Business context and reporting period
Brady Corporation’s Form 10-K covers the fiscal year ended July 31, 2013; fiscal fourth quarter ended the same date. Brady manufactures identification solutions, specialty materials and workplace safety products. Effective May 1, 2013, it reorganized reporting into Identification Solutions (IDS) and Workplace Safety (WPS).
The company shifted its portfolio toward core identification and healthcare markets. It acquired healthcare identification supplier Precision Dynamics Corporation (PDC) for $301.2 million and classified its Asia Die-Cut and Balkhausen businesses as held for sale. Results of those businesses and certain previously divested operations are reported as discontinued operations.
Financial results and liquidity
| Metric | FY2013 | FY2012 |
|---|---|---|
| Continuing-operations net sales | $1,152.1 million | $1,068.7 million |
| Gross margin | $606.1 million; 52.6% of sales | $589.6 million; 55.2% |
| Operating income (loss) | $(85.6) million; (7.4%) | $156.4 million; 14.6% |
| Continuing-operations earnings (loss) | $(140.8) million | $102.5 million |
| Net earnings (loss), including discontinued operations | $(154.5) million | $(17.9) million |
| Class A diluted continuing-operations EPS | $(2.75) | $1.94 |
| Cash from operating activities | $143.5 million | $144.7 million |
| Capital expenditures | $35.7 million | $24.1 million |
| Cash and cash equivalents at year-end | $91.1 million | $305.9 million |
| Working capital at year-end | $189.0 million | $383.8 million |
FY2013 reported operating results included $204.4 million of impairment charges and $26.0 million of restructuring charges. Excluding those items, management reported continuing-operations operating income of $144.9 million, compared with $162.5 million in FY2012 excluding restructuring charges. Gross margin declined 2.6 percentage points, partly due to PDC’s lower-margin business and WPS pricing and volume pressures.
Continuing-operations sales grew 7.8%, comprising 11.3% growth from acquisitions, offset by a 2.6% organic decline and 0.9% adverse currency impact. IDS sales rose 15.7%, primarily from PDC; organic IDS sales grew 0.3%. WPS sales declined 3.7%, including a 7.0% organic decline. Segment profit was $171.3 million for IDS, down from $159.4 million? Correction: IDS segment profit increased from $159.4 million to $171.3 million; WPS segment profit declined from $117.2 million to $95.2 million.
Total debt was approximately $313 million at year-end, including $262.4 million of long-term debt obligations and $50.6 million of notes payable. Brady had $261 million available under its $300 million revolver and $14.6 million available under its China credit line. It reported compliance with debt covenants: leverage ratio 1.6x and interest coverage 9.2x. Cash declined chiefly because of the PDC acquisition. Operating cash flow was nearly flat year over year, with improved working capital offsetting lower pre-tax cash generation.
Material changes, outlook and risks
- Impairments and discontinued operations: Brady recorded $172.3 million of goodwill impairment in WPS Americas, $18.2 million in IDS APAC, and $10.6 million of WPS tradename impairment. The Asia Die-Cut and Balkhausen disposal group was written down by $15.7 million. Discontinued operations produced a $13.7 million loss in FY2013, versus a $120.4 million loss in FY2012, which included a separate $115.7 million goodwill impairment.
- Restructuring: FY2013 actions included a planned 5–7% workforce reduction, with expected annual savings of approximately $25–30 million before reinvestment. A subsequent facility-consolidation plan approved in September 2013 was expected to incur approximately $30 million of pre-tax charges, mostly in FY2014, and about $25 million of cash expenditures.
- Management outlook: Brady planned to invest in WPS e-commerce, pricing, product range and industry expertise, and to focus IDS on markets including healthcare. Management expected benefits from WPS strategy changes in future years but cautioned that execution and a return to historic sales and profit levels were uncertain. No consolidated sales or earnings guidance is provided in the filing.
- Tax and acquisition effects: The effective tax rate on continuing operations was (42.6%), affected by $168.9 million of nondeductible goodwill impairment and a $26.6 million tax charge related to funding PDC. Further U.S. cash repatriation could trigger additional tax charges. PDC contributed approximately $102.3 million in sales and $0.8 million in net income from acquisition through year-end; its preliminary allocation included $170.2 million of goodwill.
- Key risks: WPS faces sustained internet competition, pricing pressure and declining organic sales; economic weakness affected Europe and Australia. Other material risks include execution of acquisitions, divestitures and restructuring, further impairment of goodwill and intangibles, foreign-exchange movements, tax audits and deferred-tax valuation, supply disruptions, cyber threats, and debt covenant compliance. Approximately 50% of sales were outside the United States; 92.8% of cash was held outside the country.
- Other matters: No material pending legal proceedings or material off-balance-sheet arrangements were disclosed. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Important facts for investors to verify
- Whether WPS can stabilize organic sales, pricing and profitability as customers shift from catalogs to e-commerce.
- Whether the announced restructuring achieves expected savings and whether FY2014 charges and cash costs track management’s estimates.
- Progress and final purchase-price allocation for PDC, including integration, profitability, and the sensitivity of its goodwill to sales growth and margins.
- Completion terms, timing and proceeds for the Asia Die-Cut and Balkhausen divestiture, including any further write-downs or retained liabilities.
- Cash generation, working capital, debt repayment and covenant headroom, particularly given lower year-end cash and substantial cash held abroad.
- Tax exposure, including potential costs of further repatriation, uncertain tax positions and recoverability of deferred tax assets.