Brady Corp (BRC) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2015 Brady Corporation earnings conference call. My name is Mark and I will be your operator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Ann Thornton, Director of Investor Relations. Please proceed, ma'am.

Good morning and welcome to the Brady Corporation fiscal 2015 third-quarter earnings conference call.

The slides for this morning's call are located on our website at www.bradycorp.com. 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, believe, forecast, and anticipate are just a few examples of words identifying forward-looking statements.

It is 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 2014 Form 10-K, which was filed with the SEC in September 2014.

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.

Thank you. I will 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.

I am pleased to report that Brady generated total Company organic sales growth again this quarter, which was driven by continued strength in our identification solutions business. Sales within our workplace safety business were below our expectations in the quarter, but I am optimistic that with the progress we're making in our digital and other initiatives that this business will soon return to its trend of organic growth.

As mentioned last quarter, we continue to anticipate the IDS business will show low single-digit organic growth for the full year ending July 31, 2015. However, organic revenue in our WPS business is expected to decline in the fourth quarter.

Looking at the fourth quarter, we are pushing for a strong finish to the fiscal year and to execute on the six critical activities we set out to achieve at the beginning of the year.

First, we have recently completed the consolidation of selected manufacturing facilities in North America, South America, and Europe. Through these consolidation efforts, we are creating scale and more consistent processes that will enable us to better serve our customers. We continued to incur incremental cost in our third quarter, such as duplicate labor, increased supplies, rent, utilities, and moving costs, and we're working to return our customer service level metrics to pre-move levels and are pushing for improved operational performance in our newly consolidated facilities.

Our second focus area is operational excellence, which we define broadly as our ability to deliver an unrivaled customer experience in every customer interaction, from the moment we quote a customer to the final collection of cash. I have had the opportunity to meet most of our employees since I joined Brady just over nine months ago, and it's clear to me that each and every employee is working incredibly hard to improve an unrivaled customer experience. They are all on board in our effort to do this.

Operational excellence is closely linked to our facility consolidation project, because as we complete the logistical moves, we are immediately focused on ensuring that our customers' needs are met out of the new facility. The fact that the teams are working so hard in this focus area it is a testament to Brady's long-standing culture of providing great customer service, while at the same time realizing that our service must continue to improve.

The third area that we are working on is driving an innovative new product pipeline and a more rigorous product refresh cycle. We are achieving this through focused investments in R&D and by identifying emerging technologies and aligning them with our customers' needs, as well as opportunities within our target markets.

Our fourth area is enhanced innovation development process. Although Brady has a 100-year track record of innovation and success in launching technical high-value products, this is an area where I believe we can do better. We have developed a more efficient innovation development process, which includes prioritizing and allocating our resources towards high-value, high-impact products and solutions and to accelerate the time frame from product conception to product launch.

Our fifth priority is our focused market sales strategy. Our sales and marketing teams are driving comprehensive efforts to implement plans in high-opportunity markets, such as food and beverage, healthcare, aerospace, and mass transit. Our knowledge and understanding of the current and future needs of our customers in these markets ties directly with our new product and emerging technology efforts to launch innovative new products with more speed and a higher success rate.

It is critical that our marketing and product development teams collaborate in order to fully capitalize on our opportunities in these areas.

The final area of focus is our One Digital Platform strategy. We continue to dedicate significant resources toward the creation of a standardized product content management system across all of Brady's digital platforms. We are enhancing the overall customer experience through improved customer-facing websites and a better mobile experience, which has resulted in increased online traffic and revenue.

A single data platform is critical to improving our customer experience and our long-term efficiency, and we are on track to convert nearly half of our workplace safety online revenues to One Digital Platform by the end of fiscal 2015.

Through the third quarter of fiscal 2015, it is clear to me that our focus on the short list of priorities that are tied to the core of our business has improved our execution and is driving growth in organic sales, profitability, and cash flow. However, we still remain challenged by operational inefficiencies stemming from certain facilities that were recently consolidated.

Let me now turn the call over to Aaron to discuss the third-quarter financial results. Aaron?

Thank you, Michael, and good morning, everyone. Please turn to slide number 4 for an overview of our third-quarter financial results.

Organic sales growth for the quarter was 1.7%. The substantial strengthening of the US dollar resulted in foreign-currency translation negatively impacting sales by 8% when compared to the prior year. Overall, including this headwind from foreign currency, revenues were down 6.3% to $290.2 million.

Our third-quarter gross profit margin finished at 48.6%, down from 50.1% in the prior year. SG&A expense finished at $103.0 million or 35.5% of sales in the third quarter. This compares to $116.7 million or 37.7% in last year's third quarter.

GAAP EPS from continuing operations was $0.33 in the quarter, compared to $0.39 in the third quarter of last year.

Bridging from our GAAP financial results to our non-GAAP financial results, we're adjusting for $3.2 million of after-tax restructuring charges and we're also adjusting for a $2.8 million after-tax benefit from the discontinuation of our retiree medical defined benefit plan. Excluding these two items, our non-GAAP earnings per share from continuing operations were $0.34 in the third quarter, compared to non-GAAP EPS of $0.43 in the prior year.

Slide number 5 summarizes our guidance for the remainder of this fiscal year. As a result of the heightened operating expenses in our recently consolidated facilities and anticipated organic sales declines in our workplace safety business, we do not anticipate our fourth-quarter financial results to significantly improve over what we experienced in the third quarter.

We are expecting non-GAAP EPS from continuing operations to range from $0.30 to $0.40 during the quarter ending July 31, 2015. Included in our fourth-quarter guidance is low single-digit organic sales growth in the IDS business and slightly negative organic sales in the WPS business.

The other full-year fiscal 2015 guidance elements include restructuring charges of approximately $15 million to $17 million, capital expenditures of approximately $35 million, depreciation and amortization of just under $40 million, and a tax rate in the mid to upper 20% range.

This guidance reflects the significant strengthening of the US dollar against most of the major currencies in which we do business, the most impactful change coming from the euro, which has dropped approximately 20%, from $1.35 at the beginning of this fiscal year to $1.12 when we closed the quarter.

As is our historical practice, we expect to provide our fiscal 2016 guidance in conjunction with our fourth-quarter earnings release in September.

Slide number 6 is a summary of our quarterly sales trends. In the third quarter, revenues finished at $290.2 million, as I mentioned. We did have organic sales growth, but we also had significant FX headwinds.

Moving along to slide number 7, you can see the trending of our gross profit margins. Our third-quarter gross profit margin was 48.6%, which is down from 50.1% in last year's third quarter. This decline is primarily due to reduced sales volumes in the WPS business and operational inefficiencies in our IDS business.

This quarter, we completed the final movement of our facilities, but we continued to incur heightened operating expenses that led to customer service challenges impacting our third-quarter gross profit margin. We are still working through a number of service issues and our first priority is to serve our customers in the best possible manner.

On the right-hand side of this slide, you can see the trending of SG&A expense. SG&A expense was down from $116.7 million in Q3 of last year to the $103 million in Q3 of this year. This decline was driven by a few key items.

First, the curtailment of our defined-benefit retiree medical plan resulted in a one-time non-cash $4.3 million pretax benefit this quarter. Second, the impact of the stronger dollar decreased SG&A expense by approximately $2.3 million when compared to the prior year. Third, amortization expense was down $2 million.

And lastly, the remaining decrease was driven by general reductions in selling expenses this quarter in response to our weaker-than-anticipated gross profit margins, combined with elevated levels of expenses last year in the third quarter as we made increased investments in digital advertising and catalog costs.

Moving on to slide number 8, you can see that our non-GAAP EPS from continuing operations was $0.34, which compares to our non-GAAP EPS from continuing operations of $0.43 generated in the third quarter of last year.

We have summarized our cash generation on the next slide, which is number 9. During the quarter, we generated $28.8 million of cash from operating activities, compared to $5.3 million in the second quarter of this year and $34.1 million in last year's third quarter. On a sequential quarter-on-quarter basis, this improved cash generation is due to an increase in net earnings, as well as a planned reduction in inventory levels in the third quarter compared to previous quarters when we were building inventories.

We spent $5.7 million on capital expenditures this quarter. The majority of our capital spend was either directly related to our facility consolidations or was part of our digital focus area. As you can see, with this level of capital spend we are starting to revert to our historical capital expenditure norm of approximately 2% of sales and our historical trends of free cash flow in excess of net earnings.

Free cash flow finished the third quarter at $23.1 million, which is approximately 130% of net earnings.

Our thoughts on capital allocation are unchanged. Our first priority is to invest in organic growth opportunities, which includes funding incremental selling personnel, as well as R&D resources, to drive growth in selected vertical markets and delivering on operational improvements to execute our key business fundamentals.

Our second priority for capital deployment is to return cash to our shareholders in the form of dividends.

Third, we view share buybacks as a way to further enhance shareholder return and we approach these in an opportunistic manner. We intend to repurchase shares when we believe we are trading at a discount. We have balance-sheet capacity and we do not have higher priority competing uses for our capital, such as the recent period of elevated core business cash outlays.

Our fourth and final use of cash would be for acquisitions, which we do not expect to be a significant use of cash in the near term as we currently focused on driving the key initiatives that Michael outlined.

Our EBITDA trending and net debt trending are on slide number 10. Our balance sheet is strong, giving us the flexibility to fund future growth opportunities or return funds to our shareholders. Our net debt to EBITDA was approximately 1.2 to 1 at the end of the quarter. Our total net debt position has been trending down since December 2012, and at April 30, 2015, it was $168 million, compared to net debt of $221 million at this time last year.

I will now turn the call back to Michael to cover our platform results and provide some closing comments before turning it over to Q&A. Michael?

Thank you, Aaron. Let's turn to slide 11 for a summary of the third-quarter identification solutions financial results.

Organic sales were up 3%, while foreign-currency translation decreased sales by 5.7%. In total, sales were down 2.7% to $200.8 million in the third quarter.

As I mentioned, one of our focus areas is to expand our IDS business in selected industries where Brady's products can provide significant value. We have been increasing our focus in industries such as chemical, oil and gas, food and beverage, laboratories, industrial OEMs, and healthcare and continue to see a positive sales trend in the industries where we have focused expansion efforts.

During the quarter, our areas of strongest growth were in selected product lines in our global safety and facility identification product family. Safety and facility ID grew globally, with specific growth coming from our facility ID consumables. Our printer sales were also strong this quarter, with the standout product continuing to be the BMP21-PLUS and its associated consumables, which were launched last year.

Product ID was another area of strength, which grew in the mid-single digits, fueled by continued growth in the Asia-Pacific region. Our healthcare ID product offerings also grew in the low single digits during the quarter.

Segment profit finished at $41.6 million in the quarter, compared to $44.3 million in last year's third quarter. As a percentage of sales, segment profit was 20.7% this quarter, compared to 21.5% in last year's third quarter. The decline in segment profit as a percentage of sales was the result of a reduction in gross profit margin that we mentioned led into the heightened operational costs in North America, along with geographic product mix as Asia continues to be our region with greatest growth, and in general Asia has our lowest segment profit margins.

Foreign currency also is providing a bit of a gross margin headwind. Overall, our footprint is such that most costs are in the currency of the ultimate sale. However, we do have a higher percentage of selling expenses that are US based and we're also a net exporter from the US, so we do see some margin compression when the US dollar strengthens this significantly.

We anticipate the trend of low single-digit organic sales growth to continue into the fourth quarter of fiscal 2015, with growth continuing to come from our global Brady brand business, primarily in the US and Asia. Overall, the prospect for organic sales growth through our business are positive. Although some economies including western Europe and Brazil may not be growing at a robust rate, our sales force expansion and our investment in organic sales initiatives are expected to help drive future revenue increases in the near term.

Looking at future profitability trends, we certainly expect to see improvements in our segment profit trends in the mid to long term. However, we do not expect to see improvements in the fourth quarter of this year, as we continue to work through customer issues and inefficiencies following the facility consolidation moves.

For the full year, we expect our total fiscal 2015 segment profit to be comparable with the run rate as we exited fiscal 2014, which was approximately 20% of sales.

We have invested in sales generation activities in focus industries and we're increasing our R&D investment to continue to stay ahead of our competition through the development of proprietary new products, which are showing returns. These sales growth initiatives should provide a catalyst for continued organic sales growth, as well as improved profitability over the mid to longer term.

Now let's turn to slide 12 for the workplace safety review. Organic sales declined 1.1% this quarter and foreign currency decreased sales by another 12.2%. These sales results were below our expectations coming into the quarter.

Approximately half of WPS business is in western Europe and another 15% of the WPS platform is in Australia. As such, the strengthening of the US dollar versus euro and the Australian dollar has put a much larger impact on WPS than it did on our IDS business.

Although we are not overly pleased with our sales results in WPS this quarter, we believe that our strategy and focus on execution are gaining momentum and creating a foundation for future sales growth. We are focused on improving business fundamentals and our WPS team is dedicated to five main improvement areas that are catalysts for improving financial results.

First, we are expanding our e-commerce platforms and driving towards the One Digital Platform. Our investment in digital capabilities is ongoing as we build upon the foundation of our digital team that was formed last fiscal year. We have been building momentum this year and have launched improved web interfaces for many of our businesses in the US, Europe, and Australia. We are working to delicately balance our activities between actions that generate sales now and those set up our businesses for long-term success.

Secondly, we have expanded our offering of ID workplace safety products that are differentiated and customizable. These products make up the core of our product offering and allow us to leverage our broad customer reach and compliance knowledge to create opportunities for organic growth globally. Our ability to customize products based upon our customers' needs has always been one of our strengths and the team has developed the online interface to greatly improve the experience for customer online ordering.

Third, we are driving the segments of our business where we can add the most value and are continually enhancing our industry experience to further differentiate and, in turn, create value for our customers. These segments include businesses in the workplace safety critical industries, such as construction, where we are well positioned to provide our customers with our expertise and the high levels of customer service and quality through each and every interaction.

Fourth, we are continuously evaluating and optimizing our value proposition. Our business has been built on a foundation of providing expertise in the area of facility safety, compliance, and a broad range of unique and customized identification solutions. We will continue to build on this foundation of high service levels and a broad offering of unique and customizable products that are attractive to our customers.

Lastly, we will continue to invest in our catalogs, which serve high-value customers that are at the core of this business. The primary data elements of our One Digital Platform program will help us create catalogs faster in a more cost-effective manner. Our catalog marketing strategy is well established, but we will utilize our enhanced digital platform to gain efficiency in our catalog spend. Catalogs will continue to be an important component of our multichannel strategy for years to come.

Our continued focus in investments in these areas will allow us to drive value over the long term through new customers and an increase in digital traffic and digital revenues.

Segment profit in the workplace safety global platform was $12.3 million in the quarter, compared to $14.8 million in last year's third quarter. As a percentage of sales, segment profit was 13.7% this quarter, compared to 14.3% in last year's third quarter.

Our segment profitability is still not where we would like it to be, due to the growth in investments I just described and the lack of topline revenue. Although we were planning for quicker progress in improving profitability, I am optimistic that we are on the right track for future segment profit growth.

Before turning the call over to the Q&A session, I would like to provide a few concluding comments with respect to our priorities, where I believe we are in a profitable growth improvement effort. As our third-quarter results indicate, we are seeing signs of improvement in our business, but foreign currency presents a strong headwind. We're not where we want to be with our WPS revenues and our gross margins in IDS continue to be challenged as we work through customer service and operating issues related to the facility consolidation.

Overall, we have made quite a bit of progress, but I do expect that the next several quarters will continue to be challenging as we work through our actions to not only improve our short-term results, but more importantly to set up Brady for long-term success.

We remain focused on the key items that I mentioned at the start of our prepared remarks, which I would like to reiterate.

First, we are focused on improving our customer service and delivering gross margin improvements. Second, our team throughout the globe is focused on delivering operational excellence every time we interact with our customers, operational excellence being driven towards having the perfect order in the eyes of our customers.

We're actively driving a robust new product pipeline and we are allocating our product development resources to the highest-value, highest-impact products to accelerate the time frame from product concept to launch.

The team is driving our One Digital Platform strategy to enhance our overall customer experience and drive revenue growth. We're expanding sales opportunities in our focus vertical markets.

And lastly, the key element that will allow us to succeed in both the short term and long term is the development of our people and enabling them to pursue excellence in everything they do.

I would like to start the Q&A at this point. Operator, would you please provide instructions to our listeners?

(Operator Instructions). George Staphos, Bank of America.

This is Alex Wong sitting in for George. Thanks for taking the question. First question, can you just talk us through full-year guidance? The guided $0.30 to $0.40 for fiscal fourth quarter implies roughly $1.34 for the full year and this compares with the last guidance of $1.50.

Can you just discuss the $0.15 delta and maybe one or two things that contributed to the reduction? I assume FX is a component, but the euro was actually relatively stable from mid-February to about end of April.

Good morning, Alex. This is Aaron. Yes, I can answer that question.

First, I will address the FX piece, just because you brought that up. I agree with you. We exited the quarter with the euro basically where we started the quarter at February 1. However, we did have a dip, of course, in the middle of the quarter where the euro was down in the, call it, $1.04, $1.05 range.

It clearly had an impact, but to be quite candid, it was probably $0.02 or less on the full year, so the real reason for the guidance reduction was frankly coming into the quarter we were anticipating earnings somewhere in the neighborhood of $1.35. Implied guidance for the full year is $1.34 now and it is really two main items.

First is our WPS business. It just flat out has not shown as much growth as we anticipated. We finished the quarter with organic sales down 1.1% and we were anticipating growth in what is typically our seasonally stronger third and fourth quarters, and, frankly, we expect a bit of this weakness to continue into the fourth quarter.

And then, the second component relates to the IDS business, and I know Michael alluded to this on the call quite a bit, and that is that we continue to experience some elevated costs, which are driving our margins down, as relates to the facilities that we've recently consolidated.

So, it's really the combination of gross margin in our IDS business and then the topline in our WPS business.

I appreciate that color, and just two quick follow-ons, all around WPS. Maybe starting out, what tangible two or three reasons would you expect WPS to see improved earnings in fiscal 2016 and is there any way to quantify the drivers?

I fundamentally believe that our efforts in our digital platforms and our web interfaces, our mobile interfaces, are strong and we are seeing growth in that area to the neighborhood of our sales are now about 15% off the web, and I think that the Internet platforms -- and I believe we will continue to see that grow and we will see that grow at a more accelerated rate.

In addition to that, the whole team is executing our catalog strategy more effectively and we are starting to see some results from that.

And then, the final element that I think is important is our emphasis on a total solution to the customer that is perceived by the customer as flawless is continuing to show very positive results in our metrics as we move them up.

So those elements are very significant. I would add one more. We believe that we are continuing to add differentiated products to their offering that give our customers the unique opportunity when they buy from us not only to have a more total solution, but to have one with a level of expertise provided that more opaque sites and more opaque suppliers just can't offer.

That's helpful. Appreciate that. And then just quickly, again on workplace safety, we have seen the year-over-year margin compression lessen as we progress through the fiscal year. Are you expecting a similar year-over-year change in fiscal fourth quarter relative to what we saw in fiscal third quarter? How should we think about the moving pieces, i.e., topline growth versus the increased investment spending?

Yes, Alex, I can answer that question. As you look at the segment profit in the workplace safety business, we finished at 13.7% this quarter, which clearly is not where we want it to be.

And actually if you go back and look at our original guidance, at the beginning of the year we anticipated to do quite a bit better than that by the end of the year. Clearly, we expect to move upwards from the 13.7% segment profit in our fourth quarter and beyond, of course, but I absolutely don't expect it getting back to that 18% level.

And it's not so much the increased investment, because the investment was factored into our guidance; it's really the topline. This is a business that has quite a bit of leverage, as you know, so a 1.1% decline organically clearly has an impact on our gross margin, which, of course, flows all the way down through segment profit. Does that answer your question?

Yes, Aaron. Thanks very much. Good luck in the quarter.

Allison Poliniak, Wells Fargo.

On ID solutions, obviously it sounds like some of those operating efficiencies, customer service issues could be transitory. Is this one of those things that, yes, impacting Q4, but should obviously improve as we head into the next year?

Yes, I appreciate that thought, Allison. It's absolutely true.

You could look at these things two ways. I look at them as a great opportunity. As I see the consolidations of our factories together, we brought multiple factories into (technical difficulty) factories simultaneously. That obviously creates an awful lot of challenges to your existing workforce and your new workforce in those facilities.

So as I go around, and I have actually been to those facilities multiple times in the last quarters, helping to support this effort, I see a lot of upside.

Your point of several quarters is important. Those upsides don't just take place overnight. As we drive more efficiencies into the organization, as we lean them out, as we really apply the principles of proper optimization to those organizations, you will see a continued pattern of improvement, and I'm actually very excited about that.

Great, and then --

Thanks, Allison. I hope that answers your question.

It does. It does. And then, just with workplace safety, obviously FX is a big headwind there. Is there any way to help us quantify what the impact to margins were? Obviously, you have increased investment, but what the FX particular impact was in that segment for the quarter?

Allison, this is Aaron. Actually, I don't have that at the segment level. I can tell you that for the full quarter, including translation and transaction, the impact of FX on our bottom line was about $0.06 versus the prior year, but I don't have that broken out by segment.

Okay, no, that's perfect. Thank you.

Mig Dobre, Robert Baird.

Michael, sorry to have to do this, but I guess my perspective on the quarter and performance is a little bit different than yours. You were talking about strong performance and about delivering on goals going into year-end.

But the way I see it, you ended up cutting guidance by 11%, and when I am looking at segment level, it's hard for me to see really any improvement anywhere. I mean, the margin performance in the third quarter in workplace safety is the worst on record. And I understand that there is some issues with FX, which I wish we could have broken them out a little bit further so that we really understand what we are working with here.

But how can we as outsiders evaluate the change that is occurring within this Company to gain any kind of confidence that 2016 is going to be a better year than 2015, when 2015 seems to have worked out so much different than what you were expecting initially?

Mig, I will tell you when I came into this position nine months ago and as I have continued throughout the process, I believe I have been very frank with our community of investors, in addition with our employees, our customers, and our suppliers.

We are definitely in a rebuilding effort and those efforts have moments of easily perceived upside on the outside and some moments of downside, as perceived from the outside.

But what we actually are seeing is a solid momentum to transition ourselves from an organization that had been focused on acquisitions into one that is focused back on the key fundamentals of business, those fundamentals being getting the products out the door in the way we expect them to and when we expect them to.

Those changes are absolutely the taking place. Those changes don't instantly reflect in results, but over the long haul they do.

Redeveloping a true differentiated R&D product pipeline that our customers want, once again we are actually driving those products significantly into and therefore out of our organization. But as you well know, as we introduce new products -- a great example is the BMP21-PLUS, the traction from that development that started a couple years ago doesn't really impact until the second year and even the third year of a product being introduced, so the fact that we are tremendously strengthening the differentiated pipeline of our product offering isn't going to show as effectively as we would like this year.

A final big point I would like to make is that as we go to one global platform, once again large, large investments, you can see the numbers that we are putting into that, but the efficiencies that we gain from everywhere, from the operational elements all the way through the interfaces to our customers, are tremendous, but those efficiencies once again are not ones that are a light switch effect. I view them as a rheostat or a dimmer switch; you will slowly start to see those and those improvements, though, will accelerate over time as we complete those efforts and they are able to grab hold of our organization and our customers' interface experience.

So fundamentally, the improvements are there. We are telling you about them, but there are going to be bumps in this road as we move from what had been an acquisition strategy to a more fundamental business strategy going forward. Thanks for the question.

Well, I appreciate that. Unfortunately, I'm going to have to stick with this topic. When we are looking at workplace safety, I guess one of the things that I am having a hard time understanding is why we continue to see organic declines in this business and you're guiding for additional organic declines going forward, considering the level of investment that you have applied recently here, especially in catalogs.

And I'm wondering what is the ROI that you're getting from your increased investment?

And I also want to tack onto your comment about 15% of sales coming from online. If I remember correctly, that's a statistic that was used roughly a year ago as well, so maybe my memory doesn't serve me well. Have online sales grown significantly for Brady in the past six to 12 months?

The number that I believe you were given was about 12%, so that is growing.

As far as further details, we will stick to the details we have given. I will tell you that the fundamentals of the business do have some challenges and that is areas like North America that we are seeing a downturn and we believe we have a basis to see. Many of our direct competitors are seeing a downturn. It is a challenging environment.

It is more challenging than we expected it to be, and if you take a look at analyst reports and competitors' comments, although I won't reflect on them specifically today, you certainly can do that, you'll see that many of them were also surprised by what had been stronger growth going into the quarter and clearly was a negative impact during the quarter. Thank you, though. Appreciate the questions.

Jason Ursaner, CJS Securities.

Just first on IDS, you pointed to strength in the safety and facility ID and product ID groups. Just wondering how growth broke down in the other three groups and directionally whether all of them were positive.

Yes, Jason, I can answer that question and -- well, I can attempt to answer the question. I can tell you that those were the two groups where we had the strongest growth. We also grew in our healthcare ID -- in healthcare ID space as well. Beyond that, actually, I don't have the data sitting in front of me, but frankly those were the standout areas.

The other functions, of course, would include wire ID and the People ID business, and I just don't have that in front of me, but the other area of growth was healthcare ID as well.

Okay, and the expectations for low single-digit growth in Q4, is that assuming a negative trend in any other groups or pretty broad-based low single-digit growth?

It's very broad based.

Okay. And at the gross-margin level, just maybe following up on Mig's question a little bit, is there any way to think about how big an impact the facility consolidation is on the impact on gross margin in the IDS segment?

No, we don't really have a breakout for you on that. I can tell you that I do see it as a fundamental large opportunity for us and I am excited that we can actually translate that into positive gains in the future.

Okay. Would it be the majority? If we look historically relative to where the segment is, is the majority of the variance entirely that consolidation activity?

Well, I can answer that. The majority of segment profit decline absolutely is, so there was an 80 basis-point decline in segment profit this quarter. That was definitely the driver. (multiple speakers)

(multiple speakers) fundamentals of those facilities, I believe we will be able to have large improvements, because the improvement possibilities are visible.

Got it. I am asking more gross margin, rather than operating profit.

Oh, I'm sorry. Well, we don't give gross margin by platform, as you know, but the drop in segment profit in ID solutions was driven by gross margin. So, I guess indirectly I actually answered the gross margin question.

Okay. And in WPS, maybe just taking Mig's question from a different angle, you had had three consecutive quarters of organic growth there, obviously back a little bit negative this quarter. Just maybe more qualitatively, how would you look at that in terms of a true operational sales contraction with some of the fundamental challenges you mentioned versus maybe more of just a timing issue, since this was up against a pretty difficult comp from last year?

I'm sorry, Jason, can you --

Could you repeat the question? I apologize.

When you look at the organic decline in WPS, how much of that are you qualitatively seeing as a true organic contraction from fundamental issues versus just being up against a more difficult comp last year?

That is a very good question. We have not broken that out.

I will tell you that if you look at the industry, you will see that a large part of it appears to be, both from our analysis and from a general overview of our competitors, related to an overall decline. At the same time, your comment about being up over a more difficult comp is also true. We are not prepared at this moment to give a breakout of that, but to tell you both factors are real.

Okay, and the One Digital Platform, is this in terms of the front end or back end? I guess I'm just slightly confused.

It is a great question. It actually is the back end, so you'll see the very front end of the interface, we're actually allowing our businesses to customize it to their needs much more.

We are creating a modular approach, so that all of the key core data, the data integrity, the ability to use it, the ability to integrate it into different platforms and different mediums, that's all going to become much, much more focused and efficient. But then at the very front end that touches the customer, we want that to be highly modular -- customized so that each of our units can specifically adapt to their customer needs and the product focuses that they are looking at and the methodologies they are looking at.

So it is a two-pronged effort, as you pointed out, that way.

Okay. And on the digital business, you mentioned that is now 15% or so of segment sales. Any measure for organic growth there versus the broader segment? And just directionally, assuming it's broken out on its own P&L internally, is it profitable at this level?

Yes, and up and up. Yes, up, and yes, profitable.

Okay, appreciate all the details. Thanks, guys.

Absolutely, sir, thank you.

Joe Mondillo, Sidoti & Company.

So the first question that I had was just related to WPS, so you talk about how obviously there has been challenges not only within your internal business that you have been trying to obviously fix, but the industry sounds like they were seeing some pressure.

One, I was just wondering how you think that negative 1% measures up to the industry. And two, how does the pricing at that business look like?

I think fundamentally that we did see some differentiation in that answer on the first one, that some competitors did slightly better than others. I would say we were in, I have seen, mid pack in overall results from what I saw.

In addition as far as the pricing, I assume you mean -- could you clarify what your question is in regard to pricing?

Yes, just a large part of the margin erosion over the last several years, I believe, was related to competition and pricing, and just wondering what those competitive headwinds look like in terms of overall pricing and how you are pricing -- how you are able to push price there?

I think the team has done a much better job of overall pricing. We have actually been able to improve our pricing and have not seen it hurt where we have improved our revenue growth. So that's actually a positive story we have.

And in some of our regions, we have been able to improve our pricing more than others, so it is differentiated in regions and product sets.

But overall, there is some impact of the more open channel access that you see today, but at the same time if we niche it properly and particularly by region, we have been able to have some price gains.

Okay. And then in terms of the first bullet of your five-point strategy at WPS, the e-commerce expansion, that's been going on for, I believe, almost a year now and you mentioned that, as a total of sales, online sales were up compared to a year ago. So does that mean -- can we interpret that to mean that we are seeing growth in the online sales and it is really maybe on the catalog side that is more of a challenge?

Yes, that's absolutely true.

Okay.

Dead on.

And then, I also wanted to ask in regard to the cost structure. I know in the recent past, on the last call, I asked this. I just wanted to get an update on how you are looking at SG&A, the cost structure. I believe in the past you have thought that it is somewhat bloated and can be possibly reduced somewhat over the next year or two. Just wondering on your updated thoughts on that.

Absolutely. I have sat in recent meetings. It is wonderful to see a transition of mentality here within Brady where we are looking at costs and we are looking at investments very, very differently.

I have an overall view that everything we do has to have a return and that you can determine a return, and I don't believe that had been the view before, certainly within segments of our business. Now people are looking at it much more entrepreneurially and much more as businessmen, and we're also driving a lot of cost.

The recent example is our plan to take a lot of the IT resources that are actually fundamental to the businesses and put those in the business. That had been an area that we had struggled with as we initially worked through the concept of driving costs into the businesses, but we now see a very solid, very exciting path forward.

And the proof of that is the IT team is the one that is most excited about it and they are driving it and the businesses are thrilled with it.

So as we do that, that is fundamental for our ability, as I said last time, to put costs into the businesses where they are far more accountable, and then, as we lower the water in the corporate areas, to be able to see where the alligators are, where the rocks are, where the elements that we need to fix are. And we are doing that.

That process, as I believe Aaron outlined last time, does take a while. It is like any other major initiative, like product rationalization; usually, those are not a quick fix. They are a two- or three-year transition. But going down that path, we were already established on it, and as we move down it, we are seeing more and more accountability and more and more reality checks as to what we are working on and why (multiple speakers)

So, just to follow up on that, the administrative cost line that you report, that's been declining year over year for six quarters now. Is that related to that? What was the timing of starting to push? I guess it is related to those admin costs or -- why are the admin costs falling for six straight quarters and, I guess, how is that related to your comments that you just made?

I can answer that, Joe, and that is we have been working on driving down admin costs, frankly, for quite a while, and as Michael talks about, I will say, pushing costs into the segments, there's no classification issues here. We are looking at apples to apples, so the year-on-year reductions that you have seen included in this quarter are true efforts to drive down G&A expense.

Now I will say this, and that is if you look at quarter on quarter, so from Q2 to Q3 of this year, our true G&A expense actually bumped up a little bit, which I actually believe is quite normal, that you will have a little bit of choppiness as we work to take out admin costs.

But overall, I feel pretty good about where we are headed with admin expense. It is clearly a focus area, will clearly continue to be a focus area to really drive down as much as we possibly can.

Absolutely. I want to be quite clear that it is not just driving the cost into the business for accountability. It is our belief that we need to optimize those costs much more effectively or drive them down into a -- to a level that is more efficient than we had in the past. And we are doing that.

Okay, and so just lastly, following up on this topic, how long of a process do you see these centralized costs being pushed into the businesses? How long does that take? And then, how long does the process of maybe that translating into actual overall costs coming out of the entire business or more efficient -- more efficiency take place?

Aaron and I are tied into this one very closely because we see this as a very mutually interdependent effort. We will see continued progress in this area literally for two to three years.

It does take some while to -- I always equate these things to peeling back the onion. As we peel back different layers and look at different opportunities, we suddenly realize we can drive more costs than we expected or different costs than we expected into the businesses. As the businesses see the positive result, they are more excited about doing that. As the functions are seeing the results, they are more excited about doing that.

So we don't want to do anything drastic because we believe it is much more about getting ourselves aligned properly over time to where we should be. So I would say that you should see this continue to transpire for the next two to three years.

Okay, thanks. Appreciate that.

And that's a good (multiple speakers)

Thanks for taking my questions.

Thank you, sir. Appreciate the time.

Keith Housum, Northcoast Research.

Thanks for taking the question. My questions here are probably just going to be more derivatives of what we have already asked before, but I appreciate the opportunity here.

As we look at pricing in your WPS business in Europe and the way the dollar has strengthened, if we assume that the euro stays where it's at against the dollar, are you guys at parity with your competitors there based on pricing because of the fact that you are a US company or are you guys disadvantaged there on a go-forward basis?

Because Europe is a -- I will answer the question. Because Europe is a net importer, actually, as they are in our industry, many of our competitors, if not most -- I would say most, are in very similar situations to us.

And we have actually seen positive results in growth and outsized results in growth and profitability versus the economy in Europe and, we believe, most of our competitors. So the good news is we could be in their position.

Got you. Okay. As we look at R&D, Michael, you know, R&D is obviously a core tenet of what you hope to do at Brady here going forward, but yet we haven't seen a change in the amount of money you guys are spending on R&D. I am assuming that's because you guys are probably doing things smarter as opposed to trying to throw more money at it.

But how should we look at that going forward? Do you expect R&D to increase, because it sounds like you are changing the way that you are doing R&D, so is that -- if that's elongating the process, is that starving products from being put out today versus [invariably] what's going to come out tomorrow?

Great question. I won't dive into the specific segments, because we don't do that, but I will talk to you philosophically. I have actually been looking at where we invest by segment and reallocating money.

One of the challenges with a more established company is that you tend to continue to do the things that made you successful in the past, even when going forward the dynamics are changing and the way that you need to invest is changing. And so, what you have to do is you have to eliminate the investment in the trapped older technologies that you just continue to sustain.

I will give an example. If you look at a market totally unrelated, telecommunications, if you would continue to invest your resources into some of the larger platform providers of old, you would end up being in trouble. And I think -- instead of moving those resources to newer platform providers that are much more successful and you see them being much more successful in the future.

What we have had to do is look at where we have been making those investments, realize that some of those, although legacy, had been important, but they needed to be diverted. In the medical space, for instance, I believe we are fundamentally underinvesting overall, like in labs, in areas like that, and we are transitioning investment into there. And there is other spaces that I would rather not talk about specifically that we have been overinvesting for what we believe is the future potential.

If you look at the actual percentage by segment, that's what we are trying to drive into what is the efficient R&D spend there. But you are fundamentally correct. As a result both of the methodology we used to use to invest -- if you have noticed, I continually reference a more strategic approach, a more filtered approach to investments -- and where we are investing in product sets and opportunities, I believe we can become both more efficient and more effective at the same time.

Okay, so going forward if we assume (multiple speakers)

(multiple speakers) I want to be quite clear. I believe R&D is a core backbone to our future success. Product differentiation is something that Brady has always done and I believe we can do an even better job in the future.

Okay. So we shouldn't expect a change of R&D spending from roughly 3% of your sales?

No.

Okay, got you. Next question for you, it goes over to the WPS segment, your digital platform. You talked about the 12% to 15% growth in the digital sales. How are you thinking about that going forward? Is there any point in time that you think there is going to be a significant jump in sales to the digital platform? For example, do you have any type of digital strategy that you think is going to push sales dramatically in that direction or should we expect to see digital sales just slowly creep up over time?

So I will equate this one to something initially you may find bizarre, but paper consumption in the United States, I believe, did peak in 2002, and the reason I say that is when the Internet was introduced, the comment was made that paper would be dead within a couple of years.

In reality, paper continued to grow for a decade plus after that and is actually still strong because people still utilize that.

In the same way, I don't believe you're going to see an instant switch, but there are going to be moments of quick acceleration between catalog users and Internet users. But at a certain point, we are going to get to what I will call a platform bottom that will last for an extended period of time as that user base ages, but doesn't walk out of the workforce.

And in addition to that, there are people who fundamentally use an interactive approach, which is a combination of catalogs, Internet, and phone that they find to be the most useful for themselves, so that catalogs can often still act as a trigger point, although your in-sale may either be over the phone or the Internet.

And so, we do think it is going to be a three-tiered platform in the long term going forward for certainly a significant period of time, but to be very specific in answering your question, we expect a general decline and a change in the mix over time, with some bursts as different people groups and technologies accelerate the transition. Is that a clear answer?

I think so. I guess in summary what I am hearing is that we shouldn't expect digital sales to be a dramatic driver of WPS sales in a quick manner. You are going to see it more extended over in time if it is a combination of being driven by catalog sales or just by itself.

Absolutely, but you should see, continue to see an upward growth trajectory of our digital sales as both a result of our specific efforts and as a result of the marketplace changes (multiple speakers)

Will you guys call this out every quarter going forward?

Pardon?

Will you call out your digital sales -- call it out every quarter on these quarterly calls?

I don't know that we will commit to that here on the call today, but if it is a relevant topic, we will certainly -- we certainly try to bring up all relevant topics, absolutely.

Joe Mondillo, Sidoti & Company.

Just two quick -- actually, one quick follow-up. First off, the debt increase from quarter to quarter, why increasing the debt? Why did that increase? And should that start to tick down at all?

And then, secondly, in terms of your working capital, how are you looking at investment to working capital and really use of cash? With all the efficiency improvements and lean manufacturing going forward that you see, do you see a smaller need for investment in working capital in the next -- at least in the next year or two or how do you think about that?

Well, I will start with the second question, and then I will let Aaron answer the first question.

Philosophically, I would like to say that we are strongly aligned in that we think cash, that it is an important element of how we think about going about doing our business, and cash efficiency and the use of cash.

I am a big believer of when you stop thinking that way, your employees stop thinking of it as their own business and their own business concerns, so cash efficiency and effectiveness is absolutely a mantra that we are driving.

But on top of that, you are right. As we geared up for the consolidations, we saw things like inventory builds and the like, we believe, in those areas that we have already seen some positive cash improvements this last quarter and we continue to plan to not only see those, but to drive those.

But in very even simple ways that I want to point out, often we make the topic complex and it needs to be simple. We talk turns, which honestly are not relevant to most employees. Instead, we're switching to days because people can get and relate to the number of days of inventory. How many days does it take to get in? How many days do you need in stock, and therefore what should your optimum number of days inventory be?

So we actually are not only looking at a fundamental change of how we think about the process in that we really want to align to cash flow being critical, but we also have changed how we communicate the topic to our employees, so that all the way down the organization, they can get it. I am a firm believer if you can't explain a topic, you probably don't understand it enough, and if you can't explain it to where they understand it, it's not going to impact results.

So, I hope that answers that question. I wanted to answer it personally because I feel very passionately about it, but I will let Aaron answer the other question.

The debt question?

Yes, sir.

Yes, Joe, so your question was why is debt up in the quarter? Actually, debt is actually down a bit in the quarter. It is down about $9 million.

I am assuming that you're looking at one of our slides, which compares July 31 debt balance to the current debt balance, and that's basically driven by a change in our cash balance. So our cash from July 31 is actually up about $18 million.

So that's really the driver, and frankly, the way that we look at this is we look at net debt and net debt has been trending down, and frankly, we expect it to continue to trend down.

Are those fair answers, Joe?

Okay, yes. Thank you very much.

Thank you. I appreciate the questions.

I would now like to hand it back over to Ann Thornton for closing remarks.

We thank you for your participation today. As a reminder, the audio and slides from this morning's call are also available on our website at www.bradycorp.com.

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Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.