Veritiv Corp (VRTV) 2017 Q3 法說會逐字稿

Good morning, and welcome to Veritiv Corporation's Third Quarter 2017 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.

Thank you, Andrea, 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 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 2016 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 on 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 Investors section of our website.

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

Thanks, Tom. Good morning, everyone. And thank you for joining us today as we review our third quarter financial results and provide an update on some important drivers of our full year outlook. We will also offer some initial thoughts on 2018.

We are pleased with our improved revenue trajectory in the third quarter, which was driven by strong top line growth in our Packaging and Facility Solutions segments. Reported net sales were $2.1 billion, down only 0.5% when compared to the prior year period. Since the beginning of 2016, our year-over-year quarterly core net sales comparisons have been improving, driven by significant growth in Packaging and a turnaround in Facility Solutions revenues due to the investments we've made in selling resources. For the third quarter, this is the first time since the merger, in which our consolidated core net sales were a positive comparison to the prior year period. In addition, this is also the first time since the merger that net sales per day were positive relative to the prior year period for each month within a quarter.

The earnings from this improved revenue performance were offset by several factors, including continued industry pressures in the Print and Publishing segments, impacting both volume and price; a significant increase in bad debt charges, especially in Print; investments in our growth segments; slightly higher operating expenses due in part to the complexity of our integration; the impact of the hurricanes and an increase in fuel prices. As a result, we reported a consolidated adjusted EBITDA of approximately $44 million for the quarter, which was below the prior year period.

Although we reported a net sales decline of 0.5% in the quarter, excluding the positive effect of foreign currency exchange rates and the negative effect of 2 less shipping days, our core net sales increased 2.3% from the prior year quarter.

As mentioned, our third quarter revenue performance was driven by growth in Packaging and Facility Solutions, offset by the continued secular decline in our Print and Publishing segments.

In March, we shared with you that over several years, including 2017 through 2021, there would be a significant shift in the mix of our consolidated earnings among the segments. This shift will occur as gross margin dollars contributed by our growth segments more than offset the gross margin dollars lost by our contracting segments. However, in the third quarter, continued price and volume declines in the Print segment had an even greater-than-anticipated impact on earnings.

Now I would like to provide some additional details on the third quarter and update our expectations for the remainder of 2017. I will also offer an initial view on 2018.

First, the Packaging segment performed very well in the third quarter. Core revenues increased 12.5% year-over-year, driven by strength in our corrugated, film and folding carton categories. The growth was due to an 8% increase in volume, a 2.5% increase in price and a 2% increase from our recent acquisitions, which I'll speak to in a moment. For the remainder of 2017, we expect to see continued solid revenue performance and modest improvements in margins and costs from this segment when compared to 2016.

Second, Facility Solutions continued its improving trend line for sales growth. In the third quarter, Facility Solutions grew its core revenues 5.8% year-over-year. Over the past several quarters, we have been pleased with the improving revenue trends for this segment. Steve will speak to this as well as the sequential quarterly improvement in margins. For the remainder of 2017, we expect continued improvement in revenue and cost trend lines from Facility Solutions when compared to 2016.

Third, industry pressures continued to impact the Print and Publishing segments. Print core revenues declined 8.4% in the third quarter, driven by secular declines in both market volumes and market price. The Print segment was also negatively impacted by several charges for bad debt. Publishing core revenues declined 1% and showed some progress on historical levels due to modest improvements in market share. For the remainder of 2017, we expect the secular industry trends to continue to impact revenues and margins in both segments.

Shifting now to our integration work and synergy capture. We remain on track with our multiyear plan. After a very busy second quarter, our warehouse consolidation effort continued in the third quarter. We reduced the number of our warehouses by nearly 10% from prior year period, not including our recent acquisition. While some of the consolidations have resulted in additional near-term expenses over the past couple of quarters, these complex, multilocation moves remain a key component of our strategy and over time should allow us to lower our long-term cost.

On the second quarter call, I mentioned that a next milestone in our operating systems integration would be the completion of a multistate conversion of the entire southeast, which is well underway. This completes about 2/3 of the operating system conversion, with remainder being complete in 2018.

As stated on prior calls, this has been a challenging year for the integration. But these activities are critical to support our future optimization effort and we remain on track.

Next, I would like to mention the All American Containers' acquisition, which was announced on September 5 and support our strategy to transition the company to higher growth, higher-margin segments, both organically and inorganically through acquisitions. We are pleased with the All American Containers' transaction, and I would like to welcome the AAC employees, suppliers and customers who may be listening to today's call.

All American Containers is a leading distributor of rigid packaging, which includes plastic and glass containers, caps and closures. AAC has a highly diverse customer and supplier base with a focus on pharmaceuticals, food, beverage, wine and personal care. With AAC's rigid product offerings, sales of which are growing at a faster rate than other packaging substrates and limited overlap to Veritiv's existing customers, there are significant opportunities for growth.

Now I'd like to turn to our expectations for the remainder of 2017. We expect continued growth in Packaging and Facility Solutions, but today, we are lowering our 2017 adjusted EBITDA guidance from the previous range of $190 million to $200 million to a range of $170 to $175 million for 3 main reasons. First, the Print and Publishing segments continue to face strong secular headwinds, particularly the competitive environment in Print. Second, we are seeing an increase in bad debt expense, largely in the print segment, and this could continue to be an issue given the challenging environment in the Print industry.

Third, we are experiencing an increase in delivery and handling expenses, which are comprised of several elements. These include: inefficiencies inside our warehouses as consolidations are completed; increases in third-party freight shipments making it more expensive to move inventory between locations as a result of warehouse consolidations and an uptick in fuel prices.

We are also lowering our guidance for 2017 free cash flow from our previously stated of at least $60 million, and we are now expecting 2017 free cash flow to be near $0. The lower forecast is driven by deteriorating accounts receivable collections in our Print segment, our reduced earnings expectations and an increase in onetime uses of cash [steps] as acquisition cost.

I would now like to offer some initial thoughts on our 2018 expectations. As a reminder, 2018 is the year where we will complete our operating system conversion as well as the majority of our warehouse consolidation. Both of which should improve our customers' experiences and move us toward the optimization phase of our strategy. 2018 will be a turning point with the integration essentially complete and our mix of business improving to higher growth, higher-margin segments. We believe that Veritiv will be a better positioned, stronger and more efficient at the end of next year.

For 2018, we currently expect adjusted EBITDA to improve over 2017. This initial guidance is driven by continued growth in Packaging and Facility Solutions, continued declines in Print and Publishing and accounting changes where previously capitalized leases may become operating expenses.

We expect free cash flow in 2018 to improve over 2017, as we focus on improving working capital, in part enabled by the operating system integration and warehouse consolidation. As we do each year, we will offer formal 2018 guidance when we report our fourth quarter and full year 2017 results early next year.

Now I'll turn it over to Steve, so he can take you through the details of our third quarter financial performance.

Thank you, Mary, and good morning, everyone. Let's first look at the overall results for the third quarter ended September of 2017. 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 exchange and adjusting for any day count differences.

There were 2 less shipping days in the third quarter of 2017 as compared to the third quarter of 2016. And for modeling purposes, we will have 1 additional day in the fourth quarter. As a result, for the year, we will have 1 less day.

For the third quarter of 2017, net sales of $2.1 billion were down 0.5% from the prior year period. Removing the impact of foreign currency changes and 2 less shipping days, core net sales increased 2.3%. As Mary mentioned, our sequential quarterly pattern in core net sales has been steadily improving since the beginning of 2016, and we were pleased to see a swing to the positive in the third quarter. This trend line improvement in our core net sales is, in part, driven by the investments we're making in our growth segments and is occurring despite a tough revenue environment for our Print and Publishing segments.

Our cost of products sold for the quarter was approximately $1.7 billion. Net sales less cost of products sold was $380 million. Net sales less cost of products sold as a percentage of net sales was 18.0%, flat with the prior year period.

Adjusted EBITDA for the third quarter was $44.1 million, a decrease of 22.8% from the prior year period. Adjusted EBITDA as a percentage of net sales for the third quarter was 2.1%, down 60 basis points from the prior year period. Due to increased bad debt charges, supply chain cost for warehouse consolidations and investments in selling personnel in our growth segments, our adjusted EBITDA margins at the consolidated level were reduced versus the third quarter of last year.

Let's now move into the segment results for the quarter ended September 30 of 2017. The Packaging segment grew its net sales 9.5% and core net sales were up 12.5%, which is much better than market performance. This growth in net sales was largely driven by increases in our corrugated, film and folding carton categories, mostly due to higher volume and to a lesser extent, market price. The acquisition of All-American Containers contributed about 2% of the 12% growth in the quarter.

Packaging contributed $62.1 million of adjusted EBITDA, up 4.4% year-over-year. Adjusted EBITDA as a percentage of net sales was 7.8%, down 30 basis points from the prior year period. Adjusted EBITDA margins for Packaging were impacted by the competitive environment for our standard product offerings, investments being made in the sales force for the segment, higher supply chain costs and higher resin prices.

Facility Solutions net sales increased 3.3%, while core sales increased 5.8%, which is significantly above the market performance. The higher growth categories this quarter were foods service products, chemicals and safety supplies. We also saw strength from our Canadian operations this quarter.

Facility Solutions contributed $10.3 million in adjusted EBITDA, down 20.8% year-over-year. Adjusted EBITDA as a percentage of net sales decreased 100 basis points from the prior year period. The adjusted EBITDA decline was driven by higher operating expenses due to increased headcount to support the company's growth strategy, higher supply chain cost and customer mix.

The Print segment had an 11% decline in net sales, while core sales were off 8.4%. Secular declines in both market pricing and volumes continued to impact this segment's sales with price driving about 3% of the 8% decline quarter-over-quarter. Print contributed $13.1 million in adjusted EBITDA, down about 35% year-over-year. Adjusted EBITDA as a percentage of net sales was down 60 basis points versus the prior period. A reduction in operating expenses mostly offset the adjusted EBITDA margin impact in the net sales decline.

The Publishing segment had a 3.9% decline in net sales and a 1.0% decline in core sales. This reduction in revenue was mostly driven by secular declines in market volumes. The volume reductions were particularly pronounced in the magazine, and educational book verticals, as customers adjusted their promotional mix and spend. Publishing contributed $5.5 million in adjusted EBITDA, down 16.7% year-over-year. Adjusted EBITDA as a percentage of net sales decreased 40 basis points from the prior period. The decrease in earnings can be attributed to the mix of businesses within the segment.

Switching from a segment analysis, let's take a look at our synergy time line. As a reminder, our synergy percentages are calculated using the cumulative effect of synergy benefits already achieved in the 2014 through 2017 period. We've already surpassed the low end of the original synergy range, largely due to strong execution of our sourcing strategies. Our current expectation for net synergy capture for 2017 remains in the range of approximately 80% to 90% of the ultimate goal of $225 million over the 5 years post merger.

Shifting now to our balance sheet and cash flow. At the end of September, we had drawn approximately $969 million against the asset-based lending facility and had available borrowing capacity of approximately $272 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business.

At the end of September, our net debt-to-adjusted EBITDA leverage ratio was 5.4x, including borrowings for the AAC acquisition. At the time of the merger, our net leverage ratio was 5.5x and our strategic goal is a net leverage ratio of about 3x.

For the quarter ended September 30, 2017, our cash flow from operations was a negative $14 million. Subtracting capital expenditures of about $5 million from cash flow from operations for the third quarter and adding back $21 million of cash items from acquisition, integration and restructuring items, adjusted free cash flow for the third quarter would have been approximately $2 million.

Free cash flow was impacted by our increased investment in our accounts receivable and inventory to support sales growth in our Packaging segment. Versus prior year quarter-end, net working capital for the company increased approximately $87 million, and our Packaging segment was up approximately $86 million of that $87 million. Our net working capital is down in both of our contracting segments. As a reminder, our working capital pattern can be seasonal.

For 2017, as Mary mentioned, we now expect 2017 free cash flow to be near $0, down from our previous guidance of at least $60 million. The lower forecast is driven by deteriorating accounts receivable collections in our Print segment, our reduced earnings expectations and an increase in our onetime uses of cash, such as for acquisitions and integration expenses. We have 2 types of integration and restructuring costs. They are those costs that run through the income statement directly and those that are within capital expenditures. Onetime integration and restructuring costs expected to run through the income statement in 2017 will be about $50 million. We expect capital expenditures related to integration and restructuring projects to be in the range of $10 million to $20 million, which will help enable the synergy capture in 2018 and beyond.

Similar to prior years, this incremental capital spending is principally for information systems integration. For 2017, our ordinary course capital expenditures are expected to be approximately $20 million to $30 million. For comparison purposes, capital expenditures totaled $5 million for the third quarter. Of that spending, there was about $3 million related to the integration projects.

So that concludes our prepared remarks. Leander (sic) [Andrea], we are now ready to take questions.

(Operator Instructions) And your first question comes from the line of Jason Freuchtel with SunTrust.

Can you remind us of All American Containers financial results over the last 12 months and -- as well as how should we think about potential synergies from potential warehouse footprint consolidation? And I apologize if I missed this, but is the strategic rationale more for growing into an untapped customer base or are there -- is there any ability for All American Containers offerings to strengthen the relationships with your current customer base?

Okay. So let me first talk the rationale for the strategy, and I'll have -- I'll turn over the financials to Steve. So we made the decision to acquire All American Containers, because as part of the -- our strategy is to focus the business into higher growth, higher-margin segments. This business and the product categories within this business and the segments that they participate in, demonstrate and have demonstrated historical growth near double digits over the course of time. And the product categories also continued to support strong growth. When we look at -- and so that links directly to the shift in mix of our company over time. The value that it brings to us from a customer standpoint or how do we think about this, when we acquired it and paid for the assets -- or the company, we did not take into consideration any synergy values, although they will exist. But at this point in time, we chose not to put that in as part of the valuation, but over time we would anticipate that there will be some synergies, primarily -- probably in warehouse footprint would be the area of greatest opportunity. In terms of the potential for growth, today, there is very, very little customer overlap between AAC's customer base and the Veritiv customer base. So the opportunity to place our existing product categories into their customer base is a tremendous opportunity, because their customers are buying many of our and almost all of our current standard product offering today. Likewise, we do have customers at the Veritiv business in the Packaging space that have the need for rigid where we have not been able to sell to them. So there is a significant opportunity to accelerate growth on both sides of the customer base, both with Veritiv and AAC. And Steve?

Jason, in answer to your questions, the trailing 12 months revenue for this business has been in the neighborhood of about $225 million, its adjusted EBITDA just shy of $15 million. Its compounded average growth rate in earnings has been in the high single digits recently. And I think that answers the elements of the question you were seeking.

Okay. And, I guess, in terms of the costs you saw in the quarter, can you describe, I guess, either the actual costs or describe the magnitude for each of the bad debt charges, expenses related to the complexities and consolidating the warehouses as well as the investments made in expanding your sales force in your growth segments?

Sure.

Go ahead, Steve.

So if we look at this year's $44 million of adjusted EBITDA and compare it to last year's $57 million, there are 4 items, Jason, that address that $13 million and they are the items you mentioned. First, the bad debt expense. Bad debt expense incremental year-over-year was $5 million, around $3 million last year and just shy of $8 million this year. So incremental $5 million. The expenses you mentioned for the handling and delivery in the warehouses was up $4 million year-over-year. Separate from that was an incremental $1 million for fuel year-over-year. And then lastly, $3 million related to the investment in sales that you and Mary have both spoken to already. So I'll repeat that. $5 million of bad debt expense, handling and delivery expense of about $4 million, fuel of about $1 million and then investment in our sales force of about $3 million, comprising the $13 million delta.

Okay. And in your prepared remarks, I believe you may have indicated that hurricane Harvey had a slight impact. Is that true?

It's a slight impact versus our forecast of about $1 million. So it's about $0.5 million to $1 million.

Okay. And which -- I think you indicated that the bad debt expense may continue to exist beyond 3Q '17. Do you have any expectation in terms of how long that will continue?

Jason, the answer to that is not a clear understanding or expectation. The market dynamics are changing rapidly. We are trying to manage that risk in our portfolio around customer choices, but frankly it's impossible to know. What I'll say is there is a tremendous amount of restructuring going on in the industry, even as we speak. Even just since our second quarter call, significant amounts of capacity reductions have been taken out. There is also more price increase announcements that have been made. And so, frankly, the industry could go either way for us. We could have continued challenges with bad debt with our customers, and our goal is to better -- is to continue to manage that risk. And on the flip side of it, if -- given the amount of capacity reductions that have occurred, there could be opportunities for strengthening in the pricing of the -- in the business as well.

Okay. And, I guess, lastly, do you have an estimate of how much operating expenses could increase in 2018 from the accounting change to capitalized lease obligations?

Yes. The current expectation is high single digits, somewhere between $5 million and $10 million for the second half of the year. So we are going to suggest something in the neighborhood of $7 million for the second half.

Your next question comes from the line of John Dunigan with Barclays.

I first wanted to talk about some of the cost savings, looking ahead. So from 2014 EBITDA was $154 million. The 2017 guide is now $170 million to $175 million. So about $20 million higher despite the synergy savings of almost $200 million. So absent another meaningful savings program, the impact of paper declines are going to lead to flat or declining EBITDA in the future, is that appropriate?

Okay. So John -- so first of all, the way you look at it is appropriate. We have been able to capture the synergies, and the structural decline has an impact on Print and Publishing, has -- as we shared back in March, has eroded the value of those synergies in addition to some inflation. But as you look forward in the business, what we are beginning to see already in 2017 is whereas in '14, '15, and '16, we saw adjusted gross margin dollars net decline in the business because the Print was declining faster than Packaging and FS was growing. But in 2017 and '18 and beyond, we're already beginning to see that shift, where the growth in adjusted gross margin dollars in Packaging and Facilities begins to more than offset the decline in Print and Publishing. So it is a timing factor, and we've given indication of guidance for '18. But we're already in that transition, where we are beginning to see a shift in the mix of the business to offset that structural decline in Print. So there is light at the end of the tunnel.

Got it. Thank you. And you just touched on some of the moving pieces. But as you look into your EBITDA in 2018, you said you expect it to prove over the relatively low base in 2017. But maybe you can parse out some of the bigger moving pieces in the buckets going into 2018, where you see the improvement?

Yes, the bigger -- and again, we will give more clarity for this in the full year earnings call in the first part of the year. But the biggest movements that we see is continued strength in our Packaging and Facilities businesses. We are also hopeful that there'd be some modest margin improvement associated with that strengthening, the continued strong performance that we have seen. We also anticipate continued structural decline in Print and Publishing. And we also have some headwinds as a result of the capital leases moving into operating leases. And then lastly, we anticipate benefit from the AAC acquisition. So those would be the big drivers in the earnings outlook for 2018.

Okay. And to go back to the consolidation complexity that was seen in 3Q, are you expecting that to get worse either next quarter or beginning in 2018 before getting better?

We would not expect it to get worse. We believe we are at our peak in terms of the cost associated with that, but we would expect 2018 to be somewhat similar with a trending -- a significant trending in improvement towards the end of the year.

Okay. And my last question, you touched on the hurricane cost in the quarter. But do you expect any continued cost into 4Q impacting operating profits?

A very small amount of impact.

Your next question comes from the line of John Babcock with Bank of America Merrill Lynch.

Just want to actually start out on a slightly different topic, just on the ERP implementation. I wanted to get a sense for how that's progressing relative to your expectations. And as a whole, I mean, how we should think about the impact of that next year as well?

Yes. So I'm really pleased to say that our -- what we call the Veritiv operating system implementation is going very, very well. We had our biggest transition that actually started less than a week ago and -- for the entire southeast plus Texas and Oklahoma. And we've completed that through the weekend. We're back up and running on schedule as planned. And it was, as you can tell by just the sheer geography, was significant for us. So that has gone very, very well. And so by the end of the year, we'll have about 2/3 of our volume transitioned onto a single operating system.

And as we head into '18, we have 2 more large conversions that will occur. And again based on the history that we've had with this, they've all gone very well and don't expect any business disruptions per se as a result of the systems conversions.

Okay. And just on that sentiment, can you remind us of essentially the timing of when you expect that to be completed and then also what benefits you expect to get from the ERP implementation as well?

So the completion of the systems integration will be toward the end of the third quarter of 2018. And most all of the warehouse consolidation efforts will be complete by the end of 2018. And the benefits that we anticipate from this, we would see beginning to roll into our outlook at the end of '18, but carryover into the optimization phase of '19 and '20 and '21. And those benefits come in several areas. First and foremost, they do come in the way of working capital reduction, which we spoke of back in March, and we committed to $60-plus million of working capital reduction. Frankly, it's probably -- could be incremental over where we anticipate being in '18. We also committed to cost reductions that cut across SG&A and fixed costs as well and margin improvements to the tune of about $100 million as well.

Okay. Appreciate that. And then I was wondering if you could talk a little bit about the warehouse consolidation. If you -- realizing you may not want to kind of share all the figures here, but if you could kind of talk about relative to the first and second quarters, how much of that warehouse consolidation occurred in the third quarter? And then also what are kind of expectations for 4Q and early 2018?

So in the third quarter, we -- it was about 8% of our network footprint, which was less than what we incurred in the first half of the year. And so we're already on a pretty significant downward sloping trend.

Okay. No, I thought, maybe I misheard this, so I thought you guys mentioned that you had closed -- or consolidated rather 10% of your facilities for the year. Was that right?

From where we were last year at this time.

Okay. And so then...

So you asked about the first of the year versus where we were last year. Yes.

Yes. So how many facilities, I guess, were closed then this year? And how many, if you can say specifically?

I think we're on a track about to close about 15 to 18 facilities this year.

And so how many have you done so far then?

Most of those.

All right. That's helpful. And then the last kind of question before I turn it over. Just want to get a sense for the kind of bad debt expense. I mean, you talked about the impact of that. But I want to kind of understand how you are now evaluating essentially the Print and Publishing businesses given kind of these headwinds?

So John, it's Steve. The -- we're evaluating it as we have in the past, which is we understand the secular decline in the Print and Publishing sectors of the economy. What we're doing to try to minimize the impact of bad debt in future quarters are 2 different actions. One, to be even more selective with the customers with whom we choose to work. And secondly, with those customers with whom we are working, where there is a higher-risk account, we will move them more rapidly into cash accounting, which will impact the quarter in which we are moving them, but would also reduce future quarters potential bad debt.

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

So want to go back to Print for a minute. Sales down about 11%. Can you give us a breakdown of volume and price?

Sure. So we were down about 11%, volume was about 8% of that and price was 3%.

Can you remind me is that price down 3%, has that been pretty consistent in the last few quarters?

Yes, it is, although we were anticipating that it would actually slightly get better in the third quarter and it did not.

Okay. And then stepping back, a high-level question here. Just thinking about modeling Print and really Publishing the next couple of years, is the plan sort of limit the bleed of EBITDA declines with cost cutting? And you think you should be able to keep EBITDA margins positive over the next few years? Or is that maybe a little optimistic based on what we know today?

No. We will be keeping EBITDA margins positive over the next couple of years. We're very confident being able to do that. I think the challenge will be more on the working capital front depending on how fast it goes down, how fast we can get out the working capital. Now we will get the working capital out, but it is a matter of timing more than whether you are able to do it. But we have fairly high confidence that we can manage the EBITDA margins and maintain positive EBITDA margins and cash flow.

Okay. All right. And then moving to Packaging, EBITDA growth has been a little disappointing year-to-date. And it sounds like it should improve in '18. I just want to understand the driver. Is it mostly about harvesting the investments that you are making?

Yes. So there are a couple of impacts that are impacting -- that are affecting our EBITDA margins in Packaging. First of all, we have had fairly significant year-over-year investment in that segment to support the selling effort. And so when you look at the incremental spend around investments, it's been almost $12 million more this year than last year. Packaging took a big -- the lion's share of that, frankly. We also have had some pressure with resin prices. And we anticipated that, that would be improving in the third quarter as prices moderated. But in fact, the hurricane, in particular, Harvey did impact our ability to drive the outcome we anticipated there. So we -- between less incremental spend on investments, retaining better margins as a result of the resin price increases and we would anticipate an improvement in operating expenses over the course of the next year, we would anticipate margins continuing to either trend in a more positive light. I would also point out, though, that our part of our growth is coming from larger national accounts and some of those accounts put a damper on the margins. But it's not the overriding factor in what happens with those margins.

Okay. It's helpful. And then lastly, just stepping back again. I think on the last call, you talked about $100 million of cost take-out over the next couple of years, now that the integration is largely going to be complete and then I think another $100 million of working capital improvement over the next couple of years. And then you think you're going to grow EBITDA in the Packaging business, you think you grow it in Facility Solutions. We've obviously got declines in the other 2 businesses. So net-net is that sort of the high-level build as to how we are going to start growing EBITDA looking forward the next few years?

Absolutely. And so again, as I mentioned earlier, already in this year, the second part of this year, we began to see the adjusted gross margin dollars generated from Packaging and Facilities offset the Print and Publishing decline. That will continue and only get better in '18, '19 and '20. That coupled with the reductions of cost that we would anticipate through the optimization effort of about $100 million. That's comprised of couple of factors. That's comprised of improved -- frankly, pricing and improved margins as well as fixed cost reductions and SG&A reductions. And then lastly, we do anticipate improvement in working capital as we get through the systems integration, warehouse consolidation. And have better line of sight of our inventory and taking down our working capital as well. And what we committed to was about $60 million of increased free cash flow on a reduction of working capital.

Your next question comes from the line of Chris Manuel with Wells Fargo Securities.

Wanted to kind of start with perhaps free cash flow. So a few months back we were thinking about having at least $60 million this year, that's kind of now gone to $0. Help us with what's changed. I think you talked about a few elements on the expense side, although a lot of the expenses you guys have highlighted for a couple of quarters now with integration costs and other elements are already there. I'm guessing, Steve, perhaps it has to do with working capital, but help me with what changed kind of from $60 million to zero? What were the moving parts and perhaps size them for us, if you could? And then I have a follow-on related as well.

So Chris, there were 3 major drivers of the delta in the guidance and free cash flow quarter-over-quarter. Half of the delta, half of the $60 million, actually a little bit more than that is driven by our Print working capital deterioration, mostly in the accounts receivable bucket. There was a little bit of inventory deterioration in the quarter-over-quarter forecast or guidance, but let's call it around $30 million or 50% of the total. 20% of the total, $12 million is the earnings call down, that's the after-tax effect of it of roughly $20 million. And then thirdly, there were some additional costs of about $6 million due to the AAC acquisition, which you'll see in our free cash flow. That's about 80% of it and there are just a few miscellaneous other items.

So I guess, my follow-on then is as we move to 2018, what appreciably changes? I mean, when I think about the working capital element, we cover a lot of the corrugated and other traditional packaging guys and we have seen substantial inflation, whether it's some of the protective packaging components, whether it's the corrugated or in fact even the primary print grades of paper and such that are up a lot. When we think about $1 billion-or-so plus of working capital you have, how do you think about next year that potentially changing some of these different buckets -- or I think you said next year, free cash flow may be better, but kind of help us sort of size that?

Sure. You're right on, Chris, that there are risks and opportunities both in our working capital for '18. Let's look at both. On the opportunity side, in our mind, it's clearly inventory. We need to work more diligently on our day's inventory on hand, which you can imagine with the [DC] consolidations that have been ongoing and some of the supplier choices we've made, there is more than adequate inventory in our stockpile. So we need to bring that down. The risks are interesting. If we think about it, with you, -- that is that if Packaging grows at a rate greater than anticipated, it will consume working capital year-over-year, which it's doing in 2017. So a bit of a high-class problem. On the flip side of that, if our Print business doesn't decline at the rate we are anticipating, that would also consume working capital. Although if it falls faster than predicted or modeled, then it would throw off working capital. So those are the major opportunities and risks as we see free cash flow for '18.

And Chris, I would also add that we do believe that we can improve our accounts receivable in general through some other efforts we have underway.

I guess, maybe take a step back, I mean, I'm also trying to size or get my arms around. I appreciate growth or degradation would impact the absolute level. But at the same time, we've seen significant inflation, mid-single digits across a lot of the different packaging components that you ship out as well as significant bumps just in underlying all the different grades of paper corrugated, et cetera. I'm trying to also just look at it on a base level without assuming up or down from respect to volume. I mean, could there be something in the mid-single digits?

So on the inflation front. So let's just talk about packaging for a minute. There is a couple of dynamics occurring there that we would expect to play out. So we did -- we grew -- you are most familiar, I think, with corrugated packaging, which has been most pronounced out there in terms of what's happening in the industry. There is no question those prices have been inflated. But when you look at our absolute results and what we're seeing in our total Packaging business, it only rolls up to about 2.5% inflation. So it's -- on the total set, it's not that significant in our business. And on the resin front, where we have seen historically a little bit of inflation on resin and actually more recently it's been a little bit higher due to the hurricanes, we actually -- based on supply-demand dynamics in that industry, we actually see inflation or pricing coming down in resin over the course of the next 12 months. And so yes, there is some inflation. It's not hitting us as significantly as you might think as compared to some of the manufacturers of the business -- of these types of product categories.

Okay. That's helpful. Maybe I'll follow up on that. Last question I had was, look, and you guys to an extent have been a victim of this as well, is kind of the Amazon effect as a lot of the big distribution companies not just in your end markets, but across other industrial end markets or other components as well have been hit hard with the thoughts of Amazon encroaching. Just remind us what's perhaps different with your business with respect to service components or what have you that might insulate you a little better from potential encroachment?

Yes. Great question. So actually the Amazon effect or whatever you want to call, we have actually seen benefits from that, where we have seen our fulfillment business grow appreciably. And part of the reason we are able to do that is because of the service proposition we can provide some of those people in that marketplace for daily deliveries, for example, even though they are ordering large quantities. So we've actually to date been able to take advantage of that. But now let's take a step back and look at strategically our business and why there is probably not as big of an impact on our business. First of all, in our Print business, we are not selling the small order desktop delivery, like a Staples might or others in that space. We are selling to commercial printers, pallet deliveries, rolls and that need special handling equipment as well as large sheets. And, so it's a different delivery platform and a different targeted customer. In our Facilities business, it's also similar, whereas you've seen a lot of approachment on products like cleaning supplies, break room supplies, the things that we do sell. Again, we are not into the small order delivery platform at all. We are not doing the desktop delivery, and we are trying to target in that space customers that require a specialized need around understanding LEED certification, for example. How do you get products in your building that are LEED certified versus the alternative or lean efforts to optimize their spend. And so we're going after a very specific targeted set of customers that have a different -- that need a different value proposition and a different delivery platform. And then in our Packaging business, again, 50% of our packaging is specialty, which is -- starts with design of the package structurally and graphically, sourcing and delivering. And again, that's a very specialized sell, whereas we have the design capabilities to provide that from an end-to-end solution. And then even in our standard product offering, that is targeted, it complements our specialty customers, but is also targeted towards pallet deliveries and, again, not in the small order space. So that's how we differentiate ourselves. And then I'd also add on as part of our strategy, we're going to continue to focus on accelerating growth in our services that we currently offer that sometimes supports our core businesses of both Packaging and Facility Solutions.

Your next question comes from the line of Jason Freuchtel with SunTrust.

It looks like capital expenditures declined in the quarter. How should we think of the breakdown between ordinary course capital expenditures relative to integration-related capital expenditures going forward?

Steve?

Sure, Mary. So you're seeing a shift in our spending as it relates to capital expenditures. The company is migrating more from its integration and restructuring CapEX toward more ongoing CapEX. And so for this year, we guided to $10 million to $20 million of integration and last year we had $26 million for comparison purposes. So we'll be in that $10 million to $20 million range this year. And then for ordinary course, we said $20 million or $30 million and last year we were only at $16 million. So you're seeing a shift in our spending. Last year, we spent $41 million and this year we won't be much different, but it'll be much more ongoing and less onetime.

Okay. And, I guess, we should continue to see that shift continuing going forward?

That's our current expectation. We haven't really looked out to '19 and beyond. But that's our expectation.

Okay. Also, I believe last quarter, you indicated rebate should contribute to your earnings in the back half of the year. Are you still expecting to see some benefit of those rebates coming in next quarter?

Yes, we are. We continue to expect that a couple of our segments will benefit from the enhanced growth pattern of the second half.

Okay. Great. And a final question. I believe, you indicated you now have 2/3 of your volume on a single operating system. Will you see any working capital benefit from what you achieved so far? Or do you really need all your volume to be on one operating system to experience a benefit?

Some of both, Chris. There are some opportunities that we can begin to take advantage, for example, in the southeast region, where we -- our supply chain is configured to that region only. And so there are opportunities there for sure. But the real benefit will come later into next year as we get the entire company and have full line of sight of our products and customers in our entire system.

All right. Well, I think that's it. And so first of all, I would like to thank you, everyone, for their questions. There is no doubt this is a challenging quarter for us, but we remain very optimistic about the future of Veritiv. Our Packaging and Facility Solutions businesses are both demonstrating increasingly favorable year-over-year revenue growth, which should continue to be a key driver for the company's performance going forward.

We also completed our first acquisition, which complements our organic packaging growth and should provide further momentum for the segment. The integration has been long and complex, but the good news is, there is light at the end of the tunnel as we head out of 2018. So while near term earnings continue to be impacted by several factors, some of which are under our control, such as the investments in our growth businesses and others which are out of control, like our secular decline in our Print segment, I believe we're taking the right steps to ensure the long-term success and health of Veritiv.

So again, thank you for joining us today on the call. Look forward to speaking with you early next year as we share our fourth quarter and full year 2017 results and offer more specifics on 2018 expectations. Thank you, and have a great day.

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