Veritiv (VRTV) Q1 2020 Earnings Call Transcript

Veritiv (VRTV)
Q1 2020 Earnings Call
May 06, 2020, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello, and welcome. Good morning, and welcome to the Veritiv Corporation's first-quarter 2020 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 Tom Morabito, director of investor relations. Mr. Morabito, you may begin.

Tom Morabito -- Director of Investor Relations

Thank you, Ian, 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; Sal Abbate, our chief operating officer; and Steve Smith, our chief financial officer. Afterward, 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 2019 annual report on Form 10-K and in the news release issued this morning, which is posted in the investor relations section at veritivcorp.com.

Non-GAAP financial measures are included in our comments today and in the presentation slides. The reconciliation of these non-GAAP measures to the applicable 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. The COVID-19 pandemic is taking a toll on everyone, both professionally and personally, and we hope you are all able to successfully navigate through the issues you are facing during these challenging times. As a company, we remain focused on ensuring the safety and well-being of our employees while continuing to safely and effectively serve our customers.

During today's call, in addition to reviewing our first-quarter 2020 financial results, we will provide an update on the impact of the pandemic is having on our business and the actions we are taking to address the rapidly changing environment. Turning now to our results for the first quarter. Our consolidated first-quarter 2020 results were highlighted by a significant improvement in both adjusted EBITDA and free cash flow as our optimization initiatives improve margins, reduced our overall cost structure, and lowered working capital. Consolidated reported net sales for the first quarter were $1.7 billion, down 12% compared to the prior-year period, with core revenues declining 13%.

Consolidated adjusted EBITDA for the first quarter was $36 million, up 78% year over year. The improvement in earnings was largely due to improved margins, lower supply chain, and selling expenses and one additional selling day. These benefits were somewhat offset by the earnings impact of volume declines. The coronavirus did not have a significant impact on our first-quarter operations or results.

I will speak to the nature of the coronavirus impact on the balance of the year in a few minutes. While Steve will provide more detailed information, I want to briefly comment now on our balance sheet and liquidity position. At the end of the quarter, we had $75 million in cash on hand, as well as, $286 million in borrowing capacity under our asset-based lending facility. We recently refinanced the ABL under substantially similar terms and extended the facility to 2025.

Our first-quarter free cash flow generation enabled a reduction in our net debt to adjusted EBITDA ratio from 4.1 times at the year-end 2019 to 3.5 times at the end of March 2020. I would now like to turn it over to Sal, who will take you through our first-quarter performance by segment.

Sal Abbate -- Chief Operating Officer

Thank you, Mary, and good morning, everyone. In the first quarter, packaging's core revenues were down 6% year over year, which is an improvement from the fourth quarter of 2019, although, market conditions in the U.S. have become more challenging. Industry box shipments were up in the first quarter, partly due to panic buying in March.

However, pricing pressures in the corrugated category contributed to an overall market decline. Packaging was also affected by the slowdown in the industrial manufacturing sector. Packaging's adjusted EBITDA increased 24% year over year. Despite the revenue decline, our business optimization initiatives, improved margins and lowered our expenses, resulting in packaging's adjusted EBITDA margins improving from 5.7% in the first quarter of 2019 to 7.4% in the first quarter of 2020.

Moving on to our facility solutions segment. Core revenues were down 14% year over year, which was in line with our expectations. The first-quarter revenue decline was due to the repositioning of this segment for success in 2019 by making strategic customer choices to better align with our supply chain strengths, as well as, market, product, and customer dynamics. These choices have resulted in facility solutions becoming a smaller but more profitable business, as demonstrated by our first-quarter results.

Our adjusted EBITDA more than doubled year over year due to improved margins from our strategic repositioning, which lowered supply chain and selling expenses. Switching to our print segment. Secular pressures driven by lower demand continue to affect our revenues. Print core revenues declined 19.6% in the first quarter.

This decline was driven by market dynamics, as well as, our continued decisions regarding customers, suppliers, products, and service requirements. The print segment's adjusted EBITDA was up nearly 56% year over year due to lower expenses and better margins, partially offset by the earnings impact of the revenue decline. The publishing segment's core revenues decreased nearly 22% in the first quarter. Similar to print, publishing was impacted by continued secular declines in market volumes, but also by changes in order patterns due to customer consolidation, digital advertising, and other factors, as well as, credit reasons.

Adjusted EBITDA in this segment decreased 25% year over year due to the reduction in revenue and increase in charges for high-risk credit accounts, slightly offset by improved pricing and lower costs. Adjusted EBITDA margins were relatively flat. I will now turn it back over to Mary.

Mary Laschinger -- Chairman and Chief Executive Officer

Thanks, Sal, and shifting now to our strategy. In 2017, I shared with you that our strategy to shift our portfolio mix to higher-growth, higher-margin businesses, and we would do that by investing in packaging and services, protecting our leading market positions where we choose to compete in facility solutions, print, and publishing and optimizing our business processes post integration across commercial, supply chain, and back-office operations. All these initiatives were designed to grow adjusted EBITDA and cash flow and lead to a higher return on invested capital. Last year, I also shared with you how we expect to create value across these three levers of our business model.

First, more efficient commercial operations with better processes and controls will improve margins through better pricing and supplier cost management, greater emphasis on higher-margin products and categories, including private label, and narrowing our focus to end-use markets with greater growth and profitability opportunities. Through these initiatives, we also expect to lower our selling expenses. Second, improvements in handling, delivery, and inventory management will drive supply chain operational efficiencies. And third, more standardization and greater efficiencies will drive significant improvement in our back-office operations.

Our first-quarter 2020 results demonstrated the continuing execution of our strategy around our segments and optimization initiatives. This was evident as we grew margins across our segments, reduced our cost structure, and improved our processes around working capital. As part of this strategy, we recently filed an 8-K regarding the evaluation of alternatives to restructure our integrated supply chain to optimize our Packaging business, while managing the structural decline of the print industry. We continue to evaluate alternatives to reduce complexity and lower overall supply chain costs, as well as, drive greater alignment with our packaging customers while adapting to the market dynamics of print.

Now turning to an update on the coronavirus, how it is impacting our business and the actions we are taking to adjust to this unprecedented and rapidly evolving environment. Veritiv is operating as an essential business. Our business is fully functional and operating consistent with guidelines provided by federal, state, and local officials, so we can continue to safely meet the needs of our customers. As a distributor, our business model allows us to temporarily remove costs associated with our selling efforts, supply chain, and back-office based on order activity.

Additionally, due to our integration and optimization initiatives, we have both the experience and processes to quickly adapt to the changing environment, as well as, effectively manage our costs and minimize working capital. These factors positively contributed to free cash flow as shown in our full-year 2019 results. Our business also serves a broad range of industries and we have very little revenue concentration with specific customers in particular sectors or in certain geographies within North America. No single customer represents 3% of our aggregate annual revenue.

The coronavirus will have a negative impact on our results for the remainder of the year. We expect revenue declines in each of our segments with packaging experiencing the least significant revenue declines followed by facility solutions, print, and then, publishing. The extent and duration of declines is very difficult to predict. We also anticipate that some customers will delay or fail to make payments.

For planning purposes, we have been modeling a range of scenarios for our business that assume potential revenue declines for the remainder of 2020, greater than those of the first quarter. Given our current financial profile and our business model flexibility, combined with our experience in removing costs, as well as, specific actions we are taking. At this time, we are confident that we will have adequate liquidity. We have taken several significant proactive steps to help mitigate the effects of the revenue decline on our earnings, as well as, to strengthen our access to capital.

These actions include the following: temporarily reducing salaries for senior leaders from 10% to 50% depending on a position, temporarily reducing annual cash retainers for our independent directors by 50%, placing approximately 15% of the company's salaried workforce on temporary furlough based on business activity; flexing our supply chain operation staff, depending on volume at specific locations. We also suspended our share repurchase program. We're delaying the merit increase for sal -- increases for salaried employees. We also temporarily suspended the company's matching contributions for salaried employees defined contribution plans.

And finally, we are further reducing spending, including capital expenditures. Given the uncertain environment, we are withdrawing our prior 2020 guidance for adjusted EBITDA, free cash flow, and capital expenditures, and will not be providing updated guidance at this time. Now, I'll turn it over to Steve, so he can take you through the details of our first-quarter 2020 financial performance.

Steve Smith -- Chief Financial Officer

Thank you, Mary, and good morning, everyone. We will first review the overall results for the first quarter ending March 31st, 2020. 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 one more shipping day in the first quarter of 2020 than we had in the first quarter of 2019.

For the remainder of 2020, each quarter will have the same number of shipping days as the previous year's comparable quarter. Consolidated net sales for the quarter were $1.7 billion, down 12.1% from the prior-year period, with core revenues declining at 13.4%. Our cost of products sold for the quarter was approximately $1.4 billion. Net sales less the cost of products sold was $348 million.

Net sales less cost of products sold as a percentage of net sales was 20.4%, up 240 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 first quarter was $36.2 million, up $15.8 million or 78% versus the prior-year period. The improvement in earnings was largely due to strong margin management, lower supply chain, and selling expenses and one additional selling day, somewhat offset by lower earnings from volume declines in print and publishing. Adjusted EBITDA as a percentage of net sales for the first quarter was 2.1%, nearly double the prior-year period.

Let's now move into the segment results for the first quarter ended March 31st, 2020. Packaging net sales and core revenues were down 5.1% and 6.4%, respectively, as market conditions in the U.S. further eroded, coupled with pricing pressure in some product categories. As Sal mentioned, we've also been affected by the slowdown in the industrial manufacturing sector.

Packaging contributed $59.6 million in adjusted EBITDA, up 23.7% from the prior-year period. Adjusted EBITDA as a percentage of net sales was 7.4%, up 170 basis points from the prior-year period. The increase in earnings was due to our business optimization initiatives, which improved margins and lowered expenses and was partially offset by the decline in revenues. Facility solutions net sales were down 13% and core revenues decreased 14.1%.

The revenue decline was due to the repositioning of this segment for success by making strategic customer choices to better align with our supply chain strengths, as well as, market, product, and customer dynamics. Facility solutions contributed $9 million in adjusted EBITDA, up 114% year over year. Adjusted EBITDA as a percentage of net sales increased 210 basis points to 3.5% in the quarter. The earnings increase was primarily driven by improved margins from our strategic repositioning, which lowered supply chain and selling expenses.

The print segment experienced an 18.4% decline in net sales, and core revenues were down 19.6%. This decline was driven by market dynamics, as well as, our continued decisions regarding customers, suppliers, products, and service requirements. Print contributed $11.2 million in adjusted EBITDA, up nearly 56% year over year due to lower expenses and better margins, partially offset by the earnings impact of the revenue decline. Publishing net sales decreased 20.7% and core revenues declined 21.9% from the prior-year's quarter.

The lower revenue was due to continued secular declines in market volumes, changes in order patterns due to customer consolidation, digital advertising, and credit reasons. Publishing contributed $3.6 million in adjusted EBITDA, down 25% year over year. Decrease in adjusted EBITDA can be attributed to the reduction in volume and increases in charges for high-risk credit accounts, slightly offset by improved pricing and lower costs. Shifting now to the balance sheet and cash flow.

At the end of March, we had drawn approximately $667 million against the asset-based lending facility and had available borrowing capacity of approximately $286 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business. At the end of March, our net debt to adjusted EBITDA leverage ratio was 3.5 times, down from 4.7 times in the prior-year period. Regarding the ABL, we recently refinanced and extended the facility to 2025 under substantially the same terms.

Our long-term debt, net of current portion on the balance sheet has dropped 22% from $944 million at the end of March of 2019 to $740 million at the end of March of 2020. For the quarter ended March 31st, 2020, cash flow from operations was approximately $85 million. Subtracting capital expenditures of about $9 million from cash flow from operations, we generated free cash flow of approximately $76 million. Our strong free cash flow in the quarter was primarily due to lower inventories and higher accounts payable enabled by volume reductions and process improvements.

That concludes our prepared remarks. Ian, we are now ready to take questions.

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of John Babcock of Bank of America. Your line is open.

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

Good morning. I guess I just wanted to start. I was wondering if you could talk about the trends that you're seeing so far in 2Q, the different businesses.

Mary Laschinger -- Chairman and Chief Executive Officer

Good morning, John. Thanks for being on the call. I'll speak to print and publishing, and then, I'll ask Sal to speak to packaging and FS. So your question is what are the trends we're seeing in the segments as we come out of the quarter.

Is that correct?

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

Yeah. Actually, more in 2Q, just given kind of the coronavirus and the impact here. So just trying to get a better read on that.

Mary Laschinger -- Chairman and Chief Executive Officer

Yeah. OK. So in the print space, in April, we did see a significant decline relative to the first quarter as we came into April and ending April. You've seen a lot of the recent publications coming from other people in the space.

It's down roughly 50%. We're experiencing something similar to that. We would expect that to stay down for -- it could be the next couple of quarters with an unknown of what that absolute recovery looks like. We would also see something similar to that in the publishing space for the same reasons as what we saw in print.

And so, that's what we're seeing in print and publishing. And Sal, I'll ask you to respond to packaging and FS.

Sal Abbate -- Chief Operating Officer

Sure, Mary. Good morning, John. In the packaging segment for April, we were off approximately 2.5 times the quarter one rate but we did see an improvement in the second half of April later in the month. And for the balance of Q2, we're anticipating being off about 2 times the rate of the first quarter.

After the second quarter, the rest of the year is really difficult to predict, depending on what happens with the economic reentry. For facility solutions, we were off approximately 2.5 times the rate of Q1 decline for facility solutions. We had greater demand, but as you -- I'm sure you know, the inventory shortages in some categories prevented us from gaining against our first quarter. So, we started to see those declines late March and they carried into April, about 2.5 times the rate in packaging and about 2 times the rate in facility solutions.

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

OK. That's helpful. And then also, if you could just kind of go back to patch in a little bit. And I think you mentioned some weakness, particularly on the industrial side.

Are there -- just generally, how are trends in some of the other areas of your business right now?

Mary Laschinger -- Chairman and Chief Executive Officer

Sal?

Sal Abbate -- Chief Operating Officer

Sure. Sure, Mary. So that's right, John. The industrial segments, heavy manufacturing, aerospace, automotive, they're all significantly strained, and then also, our customers in the print segment, slightly offset though by strength in e-commerce and in food packaging and fulfillment, but not enough to overcome declines in those large industrial manufacturing-based companies.

We do anticipate a little bit more strength in May than April as we start to see folks return to work. But most of the customers that we're tracking are coming in at 25%, 30% of capacity as they reenter the workforce.

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

That's helpful. And then, I guess, kind of like the next question I had was kind of touching on a little bit what you were talking about previously, just on inventories as a whole. I was wondering if you can kind of talk about where inventory stand for your customers in packaging, print, facility solutions, and publishing?

Mary Laschinger -- Chairman and Chief Executive Officer

Sal, do you want to give some perspective on our customer inventories in packaging and facility solutions?

Sal Abbate -- Chief Operating Officer

Sure, Mary. So on the packaging front and in conversations with our suppliers, and we are in relatively good shape with inventories on the Packaging front. We did have indications that there was some forward buying in March and that's why we saw a propped-up-March box shipment. But folks anticipate those shipments coming down in the second quarter.

In facility solutions, we did see a very strong run-up in the middle, early part to the middle part of March, and then, the shortages began to occur. And they really have stayed down through most of the month of April. But we are starting to see some improved shipments and we're starting to see our inventory positions improve throughout our facility solutions segment, but still constrained in one or two items that would be in most demand.

Mary Laschinger -- Chairman and Chief Executive Officer

And then, John, on the print side, we believe that inventories have the likelihood of being relatively high. The reason for that is because we began to see across the board, not just our customers, but across the board with the mills, a lot of canceling of orders and a lot of those were not canceled soon enough in April and ended up falling into May. And so, we would anticipate that inventories could be reasonably high at our customers.

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

OK. And then kind of next, more kind of to your strategic vision going forward. I was wondering if you can talk more about how you plan to orient spending to drive higher growth and improved mix in packaging?

Mary Laschinger -- Chairman and Chief Executive Officer

So as I shared with you, we announced what our strategy was going to be back in '17 already in terms of focusing on higher-growth and higher-margin businesses, which is what packaging was at the time. And now, frankly, facility solutions is getting stronger and stronger as we've made those choices. So, we put a lot of effort into where we're going to focus, both in product category end use -- as well as, end use segments, and felt very good about that in the first quarter as you can see with our results. It's a little hard today to estimate what the impact of all this is going to be here for the balance of the year in our growth segments of packaging, and ultimately, FS.

But again, it's a focus on the right end use segments. It's a focus on the product categories that would have the higher growth and better management across the board post integration of all our processes to improve profitability and lower costs.

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

OK. And as you move forward with the strategy toward kind of more efficient commercial operations, what impact do you see this having on your footprint of facilities, if any?

Mary Laschinger -- Chairman and Chief Executive Officer

So, I think you actually mean supply chain operations and the impact on our supply chain operations. We do believe there will be an impact on supply chain operations. Part of the reason for issuing the 8-K that we issued, I think it was in February already, was to give some perspective that we could be looking at potentially some restructuring of the supply chain to adapt to the changes that we're seeing in print. And also to get the footprint right-sized for what we think is the go-forward packaging part of the company, which has different service requirements than what we see in print.

So, we would anticipate some changes in the supply chain over the course of the next 12 to 24 months.

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

That's great. And then just last question before I turn it over. I was wondering if you can -- obviously, you kind of talked about some different credit reasons and touched on that a little bit. And I guess, how are you kind of seeing bad debts trending? I mean, I have to imagine they're going up at this point.

But I wanted to get a sense for how you are imagining that progressing as the year goes forward.

Mary Laschinger -- Chairman and Chief Executive Officer

Yeah. Yeah. OK. So, we are anticipating that there could be some challenges, as I mentioned, with customers going into bankruptcy.

We have done, frankly, an excellent job in our print space in managing high-risk customers, which is the process we went through over the course of '18 and '19 and our bad debt situation and risk in print is in a very good place, actually. The lowest has probably been in the history of the company. Hard to predict whether it will stay that way, but we've been very successful in making sure we've got the right customer portfolio in that space, which we considered some of the higher risk space. When you look at publishing, we're beginning to see some risk, although, again, we've managed it very well, in particular, in the retail space and I'm sure you've seen some of those announcements.

Again, that's an area where we have also continued to pull back and have managed that and feel like we're managing it very well and so are not expecting a huge surprises. The packaging and FS, we are beginning to see, in particular in FS, some extension request for extension of payments. We've been holding firm on that. And -- but it's more from large customers that we know will be able to pay, but their business is such right now that they're probably cash challenged, and our packaging business has been very stable.

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

That's great. I appreciate all the help.

Mary Laschinger -- Chairman and Chief Executive Officer

OK.

Operator

There are no further questions over the phone lines at this time. I turn the call over to Mary Laschinger for closing remarks.

Mary Laschinger -- Chairman and Chief Executive Officer

Thank you for your questions, and thank you, everyone, for being on the call this morning. Let me wrap up quickly here. Our consolidated first-quarter 2020 results were highlighted by a significant improvement in both adjusted EBITDA and free cash flow as our strategy around our segments and optimization initiatives improved margins, reduced our overall cost structure, and lowered working capital. In addition, the strong free cash flow helped significantly reduce our debt leverage ratio.

I am very pleased with our first-quarter results and I'm proud of the entire Veritiv team, which has done an excellent job navigating through these unprecedented and challenging times. While our business is certainly being impacted, we do have the -- we believe we have the flexibility with our business model, which serves a broad range of industries and very little revenue concentration in terms of specific customer sectors or geographies within North America, all positions us well to manage the impact of the coronavirus on our business. I would like to thank our employees, customers, and suppliers for all your hard work and support. While we cannot predict how long this current situation will last, we remain committed to supporting our employees and serving our customers while ensuring the long-term success of the company.

Thank you again for joining us today. Please stay healthy and safe, and we look forward to speaking with you in August as we share our second-quarter 2020 results. Ian, that's a wrap-up.

Operator

[Operator sign-off]

Duration: 34 minutes

Call participants:

Tom Morabito -- Director of Investor Relations

Mary Laschinger -- Chairman and Chief Executive Officer

Sal Abbate -- Chief Operating Officer

Steve Smith -- Chief Financial Officer

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

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