Matthews International Corporation (MATW) Q3 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to Matthews International Corporation Third Quarter Fiscal Year Financial Results. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the conference over to Mr. Bill Wilson, Director of Finance, Corporate Development. Thank you, sir. You may begin.

Thank you, Latonya, and good morning, everyone, and welcome to the Matthews International third quarter fiscal year 2020 conference call. This is Bill Wilson, Senior Director of Corporate Development. With us today are Joe Bartolacci, President and Chief Executive Officer; and Steve Nicola, our Chief Financial Officer. Before we start, I would like to remind you that our earnings release was posted on our website, www.matw.com, in the Investors section last night. The presentation for our call can be accessed in the Investors section of the website as well. As a reminder, any forward-looking statements in connection with this discussion are being made pursuant to the safe harbor provisions of the Private Securities Litigations Reform Act of 1995. Factors that could cause the company's results to differ from those discussed today are set forth in the company's annual report on Form 10-K and other periodic filings with the SEC. In addition, we will be discussing non-GAAP financial metrics and encourage you to read the disclosures and reconciliation tables carefully as you consider these metrics. In connection with any forward-looking statements and non-GAAP financial information, please read the disclaimer included in today's presentation materials located on our website. And now I'll turn the call over to Steve Nicola, our Chief Financial Officer.

Thank you, Bill. Good morning. Please turn to slide four. As you read in our earnings announcement yesterday, the company generated strong cash flow from operations during the fiscal 2020 third quarter, and reported a significant reduction in outstanding debt. Our consolidated earnings for the quarter, combined with our working capital management efforts and proceeds from the divestiture of an investment, facilitated debt reduction of $104.9 million for the three months ended June 30, 2020. With respect to our operating results for the fiscal 2020 third quarter, the company reported consolidated sales of $359 million compared to $379 million a year ago. Year-to-date fiscal 2020 consolidated sales were $1.1 billion compared to $1.14 billion last year. For both the quarter and year-to-date periods, fiscal 2020 reflected higher sales for the Memorialization segment compared to a year ago, offset by lower sales in the SGK Brand Solutions and Industrial Technologies segments. All segments continue to experience some level of commercial impact from COVID-19 during the third quarter, although these impacts remain difficult to quantify. On a GAAP basis, the company reported earnings per share of $0.07 for the current quarter compared to $0.46 per share last year. A significant portion of the decrease related to noncash charges, including the acceleration beginning in the fiscal 2019 fourth quarter of the amortization of certain discontinued trade names in the SGK Brand Solutions segment, and a $10.6 million reserve for a letter of credit in connection with the previous incineration equipment project in Saudi Arabia. Intangible asset amortization expense was $17.8 million or $0.43 per share for the fiscal 2020 third quarter compared to $9.5 million or $0.24 per share a year ago. In addition, the decline in net income reflected charges related to the company's cost reduction program. Net income for the current quarter also reflected a gain of $11.2 million on the divestiture of the company's ownership interest in a pet cremation business. For the nine months ended June 30, 2020, the company reported a GAAP loss per share of $3.04 compared to income of $1.05 per share last year. In addition to the items impacting the third quarter, the year-to-date decline reflected the second quarter writedown of $90.4 million of goodwill for the SGK Brand Solutions segment. Adjusted EBITDA, which represents net income before interest expense, income taxes, depreciation and amortization and other adjustments for the fiscal 2020 third quarter was $49.4 million compared to $59 million a year ago. The decrease primarily reflected the impacts of lower consolidated sales and unfavorable changes in currency rates. In addition, performance-based compensation expense approximated more normal levels for the current quarter compared to lower expense for the same quarter last year. These items were partially offset by realized savings from the company's recent cost reduction program and lower travel-related expenses. Year-to-date, adjusted EBITDA was $139 million compared to $161.6 million last year. On a non-GAAP adjusted basis, earnings for the fiscal 2020 third quarter were $0.80 per share compared to $0.90 per share a year ago. Lower adjusted EBITDA was partially offset by tax benefits for the current quarter and a decrease in interest expense. Please see the reconciliations of adjusted EBITDA and non-GAAP adjusted earnings per share on our website. Year-to-date adjusted earnings per share were $1.90 as of June 30, 2020, compared to $2.30 last year. Interest expense for the fiscal 2020 third quarter was $8.1 million compared to $10.5 million a year ago, reflecting lower average debt and a decline in average interest rates for the current quarter relative to the same quarter last year. For the nine months ended June 30, 2020, interest expense was $26.9 million compared to $31.1 million last year. Other income and deductions net for the quarter ended June 30, 2020, represented a decrease in pre-tax income of $2.8 million compared to $1.4 million for the same quarter last year. Other income and deductions net for the nine months ended June 30, 2020, represented a decrease in pre-tax income of $7.4 million compared to $3.4 million last year. Other income and deductions include the nonservice portion of pension and post-retirement costs. For the quarter ended June 30, 2020, the nonservice portion of pension and post-retirement cost was $2.2 million compared to $951,000 last year. For the nine months ended June 30, 2020, the nonservice portion of pension and post-retirement costs was $6.7 million compared to $2.9 million last year. Consolidated income taxes for the three months ended June 30, 2020, were a benefit of $6.2 million compared to expense of $4 million for the same quarter last year. The income tax benefit for the current quarter primarily reflected an expected net operating loss carryback to tax years with higher federal tax rates. Consolidated income taxes for the nine months ended June 30, 2020, were a benefit of $22.7 million compared to expense of $4.4 million last year. Please turn to slide five to begin a review of our segment results. Memorialization segment sales for the current quarter were $162 million compared to $158 million for the third fiscal quarter last year, representing an increase of $3.9 million or 2.5%. The increase primarily reflected higher sales of caskets and cremation equipment, partially offset by lower cemetery memorial product sales. The increase in casket sales primarily resulted from the increase in U.S. deaths due to COVID-19. Cemetery memorial product sales were impacted by local stay-at-home orders related to COVID-19, which limited families access to cemeteries to order their memorials. For the nine months ended June 30, 2020, Memorialization segment sales were $478 million compared to $474 million last year. Changes in foreign currency exchange rates had an unfavorable impact of approximately $369,000 on the segment sales compared with the same quarter last year, and $1.1 million on a year-to-date basis. Memorialization segment adjusted EBITDA for the fiscal 2020 third quarter was $37.7 million compared to $36.1 million a year ago. For the nine months ended June 30, 2020, Memorialization segment adjusted EBITDA was $103 million compared to $101.4 million last year. The current year's results primarily reflected the benefits of higher revenues, productivity initiatives and lower travel-related expenses, offset partially by higher material costs and performance-based compensation expense. Please turn to slide six. For the SGK Brand Solutions segment, sales were $166 million for the current quarter compared to $182 million a year ago. The decline primarily reflected lower brand packaging sales in the segment's North America and European markets. Competitive pricing was a factor for the current quarter as volumes declined only modestly from a year ago. In addition, sales of cylinders and surfaces products decreased from the same quarter last year. All regions reported some level of commercial impact from COVID-19, although it remains difficult to quantify. These declines were partially offset by an increase in sales of engineered products in Europe and higher sales for our merchandising solutions business compared to the same quarter last year, partly the result new sales of face shields. For the nine months ended June 30, 2020, sales for the SGK Brand Solutions segment were $514 million compared to $558 million last year. Changes in foreign currency rates had an unfavorable impact of $3.4 million on the segment's third quarter sales compared with the same quarter a year ago, and $8.5 million on a year-to-date basis. Fiscal 2020 third quarter adjusted EBITDA for the SGK Brand Solutions segment was $20.8 million compared to $29.9 million a year ago. The segment's adjusted EBITDA for the nine months ended June 30, 2020, was $61.8 million compared to $86.6 million last year. The quarter and year-to-date declines primarily reflected the impact of lower sales, combined with an unfavorable product mix shift and pricing. The unfavorable shift in product mix partly reflected lower tobacco-related sales in our cylinders business, which generally have higher incremental margins. In addition, as I noted earlier, performance-based compensation expense for the current quarter was higher than the same quarter a year ago. Realized savings from the segment's recent cost reduction initiatives and lower travel-related expenses favorably impacted adjusted EBITDA for the current quarter and year-to-date periods. Please turn to slide seven. Sales for the Industrial Technologies segment for the fiscal 2020 third quarter were $31.5 million compared to $39.1 million a year ago. The decrease reflected lower sales in each of the segment's principal product lines, primarily reflecting the global economic downturn resulting from COVID-19. For the nine months ended June 30, 2020, industrial technology sales for fiscal 2020 were $107.3 million compared to $112.7 million a year ago. Higher product identification sales were partially offset by lower sales of warehouse automation systems. The declines in warehouse automation sales for the quarter and year-to-date were primarily attributable to product delays by customers as backlog in this business continues to remain solid. Changes in foreign currency exchange rates had an unfavorable impact of $166,000 on the segment sales compared with the same quarter last year, and $824,000 on a year-to-date basis. Adjusted EBITDA for the Industrial Technologies segment for the current quarter was $4.7 million compared to $7.3 million a year ago. Year-to-date, the segment's adjusted EBITDA was $15.2 million compared to $15.7 million last year. The decrease in the segment's adjusted EBITDA for the current quarter and year-to-date periods primarily reflected the impact of lower sales, which was offset partially by lower travel-related expenses. Please turn to slide eight. Cash flow from operating activities for the fiscal 2020 third quarter was $57.6 million compared to $44.1 million a year ago. Cash flow from operating activities for the nine months ended June 30, 2020, was $123.6 million compared to $89.4 million a year ago. The significant increase in operating cash flow compared to last year primarily reflected favorable changes in the company's working capital, particularly from our accounts receivable collection efforts. Also during the quarter, the company sold its ownership interest in a pet cremation business, which resulted in cash proceeds of $42.2 million, plus preferred stock of $15 million. The company recorded a gain of $11 million on the sale. As a result of the company's strong operating cash flow and proceeds from the sale, the company reduced its outstanding debt during the fiscal 2020 third quarter by $104.9 million. Outstanding debt was $860.9 million at June 30, 2020, with net debt, which represents outstanding debt less cash, at $818 million. The leverage ratio covenant in our domestic credit facility is based on net debt. At June 30, 2020, the company was well within its this bank covenant as our net leverage ratio for bank covenant purposes approximated 4.0 compared to the covenant limit at June 30, 2020, of 5.0. As you may recall, in the renewal of the revolving credit facility last quarter, the company proactively negotiated a temporary increase in the net leverage ratio covenant threshold due to the global economic uncertainties of COVID-19. This limit reduces to 4.75 at September 30, 2020. However, the company has remained well within the original 4.5 net leverage ratio limit. The company intends to continue to focus fiscal 2020 cash flow primarily on debt reduction. As previously reported, we renewed our domestic revolving credit facility and accounts receivable securitization facility in March 2020. The renewed revolving credit facility provides for borrowings up to $750 million and has a five-year term. The renewed revolving credit facility generally maintains the same terms and interest rate structure of the previous facility. Approximately 31.3 million shares were outstanding at June 30, 2020. During the recent quarter, as our primary focus was on debt reduction, the company purchased only 722 shares under its share repurchase program. Year-to-date, the company has purchased only approximately 74,000 shares. With the reduction in debt during the third quarter and the recent stock price, the company will likely consider repurchasing shares to some degree in the fourth quarter. Finally, the Board last week declared a dividend of $0.21 per share on the company's common stock. The dividend is payable August 17, 2020, to stockholders of record August 3, 2020. This concludes the financial review, and Joe will now comment on our company's operations.

Thank you, Steve. Good morning. We are very pleased by our results for the quarter, particularly given the challenging circumstances in which we operated, notwithstanding what we think is very good performance. Our reported results belie even better performance within the business segments, which give us confidence in the quarters to come. Several of our businesses outperformed prior-year results, but all of our businesses stepped up their efforts to manage their operating cash flow so as to deliver very strong operating results for the quarter. The combined efforts of good operating performance and strong cash management have allowed us to reduce our gross debt by $105 million during the most challenging times in modern history. We did all of this while maintaining a high level of compliance with strict safety protocols, which are designed to protect the health and safety of our employees. We are extremely proud of our colleagues in their performance on all fronts. We believe that this quarter, like no other quarter, demonstrates the significant underlying value of our consolidated business which is not reflected in our stock price today. Let's talk about some of those businesses. In our Memorialization segment for the quarter, our funeral home products business ramped up casket production early. And thanks to the sheer dedication of that team, we delivered revenue that was 17% higher than prior year. This team worked endless hours from manufacturing through distribution and sales to meet the needs of families during the pandemic. The performance of our funeral home products business helped offset a 17% decline in cemetery product revenue, which resulted from the various state shutdown orders and the general concern of the public to attend gathering such as funerals and burial services. We strongly believe that the lower cemetery products revenue is only deferred and not lost. In fact, during the month of July, we have seen a return-to-normal cemetery product order rates and a slight recovery of some of those deferred sales, while funeral home products revenue remains elevated, but not to the same degree as the third quarter. Similarly, our environmental solutions business saw strong sales of North American cremation equipment, allowing them to deliver solid results year-over-year excuse me, to deliver solid year-over-year results despite delays in service revenues caused by the inability to travel and delays in large incineration projects, which were expected to add to the otherwise strong results. Again, in this business, backlog of cremator sales, service and large incineration projects grew during the quarter, which bodes wells for the quarters to come. In our SGK Brand Solutions business, we had solid volumes in North America and the Asia Pacific region, particularly in our core packaging businesses, as brands invested strongly in new products and updated packaging, particularly in the packaged good – packaged foods segment. The core packaging business has held up very well in this environment, but portions of the overall brand segment has been deferred – has seen deferral of projects. In particular, our cylinders business has been impacted by slow tobacco revenues as tobacco brands have all but shut down marketing efforts in Europe, while our surfaces business, which produces high-dollar cylinders, which are often part of larger capital expenditures, has seen a slower order rate during the quarter. Again, these results belie the underlying performance of the cylinders, surfaces and engineering business as we have had strong results in our engineering business, which continues to make progress on projects for the energy storage industry. That opportunity continues to grow. Also, our surfaces business provides large-scale cylinders to the nonwoven industry like tissues, medical gowns and masks, which is an area we are seeing increased interest and expect long-term demand to grow. SGK, including cylinders, surfaces and engineering business, is expected to deliver normalized results for the fourth quarter and is positioned to deliver a strong recovery into next year. Also during the quarter we made good progress on our cost reduction efforts in all of our businesses, and we see significant opportunity to continue to improve the profitability of our entire business, with particular emphasis on our SGK Brand business. During the quarter, those efforts made a significant impact on the segment's results, which were masked by normalized incentive compensation in SGK when compared to prior year. Our Industrial Technologies business typifies the comment I made earlier that the reported results belie the underlying performance of the business. Within this segment, in our warehouse automation business, our inability to get into several client warehouses due to shutdown orders resulted in deferral of projects which were well under way. As a result, the business showed lower year-over-year revenue but currently is approaching record backlogs and has nothing but opportunity before it. Similarly, our product identification business reported lower sales versus prior year, but also saw the deferral of several large products due to the inability to travel. Much of these deferred revenues were expected to be realized in our fourth quarter and beyond. But again, the results in this business belie the underlying performance, as we made significant strides in the development of our new product despite reduced R&D spending. We have gained further confidence in our new products and the opportunities that it presents. Looking forward, our ability to forecast has improved, but we remain cautious as events can still arise, which impact – which can impact our results. Although to date, we have not had any experience of significant disruption in our businesses. Broad exposure to the virus can cause plant shutdowns at our facilities or those of our clients, which can impact our performance at any time. Having said that, our businesses have remained operational, and we remain confident that we have demonstrated an ability to manage during these uncertain times, which will ultimately be reflected in our stock price. Demand for our products and services remain solid, and our leading market positions in stable end-markets will ultimately allow us not only to survive, but to thrive in this environment. All in all, our colleagues and our company remain strong and healthy. During this next quarter, we expect continued focus on cost containment and cash generation, which should allow us to again perform well. Although we will not be providing guidance because of the uncertainties of the current environment, our expectations for the fourth quarter are that our results will be better than our third quarter. We have the orders to have a stronger quarter, but cannot be sure of our ability to deliver due to matters outside of our control. Nevertheless, we expect further significant liability reductions during the balance of the year. Now let's open it up for questions.

Thank you. [Operator Instructions] Our first question comes from Daniel Moore with CJS Securities. Please proceed with your question.

Joe, Steve, good morning.

Hi, Dan.

Good morning, Dan.

Start with Brand Solutions SGK, seemingly held up better than I think some people feared in general. But can you elaborate on some of the incremental pricing pressure you're seeing? Is that more U.S., Europe, both? Is it in the core kind of prepress and creative, just pockets of where you're seeing that? And how long we would expect that to linger?

So I mean, much of what you're seeing in pricing pressure are contracts that were negotiated over the last 12 months. It's not we don't price on a day-to-day basis. So much of what we're seeing has been contractually anticipated. But when you look at the overall business then, I mean, if I can break it down a little better for you, just assume it's this simply, that in that brand business there are multiple segments of businesses that we serve. When you look at anything retail related, whether it’d be point of sale, whether it’d be private label, we are challenged. And that's where – that's why when we say our core packaging business has performed better than most people have expected. But consistent with what we've always said, that in challenging times brands often spend more, we are seeing that because we do expect that, that private label and retail business will come back. And if our rest of our brand business remains intact as we expected it will, we should have a good recovery into next year. The other side of it, we've talked about earlier, and these are pieces of the puzzle that are hard to discern. When we look at tobacco, tobacco, all but fell off a cliff, and that has everything to do with their unwillingness to kind of do any marketing initiatives in this environment. It just didn't need to. That business was significantly down year-over-year. We expect that to come back, albeit at maybe slower rates and but the pricing pressure is not something that is day-to-day. It's contractually anticipated, and we adjust our cost for that. And that's what you're seeing in our bottom line.

Got it. That's helpful. I think I heard you say, Joe, that you expect more "normal results" in Q4 and a strong recovery next year. Is that should we think of that as closer to flat in terms of revenue and EBITDA for Q4 or still down modestly – get back to growth. Go ahead.

I would tell you, down modestly in the fourth quarter, Dan. I mean, we're not seeing a strong recovery in retail yet. So that portion of the business remains a little bit under pressure, but it will be – it should be better than this – the results should be better than this quarter. And right now, we would say they are. Going into next year, I would say that the recovery in retail will be critical to the top line of our business as we move forward. We have made some gains in that from a client and opportunity side because of our ability to deliver in these uncertain times. So until those come to fruition, we're not going to be able to give you a look in the next year.

Okay. Understood. If we look beyond COVID, I know this is a tougher question, but what do you – what's the long-term growth algorithm for these businesses from your perspective? And what are the drivers that might get us there?

When you're speaking specifically of SGK?

Correct. Yes.

Okay. So when you're looking at SGK, I mean this is – I mean, it's what you're seeing is a good example of when brands choose to go back into the investment of new packaging, new products and new SKUs. I mean, our growth algorithms would predict what we've always said, which is volumes should increase 1% to 2%, maybe 3% a year. Pricing has been a little bit of a challenge as they have kind of constrained their costs. But in these uncertain times, we've seen that we've been able to deliver and some of our competitors have not. We're hoping that will ultimately result in a better market share for us as we move forward. And so that could give us some additional bump as well. But we are dependent on our brand's willingness and abilities to invest in new products and new SKUs.

Helpful. Okay. Switching gears, Joe, warehouse automation, it sounds like backlog is building, when would we expect to see growth pick up? And how large do you think that opportunity can be over the next kind of two to three years?

Well, that business is working in an environment where everything you talk about is e-commerce. And with the client base that we have, which reads like a who's who of retail and consumer brands, we expect – we see that business operating in a segment that is a high single, low double-digit opportunity for us over time. It's not going to be on a quarter-to-quarter basis, it's subject to the wins and timing of being able to get the warehouses and not be you're not going to see it in the fourth quarter, but in our first quarter of next year, excuse me, because we're not able to get into people's warehouses during the Christmas season. But the demand for that product continues to grow, and we have the reputation in the marketplace as being a leader to be able to deliver that for them. So we're confident of that business.

Got it. Got it. And one more topic for me, and I'll jump out. Very nice, obviously, strides on debt paydown. Leverage seems to be the number one focus on investors' minds these days. Do you – it sounds like you expect leverage to tick lower into Q4 as you generate more cash, but on the flip side, EBITDA may be down a little bit year-over-year. So do we see that 4.0 ticking slightly higher, slightly lower this coming quarter? And maybe over the next two to three years, Steve, what kind of ratios do you think are achievable to get down to?

So right now, Dan, based on what we see in the fourth quarter and what we see in our typical strong quarter operating cash generation quarter, if I can say it that way, I would expect at least relatively stable on the leverage ratio itself and maybe tick down a little bit depending on how successful we are on some of our cash flow efforts. And again, that's as we continue to primarily focus on debt reduction. But I will say, and I'll just – I'll refer to what I said in my comments earlier, that because of the strides we've been able to make and given the recent stock price, you may see us back in the market this quarter as well. So that obviously has an impact on where our cash flow is going for the quarter. And then, as we go forward, and, hopefully, as the whole country and world normalizes, we start to see growth on that on the EBITDA part of that equation. And that certainly helps the leverage ratio decline.

Got it. And just a follow-up, would you like to keep leverage at a minimum somewhere in level? Just getting a sense for how aggressive you could be on buybacks.

I would tell you that will be prudent on our capital allocation. If the price of our stock gets unreasonably low as it has been, we'll become more aggressive. We're comfortable with our ability to pay down our debt. And we've demonstrated that in this quarter. So I expect that if it gets silly out there, we'll be there. But otherwise, we'll be focused on what we've committed at the beginning of the year, which is paying down debt. Our long-term target still remains to get under three.

Okay. I'll jump back in queue. Then you follow-ups. Thank you.

At this time, I will turn it back over to management, there are no questions in queue, for closing comments.

Okay. Thank you, Latonya. And again, thank you for joining us today, and thank you for your interest in Matthews. For additional information about the company and our financial results, please visit our website. Thank you, and enjoy the rest of your day.

Ladies and gentlemen, thank you for your participation. You may disconnect your lines at this time. And have a great day.