Earnings Call Transcript - BRC Q3 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the Brady Corporation Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation there will be a question and answer session. 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.

Ann Thornton, Chief Accounting Officer

Thank you. Good morning, and welcome to the Brady Corporation fiscal 2022 third 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 three. 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 and 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 new President and Chief Executive Officer, Russell Shaller. Russell?

Russell Shaller, President and CEO

Thank you, Ann. Good morning, and thank you all for joining us. This morning, we released our fiscal ’22 third quarter financial results, which before getting too deep into the quarter results, I'd like to start with a few of my views since taking the CEO role on April 1. Brady is a great organization with incredible brands. We have loyal customers who place their trust in Brady every single day. We have an expansive and relevant product offering of safety and identification products, most of which have deep moats and create defensible competitive positions. We have an outstanding group of highly innovative people who are focused on providing excellent customer service, always doing what's right and ensuring that we serve all of our stakeholders, including our employees, our communities, and, of course, our shareholders. To that end, we are committed to an inclusive culture where our employees are encouraged to take ownership and seek out solutions together. Financially, Brady is incredibly strong; we are in a net cash position, and we have a history of robust cash generation. Lastly, we are well on our way in transforming Brady into a company that will consistently grow in excess of GDP. So far this year, we've grown organic sales by nearly 10%. Brady has a rich history, a solid foundation, and is financially strong. However, there are areas where we can do better. First, while we have a fantastic culture that puts the customer at the center of all that we do and where we value and encourage innovation, we could be better at addressing the competitiveness of some of our businesses. For instance, in our Workplace Safety business, we have a solid core, but historically, we were too slow in adjusting our business model. At the beginning of the third quarter, the WPS team took actions to improve profitability, and you can see that in the positive results of these actions in our much improved financial results. Second is our portfolio management. There are certain pieces of our portfolio where we need to make changes including additional acquisitions to strengthen our foundation and to position us well for long-term growth. Third is our geographic footprint. We have an opportunity to invest more in certain economies in Southeast Asia and other markets where we are underpenetrated. We strive to be closer to our customers, and there are several areas that we see as ripe for expansion. Fourth, we need to be aggressive in providing solutions to our customers and shifting our portfolio into faster-growing end markets where there are clear macro tailwinds. For instance, the industrial track and trace is an area that has several positive macro trends behind it and is an area where Brady's product portfolio and capabilities definitely give us the right to win. And lastly, would be our uses of capital. We generate significant cash, which gives us the ability to drive shareholder value through buying back stock and we are trading below intrinsic value and being more aggressive with acquisitions. Last quarter, we accelerated our buyback program as we saw a disconnect in what we believe the intrinsic value of Brady is versus our trading price. I'd like to touch on one last item before moving into the financials, and that's ESG. ESG is definitely a passion of mine because doing our part is both the right thing to do and can be very positive to our shareholders. ESG must be executed in a smart manner and must be woven into the overall fabric of our company. To generate the strongest return from our environmental investments, we can't just focus internally on reducing Brady's environmental footprint, we must also focus on designing products aimed at reducing the environmental footprint and improving the efficiency of our customers as well. This has been a clear focus of ours, and we've launched many new products that our customers want and need that will aid in their own ESG journey while increasing their efficiency. Earlier this week, we published our 2021 ESG report. I encourage you to download the report from our website and take a look at some of the great things we're doing as we move forward on our ESG journey. Finally, I'm pleased to announce that we've created and filled a new position, Director of ESG. For a company with our complexity and scope to truly have a successful ESG program, it's clear we need someone who can see the big picture and drive accountability across the organization. Now to our quarterly results. This morning, we released our Q3 financial results, which showed excellent sales growth and all-time record high earnings per share. I'm proud of how the team has been able to work through this challenging macro environment and deliver for both our customers and our shareholders. We grew sales by a healthy 14.6% and we increased GAAP earnings per share by 9.9%. This quarter, we incurred certain costs to streamline and improve the overall competitiveness of our WPS business. Included in these changes were severance, which executed early in the third quarter, helping to improve the overall profitability of our WPS business. If you exclude the impact of these WPS-related charges and exclude amortization expense, from all periods presented, then our earnings per share was up even more significantly at 17.8%. We're proud of what we've accomplished at Brady, and we have a solid foundation, but we're far from done. As we look ahead, our priorities are, first and foremost, to continue our evolution into a company that consistently grows in excess of GDP. Second is to continue integrating our recent acquisitions in order to improve our capabilities in the industrial track and trace segment. Third is to take the necessary pricing and efficiency actions to mitigate the impacts of this inflationary environment and return to pre-pandemic gross margin levels, all while ensuring that we are providing the best possible customer service and have the products available to meet customer demands. And finally, to effectively deploy our capital in order to drive long-term shareholder value, which would include organic investments, acquisitions, and returning funds to our shareholders. Although we don't know what the next challenge will be, I'm confident in our ability to deliver results for our customers, our employees, and, of course, our shareholders. I'll now turn the call over to Aaron to provide some more details on our financial results. Then I'll return to provide specific commentary about our Identification Solutions and Workplace Safety businesses and what I see as the strategic priorities for each of these businesses.

Aaron Pearce, CFO

Thank you, Russell, and good morning, everyone. Please turn to Slide number three for the start of our financial review. There are five key financial highlights that we'd like you to take away from this quarter. One, we once again had very strong sales growth with total sales up 14.6%. Two, even in this challenging macro environment, we improved our gross profit margin. Sequentially, we improved our margin from 47% in Q2 to 48.4% this quarter. Three, we had record EPS this quarter. Non-GAAP EPS was up a full 17.8% over Q3 of last year. And we also increased our full year fiscal 2022 non-GAAP EPS guidance. Four, each of our divisions performed very well. IDS grew segment profit by 13.5%. WPS increased segment profit by 58.2% and segment profit as a percent of sales increased to 12% after you exclude the non-routine charges to streamline its cost structure. Fifth, and finally, we took advantage of the recent market pullback and repurchased nearly 1.4 million shares this quarter. And subsequent to quarter end, we repurchased more shares, bringing our total share repurchases to $2 million this year. Overall, this was a very strong quarter. Let's move to Slide number 4 for our quarterly sales trends. Our nearly 15% sales increase consisted of organic growth of 9% and an increase from acquisitions of 8.6%. This was partially offset by a decline of 3% from foreign currency translation. Organic sales grew in each of our two segments. ID Solutions had robust organic growth of 11.8% and Workplace Safety had organic growth of 0.9% this quarter. Our teams have been focused on serving our customers extremely well. We're meeting our customers' demand for high-quality products provided in a timely manner, where some of our competitors are stocked out of some products, thus giving us the opportunity to take share through strong customer service and product availability. Please turn to Slide number 5 for our gross profit margin trending. Our margin was 48.4% this quarter. We're driving significant automation within our factories and distribution centers, which is absolutely critical in a period marked by scarcity of labor and rising costs. However, we're seeing inflationary pressures across many different cost categories from wages to utilities to shipping costs and everything in between. The supply chain continues to be challenged, especially for critical components from Asia. In general, we've been overcoming these shortages through the buildup of critical inventories, along with the use of more expensive air freight, which is having a negative impact on our gross profit margins. Price increases helped us improve our gross margins from Q2 to Q3. This quarter, we realized approximately 4.2% sales growth from pricing. That said, we don't see any signs of inflation abating, which means that we'll need to continue to drive efficiencies throughout our facilities and continue to increase prices to offset increasing input costs. We're confident that we're providing our customers with significant value. As a result, we expect our gross profit margins to eventually return to historic levels in the 50% range. On Slide number 6, you'll find our SG&A expense trending. As you can see, we continue to make progress in driving down SG&A as a percent of sales. GAAP SG&A was 28.4% of sales this quarter compared to 30.7% in the third quarter of last year. Plus, if you exclude amortization expense and the non-routine charges mentioned in the slides, then SG&A would have declined even further, decreasing from 30.3% of sales in Q3 of last year to 26.8% of sales this quarter. You can clearly see the benefits of our focus on efficiency as we reduced SG&A expense from over 36% of sales just a half dozen years ago to less than 28.5% of sales this quarter. Slide number 7 is the trending of our investments in R&D. This quarter, we invested $14.9 million in R&D, which equates to approximately 4.4% of sales. We're committed to maintaining this increased level of investment as we continue to see opportunities for R&D across our businesses, including building out a comprehensive industrial track and trace platform that encompasses our printers, high-quality materials, RFID scanners, and barcode scanners. These investments in R&D are critical to sustaining our increased growth rate over the long term. Slide number 8 illustrates our pretax income trends. Pretax earnings increased 7.3% on a GAAP basis. Impacting earnings this quarter was a significant increase in amortization expense from the acquisitions completed at the end of last year as well as the non-routine WPS charges that I mentioned. If you exclude these items from all periods presented, then our pretax earnings would have increased by 15.7% to $56.8 million. Slide number 9 illustrates our after-tax income and EPS trends. GAAP diluted EPS increased by 9.9% to $0.78 this quarter. If you exclude the after-tax impacts of the non-routine WPS charges and amortization expense, then our EPS would have increased by an even stronger 17.8% to $0.86 this quarter compared to $0.73 of non-GAAP EPS in the third quarter of last year. This quarter, our GAAP EPS of $0.78 and our non-GAAP EPS of $0.86 were both all-time record highs for Brady. If you look at the first 9 months of this fiscal year, our non-GAAP EPS is running a full 14% ahead of last year. On Slide number 10, you'll find a summary of our cash generation. Although we still increased our inventory levels to support our increased sales volumes and to ensure a steady stream of supply to our customers, the rate of increase has slowed. As a result, you can see a bounce back in our cash generation. Cash flow from operating activities was $40.9 million this quarter, and we expect to finish the year with strong cash generation in Q4. Now if you'll turn to Slide number 11, you can see the impact that Brady's historically strong cash generation has had on our balance sheet. Even after stepping up our share buybacks and building up inventories to ensure that we're poised to meet future customer demand, on April 30, we were still in a net cash position of more than $26 million. Our strong balance sheet puts us in a fantastic position to execute additional value-enhancing activities, including investing in R&D, completing additional acquisitions, and returning funds to our shareholders. Our approach to capital allocation is to first, use our cash to fully fund organic sales and efficiency opportunities throughout the economic cycle. This includes investing in new product development, sales-generating resources, capability-enhancing capital expenditures, and automation-focused CapEx. We will absolutely keep funding these investments where it makes sense and where the investments are ROI positive. Second, we focus on returning cash to our shareholders in the form of dividends. We've now increased our annual dividend for 36 consecutive years. After fully funding organic investments and dividends, we then deploy our cash in a disciplined manner for either acquisitions where we have strong synergistic opportunities or for buybacks in a highly opportunistic manner when we see a disconnect between intrinsic value and Brady's trading price. Recently, we've seen what we believe is a disconnect between our view of intrinsic value and Brady's stock price. As such, in Q3, we repurchased 1.4 million shares for $63.2 million. Subsequent to quarter end, we repurchased another 200,000 shares. All in, between share repurchases and buybacks, we've returned nearly $120 million to our shareholders in the first 9 months of this fiscal year, which clearly illustrates our commitment to return capital to our shareholders. Slide number 12 summarizes our updated guidance for the year ending July 31, 2022. Our Q3 results were stronger than we had initially anticipated, and these stronger results and positive momentum are factoring into our view on the remainder of this fiscal year. As such, we are increasing our non-GAAP EPS guidance to a range of $3.08 to $3.17 from the previous range of $3 to $3.15 per share. Our updated guidance range implies fourth quarter non-GAAP EPS of $0.80 to $0.89 per share. This guidance range implies that we expect our full fiscal year 2022 non-GAAP earnings per diluted share to increase from 12% to 15% when compared to our previous record EPS year of fiscal 2021. Subsequent to quarter end, order intake has remained solid. As such, we expect our positive sales momentum to continue, and we also expect this inflationary environment to remain for at least the near term. The other elements of our guidance are pretty much in line with what we shared last quarter. Specifically, we expect a full year income tax rate of approximately 21% and depreciation and amortization expense to range from $34 million to $36 million. Capital expenditures, excluding any future facility purchases, are expected to range from $28 million to $33 million. This CapEx guidance range of $28 million to $33 million is inclusive of the $8 million of facility purchases we already incurred in the first half of this year. This guidance is based on foreign currency exchange rates as of April 30 and assumes continued global economic growth. Potential risks to this guidance, among others, include further strengthening of the U.S. dollar versus other major currencies such as the euro or the British pound, worsening logistics that don't allow us to meet our commitments to our customers, further lockdowns, or increased inflationary pressures that we can to offset in a timely enough manner.

Russell Shaller, President and CEO

With that, I'll now turn the call back to Russell to cover our divisional results and to provide some closing thoughts before the Q&A. Thank you, Aaron. Slide 13 outlines the third quarter financial results for our Identification Solutions business. IDS sales increased 21.1% to $264.1 million. Organic sales in our IDS division were once again very strong, up 11.8% versus the third quarter of last year. Like most companies, we're experiencing significant inflationary pressures. However, we've been driving automation and efficiencies and increasing prices where feasible to offset as much of this inflation as we can. Segment profit as a percentage of sales was 20.4%, down from 21.8% last year. If you exclude the sizable increase in amortization expense from our three acquisitions last year, then segment profit as a percentage of sales would have been 21.8% this quarter compared to 22.4% in last year's third quarter. Our previous R&D investments are generating a steady stream of new product launches that we expect to continue to propel us above GDP sales growth. In fact, we've increased our investments in R&D, including the incremental R&D necessary to integrate our recent acquisitions, which includes building out our industrial track and trace solution set. Overall, these acquisitions are progressing as planned, and the teams have done a great job navigating the global chip shortage and the inflationary environment. We're increasing Brady's relevance to our customers by providing complete solution sets that solve their unique challenges, and we're making critical investments in our facilities, in factory automation, and engineering talent in our sales force that will almost certainly pay future dividends. My point is that we're making the investments necessary to keep propelling our organic sales growth forward and to move Brady into faster-growing end markets, which will accelerate sales growth for the years to come. Regionally, organic sales in Asia were strong this quarter despite periodic lockdowns in China with growth in the mid-single digits when compared to the third quarter of last year. Organic sales were also up more than 15% in EMEA despite the macro challenges facing Europe, which include sky-high energy costs. And organic sales growth was strong in Americas region with growth of over 11% this quarter. Overall, our sales trends in IDS are positive. Our margins have been slightly compressed, but we have intentionally prioritized product availability and strong customer service over pushing for every last dollar of gross margin. We believe that this is the right long-term winning strategy as it results in us taking share, which bodes well for our future. Our strong new product lineup, investments to drive sales, and our positive momentum in automation and efficiencies give us confidence that we'll continue to generate strong organic sales growth with healthy margins over the rest of the fiscal year and for years to come. Moving to Slide 14, you'll find a summary of Workplace Safety financial performance. Our WPS business finished with sales of $74.4 million and organic growth of 0.9%. Profitability also increased nicely, growing from $5.7 million in Q3 of last year to $7.1 million in the current quarter. If you exclude the $1.8 million of non-recurring costs incurred to streamline the WPS business, segment profit increased 58.2% in the quarter. Some pieces of our WPS business are performing well and have been performing well for quite some time. For instance, profitability improved nicely in Europe this quarter as the business shifted back into more sales of core workplace safety products and fewer COVID-related products. On the other hand, our WPS business in Americas historically has not performed quite as well. However, the team is accelerating their initiatives, including optimizing their online prices to increase our competitiveness, simplifying our SKU count, and reducing our SG&A expense, which includes reducing headcount and catalog distribution costs. These actions resulted in a solid profit improvement in our WPS Americas business this quarter. The foundation of our WPS business is strong with several key brands and many businesses that are performing well. In WPS, our internally produced custom solutions provide significantly more value to our customers than simple buy-and-resell items. These strong brands, strong businesses, and strong customer solutions have been masked by some underperforming business units. We are actively working to improve. Looking ahead, we'll continue to drive profit improvements and will look critically at our product portfolio, even if that means walking away from unprofitable or marginally profitable SKUs and product offerings. The WPS team did a nice job this quarter, but we still have more work ahead of us. Let me quickly recap our Q3 performance one more time before turning it over to questions. First, our GAAP earnings per share was an all-time record high of $0.78 and our non-GAAP earnings per share was also a record high at $0.86, nearly 15% above our previous record. Second, we grew revenues by more than 14% this quarter. Third, we took actions to improve our WPS business, which resulted in a meaningful improvement in profitability. And fourth, we were much more aggressive in buying back shares. In fact, we fully exhausted our share repurchase authorization two days ago. Our Board approved authorization for us to repurchase another $100 million worth of shares, which, based on our current share price, equates to approximately 2.2 million shares in just under 4.5% of total outstanding shares. Brady performed very well this quarter. However, the pace of macro change has accelerated over the last several years. It seems like we have a new major macro event every month or so. We've been dealing with stressed supply chains in Europe, more lockdowns in China, increased input costs, increased labor shortages, and overall increased inflation. While we can't predict the next event will be, recent history has taught us anything, is that there will likely be some sort of unforeseen event in the near term. Our crystal ball is hazy, but we are positioning ourselves to thrive regardless of what the world throws at us, specifically. We're heavily focused on daily execution and serving our customers better than our competition. We believe that strong customer service and consistent execution are more important today than ever. We've increased inventory levels of critical parts to ensure that we can meet the needs of our customers. This has resulted in increased air freight and has hurt our gross margins, but this is a trade-off that I would make every day. Every time that we're able to convert a customer to Brady printers and materials, we have the opportunity to demonstrate our superior solution set and strong customer service, which will result in a positive long-term customer relationship. Simply stated, our goal is to out-execute our competitors and take advantage of this challenging macro environment to build long-term customer relationships. Plus, we have a strong balance sheet that affords us the opportunity to focus on long term and to drive profitable growth for years to come. Brady is in an enviable financial position. Fiscal 2021 was a record earnings per share year. So far, in fiscal '22, EPS is running well above fiscal 2021 levels, and our revenues are up by more than 16% so far this fiscal year. The Brady team has done an excellent job serving our customers while continuing to invest in our future. We have a solid foundation and we're transitioning into a faster-growing company. Yes, we have significant inflationary pressures, but we are still forecasting earnings per share for the year-end July 31, 2022. We're forecasting GAAP earnings per share to grow from 12% to 15% over last year's record earnings per share level, and we have positive momentum that will deliver increasing levels of shareholder value. With that, I'd like to start the Q&A. Operator, would you please provide instructions to our listeners?

Operator, Operator

Our first question is from George Staphos with Bank of America. Your line is open.

Cashen Keeler, Analyst

This is actually Cashen Keeler on for George Staphos. Congratulations to Russell on your new role. Just going back to your opening remarks, you mentioned that you may want to explore some additional acquisitions. So can you just talk about what opportunities or markets you might consider? And what your appetite for this is right now, just given you're still integrating some past acquisitions?

Russell Shaller, President and CEO

Yes. So obviously, we're not going to comment on specific acquisition spaces or targets. But I will say, if you look at our industrial business, I think anything that is closely related to the things that we've done so far is fair game. And I guess that's probably all that I would comment on that.

Cashen Keeler, Analyst

And then, I guess, in Workplace Safety, it sounds like you may have had some mix benefits. Can you just talk about, particularly which businesses were underperforming your expectations? And then just in terms of streamlining the cost structure there, can you just detail that a little bit more and what you might expect the margin benefit from that, moving forward, to be?

Russell Shaller, President and CEO

Yes, sure. So as I mentioned earlier in the call, the Americas business, in particular, has faced a number of challenges. The move to online distribution has certainly been a significant headwind for them as a business. As we look at that portfolio in the coming months and years, we're looking at optimizing how we serve our customers. We're expanding our digital footprint and addressing that. I'm not going to predict the exact uplift that we would assume from that, but I think the third quarter of this year, where we started to institute those changes, is indicative of what we plan to see in the future.

Cashen Keeler, Analyst

Just one final one for me. Can you just talk about any particular volume or pricing assumptions embedded in your guidance for the remainder of the year?

Russell Shaller, President and CEO

Yes. So right now, we're clocking in some pretty heavy growth, and we foresee the fourth quarter to be essentially on track for what we were doing in the third quarter, barring some significant new events, which I seem to read about every other month. So I would just say more of the third quarter in the fourth quarter.

Operator, Operator

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

Steve Ferazani, Analyst

Russell, Aaron, a couple of numbers I want to key in on obviously coming out of the last quarter, where you were seeing margin pressure with ID solutions. Certainly, we know that rapid increase in shipping and freight costs clearly didn't get any better this quarter, but your margins improved. Looks like you're catching up on price. Is that how we should think about that? Because I know that was clearly the big concern entering the quarter.

Russell Shaller, President and CEO

Yes, definitely. I think similar to most industrial companies that sell through distribution. We have contracts in place that dictate some of the terms and the speed at which we can increase our prices. We've been doing this as contracts roll off or by amending terms in our contracts. So I would clearly say in the first few quarters of this year, there was a bit of a catch-up effect. I think we're not finished, but we've certainly made a lot of progress towards reconciling our input costs, pricing, and selling costs. You can see it in the improvement in Q3. Also, with that said, while freight has been a significant burden to us in the past year, we eventually see that relaxing back to more normal positions, less air freight, more cargo container freight, and more realistic cargo prices. I think there are a number of things that will continue to give us improvement over the coming quarters.

Steve Ferazani, Analyst

And then the hardest number to model every quarter for us analysts, and I'm sure internally it's challenging, is that Workplace Safety margin obviously much, much stronger this quarter. But to some degree, it looks like the Q1 a year ago. The question is sustainability of that number versus what was one-off and mix and how to think about that. Now I know you came in and we're going to make some changes and you've seen some of that, but I'm guessing that wasn't surely that margin number this quarter and just how to think about that.

Russell Shaller, President and CEO

Yes. Over the last several years, I've been with Brady for 7 years and being the President of IDS, we focused on a lot of efficiency gains and positioning our portfolio to improve our margins and to improve growth. I'd look to bring some of those same things to EPS over the next few quarters. I do see opportunities to consolidate some operations, I've elevated my Chief Operating Officer who was previously my head of manufacturing, and we're going through all of our operations for areas where we can improve our cost position.

Steve Ferazani, Analyst

In terms of that 10% number, that's not a reasonable number to expect in the next few quarters sustainable, is it? Or is it?

Russell Shaller, President and CEO

When you mention 10%, are you referring to the 10% operating income for this quarter or are you asking which 10%?

Steve Ferazani, Analyst

Yes, exactly. Exactly. Yes.

Russell Shaller, President and CEO

I would certainly hope that we can be in that territory in the future, if not better.

Steve Ferazani, Analyst

Did you provide the healthcare growth number for the quarter in ID solutions?

Russell Shaller, President and CEO

We did not.

Aaron Pearce, CFO

I certainly can. We grew health care by just over 1% this quarter, year-end number.

Steve Ferazani, Analyst

So that's not really the big contributor to the strength there. Would you think that's more product development in other markets? Because I would have thought health care would have been a bigger contributor to the improvement.

Aaron Pearce, CFO

No. The hands down, the biggest contributor is the portfolio in IDS. We spend a considerable amount on R&D as a percentage of sales, some of which takes years to bring to market. We have launched several new products this year, which was also contributing to our growth as well as we've got a great overall business base in that. That's what you're seeing in both the profit and in the growth of the IDS part of the business.

Operator, Operator

Next question comes from Mike McGinn with Wells Fargo.

Mike McGinn, Analyst

You talked about some products and portfolio management within Workplace Safety, suggesting a balance similar to an 80-20 split without stating it directly. I’d like to understand the level of substitution within that product range. Additionally, as you reduce some of these SKUs, do you notice any decline in core growth, and how far along do you think you are in that process?

Russell Shaller, President and CEO

So I'm not 100% I understood the question, but I'll give you a few answers, and then you can follow up if I didn't hit it. So what inning are we? I would clearly think we're probably in the third inning out of 10. We've got some room to move. In terms of the SKUs, it's absolutely a long-tail business. But with that said, with hundreds of thousands of SKUs, some of that tail really is not marginally helpful or even profitable. It is a significant task when you have hundreds of thousands of SKUs to go through the portfolio and decide what really isn't aligned with the profitable part. I do want to emphasize that there is a part of WPS, a significant part of WPS that is very profitable, very strong and actually, frankly, is growing. It is clouded by a lot of the other things going on in WPS that makes it look less exciting and compelling. As I look through this over the next several innings to use your analogy, we still have a lot more work to do. Yes. I'm super excited to have negotiated the license with Honeywell. Brady respects their intellectual property rights. They built up a great portfolio in, probably arcane to most of our listeners, 2D imaging technology based on a global shutter. But we see that in high-speed industrial track and trace imaging as a core technology and having that license builds on codes licenses already and gives us a relatively free rein to practice what we're looking to do over the coming years. That is still very much an emerging technology. We are at least 18 months or longer away from a full suite of products. There's a lot of engineering that needs to happen between now and then. But we've got a clear path, essentially through to 2030, do what we need to do from an IP perspective.

Keith Housum, Analyst

Let me congratulate you, Russell, on the appointment to CEO. I guess starting more at a higher level here, Russell, I guess any differences with your predecessor in terms of your priorities or strategies in the near term that we should be thinking about?

Russell Shaller, President and CEO

Yes. I would say Michael did a great job of being cost-focused and coming into the organization and looking at a number of ways to cut costs. I would say I am far more growth-oriented and more about optimizing the portfolio. My track record is I worked for a number of years at Teledyne where we were very aggressive in terms of both portfolio shaping and mergers and acquisitions as well as the occasional divestiture. So that was kind of my training, and that's what I'm looking to bring to bear as CEO.

Keith Housum, Analyst

Good to hear it. In terms of the WPS segment, it sounds like you're still in the early innings of perhaps calling out some more of the WPS portfolio has been necessary. Possible do you see that's going to be a headwind for growth in the next year or two that you'll be satisfied if you have no growth as long as you see profitability increasing? How are you thinking on a higher level?

Russell Shaller, President and CEO

Yes. I would say it's all business; you look to optimize your portfolio and maximize both current and future cash generation. So I'm not really going to make a lot of guidance about next year's revenue and whether we will or won't face headwinds. But I will say we're looking at every business, every segment to see whether it is additive to our organization for the future, which I would hope all corporations are doing.

Keith Housum, Analyst

And you provided some color on the ability to raise prices on IN, the IBS with the distributors. Perhaps can you touch on the WPS segment in PDC? What's your ability to raise prices there?

Russell Shaller, President and CEO

Yes. It's quite detailed and not unexpected. If you consider your economic position regarding market power or proprietary advantages, you’re in a strong place to increase prices. The more your product is commoditized, the more you need to align with market trends. That being said, we are noticing that most competitors and solutions are beginning to raise their prices. Some were slower to determine how temporary this situation would be. Overall, the industry has continued to implement price increases, which is evident in the performance results of certain distributors over the past few quarters.

Keith Housum, Analyst

I have one more question before I return to you. Regarding the supply chain issues that have persisted for several quarters, do you expect any improvement soon? Are there any indications that things might be getting better, or is it still difficult to determine?

Russell Shaller, President and CEO

Yes, I would say that we have factored in the current supply chain challenges into our planning. As long as conditions do not worsen, which we don't anticipate, these issues are fully integrated into our performance and strategy. We've also increased our inventory by about $20 million, possibly a bit more, to safeguard against some of the supply chain problems that have impacted our cash flow, which I would have preferred to allocate elsewhere. If we start to see more normalized conditions, especially in shipping and logistics, I can see us reducing this inventory buildup. For now, we are maintaining a steady approach. We have managed to navigate the Shanghai lockdown reasonably well, and conditions there seem to be improving slightly, so I would consider our situation to be stable at this point.

Keith Housum, Analyst

Last question, maybe I'll just follow up on that one. In terms of the impact of air freight on your gross margins, can you kind of contextualize that for us?

Russell Shaller, President and CEO

Yes. So excess shipping rates are about 150 basis points headwind for us. It's a mix of just increased container shipping as well as air freight. We know the air freight will come down. We've been able to put a lot more because of our increased inventory. We've been able, in just very recently in the last few weeks, started to convert much more to cargo containers as opposed to airfreight. That is something that we see is helping us in the coming year. I don't see us abandoning air freight entirely until the supply chain is really sorted out, which is anybody's guess, but I can't imagine will happen in the next quarter or two.

Operator, Operator

And I'm currently showing no other questions at this time. I'd like to turn the call back over to Russell Shaller for closing remarks.

Russell Shaller, President and CEO

Great. Thank you all for calling in and the Q&A. I'd like to thank you all for your time. I do want to leave you with a few concluding thoughts. I really am excited about taking over as CEO and the future of Brady. We're a 107-year-old company. While we live in an uncertain world, we have a fantastic company that I see as a great long-term value proposition. We've changed our profile to move faster than GDP and grow the company with an increasing foothold in faster-growing end markets. This quarter, we grew at 14.6%. Our pricing and efficiency actions are improving our gross profit margins, subsequently, we improved from 47.0% in Q2 to 48.4% this quarter. Our IDS division continues to perform extremely well, and the actions we've taken to improve our Workplace Safety business are working as evidenced by the significant increase in WPS profitability this quarter. We're aggressively investing in R&D to round out our industrial track and trace product offering. These investments are moving Brady into faster-growing end markets, making us much more relevant to our customers and creating a paradigm shift in our long-term profit profile. Finally, we have a strong balance sheet, which enables us to keep investing in both organic and inorganic growth while also returning funds to our shareholders. Our balance sheet and strong cash generation make Brady a safe port from future market turbulence. Even though the future of the macro economy is uncertain, I'm optimistic about the future of Brady. Thank you for your time this morning. Have a great day. Operator, you may disconnect the call.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.