Brady Corp: Form 10-Q for the period ended Apr 30, 2023

Overview

Brady Corporation is a global manufacturer and supplier of identification solutions and workplace safety products that identify and protect premises, products and people. Effective February 1, 2023, the Company is organized and managed on a geographic basis with two reportable segments: Americas & Asia and Europe & Australia. As such, all segment-related data has been recast to reflect our new reportable segments in the Management's Discussion and Analysis of Financial Condition and Results of Operations section. Prior to February 1, 2023, the Company operated two former segments: Identification Solutions (“IDS”) and Workplace Safety (“WPS”). The IDS segment is primarily involved in the design, manufacture, and distribution of high-performance and innovative identification and healthcare products. The WPS segment manufactures a broad range of stock and custom identification products and is a distributor of a wide variety of resale products.

The ability to provide customers with a broad range of proprietary, customized and diverse products for use in various applications across multiple industries and geographies, along with a commitment to quality and service, have made Brady a leader in many of its markets. Brady's long-term sales growth and profitability will depend not only on the overall economic environment and our ability to successfully navigate changes in the macro environment, but also on our ability to develop and market innovative new products, deliver a high level of customer service, advance our digital capabilities, and continuously improve the efficiency of our global operations. Our strategy for growth includes an increased focus on the development of technologically advanced, innovative and proprietary products and a focus on providing customers with relevant, comprehensive and complimentary solutions. We are enhancing our omnichannel experience for customers, streamlining our product offerings and improving our price competitiveness while delivering relevant products to our customers.

The following are key initiatives supporting our strategy in fiscal 2023:

• Investing in organic growth by enhancing our research and development process and utilizing customer feedback and observations to develop innovative new products that solve customer needs and improve environmental sustainability.
• Providing our customers with the highest level of customer service.
• Expanding and enhancing our sales capabilities through an improved digital presence and the use of data-driven marketing automation tools.
• Maintaining profitability through pricing mechanisms to mitigate the impacts of ongoing supply chain disruptions and inflationary pressures while ensuring prices are market competitive.
• Investing in acquisitions that enhance our strategic position and accelerate long-term sales growth and profitability.
• Driving operational excellence and executing sustainable efficiency gains within our selling, general and administrative structures and within our global operations including insourcing of critical products and manufacturing activities while reducing our environmental footprint and managing working capital.
• Building on our culture of diversity, equity and inclusion to increase employee engagement and enhance recruitment and retention practices in order to drive differentiated performance and execute our strategy.
• Executing our reorganization to a regional operating structure to support continued growth in key geographies, facilitate new product development in our recent acquisitions, and simplify and further integrate our businesses.

Macroeconomic Conditions and Trends

The Company has experienced, and expects to continue to experience, inflationary pressures and supply chain and other business disruptions. The Company has taken and will continue to take actions to mitigate inflation issues through pricing actions and the execution of sustainable efficiency gains.

We believe we have the financial strength to continue to invest in organic sales growth opportunities including sales, marketing, and research and development ("R&D") and inorganic sales opportunities including acquisitions, while continuing to drive sustainable efficiency gains and automation in our operations and selling, general and administrative ("SG&A") functions. At April 30, 2023, we had cash of $135.0 million, as well as a credit agreement with $247.6 million available for future borrowing, which can be increased up to $1,047.6 million at the Company's option and subject to certain conditions, for total available liquidity of $1,182.6 million.

We believe that our financial resources and liquidity levels, including the remaining undrawn amount of our credit agreement and our ability to increase our credit line as necessary, are sufficient to manage the impact of economic or geopolitical events which may result in reduced sales, net income, or cash provided by operating activities. Refer to Risk Factors, included in Part I, Item 1A of our Annual Report on Form 10-K for the year ended July 31, 2022, for further discussion of the potential impact of global economic or geopolitical events or the COVID-19 pandemic on our business.

Results of Operations

A comparison of results of operating income for the three and nine months ended April 30, 2023 and 2022, is as follows:

(Dollars in thousands)

References in this Form 10-Q to “organic sales” refer to sales calculated in accordance with GAAP, excluding the impact of foreign currency translation, sales recorded from divested companies up to the first anniversary of their divestiture and sales recorded from acquired companies prior to the first anniversary date of their acquisition. The Company's organic sales disclosures exclude the effects of foreign currency translation as foreign currency translation is subject to volatility that can obscure underlying business trends. Management believes that the non-GAAP financial measure of organic sales is meaningful to investors as it provides them with useful information to aid in identifying underlying sales trends in our businesses and facilitating comparisons of our sales performance with prior periods.

Net sales for the three months ended April 30, 2023 declined 0.4% to $337.1 million, compared to $338.6 million in the same period in the prior year. Organic sales growth of 1.9% was offset by a decrease from foreign currency translation of 2.1% and a decrease of 0.2% due to the divestiture of a business. Organic sales grew 1.2% in the Americas & Asia segment and 3.4% in the Europe & Australia segment during the three months ended April 30, 2023 compared to the same period in the prior year.

Net sales for the nine months ended April 30, 2023 increased 0.8% to $985.9 million, compared to $978.1 million in the same period in the prior year. The increase consisted of organic sales growth of 5.0%, which was partially offset by a decrease from foreign currency translation of 4.1% and a decrease of 0.1% due to the divestiture of a business. Organic sales increased 4.0% in the Americas & Asia segment and 7.0% in the Europe & Australia segment during the nine months ended April 30, 2023 compared to the same period in the prior year.

Gross margin increased 3.5% to $169.7 million in the three months ended April 30, 2023 compared to $164.0 million in the same period in the prior year. As a percentage of net sales, gross margin increased to 50.3% from 48.4% in the three-month period. Gross margin increased 2.8% to $481.4 million for the nine months ended April 30, 2023 compared to $468.4 million in the same period in the prior year. As a percentage of net sales, gross margin increased to 48.8% from 47.9% in the nine-month period. The increase in gross margin as a percentage of net sales was primarily due to operating efficiencies, reductions in freight expenses and pricing actions in response to higher costs.

R&D expenses increased 5.3% to $15.7 million in the three months ended April 30, 2023 compared to $14.9 million in the same period in the prior year. As a percentage of net sales, R&D expenses increased to 4.7% from 4.4% in the three-month period. R&D expenses increased 5.2% to $45.0 million in the nine months ended April 30, 2023 compared to $42.8 million in the same period in the prior year. As a percentage of net sales, R&D expenses increased to 4.6% from 4.4% in the nine-month period. The Company remains committed to investing in new product development to increase sales within our businesses. Investments in new printers, materials and the build out of industrial track and trace solutions remain the primary focus of R&D expenditures for the remainder of fiscal 2023.

SG&A expenses include selling and administrative costs directly attributed to the Americas & Asia and Europe & Australia segments, as well as certain other corporate administrative expenses including finance, information technology, human resources, and other administrative expenses. SG&A expenses decreased 5.4% to $91.0 million in the three months ended April 30, 2023 compared to $96.2 million in the same period in the prior year. As a percentage of net sales, SG&A decreased to 27.0% from 28.4% in the three-month period. SG&A expenses decreased 4.3% to $273.2 million for the nine months ended April 30, 2023 compared to $285.5 million in the same period in the prior year. As a percentage of net sales, SG&A decreased to 27.7% from 29.2% in the nine-month period. SG&A expenses include a gain of $3.8 million from the sale of the PremiSys business during the three months ended April 30, 2023. The decrease in SG&A expenses during the three and nine months ended April 30, 2023 was due to foreign currency translation, the gain on the sale of the divested business and ongoing efficiency activities.

Operating income increased 19.1% to $63.0 million and increased 16.5% to $163.2 million for the three and nine months ended April 30, 2023, respectively, compared to $52.9 million and $140.1 million in the same periods in the prior year. The increase in operating income in both the three and nine-month periods was primarily due to the increase in segment profit in the Americas & Asia segment as a result of organic sales growth and the realization of pricing actions taken during fiscal 2022 and the beginning of fiscal 2023, and to a lesser extent due to the gain on the sale of the PremiSys business.

OPERATING INCOME TO NET INCOME

(Dollars in thousands)

Investment and other income was $0.8 million and $1.6 million for the three and nine months ended April 30, 2023, respectively, compared to investment and other expense of $1.3 million in both the three and nine-month periods in the prior year. The increase in income during the three and nine-month periods was primarily due to an increase in the market value of securities held in deferred compensation plans and, to a lesser extent, an increase in interest income.

Interest expense increased to $0.8 million and $2.9 million for the three and nine months ended April 30, 2023, respectively, compared to $0.3 million and $0.8 million in the same periods in the prior year. The increase in interest expense was primarily due to an increase in benchmark interest rates compared to the same periods in the prior year.

The Company's income tax rate was 23.8% and 21.8% for the three months ended April 30, 2023 and 2022, respectively, and the income tax rate was 22.5% and 21.1% for the nine months ended April 30, 2023 and 2022, respectively. Refer to Note L, "Income Taxes" for additional information on the Company's income tax rates.

Business Segment Operating Results

The Company evaluates short-term segment performance based on segment profit and customer sales. Interest expense, investment and other income (expense), income tax expense, and certain corporate administrative expenses are excluded when evaluating segment performance.

The following is a summary of segment information for the three and nine months ended April 30, 2023 and 2022:

Americas & Asia

Americas & Asia net sales were essentially flat at $222.8 million for the three months ended April 30, 2023 compared to $222.6 million in the same period in the prior year, which consisted of organic sales growth of 1.2% and decreases from foreign currency translation of 0.8% and the sale of the PremiSys business of 0.3%. Americas & Asia net sales increased 2.8% to $661.4 million for the nine months ended April 30, 2023 compared to $643.3 million in the same period in the prior year, which consisted of organic sales growth of 4.0% and decreases from foreign currency translation of 1.1% and the sale of the PremiSys business of 0.1%.

Organic sales in the Americas increased in the low-single digits in the three months ended April 30, 2023 and increased in the mid-single digits in the nine months ended April 30, 2023 compared to the same periods in the prior year. The increase in organic sales during the three-month period was primarily due to organic sales growth in IDS with the strongest growth in the safety and facility identification and healthcare identification product lines, which was partially offset by organic sales declines in wire identification and product identification. During the nine-month period, organic sales grew in the safety and facility identification, healthcare identification and wire identification product lines, which was partially offset by an organic sales decline in the product identification product line. Organic growth in IDS was partially offset by a mid-single digit organic decline in WPS during both the three and nine months ended April 30, 2023.

Organic sales in Asia declined in the low-single digits in the both the three and nine-month periods ended April 30, 2023 compared to the same periods in the prior year. The organic sales decline during the three-month period was primarily driven by decreased sales in Malaysia and Singapore, which were partially offset by sales growth in China and India. The organic sales decline during the nine-month period was primarily driven by decreased sales in China due to the spread of COVID-19 during the second quarter of fiscal 2023, which was partially offset by strong sales growth in India and Japan during the nine-month period.

Americas & Asia segment profit increased 9.3% to $49.2 million for the three months ended April 30, 2023 compared to $45.0 million in the same period in the prior year. Segment profit increased 13.8% to $130.5 million for the nine months ended

April 30, 2023 compared to $114.7 million in the same period in the prior year. As a percentage of net sales, segment profit increased to 22.1% from 20.2% for the three-month period, and segment profit increased to 19.7% from 17.8% for the nine-month period ended April 30, 2023 compared to the same periods in the prior year. The increase in segment profit as a percentage of net sales was primarily due to ongoing efforts to streamline processes to drive operational efficiencies as well as price increases, which were partially offset by an increase in costs due to inflationary pressures.

Europe & Australia

Europe & Australia net sales declined 1.4% to $114.3 million for the three months ended April 30, 2023 compared to $116.0 million in the same period in the prior year, which consisted of organic sales growth of 3.4% and a decrease from foreign currency translation of 4.8%. Europe & Australia net sales declined 3.1% to $324.6 million for the nine months ended April 30, 2023 compared to $334.8 million in the same period in the prior year, which consisted of organic sales growth of 7.0% and a decrease from foreign currency translation of 10.1%.

Organic sales in Europe increased in the low-single digits in the three months ended April 30, 2023 and increased in the mid-single digits in the nine months ended April 30, 2023 compared to the same periods in the prior year. The increase in organic sales during the three-month period was primarily driven by mid-single digit growth within WPS, which included digital sales growth of approximately 15%. Organic sales in IDS increased in the low-single digits during the three-month period, which consisted of growth in the safety and facility identification product line, which was partially offset by a decline in the product identification and wire identification product lines. Organic sales growth during the nine-month period was driven by mid-single digit growth in both IDS and WPS. Organic sales growth in IDS was strongest in the safety and facility identification and product identification product lines, followed by wire identification. Organic sales in WPS included digital sales growth of approximately 13%.

Organic sales in Australia increased in the low-teens in both the three and nine months ended April 30, 2023 compared to the same periods in the prior year. Organic sales were driven by consistent growth in both digital and sales from all other channels, including catalogs, in both the three and nine-month periods, which was primarily the result of price increases implemented throughout the nine months ended April 30, 2023. Organic sales growth was led by core safety and facility identification products.

Europe & Australia segment profit increased 6.5% to $17.1 million from $16.1 million, and as a percentage of net sales, segment profit increased to 15.0% from 13.8% for the three months ended April 30, 2023 compared to the same period in the prior year. Segment profit increased 2.5% to $47.3 million from $46.2 million and as a percentage of net sales, segment profit increased to 14.6% from 13.8% for the nine months ended April 30, 2023 compared to the same period in the prior year. The increase in segment profit for both periods was primarily due to actions taken during fiscal 2022 to reduce the cost structure as well as pricing actions implemented throughout the nine months ended April 30, 2023.

Liquidity and Capital Resources

The Company's cash balances are generated and held in numerous locations throughout the world. At April 30, 2023, 99% of the Company's cash and cash equivalents were held outside the United States. The Company's organic and inorganic growth has historically been funded by a combination of cash provided by operating activities and debt financing. The Company believes that its cash flow from operating activities and its borrowing capacity are sufficient to fund its anticipated requirements for working capital, capital expenditures, research and development, common stock repurchases, and dividend payments for the next 12 months and beyond. Although the Company believes these sources of cash are currently sufficient to fund domestic operations, annual cash needs could require repatriation of cash to the U.S. from foreign jurisdictions, which may result in additional tax payments.

Cash Flows

Cash and cash equivalents were $135.0 million at April 30, 2023, an increase of $21.0 million from July 31, 2022. The significant changes were as follows:

(Dollars in thousands)

Net cash provided by operating activities was $129.9 million for the nine months ended April 30, 2023 compared to $65.2 million in the same period of the prior year. The increase in cash provided by operating activities was primarily due to improved profitability and reduced inventory purchases compared to elevated inventory purchases in the prior year to reduce the risk of supply chain disruption.

Net cash used in investing activities was $4.9 million in the nine months ended April 30, 2023, which consisted of capital expenditures of $12.9 million partially offset by proceeds of $8.0 million received from the sale of the PremiSys business. Net cash used in investing activities was $22.1 million in the nine months ended April 30, 2022, which was elevated due to the purchase of two facilities that were previously leased.

Net cash used in financing activities was $105.9 million in the nine months ended April 30, 2023 compared to $81.8 million in the same period of the prior year. The increase in cash used by financing activities was primarily due to $44.2 million of net repayments on the credit agreement in the nine months ended April 30, 2023 compared to $39.0 million of net borrowings on the credit agreement in the same period of the prior year, which was due to the increase in net cash provided by operating activities in the current nine-month period. The increase in cash used in financing activities was partially offset by a decrease in share repurchases compared to the prior period.

Material Cash Requirements

Our material cash requirements for known contractual obligations include capital expenditures, borrowings on our credit agreement and lease obligations. We believe that net cash provided by operating activities will continue to be adequate to meet our liquidity and capital needs for these items over the next 12 months and in the long-term beyond the next 12 months. We also have cash requirements for purchase orders and contracts for the purchase of inventory and other goods and services, which are based on current and anticipated customer needs and are fulfilled by our suppliers within short time horizons. We do not have significant agreements for the purchase of inventory or other goods or services specifying minimum order quantities. In addition, we may have liabilities for uncertain tax positions, but we do not believe that the cash requirements to meet any of these liabilities will be material.

Credit Agreement

On August 1, 2019, the Company and certain of its subsidiaries entered into an unsecured $200 million multi-currency credit agreement with a group of five banks.

On December 21, 2021, the Company and certain of its subsidiaries entered into an amendment to the credit agreement dated August 1, 2019. The amendment modified the credit agreement to, among other things, (a) change the interest rate under the credit agreement for borrowings (i) denominated in British Pounds from the London Inter-bank Offered Rate ("LIBOR") to a daily simple SONIA-based rate, (ii) denominated in Euro from a LIBOR-based rate to a rate based on the Euro Interbank Offered Rate and (iii) denominated in Japanese Yen from a LIBOR-based rate to a rate based on the Tokyo Interbank Offered Rate, in each of the foregoing cases subject to certain adjustments specified in the credit agreement; and (b) provide mechanics relating to a transition away from U.S. dollar LIBOR (with respect to borrowings denominated in U.S. dollars) and the designated benchmarks for the other eligible currencies as benchmark interest rates and the replacement of any such benchmark by a replacement benchmark rate. The amendment to the credit agreement did not have a material impact on the interest rate or related balances in the Company's consolidated financial statements.

On November 14, 2022, the Company and certain of its subsidiaries entered into a Second Amendment to Credit Agreement (“Amendment No. 2”) with a group of six banks, which amended the original credit agreement dated August 1,

2019. Amendment No. 2 amended the credit agreement to, among other items, (a) increase the lending commitments by $100 million for total lending commitments of $300 million, (b) extend the final maturity date to November 14, 2027, (c) increase the interest rate on certain borrowings by 0.125%, and (d) increase the available amount under the credit agreement, at the Company's option and subject to certain conditions, from $300 million up to (i) an amount equal to the incremental borrowing necessary to bring the Company's consolidated net debt-to-EBITDA ratio as defined in the credit agreement to 2.5 to 1.0 plus (ii) $200 million. Borrowings under Amendment No. 2 are unsecured and are guaranteed by certain of the Company's domestic subsidiaries.

As of April 30, 2023, the outstanding balance on the Company's credit agreement was $50.8 million. The maximum amount outstanding on the credit agreement during the nine months ended April 30, 2023 was $103.0 million. As of April 30, 2023, the U.S. dollar-denominated borrowings of $13.0 million bear interest at 6.0%; the Euro-denominated borrowings of €23.0 million bear interest at 3.9%; and the British Pound-denominated borrowings of £10.0 million bear interest at 5.1% for a weighted average interest rate of 4.7%. The Company had letters of credit outstanding under the credit agreement of $1.6 million as of April 30, 2023, and there was $247.6 million available for future borrowing, which can be increased to $1,047.6 million at the Company's option, subject to certain conditions. The credit agreement has a final maturity date of November 14, 2027. As such, borrowings were classified as long-term on the condensed consolidated balance sheets.

Covenant Compliance

The Company's credit agreement requires it to maintain certain financial covenants, including a ratio of debt to the trailing twelve months EBITDA, as defined in the credit agreement, of not more than a 3.5 to 1.0 ratio (leverage ratio) and the trailing twelve months EBITDA to interest expense of not less than a 3.0 to 1.0 ratio (interest expense coverage). As of April 30, 2023, the Company was in compliance with these financial covenants, with a ratio of debt to EBITDA, as defined by the agreement, equal to 0.19 to 1.0 and the interest expense coverage ratio equal to 77.1 to 1.0.

Forward-Looking Statements

In this quarterly report on Form 10-Q, statements that are not reported financial results or other historic information are “forward-looking statements.” These forward-looking statements relate to, among other things, the Company's future financial position, business strategy, targets, projected sales, costs, income, capital expenditures, debt levels and cash flows, and plans and objectives of management for future operations.

The use of words such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “should,” “project” or “plan” or similar terminology are generally intended to identify forward-looking statements. These forward-looking statements by their nature address matters that are, to different degrees, uncertain and are subject to risks, assumptions, and other factors, some of which are beyond Brady's control, that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For Brady, uncertainties arise from:

• Increased cost of raw materials, labor and freight as well as raw material shortages and supply chain disruptions
• Decreased demand for the Company's products
• Ability to compete effectively or to successfully execute the Company's strategy
• Ability to develop technologically advanced products that meet customer demands
• Ability to identify, integrate, and grow acquired companies, and to manage contingent liabilities from divested businesses
• Adverse impacts of the novel coronavirus ("COVID-19") pandemic or other pandemics
• Difficulties in protecting websites, networks, and systems against security breaches and difficulties in preventing phishing attacks, social engineering or malicious break-ins
• Risks associated with the loss of key employees
• Extensive regulations by U.S. and non-U.S. governmental and self-regulatory entities
• Litigation, including product liability claims
• Foreign currency fluctuations
• Potential write-offs of goodwill and other intangible assets
• Changes in tax legislation and tax rates
• Differing interests of voting and non-voting shareholders
• Numerous other matters of national, regional and global scale, including major public health crises and government responses thereto and those of a political, economic, business, competitive, and regulatory nature contained from time to time in Brady's U.S. Securities and Exchange Commission filings, including, but not limited to, those factors listed in the “Risk Factors” section within Item 1A of Part I of Brady's Form 10-K for the year ended July 31, 2022.

These uncertainties may cause Brady's actual future results to be materially different than those expressed in its forward-looking statements. Brady does not undertake to update its forward-looking statements except as required by law.

Refer to the Company’s Annual Report on Form 10-K for the year ended July 31, 2022. There has been no material change in this information since the 2022 Form 10-K.

Brady Corporation maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports filed by the Company under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports the Company files under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Company carried out an evaluation, under the supervision and with the participation of its management, including its President and Chief Executive Officer (the "Chief Executive Officer") and its Chief Financial Officer, Chief Accounting Officer and Treasurer (the "Chief Financial Officer"), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.

There were no changes in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company's most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

The Company’s business, results of operations, financial condition, and cash flows are subject to various risks and uncertainties, including those described in Part I, Item 1A, “Risk Factors” of Company’s Annual Report on Form 10-K for the year ended July 31, 2022. There have been no material changes from the risk factors set forth in the 2022 Form 10-K.