Veritiv Corp (VRTV) 2015 Q2 法說會逐字稿

Good morning and welcome to the Veritiv Corporation's second-quarter 2015 financial results conference call. As a remainder, 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.

Thank you, Michelle, and good morning, everyone. Thank you all for joining us. Today will you hear prepared remarks from Mary Laschinger, our Chairman and Chief Executive 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 2014 annual report on Form 10-K, and in the news release issued this morning, which is posted in the Investors 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 GAAP measures are included at the end of the presentation slides and can also be found in the Investor section of our website.

At this time, I would now like to turn the call over to Mary.

Thanks, Tom. Good morning, everyone, and thank you for joining us today as we review our second-quarter 2015 financial results. We will also cover key developments in the quarter and provide an update on our ongoing integration efforts. For the second quarter 2015, net sales were approximately $2.2 billion, down 6.4% on a pro-forma basis from the prior year. Despite the net sales decline, we reported consolidated adjusted EBITDA of approximately $41 million, a 7.5% pro-forma increase year-over-year. This favorable increase was primarily a result of solid execution against our integration plan and continued synergy capture. We remain on track with our long-term goal to improve adjusted EBITDA by an incremental $100 million over the first few years post-merger and are pacing on or slightly ahead of this year's -- of our synergy goal.

Next I would like to take a few minutes to walk you through two factors that drove the year-over-year decline in net sales for the second quarter. First, our core business accounted for about 5.3% of the revenue decline, as the secular pressures in the print industry continue to impact our Print Solutions and Publishing and Print Management businesses. For example, the Print segment experienced a steeper than anticipated decline in paper demand for commercial print application. The Publishing segment experienced volume declines in both the retail and magazine sectors. However, it's important to note that the overall decline in the core business performance includes the impact of strategic voluntary decisions to be more selective with our revenue streams. We remain focused in our efforts to optimize the balance between revenue and profit improvement, while driving cost reductions related to our integration activities. As Steve will speak to you later, we are already seeing the benefits of these decisions through margin improvement, reflected in improved adjusted EBITDA for both our Print businesses and Veritiv as a whole. Second, currency headwinds, primarily associated with the weakened Canadian dollar, continued to negatively impact the top line by about 1.1%. Our Packaging and Facility Solutions segment, in particular, were effected. Packaging revenue growth slowed in the second quarter, and Facility Solutions was impacted in both revenue and earnings. Facility Solutions had a difficult second quarter. As anticipated, it will take the majority of this calendar year to reach the inflection point we are working toward. In order to reach that inflection point, we are repositioning our customer and product mix and making improvements to the supply chain. We are continuously evaluating the performance drivers at play and remain optimistic about our long-term success for this segment.

Having reached the Company's one-year mark, we are proud of our accomplishments to date, and we remain on track with our overall integration plans. We achieved several important milestones in the first half of 2015 that will help us better serve our customers and improve the efficiency of our operations. Last quarter, I said that much of our work is centered on standardizing processes and technology networks that [can] serve as a platform for synergy capture in 2016 and beyond. In the second quarter, we achieved an important milestone as part of this work, an on-scheduled separation of our information technology and the majority of our financial systems from International Paper's platform. This transition will significantly contribute to synergies and process improvements going forward. I would like to thank the information technology, accounting, and shared service teams who put in long hours to complete this important work, and did so on time, on budget, and with minimal disruption to our customers and employees. Through the first half of 2015, we also made significant improvements in standardizing processes across our fleet and leveraging our North American warehouse footprint. These decisions will set the stage for multi-year synergy capture. From a fleet standpoint, we implemented a common on-board monitoring system across the nation. This will allow us to analyze fleet performance, proactively monitor people and assets, and focus on increasing employee safety. We also installed the latest version of a best-in-class routing system to facilitate route optimization, which will contribute to lowering transportation costs and improved customer satisfaction. Combined, these tools will allow us to better evaluate our transfer and delivery network and provide us with the insight necessary to make informed decisions regarding our network optimization road map and rollout. We also initiated several warehouse consolidations, which enables fixed-cost reductions. This work is ongoing, as we continue to leverage our improved visibility to the Veritiv network.

Looking ahead to the second half of 2015, we expect decisions to be finalized regarding two related long-term milestones that I would like to bring to your attention. First, we are nearing completion of standardizing go-forward processes, which will enable us to make a decision on our common suite of information technology applications and core operating system as part of our overall integration plan. We are currently sizing up the various system capabilities and plan to make a decision before the end of the year, which will enable us to further integrate in 2016 and 2017. And second, as I mentioned before, we have already completed several warehouse consolidations and are finalizing our longer-term plan for the entire network. This involves a market-by-market analysis of the necessary warehouse capacity, locations, and transfer and delivery network required to support our customer demand and expected service levels. We continue to refine our network optimization road map. I am pleased with the integration work we have accomplished in our first year of operations, and I would like to thank the entire team for their continued dedication to making Veritiv a leading distribution solutions Company.

Now I'm going to turn it over to Steve, who can take you through the details of our second-quarter financial performance. Steve?

Thank you, Mary, and good morning, everyone. Let's look at the overall results for both the quarter and half year ended June 30, 2015, compared to the prior-year period on a pro-forma basis, as if the merger had occurred on January 1 of 2013. For our second-quarter 2015, we had net sales of $2.2 billion, down 6.4% from the prior-year period. Net sales per shipping day were also down 6.4% quarter-over-quarter. There was no difference in day count when comparing the two second quarters. Excluding the effect of foreign currency, which represented a drag of 1.1% quarter-over-quarter, core Company sales declined 5.3%. Our cost of products sold for the quarter was approximately $1.8 billion. Net sales less cost of products sold was $391 million. Net sales less cost of products sold as a percentage of net sales was 18.1%, an improvement of approximately 1.3% from the prior-year period. Adjusted EBITDA for the second quarter was $40.7 million, an increase of 7.5% from the prior-year period. Adjusted EBITDA as a percentage of net sales for the second quarter increased to 1.9%, up 24 basis points from the prior year period. In other words, despite a core revenue decline of 5.3%, Veritiv improved both its margins and absolute level of adjusted EBITDA. This was accomplished through a strong program management on the integration and a continued Company-wide focus on process improvements and cost reductions.

For the six months ended June 30, we had net sales of $4.3 billion, down 5.4% from the prior-year period. However, our net sales per shipping day was down 4.6% year-over-year. This decline is attributable to the day count difference in our first quarter of 2015, when we had one less shipping day compared to the prior-year period. This day count difference only exists in the first quarter of 2015 but will impact all of 2015 year-to-date comparisons versus 2014, and will generate a drag on the full-year revenue comparisons of about 40 basis points. Excluding the effect of foreign currency, core Company sales on an identical day count basis declined 3.6%. Year-to-date, our cost of products sold was approximately $3.5 billion. Net sales less cost of products sold was $767 million. Net sales less cost of products sold as a percentage of net sales was 17.8%, an improvement of 82 basis points from the prior-year period. Adjusted EBITDA year-to-date was $69.1 million, an increase of 12% from the prior-year period. Adjusted EBITDA as a percentage of net sales increased to 1.6%, up 25 basis points from the prior-year period.

Let's now move into the segment results for both the quarter and half year ended June 30, 2015, again, compared to the prior-year period on a pro-forma basis, as if the merger had occurred, again, January 1 of 2013. In the second quarter, the Print segment experienced an 11.3% decline in net sales. Removing the impact of foreign currency, our Print revenue was off about 10.5%. Year-to-date the Print segment reported a 10.5% decline in net sales, and removing the effect of FX and the one extra day in the prior period, the Print segment was off about 9% on sales year-to-date. In spite of these declines, adjusted EBITDA for the Print segment increased 14.6% year-over-year to $18.4 million in the second quarter, resulting in an increase in adjusted EBITDA as a percentage of net sales of 51 basis points. Year-to-date, adjusted EBITDA for the Print segment increased 13.6% year-over-year to $33.9 million, resulting in an increase to adjusted EBITDA as a percentage of net sales of 44 basis points. This growth in adjusted EBITDA was partially a result of customer mix, as well as our operating and selling expense reductions that more than offset the volume pressures.

In the second quarter, the Publishing segment had a 7.1% decline in net sales. This decline was partially attributed by reduced volumes as customers adjusted their promotional mix. As we have shared before, the revenue pattern in this segment fluctuates quarter-to-quarter. Our first quarter was off about 2% on a reported basis, and almost flat on a consistent day count basis. This quarter, we experienced some of the fluctuation we've previously mentioned, but we don't believe that long-term trends have changed. Year to date, the Publishing segment experienced a 4.6% decline in net sales and was off 3.8% after adjusting for one more day in the prior year versus the current year. This segment contributed $7.4 million of adjusted EBITDA in the quarter, which was an 11.9% increase year-over-year and largely a result of lower selling expenses. Adjusted EBITDA as a percentage of net sales was 2.5%, an improvement of 42 basis points versus the prior-year period. For the first half of 2015, adjusted EBITDA was $13.8 million, and essentially flat year-over-year. Adjusted EBITDA margins for the six months improved slightly from the prior-year period. In the second quarter, Facility Solutions declined 7.4% in net sales and contributed $10.6 million in adjusted EBITDA. Removing the effect of foreign currency, net sales for the quarter declined 5%. Year-to-date, Facility Solutions declined 7.1% in net sales and contributed $17.5 million in adjusted EBITDA. Excluding currency impacts, and the effect of one extra day in the prior period, net sales for the first half declined 4%. For the second quarter of 2015 compared to the prior year, the Facility Solutions business saw adjusted EBITDA as a percentage of net sales decline by 50 basis points. The decline was largely due to lower sales, which had not yet been offset proportionately by operating expense reductions. Second-quarter and year-to-date revenue declines in Facility Solutions were driven by a combination of factors, including softness in the Canadian business, especially in western Canada, the weakening Canadian currency, and domestic losses as a result of our effort to improve customer mix.

As Mary mentioned, we experienced some headwinds in our Packaging segment in the second quarter. The net sales decline of approximately 40 basis points from the prior-year period was affected by relatively softer volumes than the prior quarters in the food and manufacturing industries, and partially driven by lower film pricing, triggered by the resin market. The impact from a decline in resin prices accounted for about 80 basis points in the net sales decline in the quarter. The Packaging revenue decrease was also impacted by foreign exchange pressures, accounting for 1.3% of the net sales decline in the quarter. Net sales from the core business alone, excluding the impact of foreign currency, actually increased about 80 basis points for the second quarter. Year-to-date, our Packaging net sales increased about 60 basis points. Net sales excluding the foreign currency impact, and on a comparable day basis increased 2.6%. Despite the slight decline in net sales, Packaging contributed $51.8 million of adjusted EBITDA in the second quarter, resulting in a 16.5% increase quarter-over-quarter. Adjusted EBITDA as a percentage of net sales increased to 7.4%, an increase of approximately 1% from the prior-year period. Year-to-date, our Packaging group also contributed $97.5 million of adjusted EBITDA, resulting in a 15.3% increase year-over-year. Adjusted EBITDA as a percentage of net sales increased 7.1%, up 90 basis points from the prior-year period. The continued adjusted EBITDA growth in this segment was attributable to both product sourcing improvements and a reduction in operating expenses.

Now switching from the segment analysis, let's touch on our progress on synergies and then take a look at our balance sheet, cash flow, and expectations for the allocation of capital. For 2015, we originally forecasted synergy capture of approximately 25% to 35% of the ultimate goal of $150 million to $225 million over the first five years post-merger. Through the first half of 2015, we've kept the momentum established in the second half of 2014 and we continue to pace on or ahead of our plan. At this time, while our synergy pacing is ahead of plan, we believe that the ultimate multi-year aggregate goal should remain unchanged as the integration gets more challenging. We expect to provide the actual full-year synergy capture achieved when we report full-year 2015 financial results in early 2016. Turning to our balance sheet, at the end June, we had drawn approximately $800 million of the asset based loan facility and had available liquidity of approximately $400 million. As a reminder, the ABL facility is backed by the inventory and receivables of our business. Shifting now to cash flow. For the first six months ended June 30, 2015, our net cash flow from operations was $124 million. Adjusting for capital expenditures and the cash impact of restructuring and other integration-related items, adjusted free cash flow was $145 million. As we've shared before, we are increasing our focus on the balance sheet, but we are still refining both our knowledge of the working capital patterns of the merged businesses, as well as the tools used to effect change in our working capital accounts. Our quarterly cash flow pattern has meaningful variability related to both our seasonality and the exact timing of our integration costs. As a reference point, in the second half of 2014, we experienced an outflow of $48 million on our free cash flow line due to both seasonality and the merger integration activities.

Next, I would like to address how we plan to deploy capital. We continue to believe that cash flow from operations, due in part to an anticipated improvement in our adjusted EBITDA, will allow us to accomplish three objectives. Our first and current priority is to continue investing in the Company. Along those lines, capital expenditures totaled approximately $23 million for the first half of the year, with about $16 million related to the integration projects. Ordinary capital expenditures were lower than anticipated in the second quarter, and for that reason we are updating our 2015 expectations. For the year, we now expect ordinary course capital expenditures to be approximately $20 million in 2015, about $5 million less than previously forecasted. We continue to expect incremental capital expenditures related to the integration projects to be in the range of $30 million to $40 million, which will help enable the synergy capture in 2015 and beyond. This incremental capital spending is principally for information systems integration. Our second priority for capital deployment is to begin paying down debt, and our third priority is then to return value to our shareholders. In summary, we are pleased with our second-quarter earnings. Our improved earnings were primarily driven by synergy savings from our integration initiatives, especially the accelerated pacing on the synergy capture, and a continued Company-wide focus on customer mix, process improvements, and cost reductions. Looking forward, we expect to reach the middle to higher end of our range of adjusted EBITDA of $165 million to $175 million for the full year 2015. Michelle, we are now ready for questions.

(Operator Instructions)

Your first question comes from Ryan Merkel from William Blair. Your line is open.

Hey, good morning, everyone.

Good morning, Ryan.

Maybe just to start, could you just talk about the cadence of sales throughout the quarter, April through June, and then maybe comment on July?

Well, Ryan, first of all, I probably won't comment on July, but I can give you some perspective. As you recall last quarter, someone asked the question, the similar question, around the cadence in the first quarter, and I expressed that the early months, January and February, were stronger than what we anticipated, and March was actually weaker. We saw some of that weakness in March carry into April, and then it rebounded a little bit as we came out of the quarter, but it's not been as robust as we would have anticipated overall.

Okay. Do you have an estimate for how much the print and packaging markets might have been down in the second quarter?

Yes. The industry estimates -- the sensitivity on reporting this number is that there's wide variation between segments, or between products within the segment. So in the print industry, the number that's been reported was down about 2%, but there was a wide range of product categories in there from 3% to 16% decline. Then if you looked at the publishing industry, it was actually down 6% in publishing, again with a wide range from 1.5% to 12%. So what's been reported is total demand for printing and writing in North America was down about 3.5% for the first half of the year.

Got you. And do you have a packaging estimate as well?

From a packaging standpoint, that relates stronger to GDP-type numbers, but one of the parameters that we look at is what has happened with corrugated shipments, for example, because it's an indicator of manufacturing, for example, and those shipments were up about 1%, which is where we were in line with that number, if you adjust for FX.

Got you. And then can you remind me, when does the customer pruning stop in the Packaging business? I thought it was going to get better in the second half of this year, but remind me?

The pruning is not occurring in Packaging, just to correct your question. It's in the FS business. We also engaged in some of the activity in our Print business, as well. Let me speak to our Facilities business for just a moment. We did report a decline of about 7.5% for the quarter. About 2.5% of that was due to currency, related to the Canadian currency.

We also have determined that about another 2% is due to the economy in Canada. We had a significant drop-down, especially in western Canada, largely driven by the oil and gas industries. When you net that out, our decline in the US business, which is really the benchmark, it's about 75% of our total business, was down about 3% year-over-year, which was comparable to what we did in the first quarter.

Where I'm leading with all of this is that a big percentage of the pruning has been done, but we have carryover, almost for 12 months from the time we make the decision going forward. So we would hope that this will stabilize on the core business here going forward, but again, as I shared with you last quarter, we probably wouldn't see this -- it was going to take us most of the year to deal with this effect.

Right.

Now I would like to just -- a comment on the print business, because our margin -- I'm sorry, our revenues were down greater than the industry in our Print business, and a big portion of that had to do with making strategic choices on a few large accounts where we just felt that the profitability did not warrant the support and you can see the benefits of that moving into our adjusted EBITDA performance where our margins are up significantly.

Yes, I did mean the FS business. When do you think the EBITDA margins will start to improve, then, in the Facilities business? Is that a 2016 event?

It certainly will be toward the end of the year at the earliest, and we would hopefully anticipate for sure in 2016.

All right, I'll get back in line. Thank you.

Thank you, Ryan.

Your next question comes from Chip Dillon from Vertical Research. Your line is open.

Yes, good morning, Mary. How are you?

Good morning, Chip. I'm doing fine, thank you.

Great. First question has to do with -- you mentioned the lower CapEx. I know $5 million, percentage-wise, it is a pretty significant number. Does this mean you feel you can live with more -- or shall I say with less ongoing CapEx than maybe you thought when you were starting out with the Veritiv spin-off? And do you think this represents a number that could actually go down as, let's say, some of the segments shrink over time?

Yes, Chip, in answer to your question, this is not a permanent reduction estimate on ongoing CapEx. The fact of the matter is, we've got so much going on with integration, we're not in a position to spend more in CapEx, and so it is a -- what I would characterize as an integration phenomena, and not ongoing. So we're holding to our ongoing estimates of the combined business, with ongoing normal capital expenditure.

Okay. And then could you talk a little bit about -- it looks like the working capital, looking at that, at least as I threw the numbers together, it looks like they were flat sequentially. I know there's a lot of seasonality, and one quarter doesn't matter, but that would suggest that the receivables and inventories are declining at the same rate as the payables.

I just didn't know if there's an opportunity, as I would imagine that there is a net number, the asset side being bigger than the liability side for most companies, and certainly for yours, that as your sales do come down, as you -- in some of the segments, of course, some grow, but overall, as it declines, if you have any updated thoughts on the ability to extract cash out of the working capital commitment, which is nearly $1 billion?

I am going to turn that over to Steve to address really the dynamics of what happened with working capital, as well as how we see working capital going forward with our business. Steve?

Sure, Mary. On the short-term, Chip, in the period in the half year we saw that we had a $39 million increase in free cash flow, half-on-half. 50% of that is due to working capital, about $19 million of the $39 million, with most of that due to working capital improvements in accounts receivable. Getting into your question's detail, the AR decline was 80% driven by our revenue decline, so following the volumes and activities. But about 20% was due to a one-day improvement in our days sales outstanding, or DSO, so we are seeing some improvement in process.

On the longer-term, we'd agree with you, there's opportunity in working capital, but as you can imagine, with all this integration work going on, we're careful with our safety stocks and other activities, so as to maintain good relations, and with the cost of capital where it is, we feel that's prudent to protect the revenue stream.

And then also, Chip, I would just like to add, our sourcing strategies are going to drive some fluctuations near-term in our working capital as we're making choices on suppliers and product lines or categories or launching private labels or new brands that could short-term drive up some of our working capital, as we work toward implementation of new programs, as at the same time while we're trying to exit old ones.

Okay. And then the last question is that we've actually come up with our own view of what, as an equity investor would view as adjusted EPS. What we did is we used a 38% tax rate on your income less the restructuring-related charges. But we don't -- we have to guess at least at the segments in terms of depreciation because we're just throwing in a pro-ration there.

I didn't know if there was any thought in the future to how we should look at depreciation by segment. If that's something will you ever -- if you will ever move to a model, or does it maybe just not make reporting sense for you, so that we can actually see what the EBIT by segment is?

I'm going to let Steve answer the questions on the earnings per share and give you some perspective on that along with depreciation. Steve?

Sure, Mary. Chip, the EPS a challenge, for you and for many others, to anticipate precisely because we have two things going on simultaneously. We have a very low pre-tax level, and we have fluctuations in our tax, discrete items that impact EPS significantly. So we appreciate how hard it is to forecast quarterly, let alone annually, the EPS for our Company.

We hope that, that will settle down in 2016 as our pre-tax grows, along with other factors, and some of the discrete items due to the merger fall away. Those two should help us and you with EPS forecasting. And we would hope to have some point of view on EPS next year for The Street as far as guidance. As it relates to depreciation by segment, at this time we don't anticipate breaking that out, but we will give it some consideration, given your question.

And if you don't break it out, is there any reason that just sticks out in your mind why, just as a simple -- and I know it's not at all how you look at the business nor is it how you should look at the business, so I totally get that, but is there any reason one segment would be more capital intensive than the other, or are they roughly proportional, very roughly proportional to their revenues?

No, there is a significant difference in our thinking about and actual asset levels in the business segments. Some segments are more capital light than others, and we do think about the considerations around return on invested capital, and we think about the deployment of that capital relative to the long-term value in that segment. We just haven't gone through the internal processes to decide whether or not we would share depreciation, but on capital deployment, we definitely think about it by segment.

Okay, great. Thank you.

(Operator Instructions)

Your next question comes from Keith Hughes from SunTrust. Your line is open.

Thank you. Questions in Packaging. You referred to resins hitting the revenue by about 80 basis points. Are resin prices, is that a pass-through for you in that it doesn't affect your financials, is it a pass through for the customers, or are you taking some of the resin risk on the upside downside? How specifically does it work in [this segment]?

Keith, it's a great question. There is a pass-through, but timing is always involved, and it's not always a one-for-one pass-through. So there could be -- there's a timing both as prices go down, where customer prices eventually will catch up, but there's the reverse effect when commodity prices go up. So there's a lag with our business, and again, it is not always a one-for-one dimension, either.

So in the second quarter, even though it affected the revenue on the downside, was this an add to the EBITDA number in the quarter?

It had some additive effect. It's not the sole reason why margins were better.

Okay. Second questions, and back to working capital, just as we think about your working capital flow for the year, is there any part of the year where there's a peak and/or valley, or should the working capital be fairly constant throughout the calendar year?

No, there is a trough to peak of about $100 million, as best we can determine at this time, as the models come together. It tends to be the case that we have inflow, working capital comes down in the first quarter of the year. We build in the second a bit, even more in the third, and we are relatively flat in the fourth.

Last year, in the second half of the year, you see an outflow with regard to working capital that was in the neighborhood of $30 million. That would be a fairly typical pattern, an outflow in the second half. The exact amount, again, is being worked through, as Mary mentioned, as we handle integration and other priorities.

So if I understand you right, the end of the first quarter, is that the trough in the working capital year?

Yes, it is. It's actually within the quarter, but, yes.

Within the quarter. Within the second quarter or within--?

Within the first quarter.

Within the first quarter, and then we would see the peak after the third, is that right?

Yes, during the third. We trough in the middle of the first quarter, and we peak in the middle of the third quarter.

Okay. And final question in Facility Solutions, you've talked about some of the things going at the revenue line. Was there any impact on mix, negative mix, within the business that led to the decline year-over-year in margins?

Keith, I would say not, not anything material for sure.

Thank you.

At this time, we have no further questions in queue. I would like to turn the call back over to Mary Laschinger for closing remarks.

Thank you, everyone, for your questions. I would like to say in closing that, in just one year, I think we've made significant progress bringing these two great Organizations together as Veritiv. Veritiv is an industry leader. We're financially sound and a trusted partner to world-class customers and suppliers. We continue to make good progress against our financial and integration goals, and I am really proud of all that we've been able to achieve to date, none of which would have been possible without our hard-working, dedicated team of people here at Veritiv.

We have another solid quarter in the books, and I'm confident that we have the people and resources we need to grow and succeed in the marketplace. For the second half of the year, the Veritiv team and I look forward to continuing to execute our integration and synergy capture plans, while we keep our customers at the center of our work. Thank you again for joining us today.

Thank you, everyone. This concludes today's conference call. You may now disconnect.