Brady Corporation — Q3 FY2014 Form 10-Q
Reporting period: Fiscal quarter and nine months ended April 30, 2014. Dollar amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise. Results distinguish continuing operations from discontinued Die-Cut and previously divested businesses.
Business context
Brady manufactures identification solutions, specialty materials, and workplace safety products. It reports two segments: Identification Solutions (IDS) and Workplace Safety (WPS). The company is pursuing IDS growth, a WPS turnaround, facility consolidation, and divestiture of its Die-Cut business.
Financial performance
| Metric | Three months ended April 30 | Nine months ended April 30 |
|---|---|---|
| Net sales | $309.6 million, up 2.3% | $908.3 million, up 7.2% |
| Gross margin | $155.1 million; 50.1% of sales vs. 52.7% | $455.5 million; 50.1% vs. 53.3% |
| Operating income | $26.8 million, down 13.5%; 8.6% margin vs. 10.2% | $74.8 million, down 22.1%; 8.2% margin vs. 11.3% |
| Continuing-operations earnings | $20.2 million vs. $21.7 million; diluted Class A EPS $0.39 vs. $0.42 | $48.8 million vs. $37.3 million; diluted Class A EPS $0.93 vs. $0.72 |
| Net earnings | $24.1 million vs. $4.2 million | $64.4 million vs. $22.7 million |
| Operating cash flow | Not presented separately for the quarter | $75.8 million vs. $89.6 million |
Quarterly sales growth was primarily organic: 2.5% organic growth, offset by 0.2% adverse currency impact. Nine-month growth benefited from the prior-year PDC acquisition, which contributed 7.7%; organic sales declined 0.1% and currency reduced sales 0.4%. Quarterly and nine-month earnings from discontinued operations were $3.9 million and $15.6 million, respectively, versus losses of $17.4 million and $14.6 million in the prior-year periods.
Segments and material changes
- IDS: Sales rose 4.6% in the quarter and 15.7% year to date; organic growth was 4.8% and 3.6%. Segment profit was $44.3 million for the quarter, down 5.3%, and $132.8 million year to date, up 5.4%. Profit margin fell to 21.5% from 23.7% in the quarter and to 21.7% from 23.9% year to date.
- WPS: Sales fell 1.8% in the quarter and 6.8% year to date; organic declines were 1.9% and 6.3%. The quarterly decline improved from 10% in Q1 and 6.8% in Q2. Segment profit fell to $14.8 million from $23.5 million in the quarter and to $47.8 million from $74.9 million year to date; quarterly margin declined to 14.3% from 22.3%.
- Consolidated gross margin was pressured by higher incentive compensation, WPS sales declines and pricing, and IDS mix and facility-consolidation costs. Management noted that the prior-year quarter included reversal of bonus accruals, making year-over-year comparisons less favorable.
- Continuing-operations income tax expense was $4.1 million for the quarter and $17.1 million year to date. Effective tax rates were 16.8% and 25.9%, compared with 22.2% and 56.4%; the prior-year YTD rate included a $25 million non-cash tax charge related to repatriation for the PDC acquisition.
Cash, debt, and liquidity
- Cash and cash equivalents were $78.7 million at April 30, 2014, down from $91.1 million at July 31, 2013. Operating cash flow was $75.8 million; capital expenditures were $29.8 million. Dividends paid were $30.5 million and treasury-stock purchases were $23.3 million during the nine months.
- Cash used in investing was $30.5 million, versus $318.3 million in the prior-year period, which included the $301.2 million PDC acquisition. Cash used in financing was $61.6 million.
- Current assets were $522.5 million and current liabilities $344.5 million. Notes payable were $75.6 million; current maturities of long-term debt were $61.3 million; long-term obligations were $162.5 million. These amounts imply total borrowings of approximately $299.3 million, including notes payable.
- The revolver had $63 million outstanding and $237 million available, potentially expandable to $387 million subject to conditions. The China credit line had $12.6 million outstanding and $13.6 million available. Management said it expects to repay the remaining revolver borrowing within 12 months.
- Brady reported compliance with debt covenants: leverage ratios of 1.8x versus applicable limits of 3.5x and 3.25x, and interest coverage of 11.5x versus a 3.0x minimum. About 90.4% of cash was held outside the United States. Management believes operating cash flow and borrowing capacity are adequate for anticipated needs.
Outlook, risks, and unusual items
- The FY2014 facility-consolidation plan is expected to generate approximately $22 million of pre-tax charges, with about $10 million in annualized pre-tax operating savings once completed. Work extends into FY2015 and could result in additional charges; most remaining restructuring payments were expected within 12 months.
- The first phase of the Die-Cut sale closed May 1, 2014, for approximately $53 million in cash proceeds. It covered businesses in Korea, Thailand, and Malaysia and the Balkhausen business in Europe. The remaining China business was expected to close in the quarter ending July 31, 2014. These proceeds occurred after the reporting date.
- Management said WPS sales improvement and IDS organic growth remain priorities; it provided no specific consolidated sales or EPS guidance in the supplied filing text. WPS management initiatives include investment in e-commerce and catalogs, broader product offerings, and cost actions.
- Goodwill impairment is a risk. The PeopleID reporting unit’s estimated fair value exceeded carrying value by 12%, but a 100-basis-point reduction in annual sales-growth or profitability assumptions would reduce fair value below carrying value. Management also warned that WPS EMEA and APAC goodwill could be impaired if strategic investments do not produce sufficient returns.
- Other stated risks include economic and market weakness, competition and pricing, currency movements, supply costs, product development, execution of restructuring and divestitures, debt covenant compliance, and potential write-offs of intangible assets. No material change in market-risk disclosures was reported.
- Quarterly net earnings growth was substantially affected by discontinued operations: the prior-year quarter included a $15.7 million Die-Cut write-down. Current-period discontinued results benefited from discontinued depreciation and amortization and tax-reserve releases. A $5.2 million Thailand flood-insurance settlement was included in prior-year YTD discontinued results.
Important facts for investors to verify
- Whether WPS organic sales and segment margins continue to recover, and whether IDS growth converts to improved consolidated profitability.
- Actual restructuring charges, completion timing, and realization of the estimated $10 million annualized savings.
- Completion and final proceeds for the remaining China Die-Cut divestiture, including any closing adjustments or liabilities.
- PeopleID and WPS goodwill assumptions and impairment headroom, particularly given the disclosed sensitivity of PeopleID valuation.
- Debt repayment, liquidity, covenant headroom, and the impact of cash held predominantly outside the United States.
- How much reported earnings improvement reflects recurring continuing operations versus discontinued-operation results, tax benefits, and prior-year comparison items.