U.S. Markets close in 3 hrs 10 mins

Edited Transcript of BRC earnings conference call or presentation 6-Sep-19 2:30pm GMT

Q4 2019 Brady Corp Earnings Call

MILWAUKEE Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Brady Corp earnings conference call or presentation Friday, September 6, 2019 at 2:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Aaron James Pearce

Brady Corporation - CFO & Treasurer

* Ann E. Thornton

Brady Corporation - CAO & Corporate Controller

* J. Michael Nauman

Brady Corporation - President, CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Allison Ann Marie Poliniak-Cusic

Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst

* 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

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2019 Brady Corporation Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to Ann Thornton, Chief Accounting Officer. You may begin.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you. Good morning, and welcome to the Brady Corporation Fiscal 2019 Fourth Quarter Earnings Conference Call. The slides for this morning's call are located on our website at www.bradycorp.com/investors. 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 2019 Form 10-K, which was filed with the SEC this morning as well.

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.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Ann. Good morning, and thank you all for joining us. This morning, we released our 2019 fourth quarter financial results. We have a lot to be proud of this year.

We continued to improve our manufacturing processes, we've rebuilt our new product pipeline through our focused investment in R&D, and we're driving operational efficiencies throughout our organization. All of this has resulted in increased organic sales, reduced SG&A expenses and increased profits. This quarter marks our ninth straight quarter of organic sales growth, which was driven by our focus on new product development and consistent execution of our strategy.

We sold a business during last year's fourth quarter and recognized a gain of $4.7 million on that sale. When we exclude this onetime gain, pretax income increased 16%, which marks our 16th consecutive quarter of profit improvement. I'm incredibly proud of the entire team at Brady for hitting this milestone. The ability to improve quarterly pretax profit for 4 straight years takes a great deal of focus on our consistent set of priorities, which are developed and deliver innovative new products that solve our customers' problems, to drive operational efficiencies throughout our business, to improve the businesses that are not performing as well as they should be, and most importantly, to ensure that the actions we take today are the right decisions for the long term.

Organic sales growth of 1.7% was driven by our Identification Solutions business, which posted organic sales growth of 3.3% this quarter. The strongest growth continues to come from the U.S. We're growing in most end markets and almost every major product line. We've launched some exciting new product this quarter, and I'm pleased to report that our health care product line grew organic sales in the mid-single digits this quarter. Our investments in the sales force and R&D in the health care product line are beginning to pay off as we improve both organic sales and profit this quarter.

Organic sales declined 2.6% in WPS this quarter. Our North American WPS business showed improvement as its rate of decline decreased from approximately 10% last quarter to mid-single-digit decline this quarter. During our last 2 quarterly conference calls, we discussed how we took actions to enhance our digital platform by moving to a new platform. This new platform is working well, and our digital sales are improving, but we still see it will take time to build our customer base back to the level we experienced prior to the initial digital platform change.

We believe that we're on the right track to return the WPS Americas business to profitable growth. There were positive trends with this business in the quarter as May was our toughest sales month, and we saw improvements in June and then again in July. With the fundamental building blocks for sustainable organic sales growth in place, we're looking ahead to what we believe will be the start of a trend of organic sales and profit improvements in fiscal 2020.

We've made incredible progress. Four straight years of quarterly pretax income improvement is not easy, but the Brady team took on the challenge and delivered. I see more energy in driving our people than ever before. We've returned over health care business to growth, and we've taken actions in our Workplace Safety business that will set us up for future success. The industrial economy is challenging, but we believe the actions we've been taking over the last several years to invest in our organic sales engine and drive sustainable efficiency gains to reduce our cost structure position us well for future revenue and profit growth. We continue to focus on the future by taking actions today that will ensure our success in the long term.

I'll now turn the call over to Aaron to discuss our financial results. I'll then return to provide specific commentary about our Identification Solutions and Workplace Safety businesses. Aaron?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Michael, and good morning, everyone. The financial review starts on Slide #3. Sales were $295.3 million in the fourth quarter, which consisted of organic sales growth of 1.7%, a decrease of 1.9% from foreign currency translation and a decrease of 0.5% from the sale of our Runelandhs business, which we finalized in the fourth quarter of last year.

Net income finished at $36.6 million compared to $35 million in last year's fourth quarter. If you would exclude last year's onetime gain on the sale of a business, net income would have increased by 20.9%. Diluted EPS was $0.68 this quarter compared to $0.66 in last year's fourth quarter. The sale of Runelandhs increased the EPS by $0.09 per share last year. So excluding this onetime gain from last year, diluted EPS increased 19.3% this quarter.

Cash generation, which is a hallmark of Brady and a never-ending focus area, continues to be strong. Cash flow from operating activities was $65.3 million this quarter compared to $53.8 million in the fourth quarter of last year, an increase of more than 20%.

On Slide #4, you'll find our quarterly sales trends. Our Identification Solutions business continues to grow nicely with organic sales growth of 3.3%, while our WPS business experienced an organic sales decline of 2.6% this quarter.

Turning to Slide #5, you'll find our gross profit margin trending. Our gross profit margin was 49.6% this quarter, which was consistent with last year's fourth quarter. We continue to see cost pressure in both IDS and WPS, but we've been successful in offsetting these increases through selected price increases and our constant focus on process improvements and manufacturing efficiencies across all of our facilities.

Slide #6 outlines our SG&A expense trending. SG&A was $89.1 million this quarter compared to $90.9 million last quarter. Last year's SG&A was reduced by the $4.7 million gain on the sale of a business. If we exclude this gain, we would have reported a decrease in SG&A of $6.5 million this quarter. Approximately 1/3 of this decrease was due to foreign currency translation as the U.S. dollar strengthened against most major currencies and the other 2/3 of the decrease was due to our ongoing efforts to drive process improvements and efficiency gains throughout our businesses. Excluding the onetime gain in the fourth quarter of last year, SG&A expense decreased from 32.1% of sales in last year's fourth quarter to 30.2% of sales this quarter.

Turning to Slide #7, you'll find the trending of our investments in research and development, which decreased from $11.7 million in the fourth quarter of last year to $11.3 million this quarter. Excluding the impact of foreign currency, R&D expenses were effectively flat for the full fiscal year 2019 compared to last year. We remain committed to new product development, while at the same time we're focused on making disciplined investment decisions to ensure that our R&D spend is efficient and effective.

Slide #8 outlines the quarterly trending of pretax income. Excluding the gain on the sale of a business from last year's fourth quarter, we increased pretax income by 16% to $47.1 million compared to $40.6 million (sic) [$45.2 million] last year. This is an indication that our focus on organic sales growth and driving sustainable efficiency gains is working.

Turning to Slide #9, you'll find our after-tax income trends and our quarterly EPS trends. The sale of our Runelandhs business in last year's fourth quarter added $0.09 to diluted EPS. Adjusting for this onetime gain, diluted EPS increased from $0.57 last year to $0.68 this year, an increase of 19.3%.

Slide #10 details our quarterly cash generation. We generated $65.3 million of cash flow from operating activities compared to $53.8 million in last year's fourth quarter, and free cash flow was $50 million compared to $46.8 million in the same quarter of last year. We continue to generate cash flow in excess of net income, and for the full fiscal year, cash flow from operating activities was 124% of net income.

We also returned $11.2 million of shareholders in the form of dividends this quarter, and we invested $15.3 million in capital expenditures. This quarter's CapEx was larger than normal as we have been actively upgrading our machinery and equipment to both add more capabilities as well as to drive efficiencies and increase productivity. This quarter, we also completed the purchase or moved forward with the construction of several manufacturing facilities that we've historically leased. These are manufacturing facilities we intend to be in for the long term and where it makes financial sense, to own instead of lease.

Slide #11 outlines the trending of our net cash position along with our debt structure at the end of the quarter. We increased our net cash position by $100 million this year, while increasing our investment in capital expenditures and increasing our dividends, which, again, highlights our ability to consistently generate strong cash flow. We finished the year in a net cash position of $228.9 million at July 31. Our debt consists of a $45 million Euro-denominated private placements scheduled for repayment in May of next year, and we have no borrowings outstanding on our recently renewed line of credit.

Our approach to capital allocation is consistent. We're disciplined, and we are patient. First, we use our cash to fund organic sales and efficiency opportunities throughout the economic cycle, which includes funding investments in new product development, sales-generating resources, IT improvements, capability-enhancing capital expenditures and capital expenditures to increase efficiency and automation in our facilities.

And second, we focus on returning cash to our shareholders in the form of dividends. In fact, yesterday, we announced our 34th consecutive year of annual dividend increases as we increased our full year dividend to $0.87 per share.

After funding organic investments and dividends, we then 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. Overall, our cash generation is strong, our balance sheet is strong, and we're focused on driving long-term value for our shareholders through the disciplined allocation of capital.

Before moving to our fiscal 2020 EPS guidance, let's take a look back at our financial results for the full fiscal year 2019, which is on Slide #12. This year, we increased organic sales in each quarter and grew 2.8% organically for the full year. We increased our GAAP pretax income by 8.3%. And if you exclude the gain we recorded from the sale of Runelandhs business, then our pretax profit grew by 11.7%. We returned the health care product line of our Identification Solutions business to organic growth. We took actions to address the cost structure of our WPS North America business, and we expect to see the benefits next year from the digital platform change and cost structure realignment.

We recorded a healthy gross profit margin of 49.9%, and we remain focused on executing sustainable process improvements, which is evidenced in our SG&A expense, which decreased to $19.3 million this year -- increased -- decreased by $19.3 million this year, marking the fourth consecutive quarter of decreased SG&A expense as a percent of sales.

We generated $162.2 million of cash flow from operating activities, which equates to approximately 124% of net income. This strong cash generation also led to our nonoperating income and expense items turning from a net expense in fiscal 2018 to a net benefit of $2.2 million in fiscal 2019 due to reduced borrowing costs as well as increased investment earnings as a result of our strong balance sheet.

Our fiscal 2019 results were strong, and our balance sheet is strong. We are seeing weakness in the global industrial economy, but we believe that the actions we've taken to improve our WPS Americas business, to return our health care product line to growth and to drive sustainable growth in all of our businesses through an increased focus on innovation will enable us to maintain our positive momentum into fiscal 2020. We believe we're taking the right actions today to ensure our long-term success. But as always, execution remains critical, which brings us to our fiscal 2020 guidance, which is summarized on Slide #13.

We expect earnings per diluted Class A nonvoting common share to range from $2.45 to $2.55 for the fiscal year ending July 31, 2020. Our EPS growth will be driven by organic sales growth of approximately 1.5% to 2.5%, along with continued efficiency gains in both our manufacturing facilities and our SG&A structure. We expect our income tax rate to be in the low 20% range, depreciation and amortization expense to approximate $25 million, and we anticipate capital expenditures of approximately $35 million. We also expect to continue to realize nonoperating income in excess of interest expense as a result of our strong balance sheet. This guidance is based on foreign currency exchange rates as of July 31, which continue to be a headwind due to the strength of the U.S. dollar. We're not anticipating any restructuring charges and are not excluding any onetime income or expense items from this guidance. This guidance is based on financial results that are fully in accordance with U.S. GAAP.

I'll now turn the call back over to Michael to cover our divisional results and to provide some closing comments before turning the call over to Q&A. Michael?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Aaron. Slide #14 summarizes the fourth quarter financial results for our Identification Solutions business. IDS sales increased 1.8%, finishing at $221.8 million with organic sales growth up 3.3%, while foreign currency translation decreased sales by 1.5% this quarter. Organic sales increased in the low single digits in all 3 regions. We also increased organically in the majority of our key product lines, with the strongest growth in safety and facility identification.

As I mentioned earlier, I'm pleased to report that our health care identification product line increased organic sales in the mid-single digits this quarter. The additions we've made to our sales force as well as the products we've added to our new product pipeline are starting to result in organic sales growth and profit improvement. We finished fiscal 2019 with positive momentum that will carry into next year.

Organic sales increased in the low single digits in IDS Europe this quarter. We're increasing sales in most major product lines in Europe, but we believe there has been an overall reduction in the industrial economy, which caused our growth rate to slow from mid-single digits last quarter across most geographies and product lines to the low single-digit rates we saw this quarter.

In Asia, we experienced low single-digit organic sales growth, even though we've clearly seen a decreasing demand in certain end markets, such as electronics in China and automotive in India. In general, our growth rates have flowed throughout Asia, and there appears to be economic weakness in China, which is our largest Asian market.

IDS segment profit increased 25% to $45.6 million in the fourth quarter compared to the fourth quarter of the last year. As a percentage of sales, segment profit improved to 20.6% this quarter compared to 16.8% last year. Our improved financial performance continues to be due to a combination of successfully driving organic sales growth, while at the same time driving efficiencies throughout our businesses.

We've launched several new products in our IDS business this quarter. We launched the BatteryBlock Battery Cable Lockout device, which is part of our lockout tagout product line. This is a simple but effective device that is designed to be secured around the battery connection or electrical system of a commercial vehicle for performing maintenance, which prevents an accidental battery connection that could endanger the safety of the mechanic or cause other damage to the vehicle. We also launched a similar product that is designed to lockout the battery connection on forklifts.

We also launched 2 new printer models in our health care product line this quarter. The first is a service desktop printer, which is a high-speed patient wristband printer that's easy to use and fully integrated with electronic medical records software.

The second is a portable mobile printer, which is WiFi and Bluetooth-enabled and allows medical professionals to print bar-coded labels on the spot at the point of care of the patient. I'm excited about the addition of these printers to our health care product line and our expanded pipeline of new products. It's a direct result of the increased investment in R&D that we've made over the past several years.

Looking ahead to fiscal 2020, we expect IDS organic sales to grow between 2% and 3%. We'll continue to invest in R&D, and we'll continue to drive efficiency throughout our manufacturing and SG&A processes. We believe that F '20 will be a challenging macroeconomic environment for global manufacturers, but we're confident that the changes we've put in place will enable us to grow -- continue to grow above GDP.

Turning to Slide #15, you'll find our Workplace Safety review. WPS sales declined 7.8%, which consists of organic sales declines of 2.6%, a decrease from foreign currency of 3.3% and a decrease from the divestiture of Runelandhs business of 1.9% compared to the fourth quarter of last year.

Organic sales declined in the low single digits in European and Australia businesses, and organic sales declined in the mid-single digits in the North American business.

As we discussed in previous calls this year, we've made a change to our digital platform in the U.S. business, and we are now seeing consistent improvements in our digital sales, but it will still take more time for us to build sales back to the level we experienced prior to the initial platform change.

We remain focused on 3 priorities to return our WPS Americas business to consistent organic sales growth.

First, we're improving the buying experience for our customers so that it's as simple as possible, reaching our customers the way they prefer to be reached, whether it's online, mobile, catalog, in person or through a combination of these channels is essential to returning this business to growth, which is exactly why we're are focusing on having industry-leading websites.

Second, we're increasing our customer interactions, rather than only fulfilling orders. This allows us to better understand what our customers are dealing with from a safety and identification perspective and it helps us better serve those needs by offering our compliance expertise and complete solutions. We're just doing this through an expanded sales force that is capable of providing full solutions for our customers that has also provided industry knowledge and regulatory expertise that our competitors do not possess.

Third, one of our strengths is our ability to customize product and quickly turn orders. We've improved our portfolio of products by introducing more customized and proprietary products that our customers need.

We believe we're increasing the value that we bring to our customers by focusing on these 3 priorities, which creates customer loyalty and improves our sales and profitability over the long term. We believe we're taking the right action to return our North American business to sustainable organic sales and profit growth. Our recovery has been and will continue to be choppy. Our sales declined at a lesser rate this quarter than in the third quarter, although they -- but they still declined. We need to stop the decline in sales and then return the business to growth. We believe we're on the right track as we finish this fiscal year and move into 2020.

Our European WPS business declined organically in the slow -- low single digit this quarter, but sales growth steadily improved through the quarter, and we closed July on a positive note. Digital sales continued to be strong in Europe, where we saw growth in the mid-single digits. But this quarter, the -- that growth wasn't enough to fully offset the decline in catalog sales.

Organic sales decline in the low single digits in this -- in Australia this quarter. We had been growing steadily for the past couple of years, but more recently, the growth rate in the Australian economy appears to have slowed. We were still able to improve profit in Australia this quarter despite the modest sales decline. This profit improvement was entirely due to our focus on driving sustainable operational efficiencies.

WPS segment profit was $6.7 million compared to $10.7 million in last year's fourth quarter. The decline in segment profit was due to the organic sales decline, foreign currency translations and the sale of the Runelandhs business, which closed on May 31, 2018.

For the full fiscal 2020, we expect organic sales to be approximately flat in the WPS business, and we expect to improve segment profit through our reduced cost structure and through continued efficiencies in SG&A. As I look back at this year, I'm proud of what we've accomplished. We're growing organic sales, we're launching innovative new products, we're executing efficiency opportunities throughout our SG&A structure, we returned our health care product line to growth and we're on our way to turning our WPS North American business around.

Our IDS business is strong and continues to lead our consistent improving financial results. And WPS Europe and Australia are executing their digital strategies and growing their online presence of driving efficiencies throughout their businesses.

This quarter marks my completion of 5 years with Brady. As I look back, I'm proud of the progress we've made not only through improved financial results, but as an organization. We're committed to providing our customers with high-quality products that meet their needs and solve their problems with responsive customer service and ongoing sales support. I regularly challenge our employees to get close to the customer and think about how they're supporting this fundamental initiative, which at its core is simply focused on what we do well. This has resulted in consistent growth in organic sales and significant profit improvements over the past 4 years and has made us a more effective and efficient organization that is better able to react and adapt to change.

Labor continues to be a competitive situation, especially in certain locations where the unemployment rate is historically low. Because of this, we're challenging ourselves to think differently, to take our processes to the next level of automation, to use our IT systems more effectively. This reduces our need for resources that are already scarce. Innovation is not only relevant to our new product development teams. Being innovative about what we do and how we do it has been a primary driver of our ability to drive 4 straight years of pretax profit improvement. It takes the entire organization working towards a common goal to deliver this level of consistent financial improvement. I'm proud of the team for eliminating distractions and making themselves accountable for our results.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from George Staphos of Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

This is actually Molly Baum sitting on for George. Congrats on the quarter. I just wanted to start by asking a quick question about margins in IDS. You mentioned process improvement and efficiency gain, sorry. But can you provide more detail on maybe some of the specific actions that you've been taking that have really driven such strong incremental margin in the segment, particularly in your fiscal fourth quarter?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Molly. Glad to have you on the call this morning. As we take a look at our portfolio, we have really focused strongly, not only making our products relevant to our customers as we go forward, but also making sure our factories, in particular, are an avenue for us to provide a very positive customer experience. And that starts with making sure we get the products out faster to the customer.

By doing that, it inherently has us looking at automation, more EDI interfacing, direct communications between our software and our machinery, and therefore, having the right machinery to be able to do all of that. That has been coming through this quarter as you can see, and we have more projects on the road in the future. But it's definitely had a significant impact.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

And then for my second question, you mentioned some slight slowing in IDS in both Europe and Asia. Can you talk about how those 2 regions trended through the quarter? And when we're looking at guidance for the segment and that organic growth of 2% to 3%, what are your assumptions for how each region is you expect it to trend for the year?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

So obviously, there are a lot of dynamic issues going on in Asia, particularly in China. If I had a crystal ball, I would give it to you. I think there are a lot of pieces in action there. We will hope for the best in our trade negotiations throughout the world. But at the same time, we are prepared to make sure we're the most efficient and effective supplier. And as you've seen, I think we've held up pretty well in Asia and China despite the headwinds that we've seen. We are, as an organization, planning for further headwinds, but I don't think that it's been getting significantly worse. I think it's just a challenging environment.

Now if we flip to Europe on the other hand, we've got a lot of pieces moving there. Some of those pieces are once again related to the situations in Asia. If you take a look at countries like Germany where they export a ton of machinery and equipment, and they are the backbone of the industrial heartland of Europe, you will see that, that economy is struggling mildly right now. And as a result, that is having an impact on our business, and we see that we'll continue to have an impact.

At the same time, we've got the Brexit situation there. The outcome once again is unknown and uncertainty often drives forward market challenges. And that situation has been deteriorating in the U.K., but also it has a great effect on Europe.

As an example, if you take out U.K. from the EU, they are literally a major trading partner with Germany once again, as an example. So those situations, Italy is seeing some issues and even France is having some issues, creates a dynamic where we've actually been doing a good job, I believe. Our teams there, very proud with the introductions of our new products, with really getting to our customers faster and really interacting with them more, have been able to overcome those headwinds. But I don't see that changing in the next quarter.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

And our next question comes from Allison Poliniak of Wells Fargo.

--------------------------------------------------------------------------------

Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [7]

--------------------------------------------------------------------------------

Just wanted to talk on new products. You mentioned a quite -- in quite a few of your remarks, new products benefiting organic growth. You've, obviously, been putting a lot of effort into R&D. Is there any way to help us quantify or directionally what that benefit is? Is it a point of growth? Is it growth above market? Just any color there.

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [8]

--------------------------------------------------------------------------------

So Allison, I will say, what you should see is specifically when we mentioned 2 new printers in our health care space, those printers are a significant move forward. As you know, we made an acquisition a number of years ago in health care, and we've now really positioned ourselves to integrate the capabilities that I think have been hoped for with the capabilities Brady has. And so, yes, that is making a significant difference.

We don't quantify the actual breakouts. And the reason for that is, as you know, we have so many segments and so many different product lines, that it varies by the product line and the investments we're making. But we are making broad investments. We've talked about lockout tagout with you. We've talked about our capabilities for wire marketing they've been improving. We've talked about our wrapping capabilities -- automated wrapping capabilities, and now we're talking about integrating printers into our health care space. So we do see internally product by product changes to our growth rates effect, but we don't break that out.

--------------------------------------------------------------------------------

Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [9]

--------------------------------------------------------------------------------

Got it. And then just R&D, another -- entering 2020. Is the fiscal '19 a good run rate from a dollar amount that we should be thinking about for 2020? Or is that going to go up again?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Expect it to go up a little. We are being challenged in that area as in all areas with the tightening market. We are not seeing significant turnover. We really do believe we are a great place to work, a great place to have a career and challenge yourselves in a positive way. So we think that has a big impact on the longevity of our workforce.

But at the same time, when we are looking to fill roles, it is a little more challenging. All of that said, yes, we do expect to increase our R&D, specifically key talent strengths that we want to work on.

--------------------------------------------------------------------------------

Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [11]

--------------------------------------------------------------------------------

Got it. So should we be thinking as sort of keeping it at 4% of sales this range, just under that?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes, you can certainly.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

And the next question comes from Joe Mondillo of Sidoti & Company.

--------------------------------------------------------------------------------

Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [14]

--------------------------------------------------------------------------------

Just on IDS on the quarter itself. Just wondering, as far as with all these new products that are coming out, and as I understand, I think a lot of these are much more value-add, higher margin. So I imagine sort of product mix and just the higher volumes itself is definitely driving volume. I'm just wondering how much is that driving the operating margin growth that we saw. Because operating margin growth was actually slowing on a year-over-year basis in the first 3 quarters and then it really accelerated strong in the fourth quarter. So how much is it based on that versus operational productivity improvements?

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [15]

--------------------------------------------------------------------------------

Joe, if we take a look, as you know, we have very good margins on our products. We grew in all quarter -- in all 3 regions. That had an impact, but the biggest impact was out of our health care growth, specifically.

--------------------------------------------------------------------------------

Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [16]

--------------------------------------------------------------------------------

Okay. And like I said, the sort of -- the way that the year sort of progressed, we saw a huge spike up in the fourth quarter. Can you give us more color exactly what happened in health care? Was it those 2 printers and those added to the sales and the product mix? What happened in the fourth quarter? And is it sustainable over the next few quarters?

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [17]

--------------------------------------------------------------------------------

As you -- first of all, it is sustainable. Second, as you recall from previous calls, the health care had been our biggest challenge in the IDS space and had not been growing. In fact, it'd been declining. We were able to turn that around. And that turnaround on a healthy margin business with new types of products that are strong products for our future has been the most significant fact.

I do not want to understate though the growth in all 3 regions because of the strength of our general margins has had a big impact as well. And we do expect the health care part of that to maintain, and we do expect the regions to continue to grow. So, yes.

--------------------------------------------------------------------------------

Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [18]

--------------------------------------------------------------------------------

Okay. And -- perfect. Now that definitely got clarified. Also wanted to ask regarding these new tariffs that are coming online this fall. Is that going to affect any of your business, do you think?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

We do have business that exports out of China. We also have imports into China. We are a multinational company with 70-plus locations in 31 countries. So those dynamics can be complex. We are working hard to overcome the dynamics. The good news is most of our revenue because of the type of products we make, are local, right? The reason we have so many locations and so many even manufacturing locations is to provide local capability and local sourcing to our customer base.

It doesn't mean we won't be impacted in some of our product lines. And we've already had to pass on significant price increases to some of our channel partners and end users. They have accepted those increases, not happily, but they have accepted them because they understand the reality. We all hope that there is an end to this situation in a positive light for all participants, but we are planning as though that won't change for the foreseeable future.

--------------------------------------------------------------------------------

Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [20]

--------------------------------------------------------------------------------

Okay. Great. And then last question. The nonoperating income doubled for the year year-over-year compared to last year and it was higher than I was expecting in the fourth quarter. Just wondering what is driving that line there? And then in terms of the guidance, I guess, for fiscal '20, how do we think about that in terms of the drivers there?

--------------------------------------------------------------------------------

Aaron James Pearce, Brady Corporation - CFO & Treasurer [21]

--------------------------------------------------------------------------------

Yes. In the nonoperating line, we basically have interest income and interest expense. Those are by far the 2 biggest components. Interest expense, as you know, has been relatively consistent because we have the one piece of debt outstanding, which we intend to pay off at the end of May of next year. And interest income has been growing, and it's been growing because of the cash that we have on our balance sheet today.

We're in a very enviable balance sheet position. So we anticipate that, that interest income will continue to be strong unless we deploy that capital. So as you look forward, I would definitely anticipate that nonoperating items would continue to be positive into F '20.

--------------------------------------------------------------------------------

Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [22]

--------------------------------------------------------------------------------

Okay. So that other income line is mainly interest income line?

--------------------------------------------------------------------------------

Aaron James Pearce, Brady Corporation - CFO & Treasurer [23]

--------------------------------------------------------------------------------

That's correct.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

And our next question comes from Keith Housum of Northcoast Research.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Congratulations on the turnaround of the health care business.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Keith.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Absolutely. So in terms of the CapEx investments, if I heard right, you guys are investing in machinery, which is consistent with what you guys said in the past. But also it may sound like you're investing in some new buildings as well. In terms of your progress along that front, are we -- are you seeing some of that in the operating -- in the lower SG&A now in anticipation that we'll continue to see a decline next year as some of those facilities come online and you can get rid of some of lease payments and whatnot?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

We do, and Keith, you're aware, it is financially more advantageous for us to own than lease, but the biggest reason for us owning, we really have a couple of reasons. One, as we build buildings, we can customize them for our particular applications. Two, as we go down the road, we're not reluctant to invest properly in those buildings because we aren't going to be double hit by landlords, telling us what a terrific new building they have because of our investments. And then three, the actual soft side of this relates to our people.

It is amazing the positive comments I've received from people who have been in buildings that we've leased for 25 years when they found that we are dividing the building or building a new building, and the comment about the commitment of the company and how strong that makes their commitment to the company. It's an interesting dynamic that, frankly, is even much stronger than I expected, but one that is so positive I point it out to you.

But those are the real reasons. And you're absolutely correct, the financial difference between leasing and owning is real, but that's not really the driver of us doing it. We need the buildings to be able to be configured in the way we want them, when we want them, and we want to make sure that people are treating the buildings in the high-quality manner that we expect. I just have a fundamental belief that if you are working in and walking into a building, that is a well-run, efficient, clean, you will end up making a better, more-effective product and that's also showing. So there's a lot of benefit to this, just beyond the accounting treatment.

--------------------------------------------------------------------------------

Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [29]

--------------------------------------------------------------------------------

Got you. Appreciate that. And can you walk me through, I guess, your guidance, I guess, the puts and takes that you guys are thinking about and then midpoint of the EPS range because you're about only 2% above where you were for this year. But yes, it looks like your SG&A improvements have really kind of stepped up, especially as you closed out the year. So what's kind of, I guess, offsetting some of that SG&A guidance? Why we're not seeing more of that fall to the bottom line.

--------------------------------------------------------------------------------

Aaron James Pearce, Brady Corporation - CFO & Treasurer [30]

--------------------------------------------------------------------------------

Well, I can take that question, Keith. I mean, as we look at our guidance, it's -- the major components are relatively consistent with what we talked about in the past. As we look at gross margins, we have very, very strong gross margins at nearly 50%, as you know. We're not anticipating massive changes in our gross profit margins, and in fact, we're quite happy where we're at and the efficiencies that we put in place have been offsetting actually effectively all of the cost increases we saw in the fourth quarter.

We do continue to make improvements in SG&A, as you saw in the fourth quarter. Actually as you saw throughout this year and the last 2 previous years as well. And Michael mentioned that we will be investing back into R&D as well. So R&D, you should expect to see that as an increase in cost next year.

In addition to R&D, when we look at our tax rate, we would anticipate that our tax rate would be in the low 20% range this year. So overall -- sorry, the one item that I failed to mention is foreign currency. This continues to be a headwind for us as the U.S. dollar just continues to strengthen against most of the major currencies as well. So the major headwinds, if you will, versus EPS would be foreign currency, continued -- and our continued investment back into R&D expense.

--------------------------------------------------------------------------------

Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [31]

--------------------------------------------------------------------------------

Okay. And then I guess maybe last question I have for you. If I think the -- historical conversations, there's always kind of thought process that Brady's performance kind of lagged the overall macro economy at least by 1 to 2 quarters. Is that still a valid assumption? Or you think it's more immediate response to the macro economy?

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [32]

--------------------------------------------------------------------------------

Well, as you know, we don't have a large backlog, but the -- a lot of our industrial products are towards the -- are used in building construction, used when you lay out new spaces. So we do find that the later end of an economic upturn, we tend to do better. That would be absolutely correct.

And if you look at our history, we didn't go down as far during the last recession as the overall economy did. And we don't see that situation changing either because a lot of our products are needed, regardless of the revenue stream at the moment. We certainly aren't immune, as you well know, but we do see a little less sharp decline when we have a big recession, and we do see a bigger improvement at the end of the cycle.

That said, I also believe we have a strategy now where we're financially deploying ourselves in a very consistent manner that as we come out of recession, I feel fundamentally very good. And I'm not predicting one by the way so don't take that the wrong way, but we think this way long term because you asked long term. We think that we'll have an ability to grow better than our competition coming out of the recession because of our continuous investment in R&D and our very close effort to contact and deal with our end users.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

And we do have a follow-up question of George Staphos' line of Bank of America Merrill Lynch.

--------------------------------------------------------------------------------

Molly Rose Baum, BofA Merrill Lynch, Research Division - Research Analyst [34]

--------------------------------------------------------------------------------

The first -- just 2 additional questions. The first one, can you talk about kind of what you're seeing in terms of the lockout tagout regulatory landscape? I saw an article come up that trade groups are talking about potentially changing potentially some of the current OSHA regulations. So just wanted to know what you're seeing in that sense.

And then the second one was to just follow up on Joe's question about IDS. Can you just, again, and sorry if I missed this, highlight what the biggest driver of the margin improvement was, whether it's the mix benefits from health care growth or the cost-outs that you talked about earlier, reduction in SG&A, et cetera?

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [35]

--------------------------------------------------------------------------------

Molly, absolutely. Let me start with the lockout tagout. We're developing a variety of new products in that space, both anticipating change and leading the change. We are absolutely a driver in that space, and we feel it's fundamentally a great space, both for us and our customers.

What I challenge our employees with is we make the world a better and safer place every day and there are darn few companies and people who can say that. And in lockout tagout, we push our leadership in that area to make sure we're are doing an even better job with that. So these things take time. As you are well aware, but we believe that if changes do come about, we are well positioned to handle all of them.

The second question you have relates to our margins and the biggest element of that was our health care growth, absolutely, followed by our regional growth.

--------------------------------------------------------------------------------

Operator [36]

--------------------------------------------------------------------------------

And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Michael Nauman for closing remarks.

--------------------------------------------------------------------------------

J. Michael Nauman, Brady Corporation - President, CEO & Director [37]

--------------------------------------------------------------------------------

Thank you so much. I'd like to leave you with a few concluding comments this morning.

We reported another strong year in 2019. We're growing our organic sales, while continuing to generate strong gross margins and reduce SG&A expenses. We're investing in capital expenditures in our facilities to upgrade machinery and to improve our level of automation, and we're purchasing or building certain critical manufacturing sites where it is a strategic fit and makes financial sense. New products launched in 2019 were the results of our increased investment in R&D over the last several years, and we have more exciting products in our pipeline for future development.

Our team is motivated, and I'm motivated to carry this momentum into 2020 and beyond. Even in the tough economic environment, we expect to grow organic sales, drive efficiencies to the organization and grow earnings. I'm proud of what we've accomplished so far, and I know that we're making the right decisions today to set us up for an improved long-term financial situation.

As always, if you have questions, please contact us. Thank you all for participating today, and have a great day. Operator, you may disconnect the call.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect.