Matthews International Corporation — Q2 FY2016 Form 10-Q
Reporting period: Quarter and six months ended March 31, 2016; fiscal year ends September 30. Dollar amounts below are in millions except per-share data. Comparatives for 2015 were revised to reflect additional expense from an employee theft spanning multiple years.
Business context and results
Matthews operates in SGK Brand Solutions, Memorialization, and Industrial Technologies. It acquired certain Digital Design, Inc. assets in February 2016 for approximately $7.7 million. The prior-year acquisition of Aurora contributed to Memorialization growth.
| Metric | Three months ended March 31 | Six months ended March 31 |
|---|---|---|
| Sales, 2016 / 2015 | $367.2 / $349.4 | $721.4 / $693.0 |
| Gross profit, 2016 / 2015 | $137.8 / $127.7 | $264.3 / $252.4 |
| Operating profit, 2016 / 2015 | $26.4 / $19.3 | $38.5 / $44.9 |
| Net income attributable to Matthews, 2016 / 2015 | $14.4 / $9.0 | $19.0 / $23.3 |
| Diluted EPS, 2016 / 2015 | $0.43 / $0.27 | $0.57 / $0.70 |
Second-quarter sales increased about 5.1% year over year and attributable net income rose about 60%. For the six-month period, sales grew about 4.1%, but attributable net income declined about 18.7%. Gross margin for the first half was 36.6%, versus 36.4% a year earlier. First-half operating margin was approximately 5.3%, versus 6.5%; the quarterly operating margin improved to approximately 7.2% from 5.5%.
For the first half, SGK sales declined to $362.7 million from $392.6 million, while operating profit improved to $8.3 million from $0.3 million. Memorialization sales rose to $305.0 million from $246.5 million, principally reflecting Aurora and stronger memorial and cremation-equipment sales; operating profit fell to $27.2 million from $39.7 million. Industrial Technologies sales were $53.7 million versus $53.9 million and operating profit was $3.1 million versus $5.0 million.
Cash flow, debt and liquidity
- First-half operating cash flow was $51.9 million, compared with $52.4 million; working-capital changes used approximately $6.6 million, versus a $9.6 million source in the prior-year period.
- Investing activities used $28.9 million, including $23.9 million of capital expenditures and $6.1 million for acquisitions. Financing activities used $36.1 million, including net debt repayment, $8.2 million of share repurchases, $9.6 million of dividends, and $4.2 million to acquire a noncontrolling interest. Cash declined $12.9 million to $59.3 million.
- At March 31, current assets were $578.6 million and current liabilities were $230.1 million; working capital was $348.6 million and the current ratio was 2.5. Total balance-sheet debt, including current maturities, was approximately $888.2 million, versus $903.0 million at September 30, 2015. Cash less reported debt was approximately $828.8 million.
- Domestic revolving-facility borrowings were $859.4 million against a $900 million facility; the company was subject to leverage and interest-coverage covenants. Weighted-average domestic borrowing cost was 2.52%. Interest expense for the first half increased to $11.9 million from $10.3 million, mainly reflecting debt associated with Aurora.
- On April 26, 2016, after quarter-end, the company amended its loan agreement, increasing total borrowing capacity to $1.15 billion through a $900 million revolving facility and a $250 million term loan, both maturing April 26, 2021. Management said the additional liquidity supports growth and share repurchases.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance is provided. Management expected fiscal 2016 capital spending of approximately $45 million and anticipated operating cash flow would fund planned capital projects.
- Management expected substantial Schawk and Aurora integration work to continue for an extended period. Integration costs and acquisition-related inventory step-up expense were expected to affect FY2016 results; first-half selling and administrative expense included $18.9 million of charges, primarily acquisition integration costs. Aurora inventory step-up write-offs reduced first-half gross profit by approximately $4.0 million.
- First-half sales included an estimated $19.2 million adverse foreign-currency effect. Management cited slower SGK markets in the U.S. and Europe, slower Industrial Technologies markets, lower casket unit sales, and an estimated 4% decline in U.S. casketed, in-ground burial deaths. A 10% stronger U.S. dollar was estimated to reduce first-half reported sales by $24.2 million and operating income by $2.1 million.
- Other principal exposures include material-cost inflation, competition and customer/distribution changes, acquisition integration and execution, interest rates, and pension assumptions. Interest-rate swaps had a net unrealized loss of $5.7 million; approximately $0.9 million after tax was expected to be reclassified to earnings over the next 12 months, assuming market rates remained unchanged.
- A $12.9 million Saudi Arabia letter-of-credit dispute remained unresolved. Matthews considers the customer claim without merit and expects a favorable court outcome, but warns that an unfavorable resolution could affect results. The funded amount is reported in other current assets.
- Environmental remediation accruals were approximately $4.1 million. Management did not expect ordinary-course legal proceedings or environmental contingencies to have a significant consolidated impact, while acknowledging final costs could differ from accruals. Tax authorities were examining the company in several jurisdictions; unrecognized tax benefits were $3.8 million, excluding penalties and interest.
- The annual goodwill impairment review found reporting-unit fair values above carrying values, with no impairment recorded. Management reported disclosure controls were effective as of March 31, 2016 and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether integration expenses and Aurora-related amortization/step-up costs decline as integration progresses, and how they affect segment profitability.
- Debt levels, covenant headroom, interest expense, and the terms and use of the post-quarter-end $1.15 billion credit agreement.
- Resolution and recoverability of the $12.9 million Saudi letter-of-credit dispute.
- Underlying segment trends apart from Aurora acquisition contributions, foreign exchange, and the prior-year litigation settlement and theft-related revision.
- Delivery of the approximately $45 million capital-spending plan and the company’s ability to fund it from operating cash flow.