Ladies and gentlemen, thank you for standing by and welcome to the Q2 2020 Brady Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions] I would now like to introduce the host of this conference call, Ms. Ann Thornton. You may begin, ma'am.

Thank you. Good morning and welcome to the Brady Corporation's fiscal 2020 second quarter earnings conference call. The slides for this morning's call are located on our website at www.bradycorp.com/investors. We will begin our prepared remarks on Slide 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 the forward-looking statements. It's important to note that forward-looking information is subject to various risk factors and uncertainties which could significantly impact our expected results. Risk factors were noted in our news release this morning and in Brady's fiscal 2020 second quarter Form 10-Q, which was filed with the SEC this morning. Also please note that this teleconference is copyrighted by Brady Corporation and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the internet. As such, your participation in the Q&A session will constitute your consent to being recorded. I'll now turn the call over to Brady's President and Chief Executive Officer, Michael Nauman.

Thank you, Ann. Good morning and thank you all for joining us today. We released our fiscal 2020 second quarter financial results this morning, and I'm pleased to report another quarter of improved profitability. This quarter we increased our pre-tax income by 15.4%, increased net income by 14.8%, and increased our earnings per share by 12.7%, all while continuing to generate strong cash flow and make strategic investments to drive future revenue growth. The general slowing in economic activity continued to our second quarter as global demand for industrial products weakened. To put this in perspective even in the U.S. which has been and continues to be our strongest market, ISM manufacturing activity in December posted its lowest results in a decade. This reduction in economic activity led to our 1.2% organic sales decline this quarter. We’ve seen the effects of a challenging industrial economic around the globe including Europe, the Middle East and certainly in China. Our China business accounts for only about 4% of our global sales. The majority of products we make in China are for consumption in China and in general are not major inputs into the other products we sell elsewhere around the world. Our global sales decline in IDS was 1.3%, our organic revenues in our WPS business declined 1% this quarter. We continue to invest in new product development and these investments are providing benefits. We launched seven new products in IDS business this quarter that we've been looking forward to bringing to our customers. And we're further expanding our sales force in selected end markets where we see opportunities for growth. Our WPS business in North America, which has been a self-help story continues to rebuild its digital presence. We're making progress and we believe we're on the right path to turn…

Thank you, Michael and good morning, everyone. The financial review starts on Slide 3. Sales in the second quarter were $276.7 million, which consisted of an organic sales decline of 1.2% and a decline of 0.8% from foreign currency translation. Pretax income increased 15.4%, while net income was up 14.8% to $33.6 million, compared to $29.2 million in the second quarter of last year. And diluted EPS increased to 12.7% to $0.62, compared to $0.55 last year’s second quarter. Overall our earnings growth was quite strong, especially given the economic challenges that Michael mentioned. Turning to Slide 4, you'll find our quarterly sales trends. Organic sales in our Identification Solutions division declined 1.3% while organic sales in our Workplace Safety division declined 1.0%. The decline in IDS was due to overall macro challenges in the industrial economy. Despite the weak economic environment, our U.S. business was effectively flat this quarter, while both our European and Asian businesses declined. The decline in WPS organic sales was due to our North American business where organic sales were down in the low single-digits as we continue to work through our digital sales recovery. Organic sales in both our European and Australian WPS businesses were effectively flat this quarter. Slide 5 is our gross profit margin trending. Our gross profit margin was 50.3% this quarter, which is an increase of 80 basis points from last year’s second quarter. We're seeing input cost pressures, but we remain focused on investing in automation and aggressively driving process improvements throughout our manufacturing facility. This efficiency focus has been extremely effective in offsetting these input cost increases and enabling us to expand our gross profit margins. We have a culture that is focused on continually improving and executing our strong pipeline of opportunities each and every day. Turning…

Thank you, Aaron. Slide 13 outlines our first quarter financial results for our Identification Solutions business. IDS sales declined 1.8% finishing at $205.4 million with an organic sales decline of 1.3% and a decrease in foreign currency translation of 0.5% this quarter. Although organic sales were effectively flat in the U.S., organic sales decreased slightly in the entire Americas region this quarter. Our safety and facility identification, our product identification product lines are effectively flat in the Americas whereas our healthcare product line decreased this quarter. Organic sales increased in the low single-digits in Europe and declined in mid-single digits in Asia this quarter. We started to see an overall reduction in organic growth rates in the back half of last year, and the softer economic conditions continue into this year, resulting in an organic sales decline in both Europe and Asia. IDS segment profits increased 7.4% to $40.7 million this quarter, as a percentage of sales segment profit, but a very strong 19.8% which was an improvement over last year’s second quarter segment profit of 18.1%. We improved our profitability compared to the prior year, even though we had a modest organic sales decline and foreign currency headwind. This profitability improvement was a result of ongoing process improvements and efficiency gains that we've been pushing for several years throughout our businesses. The soft industrial economy makes our process improvement initiatives that much more important as we continue to drive increases in gross profit margins and reduction in SG&A expense. We remain committed to investing in R&D as innovative new products have been and will continue to be a competitive differentiator for Brady. This quarter, we launched the A5500 Flag Printer Applicator. This printer is designed to apply labels with flags to small diameter wires, which allow our customers to…

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

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

Good morning, Molly. Glad to have you on the call today. We feel very confidently that the structure we put in place, the philosophies we put in place, make Brady actually a company that will not only be able to handle downturns like this, but fundamentally the key to our success is that coming out of these down turns because we continue to invest throughout the downturn, we will be much stronger than our competitors on the other side. So, as you take a look at why we're improving our guidance, it's because we are improving sustainably in our processes and our performance. If I look at automation, I regularly get around the world to our facilities, I think that's very important and we're able now to work so much better interactively on improving our manufacturing processes that are focused on how we're implementing automation. As a couple of examples, years ago when I got here, many of our processes were unique in every location. And now we're looking at literally best-in-class ways of doing things and sharing those around the world. And as a result, we're not only becoming more efficient in individual facilities, we're collectively becoming much more efficient. In our SG&A structure, we're really looking fundamentally, as Aaron, I think, has spoken in the past about making sure we do things that - not our cost saving opportunities but changing how we do business, first, to help our customers more effectively and efficiently, but also to drive ourselves into a more efficient perspective. But what we find is if we're more efficient in helping our customers, it actually also drives down our costs. So, nothing we've done this quarter is outside of the norm at all. It's literally focused on doing better as an organization and we continue to do that and plan to do that and that's why you see expanded expectations for the rest of the year.

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

Yes. So, we're actually talking geography versus industries. We have very broad coverage in industries. In fact, Brady has some of the broadest coverage of any company you're going to see. Really, very few markets and industries that were not in. We are looking at specific geographies where we feel that are underserved and have an opportunity to accelerate our growth rates even in a declining economic situation. Once again, those type of proactive efforts are sustainable because of our strong financial position. And those type of efforts will help us. When others are retracting their interaction with customers during the decline, we're increasing our interaction. And when you come out of the decline, that once again helps you tremendously. So really, it's a geographic play as opposed to otherwise. As far as our investment in marketplaces, you can take a look at many of the different segments and see that we are improving in places like our wider identification space. We believe, we have world-class applicators at this point and are continuing to push the boundaries in a world that is constantly being challenged by labor cost increases, and actually far more importantly, a lack of labor throughout many parts of the world to do manual jobs. Our type of products are giving our customers everywhere from harness shops to aerospace to hundreds of other types of businesses, the opportunity to do a higher quality job at a lower cost but also eliminate the need for very difficult to find labor. So, there's an example right there.

Our next question comes from Keith Housum with Northcoast Research.

Mike, I know healthcare is an area that's been a focus of yours particularly for the past several years. It's down again this quarter. Provide a bit more color on what you're experiencing in that area and your expectations for it to turn around and be a growth driver here the next year or two?

Well, Keith, I think that's a good point. Effectively, we did say it was a self-help story. We really need to work on issues that were - challenges that we hadn't focused enough on is new product development. As you saw in our overall IDS space, we've done a good job of rebuilding our pipeline there and we are doing that on healthcare. Also, we are really operating our capabilities and capacities in the space. Literally, just in our Tijuana facility, which is the primary manufacturing location for this business, and we can do a much more cost-effective manufacturing model now than we were able to do even six months ago on many key products. That puts us in a tremendous position in some of the more cost-effective elements of that business to be very competitive, and also very competitive in regions of the world who weren't competitive as much in the past. And so, I think we not only are looking at new product innovation, but we're also looking to position ourselves to be able to handle a good, better, best approach to the marketplace in a way we haven't before. Not all of our customers have the same level of needs in that space and not all of the products we make serve every application perfectly. So, we're doing a much better job of manufacturing at the right cost point and also creating the right products for each type of segments than we were before. That is going to take a little time to develop in the marketplace, because as you know, healthcare is a slower adapter. They are more careful industry than others for very valid reasons. But as they adopt our products, we do believe that we're going to see continued traction.

And I know healthcare is primarily a U.S. based business. Is there an opportunity to go international and is that one of the primary focuses or is that more a secondary focus?

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

And changing gears on you with the coronavirus, I appreciate the China 24% of the business. But can you provide a little more color there in terms of your factories ability to produce right now? And perhaps it's a challenging market now because of coronavirus. Is that more demand issue, is that more supply chain, or is it perhaps both?

Keith, I want to start with, just - the outcome of coronavirus, I don't believe is known by anybody at this point. So, I'm not going to pretend to give you a long-term diagnosis. What I can tell you is this, that I believe we're in as good or better position as any of our industrial competitors by far. First, we've looked at our inventory positions for finished goods throughout the world on anything that is coming from China and we're in very strong positions across the board. There's a lot of reasons for that, but the result is that we're in very strong position. Second of all, we look at our raw materials that are coming out of China and we also feel that we're in very strong position. Finally, the issue of our customer base that's impacted by China, that one, that's a global impact and certainly will impact us. As customer needs to go down because of their impact by China, we'll definitely be impacted by that. But we certainly don't believe we'll be deleting edge of the problem. Now, let's talk about our people and our product manufacturing in China. We do have a number of facilities there. None of them are in the worst impacted region. Most of our factories are back up and running, most of the - the majority of our people have been able to make it back to our factories and are working. Logistics are still a problem, suppliers are still a problem. But we're getting tremendous support and my hats are off to our incredible management team both in China and Asia and in the U.S. and Europe, really working together to drive the best solutions possible. This really shows that brave approach to working together and helping each other does make a big difference. We've already been able to resolve some critical component issues that would be very problematic if we hadn't solved them. So, we feel good that if this isn't extended that we'll be in a solid position. And if it extends globally for a long period of time, that's going to have a lot of impacts to world economy that certainly Brady won't be immune from.

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

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

Joe, well, I don't see it as a significant decline. In fact, our focus on R&D is strong. We've been looking at some other approaches to be very effective in our spend. It's not just for us about the spend, it's how we spend, what we're focusing on and how we're doing it? And actually, our pipeline is very exciting and is getting stronger. The big difference between just a few years ago is every product line that we have, I can show you a product pipeline, literally a road map to the future, I can show you how we're bringing out products and have brought out products and that all of our product managers can give you a holistic approach of how we want to be the #1 player in their space and how we can get there. So, I feel very good about our invest in R&D and there is no correlation to any particular numbers with any less emphasis on R&D, quite the opposite. Our focus is very strong. And as we are in an economic downturn, I'm pushing our team's very hard to make sure we're focused on the products that would be the most likely to succeed as we come out of a downturn, and to make sure if we see markets changing at all because of different needs then we're on top of that and willing to flex in that direction if needed. We need to have the best products for our customers. It is our major sustainable advantage in the future.

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

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

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

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

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

Yes, Joe. We have remained consistent. We have said - and when I first got here, we pulled away from acquisitive mode because our acquisitive mode, it's not been as effective as I believe it should have been. We had to refocus on the fundamentals of our business, we've done that. I think we continue to do that. We haven't stopped doing. But we are in a position, have been, to look carefully at acquisitions. And particularly, use of cash, those acquisitions should be technology-focused, they should be able to allow both the acquired company and us to be better off. We want to win-win-win because we believe that's the most effective way. And of course, the price points have to be realistic. Until recently, believe me, the acquisition price points have not been realistic, but the market itself is in some spaces getting more realistic and will continue to get more realistic. And as that happens, we have a number of technologies and companies that we are looking at, but I'm never going to predict timing of use of cash like that, I'm never going to predict timing of acquisitions, because that's not the goal. The goal for us is to use our capital wisely and effectively and we believe that we're in a great position to do that.

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

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

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

Thank you very much. I'd like to leave you with a few concluding comments this morning. Looking forward, I believe that Brady is in a very enviable position despite weakness in the industrial economy. Over the last several years, we've made increased investments to develop high quality, innovative new products. And those new products are now coming to market. We've improved our customer service and support, which is improving customer loyalty. We have healthy gross profit margins that further improved this quarter and we expect to remain consistent and we've been aggressively driving sustainable efficiency gains, which you can see in our continued reductions in SG&A expense. All of this has made us a more effective and efficient organization that is better able to react and adapt to change. And that is critical at this point in our global situation. These improvements combined with our solid balance sheet puts Brady in a position of strength as we continue to invest in our future, so that when our end markets recover, we will be in an even stronger position and emerge with even stronger financial results. Our team is very motivated and I'm motivated to move Brady forward every single day. We plan to keep investing in organic sales vision, keep driving efficiency throughout the organization and to keep growing earnings and cash flow. I'm proud of what we've accomplished so far and I know that we're making the right decisions today to set us up for long-term improved financial results. As always, if you have any questions, please contact us. Thank you all for participating today and have a great day. Operator, you may disconnect the call.

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