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Edited Transcript of BRC earnings conference call or presentation 24-May-18 2:30pm GMT

Q3 2018 Brady Corp Earnings Call

MILWAUKEE Jun 22, 2018 (Thomson StreetEvents) -- Edited Transcript of Brady Corp earnings conference call or presentation Thursday, May 24, 2018 at 2:30:00pm 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

* George Leon Staphos

BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research

* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Keith Michael Housum

Northcoast Research Partners, LLC - MD & Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Brady Corporation Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ann Thornton, Chief Accounting Officer. Ma'am, you may begin.

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

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Thank you. Good morning, and welcome to the Brady Corporation Fiscal 2018 Third 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 forward-looking statements. 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. We released our fiscal 2018 third quarter financial results this morning, and I'm proud to report our 11th consecutive quarter of improved year-on-year profitability.

Our pretax earnings increased by 20.7% compared to the third quarter of last year. Total sales growth was 8.2% this quarter, which made up of 3.2% organic growth and an increase of 5% from foreign currency translation.

This marks our fourth consecutive quarter of organic sales growth, which is a direct result of the focus and dedication of the entire team on the development of innovative new products and executing our strategy every day.

We've focused on the same set of priorities, which are to develop innovative, high-quality products; provide excellent customer service; to drive improvements throughout our facility; and to identify and execute on efficiencies throughout our SG&A structure. Maintaining our focus on these consistent priorities is the key to our organic sales growth and our pretax earnings improvement.

We now have momentum, and we're using this momentum to move the organization forward. Our investment in research and development increased by more than 17% this quarter, and our talented engineers are building our pipeline with innovative new products.

We're observing and listening to our customers to understand their problems and then turning them into our problems to solve. For instance, as the direct result of these customer observations, this quarter, we launched the Quicksleeve handheld sleeve applicator, which is a multi-tool designed to make label applications to wires easier and more efficient.

The focus on innovation is spreading throughout the organization, and we have some exciting new products in the pipeline. Our Identification Solutions business grew in all 3 regions. Our health care product line is still challenging, but I know that we're taking the proper actions and making the appropriate investments in people and processes to set this business up for consistent improved sales growth in the future. Our global IS team is executing every day, driving organic sales growth, developing innovative new products and always focusing on the customer.

I'm pleased to report that our Workplace Safety business posted organic sales growth of 1.7% this quarter, which was driven by growth in all 3 regions, including the U.S., which had historically been a challenge. Every member of the WPS team has been working extremely hard to execute our strategy, and the results are positive as we return this division to organic sales growth.

WPS also posted a significant profit improvement of 47% compared to the third quarter of last year. I'm proud of this team's ability to maintain their focus on a consistent strategy, which is paying off through greatly improved financial results.

We also made certain portfolio shifts in May through the sale of our Runelandhs business based in Sweden. Runelandhs is a direct marketer of office furniture, equipment for lifting and transport as well as warehouse equipment and material handling supplies. The Runelandhs business is a high-quality operation, but it's a better fit with a parent company where these products are core to their offering.

Our strategy for the WPS business remains unchanged, which is to provide our customers with a vast offering of workplace safety products along with our industry-leading safety and compliance expertise, custom capabilities and excellent customer service.

I'm proud of our consistent quarterly financial improvement, but I want to be clear that we remain focused on the long term by taking actions that may not pay off this quarter or even this year but that will result in sustainable improvement in the future.

We remain focused on a consistent set of priorities, which are to develop innovative, high-quality products; to provide excellent customer service; to drive improvement throughout our facilities; and to identify and execute on efficiencies throughout our SG&A structure. Maintaining a consistent set of priorities and executing on them every day has resulted in the achievement of our financial goals and allowed us to deliver longer-term value to our shareholders.

I'll now turn the call over to Aaron to discuss our financial results for the third quarter, then I'll return to provide some more specific comments 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 8.2% to $298.4 million in the third quarter, which consisted of organic sales growth of 3.2% and an increase of 5% from foreign currency translation.

We once again increased our investments in research and development this quarter. R&D expense was $11.7 million, which was an increase of 17.4% over last year's third quarter.

Our trend of improving profitability continued this quarter as well with pretax earnings increasing 20.7% to $37 million compared to $30.6 million in last year's third quarter. This profit improvement was driven by organic sales and profit growth in both our IDS and WPS businesses as well as our consistent focus on driving sustainable efficiency gains throughout our SG&A structure.

Our tax rate was a bit higher than last year, and net earnings finished at $26 million this quarter compared to $22.6 million in the third quarter of last year. Diluted EPS increased 14%, finishing at $0.49 compared to $0.43 in last year's third quarter. This increase is a direct result of the organic sales growth and our ongoing efforts to identify and take action on efficiency opportunities throughout the globe.

Our cash generation was very strong with cash flow from operating activities of $46.8 million this quarter compared to $37.8 million in last year's third quarter. And free cash flow was $40.5 million compared to $34.2 million in last year's third quarter.

Moving along to Slide #4, you'll find our quarterly sales trends. Total sales growth was 8.2%, and organic sales increased 3.2% compared to the third quarter of last year. This quarter marks our fourth consecutive quarter of total company organic sales growth. We're building on our positive momentum with both segments of the business now growing organically, and we're focused on continuing this positive trend throughout the rest of this fiscal year and into fiscal 2019.

Slide #5 details our gross profit margin trending. Our gross profit margin was 50.6% this quarter, which marks our highest gross profit margin percentage realized so far this year and was effectively in line with last year's third quarter gross profit margin of 50.7%.

On Slide #6, you'll find our SG&A expense trending. SG&A was $101.7 million this quarter compared to $98.4 million in the third quarter of last year. The increase was entirely due to foreign currency translation. In fact, in constant currency, our SG&A expense decreased by approximately $1.6 million or 1.7%.

We continue to identify opportunities to improve processes throughout our SG&A structure with a focus on ensuring that all savings are sustainable. At the same time, we're reinvesting a portion of these savings back into direct selling and R&D resources to help drive future sales growth.

On Slide #7, you can see our increased investment in R&D. R&D expenditures increased both in absolute dollars and as a percentage of sales again this quarter. We remain committed to investing in new product development as we believe that these investments will ultimately have the highest rate of return and are crucial to our long-term success. R&D expense was up 17.4% this quarter, and we expect this trend to continue with our full fiscal year 2018 R&D expense up approximately 15% compared to last year.

Slide #8 details the quarterly trending of pretax earnings. We increased pretax earnings this quarter by $6.4 million or 20.7%. Again, this marks our 11th consecutive quarter of pretax earnings improvement, which we've delivered while significantly increasing our investments in R&D.

On Slide #9, you can see the trending of our earnings per share and net earnings. Our diluted EPS increased to $0.49 this quarter compared to $0.43 in last year's third quarter. Our tax rate was 29.7%, which included certain additional charges from the implementation of the new U.S. tax legislation, which was signed into law on December 22 of last year.

As a result of our fiscal year-end, the new reduced U.S. tax rate does not fully take effect for Brady until August 1, 2018, which is the start of our fiscal year 2019, at which point in time we expect our ongoing global income tax rate to decline to approximately 26%.

Slide #10 summarizes our quarterly cash generation. We generated $46.8 million of cash flow from operating activities compared to $37.8 million in last year's third quarter. And even with increased investments in machinery and equipment to add new capabilities and to increase automation, free cash flow was up 18.3% to $40.5 million in the third quarter compared to $34.2 million in the same quarter last year.

And as you can see from this chart, we have a history of consistently generating operating cash flow in excess of net earnings. This quarter, operating cash flow was 180% of net earnings.

Slide #11 details the trending of our net cash position and provides a summary of our debt structure at the end of the quarter. At April 30, we are in a net cash position of $73 million compared to a net debt position of $9 million at this time last year. This is an improvement of $82 million over 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 opportunities throughout the 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 factories.

Second, we focus on returning cash to our shareholders in the form of dividends, which we've consistently increased for the last 32 years. After funding organic 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. We have approximately 1,964,000 shares authorized to repurchase as of April 30.

Overall, our cash generation is strong. Our balance sheet is strong. And we're focused on driving long-term value for our shareholders through our disciplined allocation of capital.

Slide #12 summarizes our diluted EPS guidance for the full fiscal year ending July 31, 2018. As a result of our improving financial results characterized by increasing sales, well-controlled expenses, ongoing smart investments in R&D and CapEx to drive the long-term and very strong cash generation, we're increasing the low end of our guidance range.

We're tightening our guidance from the previous range of $1.90 to $2 per share to our new range of $1.95 to $2, exclusive of the tax charge that we recorded last quarter of approximately $0.40 and any potential future tax charges or benefits we may take in the fourth quarter as we move towards finalizing the implementation of the tax legislation that was passed in the U.S. in December of 2017.

Included in this guidance is low single-digit organic sales growth, which will be led by our ID Solutions business. This guidance is based on foreign currency rates as of April 30, 2018, and includes other key operating assumptions of depreciation and amortization of approximately $26 million and capital expenditures ranging from $20 million to $25 million.

We're not anticipating any restructuring charges and we're not excluding any onetime items from this guidance other than the impact of U.S. tax legislation that I just mentioned.

I'd now like to turn the call back over to Michael to discuss 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 Identification Solutions third quarter financial results. IDS sales increased by 7.8%, finishing at $212.2 million with organic sales improving 3.7% and foreign currency translation increasing sales by another 4.1%. Organic sales growth was led by Europe and Asia with both regions posting growth in the mid-single-digits while organic sales increased in the low single digits in the Americas in the quarter.

In the Americas, organic sales growth was the strongest in our Wire ID and Product ID product lines. We're building on our momentum in improving both sales and profit within most of our primary product lines in the Americas. Mid-single-digit sales growth with our U.S. industrial customers was partially offset by a low single-digit decline in organic sales in our health care product line. To adjust this we're continuing to invest in high-quality proprietary products that our customers want and need.

This quarter, we launched the TimeAlert IV time-indicating reminder label. This label includes a visual time indicator that is easily activated with a push of a button. It uses color-changing technology to indicate when IV tubing must be changed, which helps health care providers comply with CDC requirements and reduces the risk of blood stream infections.

With this product, we've added an element of technology to an otherwise simple label to reduce the risk of human error in monitoring and handling IV tubing. This is an example of the type of innovation that we're incorporating into our health care product line. It will take time for us to fill our pipeline and return to strong organic growth, but I'm confident we're moving in the right direction.

Sales growth in Asia was driven by China and India where we've realized increases in both new customer wins and with our existing strong base of customers. There are excellent opportunities in Asia, and I'm looking forward to the future within this region.

Low single-digit sales growth in Europe was driven by Western Europe and our emerging market regions. Our Wire ID and Product ID lines continued to drive sales in this region, and we grew organic revenues in all of our major geographies in Europe this quarter.

Segment profit for the IDS division was $37 million in the third quarter, which was an increase of 13.3% over the third quarter of last year. The team's focus on generating organic sales while driving efficiencies throughout our manufacturing facilities and SG&A is working as the business has now posted quarterly segment profit improvements for 2.5 straight years.

As a percentage of sales, segment profit improved to 17.4% this quarter compared to 16.6% last year. This quarter, we launched the S3100 sign and label printer. This is a WiFi-enabled printer with an easy-to-use touchscreen that can print labels and signs on a variety of materials for use in many different industries. The touchscreen interface includes a selection of preset templates to ensure 100% compliance with complex regulatory requirements.

Our customers will be able to print chemical GHS labels, arc flash labels, safety identification signs, pipe markers, equipment identification, inventory identification labels, floor marking tape and many more options with this versatile and easy-to-use printer. Making it easier for our customers to solve their problems is important to us.

Our expectations for IDS for the full fiscal 2018 are for continued low to mid-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 while our efficiency activities in our facilities and throughout our SG&A structure will 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. I'm pleased to report that the WPS business returned to organic sales growth in the third quarter. We've been committed to a consistent strategy in this business, and this strategy is working. Organic sales increased in all 3 regions in the quarter.

We expect that our organic sales turnaround will continue to be choppy over the next several quarters, but I know that we're taking the right actions now and that we're on our way to delivering consistent organic sales growth in WPS. WPS sales increased by 9.1%, which consisted of organic sales growth of 1.7% and increase from foreign currency translation of 7.4%.

Sales growth was led by our Australian-based business this quarter with growth in the mid-single digits. We're building momentum in this region by identifying new sales opportunities while growing sales with existing customers. This business added another quarter of solid profit improvement compared to last year, which is a direct result of the team's focus on driving organic sales growth while pursuing efficiency throughout SG&A.

Our WPS business in Europe continues to be consistent as it grew organically in the low single digits this quarter. Underlying sales continued to be the driver of growth in the region, and we saw double-digit growth in this channel in the quarter.

The European team is capturing new sales opportunities by focusing on providing complete solutions to our customers while ensuring that our sites remain optimized and able to capture the catalog-to-digital shift, which has been underway for several years. The team has also been addressing its SG&A cost structure for several years now and has continued to drive efficiencies, which is resulting in profitability improvements.

Sales growth in our North American business is turning the corner as sales increased in the low single digits compared to last year's third quarter. Our average order sizes are increasing, and we're gaining momentum that we expect to continue throughout the fourth quarter of fiscal 2018.

Our strategy is to focus on our custom capabilities, proprietary products and solutions selling. These are our areas of strength and are how we differentiate ourselves from our competition. Maintaining our focus in these areas will help us to continue to increase margins and return the business to consistent profitable growth.

Our focus within the WPS division is consistent and is centered on 3 priorities. First, we're improving the buying experience for our customers so that it's as simple as possible, reaching our customers the way they would like to be reached, whether it's online, mobile, catalog, in person or a combination of these channels. It is essential to our gaining market share and growing this business.

Second, we're increasing our customer interactions to provide more value than simply fulfilling orders, which allows us to better understand what our customers are facing 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 for our customers through improving our portfolio of products by introducing more customized and proprietary products that our customers need while offering our extensive safety and compliance expertise. This consistent focus on adding significant value to our customers is working as we return to organic growth, not only for the overall WPS business, but also for the North American business.

We believe that, over the long term, we need to continue to offer industry and compliance expertise while providing high-quality custom solutions. It's this focus on providing solutions to our customers that others cannot or will not provide that is enabling us to turn around and grow this business.

Segment profit in the WPS business was $7.5 million compared to $5.1 million in last year's third quarter, a significant increase of 47.2%. As a percentage of sales, segment profit was 8.7% this quarter compared to 6.5% in last year's third quarter. We continue to address our cost structure throughout the global WPS segment, and we're investing in sales-generating resource while, at the same time, streamlining processes and reducing the cost to process orders.

Our expectations for WPS financial performance for the full year are for organic sales to be approximately flat to slightly positive and for segment profit to continue to be in the high single digits as a percentage of sales.

As I reflect on the first 3 quarters of this fiscal year, I'm proud of what we've accomplished. Brady has delivered 4 straight quarters of organic sales growth, 11 consecutive quarters of pretax profit growth. And I'm excited about the new opportunities that we're identifying every day. That is a trend, but we have more work to do.

We must continue to invest in sales and R&D resources while at the same time ensuring that we're driving operational excellence throughout every department at Brady. It's up to us to differentiate ourselves and to drive value through innovative new product development and providing the highest level of customer service.

Our focus on reducing complexity in our global structure remains unchanged, and we continue to have opportunities to further simplify and streamline the way we do business. I'm a firm believer in removing barriers so that our local managers can think, decide and act on their feet every day.

It's empowering for a business leader to be given the trust and support to shape the future of their business, and the impact of this culture shift is apparent in our financial results.

I'm proud of our results so far this fiscal year, but we're continuing to push hard for a solid fourth quarter and a strong finish to the year. I'm motivated and I know the entire Brady team is motivated and excited for what the future will bring.

We're constantly working to identify and eliminate nonvalue-added activities that are not part of designing a product, making a product or serving our customers, we're directly in support of those efforts. With our focus on innovation and operational excellence, I know we can exceed our goals and continue to drive to deliver what we promised to our customers, our employees and our shareholders.

I would 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) Our first question comes from George Staphos with Bank of America Merrill Lynch.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [2]

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Mike, first question for you. You mentioned the new IV bag tubing, and that sounds like an interesting idea. What other investments do you expect we'll see that you can obviously comment on in this kind of forum?

And what kind of -- I don't know what the right phrasing would be, but payback or time to see incrementally better performance in health care should we expect from those investments? And I had a couple of quick follow-ons.

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

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Absolutely, George. As far as investments, we are investing in core products to our technology space across the board, so printer capabilities that will directly enhance all of our other product platforms and throughout our different product lines.

I think the key differentiation is that today you can look at every one of our major product lines and see that not only do we have a solid pipeline, but we'll be introducing products in a standardized cadence in the next few quarters.

Now how long does that take to really change the marketplace? Depending on the product set it can be 6 months to 2.5 to 3 years, depending on the ramp-up of the products. So it is very product and market segment and customer dependent. But overall, it will give us a good, strong cadence of growth as we move forward in the future years.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [4]

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Mike, if you wanted to add a little bit of additional color to the extent possible relative to health care, kind of the same question, where are you investing?

Again, you mentioned that new tubing. And how long do you think it would take to see improved performance? I'm guessing it would maybe -- that would be more towards the larger end, if you will, of the spectrum, 2.5 years in terms of payback. But your thoughts?

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

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Yes. It does take a little longer in the medical space for adoption. One of the real reasons is, understandably, in medical applications, the risk for them is higher, so they're more careful about introducing the products.

But you can assume that our product sets are looking at it, making it easier and more reliable for our customers to properly take care of their patient set. So anytime we take a look at a product, we want to make sure that we're adding to the reliability, reducing their cost profile and improving their performance profile.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [6]

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Okay. One last one, I'll turn it over. I mean, you gave us your guidance factors, but are there any particular issues or things we should focus on from where we sit that would indicate whether you'd be at the lower end or higher end of your range implicit for the fourth quarter?

And then what effect do you think you're getting right now in terms of a benefit from what's been a positive currency translation with the dollar more recently strengthening? Does that add any headwind? I'll turn it over.

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

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So I'll start with the first half and then flip it over to Aaron for the second half of your question, George. As far as the first half, there are no specific identifiers that would trigger a change in our guidance at this point, save a gigantic change in the economic model throughout the world. We're really focused on executing. And we believe if we execute and execute strongly, that we will be able to perform as expected for the quarter. Aaron?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [8]

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And to the second part of your question as it relates to FX, so our top line was up 5% as a result of foreign currency this quarter. Our bottom line, of course, was up 20.7% -- pretax was up 20.7% in total.

As we look at how that 5% flows to the bottom line within the organization, I'll say it has a very minimal effect on the percentages of margins, et cetera. But it does have a slightly larger impact ultimately on the bottom line, slightly larger than the 5%, but it's not massive.

And as we look into the fourth quarter, by the way, related to foreign currency, clearly, we've had some benefits of the weakening U.S. dollar. However, the last -- basically, the last several weeks, that trend has reversed a bit. But as we look at our fourth quarter, we still do anticipate some benefit from foreign currency, just not at the same level that we saw in Q3.

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Operator [9]

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Our next question comes from Charley Brady with SunTrust.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [10]

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I want to go back to your comment on WPS, the organic growth, which you described is going to be choppy going forward. Can you just expand on that as to what's really kind of driving that and where are areas that might not be as consistent?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [11]

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Sure. I think, Charley, anytime that you're having a business in a recovery mode, and you've seen it in all of our different businesses at Brady as we've improved them from about 3.5 years ago to today, that as you turn that corner, it is -- you are working to get momentum. And the result is you sometimes can have a little movement backwards as you move consistently forward. So that is how we articulate the choppiness.

Effectively, we're doing very well on selling complete solutions to our customers, really becoming a strong expert for them in their safety and identification need sets in WPS in North America, in particular. And we're overcoming the changing dynamics of the more commoditized segments of that market. And that is why you're seeing a little choppiness.

But you saw that as we pulled IDS out of a negative revenue model and profit model, and you'll see that as -- we saw that as we moved the other segments of WPS forward and now as we are moving North America forward. It's just been, as you know, from past conversations our most challenging segment.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [12]

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Yes. No -- understood. And then just on IDS, Q4 -- you've got probably the -- well, you do have the toughest comp of the year. Q4 organic last year was, I think, over 4%. Are you still expecting positive organic growth in this Q4?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [13]

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Yes, absolutely. You did astutely note it's our toughest comp. We had a very strong IDS quarter compared against the year ago. However, we believe the momentum that we have, the products that we're introducing and continuing to develop will give us a good quarter, absolutely, as compared to last year.

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Charles Damien Brady, SunTrust Robinson Humphrey, Inc., Research Division - MD [14]

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Okay. Just one more for me then. On the health care medical new products that you're putting into the market, do those have to be certified by any regulatory agency?

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

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We -- there are rare occasions where that is true, but the predominant elements of our products can be introduced without regulatory approval.

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Operator [16]

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Our next question comes from Joe Mondillo with Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [17]

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I wanted to ask about just the -- sort of the cost structure and more specifically sort of productivity improvement-type projects. What kind of opportunities do you see as we head into the following fiscal year? Do you think there's a ramp-up of actual opportunities? Or is it consistent with this year? Just talk about ways that you think you can continue to expand the bottom line without seeing any revenue growth?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [18]

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Well, Joe, it's interesting. This is a passionate topic of mine and not for cost savings, but cost savings are going to be a direct benefit of it. The reality of our marketplace is quite different from what we might have seen a few decades ago where people were trying to push labor overseas, push to low-cost countries, to push labor out of every process for the strict purpose of profit.

The world is changing. And around the globe, with a couple of exceptions, the workforce is aging out. And that's particularly true in our stronger markets of North America and Europe. And as that workforce ages out, we must focus on automation and actually have been for the last 2-plus years. Because if we hadn't been, quite frankly, we wouldn't be in a position today for the large number of employees that we are seeing move on to the next phase of their life by their own desire.

At this point, we already have a workforce that is approximately 50% composed of millennials. But those numbers will continue to shift as the baby boomers head out. And yes, as a result, I do expect to see continued and stronger drive into automation and making our processes much less dependent on skill sets that we just can't replicate.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [19]

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All right. And then WPS segment, the last, I think, 4 years, we've seen the operating margin at that segment sort of come in at the low of the year within the third quarter. However, this year, you're pretty much at least equating to -- close to the high of the year, even though the fourth quarter is probably going to be the high, as it usually is.

Just wondering if you could comment on why -- what drove the third quarter strength within margin. Do we -- should we continue to anticipate a seasonal low within that margin in the third quarter? And is it sort of product mix driven? If you could talk about the product mix.

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J. Michael Nauman, Brady Corporation - President, CEO & Director [20]

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We'll start with the word momentum. In that space, momentum and growth are key elements in our ability to really improve our margins and our ability to drive money to the bottom line. We are becoming much better, and that's why you're seeing growth at addressing our customers' specific needs and adding significant value to them.

And when you can do that, and we're doing that, in a way that's unique to your competitors, we are able to drive better revenue but better profitability in the end. And so yes, we're proud that our results show a break from our historic past, but that break is consistent with what we're doing and why we're doing it.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [21]

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Okay. And just last question for me. The administrative costs have been up quite substantially this year. Just wondering what your thoughts are on that. And do we foresee that being able to sort of come down? Because we've seen that come down over the last several years. Where do you see that going in the next year or so? And why have they been sort of -- are you investing in anything there? Why are they up this year?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [22]

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We've made a significant number of changes, and we are continuing to move our structure. At the end of the day, we cannot reduce our cost structure through just cutting. And we have to think differently about how we administer our business and run our business.

We are looking at several ways in which -- in some of our particular functions that I at this point don't want to clarify publicly -- to relook at the approach to handling that business. So we would expect a continued drive to move our SG&A down.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [23]

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Okay. And just sort of on this topic, the last follow-up for me. I know you don't like to sort of highlight or quantify or even talk about sort of onetime-type items or whatnot, but do you see anything maybe within admin or anything that's maybe a little higher than -- or a little abnormal in this quarter, this year that you may see as an easier comp next year?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [24]

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Joe, this is Aaron. I'll say -- I'll just answer that and say, no, not really. Really, the only unusual item that we had this -- actually, this whole entire year in our financial statements was the impact of the tax legislation. So no, I would not see that in G&A.

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Operator [25]

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Our next question comes from Keith Housum with Northcoast Research.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [26]

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I missed it in your script a little bit, can you provide a little more color on the segment in WPS you guys disposed of in Sweden? I guess, specifically, how much in revenue did that contribute? And how should we think of that going forward in terms of any proceeds you might have gotten?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [27]

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Keith, I think that as you're looking at that, we're talking about the segment Runelandhs. And about 1.5 years ago, we were looking at our strategy for the WPS segment, and we really felt that the businesses that they were in, and actually an even smaller business that was insignificant to our financials called Welco, really didn't marry with the rest of our product portfolio.

It's a great business, well run, in a good country, but we felt that the benefits could be derived more appropriately from a company that was more tightly tied into that segment. And so as far as the factory and the office, the furniture and equipment segment, we no longer do that as an independent. Now we certainly have catalogs that include those products, but we don't have an independent focus. And that was why we got out of it. And then as far as -- go ahead.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [28]

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No, I was -- and how big was that segment?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [29]

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Revenues are about $16 million. So I'll just give you a couple of the key numbers that you probably want to know. First of all, annual revenues are in the neighborhood of $16 million. Our sale price was around 20 -- of course, it was denominated in SEK, but our sales price in USD is about $20 million and it was about a 9 EBITDA multiple. So clearly, to echo Michael's point, clearly, a very, very nice business, just not a business that fit with our core strategy.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [30]

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Great. I appreciate the color. If I look at your gross margins over the past several years, it looks like the third quarter has been the high point and then to have them drop sequentially in the fourth quarter. Is there anything in the business makeup in the third or fourth quarter that we should be thinking about as we look at the fourth quarter?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [31]

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No. Historically, our third quarter absolutely is our strongest gross profit margin quarter. I mean, there's -- there are a couple of business mix issues that tend to drive that, and it's mostly within our Workplace Safety business, where we have a couple of businesses that have some very nice profit -- very nice gross margins.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [32]

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Got you. And then final question for me. Michael, you guys have made this concentrated effort to focus on R&D over the past several years and clearly the increase of roughly 15% in spending this year. As we look out into '19 and '20, should we expect the R&D investment to continue at that level? Or do you foresee ever pulling that back?

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

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We have fundamentally moved into a model where we are developing more innovative products, and so I do expect that to continue. And we also are moving into a model where we control more of our own destiny for innovation. So I -- as a result of that, I also expect it to continue to improve.

We're looking at investment not just for a primary product, but we're seeing as we add the technology cores to our business, our people are becoming much more creative about secondary products, which was a key element in wanting to control that moving forward.

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Operator [34]

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Our next question is a follow-up from George Staphos with Bank of America Merrill Lynch.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [35]

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Just some housekeeping here, to some degree. So I just want to go back to the discussion on the fourth quarter implicit guidance. So it sounded like, Mike, really, barring a major change in the macro environment, whether you're at the lower or higher end of the range, really gets down to your own execution, would that be fair?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [36]

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Very fair.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [37]

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Okay. And then secondly, as you enumerated the capital allocation priorities, obviously, internal investment between innovation and productivity, that is -- remains at the top of the list.

When you've looked back at investments over the last, say, 3, 4 years and done a postmortem, where are you getting your highest return? Are you getting it from the organic growth investments? Are you getting it more from productivity? And how might those paybacks have changed in the last couple of years, and therefore, frame your investment practice going forward?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [38]

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Well, a couple of factors there. First of all, in the short term, absolutely, our productivity improvements have given us the highest return, and we see a good path to continue that. However, in the longer term, we're seeing that the innovation development is really starting to pay off. And I'd like to say, we do definitely monitor this for success or completion of products.

And if you take a look at 3 or 4 years ago versus today, we have a substantially higher, although I'm not going to clarify exactly how much higher, but it's appreciably higher success rate in introduction of our products to the marketplace versus the initial start of development. So we're, as a result, even more enthusiastic about the long-term ability of R&D to provide substantial improvements.

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George Leon Staphos, BofA Merrill Lynch, Research Division - MD and Co-Sector Head in Equity Research [39]

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Okay. Mike, last question and maybe a little bit from left field. Are there any products within your suite of businesses that might be accelerated or enhanced by blockchain technology? Or for that matter, is there anything in the world that you produce perhaps inhibited by the advent of blockchain?

I mean, our view is that it's ultimately an accelerator in smart label technology, probably more of a consumer-bent there. And obviously, that's not necessarily your world. But any thoughts there? Or is it really not a relevant topic for you at this juncture?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [40]

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Well, personally, I am a big fan of blockchain technology, and I want to make sure that is differentiated from cryptocurrency -- because they're very different, although they seem to often get married together because of the need for blockchain.

I definitely see it as a path in the longer term. But in the shorter term, it is more of a consumer play, which is not our space. That said, that capability and that capacity incorporated into security measures, labels, et cetera, is an exciting avenue.

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Operator [41]

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And I'm showing no further questions at this time. I'd like to turn the call back over to Michael Nauman for closing remarks.

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J. Michael Nauman, Brady Corporation - President, CEO & Director [42]

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Thank you. I'd like to leave you with a few concluding comments this morning. We're growing sales, profit and cash generation. We're making sustainable improvements to our SG&A structure and increasing automation in our factories, all while increasing our investment in R&D and sales-generating resources, which will drive future sales growth.

Brady was founded as a highly innovative company, and we're committed to delivering on our investment in R&D with exciting new products in the upcoming quarters. Growing our pipeline of new products is essential to our long-term success, and we're focused on doing just that.

We know what we need to do to improve our business, and we're committed to our strategy. We've cleared the way for local ownership and accountability, and we're creating a winning culture with a team that is highly motivated to achieve our goals and deliver strong financial results for our shareholders for years to come.

I'm proud of what we've accomplished, and I'm excited for our future because I know that we can continue to deliver more as an organization to our customers, our employees and our shareholders.

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 [43]

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Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.