Veritiv Corporation (NYSE:VRTV) Q3 2019 Results Earnings Conference Call November 5, 2019 10:00 AM ET
Tom Morabito – Director of Investor Relations
Mary Laschinger – Chairman and Chief Executive Officer
Stephen Smith – Senior Vice President and Chief Financial Officer
Conference Call Participants
John Babcock – Bank of America
Good morning and welcome to Veritiv Corporation’s Third Quarter 2019 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’d like to turn the call over to Tom Morabito Director of Investor Relations. Mr. Morabito you may begin.
Thank you Denise and good morning everyone. Thank you all for joining us. Today you’ll 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 2018 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. 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.
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 2019 financial results and provide an update on our full year outlook. Our third quarter results were highlighted by strong free cash flow as well as improved margins and adjusted EBITDA in our Packaging and Facility Solutions segments. However consolidated revenues were well below expectations and declined year-over-year largely due to the ongoing structural decline in our Print and Publishing segments and general market softness in Packaging. Additionally similar to previous quarters some of the revenue decline was planned as we made strategic customer choices in Facility Solutions Print and Publishing in the quarter. Consolidated reported net sales for the third quarter were $1.9 billion down about 12% compared to the prior year period with our core net sales declining 13.5%. All 4 of our segments experienced revenue declines this quarter. Consolidated adjusted EBITDA for the third quarter was $45 million down about 15% year-over-year. The reduction in earnings was largely due to the volume declines in print and publishing somewhat offset by lower cost and margin improvements in Packaging and Facility Solutions. Shifting now to the review of our performance by segment.
Packaging’s adjusted EBITDA in the third quarter increased just over 5% year-over-year. The earnings increase was due to improved margins from customer mix and process improvements in margin management. Packaging core revenues were down 4.5% year-over-year due to changes in customer mix market conditions in the U.S. a slowdown in certain non-U.S. markets and price pressures in some categories. The U.S. market has weakened over the past year with box shipments and sales of resin-based products flat to slightly down year-to-date. For the remainder of 2019 we expect packaging revenues continue to be soft in the fourth quarter and for adjusted EBITDA margins to improve from last year. Moving on to our Facility Solutions segment. As stated in prior quarters we are repositioning this segment for success by continuing to make strategic customer choices to better align with our supply chain strength as well as market product and customer dynamics. These choices have put significant pressure on our top line results with a third quarter decline of 8% in core revenues year-over-year. We believe these choices will result in Facility Solutions being a smaller but more profitable business as demonstrated by our third quarter results. Our adjusted EBITDA increased about 36% year-over-year due to lower supply chain and selling expenses as well as improved margins from our strategic repositioning. And prior quarters, we indicated we were exiting certain retail customers due to supply chain dynamics and credit risks.
During the third quarter we made the decision to exit our US based redistribution business known as soft sell. This business serve smaller distribution companies in the US With a broad array of products and services, oftentimes characterized by smaller orders of non core products, as well as having greater delivery distances. Saalfeld generated approximately 2% of Veritiv’s annual revenue and accounted for about 12% of the Facility Solutions revenue but was less profitable than the rest of the segment. While the exit did not have a material impact on our third quarter results year-over-year revenue comparisons will be affected in the fourth quarter and more so in 2020 where we expect to see a double-digit revenue declines for the segment. For the remainder of 2019. We expect facility solutions revenue to see further decline due to the choices just mentioned. However, we expect to see an improvement in year over year just study that data read by a continuation of the key drivers experienced during the first nine months of the year, but subject to risk of recent revenue trends. Switching to our Print segment. Secular pressures driven by lower demand disintermediation and industry consolidation continued to affect our revenues. Print core revenues declined nearly 23% in the third quarter. Approximately 3/4 of this decline was driven by a combination of market dynamics and certain supplier and customer actions which disproportionately impacted our results. In addition we have been making choices to manage credit risk in our Print segment which may continue to have a negative impact on our volumes. These choices have improved the quality of our accounts receivable portfolio and have significantly reduced bad debt charges. The Print segment’s adjusted EBITDA was down approximately 27% year-over-year due to revenue decline and margin pressure partially offset by lower expenses.
We expect secular industry trends will continue to negatively impact Print’s revenue for the balance of 2019. The print business model changes executed in 2018 along with our ongoing optimization efforts to reduce costs will only partially offset the earnings impact of the volume declines in 2019. Taking all these factors into account we expect print adjusted EBITDA in the fourth quarter of 2019 to be lower than the fourth quarter of 2018. The Publishing segment’s core revenue declines decreased nearly 28% in the third quarter. Similar to Print Publishing was impacted by continued secular declines in market volumes but also was negatively affected by the loss of certain retail accounts some for credit reasons. Adjusted EBITDA in this segment decreased about 18% year-over-year due to the reduction in revenue slightly offset by improved pricing and better cost management. For the fourth quarter of 2019 we expect the segment’s revenues to decline at a slightly greater rate than the previous 2 quarters. We also expect earnings to decline at roughly the same rate as the prior year’s fourth quarter. Turning now to our consolidated 2019 guidance.
The deterioration of the Print and Publishing businesses has been significant. To give you an idea of the effect of this decline has had on our income statement we are forecasting that print and publishing will negatively impact our 2019 gross profit defined as net sales less cost of goods sold by approximately $85 million. The positive effects of optimization efforts will offset the majority of the declines in both print and publishing. Due to these factors for full year 2019 we now expect adjusted EBITDA to be in the range of $150 million to $160 million down from our previous guidance of $165 million to $180 million. A key assumption for reaching this range includes a rate of decline in Print and Publishing segments similar to our third quarter. In the third quarter of 2019 we generated approximately $81 million of free cash flow compared to negative $13 million in the third quarter of 2018. The increase was due to both volume declines as well as successful post integration working capital process improvements which resulted in a meaningful lowering of accounts receivable and inventory. Due to the strong cash flow results year-to-date and a continued focus on post-integration process improvement we are raising our 2019 expectation for free cash flow to at least $170 million up from our previous guidance of at least $85 million.
Given the challenges we have had with our Print and Publishing businesses this year we thought we would briefly update you on our strategy including our optimization initiatives. Previously outlined our strategy — we outlined our strategy to transition the company into higher growth higher-margin business by investing in Packaging and providing value-added services protecting our leadership positions in Facility Solutions Print and Publishing and optimizing our business processes post integration. We are successfully implementing our optimization plans and are ahead of our optimization targets. Our business mix also continues to shift into higher growth and margin business with Packaging and to a lesser extent Facility Solutions. However the structural declines in print and publishing is putting significant near-term pressure on achieving our previously communicated cumulative adjusted EBITDA improvement goal. While we expect to achieve this goal it will likely take longer than originally expected. We will provide a more detailed update on our multiyear optimization guidance when we report 2019 full year earnings next February.
Now I’ll turn it over to Steve so he can take you through the details of the third quarter financial performance.
Thank you Mary and good morning everyone. We will first review the overall results for the third quarter ending September 2019. As we review these results please note that 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. As it relates to day count we had 1 more shipping day in the third quarter of 2019 than we had in the third quarter of 2018. As a reminder we had 1 less shipping day in the first quarter with the second and fourth quarters having the same number of days as in 2018. Consequently we will have the same number of shipping days during 2019 as we had in 2018. Consolidated net sales for the quarter were $1.9 billion down 12% from the prior year period with core net sales down 13.5%. Our cost of products sold for the quarter was approximately $1.6 billion. Net sales less cost of products sold was $374 million. Net sales less cost of products sold as a percentage of net sales was 19.4% up about 180 basis points from the prior year period largely due to improvements in pricing as well as both segment and customer mix.
Consolidated adjusted EBITDA for the third quarter was $45 million down $7.7 million or 14.6% versus the prior year period. Our adjusted EBITDA as a percentage of net sales for the third quarter was 2.3% down 10 basis points versus the prior year period. Consolidated adjusted EBITDA declined approximately $7.7 million year-over-year with a decrease in the Print segment’s earnings driving approximately 1/2 of that decline versus the prior year quarter. In addition there was an increase in our corporate and other expenses as the prior year’s third quarter had an unwind of an incentive compensation plan expense and this year’s third quarter did not have that earnings benefit. Margin management the mix of products sold lower supply chain and back-office costs as well as 1 extra day helped to partially offset these headwinds. Let’s now move into the segment results for the third quarter. Packaging’s net sales and core revenues were down 3.1% and 4.5% respectively due to changes in customer mix market conditions in the U.S. a slowdown in certain non-U.S. markets and price pressures in some categories. Packaging contributed $67.4 million in adjusted EBITDA up $3.4 million or 5.3% year-over-year. Adjusted EBITDA as a percentage of net sales was 7.7% up 60 basis points from the prior year period.
The earnings increase was due to improved margins from our customer mix and process improvements in margin management. Facility Solutions net sales decreased 6.8% while core revenues decreased 8%. The revenue decline in this increasingly competitive segment was due to channel dynamics as well as the fact that we are making customer choices to align to our product and service capabilities. Facility solutions contributed $11 million in adjusted EBITDA up 35.8% year-over-year. Adjusted EBITDA as a percentage of net sales increased 110 basis points from the prior year period. The earnings increase was primarily driven by lower supply chain and selling expenses as well as improved margins from our strategic repositioning. The Print segment experienced a 21.7% decline in net sales and core revenues were down 22.9%. Approximately 3/4 of this decline was driven by a combination of market dynamics and certain supplier and customer actions which disproportionately impacted our results. The ongoing effect of these choices that we’ve made to manage credit risk also impacted the top line. For the third quarter Print contributed $10.6 million in adjusted EBITDA down 27% year-over-year.
The earnings impact of the sales decline and margin pressure was only partially offset by lower expenses. Publishing’s net sales and core revenues decreased 26.5% and 27.6% respectively from the prior year quarter. The lower revenue was due to a reduction in volumes primarily driven by continued secular decline in the industry and the loss of certain retail accounts some for credit reasons. Publishing contributed $4.6 million in adjusted EBITDA down 17.9% year-over-year. The decrease in adjusted EBITDA can be attributed to the reduction in volume slightly offset by improved pricing and cost management. For the entire company we had $4.8 million of bad debt expense in the third quarter down from $8.1 million in the third quarter of 2018. For the second consecutive quarter the Print segment experienced a year-over-year reduction in bad debt expense and on an absolute basis it was Print’s lowest quarterly level in 3 years. Shifting now to our balance sheet and cash flow. At the end of September we had drawn approximately $665 million against the asset-based lending facility and had available borrowing capacity of approximately $354 million. As a reminder the ABL facility is backed by the inventory and receivables of the business. At the end of September our net debt to adjusted EBITDA leverage ratio was 3.6x down from 4.8x in the prior year period. Our long-term strategic goal continues to be a net leverage ratio of around 3x. I would also note that our long-term debt net of current portion on the balance sheet has dropped 27% year-over-year from $998 million to $726 million.
Cash flow from operations for the third quarter was approximately $88 million. Subtracting capital expenditures of about $7 million from cash flow from operations we generated free cash flow of approximately $81 million. If we add back the roughly $11 million of cash items due to acquisition integration and restructuring activities adjusted free cash flow for the quarter would have been approximately $92 million. As anticipated and shared with our annual guidance both our capital expenditures as well as our cash cost for integration and restructuring have declined quarter-over-quarter as well as in the nine-month comparison. Our strong third quarter free cash flow was primarily due to the lowering of both accounts receivable and inventory which combined are down approximately $380 million versus the prior year quarter. Approximately 2/3 of the improvement was enabled by volume reductions. The other 1/3 was the result of process improvements many of which had been enabled by the integration of the last several years and deployed for our optimization initiatives. As a result our cash conversion cycle has improved 4 days versus the prior year quarter. While we are experiencing strong free cash flow year-to-date we do not expect to duplicate this level of performance in 2020. We believe that the annual level of sustainable free cash flow is approximately $50 million to $75 million. This range uses the midpoint of this year’s adjusted EBITDA guidance and assumes no ongoing working capital benefit. While we do not assume any working capital benefits and our sustainable free cash flow guidance we currently anticipate incremental reductions in working capital in 2020. And lastly for 2019 our total capital expenditures are expected to be approximately $45 million.
That concludes our prepared remarks. Denise we are now ready to take questions.
Thank you [Operator Instructions] Your first question comes from John Babcock with Bank of America. Your line is open.
Good morning, Just wanted to start — just on kind of the optimization plans. I was wondering if you could — generally it sounds like everything was going pretty well there but I also want to get a sense for how that has impacted earnings this year and also how we should think about that in 2020.
Good morning, John thank you for being on the call. So going back over a year ago we laid out some optimization initiatives that were broad based around improving margins as well as reducing costs and it has had — we haven’t reported the actual benefit of that this year. It has been significant as you can imagine and — but we do anticipate updating that in the first quarter and we would expect something similar in terms of benefit for 2020. Go ahead. Steve may add to that.
And also John as you think about how it’s impacting us we would tell you that margin improvements have been about 1/3 of the total benefit this year and cost reductions which we could get into at some point have been about 2/3 of the benefit.
Okay. That’s helpful. And then realizing it maybe a little bit early also to think about 2020 earnings guidance and assuming you guys already have plan for that but at least from our vantage point how should we think about the key factors to bridge from 2019 to 2020.
Well I think one of the biggest key factors is how we are looking at our Print business revenues across the board and what we share with you today is we anticipate continuos structural decline in print maybe not to the same degree as what we saw in 2019 Print and Publishing. We already alluded that we would have declines in Facility Solutions due to the exit of our Saalfeld business and as we look at our Packaging business we haven’t given estimates on growth. We do see in the fourth quarter that the outlook could be similar to what we saw year-to-date but we haven’t given specific guidance but that is an area where we are going to continue to focus and grow the business as well as we expect to continue to improve margins in our Packaging business. So it is a combination of making estimates around revenue in the 3 segments in terms of decline growth in Packaging whether it’s revenue or margin growth. We will also have margin improvement in our Facility Solutions business and then those supported also with additional cost decreases driven by our optimization efforts. We haven’t given specific guidance yet obviously but we will do that in February John.
And then net debt it sounds like you were able to bring that down a fair bit this quarter. Ultimately what are you thinking as kind of like longer-term target? What do you think is achievable by the end of this year? And then kind of over the next couple of years?
So first of all John the $3.6 million is a seasonal trough in our leverage because of the fact that typically in the fourth quarter we have an accounts payable outflow as we have the last few years. And so we would expect leverage to tick back up in the fourth quarter because of that seasonal outflow of AP. With the guidance being brought down we also will see LTM trailing EBITDA to coming down in the forward forecast. So that will also cause leverage to go up. So the combination of seasonality and a slightly lower earnings stream will cause leverage to go up. As it relates to the longer term we have targeted 3x leverage ratio as a long-term target. There’ll be times where we go above that for purposes of investment as we did with the AAC acquisition at times where we might surpass that going below it due to our strong cash flow.
Okay. And then in the Packaging business ultimately sustainability has become a harder topic there. And I just wanted to get a sense how is that impacting the types of packaging solutions that you provide to customers? And also generally how you serve them?
So we agree with you that sustainability is an incredible and very important topic in the packaging space today. We do offer already a broad array of products that meet various customer needs. It is also a platform that we’re continuing to build out and is actually one of the pillars of our strategy that we just shared with our Board of Directors a couple of weeks ago. So where we are today is we have product offerings that will meet customer needs and demands. And the fact that we’re substrate agnostic as well helps benefit from that because we’re not tied to a specific product type like a resin-based product or a fiber-based product it’s all about what the customer needs. And constantly working with our supplier partners on developing those products that meet that are more sustainable or environmentally friendly. But we feel we’re in a great position to support the customer needs in that area going forward.
Okay. And then just the last question. Just it looks like paper inventories have started to improve in the channel at least in North America. Are you seeing any signs of improvement in the Print and Publishing businesses so far this quarter? And also how are you thinking about that over the next couple of quarters?
So we would agree with you that the inventories are improving slightly but there’s a lot of changes going on in the industry. And some of them disproportionately impacting the distribution channel as well. Because there’s been customer consolidation for example that have impacted the distribution channel as well as mills making decisions to no longer sell certain products which are some of the implications that we’ve had. In the fourth quarter we alluded that we would have revenue similar to what we saw all year. And as we look into the next year we’re not anticipating them to be quite that negative because of some — the choices that we made around high credit risk customers some product choices that we no longer do support will have gone through all of that. And so we would expect our revenue declines to be not as severe as they were in 2019.
There are no further questions queued up at this time. I’ll turn the call back over to Mary Laschinger.
Thank you John for your questions. Our third quarter results were highlighted by improved margins and increased adjusted EBITDA in Packaging and Facility Solutions as well as strong free cash flow which has enabled us to significantly reduce our debt. The performance of our Print and Publishing businesses has been very challenging. However our optimization efforts which began in 2018 have resulted in significant cost reductions and margin improvements as well as improved working capital and cash flow. The team has done an outstanding excellent job in executing on our multiyear optimization plan which has offset much of the unanticipated gross profit declines in our Print and Publishing segment. Thank you again for joining us today and we look forward to speaking with you early next year as we share our fourth quarter and full year 2019 results. Have a great day.
This concludes today’s conference call. You may now disconnect.