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Edited Transcript of BRC earnings conference call or presentation 23-May-19 2:30pm GMT

Q3 2019 Brady Corp Earnings Call

MILWAUKEE Jun 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Brady Corp earnings conference call or presentation Thursday, May 23, 2019 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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* Allison Ann Marie Poliniak-Cusic

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

* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Keith Michael Housum

Northcoast Research Partners, LLC - MD & Equity Research Analyst

* Molly Rose Baum

BofA Merrill Lynch, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q3 2019 Brady Corporation Earnings Conference Call. (Operator Instructions) As a reminder this conference is being recorded.

I would now like to introduce your host for today's conference, Ann Thornton, Chief Accounting Officer. 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 2019 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 a forward-looking statement. It's important to note that forward-looking information is subject to various risk factors and uncertainties, which could significantly impact expected results. Risk factors were noted in our news release this morning and in Brady's fiscal 2019 third 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, everyone, and thank you for joining us. This morning, we released our financial results for the third quarter of fiscal 2019. I'm pleased to report another quarter of year-on-year pretax earnings growth with an increase of 10.8% compared to the third quarter of last year. This marks our 15th consecutive quarter of pretax income growth, nearly 4 years of quarterly profit improvement taking incredible amount of focus. And I'm proud of the entire Brady team for executing our strategy and consistently delivering on our goals.

We increased organic sales 2.4% this quarter for our eighth straight quarter of organic sales growth. Our sales growth continues to be driven by the Identification Solutions business, particularly in the U.S., where we're growing in most end markets and in almost every major product line.

We continue to focus on innovation and new product development, and we have some exciting new products to introduce this quarter. This, along with great customer service, has led to the growth.

Maintaining our focus on consistent priorities has been the key to delivering improved profits. We're investing in organic business. We're adding selling resources in key product lines. We're increasing new product development, and we are adding new machinery in our facilities. Meanwhile, we continue to drive sustainable efficiency, improvements throughout our operations and SG&A structure while we're focusing on improving underperforming businesses, eliminating distractions, focusing on what we do well and executing this consistent set of priorities has allowed us to deliver improved financial results quarter-after-quarter, year-after-year.

Organic sales were driven by the IDS division with growth of 4%. We continued to increase organic sales in all 3 regions and within all of our major product lines, except for health care, which were improving our returning to growth and where we are seeing improvements.

Organic sales in our WPS business declined 1.6% this quarter. Our European and Australian businesses continue to drive steady, low single-digit organic sales growth, while our North American Workplace Safety business declined approximately 10% this quarter. Last quarter, we mentioned we took actions in January to enhance our digital platform by moving to a new platform. This new platform is working well and has been an improvement, but will take some time to build our customer base back to the level that we experienced prior to the initial digital platform change.

We're improving every single day, and we believe we're on the right track with this business.

We have 3 solid quarters behind us and expect a strong finish to 2019. We have positive momentum in our Identification Solutions business as we continue to launch new products to provide excellent customer service and drive efficiencies every day. We're taking actions to improve those businesses that are not performing as well as our core IDS business. These changes include investing in sales-generating resources and improving our digital and manufacturing capabilities.

We continue to focus on the long term by taking action today that will set us up for success in the future.

I'm pleased with our progress so far this year, and I'm looking forward to closing the year on a positive note.

Now I'll turn the call over to Aaron to discuss our financial results for the third quarter. 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 were $289.7 million in the third quarter, which consisted of organic sales growth of 2.4%, a decrease of 3.8% from foreign currency translation and a decrease of 1.5% from the sale of our Runelandhs business, which was finalized in the fourth quarter of last year. Pretax income increased 10.8% and after-tax earnings increased 33.8% to $34.8 million this quarter. Our tax rate had a significant impact on our after-tax earnings as we had a tax rate of 15.1% this quarter compared to a tax rate of 29.7% in last year's third quarter.

Diluted EPS increased 32.7% to $0.65 this quarter compared to $0.49 in last year's third quarter.

Cash flow from operating activities was also very strong, finishing at $52.7 million this quarter compared to $46.8 million in last year's third quarter.

Turning to Slide #4, you'll find our quarterly sales trends. Organic sales growth was driven by our Identification Solutions business, which continues to perform very well, while foreign currency continues to be a headwind due to the strength of the U.S. dollar versus other major currencies such as the euro.

Slide #5 shows our gross profit margin trending. Our gross profit margin finished at 50.3% this quarter, which was down 30 basis points from last year's third quarter gross profit margin of 50.6%.

We continue to realize cost pressures from both freight and labor in our ID solutions and Workplace Safety businesses. We've been successful in offsetting most of these increased costs through increased volumes and selected price increases in our ID Solutions business and ongoing process improvements in automation throughout our facilities.

We constantly focus on driving efficiency gains across all of our businesses and on targeted price increases where feasible. We believe that these activities will effectively offset the majority of any future input cost increases and enable us to maintain our historically strong gross profit margins.

On Slide #6, you'll find our SG&A expense trending. SG&A was $94.7 million this quarter compared to $101.7 million in last year's third quarter. The decrease was due to a combination of factors, including foreign currency translation, reduced SG&A from the sale of our Runelandhs business and our ongoing efforts to drive efficiencies. As a percent of sales, SG&A expense decreased from 34.1% in the third quarter of last year to 32.7% this quarter.

Slide #7 outlines the trending of our investments in research and development, which decreased from $11.7 million in the third quarter of last year to $11.4 million this year. Year-to-date, R&D expenses are effectively flat when compared to last year. And for the full year, we believe we'll finish with R&D expense approximating the prior year level at a little over $45 million. We remain committed to investing in new product development. However, we haven't been able to fill certain open R&D roles as quickly as we'd originally anticipated, and we're also very much focused on ensuring that our R&D spend is as effective as it can be.

Moving along to Slide #8, you'll find the trending of quarterly pretax income. This quarter, we increased pretax income by 10.8%, finishing at $41 million compared to $37 million in the third quarter of last year. As Michael mentioned, our focus on a consistent set of priorities is producing improved financial results.

Slide #9 shows our after-tax income trends and our quarterly EPS trends. Our diluted EPS increased from $0.49 in last year's third quarter to $0.65 this quarter. As I mentioned, we benefited from a lower-than-normal tax rate this quarter due to the reversal of certain tax reserves related to favorable audit settlements.

Turning to Slide #10, you'll find the details of our quarterly cash generation. We generated $52.7 million of cash flow from operating activities compared to $46.8 million in last year's third quarter, and free cash flow was $47.3 million compared to $40.5 million in the same quarter of last year.

In addition to paying $11.2 million in dividends this quarter, we also invested $5.4 million in capital expenditures as we continually work to increase efficiencies within our factories and invest in equipment that helps us improve our production capabilities.

Moving along to Slide #11. This table outlines the trending of our net cash position and provides a snapshot of our debt structure at the end of the quarter. We increased our net cash position by $37.5 million this quarter and finished in a net cash position of $188.1 million at April 30. Our debt consists of a EUR 45 million-denominated private placement scheduled for repayment in May of next year, and we have no borrowings outstanding on our line of credit. Our approach to capital allocation is consistent. We are disciplined and patient.

First, we use our cash to fund organic sales and efficiency opportunities throughout the economic cycle, which includes funding investments in new product development, sales-generating resources, IT improvements, capability-enhancing capital expenditures and capital expenditures to increase efficiency and automation in our facilities.

And second, we focus on returning cash to our shareholders in the form of dividends. 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 1.9 million shares authorized for 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 the disciplined allocation of capital.

Slide #12 summarizes our updated fiscal 2019 guidance. As a result of our stronger-than-anticipated pretax income and a lower-than-anticipated tax rate this quarter, we are increasing our full year guidance from a range of $2.25 to $2.35 per share to our new diluted EPS guidance range of $2.35 to $2.40 per share. This guidance is based on foreign currency exchange rates as of April 30, which continue to be a headwind due to the strengthening of the U.S. dollar.

We're anticipating a fourth quarter income tax rate projection in the mid-20% range, and we expect organic sales growth to be approximately 3% for the full fiscal year ending July 31, 2019. We're also anticipating R&D expenditures of approximately $45 million, depreciation and amortization expense of approximately $24 million and capital expenditures ranging from $28 million to $30 million. Our capital expenditure guidance is down a bit from our previous guidance due solely to the timing of certain projects.

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

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

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Thank you, Aaron. Slide #13 summarizes the third quarter financial results for our Identification Solutions business. IDS sales increased 0.9%, finishing at $214 million, with organic sales growth of 4%, while foreign currency translation decreased sales by 3.1% this quarter. Organic sales increased in the low single digits in the Americas and Asias and in the mid-single digits in Europe this quarter. We also grew organic sales in the majority of our key product lines, with the strongest growth in Safety and Facility Identification. Our health care identification product line declined slightly this quarter. We've expanded our sales force, and we're growing our pipeline of new products, which will ultimately return this product line to sales and profit growth. I know that we've built a strong team, and I'm confident that we're making the right long-term moves in health care.

We increased organic sales in the mid-single digits in EMEA this quarter. We continue to grow the sales in Safety and Facility ID, Product ID and Wire ID, particularly in Western Europe, where we've also had success in the Middle East in the oil and gas industry. Organic sales also increased in the low single digits in Asia this quarter. Sales growth was led by our business in India.

In general, our growth rates have been slower throughout Asia. And although we realized growth in China at a consistent rate with the last quarter, this growth rate was behind the average of the rest of the region and there does appear to be economic weakness in this country.

Profit in the IDS segment was $39.9 million in the third quarter, which was an increase of 7.9% compared to the third quarter of last year. As a percentage of sales, segment profit improved to 18.6% this quarter compared to 17.4% last quarter.

The IDS business continues to lead Brady's improved financial performance as a result of our dual focus on growing organic sales over the long term and driving efficiencies throughout the organization.

This quarter, we launched a number of new products, including the first-ever Brady Proprietary Safety Padlocks for the lockout tagout market. We believe that this is a superior product to any other products in the market, which will continue to set us apart from our competitors as we now offer the widest breadth of lockout tagout devices as well as a superior locking mechanism. At the same time, this gives us a much stronger control of our supply chain as we become further vertically integrated.

We also launched the S3000 Sign and Label Printer this quarter. This is a compact, highly versatile printer that is capable of printing on a wide variety of materials. Changing materials is simple with a drop-in low design and software that auto calibrates print setting and the Brady Workstation app allows you to easily create signs and labels on your mobile device.

The S3000 is ideal for many different industries and applications, including lockout tagout labeling, cold temperature labeling, facility and safety identification and many more industrial applications. I'm proud of the suite of printers that we've launched over the last 2 years. We've introduced excellent functionality and technology into durable, high-quality printers that help our customers to be both efficient and effective.

Our expectation for IDS for 2019 are consistent with the guidance that we released last quarter, which is for the full year organic sales growth of 4% to 5%.

We'll continue to invest in R&D and sales and marketing resources while efficiency activities in our manufacturing sites and throughout SG&A will provide benefits that will more than offset our organic growth investments.

Slide #14 details our Workplace Safety review. WPS sales declined 12.2%, which consisted of organic sales decline of 1.6%, a decrease from foreign currency of 5.3% and the sale of Runelandhs business in Sweden, which reduced sales by 5.3% compared to the third quarter of last year. This decrease in organic sales was due to the performance of our North American business, which declined approximately 10% this quarter.

During our conference call last quarter, we discussed the change in our digital platform that we made at the end of the quarter ending January 31. We are now seeing consistent improvements in our digital sales as a result of this change. But this effort will still take more time as we work to build sales back to the level we experienced prior to the initial platform change over a year ago.

Our plan to return our WPS Americas business to consistent growth is focused on 3 key areas. First, we're improving the buying experience for our customers so that it's as simple as possible, reach our customers the way they prefer to be reached whether it's online, mobile, catalog, in-person or through a combination of these channels is essential to returning this business to growth, which is exactly why we're focused on having industry-leading websites.

Second, we're increasing our customer interactions, which provides more value than simply fulfilling orders. This allows us to better understand what our customers are dealing with from a safety and identification perspective and helps us to serve those needs by offering our compliance expertise and complete solutions. We'll do this through having a sales force that is focused on solving our customers' challenges by providing unique solutions, provided industry knowledge with regulatory expertise 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 want and need.

By focusing on these areas, we've increased the value we bring to customers, which creates customer loyalty and improves our sales and profitability over the long term. We believe that these actions, along with our focus on reducing our cost structure to better reflect our current revenue levels, will return our North American business to profitable and sustainable organic sales growth.

Our recovery has been and will be continued to be choppy for WPS Americas, but we believe we're on the right track as we enter the fourth quarter in line with our expectations for a recovery of this business.

Our Australian and European WPS businesses, which together make up 2/3 of the total of the WPS division revenue, continue to drive solid financial results.

Our European business was our strongest performer in the WPS division this quarter with low single-digit organic sales growth. The digital marketing team continues to execute their strategy and grow online presence with our sales and through the digital channel increasing sale nearly 15% this quarter through that channel. We continue to identify and execute efficiencies throughout this business while constantly improving our digital capabilities.

Australia grew organic sales in the low single digit this quarter, which marks 2 straight years of quarterly sales improvement. We've expanded into additional target markets in Australia and are winning new customers every day. Although the economy in Australia does not appear to be in a robust growth mode, we're optimistic that we can take additional share, continue to grow and finish the rest of this year strong.

WPS segment profit was $6.1 million compared to $7.5 million in last year's third quarter. The decline in segment profit was due to reduced sales volume in the North American business, the sale of Runelandhs business and foreign currency translation. We expect organic sales in the WPS division to be effectively flat this fiscal year.

I'm pleased with our results in 2019 so far. We're growing organic sales, we're launching innovative new products, we're investing in automation and we continue to identify and execute efficiency opportunities throughout our SG&A structure.

Our IDS business is strong and continues to lead our consistent, improving financial results. WPS Europe and Australia continue to perform well. They're growing their digital presence, and they are delivering efficiencies throughout their businesses. We're also improving our businesses in WPS North America and our health care product line in IDS. The fundamentals are in place, and I believe we're taking the right actions in order to reverse the trend of declining revenues in these businesses. We are reacting quickly to stop what isn't working, tracking resources to what is working and are identifying areas to improve our cost structure every single day. We're on the right track.

Competition for labor continues to be challenging, especially in certain locations where the unemployment rate is at historical lows. This makes our focus on efficiencies and automation and our manufacturing processes crucial to our ability to control input costs over the long term.

I'm a strong believer in reducing complexity in everything that we do. We need to be agile and adaptable. Internal obstacles to making quick, effective decisions are not acceptable. I'm committed to removing barriers so that our local managers are empowered and can think, decide and act on their feet every single day. We've been working on this for several years, and the results are real. We're growing sales, we're improving profits and the team is motivated and determined to deliver what they've promised.

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) And our first question is from George Staphos from Bank of America.

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

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This is actually Molly Baum sitting in for George. I had a -- the first question I had was on IDS. Obviously, organic growth has remained very strong in the segment despite kind of what we've been seeing. Some other packaging companies, but a bit -- maybe some industrial end markets getting hit by a macro slowdown. So can you kind of help us reconcile that with Brady's continued strong growth in IDS? Are the markets just continuing to grow at these low- to mid-single digits? Or is Brady taking share? Is it primarily the new product launches? Just any additional detail you can provide there would be helpful.

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

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Good morning, Molly. Glad to have you on the call this morning. You actually hit it on the head at the end. We've looked at a business that had actually -- before about 5 years ago been declining. And we've literally turned that around from decline to low growth to GDP-type growth to better than GDP/industrial growth. And fundamentally, we believe that's been affected by a couple of key areas. We have become much better at touching our end customers, interacting with our end customers and solving their particular unique problem. That joined with all the new developments that we've been bringing out, we are starting to see that. As you can tell and I think you pointed out, having a real impact and we believe it'll be having a stronger impact over the long run. As you know, industrial changeovers take longer than other industries. And so we actually build momentum with our new products over time in a way that is really sustainable. So we're seeing that. But now put those 2 together, also some of our R&D effort and our customer effort is going into making sure that the products we're creating fit unique requirements of each and every customer that we have. And that is a powerful tool for us. And we believe, to your point, that that's been a key driver. And will continue to be a key driver of IDS' successes.

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

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Great. The second question I had is on WPS and just on the digital business. How much of the digital business in North America has transitioned over to this new platform versus how much you still have left to do over the coming quarters? And then for those that have already made a shift, what have you seen in terms of kind of the effectiveness of this new platform and kind of your expectations there going forward?

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

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So, Molly, in WPS digital in the Americas, we've seen a couple of things. First of all, all the business has transferred to the new platform. But what you typically see when you transfer to a new platform like that is actually an initial dip and then an improvement in sales. And the goal, of course, obviously, is to go beyond your original levels. A couple of unique things here that we were very pleased with. When we transferred platforms, we did not see a dip at all. In fact, literally, the very first day, our revenue went up. That's a tremendously positive sign and one, honestly, that we do not typically see with a platform transfer. And we have since then been seeing slow, but steady sales improvement in our digital platform. Now it takes a while for you to reconnect all of those interfaces with some of the search engines. And that is happening and will continue to happen. So our expectation is to see continued improvement on that platform as we go forward into the future.

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

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So in terms of the decline of 10% in North America, sorry, after this I'll turn it over, but can you kind of highlight what was -- what the primary drivers were behind that decline?

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

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We fundamentally believe the primary drivers do interrelate with our digital presence overall and the historic issues that we had with those -- we're comparing year-over-year, Molly. We're not comparing just a couple of months ago to today. So we believe unequivocally. Now that said, it is harder to bifurcate where all your revenue comes from these days. So we have catalogs, we direct sales, we have phone sales, outside sales and digital. And many of our customers may start -- I personally often start on the web. And I may being a little more old school, once I know what I want, convert to a direct phone conversation with whatever company I'm dealing with. So we do see a cross-pollinization of all our businesses, which means that the issues that we had with our digital platform, we absolutely know impacted all areas that we do business, the catalog, the phone sales, et cetera. The problem with that is, we're not able to 100% define the exact levels of that impact. But yes, that's what we are confident the cause is.

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Operator [8]

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Our next question is from Joe Mondillo from Sidoti.

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

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So I wanted to ask you quickly I'm not sure if the answer could be really quick, but about tariffs and specifically their most recent ones that were implemented both here and overseas, wondering what, if any, effects that your business would see.

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

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So we obviously have a lot of dynamic factors in our business. The good news about Brady is that we often sell in country for country. So in the case of China, the vast majority of our revenue that is produced in China, with the exception of 1 key -- 1 product line, is actually China for China. And so the tariffs don't have as large of an impact in our business as you would see in most business models of multinational companies. So that is good news for us. But the dynamics of tariffs, Brexit, everything else clearly does have an overall impact on us. But we fundamentally believe we're in a better position than the vast majority of companies. And that even with specific callouts to certain companies in China, that it won't be an effective hit to us that would be detrimental beyond what we can handle.

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

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Okay. And then the -- at the IDS segments, the incremental margins, taking out the effect of currency, looks like it was a little softer than it has been in the last few quarters. And your revenue was up -- your organic revenue was up pretty well obviously. So I'm just wondering, was that a product mix thing? Or what was sort of going on there? And then looking out to sort of, say, fiscal '20 or sort of your normalized or what you expect in the medium term, what do you anticipate sort of incremental margins at that segment?

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

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So, Joe, we actually look at it and as we look at the layers of it, we don't see a fundamental shift in margin. Any shift we see is directly attributable to mix. And that mix is not necessarily indicative of a real change in buying patterns. We do, as you know, see shifts in mix month-to-month, quarter-to-quarter. So we expect to have a consistent margin going forward. As we've said in past calls, we believe we've done a very effective job of improving our margins back to the levels we believe they should be. And we also believe we're able to still see good direction to consistently be able to address pricing pressures and cost pressures in any of the marketplaces that we have to continue to maintain solid margins.

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

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I guess just to follow up on that. I guess what I'm sort of curious or wondering about is the -- and granted the margin expansion was very good this quarter, I'm probably nitpicking. But the year-over-year margin expansion relative to the growth you're seeing compared to the last couple quarters, it has -- sort of that year-over-year margin has slowed a bit, and I was just wondering is that -- was that sort of a one-off quarter? Or was the last couple quarters just really not -- I mean, it was so good that it was just really not that sustainable and more -- maybe at more of a normalized sort of year-over-year expansion in terms of the incremental margins? That's what I was sort of getting at.

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Aaron James Pearce, Brady Corporation - CFO & Treasurer [14]

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Well, Joe, this is Aaron. I can add a bit of commentary, if you will. So we actually feel really good. Actually, we feel really good about our ID Solutions' financial results this quarter. To put it in perspective, our top line increased $1.8 million and our bottom line increased actually more than $1 million and more than that. So $2.9 million on the bottom line. So overall, we feel really good about the performance. That business continues to drive efficiency gains, effectively offset the cost pressures that I mentioned in the prepared comments from a labor perspective. Actually, that's the biggest cost, but also freight and some others. So overall, the business continues to perform well. They continue to drive efficiencies. We typically don't go back and compare quarter on quarter on quarter, if you will. We just keep -- we keep lowering the water, seeing more opportunities and driving efficiency gains throughout the organization. And we think we'll continue to do that as we look forward.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [15]

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Okay good. So the last thing, just actually 2 quick things. The R&D, you ramped that R&D budget up quite a bit last year, and we're obviously seeing the positive effects from that this year. But as a percent of sales, it's sort of leveled out. So you -- do you think sort of at this 3.9%, 4% sort of range as a percent of sales that, that is sort of where you want it to be? Or is it sort of a period-by-period basis? And when you see the opportunities maybe that changes? And then last question would be what you anticipate sort of the tax rate will be sort of normal in fiscal '20? I know you commented on the fourth quarter. Is that fourth quarter sort of a normal going forward or just the fourth quarter?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [16]

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Joe, I'll answer the first half of the question. And we are very bullish on our IDS business and in particular on our R&D efforts. We saw an opportunity a few years ago to really relook at how we developed our products, what products we developed, the teams that were involved and we clearly have increased substantially over the last 2 years our R&D efforts. We are going to continue to look at that to continue to opportunistically go after products. And if we see a particularly R&D intensive opportunity that we believe fundamentally will make a great difference for Brady, we will not hesitate to put our money into that. And we'll be very clear in calling out the fact that we're specifically doing it if we see a substantial difference. But overall, we're looking at all of our product lines. The great news is that we have road maps, we have product pipelines, we have teams that are really functioning extremely well and, by the way, much more efficiently than we had in the past. And efficiently is the key. So although we continue to improve the number of products and the quality of products we're turning out, the cost is not proportional to those products coming out and the higher differentiation that those products have. So I would say that we expect to continue to improve our R&D in a reasonable relationship to our growth improvement, but we certainly aren't going to be increasing at the same rate that we had in the past because we're getting great benefits over efficiencies and effectiveness, and we really have staffed up and created teams that are highly driven and getting to the point of what we need to do. That caveat is, we are always open and looking for opportunities that could be differentiating where we can drive teams that we need to increase to do that and we'll be happy to do that incidentally. The great news about where we're at financially is we're not in a position to avoid those types of opportunities. We're in a position to take advantage of them. Aaron, you want to talk about taxes?

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

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Sure, of course. Well, to specifically answer your question, we definitely expect our long-term tax rate to decline from, I'll say, the pre-U.S. tax reform rate to the new rate, if you will, as a result of that guidance. Previously, our rate was in, call it, 27% to 29% range. And we're now down in a newer range, which is several hundred basis points below that. We anticipate a tax rate in the mid-20% range in Q4. There's clearly volatility in our tax rate when things like the audit settlements that we experience this quarter comes up. So there's clearly some volatility. But as we look into 2020, well, 2 things. One, we're still in the process of pulling together what we would anticipate our tax rate to be for next year. But I would say this, I would absolutely expect a rate below what we had been seeing in the 27% to 29% range as the old rate, if you will, and get more into the range of the mid-20% range.

But again, I want to be a little careful because it is absolutely a work in process at the moment. And I can tell you this, there's not a day that goes by that we aren't focused on driving our cash tax rate down. So you combine that constant focus with what appears to be never-ending guidance coming out from the U.S. treasury on the implementation of the U.S. tax reform. It becomes a bit volatile. But we'll give you much more detail come September when we come out with our F '20 guidance.

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Operator [18]

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Our next question is from Allison Poliniak from Wells Fargo.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [19]

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Can we just go back to the R&D? I think, Aaron, you talked about not getting enough people or the right people in place and the sort of flattened out the R&D expense. Where are you in those hires? Are they done? And just sort of -- how should we think about the opportunity cost of not having that incremental investment if there is anything as we move in the out years?

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

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I'll actually answer that one, Allison. We are -- in certain of our geographies, I believe the current rate, although like it could change by the day, is 2.8% unemployment in Wisconsin, which is our largest R&D center. That is literally the lowest recorded rate ever. Now we haven't been recording unemployment forever, but I believe we've been recording it since '73 maybe somewhat early, a long, long time. So these rates are incredibly low. That said, we are a very strong R&D company. We've got a great culture. We're able to attract and retain tremendous talent within our organization. We give people good things to work on and good opportunities. But when you're down at that level, it is a longer process and certainly a more dynamic and interactive process than you historically have had to have to bring in the best talent. We're not going to settle. We will not bring in people that we don't believe will be strong contributors. But even more importantly, we really love working at Brady and being part of Brady. I tell new employees here. After 2 years, I want them to be able to truly say to me, "It's the best place I've ever worked. It's the best job I've ever had. It's the best team I've ever worked with." And if we can have talents and employees who can say that, then we are going to continue to win. So yes, it is taking us longer. There was a case just yesterday where I thought we're going to end up hiring some people. You just looked at the team and the team support wasn't holistic and wasn't strong. And my answer back was, we need to bring on people that you really, really love. So it is challenging, but we're actually, every day, finding great people who really come here and figure out this is where they want their career to be, whether it's the beginning of their career, mid-career or late career, they're finding this a great place. But one other analogy that I love is I always tell people, you never love that outfit as well as you did when you first saw it in the store, right? That jacket, that coat, whatever it is. And on both sides of this relationship I strongly encourage the candidates coming in, I want you to really look hard at us. This is a mutual decision, and you need to really believe this is going to be a great place and so do we. And so that approach, some would say, in a very tight labor market might be difficult, but we believe in the long game. And that's how we're approaching it. So hopefully that answers your question, Allison.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [21]

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No, that's fair. And then I want to talk WPS on a broader level. In the past, that 5, 7 years, the revenue and profit contribution from that business has obviously substantially declined. What piece of that is structural for you? And can you talk -- you guys kind of sort of centering where you're focusing on in that business, I guess, particularly in North American which is -- where some of the challenges have been? And the digital platform is certainly helping, but is there other something you're thinking about in order to right size that shift there?

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

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Yes. I think a couple of things. One, you have focus on the correct statement. Our European business as an example and Australia which is 2/3 of our business in combination, actually has been doing well, Europe for a long time for years, Australia for 2 solid years. So we truly look at that, look at the organization created, look at the skill sets we have, look at the type of bifurcation and differentiation we're providing those markets and we're very confident that at least, at this time, because the world does change, and you need to keep on top of it, we're continuing to do the right things there. Now as you said, you flip to North America and you say "Wow, that's a very different story." And I would say, "Yes, wow, that's a very different story." Different market. We made some very fundamental mistakes. We had some technology issues that right when we're seeing a recovery flipped us backwards. So knowing that we were actually seeing a pretty strong recovery, knowing we've made those significant changes and they seem to be -- when I say seem to be because I'm a believer if you cannot show a line from just a few points, you need to show a line from a lot of data points, but they seem to be absolutely working. I'm confident that we're on track to finish the year in that group in a better position than we were 3, 6 months ago. Are we done working? Absolutely not, Allison. We are in it. We're involved in it. But let me give you a specific example of why I feel very good. If you go to our long-term manufacturing center in Buffalo, New York, great people, great town, really the type of town that you -- that I love. FYI, I did grow up in Rochester, New York next door, so I'm a little prejudiced, upstate. But if you walked into that factory now versus literally a year ago, you wouldn't recognize how our manufacturing footprint is aligned, the technology, the equipment, the way we handle our warehousing and distribution. It is fundamentally and radically improved. I can talk to you about the front end, et cetera. So we are making major steps forward that aren't initially apparent on the outside. But we believe our fundamental to us being a much more cost effective, efficient and quick organization throughout that North American structure in addition to the front end stuff that we're doing with our sales people, our customer service people, our website people, our catalogs, et cetera. So a lot of what we're doing that we believe will have a fundamentally positive impact on both our ability to have market-based sales prices, and excellent profit isn't even easily seen on the outside.

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Operator [23]

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Our next question is from Keith Housum from Northcoast Research.

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Keith Michael Housum, Northcoast Research Partners, LLC - MD & Equity Research Analyst [24]

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Michael, as you think about the pressure that the labor costs are having, is the pressure equal across the entire -- I guess, your entire geography? And then assuming it goes over for a long term, so I know it could potentially be a short-term issue, is there the ability to move products around where you are susceptible to some of the pressure that you're seeing?

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

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Okay. I'll start with the pressure, and then I'll talk with our general ability because there's lots of reasons we move products around. Let me start with the pressure. There's no question that we have hotspots. If you do some finite element analysis, you can see exactly where the load is really putting the most stress. And we definitely have hotspots or pain points of labor. Places like Louisville, Kentucky, very, very challenging. Milwaukee, Wisconsin, although we have such a great reputation here that does help us tremendously. Other locations are a little easier, but throughout U.S., labor is not as a fungible, a movable resource as it used to be when I was younger. But you still have wage transparency. And so we see a general pressure across the country. That said, as you go into other economies we do, we have a tremendous precedence in Asia, Australia and Europe. They have their own idiosyncrasies of labor. In some cases, some of our countries' movement of labor is very, very limited. If you come from a village, you have no intention of ever leaving that village. And so that provides a different type of pressure. Because if that particular village has a very strong economy at the moment, it is harder to pull in people from outside of that. Whereas if that particular village for some reason is not as strong, we have an easier setting. So I'd say, we don't -- in fact, we do not look at it as a globally even or a country issue, but we actually look at labor pressure country-by-country, region-by-region. And we do that multiple times a year to make sure that we're understanding what are the wage pressures in Turkey. Earlier in the year, they were tremendous, right? So we need to pay attention to those type of things. So, Keith, I would say that.

Now the other half is, how we're able to move products? The great news about Brady is that because we do have manufacturing and course of excellence around the world and because we are small-volume, high-mix manufacturer, we do have the ability and have moved products as needed. And as we look at different tariffs and we look at different -- other pressure issues, we look at the long term, I want to be quite clear about that. I always tell people, we do not locate facilities for tax reasons ever. We take full advantage of the taxes and the locale, but we make sure all of our decisions are long term based on business. So short-term wage pressures, short-term tariff issues, those are not the type of things that we flinch over, but we do regularly and have been regularly over the last 2 years, moving products to more logical locations. Probably the biggest reason we move -- in fact, I won't say probably, the biggest we've been moving is our ability to turn around products in a faster manner. I want to be able to get our products out that day or next day worst case in most cases. If I can't do that because of whatever barriers or logistics, we look for ways to do that without giving up our cost position.

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

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Okay. Great. And as a follow-up, health care is expected to turn the corner this year. And I know where you guys are heading in that direction. But can you drill down a little bit more and talk about some of the R&D that you guys have launched plus new products? And are you guys still expecting to turn the corner here relatively shortly in health care and what that trajectory will be?

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

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Yes. Just very frankly, we probably, in the past, had too much of our R&D effort focused on big bangs. And you need a good mix to that. And so as you struggle with some of the big bangs because you do, some come out great and some don't. It's a statistics game. We've really looked at that and said we have to be putting in more money into across-the-board applications, less into acute care possibly, more into the fact that the world is turning into a different business. But let's talk about this also. It's not the same all over the world. And I'm not going to quote the exact days because I will get it wrong. But in the U.S., it appears and I'll say appears because I'm not going to give you an exact time, they want you out of the acute care in hours, maybe minutes. If I go to Japan, and please don't quote me, I believe the new number is around 19 days in a hospital on average. A very different philosophy in medicine, medical care, et cetera. So as we go around the world and if you look at the U.K., you know the pressures that they're under are quite different additionally. As you go around the world, it is not a one-size-fits-all application and situation. So I'll give you an example. If I have a wristband that I'm developing for North America, that wristband, I believe, is designed for the typical, say, true stay of 3 to 4 days on average. That wristband is not appropriate in Japan where they're in there for weeks, not days. And so we are bringing out more products in that group, but we're also bringing out more bifurcated products and we're bringing out a better road map of, what I'll call, A, Bs and Cs, home runs, solid opportunities and gap fillers. So hopefully that helps, Keith.

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

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Yes. Any new product launches over the past few months that you can talk about that we can look as perhaps an opportunity for the next several years?

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J. Michael Nauman, Brady Corporation - President, CEO & Director [29]

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We disclosed the ones that we disclosed in the announcements. Obviously, we have our reasons for sometimes not disclosing products for competitive reasons. I would state, that's the case here. We don't, at this time, want to disclose products so that to give us a better differential advantage as we launch them.

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Operator [30]

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At this time, I am showing no further questions. I would like to turn the call back over to Michael Nauman, CEO, for closing remarks.

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

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Thank you so much. I'd like to leave you with a few concluding comments this morning. I'm proud of what we've achieved so far this year. We're growing sales organically. We increased pretax earnings by 10.8%, which represents our 15th consecutive quarter of year-over-year pretax earnings growth. We remain committed to research and development, and we continue to launch innovative new products. We're increasing our investment in new equipment and automation in our facilities, and we're focused on driving sustainable efficiencies throughout our SG&A cost structure. We're working to improve our WPS North America business and our health care ID product line I believe in the direction we're taking these businesses, and I'm confident in our ability to turn them around. We've done well, but I know we have more to deliver to our shareholders, our customers and our employees. We have a motivated, highly engaged team at Brady, and we're committed to making the right decision today to drive improved long-term financial results. And as always, if you have questions, please contact us.

Thank you all for participating today, and have a great day. Operator, would you please disconnect the call?

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Operator [32]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.