Brady Corp: Form 10-Q for the period ended Oct 31, 2023

Brady Corporation is a global manufacturer and supplier of identification solutions and workplace safety products that identify and protect premises, products and people. The Company is organized and managed on a geographic basis with two reportable segments: Americas & Asia and Europe & Australia. Within each of the reportable segments, the Company sells products under the product identification, wire identification, healthcare identification and safety and facility identification product lines to a diverse base of customers. The product identification, wire identification, and healthcare identification product lines include high-performance and innovative products that are designed, manufactured, and distributed within the Company’s value chain. The safety and facility identification product line includes a broad range of stock and custom products that the Company manufactures, as well as a wide variety of products that the Company purchases and resells as a distributor.

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 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 certain industries and products, streamlining our product offerings, expanding into higher growth end-markets, improving the overall customer experience, developing technologically advanced, innovative, and proprietary products, and improving our digital capabilities.

The following are key initiatives supporting our strategy in fiscal 2024:

• 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.
• Integrating recent acquisitions to further enhance our strategic position and accelerate long-term sales growth.
• 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.
• 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.

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 R&D as well as 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 and return capital to our shareholders in the form of dividends and share repurchases. At October 31, 2023, we had cash of $175.4 million, as well as a credit agreement with $245.8 million available for future borrowing, which can be increased up to $1,090.8 million at the Company's option and subject to certain conditions, for total available liquidity of $1,266.1 million.

We believe that our financial resources and liquidity levels including the remaining undrawn amount of the credit agreement and our ability to increase that credit line as necessary are sufficient to manage the continuing 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, 2023, for further discussion of the possible impact of global economic or geopolitical events on our business.

Results of Operations

The comparability of the operating results for the three months ended October 31, 2023 compared to the three months ended October 31, 2022 has been impacted by the divestiture of two non-core businesses, one in March 2023 and another in October 2023. Both divestitures impacted the Americas & Asia reportable segment.

A comparison of results of operating income for the three months ended October 31, 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 and sales recorded from divested companies up to the first anniversary of their divestiture. 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 October 31, 2023 increased 2.9% to $332.0 million compared to $322.6 million in the same period in the prior year. The increase consisted of organic sales growth of 2.7% and an increase from foreign currency translation of 1.5%, partially offset by a decrease of 1.3% due to divestitures. Organic sales grew 3.3% in the Americas & Asia segment and 1.4% in the Europe & Australia segment during the three months ended October 31, 2023 compared to the same period in the prior year.

Gross margin increased 10.6% to $171.7 million in the three months ended October 31, 2023 compared to $155.3 million in the same period in the prior year. As a percentage of net sales, gross margin increased to 51.7% in the three months ended October 31, 2023 compared to 48.1% in the same period in the prior year. The increase in gross margin as a percentage of net sales was primarily due to product mix, reductions in freight expenses, and improvements in inventory management.

R&D expenses increased 12.7% to $15.7 million in the three months ended October 31, 2023 compared to $13.9 million in the same period in the prior year. As a percentage of net sales, R&D expenses increased to 4.7% in the three months ended October 31, 2023 compared to 4.3% in the same period in the prior year. The increase in R&D spending was primarily due to an increase in R&D headcount in the Americas & Asia segment. The Company remains committed to investing in new product development to increase sales within our businesses. Investments in new printing systems, materials and the build out of a comprehensive industrial track and trace solution remain the primary focus of R&D expenditures in fiscal 2024.

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 increased 7.1% to $96.3 million in the three months ended October 31, 2023 compared to $89.9 million in the same period in the prior year. As a percentage of sales, SG&A increased to 29.0% in the three months ended October 31, 2023, compared to 27.9% in the same period in the prior year. The increase in SG&A expenses was primarily due to increased headcount in sales and technology roles, foreign currency translation and investments in digital advertising, partially offset by a decrease in amortization expense.

Operating income increased 16.2% to $59.7 million in the three months ended October 31, 2023, compared to $51.4 million in the same period in the prior year. The increase in operating income was due to an increase in segment profit in the Americas & Asia segment as a result of organic sales growth and improved gross profit margin as noted above.

OPERATING INCOME TO NET INCOME

(Dollars in thousands)

Investment and other income was $0.4 million in the three months ended October 31, 2023 compared to investment and other expense of $0.2 million in the same period in the prior year. The change was primarily due to an increase in interest income which was partially offset by a decrease in the market value of securities held in deferred compensation plans.

Interest expense decreased to $0.8 million in the three months ended October 31, 2023 compared to $0.9 million in the same period in the prior year. The decrease in interest expense was primarily due to a decrease in outstanding borrowings on the Company's credit agreement, which was partially offset by an increase in interest rates on the Company's credit agreement compared to the same period in the prior year.

The Company’s income tax rate was 20.5% and 21.6% for the three months ended October 31, 2023 and 2022, respectively. Refer to Note M “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 months ended October 31, 2023 and 2022:

19

Americas & Asia

Americas & Asia net sales increased 1.4% to $221.6 million in the three months ended October 31, 2023 compared to $218.5 million in the same period in the prior year, which consisted of organic sales growth of 3.3% and a decrease of 1.9% due to the divestiture of two businesses.

Organic sales in the Americas increased in the mid-single digits in the three months ended October 31, 2023. Organic sales growth was primarily driven by the wire identification, safety and facility identification, and product identification product lines, which was partially offset by an organic sales decline in the healthcare identification product line.

Organic sales in Asia declined in the mid-single digits in the three months ended October 31, 2023. The organic sales decline was primarily driven by decreased volume in China, which was partially offset by increased volume in India and Japan.

Segment profit increased 21.3% to $49.9 million in the three months ended October 31, 2023 compared to $41.1 million in the same period in the prior year. As a percentage of net sales, segment profit increased to 22.5% from 18.8% in the same period in the prior year. The increase in segment profit was primarily due to increased sales volumes in the Americas, reductions in freight costs, as well as our ongoing efforts to streamline manufacturing processes through automation.

Europe & Australia

Europe & Australia net sales increased 6.0% to $110.4 million in the three months ended October 31, 2023 compared to $104.1 million in the same period in the prior year, which consisted of organic sales growth of 1.4% and an increase from foreign currency translation of 4.6%.

Organic sales in Europe increased in the low-single digits in the three months ended October 31, 2023. Organic sales grew in the safety and facility identification product line, which was partially offset by an organic sales decline in the product identification and wire identification product lines. The increase in organic sales in Europe was primarily driven by growth in Western Europe, which was partially offset by a decline in sales in the United Kingdom.

Organic sales in Australia increased in the mid-single digits in the three months ended October 31, 2023. Organic sales were driven by consistent growth in both digital and sales from all other channels, which was primarily the result of price increases implemented in the prior year and sales volume in all major product lines.

Segment profit was essentially flat at $16.7 million in the three months ended October 31, 2023 compared to $16.8 million in the same period of the prior year. As a percentage of net sales, segment profit decreased to 15.2% from 16.1% in the same period of the prior year. The decrease in segment profit was primarily due to increasing labor and other costs as a result of ongoing inflation, which were partially offset by pricing actions taken by the Company implemented during the prior fiscal year.

Liquidity and Capital Resources

The Company's cash balances are generated and held in numerous locations throughout the world. At October 31, 2023, approximately 98% 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. 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 $175.4 million at October 31, 2023, an increase of $23.8 million from July 31, 2023. The significant changes were as follows:

(Dollars in thousands)

Net cash provided by operating activities was $62.3 million in the three months ended October 31, 2023, compared to $28.0 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 levels compared to elevated inventory levels in the prior year to reduce the risk of supply chain disruption.

Net cash used in investing activities consisted of $11.3 million of capital expenditures in the three months ended October 31, 2023, compared to $3.9 million of capital expenditures in the same period of the prior year. The increase in cash used in investing activities is primarily due to facility construction costs in Europe.

Net cash used in financing activities was $21.5 million in the three months ended October 31, 2023 compared to $20.5 million in the same period of the prior year. The increase in cash used in financing activities was primarily due to increased share repurchases during the three months ended October 31, 2023 compared to the same period in the prior year.

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 to adjust to alternative benchmarks due to the elimination of the London Inter-bank Offered Rate (“LIBOR”).

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 October 31, 2023, the outstanding balance on the Company's credit agreement was $52.3 million. The maximum amount outstanding on the credit agreement during the three months ended October 31, 2023 was $56.2 million. As of October 31, 2023, the U.S. dollar-denominated borrowings of $16.0 million bear interest at 6.3%; the Euro-denominated borrowings of €25.0 million bear interest at 4.7%; and the British Pound-denominated borrowings of £8.0 million bear interest at 6.1%. The Company had letters of credit outstanding under the credit agreement of $2.0 million as of October 31, 2023 and there was $245.8 million available for future borrowing, which can be increased to $1,090.8 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 debt agreements, 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 October 31, 2023, the Company was in compliance with these financial covenants, with a ratio of debt to EBITDA, as defined by the agreements, equal to 0.18 to 1.0 and the interest expense coverage ratio equal to 82.0 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
• Difficulties in protecting websites, networks, and systems against security breaches and difficulties in preventing phishing attacks, social engineering or malicious break-ins
• Ability to identify, integrate, and grow acquired companies, and to manage contingent liabilities from divested businesses
• 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
• Adverse impacts of the novel coronavirus ("COVID-19") pandemic or other pandemics
• 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, 2023.

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, 2023. There has been no material change in this information since the 2023 Form 10-K.

Brady Corporation maintains 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, 2023. There have been no material changes from the risk factors set forth in the 2023 Form 10-K.