Brady Corp (BRC) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Brady Corporation fourth-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Ann Thornton, Director, Investor Relations. Ms. Thornton, you may begin.

Thank you. Good morning and welcome to the Brady Corporation fiscal 2016 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 fiscal 2015 Form 10-K, which was filed with the SEC in September of last year.

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

I 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. This morning we released our fourth-quarter financial results, and I am pleased to report that we finished fiscal 2016 with four consecutive quarters of improved profitability. This quarter we increased earnings per share by 75% when compared to non-GAAP results of the fourth quarter of last year, and we had another quarter of strong cash generation. Our consistent focus on the fundamentals of producing high-quality products, providing excellent customer service, developing stronger manufacturing processes, and pushing for efficiencies in our G&A structure are the primary drivers of our improved financial results.

We finished the year well, and I'm pleased with our consistent drive throughout fiscal 2016. Our improved financial performance is a direct result of the team's focus on continuous improvement and operational excellence.

Our goal, however, is not only to improve short-term financial results, but to provide the foundation for a strong future. Each employee is focused on making the right decisions today that will ensure our long-term success -- whether this is through creating a new, innovative solution for our customers; taking the additional time and effort to implement a process improvement; or taking those additional steps necessary to make our customer's experience an excellent one. In many instances these actions don't pay off immediately, but instead set up Brady for a longer-term success model.

Organic sales declined by just under 1% in our fourth quarter, which was effectively in line with our expectations coming into the quarter. Our R&D and new product development efforts continue to be a top priority, as a strong pipeline of innovative product offerings is essential to our ability to grow organic sales over the long-term.

As I have commented on in the past, we are driving down two parallel paths, with the first path focused on driving operational improvements, which includes creating the right culture for success -- a culture based on local ownership and accountability, where the right behaviors are incentivized. We deliver what we promise, and we put the customer at the center of everything that we do. And driving efficiencies and simplifying processes in our manufacturing facilities: investing in more effective high-quality equipment, optimizing our product offering, reducing our centralized G&A structure, and streamlining the processes that will result in a relatively high current SG&A expense. Our drive for operating improvement has clearly had a positive impact on our financial results this year.

The second path is focused on rebuilding our organic sales engine. In our WPS business we are actively managing the catalog-to-digital shift. I'm excited to say that we are creating an industry-leading digital marketplace with a mobile-first mentality, and we are sharpening our focus on compliance and customization for workplace safety-critical industries.

In our IDS business we are investing in our new product development process and emerging technologies to create smarter products. Our product development process and pipeline are clearly getting better, but will continue to take some time before the real impact of new product launches is evident in our financials.

Across the entire Company we are driving a renewed focus on innovation. We are hiring selected commercial resources where we see opportunities for growth, and we're reinvigorating our focus on improved customer experience. Putting the customer at the center of everything we do will always be a bedrock of Brady's approach to innovation.

Despite the challenging economic environment, I am more confident than ever in Brady's future. Our ability to take action and execute our financial and operation goals has improved significantly compared to last year, but we do have more work to do.

Achieving certain goals this year only means we will push for more next year, but this is the core of continuous improvement. And it is what I believe is essential to delivering long-term value to our shareholders. I want to reiterate that I am proud of what we accomplished this year, but we have to continue to push for more in fiscal 2017.

We expect economic conditions to be challenging, resulting in low single-digit organic sales declines to slightly positive organic sales growth next year. Our channel partners have noted challenging economic conditions, and many other industrials have reported weak revenue growth, specifically within the US and Canada. Our top priorities will be to continue to have efficient and effective R&D spending, a focus on operational efficiencies throughout our manufacturing facilities and within G&A, and growing organic sales.

I will now turn the call over to Aaron to discuss our fourth-quarter financial results. I will then be back to provide some specific commentary on our identification solutions and workplace safety businesses and a few closing comments. Aaron?

Thank you, Michael, and good morning, everyone. I'll start the financial review on slide number 3.

This quarter revenues were down 2.3% to $282.1 million when compared to the fourth quarter of last year. This decrease consists of an organic sales decline of 0.9% and a decrease of 1.4% due to foreign currency translation.

Our GAAP diluted EPS finished at $0.49 in the fourth quarter of this year compared to a GAAP loss of $0.77 in last year's fourth quarter. We benefited from a lower than normal tax rate in the fourth quarter of this year due to the conclusion of certain audits. If our tax rate would have been closer to our historical norm of approximately 28%, our EPS would have been $0.04 lower this quarter. These results compared to non-GAAP diluted EPS from continuing operations of $0.28 in last year's fourth quarter.

Turning to slide number 4, you will find a summary of our quarterly sales trends. By division, organic sales decreased 0.2% in the ID solutions segment and decreased by 2.7% in the workplace safety segment.

Looking at our organic sales decline geographically, we saw a decrease in sales in the US and in Australia, where we continue to experience reduced demand. These declines were partially offset by organic sales growth in Western Europe, where our businesses have performed quite well throughout fiscal 2016 despite a lack of significant economic growth. Foreign currency continued to be a headwind as sales declined 1.4% from foreign currency translation this quarter.

Slide number 5 shows that our fourth-quarter gross profit margin finished at 50.0%. Excluding one-time charges recognized in the fourth quarter of last year, our gross profit margin was approximately 47% from last year's fourth quarter. This significant year-over-year improvement was primarily realized in the facilities that we consolidated in fiscal 2015, as our manufacturing teams have done a great job improving our customer experience and driving operational efficiencies.

Looking sequentially, our gross margin decreased from 50.7% in the third quarter to 50.0% this quarter. The biggest driver of this sequential reduction in gross margin was business mix.

Slide number 6 shows the trending of SG&A expense. SG&A expense was $98.4 million this quarter compared to $102.9 million in Q4 of last year. Approximately half of this decrease was caused by the impact of the stronger US dollar was caused by reduced selling expenses as we continued to drive efficiency gains. We are encouraged by this decrease in SG&A, as it is an indication that our efforts to identify operational efficiencies and savings throughout the organization are paying off.

Turning to slide number 7, our diluted earnings per share was $0.49 this quarter, which compares to our non-GAAP EPS of $0.28 in the fourth quarter of last year. We were able to realize this nice improvement in EPS even though revenues were down a total of 2.3%. These profitability improvements were driven by a combination of operational efficiencies and the lower tax rate that I just mentioned.

We were anticipating revenue challenges coming into this quarter, so we were also very tight with our expenses, curtailing discretionary spending and delaying certain hirings. Overall the teams executed well on the cost side in the fourth quarter. As you will see in our fiscal 2017 guidance, we do expect that some costs will increase next year as we increase hiring of certain sales professionals and increase our R&D spend.

Slide number 8 summarizes our cash generation. This quarter we finished with $40.4 million of cash flow from operating activities compared to $40.6 million in last year's fourth quarter.

Looking at free cash flow, we finished this quarter at $30.8 million compared to $37.5 million in last year's fourth quarter. This decline in free cash flow was a direct result of increased capital expenditures. Last year's fourth quarter had unusually low CapEx, while this year we had a project hit in the fourth quarter that we had originally anticipated hitting in Q1 of fiscal 2017.

The chart in the upper left-hand corner of this slide provides more detail on cash generation. The bars represent cash flow from operating activities and illustrate how we have realized improved cash flow over the last five quarters. We have moved beyond a period of elevated cash outflows from our restructuring programs and into a period of much stronger cash generation.

We returned $10.2 million to our shareholders in the form of dividends this quarter while repaying $24.3 million of debt. Cash generation in fiscal 2016 was strong, benefiting from improved net earnings and improved working capital, especially inventories, which were built up in fiscal 2015 during our facility consolidation phase and then reduced in fiscal 2016 following the completion of these projects. Plus, capital expenditure levels were lower than our historical norms for the full year ended July 2016, as our teams were focused on executing the fundamentals in our facilities.

Looking ahead to fiscal 2017, we expect cash generation to continue to be solid. However, we don't expect the fiscal 2016 pace of working capital improvements to continue into fiscal 2017.

We also expect our capital expenditures to increase to a more normalized level in fiscal 2017. As such, we don't anticipate the pace of free cash flow improvements shown in fiscal 2016 to continue into this upcoming year. Our EBITDA and net debt trending are presented on slide number 9. Our net debt to EBITDA was approximately 0.5 to 1 at the end of the quarter. Our total net debt position has benefited from the strong cash generation and continues to trend downwards.

At July 31, 2016, net debt was $75.7 million compared to $139.2 million at the same time last year. Our strong balance sheet gives us the flexibility to fund future growth opportunities and return funds to our shareholders. Our disciplined and patient capital allocation approach remains unchanged: first, we use our cash to fund organic growth opportunities, which includes funding investments in new product development, digital enhancements, sales-generating personnel, and capital expenditures. Second, we focus on returning cash to our shareholders in the form of dividends. Our streak of annual dividend increases has now reached 31 consecutive years.

Third, we use our cash to improve shareholder returns through share repurchases. Share repurchases are executed in an opportunistic and patient manner, whereby we only repurchase shares when we see an opportunity to drive meaningful incremental shareholder value. During fiscal 2016 we repurchased a total of 1.154 million shares at an average price of approximately $20.50 a share.

Fourth and finally, we use our cash for acquisitions. As we have stated, we don't expect acquisitions to be a significant use of cash in the near-term, as we have been focusing the organization on driving operational improvements, improving customer service, and driving organic sales opportunities.

Slide number 10 introduces guidance for our fiscal year ending July 31, 2017. We expect earnings per diluted Class A nonvoting common share to range from $1.55 to $1.70 in fiscal 2017. Our guidance reflects our expectations for continued profit improvement in an environment where we believe organic sales growth will be a challenge; foreign currency translation will provide a headwind; and where we will be increasing our investments in organic growth opportunities.

Our business is a very short cycle from the time we receive an order to when we ship the product to the customer. This limits our visibility into future orders and makes it challenging to predict future revenue trends. When constructing our view on future organic sales, we take into account historical sales trends; upcoming new product launches; internal initiatives; recent economic news; and, of course, what we are seeing and hearing from other industrials.

At this point we just aren't seeing the catalysts that will materially increase our future organic sales growth. And in fact, we expect to continue to see pockets of decline, including in markets where there are significant oil and gas exposure. Based on these analysis, we are expecting organic sales to range from a low single-digit decline to slightly positive growth in fiscal 2017.

Over the last five years or so the trend of a strengthening US dollar versus many other currencies has certainly been detrimental to the financial results of many net exporters such as Brady; and based on foreign currency exchange rates as of July 31, 2016, we expect that year-over-year impact of the strengthening US dollar to reduce revenues by another 1.5% in fiscal 2017.

Looking at our cost structure, we expect to see our investments in R&D grow in fiscal 2017. As Michael mentioned, R&D and innovation are key drivers of our long-term organic sales growth. We also expect that our tax rate will return to our typical historical range of 27% to 29%.

Offsetting this challenging revenue environment and the increased expenses that I just mentioned are ongoing efficiency gains in our manufacturing facilities and in our selling, general, and administrative expenses. Our fiscal 2017 guidance is consistent with our stated capital allocation approach, whereby our first priority is to invest in organic growth opportunities. And we are doing that through increased investments in R&D, increased hiring of sales personnel, and increased capital expenditures.

Our second priority is the return of funds to our shareholders in the form of dividends. And we are doing that as well, as we announced our 31st consecutive increase in our annual dividend yesterday.

Other key operating assumptions in our guidance are depreciation and amortization of approximately $30 million and capital expenditures of approximately $25 million. At this point we are not anticipating any restructuring charges, and we are not excluding any one-time items from this guidance. So said another way, we expect GAAP and non-GAAP earnings to be consistent in fiscal 2017.

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

Thank you, Aaron. Slide number 11 summarizes the identification solutions financial results for the fourth quarter. Organic sales were down by 0.2%, and foreign currency translation further decreased sales by 1.2%. In total, IDS were down 1.4% to $198.7 million this quarter.

Our European IDS business continued to lead the segment in organic sales, increasing by low single digits compared to last year. Sales growth in Europe has been consistent throughout all of fiscal 2016, and the business has increased organic sales for six consecutive quarters, which is a direct result of the efforts of our strong team in Europe.

Organic sales in the IDS segment were weakest in our Americas region. We continue to be impacted by the economy in Brazil as well as reduced demand in the US and Canada. Organic sales decreased in both Brazil and Canada in the high single digits in the fourth quarter, while sales decreased in the US in the mid-single digits compared to the same quarter last year.

Fourth-quarter organic sales growth was effectively flat in Asia as the rate of decline in China sales slowed compared to previous quarters. These modest declines in China were offset by increased organic sales throughout the rest of the Asian region.

We are continuing to introduce new products to the marketplace that we are really excited about. This quarter we launched the new BMP61 label printer, which is a handheld printer designed for quick and efficient identification of wires, cables, and components. This printer uses Brady's high-performance materials designed for tough industrial ID applications and features multiple user interfaces; a touchscreen; and multiple ways to connect, manage, and save data. We're excited about this new printer, as it combines new technology with a proven design for use in a wide range of applications.

IDS finished with $46.3 million in segment profit in the quarter compared to $29 million in last year's fourth quarter. During the fourth quarter of last year, we incurred approximately $7.4 million of nonroutine charges, which did not recur this year. Excluding these items, IDS's segment profit would have been $36.4 million or 18.1% of sales in last year's fourth quarter. Segment profit increased almost $10 million when compared to the adjusted fourth quarter of last year.

This increase is a direct result of the focus on efficiency and operational excellence that we have been working so diligently to improve on this entire fiscal year. As a percentage of sales, segment profit improved to 23.3% this quarter. I am pleased with the increase in segment profit margin in the IDS business. It is a testament to the focused efforts of this entire team.

Looking to fiscal 2017, we expect to see modest improvements in segment profit as a percentage of sales when compared to fiscal 2016. Specifically, we expect IDS segment profit to be in the low 20% range for sales in FY17. We are investing in R&D and commercial resources, and we expect to incur additional incentive compensation in fiscal 2017 as well -- while at the same time, we expect our ongoing efficiency activities offset these cost increases.

The workplace safety review begins on slide number 12. Organic sales decreased 2.7% in the WPS segment this quarter. Our European business continues to perform well, with organic sales increases in the low single digits compared to the prior year. This is consistent with the first three quarters of fiscal 2016.

European digital sales increased by 24% compared to the fourth quarter of last year. Digital sales were the driver of organic growth in the quarter as catalog sales declined in the low single digits. Increased organic sales in relatively challenging economic conditions was a direct result of our European leadership team's ability to drive results and execute their strategy in fiscal 2016.

The improvement in organic sales in our European-based businesses was offset by mid-single-digit declines in our North American business and high single-digit declines in our Australian business. Much like our IDS business, we experienced sluggish demand in the US.

We continue to adjust our cost structure in both the US and Australia, where we have been successful in improving segment profit as a percentage of sales every quarter this year.

Throughout this fiscal year we have been experiencing foreign currency headwinds in our European and Australian businesses. Combined, these two regions represent approximately two-thirds of our WPS business. These foreign currency headwinds continued in Q4, reducing our WPS sales by 1.6% this quarter, primarily due to the impact of the British pound depreciating against the US dollar following the impact of the Brexit vote.

During fiscal 2016 each and every member of the WPS team has been driving three primary goals. First, we are managing the catalog-to-digital shift through efficient and effective catalog prospecting. Our digital sales are growing, with four-quarter digital revenue up low single digits in Americas and up in strong double digits in Europe. We clearly have momentum, and we are starting to see the payback on our digital investments.

Second, we are creating an industry-leading digital business by building websites with a mobile-first mentality. We now have 17 websites converted to mobile in our WPS business. Although mobile sales are new for us and therefore still a relatively small part of our business, sales generated on mobile devices are increasing every month as a result of improved capabilities of these new sites. We believe that having a strong mobile presence is necessary in order to be an industry leader in this area.

Third, we are working toward regaining product leadership in the safety identification product category through our focus on unique and customized offerings. Our focus and investments in these areas are creating long-term value through an improved customer experience in our digital and mobile applications and a strong, innovative product line in every key category.

Segment profit in the workplace safety platform was $16 million this quarter compared to $15.9 million in last year's fourth quarter. As a percentage of sales, segment profit was 19.2% this quarter compared to 18.2% in last year's fourth quarter. This improvement in segment profit margin is encouraging, as it marks the fifth consecutive quarter of improvement over the prior-year comparable.

Looking forward, we are anticipating organic sales to range from a low single-digit decline to slightly positive growth. We also expect to see continued foreign currency challenges, as a full half of our WPS business is in Europe.

Historically, our fourth quarter is our highest profit quarter, partly due to stronger sales volumes. It is also partly due to the timing of certain advertising campaigns in Europe as we slow down advertising campaigns in advance of European summer holiday season.

Looking ahead to fiscal 2017, there are a number of uncertainties, not the least of which is the impact of Brexit. Given what we know today, we expect segment profit to be in the upper teens as a percentage of sales in fiscal 2017.

Slide 13 is an update to the midterm financial targets we released in September 2015. Our target of exiting fiscal 2018 on pace to achieve $2 per share remains consistent. Since releasing our financial targets one year ago, the industrial economy has not strengthened. In fact, earnings of the S&P 500 has decreased in each of the last several quarters, and the US dollar has further strengthened. This has put additional earnings pressure on US-based multinational industrials such as Brady.

These less-than-ideal economic conditions further our resolve to drive a path parallel of aggressively driving operational efficiencies while investing in our organic growth engine. Looking ahead over the next several years, we do not expect our organic growth to outpace GDP. Our emphasis on R&D processes, new product launches, and the development of integrated solutions and embedded technologies to create smarter products allow us to accelerate our organic growth in the future, but these types of growth drivers will take time before they show up in our revenue.

We believe that this renewed focus on innovation, combined with our ongoing digital investment, a relentless focus on great customer service, and our overall shift toward local ownership and accountability is a winning combination that will enable Brady to accelerate its organic sales growth to a point where we are exceeding GDP and taking share.

Given these foreign currency headwinds and the challenging economic environments, we are relying more heavily on operating efficiencies to achieve our $2 per share EPS target exiting fiscal 2018. We expect our gross profit margins to range from 51% to 52% versus the 50% range where we finished this year.

We expect SG&A to finish closer to 33.5% to 34.5% versus the 36.1% of sales that we finished at this year. I am proud to say that we made excellent progress in this area this fiscal year, but we must continue to focus on operational efficiencies within all of our facilities, as we know there is more room for improvement.

As relates to SG&A, we have significant opportunity for improvement. And as we have discussed in prior earnings calls, we are moving toward a decentralized operating model with standardized processes. We are actively taking steps to simplify the organization and reduce our G&A structure, and we're taking actions to better align the cost structure of our underperforming businesses. Again, we don't see the economy or the strengthening US dollar helping us along the path to our $2 earnings-per-share target, but we remain confident in hitting this target due to the positive momentum we have built in driving operational efficiencies.

Before turning the call over to Q&A, I would like to add a few concluding comments. As I reflect on my two years with Brady, I know that I have joined a company with some of the strongest fundamentals I could hope for: a powerful brand, a strong reputation, and a commitment to quality that is the foundation of the organization's culture and people. Over the past two years I have traveled extensively and visited almost every location globally. I have personally met with almost all of our employees, and I know that we have a strong, talented, and dedicated team, made up of both experienced, dedicated Brady employees and energetic new talent.

We made significant progress improving our operational issues, and our improved financials in fiscal 2016 are the result. We have delivered four consecutive quarters of year-over-year profit improvement, which is something that hasn't happened to Brady in many years.

But we have more work to do. There are more opportunities to improve our manufacturing processes and simplify our SG&A structure, both of which remain the top priority in fiscal 2017. We have created a culture of local accountability and ownership. Our team is motivated and aligned to each of our total Company goals and our overall strategy. And we know that Brady's powerful brand, high quality product, and commitment to delivering the best possible customer experience allow us to deliver what we promise to our customers, employees, and shareholders.

As we stated last quarter, we expect to see a decline in organic sales this quarter, but our profitability improvements were better than we expected. Even with these better-than-anticipated profit results, we are highly concerned about our ability to deliver organic sales growth in fiscal 2017 due to challenging economic conditions in several geographies, including the US. This will in turn make our ability to control costs and drive operational efficiencies that we have much more essential to hitting our long-term plan.

I am pleased with our progress and achievements in fiscal 2016, but I know that we have the ability to do much more as an organization. We are pushing ourselves to carry this positive momentum into fiscal 2017 and beyond.

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

(Operator Instructions) Allison Poliniak, Wells Fargo.

Could you guys -- the European outgrowth relative to the other regions: is it end-market specific? I know you highlighted a stronger team and such. And if not, are there things you could be replicating in the other regions to drive some increased growth outside of the end markets?

Good morning, Allison. Yes, absolutely. It is a two-fold situation. We do have a very strong team in Europe that we are proud of, and in some ways they are ahead of the curve. We are sharing those practices with our other teams.

I will say at the same time, because of the nature of the European market and the industries it involves versus, for instance, Brazil; US oil and gas, areas, et cetera; and Australia, we are seeing better demand there as well. So it is a combination of factors. But absolutely -- in the areas of overachieving, we are sharing those best practices with our other teams actively and are also seeing results from that as an effect.

Great, thanks. And then just on SG&A for 2017, I know, Aaron, you highlighted R&D -- increasing some investments there. What level of R&D increase are we looking at for 2017? And how should we think about the pace of SG&A throughout the year?

Let me start with the R&D. We clearly are anticipating increases in R&D. As we pulled our guidance together, it could have approximately a $0.05 increase -- sorry, $0.05 impact on our earnings per share, so it is a pretty material increase in our R&D expense.

As we look at SG&A next year, as Michael commented, we're absolutely focused on driving down our SG&A while still making investments in certain of selling functions. And it all comes down to driving efficiencies everywhere that we possibly can.

I certainly don't want to give exact guidance with respect to SG&A, but rest assured this continues to be a focus area for us.

Okay, great. Thank you.

George Staphos, Bank of America Merrill Lynch.

Mike, congratulations to you and your team for really great progress this year. I wanted to pick up on that --

Thank you very much.

Well, it is well-deserved. I wanted to pick up on the question from Allison on SG&A.

So if we think about this past year that has just concluded, you know, you raised guidance several times during the year. As you think about it, what was the primary -- if you had to nail it down to one thing, driver of that, was it the operational efficiency, or was it the SG&A reductions that drove that?

The biggest driver was definitely on the operations side versus the SG&A side. In fact, I think in some calls previously, I actually mentioned that the SG&A improvements were coming a bit slower than we had hoped for. So operation -- so gross margin, if you will, was clearly the driver of overperformance versus our initial guidance.

Okay. So as we sit here on this side of the phone, Aaron, obviously we can look at GDP. We can look at industrial reduction; we can look at non-res. But obviously, the operations and the SG&A are things that we don't really get visibility into until you report for the next quarter.

As you think about fiscal 2017 and the guidance that you have provided, where do you think the upside and downside swing factors are? And are they more leveraged, you think, this year to SG&A relative to operations? Or how would you have us -- how would you counsel us?

Great question. So as we look at our guidance, I would say offsetting the challenging revenue environment are clearly these ongoing efficiency gains in the manufacturing facilities as well as SG&A expense. So if we dig down one level deeper and we look at gross margin, we clearly expect modest improvements in gross margin. The ongoing efficiency efforts will continue.

And we stay very, very, very focused on driving efficiencies. We have a long runway of opportunities, as we have talked about, and we certainly expect that we will drive efficiencies in excess of cost increases and greater than any pricing challenges we have as well.

In SG&A we absolutely expect to see some continued efficiencies as well, which would offset virtually all of the cost increases that we mentioned in our prepared remarks -- i.e., increased selling resources, a bit of increased incentive compensation, et cetera. But again, from our perspective it all comes back to the anticipated revenue challenges. That's really where we have the biggest concern.

So I am not giving you the exact answer on R&D -- I'm sorry, on gross margin and SG&A, because I want to avoid giving guidance at that level. But the point is that we should get improvements in both areas, and we will continue to focus on them.

Yes, I understand, Aaron; and I wasn't necessarily trying to get you to the basis point on margin at all. I was just -- directionally, do you feel more comfortable about the gross margin trajectory or more comfortable about SG&A, recognizing you are comfortable in both?

Yes, actually, let me take a step back. If you would have asked me that question one year ago, I would have said I feel more comfortable with the gross margin improvements. As we sit here today, I feel pretty darn comfortable with both gross margins and SG&A improvements, because we now have started to get that momentum.

Okay, that's very helpful. My last one and then I will turn it over: just very quickly on working capital, were you saying you expect less of a benefit this year from working capital improvement, or you actually could invest some funds into working capital this year as we think about the free cash flow model? Thank you.

No, I was absolutely coming at it from the perspective of less of an improvement.

Okay. Thank you very much.

Charley Brady, SunTrust.

I just want to go back to your comments in the catalog and the digitization, kind of a bigger-picture question. Can you give us a sense, remind us where that mix is today?

And really, more importantly, as you are looking out over a longer time period, where do you see that getting to? I guess, how much does catalog sales kind of become -- acknowledging that it's going to be an important piece of the Brady story for a long time, but I'm just trying to really gauge visionarily what you're looking at in terms of where that mix could ultimately be, which obviously would have a pretty important margin impact on you guys?

Thanks, Charley. We are not breaking that split out. We have given you some guidance about growth in the past, and we will continue to do so.

But I will say this: we believe that there are typically step functions in change as you go from one model to the other. They are somewhat based on technology changes, somewhat based on generational changes. And so we do expect to see platforms of change or steps of change in the future as we go through literally the next decade. And so you will see a continuing shift in models to a much more real-time interactive approach as opposed to a more reactive catalog approach as we go forward.

Okay, that's helpful. And just a little bit related to that, can you talk about -- without giving specific numbers -- the spending trends on optimizing that digital footprint that you have got? Obviously, in the early days a lot of money was being spent, because you had a lot of heavy lifting to do.

You are farther down that road today. Can you give us a sense of how much you have been able to back off the accelerator on spend on that -- obviously not to zero, but just -- and that is translating into margin?

Right. So we clearly continue to spend in that area and will continue to invest in that area, but as you noticed, we had to turbocharge it in the beginning of the process as we were converting a number of our sites and making some very dramatic changes.

I believe just a couple of years ago we were behind the curve in our digital resolve. I believe we are now in some cases ahead of the curve, although we have a lot more opportunity. So you will see us to continue to invest in this area, but we are not investing at quite the rate that we were in the past.

Thanks.

Mig Dobre, Robert Baird.

Good morning, everyone. Maybe looking -- I might have missed this in your prepared remarks. I understand ID solutions is expected to see a little bit of margin expansion. Did you comment on workplace safety for next year as well?

Yes, actually we did. And I will actually just go right back to the script, because effectively our comment was that we expect our segment profit to be in the upper teens as a percent of sales, which of course would be a slight expansion over what we just saw this year.

Oh, okay. Sorry. I appreciate that. Sorry for missing it.

Oh, no, it's okay. Don't worry about it. I just didn't want to misquote it.

No, no, that's fair. And then I am looking maybe for a little bit of color with regards to the cadence of margin in ID solution into next year. Is there a seasonal aspect to it that we need to be aware of? I guess to be blunt, when I'm looking at the margin performance that you had in the back half of 2016, which has been fairly consistent -- above 23% at segment level -- is that the right way to think about it going into 2017?

Well, I think historically our second quarter is always our most challenging quarter for revenue, and that definitely has a margin impact. So I would look at it from the perspective of we typically have a very strong fourth quarter, although as an overall company, in IDS we also have a reasonably strong fourth quarter; whereas our second quarter, because a variety of timing issues in our industries, is our slowest revenue quarter, hence our most challenging margin quarter. We were making significant improvements that were able to offset that this year.

But can you comment at all on the first quarter, for instance, where you don't have the seasonal weakness?

Yes, we continue to expect good results in our margins in the first quarter.

Okay, great. And last question for me is really more surrounding growth. Can you maybe help us understand or maybe put in some perspective the last couple of years in terms of organic growth? The way you are guiding for fiscal 2017, obviously we're not really looking at a lot of growth there either. I am trying to understand what was end-market-driven here versus maybe some Company-specific items? And at what point you think you'll be able to actually start narrowing the gap versus nominal GDP?

If you go back to my very first guidance, I believe I spoke about the need to reinvigorate our product development pipeline. I also spoke about the fact that that would take an extensive period time, in the range of three years.

We are on track. We are in industrial segments where new product development, and more specifically the revenue stream coming from new product development, takes longer. The positive of that is the revenue streams last a lot longer. So once we do invigorate that pipeline, once we do start developing those streams, which we are, it will take -- it will have a longer-term benefit.

I will say that we did not anticipate the challenges at this point from the overall industrial economy that we are having. And I am pleased that we are able to overcome those, but there is no question that the economic environment that we are in today is a challenging one.

The good news is despite that, I think you have seen some changes and some turnarounds in the area particular of a WPS, but overall in our approach. And some of that comes from a better focus on what we are really good at, and some of that comes from the fact that we are creating a stronger, more exciting product line that -- I think you're going to continue to see more significant results down the road. But it is going to take a while, as I have said.

Would down the road mean fiscal 2018, fiscal 2019?

Correct.

Thank you.

Joe Mondillo, Sidoti & Company.

So I think you might have just answered this, but considering the guidance that you provided for fiscal 2017 relative to your long-term 2018 guidance, it's obviously back-end weighted. And I'm just wondering if there is anything relative to the internal initiatives that you're doing, productivity improvement, projects, cost cutting that is more back-end weighted that you can see hit more in 2018? Or is it more so just the environment may be weighing a little more on 2017, and hopefully that improves, and maybe you get a long-term benefit relative to the R&D innovative new products? Is there anything internal in terms of cost cutting, or that's back-end weighted, or --?

Joe, you hit it on the head. We continue to expect our efficiency and effectiveness efforts to garner improvements in our profitability, but the most significant factor, we believe, in the longer-term that is really going to impact us in a positive way is the innovation initiative that we are in the middle of right now. We are very excited about the products that we are working on and the opportunities that we are working on. But those obviously take longer.

And as I mentioned, looking at that longer-term horizon, you're going to see, therefore, a bigger benefit from those. And given that we expect to those products to garner better margins being newer products for us, that should have a very solid impact on our earnings.

Okay. And then my second question, just regarding SG&A, it is sort of a two-part question. First, administrative costs were up about 4% in 2016 after actually falling, like, 11% in 2015. So just wondering if those are going to start coming down again, or what's going on there?

And then in terms of long-term, if you will, normalized SG&A as a percent of sales, if you could flip a switch here and do everything overnight and not affect any of your businesses, or customer service, or anything like that, where do you see a normalized SG&A as a percent of sales? Because obviously, even with, quite frankly, maybe your 2018 goals -- and you can tell me if I'm wrong or not -- even those goals seem maybe a little lofty to maybe some of your peers. So just wondering what sort of may be a 5-plus-year outlook would be relative to normalized SG&A as a percent of sales?

Joe, I will handle that question. So the first part of your question, with respect to G&A expense being up in fiscal 2016 versus 2015, that certainly is true. And there is really two primary drivers -- actually, two primary drivers offset by one item.

First would be our equity-based compensation, which you can see is up this year versus prior years. And it is not that we have issued more equity. In fact, that's not the case at all. It comes down to the fact that in prior years, we actually had some reversals due to turnover in executive team, et cetera. So that's a piece of it.

Another piece of it is our bonus expense is actually up this year as well. As you know, in 2015 the bonuses were pretty -- I will say modest, but basically nil throughout the organization. And a piece of that has come back. And that has been offset, at least partially offset, by the efficiency gains that we've been talking about that, like I said, have clearly now garnered some traction.

So that's the reason that G&A expense was actually up slightly in 2016. And as far as F 2017, I don't want to get too granular with respect to that level of detail what we expect.

Now, switching to the normalized SG&A, so looking out into many, many years, so the hypothetical question that you raised: I really struggle to answer a question like that, to be quite candid. The guidance that we just laid out that we slightly modified with respect to our three-year plan -- you can see that those targets are 33.5% to 34.5% of sales for SG&A. And frankly, we also look at it the same way you do, Joe, and that is: it is lofty compared to our peers. But the reality is that we can't pull it down overnight without having a very significant impact on our customer experience, et cetera.

So we will continue to chop away at it. We will continue to drive efficiencies everywhere that we possibly can within the organization. But beyond what you see in our three-year plan, that's basically what we are willing to commit to at the moment. But rest assured we are pushing efficiencies everywhere we possibly can.

Okay. And just a follow-up. There is nothing -- is there anything sort of unique with your business relative to maybe -- you know, your peers are not exactly the same as you guys, and your footprint and facilities and such? Is there anything that may hold you back long-term to maybe get closer to -- you know, obviously, you're getting closer, but -- much closer, I guess, over a 5-plus-year period? Or is it just going to take time and effort and such?

You know, that -- an important point as we take a look at how we are configured and the complexity of our Company: we are more complex than some of our peers. That provides us with some great benefits. In addition, it provides challenges in the area of G&A.

The benefits being that really we come at the market in many different ways and are in many, many different markets that often our peers are not. That's a great foundational strength we have, and that makes us a very robust company year in and year out.

As you noted, though, the result of that is we are going to be challenged to hit best practices rates or peer rates of G&A. That does not mean that we aren't going to work hard to drive to that effect. One of the mantras that I think you have repeatedly heard me say is: we are driving decisions down into our organization by creating a structure they can work within.

By doing that it will inherently drive our G&A down. And that's one of the big focuses we have. If they know the limits with which they can run and they can make the decisions, we don't have to have a larger overhead structure, particularly in our corporate area, to accommodate that.

Okay, great. Thank you. Appreciate it.

Keith Housum, Northcoast Research.

Congratulations on the restructuring efforts so far. I am seeing some great dividends.

As we look at your fourth-quarter results, clearly they're better than expectations. Was there any of that due -- or how much of that was to due to the delayed hiring and curtailing of some of your spending that perhaps you were previously doing, planning on?

I think that had a very modest factor. In fact, it was extremely modest. Effectively, we're at employment rates that are similar to when I arrived two years ago. We are not doing this by attacking people directly. We are doing this by truly making ourselves a much more efficient and effective organization.

I think when you delay hiring in a significant manner, or have temporary riffs or things of that nature without a huge disconnect in the economy, it really is counterproductive to our long-term goals. So our efforts really are designed to two always look at the long-term as we make the short-term decision. So yes, we did have some limited delayed hirings, but we don't believe in any way did that impact our ability to grow in the longer term.

Okay, great. And then as we look a little bit at your workplace safety segment, as you look at the performance during the quarter and your expectations for 2017, is there greater pressure on volume versus pricing? Or is it purely just volume driven at these levels?

Well, obviously, volume has a solid impact in our ability. If we can get a little help from the economy, it helps us disproportionately, without question.

That said, we regularly and carefully look at our pricing models. We do a lot of beta testing of those and making sure that we are at a price point that is positive for our customers and positive for us.

Okay, great. And then my final question for you it is in the identification solutions group. Is there one part of IDS that is outperforming the others as we look to current performance as well as into 2017?

You know, we try not to break out our different segments below that point. However, as you know, healthcare is a little healthier at the moment. Admission rates are down, but there are opportunities there.

In addition, any time that you're looking at legislative changes, that helps us. And those segments that are involved in some of the legislative changes out there certainly are able to do better, because despite the economy, people have to respond to those type of factors -- health and governmental requirements.

Got it. Thank you.

George Staphos, Bank of America Merrill Lynch.

Mike, can you comment at all in terms of what you see for the pace of nonresidential construction and how that might play out in the next couple of years in terms of your markets? Do you see things as getting somewhat better? Do you see things as being somewhat challenged, recognizing your overall view is that is going to be a tough growth environment next year, or this fiscal year that you are entering?

Well, let's start with: yes, it is hurting us today. There is no question about that.

I think the real factor involved in that has so much to do with the macroeconomy that I am reticent to make unequivocal statements. Clearly, our history is that as a economy turbocharges and capacity ends up running out, we end up benefiting more at the end of that cycle than the beginning, because people are changing the configurations of their factories; they are expanding; so on and so forth.

So I think as you look at us, and you see construction or the capacity issues coming into play, that is a good sign for our future. That said, right now we have -- and you have, and you can read, just as I do, all the models; and we can look at our customers -- so many different indicators in the economy right now. I would not plan on forecasting a stronger model in the near future.

Okay. But also from where you sit, perhaps because it is -- well, maybe I shouldn't answer the question for you. Do you think the non-res trend is decelerating at this juncture, status quo, or moderately accelerating? And I realize it is a very broad question.

I would actually prefer you entering your own questions, but I certainly will do that for you if you'd like. It is so market dependent at this point. I mean, giving you a great example, oil and gas -- that is a huge segment of the US economy, the Canadian economy. You look at a couple of the Scandinavian countries, like a Norway -- it had a huge impact.

You look at mining industries and things like that in Australia, where those are significant, not only to their economy, to us. And there is no question those are in a moribund state in some cases. So in the future you would hope and expect that those could improve. But there are other cases that are unrelated that we may see different trends coming the other way.

But some of the major ones that we are really being hurt on right now -- there is very, very little movement in those spaces at all. So you would hope in the next couple of years, as things work out to a more normalized state, you would expect that those would improve.

Okay. I appreciate that.

I would have preferred you entering the question, though, but hopefully you're happy.

I would be less accurate, based on my track record. But in any event, I know it's a somewhat challenging question to answer on a live mic, but do you think there is a normalized level of margin in IDS that at some point you don't want to go past? And where would we stand relative to that threshold? And I know you're not going to put out a single point number, but any thoughts would be helpful there. Thank you.

Sure. I think the key to us moving the margin over the long-term has to do with the products we innovate and how we innovate them. We are unequivocally putting more effort, more consistent effort, and I think really more focused effort -- I know more focused effort -- into how we develop our products and what products we are developing. Receiving a lot more customer input into what their problem sets are that allow us to be much more creative in our solution sets. So I am very excited about that.

But that excitement is not just a revenue excitement. My history and the history of this Company is the newer -- and most companies -- the newer the products, of the better you can gain margin traction. So I would say the most significant way we can change our margin mix in IDS is to have a fresher, more vibrant product introduction.

So to conclude, then, once we get into 2018/2019, that has really got to be the driver of your margin in IDS. Would that be fair?

Unequivocally.

Okay. Thank you very much. Good luck in the year coming up.

Mig Dobre, Robert Baird.

Thank you for taking my follow-up. I am just trying to understand your FX guidance a little bit better. Correct me if I am wrong, Aaron, but you are talking about something like a 1.5% headwind, and I'm looking at a broad dollar index. It is basically flat year-over-year; down, call it, 3% year-to-date. I am just having a hard time figuring out how you end up with a headwind.

So the 1.5% -- two things to comment on. First of all, it is based on exchange rates as of the end of our fiscal year, so as of July 31. So that is item number one.

And then item number two is it really comes down to where our business is. So, for instance, we have a very vibrant business in the UK, as an example. And if you look at what happened with the pound, I think it was probably $1.46 at the end of our third quarter and somewhere in the $1.32 or $1.33 range at the end of July.

So, you look at a big market like that -- clearly, that will provide a headwind. You look at the euro, on the other hand, and the euro has been somewhat stable, frankly. But it really comes down to the basket of currencies where our revenues ultimately come out at. So it is a very calculated number.

So how big is your UK exposure?

I don't want to get into the revenues, but I will say this: it is a very nice-sized business for us in Europe. But I don't want to give the exact revenues.

Well, I understand. Is it larger than the euro-denominated business?

No. No, it is not.

Okay. I can follow up off-line with you. Thank you.

Thank you. This concludes our Q&A session for today. I would now like to turn the call back over to Ms. Thornton for any 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. The replay of this conference call will be available over the phone beginning at 12:30 Central Time today, September 9. The phone number to access the call is 1-855-859-2056. International callers can dial 404-537-3406, and the passcode is 64003281.

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone have a great day.