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Brady Corp
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Good day, ladies and gentlemen, and welcome to the Q2 2019 Brady Corporation Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded.
I would now like to introduce your host for today's conference call, Ms. Ann Thornton. You may begin, ma'am.
Thank you. Good morning and welcome to the Brady Corporation fiscal 2019 second quarter earnings conference call. The slides for this morning's call are located on our website at www.bradycorp.com/investors.
We will begin our prepared remarks on Slide number 3. Please note that during this call, we may make comments about forward-looking information. Words such as expect, will, may, believe, forecast and anticipate are just a few examples of words identifying a forward-looking statement. It's important to note that forward-looking information is subject to various risk factors and uncertainties, which could significantly impact expected results. Risk factors were noted in our news release this morning and in Brady's fiscal 2019 second quarter Form 10-Q, which was filed with the SEC this morning. Also please note that this teleconference is copyrighted by Brady Corporation and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the Internet. As such, your participation in the Q&A session will constitute your consent to being recorded.
I'll now turn the call over to Brady's President and Chief Executive Officer, Michael Nauman.
Thank you, Ann. Good morning and thank you all for joining us. We released our financial results for the second quarter of fiscal 2019 this morning. I'm pleased to report another quarter of year-on-year pretax earnings growth with an increase of 4.8% compared to the second quarter of last year.
At constant currencies, this would be an increase of approximately 8%, which is another quarter of very strong growth and marks our 14th consecutive quarter of pretax earnings growth and our seventh consecutive quarter of organic sales growth with an increase of 2.3%.
Focusing on our consistent set of priorities has been essential to our ability to deliver profit improvement every quarter for more than 3 years. We're investing in research and development and we continue to bring innovative new products to our customers. We're investing in automation in our manufacturing facilities. We're driving sustainable efficiency throughout our SG&A structure.
And we're focused on improving our under-performing businesses. Our ability to consistently improve our financial results is a direct result of the entire Brady team's focus and dedication to consistently delivering on these objectives. Over the last 4 years we worked hard to significantly enhance Brady's long history of innovation.
We've taken many actions to build a much stronger culture of innovation including many events where new product ideas are pitched, innovation day events where teams worked off-site our new product offerings, and even large global innovation events that engage the entire Brady organization.
We now have a much stronger R&D organization and even an innovation incubator that is working on some of our more challenging new product ideas. And our R&D spend is anticipated to be at an all-time high this year, which bodes well for our future organic sales growth.
We believe that our commitment to innovation is having a positive impact on Brady's culture and is also having a positive impact on Brady's financial results beyond organic sales growth. Innovation is not just about new products, it's also about how we approach and solve problems.
And this type of innovative thinking is positively impacting our financial results in areas such as SG&A expense where we've seen a relatively steady decline in our non-customer facing SG&A expenses over the last several years. We will remain committed to strengthening our innovative culture and remain committed to development of new products.
In fact this quarter we announced the launch of another new printer in our Identification Solutions business and we have a robust new product pipeline, which should result in a steady stream of innovative new product introductions in the coming quarters.
Organic sales were driven by our Identification Solutions business with growth of 3.6%. We saw increased sales in all 3 regions and within all major lines except for our healthcare product line, which declined in the low single digits. The good news is that our healthcare unit ended the quarter on a positive note.
We have work ahead of us to drive consistent organic sales growth in the healthcare product line, but we're adding to our sales force and building a new product line, which we believe are the right moves to set up for long-term success.
Organic sales for our Workplace Safety business declined 0.9% this quarter. We continue to see consistent organic sales growth in our European and Australian businesses where we're increasing sales volumes and improving our digital presence. The organic sales decline this quarter was driven by our North American business.
To address the performance of this business, we took quick actions toward the end of the quarter to enhance our digital platform by moving to a new platform and we also took action to further right-size our cost structure in North America. We remain on track to improve WPS Americas in the back half of the year.
We're halfway through our fiscal year 2019 with solid performance so far, but we still have work ahead of us to improve our businesses in WPS North America and our healthcare product line in the IDS business. We're focusing on the long term by taking actions today that will set us up for success in the future.
We're investing in new product development, manufacturing automation, and efficiency throughout our global cost structure. We're growing sales and generating strong cash flow while driving an improvement in the bottom line. We continue to identify opportunities for efficiencies and working hard to capitalize on these opportunities every single day.
I'll now turn the call over to Aaron to discuss our financial results for the second quarter. Then I'll return to provide specific commentary about our Identification Solutions and Workplace Safety businesses. Aaron?
Thank you, Michael, and good morning, everyone. The financial review starts on Slide number 3. Sales decreased 1.9% to $282.4 million in the second quarter; which consisted of organic sales growth of 2.3%, a decrease of 2.6% from foreign currency translation, and a reduction of 1.6% from the sale of our Runelandhs business which was finalized in the fourth quarter of last fiscal year,
We increased pretax earnings by 4.8% when compared to the second quarter of last year. Looking at after-tax earnings, we finished at $29.2 million which was up substantially compared to last year's earnings of $4.3 million.
In last year's second quarter, we took a tax charge of $21.1 million related to the U.S. tax legislation passed by Congress in December of 2017. Without this tax charge, our prior year net earnings would have been $25.4 million. Diluted earnings per share was $0.55 this quarter compared to diluted EPS of $0.08 in last year's second quarter.
The income tax charge that I just mentioned reduced EPS by approximately $0.40 last year. Without this charge, our prior year second quarter EPS would have been $0.48. Cash flow from operating activities was $25.4 million this quarter compared to $7.7 million in last year's second quarter and free cash flow was $19.3 million compared to $3 million in last year's second quarter. Much of this improvement is a result of the timing of our annual incentive compensation payments.
Moving along to Slide number 4, you'll find our quarterly sales trends. Organic sales growth was driven by our IDS business while we realized a slight decline in WPS organic sales due to the performance of our North American business.
Our gross profit margin trending is summarized on Slide number 5. Our gross profit margin finished at 49.5% this quarter, which is down 40 basis points from last year's second quarter gross profit margin of 49.9%.
This decline was due to an increase in certain costs, including freight and labor in both our IDS and WPS businesses, We've been able to partially offset increased costs in our IDS business with increased volume, selective price increases, and ongoing efficiency gains.
In our WPS business, we've also focused heavily on efficiency gains and cost controls, but it hasn't been enough to fully offset input cost increases. We continue to drive efficiency gains across all of our businesses and increased prices where feasible, which we expect will offset the majority of input cost increases and enable us to maintain a strong gross profit margin in future quarters.
Moving along to Slide number 6, you'll find our SG&A expense trending. SG&A was $92.7 million this quarter compared to $97.6 million in last year's second quarter. The decrease was due to a combination of foreign currency translation, reduced SG&A from the sale of our Runelandhs business, and our ongoing efficiency activities. As a percentage of sales, SG&A expense decreased from 33.9% in the second quarter of last year to 32.8% this quarter.
Turning to Slide number 7, you'll find the trending of our investments in research and development, which decreased from $11.3 million in the second quarter of last year to $11.1 million this quarter. Year-to-date R&D expenses are up 2.6% and we expect to finish the year with R&D expense up around 6% for the full fiscal year ending July 31 as we continue to increase our investment in the development of new products.
Slide number 8 is the quarterly trending of pretax earnings where we've experienced year-on-year growth in each quarter for more than 3 years. This quarter we increased pretax earnings by 4.8% finishing at $36.7 million compared to $35 million in the second quarter of last year.
Moving to Slide number 9, you'll find the trending of quarterly earnings per share and net earnings. As I mentioned, in last year's second quarter we recognized additional income tax expense equal to approximately $0.40 of EPS from the enactment of the US tax reform. If you exclude this item, our diluted EPS increased from $0.48 in last year's second quarter to $0.55 this quarter.
Slide number 10 details our quarterly cash generation. We generated $25.4 million of cash flow from operating activities compared to $7.7 million in last year's second quarter and free cash flow was $19.3 million compared to $3 million in the same quarter of last year.
The increase in cash generation in the second quarter was due to our improved earnings along with a change in the timing of our annual incentive compensation payments to employees. Last year, all of these payments were made in the second quarter whereas this year, the payments were split between the first and second quarters.
So the best way to look at our cash flow performance is to remove this timing noise by simply looking at our year-to-date cash flow from operating activities, which was up 4.1%. This quarter we used our cash to invest in the organic business and to return funds to our shareholders in the form of dividends as well as a modest amount of share repurchases.
Turning to Slide number 11. This chart outlines the trending of our net cash position as well as a snapshot of our debt structure at the end of the quarter. We increased our net cash position by $12.8 million this quarter and finished in a net cash position of $150.6 million at January 31.
Our debt consists of a €45 million private placement scheduled for payment in May of 2020 and we have no borrowings outstanding on our $300 million line of credit. Our approach to capital allocation is consistent, we are disciplined and we're patient.
First, we use our cash to fund organic sales and efficiency opportunities throughout the economic cycle, which includes funding investments in new product development, sales generating resources, IT improvements, capability enhancing capital expenditures, and capital expenditures to increase efficiency and automation in our factories.
And second, we focus on returning cash to our shareholders in the form of dividends. After funding organic investments and dividends, we then patiently deploy our capital in a disciplined manner for acquisitions where we believe we have strong synergistic opportunities and we use our cash to improve shareholder returns through opportunistic share repurchases. We have approximately 1.9 million shares authorized for repurchase as of January 31.
Overall, our cash generation is strong, our balance sheet is strong, and we're focused on driving long-term value for our shareholders through the disciplined allocation of capital.
Slide number 12 summarizes our fiscal 2019 guidance. We're increasing our full-year EPS guidance from a range of $2.20 to $2.30 per share to our new range of $2.25 to $2.35 per share. Our increased guidance range is primarily due to the lower than originally anticipated full-year income tax rate, which is now expected to be between 22% and 24%.
This guidance is based on foreign currency exchange rates as of January 31, which is a headwind due to the strengthening of the US dollar. We also expect organic sales growth to be at the lower end of our previously provided range of 3% to 5% for the full fiscal year ending July 31, 2019.
Included in this guidance is an increase in our R&D expense of approximately 6%, depreciation and amortization expense of approximately $26 million, and capital expenditures ranging from $30 million to $35 million.
Included in our CapEx guidance is approximately $10 million of expenditures related to the construction of certain facilities that are currently leased. Excluding this incremental CapEx for facility construction cost, we're still running a bit higher than our historical average due to the increased investments we're making in automation and manufacturing capabilities, which are meant to drive efficiency gains and increase our capabilities. Lastly, we're not anticipating any restructuring charges and we're not excluding any one-time items from this guidance.
I'll now turn the call back over to Michael to cover our divisional results. Michael?
Thank you, Aaron. Slide number 13 summarizes the second quarter financial results of our Identification Solutions business. IDS sales increased by 1.3% finishing at $209.2 million with organic sales growth of 3.6%. Foreign currency translation decreased IDS sales by 2.3% this quarter.
Organic sales increased in the mid-single digits in the Americas and Asia and in the low single digits in Europe. We had organic sales growth in the majority of our product lines with the strongest growth in safety and facility identification. Our healthcare identification product line decreased in the low single digits this quarter.
We have work ahead of us to expand our sales force and to grow our pipeline of new products and to ultimately return this product line to a consistent level of meaningful sales growth and profit improvement. We did end the quarter in an improving situation.
We're developing a strong team and I'm confident that we're making the right long-term moves and that we're on our way to building a stronger business in healthcare. Our European businesses increased organic sales in the low single digits this quarter.
We continue to see growth in the safety and facility ID, product ID, and wire ID product lines. Sales growth was led by our U.K. business as well as emerging markets.
Organic sales increased in the mid-single digits in Asia this quarter. Sales increased throughout our Asian businesses with low single-digit growth in China and high single-digit growth outside of China.
Consistent with last quarter, our sales growth in China was behind the average for the rest of the region and it appears that the general economic growth rate has slowed. Segment profit in the IDS division was $37.9 million in the second quarter, which was an increase of 11.1% compared to the second quarter of last year.
As a percentage of sales, segment profit improved to 18.1% this quarter compared to 16.5% last year. The IDS business continues to lead the company's improved financial performance. We have been able to consistently grow segment profit while increasing our investment in R&D and investing in automation and efficiency throughout our SG&A functions.
I'm pleased to announce another new printer in our IDS business. This quarter we launched the i3300 Industrial Label Printer with WiFi. This is a mid-volume industrial label printer that is ideal for identification needs throughout a facility, including everything from wires and panels to safety and facility labels.
It's lightweight and compact to save space. It has the easy to use touchscreen and it's WiFi enabled. The i3300 can be used in a variety of industries and applications including barcode labeling, cable and wire marking, GHS and chemical labels, pipe and valve marking, and our Flash labels.
This quarter we also launched our first new product out of our innovation incubator, which helped complement an existing product line that had very limited new product introduction in the last several years. I'm proud of the work we're doing in R&D to improve our new product pipeline and to improve the cadence of our new product launches.
Our expectations for IDS for 2019 are consistent with guidance that we released last quarter, which is for a full-year organic sales growth of 4% to 5%. We'll continue to invest in R&D while efficiency activities in our manufacturing sites and throughout SG&A will provide benefits that will more than offset our investment in R&D.
Moving to Slide number 14, you'll find our Workplace Safety review. This quarter WPS organic sales declined 0.9%, foreign currency reduced sales by 3.3%, and the sale of our Runelandhs business in Sweden reduced sales by 5.8% compared to the quarter of last year.
This decrease in organic sales was due to the performance of our North American business, which declined in the high single digits this quarter. We took action by changing 1 of our digital platforms toward the end of the second quarter and we also took action to further address our cost structure. We believe these changes will set us up to drive future organic sales growth and profit improvement.
Meanwhile, our Australian and European WPS businesses, which together make up more than two third of the total of WPS division revenue, continued to drive solid financial results. Our Australian business was our strongest performer in WPS segment this quarter with mid single-digit organic sales growth.
We continue to both win new customers and expand into additional target markets in Australia. We've realized a meaningful growth in sales in this business. The team has been executing extremely well and we have positive momentum.
Our WPS Europe business grew organic sales in the low single digits this quarter. We continue to execute our strategy to improve our online presence and our sales to the digital channel increased by nearly 12% this quarter.
This business has steadily improved its business fundamentals while gaining efficiencies in its cost structure, which sets it up for long-term profitability improvements. Our WPS strategy is focused on three priorities.
First, we're improving the buying experience for our customers so that it's simple as possible, reaching our customers the way they would like to be reached; whether it's online, mobile, catalog, in person or through a combination of these channels. It's essential to gain market share and grow this business. Second, we're increasing our customer interactions to provide more value than simply fulfilling orders.
This allows us to better understand what our customers are dealing with from a safety and identification standpoint and to better serve those needs by offering our compliance expertise and complete solutions. Third, one of our strength is our ability to customize products and to quickly turn orders.
We're improving our portfolio of products by introducing more customized and proprietary products that our customers need while providing our extensive safety and compliance expertise. Returning our North American business to profitable organic sales growth is our top priority in the WPS division.
WPS segment profit was $4.7 million compared to $7.1 million in last year's second quarter. The decline in segment profit was due to the reduced sales volumes in the North American business, an approximate $1 million asset write-off, the sale of the Runelandhs business, and foreign currency translation.
Given that a full 50% of our WPS business is in Western Europe, the strengthening of the US dollar versus the euro has a much larger impact on our WPS business than our IDS business. We continue to expect the WPS business to grow organic sales by between 1% and 3% this fiscal year.
Overall, we have a solid start to 2019. We're growing sales, we're investing in research and development, we're upgrading our machinery, investing in automation, and we continue to identify and execute efficiency operations throughout our SG&A structure.
Our IDS business is strong and continues to lead Brady in organic sales growth and profit improvement. WPS Europe and WPS Australia continue to drive organic sales growth and profit improvement as they consistently execute their strategies.
But we have work ahead of us to improve our WPS North America and to bring our healthcare identification product line to consistent growth and profit improvement.
Competition for labor continues to be challenging, which makes our focus on efficiency and automation in our manufacturing processes essential to our ability to control input costs over the long term. I know we're taking the right actions today to drive sales and profit improvement for the long term.
We have the leadership in place in WPS North America and in our healthcare product line to invest in the right areas while acting quickly to stop what isn't working. We'll continue to invest in selling resources and in R&D by driving operational excellence in each of our daily decisions.
I believe that a consistent focus on key priorities is essential to driving long-term shareholder value. An organization that routinely changes its goals and its plans to achieve those goals can be left with an employee population that is confused about their roles and responsibilities, prioritization, and expectation.
At Brady we've maintained consistent priorities, we've defined goals and we're clear in expectation. We have a talented group of employees who are focused on developing innovative new products including automation within our manufacturing processes, driving sustainable efficiency throughout our SG&A functions, and improving our underperforming businesses. We’ve been working on these fundamentals for several years and we have a highly engaged motivated and tolerable Brady team to show for it.
I'd like now to start the Q&A. Operator, would you please provide instructions to our listeners?
[Operator Instructions] Our first question comes from George Staphos with Bank of America Merrill Lynch.
Hi guys. This is actually Molly Baum sitting in for George. I just wanted to go into a bit more detail on WPS North America. I know you had mentioned last quarter that you expected the supplier issue we're experiencing to get resolved.
Can you provide a bit more detail on what this new platform is that you're moving to? Is this focused specifically on digital and kind of how you expect it to play out in the back half of the year? Thank you.
Good morning. Molly. Glad to have you on the call. You're correct, we have resolved the issue as we promised. We don't go into the details at that level on our digital platforms, but I will tell you that we are moving to a rapidly more cohesive digital platform structure that allows all of our different regions to cooperate and coordinate their resources from a back-end point of view.
We want to make sure that the experience to our customer on the front end is geared toward their different cultural and business needs by location, region, and business unit; but on the back end, we want to make sure that we can leverage our technical capabilities and our ability to move forward. And so, that is the direction we're heading with that platform that we spoke about, in general the entire WPS platform stream.
Got it. Thank you for that. And then another one on WPS on the margin side. Can you -- one, the different items that you mentioned that were impacting margin, can you size those relative to kind of what you've experienced in the fiscal first quarter?
And then when you're looking at margins for the full year, I know and a few quarters back you had said that you could see WPS margins being flat for the full year, have expectations changed at all in that sense? Thank you.
Molly, this is Aaron. I can answer that question. Specifically compare -- if we specifically compare the second quarter of last year to the second quarter of this year, we basically called out three items; which would be the sale of our Runelandhs business in the fourth quarter of last year that has an impact of about $400,000.
We -- Michael mentioned a fixed asset write-off of approximately $1 million, foreign currency unfortunately continued to be a headwind as well which was another $400,000, and then effectively the -- call it the base business, if you will, declined $600,000.
So, that's -- what I'm trying to do is effectively bridge our Q2 segment profit of $7.1 million last year to the $4.7 million this year. And then as we look at -- as we look at the margin expectation for this business, as you see it's clearly down a bit. We haven't commented too much on the expectations for the back half of the year.
But as you look at the revenue guidance specifically, we're sticking with our revenue guidance of 1% to 3% organic sales growth in this business, which year-to-date we're at 0.6%. So, clearly we're anticipating an improvement in the back half of the year.
Great. Thanks. And I'll turn it over.
Our next question comes from Joe Mondillo with Sidoti & Company.
Good morning, Joe.
Hi, guys. Good morning. Could you first off let me know what the SG&A year-over-year change was excluding the currency and the divestiture?
I can. Foreign currency had about a $2.1 million impact on SG&A and the divestiture was about $1.3 million. So, effectively that leaves a $1.5 million reduction in our base SG&A.
Okay. So, I guess the follow-up is that you guys have done a really good job at taking down SG&A. Going forward, do you anticipate continued strength here? Is there any slowing at taking down SG&A or do you still see a lot of opportunity to reduce your SG&A?
Joe, good morning again. Unequivocally, we do not see a slowing of that effort initiative and as I said in the past, it continues to be a core philosophy. There's a couple of things that really are critical to how we view it. One, the reason we continue to have opportunities is I have a core mentality that I pass on and now it's been embraced by almost everyone within Brady of lowering the water, seeing the rocks, getting rid of the rocks, and lowering the water.
And what that effectively means is that we look at the biggest issues and challenges, we address them head on, we don't get distracted with the small issues and then when we lower the water, we determine what the next level of biggest opportunities are. We're continuing to do that, but we never do that from a mentality of just looking for reductions.
So if we take a look at our different business groups, they have worked in where they think they ought to be. They set targets for that. We absolutely look at restructuring how we do business as compared to coming out with a specific target of reducing headcount and costs.
So, we actually have many ongoing projects to make ourselves a more efficient and effective organization and the end result of that is we drive out those costs from the organization.
So, we are excited about our ability to continue driving that down as you can see our R&D effort simultaneously is going to be driving up our revenue. So, we've moved into the phase or initiative where I'm excited that we have an opportunity on both sides of that equation.
Okay. Thanks for that. And then on R&D, the last few quarters R&D in terms of the year-over-year growth has slowed, but sort of what you guided to suggests a pretty big ramp-up in the back half of the year.
Could you just talk about what's going on in your R&D programs, the volatility there, what you've seen benefits from so far, you're obviously anticipating a ramp up in R&D? Could you just talk about that in general?
Well, let's start with the term volatility. I do want to let everybody know that we actually have amazing stability in our R&D group and I credit the interesting exciting products and the dynamic innovation oriented culture that has been created within Brady.
Our R&D people are excited about the future, excited about their interactions with end-users, and their ability to really create products that will solve real problems. It's an amazing misnomer. Many people think that technical people want to sit in a back office and just create cool things that don't have any relevance to the world. It's quite the contrary.
They really want to make sure that their products and their ideas and their voices are heard and that's 1 of the reasons that you've been seeing an improvement in the new product innovations at our groups. They are buying into the fact that we really care about the success of those products in the marketplace and their input in that.
So, let's talk about the fundamentals of our groups and where we're headed and why we're going to continue growing that group. Our base core original leg of our technology stool was materials. To that, we added mechanical, we've been driving into electrical, and driving into software so that we have a totally integrated approach to our customers.
That results in our need to particularly add resources in the new areas while increasing the resources in our base areas, but more of the increase comes from our newer legs of the stool. We're going to continue to be doing that throughout the quarter. We are making sure we're building our groups in a sustainable method and although you won't always see an exact linear growth, you're going to see as we establish new groups and new efforts that the growth is significant and sustainable and we're on track to grow on R&D within our internal plans and structure exactly as we've announced to you. So, we don't -- we don't see a change in our direction.
And very, very excited not just about the size of the group, the technology of the group; but the energy of the group is dynamically different than it was just a couple of years ago.
All right, great. And then last question from me. The incremental margins at IDS, 140% or so, really strong. Just wondering if you could sort of break down sort of the components that are driving that and do you think that that kind of -- obviously I'm sure that 140% is not sustainable, but could you just talk about sort of the margin expansion going forward as well?
Well, we don't actually break down the elements as you well know, but I will talk philosophically about it. One, our core technology base and the proprietary nature of our products is getting stronger. In addition to that, our ability to differentiate through customization is getting stronger. Our rapid response to our customers is getting stronger.
And the most important element, our touch points with end users have become dramatically improved and so we're able to really give them more value. Fundamentally, Joe, the margins are dependent on us creating differential value to our customers so that they can provide differential value to their customer set and we believe we've been able to do that and do that well.
The other half of that though is mix. Different time periods, different strengths in different markets at different times will generate a different mix in our product sets that do have varying margin levels based on all the elements I mentioned above. So, you will see the different mixes as different cycles of the economy and in different economies in our different segments are more dynamic.
So, just to follow up on that. Was mix the biggest factor in the quarter itself? And looking at the mix itself, how do you think about the next few quarters relative to this quarter?
The mix comment was more holistic. I would actually say that we actually were driven more by high quality differentiating products this quarter and I do think that's a strength that we can work to carry on. Honestly, in a dynamic world, mix is something that is more problematic to predict. We literally have hundreds of thousands of products, 73 locations, 31 countries, 6 continents.
So as different economies move forward and backwards, mix is something that is not as easy to anticipate in the future; but the fundamentals so far as we did better last quarter are actually a stronger reality for us. I do have to mention mix because it absolutely at times makes a significant difference.
Okay. And then just finally, I hate to continue to push back, but could you just clarify the difference of high quality differentiating products and mix because that to me sounds very similar? Just trying to understand better.
No. We have an overall effort to drive more proprietary technology to our product sets. That's what I'm talking about of high proprietary products. Now we may have some product sets and we've talked historically such as our healthcare products that have a lower -- a lower margin set. If that mix for instance sells more, then we are going to have lower margins. At the same time if we're adding new higher proprietary products into healthcare, over time that overall margin set will improve for healthcare products.
So straight out if we sell significantly more healthcare products, that may lower our margin slightly; but we're at the same time working hard to improve all of our product sets capability so that the total margin for each of those product sets is improving.
Okay, great. Thank you.
Thank you.
Our next question comes from Charlie Brady with SunTrust Robinson Humphrey.
Hi. Thanks and good morning.
Good morning, Charlie.
Hey, I just want to -- on Workplace Safety, I guess I just want to try and understand a little bit better about the growth outlook -- the organic growth outlook for the year, I guess really into the second half as to given what's gone on in the first half.
What drives -- I mean what's the big turnaround in the second half to get you to kind of that full-year core guidance rate of up 1% to 3% as opposed to being flat to down for the year?
We divide that group in just 3 regions -- segments. We do expect continued and even possibly improving results in Australia, but we'll say continued. We expect strong results out of Europe and it had good solid results in Europe.
And then the real differentiator is we believe the elements that are in place, and I guided to this last quarter, for improvement during the last -- latter half of the year are based on all of the different changes we're making in our WPS Americas business.
Part of that is our digital platform and we -- but we are definitely seeing better traction in our digital platform due to our move to more sustainable platforms in the recent weeks.
So we feel like and we're confident that we'll be able to sustain and improve that, which will lead to particularly in the later half of -- the second half of the year strong -- much stronger overall results there that will lift that part of the boat which will allow the other two parts to help drive our overall growth.
Okay. That's helpful. Thanks. And I guess just on the margin side for both of the segments, I didn't see you'll provide specific kind of margin expectations for the year again. Are you -- should we expect particularly in Workplace Safety to see year-over-year increase in margin if the back half is going to be strong organically as you're saying it's going to be or are there factors such as the costs that are not fully offset kind of being a headwind to keep that down year-on-year from an operating margin perspective?
Yes. So as you look at Workplace Safety in the back half of the year, let me just say it this way. I absolutely expect our segment profit margin so as a percent of sales to increase from what you saw in the second quarter of this year. But if you remember back to the fourth quarter of last year, we had a very strong fourth quarter from a profitability standpoint.
So, I'm certainly not going to commit and say we're going to grow over what we saw last year, but I can absolutely tell you this and that is we're headed in the right direction with this business and segment profit as a percent of sales should move up from what you just saw in the second quarter.
Okay. That's helpful directionally. And I guess I would ask a similar question. It sounds like from a IDS perspective, the margin profile's clearly different there that margins ought to be up nicely on a year-over-year basis for IDS. Is that fair?
Yes, that's absolutely fair. We feel that the business is strong and the new products that we're innovating are strong. You've observed us for a while, Charlie. I think you'll see as the other people have that our cadence of new products, printers, technologies has become very dependable and reliable and that is not something historically I think we could say.
That cadence is even more significant than the particular specific products. I think we have a large number of products in our portfolio. Although we will highlight some that we find interesting during the calls, many, many more are actually being released throughout each month and each quarter and throughout each year.
So, the end result is that we have a steady stream of new products that are going out from all of our different product lines every quarter and that is definitely a change that we believe will help with that and also revenue in general.
All right. And just 1 more for me and maybe you'll not be able to answer it, but I'll ask it anyway. If you look at the two segments, profitability profiles are different, the growth profiles are very different, geographic exposure is very different.
With IDS being three quarters of sales, roughly 80% plus of operating profit; is any thought given to does Workplace Safety still seem like a core asset that ought to be part of the company or not?
Charlie, we challenge ourselves in who we are and who we should be on a regular basic -- basis. Actually we literally just got out of a strategy review and a strategy update. So there is no question that we put a spyglass -- a magnifying glass to all of our businesses, all of our product lines asking the questions; how do they interrelate, how do they help each other? We absolutely do that.
I won't get into specifics on the call obviously, I think you knew that with the way you worded the question, but I will tell you that we don't in any way, shape, or form see ourselves as some kind of conglomerate.
We -- I fundamentally believe and our leadership fundamentally believes that to be valued as an organization, we have to take a look at how we work together and make each other stronger. We feel that the units that are involved in our business today absolutely do that.
There are times that we will look and re-evaluate that, a great example was our furniture division. We really looked at our furniture division and saw that it was good business, a solid business, but we didn't really see how we really helped them significantly enough and vice versa how they helped our business significantly enough.
So we will continue to look at not just WPS, but all of our businesses to make sure that we're being realistic and honest in our assessment of the fact that we're lifting each other up.
Thanks. I appreciate the answer. Thank you.
Thank you, Charlie.
Our next question comes from Keith Housum with Northcoast Research.
Good morning, Keith.
Can you hear me?
Good morning, Keith. Yes, we can hear you.
Great. Thank you. Michael, question for you on the healthcare business. If I recall conversations from earlier in the year, the thought process was in the second half of the year the healthcare practice would be like a flattish type business. Do you still feel you're on that trajectory that that business is going to be flattish towards second half of the year?
Yes. I think as you watched us fix and build each of our different businesses, we do go through those transition moments, we feel that we're definitely on track. I will tell you that that business is headquartered out of California.
I was just there a week ago. We do full deep dives, reviews with all the team. I feel very good about the new leadership in place there, the direction they're heading. I also describe it as peeling an onion.
When you look at needing to change the outside, often you find incredible depth and capability within the organization. I feel very strongly that all the indications are really blooming capability within that group and that they can continue the trajectory that we mapped.
Okay, got it. If I can turn my attention over to WPS. Can you give us some comfort here that the issues that we see in the North America segment or the Americas segment won't come down the line and affect the Australia and the European business?
Because when I think about the WPS business, it's been in trouble in the Americas since as long as I can remember and I just want to make sure that these issues are more isolated geographically as opposed to being secular of that, the other geographies might be a few years late to encounter?
Well, first, I do believe we can and will address some of the fundamental issues in North America. But yes, there is a differentiation. You take a look at the business in Europe, it is much more of a segmented business, very strongly segmented whereas you look at North America and you look at it as a more homogeneous effort.
And without getting into details of mistakes of the past, we believe we made some fundamental different moves in -- we know we made some fundamentally different moves in North America than we made in Europe that have had lasting impacts and that have been very challenging to overcome. So, we believe we are in the business in a much more strategically effective way in Europe.
In addition, it's much more segmented and will remain so. I have -- in fact my confidence of that has grown and not decreased. Now you look at Australia, we're able to bring the full weight of all of Brady's capabilities to Australia through that business. It is a more isolated region, they have unique sets that we're geared to respond to.
So once again although it is a smaller market, even within that market we actually segment it fairly effectively. There are very different business needs in different areas of that -- of Australia that are identical to Europe, but certainly are not identical to the United States.
Okay. I appreciate that. Maybe I can squeeze 1 more here for Aaron. Aaron, as I look at your inventory levels at the end of the quarter compared to say last quarter or even last year, it looks like they're up almost 5% on a FX adjusted basis.
Do I read that in terms of you guys are gearing up for higher growth levels that you expect in next quarter or is it due to some of the machinery you're putting in and just need to account for perhaps the time lapse there or am I missing something else?
Yes. I wouldn't try to read too much into our inventory levels. Inventories absolutely are up this quarter. As we look at it, we increased inventories in a handful of locations Frankly, an element of our increase in inventory levels is in response to working to reduce our shipping costs.
So for instance if we were to have multiple shipments into a location in the same month or week, we've consolidated some of those shipments in order to save on shipping costs and frankly it's been working. So, that's a piece of it.
We also built a bit of inventory in advance of Brexit in a couple of our European locations, which we think is the prudent approach. And also just from a timing standpoint in a couple of locations, we've built up some inventories. We obviously look at inventories.
We're not in the business of intentionally growing inventories for no reason at all. So, we do look at it closely and we believe that the increases that we saw this quarter were appropriate from an overall standpoint. But don't read too much into it other than basically what I just said.
Fair enough. Thank you.
Our next question is a follow-up question from Joe Mondillo with Sidoti & Company.
Hi guys. Thanks for taking my follow-up. Just wanted to ask sort of the sales guidance that you provided, Aaron, you pointed to the lower end of the 3% to 5%. Considering that and considering that you're anticipating an acceleration in sales at WPS here, it sounds like you're assuming improvement in the healthcare business in the back half of the year, you have R&D costs going up.
So, that sort of tells me that sort of your core IDS ex-healthcare could potentially see some headwinds to margin expansion at least compared to the second quarter. Is that a fair read for the back half of the year?
Not necessarily. So, we have our guidance out of 3% to 5% organic sales growth. If you look at where are we year-to-date, we're -- actually we're at the lower end of that guidance range right now on a year-to-date basis. And actually as you look at healthcare, I just want to make sure we're all square.
Healthcare grew slightly in Q1, declined slightly in Q2. When you look at it, we're effectively flattish year-to-date and as Michael just mentioned, that's about where we expect to end up this year is still in that flattish range, if you will.
So, I wouldn't read too much into our IDS margins as a result of our guidance. Business is super strong, they're doing very well.
Okay. And then just a couple of housekeeping items if you will. The $1.4 million of non-operating income that hit the quarter, I know you saw something similar to last year. I'm not sure what hit that line, but could you just comment on that? And is there anything baked into the guidance for the back half of the year in that -- on that line at all?
Sure. So for instance if you compare Q1 of this year to Q2 of this year, in our first quarter it was effectively 0 -- effectively flat in the investment and other income line and in our second quarter, it was $1.4 million. There's 1 item that plays a significant component in that, which is the accounting for our deferred comp plans.
So, to put this in perspective. In the first quarter we actually had some expense on our deferred comp plans in investment and other income. That is a net 0 impact on our total income statement, however, because the way that the accounting works is you take an expense in investment and other income, but you also get a benefit in SG&A expense.
Now fast forward to the second quarter, it's the exact opposite of what happened. We have a benefit in investment and other income expense and additional G&A expense. So, it really comes down to swings in the assets that are in these Rabbi trusts. So beyond that, nothing unusual flows through these lines basically except interest income and some foreign currency gains and losses.
Okay. And then the -- so the accounting in terms of going forward, is that -- that switch, will that be consistent for the quarters going forward?
Unfortunately I can't answer that question because it's contingent upon what the market does because these investments are mark-to-market every -- every quarter. So, you should continue to see some volatility -- and again, it's a net zero on our pretax income. It's just a classification between SG&A and investment and other income.
Okay. And then the tax guidance that you provided, seems like it implies a mid 20% range that your original sort of guidance was for the back half of the year. Is that a fair tax rate to continue to use going forward?
Well, our tax rate guidance for this year is 22% to 24%. We had guided to a slightly higher tax rate in previous quarters. So, we would expect our tax rate -- I guess it's implied to be in the neighborhood of 23% for the back half of this year, which was basically a couple of -- only a couple of points lower than what we had originally anticipated.
But isn't the first half of the year more like 21.5% or 22% so the net average would be a little higher than 23% in the back half of the year.
Yes, I think our first quarter tax rate was 23.2% and second quarter was 20.3%. So if you do that -- if you do the math on it with our -- with our third and fourth quarters, we basically fall right in the middle of that 22% to 24% range. It's all -- it's very close.
Okay. And then lastly the CapEx, it looks like you're anticipating a decent ramp up in CapEx. Could you just talk about the investments that you're making? And you sort of alluded to bringing that down potentially closer to $30 million potentially compared to the $35 million that you're originally guiding to. Is this just a timing thing so things are pushed out a little bit into fiscal '20? Just talk about the investments that you're making in sort of that timing or lumpy aspect of it.
Yes, I definitely will. So, our guidance for this year is $30 million to $35 million. The only change in that guidance relates solely to timing of some of our -- some of our facilities that are currently leased facilities that we're constructing new facilities to effectively remove that lease.
We continue to invest at a pretty healthy clip in machinery and equipment that's meant to drive efficiency gains and to increase our capabilities. It's all timing related to these facilities.
Okay. And then just a follow-up, just last follow-up. The new facility, is this just to -- so that you're not leasing anymore or is there also productivity gains and aspects of that with these new facilities that they are brand new and could you talk about what you're doing there?
Sure. We invest in the long term, we think long term, and philosophically that has been somewhat of a different change. I think it was more of a private equity model for a few years ago where you looked at a shorter tenure. What I believe fundamentally is you're very small, you're still five facilities, ones that are likely to dynamically change maybe need locational changes; those should be leased.
But your core facilities, the backbone of your different businesses, your core manufacturing; if you lease those, what we find is that we don't invest properly in technology capabilities because there's always a mentality of this is a leased facility.
Also the secondary benefit is your cost structure does go down as well. So you get more stability, your employees realize you have more stability, you have more flexibility about how you handle and run the buildings, and as I said the final benefit is going down but what -- the cost will be going down.
But what you really will see is a continuation of that as major leases come up on facilities that we really believe should be Brady in the long term.
Okay. Thanks.
Thank you.
And I'm not showing any further questions at this time. I turn the call back over to the company's CEO, Michael Nauman. You may continue, sir.
Thank you. I'd like to leave you with a few concluding comments this morning. We've got two solid quarters behind us in fiscal 2019. Our organic sales growth was 2.3% this quarter and our pretax earnings increased by 4.8%, which represent our 14th consecutive quarter of year-over-year pretax earnings growth.
We increased our investment in R&D consistently over the past 2.5 years and we will continue to do some -- so throughout the balance of this year demonstrating our commitment to new product development and innovation to drive organic sales growth over the long-term.
We've increased capital expenditures to improve automation in our factories and we continue to identify and execute improvement in our SG&A cost structure. We're focused on improving our underperforming businesses in WPS North America and the healthcare product line and we have strong leadership in place to turn these businesses around.
We've done well and I know we can do better. We're pushing ourselves to deliver more for our shareholders, our customers, and for our employees. I'm motivated and I know that the entire Brady team is engaged and focused on delivering results.
As always, if you have questions, please contact us. Thanks for participating today and have a great day. Operator, would you please disconnect the call.
Ladies and gentlemen, this does conclude the conference. You may all disconnect.