Matthews International Corporation
Q4 2014 Earnings Call Transcript

Published: 14 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Matthews International year-end financial call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Chief Financial Officer, Steve Nicola. Please go ahead.

[Steven F. Nicola:]

Thank you, Toni. Good morning. I'm Steve 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 [phone] and enter the access code 341413. The replay will be available until 11

[Joseph C. Bartolacci:]

Thank you, Steve. Good morning, everybody. Before we get started, let me take a moment to welcome our new SGK colleagues on to this call. We know that many are listening and we welcome them to our team. Now on to the business of the day. As you all are aware, we closed our acquisition of SGK during the fourth quarter and we've begun to see the benefits of the transaction even in these early days. Although we are still in the early phases, enthusiasm is high and our integration is on track. Our integration teams, scattered around the world, have verified that -- verified synergies that meet our expectations of at least $35 million and we see a pathway to more. We have also spoken to a significant number of our clients around the world and they have generally been enthusiastic about the combination of the 2 companies. Together, we are the global leading provider of premedia services to the packaging market. With operations in over 20 countries and more than 5,000 employees servicing consumer product companies and printers around the world, we have the breadth and the depth to meet any packaging need better than anybody else. When these capabilities are combined with our leading Merchandising Solutions team, we truly believe that we have a unique set of products and services that nobody else can offer. From a financial perspective, we expected that the addition of SGK to be modestly dilutive for the fiscal year ending 2014 on a GAAP basis when adjusted for transaction-related expenses. And when we look at our 2014 results on a non-GAAP adjusted basis, SGK was accretive. For 2015, we expect SGK to continue to be accretive on a full year basis once integration costs are excluded and we expect that trend to improve over the years to come. All in all, we're off to a good start and we've had no surprises. Even with the positive news coming from the SGK transaction, we have not taken our eye off the balance of the business where we continue to see strong performance. On a stand-alone basis, I'm happy to note that we met our initial guidance that we communicated last November. This is a tribute to our team who have, in many ways, stepped up to do double duty during a stressful integration in a much needed strong fourth quarter. For example, our Marking and Fulfillment business had a strong fourth quarter and continues to show year-over-year improvement despite significant R&D spending. This business has seen strong equipment and ink sales in the U.S. and Europe, which should continue into 2015. We have also seen continued good performance from our Fulfillment business, including a strong backlog for 2015. Despite these successes which have propelled us for 2014, however, we continue to be challenged by a slowing economy in China where the introduction of new equipment is expected to improve operating results in 2015. Again, as I've stated in the past, this team has made substantial progress with adjacency businesses like Fulfillment and new products and we expect to continue to invest in R&D and acquisitions to position this business for more substantial growth. In addition, our stand-alone Packaging Graphics business had a very strong quarter, led by European group, particularly Saueressig, which saw strong cylinder volumes and the shipment of a large equipment order from our engineering group. Nonetheless, in this division, we saw good performance from all geographies. Our Cemetery Products business also had a good quarter, driven by strong volume and good production efficiencies. Although we've had our challenges in this business, we are seeing positive signs from some of our marketing and Lean initiatives. As I said earlier, we are early into the SGK integration and we are still learning the nuances of that business. The timing of marketing spend by our clients is the most uncertain part of our planning. Also despite our confidence in our ability to capture the expected synergies and continue to deliver high-quality products and services to our clients around the world, we will err on the side of prudence in our early actions and therefore it may impact the timing of synergies and we will make the right long-term decisions for the business as we proceed. We also expect to have negative currency translation working against us on a comparative basis, which can change over the coming year. Also going in 2015, we are seeing volatile input costs in some of our businesses, which could unfavorably impact the year. So despite our enthusiasm and confidence regarding our prospects for next year, we remain cautious with our expectations and are targeting $3 per share of adjusted non-GAAP EPS. With that, we'll open up for questions.

[Steven F. Nicola:]

[Operator Instructions] Toni?

[Operator:]

[Operator Instructions] Our first question comes from the line of Daniel Moore with CJS Securities.

[Daniel Moore:]

Two quick things. Wanted to focus on -- if I missed it, I apologize. Cemetery Products past quarter growth in sometime, up 6%. Was that all organic? What were the key drivers, particularly given casket and deaths continue to remain flat to down?

[Joseph C. Bartolacci:]

Yes, Dan, they were all organic. Timing in that market is hard to predict sometimes when an order is actually placed for a marker versus when death actually occurs, but it was all organic. We had some price in there as we -- we implemented a price increase earlier in the year, but at the end of the day, there were no acquisitions and some pretty good performance out of that group.

[Daniel Moore:]

Okay. And then in your legacy Graphics Imaging business, obviously you just talked about accelerated in Q4. What were the kind of drivers there? And you gave some brief comments, but what's your outlook as we look out to 2000 -- fiscal '15 for sustaining the growth.

[Joseph C. Bartolacci:]

Dan, over the last couple of years, we made a couple of acquisitions over what I will call the stand-alone Graphics -- the pre-SGK Graphics business, particularly in Europe. We have solidified a leading position by a long shot in the cylinder production business in Europe with operations in multiple locations around that part of the world. That has led to some very good contracts with large CPGs, particularly in the tobacco business. We're starting to see the benefit of that and we're also starting to see the benefits of some of the synergies that we expected to see out of those businesses as we integrate them into our Saueressig business. The last piece of that, and this is part of the business we do not talk a lot about in our European business, is our engineering solutions business where we -- where the team over there very, very confident, very strong engineers have taken cylinder production to a different level. So we do things like produce equipment from lithium ion battery production or we use machines that use our cylinders for tissue production. That business is lumpy, but it is a wonderful addition to what I would call traditional cylinders and we shipped a very nice piece of equipment and hope to have more. Although a little less predictable than the rest of the business, they're good margins and unique solutions that we are building adjacencies in the business we have. As I said in my call, though, the reality is we performed in all segments. All geographies of that division performed well and some of it has been new wins and accounts and some of it has just been volume picking up as economies around the world have improved and we expect that to continue. Our expectations for 2015 is that will continue.

[Daniel Moore:]

Great. Lastly, Steve, just -- of the $3 in adjusted EPS, as Joe mentioned, how much of that is, in terms of EPS, will be the impact of intangible amortization?

[Steven F. Nicola:]

The incremental intangible amortization, Dan, from the acquisition, and this is the amount over what SGK was previously reporting, is in the $12 million to $13 million range.

[Operator:]

Our next question comes from the line of Liam Burke with Wunderlich Securities.

[Liam D. Burke:]

Joe, you saw a decline -- lower year-over-year margins in both Funeral Home and Cremation and you mentioned materials costs as being part of the reason. Do you have any flexibility to move prices up in response to that?

[Joseph C. Bartolacci:]

Yes, interestingly, the industry, we're not the price leader in the funeral home industry. The leader is Batesville in that case and their price increases come out in September. Because of the nature of the industry, that only occurs once a year and they recently came out. I would tell you that their price increase was probably not what we would like to have seen, but we've matched that going forward. Lumber and steel are the 2 drivers in the particular business right now. Lumber is seeing double-digit increases and steel is moving on us as well. So that's a bit of the challenge in that industry. Couple that with the volume decline that we saw in death rates and we had a tough quarter in there. Having said that, though, I would stress that division, on a clean basis, has hit our targets from an operating margin. They've done a great job in getting their costs under control. We've long talked about getting that to a mid- -- double-digit operating profit. Their EBITDA is pushing 20% when you look at it on a pre-corporate basis. That's a good business right now.

[Liam D. Burke:]

Okay. And when you mentioned the lower distribution sales, was that designed to back out of the distribution market and go entirely to direct selling on the casket side?

[Joseph C. Bartolacci:]

That's timing. I mean, distribution -- when we talk about distribution, these are some of our legacy distributors that remain with us after the Milso acquisition a few years back and we also sell into the distribution -- the independent distribution market that's more timing when they choose to manage their inventory than anything else.

[Liam D. Burke:]

Great. And just one more. You mentioned Fulfillment backlog in the Marking and Fulfillment was strong. How were Fulfillment sales in the quarter?

[Joseph C. Bartolacci:]

Fulfillment sales are okay. They weren't stellar. They weren't bad. They were kind of as expected, but I will tell you that team is bringing together a pretty good solution. When we look at some of the products that we put together and some of the other pieces to the puzzle that we want to add, we've got great hopes for Fulfillment. We're pretty -- we're bullish in that segment going forward and in -- also in 2015.

[Operator:]

Our next question comes from the line of Scott Blumenthal with Emerald Advisors.

[Scott B. Blumenthal:]

Steve, just as a refresher, we realized that bulk, if not all, of SGK falls in Graphics Imaging, is there anything in Merchandising as well?

[Steven F. Nicola:]

No. For purposes of the reporting that you see on our financial summary we put on the website, SGK is classified under the Graphics Imaging segment.

[Scott B. Blumenthal:]

Okay, terrific. And the merchandising project that provided a bump in the last couple of quarters, is that expected to continue into this quarter? And if so, how much more legs does that thing have?

[Joseph C. Bartolacci:]

For the most part, Scott, that is completed. Obviously, what -- our client, in that case, uses a successful launch. And our part should build some relationship that'll put us in a position for the next launch, but nothing is in the works today.

[Scott B. Blumenthal:]

Okay, great. And one last one, if I may. Liam touched on the Marking and Fulfillment. I know that you had a couple of meaningful pilot projects underway for a while. I was wondering how those were progressing, what the outlook is there?

[Joseph C. Bartolacci:]

Those progressed very well and are leading to other opportunities. So that's one of the reasons why we remain so bullish. We have an excellent team on that side and I can't speak highly enough of the whole team and they continue to integrate and add different solutions on a unique basis. We're expecting big things over time from this division from where it was. If you look back in the history of this business, this was a $30 million, $35 million business just 8, 9 years ago. And the profit in this business today versus where it was then is light years of difference. So we expect similar kind of growth, if not better, from this team. I know they're listening, so they'll get that message.

[Operator:]

Our next question comes from the line of Jamie Clements [ph] with Macquarie.

[Unknown Analyst:]

Wondering if you can help me kind of reconcile some of -- the $3 adjusted EPS kind of to the cash flow statement to the best of your ability. Steve, the intangible amortization that you all are backing out of the adjusted EPS, is that the sort of the new kind of $12 million associated with the deal? Or is it closer to the $20 million that, I think, is kind of full, all-in deal plus preexisting Schawk?

[Steven F. Nicola:]

Well, if you take the $12 million to $13 million that is incremental and Schawk -- existing Schawk was somewhere around $4 million or so and then our intangible amortization, stand-alone, was about $4 million. That gets close to the $20 million number that you just referenced.

[Unknown Analyst:]

So the $20 million is going to be backed out for adjusted purposes now, not just the $12 million, right?

[Steven F. Nicola:]

That's correct.

[Joseph C. Bartolacci:]

For a long time, Jamie [ph].

[Unknown Analyst:]

Yes, yes. Got it, got it. Schawk's CapEx over the last 9 or 10 years has really bounced around a lot as a percentage of revenue. Obviously, they invested a lot in systems and control and that sort of thing. All in, Matthew's CapEx for fiscal '15, Steve, do you have a rough range of what we should expect?

[Steven F. Nicola:]

Yes, Jamie [ph], let me speak to that because with the integration that we've got going on, and particularly the ERP implementation side, I expect our capital expenditures in fiscal 2015 to be higher than average. I think that, on a run rate basis, excluding incremental integration-related capital expenditures, that our run rate of about $30 million and their run rate of about $10 million is -- so totaling $40 million is probably what I would call a good number to model as a -- excluding unusual items, if you will, capital expenditures number. And as you would expect, though, it's difficult to predict what the incremental capital expenditures are related to the integration, but they could be, in fiscal 2015, $10 million or more.

[Operator:]

Our next question comes from the line of Jason Rodgers with Great Lakes Review.

[Jason A. Rodgers:]

Wonder if you could provide an update on the tobacco-related orders in Europe, if you're seeing any signs that those will be realized at least in the first half of fiscal '15?

[Joseph C. Bartolacci:]

Yes, we were expecting strong tobacco orders frankly. It was a large part -- not the only part, but a large part of the volume increase in the fourth quarter of 2014. One of the things that we expect next year is the continuation of that. Frankly, one of the things that will help or could hurt that in 2015 is an expectation to open a Russian plant and I'm sure you all are reading the papers lately and that is a good growth opportunity for us where we already have existing contracts due to more volume for the tobacco industry. If you look at Philip Morris, for example, their largest tobacco-producing facility in the world is in Moscow and we're putting a facility not far away to service them and other tobacco industry members, but we're cautiously optimistic next year and cautiously hopeful that diplomacy will get through a solution makes us comfortable to do that.

[Jason A. Rodgers:]

And looking at the Cremation side, what opportunities for the energy-related sector are you seeing? And are there opportunities in Cremation for medical waste as well?

[Joseph C. Bartolacci:]

You're tapping on to things that we continue to look at. Our U.K. business that helped us land this incineration project in Mecca does have products designed for campsite disposal. We sell a fair amount of that equipment into the Middle East and Northern Africa. And in the U.S, certain environmental rules may not allow us to do that, but we're looking for solutions that make some sense. Medical waste, we're looking at alternatives. We obviously have the competency to develop products for that. There is use -- there is a -- there are players in the business right now, not the least of which some of the large disposal companies that handle medical waste disposal. We would need a change in business model for the hospitals and medical facilities around the country to want to use our equipment today.

[Jason A. Rodgers:]

Okay, but no large deals brewing currently in the energy sector for Cremation?

[Joseph C. Bartolacci:]

We have large incineration projects being bid every day. None that we are able to talk about that are close to being landed today.

[Jason A. Rodgers:]

And finally, just your best guess on the tax rate for fiscal '15?

[Steven F. Nicola:]

Somewhere in the 34% to 34.5% range and that would be clean of any non-GAAP adjustments.

[Operator:]

Our next question comes from the line of Daniel Moore with CJS Securities.

[Daniel Moore:]

Joe, you talked about in your remarks the timing of the synergies maybe being pushed out a little bit, being prudent obviously. Excluding amortization and that whole issue, maybe can you give us a sense of when you expect the deal to turn from dilutive to being accretive? And any sense of what type of run rate synergies you think might be achievable by the end of fiscal '15 or end of fiscal '16?

[Joseph C. Bartolacci:]

So there are lot of questions there, see if I can parse that out. As I said, on a non-GAAP adjusted basis for the quarter, Schawk -- SGK was already accretive. We expect that to improve as we do a full year under our belt as well as the synergies associated with that. And in my comments on the prudent side, I was not suggesting that we don't have plans in place to continue to achieve those synergies as we have right now. But this is a service industry and disruptive -- disruption of service can really put our clients in difficult spots. We're just being cautious in our communications saying that the timing of this is really dependent on maintaining that service level for those folks. So the total synergy capture, I would say -- well, let us put it this way, not even total. The vast majority of the synergy capture is over the next 36 months and we'll have more as we move forward and continue to integrate some of our IT solutions. But for right now, we're on track for accretion -- continued accretion in 2015 and improvement in '16 and '17.

[Daniel Moore:]

Okay. And maybe now that you've had a chance to get under the hood a little for Schawk for a few months, update us on kind of the revenue and cross-selling opportunities that you see and when you might start to see some of that benefit. How long you think that -- some of that initial benefit will take?

[Joseph C. Bartolacci:]

We are seeing it already at the end of the day. We won a couple of small projects as we start to look at the cross-selling, particularly I would tell you that when I speak with the SGK team, the part of the business that they're most excited about is our Merchandising business. And the opportunities are presented in cross-selling opportunities there. I think there are some doors being opened that will continue to help us on that side of the business, but even on the CPG packaging side, the extension of what -- some of the creative work that SGK does, mostly in the U.S. and Europe and Asia. In the U.K. and Asia, we think we can extend into mainland Europe and we're starting to see entrées to be able to do that. And from a global solutions standpoint, I would tell you some -- we're probably ahead of some of the CPGs when it comes to global management of the products. Others are already there and love the deal. So it's just a matter of where they stand in their evolution from a global standpoint. But there's nobody that I would say has suggested this was the wrong thing to do.

[Daniel Moore:]

Got it. And then lastly, Steve, give us like a cutoff of the $24.5 million unusual charges in the quarter, how much of those impacted cost of goods sold versus how much were SG&A and other?

[Steven F. Nicola:]

Well, I would -- of the $24.5 million, you could -- $9.5 million of that number certainly impacted cost of goods sold because that was directed to the inventory step-up expense at SGK. And I'd say the balance or I'd say that a significant -- a very significant portion of the remainder would've been SG&A costs.

[Daniel Moore:]

Got it. And lastly, just Schawk on a pro forma or organic basis, what did their growth look like for the quarter and for the trailing 12 months?

[Joseph C. Bartolacci:]

For the quarter, it's difficult to kind of compare because at the end of the day, we had a little -- slightly more than 2 months of revenue in the cutoff on those are a little difficult to compare from a year-over-year basis. The studies that we have performed in our due diligence for this acquisition would suggest that we should expect a GDP-plus growth top line, but largely dependent on marketing spend and economies right now. So that is more of a prospective look, but I would look 2 to 4 years out we'll get there. The one thing that's going to drive revenue and we'll start to speak about this more over the coming quarters and year is that the FDA has issued new regulations for labeling, requiring clarifications in content. It's kind of like the old trans-fat labeling act. That was a -- we expect 2 things to occur from that. We expect a spike in volume on a temporary basis as packaging starts to get regulated, but we can also anticipate perhaps, we don't know, a holdback in marketing spend while they try to do a onetime launch of product rather than having to do it twice. So we're a little uncertain on how that's going to play out just yet. That is expected to take effect sometime in the 2017 period. It has been delayed in the past and these things like this. So the timing of that will probably impact the timing of some of our revenues.

[Operator:]

And we have a follow-up question from Scott Blumenthal with Emerald Advisors.

[Scott B. Blumenthal:]

Joe, just on your last point, you said that you expected the regulations to be in effect in 2017? Or you expect regulations to be, I guess, promulgated now and for your customers to wait until 2017 in order to figure out what's going on there?

[Joseph C. Bartolacci:]

Now that the comment period had ended, the timing of the regulations -- or expected implementation by 2017 or so and that means that it could be a busy period that time depending on how quickly our clients react to that, but it may also hold back some of the spending until they figure that out.

[Scott B. Blumenthal:]

Understood, got it. And I guess, following up on Jason's question about tobacco orders, you've got a meaningful business in Turkey. Obviously, things have been getting a little bit testy there as well. I was wondering if you might want to comment on how, if at all, that might impact your business other than maybe the Turks smoking more.

[Joseph C. Bartolacci:]

Well, I mean, we continue to do well there. Frankly, they're pretty much online, I would say, modestly behind our expectations when we did the acquisition. But I think that's more just the politics of the market today rather than us. So we're not disappointed with that acquisition. We think it's going to continue to be viable as things, hopefully, will stabilize there. And we are far enough away from what I would call the difficult front that it's not impacting our day-to-day ability to run the business and maybe impacting the overall economy, though.

[Operator:]

Thank you. There are no questions in the queue at this time. Please continue.

[Steven F. Nicola:]

All right. Thank you, Toni. Well, we would like to thank all participants for being on the call this morning, and we look forward to our first quarter earnings release and conference call in January 2015. Thank you, and have a great day.

[Operator:]

Thank you, ladies and gentlemen. That does conclude our conference for today. We thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.