Good day, ladies and gentlemen and welcome to the Brady Corporation Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ann Thornton, Chief Accounting Officer. Ma’am, you may begin.

Thank you. Good morning and welcome to the Brady Corporation fiscal 2018 third quarter earnings conference call. The slides for this morning's call are located on our website at www.bradycorp.com/investors. We will begin our prepared remarks on slide number 3. Please note that during this call, we may make comments about forward-looking information. Words such as expect, will, may, believe, forecast, and anticipate are just a few examples of words identifying a forward-looking statement. It's important to note that forward-looking information is subject to various risk factors and uncertainties, which could significantly impact expected results. Risk Factors were noted in our news release this morning and in Brady's fiscal 2017 Form 10-K, which was filed with the SEC in September of last year. Also, please note that this teleconference is copyrighted by Brady Corporation and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the Internet. As such, your participation in the Q&A session will constitute your consent to being recorded. I’ll now turn the call over to Brady's President and Chief Executive Officer, Michael Nauman.

Thank you, Ann. Good morning and thank you all for joining us. We released our fiscal 2018 third quarter financial results this morning and I'm proud to report our 11th consecutive quarter of improved year-on-year profitability. Our pretax earnings increased by 20.7% compared to the third quarter of last year. Total sales growth was 8.2% this quarter, which made up of 3.2% organic growth and an increase of 5% from foreign currency translation. This marks our fourth consecutive quarter of organic sales growth, which is a direct result of the focus and dedication of the entire team on the development of innovative new products and executing our strategy every day. We focus on the same set of priorities which are to develop innovative, high quality products, provide excellent customer service, to drive improvements throughout our facilities and to identify and execute on efficiencies throughout our SG&A structure. Maintaining our focus on these consistent priorities is the key to our organic sales growth and our pretax earnings improvement. We now have momentum and we're using this momentum to move the organization forward. Our investment in research and development increased by more than 17% this quarter and our talented engineers are building our pipeline with innovative new products. We’re observing and listening to our customers to understand their problems and then -- turning them into our problems to solve. For instance, as the direct result of these customer observations, this quarter, we launched the QuickSleeve handheld sleeve applicator, which is a multi-tool designed to make label applications to wires easier and more efficient. The focus on innovation is spreading throughout the organization and we have some exciting new product in the pipeline. Our identification solutions business grew in all three regions. Our healthcare product line is still challenging, but I know that…

Thank you Michael and good morning everyone. The financial review starts on slide number 3. Sales increased 8.2% to 298.4 million in the third quarter, which consisted of organic sales growth of 3.2% and an increase of 5% from foreign currency translation. We once again increased our investments in research and development this quarter. R&D expense was 11.7 million, which was an increase of 17.4% over last year's third quarter. Our trend of improving profitability continued this quarter as well with pretax earnings increasing 20.7% to 37 million compared to 30.6 million in last year's third quarter. This profit improvement was driven by organic sales and profit growth in both our IDS and WPS businesses as well as our consistent focus on driving sustainable efficiency gains throughout our SG&A structure. Our tax rate was a bit higher than last year and net earnings finished at 26 million this quarter compared to 22.6 million in the third quarter of last year. Diluted EPS increased 14%, finishing at $0.49 compared to $0.43 in last year's third quarter. This increase is a direct result of the organic sales growth and our ongoing efforts to identify and take action on efficiency opportunities throughout the globe. Our cash generation was very strong, with cash flow from operating activities of 46.8 million this quarter compared to 37.8 million in last year's third quarter and free cash flow was 40.5 million compared to 34.2 million in last year's third quarter. Moving along to slide number 4, you'll find our quarterly sales trends. Total sales growth was 8.2% and organic sales increased 3.2% compared to the third quarter of last year. This quarter marks our fourth consecutive quarter of total company organic sales growth. We're building on our positive momentum with both segments of the business now growing…

Thank you, Aaron. Slide number 13 summarizes identification solutions’ third quarter financial results. IDS sales increased by 7.8%, finishing at 212.2 million with organic sales improving 3.7% and foreign currency translation increasing sales by another 4.1%. Organic sales growth was led by Europe and Asia, with both regions posting growth in the mid single digits, while organic sales increased in the low single digits in the Americas in the quarter. In the Americas, organic sales growth was the strongest in our wire ID and product ID product lines. We're building on our momentum in improving both sales and profit within most of our primary product lines in the Americas. Mid single digit sales growth with our US industrial customers was partially offset by a low single digit decline in organic sales in our healthcare product line. Through this end, we're continuing to invest in high quality proprietary products that our customers want and need. This quarter, we launched the TimeAlert IV time indicating reminder label. This label includes a visual time indicator that is easily activated with a push of a button. It uses color changing technology to indicate when IV tubing must be changed, which helps healthcare providers comply with CDC requirements and reduces the risk of bloodstream infections. With this product, we've added an element of technology to an otherwise simple label to reach the risk of human error and monitoring and handling IV tubing. This is an example of the type of innovation that we're incorporating into our healthcare product line. It will take time for us to fill our pipeline and return to strong organic growth, but I'm confident we’re moving in the right direction. Sales growth in Asia was driven by China and India where we realized increases in both new customer wins and with…

[Operator Instructions] Our first question comes from George Staphos with Bank of America Merrill Lynch.

Mike, first question for you. You mentioned the new IV bag tubing and that sounds like an interesting idea. What other investments do you expect we'll see that you can obviously comment on in this kind of forum and what kind of, you know, I don't know what the right phrasing would be, but payback or time to see incrementally better performance in healthcare should we expect from those investments? And I had a couple of quick follow-ons.

As far as investments, we're investing in core products to our technology space across the board. So printer capabilities that will directly enhance all of our other product platforms and throughout our different product lines, I think the key differentiation is that today, you can look at every one of our major product lines and see that not only do we have a solid pipeline, but we will be introducing product in a standardized cadence in the next few quarters. Now, how long does that take to really change the marketplace? Depending on the product set, it can be six months to 2.5 to 3 years, depending on the ramp up of the products. So it is a very product and market segment and customer dependent, but overall, it will give us a good strong cadence of growth as we move forward in the future years.

Mike, if you wanted to add a little bit of additional color to the extent possible, relative to healthcare, kind of the same question. Where are you investing? Again, you mentioned that new tubing and how long do you think it would take to see improved performance, I'm guessing, that would be more towards the larger end, if you will, of the spectrum, 2.5 years in terms of payback, but your thoughts?

Yeah. It does take a little longer in the medical space for adoption. One of the real reasons is understandably in medical applications, the risk for them is higher, so they're more careful about introducing the products. But you can assume that our product sets are looking at making it easier and more reliable for our customers to properly take care of their patient sets. So any time we take a look at a product, we want to make sure that we're adding to the reliability, reducing their cost profile and improving their performance profile.

One last one, I’ll turn it over. I mean, you gave us your guidance factors, but are there any particular issues or things we should focus on from where we sit that would indicate whether you'd be at the lower end or higher end of your range, implicit for the fourth quarter. And then what effect do you think you're getting right now in terms of the benefit from what's -- positive currency translation with the dollar more recently strengthening, does that add any headwind?

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

And the second part of your question, as it relates to FX, so our top line was up 5% as a result of foreign currency. This quarter, our bottom line of course was up 20.7, pretax was up 20.7% in total. As we look at how that 5% flows to the bottom line within the organization, I’ll say it has a very minimal effect on the percentages of margins, et cetera, but it does have a slightly larger impact ultimately on the bottom line, slightly larger than the 5%, but it's not massive. And as we look into the fourth quarter by the way, related to foreign currency, clearly, we've had some benefits of the weakening US dollar. However, the last – basically the last several weeks, that trend has reversed a bit, but as we look at our fourth quarter, we still do anticipate some benefit from foreign currency, just not at the same level that we saw in Q3.

Our next question comes from Charley Brady with SunTrust.

Just wondered about your comments on the WPS organic growth, which you described, it's going to be choppy going forward. Can you just expand on that as to, what's really kind of driving that? Where are areas that might not be as consistent?

Sure. I think Charley, any time that you're having a business in a recovery mode and you’ve seen it in all of our different businesses at Brady [indiscernible] from about 3.5 years ago to today, that as you turn that corner, you are working to get momentum and the result is, you sometimes can have a little movement backwards as you move consistently forward. So that is how we articulate the choppiness effectively. We're doing very well in selling complete solutions to our customers, really becoming a strong expert for them in their safety and identification need sets in WPS in North America in particular and we're overcoming the changing dynamics of the more commoditized segments of that market and that is why you're seeing a little choppiness, but you saw that as we pulled IDS out of a negative revenue model and profit model and you'll see that as we – we saw that as we moved the other segment to WPS forward, and now is we’re moving North America forward. It's just been, as you know from past conversations, our most challenging segment.

And just on IDS, Q4, you’ve got probably the – you do have the toughest comp in the year, Q4 organic last year was I think over 4%. Are you still expecting positive organic growth in this Q4?

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

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

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

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

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

Joe, it’s interesting. This is a passionate topic of mine and not for cost savings, but cost savings are going to be a direct benefit of it. The reality of our marketplace is quite different from what we might have seen a few decades ago, where people were trying to push labor overseas, push to low cost countries, to push labor out of every process for the strict purpose of profit. The world is changing and around the globe, with a couple of exceptions, the workforce is aging out and that's particularly true in our stronger markets of North America and Europe. And as that workforce ages out, we must focus on automation and actually have been for the last two plus years, because if we hadn't been, quite frankly, we would be in a position today for the large number of employees that we are seeing move on to the next phase of their life by their own desire. At this point, we already have a workforce that is approximately 50% composed of millennials, but those numbers will continue to shift as the Baby Boomers head out. And yes, as a result, I do expect to see continued and stronger drive into automation and making our processes much less dependent on skillsets that we just can't replicate.

And then WPS segment, the last I think four years, we’ve seen the operating margin at that segment sort of coming at the low of the year within the third quarter, however, this year, you're pretty much at least equating to close to the heart of the year, even though the fourth quarter is probably going to be the high as it usually is. Just wondering if you can comment on why -- what drove the third quarter strength within margin? Do we -- should we continue to anticipate a seasonal low within that margin in the third quarter? And, is that sort of product mix driven? If you could talk about the product mix?

We'll start with the word momentum. In that space, momentum and growth are key elements in our ability to really improve our margins and our ability to drive money to the bottom line. We're becoming much better and that's why you're seeing growth at addressing customer specific needs and adding significant value to them. And when you can do that and we're doing that in a way that’s unique to your competitors, we are able to drive better revenue, but better profitability in the end. And so yes, we're proud that our results show a break from our historic path, but that break is consistent with what we're doing and why we're doing it.

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

We've made a significant number of changes and we are continuing to move our structure. At the end of the day, we cannot reduce our cost structure through just cutting and we have to think differently about how we administer our business and run our business. We are looking at several ways in which in some of our particular functions that I, at this point, don't want to clarify publicly to relook at the approach to handling that business. So we would expect a continued drive to move our SG&A down.

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

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

Our next question comes from Keith Housum with Northcoast Research.

I missed in your script a little bit. Can you provide a little more color on the segment that in WPS, you guys disposed off in Sweden? I guess this is – specifically, how much of revenue do that contribute and how should we think about that going forward in terms of any approaches you may have gotten.

I think that as you're looking at that, we're talking about the segment, Runelandhs and about a year and a half ago, we were looking at our strategy for the WPS segment and we really felt that the businesses that they were in and actually even smaller business that was insignificant to our financials called Welco really didn't marry with the rest of our product portfolio. It's a great business, well run in a good country, so we felt that the benefit could be derived more appropriately from a company that was more tightly tied in to that segment and so as far as the factory and the office, the furniture and equipment segment, we no longer do that as an independent. Now, we certainly have catalogs in few of those products, but we don't have an independent focus and that was while we got out of it.

And how big was that segment?

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

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

Historically, our third quarter absolutely is our strongest gross profit margin quarter. I mean, there are a couple of business mix issues that tend to drive that. And it's mostly within our workplace safety business where we have a couple of businesses that have some very nice profit -- very nice gross margins.

And then final question from me, Michael, you guys have made this conscious effort to focus on R&D over the past several years and clearly the increase of roughly 15% in spending this year. As we look out in to ‘19 and ‘20, should we expect the R&D investment, or do you foresee a poor netback?

We have fundamentally moved into a model where we are developing more innovative products and so I do expect that to continue and we also are moving into a model where we control more of our own destiny for innovation. So as a result of that, I also expect it to continue to improve. We're looking at investment, not just for a primary product, but we're seeing as we add the technology cores to our business, our people are becoming much more creative about secondary products, which was a key element in wanting to control that moving forward.

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

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

Very fair.

Okay. Thank you. And then secondly, as you enumerated the capital allocation priorities, obviously, internal investment between innovation and productivity, that has remained at the top of the list. When you’ve looked back at investments over the last say three, four years and done a post-mortem, where are you getting your highest return? Are you getting it from the organic growth investments? Are you getting it more from productivity and how might those paybacks have changed in the last couple of years and therefore from your investment practice going forward.

There are a couple of factors there. First of all, in the short term, absolutely, our productivity improvements have given us the highest return and we see a good path to continue that. However, in the longer term, we're seeing that the innovation development is really starting to pay off and I’d like to say, we do definitely monitor this for successful completion of products. And if you take a look at three or four years ago, versus today, we have a substantially higher, although, I'm not going to clarify exactly how much higher, but it is substantially higher success rate in introduction of our products in the marketplace versus the initial development. So, we’re, as a result, even more enthusiastic about the long term ability of our R&D to provide substantial improvements.

Mike, last question and maybe a little bit from left field, are there any products within your suite of businesses that might be accelerated or enhanced by blockchain technology or for that matter, is there anything in the world that you produce, perhaps inhibited by the advent of blockchain? I mean, our view is that it's ultimately an accelerator smart label technology, probably more of a consumer bent there and obviously that's not initially your world, but any thoughts there -- is it really not a relevant topic for you at this juncture?

Well, personally, I am a big fan of blockchain technology and I want to make sure that is differentiated from crypto currency. So they are very different, although they seem to often get married together because of the need for blockchain. I definitely see it as a path in the longer term, but in the shorter term, it is more of a consumer play, which is not our space. That said, that capability and that capacity incorporated into security measures, labels, et cetera is an exciting avenue.

Thank you. And I’m showing no further questions at this time. I would like to turn the call back over to Michael Nauman for closing remarks.

Thank you. I'd like to leave you with a few concluding comments this morning. We’re growing sales, profit and cash generation. We’re making sustainable improvements to our SG&A structure and increasing automation in our factories, all while increasing our investment in R&D and sales generating resources, which will drive future sales growth. Brady was founded as a highly innovative company and we're committed to delivering on our investment in R&D with exciting new products in the upcoming quarters. Calling our pipeline of new products is essential to our long term success and we're focused on doing just that. We know what we need to do to improve our business and we're committed to our strategy. We’ve cleared the way for local ownership and accountability and we're creating a winning culture with the team that is highly motivated to achieve our goals and deliver strong financial results for our shareholders for years to come. I'm proud of what we've accomplished and I'm excited for our future, because I know that we can continue to deliver more than the organization to our customers, our employees and our shareholders. As always, if you have any questions, please contact us. Thank you all for participating today and have a great day. Operator, you may disconnect the call.