UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

Form 10-Q


x
Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934


For The Quarterly Period Ended June 30, 2005

Commission File No. 0-9115


MATTHEWS INTERNATIONAL CORPORATION
(Exact Name of registrant as specified in its charter)


PENNSYLVANIA
  
25-0644320
(State or other jurisdiction of
  
(I.R.S. Employer
Incorporation or organization)
  
Identification No.)


TWO NORTHSHORE CENTER, PITTSBURGH, PA
  
15212-5851
(Address of principal executive offices)
  
(Zip Code)
     
     
Registrant's telephone number, including area code
  
(412) 442-8200



NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 
Yes x
No o
  

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 
Yes x
No o
  

As of July 31, 2005, shares of common stock outstanding were:

Class A Common Stock 32,017,174 shares


PART I - FINANCIAL INFORMATION
MATTHEWS INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands, except per share data)

   
June 30, 2005
  
September 30, 2004
  
 
(unaudited)
            
ASSETS
                          
Current assets:
                          
Cash and cash equivalents
       
$
40,263
        
$
65,830
  
Short-term investments
         
7,683
         
858
 
Accounts receivable, net
         
88,509
         
87,490
 
Inventories: Materials and finished goods
 
$
43,480
        
$
38,395
        
Labor and overhead in process
   
6,491
         
4,141
       
           
49,971
         
42,536
 
Other current assets
         
5,982
         
5,764
 
                           
Total current assets
         
192,408
         
202,478
 
Investments
         
10,856
         
7,694
 
Property, plant and equipment: Cost
   
175,696
         
157,936
       
Less accumulated depreciation
   
(94,863
)
        
(85,222
)
      
           
80,833
         
72,714
 
Deferred income taxes and other assets
         
22,229
         
26,360
 
Goodwill
         
201,921
         
189,016
 
Other intangible assets, net
         
30,888
         
32,280
 
                           
Total assets
       
$
539,135
        
$
530,542
  
                           
LIABILITIES AND SHAREHOLDERS' EQUITY
                          
Current liabilities:
                          
Long-term debt, current maturities
       
$
14,886
        
$
17,003
  
Accounts payable
         
24,195
         
26,130
 
Accrued compensation
         
30,036
         
31,274
 
Accrued income taxes
         
13,415
         
13,018
 
Other current liabilities
         
26,523
         
24,147
 
                           
Total current liabilities
         
109,055
         
111,572
 
                           
Long-term debt
         
49,840
         
54,389
 
Estimated finishing costs
         
4,800
         
4,730
 
Postretirement benefits
         
17,356
         
17,407
 
Deferred income taxes
         
3,938
         
4,225
 
Environmental reserve
         
9,688
         
10,604
 
Other liabilities and deferred revenue
         
15,058
         
15,365
 
                           
Shareholders' equity:
                          
Common stock
   
36,334
         
36,334
       
Additional paid in capital
   
13,936
         
11,699
       
Retained earnings
   
348,254
         
308,435
       
Accumulated other comprehensive income
   
8,685
         
11,538
       
Treasury stock, at cost
   
(77,809
)
        
(55,756
)
      
 
          
329,400
         
312,250
 
                           
Total liabilities and shareholders' equity
       
$
539,135
        
$
530,542
  

2

MATTHEWS INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollar amounts in thousands, except per share data)


   
Three Months Ended
  
Nine Months Ended
  
   
June 30,
  
June 30,
  
     
2005
    
2004
        
2005
    
2004
  
                               
                               
                               
Sales
  
$
158,983
  
$
120,635
      
$
463,932
  
$
362,524
  
Cost of sales
    
(101,863
)
  
(72,181
)
      
(304,007
)
  
(223,815
)
                               
Gross profit
    
57,120
   
48,454
       
159,925
   
138,709
 
                               
Selling and administrative expenses
    
(29,643
)
  
(23,242
)
      
(85,944
)
  
(69,478
)
                               
Operating profit
    
27,477
   
25,212
       
73,981
   
69,231
 
                               
Investment income
    
366
   
435
       
1,005
   
1,097
 
Interest expense
    
(519
)
  
(613
)
      
(1,540
)
  
(1,493
)
Other income (deductions), net
    
(39
)
  
(118
)
      
1,552
   
(203
)
Minority interest
    
(1,230
)
  
(1,418
)
      
(3,802
)
  
(3,984
)
                               
Income before income taxes
    
26,055
   
23,498
       
71,196
   
64,648
 
                               
Income taxes
    
(9,901
)
  
(9,118
)
      
(27,054
)
  
(25,084
)
                               
Net income
  
$
16,154
  
$
14,380
      
$
44,142
  
$
39,564
  
                               
Earnings per share:
                              
Basic
  
$
.50
  
$
.45
      
$
1.37
  
$
1.23
  
                               
Diluted
  
$
.50
  
$
.44
      
$
1.36
  
$
1.21
  


3

MATTHEWS INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollar amounts in thousands, except per share data)


   
Nine Months Ended
  
   
June 30,
  
   
2005
  
2004
  
               
               
Cash flows from operating activities:
              
Net income
 
$
44,142
  
$
39,564
  
Adjustments to reconcile net income to net cash
provided by operating activities:
              
Depreciation and amortization
   
14,724
   
11,138
 
Minority interest
   
3,802
   
3,984
 
Change in deferred taxes
   
(287
)
  
165
 
Changes in working capital items
   
(8,397
)
  
7,526
 
Decrease in other assets
   
4,112
   
5,138
 
Increase (decrease) in estimated finishing costs
   
69
   
(65
)
Decrease in other liabilities
   
(509
)
  
(1,473
)
Decrease in postretirement benefits
   
(51
)
  
(212
)
Tax benefit of exercised stock options
   
2,765
   
2,805
 
Net gain on sale of assets
   
(188
)
  
(133
)
               
Net cash provided by operating activities
   
60,182
   
68,437
 
               
Cash flows from investing activities:
              
Capital expenditures
   
(21,636
)
  
(6,826
)
Proceeds from sale of assets
   
867
   
850
 
Acquisitions
   
(14,210
)
  
-
 
Purchases of investments
   
(11,554
)
  
(15,193
)
Proceeds from disposition of investments
   
1,519
   
17
 
               
Net cash used in investing activities
   
(45,014
)
  
(21,152
)
               
Cash flows from financing activities:
              
Proceeds from long-term debt
   
12,518
   
52,066
 
Payments on long-term debt
   
(18,520
)
  
(45,907
)
Proceeds from the sale of treasury stock
   
5,351
   
7,271
 
Purchases of treasury stock
   
(27,932
)
  
(12,570
)
Dividends
   
(4,323
)
  
(3,859
)
Dividends to minority interests
    
(4,394
)
  
(2,341
)
               
Net cash used in financing activities
   
(37,300
)
  
(5,340
)
               
Effect of exchange rate changes on cash
   
(3,435
)
  
582
 
               
Net increase (decrease) in cash and cash equivalents
 
$
(25,567
)
$
42,527
  



MATTHEWS INTERNATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Dollar amounts in thousands, except per share data)


Note 1. Nature of Operations

Matthews International Corporation ("Matthews"), founded in 1850 and incorporated in Pennsylvania in 1902, is a designer, manufacturer and marketer principally of memorialization products and brand solutions. Memorialization products consist primarily of bronze memorials and memorialization products, caskets and cremation equipment for the cemetery and funeral home industries. Brand solutions include graphics imaging products and services, merchandising solutions, and marking products. The Company's products and operations are comprised of six business segments: Bronze, Casket, Cremation, Graphics Imaging, Marking Products and, as of July 19, 2004, Merchandising Solutions. The Bronze segment is a leading manufacturer of cast bronze memorials and other memorialization products, cast and etched architectural products and is a leading builder of mausoleums in the United States. The Casket segment is a leading casket manufacturer in the United States and produces a wide variety of wood and metal caskets. The Cremation segment is a leading designer and manufacturer of cremation equipment and cremation caskets primarily in North America. The Graphics Imaging segment manufactures and provides printing plates, pre-press services and imaging services for the corrugated and primary packaging industries. The Marking Products segment designs, manufactures and distributes a wide range of marking equipment and consumables for identifying various consumer and industrial products, components and packaging containers. The Merchandising Solutions segment designs and manufactures merchandising displays and systems and provides creative merchandising and marketing solutions services.

The Company has manufacturing and marketing facilities in the North America, Australia, and Europe.


Note 2. Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information for commercial and industrial companies and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three months and nine months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2005. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended September 30, 2004.

The consolidated financial statements include all majority-owned foreign and domestic subsidiaries. The consolidated financial statements also include the accounts of the Company's 50%-owned affiliate, S+T GmbH & Co. KG. All intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with generally accepted accounting principles 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. Actual results could differ from those estimates.

Reclassifications:
Certain reclassifications have been made in the Consolidated Statements of Cash Flows to conform to the current period presentation.


4

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)


Note 3. Stock-Based Compensation

The Company has accounted for its stock-based compensation plans in accordance with the intrinsic value provisions of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”). Accordingly, the Company did not record any compensation expense in the consolidated financial statements for its stock-based compensation plans. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”, the following table illustrates the effect on net income and earnings per share had compensation expense been recognized consistent with the fair value provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”).

   
Three Months Ended
  
Nine Months Ended
  
   
June 30,
  
June 30,
  
   
2005
  
2004
      
2005
  
2004
  
                               
Net income, as reported
  
$
16,154
  
$
14,380
      
$
44,142
  
$
39,564
  
Net income, pro forma
   
15,613
    
13,939
        
42,668
    
38,359
  
Basic earnings per share, as reported
 
$
0.50
  
$
0.45
      
$
1.37
  
$
1.23
  
Diluted earnings per share, as reported
    
0.50
    
0.44
        
1.36
    
1.21
  
Basic earnings per share, pro forma
  
$
0.49
  
$
0.43
      
$
1.33
  
$
1.19
  
Diluted earnings per share, pro forma
    
0.49
    
0.43
        
1.32
    
1.18
  

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123 and supercedes APB Opinion No. 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro-forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. In April 2005, the Securities and Exchange Commission (“SEC”) delayed the effective date of SFAS 123R for public companies to annual, rather than interim, periods that begin after June 15, 2005. Accordingly, the Company is not required, and does not expect to adopt SFAS 123R until October 1, 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption alternatives.

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company is evaluating the requirements of SFAS 123R and SAB 107 and has not yet determined the method of adoption. The Company expects the effect of adopting SFAS 123R and SAB 107 will result in amounts that do not differ materially from the current pro forma disclosures under SFAS 123. In addition, the Company currently discloses the fair value of grants of employee stock options over the normal vesting period for all participants. Beginning in fiscal 2006, expense will be recognized immediately for participants eligible for normal retirement. The financial impact on the expense disclosed for participants eligible for retirement on the date of grant on the periods presented is not expected to be material.


5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)


Note 4. Income Taxes

Income tax provisions for the Company’s interim periods are based on the effective income tax rate expected to be applicable for the full year. The difference between the estimated effective tax rate for fiscal 2005 of 38.0% and the Federal statutory rate of 35.0% primarily reflects the impact of state and foreign income taxes.

In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”). FSP 109-2 provides guidance under SFAS No. 109, “Accounting for Income Taxes,” for recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”), on a company’s income tax expense and deferred tax liabilities. FSP 109-2 states that a company is allowed time beyond the financial reporting period of enactment, which was October 22, 2004, to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB Statement No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions as provided for in FSP 109-2.


Note 5. Earnings Per Share

   
Three Months Ended
  
Nine Months Ended
  
   
June 30,
  
June 30,
  
   
2005
  
2004
      
2005
  
2004
  
                               
Net income
 
$
16,154
    
14,380
      
$
44,142
  
$
39,564
  
                               
Weighted-average common shares outstanding
   
31,958,308
    
32,252,258
        
32,144,329
    
32,172,931
  
                               
Dilutive securities, primarily stock options
   
377,746
    
466,418
        
398,313
    
486,574
  
                               
Diluted weighted-average
common shares outstanding
    
32,336,054
    
32,718,676
        
32,542,642
    
32,659,505
  
                               
Basic earnings per share
  
$
.50
  
$
.45
      
$
1.37
  
$
1.23
  
                               
Diluted earnings per share
  
$
.50
  
$
.44
      
$
1.36
  
$
1.21
  


Note 6. Segment Information

The Company is organized into six business segments based on products and services. The segments, which are Bronze, Casket, Cremation, Graphics Imaging, Marking Products and, as of July 19, 2004, Merchandising Solutions, are described under Nature of Operations (Note 1). Management evaluates segment performance based on operating profit (before income taxes) and does not allocate non-operating items such as investment income, interest expense, other income (deductions), net and minority interest.

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)

Information about the Company's segments follows:

   
Three Months Ended
  
Nine Months Ended
  
   
June 30,
  
June 30,
  
 
  
2005
  
2004
      
2005
  
2004
  
Sales to external customers:
                              
Memorialization:
                              
Bronze
  
$
55,574
  
$
51,666
      
$
150,137
  
$
144,271
  
Casket
   
29,910
    
27,013
        
92,785
    
91,155
  
Cremation
    
5,283
    
5,163
        
15,982
    
16,552
  
                               
     
90,767
    
83,842
        
258,904
    
251,978
  
Brand Solutions:
                              
Graphics Imaging
    
36,175
    
27,495
        
106,578
    
82,420
  
Marking Products
   
11,864
    
9,298
        
32,747
    
28,126
  
Merchandising Solutions
   
20,177
    
-
        
65,703
    
-
  
                               
     
68,216
    
36,793
        
205,028
    
110,546
  
                               
   
$
158,983
  
$
120,635
      
$
463,932
  
$
362,524
  
Operating profit:
                              
Memorialization:
                              
Bronze
 
$
16,937
  
$
14,948
      
$
42,277
  
$
35,338
  
Casket
    
3,521
    
3,763
        
12,371
    
13,390
  
Cremation
    
165
    
(128
)
      
264
    
829
  
                               
     
20,623
    
18,583
        
54,912
    
49,557
  
Brand Solutions:
                              
Graphics Imaging
   
3,918
    
4,959
        
10,908
    
14,634
  
Marking Products
   
2,406
    
1,670
        
5,633
    
5,040
  
Merchandising Solutions
   
530
    
-
        
2,528
    
-
  
                               
     
6,854
    
6,629
        
19,069
    
19,674
  
                               
   
$
27,477
  
$
25,212
      
$
73,981
  
$
69,231
  

Note 7. Comprehensive Income

Comprehensive income consists of net income adjusted for changes, net of related income tax effect, in cumulative foreign currency translation, the fair value of derivatives, unrealized investment gains and losses and minimum pension liability. For the three months ended June 30, 2005 and 2004, comprehensive income was $8,784 and $13,672, respectively. For the nine months ended June 30, 2005 and 2004, comprehensive income was $41,289 and $43,230, respectively.


7


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)


Note 8. Goodwill and Other Intangible Assets

Under SFAS No. 142, "Goodwill and Other Intangible Assets,” goodwill is no longer amortized but is subject to annual review for impairment. In general, when the carrying value of a reporting unit exceeds its implied fair value, an impairment loss must be recognized. For purposes of testing for impairment the Company uses a combination of valuation techniques, including discounted cash flows. Intangible assets are amortized over their estimated useful lives unless such lives are considered to be indefinite. The Company performed its annual impairment review in the second quarter of fiscal 2005 and determined that no additional adjustments to the carrying values of goodwill were necessary.

Changes to goodwill, net of accumulated amortization, for the nine months ended June 30, 2005, are as follows.

               
Graphics
  
Merchandising
  
Marking
      
   
Bronze
  
Casket
  
Cremation
  
Imaging
  
Solutions
  
Products
  
Consolidated
  
                                             
Balance at September 30, 2004
  
$
73,641
  
$
40,706
  
$
6,536
  
$
58,618
  
$
8,019
  
$
1,496
  
$
189,016
  
Additions during period
    
-
    
-
    
-
    
8,620
    
2,102
    
3,717
    
14,439
  
Translation and other adjustments
    
(500
)
  
-
    
-
    
(1,034
)
  
-
    
-
    
(1,534
)
Balance at June 30, 2005
  
$
73,141
  
$
40,706
  
$
6,536
  
$
66,204
  
$
10,121
  
$
5,213
  
$
201,921
  

The additions to Marking Products goodwill relate mostly to additional consideration paid in accordance with the Holjeron Corporation (“Holjeron”) purchase agreement. The additions to Merchandising Solutions goodwill relate to purchase accounting adjustments associated with the acquisition of The Cloverleaf Group, Inc. (“Cloverleaf”) in July 2004 and a small acquisition in 2005. The additions to Graphics Imaging goodwill relate to the purchase of the remaining interest in ReproBusek Druckvorstufentechnik GmbH & Co. KG (“Busek”), a European graphics business, in accordance with the terms of the original purchase agreement and a performance payout to the minority owner of Rudolf Reproflex GmbH, another European graphics business.

The following tables summarize the carrying amounts and related accumulated amortization for intangible assets as of June 30, 2005 and September 30, 2004, respectively.


   
Carrying
  
Accumulated
      
   
Amount
  
Amortization
  
Net
  
June 30, 2005:
                    
Trade names
  
$
17,885
  
$
- *
  
$
17,885
  
Customer relationships
    
10,406
    
(1,238
)
  
9,168
  
Copyrights/patents/other
    
4,994
    
(1,159
)
  
3,835
  
                     
   
$
33,285
  
$
(2,397
)
$
30,888
  
                     
                     
September 30, 2004:
                    
Trade names
  
$
17,964
  
$
- *
  
$
17,964
  
Customer relationships
    
10,427
    
(742
)
  
9,685
  
Copyrights/patents/other
    
5,024
    
(393
)
  
4,631
  
                     
   
$
33,415
  
$
(1,135
)
$
32,280
  
* Not subject to amortization
                    


8


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)

The decrease in intangible assets during fiscal 2005 was due to amortization and the impact of fluctuations in foreign currency exchange rates on intangible assets denominated in foreign currencies.

Amortization expense on intangible assets was $430 and $87 for the three month periods ended June 30, 2005 and 2004, respectively. For the nine month periods ended June 30, 2005 and 2004, amortization expense was $1,262 and $261, respectively. Amortization expense is estimated to be $1,700 in 2005, $1,700 in 2006, $1,300 in 2007, $1,300 in 2008 and $1,250 in 2009.


Note 9. Debt

The Company has a Revolving Credit Facility with a syndicate of financial institutions scheduled to mature on April 30, 2009. In February 2005, the facility, which was originally in the amount of $125,000, was amended to increase the borrowing capacity to $150,000. Borrowings under the amended facility bear interest at LIBOR plus a factor ranging from .50% to 1.00% based on the Company’s leverage ratio. The leverage ratio is defined as net indebtedness divided by EBITDA (earnings before interest, taxes, depreciation and amortization). The Company is required to pay an annual commitment fee ranging from .20% to .30% (based on the Company’s leverage ratio) of the unused portion of the facility. The Revolving Credit Facility, as amended, requires the Company to maintain certain leverage and interest coverage ratios. A portion of the facility (not to exceed $10,000) is available for the issuance of trade and standby letters of credit.

In April 2004, the Company entered into an interest rate swap that fixed the interest rate on borrowings of $50,000 for a five-year period. The interest rate was fixed at 2.66% plus a factor based on the Company’s leverage ratio (the factor was .50% at June 30, 2005). The interest rate swap was designated as a cash flow hedge of the future variable interest payments under the Revolving Credit Facility which are considered probable of occurring. Based on the Company’s assessment, all of the critical terms of the hedge matched the underlying terms of the hedged debt and related forecasted interest payments and as such, these hedges were considered effective.

The fair value of the interest rate swap reflected an unrealized gain of $1,000 ($600 after tax) at June 30, 2005 that is included in equity as part of accumulated other comprehensive income. Assuming market rates remain constant with the rates at June 30, 2005, approximately $160 of the $600 gain included in accumulated other comprehensive income is expected to be recognized in earnings as an adjustment to interest expense over the next twelve months.

Outstanding borrowings on the Revolving Credit Facility at June 30, 2005 were $40,000. The weighted-average interest rate on outstanding borrowings at June 30, 2005 was 3.16%. Equal quarterly payments of $2,500 plus interest are due on the facility until its maturity in April 2009.

On July 11, 2005 the Company increased its outstanding borrowings under the facility to $130,000. The additional borrowings were used to complete the acquisition of Milso Industries (“Milso”). Additionally, the Company has entered into a forward interest rate swap, to be effective September 30, 2005, that will fix the interest rate on $50,000 of the additional borrowings through the facility’s maturity. The interest rate will be fixed at 4.14% plus a factor based on the Company’s leverage ratio (the factor was .50% at June 30, 2005). The interest rate swap has been designated as a cash flow hedge of the future variable interest payments under the Revolving Credit Facility which are considered probable of occurring. Based on the Company’s assessment, all of the critical terms of the hedge match the underlying terms of the hedged debt and related forecasted interest payments and as such, these hedges are considered effective. Equal quarterly payments of $3,333 plus interest will be due on this $50,000 borrowing through April 2009.

The Company, through its wholly-owned subsidiary, Caggiati S.p.A., has several loans with various Italian banks. Outstanding borrowings on these loans totaled $11,234 at June 30, 2005. Caggiati S.p.A. also has four lines of credit totaling approximately $13,106 with the same Italian banks. Outstanding borrowings on these lines were $3,402 at June 30, 2005. The weighted-average interest rate on outstanding Caggiati S.p.A. related borrowings was 2.89% at June 30, 2005.


9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)


In April 2005, the Company, through its wholly-owned subsidiary, Matthews International GmbH, entered into a credit facility with National Westminster Bank Plc for borrowings up to 10.0 million Euros. At June 30, 2005, outstanding borrowings under the credit facility totaled 8.0 million Euros ($9,700 USD).


Note 10. Pension and Other Postretirement Benefit Plans
 
The Company provides defined benefit pension and other postretirement plans to certain employees. The following represents the net periodic pension and other postretirement benefit cost for the plans in accordance with the revised version of SFAS No. 132, “Employer’s Disclosures about Pensions and Other Postretirement Benefits.”
 

   
Pension
  
Other Postretirement
  
Three months ended June 30,
 
2005
  
2004
  
2005
  
2004
  
                           
Service cost
  
$
804
  
$
906
  
$
126
  
$
99
  
Interest cost
    
1,310
    
1,266
    
293
    
262
  
Expected return on plan assets
    
(1,521
)
  
(1,484
)
  
-
    
-
  
Amortization:
                          
Prior service cost
    
20
    
28
    
(322
)
  
(322
)
Net actuarial loss
    
350
    
293
    
123
    
112
  
                           
Net benefit cost
  
$
963
  
$
1,009
  
$
220
  
$
151
  


   
Pension
  
Other Postretirement
  
Nine months ended June 30,
 
2005
  
2004
  
2005
  
2004
  
                           
Service cost
  
$
2,413
  
$
2,719
  
$
379
  
$
296
  
Interest cost
    
3,931
    
3,797
    
879
    
786
  
Expected return on plan assets
    
(4,563
)
  
(4,452
)
  
-
    
-
  
Amortization:
                          
Prior service cost
    
60
    
84
    
(966
)
  
(966
)
Net actuarial loss
    
1,050
    
879
    
370
    
335
  
                           
Net benefit cost
  
$
2,891
  
$
3,027
  
$
662
  
$
451
  

Benefit payments under the Company’s principal retirement plan are made from plan assets, while benefit payments under a supplemental retirement plan and postretirement benefit plan are made from the Company’s operating funds. Due to the IRS full funding limitations, the Company is not required to make any significant contributions to its principal retirement plan in fiscal 2005. As of June 30, 2005, contributions of $290 and $522 have been made under the supplemental retirement plan and postretirement plan, respectively. The Company currently anticipates contributing an additional $75 and $528 under the supplemental retirement plan and postretirement plan, respectively, for the remainder of fiscal 2005.


Note 11. Acquisitions

In June 2005, the Company paid additional consideration of $6,000 to the minority owner of Rudolf Reproflex GmbH (“Rudolf”) under the terms of the original acquisition agreement. The Company had acquired a 75% interest in Rudolf in 2001.


10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Dollar amounts in thousands, except per share data)

In August 2004, the Company acquired The InTouch Group Limited (“InTouch”), a leading provider of reprographic services to the packaging industry in the United Kingdom. InTouch is headquartered in Leeds, England and has operations in London, Portsmouth, Manchester and Boston, Massachusetts. The transaction was structured as a stock purchase, at a cost of approximately $39,000. The acquisition was intended to further the Company’s position as a provider of reprographic services to the European packaging industry.

In July 2004, the Company acquired Cloverleaf, a provider of merchandising solutions. Cloverleaf was formed by the merger of iDL, Inc., which is a merchandising solutions company headquartered near Pittsburgh, Pennsylvania, and Big Red Rooster, which is a marketing and design services organization located in Columbus, Ohio. The transaction was structured as an asset purchase, at a cost of approximately $34,000. The transaction was structured to include potential additional consideration during the next six years contingent on the future growth in value of the acquired operations. The Company expects to account for this additional consideration as additional purchase price. The acquisition was designed to expand the Company’s products and services into the merchandising solutions market.

The following unaudited pro forma information presents a summary of the consolidated results of Matthews combined with Cloverleaf and InTouch as if the acquisitions had occurred on October 1, 2003:


   
Three Months Ended
  
Nine Months Ended
  
   
June 30,
  
June 30,
  
   
2005
  
2004
  
2005
  
2004
  
Sales
  
$
158,983
  
$
150,523
  
$
463,932
  
$
443,803
  
Income before taxes
    
26,055
    
23,862
    
71,196
    
67,322
  
Net income
    
16,154
    
14,602
    
44,142
    
41,201
  
Earnings per share
  
$
.50
  
$
.45
  
$
1.36
  
$
1.26
  


These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as interest expense on acquisition debt. The pro forma information does not purport to be indicative of the results of operations which actually would have resulted had the acquisition occurred on the date indicated, or which may result in the future.

In July 2004, the Company acquired Holjeron, an industrial controls manufacturer located in Wilsonville, Oregon. The acquisition was structured as a stock purchase, at an initial cost of approximately $1,700, plus potential additional consideration based upon calendar 2004 financial performance. In February 2005, additional consideration of $3,100 was paid in accordance with the purchase agreement to complete the transaction. The acquisition is a part of Matthews’ strategy to increase its presence in the marking products industry.


Note 12. Subsequent Event

On July 11, 2005, the Company acquired Milso, a leading manufacturer and marketer of caskets in the United States. Milso, headquartered in Brooklyn, New York, has manufacturing operations in Richmond, Indiana and maintains distribution centers throughout the Northeast, Mid-Atlantic, Midwest and Southwest regions of the United States. The transaction was structured as an asset purchase, at an initial purchase price of $95,000. The transaction was also structured to include potential additional asset purchase consideration of $7,500 contingent on the fiscal 2006 performance of the acquired operations. The acquisition is designed to expand Matthews’ products and services in the United States casket market.


11


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


Cautionary Statement:

The following discussion should be read in conjunction with the consolidated financial statements of Matthews International Corporation and related notes thereto included in this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended September 30, 2004. Any forward-looking statements contained herein are included pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks and uncertainties that may cause the Company's actual results in future periods to be materially different from management's expectations. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove correct. Factors that could cause the Company's results to differ materially from the results discussed in such forward-looking statements principally include changes in domestic or international economic conditions, changes in foreign currency exchange rates, changes in the cost of materials used in the manufacture of the Company’s products, changes in death rates, changes in product demand or pricing as a result of consolidation in the industries in which the Company operates, changes in product demand or pricing as a result of domestic or international competitive pressures, unknown risks in connection with the Company's acquisitions, and technological factors beyond the Company's control.


Results of Operations:

The following table sets forth certain income statement data of the Company expressed as a percentage of net sales for the periods indicated.

   
Nine months ended
  
Years ended
  
   
June 30,
  
September 30,
  
   
2005
  
2004
  
2004
  
2003(1)
  
Sales
    
100.0
%
  
100.0
%
  
100.0
%
  
100.0
%
Gross profit
    
34.5
%
  
38.3
%
  
38.1
%
  
37.1
%
Operating profit
    
15.9
%
  
19.1
%
  
19.2
%
  
17.5
%
Income before taxes
   
15.3
%
  
17.8
%
  
18.0
%
  
16.0
%
Net income
   
9.5
%
  
10.9
%
  
11.0
%
  
9.8
%


(1) The fourth quarter of fiscal 2003 included a net pre-tax charge of approximately $1.0 million from special items which consisted of a pre-tax gain of $2.6 million on the sale of a facility and a goodwill impairment charge of $3.6 million.
 

Sales for the nine months ended June 30, 2005 were $463.9 million and were $101.4 million, or 28.0%, higher than sales of $362.5 million for the nine months ended June 30, 2004. The increase resulted principally from the acquisitions of The Cloverleaf Group, Inc. (“Cloverleaf”), The InTouch Group, Limited (“InTouch”) and Holjeron Corporation (“Holjeron”) during the fourth quarter of fiscal 2004, and higher foreign currency exchange rates. Sales for Cloverleaf, which is reported as the Company’s Merchandising Solutions segment, were $65.7 million for the first nine months of fiscal 2005. Sales for InTouch and Holjeron were $22.9 million and $3.8 million, respectively. For the nine months ended June 30, 2005, higher foreign currency values against the U.S. dollar had a favorable impact of approximately $5.5 million on the Company’s consolidated sales compared to the nine months ended June 30, 2004. Bronze segment sales for the first nine months of fiscal 2005 were $150.1 million compared to $144.3 million for the first nine months of fiscal 2004. The higher level of Bronze sales principally reflected higher memorial sales (which included a price surcharge implemented in fiscal 2004) and the favorable impact of increases in the values of foreign currencies against the U.S. dollar. These increases were offset partially by a decline in mausoleum sales. Sales for the Casket segment were $92.8 million for the first nine months of fiscal 2005 compared to $91.2 million for the same period last


12
Results of Operations, continued:

year. The increase primarily reflected higher unit prices offset by a slight reduction in volume compared to a year ago. Unit volume improved during the third quarter compared to the same period last year. Sales for the Cremation segment were $16.0 million for the first nine months of fiscal 2005 compared to $16.5 million for the same period a year ago. The decrease reflected a decline in volume of cremation caskets partially offset by higher sales of cremation equipment and related supplies and services compared to the same period a year ago. Sales for the Graphics Imaging segment in the first nine months of fiscal 2005 were $106.6 million, compared to $82.4 million for the same period a year ago. The increase primarily reflected the acquisition of InTouch and an increase in the value of the Euro against the U.S. dollar. These increases were partially offset by lower sales in domestic markets. Marking Products segment sales for the nine months ended June 30, 2005 were $32.7 million, compared to $28.1 million for the first nine months of fiscal 2004. The increase of $4.6 million was principally due to the acquisition of Holjeron, higher sales volume, and the increase in value of the Swedish Krona against the U.S. dollar.
 
Gross profit for the nine months ended June 30, 2005 was $159.9 million, compared to $138.7 million for the nine months ended June 30, 2004. Consolidated gross profit as of percent of sales decreased from 38.3% for the first nine months of fiscal 2004 to 34.5% for the first nine months of fiscal 2005. The increase in consolidated gross profit primarily reflected the acquisitions completed in the fourth quarter of fiscal 2004, the effects of manufacturing improvements and cost reduction initiatives, and higher foreign exchange values against the U.S. dollar. These gains were partially offset by lower sales in the Cremation segment and domestic graphics businesses, higher costs for bronze ingot and steel, and costs incurred in connection with the establishment of a casket manufacturing facility in Mexico. The gross margin percentage decline principally related to the factors discussed above, as well as the acquisition of Cloverleaf which generally has lower gross margins than other Matthews’ businesses.
 
Selling and administrative expenses for the nine months ended June 30, 2005 were $85.9 million, compared to $69.5 million for the first nine months of fiscal 2004. The increase resulted primarily from the acquisitions completed during the fourth quarter of fiscal 2004. Consolidated selling and administrative expenses as a percent of sales were 18.5% for the nine months ended June 30, 2005 compared to 19.2% for the same period last year. The decrease primarily reflected cost controls in the Bronze segment and the acquisition of Cloverleaf, which generally has lower selling and administrative expenses as a percentage of sales than other Matthews’ businesses.

Operating profit for the nine months ended June 30, 2005 was $74.0 million, representing an increase of $4.8 million, or 6.9%, over operating profit of $69.2 million for the nine months ended June 30, 2004. The Cloverleaf acquisition, reported as the Merchandising Solutions segment, contributed $2.5 million of operating profit during the first nine months of fiscal 2005. Higher foreign currency values against the U. S. dollar had a favorable impact of approximately $1.5 million on the Company’s consolidated operating profit for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004. Bronze segment operating profit for the first nine months of fiscal 2005 was $42.3 million, compared to $35.3 million for the first nine months of fiscal 2004. The increase reflected higher sales, the continuing effects of prior year cost reduction initiatives and the favorable impact of the increase in the value of foreign currencies against the U.S. dollar. In addition, the segment’s operating profit during the prior year included one-time severance costs related to personnel reductions. Operating profit for the Casket segment for the first nine months of fiscal 2005 was $12.4 million compared to $13.4 million for the same period a year ago. The decrease reflected the higher cost of steel and costs incurred in connection with the establishment of a casket manufacturing facility in Mexico. Year-to-date costs incurred related to the Mexico project approximated $2.1 million. These factors were partially offset by higher sales, operating efficiencies realized in connection with productivity initiatives, and a reduction in administrative expenses. Cremation segment operating profit was $264,000 for the first nine months of fiscal 2005 compared to $829,000 for the same period in fiscal 2004. The decrease primarily reflected lower sales volume and higher steel and other raw material costs. The Company estimates that for the first nine months of fiscal 2005 the aggregate impact on consolidated operating profit of increases in the cost of steel and bronze, net of the bronze price surcharge, approximated $700,000. Graphics Imaging operating profit for the nine months ended June 30, 2005 was $10.9 million compared to $14.6 million for the nine months ended June 30, 2004. The segment's decrease in operating profit reflected lower domestic sales volume, lower margins in several European graphics businesses and investments during the current period in developing new accounts. Operating profit for the Marking Products segment for the first nine months of fiscal 2005 was $5.6 million compared to $5.0 million for the same period a year ago. The increase resulted from the acquisition of Holjeron and the benefit of higher sales partially offset by an increase in new product development costs.


13
Results of Operations, continued:

Investment income for the nine months ended June 30, 2005 was $1.0 million, compared to $1.1 million for the nine months ended June 30, 2004. The decrease from the prior period reflected lower average levels of invested cash. Interest expense was $1.5 million for the first nine months of fiscal 2005, which was relatively consistent with the same period last year.

Other income (deductions), net, for the nine months ended June 30, 2005 represented an increase in pre-tax income of $1.6 million, compared to a reduction in pre-tax income of $203,000 for same period last year. Other income in the first nine months of fiscal 2005 primarily reflected foreign currency exchange gains on intercompany advances to foreign affiliates. Minority interest deduction for the first nine months of fiscal 2005 was $3.8 million, compared to $4.0 million for the first nine months of fiscal 2004. The lower minority interest deduction for fiscal 2005 primarily resulted from lower operating income in the Company's European Graphics Imaging businesses that are not wholly-owned.

The Company's effective tax rate for the nine months ended June 30, 2005 was 38.0%, compared to the effective rate of 38.8% for the fiscal year ended September 30, 2004. The reduction reflected a lower effective tax rate on foreign income and a reduction in state income taxes. The difference between the Company's effective tax rate and the Federal statutory rate of 35% primarily reflected the impact of state and foreign income taxes.


Liquidity and Capital Resources:

Net cash provided by operating activities was $60.2 million for the nine months ended June 30, 2005, compared to $68.4 million for the first nine months of fiscal 2004. Operating cash flow for the first nine months of fiscal 2005 principally reflected net income adjusted for depreciation and amortization, minority interest (non-cash charges) and a tax benefit of $2.8 million from exercised stock options, which were partially offset by an increase in inventory. For the nine months ended June 30, 2004, operating cash flow primarily reflected net income adjusted for depreciation and amortization, minority interest, an increase in accrued income taxes, and a tax benefit of $2.8 million from exercised stock options.

Cash used in investing activities was $45.0 million for the nine months ended June 30, 2005, compared to $21.2 million for the nine months ended June 30, 2004. Investing activities for the first nine months of fiscal 2005 primarily included capital expenditures of $21.6 million, net purchases of investments of $10.0 million and acquisitions of $14.2 million. Investing activities for the first nine months of fiscal 2004 included capital expenditures of $6.8 million and net purchases of investments of $15.2 million, partially offset by proceeds of $850,000 from the sale of assets.
 
Capital expenditures reflected reinvestment in the Company's business segments and were made primarily for the purchase of new manufacturing machinery, equipment 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 $9.9 million for the last three fiscal years. The capital budget for fiscal 2005 is approximately $24 million, which reflects projected capital spending in connection with establishing a casket manufacturing facility in Monterrey, Mexico. The total cost of establishing this facility is projected to be in the range of $11 to $12 million (including capital and expense portions). 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, 2005 was $37.3 million, reflecting net payments on long-term debt of $6.0 million, treasury stock purchases of $27.9 million, dividends of $4.3 million to the Company's shareholders and dividends of $4.4 million to minority interests. These payments were partially offset by proceeds of $5.4 million from the sale of treasury stock (stock option exercises). Cash used in financing activities for the nine months ended June 30, 2004 was $5.3 million, reflecting stock repurchases of $12.6 million, dividends of $3.9 million to the Company's shareholders and dividends of $2.3 million to minority interests, partially offset by a net increase in long-term debt of $6.2 million and net proceeds from the sale of treasury stock of $7.3 million (stock option exercises).

14
Liquidity and Capital Resources, continued:

The Company has a Revolving Credit Facility with a syndicate of financial institutions scheduled to mature on April 30, 2009. In February 2005, the facility, which was originally in the amount of $125.0 million, was amended to increase the borrowing capacity to $150.0 million. Borrowings under the amended facility bear interest at LIBOR plus a factor ranging from .50% to 1.00% based on the Company’s leverage ratio. The leverage ratio is defined as net indebtedness divided by EBITDA (earnings before interest, taxes, depreciation and amortization). The Company is required to pay an annual commitment fee ranging from .20% to .30% (based on the Company’s leverage ratio) of the unused portion of the facility. The Revolving Credit Facility, as amended, requires the Company to maintain certain leverage and interest coverage ratios. A portion of the facility (not to exceed $10.0 million) is available for the issuance of trade and standby letters of credit.

In April 2004, the Company entered into an interest rate swap that fixed the interest rate on borrowings of $50.0 million for a five-year period. The interest rate was fixed at 2.66% plus a factor based on the Company’s leverage ratio (the factor was .50% at June 30, 2005). The interest rate swap was designated as a cash flow hedge of the future variable interest payments under the revolving credit facility which are considered probable of occurring. Based on the Company’s assessment, all of the critical terms of the hedge matched the underlying terms of the hedged debt and related forecasted interest payments and as such, these hedges were considered effective.

The fair value of the interest rate swap reflected an unrealized gain of $1.0 million ($600,000 after tax) at June 30, 2005 that is included in equity as part of accumulated other comprehensive income. Assuming market rates remain constant with the rates at June 30, 2005, approximately $160,000 of the $600,000 gain included in accumulated other comprehensive income is expected to be recognized in earnings as an adjustment to interest expense over the next twelve months.

Outstanding borrowings on the Revolving Credit Facility at June 30, 2005 were $40.0 million. The weighted-average interest rate on outstanding borrowings at June 30, 2005 was 3.16%. Equal quarterly payments of $2.5 million plus interest are due on the facility until its maturity in April 2009.

On July 11, 2005 the Company increased its outstanding borrowings under the facility to $130.0 million. The additional borrowings were used to complete the acquisition of Milso Industries (“Milso”). Additionally, the Company has entered into a forward interest rate swap, to be effective September 30, 2005, that will fix the interest rate on $50.0 million of the additional borrowings through the facility’s maturity. The interest rate will be fixed at 4.14% plus a factor based on the Company’s leverage ratio (the factor was .50% at June 30, 2005). The interest rate swap has been designated as a cash flow hedge of the future variable interest payments under the revolving credit facility which are considered probable of occurring. Based on the Company’s assessment, all of the critical terms of the hedge match the underlying terms of the hedged debt and related forecasted interest payments and as such, these hedges are considered effective. Equal quarterly payments of $3.3 million plus interest will be due on this $50.0 million borrowing through April 2009.

The Company, through its wholly-owned subsidiary, Caggiati S.p.A., has several loans with various Italian banks. Outstanding borrowings on these loans totaled $11.2 million at June 30, 2005. Caggiati S.p.A. also has four lines of credit totaling approximately $13.1 million with the same Italian banks. Outstanding borrowings on these lines were $3.4 million at June 30, 2005. The weighted-average interest rate on outstanding Caggiati S.p.A. related borrowings was 2.89% at June 30, 2005.

In April 2005, the Company, through its wholly-owned subsidiary, Matthews International GmbH, entered into a credit facility with National Westminster Bank Plc for borrowings up to 10.0 million Euros. At June 30, 2005, outstanding borrowings under the credit facility totaled 8.0 million Euros ($9.7 million USD).

The Company has a stock repurchase program, which was initiated in 1996. Under the program, the Company's Board of Directors has authorized the repurchase of a total of 10,000,000 shares (adjusted for stock splits) of Matthews common stock, of which 8,621,396 shares 

15
Liquidity and Capital Resources, continued:

have been repurchased as of June 30, 2005. 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 of the Company’s Restated Articles of Incorporation.

Consolidated working capital of the Company was $83.4 million at June 30, 2005, compared to $90.9 million at September 30, 2004. Cash and cash equivalents were $40.3 million at June 30, 2005, compared to $65.8 million at September 30, 2004. The Company's current ratio was 1.8 at June 30, 2005 and September 30, 2004.

Environmental Matters:

The Company's operations are subject to various federal, state and local laws and regulations relating to the protection of the environment. These laws and regulations impose limitations on the discharge of materials into the environment and require the Company to obtain and operate in compliance with conditions of permits and other government authorizations. As such, the Company has developed policies and procedures with respect to environmental, safety and health, including the proper handling, storage and disposal of hazardous materials.

The Company is party to various environmental matters. These include obligations to investigate and mitigate the effects on the environment of the disposal of certain materials at various operating and non-operating sites. The Company is currently performing environmental assessments and remediation at these sites, as appropriate. In addition, prior to its acquisition, York Casket was identified, along with others, by the Environmental Protection Agency as a potentially responsible party for remediation of a landfill site in York, PA. At this time, the Company has not been joined in any lawsuit or administrative order related to the site or its clean-up.

At June 30, 2005, an accrual of $10.6 million was recorded for environmental remediation (of which $812,000 has been classified in other current liabilities) representing management's best estimate of the probable and reasonably estimable costs of the Company's known remediation obligations. The accrual, which reflects previously established reserves assumed with the acquisition of York Casket and additional reserves recorded as a purchase accounting adjustment, does not consider the effects of inflation and anticipated expenditures are not discounted to their present value. While final resolution of these contingencies could result in costs different than current accruals, management believes the ultimate outcome will not have a significant effect on the Company's consolidated results of operations or financial position.

Acquisitions:

On July 11, 2005, the Company acquired Milso, a leading manufacturer and marketer of caskets in the United States. Milso, headquartered in Brooklyn, New York, has manufacturing operations in Richmond, Indiana and maintains distribution centers throughout the Northeast, Mid-Atlantic, Midwest and Southwest regions of the United States. The transaction was structured as an asset purchase, at an initial purchase price of $95 million. The transaction was also structured to include potential additional asset purchase consideration of $7.5 million contingent on the fiscal 2006 performance of the acquired operations. The acquisition is designed to expand Matthews’ products and services in the United States casket market.

In June 2005, the Company paid additional consideration of $6.0 million to the minority owner of Rudolf Reproflex GmbH (“Rudolf”) under the terms of the original acquisition agreement. The Company had acquired a 75% interest in Rudolf in 2001.
 
In August 2004, the Company acquired InTouch, a leading provider of reprographic services to the packaging industry in the United Kingdom. InTouch is headquartered in Leeds, England and has operations in London, Portsmouth, Manchester and Boston, Massachusetts. The transaction was structured as a stock purchase, at a cost of approximately $39.0 million. The acquisition was intended to further the Company’s position as a provider of reprographic services to the European packaging industry.


16
Acquisitions, continued:

In July 2004, the Company acquired Cloverleaf, a provider of merchandising solutions. Cloverleaf was formed by the merger of iDL, Inc., a provider of merchandising systems and displays, headquartered near Pittsburgh, Pennsylvania, and Big Red Rooster, a marketing and design services organization located in Columbus, Ohio. The transaction was structured as an asset purchase, at a cost of approximately $34.0 million. The transaction was also structured to include potential additional consideration during the next six years contingent on the future growth in value of the acquired operations. The acquisition was designed to expand the Company’s products and services into the merchandising solutions market.

In July 2004, the Company acquired Holjeron Corporation, an industrial controls manufacturer located in Wilsonville, Oregon. The acquisition was structured as a stock purchase, at an initial cost of approximately $1.7 million, plus potential additional consideration based upon calendar 2004 financial performance. In February 2005, additional consideration of $3.1 million was paid in accordance with the purchase agreement to complete the transaction. The acquisition is a part of Matthews’ strategy to increase its presence in the marking products industry.

Forward-Looking Information:

The Company’s objective with respect to operating performance is to increase annual earnings per share in the range of 12% to 15% annually. For the past ten fiscal years, the Company has achieved an average annual increase in earnings per share of approximately 16%. Matthews has a three-pronged strategy to attain the annual growth rate objective, which has remained unchanged from the prior year. This strategy consists of the following: internal growth (which includes productivity improvements, new product development and the expansion into new markets with existing products), acquisitions and share repurchases under the Company’s stock repurchase program.

The significant factors impacting the Company’s results for the first nine months of fiscal 2005 were the acquisitions of Cloverleaf, InTouch and Holjeron during the fourth quarter of fiscal 2004 and the favorable impact of foreign currency exchange rate changes. The Company remains concerned with the continued high cost of bronze and steel. While fiscal 2004 cost initiatives and productivity improvements have mitigated some of this impact, the significantly higher costs of bronze and steel affected the first nine months of fiscal 2005 and will be a challenge for the remainder of the fiscal year, particularly in the competitive markets served by the Company. Additionally, the Company has initiated a restructuring and facility consolidation program within the Merchandising Solutions segment. Finally, costs associated with the Company’s project to establish a new lower cost casket manufacturing plant in Mexico in fiscal 2005 have negatively affected, and will continue to negatively affect, fiscal 2005 operating results until project completion.

Based on anticipated internal growth, the impact of the Company’s recent acquisitions (including Milso) and the factors discussed above, the Company expects to achieve diluted earnings per share in the range of $1.80 to $1.85 for the fiscal year ending September 30, 2005.


Critical Accounting Policies:

The preparation of financial statements in conformity with generally accepted accounting principles 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 "Quantitative and Qualitative Disclosures about Market Risk" in this Quarterly Report on Form 10-Q.

A summary of the Company's significant accounting policies are included in the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2004. 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 following accounting policies involve significant estimates, which are considered critical to the preparation of the
Company's consolidated financial statements.

17
Critical Accounting Policies, continued:

Allowance for Doubtful Accounts

The allowance for doubtful accounts is based on an evaluation of specific customer accounts in which available facts and circumstances indicate collectibility may be a problem. In addition, the allowance includes a general reserve for all customers based on historical collection experience.

Long-Lived Assets

Property, plant and equipment, goodwill and other intangible assets are carried at cost. Depreciation on property, plant and equipment is computed primarily on the straight-line method over the estimated useful lives of the assets. Goodwill is no longer amortized, but is subject to periodic review for impairment. In general, when the carrying value of a reporting unit exceeds its implied fair value, an impairment loss must be recognized. For purposes of testing for impairment, the Company uses a combination of valuation techniques, including discounted cash flows. The Company performed its annual impairment review in the second quarter of fiscal 2005 and determined that no adjustments to the carrying values of goodwill were necessary. Intangible assets are amortized over their estimated useful lives, unless such lives are considered to be indefinite. A significant decline in cash flows generated from these assets may result in a write-down of the carrying values of the related assets.

Pension Costs

Pension assets and liabilities are determined on an actuarial basis and are affected by the market value of plan assets, estimates of the expected return on plan assets and the discount rate used to determine the present value of benefit obligations. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets, the expected return on plan assets and changes in the selected discount rate will affect the amount of pension cost.

Environmental Reserve

Environmental liabilities are recorded when the Company's obligation is probable and reasonably estimable. Accruals for losses from environmental remediation obligations do not consider the effects of inflation, and anticipated expenditures are not discounted to their present value.

Revenue Recognition

Revenues are generally recognized when title and risk of loss pass to the customer, which is typically at the time of product shipment. For pre-need sales of memorials and vases, revenue is recognized when the memorial has been manufactured to the customer’s specifications (e.g., name and birth date), title has been transferred to the customer and the memorial and vase are placed in storage for future delivery. A liability has been recorded in Estimated Finishing Costs for the estimated costs of finishing pre-need bronze memorials and vases that have been manufactured and placed in storage prior to July 1, 2003 for future delivery.

In July 2003, the Emerging Issues Task Force (“EITF”) issued Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables.” Issue No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue generating activities. The provisions of Issue No. 00-21 were effective July 1, 2003 and have been applied prospectively by the Company to the finishing and storage elements of its pre-need sales. Beginning July 1, 2003, revenue is deferred by the Company on the portion of pre-need sales attributable to the final finishing and storage of the pre-need merchandise. Deferred revenue for final finishing is recognized at the time the pre-need merchandise is finished and shipped to the customer. Deferred revenue related to storage is recognized on a straight-line basis over the estimated average time that pre-need merchandise is held in storage.

At June 30, 2005, the Company held 351,245 memorials and 231,266 vases in its storage facilities under the pre-need sales program.

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Critical Accounting Policies, continued:

Construction revenues are recognized under the percentage-of-completion method of accounting using the cost-to-cost method. The Company offers rebates to certain customers participating in volume purchase programs. Rebates are estimated and recorded as a reduction in sales at the time the Company’s products are sold.

 
LONG-TERM CONTRACTUAL OBLIGATIONS AND COMMITMENTS:

The following table summarizes the Company’s contractual obligations at June 30, 2005, and the effect such obligations are expected to have on its liquidity and cash flows in future periods.

   
Payments due in fiscal year:
  
       
2005
          
After
  
   
Total
  
Remainder
  
2006 to 2007
  
2008 to 2009
  
2009
  
Contractual Cash Obligations:
  
(Dollar amounts in thousands)
Revolving credit facilities
  
$
49,673
  
$
2,500
  
$
20,000
  
$
27,173
  
$
--
  
Notes payable to banks
    
11,229
    
1,190
    
2,438
    
2,438
    
5,163
  
Short-term borrowings
    
3,402
    
3,402
    
-
    
-
    
-
  
Capital lease obligations
    
422
    
123
    
299
    
-
    
-
  
Non-cancelable operating leases
    
21,758
    
1,399
    
8,769
    
5,898
    
5,692
  
                                 
Total contractual cash obligations
  
$
86,484
  
$
8,614
  
$
31,506
  
$
35,509
  
$
10,855
  

Benefit payments under the Company’s principal retirement plan are made from plan assets, while benefit payments under the supplemental retirement plan and postretirement benefit plan are made from the Company’s operating funds. Due to the IRS full funding limitations, the Company is not required to make any significant contributions to its principal retirement plan in fiscal 2005. As of June 30, 2005, contributions of $290,000 and $522,000 have been made under the supplemental retirement plan and postretirement plan, respectively. The Company currently anticipates contributing an additional $75,000 and $528,000 under the supplemental retirement plan and postretirement plan, respectively, for the remainder of fiscal 2005.

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.


Accounting Pronouncements:

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123 and supercedes APB Opinion No. 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro-forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. In April 2005, the Securities and Exchange Commission delayed the effective date of SFAS 123R for public companies to annual, rather than interim, periods that begin after June 15, 2005. Accordingly, the Company is not required, and does not expect, to adopt SFAS 123R until October 1, 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption alternatives.
 
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company is evaluating the requirements of SFAS 123R and SAB 107 and has 

19
Accounting Pronouncements, continued:

not yet determined the method of adoption. The Company expects the effect of adopting SFAS 123R and SAB 107 will result in amounts that do not differ materially from the current pro forma disclosures under SFAS 123. In addition, the Company currently discloses the fair value of grants of employee stock options over the normal vesting period for all participants. Beginning in fiscal 2006, expense will be recognized immediately for participants eligible for normal retirement. The financial impact on the expense disclosed for participants eligible for retirement on the date of grant on the periods presented is not expected to be material.

In December 2004, the FASB issued FASB Staff Position No. 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP 109-2"). FSP 109-2 provides guidance under SFAS No. 109, "Accounting for Income Taxes," for recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the "Jobs Act"), on a company's income tax expense and deferred tax liabilities. FSP 109-2 states that a company is allowed time beyond the financial reporting period of
enactment, which was October 22, 2004, to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB Statement No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions as provided for in FSP 109-2.


Item 3. Quantitative And Qualitative Disclosures About Market Risk

The following discussion about the Company's market risk involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company has market risk related to changes in interest rates, commodity prices and foreign currency exchange rates. The Company does not generally use derivative financial instruments in connection with these market risks, except as noted below.

Interest Rates - The Company's most significant long-term debt instrument is the Revolving Credit Facility, as amended, which bears interest at variable rates based on LIBOR. In April 2004, the Company entered into an interest rate swap that fixed the interest rate on borrowings of $50.0 million at 3.16% for a five-year period. The interest rate swap was designated as a cash flow hedge of the future variable interest payments under the Revolving Credit Facility. The fair value of the interest rate swap reflected an unrealized gain of $1.0 million ($600,000 after tax) at June 30, 2005 that is included in equity as part of accumulated other comprehensive income. A decrease of 10% in market interest rates (i.e., a decrease from 3.5% to 3.15%) would result in a decrease of approximately $500,000 in the fair value of the interest rate swap.

Commodity Price Risks - In the normal course of business, the Company is exposed to commodity price fluctuations related to the purchases of certain materials and supplies (such as bronze ingot, steel and wood) used in its manufacturing operations. The Company obtains competitive prices for materials and supplies when available.

Foreign Currency Exchange Rates - The Company is subject to changes in various foreign currency exchange rates, including the Euro, the British Pound, Canadian dollar, Australian dollar and Swedish Krona, in the conversion from local currencies to the U.S. dollar of the reported financial position and operating results of its non-U.S. based subsidiaries. An adverse change of 10% in average exchange rates would have resulted in a decrease in sales of $12.3 million and a decrease in operating income of $2.1 million for the nine-month period ended June 30, 2005.


Item 4. Controls and Procedures

Based on their evaluation at the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.  There have been no changes in the Company’s internal controls over financial reporting that occurred during the fiscal quarter ended June 30, 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.


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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

On May 18, 2005, Ralph Lee Fancher (“Fancher”) filed an anti-trust suit against several national owners and operators of funeral homes as well as several manufacturers and marketers of caskets, including Matthews International Corporation’s wholly-owned subsidiary, The York Group, Inc. (“York”). The anti-trust suit was filed in the United States District Court for the Eastern District of Tennessee. Fancher alleges violations of various state anti-trust laws, state consumer protection statutes and state unjust enrichment laws. No violations of federal law are alleged. In general, Fancher alleges a conspiracy to suppress competition for caskets, disparagement against “Independent Casket Discounters” and efforts to restrict casket price competition. Fancher seeks certification of two classes of consumers based on different groups of state laws and seeks unspecified monetary damages, trebling of any such damages that may be awarded, where appropriate, and recovery of attorney’s fees and costs. As of the date of the filing of this Form 10-Q, the suit has been voluntarily withdrawn by the plaintiff. However, it is likely that the suit will be re-filed in another jurisdiction.

It is possible that resolution of this matter could be unfavorable to the Company, however the Company does not presently have sufficient information to estimate the materiality of such impact. The Company believes York’s inclusion in this anti-trust suit is without merit and intends to aggressively defend itself against the allegations.


Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities

Stock Repurchase Plan

The Company has a stock repurchase program, which was initiated in 1996. Under the program, the Company's Board of Directors has authorized the repurchase of a total of 10,000,000 shares (adjusted for stock splits) of Matthews common stock, of which 8,621,396 shares have been repurchased as of June 30, 2005. All purchases of the Company’s common stock during the first nine months of fiscal 2005 were part of this repurchase program.

The following table shows the monthly fiscal 2005 stock repurchase activity:


Period
  
Total number of shares purchased
  
Average price paid per share
  
Total number of shares purchased as part of a publicly announced plan
  
Maximum number of shares that may yet be purchased under the plan
 
                           
October 2004
    
112,300
  
$
32.61
    
112,300
    
2,059,032
  
November 2004
    
66,200
    
35.90
    
66,200
    
1,992,832
  
December 2004
    
160,519
    
37.03
    
160,519
    
1,832,313
  
January 2005
    
133,509
    
36.02
    
133,509
    
1,698,804
  
February 2005
    
114,700
    
35.01
    
114,700
    
1,584,104
  
March 2005
    
204,500
    
34.66
    
204,500
    
1,379,604
  
April 2005
    
-
    
-
    
-
    
1,379,604
  
May 2005
    
-
    
-
    
-
    
1,379,604
  
June 2005
    
1,000
    
38.32
    
1,000
    
1,378,604
  
                           
Total
   
792,728
  
$
35.23
    
792,728
        


Item 4. Submission of Matters to a Vote of Security Holders

None


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Item 6. Exhibits and Reports on Form 8-K

(a)
Exhibits
  
     
 
Exhibit
  
 
No.
Description
     
 
31.1
Certification of Principal Executive Officer for David M. Kelly
 
31.2
Certification of Principal Financial Officer for Steven F. Nicola
 
32.1
Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for David M. Kelly.
 
32.2
Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Steven F. Nicola.
     
(b)
Reports on Form 8-K
     
 
On April 21, 2005, Matthews filed a Current Report on Form 8-K under Item 2.02 in connection with a press release announcing its earnings for the second fiscal quarter of 2005.
 
On June 1, 2005 Matthews filed a Current Report on Form 8-K under Item 1.01 in connection with the signing of a definitive agreement to purchase substantially all of the assets and assume certain liabilities of Milso Industries.

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SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



   
MATTHEWS INTERNATIONAL CORPORATION
   
(Registrant)
     
     
     
Date 8/9/05
  
David M. Kelly
   
David M. Kelly, Chairman of the Board,
   
President and Chief Executive Officer
     
     
     
     
Date 8/9/05
  
Steven F. Nicola
 
  
Steven F. Nicola, Chief Financial Officer,
 
  
Secretary and Treasurer
     
 
 
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