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Good morning, and welcome to Veritiv Corporation's Second Quarter 2018 Financial Results Conference Call. As a reminder, today's call is being recorded. [Operator Instructions] 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, Leandra. 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 matter. Additional information that could cause results to differ from those in the forward-looking statements is contained in the company's SEC filings. These 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 in 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 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 second quarter financial results, provide some thoughts on the important drivers our expected full year 2018 performance and discuss our guidance for the year. During the second quarter, we once again saw improved revenues driven by strong top line growth in our Packaging segment. Facility Solutions and Publishing achieved positive revenue growth, and the declines in Print were smaller than prior levels. For the second quarter of 2018, reported net sales were $2.2 billion, up 7% when compared to prior year period. Excluding the positive effect of foreign currency exchange rates, our core net sales increased 6.6% from the prior year. Since the beginning of 2017, our year-over-year quarterly core net sales comparisons have been improving due to the investments in Packaging. The second quarter of 2018 is the fourth consecutive quarter in which our consolidated core net sales were positive year-over-year. For the second quarter of 2018, we reported consolidated adjusted EBITDA of approximately $45 million, up 7% year-over-year. The incremental earnings were driven by the revenue growth, and margins were stable compared to the second quarter of 2017. Shifting now to our segment results. Packaging performed very well in the second quarter. Core revenues increased nearly 19% quarter-over-quarter, with 10% coming from organic growth and 9% due to the All American Containers acquisition. Approximately 7% of the organic growth came from volume, and 3% came from price. The volume growth was driven by strength across all major product categories. 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 the first half of 2018 because we are expecting to see less benefit from price increases, more modest growth from certain large customers, and we will lap the incremental revenue benefit from AAC, starting in September. Our Facility Solutions segment grew its core revenues nearly 1% year-over-year. As we mentioned last quarter, we are experiencing slowdown in revenue growth in this segment as we selectively prune some higher-risk accounts. Second quarter revenue was also tempered due to our being more selective with customers that align with our product and service capabilities. Earnings were negatively impacted by both customer mix and operating expenses. For the balance of 2018, we believe Facility Solutions' revenues will grow near the rate of GDP, reduced somewhat as a result of our ongoing effort to limit exposure to higher-risk accounts. Industry pressures continued to impact revenue within the Print segment, although the rate of decline was the lowest it has been in several years. Print core revenues declined 2.6% in the second quarter, driven by continuing secular declines in market volumes partially offset by recent slight price increases. And for the second quarter in a row, Print's rate of decline improved sequentially from the previous quarter. The Print segment's earnings were up 10% year-over-year due to the positive impact of price increases and business model changes, which were partially offset by charges for bad debt. Bad debt continues to be a significant issue for the Print segment, and we are taking proactive actions which may result in lower volumes but should help improve the quality of our customer portfolio. As we shared on our first quarter call, we made significant changes to our Print business model to be more flexible to adapt to the secular declines in the industry. To date, these changes have been well received by customers, suppliers and employees. During the second quarter, we began to see the financial benefits of the Print business model change, primarily in the form of lower selling and administrative expenses. We expect to see further positive benefits in the second half of 2018 and into 2019. For the balance of 2018, we expect the secular industry trends to continue to negatively impact our Print segment's revenue. However, we do expect our earnings to be somewhat stable in this segment as a result of the Print business model change. The Publishing segment's core revenues increased 6.2%. Although industry volumes continued to decline, we benefited from an increase in prices, a favorable mix shift within certain customers and a slight increase in volume. Despite the improvements in revenue, earnings in this segment were down year-over-year due to the competitive nature of the industry. We expect this trend to continue for the second half of the year. Shifting now to our operating system conversions. During the second quarter, another significant multistate conversion was completed as planned. For the remainder of 2018, we have 2 additional large-scale conversions scheduled. Overall, our operating system conversions will be substantially complete by the end of 2018. We would like to remind you that 2018 is a complex year due to the combination of system conversions, warehouse consolidations and warehouse management system installations. As expected and as mentioned in our First Quarter Earnings Call, these 3 major programs are putting short-term pressures on our processes and our costs, but we continue to see improvement as we wrap up integration and proceed to the optimization element of our long-term strategy. The optimization is underway with the previously mentioned benefits from the Print business model change already being realized by the company during the second quarter. Now I'd like to turn to our expectations for the balance of 2018. For the full year of 2018, we continue to expect our adjusted EBITDA to be in the range of $100 million (sic) [ $180 million ] to $190 million. This expectation is being driven by continued earnings growth in Packaging, along with a full year of All American Containers, somewhat offset by a decline in Publishing, risk of bad debt as well as the negative earnings impact of financing leases becoming operating leases. Based on our first half results and our expectations for the remainder of the year, we remain confident in our full year guidance range of adjusted EBITDA. We are also reiterating our 2018 free cash flow guidance of at least $30 million. Achieving this target will require improvement in accounts receivable, partially offset by higher working capital to support Packaging growth. Now I'll turn it over to Steve so he can take you through the details of our second quarter financial performance.
Thank you, Mary. And good morning, everyone. Let's first look at the overall resorts -- results for the quarter ending June 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 second quarter of 2018 compared to the second quarter of 2017. I would note that in 2018, we will have 1 additional shipping day in the 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 second quarter 2018, we had net sales of $2.2 billion, up 7% from the prior year period, while core net sales increased 6.6%. As Mary mentioned, we were pleased to see a fourth quarter in a row of positive core net sales. This trend line improvement is being driven by the investments we are making in Packaging as well as recent improvements in the revenue trajectory of our Print and Publishing segments. Our cost of products sold for the quarter was approximately $1.8 billion. Net sales, less cost of products sold, was $383 million. Net sales, less cost of products sold, as a percentage of net sales was 17.7%, down 50 basis points from the prior year period. Adjusted EBITDA for the second quarter was $45.4 million, up 6.8% versus the prior year period. Adjusted EBITDA as a percentage of net sales for the second quarter was 2.1%, flat versus the prior year period. The incremental earnings from our revenue growth were partially offset by margin compression due to a number of factors, including customer mix and incremental bad debt. Let's now move into the segment results for the quarter ended June 30, 2018. In the second quarter, the Packaging segment grew its net sales 19.1%. Core revenues increased 18.7% quarter-over-quarter. Excluding the benefit of AAC revenues in the quarter, our organic revenue growth year-over-year was approximately 10%, which is much better than the market performance. Approximately 7% of our organic growth came from volume, and about 3% from price. For the second quarter, Packaging contributed $64.4 million in adjusted EBITDA, up about 19% from the prior year period. Adjusted EBITDA as a percentage of net sales was 7.3%, consistent with the prior year period. In the second quarter, adjusted EBITDA margin was flat to prior year, as earnings from increased revenues were offset by a combination of customer mix and higher resin costs. In the second quarter, Facility Solutions net sales increased 1.6%, while core revenues increased 0.8%. The higher-growth categories this quarter were food service, can liners, 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 $7.6 million in adjusted EBITDA, down about 22% from the prior year period. Adjusted EBITDA as a percentage of net sales decreased 70 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 costs. These additional expenses were partially offset by reductions in both variable and fixed selling costs. In the second quarter, the Print segment had 2.3% decline in net sales, and the core revenues were down 2.6%. The revenue performance was driven by secular declines in market volumes, partially offset by slight increases in market pricing. Print volumes declined approximately 4% quarter-over-quarter, while pricing increased roughly 1%. For the second quarter, Print contributed $19.4 million in adjusted EBITDA, up 10.2% from the prior year period as the earnings impact of the sales decline was more than offset by a reduction in selling and administrative expenses largely stemming from the recent Print business model changes. In the second quarter, the Publishing segment had a 6.4% increase in net sales and a 6.2% increase in core revenues. This increase in revenue was primarily driven by an increase in prices. For the second quarter, Publishing contributed $4.8 million in adjusted EBITDA, down 20% from the prior year period. The decrease in earnings can be attributed to the increase in cost of products sold, offset slightly by a reduction in operating expenses. Shifting now to our balance sheet and cash flow. At the end of June, we had drawn approximately $927 million against our asset-based lending facility and had available borrowing capacity of approximately $273 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business. At the end of June, our net debt-to-adjusted EBITDA leverage ratio was 4.8x. By year-end 2018, we expect our net leverage ratio to be approximately 4x. And our long-term strategic goal is a net leverage ratio of around 3x. For the quarter ended June 2018, our cash flow from operations was approximately $30 million. Subtracting capital expenditures of about $12 million from cash flow from operations, we generated free cash flow of approximately $18 million. If we add back just over $23 million of cash items from acquisition, integration and restructuring activities, our adjusted free cash flow for the second quarter would have been approximately $41 million. Our second quarter free cash flow was approximately $10 million lower than last year's second quarter. As a reminder, our working capital can be seasonal. Seasonality also plays a role in our overall adjusted EBITDA performance, as our first quarter results are usually the lowest and the fourth quarter usually the highest. We generally expect this year's adjusted EBITDA pattern to be similar to 2017, with approximately 60% of our full year earnings in the second half, but we note that bad debt expense can have an impact that could distort our quarterly seasonality. Bad debt expense last year was about $16 million, with about $12 million of that $16 million occurring in the second half of 2017. As Mary mentioned, for 2018, we expect at least $30 million of free cash flow, 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. However, the growth we are experiencing in Packaging could offset some of these anticipated improvements. 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 $12 million for the second quarter, and of that spending, there was about $6 million related to the integration projects. So that concludes our prepared remarks. Leandra, we are now ready to take questions.
[Operator Instructions]
And Leandra, while we're waiting, I want to confirm a statement I made. I wanted to confirm what I meant to say about reaffirming guidance is that we are reaffirming adjusted EBITDA guidance of $180 million to $190 million of adjusted EBITDA. And we're ready for questions.
Your first question comes from the line of John Babcock with Bank of America Merrill Lynch.
I just wanted to start out on the topic of bad debt expense. You mentioned that it was $16 million last year, including $12 million in the second half. I was just wondering what it was in the first half of 2018 and if you have expectations that you can lay out for the second half of this year.
Sure, John. It...
Go ahead.
Yes. The first half of this year was $10.4 million, with $6.8 million in the second quarter and $3.6 million in the first quarter. And our expectations are that we will be closing the gap on the delta quarter-over-quarter versus last year in our second half of '18 because, in the second half, we had -- of '17, we had about $8 million in the third quarter and just over $4 million in the fourth quarter. So the -- while elevated, the delta to the prior year second half should be less than the first half of this year.
Okay, that's helpful. And then the next question I had was just on pricing. You mentioned, I think, it was about 3% in the Packaging segment. And I wanted to get a sense for how much that was in Print and Publishing.
So John, yes, it was about 3% in package, on our core base revenues. We do not have any price in our Facility Solutions business. In our Print business it was about 1%, and in our Publishing business it was about 5%.
Okay, that's helpful. And then next I was wondering on inflation; and how you're thinking about that now versus how you were thinking about it at the end of 1Q; and whether or not those have changed materially, particularly in certain areas like transportation where we've heard of ongoing cost increases there.
Yes. So we continue to see, just like the rest of the market is, inflation impacting the business. I guess I'd say a couple of things. We do look for opportunities to manage that or where it seems appropriate. For example, we're more aggressively dealing with our third-party freight. We're using less third-party freight. It's going to have less of an impact on us in the second half of the year as a result of that. And we also have inflation factors in our business in terms of, if fuel costs go up to a certain level, it triggers surcharges. And so we are and continue to look for opportunities to manage inflation in the business.
Okay, and nothing out of the ordinary in other areas like labor.
We see that has been fairly stable in terms of what it's been over the course of the last few years, in the range of a couple of percent. And that's currently what we are experiencing.
Okay. And then the next question I had was on the logistics solutions business. Realizing this is a relatively a small part of the whole, but it looks like sales were down year-over-year. And I was wondering if there's anything we should take note of there.
Yes. So it is -- that is correct. Revenues are down year-over-year. It's -- I think, the first quarter we've printed that. What we're doing there, John, is we are working the portfolio. Given the supply-demand balance with freight, and this is a brokerage business, it becomes more challenging to find the right opportunities to make money. And so we've gotten more selective on lanes that we're going to -- that we're supporting, but as a result of that, our earnings are actually up year-over-year. So although our revenues are down for the quarter, our earnings are actually up.
Okay, appreciate that. And then just the last question was just -- I wanted to get a sense for really the greatest risk you see from the ongoing trade tensions between China and the U.S., whether direct or indirect, on your business.
Yes. With China, we have limited exposure relative to the size of the business. We -- the primary product categories that we're importing in -- from China into the U.S. is glass. And our plans at this point, like what we're doing with Canada, is to pass those cost increases along into pricing with our customers. And so that's our expectation and plan as of now. So it's a overall limited exposure, but what -- where we do have it, depending on what does actually occur, our intentions are to pass those cost increases along to customers.
Your next question comes from the line of Scott Gaffner with Barclays.
This is actually John Dunigan sitting on for Scott. So I first had a question, Mary, based on your comment in the earnings release this morning. You had noted that the consolidated margins had improved sequentially but you still see room for improvement. Was that more targeted towards the 2Q results? Or do you have better expectations for margins going into the second half of the year?
So we would expect to see some modest, slight continued margin improvement over the balance of the year on a consolidated basis. And that's being driven by a number of factors, with the benefit of the AAC acquisition; as well as we continue to see a positive shift, mix shift, within our portfolio of higher-margin packaging business; as well as we'll continue to see benefits from the Print model change all impacting the margins modestly as we continue through the year on aggregate...
And just -- okay. And just on that topic of the optimization you had been making and that was evident in this quarter in the Print business. Is that expectation going to continue moving forward, that margins will continue to improve year-over-year for the Print business as you've already been making these changes, these investments?
Yes, yes, John. We would expect the margins to improve as a result of continued positive price momentum as well as lower selling and administrative costs as a result of the business model changes. However, I also need to point out we do have the continued challenges of bad debt. In spite of that, we would expect to see something similar, in the latter half of the year, to what we experienced in the second quarter.
Okay. And then moving to Facility Solutions: You had called out that there was still some customer pruning going on. Is that expected to continue throughout the year? Or is there a time that you could see this kind of coming to an end or start to be lapped and you can see a bit more of the benefits in the margin percentage going forward?
Yes, so let me be clear about what we're pruning here and how we're thinking about the business. So we're looking at the higher-risk credit quality accounts that a lot of times fall into the retail space. You recognize the challenges that are going on in retail. And so we're making some of those choice to limit that risk. We're also being more selective on what new business we're taking on, that is more in alignment with our supply chain capabilities. So that's putting pressure on growth, where we had growth over the course of last year that was in the 3% to 4% range. We're -- we'll probably see something less than that this year, although we still are anticipating growth. From a margin standpoint, we did have pressures in margin. And what we're anticipating is that we'll have some continued pressures for the balance of the year due to the customer mix changes, where we've got higher -- larger accounts with less -- lower margin percentage in those accounts but better-quality accounts. And we also are having some operating expenses that are hitting the business as a result of integration. So we would expect to see some similar-type performance for the balance of the year, with maybe some modest improvement, but as we look into '19 and beyond, we would expect that business to be at a turning point.
Okay. And then Steve, you had mentioned that the -- also in the earnings release that the system conversions and warehouse consolidations have gone relatively well. Is there anything that you've seen that could have gone better or haven't met your expectations?
Yes. So first of all, recognize the complexity of doing all 3 of those things at a given time, in -- within a given time period, at the same time period. I think the area where we would have liked to have seen maybe slightly better execution is just making sure we -- as we've gotten into conversions of larger customers, in particular in our Packaging space, that had special requirements around billing, it caused us some delays on billing and collections that have impacted our accounts receivable. So it's about process changes and with some of these larger accounts, they're not high-risk accounts, but that would be an area where I called out that we wish that things were a little stronger there. But part of that too was the complexity of we were not only going through the systems conversions but we were also managing price and cost changes at the same time. So it's been more challenging in a -- how should I say it, a nonstable data environment that has caused us to pause and has created a few more challenges than we would have liked. So it's like the perfect storm of a lot of cost increases, a lot of price increases while we're doing conversions.
Okay. And that kind of brings me to my last question. As you had mentioned, the -- to hit the $30 million free cash flow target requires an improvement in those accounts receivable, but that's also being partially set -- offset by the working capital needs for Packaging. I -- for the full year, is the expectation still in that 0 to $10 million range for total working capital? I guess there's still half a year left with a lot of conversions that will happen, but is that still the expectation thus far?
Steve?
It is. Year-to-date, the net working capital is up a couple million dollars. And the outperformance of this year's first half versus last year's first half is about $12 million. If you were to double that, clearly that would be $24 million. And last year, we printed about $4 million as a full year free cash flow. So the $4 million of last year plus roughly the $24 million of outperformance, assuming we do achieve the metric improvement we're anticipating in accounts receivable, will put us right around $30 million, with some of that provided by working capital.
Your next question comes from the line of Keith Hughes with SunTrust.
Two questions. First, you've discussed the Print. The declines were less. I know there's probably some pricing in there, but is lower declines, you think, going to be consistent in the future as you kind of get down to a core customer base? Or is it just too hard to predict in the future what this is going to look like?
Well, I will be the first one to admit, Kurt -- Keith. And you've been around that business for a long time too. It's very -- it is unpredictable. However, we are continuing to see strengthening on the pricing front. And volumes have been consistent with historical, the last couple of years of declines in the range of about 5% to 6% in most categories. And so what we're starting to see is that volume decline continuing in that range and then -- but we're getting positive impact of pricing, which we think will continue to get slightly better. The reason for that is because, if you look at the makeup of what's in that, those product categories, uncoated freesheet pricing has been going up, but it's just now at a point where it's slightly above the bottom that it hit from a year ago. And so we believe there is more upside there. And then on the coated front, pricing has been going up but against -- and it has been above prior year lows, but supply-demand balance remains quite tight. And mills do have companies on allocation. So continued volume decline. We think there's continued positive price momentum.
So that -- in that scenario you still would be able to grow margins like we saw in this quarter, as long as those variables stay in place. Is that fair to say?
We would be able to grow margins, as long as we don't have significant issue with a bad debt that we're not anticipating. And we have been quite aggressive in managing that portfolio, but again sometimes it is unpredictable. But we feel like we do have our arms around it.
Okay. And then Facility Solutions, you discussed some customer rationalization. Is that the primary reason for what happened in EBITDA, decline in EBITDA in the quarter?
Well, I think it's a combination of that. Plus, we've got the customer mix challenge that, with the change of customer mix, we're growing the higher -- the larger, higher-volume customers with slightly lower margins, but we also continue to have some operating expenses. They're rolling into this as a result of integration. We still don't have stable supply chain capabilities around our hub and spoke. We're still moving products around, and this business in particular is hit by that. So it's a combination of those factors.
There are no further questions at this time. We'll now turn the call back over to Mary Laschinger for closing remarks.
Well, thank you, everyone, for your questions. Overall, we are pleased with our second quarter results. With the integration expected to be substantially complete by the end of the year, we are now moving on to the optimization element of our long-term strategy. We still have a complicated set of initiatives underway between now and the end of the year. And even these complex operational activities -- even with these, we are committed to achieving our financial targets for 2018, with guidance of adjusted EBITDA of $180 million to $190 million and at least $30 million in free cash flow. Thank you again for joining us today, and we look forward to speaking with you in November when we share our third quarter results. Thank you. Have a great day.
And this concludes today's conference call. You may now disconnect.