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Veritiv Corp (VRTV)
Q3Â 2020 Earnings Call
Nov 5, 2020, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to Veritiv Corporation's Third Quarter 2020 Financial Results Conference Call. [Operator Instructions] 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.
Scott Palfreeman -- Director of Finance and Investor Relations
Thank you, Lency and good morning, everyone. Thank you all for joining us. On today's call, you'll hear prepared remarks from our new CEO, Sal Abbate; and our CFO, Steve Smith. After that, 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 and other factors described in our 2019 Annual Report on Form 10-K, subsequent quarterly reports on Form 10-Q 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 US GAAP measures included at the end of the presentation slide -- is 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 Sal.
Salvatore A. Abbate -- Chief Executive Officer
Thanks, Scott. Good morning, everyone and thank you for joining us. Before we get into our third quarter results, I would like to take a moment to personally thank our recently retired CEO, Mary Laschinger for her leadership, effort and advice. We wish her the very best in her retirement. I'm honored by the Trust that Mary, the Board, and the broader organization have placed me and my new role as CEO. When I joined Veritiv in 2018, I strongly believed in the vision and future of the company. The structural changes made and the strategic direction we embarked on over the last 18 months have moved us even closer toward this vision of a leading provider of value added packaging goods and services from concept to delivery. I'm now more confident than ever in our ability to execute against this vision.
As you will hear on the call today, the fundamentals of our business are improving and the flexibility of our business model is helping us weather the challenges of the COVID-19 pandemic. As we move into this quarter's results, I will briefly discuss how COVID-19 is impacting our operations and then cover the consolidated performance of the quarter. I'll then turn it over to Steve for more details on our segment results, balance sheet and cash flow.
Due to the uncertainty and ongoing impacts of COVID-19, we virtue our full year guidance earlier this year. However, we did provide some perspective on our outlook for the second half of the year during our call last quarter. During today's call, we will provide an updated outlook on our anticipated performance for 2020 and a view of the 2021 expected market dynamics. During these unprecedented times of the COVID-19 pandemic, we continue to remain focused on ensuring the safety of our employees, while meeting the needs of our customers.
Despite a challenging and dynamic market environment, we are proud of our employees' efforts to effectively and efficiently support the needs of businesses around the globe. Our operations are fully functioning and our office employees continue to have the flexibility to work from home while our offices remain opened for employees that prefer that option.
Now turning to our results for the third quarter. Our third quarter 2020 results were highlighted by an improving trend in packaging revenues, improved consolidated adjusted EBITDA and positive free cash flow. Stronger demand and lower bad debt expense drove better-than-expected earnings in the third quarter. Clearly, it has been a tough year to predict revenues and costs and therefore earnings. Our third quarter revenue started to rebound from the COVID-19 driven [Indecipherable] in the second quarter and that rebound along with meaningful cost reductions, contributed to the year-over-year and quarter-over-quarter earnings improvement in the third quarter.
Revenue per day improved in the third quarter versus the second quarter for all segments. Consolidated revenues in the quarter were down 17% versus prior year, a sequential improvement from the second quarter's decline over prior year of 28%. Selling and supply chain expense reductions, productivity gains and sustained pricing discipline more than offset the effects of lower revenue in the third quarter. As a result, third quarter 2020, adjusted EBITDA was $50 million, which is approximately 11% above last year's third quarter.
For our Packaging segment, we are encouraged to report sales in the third quarter were near pre-COVID levels. Packaging revenue increased 8% when compared to the prior sequential quarter as a result of improving market demand, sales discipline around share of wallet initiatives, and a focused on higher growth sectors. During the third quarter, we saw some improvement in the broader industrial manufacturing sector, while fulfillment and e-commerce volumes continue to be relatively strong.
Our rigid packaging sales in the third quarter were better than prior year, and we continue to be pleased with our 2017 acquisition in that space. However, demand does remain soft in the aerospace and automotive manufacturing sectors. The cost saving actions taken at the beginning of the second quarter to mitigate the potential impacts of COVID-19 along with our ongoing efficiency programs continue to drive improved margins and kept costs in check [Phonetic] in the third quarter. The strong earnings results were partially offset by an adjustment to performance-based compensation.
For more than two years, we have been taking proactive steps to improve the quality of our customer portfolio and reduce our bad debt expense. We believe these efforts have had a favorable impact on earnings by lowering sequential quarterly bad debt expense during 2020, despite pandemic related customer liquidity challenges. Our bad debt expense is down over $2 million compared to the prior year's third quarter. As a result of all these factors, consolidated adjusted EBITDA margin for the third quarter was 3.1%, an improvement of approximately 80 basis points from the prior year period and the best in the history of the company.
Now I'm going to ask Steve to review our results in more detail. Steve?
Stephen J. Smith -- Senior Vice President and Chief Financial Officer
Thank you, Sal and good morning, everyone. As we review these results, please note that when we speak to core net sales, we're 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 third quarter of 2020, as we had in the third quarter of 2019. The fourth quarter of 2020 will have the same number of shipping days as the previous year. As a reminder, we had an extra day in the first quarter of this year, so for the full year 2020, we have one more shipping day than in 2019.
With Sal having covered consolidated performance, I will focus on segment performance along with our balance sheet and cash flow. As we look at the segment performance versus expectation, we expected our packaging volume and earnings to be similar in the second half of the year than in the first half. However, both sales and expenses and therefore earnings were better than expected. Packaging net and core sales were down 2.7% compared to prior year. Packaging revenues were bolstered this quarter by sequential increase in sales to our customers within the industrial manufacturing sector as well as year-over-year growth in rigid packaging products.
Sales to our customers in the fulfillment and food sectors continue to be relatively strong. Packaging's adjusted EBITDA increased 27% year-over-year. With stabilizing demand and our operating expenses, adjusted to current volume levels, the segment's earnings are on a positive trajectory. Given our efficiency initiatives, Packaging's adjusted EBITDA margins improved from 7.7% in the third quarter of 2019 to a record high of 10.1% in this year's third quarter.
Now shifting to the Facilities Solutions segment. Net in core sales were down 25% year-over-year with continued headwinds related to COVID-19. During the third quarter, personal protective equipment and hygiene related product sales remained strong, but we began to see signs of market saturation in some of those categories. Our traditional away from home sectors which make up a large share of this segment portfolio continue to be depressed by current market dynamics and did not improve as much as expected. Third quarter revenues continue to be negatively impacted by the strategic choices we made in 2019 to better align this segment with our supply chain strengths as well as market, product and customer dynamics.
Adjusted EBITDA for the segment was up approximately 19% compared to the prior year, despite the significantly lower sales due to improved margins from the strategic choices as just mentioned. These strategic choices helped to both improve the segment's gross margins as well as lower selling costs and supply chain expenses such as delivery and handling. These results continue to support the strategic directive to make Facilities Solutions a smaller but more profitable business.
The Print segment experienced a 30% decline in both net and core revenues compared to the prior year. This revenue reduction was driven by both the ongoing secular decline and the effect of COVID-19. However, sales over this prior sequential quarter did improve faster than expected as second quarter net sales had fallen 47%. Print contributed $8.8 million in adjusted EBITDA, down only $1.8 million from last year's third quarter. The print business continues to quickly align costs to the volume trends. Publishing net and core revenues, both decreased 37% from the prior year. As with our Print segment, the lower revenue was due to both the ongoing secular decline in the market and the effects of COVID-19. Publishing had an adjusted EBITDA of $3.5 million, down from $4.6 million in last year's third quarter.
Shifting now to our balance sheet and cash flow. At the end of September, we had drawn approximately $520 million against the asset-based lending facility and had available borrowing capacity of approximately $359 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business. At the end of the quarter, our net debt to adjusted EBITDA leverage ratio was 2.4 times, down from 3.6 times in September of 2019 and down from 4.1 times in December of 2019.
Our long-term debt not including the current portion has declined 19% year-over-year from $726 million to $591 million. For the quarter ended September 30, 2020, cash flow from operations was approximately $54 million. Subtracting capital expenditures of about $5 million from cash flow from operations, we generated free cash flow of approximately $49 million. Our strong free cash flow in the quarter was primarily due to positive earnings, the lower days sales outstanding and days inventory on hand over sequential quarters driven by our continuing efforts to improve working capital.
One last comment before I turn it back to Sal, who will comment on the balance of 2020. As we continue to improve pre-tax earnings, our effective tax rate continues to be volatile due to the level in variation of pre-tax earnings by our jurisdictions. We continue to evaluate the need for increases in our deferred tax valuation allowances in all our jurisdictions. We do not believe at this time that any changes in our tax rate will impact cash taxes paid in 2020.
I will now turn it back over to Sal.
Salvatore A. Abbate -- Chief Executive Officer
Thanks, Steve. Shifting to our outlook for the balance of the year, we expect to see further impacts on our business related to COVID-19, primarily related to our non-packaging businesses. The environment remains dynamic and there is still significant uncertainty. As a result, we expect fourth quarter's consolidated net sales to remain similar to third quarter levels once adjusted for the two fewer shipping days.
As we announced earlier this year, we have taken permanent actions to reduce costs in light of COVID-19. We are pleased to report that the restructuring plan as announced in July remains on schedule and on target. Our business is showing the benefits of improved operating leverage as volumes have increased since our lowest levels in the second quarter. At this time, we expect the fourth quarter earnings will drive our 2020 full year adjusted EBITDA above our 2019 full year adjusted EBITDA.
Regarding 2021 market dynamics, we expect significant market volatility through the first half of the year as the COVID-19 situation remains uncertain. With that in mind, we expect our packaging performance to improve despite potential pricing pressure headwinds, particularly in the corrugated and resin-based markets. We expect our Facility Solutions business to remain suppressed through first half of the year, driven by continued softness in the entertainment and hospitality and office sectors as large entertainment venues continue to be shut down and the work from home trend continues. We expect to see continued increased demand for our hygiene products, but a full recovery will not ensue until these sectors open back up more fully.
Lastly, while we believe we have already experienced the worst downturn for Print and Publishing in quarter two of this year, ongoing secular declines will shape our Print and Publishing results for 2021. We will continue to be proactive and responsive in addressing future market volatility.
This concludes our prepared remarks. Operator, we are now ready to take questions.
Questions and Answers:
Operator
[Operator Instructions] Our first question comes from the line of John Babcock with Bank of America. Your line is now open.
John Babcock -- Bank of America -- Analyst
Hey. Good morning and thanks for taking my questions. Starting that [Phonetic] as, I was wondering if you could maybe help me a little bit in understanding the guidance for 4Q. I mean, obviously it sounds like you're expecting full year earnings to be higher than the 2019, which obviously allows some room for interpretation there. But overall, it seems like perhaps you might be expecting 4Q to be a little bit lower than 3Q. And I think you mentioned you have to two fewer shipping days. Is there anything else that's coming into play in the quarter that I should be or that we should be mindful here?
Salvatore A. Abbate -- Chief Executive Officer
Good morning, John. Thanks for the question. This is Sal. I know, I think you summed it up, which is, we expect our full year to be improved over last year. We expect our Q4 run rate to be similar to Q3 and then impacted by two fewer shipping days will foot out [Phonetic] to be lower than Q3, but for the full year, we do expect to be last year.
John Babcock -- Bank of America -- Analyst
Okay. That's helpful. And then on the Packaging business, you obviously had very good improvement in margins here and I was wondering, if you might be able to provide some color on where those margins should ultimately be longer term? And also it's clearly, the improvements pretty significant and you talked about some of the improvements in the business, but also, were there any other factors like mix for example that might have come into play there?
Salvatore A. Abbate -- Chief Executive Officer
Yeah. So I'll just comment on overall mix. So our overall consolidated margins are up due to a shift in segment mix toward packaging. And then inside of packaging, the factors that are driving our margin improvement. One are the ongoing customer choices that we've made over the past couple of years. The second is, our pricing discipline which we put in last year, both from a customer perspective and a supplier perspective. And so that is really what's helping us hold margins pretty consistently throughout the last 18 months or so.
In terms of where we're headed, we do expect some pressure as I mentioned on the pricing front in corrugated and in resin based products. Again, though, our discipline around our processes will allow us to be able to sustain that as best as we can, where they're going in the future beyond today, we believe that we're going to be in the fourth quarter and heading into next year quite similar to where we are now. You've seen probably in the market, John, that there have been announced increases for both corrugated and resin based products and we are planning accordingly for those increases.
John Babcock -- Bank of America -- Analyst
Okay. Yeah. That was actually part of my next question there. So I mean you mentioned that you expect some pressure in corrugated as part of that because of the near-term increase in containerboard and then ultimately, as we look out over the next couple of quarters as those guys fully as the producers start to fully implement those increases at what point does vary to you perhaps get some spread on that to help margins, if at all?
Salvatore A. Abbate -- Chief Executive Officer
Yeah. That's right, John. It's really a wholesale increase from the entire market and we've seen that actually already implemented in many cases and therefore, we have already taken action around that. It really will -- and it is due to the ongoing strength in the fulfillment sectors and e-commerce, which are anticipated to be strong in the quarter -- in the fourth quarter and then into next year. Now as additional capacity comes online as folks are shifting their print assets to packaging that will have a determination of what future prices might look like as we head into, say, Q2 of next year.
John Babcock -- Bank of America -- Analyst
Thank you. And then next question, just quickly on the holiday season. We saw Amazon Prime Day was in early October, now the next look is really on the holiday season, how that might pan out? And I was wondering based on your packaging business, what sort of initial read you might have, if you can share anything on that front?
Salvatore A. Abbate -- Chief Executive Officer
Yeah. I mean, we are seeing -- our business is really following the trends you see in the market, which is strong holiday shipping and in the e-commerce fulfillment actually home, grocery is doing well, our international business, consumer electronics, luxury retail those are all driving as positive Q3 into Q4, as well as the food processing segment, which did dip a little bit in the market in Q3, we actually fairly well in the food processing in Q3. But that's also a segment that will -- we think be strong, especially if there is a more protracted lock down coming from the effects of COVID-19.
John Babcock -- Bank of America -- Analyst
Okay. Thanks. And then just last question before I turn it over. Just on cash flow, I was wondering if you might be able to provide some color on how we should think about working capital for the full year?
Salvatore A. Abbate -- Chief Executive Officer
Steve, please.
Stephen J. Smith -- Senior Vice President and Chief Financial Officer
Yeah. So good morning, John. So we expect that the COVID impact, the income statement will flow over into the balance sheet this year, we know that some customers will be looking at addressing their balance sheet at year-end and we expect that in our own patterns. It will be a little bit atypical because of that as far as our fourth quarter. And so we do not expect an inflow in the fourth quarter. We expect an outflow over the fourth quarter in cash flow, John this year. But given our excellent year-to-date cash flow, free cash flow and low net leverage, we expected that will continue to march toward an improved working capital set of metrics in the fourth quarter and into '21, but the actual flow will be negative probably in the fourth quarter.
John Babcock -- Bank of America -- Analyst
Okay. Thank you, Steve. Appreciate all the details. [Phonetic]
Stephen J. Smith -- Senior Vice President and Chief Financial Officer
Yeah.
Operator
And there are no further questions in queue at this time. I'll turn the call back to Sal Abbate for closing comments.
Salvatore A. Abbate -- Chief Executive Officer
Great. Well, thank you and thank you for your questions. Our results over the last two quarters have illustrated our ability to be nimble and responsive in an unprecedented dynamic [Phonetic] market. The fundamentals of the business continued to improve. As we conclude a strong quarter during this unusual operating environment, we thank both our former CEO, Mary Langer for her vision [Indecipherable] and our many employees who are executing so well against this shared vision. Thanks for joining us today. Please stay healthy and safe and we look forward to speaking with you in March as we share our fourth quarter and full year 2020 results.
Operator
[Operator Closing Remarks]
Duration: 24 minutes
Call participants:
Scott Palfreeman -- Director of Finance and Investor Relations
Salvatore A. Abbate -- Chief Executive Officer
Stephen J. Smith -- Senior Vice President and Chief Financial Officer
John Babcock -- Bank of America -- Analyst
