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Veritiv (NYSE:VRTV)
Q2 2019 Earnings Call
Aug 06, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning and welcome to Veritiv Corporation's second-quarter 2019 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.

Tom Morabito -- Investor Relations

Thank you, Jody. 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 was 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.

At this time, I'd like to turn the call over to Mary.

Mary Laschinger -- Chairman and Chief Executive Officer

Thanks, Tom. Good morning, everyone, and thank you for joining us today as we review our second-quarter 2019 financial results. We will also provide some thoughts on the important drivers of our expected full-year 2019 performance. Our second-quarter results were highlighted by strong free cash flow and adjusted EBITDA improvements in three of our four segments.

However, consolidated revenues were below expectations and declined year over year, largely due to the ongoing structural declines in our print and publishing segments and general market softness in packaging. Some of the revenue loss was planned as we made strategic choices in facility solutions and derisked the print customer portfolio in the quarter. Consolidated reported net sales for the second quarter were $2 billion, down about 10% compared to the prior-year period with our core net sales declined and also at about 10%. Our packaging core revenues were flat year over year, while our print, facility aolutions and publishing segments all experienced declines.

Consolidated adjusted EBITDA for the second quarter was $43 million, down about 5% year over year. The reduction in earnings was due to the volume declines in print and the negative earnings impact of certain financing leases being replaced by operating leases. This is the last quarter in which these incremental lease costs will have a negative year-over-year impact on adjusted EBITDA. Somewhat offsetting these pressures on earnings were margin improvements and lower costs.

Shifting now to review our performance by segment. Packaging's adjusted EBITDA came in as expected in the second quarter, with core revenues flat year over year but with improved margins. Our U.S. packaging business is experiencing some softness.

We believe our results are roughly in line with the overall market. The U.S. market has weakened from the second half of 2018 into the first half of 2019, with box shipments and sales of resin-based products flat to slightly down year to date. However, our rigid packaging product line has experienced strong year-over-year growth and is up high single digits in both sales and earnings over the prior-year quarter.

Packaging's adjusted EBITDA increased about 2% in the second quarter. The earnings increase was due to improved margins and lower delivery costs in our U.S. business, partially offset by increased storage costs. For the full year of 2019, we expect packaging adjusted EBITDA margins to improve from last year and for revenue growth to be around GDP.

Rigid is -- packaging, our product line, is expecting high single-digit growth, but the balance of the packaging business will likely not be as robust as 2018 due to less of a benefit from supplier price increases, more modest growth with certain large customers and continued softness in parts of our U.S. business. Our facility solutions segment saw a decline in the second-quarter core revenues of 6% year over year. This decrease was driven principally by strategic choices.

Facility solutions adjusted EBITDA increased about 9% in the second quarter, driven by improved margins, as well as lower operating and selling expenses. We are repositioning the segment for success by continuing to make strategic customer choices in order to focus on our strengths; and better align with market, product and customer dynamics, as well as channels of distribution, particularly in the United States. As we have said before, these choices are resulting in facility solutions being smaller but a more profitable business. For full-year 2019, we expect facility solutions revenue trend to be similar to that of the first half of 2019 due to the choices just mentioned.

However, we expect to see an improvement in year-over-year adjusted EBITDA led by a continuation of the key drivers experienced during the first half of the year, as well as a further focus on core product offerings, including private label. Switching to our print segment. Unfavorable industry pressures continued to affect our revenues. Print's core revenues declined nearly 22% for the second quarter, driven by continuing secular declines in market volumes, coupled with excessive inventories throughout the channels, partially offset by increased prices.

In addition, as we have mentioned on previous calls, we are making choices to manage credit risk in our print segment, which has, and they continue to have, a negative impact on our volumes. These choices have improved the quality of our accounts receivable portfolio and have reduced our bad debt charges. The print segment's adjusted EBITDA was down approximately 37% year over year due to the revenue decline and margin pressure, partially offset by lower expenses. We expect secular industry trends will continue to negatively impact print's revenue in the second half of 2019.

We could also experience worsened market volume declines as we continue to make adjustments to our customer base and product offerings. The print business model changes we implemented in 2018 will only partially offset the earnings effect of the volume declines in 2019. Taking all these factors into account, we expect print adjusted EBITDA in 2019 to be significantly lower than the 2018 level. The publishing segment's core revenues decreased approximately 15% in the second quarter.

Similar to print, publishing was impacted by the continued secular declines in the market volume. Adjusted EBITDA in this segment actually increased nearly 17% year over year due to improved margins from the stabilization of prices and effective cost management. For the remainder of 2019, we are expecting a more stable environment for publishing, with volume declines consistent with industry declines and prices moderating. We expect earnings to be roughly at the same level as 2018.

As we have noted in the past, this business can be impacted by changes in customer order patterns. Turning now to our consolidated 2019 guidance. We expect adjusted EBITDA to be in the range of $165 million to $180 million for 2019. Key assumptions for reaching this range include a GDP growth rate of about 2% and revenue declines in the print segment similar to our second-quarter performance.

In the second quarter of 2019, we generated approximately $130 million in free cash flow, compared to $18 million in the second quarter of 2018. The increase was due to volume declines and post-integration process improvement, which resulted in a lowering of accounts receivables and inventory. Due to the strong cash flow results in the first half and a continued focus on post-integration process improvement, somewhat offset by the seasonality of working capital in the second half, we are confident we can achieve free cash flow of at least $85 million in 2019. Now I'll turn it over to Steve, who can take you through the details of our second-quarter financial performance.

Steve Smith -- Chief Financial Officer

Thank you, Mary. And good morning, everyone. We will first review the overall results for the second quarter ending June 2019. As we review those 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 have the same number of shipping days in the second quarter of 2019 as we had the second quarter of 2018. As a reminder, we had one less shipping day in the first quarter, and we'll have one additional shipping day in the third quarter, with the fourth quarter 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, but the difference in day count will shift our already seasonal earnings pattern slightly more into the second half. Consolidated net sales for the quarter were $2.0 billion, down 9.8% from the prior-year period, with core net sales down 9.5% after adjusting for a small impact from foreign currency.

Our cost of products sold in 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 19.1%, up about 140 basis points from the prior-year period largely due to improvements in pricing and mix. Consolidated adjusted EBITDA for the second quarter was $43.3 million, down about $2 million or 4.6% versus the prior-year period.

Adjusted EBITDA as a percentage of net sales for the second quarter was 2.2%, up 10 basis points versus the prior-year period. While consolidated adjusted EBITDA declined approximately $2 million year over year, the print segment's earnings declined about $7 million versus the prior-year quarter. Consolidated adjusted EBITDA was negatively affected by about $3 million as a result of how our leases are treated from an accounting perspective. Most of that incremental $3 million in expense was absorbed by the packaging segment.

Offsetting these pressures on earnings were margin improvements and lower costs. Said differently, even with approximately $10 million in adjusted EBITDA headwinds from the print segment and the lease accounting changes, our earnings declined only $2 million year over year as margin management, the mix of products sold and reduced operating costs helped offset these headwinds. Let's now move into the segment results for the second quarter. Packaging's net sales and core revenues were both flat and were negatively impacted by a slowdown in parts of our U.S.

business. We believe we are performing roughly in line with the market. Offsetting a portion of this revenue slowdown, our rigid products line achieved revenue gains over the prior-year quarter. Packaging contributed $65.5 million in adjusted EBITDA, up nearly 2% year over year.

Adjusted EBITDA as a percentage of net sales was 7.4%, up 10 basis points or approximately $1 million from the prior-year period. The earnings increase was due to improved margins and lower delivery costs in our U.S. business, partially offset by increased storage costs of approximately $3 million. Facility solutions net sales decreased 6.8%, while core revenues decreased 6%.

The revenue decline in this increasingly competitive segment was due to channel dynamics and the fact that we are making customer choices that align to our product and service capabilities. Facility solutions contributed $8.3 million in adjusted EBITDA, up 9.2% year over year. Adjusted EBITDA as a percentage of net sales increased 40 basis points from the prior-year period. The earnings increase was primarily driven by improved margins, as well as lower operating and selling expenses.

The print segment experienced a 22.2% decline in net sales, and core revenues were down 21.9%. The revenue decrease was driven by secular declines in market volumes, coupled with excessive inventories throughout the channel, as well as choices we are making to manage credit risk. These declines were partially offset by increased market prices. For the second quarter, print contributed $12.3 million in adjusted EBITDA, down 37% year over year.

The earnings impact of the sales decline and margin pressure was only partially offset by a reduction in supply chain and selling expenses. Publishing's net sales and core revenues both decreased 14.6% from the prior-year quarter. The revenue decline was due to a reduction in volumes, primarily driven by continued secular decline in the industry. Publishing contributed $5.6 million in adjusted EBITDA, up nearly 17% year over year.

The increase in adjusted EBITDA can be attributed to improved margins from the stabilization of prices and effective cost management. For the entire company, we experienced $5.2 million of bad debt expense in the second quarter, down from $6.8 million in the second quarter of 2018. For the first time in three years, the print segment experienced a year-over-year reduction in bad debt expense. Shifting now to our balance sheet and cash flow.

At the end of June, we had borrowed approximately $757 million against the asset-based lending facility and had available borrowing capacity of approximately $320 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 4.0 times, down from 4.8 times in the prior-year period and 4.7 times at the end of March 2019. Taking -- our long-term strategic goal continues to be a net leverage ratio of about three times.

Cash flow from operations for the second quarter was approximately $138 million. Subtracting capital expenditures of about $7 million from cash flow from operations, we generated free cash flow of approximately $131 million. If we add back the roughly $11 million of cash items due to acquisition, integration and restructuring activity, adjusted free cash flow for the quarter would have been approximately $142 million. Our strong second-quarter free cash flow was due to the lowering of both accounts receivable and inventory.

For 2019, our total capital expenditures are expected to be approximately $45 million. That concludes our prepared remarks. Jody, we are now ready to take questions.

Questions & Answers:


Operator

[Operator instructions] And your first question comes from the line of John Babcock of Bank of America Merrill Lynch. Please go ahead. Your line is open.

John Babcock -- Bank of America Merrill Lynch -- Analyst

Hey, good morning.

Mary Laschinger -- Chairman and Chief Executive Officer

Good morning, John.

John Babcock -- Bank of America Merrill Lynch -- Analyst

Good morning. How are you? A couple questions. I mean, first of all, you talked about kind of managing credit risk and some customer churn during the quarter across a couple of your businesses. And I just wanted to first get a sense.

Were those customers -- some of that churn, did that help EBITDA during the quarter? So in other words, were they an EBITDA drag on the company?

Mary Laschinger -- Chairman and Chief Executive Officer

The customer churn. So it was about a couple different topics within this context. In our print business we made choices around exiting specific customers because of bad credit risk. So they heard us from the standpoint that it impacted our volume.

And so to respond to that, we have to take out costs correspondingly. And we're never sure precisely how much this is, and there's always a lag between losing the volume and getting the costs out. So in that regard, it did hurt our adjusted EBITDA, but on the flip side of that we had lower bad debt expense for the quarter than what we did prior year. So it's a combination of both positive and negative impact.

We also had, as we alluded to, in our facility solutions business, where we are making customer choices around specific channels that we want to support or certain types of customers that have service needs that don't necessarily match our supply chain capabilities or what we want our supply chain capabilities to be as we move forward. As -- exiting those customers, again, have negative pressure on our revenues and volumes, which does put pressure on our cost structure, but we've been able to take out costs at least as fast or more as we made those customer choices. So it actually improved our margins, which improved our adjusted EBITDA.

John Babcock -- Bank of America Merrill Lynch -- Analyst

And then obviously a lot of us have read kind of about the U.S.-China trade dispute. And I want to get a sense, I guess, first of all, for how the new set of tariffs set to go into effect on September 1 might impact Veritiv. And then also, is there any incremental impact there to guidance?

Mary Laschinger -- Chairman and Chief Executive Officer

So we've had a minimal impact of the tariff situation unto our business to date. The biggest impact that we've had is with products that we're buying in Asia specifically that we resell, obviously. And we, to date, have been able to pass those incremental costs on to our customers. We anticipate continuing to do that.

We also have had some impact with our outside-U.S. business, in particular in the Asian markets where we support customers in that geography that have had to make choices to move manufacturing out of China specifically into other regions. And that has had a short-term impact on volumes and products going into those customers as they move to other parts of the world such as Mexico, Indonesia and Vietnam. And so there's been some short-term impact on us as it relates to that.

We do not anticipate any impact on this tariff situation with regards to our outlook in terms of our guidance for adjusted EBITDA or cash flow.

John Babcock -- Bank of America Merrill Lynch -- Analyst

OK. And on this topic. And we've heard from some of our contacts that, I guess, some shipments that have initially -- with this kind of uncertainty in the market and what's going on between the U.S. and China, it sounds like some shipments have been moved into 4Q that in prior years might have been -- in part because of e-commerce, been put in 3Q.

And so I guess I want to get a sense, particularly on the packaging side, whether you're seeing any change in the trajectory of shipments, in the second half of the year, from 3Q to 4Q or vice versa.

Mary Laschinger -- Chairman and Chief Executive Officer

In the packaging space, we have not seen that at all to date. What I would say is that we saw a change in shipments, in the first half of the year, of imports on the paper side as global demand and -- supply and demand has moved between Asia and the Middle East and other parts of the world that has -- that have actually pushed more imports into the U.S. on the paper front, in particular on the West Coast. But that's not -- it is somewhat related to tariffs, but it's also related to other world issues that are happening in the Middle East.

But we have not seen an impact of the tariffs in the packaging business. Having said that, what we would anticipate and are anticipating is pressure on pricing in the U.S. and in particular in packaging, in boxes, just because of the falloff of demand in Asia and the impact it's having on linerboard, the supply demand balance on linerboard, which could impact pricing going forward in that segment.

John Babcock -- Bank of America Merrill Lynch -- Analyst

OK. And on that, that actually kind of leads me to the next question. It was really to kind of talk about how declining containerboard prices impact your results. And if you can just kind of remind us of the flow-through there, that would be great.

Mary Laschinger -- Chairman and Chief Executive Officer

Sure. We generally lag behind both price increases and price declines, with an effort to try and stabilize our margins. We do have a percentage of our business, it's less than 30%, that's tied to indices. And so we would move with that when the indices are posted, but it's a relatively small percentage of our business.

And so you could expect, because of the time lag, we might have improving margins for a time period. And then they would level off, come back down. Generally, we try to target them to be stable over the course of time.

John Babcock -- Bank of America Merrill Lynch -- Analyst

OK. Then last question before I turn it over. Just it looked like you paid down some debt during the quarter. I just wanted to get a sense for how you're thinking about leverage by the year end and also whether we should expect some pickup in debt, I guess, particularly in 3Q, given that you took a bit more working capital usage during that time.

But if you can just kind of talk through that that would be great.

Steve Smith -- Chief Financial Officer

Yes, John, we're very pleased with our first-half free cash flow. And we did use, as you mentioned, that excess cash flow to pay down debt, bringing it down to 4.0 times. Due to seasonality, we do expect our leverage to increase because we will have free cash outflow in the third quarter and possibly in the fourth. And so we would typically see an increase in leverage in the second half.

We would expect that for this year. Although, we're working hard to continue to reduce working capital components, and that should help us versus historical averages.

Operator

There are no further questions. I will turn the call back over to Mary Laschinger, chairman and executive -- sorry, and chief executive officer, for closing remarks.

Mary Laschinger -- Chairman and Chief Executive Officer

Thank you. Well, everyone, thank you for your questions today. I would just like to summarize our quarter with a few comments. Our optimization efforts are leading to significant improvements in our margins, meaningful cost reductions and in general improved working capital.

Despite the revenue headwinds we had in the print industry, our second-quarter results were highlighted by adjusted EBITDA improvements in three out of our four segments and very strong free cash flow which has enabled us to significantly reduce our debt. So again, we feel good about the quarter, as well as the balance of the year. Thank you for taking the time to join us today, and we look forward to speaking with you in November as we talk about our third-quarter results. Have a great day.

Operator

[Operator signoff]

Duration: 27 minutes

Call participants:

Tom Morabito -- Investor Relations

Mary Laschinger -- Chairman and Chief Executive Officer

Steve Smith -- Chief Financial Officer

John Babcock -- Bank of America Merrill Lynch -- Analyst

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