Good day, ladies and gentlemen, and welcome to the Q3 2019 Brady Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. [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.

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 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 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.

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 fifteenth consecutive quarter of pretax income growth. Nearly four years of quarterly profit improvement takes an incredible amount of focus and I am 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 are growing in most end-markets and in almost every major product lines. We continue to focus on innovation, 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 are investing in organic business. We are adding selling resources in key product lines. We are 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 by refocusing on improving underperforming businesses, eliminating distractions while continuing 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 three regions and within all of our major product lines except for healthcare, which we are improving and returning to growth…

Thank you, Michael, and good morning, everyone. The financial review starts on Slide number 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 $0.55 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 number 4, you will 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 number 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 selective 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…

Thank you, Aaron. Slide number 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 Asia 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 healthcare identification product line declined slightly this quarter. We expanded our sales force and we are growing our pipeline of new products which will ultimately return this product line to sales and profit growth. I know that we have built a strong team and I am confident that we are making the right long-term moves in healthcare. We increased organic sales in mid-single-digits in EMEA this quarter. We continue to grow the sales in safety and facility ID, products ID and wire ID particularly in Western Europe where we’ve also had success in the Middle East in the oil and gas industries. 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 it does appear to be economic weakness in this country. Profit in the 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…

[Operator Instructions] And our first question is from George Staphos from Bank of America. Your line is now open.

Hi, guys. This is actually Molly Baum sitting in 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 from other packaging companies 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. Thank you.

Good morning. Glad to have you on the call this morning.

Good morning.

You actually, hitting on the head at the end, we’ve looked at a business that had actually before about five 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 in-customers, interacting with our in-customers and solving their particular unique problems. That joined with all the new developments that we’ve been bringing out, we are starting to see that. As you can tell what I think you pointed out having a real impact and we believe that’ll be having a stronger impact over the long run. As you know, Industrial’s changeovers takes longer than other industries. And so, we actually build momentum with our new products over time in a way that it’s really sustainable. So we are seeing that. But now put those two together, also some of our R&D effort and our customer effort is going into making sure that the products we are creating fit the 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’s success.

Great, and thank you for that. A quick – 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 the shift, I mean, what have you seen in terms of kind of the effectiveness of this new platform and kind of your expectations are going forward? Thank you.

So, in WPS digital in the Americas, we’ve seen a couple of things. First of all, all the business is 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 the original levels. A couple unique things here is 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 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.

So, in terms of the decline of 10% in North America, sorry, I have the turn it over, but that can you kind of highlight what was – what the primary drivers were behind that decline? Thanks.

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 are not comparing just a couple of months ago to today. So we believe unequivocally. Now that said, it is harder to bifurcate where are your revenue comes from these days. So we have catalog. We have direct sales. We have phone sales. Outside sales in digital and many of our customers may start, I personally often started on the web and I may being little more old school what – I know what I want, convert to a direct phone conversation with whatever company I am dealing with. So we do see a cross pollinization of all our businesses which means that the issues that we had with our digital platforms, we absolutely no impacted all areas that we do business, the catalogs, the phone sales, et cetera. The problem with that is we are not able to 100% define the exact levels of that impact. But yes, that’s what we are confident the causes.

Got it. Thank you for that. It’s actually helpful. I’ll turn it over.

Thank you, Molly.

Thank you. Our next question is from Joe Mondillo from Sidoti. Your line is now open. Joe?

Good morning, Joe.

I am sorry. I think I was on mute. Sorry about that. Thanks. Good morning everyone.

Good morning, Joe. How are you today? Good.

Doing well. So, I wanted to ask you quickly, I’m not sure if the answer could be really quick, but – about tariffs and specifically they’ve mostly been ones that were implemented both here and overseas. Wondering what if any effects that your business would see?

So, we obviously have a lot of dynamic factors in our business. The good news of our Brady is that, we often sell in-country four countries. So, in the case of China, the vast majority of our revenue that is produced in China with the exception of one 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 you know the dynamics of tariffs, Brexit, everything else, clearly does have an overall impact in us. But we fundamentally believe we are 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.

Okay. And then, the – at the IDS segment, the incremental margins, taken out the effective currency, it 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 am 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 2020 or sort of your normalized or what you expect in the medium-term, what do you anticipate sort of incremental margins at that segments?

So, Joe, we actually look at and as we look at the layers of it, we don’t see a fundamental shift in margin. Any shift we see is directly attributed both 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 are 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.

I guess, just a follow-up on that. I guess, what I am sort of curious or wondering about is – and granted the margin expansion was very good this quarter. I am probably nitpicking. But the year-over-year margin expansion relative to the growth you are 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 of quarters just really not, I mean, it was so good that it was just really not that sustainable and we are maybe at more of a normalized sort of year-over-year expansion in terms of incremental margins? That’s what I am sort of getting at.

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, 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, this business continues to perform. 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.

Okay. Good. So, the last thing, just actually two quick things. On the R&D, you ramped that R&D budget up quite a bit last year and we are obviously seeing the positive effects from that this year. But as a percent of sales, it’s sort of leveled out. So, 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, a last question would be on, what you anticipate sort of the tax rate will be sort of normal in fiscal 2020? I know you commented on the fourth quarter is – that fourth quarter is sort of a normal going forward or it’s just the fourth quarter?

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 two 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 will be very clearly calling out the fact that we are specifically doing it if we see a substantial difference. But overall, we are looking at all of our product lines. The great news is that, we have roadmaps. 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 efficiency is the key. So, although we continue to improve the number of products and the quality of products we are 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 regional relationship to our growth improvement. But we certainly are going to be increasing at the same rate that we had in the past, because we are 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 will be happy to do that instantly. The great news about where we are at financially is, we are not in a position to avoid those types of opportunities. We are in a position to take advantage of it. Aaron, do you want to talk about taxes?

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 rates to the new rate if you will as a result of that – as a result of that guidance. Previously, our rate was in – call it 27% to 29% range and we are 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 is clearly volatility in our tax rate when things like the audit settlement that we experienced this quarter comes up. So, there is clearly some volatility. But as we look into 2020, well, two things, one, we are still in the process of going 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. That’s 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 is 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 a never ending guidance coming out from the U.S. Treasury and the implementation of the U.S. Tax Reform. It becomes a bit volatile. But we will give you a much more detail come September when we come out with our F20 guidance.

Okay. Perfect. Thanks a lot. Appreciate you taking my questions gentlemen.

Thanks, Joe.

Thank you. Our next question is from Allison Poliniak from Wells Fargo. Your line is now open.

Hi guys. Good morning.

Good morning, Allison.

Can we just go back to the R&D, I think Aaron, I think you talked about not getting enough people or the right people in place and that 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 also not having that incremental investment if there is anything as we move in the out years?

I’ll actually answer that one, Allison. We are – in certain of our geographies, I believe the current rate although 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 1973, maybe, something 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 are able to attack and retain tremendous talent within our organization. We give people good things to work on good opportunities. But when you are 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 are 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 two years, I want them to be able to truly say to me, it’s the best place I have 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 talented 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 are going to end up hiring some people. You know, you just looked at the team and the team support wasn’t holistic and wasn’t strong. And my answer back was, you know, we need to bring on people that you really, really love. So it is challenging. But we are 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 are finding this a great place. But one other analogy that I love is how we felt 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 going to be a great place and so do we. And so, that approach, you know some would say in a very tight labor market might be difficult, but we believe in the long game. And that’s how we are approaching it. So, hopefully that answers your question, Allison.

That’s fair. And then, just – I want to talk WPS in a broader level. In the past, back five, seven years, the revenue and profit contribution from that business, that 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 are focusing on that business. I guess, particularly in North America, which is where some of the challenges have been? And you know the digital platform is certainly helping. But is there other stuff that you are thinking about by that shift there?

Yes, I think a couple things. One, you have focused on the correct statement. Our European business as an example, and Australia was two-thirds of our business in combination, actually has been doing very well, Europe, for a long time, for years, Australia for two solid years. So we truly look at that – look at the organization. Create and look at the skill sets we have, look at the type of bifurcation and differentiation we are providing those markets. And we are very confident that, at least at this time, because the world does change and you need to keep on top of it. We are continuing to do the right things there. Now as you said, you flipped the North America and you say, wow, that’s a very different story. And I would say, yes. Well, that’s a very different story, different market. We made some very fundamental mistakes. We had some technology issues that are right when we were seeing a recovery, slipped 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 am a believer of 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 am confident that we are on track to finish the year in that group and are better positioned than we were three, six months ago. Are we done working? Absolutely not often. We are in it. We are 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, ext door, so I am a little prejudiced upstate. But, if you walk into that factory now versus literally a year ago, you would have recognized 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 are 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 are doing with our sales people, our customer service people, our website people, our catalogs, et cetera. So, a lot of what we are doing that we believe will have a fundamentally positive impact than both our ability to have market-based sales prices and excellent profit isn’t even easily seen on the outside.

Great. That’s helpful. Thank you.

Thank you.

Thank you. Our next question is from Keith Housum from Northcoast Research. Your line is now open.

Good morning everyone. I appreciate it.

Good morning. Good morning, Keith.

Michael, as you think about the pressure that – the labor costs are having, is the pressure equal across the entire – I guess, your entire geographies? And then, assuming it goes over for a long-term, I know it can potentially be a short-term issue, is there the ability to move products around where you aren’t as susceptible due to some of the pressures you are seeing?

Okay. I will start with the pressure and then I’ll talk with our general ability, because there is lots of reasons we move products around. Let me start with the pressure. There is 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, movable resources that 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 presence 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 the 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 are understanding what are the wage pressures in Turkey. Earlier in the year, they were tremendous,…

Okay, great. Thank you. As a follow-up, healthcare, it seems like you have turned the corner this year and I know you guys are heading in that direction. But can you talk about a little bit more and talk about some of the R&D that you guys launched, perhaps some new products? And are you guys still expecting to turn the corner here relatively shortly in healthcare and what the trajectory will be?

Yes, just very frankly, we probably, in the past, had too much of our R&D efforts focused on big bangs. And you need a good mix to that. And so, as we struggle with some of the big bangs because you do, some come out great and some go on 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 am not going to quote the exact things, because I will get it wrong. But in the U.S., it appears, and I all say appears, because I am not going to give any exact time, once you are out of the acute care in hours, maybe minutes. If I go to Japan, and please don’t quote me, I believe the number is around 19 days in a hospital on average. Very different philosophy on medicine, medical care, et cetera. So, as we go around the world, if you look at the UK, you know the pressures that they are under are quite different additionally. As you go around the world, it is not a one size fits all application situation. So, give you an example, if I have a wrist band that I am developing for North America, that wrist band I believe is designed for the typical stay of – true stay of three to four days on average. That wrist band is not appropriate in Japan where they are 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 roadmap of, what I’ll call, A Bs and Cs. Home run, solid opportunities and gap covers. So, hopefully that helps, Keith?

Yes, any new product launches over the past few months or you can talk about, are we going to look at perhaps opportunities in the next several years?

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 say, 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.

Great. Thank you.

Thank you.

Thank you. 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.

Thank you so much. I'd like to leave you with a few concluding comments this morning. I am proud of what we have achieved so far this year. We are growing sales organically. We increased pretax earnings by 10.8%, which represents our fifteenth 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 are increasing our investment in new equipment and automation in our facilities and we are focused on driving sustainable efficiencies throughout our SG&A cost structure. We are working to improve our WPS North America business and our healthcare ID product line. I believe in the direction we are taking these businesses and I am 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 are committed to making the right decision today to drive improved long-term financial results. 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?

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