Good day, and thank you for standing by. Welcome to the Third Quarter 2021 Brady Corporation Earnings Conference Call [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ann Thornton, Chief Accounting Officer. Please go ahead.

Thank you. Good morning, and welcome to the Brady Corporation Fiscal 2021 Third Quarter Earnings Conference Call. The slides for this morning's call are located on our Web site 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 are 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 2020 Form 10-K, which was filed with the SEC in September of 2020. Also, please note that this teleconference is copyrighted by Brady Corporation and may not be rebroadcast without the consent of Brady. We will be recording this call and broadcasting it on the Internet. As such, your participation in the Q&A session will constitute your consent to being recorded. I'll now turn the call over to Brady's President and Chief Executive Officer, Michael Nauman.

Thank you, Ann. Good morning, and thank you all for joining us today. This morning, we released our fiscal 2021 third quarter financial results, which was a very strong quarter in a challenging but improving economic environment. The Brady team is executing well, innovating for our customers and providing many of the products that are needed to help fight this pandemic. I'm proud of the accomplishments of the entire Brady team. Although this pandemic isn't yet quite behind us, as COVID cases are still high in many countries around the globe and businesses continue to have many people working remotely, demand has increased. Our salespeople are starting to travel again and there are pockets where our business is growing beyond 2019. The cost side of this recovery has definitely been swift and has absolutely resulted in inflation in areas such as resin, freight, paper, base materials and wages. As you can see, we continue to maintain a healthy gross profit margin of around 50% as we've never slowed down or pushed to automate our facility and drive sustainable efficiency gains, which when combined with target price increases, are offsetting input cost increases. Driving efficiencies is a never ending focus for us at Brady. However, what's more important at this juncture is ensuring that we're taking aggressive actions to accelerate sales growth. We're upgrading our Web site. We're improving our marketing capabilities. We're developing new products and we're investing in capacity enhancing machinery. We're making the investments necessary to grow our top line now and into the future. Profitable sales growth is our number one financial priority. For instance, in our ID Solutions business, we've been increasing our R&D spend, and we're seeing the positive results as we launch new products at an increasing rate, and we're continuing to distance ourselves…

Thank you, Michael. Good morning, everyone. I'll start the financial review on Slide number 4. Sales in the third quarter were $295.5 million, which was an increase of 11.1% compared to the same quarter last year. And pretax income was $47.8 million, which was an increase of 116% compared to Q3 of last year. Diluted EPS finished at $0.71 this quarter compared to last year's third quarter EPS of $0.26. We also had another very strong quarter of cash generation. Cash provided by operating activities was $56 million, which is more than 30% higher than the $42.8 million of operating cash flow generated in the third quarter of last year. So financially, Q3 was a very strong quarter. Moving to Slide number 5, you'll find our quarterly sales trends. Our double digit sales growth consisted of organic growth of 6.5% and an increase from foreign currency translation of 4.6%. Organic sales continued to improve sequentially in our ID Solutions business and finished Q3 up a robust 9.8%. Our Workplace Safety business benefited from strong COVID related product sales in last year's third quarter. As a result of these tough comparables, we saw a decline in WPS organic sales of 2.2% this quarter. However, we remain optimistic about the future of our WPS business and we've increased our customer base, improved our digital presence and we have many new proprietary products, all of which bode well for the future. Turning to Slide number 6, you'll see our gross profit margin trending. Our gross profit margin increased by 170 basis points this quarter, finishing at a healthy 50.4% compared to 48.7% in the third quarter of last year. This improvement was a direct result of the increased sales volumes and the many efficiency activities that we've been driving throughout our manufacturing facilities.…

Thank you, Aaron. Slide number 14 outlines the third quarter financial results for our Identification Solutions business. Our ID Solutions business continues to steadily improve by the initial shock from the pandemic, which was over a year ago now. In fact, this quarter we accelerated our way out of the decline. IDS sales increased 12.9%, finishing at $218.1 million with an organic sales increase of 9.8%, an increase of 3.1% from foreign currency translation. Organic sales in our IDS division were very strong not only versus the third quarter of last year but also against the previous sequential quarters. And on the cost side, our strong focus on efficiencies led to a 300 basis point increase in segment profit as a percentage of sales when compared to the third quarter of last year. Regionally, organic sales in Asia were strong this quarter with growth of just over 10% compared to the third quarter of last year. This is the second quarter in a row of Asian organic sales growth in excess of 10%. In Europe, organic sales were up nearly 12% despite several lockdowns occurring throughout the third quarter. Our European team did an outstanding job driving sales growth while handling the periodic interruptions of lockdown. We also had strong high single digit organic sales growth in the Americas. We saw growth in all product lines and geographies throughout the quarter. Demand in our health care business has improved and we exited Q3 near pre-pandemic levels. Sales in our healthcare product lines grew in the low single digits this quarter, which is a solid improvement from the 6% decline we saw in the second quarter of this year. In general, our sales trends in IDS are very positive. However, we do have a number of small end markets that have…

[Operator Instructions] Our first question comes from Michael McGinn with Wells Fargo.

Nice quarter. I just wanted to start with the comments on Nordic ID and the dilution, just want to confirm that was an IDS segment comment. Also regarding the strong operating margin performance you put up in that segment, and it's going to be -- you mentioned the cost out synergies are going to be somewhat muted and you're going to grow into this business it seems like. Does that mean Q3 is going to be the high watermark for IDS profitability for the next couple of quarters?

I can address this. Nordic ID will absolutely be in the ID Solutions segment. I would not anticipate that Q3 would be the high watermark. If you look at the size of Nordic ID compared to the ID Solutions segment, it's very small. Now it's very small. It doesn't mean it's not important to us, it absolutely is. We think it's a very well run organization with great technology, and we're very excited to have them in the Brady portfolio. But to be quite candid, it's not big enough to significantly move the needle outside of this Q4 period where we have these acquisition related costs.

And so switching gears to the gross margin, good number there. If you were -- you mentioned a couple of highlights there. automation investments, some recovery in some important markets and then pricing. If you were to bucket the big items within your gross margin inflection, how would you rank order those? Any color there would be great.

One thing I want to mention, let's start with automation. I believe that's had the largest impact on Brady being able to really enhance our margins and maintain our margins. And this is a journey we've been on for approximately four years. We saw ahead of the curve that labor around the world was going to become more and more expensive but more important than the expense is the difficulty to procure labor. Now to be honest I didn't anticipate the global pandemic that has accelerated that labor shortage but the fact that we were ahead of the curve in my mind of really driving in that area has made a significant difference. And I want to be clear, often, we have the question, how far along in this process are you, it's never ending. In fact, I've not only challenged our teams to double down on automation efforts because we're working on some very large ones right now, but I've asked them to work to accelerate to a next generation of automation as we go forward. So really, you're going to see a one-two punch going forward in that projects we're working on, challenging a parallel approach versus a serial approach. And I'm asking our teams to think even larger and bigger as we go forward. The good news in that area is we're already thinking that way as a company. We're philosophically aligned with that. So as many of our competitors are literally just looking at different ways to automate, not just manufacturing but to start to the finish of the process, we're already well along the intellectual curve and, in many ways, the physical curve of getting there. So that was a big determinant. The second factor is we have done a very good job of taking…

And If I could sneak one more in on the capital allocation strategy, understanding you have the cash to self fund a lot of goals if it need be. It seems like this is more of an evolution versus a revolution. That said, when we look towards inorganic growth, are you also looking and mirroring that with divestitures or do you feel comfortable with the portfolio of the two segments you have in place right now?

We have definitely looked at divesting parts of our business in the past. We got out of the furniture business, which I think was a wise move on our part, particularly at the time we've got great value for those businesses and hopefully, those businesses have add value to their new owners. But we are always looking at that. And I think that's an area that we need to continue to look at, making sure that we're really focused on the businesses that will be strongest for Brady in the future. So although there is -- I'm not signaling anything. By saying that, I am telling you that, that is definitely an active part of our mentality. We want to be focusing on the best businesses to synergistically work together. I'm not a big believer in conglomerates in that if we don't find reasons to be together to help each other then there's probably a better owner for that business.

Our next question comes from Keith Housum with Northcoast Research.

And I want to echo that. Good job on the quarter. It's great to see those gross margins. If I can go along with similar lines of expanding on the gross margins a little bit more. You obviously had a lot of puts and takes this quarter and especially with the WPS micro business being down, it was nice to see your gross margins. And I understand the automation and your prior comments leading up to that. But really, I guess the question is, do we have the capability going forward to see gross margin expansion or is it really more just [letting off] (ph) all the price pressures you have from wage cost, freight, raw materials and elsewhere?

Keith, as I think I've said in the past, we are very proud of our margins. They show solid, in fact, excellent differentiation in industrial space, showing that our customers see real value in the Brady products. That said, we are seeing cost pressures. I listed a lot of the areas. But the cost pressures are definitely real. The inflation we're seeing is definitely real, and we believe it will be sustained. The good news about that is we're also projecting that we'll be able to maintain our margins plus or minus a hair going forward. We think that we maintain those because of our excellent position with our customers and also our ability to continue to be more efficient and effective in how we approach our business. So we are not projecting a margin expansion but we are projecting despite inflationary pressures to be able to maintain those as we grow revenue, therefore, hitting our total dollar margin as an increase.

And then turning over to Nordic ID, I apologize if I missed this. Did you cover how much revenue you expect Nordic ID to bring in for you guys?

We didn't. We expect to have a little over two months of revenue. And to put it in perspective, their calendar 2020 sales were EUR6.7 million. So take a sixth of the EUR6.7 million, so not that significant.

And is that business growing for them or is it stagnant?

Yes, the business is growing. But more importantly, the combination of Brady in that business is an excellent growth opportunity. By creating umbrella, tying in software between the two groups, creating a synergistic sale, we are very confident in twofold. One, we'll expand the customer base, period. But two, we have the North American marketplace where we see an awful lot of opportunity to grow their product set. But remember, the reason we're excited is that technology, combined with our technology, i.e., the total product offering to our customers, is one that we are confident we will do very, very well with that our customers will really appreciate.

And if I could squeeze one more in here. Does Nordic ID manufacture their own goods? And if they don't, will you plan on in sourcing that or are you going to maintain the same manufacturing process?

We're not making any public comments at this time on their manufacturing. To say Brady always looks at the best way to manufacture our products, you know that if we believe we can add more value to our customer by doing that, we are a manufacturing company. But at the same time, we know there are things that we do very, very well and things that other people do very, very well. So I can't speak specifically to what we'll do with Nordic ID, but I can tell you the biggest opportunity by far is taking this very talented team, marrying them with our very talented team, their great products with ours. putting an umbrella of software over the two and really creating a strong growth driver. That's where I'd focus on Nordic ID is that this is an engine for growth.

Our next question comes from Steve Ferazani with Sidoti.

So you talked a little bit about the end markets we know aren't really recovered yet, the workplace ID I'm guessing hospital and healthcare ID deviation, oil and gas and just got back. So a lot of these end markets haven't recovered and you can expect those to grow over the next few quarters, yet your revenue is above pre COVID levels on a quarterly basis. So I'm just trying to get a better indication of where the strength is coming from that's offsetting all those areas that are going to be in the quarter…

You hit very well -- Steve, I didn't mean interrupt. You hit the areas very well that haven't recovered. I would say the best markets are in general industrials, extremely strong. But the other thing, Steve, that I think is important, we really know we've grown because we brought out the products they really need right now. Particularly, let's talk about some of our wrapping products, again, that we've brought out. These products literally eliminate labor. It's not, once again, just an equation of saving them money. One of the things that our people go in and say is can you get the people to do this work. No. Well, then is it an issue of saving money or an issue of getting your products out that you need to get out. So the fact that we have really created some great industrial products during this time when a lot of people were pulling back that are exciting to our end markets has made a big, big difference to us. But specifically, again, biggest change is in industrial markets.

And did you mention how -- where do you see the hospital and health care segment area right now versus where it's been? Do you see some improvement…

So I think I mentioned in my comments, the areas where we really aren't seeing as much is the areas where people are getting together. Hospitals, we are seeing basically a recovery to be back where we were or close pre pandemic. People have put off surgeries as much as they can. People literally weren't probably going in to get surgeries they desperately needed are going in. The hospitals are -- to come back and are feeling comfortable coming back and their focus on COVID, as you look at the numbers go down dramatically, has been able to pull away. We're thankful for that as a society. But we're grateful for that as a company, obviously, because our products are definitely more geared. Although we did tremendously well with COVID products, I would far rather sell products to help the world be a healthier place in general. So we are -- to clearly answer your question, yes, we're seeing that market coming back to pre pandemic levels.

And then just on the last quarter, obviously, 2Q, you had the issues in product mix on the Workplace Safety and that bounced right back in terms of margin back to more normalized level, which I think you were expecting. Can you just talk a little bit about the dynamics there on the mix on Workplace Safety…

I mean the COVID products were at lower margins, period. But you know as a human being that doesn't bother me at all because we got out products people really needed when nobody -- in many cases, we are the only person able to provide them. So I feel very, very good about what those products did to help the Brady employees get through this, help our customers get through this, help the world get through this. But the margins on our core products are superior. And as we convert, even though we're not right now able to convert total revenue to the extent of the decline, I feel very good that the margins that we'll end up with this customer base are in line with the margins that we've historically gotten off our core products. So that switch will be good for margin and the customer base that we brought in would be very good for Brady. And they do appear to be as solid or even more solid as far as being recurring customers as our historical base has been.

Just one more, given how quickly you had the recovery on the ID side, you talked about labor shortages. Did you have to push off any work in the quarter? And Is that a risk going forward if activity continues to pick up?

You know what? Super proud of what Brady has been able to do in regards to getting our products out in a timely manner. Our numbers, although, we don't publish them, are excellent on delivery and have not deteriorated. There are some areas that are particularly oil based that have been somewhat super challenged, but we've been able to keep making everything work on a very tight schedule. So although labor in particular is the area that drives the most concern, so far, we've been able to use a combination of efficiency, great employees and new hires to meet the needs. There is no question that as the whole world heats up, the economy heats up, that will become more and more of a challenge.

Our next question comes from [Kashi Keeler] with Bank of America.

This is [Kashin Keeler] on behalf of George Staphos. So first off, you're raising guidance, but you're obviously seeing some more inflation. So I guess is it possible to quantify or break out what benefit you expect to get from volumes versus some price actions with customers?

I would like to say yes/no. We have such a good mix. We do have good control over our costs, as you know. We do have good control over our pricing. But it would be very hard to break that out as an indicator for you for a model, particularly for others. But I can tell you this and I will repeat it. For us, I'm not speaking anybody else, inflation is real. There is no doubt that inflation is here and I don't see it as a very temporary blip.

And then I guess going back to Nordic ID, you noted that you intend to increase R&D efforts there. I guess can you just talk about that a little bit more and I guess what specifically you expect to spend on?

If you take their scanners with our printers, we need to create an ecosphere between the two. So there's a lot of software involved with that. But also we want to make sure that they have the products that fit our industrial mindset and mentality, North American market, et cetera. So you will see a hardware but the biggest lift is going to be in the software area.

And I'm showing no further questions in the queue, I'd like to turn the call back to Mr. Michael Nauman for any closing remarks.

Thank you very much. I'd like to leave you with a few concluding comments this morning. We're certainly living in interesting times. While we're still on the back half of the global pandemic, the economy appears to be accelerating. At the same time, there is significant geographic and end market dispersion and we're seeing inflationary pressures all around us. Regardless of the macroeconomic changes ahead of us, I am very confident that Brady will continue to thrive as a result of our strong team and the actions we've taken to ensure that we have a strong foundation. We've committed to come out of any downturn stronger than our competition and we are doing that. This quarter, we experienced excellent sales and profitability growth. In fact, this was a record EPS quarter for Brady. Our ID Solutions business returned to strong organic sales growth and once again increased its profit as a percentage of sales. Our Workplace Safety business continued to enhance its digital presence and serve its customers extremely well, further strengthening its already strong foundation for future growth. And we had another great quarter of tremendous cash generation with free cash flow up more than 40%. We're in a net cash position, which gives us tremendous flexibility to add incremental shareholder value. We're prioritizing investments in growth. And we're confident that Brady is well positioned to capitalize on global market trends. We will finish our fiscal 2021 with strong momentum, thus setting ourselves up for an even stronger fiscal 2022. We are very well positioned to generate significant value for both our customers and our shareholders. Please stay safe, and thank you for your time this morning. Have a great day. Operator, you may disconnect the call.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.