OVERVIEW Between fiscal 1996 and 1999, the Company experienced sales growth while reducing cost of products sold as a percentage of net sales. It made significant improvements in productivity and asset utilization through the successful implementation of a team-oriented approach to quality, growth and cost reduction. To further enhance teamwork, in February 1995, the Company's operations were realigned into three global groups, each headed by a group vice president. The groups are (i) the Identification Solutions & Specialty Tapes Group, (ii) the Graphics Group, and (iii) the Direct Marketing Group. During fiscal 1996, to implement the Company's growth strategy discussed below, the Company increased expenditures related to new products, geographic expansion and acquisitions. This included investments in global information systems and increased sales and marketing activities. Investments in these key areas resulted in selling, general and administrative expenses as a percentage of sales of 39.1% for fiscal 1996, 38.8% for fiscal 1997, 39.3% for fiscal 1998 and 39.9% for fiscal 1999. Management believes these investments will solidify the Company's competitive position and assist the Company in building a base for sustainable long-term growth. The Company's growth strategy is focused on four key elements: introducing new products for current and new markets and applications; geographic expansion in selected markets worldwide; strategic acquisitions and joint ventures; and increasing market penetration in existing markets. The Company introduced several new products in fiscal 1999, including the TLS2200™ Thermal Labeling System, the HandiMark™ Portable Label Maker, the Merlin® II Portable Labeling System, Bradyprinter™ Model 600 X-Plus Labeling System, PAM 6000 printer applicator machine, Markware™ Facility Identification Software, Brady Clean ID™ labels, heavy-duty tire identification labels, Mondo Bondo™ high-adhesion labels and WavePoint™ Read/Write Radio Frequency Identification tags and readers. During fiscal 1999, the Company opened a distribution center in California serving the western United States. The Company completed the acquisitions of SOFT S.A. (France) and the Holman Groupe S.A. (France) in July 1999, Visi Sign Pty. Ltd (Australia) in May 1999, Barcodes West Inc. (United States) in March 1999, VEB Sistemas de Etiquetas Ltda. (Brazil) in August 1998, GrafTek Inc. (Canada) in April 1998, Techniques Avançées (France) in March 1998, Signals S.A. (France) in April 1997, Varitronic Systems, Inc. (United States) in April 1996, The Hirol Company (United States) in January 1996 and TechPress II Limited (England) in November 1995. To increase market penetration in fiscal 1999, the Company continued its investment in sales, marketing and catalog efforts worldwide. Access to information about Brady products was made easier through the launch of an improved Internet site. The trading market and profile of Brady stock was also improved when the Company listed on the New York Stock Exchange in May 1999. YEAR ENDED JULY 31, 1999, COMPARED TO YEAR ENDED JULY 31, 1998 Sales for fiscal 1999 increased by $15,712,000 or 3.5% over fiscal 1998. Sales of the Company's international operations increased 5.9%. In local currencies, continued market penetration in Brady's operations outside the United States increased international sales by 3.4%. The acquisitions of Techniques Avançées, GrafTek Inc., VEB Sistemas de Etiquetas Ltda. and Visi Sign Pty. Ltd increased international sales in local currencies by another 3.4%. These increases were somewhat offset by the negative effect of fluctuations in the exchange rates used to translate financial results into U.S. currency, which reduced international sales growth by 0.9 percentage points. Sales of the Company's U.S. operations increased 1.6%, due primarily to the acquisition of Barcodes West Inc. The cost of products sold as a percentage of sales decreased from 45.0% to 42.9%. Last year's cost of products sold included a charge of $1,515,000 ($920,000 after tax) for the write-down of certain inventories. Excluding this charge, cost of products sold as a percentage of sales decreased from 44.7% to 42.9%. This improvement was primarily caused by changes in product mix towards products with higher margins, reduced expenses as a result of the workforce reduction in August 1998 and manufacturing efficiencies from the Company's continuous improvement efforts. Selling, general and administrative expenses as a percentage of sales increased from 39.3% to 39.9%. Last year's expenses included a charge of $540,000 ($328,000 after tax) for the write-down of certain assets. Excluding this charge, selling, general and administrative expenses as a percentage of sales increased from 39.1% to 39.9%. The increase was primarily caused by a higher bonus accrual as a result of the Company's significant improvement in profitability and higher amortization expense from the goodwill generated by the Company's acquisitions. The completion of certain product development projects as well as restructuring of the research and development effort to increase teamwork and focus on key product segments caused research and development expenses to decrease 12.6% from the prior year. As a percentage of sales, research and development expenses decreased from 4.5% to 3.8%. The Company recorded a $611,000 ($366,000 after tax) nonrecurring credit this year for adjusting the severance costs associated with the workforce reduction. Last year the Company recorded a nonrecurring charge of $5,390,000 ($3,272,000 after tax) related primarily to a provision for severance costs associated with a 7.5% reduction in its workforce. Operating income increased $17,842,000 to $63,772,000 in fiscal 1999 as the improved gross margin more than offset the higher selling, general and administrative expenses. Excluding the nonrecurring items in both years (a charge in 1998 and a credit in 1999), operating income increased 18.3%, from $53,375,000 to $63,161,000. Investment and other income increased $817,000 from the prior year. Last year included losses of $406,000 ($246,000 after tax) on the disposal of certain assets. Income before income taxes was $64,782,000, an increase of 40.3% compared to fiscal 1998's $46,165,000. Excluding the nonrecurring items in both years, income before income taxes increased 18.8% compared to the prior year. The Company's effective tax rate decreased slightly from 39.3% for fiscal 1998 to 38.9% for fiscal 1999. Net income was $39,584,000 for fiscal 1999, compared to $28,036,000 for fiscal 1998 because of the factors cited above. Excluding the $366,000 nonrecurring credit in fiscal 1999 and the $4,766,000 one-time charges in fiscal 1998, net income increased 19.6% over the prior year. BUSINESS SEGMENT OPERATING RESULTS Identification Solutions & Specialty Tapes (ISST) Group ISST sales increased 5.6% in fiscal 1999 (up about 6% in constant currency) from fiscal 1998, following an increase of 5.6% in fiscal 1998 versus 1997. The increase in 1999 was primarily the result of the acquisitions of GrafTek and Techniques Avançées late last year and this year's acquisitions of VEB and Barcodes West. Sales were up in the Americas and Europe and down in Asia. The increase in 1998 versus 1997 was primarily a result of the growth in base business, solid new product sales and the two software acquisitions late in fiscal 1998. Excluding the effect of one-time items, profit as a percentage of sales increased slightly from 14.9% last year to 15.1% this year. Cost savings from the workforce reduction early in the fiscal year offset increased expenses from the new coating line and acquisitions. Comparing fiscal 1998 to 1997, profit as a percentage of sales declined from 15.3% to 14.9% primarily as a result of a planned scaling back of external coating to focus on upcoming new material product developments. Graphics Group Graphics sales decreased 1.9% in fiscal 1999 (down about 2% in constant currency) from fiscal 1998, following an increase of 2.1% from 1997. The decrease in sales of Colorpix wide-format color inkjet printers and related materials was the primary reason for this change in 1999. This product line was de-emphasized in the face of industry stagnation and thinning margins. Sales were down slightly in the Americas and Europe and up in Asia. The 1998 increase from 1997 was a result of higher sales of the Colorpix product line. Excluding the effect of one-time items, profit as a percentage of sales increased significantly from 8.9% last year to 14.8% this year. This profit improvement was generated despite the drop in sales as a result of a reduced expense structure after the workforce reduction and the group's refocusing of resources on the most value-adding growth and profit opportunities. Profit as a percentage of sales decreased from 11.6% in fiscal 1997 to 8.9% in fiscal 1998 due primarily to technical and developmental expenses associated with the Colorpix product line. Direct Marketing Group Direct Marketing sales increased 5.4% in fiscal 1999 (up about 6% in constant currency) from fiscal 1998 and 12.7% in fiscal 1998 over 1997. Sales growth continued to be stronger in Europe than in the United States. In general, sales in Europe were strong in the first six months of fiscal 1999, but growth slowed in the second half of the fiscal year. For the year, sales were up in Europe and flat in the Americas. The sales increase in 1998 compared to 1997 was helped by the acquisition of Signals in April 1997. Excluding the effect of one-time items, profit as a percentage of sales increased from 13.1% in fiscal 1997 to 14.9% last year and 18.0% this year. The primary reasons for this improvement are higher gross margins as a result of vertical integration and better return on advertising investments due to detailed profit analysis by product and improved mailing effectiveness. YEAR ENDED JULY 31, 1998, COMPARED TO YEAR ENDED JULY 31, 1997 Sales for fiscal 1998 increased by $29,069,000 or 6.8% over fiscal 1997. Sales of the Company's international operations increased 9.5%. In local currencies, continued market penetration in Brady's operations outside the United States increased international sales by 13.2%. The acquisitions of Signals S.A., Techniques Avançées and GrafTek Inc. increased international sales in local currencies by 4.4%. These increases were somewhat offset by the negative effect of fluctuations in the exchange rates used to translate financial results into U.S. currency, which reduced international sales growth by 8.1 percentage points. Sales of the Company's U.S. operations increased 4.9%, due primarily to increases in the sales of the Company's core products. The cost of products sold as a percentage of sales decreased from 45.6% to 45.0%. Reduced costs due to changes in product mix and manufacturing efficiencies from the Company's continuous improvement efforts were partially offset by increased depreciation and amortization expenses from the acquisitions. Cost of products sold for fiscal 1998 included a charge of $1,515,000 ($920,000 after tax) for the write-down of certain inventories. Cost of products sold for fiscal 1997 included a charge of $1,200,000 ($715,000 after tax) for restructuring the Company's European operations and consolidating the Hirol Division's production operations into the Company's existing operations in the United States and in the United Kingdom. Excluding these charges, the cost of products sold as a percentage of sales decreased from 45.3% to 44.7%. Selling, general and administrative expenses as a percentage of sales increased from 38.8% to 39.3%. The increase reflects the expenses related to the Company's ongoing investment in sales and marketing activities and building its global information technology infrastructure. The 1998 expenses included a charge of $540,000 ($328,000 after tax) for the write-down of certain assets. The 1997 expenses included a charge of $300,000 ($180,000 after tax) for the restructuring mentioned above. Excluding these charges, selling, general and administrative expenses as a percentage of sales increased from 38.7% to 39.1%. Research and development expenses increased 24.5% over the prior year, reflecting the Company's continued commitment to process improvement and new product development. As a percentage of sales, research and development expenses increased from 3.8% to 4.5%. During fiscal 1998, the Company recorded a nonrecurring charge of $5,390,000 ($3,272,000 after tax) related primarily to a provision for severance costs associated with a 7.5% reduction in its workforce at its operations around the world. Severance payments for approximately 200 people totaled $5,024,000. The remainder of the charge related to the write-off of assets associated with discontinuing the Company's contract taping service and cover tape product line. Operating income decreased $4,438,000 to $45,930,000 in fiscal 1998 as the one-time charges and the increase in research and development expenses more than offset the improvement in gross margin. Excluding the one-time charges in both years, operating income increased 2.9% from $51,868,000 to $53,375,000. Investment and other income decreased $521,000 from 1997. The 1998 results include $406,000 ($246,000 after tax) of losses on the disposal of certain assets. Income before income taxes was $46,165,000, a decrease of 10.0% compared to fiscal 1997's $51,271,000. Excluding the one-time charges in both years, income before income taxes increased 2.4% compared to the prior year. The Company's effective tax rate increased from 38.2% for fiscal 1997 to 39.3% for fiscal 1998 due to higher tax rates for the Company's international operations. Net income was $28,036,000 for fiscal 1998, compared to $31,707,000 for fiscal 1997 because of the factors cited above. Excluding the $4,766,000 one-time charges in fiscal 1998 and the $895,000 restructuring charge in fiscal 1997, net income increased 0.6% over the prior year. YEAR ENDED JULY 31, 1997, COMPARED TO YEAR ENDED JULY 31, 1996 Sales for fiscal 1997 increased by $66,539,000 or 18.5% over fiscal 1996. Sales of the Company's international operations increased by 15.5%. Real growth through continued market penetration in Europe and the Far East increased international sales 12.7%. The acquisitions of TechPress II Limited and Signals S.A. and the startup of the Company's Korean joint venture increased international sales 5.7%. These increases were offset by the negative effect of fluctuations in the exchange rates used to translate financial results into U.S. currency which reduced international sales by 2.9%. Sales of the Company's U.S. operations increased 20.8% for the year ended July 31, 1997. The acquisitions of Varitronic Systems, Inc. and The Hirol Company contributed 11.8% of this increase, with growth in the sales of the Company's core products making up the balance. The cost of products sold as a percentage of sales decreased from 46.3% to 45.6% due to changes in product mix and manufacturing efficiencies from the Company's continuous improvement efforts, offsetting increased depreciation expenses from the acquisitions. Cost of products sold for fiscal 1997 included a charge in the second quarter of $1,200,000 ($715,000 after tax) for restructuring the Company's European operations and consolidating The Hirol Company's production operations into the Company's existing operations in the United States and in the United Kingdom. Selling, general and administrative expenses as a percentage of sales decreased slightly from 39.1% to 38.8%, as the Company's continuing cost control efforts more than offset the Company's ongoing investment in building its global information technology infrastructure. Selling, general and administrative expenses for fiscal 1997 included a charge of $300,000 ($180,000 after tax) for the restructuring mentioned above. The acquisitions and the Company's commitment to process improvements and new product development resulted in research and development expenses increasing by 44.1% over fiscal 1996. As a percentage of sales, research and development expenses increased from 3.2% to 3.8%. Operating income increased by $9,203,000 or 22.4% over fiscal 1996, as the increase in research and development expenses was offset by improved gross margins and the spreading of fixed costs over a larger sales base. Investment and other income decreased $3,411,000 from the prior year as a result of lower investment income because of lower cash balances as a result of the acquisitions in the prior year and foreign exchange losses. In addition, investment and other income for fiscal 1996 included $1,750,000 ($950,000 after tax) from the gain on the sale of a building in Germany. Income before income taxes increased to $51,271,000, an increase of 12.9% compared to fiscal 1996's $45,433,000. Excluding the 1997 restructuring charges and the 1996 gain on the sale of the German building, income before income taxes increased 20.8% compared to the prior year. The Company's effective tax rate decreased slightly from 38.3% for fiscal 1996 to 38.2% for fiscal 1997. Net income was $31,707,000 for fiscal 1997, compared to $28,027,000 for fiscal 1996 because of the factors cited above. Excluding the $895,000 restructuring charge in 1997 and the $950,000 gain on the sale of the building in Germany in 1996, fiscal 1997 net income increased 20.4% compared to the prior year. LIQUIDITY The Company's liquidity remains strong. Cash and cash equivalents were $75,466,000 at July 31, 1999, compared to $65,609,000 at July 31, 1998, and $65,329,000 at July 31, 1997. Working capital increased $4,498,000 during fiscal 1999 and equaled $129,884,000 at July 31, 1999. The Company has maintained significant cash balances due in large part to its strong operating cash flow, which totaled $61,357,000 for fiscal 1999, $47,207,000 for fiscal 1998, and $39,911,000 for fiscal 1997. Capital expenditures were $9,889,000 in fiscal 1999, $17,189,000 in fiscal 1998, and $8,777,000 in fiscal 1997. The increase in fiscal 1998 was primarily from progress payments made on the Company's new coating line. Financing activities, primarily the payment of dividends to the Company's stockholders, consumed $12,533,000 of cash in fiscal 1999, $12,147,000 in fiscal 1998, and $9,166,000 in fiscal 1997. In September 1999, the Company entered into a $150,000,000 revolving loan agreement with six banks. Long-term debt as a percentage of long-term debt plus stockholders' investment was 0.5% at July 31, 1999, compared to 1.6% at July 31, 1998, and 1.8% at July 31, 1997. The Company continues to seek opportunities to invest in new products and new markets and in strategic acquisitions and joint ventures which fit its growth strategy. Management believes the Company's cash and cash equivalents, available line of credit, and the cash flow it generates from operating activities are adequate to meet the Company's current investing and financing needs. INFLATION Essentially all of the Company's revenue is derived from the sale of its products in competitive markets. Because prices are influenced by market conditions, it is not always possible to fully recover cost increases through pricing. Changes in product mix from year to year and timing differences in instituting price changes make it virtually impossible to accurately define the impact of inflation on profit margins. MARKET RISK The Company's business operations give rise to market risk exposure due to changes in foreign exchange rates. To manage that risk effectively, the Company enters into hedging transactions, according to established guidelines and policies, that enable it to mitigate the adverse effects of this financial market risk. The global nature of the Company's business requires active participation in the foreign exchange markets. As a result of investments, production facilities and other operations on a global scale, the Company has assets, liabilities and cash flows in currencies other than the U.S. Dollar. The primary objective of the Company's foreign exchange risk management is to minimize the impact of currency movements on intercompany transactions and foreign raw material imports. To achieve this objective, the Company hedges known exposures using forward contracts. Main exposures are related to transactions denominated in the British Pound, the Euro (primarily the Belgian Franc, Deutsche Mark and French Franc), Canadian Dollar, Japanese Yen and Australian Dollar. The risk of these hedging instruments is not material. EURO CONVERSION On January 1, 1999, the Euro was adopted as the national currency of 11 European Union member nations. During a three-year transition period, the Euro will be used as a non-cash transactional currency. The Company began conducting business in Euros in January 1999, and will change its functional currencies during the three-year transition period. The conversion to the Euro is not expected to have a significant operational impact or a material impact on the results of operations, cash flows or financial condition of the Company. YEAR 2000 COMPLIANCE The inability of computers, software and other equipment utilizing microprocessors to recognize and properly process data fields containing a two-digit year is commonly referred to as the Year 2000 Compliance issue. As the year 2000 approaches, such systems may be unable to process certain date-based information. This could result in a system failure or miscalculations causing disruptions of operations and the inability to engage in normal business activities. Many of the Company's systems, including information and computer systems and automated equipment, will be affected by this issue. The Company has a comprehensive plan to address potential Year 2000 issues. The plan includes (i) the complete inventory of all in-house computers, software and other equipment utilizing microprocessors and the identification of all hardware and software; (ii) modification of the affected systems; and (iii) testing the modified systems and auditing the system for final compliance. The Company is using both internal and external resources to implement its plan. The Company has generally completed the inventory and modification phases of the plan and is at various stages of testing and auditing these systems. The Company feels it has adequate time to assess and correct any significant issues that materialize. The Company estimates that at the conclusion of its various Year 2000 efforts, including conversion, testing and contingency planning, it will have spent approximately $2,500,000 over a multi-year period. Costs associated with this issue have been and will continue to be expensed as incurred and are not expected to have a material effect on the results of operations, cash flows or financial condition of the Company. Although the Company believes its efforts will be successful, any failure or delay could result in the disruption of business and in the Company incurring substantial expense. To minimize any such potential impact, the Company initiated a global contingency planning effort designed to support critical business operations. As a third-party supplier of software and printing systems to other companies, the Company has posted its own product compliance status on its Internet site ( www.bradycorp.com). The Company has completed the process of formally communicating with all of its significant suppliers and customers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate their own Year 2000 Compliance issues. A failure of the Company's suppliers, customers and other third parties to address adequately their Year 2000 readiness could significantly affect the Company's business. As part of its contingency planning efforts, the Company identified alternate sources or strategies where significant exposures were identified. Finally, the Year 2000 presents a number of other risks and uncertainties that could affect the Company, including utilities and telecommunications failures, competition for personnel skilled in the resolution of Year 2000 issues, and the nature of government responses to Year 2000 issues, among others. While the Company continues to believe that the Year 2000 matters discussed above will not have a material impact on its results of operations, cash flows or financial condition, it remains uncertain whether or to what extent the Company may be affected. The Year 2000 statements set forth above are designated as "Year 2000 Readiness Disclosures" pursuant to the Year 2000 Information and Readiness Disclosure Act (P.L. 105-271). FORWARD-LOOKING STATEMENTS Matters in this Annual Report may contain forward-looking information, as defined in the Private Securities Litigation Reform Act of 1995. All such forward-looking information in this report involves risks and uncertainties including, but not limited to, variations in the economic or political conditions in the countries with which the Company does business; fluctuations in currency exchange rates for international currencies versus the U.S. dollar; technology changes; the continued availability of sources of supply; domestic and international economic conditions and growth rates; the ability of the Company to timely adjust its cost structure to changes in levels of sales, product mix and low levels of order backlog; the ability of the Company to make sufficient strategic acquisitions at reasonable prices; the ability of the Company to integrate the acquired businesses within a reasonable period of time; and other risks indicated in filings by the Company with the Securities and Exchange Commission. The Company cautions that forward-looking statements are not guarantees, since there are inherent difficulties in predicting future results, and that actual results could differ materially from those expressed or implied in forward-looking statements.