Matthews International Corporation
Q4 2016 Earnings Call Transcript

Published: 18 Nov 2016

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Fourth Quarter Year End Financial Results Conference Call. At this time all participants are in a listen-mode. Later, we will conduct the question-and-answer session, instructions. Instructions will be given at that time [Operator Instructions]. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your Chief Financial Officer, Mr. Steven Nicola. Please go ahead sir.

[Steven Nicola:]

Thank you, Marybeth. Good morning. I’m Steven Nicola, Chief Financial Officer of Matthews. Also on the call this morning is Joe Bartolacci, our Company’s President and CEO. Today’s conference call has been scheduled for one hour and will be available for replay later this morning. To access the replay, dial 1-320-365-3844, and enter the access code 405604. The replay will be available until 11

[Joe Bartolacci:]

Thank you, Steve. Good morning. Thanks to the strong efforts in several of our businesses; we finished fiscal 2016 very positively, ending with another record for earnings per share. During the fourth quarter, we continued to deliver strong synergy capture; raised our synergy expectations on both of our recent acquisitions; saw good growth in our cemetery products division; improved cost structure, thanks to several strategic initiatives; and contained costs in markets where our revenue was challenged. All of these efforts have allowed us to exceed market expectation for the quarter and the full year. Regarding our Aurora acquisition; the integration continues to go very well with expected synergies continuing to grow; good management practices has allowed us to take over $9 million out of inventory during the year; and we expect that trend to continue as we consolidate warehouses and align on a common product line. We are excited about the synergies that are scheduled to be delivered in 2017, which is a large part of our anticipated year-over-year growth. Much of our efforts during 2016 were mitigated by early dis-synergies and lower death rates. As death rates normalized, perhaps in 2017, we should see significant improvement in our results. Our hats go off to the combined integration teams who're handling tremendous stress from numerous projects with great professionalism and confidence. With regard to our brand business, our SGK integration continues to go well and is in the final stages. As I mentioned in our last call, we still have to implement our ERP solution in our legacy Matthews brand businesses in Europe, and we still have a piece of the ERP implementation in the legacy SGK, which will help with order entry, job tracking and filed management. Both of these remaining projects will be ongoing throughout 2017 and into early 2018; and would help drive the remaining synergies left to be achieved on this acquisition. As I mention in the past, we have completed much of the integration spending as it relates to SGK. Therefore, our integration costs will come down significantly during 2017. We still have significant integration costs related to the Aurora integration yet to be incurred, and we expect our peak to be in 2017. Therefore, as we move in to fiscal 2018, our GAAP and non-GAAP earnings should be much more aligned, and result in stronger cash flows as transaction related expenses wane. During the year, we repurchased approximately 1.1 million shares as part of our goal to return our outstanding shares to pre-acquisition levels. Although, we do not expect to repurchase as many shares during 2017, we will return to the market if we see opportunities. Also, as committed, we repaid the entire purchase price of the $50 million for the shares that we acquired from the Shark family in late second quarter. From another positive perspective, during fiscal 2016, our operating cash flow was $140 million. This strong cash flow has allowed us to gain -- to again raise our annual dividend by 13% to $0.68 per share. We are pleased to note that we have almost doubled our dividend rate in the last five years, while making gross debt repayments of over $400 million. We believe this to be a very positive sign of our discipline and our desire to returning capital to our shareholders. Our industrial technologies group finished the difficult year where prior year comparables were challenging, especially in our fulfillment business. Still the team continued to deliver solid equipment sales driven by recent product launches as our new products continue to gain acceptance throughout the markets. As you are aware, we are spending significantly on development of yet another new product with R&D spending in this segment of over $4 million during 2016. As we approach completion of the development phase of our new project, we expect 2017 to be our highest R&D spend on this project with total spending approaching $7 million. Looking at 2017, we remain confident in our ability to achieve our goals, including the amount of synergies that we expect to realize. In overachieving expectations for 2016, we saw an acceleration of synergies and a few projects being pulled forward; thus, possibly taking away from 2017. Moreover, we remain cautious giving uncertainty around expected death rates, sluggish North American and European brand markets, currency fluctuations and commodity headwinds. Nonetheless, we remain pleased with the direction of all of our businesses and the investments that we have made. Therefore, assuming stability in the markets in which we operate, we expect our 2017 earnings to grow in the high single-digit range. With that, let's open it up for questions.

[Steven Nicola:]

At this time, we will open the call to questions for those of you who'll be asking questions. We request that you limit them to one question and a follow-up question until all those who wish to participate in the Q&A session have had an opportunity to do so. Marybeth?

[Operator:]

[Operator Instructions] And we'll go to the line of Mr. Daniel Moore from CJS Securities. Please go ahead.

[Daniel Moore:]

So want to focus first on the Memorializations, can you break-out the organic growth between the casket side of the business and the memorial side, and what drove the uptick in improvement in memorials volume in the quarter?

[Joe Bartolacci:]

Sure. I would tell you the best way to look at it Dan is that we saw consistent growth rates, actually a little bit of a decline on the organic volume rate for our funeral home products business, which is modestly ahead of the death rate that we see in the casket and burials. On the cemetery side of the products, we've done a great job. The team out there has gone back to several customers that we may have lost throughout that integration of the SAP that you all may recall; regained their confidence and regained their business. We've seen low to mid single digit growth in that business relative to the death rates when you take that into consideration. So we're very-very pleased with that. More importantly, if you recall we made a couple of investments in some smaller brand-up business with the expectation to expand that opportunity across the country. That business is performing very well relative to where it's been over the last several years. So, we think that business is on-track to be the kind of business that we can continue to invest in, and we hope to see more out of it.

[Daniel Moore:]

Very helpful. Good to hear about the recapturing market shares. As we look out to ’17, it sounded in your prepared remarks a little bit of optimism around the death care side of the business. And I think we heard from one of our competitors, expected more of the same down low single digits for next year. So are you seeing anything that gives you confidence, that we could see a flattening, what are your expectations?

[Joe Bartolacci:]

When we look forward, we anticipate what the Census Bureau has predicted going forward. We expect death rates over the next 20-years or so to grow at about 1.1% and 0.5% per year, much of that being consumed by burials, excuse me by cremations, so a relatively flat barrel rate. As you might expect, at this point and in history, what we’re seeing is a little bit of choppiness on that top 1% or 2% that’s going either way. We have a down year from a volume stand-point last year. Will that come back this year, we don’t know. But I can tell you what we do now is that, we given a relative stable base of burials, the synergies that remain to be captured in our Aurora business will give us the kind of growth we expect, plus some of the efforts on the cemetery side, both in granite and bronze, give us pretty good confidence. And unless the bottom falls out on us next year, we’ll be better than we were this year.

[Daniel Moore:]

And just switching gears quickly to the shock side of the business, SGK side of the business. Any tangible evidence it's not dollar volume in terms of conversations around potential benefits for the Food Labeling act in ’17. And then another question as it relates to that; private label, the increased penetration in private labels. Is that part of the reason why we’ve seen kind of modest growth in U.S. and Europe, or is that not having as much of an impact?

[Joe Bartolacci:]

I think it’s clearly having an impact. But let me answer your first question. Your first question with regard to FMLA, we are starting to hear conversations from our food providers that many of them are going to reformulation of their product first, before they go out and disclose exactly what is in it; so, there is improvements going into the formulations. Those are occurring as we speak. We’re starting to have conversations that some of this may start to hit in the second and third quarter of ’17. How much that is, we cannot tell. But we would tell you that with 2018 implementation date, we’re going to have to start to see some things coming on pretty soon. So we expect something, but I can’t give you a feel. We’re not anticipating big numbers in our forecast going into next year. With regard to private label, clearly I think there is a couple of things going on in there. And as we look at, what I would call zero based budgeting going forward for some of our CPGs as they try to understand what is the right level of marketing spend, what innovation do they need, what type of moments are going to private label versus, what needs to, be continue to invest in their brands. We’re seeing some of that sluggishness both in North America as well as in Europe. As we look forward though for brands to continue to be a value, there is going to be a need to continue to innovate and invest in those brands. So, we do think it’s cyclical. Where the new norm may be, may be lower than we might have hoped it to be. But for right now I would tell you that the sluggishness is driven by an intent on -- what CPGs re-understand what they really want to do with these brand, and how much they want to invest.

[Daniel Moore:]

Lastly not going to cover off the ball in terms of the other synergies, cost savings. What should we think about, just in terms of incremental synergies cost savings benefit in fiscal ’17 from here?

[Steven Nicola:]

Dan, I would tell you that, I would tell you to think about it this way. We’ve got to inflationary costs that are going through. You’ve seen commodities, steel is going through the roof and copper, as you see what’s happening with copper as well. We expect our actual cost synergy to be somewhere between $12 million to $15 million that we’re going to capture. But some of that may be mitigated by some of the other sizes and things that are going through our P&Ls that are hard to control from our standpoint. So we think its $12 million to $15 million. We’re pretty confident we can achieve that. How much we get to bring to the bottom line is somewhat out of our control. But I think the important message Dan in that is not necessarily how much are we’re going to bring next year, we’re going to deliver on those synergies. We’re now too going into our third year of these integrations. For those of you that have been with us for a long time, you watched us go through some challenges with our ERP implementations, trying to get ourselves into to a position to able to do this. We appreciate you all sticking with us. But where we stand today is that we have both -- we have processes, we have teams and we have systems that will allow us to do this again. So we have delivered on the cost synergies as expected. We think we’ll do that again next year. But we’re positioning ourselves to do more over the future. So, I think that’s the real story that’s comes up out of this.

[Operator:]

Thank you. And we’ll go to the next line of Jamie Clement from Macquarie. Please go ahead.

[Jamie Clement:]

Joe, quick just follow-up to Dan's question, just before people get confused, you are still handling private label packaging design for a lot of customers though. It's not like you are not in the private label space, right, let's just make that clear, right?

[Joe Bartolacci:]

Sure, we are in the retail space where a lot of private labels being done. We have some very large retail customers, both in North America and in Europe, so yes. But generally what we have seen Jamie is that private label manufacturers copy rather than necessarily go out and be innovative. So we’re doing the work probably at a lower level.

[Jamie Clement:]

Well, hopefully they don’t hear, you saying that; anyway, moving on. So as we think about free cash flow next year, Steve, any kind of change in any significant way directionally to CapEx versus what you spent in '15 and '16 versus what you anticipate spending in '17?

[Steven Nicola:]

Yes, I think CapEx will be a little bit higher next year as we continue with some of our EPR implementation; and, as we do some of the integration work in our Aurora business. So I do see it a little bit higher, maybe in the $45 million to $50 million range.

[Jamie Clement:]

And as far as cash integration spending, restriction spending in that bucket, I was little unclear, because it sounded like that number might be coming down yet you do have certain projects that are in the works also to capture additional synergies. So I mean should the cash restructuring numbers, should that be coming down or should that be staying about the same?

[Operator:]

Ladies and gentlemen, please standby, one moment. And ladies and gentlemen, we will resume the question-and-answer session at this time [Operator Instruction] Mr. Clement? We will go the next line of questioning Mr. David Stratton with Great Lakes Review. Please go ahead.

[David Stratton:]

Looking at fiscal year '17, do you have any guidance around the tax rate in D&A? I think you just spoke about CapEx before everything got disconnected?

[Joe Bartolacci:]

David, I expect the D&A to be -- maybe slightly higher next year, not much. And then what was the first piece of your question…

[David Stratton:]

Tax rate.

[Joe Bartolacci:]

Tax rate, I actually expect that -- let me explain the tax rate a little bit. This year's tax rate was a blend of what I’ll call standard effective tax rate and some items that were discreet to this year. So having said that, I would tell you next year's tax rate is somewhere -- excluding discreet, somewhere in the range of 31.5% to 32%.

[David Stratton:]

And then when we look at the synergies that you’ve outlined, are you maintaining your expectations for the three year prospect? Or are those changing with what you’ve seen in the end of 2016 and going forward?

[Joe Bartolacci:]

As we said earlier, David, our expected synergies continue to climb beyond what we had communicated early on, but many of those synergies will be out in the out-years closer to the end of third -- into the fourth year, and maybe into early fifth year as we move forward. But we'll have achieved what we originally communicated on the high-end of the range during the three year period we communicated.

[David Stratton:]

And then really quick, because you talked about, you highlighted some product pull-forwards in the last year, and I guess maybe this quarter and not necessarily knowing what that'll shape up like in fiscal year '17. Can you just give a little extra color their about the timing and what we're looking at?

[Joe Bartolacci:]

When you look at some of our businesses, brand in particular, but also on the fulfilment side, they're more episodic businesses that are project-based and whether those projects get repeated or not is a different question. Where some of the projects that were incurred in the last part of the fourth quarter, were anticipated to be delivered into the first quarter of 2017; so we had a little bit of pull-forward there. And we also got a little better synergy realization than we anticipated for the full year basis. So the total synergy rates did not change, maybe little earlier than expected by a quarter or two. So, we might expect a little lighter quarter than we’re originally forecasting for the first quarter of 2017, but on a full year basis in line with what we've always communicated.

[David Stratton:]

And then finally, what was the dollar amount synergies you realized in fiscal '16? Are you willing to break that out for us?

[Joe Bartolacci:]

Actually David I do not have a breakout of that in front of me, so I apologize.

[Operator:]

Thank you. And next we'll go to the question line of Mr. Liam Burke with Wunderlich. Please go ahead.

[Liam Burke:]

Joe, on the Aurora front, on the Aurora revenue side of the business, have you been able to maintain churn rates lower levels since you bought in Aurora under the umbrella?

[Joe Bartolacci:]

Well, what we've said Liam, we anticipated early dis-synergies. We came in pretty much in line where that is. That has stabilized probably as of the end of the third quarter, and that's why you're not seeing the full benefits of some of the actions. And that's frankly one of the reasons why you're seeing it in our fourth quarter, because that stability has allowed us to see the benefit of the synergies more clearly. So I would tell you going forward from here, it's the normal churn of up and downs within the marketplace, win some lose some, but at the end of the day, we're pretty stable.

[Liam Burke:]

And the fulfilments side of the industrial business. How does the contract pipeline look there?

[Joe Bartolacci:]

Better than it did same time last year. Let's put it that way. Last year in the fourth quarter we were tailing into the end of a couple of nice projects that moved into the first quarter. So we might see a little bit lighter performance in our first quarter of 2017 there, but our pipeline is better. And we don't -- we're not at 2015 levels but it's early in the year.

[Operator:]

Thank you. And next we'll go to a follow-up question from Mr. Jamie Clement. Please go ahead.

[Jamie Clement:]

Joe, I'm sorry I got cut out there, I apologize for that.

[Joe Bartolacci:]

Welcome back Jamie.

[Jamie Clement:]

Joe, any comments on the acquisition pipeline; it sounds like with the system, the ERP system, implementation that sounds like it's in good shape. It seems like you have the capacity to potentially do something, that's significant. Obviously, we don't know what's out there. But can you give us a little flavor of what we might see in next 12 months or so?

[Joe Bartolacci:]

Jamie, I would tell you that our integration teams are pretty well stretched right now. But we have, as you all have been with us for many years, you've seen a number of smaller deals that have come through the organization. And as you also might expect, we turned that valve-off about three years ago as we were going into planning for SGK. I would tell you that I wouldn't be surprised to see a number of smaller deals come through this year as we fulfil a couple of our pockets, whether it’d be product lines, whether it’d be geographies, whether it’d be additional products we want to offer. From a larger deals perspective, we got a lot of things we'd like to do. It takes two to tango. We're not going to overplay. So, we're confident we'll find another one. It's just a matter of when, probably not this year though.

[Operator:]

Thank you. And we now go to a follow-up question from Mr. Daniel Moore. Please go ahead.

[Daniel Moore:]

Thank you. I missed about a minute or two to call. Just did you talk about interest expense assumptions for fiscal '17?

[Steven Nicola:]

No we did not talk about interest expense assumptions, Dan. But in our expectations for next year, we're not assuming a significant increase in our overall interest cost.

[Daniel Moore:]

So Q4 is at reasonable run rate?

[Steven Nicola:]

Yes, I would say so. When I say that, Dan, I expect that we will de-lever. But again, we've also seen some creep in interest for longer term interest rates. So again on balance, I just don't expect a significant change year-over-year at this point in time.

[Joe Bartolacci:]

One thing that we have to do with interest rates Dan that is impacting us is the discount rate on our pension. So we're seeing an increase in our pension expenses, which is a non-cash expense that is impacting us. Hopefully, with interest rates starting to creep, we'll get that benefit in 2018.

[Daniel Moore:]

And that was my last question, and just had going on in that direction, has been creeping up a little bit. Do you expect that to continue to creep in fiscal '17? And is there any point at which you would consider more significant funding, cash funding to try and bring that down?

[Steven Nicola:]

Well Dan, so the interest -- the discount rates are set once a year at the end of September. So those have already been set. And so we won't have an opportunity to reset that until September of next year. With respect to impact on funding, we did because of the discount rates make a fairly sizable contribution, $15 million just a couple of months ago in September. Our expectation into next year is we'll still make a contribution, but much smaller. And with respect to where we stand in terms of required funding levels, required contributions, other than a smaller contribution, maybe mid-next year, that should be it in terms of what we're required to do. And if discount rates start to increase that actually should be beneficial in terms of required contributions.

[Operator:]

And there are no further questions in the queue. I'll yield the conference back to you sir.

[Joe Bartolacci:]

Thank you, Marybeth. Well, we appreciate everyone for participating in our conference call this morning. And we look forward to our next conference call in January for our first quarter earnings. Thank you and have a great day.

[Operator:]

Ladies and gentlemen, this conference call will be available for replay after 11am Eastern Time today through December 2nd at midnight. You may access the ATT replay system at any time by dialing 320-365-3844 and entering access code 405604. Again, that number is 320-365-3844 and access code 405604. That does conclude our conference for today. We thank you for your participation, and using AT&T Executive Teleconference Services. You may now disconnect.