Veritiv Corp (VRTV) 2016 Q2 法說會逐字稿

Good morning and welcome to Veritiv Corp's second quarter 2016 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 your conference.

Thank you, Tiffany and good morning, everyone. Thank you all for joining us. Today you will 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 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 2015 annual report on Form 10-K and in the news release issued this morning which is posted in the investor section at veritivcorp.com.

Non-GAAP financial measures are included in our comments today and in the presentation slides. Reconciliations 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 investors sections our website.

At this time I would 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 financial results and full year outlook. We will also provide an update on our ongoing integration initiatives. We are pleased with our second quarter results reporting a consolidated adjusted EBITDA of $50 million, more than a 23% increase year-over-year. This increase was primarily driven by ongoing improvements in our segment and product mix.

In addition, we continued to improve our cost structure due to the integration and we also received benefits from fuel. Given our solid second quarter results and our outlook for the balance of the year, we are now expecting our 2016 adjusted EBITDA to be near the upper end of the range of $185 million to $195 million. Our reported net sales in the second quarter were $2.1 billion, down less than 5% compared to the prior year period.

Our second quarter revenue was impacted by two main factors: Foreign currency, and our core net sales performance. We reported a net sales decline of 4.6% in the quarter, which includes the negative effect of foreign currency. Excluding the effects of foreign currency, our core net sales declined 4% from the prior year. This core decline was principally driven by economic softness and the continued structural decline in the paper industry.

As we have mentioned on previous calls, we made a series of proactive, strategic account choices in 2015 which negatively impacted our top line results and year-over-year comparisons. The impact of these choices had a minimal impact on our second quarter results. And going forward these choices will not affect our year-over-year comparisons for the second half of the year.

I would now like to go through some additional highlights from the second quarter and offer some thoughts on our outlook for the remainder of the year. As I shared with you during our May earnings call, revenue softness earlier in the year created a challenging start to 2016. Despite these top line pressures, we remain focused on executing our integration initiatives, which continues to keep us on track for our commitments in 2016 as well as for our multi-year plan.

Our integration work during the second quarter continued to focus on integrating foundational processes to prepare for the conversion to our common operating system. As a reminder, this more complex phase of integration work requires a significant investment of resources and time, and as such the pacing of synergy capture during this phase of integration will be more modest than what we saw in 2015.

This change of pace was expected and is part of our original multi-year integration timeline. Next, I would also like to highlight the Facilities Solutions business. For the past couple of quarters we have been pleased with both the improving revenue trends and the operating results in this segment. These trends continued in the second quarter, with core revenues turning slightly positive and adjusted EBITDA improving over 30%.

We attribute this progress to the lapping of our strategic account choices, better performance in our Canadian operations, and improvements in our cost structure. We believe our Facility Solutions business is headed in the right direction and we remain optimistic about the long-term success of this segment.

Lastly in the quarter, we also placed a greater emphasis on, and were better able to measure and manage, working capital throughout the corporation. Particularly as it pertains to inventory management. Despite ongoing supplier changes we were able to decrease our consolidated inventory days on hand approximately two days over the first quarter of 2016.

Now, turning to our outlook for the remainder of 2016, there are a few areas I would like to highlight. First, and as I mentioned earlier, the effects of our strategic account choices have now tailed off, and as a result will no longer be negatively impacting our year-over-year revenue comparisons.

Second, our publishing segment continues to face industry challenges. During the second quarter, reported revenues declined over 14% while adjusted EBITDA declined some 20%. The majority of the revenue decrease is attributed to the continued structural decline in the industry. The remainder is due to both lower prices and reduced volume that was moved to other channels.

Third, similar to the first half of 2016, we expect economic softness, industry pressures and currency headwinds to continue throughout the year. We are also sensitive to fluctuations in commodity prices, particularly in paper and resin-based products. In looking to the balance of the year we recognize that market dynamics will continue to challenge our top line but we feel confident in our integration plans.

As I mentioned earlier, taking these factors into account as well as our performance year-to-date, we are now expecting our 2000 adjusted EBITDA to be near the upper end of the range of $185 million to $195 million.

Now I will turn it over to Steve so he can take you through the details of our second quarter performance.

Thank you, Mary. And good morning, everyone. Let's start with the overall results for the second quarter ended June 2016 compared to the prior year period. As Mary walked you through earlier, when we speak to core net sales, we are referencing the reported net sales performance excluding the impact of foreign currency and adjusting for any day count differences.

As it relates to day count differences, we had the same number of shipping days in the second quarter of 2016 as we did in the second quarter of 2015. For our second quarter of 2016, we had net sales of $2.1 billion, down 4.6% from the prior year period. Excluding the effect of foreign currency, core net sales declined 4.0% which is a considerable improvement from the last quarter.

Peeling back the layers of our core net sales, resin prices amounted to 20 basis points of the core net sales decline. Said differently, removing the resin impact from our core net sales, our revenue decline was 3.8% for the quarter. Our cost of products sold for the quarter was approximately $1.7 billion. Net sales less cost of product sold was $373 million.

Net sales less cost of product sold as a percentage of net sales was 18.1%, consistent with the prior year period. Adjusted EBITDA for the second quarter was $50.1 million, an improvement of 23% from the prior year period. Adjusted EBITDA as a percentage of net sales for the second quarter increased 2.4%, up 50 basis points from the prior year period. As Mary mentioned, ongoing improvements in segment and product mix, continued improvements in our cost structure due to the integration, and a $2 million benefit from lower fuel expenses enabled our overall margin improvement in this quarter.

Let's now move into the segment results for the quarter ended June 30, 2016. As a reminder, 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. In the second quarter, the print segment experienced a 7.5% decline in net sales. Foreign exchange reduced reported net sales 40 basis points.

As a result, core net sales were off 7.1% in the second quarter, which we believe is closer to being in line with the market decline when compared to our first quarter 2016 shortfall to the market index. In spite of this decline, adjusted EBITDA for the print segment increased about 7% year-over-year to $19.7 million, resulting in an increase in adjusted EBITDA as a percentage of net sales of 30 basis points.

Strong execution of sourcing initiatives, better customer and product mix, and reduced operating and selling expenses more than offset the volume pressures and contributed to the increase in adjusted EBITDA. In the second quarter, the publishing segment had a 14.2% decline in both net sales and core net sales. This soft revenue performance was particularly affected by secular declines in both market prices and market volumes.

The volume reductions were particularly pronounced in the educational, book, catalog and magazine segments, as customers adjusted their promotional mix. The publishing segment contributed $5.9 million of adjusted EBITDA in the quarter, with adjusted EBITDA as a percentage of net sales coming in at 2.3%. In the second quarter, Facilities Solutions net sales decreased 0.8%.

Adjusting for foreign currency and strategic account choices, core net sales increased 50 basis points quarter-over-quarter. Going forward, Facilities Solutions will not experience the negative impact on revenues resulting from our prior strategic account choices. For the second quarter Facilities Solutions contributed $13.9 million in adjusted EBITDA, a 31% improvement compared to the prior year.

The Facilities Solutions business had an increase of 100 basis points in its adjusted EBITDA as a percentage of net sales. This margin improvement was due to the increase in sales and improved customer mix and lower bad debt expense. In the second quarter, the packaging segments reported revenue increase was about 1%. The segment faced market pressures from soft volumes in the food packaging industry.

However, we experienced sales growth in our corrugated category and the manufacturing sector, along with continued strength in our fulfillment sector. Adjusting for currency, core net sales increased 1.6%. I would also like to call out the impact of falling commodity prices on this segment's core net sales, specifically resin. A decline in resin prices put pressure on the segment.

Said differently, removing the effects of falling resin prices, packaging's core net sales were up 2.3% year-over-year, which we believe was better than market conditions. Packaging contributed $59.2 million in adjusted EBITDA for the second quarter, a 14% increase from the prior year period. Adjusted EBITDA as a percentage of net sales increased to 8.4%, off 100 basis points from the prior year period. The adjusted EBITDA improvement in this segment was driven by increased revenues, sourcing initiatives and lower operating expenses.

Switching from our segment analysis, let's take a look at our synergy timeline, balance sheet, cash flow and expectations for the allocation of our capital. As a reminder, our forecasted synergy capture for 2016 is approximately 60% to 70% of the ultimate goal of $150 million to $225 million over the first few years post merger. Through the first half of 2016, we remain on or slightly ahead of our synergy pacing targets. At the end of June we had drawn $692 million of the asset-based loan facility and had available liquidity of approximately $450 million.

As a reminder, the ABL facility is backed by the inventory and receivables of the business. Our net leverage ratio, that is the ratio of the ABL debt net of cash on the balance sheet to the last 12 months of adjusted EBITDA, was 3.3 times, down from 4.1 times at the end of last year. We are pleased with this rapid deleveraging in the first half of 2016. Since the merger, our net leverage ratio has been driven down from 5.5 to 3.3 times.

Shifting now to cash flow. For the first six months ended June 30 of 2016, our cash flow from operations was approximately $123 million. If you subtract the first half's capital expenditures from cash flow from operations, we generated free cash flow of approximately $105 million. If you were to add back to free cash flow, the negative cash impact of restructuring and other integration-related items in the first half, adjusted free cash flow for the first half of 2016 would have been $136 million.

We continue to believe that this strong level of cash flow from operations will allow us to accomplish three priorities. Our first priority is to continue investing in the Company. This investment has two elements: One, time, integration, cost, and capital expenditures. We have two types of integration costs. There are those costs that run through the income statement directly and those that are capital expenditures.

One-time integration costs expected to run through the income statement for 2016 will likely be near the lower end of the $40 to $50 million range. We expect capital expenditures related to integration projects to be in the range of $10 million to $20 million which will help enable the synergy capture in 2016 and beyond. Similar to 2015, this incremental capital spending is principally for IT systems integration.

For 2016, our ordinary course capital expenditures are expected to be approximately $20 million to $30 million. For comparison purposes, capital expenditures total nearly $9 million for the second quarter and $18 million for the first half of the year, with one-time integration projects driving about $5 million and $10 million of spending during the second and first half respectively. Our second priority for the use of cash is to pay down debt.

As I just mentioned, we have made meaningful and steady progress against this priority since the merger two years ago. And our third priority for the use of excess capital is to return value to our shareholders. In summary, then, our improved earnings were primarily driven by a combination of ongoing improvements in our segment and product mix, along with continued improvements in our cost structure due to the integration.

Tiffany, we are now ready to take your questions.

(Operator Instructions). Your first question comes from the line of Chip Dillon with Vertical Research Partners. Your line is open.

Yes, good morning, everyone.

Morning, Chip.

Hi. First question is, and I just missed this, you mentioned that -- we know the packaging sales were down -- or, sorry, up 0.7 and you mentioned the number 2.3. What was the difference in those two again?

Chip, the difference was currency.

Okay, gotcha. I missed that.

The impact of currency, yes.

Okay. And then the other -- you mentioned in the outlook that as you've pruned some of the unprofitable customer lists, you mentioned that was behind you. Does that mean that by the middle of last year you had already done that, so that as we look in the third quarter, it's been a year? Or are you saying, going forward, that you finished -- or should I say alternatively, did you finish the process in the first half of this year?

No, we finished the process in the first half of last year. So going forward for the balance of the year, we would not expect to see an impact of those choices with year-over-year comparisons.

Okay. And then I guess the next thing is that -- I mean, if you want to look at it in a certain crazy way, it looks like you guys are annualizing at about $20 a share free cash flow. So your stock has a 50% free cash flow yield. But I just wanted to throw that out there and congratulate you on the $136 million in the first half. But obviously that is not sustainable, because inventories won't go down forever.

But I wanted to ask you, I mean, two days in one calendar quarter seems to be quite impressive. And as we think about working capital for the rest of the year, how do you see that unfolding? And then maybe as you think about the future, how do you think that would fare as well?

Yes, so I'm going to answer a part of that question. Then I'm going to turn it over to Steve for more granularity. So recognize that we do have seasonality in our business and we consume more cash in the second half than the first half. And we are still -- and we are working on improvements to working capital but the real benefit of working capital improvements will compost systems integration. Having said that, I'm going to turn over to Steve that can give you some perspective on working capital and cash flow for the balance of the year.

So, Chip, as you mentioned the second quarter free cash flow was healthy. We had $39 million. Well above last year's $19 million second quarter free cash flow. Again, principally due to the better working capital management that you and Mary have talked about, especially inventory.

If you take the first half of this year and then suggest that the second half of last year repeats, which was an outflow of $33 million, you would see that the $105 million in the first half less the $33 million is about $72 million of cash flow for the year, or LTM. And our guidance was at least $70 million. So we feel very good about achieving our cash flow objective and as we continue to make progress on working capital, there might be some upside.

Okay. That's very helpful. So said differently, in the first half, and again, I just might be repeating what you said. I just wanted to clarify. I guess your integration costs were $31 million, since you mentioned $105 and then you also mentioned $136. Is that fair?

Yes. So in the cash flow, just to be clear, we have the one-time and ongoing capital expenditures in the first half of about $18 million. So that's the cash flow impact. And then as you'll note, in our income statement we mentioned that in the half of the year we had the merger and integration costs of about $12 million.

Okay. So now would there be any tax offset to the -- at least to the $12 million? Meaning that the after-tax impact was a little less? Or am I getting too cute with that?

No, no, you are, you are absolutely spot-on. Some of those items will be tax effective. That's correct.

Okay. Okay, I gotcha. And then I guess the last question is, when you look at the -- your businesses, I mean, Mary you mentioned that you see some headwinds in the second half, and could you talk about the various segments when you say that? Are you thinking packaging facilities, or are you thinking more of the secular declines we're seeing in the other two segments?

Okay, so let me just go through the segments at a high level. So from -- both in the print and publishing space, we are anticipating continued structural decline. As I've shared with you before, I have felt confident and believe that we're making progress to get the print segment more at the market decline versus it's been greater, because of the customer choices and other decisions we made.

So the balance of the year we're hoping to perform closer to the structural decline of the marketplace. In publishing, we have had a couple of tough quarters. As I've talked about that segment in the past, that segment is very lumpy because there's big movements that are made. Whether customers decide they're not going to put out a catalog or they're not going to do spending in the stores. And so we're challenged with, I would say, a greater emphasis on structural decline in that segment.

Plus volume moves in and out of the channel. So we anticipate continued weakness in the publishing segment. We're optimistic it will be a little bit better for the balance of the year, but not materially better. In our packaging business we feel confident -- that's a GDP-type growth business. We're growing better, if you look at our corrugated business, for example, which is a portion of that, we're growing above the market in corrugated but we have pressures of lower resin prices that has put a lot of pressure on the top line. And just the general economy in terms of how that will be.

So we're optimistic that it's going to be fairly stable to what we saw in the second quarter. We're hoping for some positive growth there. But there are some pressures with resin and the economy. And then on the facilities business, as I shared with you over the course of last year, we felt pretty confident that we would level out in the middle of the year and begin on a better trajectory to get that business to stable to slightly up for the balance of the year. And that's where we are today.

Okay. Thank you.

Your next question comes from the line of Ryan Merkel with William Blair. Your line is open.

Thanks. And nice quarter given the tough environment.

Thank you, Ryan.

So I wanted to start with guidance for the EBITDA guidance at $195 million. The first half of the year, EBITDA has grown kind of near 20% or so. And then the guidance implies year-over-year that that will slow to flattish to kind of down a little bit. So could you just walk through exactly what's changing in the second half of the year that's going to drive that growth rate to slow so much?

Right. So the EBITDA for the first half was $85 million and in last year's second half it was $113 million. So LTM we're running about $198 million. Importantly, the second half of last year's EBITDA was about 62% of the full year total. And because we've had the headwinds in revenue, particularly the first half of the volatility around revenue, we're looking carefully at that pattern and anticipating additional choppiness in the second half. That's what's driving it.

So to follow up on that, then, what are you assuming for sales in the second half of the year? How much is it going to be down in 3Q, 4Q, roughly?

Well, Ryan, we never give projections on sales, other than at the high level that I just shared with Chip. So we just have not giving guidance on revenue in the past. I will say that, as Steve just mentioned, we have a stronger second half, normally, than the first half. But we would expect it to be similar in many ways to the first half.

Okay. So year-over-year sales growth pretty similar to what we saw in 2Q basically?

Yes, I believe that's the trajectory that we're on.

Okay. And then maybe talk to what you have seen in the monthly sales cadence because a lot of the other distributors that I follow may sort of fall off. June was a little worse and then July is sort of the same as June. What did you guys see?

Well, we saw that -- well, first of all, going back to the first quarter we saw a lot of movement between months. And March was not a good month. April recovered for us pretty robustly. May was a little -- was worse and so May was a more challenging month for us. And then that more or less continued into the June time frame. And we're seeing -- as we look forward we are anticipating continued fluctuations on a month-to-month basis. Hard to determine what's causing that precisely. But we're seeing something similar to what other distributors are seeing.

Okay. And then lastly, you might not have this at your fingertips, and rough range is going to be fine. Year-over-year adjusted EBITDA margin was up about 50 basis points. I was wondering if you could deconstruct that between how much was the core down, and then how much did synergy capture mix, and then exiting unprofitable customers help that?

So we haven't given the synergy benefits of the quarter or year-to-date but we can tell you we're pacing on or maybe slightly above the guidance for the year. And so we could work to decompose it and share it in some form. But right now we haven't given the synergy capture figure.

Okay. Maybe we'll just talk about that off line. And then lastly, I don't know if you said this, but what's your estimate for free cash flow in 2016? The last number I had was $70 million.

Yes, the estimate, the guidance, is at least $70 million as we had a good second quarter in working capital management. If we continue to perform well in working capital management, there might be some additional upside associated with that performance. Again, in the second half of last year, in free cash flow, it was outflow in the second half. So we have to mitigate that outflow in order to perform better than the figure of at least $70 million.

Great. Makes sense. Thanks.

Thank you, Ryan.

(Operator Instructions). Your next question comes from the line of Keith Hughes with SunTrust. Your line is open.

Thank you. Kind of building on one of the last questions, the guidance does imply flattish EBITDA in the second half of the year. As we move into 2017 and I know there's more synergies you're looking to gain, would we see for seasonal reasons more of an EBITDA synergy capture in the first half of 2017 or is it going to be recurring, I guess is the question?

So, Keith, I would suggest that given where we are in the integration, and the systems integration which we've said we need to get past, that enables not only the systems integration and reduced complexity in the business and create efficiencies but it also helps us lead to warehouse consolidations. We're starting the -- those big projects at the second half of this year and they're going to be very heavy in the first half of next year. And so we would anticipate that the synergy capture would be greater in the -- towards the latter half of next year versus the front half of next year.

Okay. And kind of shifting to working capital, looks like you're going to have a good year of working capital despite the seasonal outflows in the second half. Will there be more working capital once whatever this year ends up, will there be more working capital work to be done in 2017 as well?

Keith, I would say that the working capital work to be done is going to be geared more towards 2018. Now, having said that, we are continuing to work this, and there may be modest improvements over the course of the next 12 to 18 months. But real benefits should come at a much greater level post the warehouse consolidations and the systems integration.

Okay. And just a final question on working capital, you've talked about the seasonal differences. Why is there an outflow in the second half of the year?

Because the revenues are larger and therefore the inventories increase, and receivables increase.

Okay. Thank you.

There are no further questions in queue at this time. I turn the conference back over to Mary Laschinger.

Thank you, everyone, for your questions. In closing, I just want to provide some perspective. We're really pleased with our second quarter results. Especially with the uncertain macro environment picture and the challenges that we faced in the first quarter. But we continue to execute very well on our multi-year plan and we remain on track to deliver on our commitments for this year. And I want to give a special thanks to the entire Veritiv team because it's a result of everyone's contributions that bring us these kinds of results to our business.

Again, I would like once again to thank everyone for joining us today and we look forward to sharing our third quarter results later this year. Thank you. Have a great day, everyone.

This concludes today's conference call. You may now disconnect.