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Good morning and welcome to the Veritiv Corporation's Third Quarter 2018 Financial Results Conference Call. As a reminder, today's call is being recorded. We will begin with opening remarks and introduction.
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, Jody, 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 in our comments today and in the presentation slides. A reconciliation of these non-GAAP measures to the applicable U.S. GAAP measures are included at the end of the presentation slides and can also be found in the Investor Relations section of our Web site.
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 third quarter financial results and provide an update on some of the important drivers of our full-year outlook. We will also offer some initial thoughts on 2019. During the third quarter, we once again saw improved revenues driven by top line growth in our Packaging segment.
Publishing also achieved positive revenue growth while our Facility Solutions and Print segments both experienced revenue decline. Reported net sales for the third quarter were $2.2 billion, up 3.6% compared to the prior-year period. Excluding the negative effect of foreign currency exchange rate and the positive effect of one more shipping day, our core net sales increased 2.3% from prior year.
Consolidated adjusted EBITDA was approximately $53 million, up nearly 20% year-over-year. The incremental earnings were driven by the revenue growth as well as lower operating expenses when compared to the prior-year period.
Shifting now to our segment results, packaging once again performed very well in the third quarter. Core revenues were up 11% year-over-year with 5% coming from organic growth which was driven by strengths across all major product categories, and 6% from the All American Containers acquisition.
One year into the AAC acquisition, we are pleased with the business. It is performing as expected. And it has steadily improved throughout the year. For the balance of 2018 in Packaging, we expect to see solid revenue performance. Overall, we continue to view Packaging as having a higher growth rate than GDP but not as strong as we experienced in the first nine months of 2018.
This slowdown in growth is because we are expecting to see less benefit from price increases, more modest growth with certain large customers and we will lap the incremental revenue benefit from AAC which is acquired in August of 2017. For Packaging in 2019, we currently expect a continuation of a growth rate higher than GDP but not as robust as 2018 due to the same factors just mentioned regarding the fourth quarter expectation.
Our Facility Solutions segment saw a decline in third quarter core revenues of 3.4% year-over-year. As we mentioned in the previous two quarters, we are experiencing a slowdown in revenue growth in this increasingly competitive segment as we prune some higher-risk accounts and as we continue to be selective with customers that align with our product and service capability.
These choices also have had an adverse effect on our adjusted EBITDA in the third quarter. For the fourth quarter 2018, we believe Facility Solutions revenues will be relatively flat to prior year due to the choices just mentioned. We also expect to see a reduction in year-over-year adjusted EBITDA similar to the level of decline that we experienced in the third quarter's comparison.
For 2019, we expect Facility Solutions revenue trend to be between flat and a GDP type growth. Industry pressures continued to affect our Print segment revenue. Print core revenues declined 6% in the third quarter, driven by continuing secular declines in market volume somewhat offset by increasing prices.
The Print's segment's adjusted EBITDA was up nearly 11% year-over-year due to the positive impact of price increases and business model changes. Bad debt continues to be a significant issue for the Print. We are making choices to manage risk which has and may continue to result in lower volumes, but should help improve the quality of our customer portfolio. And over time, reduce earnings volatility.
The goal for this segment is to achieve sustained profitable and healthy free cash flow. For the balance of 2018, we expect the secular industry trends to continue to negatively impact our Print segment's revenue. However, we expect the Print business restructuring announced earlier this year to contribute to earnings in the fourth quarter.
Next year for Print, we could also see worse than market volume decline as we continue to make adjustments to our customer base and product offering. In addition after seeing price increases in the second half of 2018, we expect pricing for some paper grade to stabilize in 2019. We also believe that earnings could be negatively impacted by incremental year-over-year bad debt charges.
Finally, we expect that Print business restructuring to contribute to earnings into 2019. The Publishing segment's core revenues increased 6.6%. Although industry volumes continued to decline, we benefited from an increase in prices and a favorable mix shift within certain customers. Earnings in this segment were up slightly year-over-year. For the remainder of 2018, we expect to see a slowdown in price increases.
For 2019, we are expecting a more stable environment for Publishing with volumes consistent with industry decline and prices moderating. However, as we have noted in the past, this business can be impacted by changes in customer order patterns.
Shifting now to our operating system's conversions, during the third quarter, yet another significant multi-state conversion was completed as planned. For the remainder of 2018, we have our sixth and final large scale conversion schedule. Overall, our operating system conversion will be substantially complete by yearend. We would like to remind you that 2018 has been a complex year due to the combination of system's conversions, warehouse consolidation, and warehouse management system installation.
As mentioned on previous earnings calls, these three major programs are putting short-term pressures on processes and our cost. As we finish the integration, we are well-positioned to focus on the optimization element of our long-term strategy which began this year with the print business model changes. Now I would like to turn to our consolidated expectations for the balance of the year.
For the full-year 2018, we continue to expect adjusted EBITDA to be within the range of $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 declines in our other segment, charges for bad debt, and a negative impact of some financing leases becoming operating expenses. While adjusted EBITDA remains on track, we are updating our guidance for 2018 free cash flow from our previously stated level of at least $30 million.
We are now expecting 2018 free cash flow to be near zero, largely driven by higher than anticipated accounts receivable. The elevated levels of accounts receivable is due to both growth within our Packaging segment and process-related challenges from our integration. We currently anticipate this process challenges will be reduced in 2019 as our systems integration is completed this year.
I would now like to offer some early thoughts on our 2019 expectations. For 2019, we currently expect adjusted EBITDA to improve over 2018. This improvement is driven by continued growth in packaging, our focus on improving margins, and additional benefits seen from the print business model restructuring. We also expect to see an inflection point in our free cash flow performance in 2019 as the integration will be largely behind us and we can focus on improving the business processes that impact accounts receivable. As we do each year we will offer more detailed 2019 guidance when we report our fourth quarter and full-year 2018 results next year.
Now I'll turn it over to Steve, so he can take you through the details of our third quarter financial performance.
Thank you, Mary, and good morning everyone. Let's first look at the overall results for the quarter ending September of 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 one more shipping day in the third quarter of 2018 compared to the third quarter of 2017. I would note that for the other three quarters of 2018, it will have the same number of days as 2017 resulting in net one more shipping day 2018 than in 2017.
For the third quarter of 2018, we had net sales of $2.2 billion up 3.6% from the prior year while core net sales increased 2.3%. Our cost of products sold for the quarter was approximately $1.8 billion net sales less cost of product sold was $387 million. Net sales less cost of products sold as a percentage of net sales was 17.6% down 40 basis points from the prior year period.
Adjusted EBITDA for the third quarter was $52.7 million up 19.5% versus the prior year period. Adjusted EBITDA as a percentage of net sales for the third quarter was 2.4% up 30 basis points versus the prior year period. The incremental earnings were driven by revenue growth operating efficiencies in the supply chain and less headcount related expense. Let's not move into the second result for the quarter ended September 30, 2018. In the third quarter the Packaging segment through with net sales 12.5%, core revenues increased 11% year-over-year.
Excluding the benefit of AAC revenues in the quarter, our organic revenue growth year-over-year was approximately 5% percent which we believe is better than the market performance. For the third quarter packaging contributed about $64 million in adjusted EBITDA up about 3% from the prior year period. Adjusted EBITDA as a percentage of net sales was 7.1% down 70 basis points from the prior year period as earnings from increased revenues were partially offset by a combination of higher resin costs, higher storage costs and customer and product mix.
In the third quarter, Facility Solutions and at sales decreased 2.7%, while core revenues decreased 3.4%. As Mary mentioned we are experiencing a slowdown in revenue growth in this increasingly competitive segment as we pruned some higher risk accounts and continue to be selective with customers that better aligned to our product and service capabilities. We are also seeing growth in parts of this business where we have competitive strengths. Facility Solutions contribute $8.1 million in adjusted EBITDA down about 21% from the prior year period.
Adjusted EBITDA as a percentage of net sales decrease 50 basis points from the prior year. The adjusted EBITDA margin decline was primarily driven by the low revenues and a shift in customer mix partially offset by a reduction in bad debt expense year-over-year and the third quarter of the Print segment had a 4.8% decline in net sales and core revenues were down 6%. The revenue performance was driven by secular declines in market volumes partially offset by increases and market pricing.
Prints volumes declined possibly 10% year-over-year while pricing increased roughly 4%. For the third quarter, print contributed $14.5 million and adjusted EBITDA up 11% from the prior year period as the earnings impact of the sales decline was more than offset by reduction in selling and administrative expenses, largely due to the print business model change that occurred during the first half.
In the third quarter, Publishing segment had an 8.3% increase the net sales and the 6.6% increase in core revenues. This increase in revenue was driven by an increase in prices. For the third quarter publishing contribute $5.6 million and adjusted EBITDA up about 1% from the prior year period. The slight increase in earnings contributed to a reduction in operating expenses. Shifting now to our balance sheet and cash flow, at the end of September we had drawn approximately $966 million against the asset based lending facility and had available borrowing capacity of approximately $262 million.
As a reminder, the ABL facility is backed by the inventory in receivables of the business. At the end of September, our net debt to adjusted EBITDA leverage ratio was 4.8 times. Our long-term strategically continues to be a net leverage ratio for around 3 times. For the quarter and its September 30, of 2018 our cash flow from operations was approximately zero. Subtracting capital expenditures from of about $12 million from the cash flow from operations we generated negative free cash flow of approximately $13 million which was about a $6 million improvement from last year's third quarter.
If we add back the roughly $25 million of cash items due to acquisition, integration and restructuring activities adjusted free cash flow for the third quarter would have been approximately $12 million. We experienced $8 million of bad debt expense in the third quarter, similar to the bad debt of prior year's third quarter, year-to-date bad that has totaled approximately $19 million up $7 million from last year. We are currently anticipating bad debt expense in the fourth quarter of 2018 of approximately $4 million similar to the fourth quarter of 2017, which would bring the 2018 total to about $23 million. As Mary mentioned, we now expect free cash flow to find as cash flow from operations, less capital expenditures to be near as zero for the larger, for the year largely driven by increases in accounts receivable and inventory.
The potential for higher-than-anticipated levels of accounts receivable is due to both growth within our Packaging segment and process-related challenges. Our inventory levels may also be higher than anticipated in our Print and Publishing segments due to some forward buying of certain products to ensure we have adequate availability for our customers. We are working on several initiatives to improve our working capital in the fourth quarter and in 2019. We have two types of integration costs there are those costs that run through the income statement directly and those that are within capital expenditures.
One-time integration restructuring costs expected to run through the income statement for 2018 will be between $40 million and $50 million. We expect to have capital expenditures related to integration and restructuring projects be approximately $20 million which will help enable future efficiencies. 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 about $20 million.
For comparison purposes, capital expenditures totaled $12 million in the third quarter of that spending there was about $8 million related to integration projects.
That concludes our prepared remarks. Jodie, we're now ready to take questions.
[Operator Instructions] We'll pause for just a moment to compile the Q and A roster. Your first question comes from the line of Scott Gaffner of Barclays. Please go ahead.
Good morning, Mary, Steve, this is actually John Dunigan on for Scott, how are you?
Hi, John, good, how are you today?
Good, good. So I first wanted to touch on the free cash flow. Obviously, you mentioned there was a reduction in 2018 particularly from higher accounts receivable, but as some of the processes gets fixed going into 2019, is this really just pushing out the $30 million that you're expecting this year into next year's free cash flow?
We're not giving any guidance on free cash flow for next year at this time, but to more generically answer your question is that our systems integration work will be complete over the course of the next month and with that completion, there are opportunities for - to drive considerable improvement in working capital in general with AR being a specific target for that.
Okay. And with free cash flow now closer to flat for the year, the leverage target was originally 4x for the end of this year, is that - I'd assume that has to be a little bit higher now, but do you have a specific target that you're aiming for the end of this year?
Steve?
Sure. So we will end higher than that 4.0x result of the working capital topic we just discussed, so we'd be in the neighborhood of 4.3x to 4.4x leverage at the end of the year given the current model.
Okay. And then just moving on, I think you said for facility solutions that the - going forward volume sales improvement would be somewhere between flat and GDP, that seems to be a reduction from around GDP growth rate prior, is that mainly due to the continuing pruning of low margin business or is there something else impacting that growth rate?
So we said for the fourth quarter that we're expecting revenues to be roughly flat, but as you look forward into '19, it could be a flat to GDP growth. What we're trying to do in that segment is not just - is not really what we're talking about in terms of lower margin accounts. What we're really trying to do here with that segment is to focus more on improving profitability and we're going at that in a couple of different ways. One is, is we are pruning some what we consider more high risk accounts due to the nature of the business, for example, those accounts that might be in the retail space.
The second initiative we have underway is to be more selective about the accounts that we're taking on that is more aligned with our supply chain because we are seeing our supply chain capabilities because we are seeing increasing competitiveness in some types of deliveries in that segment. So it's a combination of being more selective on who we want to service and grow with as well as managing risk in some parts of that segment.
And then just to clarify on the increased competition that you're seeing in the segment, is that more on pricing or competitors adding services, can you just expand on that a little bit more?
Yes, I think what you see in this markets are in this segment. We try very hard not to compete in the smaller order, smaller delivery space, because that's where you're seeing an increase in competition where - and I'm not going to comment on who's in that space, but that's - and so there is some pricing pressures there as well and so we're taking a more proactive measure around the types of business that we want both in terms of supply chain capabilities as well as product choices to - so that we're not in such a competitive space.
Okay, understood, and just one last one. The diluted share in the quarter, I notice had jumped up quite a bit, can you just, I guess, explain the reason for that and you know, if that's going to be in line with fourth quarter?
So the dilution is driven by the fact that we had a net income where entire quarter's - it was net loss and it would be in a dilutive so that's what you're seeing as the difference.
Okay. Thanks, I'll turn it over.
Your next question comes from the line of Keith Hughes of SunTrust. Please go ahead.
Thank you. So just to switch back to Facility Solutions for a minute for '19, you talked about - zero GDP growth and I think I heard these comments right, should the margins get back on the positive side next year given this customer selectivity you're going through right now?
Keith, we haven't commented on that at this point. What I will say though, directionally, what we're trying to do with that business segment is to focus less on top line growth and more on margin improvement.
Okay. And the - if we switch over to - well, let me step back on that for a minute, is there a certain type or a certain category of products that are causing some of this compression or is it a certain type of customer that's causing the problem?
It's more of certain types of customers that cause the variation in profitability, having to do with supply chain costs as well as competitiveness in terms of alternative sources that they can get the product.
And is online one of the challenges you're dealing with right now, online…
Well, it is, but we tried very hard not to target the small order business. That's not to say we don't have any of that, but again it's about being more selective about what we - the type of business and customers that we serve. But Keith, I think you'll also have noticed that there's been some activity in this space around mergers and acquisitions that have put more strain in this space in general as well as the other distributors that are getting more into this space because they're looking for growth opportunities and so for us it's more about fine-tuning and so for us it's more about fine-tuning where we want to play.
Okay, I guess final question, Packaging is a continuing of nice run here for you in terms of top line. As you look to '19, any reason that would [technical difficulty] from the growth we've seen recently?
Yes, we would expect that the growth in '19 would be less year-over-year for a couple of factors, Keith. One is that we're not anticipating the level of price increases that we saw in '18, because they were quite significant and we're expecting some of that to tail off as supply demand comes into play more in terms of the manufacturing base. So that would be one of the primary drivers and then we also would anticipate that we don't have the benefit of the year-over-year gain of AAC which has an impact on our revenue growth in '18 and more modest growth with some larger customers in the space. So when you add all of that up, we're planning and expecting that we grow at GDP or above, hopefully above GDP in general, but not as high as '18.
Thank you.
And our final question comes from the line of Dan Jacome of Sidoti & Company. Please go ahead.
Hi, good morning, can you touch base on the packaging segment a little more, specifically, the different end markets and any differences in trends you're seeing? I think your play in medical, food and beverage also, fulfillment of course, just wondering if there's any differences across those markets?
Hi, Dan, so we obviously are broad based supplying packaging products but some areas where we spend and we try to focus more is first of all, in the manufacturing space, in general, and that cuts across spaces such as building materials, transportation and equipment as well as general industrial. We've seen fairly strong growth higher than GDP growth in some of those parts on the manufacturing space. We also support and do target fulfillment, and we do some in area providing those companies that are doing e-commerce fulfillment, but we've seen greater growth in the range of 5% to 10% more focused on transportation and warehousing. So supplying those operations because there has been huge growth in that space overall. And then in the food space, we have seen less - more modest growth in food overall as that marketing industry continues to evolve. And so, we have seen some growth in the retail space, but again, less than what we saw both in manufacturing and fulfillment.
Great. Maybe just on the topic food and beverage, how was it exactly evolving did you say?
Well, for us, we tend to focus more on food processing, and we are somewhat in the space of e-commerce food. And so, we do see trends towards more e-commerce food packaged delivery, and we participate in that space as well as continue support in general food processing. We stay less away from the large processed food manufacturing for consumers.
Okay, got it. And then just to go back to Facility Solutions, not to beat a dead horse, but I guess, what's going to be competitive advantage as the market potential we get more challenging, is it going to be just kind of focusing on larger size orders going forward?
No, it's more than that. Where we are gearing our focus for this segment is focusing on those verticals where we can provide a value-added sale with things like in manufacturing principles, and in general, where customers need consultative selling in order to reduce their spend in the space and manage that, and we help them manage that, as well as providing them the products to bite things like bacteria that - and so, it's a broad cut across sectors such as entertainment, large venues for entertainment, theme parks, airports, where we can actually come in and provide solutions for them. And we have technical sellers that do that. Cruise lines are another example; universities. And so it's a more specialized sale that is also focused in more pallet deliveries into larger venues.
Okay, that's very helpful. Are some of these new entrants targeting a specific vertical that you guys participate in…
No. They are not new entrants for us. It's just that we are developing more focus in that space, move away from the more competitive spaces.
Okay. Okay, thank you.
And that concludes our Q&A period for today. I'll now turn the call back over to Mary Laschinger.
Thank you everyone for your questions. Overall, we are pleased with our third quarter results. With the integration expected to be substantially complete by the end of the year, we are now looking ahead to the optimization element of our long-term strategy. In 2018, despite the complicated set of initiatives, we are closed to completing - we do remain on track with our initial adjusted EBITDA guidance provided at the beginning of the year. For 2019, we currently expect to see continued growth in packaging revenues and earnings, and an improvement in consolidated adjusted EBITDA, as well as an inflexion point for free cash flow.
Thank you for joining us today, and we look forward to speaking with you next year as we share our fourth quarter and full-year 2018 results, and give additional details on our 2019 expectations. Thank you everyone, and have a good day.
This concludes today's conference call. You may now disconnect.