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 and the percentage change in such income statement data from year to year.

(1)   Fiscal 2003 included a net pre-tax charge of approximately $1.0 million from special items (see "Special Items").

(2)   Before cumulative effect of change in accounting. In fiscal 2002, the Company recorded a pre-tax charge of $5.3 million for transitional goodwill impairment (see "Goodwill").

Comparison of Fiscal 2004 and Fiscal 2003:

Sales for the year ended September 30, 2004 were $508.8 million and were $49.9 million, or 10.9% higher than sales of $458.9 million in fiscal 2003. The increase resulted principally from the acquisitions of The Cloverleaf Group, Inc., which is reported as the Company’s Merchandising Solutions segment, The InTouch Group Limited (“InTouch”) and Holjeron Corporation (“Holjeron”) during the fourth quarter of fiscal 2004, higher foreign currency exchange rates and a full twelve months of activity for Reproservice Eurodigital GmbH Munchen (“Reproservice Munich”), which was acquired in August 2003. Sales for the Merchandising Solutions segment totaled $21.1 million from the acquisition date through September 30, 2004. The higher foreign currencies values against the U.S. dollar had a favorable impact on sales of approximately $12.5 million. Bronze segment sales for fiscal 2004 were $197.4   million compared to $187.0 million for the year ended September 30, 2003. The $10.4 million increase reflected the favorable impact of increases in the value foreign currencies against the U.S. dollar, the effect of a temporary price surcharge (instituted in April 2004 in response to increases in the cost of bronze ingot) and higher sales of architectural products. These increases were partially offset by a decline in mausoleum sales. Sales for the York Casket segment were $116.6 million for fiscal 2004 compared to $120.4 million for the year ended September 30, 2003. The decline reflected the sale of a small manufacturing facility and several distribution operations in fiscal 2003 and lower volume in the fiscal 2004 fourth quarter. Fiscal 2004 sales for the Cremation segment were $22.5 million compared to $20.2 million for the year ended September 30, 2003. The $2.3 million increase reflected higher sales of cremation equipment and cremation caskets. Graphics Imaging segment sales were $113.2 million for the year ended September 30, 2004 compared to $99.1 million for fiscal 2003. The increase of $14.2 million, or 14.3%, primarily reflected the acquisitions of Reproservice Munich in August 2003 and

	18

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

 

 

Gross profit for the year ended September 30, 2004 was $193.8 million compared to $170.3 for the year ended September 30, 2003. The increase primarily reflected the acquisition of Reproservice Munich in August 2003 and the acquisitions of Holjeron, Cloverleaf and InTouch during the fourth quarter of fiscal 2004, higher sales, operational improvements and the impact of higher foreign currency values against the U.S. dollar. Bronze segment gross profit for fiscal 2003 was positively impacted by a reduction in the segment’s finishing cost liability as a result of manufacturing efficiency improvements. Bronze segment gross profit for fiscal 2004 was impacted by a charge for the cost of early retirement and other severance costs as well as increases in the cost of bronze ingot. York Casket segment gross profit for fiscal 2004 was impacted by the rising cost of cold rolled steel, stainless steel, copper and bronze, and an impairment charge on various assets. Graphics Imaging fiscal 2004 gross profit improved principally as a result of higher European sales and the closure of unprofitable operations in Southern California and North Carolina during fiscal 2003. Consolidated gross profit as a percentage of sales increased to 38.1% for fiscal 2004 from 37.1% for fiscal 2003. The Company’s improvement in consolidated gross profit as a percent of sales reflected higher sales, cost reduction initiatives and improvements in manufacturing efficiency, which were partially offset by higher raw material costs, an asset impairment charge and the addition of the Merchandising Solutions segment revenues that have a lower gross margin than the Company’s other segments.

Selling and administrative expenses for the year ended September 30, 2004 were $96.0 million compared to $89.2 million for the year ended September 30, 2003. The increase of $6.8 million primarily reflected the acquisitions of Reproservice Munich in August 2003 and Holjeron, Cloverleaf and InTouch in the fourth quarter of fiscal 2004 and the impact of higher foreign currency values against the U.S. dollar. Consolidated selling and administrative expenses as a percentage of sales were 18.9% for the year ended September 30, 2004 compared to 19.4% for the year ended September 30, 2003. The reduction principally reflected the Company’s recent acquisitions, which have lower selling and administrative costs as a percentage of sales than most of the Company’s other businesses.

Operating profit for the year ended September 30, 2004 was $97.8 million compared to $80.1 million for fiscal 2003, an increase of $17.7 million, or 22.1%. The Cloverleaf acquisition, reported as the Company’s Merchandising Solutions segment, contributed $1.6 million of operating profit from the date of acquisition to September 30, 2004. Bronze segment operating profit for fiscal 2004 was $54.3 million compared to $50.4 million for the year ended September 30, 2003. The $3.9 million increase reflected higher sales, the increase in values of foreign currencies against the U.S. dollar, manufacturing improvements and other cost reduction initiatives. These improvements were partially offset by increases in the cost of bronze ingot as well as a charge for the cost of early retirement and other severance costs. Bronze segment operating profit for fiscal 2003 was positively impacted by a reduction in the segment’s finishing cost liability as a result of manufacturing efficiency improvements. York Casket segment operating profit for fiscal 2004 was $14.6 million compared to $12.7 million for the year ended September 30, 2003. The increase of $1.9 million reflected the divestiture of unprofitable distribution and manufacturing operations in fiscal 2003, improvements in manufacturing efficiency and continued reductions in administrative costs, partially offset by the increase in the cost of steel and other metal raw materials and an asset impairment charge. Fiscal 2004 operating profit for the Cremation segment increased to $1.5 million from $1.2 million in fiscal 2003. The increase primarily reflected higher sales. Graphics

	19

 

 

Imaging segment operating profit for the year ended September 30, 2004 was $19.3 million compared to $11.6 million for the prior year, an increase of $7.7 million, or 66.8%. The increase reflected the acquisition of Reproservice Munich in August 2003 and InTouch in August 2004, the impact of the higher value of the Euro against the U.S. dollar, higher sales by the segment’s other European operations and the closure of unprofitable operations in Southern California and North Carolina in fiscal 2003. Marking Products segment operating profit for the year ended September 30, 2004 was $6.5 million compared to $4.1 million for the year ended September 30, 2003. The increase of $2.4 million, or 59.2%, reflected the acquisition of Holjeron in July 2004, the higher value of the Swedish Krona against the U.S. dollar and higher demand with improvements in the U.S. economy. Higher foreign currency values against the U.S. dollar had a favorable impact of approximately $3.2 million on the Company’s consolidated operating profit for the year ended September 30, 2004 compared to fiscal 2003.

The Company's effective tax rate for the year ended September 30, 2004 was 38.8%, which remained unchanged from fiscal 2003. 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.

Comparison of Fiscal 2003 and Fiscal 2002:

Sales for the year ended September 30, 2003 were $458.9 million and were $30.8 million, or 7.2%, higher than sales of $428.1 million for the year ended September 30, 2002. The increase primarily related to the acquisition of The York Group, Inc. ("York Casket") on December 3, 2001 and higher foreign currency exchange rates. Fiscal 2003 reflected twelve months of activity for the York Casket segment compared to ten months for fiscal 2002. Fiscal 2003 sales for the York Casket segment were $120.4 million compared to $100.4 million for fiscal 2002. For the year ended September 30, 2003, higher foreign currency values against the U.S. dollar had a favorable impact of approximately $14.7 million on the Company’s consolidated sales compared to fiscal 2002. Bronze segment sales for the year ended September 30, 2003 were $187.0 million compared to $185.9 million in fiscal 2002. The increase of $1.1 million in Bronze segment sales reflected the favorable impact of increases in the values of foreign currencies against the U.S. dollar offset partially by a decline in mausoleums sales, the divestiture of the segment's granite import business in fiscal 2002 and the divestiture of a Canadian niche bank and columbarium business in October 2002. Sales for the Cremation segment were $20.2 million for fiscal 2003 compared to $18.3 million for fiscal 2002. The increase reflected two additional months of cremation casket sales compared to fiscal 2002 as a result of the acquisition of York Casket. Fiscal 2003 sales for the Graphics Imaging segment were $99.1 million, compared to $94.8 million for fiscal 2002. The increase primarily reflected higher sales in the segment's European operations, which included the acquisition of Reproservice Munich in August 2003, combined with an increase in the value of the Euro against the U.S. dollar. These increases were partially offset by lower sales in the segment's domestic operations, which primarily related to weak demand and price pressure in the United States packaging markets

	20

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

 

and the closure, in October 2002, of an unprofitable manufacturing business in Southern California. Marking Products segment sales for the year ended September 30, 2003 were $32.3 million, compared to $28.7 million for the year ended September 30, 2002. The increase of $3.6 million, or 12.5%, was principally due to higher volume, reflecting higher demand and the addition of new distributors in Europe, and higher foreign currency exchange rates.

Operating profit for the year ended September 30, 2003 was $80.1 million, representing an increase of $11.9 million, or 17.4%, over operating profit of $68.2 million for the year ended September 30, 2002. Bronze segment operating profit for fiscal 2003 was $50.4 million, compared to $46.6 million for fiscal 2002. The increase of $3.8 million, or 8.3%, reflected the segment's higher sales for the year, a reduction in the segment's pre-need memorial finishing cost liability due to manufacturing efficiencies, and the favorable impact of increases in the values of foreign currencies against the U.S. dollar. The Bronze segment results were also favorably impacted by the divestiture of its granite import business and its Canadian niche bank and columbarium business. These two businesses generated a combined operating loss of approximately $700,000 in fiscal 2002. Operating profit for the York Casket segment for the year ended September 30, 2003 was $12.7 million, representing an increase of $3.4 million, or 36.2%, over fiscal 2002. The increase reflected two additional months of results in fiscal 2003 compared to fiscal 2002. Operating profit as a percent of sales for the York Casket segment increased to 10.6% for fiscal 2003 from 9.3% for fiscal 2002, reflecting improvements in certain of the segment's manufacturing processes and a lower percentage of administrative costs as a result of the integration with Matthews. Graphics Imaging operating profit for the year ended September 30, 2003 was $11.6 million compared to $9.7 million for fiscal 2002. The segment's fiscal 2003 operating profit reflected a net pre-tax charge of $1.0 million

	21

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

(classified under Special Items), representing a pre-tax gain of $2.6 million on the sale of the segment's building in Southern California and a pre-tax charge of $3.6 million for impairment of goodwill related to O.N.E. Color Communications (see “Special Items”). Fiscal 2003 operating profit for the Graphics Imaging segment was favorably impacted by sales growth in the Company's European operations, which included the acquisition of Reproservice Munich in August 2003, combined with an increase in the value of the Euro against the U.S. dollar. However, the European gains were partially offset by the adverse impact of lower domestic sales and costs related to the closure of the segment's operation in North Carolina. Fiscal 2003 operating profit for the Marking Products segment was $4.1 million, representing an increase of $500,000 over fiscal 2002 operating profit of $3.6 million. The increase of 14.2% resulted from higher sales combined with an increase in the value of the Swedish Krona against the U.S. dollar. Operating profit for the Cremation segment in fiscal 2003 was $1.2 million compared to an operating loss of $1.1 million for fiscal 2002. Fiscal 2002 operating results reflected costs of $2.2 million incurred in connection with a potential acquisition in the cremation equipment business, which was terminated and not completed. Higher foreign currency values against the U.S. dollar had a favorable impact of approximately $3.3 million on the Company’s consolidated operating profit for the year ended September 30, 2003 compared to fiscal 2002.

 

Goodwill:

Under Statement of Financial Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, goodwill related to business combinations 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.

	22

 

Based on this assessment, the Company recorded a pre-tax charge under Cumulative Effect of Change in Accounting in the first quarter of fiscal 2002 for transitional goodwill impairment of $5.3 million ($3.2 million after-tax). The impairment was primarily related to a reporting unit within the Company’s Bronze segment and was determined based upon a comparison of carrying value to implied fair market value.

LIQUIDITY AND CAPITAL RESOURCES:

Net cash provided by operating activities was $83.3 million for the year ended September 30, 2004, compared to $58.5 million and $55.5 million for fiscal 2003 and 2002, respectively. Operating cash flow for fiscal 2004 primarily reflected net income adjusted for depreciation and amortization (non-cash items), a $1.5 million cash contribution to the Company's principal pension plan, and a tax benefit of $4.5 million from exercised stock options. Operating cash flow for fiscal 2003 primarily reflected net income adjusted for depreciation, amortization and a goodwill impairment charge, a $7.5 million cash contribution to the Company’s principal pension plan, and a tax benefit of $5.8 million from exercised stock options. In addition, fiscal 2003 operating cash flow included final payouts to customers under various rebate programs of the York Casket segment. Most of these programs were replaced in calendar 2003 with a new discount program. Operating cash flow for the year ended September 30, 2002 primarily reflected net income adjusted for depreciation and amortization and the impairment of goodwill resulting from the adoption of SFAS No. 142. Operating cash flow for fiscal 2002 also included a tax benefit of $5.5 million from exercised stock options.

Cash used in investing activities was $82.8 million for the year ended September 30, 2004, compared to $13.3 million and $86.6 million for fiscal years 2003 and 2002, respectively. Investing activities for fiscal 2004 primarily included payments (net of cash acquired) of $74.5 million in connection with the acquisitions of InTouch, Cloverleaf and Holjeron and capital expenditures of $10.4 million. Investing activities for fiscal 2003 primarily included capital expenditures of $9.3 million, which was partially offset by proceeds of $5.6 million from sales of assets. Fiscal 2003 investing activities also included the acquisitions of Reproservice Munich in August 2003 and the remaining fifty percent interest in O.N.E. on July 31, 2003. Investing activities for fiscal 2002 included payments (net of cash acquired) of $88.8 million in connection with acquisitions, principally related to York Casket (December 2001) and Rudolf (July 2001). Although Rudolf was acquired in fiscal 2001, the purchase price (approximately $11.0 million) was paid in the first quarter of fiscal 2002. Fiscal 2002 investing activities also reflected capital expenditures of $10.1 million, proceeds of $9.0 million from the net disposition of investment securities and proceeds of $3.2 million from the sale of assets.

Capital expenditures were $10.4 million for the year ended September 30, 2004, compared to $9.3 million and $10.1 million for fiscal 2003 and 2002, respectively. Capital expenditures in each of the last three fiscal years 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

	23

ITEM 7.       MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

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 $23.9 million, which reflects projected capital spending in connection with establishing a lower cost casket manufacturing facility in Monterrey, Mexico. The Company expects to generate sufficient cash from operations to fund all anticipated capital spending projects.

 

Cash used in financing activities for the year ended September 30, 2004 was $3.2 million,   reflecting proceeds, net of repayments, from long-term debt of $6.5 million, treasury stock purchases of $14.9 million, proceeds of $10.6 million from the sale of treasury stock (stock option exercises) and dividends of $5.3 million   ($0.165 per share) to the Company’s shareholders. Cash used in financing activities for the year ended September 30, 2003 was $41.7 million, reflecting payments on long-term debt of $44.0 million, treasury stock purchases of $6.6 million and dividends of $3.9 million ($0.123 per share) to the Company's shareholders. These payments were partially offset by proceeds of $12.8 million from the sale of treasury stock (stock option exercises). Cash provided by financing activities for the year ended September 30, 2002 was $58.5 million, reflecting proceeds from long-term debt of $126.4 million, debt repayments of $71.3 million, net proceeds of $6.7 million from the sale of treasury stock (stock option exercises), and dividends of $3.3 million ($0.106 per share) to the Company's shareholders.

 

On December 3, 2001, the Company entered into a Revolving Credit Facility for $125.0 million with a syndicate of financial institutions. The facility was scheduled to mature on November 30, 2004. On April 21, 2004, the Company signed an amendment to the facility which extended its maturity to April 30, 2009. 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.

Effective April 30, 2004, the Company increased its outstanding borrowings under the facility to $50.0 million and simultaneously entered into an interest rate swap that fixed the interest rate on such borrowings at 3.16% for a five-year period. 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.

The fair value of the interest rate swap reflected an unrealized gain of $507,000 ($309,000 after tax) at September 30, 2004 that is included in equity as part of accumulated other comprehensive income. Assuming market rates remain constant with the rates at September 30, 2004, approximately $67,000 of the $309,000 gain included in accumulated other comprehensive income is expected to be recognized in earnings as a reduction of interest expense over the next twelve months.

At September 30, 2004 the outstanding balance on the Revolving Credit Facility was $52.5 million and the weighted-average interest rate on the outstanding borrowings under this facility was 3.08%. Equal quarterly payments of $2.5 million plus interest are due on the facility until its final maturity in April 2009.

	24

The Company has financed the acquisition of Caggiati S.p.A and several acquisitions by Caggiati S.p.A. through loans with various Italian banks. Outstanding borrowings on these loans totaled U.S.$14.3 million at September 30, 2004. Caggiati also has four lines of credit totaling approximately U.S.$13.4 million with the same Italian banks. Outstanding borrowings on these lines were U.S.$3.4 million and U.S.$3.6 million at September 30, 2004 and 2003, respectively. The weighted-average interest rate on these borrowings, which are collateralized by certain trade accounts receivable, was 3.6% at September 30, 2004.

The Company has a stock repurchase program, which was initiated in 1996. As of September 30, 2004, the Company's Board of Directors had authorized the repurchase of a total of 10,000,000 shares of Matthews’ common stock under the program, of which 7,829,668 shares had been repurchased as of September 30, 2004. 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 $90.9   million at September 30, 2004, compared to $89.7 million and $68.8 million at September 30, 2003 and 2002, respectively. Working capital at September 30, 2004 reflected higher levels of accounts receivable and inventories, primarily due to acquisitions, an increase in current maturities of debt, and higher levels of current liabilities, also primarily the result of acquisitions. Working capital at September 30, 2003 reflected a higher level of cash and cash equivalents compared to September 30, 2002 and a reduction in current liabilities resulting from final payouts to customers under various rebate programs of the York Casket segment.   Cash and cash equivalents were $65.8   million at September 30, 2004, compared to $67.0 million and $57.1 million at September 30, 2003 and 2002, respectively. The Company's current ratio at September 30, 2004 was 1.8, compared to 2.2 and 1.8 at September 30, 2003 and 2002, respectively.

 

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 environmental, health, and safety policies and procedures that include 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, Pennsylvania. At this time, the Company has not been joined in any lawsuit or administrative order related to the site or its clean-up.

At September 30, 2004, an accrual of $11.5 million has been recorded for environmental remediation (of which $912,000 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. Changes in the accrued environmental remediation obligation from the prior fiscal year reflects payments charged against the accrual. While final resolution of these contingencies could result in costs different than current

 

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

accruals, management believes the ultimate outcome will not have a significant effect on the Company's consolidated results of operations or financial position.

ACQUISITIONS:

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 is 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 recent merger of iDL, Inc., a provider of merchandising systems and displays, headquartered near Pittsburgh, PA, and Big Red Rooster, a marketing and design services organization located in Columbus, OH. 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 is designed to expand the Company’s products and services into the merchandising solutions market.

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

In August 2003, Matthews acquired Reproservice Munich, a German graphics and flexographic printing plate manufacturer located in Munich, Germany.  The transaction was structured as a stock purchase, at an acquisition price of 4.1 million Euros (U.S.$4.8 million). The combination of Matthews and Reproservice Munich is an important part of the Matthews strategy to increase its European presence in the graphics industry. Reproservice Munich, a family-owned business with annual sales of approximately U.S.$6.0 million, was established in 1983.  Products and services of Reproservice Munich include pre-press packaging, digital and analog flexographic printing plates, design, art work, lithography and color separation.

In May 1998, Matthews acquired a 50% interest in O.N.E. a digital graphics service company located in Oakland, California. The purchase price consisted of $2.0 million cash upon closing plus an additional $2.75 million in 2001, which was based on the attainment of certain operating performance levels of O.N.E. The purchase agreement also required Matthews to acquire the remaining 50% interest no later than May 2004, with the purchase price contingent on the attainment of certain operating performance levels of O.N.E., but not less than $4.5 million. The accounts of O.N.E. have been included in the consolidated financial statements of Matthews since May 1998 and a liability was recorded for the future minimum payout. Effective July 31, 2003, Matthews completed the purchase of the remaining 50% interest in O.N.E. for $5.7 million.

 The acquisition of York Casket was designed to expand Matthews’ position in the death care industry. York Casket operates as a wholly-owned subsidiary and separate segment of Matthews.

Matthews has accounted for these acquisitions using the purchase method and, accordingly, recorded the acquired assets and liabilities at their estimated fair values at the acquisition dates. The excess of the purchase price over the estimated fair value of the net assets acquired was recorded as goodwill.

DISPOSITIONS:

In July 2003, the Company sold its Graphics Imaging segment facility (which was closed in October 2002) in Southern California for $3.2 million. The transaction resulted in a pre-tax gain of $2.6 million, which was recorded in Special Items on the Consolidated Statement of Income.

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% over the long term. For the past ten fiscal years, the Company has achieved an average annual increase in earnings per share of 16.1%.

Matthews International Corporation 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 (see "Liquidity and Capital Resources").

 

The significant factors impacting the Company’s fiscal 2004 results were the recent acquisitions of Cloverleaf, InTouch and Holjeron and the favorable impact of foreign currency exchange rate changes. In addition, the growth in operating results by the European Graphics businesses exceeded the Company’s expectations and the Company does not currently anticipate similar growth in fiscal 2005. Additionally, the Company remains concerned with the continued high cost of bronze and steel. While fiscal 2004 cost initiatives and productivity improvements mitigated some of this impact, the significantly higher costs will be a challenge in fiscal 2005, particularly in the competitive markets which the Company serves. Finally, the Company is adding a new lower cost casket manufacturing plant in Mexico in fiscal 2005 and the costs associated with this expansion will negatively affect short-term operating results.

Based on anticipated internal growth, the impact of the Company’s recent acquisitions and the factors discussed above, the Company currently 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 Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," of this Annual Report on Form 10-K.

ITEM 7.       MANAGEMENT'S DISCUSSION AND ANALYSIS, continued

The Company's significant accounting policies are included in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. 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 for the year ended September 30, 2004.

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. Under SFAS No. 142, goodwill is no longer amortized, but is subject to periodic review for impairment. 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.

The Company's principal pension plan maintains a substantial portion of its assets in equity securities. Based on an analysis of the historical performance of the plan's assets and consultation with its independent investment advisor, the Company has maintained the long-term rate of return assumption for these assets at 9.0% for purposes of determining pension cost and funded status under SFAS No. 87, "Employers' Accounting for Pensions." The discount rate assumption used in determining the present value of the projected benefit obligation was reduced from 7.0% in fiscal 2002 to 6.5% in fiscal 2003, reflecting a decline in long-term bond rates. The discount rate remained at 6.5% in fiscal 2004.

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.

 

At September 30, 2004, the Company held 342,316 memorials and 225,375 vases in its storage facilities under the pre-need sales program.

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.

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 does not expect to make any significant contributions to its principal retirement plan in fiscal 2005.   The Company estimates that benefit payments to participants under its principal retirement plan (including its supplemental retirement plan) and postretirement benefit payments will be $4.1 million and   $1.0 million, respectively, in fiscal 2005. The amounts are not expected to change materially thereafter. 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.  

 

	29

ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS, continued.

INFLATION:

Inflation has not had a material impact on the Company over the past three years nor is it anticipated to have a material impact for the foreseeable future.

ACCOUNTING PRONOUNCEMENTS:

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation addresses consolidation by business enterprises of variable interest entities with certain characteristics. In December 2003, the FASB revised the interpretation (“FIN 46-R”), which provided for various amendments to FIN 46. The adoption of FIN 46-R during 2004 did not have a material impact on the Company’s consolidated financial position and results of operations.

In December 2003, the FASB issued a revised version of SFAS No. 132 “Employer’s Disclosures about Pensions and Other Postretirement Benefits.” This statement requires additional disclosures about assets, obligations, cash flows and net periodic benefit costs of defined benefit plans and other defined benefit postretirement plans. The disclosure requirements are effective for annual financial statements with fiscal years ending after December 15, 2003 and for interim periods beginning after December 15, 2003. The disclosure requirements of the revised version of SFAS No. 132 have been adopted by the Company.

 

In May 2004, the FASB issued Staff Position No. 106-2 ("FSP 106-2"), "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (the "Act"). The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of post-retirement health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. When adopted, FSP 106-2 will supersede FSP 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which was issued in January 2004 and permitted a sponsor of a post-retirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act until more authoritative guidance on the accounting for the federal subsidy was issued. The Company elected the one-time deferral allowed under FSP 106-1 and, as a result, any measures of the accumulated post-retirement benefit obligation or net periodic post-retirement benefit cost in the financial statements or accompanying notes do not reflect the effects of the Act on post-retirement health care benefit plans. FSP 106-2 provides authoritative guidance on the accounting for the federal subsidy and specifies the disclosure requirements for employers who have adopted FSP 106-2, including those who are unable to determine whether benefits provided under its plan are actuarially equivalent to Medicare Part D. FSP 106-2 was adopted by the Company in the fourth quarter of fiscal 2004, and did not have a material impact on the Company’s consolidated financial position or results of operations.