Matthews International Corporation — Q3 FY2016 10-Q
Business context and period. This unaudited report covers the quarter and nine months ended June 30, 2016, in fiscal 2016. Matthews operates in SGK Brand Solutions, Memorialization and Industrial Technologies. Dollar amounts below are in USD millions unless otherwise stated.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Sales | $382.1 | $364.8 | $1,103.5 | $1,057.7 |
| Gross profit | $145.3 | $135.4 | $409.6 | $387.8 |
| Gross margin | 38.0% | 37.1% | 37.1% | 36.7% |
| Operating profit | $40.7 | $27.4 | $79.1 | $72.3 |
| Net income attributable to Matthews shareholders | $23.9 | $23.1 | $42.9 | $46.5 |
| Diluted EPS | $0.73 | $0.70 | $1.30 | $1.40 |
For the nine months, SGK sales were $562.3 million (down from $597.6 million), Memorialization sales were $457.8 million (up from $372.1 million), and Industrial Technologies sales were $83.4 million (down from $88.0 million). Segment operating profit was $26.1 million, $48.1 million and $5.0 million, respectively.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $98.4 million, versus $102.3 million. Capital expenditures were $32.7 million; management estimated FY2016 capital spending of approximately $45 million.
- Cash was $74.5 million at June 30, 2016. Working capital was $333.8 million and the current ratio was 2.3.
- Balance-sheet debt, including current maturities, was approximately $919.4 million, compared with $903.0 million at September 30, 2015. Cash less balance-sheet debt implies net debt of approximately $844.9 million.
- The April 2016 amended domestic facility increased total capacity from $900 million to $1.15 billion, comprising a $900 million revolver and a $250 million term loan, maturing April 2021. At June 30, revolver borrowings were $645.0 million and term-loan borrowings were $249.6 million. The domestic facility’s weighted-average borrowing rate was 2.55%.
- Nine-month financing cash use was $57.2 million, including $57.9 million of treasury-share purchases and $14.4 million of dividends. The company said operating cash flow and borrowing capacity should meet foreseeable capital needs.
Material changes and management commentary
- Nine-month sales rose $45.7 million, principally from Aurora, acquired in August 2015. Foreign exchange reduced sales by approximately $21.6 million. Aurora contributed $98.1 million of Memorialization sales; lower casket volumes partly offset its contribution. Management estimated U.S. casketed deaths declined approximately 3% year over year.
- Nine-month operating profit increased $6.9 million. SGK profit improved with integration-related cost reductions, despite lower sales; Memorialization profit declined amid lower casket sales, Aurora-related costs and amortization, and the absence of a prior-year litigation settlement benefit. Industrial Technologies profit fell on lower sales and unfavorable product mix.
- Nine-month attributable net income and diluted EPS declined despite higher operating profit. Other income was a $0.6 million deduction in FY2016 versus $6.4 million of income in FY2015; the prior period included an $11.5 million gain on settlement of a multi-employer pension obligation. Interest expense rose to $18.1 million from $15.1 million, primarily reflecting higher average debt after Aurora.
- FY2016 gross margin benefited from cost-reduction initiatives and lower commodity costs, partly offset by an approximately $4.0 million expense for Aurora inventory step-up write-off. Nine-month selling and administrative expenses included $23.0 million of acquisition integration costs and other charges.
- Management expects continued significant Schawk and Aurora integration work and related costs and acquisition step-up expense during the remainder of FY2016. No numerical earnings or sales guidance is provided in the filing.
Risks, contingencies and unusual items
- A Saudi customer drew on an $11.5 million letter of credit tied to a performance guarantee. The court ruled in Matthews’ favor in June 2016, but the customer had not remitted the funds to the court; management warned the matter could still adversely affect results.
- Interest-rate swaps had a fair-value liability of $8.3 million. A 10% decrease in market rates would increase the swaps’ fair-value liability by approximately $1.2 million; about $1.2 million after tax in accumulated losses was expected to be recognized in earnings over the next 12 months, assuming rates stayed constant.
- Environmental remediation accruals were approximately $3.8 million. Unrecognized tax benefits were $3.5 million, excluding accrued penalties and interest; the company was under examination in several tax jurisdictions.
- Risks cited include foreign exchange, variable interest rates, commodity prices, acquisition integration and execution, competitive and demand pressures, and changes in mortality and cremation rates. Management said the annual goodwill impairment review found reporting-unit fair values above carrying values.
- In May, the company repurchased 970,000 shares from members of the Schawk family, including a director and SGK president, at $50.6921625 per share, stated to be 96.76% of the specified market-price average. Total nine-month repurchases were 1.13 million shares for $57.9 million.
Investor verification priorities
- Confirm whether Aurora integration savings and costs, including the $23.0 million of nine-month charges, translate into sustained segment-margin improvement.
- Track casket volumes, U.S. mortality trends, and whether Memorialization can offset weaker casket demand.
- Review debt reduction, covenant headroom, interest-rate exposure and cash generation against planned capital spending and shareholder returns.
- Monitor recovery of the Saudi letter-of-credit funds and any resulting financial-statement impact.
- Assess the related-party share repurchase terms and the ongoing returns from the company’s substantial buyback activity.