MATTHEWS INTERNATIONAL CORP 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued (1) Includes certain non-recurring items associated with recent acquisition activities, costs associated with global ERP system integration efforts, certain non-recurring costs associated with productivity and cost-reduction initiatives intended to result in improved operating performance, profitability and working capital levels, and exchange losses associated with highly inflationary accounting (see Note 2, "Basis of Presentation" in Item 1 - "Financial Statements"). (2) Includes certain non-recurring direct incremental costs (such as costs for purchases of computer peripherals and devices to facilitate working-from-home, additional personal protective equipment and cleaning supplies and services, etc.) incurred in response to COVID-19. This amount does not include the impact of any lost sales or underutilization due to COVID-19. (3) Represents items associated with the termination of the Company's DB Plan, supplemental retirement plan and the defined benefit portion of the officers retirement restoration plan. (4) Represents asset write-downs, net of recoveries within the SGK Brand Solutions segment (see Note 15, "Asset Write-Downs" in Item 1 - "Financial Statements"). (5) Non-service pension and postretirement expense includes interest cost, expected return on plan assets, amortization of actuarial gains and losses, curtailment gains and losses, and settlement gains and losses. These benefit cost components are excluded from adjusted EBITDA since they are primarily influenced by external market conditions that impact investment returns and interest (discount) rates. Curtailment gains and losses and settlement gains and losses are excluded from adjusted EBITDA since they generally result from certain non-recurring events, such as plan amendments to modify future benefits or settlements of plan obligations. The service cost and prior service cost components of pension and postretirement expense are included in the calculation of adjusted EBITDA, since they are considered to be a better reflection of the ongoing service-related costs of providing these benefits. Please note that GAAP pension and postretirement expense or the adjustment above are not necessarily indicative of the current or future cash flow requirements related to these employee benefit plans. * Depreciation and amortization was $5.8 million and $5.8 million for the Memorialization segment, $2.5 million and $2.8 million for the Industrial Technologies segment, $13.3 million and $25.4 million for the SGK Brand Solutions segment, and $1.3 million and $1.3 million for Corporate and Non-Operating, for the three months ended June 30, 2022 and 2021, respectively. Depreciation and amortization was $17.4 million and $17.0 million for the Memorialization segment, $7.6 million and $8.4 million for the Industrial Technologies segment, $51.1 million and $68.5 million for the SGK Brand Solutions segment, and $4.0 million and $4.0 million for Corporate and Non-Operating, for the nine months ended June 30, 2022 and 2021, respectively. ** Acquisition costs, ERP integration costs, and strategic initiatives and other charges were $902,000 and $484,000 for the Memorialization segment, $1.2 million and $881,000 for the Industrial Technologies segment, $2.0 million and $2.9 million for the SGK Brand Solutions segment, and $3.2 million and $2.9 million for Corporate and Non-Operating, for the three months ended June 30, 2022 and 2021, respectively. Acquisition costs, ERP integration costs, and strategic initiatives and other charges were $2.1 million and $1.3 million for the Memorialization segment, $1.4 million and $3.7 million for the Industrial Technologies segment, $7.7 million and $10.5 million for the SGK Brand Solutions segment, and $6.7 million and $8.1 million for Corporate and Non-Operating, for the nine months ended June 30, 2022 and 2021, respectively. *** Non-recurring/incremental COVID-19 costs were $225,000 and $1.3 million for the Memorialization segment, $1,000 and $6,000 for the Industrial Technologies segment, $74,000 and $638,000 for the SGK Brand Solutions segment, and $1,000 and $16,000 for Corporate and Non-Operating, for the three months ended June 30, 2022 and 2021, respectively. Non-recurring/incremental COVID-19 costs were $1.3 million and $3.2 million for the Memorialization segment, $6,000 and $36,000 for the Industrial Technologies segment, $464,000 and $1.3 million for the SGK Brand Solutions segment, and $466,000 and $86,000 for Corporate and Non-Operating, for the nine months ended June 30, 2022 and 2021, respectively. LIQUIDITY AND CAPITAL RESOURCES: Net cash provided by operating activities was $84.4 million for the first nine months of fiscal 2022, compared to $106.9 million for the first nine months of fiscal 2021. Operating cash flow for both periods principally included net (loss) income adjusted for deferred taxes, depreciation and amortization, stock-based compensation expense, net losses (gains) related to investments, non-cash pension expense, asset write-downs, other non-cash adjustments, and changes in working capital items. Fiscal 2022 operating cash flow also reflected $35.7 million of DB Plan contributions to fully fund the settlement of the DB Plan obligations. Net changes in working capital items decreased operating cash flow by $8.4 million and $7.5 million in fiscal 2022 and fiscal 2021, respectively. The fiscal 2022 change in working capital principally reflected proceeds from the sale of receivables under a receivables purchase agreement (see below for further discussion), offset by increased fiscal year-end compensation-related payments, higher inventory levels reflecting increased commodity costs, and changes in other accounts. Cash used in investing activities was $38.9 million for the nine months ended June 30, 2022, compared to $22.9 million for the nine months ended June 30, 2021. Investing activities for the first nine months of fiscal 2022 primarily reflected capital expenditures of $40.6 million, proceeds from the sale of investments of $3.1 million, and purchases of investments of $2.2 million. Investing activities for the first nine months of fiscal 2021 reflected capital expenditures of $24.5 million, acquisitions payments (net of cash acquired and holdback amounts) totaling $15.6 million, proceeds from the sale of investments of $15.0 million, and proceeds from the sale of assets of $2.2 million. Capital expenditures reflected reinvestment in the Company's business segments and were made primarily for the purchase of new production machinery, equipment, software and systems, and facilities designed to improve product quality, increase manufacturing efficiency, lower production costs and meet regulatory requirements. Capital expenditures for the last three fiscal years were primarily financed through operating cash. Capital spending for property, plant and equipment has averaged $35.6 million for the last three fiscal years. Capital spending for fiscal 2022 is currently estimated to be approximately $60 million. The Company expects to generate sufficient cash from operations to fund all anticipated capital spending projects. Cash used in financing activities for the nine months ended June 30, 2022 was $43.8 million, primarily reflecting proceeds, net of repayments, on long-term debt of $13.8 million, treasury stock purchases of $34.0 million, dividends of $20.8 million to the Company's shareholders, and $613,000 of holdback and deferred payments related to acquisitions from prior years. Cash used 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued in financing activities for the nine months ended June 30, 2021 was $79.8 million, primarily reflecting repayments, net of proceeds, on long-term debt of $49.0 million, treasury stock purchases of $6.1 million, dividends of $20.9 million to the Company's shareholders, and $1.6 million of holdback and deferred payments related to acquisitions from prior years. The Company has a domestic credit facility with a syndicate of financial institutions that includes a $750.0 million senior secured revolving credit facility, which matures in March 2025. A portion of the revolving credit facility (not to exceed $350.0 million) can be drawn in foreign currencies. Borrowings under the revolving credit facility bear interest at LIBOR plus a factor ranging from 0.75% to 2.00% (1.00% at June 30, 2022) based on the Company's secured leverage ratio. The secured leverage ratio is defined as net secured indebtedness divided by EBITDA (earnings before interest, income taxes, depreciation and amortization) as defined within the domestic credit facility agreement. The Company is required to pay an annual commitment fee ranging from 0.15% to 0.30% (based on the Company's leverage ratio) of the unused portion of the revolving credit facility. The Company incurred debt issuance costs in connection with the domestic credit facility. Unamortized costs were $1.7 million and $2.2 million at June 30, 2022 and September 30, 2021, respectively. The domestic credit facility requires the Company to maintain certain leverage and interest coverage ratios. A portion of the facility (not to exceed $35.0 million) is available for the issuance of trade and standby letters of credit. Outstanding U.S. dollar denominated borrowings on the revolving credit facility at June 30, 2022 and September 30, 2021 were $436.3 million and $349.8 million, respectively. The weighted-average interest rate on outstanding borrowings for the domestic credit facility (including the effects of interest rate swaps and Euro denominated borrowings) at June 30, 2022 and 2021 was 1.92% and 1.94%, respectively. The Company has $300.0 million of 5.25% senior unsecured notes due December 1, 2025 (the "2025 Senior Notes"). The 2025 Senior Notes bear interest at a rate of 5.25% per annum with interest payable semi-annually in arrears on June 1 and December 1 of each year. The Company's obligations under the 2025 Senior Notes are guaranteed by certain of the Company's direct and indirect wholly-owned subsidiaries. The Company is subject to certain covenants and other restrictions in connection with the 2025 Senior Notes. The Company incurred direct financing fees and costs in connection with the 2025 Senior Notes. Unamortized costs were $1.8 million and $2.2 million at June 30, 2022 and September 30, 2021, respectively. The Company and certain of its domestic subsidiaries sell, on a continuous basis without recourse, their trade receivables to Matthews Receivables Funding Corporation, LLC (“Matthews RFC”), a wholly-owned bankruptcy-remote subsidiary of the Company. In March 2022, Matthews RFC entered into a receivables purchase agreement (“RPA”) to sell up to $125.0 million of receivables to certain purchasers (the “Purchasers”) on a recurring basis in exchange for cash (referred to as “capital” within the RPA) equal to the gross receivables transferred. The parties intend that the transfers of receivables to the Purchasers constitute purchases and sales of receivables. Matthews RFC has guaranteed to each Purchaser the prompt payment of sold receivables, and has granted a security interest in its assets for the benefit of the Purchasers. Under the RPA, which matures in March 2024, each Purchaser’s share of capital accrues yield at a floating rate plus an applicable margin. The Company is the master servicer under the RPA, and is responsible for administering and collecting receivables. The proceeds of the RPA are classified as operating activities in the Company’s Consolidated Statements of Cash Flows. Cash received from collections of sold receivables may be used to fund additional purchases of receivables on a revolving basis, or to reduce all or any portion of the outstanding capital of the Purchasers. Gross receivables sold and cash collections reinvested under the RPA program were $247.2 million and $147.2 million for the nine months ended June 30, 2022, respectively. The fair value of the sold receivables approximated book value due to their credit quality and short-term nature, and as a result, no gain or loss on sale of receivables was recorded. As of June 30, 2022, the amount sold to the Purchasers was $100.0 million, which was derecognized from the Consolidated Balance Sheets. As collateral against sold receivables, Matthews RFC maintains a certain level of unsold receivables, which was $39.7 million as of June 30, 2022. Previously, the Company had a $115.0 million accounts receivable securitization facility (the "Securitization Facility") with certain financial institutions that matured in March 2022. The Securitization Facility did not qualify for sale treatment. Accordingly, the trade receivables and related debt obligations remained on the Company's Consolidated Balance Sheet. Borrowings under the Securitization Facility were based on LIBOR plus 0.75% and the Company was required to pay an annual commitment fee ranging from 0.25% to 0.35% of the unused portion of the Securitization Facility. Outstanding borrowings under the Securitization Facility at September 30, 2021 totaled $96.0 million. At June 30, 2021, the interest rate on borrowings under this facility was 0.85%. 30 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The following table presents information related to interest rate contracts entered into by the Company and designated as cash flow hedges (dollar amounts in thousands): June 30, 2022 September 30, 2021 Pay fixed swaps - notional amount $ 125,000 $ 250,000 Net unrealized gain (loss) $ 7,407 $ (2,062) Weighted-average maturity period (years) 3.1 2.2 Weighted-average received rate 1.79 % 0.08 % Weighted-average pay rate 1.04 % 1.34 % The Company enters into interest rate swaps in order to achieve a mix of fixed and variable rate debt that it deems appropriate. The interest rate swaps have been designated as cash flow hedges of future variable interest payments, which are considered probable of occurring. Based on the Company's assessment, all of the critical terms of each of the hedges matched the underlying terms of the hedged debt and related forecasted interest payments, and as such, these hedges were considered highly effective. The fair value of the interest rate swaps reflected an unrealized gain net of unrealized losses of $7.4 million ($5.6 million after tax) at June 30, 2022 and an unrealized loss net of unrealized gains of $2.1 million ($1.6 million after tax) at September 30, 2021, that is included in shareholders' equity as part of accumulated other comprehensive income (loss) ("AOCI"). Assuming market rates remain constant with the rates at June 30, 2022, a gain (net of tax) of approximately $1.6 million included in AOCI is expected to be recognized in earnings over the next twelve months. The Company, through certain of its European subsidiaries, has a credit facility with a European bank, which is guaranteed by Matthews. The maximum amount of borrowing available under this facility is €25.0 million ($26.1 million), which includes €8.0 million ($8.4 million) for bank guarantees. In the first quarter of fiscal 2022, the Company extended this facility to a current maturity of December 2022 and the Company intends to continue to extend this facility. Outstanding borrowings under the credit facility totaled €10.5 million ($11.0 million) and €704,000 ($817,000) at June 30, 2022 and September 30, 2021, respectively. The weighted-average interest rate on outstanding borrowings under this facility was 2.25% at June 30, 2022 and June 30, 2021. Other borrowings totaled $24.4 million and $10.2 million at June 30, 2022 and September 30, 2021, respectively. Other borrowings at June 30, 2022 included $3.4 million of collateralized borrowings in connection with the RPA arrangement discussed above. The weighted-average interest rate on these borrowings was 1.90% and 2.19% at June 30, 2022 and 2021, respectively. The Company has a U.S. Dollar/Euro cross currency swap with a notional amount of $94.5 million as of June 30, 2022, which has been designated as a net investment hedge of foreign operations. The swap contract matures in September 2028. The Company assesses hedge effectiveness for this contract based on changes in fair value attributable to changes in spot prices. A gain of $8.7 million (net of income taxes of $2.8 million) and a gain of $29,000 (net of income taxes of $10,000), which represented effective hedges of net investments, were reported as a component of AOCI within currency translation adjustment at June 30, 2022 and September 30, 2021, respectively. Income of $428,000 and $1.2 million, which represented the recognized portion of the fair value excluded from the assessment of hedge effectiveness, was included in current period earnings as a component of interest expense for the three and nine months ended June 30, 2022, respectively. At June 30, 2022 and September 30, 2021, the swap, which is included in other assets in the Consolidated Balance Sheets, totaled $11.5 million and $39,000, respectively. The Company enters into certain derivative contracts in accordance with its risk management strategy that do not meet the criteria for hedge accounting but which have the economic impact of largely mitigating foreign currency exposure. Changes in the fair value of these economic hedges are recorded in current period earnings as a component of other income (deductions), net. During the third quarter of fiscal 2022, the Company entered into a three-year U.S. Dollar/Euro cross currency swap with a notional amount of $52.8 million, which did not meet the criteria for hedge accounting. An unrealized gain of $495,000 related to this swap was included in other assets in the Consolidated Balance Sheet at June 30, 2022. 31 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The Company has a stock repurchase program. The buy-back program is designed to increase shareholder value, enlarge the Company's holdings of its common stock, and add to earnings per share. Repurchased shares may be retained in treasury, utilized for acquisitions, or reissued to employees or other purchasers, subject to the restrictions set forth in the Company's Restated Articles of Incorporation. Under the current authorization, 1,602,166 shares remain available for repurchase as of June 30, 2022. Consolidated working capital of the Company was $288.8 million at June 30, 2022, compared to $269.9 million at September 30, 2021. Cash and cash equivalents were $45.8 million at June 30, 2022, compared to $49.2 million at September 30, 2021. The Company's current ratio was 1.9 at June 30, 2022 and 1.8 at September 30, 2021. Long-Term Contractual Obligations: The following table summarizes the Company's contractual obligations at June 30, 2022, and the effect such obligations are expected to have on its liquidity and cash flows in future periods. Payments due in fiscal year: Total 2022 (1) Remainder 2023 to 2024 2025 to 2026 After 2026 Contractual Cash Obligations: (Dollar amounts in thousands) Revolving credit facilities $ 447,223 $ 10,969 $ — $ 436,254 $ — 2025 Senior Notes 353,326 — 31,500 321,826 — Finance lease obligations (2) 6,774 805 3,342 1,031 1,596 Non-cancelable operating leases (2) 79,927 6,637 42,371 24,192 6,727 Acquisition (3) 44,940 44,940 — — — Other 52,972 1,637 40,005 2,088 9,242 Total contractual cash obligations $ 985,162 $ 64,988 $ 117,218 $ 785,391 $ 17,565 (1) The Company maintains certain debt facilities with maturity dates of twelve months or less that it intends and has the ability to extend beyond twelve months totaling $11.0 million. These balances have been classified as non-current on the Company's Consolidated Balance Sheet. (2) Lease obligations have not been discounted to their present value. (3) During the third quarter of fiscal 2022, the Company signed an agreement to acquire German based engineering firms, OLBRICH GmbH (“OLBRICH”) and R+S Automotive GmbH (“R+S Automotive”), for €43 million. The closing of the transaction is expected in the fourth quarter of fiscal 2022. Benefit payments under the Company's DB Plan were made from plan assets, while benefit payments under the supplemental retirement plan ("SERP") and postretirement benefit plan are made from the Company's operating funds. In the first quarter of fiscal 2022, the Company terminated its DB Plan and made plan contributions totaling $35.7 million to fully fund the planned settlement of the DB Plan obligations. Also during the first quarter of fiscal 2022, lump sum distributions of $186.0 million were made from the DB Plan to plan participants, and non-participating annuity contracts totaling $56.3 million were purchased by the DB Plan for plan participants, resulting in the full settlement of the DB Plan obligations. The settlement of the DB Plan obligations resulted in the recognition of a non-cash charge of $30.9 million, which has been presented as a component of other income (deductions), net for the nine months ended June 30, 2022. This amount represents the immediate recognition of the remaining portion of the deferred AOCI balances related to the DB Plan. During the nine months ended June 30, 2022 contributions of $575,000 and $472,000 were made under the SERP and postretirement benefit plan, respectively. The Company currently anticipates contributing an additional $185,000 and $412,000 under the SERP and postretirement benefit plan, respectively, for the remainder of fiscal 2022. The Company also expects to make payments totaling approximately $24.2 million in fiscal 2023 to fully settle the SERP and defined benefit portion of the officers retirement restoration plan obligations. The obligations of the SERP are expected to be funded from an existing rabbi trust. The Company believes that its current liquidity sources, combined with its operating cash flow and borrowing capacity, will be sufficient to meet its capital needs for the foreseeable future. 32 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Unrecognized tax benefits are positions taken, or expected to be taken, on an income tax return that may result in additional payments to tax authorities. If a tax authority agrees with the tax position taken, or expected to be taken, or the applicable statute of limitations expires, then additional payments will not be necessary. As of June 30, 2022, the Company had unrecognized tax benefits, excluding penalties and interest, of approximately $3.0 million. The timing of potential future payments related to the unrecognized tax benefits is not presently determinable. The Company believes that its current liquidity sources, combined with its operating cash flow and borrowing capacity, will be sufficient to meet its capital needs for the foreseeable future. REGULATORY MATTERS: The Company’s operations are subject to various federal, state and local laws and regulations requiring strict compliance, including, but not limited to, the protection of the environment. The Company has established numerous internal compliance programs to further ensure lawful satisfaction of the applicable regulations. In addition, the Company is party to specific environmental matters which include obligations to investigate and mitigate the effects on the environment of certain materials at operating and non-operating sites. The Company is currently performing environmental assessments and remediation at certain sites, as applicable. FORWARD-LOOKING INFORMATION: The Company's current strategy to attain annual operating growth primarily consists of the following: internal growth - which includes organic growth, cost structure and productivity improvements, new product development and the expansion into new markets with existing products - and investments (including acquisitions and related integration activities) to achieve strategic and synergy benefits. The significant factors (excluding acquisitions) influencing sales growth in the Industrial Technologies segment include economic/industrial market conditions, new product development, and the e-commerce trend. Order rates for the Company's Industrial Technologies businesses remained strong through the fiscal 2022 third quarter and, as a result, are currently expected to support the segment’s organic growth objectives for the balance of fiscal 2022 and into next year. For the Memorialization segment, sales growth will be influenced by North America death rates, and the impact of the increasing trend toward cremation on the segment's product offerings, including caskets, cemetery memorial products and cremation-related products. For the SGK Brand Solutions segment, sales growth will be influenced by global economic conditions, brand innovation, the level of marketing spending by the Company's clients, and government regulation. Due to the global footprint of this segment, currency fluctuations can also be a significant factor. Additionally, the retail-based businesses in the SGK Brand Solutions segment continue to recover from the unfavorable sales impacts of the pandemic (see below). During fiscal 2019, the Company initiated a strategic evaluation to improve profitability and reduce the Company's cost structure. These actions leveraged the benefit of the Company's new global ERP platform, primarily targeted at the SGK Brand Solutions segment, both operational and commercial structure, and the Company's shared financial services and other administrative functions. This evaluation identified opportunities for significant cost structure improvements, which the Company expects to achieve throughout the remainder of fiscal 2022. The Company's strategic review has also resulted in improvements to the commercial structure within the SGK Brand Solutions segment. On January 30, 2020, the World Health Organization declared an outbreak of COVID-19 to be a Public Health Emergency of International Concern, and subsequently recognized COVID-19 as a global pandemic in March 2020. The Company has experienced some commercial impact and business disruptions in certain segments and geographic locations as a result of COVID-19. Recent impacts have included higher sales volumes for memorialization products and services. Additionally, recent increases in the cost of certain raw materials, labor, and other inflationary impacts are expected to impact the Company's results for the near future. The Company expects to partially mitigate these cost increases through price realization and the cost-reduction initiatives discussed above. 33 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued CRITICAL ACCOUNTING POLICIES: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Therefore, the determination of estimates requires the exercise of judgment based on various assumptions and other factors such as historical experience, economic conditions, and in some cases, actuarial techniques. Actual results may differ from those estimates. A discussion of market risks affecting the Company can be found in Item 7A - "Quantitative and Qualitative Disclosures about Market Risk" in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2021. A summary of the Company's significant accounting policies are included in the Notes to Consolidated Financial Statements and in the critical accounting policies in Management's Discussion and Analysis included in the Company's Annual Report on Form 10-K for the year ended September 30, 2021. Management believes that the application of these policies on a consistent basis enables the Company to provide useful and reliable financial information about the Company's operating results and financial condition. The Company performed its annual impairment review of goodwill and indefinite-lived intangible assets in the second quarter of fiscal 2022 (January 1, 2022) and determined that the estimated fair values for all goodwill reporting units exceeded their carrying values, therefore no impairment charges were necessary. The estimated fair value of the Company's SGK Brand Solutions reporting unit (formerly the Graphics Imaging reporting unit) exceeded the carrying value (expressed as a percentage of carrying value) by approximately 10%. The SGK Brand Solutions reporting unit has experienced recent declines, primarily resulting from weakened economic conditions (particularly in Europe) and unfavorable changes in foreign exchange rates. Additionally, recent increases in the cost of certain materials, labor, and other inflationary pressures have had an unfavorable impact on the reporting unit's results of operations. If current projections are not achieved or specific valuation factors outside the Company’s control (such as discount rates and continued economic and industry challenges) significantly change, goodwill write-downs may be necessary in future periods.