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Edited Transcript of BRC earnings conference call or presentation 20-Feb-20 3:30pm GMT

Q2 2020 Brady Corp Earnings Call

MILWAUKEE Mar 4, 2020 (Thomson StreetEvents) -- Edited Transcript of Brady Corp earnings conference call or presentation Thursday, February 20, 2020 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Aaron James Pearce

Brady Corporation - CFO & Treasurer

* Ann E. Thornton

Brady Corporation - CAO & Corporate Controller

* J. Michael Nauman

Brady Corporation - President, CEO & Director

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Conference Call Participants

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* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Keith Michael Housum

Northcoast Research Partners, LLC - MD & Equity Research Analyst

* Molly Rose Baum

BofA Merrill Lynch, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2020 Brady Corporation Earnings Conference call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to introduce your host for this conference call, Ms. Ann Thornton. You may begin, ma'am.

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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 2020 Second 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 our expected results. Risk factors were noted in our news release this morning and in Brady's fiscal 2020 second quarter Form 10-Q, which was filed with the SEC this morning.

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 today. We released our fiscal 2020 second quarter financial results this morning, and I'm pleased to report another quarter of improved profitability. This quarter, we increased our pretax income by 15.4%, increased net income by 14.8% and increased earnings per share by 12.7%, all while continuing to generate strong cash flow and make strategic investments to drive future revenue growth. The general slowing in economic activity continued through our second quarter as global demand for industrial products weakened. To put this in perspective, even in the U.S., which has been and continues to be our strongest market, ISM manufacturing activity in December posted its lowest result in a decade. This reduction in economic activity led to our 1.2% organic sales decline this quarter.

We are seeing the effects of a challenging industrial economy around the globe, including Europe, the Middle East and certainly in China. Our China business accounts for only about 4% of our global sales. The majority of products we make in China are for consumption in China and in general are not major inputs into the other practically sell elsewhere around the world. Our global sales decline in IDS was 1.3%, while organic revenues in our WPS business declined 1% this quarter. We continue to invest in new product development, and these investments are providing benefits. We launched several new products in our IDS business this quarter that we've been looking forward to bringing to our customers, and we're further expanding our sales force in selected end markets where we see opportunities for growth. Our WPS business in North America, which has been a self-help story, continues to rebuild its digital presence.

We're making progress, and we believe we're on the right path to return this business to profitable growth in the near term. We are consistently and tenaciously controlling what we can across Brady to the execution of our key priorities. We're charged to invest in sales-generating resources, to invest in new product development, to serve our customers extremely well and to drive sustainable efficiency gains throughout our business. Our focus on these fundamentals enabled us to improve our gross margin, reduce our SG&A expense, increase our profitability and generate solid cash flow even in this challenging revenue environment.

We also have a very strong balance sheet, which gives us the ability to invest in our organic business, execute strategic acquisitions and return funds to our shareholders, which puts us in enviable position compared to many of our competitors. The economy certainly is not helping us at the moment, and we don't expect it to improve in the near term. But we're controlling what we can through our reduced cost structure, which will continue to result in cost savings. And when you combine this reduced cost structure with our ongoing organic sales investments and our strong balance sheet, we are positioned extremely well for an even stronger return to growth once our key end markets recover.

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

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

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Thank you, Michael, and good morning, everyone. The financial review starts on Slide #3. Sales in the second quarter were $276.7 million, which consisted of an organic sales decline of 1.2%, and a decline of 0.8% from foreign currency translation. Pretax income increased 15.4%, while net income was up 14.8% to $33.6 million compared to $29.2 million in the second quarter of last year, and diluted EPS increased 12.7% to $0.62 compared to $0.55 in last year's second quarter. Overall, our earnings growth was quite strong, especially given the economic challenges that Michael mentioned.

Turning to Slide #4, you'll find our quarterly sales trends. Organic sales in our Identification Solutions division declined 1.3%, while organic sales in our Workplace Safety division declined 1.0%. The decline in IDS was due to overall macro challenges in the industrial economy. Despite the weak economic environment, our U.S. business was effectively flat this quarter, while both our European and Asian businesses declined. The decline in WPS organic sales was due to our North American business, where organic sales were down in the low single digits as we continue to work through our digital sales recovery. Organic sales in both our European and Australian WPS businesses were effectively flat this quarter.

Slide #5 is our gross profit margin trending. Our gross profit margin was 50.3% this quarter, which is an increase of 80 basis points from last year's second quarter. We're seeing input cost pressures, but we remain focused on investing in automation and aggressively driving process improvements throughout our manufacturing facility. This efficiency focus has been extremely effective in offsetting these input cost increases and enabling us to expand our gross profit margins. We have a culture that is focused on continually improving and executing on our strong pipeline of opportunities each and every day.

Turning to Slide #6, you'll find our SG&A expense trending. SG&A was $87.4 million this quarter compared to $92.7 million in the second quarter of last year. Approximately 1/4 of this $5.3 million decrease in SG&A was due to foreign currency translation as the U.S. dollar continued to strengthen against most major currencies. The remaining 3/4 of this decrease was due to reduced compensation and our ongoing efforts to drive sustainable process improvements throughout our SG&A structure. As a percent of sales, SG&A decreased from 32.8% in last year's second quarter to 31.6% of sales this quarter.

Slide #7 outlines the trending of our investments in research and development. This quarter, we spent $10.5 million in R&D. We continue to have opportunities for investments in new product development, and we're committed to increasing our investments over time, while at the same time, ensuring that we're very disciplined so that we get the most out of every dollar spent on R&D.

Moving to Slide #8, you'll find quarterly trending of pretax income. We increased pretax income by 15.4% to $42.4 million this quarter. This marks our 18th consecutive quarter of year-on-year increases in pretax income. Our ability to improve pretax earnings in a sluggish industrial economic environment is a direct result of the sustainable efficiency gains we've implemented over the last several years and will continue to implement in the future, all while making the necessary investments to drive future revenue growth.

Slide #9 illustrates our after-tax income and EPS trends. Feeding into this quarter's after tax results was an income tax rate of 20.8%, which compares to a tax rate of 20.3% in last year's second quarter. Over both the long-term as well as for the full year ending July 31, 2020, we expect our tax rate to be approximately 20%. Net income increased 14.8% this quarter, and diluted EPS increased from $0.55 last year to $0.62 in the second quarter of this year, an increase of 12.7%.

Turning to Slide #10, you'll find a summary of our quarterly cash generation. We generated $14.3 million of cash flow from operating activities compared to $25.4 million in last year's second quarter. Free cash flow was $8.9 million compared to $19.3 million in the same quarter last year. Operating cash flow was impacted by the timing of annual incentive compensation payments. Last year, these payments were split between the first and second quarters, while this year, the vast majority of annual incentive comp payments were made in the second quarter. Frankly, the best way to look at our cash generation is to remove the noise caused by the timing of incentive compensation payments by just looking at year-to-date cash generation. On a year-to-date basis, our cash flow from operating activities was $53.1 million, which is up just over 20% from last year's cash flow from operating activities of $44.2 million. On an annual basis, we have consistently generated cash flow in excess of net income, and we're always focused on making the right long-term cash decisions for the organization. This quarter, we returned $11.6 million to our shareholders in the form of dividends, and we invested $5.4 million in capital expenditures, most of which was for new machinery and equipment to either add new capabilities or to drive further automation in our manufacturing processes.

Slide #11 outlines the trending of our net cash position, along with our debt structure at the end of the quarter. We finished the quarter with total cash of $289.8 million, and we're in a net cash position of $240.2 million as our borrowings are minimal. Our approach to capital allocation is consistent. We are 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 further automate our facilities. And second, we focus on returning cash to our shareholders in the form of dividends. 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. Our cash generation is strong, our balance sheet is strong, and we're focused on driving long-term value for our shareholders through this disciplined approach to capital allocation.

Slide #12 is our guidance for the full fiscal year ending July 31, 2020. Looking forward to the back half of this fiscal year, we expect industrial markets to remain challenged. As a result, we're decreasing our organic sales guidance. We now expect organic sales growth to be approximately flat to slightly positive for our full fiscal year 2020. We will continue to control what we can through our ongoing focus on sustainable efficiency improvements and keeping our costs in check. Because of this focus, we're increasing our earnings per share guidance for our full fiscal year 2020. We now expect our earnings per share to finish in the range of $2.55 to $2.65 per share, which is an increase from our previous guidance range of $2.50 to $2.60 per share. We continue to expect our income tax rate to approximate 20% for the full fiscal year. We expect depreciation and amortization expense of approximately $25 million, and we anticipate capital expenditures to approximate $35 million this year. This guidance is based on foreign currency exchange rates as of January 31, which continued to be a headwind due to the strengthening of the U.S. dollar, and we're not excluding any onetime income or expense items from this guidance. This guidance is based on financial results 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?

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

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Thank you, Aaron. Slide #13 outlines the first quarter financial results for our Identification Solutions business. IDS sales declined 1.8%, finishing at $205.4 million, with an organic sales decline of 1.3% and a decrease from foreign currency translation of 0.5% this quarter. Although organic sales were effectively flat in the U.S., organic sales decreased slightly in the entire Americas region this quarter. Our Safety and Facility Identification, our product identification product lines, were effectively flat in the Americas, whereas our health care product line decreased this quarter.

Organic sales decreased in the low single digits in Europe and declined in mid-single digits in Asia this quarter. We started to see an overall reduction in organic growth rates in the back half of last year, and the softer economic conditions continue into this year, resulting in an organic sales decline in both Europe and Asia.

IDS segment profit increased 7.4% to $40.7 million this quarter. As a percentage of sales, segment profit was a very strong 19.8%, which was an improvement over last year's second quarter segment profit of 18.1%. We improved our profitability compared to the prior year even though we had a modest organic sales decline and foreign currency headwind. This profitability improvement was the result of ongoing process improvements and efficiency gains that we've been pushing for several years throughout our businesses. The soft industrial economy makes our process improvement initiatives that much more important as we continue to drive increases in gross profit margin and reduction in SG&A expense.

We remain committed to investing in R&D as

innovative new products have been and will continue to be a competitive differentiator for Brady. This quarter, we launched the A5500 Flag Printer Applicator. This printer is designed to apply labels with flags to small diameter wires, which allows our customers to automate a time-consuming manual process. The A5500 applied complex serialized flags to wires in seconds, eliminating the problems caused by manual applications such as wrinkles and edge mismatch. This printer includes a touchscreen and is WiFi enabled, making it easy to use, while significantly reducing set up time. For the full fiscal year 2020, we expect IDS organic sales to be approximately flat to slightly positive. We'll continue to invest in R&D and drive efficiencies through our facilities and in SG&A. We remain committed to our top priorities, which are to invest in organic growth in both sales and R&D, improve new products, serve our customers extremely well and continue to drive efficiencies in our manufacturing processes and SG&A.

Slide #14 outlines our Workplace Safety financial performance. WPS sales declined 2.6%, finishing at $71.3 million with an organic sales decline of 1% and a decrease from foreign currency translation of 1.6% this quarter. Organic sales were effectively flat in both Europe and Australia, while they decreased in the low single digits in North America. We remain focused on 3 priorities to return our WPS North American business to consistent organic sales growth and improved profitability.

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 a sensor to returning this business to growth, which is exactly why we're focused on having industry-leading websites.

Second, we've increased our customer interactions beyond fulfilling orders. This allows us to better understand what our customers are dealing with from a safety and identification perspective that helps us better serve those needs by offering our compliance expertise and complete solutions. We're doing this through an expanded sales force with expertise in industry-specific regulatory and compliance requirements that our competitors do not possess.

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

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 that we're on the right track for our WPS North American business to have a solid finish to fiscal 2020.

Economic conditions in Europe are challenging right now, but we're able to finish the quarter with approximately flat organic sales. Digital sales continue to be a growth driver for us in Europe with an increase of nearly 11% this quarter. Our Australian business also experienced approximately flat organic sales this quarter. Economic growth in Australia has slowed, and recently, we've kind of seen the impact of this macro environment on our sales. We're focused on improving our pipeline of opportunities to keep this business trending in a positive direction.

WPS segment profit was $5.5 million compared to $4.7 million in last year's second quarter. As a percentage of sales, segment profit was 7.7% this quarter compared to 6.4% in the same quarter last year. The actions we've taken to address our cost structure, specifically in North America, are showing in our results as we're able to increase segment profit despite a reduction in organic sales. For the full fiscal year 2020, we expect organic sales to be approximately flat in the WPS business, while we expect to improve the segment profits through benefits from our reduced cost structure and continued efficiency opportunities in our operations and SG&A structure.

Looking again at Brady's total results, I am proud of our ability to once again increase profitability in this challenging economic environment where foreign currency continues to trend against us and organic sales have slowed as a result of economic weakness in the industrial sector. We're executing efficiency opportunities, and we're controlling costs throughout our manufacturing facilities and our SG&A structure. But we must remain focused on our priorities, which are to execute sustainable efficiency opportunities in manufacturing SG&A while investing in selling resources and R&D to drive organic sales growth in both the short and long term.

We intend to come through this period of sluggish economic activity even stronger than we are today. And we're confident that by maintaining our focus and eliminating distractions, we're setting ourselves up to do just that. We're dealing with a tight labor market, increased raw material costs, foreign currency headwinds and economic challenges. Yet, our no-excuses culture has enabled us to increase our gross profit margins in a sustainable manner, reduce our SG&A expenses and ultimately grow our pretax earnings by more than 15% this quarter. Overall, we are in a very strong financial position.

With that, I'd like to now 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.

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

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This is Molly Baum sitting on for George. I wanted to first kind of ask about the increase in guidance and maybe have you go into a little more detail on some of the puts and takes in the quarter. More specifically, what came in ahead of your expectations or below? And really, what ultimately drove this increase? Was it just that the efficiency improvements more than offset some of these industrial market challenges? Any additional detail you give would be helpful.

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

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Molly, glad to have you on the call today. We feel very confidently that the structure we put in place, the philosophies we put in place make Brady actually a company that will not only be able to handle downturns like this but fundamentally the key to our success is that coming out of these downturns, because we continue to invest throughout the downturn, we will be much stronger than our competitors on the other side. So as you take a look at why we're improving our guidance, it's because we are improving sustainably in our processes and our performance. If I look at our automation, I regularly get around the world to our facilities. I think that's very important. And we're able now to work so much better interactively on improving our manufacturing processes and are focused on how we're implementing automation.

There's a couple of examples. Years ago, when I got here, many of our processes were unique in every location, and now we're looking at literally best-in-class ways of doing things and sharing those around the world. And as a result, we're not only becoming more efficient in individual facilities, we're collectively becoming much more efficient. In our SG&A structure, we're really looking fundamentally, as Aaron, I think, has spoken in the past, about making sure we do things that not are cost-saving opportunities but are changing how we do business, first, to help our customers more effectively and efficiently but also to drive ourselves into a more efficient perspective. But what we find is if we're more efficient in helping our customers, it actually also drives down our cost. So nothing we've done this quarter is outside of the norm at all. It's literally focused on doing better as an organization, and we continue to do that and plan to do that. And that's why you see expanded expectations for the rest of the year.

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

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Michael, that's really helpful. I have one other on IDS, and then I'll turn it over. You talked about further expanding the sales force in some of the selected end markets that you're kind of focusing on for growth. Could you kind of maybe outline what some of those targeted verticals are for you? And relatedly, if you could give some detail on how some of the estimates you've made in IDS health care product line are playing out relative to your expectations.

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

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Yes. So we're actually talking geography versus industries. We have very broad coverage in industries. In fact, Brady has some of the broadest coverage of any company you're going to see. There are really very few markets as industries that we're not in. We are looking at specific geographies where we feel that we're underserved and have an opportunity to accelerate our growth rate even in a declining economic situation. Once again, those type of proactive efforts are sustainable because of our strong financial position. And those type of efforts will help us when others are retracting their interaction with customers during the decline, we're increasing our interaction. And when you come out of the decline, that once again helps you tremendously. So really, it's a geographic play as opposed to otherwise.

As far as our investment in marketplaces, you can take a look at many of the different segments and see that we are improving in places like our wire identification space. We believe we have world-class applicators at this point and are continuing to push the boundaries in a world that is constantly being challenged by labor cost increases and actually, far more importantly, a lack of labor throughout many parts of the world to do manual jobs. Our type of products are giving our customers in everywhere from harness shops to aerospace to hundreds of other types of businesses, the opportunity to do a higher quality job at a lower cost but also eliminate the need for very difficult-to-find labor. So there's an example right there.

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Operator [6]

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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 [7]

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Michael, I know health care has been an area, it's been a focus for years, particularly for the past several years. It was down again this quarter. Can you provide a little bit more color on what you're experiencing in that area and your expectations for the turnaround and be a growth driver here in the next year or 2?

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

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Well, Keith, I think that's a good point. Effectively, we did say it was a self-help story. We really need to work on issues that were -- challenges that we hadn't focused enough on is new product development. As you saw in our overall IDS space, we've done a good job of rebuilding our pipeline there, and we are doing that on health care. Also, we are really upgrading our capabilities and capacities in this space. I was literally just in our Tijuana facility, which is the primary manufacturing location for this business, and we can do a much more cost-effective manufacturing model now than we were able to do even 6 months ago on many key products. That puts us in a tremendous position in some of our more cost-effective elements of that business to be very competitive and also very competitive in regions of the world where we weren't competitive as much in the past.

And so I think we not only are looking at new product innovation, but we're also looking at positioning ourselves to be able to handle a good, better, best approach to the marketplace in a way we haven't before. Not all of our customers have the same level of needs in that space, and not all of the products we make serve every application perfectly. So we're doing a much better job of manufacturing at the right cost point and also creating the right products for each type of segment than we were before. That is going to take a little time to develop in the marketplace because, as you know, health care is a slower adopter. They're a more careful industry than others for very valid reasons. But as they adopt our products, we do believe that we're going to see continued traction.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [9]

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Got you. I appreciate it. And I know health care has been primarily a U.S.-based business. Is there an opportunity to take that international? And is that one of the primary focuses? Or is that more a secondary focus?

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

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That's very true, and we are looking at Europe more effectively. Once again, cost points are different in Europe. And as we're able to manufacture both more locally and more effectively, we are in a better position to service Europe in particular.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [11]

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Got you. And changing gears on you with the coronavirus, I appreciate that China is only 4% of the business. But can you provide a little more color there in terms of your factory's ability to produce right now? And is it perhaps a challenging market now with coronavirus? Is that more a demand issue? Is that more supply chain? Or is it perhaps both?

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

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Well, Keith, I want to start with this. The outcome of coronavirus, I don't believe, is known by anybody at this point. So I'm not going to pretend to give you a long-term diagnosis. What I can tell you is this, that I believe we're in as good or better position as any of our industrial competitors by far. First, we've looked at our inventory positions for finished goods throughout the world on anything that is coming from China, and we're in very strong position across the board. There's a lot of reasons for that, but the result is that we're in very strong position. Second of all, we look at our raw materials that are coming out of China. And we also feel that we're in very strong position. Finally, the issue of our customer base that's impacted by China, that's one that's a global impact and certainly will impact us. As customer needs go down because of their impact by China, we'll definitely be impacted by that. But we certainly don't believe we'll be the leading edge of the problem.

Now let's talk about our people and our product manufacturing in China. We do have a number of facilities there. Our -- none of them are in the worst impacted region. Most of our factories are back up and running. Most of -- the majority of our people have been able to make it back to our factories and are working. Logistics are still a problem. Suppliers are still a problem. But we're getting tremendous support, and my hats are off to our incredible management team, both in China and Asia and in the U.S. and Europe, really working together to drive the best solutions possible. This really shows the Brady's approach to working together and helping each other does make a big difference. We've already been able to resolve some critical component issues that would be very problematic if we hadn't solved them. So we feel good that if this isn't extended, then we'll be in a solid position. And if it extends globally for a long period of time, that's going to have a lot of impact to the world economy that certainly Brady won't be immune from.

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Operator [13]

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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 [14]

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So Michael, I just wanted to ask about your R&D strategy. So R&D has been declining at an accelerated rate on a year-over-year basis with 2Q being down the most that we've seen. Can you just comment on the strategy, just given that context?

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

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I don't see it as a significant decline. In fact, our focus on R&D is strong. We've been looking at some other approaches to be very effective in our spend. It is not just for us about the spend, it's how we spend, what we're focusing on and how we're doing it. And actually, our pipeline is very exciting and is getting stronger. The big difference between just a few years ago is every product line that we have, I can show you a product pipeline, a -- literally a road map to the future. I can show you how we're bringing out products and have brought out products and that all of our product managers can give you a holistic approach of how we want to be the #1 player in their space and how we can get there.

So I feel very good about our investment in R&D, and there is no correlation to any particular numbers with any less emphasis on R&D. Quite the opposite, our focus is very strong. And as we are in an economic downturn, I'm pushing our teams very hard to make sure we're focused on the products that will be the most likely to succeed as we come out of a downturn and to make sure if we see markets changing at all because of different needs, then we're on top of that and willing to flex in that direction as needed. We need to have the best products for our customer. It is our major sustainable advantage in the future.

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

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Okay. And then your operating income has been slowing in terms of growth, just given the tougher comps and then also the -- obviously, the macroeconomic trends that you're facing. However, they actually spiked quite a bit in this quarter, and then your guidance is actually suggesting reverting back to that slowdown that we saw. So can you explain if there was sort of a one-off, it wasn't an easy comp in the second quarter that really spiked the growth that we saw in the quarter itself? And then just in that context, refer to the guidance is really suggesting sort of flattish, maybe modest growth, operating income in the back half of the year.

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

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Yes. Joe, this is Aaron. I can take that question. As we look at the guidance for the back half of the year, the biggest -- frankly, the biggest variable in our guidance is actually our tax rate. As you -- as I'm sure you know, last year, in the back half of the year, we had a very low tax rate. In fact, I believe we had a 15% tax rate in Q3 last year, and we're anticipating a higher tax rate in the back half of this year. Still consistent tax rate at about 20% for the full year, which would be consistent with last year. But the timing between quarters is definitely playing into the guidance. Now if you would normalize that tax rate, our guidance effectively implies flat to plus 8% EPS in the back half of the year. And given a number of the question marks from an economic and industrial economic standpoint, we'll continue to push our teams, we'll continue to drive revenue wherever we possibly can and continue to drive efficiencies that should result in a solid back half of the year. But you really got to look at our tax rate, that definitely plays havoc with the quarterly phasing.

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

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Right. So just a follow-up on that. That's essentially what I was indicating. I was indicating that operating income is going to be sort of flattish, like you just said, if you normalize the tax rate. Earnings will be sort of flattish. So the margin expansion that you saw in the quarter obviously is not going to be sustainable in the back half of the year. And I'm just curious, was the second quarter wasn't an easy comp issue with the quarter a year ago? Or was there a one-off type thing that you benefited from in the second quarter that you're not going to see in the back half?

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [19]

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Yes. Really, we haven't had one-off items at all, and it's really not a comp issue either. It was -- frankly, it was just very strong performance in the second quarter. And as I mentioned, at the low end of our guidance range, you're right, we're anticipating effectively flat. But don't forget, we still have currency that's going against us as well. And then at the top end, as I mentioned, it's somewhere in the neighborhood of 8% on the top end, which given the top line challenges that many industrials are seeing at the moment, given unfortunately the continued strengthening of the U.S. dollar, the guidance actually at the top end suggests a pretty strong operating income growth.

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

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Okay. And then I was hoping to get an update on the balance sheet. I mean you guys have consistently sort of been consistent with your approach and answer regarding use of cash and your strategy with the balance sheet. Any update regarding this as we continue to grow the cash balance and really at a underlevered standpoint?

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

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Yes, Joe, we have remained consistent. We have said that when I first got here, we pulled away from an acquisitive mode because our acquisitive mode have not been as effective as I believe it should have been, and we had to refocus on the fundamentals of our business. We've done that. I think we continue to do that. We haven't stopped doing that. But we are in a position, have been, to look carefully at acquisitions as a particular use of cash. Those acquisitions should be technology-focused. They should be able to allow both the acquired company and us to be better off. We want to win, win, win because we believe that's the most effective way to go.

And of course, the price points have to be realistic. Until recently, I fundamentally believed many of the acquisition price points have not been realistic. But the market itself is, in some spaces, getting more realistic and will continue to get more realistic. And as that happens, we have a number of technologies and companies that we are looking at. But I'm never going to predict timing of use of cash like that. I'm never going to predict timing of acquisitions because that's not the goal. The goal for us is to use our capital wisely and effectively, and we believe that we're in a great position to do that.

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

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Okay. And lastly, your CapEx is going to be ramping up in the back half of the year. Could you just talk about projects that you're investing in?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [23]

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We're investing in a number of projects. We don't give specifics on actual projects ahead of time. You can obviously understand that, but we do have some facilities that we have to invest in that are significant. Our philosophy in facilities is pretty simple. We want to own the facilities that are long term and critical. They require customization that require major investment. We want to lease facilities that are smaller, more flexible in nature. And we really don't know if -- how they're going to grow or be sustained in the future. Things like sales offices, we certainly lease those. But our key factories and facilities, we've been working hard to acquire those so that we can really control our destiny, and you will see some of that. But also, we have product development in there that we don't talk about specifically.

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Operator [24]

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And I'm not showing any further questions at this time. I'd like to turn the call back over to Michael.

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J. Michael Nauman, Brady Corporation - President, CEO & Director [25]

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Thank you very much. I'd like to leave you with a few concluding comments this morning. Looking forward, I believe that Brady is in a very enviable position despite weaknesses in the industrial economy. Over the last several years, we've made increased investments to develop high-quality, innovative new products, and those new products are now coming to market. We've improved our customer service and support, which is improving customer loyalty. We have healthy gross profit margins that further improved this quarter, and we expect to remain consistent. And we've been aggressively driving sustainable efficiency gains, which you can see in our continued reductions in SG&A expense.

All of this has made us a more effective and efficient organization and that is better able to react and adapt to change, and that is critical at this point in our global situation. These improvements combined with our solid balance sheet puts Brady in a position of strength as we continue to invest in our future so that when our end markets recover, we'll be even in a stronger position and emerge with even stronger financial results.

Our team is very motivated, and I'm motivated to move Brady forward every single day. We plan to keep investing in organic sales engine, to keep driving efficiencies throughout the organization and to keep growing earnings and cash flow. 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 long-term improved financial results.

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.

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Operator [26]

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Ladies and gentlemen, this does conclude today's presentation. You may all disconnect, and have a wonderful day.