Brady Corp (BRC) 2015 Q4 法說會逐字稿

Hello, everyone, and welcome to the fourth-quarter 2015 Brady Corporation earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to the Director of Investor Relations, Ann Thornton.

Good morning, and welcome to the Brady Corporation FY15 fourth-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, will, may, believe, forecast, and anticipate are just a few examples of words identifying a forward-looking statement. 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 FY14 Form 10-K, which was filed with the SEC in September of last year.

Also, please note that this teleconference is copyrighted by Brady Corporation, and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the internet. As such, your participation in the Q&A session will constitute your consent to being recorded.

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.

This morning, we released our fourth-quarter financial results. Although these results did not meet our expectations, we understand the issues. We understand the steps that need to be taken, and we are executing these actions. However, as you will see in our FY16 guidance and our longer-range forecasts, many of these actions will take more than a year to get fully reflected in our financials.

Our fourth-quarter under-performance was driven by two primary items, both of which are in our IDS segment. Organic sales in IDS declined by 0.3%. Coming into the quarter, we were anticipating low single digit organic sales growth. This slight organic sales decline was driven by an approximate 1% decline in the Americas, which, when digging a bit deeper, was caused primarily by ongoing macroeconomic challenges in Brazil, where organic sales were down just over 15%.

Clearly, our biggest challenge relates to our gross profit margin in the IDS segment, where we experienced a decline in the recently consolidated facilities in North America. We were operating with increased costs as we worked diligently to improve our customer service metrics. In our new facilities in Tijuana and Louisville, our freight costs have increased. Charges for inventory scrap have gone up, and excess inventory charges were also higher in the fourth quarter when compared to the same quarter last year. As we work through these types of costs and inefficiencies, we are making customer service our highest priority, which is critical to our long-term business success. It will be a continued effort and process, however, we are confident we will get back to the performance requirement to serve our customers and drive margin improvements.

The actions we're taking to address these issues as quickly as possible may be broken into two key areas. First, we've been working to acquire and retain the best possible talent for our organization. In certain sites, this has been a challenge, but we are seeing some stabilization and improvement. To put this in perspective, between our Tijuana and Louisville operations, we've hired nearly 600 people over the past 12 months. This workforce is improving its efficiency each and every day. As they become increasingly familiar with our products and processes, we continue to see opportunities for improvement in this area.

Second, we have recently added a strong operations leadership team to support local management to train these new employees, and to drive process improvements in our recently consolidated facilities. This team is dedicated full-time to Louisville and Tijuana, and has weekly milestones to meet regarding on-time delivery, reduced lead time, and reductions in backlog. We're pushing ourselves to improve upon these metrics every week, and we're making progress. Having this experienced group work interactively with our newer team members is helping to bridge the gaps, and provide the new teams with needed confidence.

With the physical facility moves behind us, we are focused on optimizing processes and serving our customers more effectively and efficiently, which I believe will return us to organic sales and profitability growth. My team and I have consistent contact with Tijuana through both in person visits and updates, and we're monitoring operational performance metrics on a daily basis. With this level of focus, we are confident that we will improve our customer service. We expect to realize operational efficiencies and improved organic sales in the back half of FY16. While in the first half of FY16, we expect to see continued year-on-year margin contraction and effectively flat organic sales as we work through our operational issues.

I'll be back to share further thoughts on the actions we're taking to drive improved financial results over the next three years. But first, let me turn the call over to Aaron to discuss our fourth-quarter financial results and our guidance for FY16. Aaron?

Thank you, Michael. And morning, everybody.

Slide number 3 includes an overview of our fourth-quarter financial results. Our fourth-quarter finished weaker than anticipated as both the ID Solutions and Workplace Safety businesses experienced organic sales declines. Total company organic sales declined 1.2%, and foreign currency translation reduced sales by another 7.7% when compared to the prior year. Including the impact of foreign currency translation, revenues were down a total of 8.9% to $288.6 million this quarter.

As we articulated in our news release this morning, during the quarter, we incurred impairment charges related to certain long-lived assets of approximately $47 million, which equates to approximately $0.91 per share. These impairment charges were primarily driven by continued sales declines in our Workplace Safety businesses in the US and Australia during the most recent year ended July 31, 2015. Although we remain confident that these businesses will improve sales in future years, the lack of historical revenue growth and the lack of sustained profit improvements are the main drivers for the impairment of these long-lived assets.

Bridging from our current quarter GAAP net loss to our non-GAAP net earnings, we are adjusting for $2.2 million of after-tax restructuring charges. $46.9 million of impairment charges, and $4.8 million of other non routine items. Excluding these items, our non-GAAP net earnings from continuing operations were $14.4 million in the fourth quarter of this year, which compares to $21 million in the fourth quarter of last year. In EPS terms, non-GAAP EPS was $0.28 in this year's fourth quarter, compared to $0.41 in last year's fourth quarter.

Slide number 4 is a summary of our quarterly sales trends. In the fourth quarter, revenues finished at $288.6 million. As I just mentioned, total Company organic sales were down 1.2%, and we had significant foreign currency headwinds further reducing sales when compared to the prior year.

Slide number 5 summarizes the trending of our gross profit margins. Our fourth-quarter gross profit margins finished at 44.7%, which is down from 48.6% in last year's fourth quarter. Excluding the non routine items that I just mentioned, our fourth-quarter gross profit margin would have been approximately 47%. The gross profit margin in our WPS segment was in line with the prior-year, and in line with our expectations coming into the quarter. Additionally, our European and Asian IDS businesses had gross margins that were effectively in line with our expectations coming into the quarter. Our gross profit margin challenges continue to be in our IDS Americas business. As Michael mentioned, this gross profit weakness is due to operational inefficiencies, as we work to restore our high level of customer service. We are working through these issues, and expect to see year-on-year improvements in gross profit margins in the back half of FY16.

On the left-hand side of slide number 6, you can see the trending of our SG&A expense. SG&A expense was down to $102.9 million in the fourth quarter of this year, from $111.3 million in Q4 of last year. Approximately two-thirds of this decrease was caused by the impact of the stronger US dollar, and the remaining one-third of this decrease was caused by reduced selling expenses versus last year's elevated fourth-quarter levels, which was primarily advertising expense in our WPS business.

As we look deeper into SG&A, let me draw your attention to the right-hand side of this page, which is a chart of just general and administrative expense. G&A expense finished at $28 million in the quarter ended July 31, 2015, which is down from $28.4 million in last year's fourth quarter. We are seeing reductions in all of our G&A categories except for IT, which is running on elevated levels due to certain system upgrade costs as well as ongoing costs related to our digital investments.

Slide number 7 shows our fourth-quarter non-GAAP EPS from continuing operations of $0.28, which compares to our non-GAAP EPS from continuing operations of $0.41 generated in the fourth quarter of last year. As I mentioned, our EPS did not meet our expectations and fell short of our guidance, due to the organic sales being below what we anticipated in our IDS business as well as the operational challenges I mentioned.

Our cash generation is summarized on slide number 8. Our cash generation was strong this quarter compared to the first three quarters of this year. During the quarter, we generated $40.6 million of cash from operating activities, compared to $17.6 million in last year's fourth quarter and $29.9 million in the third quarter of this year.

Looking at the chart on the upper left-hand corner of this page, the bars represent cash flow from operating activities and the line represents free cash flow. This chart illustrates how we have realized improved cash flow over the last two quarters, as we've put this period of elevated cash outflows behind us. The improvement in cash flow from operating activities is due to less cash outflows for restructuring, and better working capital management as inventories are no longer building, but instead, are slowly coming down.

We spent $3.1 million on capital expenditures in the fourth quarter. The majority of our capital spend was either part of our digital focus area, or was meant to drive efficiency gains in our operations. We have reverted to our historical capital expenditure norm of 2% of sales or less. Free cash flow finished the fourth quarter at $37.5 million, which was the highest level of quarterly free cash flow generated since FY13.

Slide number 9 summarizes our EBITDA and net debt trending. Our net debt to EBITDA was approximately 1.1 to 1 at the end of the quarter. Our total net debt position has been trending down since December 2012. At the end of July 31, 2015, our net debt was $139.2 million, compared to net debt of $181.4 million at the same time last year.

Our balance sheet is strong, giving us the flexibility to fund future growth opportunities and return funds to our shareholders. Given our significant improvement in cash generation in the second half of FY15 and our confidence in Brady's continued turnaround, yesterday our Board of Directors authorized additional shares for repurchase, bringing our total shares available for repurchase to 2 million. And yesterday, our Board also approved an increase in our annual dividend, marking the 30th consecutive year of dividend increases.

Our views on capital allocation are straightforward. Our first priority is to invest in organic growth opportunities, which includes funding the incremental investments in R&D, and funding any necessary investments in sales generating resources. 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 returns. We take a measured approach to share buybacks whereby we only repurchase shares when we have balance sheet capacity. And we do not have higher priority competing uses for our capital such as the recent period of elevated cash outlays for the core business. Our fourth and final use of cash would be for acquisitions. However, we do not expect acquisitions to be a significant use of cash in the near term. We believe that by executing a disciplined capital allocation approach that we can generate additional shareholder value.

Slide number 10 introduces our guidance for FY16. Our guidance reflects the realities of where we are within our turnaround, and clearly reflects our focus on improving business fundamentals in FY16. For FY16, we expect earnings from continuing operations per diluted class A non-voting common share between $1.10 and $1.30. Our guidance includes further EPS contraction from foreign currency translation when comparing FY16 to 2015. Most of this contraction will occur in the first half of this year.

If we would recast all of FY15 results at exchange rates consistent with those as of July 31, 2015, the $1.10 low end of our FY16 guidance range would effectively be flat with our 2015 financial results. And the top end of our FY16 guidance range would be approximately 16% to 18% over our FY15 results, again, using consistent foreign currency rates. Embedded in this guidance is organic sales growth ranging from approximately flat to low single-digit growth, with organic sales growth increasing as we progress throughout the year, and as comparables become less challenging. At this point, we are not anticipating any restructuring charges in FY16, and have not factored any restructuring into our guidance.

Other key operating assumptions in our guidance are a full-year income tax rate in the upper 20% range, capital expenditures moderating back to our historical norm of approximately $25 million, and depreciation and amortization of approximately $40 million. We also expect to see our investments in R&D grow in FY16, as we are focusing more time and energy on developing products, specifically in our PDC business. We expect these earnings-per-share challenges in FY16, the biggest of which, again, is foreign currency translation, to be effectively offset by operational improvements in our IDS business, where we incurred significant inefficiencies in 2015, related to our facility consolidation activities.

I'll now turn the call back to Michael to cover our platform results, to discuss our long-term financial outlook. And to provide some closing comments before we turn the call over to Q&A. Michael?

Thank you, Aaron. Slide 11 includes a summary of the fourth-quarter Identification Solutions financial results. Organic sales were down 3%, while foreign currency translation decreased sales by 5.7%. In total, sales were down 6% to $201.5 million in the fourth quarter. Sales did not meet our expectations of low single-digit organic growth this quarter, primarily due to sales weaknesses in the Americas region.

I mentioned the customer service disruptions that were an unintended outcome of the movement of facilities. And while we are working to correct these issues as quickly as possible, the short-term impact has been the reduction in profitability levels that we experienced this quarter. Setting aside the businesses that were impacted by the facility moves, the remainder of the North American IDS business performed reasonably well, showing moderate organic sales growth. We are 100% focused on fixing our operational issues, and returning the business to organic sales growth. The European-based IDS business performed well during the quarter with low single-digit organic sales growth throughout the region, while organic sales in our Asian businesses were effectively flat.

Segment profit finished at $29 million in the quarter, compared to $43.3 million in last year's fourth quarter. As a percentage of sales, segment profit was 14.4% this quarter, compared to 20.2% in last year's fourth quarter. During the fourth quarter, we incurred approximately $7.4 million of non routine charges as we wrote off certain unfavorable purchase contracts and recorded other charges, such as severance and one-off hiring costs that were not recorded in restructuring. Excluding these items, IDS' segment profit would have been $36.4 million or 18.1% of sales. The remaining drop in adjusted segment profit from 20.2% last year to 18.1% sales this year is due to the operational inefficiencies that I just mentioned. Clearly, we are not happy with IDS' finishes this year. As we look ahead, we expect that the IDS platform will return to low single-digit organic sales growth in FY16 with growth continuing to come from our Brady brand business, and accelerating in the back half of this year.

Looking at profitability in FY16, we expect to see improvements in our segment profit trends versus how we finished FY15 with full-year segment profit in the high teen percentage of sales. We have invested in sales generating activities in focused industries, and we are increasing our R&D investment in FY16 to stay ahead of our competition through the development of proprietary new products. We have several product launches planned for FY16 with our safety and facility ID product category, as well as new solutions for our customers in the aerospace and mass transit interest industries. Overall, I like where we are heading in IDS. But make no mistake, our first priority is improving our customer service levels and driving operational efficiencies. We are definitely focused on improving profitability and expect to see year-on-year improvements in profitability in the back half of this fiscal year.

The Workplace Safety review begins on slide number 12. Organic sales declined 3.2% this quarter, and foreign currency decreased sales by another 11.7%. Approximately half of the 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 the euro and the Australian dollar had a much larger impact on our Workplace Safety business. Coming out of the third quarter, we did not expect this business to return to organic sales growth in Q4, primarily due to the challenges in our North American and Australian-based businesses, where catalog sales have been declining, while the increases in digital sales have not been enough to offset the catalog sales declines. In our European-based businesses, organic sales grew in the fourth quarter throughout the region as both catalog and digital sales showed improvements over the prior year.

Looking ahead to FY16, we expect the organic sales decline for the WPS business to continue into the first half of the year, improving to low single-digit organic growth in the second half of the year, and finishing the year approximately flat with FY15. Although our European-based business is performing well, the growth in digital sales in the US is slower than originally forecasted. And the current economic weaknesses in Australia are expected to continue through at least at the beginning of FY16.

Segment profit in the Workplace Safety platform was $15.9 million in the quarter, compared to $18.4 million in last year's fourth quarter. On a constant currency basis, segment profit in WPS was relatively flat compared to the prior year. As a percentage of sales, segment profit was 18.2% this quarter, compared to 18% in last year's fourth quarter. Our segment profitability is still not where we'd like it, due to our investment in growth initiatives and the lack of top line growth. However, I'm encouraged by the more than 400 basis point improvement in segment profit as a percentage of sales compared to the third quarter this year. And I believe we're on track to continue to improve year-on-year profitability. Historically, our fourth-quarter is our highest profit quarter. Partly due to stronger sales volumes, and partly due to the timing of certain advertising campaigns in Europe where we slowdown advertising campaigns in the advance of the European summer holiday season. Looking ahead to FY16, I expect segment profit to be in the mid-teen percentage of sales.

The WPS business remains focused on driving three primary goals. First, we are focused on effectively managing the catalog to digital channel shift that is underway through effective and efficient catalog prospecting, continuing to attract new digital customers, and improving conversion rates. Second, we're creating an industry-leading digital business through a mobile led design by building websites with Mobile-First mentality, all major global sites will be on a mobile platform or by the end of FY16.

And lastly, we're driving to bring product leadership in the safety identification segment through a comprehensive product review to ensure we are offering an appropriate amount of customized and innovative products within each category. Our continued focus and investment in these areas will allow us to drive value over the long term through attracting new customers, and driving an increase in digital traffic and digital revenues.

Before turning the call over to questions and answers, I'd like to provide a few concluding comments. Over the last 101 years, we've developed powerful brand at Brady. A strong reputation, and a commitment to quality that is the foundation of the organization, the culture, and the people. Over the past year, I've traveled extensively and visited almost all of our sites around the world. I've personally met with many of our employees, and I know we have a strong team that is dedicated to executing everything we do in a world-class manner and providing the best possible experience for our customers.

As we reflect upon FY15, we know that we've achieved a great deal through the completion of our facility consolidations. And we've made significant progress in our digital and mobile efforts. However, we have to work to get back to executing the fundamentals of doing business. Slide 13 provides an overview of my expectations for the future. As we look out over the next three years, we anticipate low single-digit organic growth, effectively in line with GDP. We are also laying the groundwork for Brady to grow at a faster organic growth rate in the future as we focus on the development of integrated solutions and embedded technology to create smarter products and to improve our digital presence, which will enable us to accelerate our organic growth.

I mentioned that our primary focus in FY16 is on improving our operational efficiency and customer service levels in the facilities that we recently consolidated. This is not a one-year fix. Over the next three years, we will focus heavily on driving operational efficiencies across all our facilities that we believe will enable us to exit FY18, delivering approximately 200 to 300 basis points of improvements in our gross margins compared to FY15. This margin improvement is net of the areas where we believe we may see margin contraction due to competitive activities. We'll also strengthen our profit margins by further rationalizing our product offering.

SG&A expense is an additional area where we have significant opportunity for improvement. As we've discussed in prior calls, we're pushing a decentralized operating model with standardized processes.

We are actively taking steps to simplify and streamline our organizations. We're focused on driving down our G&A structure, and we're also taking actions to better align the cost structures of our under performing businesses. These activities, which will be partially offset by selected growth investments over the next several years, should deliver another 200 to 300 basis point improvement as we exit FY18. We absolutely will have opportunities to drive down SG&A even further. But as of right now, we do not have a clear line of sight to additional improvement beyond this 200 to 300 basis points.

By being highly focused on a few critical initiatives and executing them extremely well, we are positioning the Company to achieve double-digit net income CAGR over the next few years. This net income growth will be supplemented by disciplined cash deployment, including share buybacks and dividends, which will enhance our total shareholder return.

I'd now like to start the Q&A. Operator, would you please provide instructions to our listeners?

(Operator Instructions)

Allison Poliniak, Wells Fargo.

Hello, guys. Good morning.

Good morning, Allison.

Hello there. On the Workplace Safety, the organic decline. Is there a way you can help us dissect what was the price impact to the top line versus say a volume impact to that core number?

Allison, I apologize. Could you repeat that question?

Just looking at the organic decline in Workplace Safety, what was the price impact as well as the volume impact there? Can you dissect that a little bit for us?

I can answer that, Allison. And the answer is from a pricing perspective, we did not have much in the way of a pricing impact at all in the fourth quarter.

Okay. So it was mostly a volume impact then?

Effectively all volume, yes.

In fact for our total business to expand upon that, Allison, we are not seeing the pricing pressure as the driving point of our issues at all.

Okay. That's perfect. And then, going to the SG&A. Aaron, your comments around the -- it would of been down, absent elevated IT related costs. Can you help us -- what would quantify that impact a little bit more? If we would've not had those costs, and I understand we need it for growth. What would -- how much would SG&A have been down?

So it finished at $28 million, basically $28 million on the head. It would have been down approximately $2 million more. Now the reason that we didn't dwell on that significantly, is frankly, we need some of these investments clearly for growth. So IT is clearly an area. It has been an area of elevated spend this entire fiscal year, and we don't anticipate significant reductions in that spend in our FY16 guidance either.

But to expand upon that, we believe we've made some very, very important changes in IT to help our growth in particular. We had not gone into FY15 with a knowledge base related to really needing to make a significant and swift transfer into true mobile applications. At the end of the year, we walked out with four world-class mobile sites. I'd love anybody to feel free to go onto a [medco] using their phone as an example. The change to allow us to quickly and easily facilitate the customer's need to find our products, select our products and purchase our products on a phone or tablet device is a major shift in our ability that is paying off. And in fact, this year, we plan to expand that to include another 20 sites, for a total of all of our major sites. So we're making major strides forward. And we believe in our space, we are now creating a world-class experience in that way as compared to our competitors.

Okay. And that brings me to my last question. On the competitive side, you said -- you felt that you had to accelerate this. But in general with some of these inefficiencies that have happened and so forth, have you perceived a loss of customer share anywhere? Or this is just what you're doing to hold onto it, as well as potentially increase it longer-term?

Overall, we are not looking at a degradation in market share. I would say there are a couple of specific businesses related to consolidation, where the consolidation effort absolutely impacted our customer focus in a negative manner. We are working to regain that. But as you well know, it is easy to keep happier customers then regain them.

Yes. Sure. Fair enough. Okay. Thank you very much.

Thank you. Appreciate the questions, Allison.

George Staphos, Bank of America.

Good morning, George.

Good morning. It is actually Alex Wong sitting in for George. Thanks for all the details.

Absolutely. Thanks Alex.

Just starting out with IDS, can you provide some color around the trends by product groups? Whether it's healthcare, safety or product, and what were the trends exiting the quarter?

I'd like to talk a little more generically if I could. I will say we're very excited in the long-term growth prospects of our healthcare business. We believe going into 2015, we had not been investing in development of new products and R&D in that space at all, despite our PDC business. We have changed that methodology dramatically. And as a result, the group is both energized, motivated, and I am extremely excited about the product sets that they will be introducing in the next few years. Now, it does take a little longer, as you are aware, in healthcare, to gain traction with products. But once you've gained it, you have significant hold on the customer as opposed to some of our other industries.

In addition to that, I believe you were asking about the safety identification space. That is an area that we're doing well in. But we can obviously continue to do better. We haven't seen a downward trend. We're actually pushing for an upward trend, and believe we have differential advantages there. Once again, as we invest in new and R&D and new development efforts that are really designed to reflect the voice of our end customer, much more effectively than we had before, that we will continue to see growth in what is already a very, very strong space for Brady.

Got it. And then, just on emerging markets. Can you remind us how big Brazil is for you? I seem to recall a range of perhaps something around mid-single digits in IDS. But can you confirm that?

And then, are you seeing any spillover effect in Asia-Pacific? I know Australia is a big piece, but just wondering if you can provide some color there.

Yes. Alex, this is Aaron. I actually can. And that is our Brazil business in US dollar terms, frankly, has been shrinking quite substantially. Partly because of the organic sales decline that we just mentioned of actually a bit north of 15%. But frankly, more importantly, the depreciation of the Real. So our business is now sub $20 million, so it's been shrinking.

And that is quite a challenge, if I could add some color that, based particularly on your spillover effect. If we start by looking at Asia, that area for us has been flat, and it's been a tremendous macroeconomic challenge. In particular, if we dive down a little deeper, you'll see that it's China that is actually the cause of the challenge.

I don't think that should be a surprise to anyone on the call, based on the macroeconomic issues in China and the difficulties that everyone is facing there. That said, Brazil is a significantly bigger challenge for us. And the changes there are concerning, not just to us but once again to everyone doing business in that country right now. We are reacting quickly and actively to that situation. We have been there for a long time.

Our new President of the division is getting his feet wet in a strong way in that area. He is working actively and personally with me and with Aaron and with the leadership in that organization, to make sure we're making the best long-term decisions to maximize value for Brady.

I appreciate that. And then just a last question on the facility consolidation in IDS. Part one, is there any way to quantify maybe how much of the revenue base is being impacted by the consolidation? And then secondly, it seems like the timing of the consolidation efforts have been a little pushed out in terms of some of the issues. Understanding the details you provided, what makes you confident that this strategy laid out in terms of adding talent and having an operational team on top of that really is the right way to go about it and to see improved trends in the back half of 2016?

Let me start -- I think that's a very fair set of questions. Let me start with your first one. The impact was actually quite significant to the tune of about $6 million. But also was fairly good margin business. So we are rebuilding from that point in regard to the revenue. But beyond that, I want to be clear, operating efficiencies in our new locations are not nearly to my level of expectations, or to the level of operating efficiency that we had in our existing facilities. Long-term, we are going to change that dramatically. I know that the infrastructure we've put in place in Louisville is far superior to the infrastructure we had before. And in Tijuana, we believe fundamentally, that we can create a workforce and a dynamic environment that will improve on our situation there as well. So we are making great strides forward. Did I -- if you could repeat any other parts of your question you had? I'd be glad to answer further.

I think you touched on it. Just really wanted to gauge your temperature in terms of why expect or are confident in a return to better growth in the second half, and why this structure you've put in place it really is the way to go about it.

We were digging, as you astutely assessed, and we mentioned, we were digging out of a hole that we created. So since we no longer have that hole and are digging out, we have good confidence. That as we dig out of the situation, as we become much more efficient and effective, we will be able to drive our focus back to where it needs to be. And that is innovation, customer service, working directly with our customers and our channel partners to make sure we provide what we do very, very well. And that has not been able to be our total focus over this past year.

Thank you. I'll turn it over.

Thank you. Appreciate the questions.

Mig Dobre, Robert Baird.

Yes. Good morning, everyone. Just two questions for me. The first one, trying to clarify your guidance a little bit here. Can you confirm at the segment level IDS and WPS, whether or not you expect the margin to be flat, up, or down next year? What's embedded into guidance? And related to this, Aaron, maybe a comment as well on administrative costs. They were $107 million this year. Where do you expect this figure to trend next year? What's embedded it's your guidance at the midpoint?

Let me touch on the platforms first. So our comment was on ID Solutions that we anticipate upper teens, if you will, from a segment profit margin. We finished the year of 2015 at about 18.5% or so, 18.6% to be exact. So we would anticipate slight improvements. With year-on-year improvements in the back half of the year. On the Workplace Safety side, we finished the year at 15.5% segment profit margin. And our guidance was mid -- I'll say mid -- I'm sorry -- mid-teen segment profit margins. So we would expect, I'll say, a slight increase in our Workplace Safety profit margin.

From a G&A perspective, we do anticipate, and as Michael mentioned in his prepared remarks, we clearly are focusing on driving down our G&A expense. Actually focusing on driving down SG&A expense to be a bit broader. And as we look at the run rate coming out of the quarter, going back to your question specifically on G&A, we finished at $28 million in the quarter which is effectively, I'll say, a pretty good run rate going into FY16. So that's effectively what we've factored in. So not huge improvements in G&A in FY16, but as Michael commented, this is clearly an area that we see improvement opportunities in FY17, FY18, and beyond.

Okay.

To be very specific on that on the longer term, we're looking, as we really decentralize our model, to make sure that we're doing business differently and not the same way we've been doing it and trying to squeeze savings out of just cuts. The goal will be to make sure that we actually gain the advantages of the decentralized model.

I appreciate that. Thanks you. And then my follow-up, as I'm looking at goals that you outlined for FY18. One of the things here I see is product rationalization as a gross margin driver. And I'm wondering here, as you look at your product portfolio, where is it that you believe some products need to be rationalized? What role have these products had in compressing margins? And I'm thinking here specifically for the ID Solution business. And how big of a challenge is it to be able to accelerate growth while you're, in fact, shutting down or getting rid of product?

Those are great questions. I actually want to change the term. I realize we used rationalization in our presentation, and that's because that's more of an industry-standard term. We are using optimization within Brady. And there's a significant real difference between rationalization and optimization. And the reason for that is, we do have a large curve and a long tail in many of our products. But for us to take a look at that tail and say we're going to cut the tail, would be dramatically problematic. And therefore, a very easy solution is not one that would be very effective for us.

To give you a great example is, we sell the alphabet and we don't sell very many Qs. But you can't pull the Q out of the alphabet and say, since we don't sell a lot of them, we're not going to have them. Other examples are, we need to be offering full portfolios to our customers of offerings, and we may sell a product in red, white, black, yellow, purple, green, orange. And we literally may not sell any of the yellow, purple, green, and orange. But we need to be able to present, or extremely small amounts, we need to be able to present the full product portfolio to our customers so that they understand that if they have needs in those areas, they can create products.

Another opportunity for us is we have great, great selling, great margin products that have sister products that we have not effectively marketed together with the primary product. And as an end result, the sales difference in revenue and margin of the one product to the other is dramatic. We need to make sure we understand where those products are, how we need to tie them together, and how we need to drive them forward. Then, there are some large opportunities, and this is speaking to IDS specifically, where we have products that really, A, don't relate to our other products. B, aren't really in our driven market segments. And, C, to your point, may actually be pulling us down as opposed to raising us up. I am more than willing to take a revenue hit if the end result is better total profitability for the Company. And we will therefore, drive our revenue growth through innovation, new products, new emerging markets, which we're also excited about, and new industries. More than glad to drive our revenue that way. And we are changing some of our models with our total Company force so that they understand that it's profitable growth that counts. And growth for the sake of growth is not acceptable. And straight out, there are some segments in some parts of our business that that disconnect has been obvious to me in the recent past. And we need to work hard to fix that.

Sure. I appreciate that, but sorry to press you on this. As your coming up with this target of 200 to 300 basis points, which is obviously pretty specific. I'm wondering as you are looking at your revenue base and your SKUs, what percentage of that would be addressed as part of this optimization process?

At this point, although personally I'd like to say it for our analysts. I don't want to speak publicly to it, because of the competitive nature of that answer. I will tell you that we do have a specific target. Not based on an arbitrary number, but based on some very extensive analysis we've been doing over the past six months. And that target will shift some of our product offerings, but I want to be very careful about publicizing that target at this time. Not because of you or the analysts, I'd be thrilled. But just the competitive nature some of that information. But you should know that we have been doing an awful lot of analytical work prior to setting this as one of our major focal point initiatives for the year.

I appreciate it. Thank you, and good luck.

Thank you. Appreciate your questions.

Charley Brady, SunTrust Robinson Humphrey.

Good morning, Charlie.

Morning. How are you, Mike?

Very good sir. Thank you. I appreciate it.

I just want to touch base on the digital sales. Can you give us a sense of what percent of sales in the quarter are on digital on both of the segments? And then just maybe drilling into WPS, you talked about how the Australia catalog sales are down. Europe is up, but not enough to offset on the digital side and offset the catalog, or maybe I've got that actually flipped. But give a sense of where digital sales are today on the segments, and the maybe those two regions for WPS?

Yes. Morning, Charlie. This is Aaron. I absolutely can comment on the digital side. So with respect to Workplace Safety. If you look at the total revenue base in Workplace Safety, which would include certain businesses frankly that don't have much in the way of digital sales at all because that's not their business model. If you look at the total revenue pie, 15% of that is digital sales. And if you go back in history, a little over a year ago, it was about 13% of the total pie. So clearly, digital sales are growing in the Workplace Safety business, and that's really where our main focus is. Now we obviously have digital sales in our ID Solutions business, it's much less. It's not a critical piece of the sales, and frankly, we haven't talked about it that much externally because it isn't as relevant to the organization. So that's where we stand with digital sales.

Sure. Let me add a little color to that. Let's start with the IDS, which is a smaller portion, but we'll start. We are also transferring their platforms to be able to be mobile capable. Because we want the next generation of users, and hopefully the tech savvy generation that I'm in, to be comfortable and at ease working with Brady products regardless of the platform and able to facilitate their needs quickly. That said, a much larger driver of revenue in the near future is affected in WPS. The markets are quite different, Australia, you mentioned, as an example. There is a particular case of where the mining industry, all of the commodities, are a major factor to their economy. And therefore, to our economy within Australia. That's been a major drag.

As far as the actual digital models, the United States is changing rapidly, more rapidly than Europe, as an example. And the United States, that transformation which initially we were behind in our actual in platforms, I now believe we're ahead of our competition. But we have to migrate that to all of our different platforms, as opposed to the four that we've created. That means that we had some catching up to do, and that we have not gained the traction of that change over as significantly as we would want to. Because we really do do a tremendously good job with catalogs.

So now switch to Europe, since that transformation has been much more limited in Europe, the Europeans are and it appears remain much more comfortable with the catalog than you -- particularly with all the languages involved. I believe, and don't hold me to the exact number, but it is 15 different languages that we produce catalogs, unique catalogs in Europe. That creates a great advantage and a great niche focus for us, that has allowed our sales to grow and to grow well in that area. So really what you're dealing with is very different profiles in those different business areas. And that's why you're seeing different results, and that's why we're being a little more open today about explaining what the root causes are. So that it does help you to understand why we're seeing pressures in one area versus another area, and why that rolls up to the stream that you're looking at. Hopefully that helps.

So the color is helpful. Do you have a digital sales percent target looking into 2018 and where you see that going to?

That is not something at this point we want to speculate. And I will say, straight out, that things are changing so rapidly in some areas that I think it would be at our peril to speculate on an actual percentage. What I will say is that we understand it's a need to be properly positioned in the digital space. We have actually made a leapfrog effort in that area. Leaping beyond technology where we're behind, to the technology and platform methodologies where we're actually ahead. And we're going to stay ahead, because we believe that our product offerings, our customer service, our methodologies to get to the market, our reputation, all make us a strong presence in the market. And what has been in inhibiting us to the largest extent is the fact that people found it almost impossible in many cases to reach us in the -- through the internet, and through mobile applications.

Great. I appreciate the color. Thanks.

Thank you. Great questions.

Joe Mondillo, Sidoti & Company.

Good morning, guys.

Good morning, Joe.

Just trying to understand the IDS margins a little bit better within the quarter. You highlighted that Brazil was down, but your overall organic volume was pretty much flat. So it looks like currency and inefficiencies are the big two items there. Could you just weight how much the inefficiencies played a role in that? And it seems like it's taken a little bit longer time to work through those inefficiencies, I thought they'd be behind us by now. If you could just give us a little more color there?

Absolutely. The very good news is, we are not seeing margin pressures from the top, from the revenue line. That's excellent news, very positive. We've also done a lot of analysis in this area to make sure that we aren't seeing dramatic pushes in margin erosion from that end. That's the good news. You were correct, though. The operational inefficiencies, and I'll actually have Aaron comment specifically on that in an instant, are what's driving the key difference with what I would expect, what I want, to what we're doing.

If we take a look at how we consolidated in Europe two years ago, and how we consolidated North America last year, fundamentally, our expectations, our method to deploy things, our approach was problematic at best. We ended up transferring an awful lot of technology very, very quickly, without the level of blueprint, so to speak, the road map, and the core support that was needed. Once you get behind that curve, it becomes extremely difficult to catch up. And we've been pouring vast resources, and continue to, into that.

We have lots of employees that are very new at their jobs. They have high enthusiasm, but low experience rates in what we do. And we have been stretched thin as a result with making sure they have the proper support and proper capabilities.

We see, in looking at these operations, that customer service has to be our number one priority. As such, you are going to see a much higher level of support, and therefore, cost than we would normally believe these businesses should or would dictate. That's going to remain for a while, because we're not going to get behind that curve again. Aaron, do you want to comment on any specific numbers related to that?

Sure. Yes. Let me just recap a couple of numbers related to the IDS profitability, and that is, the reported profitability was 14.4% segment profit. Included in that 14.4% were a fair amount of non routine charges to the tune of $7.4 million pre-tax. If you exclude those items, the IDS segment profit would have been 18.1%, which of course, is still down from the 20.2% last year. And that gap from 18.1% to the 20.2% is exactly what Michael is talking about. It's the inefficiencies that we are still feeling within the platform.

Let me add one more comment. What could I have done differently in this past year? In hindsight, looking back at the situation, we needed to flood those businesses with even more support by far when we saw how bad the problems were. We began flooding them. We began bringing in people. But I believe that if we want to learn from our mistakes, we have to own up to them and we have to move forward. A couple of mistakes that I believe are key is how we went about the whole project. But then once the project was becoming such a challenge, we should have added even more resource quicker. And that may have cost us even more initially, but I believe in the long-term when you do that, it ends up costing you less over the total life. We are absolutely in that position right now. We are absolutely doing that. And, as a result of the situation, as I said, we'll be doing it longer and in a more costly manner than I would certainly like. But I'm not about to change that approach right now until we all feel confident that our customers are going to continue to get the service that they expect and deserve from us.

Okay. Just to clarify one last point regarding that question, though. Aaron, the 6% headwind on the currency, is that similar on the operating income line?

Let me think. Yes. I think that that's probably a good assumption. That it's consistent. I don't have the numbers in front of me.

Okay.

I'm shooting a bit from the hip. But yes, I think that that would be consistent.

Okay. I also just wanted to ask you, regarding the guidance. You mentioned in the prepared remarks that excluding currency, the EPS guidance is calling for flat to up around I guess 17% growth. What kind of scenario -- you also mentioned in the guidance that the top line you are expecting modest organic growth on the top line. So I guess, what kind of scenario or how do you get to the low end of guidance? Considering you're trying to reduce your G&A structure even more, hopefully improving efficiencies. That alone with some organic growth, how do you get to the low end of guidance? Are you just being conservative there? How do you get to flat EPS considering all that?

Yes. The way that you get to the low end of the range would be an assumption that some of these efficiencies, actually a big piece of the efficiencies that we've been feeling, continue into the future.

Inefficiencies?

Inefficiencies? Yes, inefficiencies.

He needed to add an i into that.

Right. Okay.

That would clearly would be the big piece. Would be the inefficiencies continuing in IDS.

And as I said before, and I don't want to be redundant. But we are going to err on the side of caution at this point. In regards to making sure our facilities are staffed with experienced people who can help the transformation continue to go at the most effective methodology. And that will be -- the change will be determined when we feel very confident that we can slowly remove some of the safety nets we've put in place.

Okay. And regarding these inefficiencies, I guess you could call them extra additional costs related to customer service as opposed to inefficiencies. But in regard to this, did these escalate in the fourth quarter? So in regard to my original question regarding the flat EPS on the low end of the guidance. If they escalated in the fourth quarter, if they remained flat for the rest of this year, you -- that would answer my question in terms of -- is that how it happened? Did they escalate in the fourth quarter?

I want to be clear. Yes, they did escalate in the fourth quarter. That relates to my earlier comment about if in hindsight, one area that I would've fixed earlier would have been to flood the businesses with even more support. Although we had given them a fair amount of support, even more support earlier. And yes, you're seeing that reflection of that change in the fourth quarter, and you're seeing that ongoing cost.

Okay. And also, I always looked at this business as a GDP type of a business. You grew the business organically 3% in 2014, in this past year, you grew it about 2%. It's hard for us to see how your, I guess, giving up some of market share related to the customer service or end. Help us understand that.

And then also, my last question, I just wanted to understand if working capital is going to be a use or source in the next 12 months.

I'm going to have to ask you -- we had a technical glitch right after you said you'd seen this as a GDP business. The technical glitch interrupted some of your question.

Sure. I'm just -- from the numbers, from our perspective, it looks like you've actually been growing quite well. I have always thought the IDS was sort of a GDP type of the business, you grew 3% in 2014, 2% in 2015. Considering the global slowdown, it doesn't seem that far off. However, you're having to throw additional costs, trying to feed customer service. I'm just trying to understand why do you feel the need to increase the costs considering that it seems to be growing organically to what I at least would think that it should be growing at, considering the global environment. Help us understand that.

And then just finally, working capital, do you think it's going to be a use or source in the next 12 months?

So to answer your question, I fundamentally believe the core of our business is a GDP growth business. I also believe that we have technologies that we are going to deploy in the future that will be supplemental to that core GDP business. So in the three to five year timeframe, we hope to have additive -- we expect to have additive revenue on top of that from these initiatives.

That said, your question comes back to, if I see the growth around GDP, and your consistent with that, and you plan to do that in the future, why are you adding the resources? And the answer back is, I think you have to look under the hood of the engine. The engine may be heading to the hill. If we aren't very, very positive with our customer interaction and we haven't been. That our customers could have reason to grow frustrated with us, despite our great history, despite our great products. We need to make sure that that doesn't happen.

With a company our size, with our history, there's a lot of natural momentum built into the flywheel. We can't afford to jeopardize that momentum to get it restarted again. As we see in the case of the revenue that we lost, is much, much more difficult than keeping it going, and so we absolutely know we have to add the resources. We had to add it to make sure the customer experience went back to the expectation that it had been. Yes, they were buying. But that doesn't mean they're happy, and you want to make sure your customers remain extremely happy with you. Now, let's get the other half of that, Aaron, if you don't mind.

Yes, your other question was on working capital and the cash flow impact. As you know, our fourth quarter, we did have a nice, I'll say, a nice tailwind from working capital. We do anticipate that a piece of that will continue into FY16, specifically with respect to inventories. Inventories are still at an elevated level, and we are planning for some of that to come down. So we expect working capital to be a slight tailwind for us in cash flow next year.

Great. Thanks a lot, guys.

Thank you. Appreciate the questions.

Keith Housum, Northcoast Research.

Good morning, everyone. Thanks for the additional detail on some of the issues of IDS, because it's very helpful.

Mike, if I can ask a question. You're looking at the margins, let's talk about margins, going back several years back to 2012, 2013. It looks like they've declined just about every year. And we've talked previously about Workplace Safety, how those segment margins are probably hit a new normal, or they're not going to be nearly what they were. Is the same thing -- can that be said for IDS as well once you get past these operational efficiencies? Or do you think you can return back to the 25% segment margins you saw several years ago?

Well for WPS, you're exactly correct. We believe that we have reset to a new norm in that area.

As far as IDS as one of the things I said earlier in my point, was very good news is we've been analyzing over the last year plus. And I don't want to go back too far in detail, but we have not been seeing pricing pressure in that regard. So we do believe fundamentally over the next two to three years, we will be able to offset some reasonable amount of pressure that we see in the future from competitive situations. And improve upon that, based on the fact that the biggest by far drag on our margins have been the operational inefficiencies created through the consolidation efforts. And there literally is no number two at this point in that the number two is much, much farther down on the scale.

Okay. Appreciate that. And that if I could just move over to I guess the Asia-Pacific region. Clearly, we all understand that that region is having some difficulties on a macro level there. But it's also been a source of what you probably -- the largest source of some of your investments over the past year. Is there the opportunity that those investments will offset some of those macro headwinds and may actually allow you to grow in that region over the next year?

Absolutely. We are a small enough player in the region, obviously both as a percentage of our sale and a percentage of the market that we do see some potential upside. We certainly don't want to count that into our guidance. We certainly don't want to plan, because some of these programs because they tend to be much more OEM based in Asia, take longer. And so we continue to invest in the region, particularly for OEM type export sales. We're not counting on that lifting the boat this year, just due to the nature of the timing of those.

Okay. And finally, just the last bit of color on the IDS issues you are having now. Is this a matter having the right people in place, is it a matter of the processes or the training? Is the right people in place, is there perhaps the risk that you've got to perhaps pay more to get a higher quality person in place?

We've made a lot of decisions in that realm. I don't want to get into the actual specifics of pay and things along that nature. But I will say we've analyzed our cost structure, our pay structure, our personnel involved, the experience levels, our overall support structure, our processes and procedures. We've literally gone under the engine every way possible. And in many ways, yes, have had to make some changes based on some initial analysis done a couple years ago in some cases wasn't actually applicable to the end situation. So that may be the level of people involved, that may be how we structured it (technical difficulty) some very positive changes in that regard.

Okay. Thank you. Appreciate it.

Thank you, sir.

I would now like to turn the call over to Ann for concluding comments.

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. The replay of this conference call will be available via the phone beginning at 12:30 PM central time today September 11. The phone number to access the call is 1-888-286-8010. International callers can dial 617-801-6888, and the pass code is 81389331.

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