Good day and thank you for standing by. Welcome to the Second Quarter 2022 Brady Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there'll be a question-and-answer session. [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 2022 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 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 2021 Form 10-K, which was filed with the SEC in September. 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. Michael?

Thank you, Ann. Good morning and thank you all for joining us today. This morning we released our fiscal 2022 second quarter financial results, which showed very strong sales growth and improved EPS. We have been successfully navigating challenging supply chain issues in a highly inflationary environment in order to manufacture and deliver the products that our customers need and have come to expect from Brady. I'm proud of how the team has been able to work through this difficult environment and deliver for both our customers and our shareholders. This quarter, we grew sales by a very robust 19.6% and we increased GAAP earnings per share by 10.2%. If you exclude the impact of amortization, then our EPS was up even more significantly at 14.8%. Along with the strong revenue growth and improving EPS, we have an extremely solid balance sheet. Even after returning $45 million to our shareholders in the form of dividends and buybacks in the first two quarters of this year and intentionally building up our inventories, we are still in a net cash position of more than $64 million as of January 31. This quarter, we also returned our WPS business to organic sales growth earlier than originally anticipated. Even with tough comparables due to strong COVID related product sales in the prior year, organic sales growth increased by 5.2% in our WPS business this quarter. In our Identification Solutions business, we continued to post excellent results with organic sales growth of 16% and a total sales growth of 26%. Over the last several years, we've built a strong foundation for success and this foundation is propelling Brady's performance. First, we worked on removing structural inefficiencies, improving execution, simplifying our business and rejuvenating leadership accountability and focus. You can clearly see the benefits of this…

Thank you, Michael. Good morning, everyone, and thank you for joining us this morning. I'll start the financial review on Slide 3. Sales in the second quarter were $318.1 million, which was an increase of 19.6% when compared to the same quarter last year. And GAAP pre-tax earnings increased 6.7% to $42 million. Impacting earnings this quarter was a significant increase in amortization expense from the acquisitions completed at the end of last year. If you exclude amortization expense from all periods presented, then our pre-tax earnings would have increased by 12.4% to $45.8 million. GAAP diluted EPS was $0.65, which was an increase of 10.2% over last year's second quarter. And if you exclude amortization expense, then EPS would have increased by 14.8% to $0.70 this quarter compared to $0.61 in the second quarter of last year. So financially, Q2 was another very strong quarter despite the logistical challenges and the inflationary pressures that Michael just mentioned. Moving to Slide 4, you'll find our quarterly sales trends. Our nearly 20% sales increase consisted of organic growth of 13.1% and an increase from acquisitions of 8.6%. This was then partially offset by a decline of 2.1% from foreign currency translation. Organic sales grew in each of our two divisions. ID Solutions had robust organic sales growth of 16% and Workplace Safety Return to growth clocking organic growth of 5.2% this quarter. Turning to Slide 5, for our gross profit margin trending, our margin was 47% this quarter compared to 48.7% in the second quarter of last year. As Michael mentioned, we're experiencing inflationary pressures in nearly all cost categories, but we're automating across our sites, we're driving efficiencies throughout the entire organization and we're putting through selective price increases to offset these cost increases. On Slide 6, you'll find our…

Thank you, Aaron. Slide 13 outlines second quarter financial results for our Identification Solutions Business. IDS sales increased 26.1% to $245 million. Organic sales on IDS division were once again very strong, up 16% versus the second quarter of last year. And on the cost side, we drove numerous automation and efficiency projects that partially offset input cost inflation that we've been experiencing. Segment profit as a percentage of sales was 18%, which was down from 20.1% last year. However, if you exclude the sizable increase in amortization that Aaron mentioned, then segment profit as a percentage of sales would have been 19.5% this quarter compared to 20.7% in last year's second quarter. Regionally, organic sales in Asia were once again very strong this quarter with growth of nearly 15% compared to the second quarter of last year. This is the fifth consecutive quarter of Asian organic sales growth in excess of 10%. Organic sales were also up more than 15% in the EMEA region despite several lockdowns continuing throughout most of the second quarter. And organic sales growth was just as strong in the U.S. with growth of over 15% as well this quarter. We saw growth in nearly all product lines and all key geographies including healthcare where organic sales growth was approximately 6%. Overall, our sales trends in IDS are very positive. Yes, our margins are temporarily challenged, but we are growing our customer base and taking share. This bodes well for our future. Our R&D investments remain a high priority. We've ratcheted up our investments to build an industrial track and trace solution and we're already experiencing stronger than anticipated synergies from our recent acquisitions, which we expect to only increase from here due to the complementary nature of Code, Magicard, and Nordic ID product portfolios.…

[Operator Instructions] Our first question comes from Michael McGinn with Wells Fargo. Your line is open.

So starting with pricing, pricing was noted I think selective was the term used, but inflation is broad based. So why not be more aggressive? And can you also address the differential in pricing strategies between devices and consumables? Do consumables have less upside given their higher starting point on margins?

First of all, I think the wording was careful. And Michael, I would say this, we have actually been aggressively increasing the broad depth and amount of our price increases and we plan to continue to do so. So that - there are a few minor areas that we are facing challenges competitively in the environment of some, what I would call even irrational price decisions by some of our competitors. But as you know, we have very broad-based competitors depending on the product. And so effectively we've been raising prices across the board in our units with a few exceptions. That said, we feel strongly that we provide significant value to our customers and we are looking to increase prices going forward more rapidly and more significantly in all areas, consumables and non-consumables.

And can you maybe walk us through - that's the price on the cost front where you guys recognize inventory, LIFO, FIFO, weighted average costs between the two separate segments?

I'm sorry, Mike, can you ask that question again.

What is your accounting methodology for inventory between the two segments?

Okay. We have portions of our U.S. business that are on LIFO and it is mostly our Identification Solutions business. So clearly, we are recording inventory LIFO on IDS and Workplace Safety is not on LIFO. And as far as the first piece of your question regarding cost increases, we are seeing cost increases across lots of different categories. Let me just put it in perspective because I don't think we gave a ton of detail on the call - I'm sorry, in the prepared remarks. So if you look at our gross margin, gross margin declined 170 basis points in total. Freight alone was up 150 basis points as a percent of sales. You add in direct materials, another 40 basis points of cost increases as a percent of sales, direct labor another 10% increase as a percent of sales. So just those three categories alone was 200% - 200 basis points - excuse me, of sales. Now, of course, we've had - we've been driving many efficiency gains that Michael mentioned as well and we'll continue to drive those down to offset wherever we can as well as price increases, but the inflationary environment is absolutely real and freight is the biggest contributor.

If I want to add a little more color actually that even, Michael, freight is contributor for a couple of factors. Across the Board, freight rates are increasing. I don't care whether it's trucking, I don't care whether it's redistribution, shipping, but the biggest factor for us in the short term is air freight. Our commitment to our customers remains priority number one. And as a result, we've been air freighting a significant amount of our products that we would never normally air freight and that in result has been tremendous pressure on our cost. Good news about that is that as we're driving our facilities, that is an element that we can take down when the market isn't necessarily going to take down overall freight costs. So we do have an upside to that in the near future as we drive back to more traditional shipping lanes. And we know that the shipping lanes still remain a tremendous challenge to us, but our numbers for instance in the Port of Los Angeles are coming down not to pre-pandemic levels, but have come down tremendously as far as wait time. So we're going to see some compression in that area as well, but the biggest opportunity, as I said, is moving back from air freight to sea freight.

Okay. Just to put a bow on this line of questioning. IDSs LIFO and then Workplace Safety is?

IDS in the U.S. is LIFO. IDS outside of the U.S. is not. And the remainder of our business is FIFO.

Okay. So that's kind of what I'm getting at. So the majority of your business being outside of the U.S. is realizing real-time pricing against the easiest cost of goods sold comps. I'm just trying to confirm that. But inside the U.S., you have the larger - you have - it's not matched up yet. So there is more price cost tailwind potentially going forward in the U.S., but maybe not so internationally.

I'm not so sure that that's - I'm not so sure I would draw that conclusion quite yet.

All right. And then I guess on the next one - next question. Can you - on the WPS margin snap back, nice to see. Can you just talk about the general tailwinds relative to Q1 that IDS didn't see and then also the tailwinds from in-sourcing and removing a layer of outside gross profit, what percentage of in-sourcing has been completed to date and does inflation kind of accelerate that trend?

Yes, it certainly does. It points that our direction is correct that not only are we in-sourcing poor costs, but we're really in-sourcing primarily poor flexibility and speed to our customers, the ability to customize to differentiate and respond very, very rapidly. You're exactly correct though. Another great benefit that is a margin improvement. And as we've seen inflation go up, we've seen the benefit of that, but we've also been driving that harder without giving specific numbers. We still have a lot of opportunity to go there. We've put out a target and a challenge to our teams there that goes through 2026 of continuing to increase the percentage of in-sourcing. I will tell you we will never be 100% because there is a certain amount of products that are required. There are commodities that have super high competitive pressures from other suppliers to keep their price to us low and that we need to provide as part of a package total solution. That said, we still, to your point, have a lot of opportunity in that space to drive internally and are doing so. Particularly in Europe, we have some great opportunities there as well as Australia and North America.

Our next question comes from Steve Ferazani with Sidoti. Your line is open.

Great, thanks. Thanks so much for all the detail during the call everyone. I do want to ask a bit about the acquisitions and where you think the integration stands versus - and your guidance versus when you first close those deals. I know you said $96 million in sales were expected in the first - in fiscal 2022. It looks like you did about $46 million in the first half and you also talked about margins would be slightly higher than historic Brady. Can you just walk us through where those businesses are now versus where you thought they would be when you close the acquisitions?

Steve, thanks for the question. Appreciate it. We're right on track. We feel very good about those acquisitions. As you know, people always worry about acquisitions because the real success is in your ability to integrate them and your ability to drive the synergies. I can tell you that I have interacted - particularly I made sure I got over to Europe which, as you know, has been a challenge. The teams are strong. They're capable. They see the benefits of being part of the Brady organization and vice versa. We're seeing a lot of benefits of them. I believe long term, there are more benefits than we actually anticipated, which particularly with - a lot of acquisitions I've seen over the years is not necessarily true. In this case, I do feel very good that right now we're on track. We had a two-year outline of when we're going to be able to integrate everything for our software umbrella overhead. We're also on track with that. And like I said, the good news is, we believe the outcome will be even stronger than we anticipated in our original models when we acquired the companies. And considering we did this in the heart of COVID without being able to really get our feet on the ground nearly as much as we wanted to normally, I think it's been a very, very successful first start and very excited, not only about the capabilities, but more importantly about the teams that are helping us to drive our success for the future. So --

[technical difficulty] and obviously you're not unique in terms of building up inventory. The question is how quickly you think about - do you think you're staying on an elevated level for multiple quarters, when do you think that starts strong down - I'm just trying to think about how this will affect full year because obviously the first-half wasn't strong on the cash flow level, but it looks like primarily due to the inventory build.

Correct. Steve, you cut out a little at the beginning, but I believe your question was totally around inventory build. If there was more to it, you may have to have the first part of that question. Fine.

No you got it.

Okay, good. The key to the inventory build is that, yes, we made a strong decision to first and foremost support our customers. And we strategically have had the cash to be able to do that without hurting our few other future investments, so that's a very important statement. We therefore believe we primarily put us in a position and we can show that through our online delivery, through our customer satisfaction that we aren't missing shipments and we do see competitors who are missing shipments, delaying shipments and a variety of other factors. So that has been very important. That said, with the exception of a few significant categories, we don't believe we will be significantly building going forward. Timing of release also depends on the timing of things like shipping lanes. Obviously if you can take an 18-week cycle and bring it back down to a six-week cycle that will take tremendous pressure off of our inventory levels. I don't have a perfect crystal ball on that. I believe right now that you can model us keeping our inventory levels where they are today with possible slight increases or decreases depending on mix and accountability, but it won't be a significant drive anywhere other than growth of sales.

Our next question comes from Keith Housum with Northcoast Research. Your line is open.

Good morning, guys, and great job on the top line there. Michael, just trying to dissect the top line a little bit further. If you look at the growth that you guys saw, how much of that would you say was from your pricing actions that you guys took in the quarter?

It was 3.87% Keith, 3.8% was price, the remaining 9.3% organic was the mix volume, et cetera.

But we did see significant sales growth, real organic sales growth.

Yes, no, it's a great organic growth number for you guys. Now in terms of your guidance, it really didn't change your topline growth guidance for the year still saying at least 12%, but obviously last quarter - this quarter, significantly more above that. Is that sort of conservatism that raising that number or you see anything in the second half of the year that may propose the challenge to really exceeding that number by good margins?

Yes, there are two items impacting our revenue guidance and our decision to leave it at. They're just above 12%. And number one was, of course, we did have very strong organic sales growth this quarter, but unfortunately offsetting that was a bit of FX headwind. And to put it in perspective, in Q1, FX was actually a tailwind of 0.7%, Q2 headwind of 2.1. And as you know about half of our business is overseas, so they can have a pretty significant impact, so it's actually the combo of those two items.

Okay. And then - Michael, you guys have talked in the past about the micro business is not coming back. And third quarter is usually a strong core for you guys in the micro business aside. I know usually incremental gross margins and obviously we got a lot of things going on now for gross margins, but how do you feel about micro businesses right now and its ability to help third quarter?

Yes, it's interesting. We are seeing an introduction of businesses into the economy. You can look at the number of startups is registered, but you were not seeing yet is those businesses turn into what I'll call real businesses, i.e., the number of zero employee businesses sort of started in the last six months is significantly higher than the normal percentage. So when [indiscernible] businesses turn into by real businesses and employ some number of people, you're still going to see a challenge there, Keith. So I wouldn't anticipate that being a major lifter in the third quarter and literally just because of that dynamic. The rest of that business is actually functioning better than before. We've made some significant changes to streamline efficiencies and costs and so we are literally at a point that is we watch those businesses really recover a green come out with, as I said, what I'll call real businesses, you'll see that happen. And you do have to bifurcate out the zero employee businesses to see that.

Yes. Got it. And then you guys have a large automated store here in [indiscernible] store, I think it was last quarter. I guess, perhaps touching that automation there and if it delivering the results that you expected and that was our full quarter benefit or was it first full quarter benefit from that operations here in this upcoming quarter?

We will first continue to see benefits over the next quarter from that Keith. These things are very complex. This is amazingly effective system. It's got an ability - I'm not a giant fan of massive inventory systems by and large because they often had bottleneck and breakout points. We don't have that with this. So, instead of being a serialized approach where there's bottlenecks, it's a massive parallel approach of which really gives us a lot of different advantages, but as a result, the programing - the performance upgrades actually build upon themselves over time and so we're going to continue to see more and more efficiencies coming out of that certainly the next quarter and frankly we have next generation plans for that system, so we expect to drive more performance gains from that approach over the next year plus.

Thank you. And that's all the questions in the queue. I'd like to turn the call back to Michael Nauman for closing remarks.

Thank you so much. I'd like to leave you with a few concluding comments this morning. We're certainly in a new phase of the COVID-19 pandemic. We're seeing stressed supply chains, increased input costs, labor shortages and overall increased inflation. We're working through this effectively and growing sales rapidly taking share and serving our customers well, but we're experiencing gross margin compression that we expect to continue for the remainder of this fiscal year. I don't know what the future holds for the global economy, but I do know that Brady is well positioned to thrive regardless of which direction the economy heads. We've changed our profile to a faster than GDP growing company with an increasing foothold in faster growing end markets. We have a strong balance sheet and strong cash generation, which enables us to keep investing in both organic and inorganic growth while also returning significant funds to our shareholders in the form of dividends and buybacks. And once our pricing and efficiency initiatives catch up to cost inflation, our strong sales growth and improved gross margins will drive significant bottom line growth. Please stay safe. 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.