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Good morning and welcome to Veritiv Corporation's Third Quarter 2021 Financial Results Conference 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 Scott Palfreeman, Director of Finance and Investor Relations. Mr. Palfreeman, you may begin.
Thank you, Patricia and good morning, everyone. On the call today, you will hear prepared remarks from our CEO, Sal Abbate, followed by our CFO, Steve Smith. After that, we will open the call for 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, risks and other factors described in our 2020 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 website.
I'd now like to turn the call over to Sal.
Thanks, Scott. Good morning, everyone and thank you for joining us. Today, we reported another record quarter for our consolidated results. Continued successful execution of our multiyear strategy, along with improved demand also drove record results in most of our business segments in our third quarter. Strong packaging demand and sales growth across all segments contributed to an 11% increase in consolidated sales in the third quarter compared to prior year. Supplier driven inflationary price increases continued throughout the third quarter and led to year-over-year sales growth for all of our business segments.
Sales and earnings growth in our print and publishing segments were better-than-expected due to both a more efficient operating model and our strategic inventory positions. The combination of strong sales growth, disciplined pass-through of market price increases and the benefits from our 2020 restructuring plan led to record net income of $40 million and diluted earnings per share of $2.54 in the third quarter, nearly double what we reported for the third quarter of last year for both figures.
Third quarter year-to-date, net income was $88 million and diluted earnings per share were $5.4. Our adjusted EBITDA in the third quarter was $94 million, reflecting a $44 million increase, a nearly 90% improvement compared to prior year and more than double compared to the third quarter of 2019. Our adjusted EBITDA margin in the third quarter was 5.3% which reflects a more than 200 basis point improvement over prior year and our highest margin level of any quarter in our history. Adjusted EBITDA margins across our three largest segments also reached record high levels in the third quarter. We are pleased with the earnings improvement and we have seen across organization and we continue to pursue additional opportunities for above-market earnings growth.
Our Packaging segment again achieved record results in the third quarter. Packaging adjusted EBITDA was $107 million which is our first time above $100 million in adjusted EBITDA for any of our segments in a single quarter. We reported Packaging adjusted EBITDA margin of 11% in the third quarter. This marks our 10th consecutive quarter of year-over-year improvement in Packaging adjusted EBITDA margin. Packaging sales grew nearly 15% in the third quarter compared to prior year and were 11% higher than the third quarter of 2019. Third quarter sales growth across our Packaging segment included double-digit growth with all of our key customer sectors and product categories compared to prior year. Sales growth was particularly strong within our consumer electronics, health care and manufacturing customer sectors. Year-to-date, we estimate that roughly half of our sales growth in packaging is related to an increase in volume, while the other half is driven by price. Price was more pronounced in our third quarter sales due to the cumulative impact of supplier driven price increases implemented throughout the year.
Moving now to other key factors impacting our third quarter results. As I just mentioned, we experienced several supplier initiated price increases during the first three quarters of this year. We worked closely with our suppliers and customers to ensure cost and price changes were managed effectively and with proper notice. As a result, our margins have not been negatively impacted by these market-related inflationary factors. Continued demand and constrained supply are expected to support prices at the current levels and we will continue to monitor market conditions and adjust quickly to any future price volatility. We saw wage inflation at a rate consistent with the broader market throughout our supply chain. Staying competitive with wage increases has allowed us to hire and retain employees despite a tight labor market. These and other increases like higher storage and fuel costs were fully offset by efficiency programs and the ongoing benefits of our 2020 restructuring plan. We will continue to look for ways to offset the effects of inflation to minimize the impact on our customers and protect recent improvements in our adjusted EBITDA margin.
Our established portfolio of best-in-class suppliers, coupled with our own trucking fleet and warehouse network, allowed us to maintain historical service levels for most of our customers despite significant constraints in the broader supply chain marketplace. Our record results in the third quarter are a reflection of the commercial discipline and has now become an integral part of how we do business. We also recognize that the current market environment has created challenges for our customers. We remain committed to the needs of our customers and will continue to make the investments necessary to improve the way they interact and do business with Veritiv.
Our employees played a significant role in the company's third quarter performance. Despite a demanding and constrained operating environment, our employees continue to execute our commitments to our customers in new and innovative ways. This year, as part of our pay-for-performance culture, we are expecting to reward employees with additional incentive compensation and recognition of the record performance.
I'll now turn it over to Steve to provide more details on our financial performance for the quarter and an update on our use of capital. I'll then share additional details about our upward revision to guidance for the remainder of the year.
Steve?
Thank you, Sal and good morning, everyone. With Sal having covered consolidated earnings performance, I will provide more details on our segment performance. I will also provide some color on both our balance sheet and cash flow results.
As we review these results, please note that when we speak to core sales, we are referencing the reported net sales performance, excluding the impact of foreign exchange and adjusting for any day count differences. As it relates to day count, we had the same number of shipping days in the third quarter of 2021 as we had in the third quarter of 2020. As a reminder, we had one less shipping day in the first quarter of 2021 than the first quarter of 2020. The fourth quarter this year will have the same number of shipping days as prior year. As a result, full year 2021 will have one less shipping day than 2020.
Packaging's net sales in the third quarter increased 14.5% and core sales were up 13.9% compared to the prior year. Strong demand continued in the third quarter and the favorable impacts of market price increases were even more pronounced in the third quarter of 2021 than in the first half of the year. Demand across our end-use customer sectors continue to be favorable in the third quarter and was particularly robust in our consumer electronics, health care and manufacturing customer sectors. In the third quarter, we reported our best Packaging adjusted EBITDA and adjusted EBITDA margin of any quarter in the company's history. A combination of timely pass-through of market price increases, operational improvements and ongoing benefits of the 2020 restructuring plan drove an adjusted EBITDA margin of 11% in the third quarter of 2021 compared to 10.1% in the third quarter of 2020. A combination of sales growth and adjusted EBITDA margin improvements drove Packaging adjusted EBITDA to $107 million in the third quarter, a 25% increase over prior year.
In our Facility Solutions segment, net sales in the third quarter increased slightly at 0.4%, while core sales decreased 1.2% compared to prior year. Sales of our traditional away-from-home products continue to improve as travel, entertainment and hospitality activities resumed. As expected, sales of our COVID-related categories like personal protective equipment and sanitizers have declined from the temporarily elevated levels experienced last year. The pace of sales recovery in our office life customer sector remained slow in the third quarter. Third quarter adjusted EBITDA in our Facilities Solutions segment was $13.4 million, an increase of 2.3% compared to prior year. Despite the lack of recovery in away-from-home office activity, favorable product mix and our ongoing selling and supply chain efficiency programs drove a record adjusted EBITDA margin of 5.8% which was slightly better than prior year.
Moving now to our Print segment. Net sales in the third quarter for Print increased 5.9% and core sales were up 5.2% compared to prior year due to price and to a lesser degree, volume. This revenue increase over the prior year period was only our second quarter of revenue growth in the last seven years. It followed revenue growth in the second quarter of this year. Demand in the third quarter remained elevated, particularly across coated paper grades. Supplier mill capacity and inventories continue to be constrained which drove market price increases across all major paper grades during the quarter. The combination of sales growth, disciplined pass-through of market price increases and the carryover benefits of our 2020 restructuring plan helped to drive all-time record highs in both adjusted EBITDA and adjusted EBITDA margin for the Print segment in the third quarter. Adjusted EBITDA in the third quarter was $26.6 million, triple the $8.8 million reported in the prior year. Adjusted EBITDA margin increased significantly to 6.9% in the third quarter of 2021 compared to only 2.4% in the third quarter of 2020.
Our Publishing segment reported both net and core sales increases of 25.1% in the third quarter compared to the prior year. The 25% increase was the highest quarterly revenue growth in the segment's history. Elevated demand in our education, books and the advertising customer sectors was the primary driver of the year-over-year increase in sales. Third quarter adjusted EBITDA for publishing was $3.9 million or 11.4% higher than prior year. Publishing adjusted EBITDA margin was 2.6% in the third quarter of 2021 compared to 2.9% in the third quarter of 2020.
Moving now to cash flow. For the quarter ended September 30, 2021, cash flow from operations was approximately $42 million. Subtracting capital expenditures of about $5 million from cash flow from operations, we generated free cash flow of approximately $37 million in the quarter. As a result of our strong earnings performance in the third quarter, we are raising our full year 2021 guidance for free cash flow to be at least $120 million. After removing the onetime impact of the 2020 restructuring plan, we expect our 2021 normalized free cash flow to be roughly $150 million. The 2020 restructuring plan is on budget and is scheduled to be substantially completed this year. At the end of the third quarter, our net debt to adjusted EBITDA leverage ratio, based on trailing 12 months, reached a record low of 1.5x.
Shifting now to capital allocation. We are pleased to report that we completed our $100 million share repurchase program by the end of September. During the course of the program, we repurchased approximately 1.7 million shares at an average price of about $58 per share which reflects an 11% reduction in shares outstanding. In addition to deploying capital for repurchase of our own shares, we continue to make capital investments in the business to drive process efficiencies, organic growth and an improved customer experience. However, some capital projects have been delayed during 2021 due to the market constraints such as the availability of materials and labor. As a result, we now expect full year 2021 capital expenditures to be approximately $25 million or about a $10 million decrease from our originally anticipated levels.
Given our low net leverage, we continue to consider inorganic growth opportunities as well as other uses of capital that will generate incremental shareholder value.
At this time, I'll turn it back to Sal to provide more details on both our market expectations and guidance. Sal?
Thank you, Steve. We will now shift focus to talk about the market dynamics we expect to see for the balance of the year. Our large domestic supplier base sheltered us from the heightened challenges experienced in the international supply chain by many of our competitors. While not immune to the current supply chain challenges, we have been making strategic inventory investments, particularly in Packaging, to help minimize the impact to our customers. However, we do expect broader supply chain constraints to continue in the fourth quarter and first half of next year which could impact product availability and lead times.
As we look to the balance of 2021 for our Packaging segment, we expect market demand to continue to be relatively strong and the supply chain to remain tight due to healthy demand and extended supplier lead times across several product categories. In anticipation of this extended lead time environment, we have intentionally invested in additional inventory to support our customers through the currently constrained environment and to prepare for the seasonal increase in volume expected during the holiday shopping season. While there has been some minor relief in certain areas of the supply chain, limited manufacturing capacity and healthy demand is expected to support pricing at current levels. As a result, the carryover effect of recent price increases should continue into the first half of 2022.
We expect sales in our Facility Solutions segment to continue to improve as travel, entertainment and hospitality activities returned closer to pre-pandemic levels. We anticipate a slow pace of recovery in those products traditionally sold into the office environment. That slow recovery will, we believe, continue for the remainder of 2021 and into at least the first half of 2022. Therefore, we project sales growth for our Facility Solutions segment in 2022 to be in line with the broader away-from-home market.
For our Print segment, we expect the supply of paper in the overall market to remain constrained and therefore demand is expected to outpace supply. We have navigated multiple price increases across all paper grades so far this year and have received notification of an additional price increase impacting some grades that will be implemented during the fourth quarter. Current operating rates and constrained capacity from our Print suppliers are really expected to continue into at least the second quarter of next year. Given our record year-to-date performance as well as our current expectations for the market conditions for the remainder of this year, we are increasing our full year 2021 adjusted EBITDA guidance to a range of $315 million to $330 million. We now expect full year 2021 net income to be in the range of $130 million to $145 million and full year diluted earnings per share to be in the range of $8 to $9.
As Steve mentioned earlier, capital expenditures for the full year are now expected to be around $25 million. As a result of our increased earnings and reduction in capital outlay this year, we are also raising our estimated free cash flow guidance for full year 2021 to be at least $120 million.
This concludes our prepared remarks. Patricia, we are now ready to take questions.
[Operator Instructions] Your first question comes from the line of John Babcock from Bank of America. Your line is open.
Hey, good morning and thanks for taking my questions. I guess just to start out talking about the supply chain and I know you elaborated on this on the call a fair bit but could you just talk about, like, generally the different areas in which that's impacting your business? And also how are you doing in terms of keeping your facilities stocked given these challenges?
John, thanks for the question. This is Sal. It really varies by business segment. I'll start with Packaging but we did make a conscious investment in our Packaging inventory really as far back as the first quarter and we've been building inventory along the way in anticipation of a strong second half. So while I mentioned we're not immune to the supply chain challenges in Packaging, we've had a little bit more protection and relief from actions we took earlier in the year. We do have a little less impact driven by our mainly domestic supply base in Packaging and so while we're experiencing the same constraints in corrugated markets and tapes, we're faring a little bit better in Packaging than in other areas. And of course, the inventory investments are benefiting our customers and that's why our volume growth in the third quarter may look a little stronger than the overall box shipment market expectations or highlights that we saw.
On the -- moving on to Print, I mean, Print is definitely a constrained environment. The capacity that's been taken out of the industry is impacting all of our suppliers and, obviously, ourselves and our competitors. And we do feel like our strategic alignment with a couple of really strong suppliers has helped bully that a little bit for us but we are definitely seeing the price increases outpace the demand -- I'm sorry, the supply and that's creating a tough environment to serve the market. Most suppliers are on allocation and we're faring as best we can within Print. Facility Solutions has not been a problem. Obviously, in the COVID products we've been well stocked. You've seen some adjustments we've made over the year with respect to Facility Solutions and so we feel like we're well positioned to handle the demand in that market. Relative to where we're seeing some constraints, we did see some constraints earlier in the year but particularly maybe heightened in the second quarter versus the third.
In our rigid business, particularly from some of the supply that comes from Asia, that's really where we have the most dependency from an international supply chain but has not prevented us from seeing double-digit growth in those categories as well as those end-use sectors. So now on the bright side, I mean, there is some relief being indicated now by some of our suppliers, particularly in areas like films and resin-based products and that could start to show some ease as early as the first quarter.
Okay, that's very helpful. And then, can you also just talk about where you're seeing the most cost inflation right now and also I don't know if you might be able to help us kind of quantify how that would impact the business on an annual basis?
Yes. I'll give you the kind of the general answers and Steve can give you some of the specifics on the quantitative impact on but we're seeing that -- we've seen multiple price increases in the Packaging environment and that's been steady. That's been -- as you know, John, it's been each and every quarter since last Q4 and so that's sort of been a steady diet of increases that we've been able to pass on in a timely manner. And it is really across almost every product category. In the Print sector, it's been more pronounced in the last two quarters. So we saw escalating prices in Q2 and Q3 and of course, as I mentioned, that's going to continue into Q4. And that is across all grades but more pronounced in the coated paper grades.
Steve, maybe you can give a feel for sort of the overall impact quantitatively.
Sure, Sal. So John, the way to think about it maybe is that we think of product inflation which is the vast majority of our cost, that's roughly 80% of our sales as the biggest concern for inflation. As Sal mentioned, we've been very disciplined about our pass-through of supplier driven price increases. You'll reflect back that in '18 and early '19, we struggled with that as a company and we've significantly improved processes such that those pass-through now are more timely and therefore, our margins aren't suffering. And so in our prepared remarks, we commented on that fact. Separately, a much smaller component for us are labor costs, roughly in the neighborhood of 10% of sales. We have been ahead of that, we've been accruing during this year for incremental incentives to our labor pool and that's been communicated to our colleagues and employees and that's helping us with retention.
It's a -- we try to be employee friendly in many actions we have to reduce those inflationary labor costs and through efficiencies, we've offset the vast majority of that. So we're not passing it through to our customers. And lastly, a small percentage of our cost in neighborhood of 1%, 2%, 3% are fuel and third-party freight. There has been a few million dollars of fuel costs incremental this year over prior and in the quarter a couple of million bucks. But we've been able to, because of our own fleet, offset some of that, again, through efficiencies and optimization of our supply chain. So those are the big three. If you have further questions, we can answer those.
No, I think that's pretty helpful overall in terms of inflation. As far as the different segments, I mean, do you have a sense whether or not you gained share in the quarter? I mean, I think especially like in Print and Publishing, it seemed like your trends there bought to what happened broadly in the marketplace. Obviously, there was some impact from the pricing front but just kind of curious why, I guess, your numbers varied so much from the market overall.
Yes. I mean, John, starting with the Print segment. I think we're keeping up with the market demand and the market volume growth. And of course, we're passing on the price increase, so we're getting some lift from price as well. Recall that we did have -- we did close our Veritiv Express stores last year. So we are comping against that from a volume perspective that does distort the numbers a little bit. And then, of course, the sale of a Rollsource business earlier this year in the first quarter. But when you strip out those two independent dynamics, we actually believe we are pacing a little bit ahead of the market on the volume front and then keeping up with the price increases.
On the Packaging segment, we do believe that our volume is outpacing the broader market. If you look strictly at the FBA box shipments, our volume, as Steve mentioned, would indicate that we outpaced the flatness that the market experienced in the third quarter. I think that's a combination of our strategic choices around end-use sectors and the dynamics within those. So, for example, we did see a higher lift in heavy manufacturing, I think transportation, that was a bit slower last year. So that's helped us outpace the market. Obviously, our focus on value-added services on the front end and then bundling our rigid business with our flexible business has all helped see healthy volume growth along that.
And then lastly, as we mentioned, the investments in inventory, more pronounced in Packaging have helped really meet the anticipated demand and the increased demand. And that's why there might be an imbalance between what we're seeing in terms of mill shipments and our ability to satisfy our unique demand with our customer base.
Okay, that's very helpful. And now as we look ahead to 2022, what are some of the key factors we should be considering in our forecast and then also could you help us understand the benefit you're getting from the pass-through of price increases?
Yes. So really, for most of the businesses, we do anticipate the supply chain constraints and the labor shortages that our suppliers are experiencing to continue at least through the first quarter, most likely into the first half. Now if we maintain the levels that we're at now with respect to volume and price, the first half will be a solid and strong first half of the year. So that's across the board for all of our businesses. On the Packaging front, we do expect healthy demand to continue through 2022, at least from what we're hearing and seeing from our customer base and we do expect in the Facility Solutions side because we haven't talked much about that this morning, some recovery, more recovery than we saw this year in the office like environments and the return to offices and government; clearly not at pre-pandemic levels but certainly stronger than we saw in 2020 and now in 2021.
And Sal, I'll just add to that, John, two items to think about as you're thinking about '22 over '21, there's this whole lapping effect, both the price increases and our restructuring benefits, that aren't fully impacting 2021 so we'll get some carryover benefit in '22 for both of those important factors as it relates to margins. And secondly, free cash flow, free cash flow '22 over '21 should benefit from the lower restructuring cash costs which we incur in 2021. So those are two other things to consider.
Got you. And you may want to comment at all on the impact of the pass-through of the price increases?
Yes. We've seen a little bit of a slowdown or at least we haven't seen anything formally announced for the balance of Q4 and into early Q1. But as Steve just mentioned, we would expect the impact of the second half of 2021 to be a benefit in the first half of 2022 and so we don't see any anticipated changes there. Now we have heard of some rumblings with regard to non-cost of goods sold, the cost increases from our suppliers and as we've mentioned on most of these calls throughout the year, we've put efficiency plans in place. Our 2020 restructuring plan has helped offset those and we have not had to pass those on to our customers. But if we begin to take on cost increases from suppliers that are unrelated to just product costs, that will really trigger a need to look hard at whether or not we need to pass those on to our customers.
Okay, that's great. And then just last question. I was wondering if you can provide kind of the goal for free cash flow bridge.
Sure. So here, you're talking about from adjusted EBITDA down to free cash flow?
Yes.
Okay, very good. So if you say we have $315 million to $330 million of adjusted EBITDA, I'll walk you through the net income and then the cash flow, so two steps. At $315 million to $330 million, let's pick a midpoint of $323 million, John, you'll have five items that will reduce us down to the neighborhood of $135 million, the midpoint of the net income guidance. Those five items are briefly restructuring of about $15 million, depreciation and amortization of about $55 million, interest expense of about $20 million, taxes of about $50 million and then other small bucket of things, mostly LIFO, of about $45 million. So that will bring you down from the midpoint of $323 million to about $338 million of net income. So we guided $130 million to $145 million.
From there, the next step and the second step is just thinking through the add-back of the noncash items. There I mentioned the depreciation and amortization of $55 million. And we also have bad debt expense this year of about $10 million, much reduced from prior years. So that's about $65 million. But we have cash costs of capital expenditures. We guided to an updated number of about $25 million. And then finally, we have working capital use this year of about $40 million. As Sal mentioned, we're investing a little bit, particularly in the inventory for Packaging and that's $65 million. So it so happens just that the add-backs equal the subtractions of cash. So that the sum of $138 million is both a figure for our net income as well as our free cash flow guidance. So we said at least $120 million of free cash flow this year and there's a little bit of upside to that.
Got you. All right. Well, thanks for all the help.
Thank you, John.
And your next question comes from the line of Michael Sesser [ph]. Your line is open.
Hi guys, congrats on a very strong quarter. I want to ask a similar question to one of John's question but just maybe in a different way. So if we -- you obviously had a very strong quarter from an EBITDA perspective, over $93 million. If we were to just take that figure and annualize it, what are the main reasons that would not be the correct way to look at it when thinking about a normalized EBITDA for Veritiv? It sounds like from your remarks that maybe it would just be that this quarter was out of the ordinary from a demand perspective. But is there -- is that correct? Is there anything else that -- is there any other reason it wouldn't be correct just to annualize that $93 million in thinking about normalized EBITDA for Veritiv?
Yes. Michael, this is Sal. Thank you. We normally speak to the seasonal patterns of our adjusted EBITDA in halves because there is some inter-quarter or intra-quarter noise. So what we typically look at is the pattern of H1 versus H2. And as we've mentioned before, even last year where we did expect it to be different, it turned out to be more historically accurate or normal which was about 41%-59%. So we have 41% of our adjusted EBITDA in the first half, 59% second half and that's really the best gauge of -- if you want to take one individual quarter or half and normalize it for the year, that would be the way to look at it.
If you took -- well, Steve, maybe you can answer where historically, that $94 million would be with respect to the seasonal pattern of Q3 and then we can talk about -- I'll come back and comment a little bit about our guidance and what that means and maybe I'll do that now. So our guidance for the year at that $315 million to $330 million would take our normal pattern for Q4 of about, let's just say, 30% of adjusted EBITDA. And if you add that to the full year adjusted EBITDA year-to-date of $227 million, that gets you in that $315 million to $330 million range, somewhere in that midpoint of $322 million to $323 million. And that's where we're coming up with our full year guidance.
Okay, very helpful. Sorry, go ahead.
Just -- I was waiting to see if there are further follow-up questions on that. Go ahead, Michael.
No, I don't have any follow-up questions. That was helpful. But any additional remarks you want to add, that would be great as well.
No, we're fine with that, Michael. Thank you.
Okay, great, thanks. Congrats, again.
Thank you, Michael.
There are no further questions. I would now like to turn the call back to Sal Abbate for closing remarks.
As we conclude today's call, I'd like to highlight the significant contributions of our employees to support the needs of our customers. We recently celebrated appreciation weeks for both our customer experience team and our truck driving team. These teams have remained resilient and steadfast in their commitment to first-class customer experiences. The safety of our employees remains a top priority. Consistent with past trends, we continue to improve on our safety performance metrics and drive a culture of continuous improvement. Thank you, again, to all of our employees for everything you do. For those joining us on the call today, please stay healthy and safe and we look forward to talking with you again early next year when we will review our fourth quarter and full year 2021 results. That concludes the call.
Thank you. And this concludes today's conference all. Thank you all for participating. You may now disconnect.