Brady Corporation — Q3 FY2017 Form 10-Q
Reporting period: Quarter and nine months ended April 30, 2017. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted. Brady manufactures identification solutions and workplace safety products. Approximately 45% of sales are outside the U.S.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Net sales | $275.9 | $286.8 | $824.1 | $838.5 |
| Gross margin | $139.9; 50.7% | $145.4; 50.7% | $414.4; 50.3% | $417.7; 49.8% |
| Operating income | $31.6; 11.4% of sales | $30.8; 10.7% | $94.7; 11.5% | $84.5; 10.1% |
| Net earnings | $22.6 | $21.0 | $70.4 | $55.0 |
| Diluted EPS, Class A | $0.43 | $0.42 | $1.36 | $1.08 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $91.2 | $98.6 |
Q3 sales fell 3.8% year over year, reflecting a 1.9% organic decline and 1.9% adverse currency impact. Nine-month sales declined 1.7% (organic decline of 0.3%; adverse currency impact of 1.4%). Q3 gross-margin percentage was flat; the nine-month improvement was attributed to manufacturing efficiencies and lower material, supplies, and labor costs. Lower SG&A supported higher operating income despite lower sales; higher R&D spending partly offset the benefit. Nine-month net earnings also benefited from a lower tax rate.
Segments and material changes
- Identification Solutions (IDS): Q3 sales were $196.9 million, down 2.3%; organic sales declined 0.8%. Nine-month sales were $589.1 million, down 0.5%, while organic sales grew 0.6%. Segment profit was $32.6 million in Q3 and $94.7 million year to date; margins rose to 16.6% and 16.1%, respectively. Management cited operating efficiencies and lower SG&A. Healthcare ID pricing pressure affected Q3; product and wire identification growth provided partial offsets.
- Workplace Safety (WPS): Q3 sales were $79.0 million, down 7.5%; organic sales fell 4.6%. Nine-month sales were $235.0 million, down 4.6%, with organic sales down 2.5%. Segment profit fell to $5.1 million in Q3 and $17.6 million year to date; margins declined to 6.5% and 7.5%. Management cited weaker catalog response, U.S. industrial pricing pressure, and challenging Australian manufacturing and mining markets. Digital sales growth partially offset declines.
Effective August 1, 2016, Brady changed its segment profit measure and realigned certain businesses between IDS and WPS; comparative segment information was restated.
Cash, debt, and liquidity
- Cash was $129.1 million at April 30, 2017, down $12.2 million from July 31, 2016. Operating cash flow of $91.2 million was below the prior-year $98.6 million, mainly due to less favorable working-capital movements.
- Capital expenditures were $10.9 million. Financing used $90.0 million, including $31.4 million of dividends, $60.4 million of net credit-facility repayments, and $16.4 million of principal payments; option exercises provided $18.7 million. No treasury shares were repurchased in the nine-month period.
- Long-term obligations were $133.9 million and current notes payable were $4.1 million at April 30, 2017. The revolving credit facility had $52.4 million outstanding and $243.4 million available; an additional $14.3 million was available on China credit lines. Approximately 76% of cash was held outside the U.S.
- Brady reported compliance with debt covenants: leverage ratio of 0.9 to 1.0 against a maximum of 3.25 to 1.0, and interest coverage of 26.5 to 1.0 against a minimum of 3.0 to 1.0. Management said operating cash flow and borrowing capacity were sufficient for anticipated needs over the next 12 months, while noting that repatriating foreign cash could result in tax charges.
Outlook, risks, and other notable items
- Management expected the fiscal 2017 annual income tax rate to be in the mid-20% range. The nine-month rate was 22.4%, primarily reflecting foreign tax credits generated by a cash repatriation; Q3's 26.4% rate reflected a reduction in reserves for uncertain tax positions. The filing provides no specific sales or earnings guidance.
- Management’s stated priorities include innovation, operational excellence, product portfolio reviews, digital and mobile capabilities, targeted sales and marketing, and talent development.
- Forward-looking risks include weaker demand and economic conditions, competition and pricing pressure, currency movements, customer retention, product development, cybersecurity, employee retention, regulation and litigation, acquisitions and divestitures, impairment of substantial intangible assets, and covenant compliance.
- Goodwill was $425.9 million; no goodwill impairment was recorded in the nine months. Accumulated goodwill impairment losses were $328.0 million. The board declared a $0.205-per-share dividend payable July 31, 2017.
- The company reported no material off-balance-sheet arrangements, and management concluded disclosure controls were effective with no significant quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether WPS sales and margins stabilize, particularly in the U.S. and Australia, and whether digital growth can offset catalog weakness.
- Whether IDS growth and efficiency gains persist, given Healthcare ID pricing pressure and mixed product-line trends.
- Cash conversion and working-capital trends, capital spending, debt repayments, and the use of foreign-held cash.
- The sustainability of the lower year-to-date tax rate and the mid-20% full-year tax-rate expectation.
- Exposure to currency changes, covenant headroom, and potential impairment risk in the company’s substantial goodwill and intangible assets.