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Good morning, and welcome to the Veritiv Corporation's First Quarter 2018 Financial Results Call. As a reminder, today's call is being recorded. We will begin with opening remarks and introductions.
At this time, I would like to turn the call over to Tom Morabito, Director of Investor Relations. Mr. Morabito, you may begin.
Thank you, Michelle, and good morning, everyone. Thank you all for joining us. Today, you will hear prepared remarks from Mary Laschinger, our Chairman and Chief Executive Officer; and Steve Smith, our Chief Financial Officer. Afterwards, we will take your questions.
Before we begin, please note that some of the statements made in today's presentation regarding the intentions, beliefs, expectations and/or predictions of the future by the company and/or management are forward-looking. Actual results could differ in a material manner. Additional information that could cause results to differ from those in the forward-looking statements is contained in the company's SEC filings. This includes, but is not limited to, risk factors contained in our 2017 annual report on Form 10-K and in the news release issued this morning, which is posted in the Investor Relations section at veritivcorp.com.
Non-GAAP financial measures are included on our comments today and in the presentation slides. The reconciliation of these non-GAAP measures to the applicable GAAP measures are included at the end of the presentation slides and can also be found in the Investor Relations section of our website.
At this time, I'd like to turn the call over to Mary.
Thanks, Tom. Good morning, everyone. And thank you for joining us today as we review our first quarter financial results, provide some thoughts on important drivers of our expected full year 2018 performance and discuss our guidance for the year. Over the past 2 years, we've been pleased with our improved revenue trajectory, which has been driven by strong top line growth in our Packaging segment and improved performance from Facility Solutions. This quarter, Publishing also achieved positive revenue growth, and the declines in Print were smaller than historical levels.
For the first quarter of 2018, reported net sales were $2.1 billion, up 5.3% when compared to prior year period. Excluding the positive effect of foreign currency exchange rate, our core net sales increased 4.9% from the prior year. Since the beginning of 2017, our year-over-year quarterly core net sales comparisons have been improving due in part to our investments in selling resources, resulting in significant growth in packaging and a positive trend for Facility Solutions' revenues.
The first quarter of 2018 is the third consecutive quarter in which our consolidated core net sales were positive year-over-year. For the first quarter of 2018, we reported consolidated adjusted EBITDA of approximately $30 million, flat year-over-year and in line with our plan. The incremental earnings from our revenue growth were offset by margin compression due to a number of factors, including customer mix and associated contract pricing as well as incremental bad debt. Additionally, due to the integration-related activities, we experienced increased inventory charges and some short-term process inefficiencies, which impacted price management. The planned improvement of processes as we move through the integration will enable us to better manage price increases by the end of 2018.
For the balance of the year, bad debt and inventory charges are not expected to be materially higher than in 2017. In short, we expect our margins to largely recover by year-end as the factors negatively impacting the first quarter result diminish during 2018.
Shifting now to our segment results. Packaging performed very well in the first quarter. Core revenues increased more than 16% quarter-over-quarter with 8% due to the All American Containers acquisition and 8% of organic growth. Approximately 6% of the organic growth came from volume and 2% from price. The volume growth was driven by strength across most of our product categories. Our packaging operations outside the United States also had a strong quarter. For the balance of 2018 in Packaging, we expect to see solid revenue performance and an improvement in adjusted EBITDA when compared to 2017. Overall, we continue to view Packaging as having growth rates higher than GDP, but not as strong as what we experienced in 2017 and in the first quarter because we are expecting to see less benefit from price increases and more modest growth from certain large customers.
Our Facility Solutions segment grew its core revenues 3.6% quarter-over-quarter. Over the past 2 years, we've been pleased with the improving revenue trends for this segment. After the growth rate dipped somewhat in the fourth quarter of 2017 due to challenges in retail, revenues rebounded in the first quarter. This improvement was mostly driven by larger accounts in the building services and hospitality verticals. For the balance of 2018, we currently believe that Facility Solutions revenues will grow at a rate of GDP, with the caveat that we plan to selectively prune some higher risk accounts, mostly in the retail sector. Industry pressures continued to impact revenue with our Print segment, while our Publishing segment had a positive year-over-year revenue comparison.
Print core revenues declined 5.7% in the first quarter, driven by secular declines in both market volume and market price. However, Print's rate of decline improved sequentially from the fourth quarter of 2017. Industry prices have been moving up recently although still not above prior year levels. The Print segment's earnings were negatively impacted this quarter by charges for bad debt, which were in line with our expectation, but higher than last year. During the first quarter, we made significant changes to the Print business model, which I will speak to in a moment.
The Publishing segment's core revenues increased 1.4% although the industry continues to decline. We benefited from our overall customer mix and our customers' spending patterns. For the balance of 2018, we expect the secular industry trends to continue to negatively impact both our Print and Publishing segment revenues and earnings.
Shifting now to our operating system conversions. Another significant multistate conversion was recently completed as planned. For the remainder of 2018, we have 2 additional large-scale conversions schedule. Overall, our operating system conversions will be substantially complete by the end of 2018. We want you to be aware that 2018 is a complicated year due to the systems conversion, warehouse consolidation and warehouse management system installations. As anticipated, these activities are putting short-term strains on our processes and our cost, but are critical to the long-term success of the company.
Before turning to guidance, I'd like to give you an update on the significant changes we made to our Print business model in the first quarter. As you know, the past several years have been challenging for the paper industry. Many of our customers are investing in new technologies or services that do not include paper. The ongoing overcapacity in paper and the resulting pressures on prices have made it very difficult, not just for Veritiv, but for the entire industry.
Recently, the manufacturing base has been -- has more aggressively managed the supply and demand balance, resulting in less capacity, greater price stability and a smaller but stronger group of suppliers. Veritiv is well positioned to take advantage of these industry dynamics, and as part of our optimization element of our long-term strategy, we restructured our Print business model and sales compensation plan to be more flexible to adapt to the secular declines in the industry. The restructuring resulted in fewer resources supporting this segment.
The financial benefits of this restructuring will be realized in the second half of 2018 and in 2019. The changes to the Print business model have been well received by our customers, suppliers and employees as they recognize we are taking the necessary steps to rightsize the Print segment to maintain our leadership position in a difficult environment.
Now I'd like to turn to our expectations for the balance of 2018. In our March earnings call, we indicated that we expected adjusted EBITDA for 2018 of $180 million to $190 million. This expectation is being driven by continued growth in Packaging and Facility Solutions, along with the full year of All American Containers, somewhat offset by continued declines in Print and Publishing, and the negative earnings impact of financing leases becoming operating leases. Based on our first quarter 2018 results, which were in line with our plan and our expectations for the remainder of the year, we remain confident with our full year range of adjusted EBITDA. In addition, we are also reiterating our existing guidance for free cash flow for 2018 of at least $30 million.
Now I'll turn it over to Steve so he can take you through the details of the first quarter financial performance.
Thank you, Mary, and good morning, everyone. Let's first look at the overall results for the quarter ending March 2018. As Mary walked you through earlier, when we speak to core net sales, we are referencing the reported net sales performance, excluding the impact of foreign exchange and adjusting for any day count differences. We had the same number of shipping days in the first quarter of 2018 compared to the first quarter of 2017. I would note that in 2018, we will have 1 additional shipping day in our third quarter, with the other 3 quarters having the same number of days as 2017, resulting in 1 more shipping day in 2018 than in 2017.
For the first quarter of 2018, we had net sales of $2.1 billion, up 5.3% from the prior year period, while core net sales increased 4.9%. As Mary mentioned, our sequential quarterly pattern in core net sales has been steadily improving over the past 2 years, and we are pleased to see a third quarter in a row of positive core net sales. This trend line improvement is in part driven by the investments we are making in growth segment and is occurring despite a cost revenue environment for our Print and Publishing segments.
Our cost of product sold for the quarter was approximately $1.7 billion. Net sales less cost of product sold was $372 million. Net sales less cost of product sold as a percentage of net sales was 17.7%, down 60 basis points from the prior year period. Adjusted EBITDA for the first quarter was $29.7 million, flat versus the prior year period. Adjusted EBITDA as a percentage of net sales for the first quarter was 1.4%, down 10 basis points versus the prior year period. The incremental earnings from our revenue growth were offset by margin compression due to a number of factors, including customer mix and associated contract pricing as well as incremental bad debt. Additionally, due to the integration-related activities, we experienced increased inventory charges and some short-term process inefficiencies, which impacted price management.
Let's now move into the segment results for the quarter ended March 31, 2018. In the first quarter, the Packaging segment grew its net sales 17.1%. Core revenues increased 16.6% quarter-over-quarter, which is much better than the market performance. Excluding the benefit of AAC revenues in the quarter, our organic revenue growth year-over-year was approximately 8%. Of that 8%, approximately 6% of this organic growth came from volume and about 2% from price.
For the first quarter, Packaging contributed $53.6 million in adjusted EBITDA, up about 6% from the prior year period. Adjusted EBITDA as a percentage of net sales was 6.3%, down 70 basis points from the prior year period. In the first quarter, the adjusted EBITDA margins for Packaging was negatively impacted by customer mix and cost increases in resin and delivery.
In the first quarter, Facility Solutions net sales increased 4.5%, while core revenues increased 3.6%. The higher growth categories this quarter were food, service, towel and tissue, can liners, and safety and personal protection supplies. We also saw strength in Canada this quarter, which was principally driven by growth in select large corporate accounts. Facility Solutions contributed $4.1 million in adjusted EBITDA, down about 18% from the prior year period. Adjusted EBITDA as a percentage of net sales decreased 30 basis points in the quarter. The adjusted EBITDA margin decline was primarily driven by a shift in customer mix as well as higher supply chain cost, some of which we expect to recover by the end of the year.
In the first quarter, the Print segment had a 5.4% decline in net sales, and core revenues were off 5.7%. Secular declines in both market pricing and volumes continued to impact this segment sales. Print's volumes declined 3.8% quarter-over-quarter, and price changes accounted for most of the rest of the decline. For the first quarter, Print contributed $13.7 million in adjusted EBITDA, down 2.8% from the prior year period as the earnings impact of the sales decline was partially offset by a reduction in operating expenses.
In the first quarter, the Publishing segment had a 1.8% increase in net sales and a 1.4% increase in core revenues. This increase in revenue was driven by an improved customer mix, slightly offset by a decline in price. The volume increases were most pronounced with our customers in educational books and direct mail. For the first quarter, Publishing contributed $6.8 million in adjusted EBITDA, up 11.5% from the prior year period. The increase in earnings can be attributed to the mix of business and a reduction in operating expenses.
Shifting now to our balance sheet and cash flow. At the end of March, we had drawn approximately $945 million against the asset-based lending facility and had available borrowing capacity of approximately $259 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business. At the end of March, our net debt to adjusted EBITDA leverage ratio was 5.0x, including borrowings for the August 2017 AAC acquisition. Our net leverage ratio had been 5.4x at the end of the third quarter of 2017, right after that AAC acquisition. By year-end 2018, we expect our net leverage ratio to be approaching 4x, and our long-term strategic goal is a net leverage ratio of around 3x.
For the quarter ended March 31, 2018, our cash flow from operations was approximately negative $22 million. Subtracting capital expenditures of about $10 million from cash flow from operations, we generated negative free cash flow of approximately $31 million. If we add back just over $20 million of cash items from acquisition, integration and restructuring activities, adjusted free cash flow for the first quarter would have been approximately negative $11 million.
While negative, our first quarter free cash flow was improved from last year's first quarter. Free cash flow was favorably impacted primarily by a reduction in our inventory balances in both Facility Solutions and Print segments. We also experienced a small reduction in our accounts receivable versus year-end 2017 driven by our Print segment. As a reminder, our working capital pattern can be seasonal. Seasonality also plays a role in our overall adjusted EBITDA performance as our first quarter results are usually the lightest and our fourth quarter usually the strongest. We would generally expect this year to pace at a similar pattern to 2017, but we would note that bad debt expense can have an impact that could distort our historic quarterly seasonality.
For your information, bad debt expense last year was about $16 million, and we expect a similar amount for 2018, but more evenly spaced throughout the year. As Mary mentioned, we expect at least $30 million of free cash flow for 2018, defined as cash flow from operations less capital expenditures. Part of this expectation is driven by our plans to improve our accounts receivable metrics for the remainder of the year.
We have 2 types of integration costs. There are those costs that run through the income statement directly and those that are within capital expenditures. Onetime integration and restructuring costs expected to run through the income statement for 2018 will be between $40 million and $50 million. We expect capital expenditures related to integration and restructuring projects to be in the range of $10 million to $20 million, which will help enable efficiencies in 2018 and beyond. Similar to prior years, this incremental capital spending is principally for information systems integration.
For 2018, our ordinary course capital expenditures are expected to be approximately $20 million to $30 million. For comparison purposes, capital expenditures totaled $10 million for our first quarter. Of that spending, there was about $6 million related to integration projects.
So that concludes our prepared remarks. Michelle, we are now ready to take questions.
[Operator Instructions] Your first question comes from Scott Gaffner from Barclays.
Steve, just a couple of questions on the account receivables. As part of the strategy within Facility Solutions, you mentioned you're walking away from some of these retail customers. First, is there additional accounts receivable at risk there as you walk away from some of those customers? And can you talk about why you believe your accounts receivables are going to improve as you move through the rest of the year?
Sure. So first of all, as it relates to the first question, Scott, we are -- as we work with our retail partners, we do not expect any incremental accounts receivable risk in our choices that would necessarily be applied and the exchanges we make. Secondly, as it relates to the balance of the year, we have a number of integration-related activities particularly our system conversions for the integration where we moved massive amount of data and they migrated from one system to the next. Unfortunately, at the same time, we had a number of price changes occurring within our business units. And that pressure on our billing systems caused some inefficiencies. That will improve as these integration activities fall away in the second half of this year and into '19 as well, and that will help improve our AR profile.
Okay. And as we think about the full year guidance, I mean, obviously you kept most of the metrics the same as they were before, but some of the commentary at least to the first quarter sounded like there's maybe a few more headwinds than you anticipated when you gave the guidance the last time. Is that fair? Or are we just reading the commentary wrong?
No, Scott. I would say that you're reading the commentary probably not quite right. We're about exactly where we thought we would be, recognizing the challenges we did have with the integration that heavily into but completing this year. So we felt -- we continue to feel like we planned appropriately and are right where we expected to be.
Okay, last question for me. When you look at the Packaging volumes, you noted that you thought -- I mean obviously 6% is extremely strong volume figure in the quarter, but you noted they might moderate as we move through the year, can you talk a little bit about what's driving the moderation in Packaging volumes?
Sure. And so we had, as you saw, the 8% organic growth. 6% of that was volume, 2% was price. We see a couple of things occurring between now and the balance of the year. First of all, as compared to prior year, there's going to be less impact of price increases just as because we are rolling on to the price increases that went into place last year. So it's more about year-over-year comps, and we're not anticipating the same level of price increase activity as we saw in 2/3 of last year. So that, by its very nature, is going to reduce the growth. We also are expecting less strength in our international business. That business, Scott, is very project-driven, and we recognize what projects are in front of us and how they come on and tailor off. And so we're expecting less growth there or more modest growth. And then lastly, as we are, I guess, fine-tuning our account base as well as we -- as you know, we have had a tendency to focus more on growing our large accounts. With that, that business comes very choppy, and we're expecting less of that large account growth coming into play into 2018 versus 2017. So again, still growth but not quite as aggressive as what we've experienced in the last 4 quarters.
I have no further questions in the queue. I turn the call back over to Mary Laschinger for closing remarks.
Well, Scott, thank you for your questions. I feel like we're off to a great start in 2018 with our first quarter results coming in as planned. Packaging and Facility Solutions continued to perform well, and a solid performance from Publishing also helped offset the secular declines in Print. Based on our first quarter results and our outlook for the remainder of the year, we are reiterating our existing full year guidance for adjusted EBITDA and free cash flow. With the integration expected to be substantially complete by the end of 2018, we have now begun the optimization element of our long-term strategy. Key part of that optimization is the recent restructuring we made in our Print business to protect our leadership position and generate better return. Overall, we are pleased with our progress.
Thank you again for joining us today, and we look forward to speaking with you in August when we share our second quarter 2018 results. Have a great day.
Thank you, everyone. This will conclude today's conference call. You may now disconnect.