Brady Corporation — Form 10-Q summary
Business context and period. Brady manufactures identification solutions, specialty materials and workplace safety products. This filing covers the quarter and six months ended January 31, 2014 (the second quarter and first half of fiscal 2014). Amounts below are in U.S. dollars; financial figures are rounded to millions unless otherwise noted. The company reports Identification Solutions (IDS) and Workplace Safety (WPS) as its two segments.
Financial performance
| Metric | Three months ended January 31 | Six months ended January 31 |
|---|---|---|
| Net sales | $291.2 million, up 6.8% | $598.7 million, up 9.9% |
| Gross margin | $142.5 million; 48.9% of sales, versus 52.0% | $300.4 million; 50.2% of sales, versus 53.6% |
| Operating income | $18.3 million; 6.3% of sales, versus $21.8 million and 8.0% | $48.0 million; 8.0% of sales, versus $65.0 million and 11.9% |
| Continuing-operations earnings | $10.5 million, or $0.20 per diluted Class A share; prior-year loss was $10.7 million | $28.7 million, or $0.55 per diluted Class A share, versus $15.6 million and $0.30 |
| Net earnings, including discontinued operations | $16.4 million, versus a loss of $8.7 million | $40.4 million, versus $18.5 million |
| Operating cash flow | $41.8 million for the six months, versus $44.2 million |
Sales drivers and segment trends. Acquisition growth, primarily from Precision Dynamics Corporation (PDC), drove sales increases; organic sales declined 1.1% in the quarter and 1.6% year to date, with currency also a small drag. IDS organic sales grew 2.5% in the quarter and 2.9% year to date. WPS organic sales fell 6.8% and 8.4%, respectively. Quarterly segment profit was $37.5 million for IDS (versus $34.6 million) and $14.7 million for WPS (versus $23.6 million); WPS profit margins fell to 15.2% from 22.6%.
Cash, debt and liquidity. Cash and equivalents were $79.1 million at January 31, down $11.9 million from July 31, 2013. Six-month investing cash outflow was $17.5 million, including $17.6 million of capital expenditures; financing cash outflow was $37.3 million, including $20.4 million of dividends and $30.0 million of debt repayment. Reported debt carrying value was approximately $288.3 million, comprising notes payable, current maturities and long-term obligations. The company had $23.9 million of notes payable outstanding, including $9.0 million under its revolving facility and $14.9 million under its China credit line. It reported compliance with debt covenants and $291 million of remaining capacity under the revolving facility. About 93% of cash was held outside the United States.
Material changes and unusual items
- Gross margin and operating income declined despite higher sales. Management attributed pressure to WPS pricing, mix and lower organic sales; PDC’s lower margins; facility consolidation costs; and higher supply and material costs.
- The prior-year continuing-operations comparison was affected by a $25 million non-cash tax charge associated with funding the PDC acquisition. The current-period effective tax rates were 29.5% for the quarter and 31.2% year to date; the filing reports prior-year rates of 158.4% and 73.0%, respectively.
- Discontinued operations contributed $5.9 million of after-tax earnings in the quarter and $11.7 million year to date. The filing cites discontinued depreciation and amortization and a $3.1 million tax benefit from the conclusion of a China tax audit among the drivers.
- Die-Cut assets and liabilities were classified as held for sale. On February 24, 2014, after quarter-end, Brady agreed to sell the business for $60 million cash, subject to specified adjustments. The filing does not establish that the transaction had closed.
Outlook, management commentary and risks
- Management expected approximately $22 million of fiscal 2014 pre-tax restructuring charges, primarily for facility consolidations extending into fiscal 2015, and approximately $10 million of annualized pre-tax savings when actions are complete. It reported $11.2 million of charges in the first half.
- Brady planned approximately $14 million of incremental fiscal 2014 investment in WPS initiatives, including catalog mailings, e-commerce, product breadth and sales growth. Management said the segment’s sales had declined for nine consecutive quarters and expected a return to annual growth over several years.
- Management described modest organic growth in IDS and continued weakness in WPS. PDC contributed $39.3 million of quarterly sales and $81.6 million year-to-date sales; its profit was described as as anticipated.
- Goodwill is a notable risk. The PeopleID reporting unit’s fair value exceeded carrying value by 12%; management said a 100-basis-point reduction in annual sales growth or profitability assumptions would put fair value below carrying value. WPS EMEA and APAC also face potential impairment risk if strategic investments do not earn sufficient returns.
- Other disclosed risks include execution of the WPS strategy and restructuring, economic and competitive conditions, pricing and input costs, foreign exchange, customer retention, acquisitions and divestitures, debt covenant compliance, and possible write-offs of intangible assets. The company reported no material off-balance-sheet arrangements.
Important facts for investors to verify
- Whether the Die-Cut sale closed, the final proceeds after adjustments, and how the company used the cash.
- Whether WPS sales and profitability improved as the planned investments and strategy were implemented.
- Actual restructuring costs, timing and realization of the projected savings.
- Whether IDS organic growth and PDC performance supported margins, and whether PeopleID and WPS goodwill remained recoverable.
- Cash generation, debt repayment, covenant headroom and the impact of cash held overseas on liquidity.
- The outcome of the announced leadership transition in WPS; the filing said its president left effective February 20, 2014, and the interim CEO/CFO would oversee the business pending a successor.