roll upstream. But in general, because we are moving more to customize in proprietary, we're able to include those products as total package sets. And the end result of that total package set is less -- a less pressure on pricing. But the final issue is, I do think we're seeing more stabilization in the base value of those commodity products as well. But we don't expect to see that go away entirely.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [32]

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Okay. And then, in terms of the European part of WPS, do you anticipate any sort of -- the only way -- the best way to put it is just sort of Amazon effect, where that market in a few quarters or at some point in time you sort of see headwinds that you just haven't seen compared to the America portion of the business?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [33]

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We are looking at our markets there very closely and carefully. I mean, we've mentioned in the past, for instance, our U.K. operations that have more challenges. We're doing better there. Overall, we actually see very strong positions in our ability to both niche and to provide significant value there. We are absolutely aware of the pricing pressures in all of the markets. But fundamentally, I would tell you, we're confident that we can continue to execute in Europe.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [34]

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And just lastly, in terms of currency, how -- in terms of the way currency affects the model, why didn't you see any -- it doesn't seem like you've seen so much effect to the bottom line in this quarter. And is that going to remain constant? Should we not expect much currency effect in this current quarter, the coming quarters, given the certain rates that we're seeing?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [35]

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When I was referring to currency, I was talking in percentages of sales. If you look at our bottom line, we did have -- we absolutely had a benefit of pretax income from currency. So our top line was up 4.2% as a result of currency. And our bottom line was up slightly more than that as a result of currency. So it is flowing through to the bottom line. (inaudible)

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [36]

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Okay. And that should sort of remain constant if rates stay constant?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [37]

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Correct. It just doesn't meaningfully change to -- it hasn't meaningfully changed the percentages of sales.

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Operator [38]

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And I'm showing no further questions in the queue at this time. So it's my pleasure to turn the conference back over to Mr. Michael Nauman, Chief Executive Officer, for some closing comments or remarks. Sir?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [39]

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Thank you. I'd like to leave you with a few concluding comments this morning. We're halfway through fiscal 2018, where growing sales in both IDS and WPS are steadily improving, we're focused on improving the businesses that are not meeting our expectations and driving growth in these businesses, which includes the WPS business in North America, where we believe we're turning the corner. We're facing pricing pressures but we're confident heading for this through efficiencies in our manufacturing processes and throughout our SG&A structure. Growing our pipeline of new products is essential to our long-term success, and our commitment to R&D is unchanged with our increased investment of 19.3% this quarter. We're creating a winning culture that allows us to achieve our goals and to continue to deliver improved results for our shareholders for years to come through our focus on new product development and high-quality customer service while driving local ownership and accountability. As always, if you have any questions, please contact us. Thank you all for participating today, and have a great day. Operator, you may disconnect the call.

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Operator [40]

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Thank you, sir. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude our program, and you may all disconnect. Everybody, have a wonderful day.