Veritiv Corp (VRTV) 2017 Q4 法說會逐字稿

Good morning, and welcome to Veritiv Corporation's Fourth Quarter and Full Year 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 Tim Morabito, Director of Investor Relations. Mr. Morabito, you may begin.

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 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 to be contained in our 2017 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 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 fourth quarter and full year financial results. We will also provide some thoughts on important drivers of our expected full year 2018 performance and share our guidance for the year.

Over the past 2 years, we've been pleased with our improved revenue trajectory, which has been driven by strong top line growth in our Packaging segment and improved performance from Facility Solutions. For the fourth quarter of 2017, reported net sales were $2.2 billion, up 5% when compared to the prior year period. For the full year 2017, net sales were $8.4 billion, up 50 basis points compared to the prior year. Since the beginning of 2017, our year-over-year quarterly core net sales comparisons have been improving due to our investments in selling resources, resulting in significant growth in packaging and a reversal in [its ramp] for Facility Solutions revenues. The fourth quarter is the second consecutive quarter in which our consolidated core net sales were positive year-over-year. In addition, as of December, we have experienced 6 consecutive months where each had year-over-year growth.

For the year, the incremental earnings from this improved revenue performance were offset by several factors. These include: the continued industry pressures in the Print and Publishing segments; a significant increase in bad debt charges, especially in Print; investments in our growth segments; and slightly higher distribution expenses. As a result, we reported a consolidated adjusted EBITDA of approximately $176 million for the year, which was below prior year period, but above our revised guidance of $170 million to $175 million.

For the fourth quarter of 2017, we reported a consolidated adjusted EBITDA of approximately $60 million, which was up nearly 20% year-over-year, driven by both strength in our Packaging business and 1 extra shipping day. For the year, we reported a net sales increase of 50 basis points and excluding the positive effect of foreign currency exchange rate and the negative effect of 1 less shipping day, our core net sales increased 70 basis points from the prior year. On both the reported and core basis, this is the first positive full year revenue comparison that we have experienced since going public.

As mentioned, our 2017 revenue performance was driven by growth in Packaging and Facility Solutions, partially offset by the continued secular decline in our Print and Publishing segment. The full year trends were also evident in our fourth quarter, where we reported a net sales increase of 5%. Excluding the effect of both foreign currency exchange rates and 1 more shipping day, our core net sales increased 2.7% over the prior year's fourth quarter.

Now, I'd like to provide some additional details on the fourth quarter, mention some key drivers for 2018 and provide our guidance for the year.

The Packaging segment performed very well in the fourth quarter. Core revenues increased 16.7% quarter-over-quarter, 7.5% of which was due to the All American Containers acquisition. Without the benefit of the AAC incremental revenue, our core Packaging segment growth was about 9% quarter-over-quarter. That was driven by strength across most of our product categories, particularly in corrugated and film. Approximately 6% of the growth came from volume and about 3% from price. For 2018, for our Packaging business, we expect to see solid revenue performance and a modest improvement in adjusted EBITDA margin when compared to 2017. Overall, we continue to view packaging as having growth rates higher the GDP. However, we would not expect to see similar revenue growth in 2018 as we experienced in 2017.

We're expecting to see fewer price increases in 2018 compared to 2017, also, a slower-growth rate in our International Packaging business and more modest growth in our certain large customer accounts. Our Facility Solutions segment grew its core revenues 1.8% quarter-over-quarter. Over the past year, we've been pleased with the improving revenue trends for this segment, although the growth slowed somewhat in the fourth quarter due to challenges in the retail space. For 2018, we view Facility Solutions as a GDP growth business, but we do plan to selectively prune some higher-risk accounts mostly in retail. Industry pressures continued to impact the Print and Publishing segments. Print core revenues declined 8.5% in the fourth quarter, driven by secular declines in both market volume and market price. The Print segment's earnings were also negatively impacted by charges for bad debt. Publishing core revenues declined 5.1%, which was driven by secular declines in both market volume and market price. For 2018, we expect the secular industry trends to continue to negatively impact both segments. We recognize the challenges in this industry, but these segments continue to generate free cash flow, which helps support our growth businesses. The industry is changing quickly, and we will continue to adjust our business model as market dynamics evolve in order to remain competitive and to generate positive free cash flow for the company.

Shifting now to our operating system conversion. Our multistate conversion of the Southeast was successfully completed, and during 2018, we have additional large-scale convergence planned. Overall, our operating system conversion and warehouse consolidations will be substantially complete by the end of 2018. Now, I'd like to turn to our expectations for 2018.

This year will be a key inflection point for Veritiv with integration substantially complete by the end of 2018, and our mix of business improving to higher growth, higher-margin segments. During the year, we will transition to the optimization element of our strategy, and that natural extension of our efficiency effort is expected to yield an additional $100 million in benefit through 2021. In our third quarter earnings call in November, we indicated that we expected adjusted EBITDA for 2018 to improve over 2017. That guidance as well as our guidance today is driven by continued growth in our Packaging and Facility Solutions, partially offset by continued decline in Print and Publishing, and the negative impact of financing leases becoming operating leases. Taking all these factors into account, along with a full year of All American Containers, we are expecting our 2018 adjusted EBITDA to be in the range of $180 million to $190 million.

In November, we also indicated that we expected free cash flow to -- in 2018, to improve over 2017, as we focus on improvements in working capital, in part enabled by the operating system integration and warehouse consolidation. For 2018, we expect free cash flow to be at least $30 million.

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

Thank you, Mary, and good morning, everyone. Let us first look at the overall results for both the quarter and the year ended December 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.

We had one more shipping day in the fourth quarter of 2017 compared to the fourth quarter of 2016. For the full year 2017, we had 1 less shipping day versus the full year 2016. I would quickly note that in 2018, we will have 1 additional shipping day in the third quarter, with the other 3 quarters having the same number of days as 2017, resulting in 1 more shipping day for the full year 2018 relative to 2017.

For the fourth quarter of 2017, we had net sales of $2.2 billion, up 5% from the prior year period, while core net sales increased 2.7%. As Mary mentioned, our sequential quarterly pattern in core net sales has been steadily improving over the past 2 years, and we were pleased to see a second quarter in a row of positive core net sales. This trend line improvement 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 product sold for the quarter was approximately $1.8 billion. Net sales less cost of product sold was $404 million. Net sales less cost of product sold as a percentage of net sales was 18.2%, up 30 basis points from the prior year period. Adjusted EBITDA for the fourth quarter was $60 million, a 19.8% increase over the prior year period. Adjusted EBITDA as a percentage of net sales for the fourth quarter was 2.7%, up 30 basis points versus the prior year period. An increasing percentage of our consolidated revenue from the higher-margin Packaging segment contributed to the improved margins. For the year ended December 31, 2017, we had net sales of $8.4 billion, up 50 basis points from the prior year period.

Our growth in net sales per shipping day increased 90 basis points year-over-year, and our core net sales growth increased 70 basis points for the year. For the year, our cost of product sold was approximately $6.9 billion. Net sales less cost of product sold was approximately $1.5 billion. Net sales less the cost of product sold as a percentage of net sales was 18.1%, up about 10 basis points from the prior year period. Adjusted EBITDA for the year was $176.4 million, a decrease of 8.2% from the prior year period. Adjusted EBITDA as a percentage of net sales was 2.1%, down 20 basis points from the prior year period. Our decreased earnings for the full year were due to 4 primary factors: the structural decline in Print, investments in selling personnel in our growth segment, increased bad debt charges and increased delivery and handling cost which were primarily related to higher fuel prices, and the All American Containers acquisition.

Let us now move into the segment results for both the quarter and year-ended December 31, 2017. In the fourth quarter, the Packaging segment grew its net sales 19.3%. Core revenues increased 16.7% quarter-over-quarter, which is much better than the market performance. For the year, the Packaging segments net sales were up 10.6% and core revenues were up 11% for the year. Without AAC of 2017, our organic revenue growth year-over-year was more than 8%. Approximately 6% of the organic growth came from volume and about 2% from price.

For the fourth quarter and full year, Packaging contributed $71.3 million and $238 million in adjusted EBITDA, up about 28% and 8%, respectively. For the quarter, adjusted EBITDA as a percentage of net sales was up 8%, up 50 basis points from the prior year period. Adjusted EBITDA margins for Packaging were positively impacted by volume rebates in the fourth quarter. For the year, adjusted EBITDA as a percentage of net sales was 7.5%, down 20 basis points from the prior year period. Adjusted EBITDA margins were negatively impacted by changes in customer mix and higher resin prices for the year.

In the fourth quarter, Facility Solutions net sales increased 4.4%, while core revenues increased 1.8%. The higher growth categories this quarter were towel and tissue, foods service products and safety supplies. We also saw strength in Canada this quarter, which was driven by growth with some large select corporate accounts.

For the year, Facility Solutions' net sales increased 3% and core revenues were also up 3%. For the fourth quarter and full year, Facility Solutions contributed $10.4 million and $35.5 million in adjusted EBITDA, down about 18% and 25%, respectively. Adjusted EBITDA as a percentage of net sales decreased 90 basis points in the quarter and 100 basis points for the year. The adjusted EBITDA decline was primarily driven by higher supply chain costs, a shift in customer mix towards larger national accounts and additional expense for our bad debt reserve.

In the fourth quarter, the Print segment had a 6.7% decline in net sales and core revenues were off 8.5%. Secular declines in both market pricing and volumes continued to impact this segment's sales shortfall, with volume declines driving 5% of the 8.5% decline quarter-over-quarter and pricing accounting for most of the rest of the decline.

For the year, the Print segment had an 8.3% decline in net sales and core revenues were off 8.1%. For the fourth quarter and full year, Print contributed [$60] million and $60.8 million in adjusted EBITDA, down approximately 24% and 21%, respectively. The earnings impact to sales decline was partially offset by a reduction in operating expenses. In the fourth quarter, the Publishing segment had a 3.3% decline in net sales and a 5.1% decrease in core revenues. This reduction in revenue was driven by roughly 3% decrease in both volume and price. The volume decreases were most pronounced in the magazine and educational book verticals. For the year, the Publishing segment had a 7.3% decline in net sales, while core performance was off 7%. For the fourth quarter and full year, Publishing contributed $8.8 million and $26.4 million in adjusted EBITDA, up about 22% and 12%, respectively. The increase in earnings can be attributed to the mix of business and a reduction in operating expenses.

Next, I would like to update you on the impact of the recent U.S. tax reform legislation. Veritiv recognized the tax effects for the tax reform legislation in the year ended December 31, 2017, and recorded a $30.2 million provisional tax expense. In addition, in December -- as of December 31, the tax receivable agreement Veritiv has with UWWH was revalued for the Tax Act changes, which reduced the value of the liability by $13.5 million. On the income statement, this item affects our other income and expense line. Pending further evaluation of the Tax Act, over time and with increasing pretax income, we estimate that our effective tax rate will trend toward approximately 26%, down from our previous expectations of around 40%.

At this time, the cash tax impact of the Tax Acts reform is not expected to be material in 2018. For additional information on the effect of the Tax Act, I will refer you to our 2017 10-K, which we'll file later today. Today, we're providing 2018 guidance and adjusted EBITDA range for capital expenditures and for free cash flow.

As Mary mentioned, we expect adjusted EBITDA for 2018 to be in the range of $180 million to $190 million, which reflects an expectation of continued strength in our growth segments of packaging and Facility Solutions, as well as a full year of All American Containers, partially offset by continued declines in Print and Publishing and the negative impact of financing leases becoming operating leases.

Shifting now to our balance sheet and cash flow. At the end of December, we'd drawn approximately $898 million against the asset-based lending facility and had available borrowing capacity of approximately $317 million. As a reminder, the ABL facility is backed by the inventory and receivables of the business.

At the end of December, our net debt-to-adjusted EBITDA leverage ratio was 4.6x, including borrowings for the August 2017 AAC acquisition. Our net leverage ratio had been 5.4x at the end of the third quarter of 2017, right after the AAC acquisition.

Our strategic goal as a net leverage ratio is about 3x. For the year ended December 31, 2017, our cash flow from operations was $37 million. Subtracting capital expenditures of $33 million from cash flow from operations for the year, our free cash flow was only $4 million in 2017. If we add back $78 million of cash items from the acquisition, the integration and restructuring, adjusted free cash flow for 2017 would have been approximately $82 million.

Free cash flow was impacted by our increased investment in accounts receivable and inventory to support sales growth in our Packaging segment. Our net working capital increased year-over-year mainly due to increases in accounts receivables, driven in part by our growth segments, partially offset by our contracting segments during 2017. As a reminder, our working capital pattern can be seasonal.

As Mary mentioned, we anticipate at least $30 million of free cash flow for 2018, defined as cash flow from operations, less capital expenditures. We've 2 types of integration 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 for 2018 will be between $40 million and $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 efficiencies in 2018 and beyond.

Similar to prior years, this incremental capital spending is principally for information systems integration. For 2018, our ordinary course capital expenditures are expected to be approximately $20 million to $30 million. For comparison purposes, in 2017 capital expenditures totaled $33 million for the year. Of that spending, there was about $16 million related to integration projects. Finally, I would like to provide an update on our synergy capture since the merger and the transition to the optimization element of our strategy in 2018.

As a reminder, our synergy percentages are calculated using the cumulative effect of synergy benefits already achieved in the 2014 through 2017 period. We ended 2017 having captured 90% of the high end of our ultimate goal of $225 million. We surpassed the low end of our range of $150 million in synergies during 2016, well ahead of our multiyear plan. The initial synergy capture is now effectively complete. We consider it to be a success because we reduced the cost structure in the core business and helped offset the structural decline in the Print segment.

As Mary mentioned, we'll now transition to the optimization element of our strategy, which is expected to generate an additional $100 million of benefit through 2021 as a result of greater efficiencies. We expect to see a greater flow through of the benefits from the optimization to our future year earnings than we experienced with the integration. This will be driven by the ongoing shift and a segment mix of our business to our higher growth higher-margin businesses. So that concludes our prepared remarks. Tiffany, we are now ready to take questions.

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

Q4 2017, Print and Publishing segments, segments both experienced the lowest year-over-year revenue declines during the year. Was there any specific actions Veritiv was taking to slow the growth or -- excuse me, slow the deceleration? Or did you see any change in the industry during the fourth quarter relative to the rest of the year?

I would say there wasn't any material change. I think if you look at quarter-over-quarter comparison throughout the year, I think, in 2016, there was probably a greater benefit from election spend in the first 3 quarters of '16. And so when we were into '17, the year-over-year declines appeared greater because of that anomaly in '16. And so -- but we did not see a material improvement or change in the industry.

Okay, thanks. And it did look like you had nice top line growth in the Packaging segment in fourth quarter. What was the main driver of the growth? I may have missed this, but how much benefit did you experience from All American Container acquisition?

So to answer your first question, the benefit, all-in we had about almost 17% growth in the quarter for our Packaging segment. About 7.5% of that came from All American Containers acquisition. So we had about 9% core growth in the business, 6% of that was volume, 3% was price. The growth in the business was broad-based across a number of sectors and across a number of product categories. We had our greatest strength in the corrugated category, followed by films and other miscellaneous products. So it was broad-based, also from a customer standpoint, also small or midsize customers as we experienced growth in our field sales operations, which was quite substantial, followed by the corrugated growth and then by our national account.

Okay. And then, in the Packaging segment, in 2018, I believe you commented you're expecting fewer price increases and less growth in Europe, and at a certain customer. Is the fewer price increases purely based on your expectation for raw material pricing during the year? And can you expand on what is contributing to your lower growth expectations in Europe and at the certain customer you referenced?

Okay. So first of all, the last item. I didn't reference a specific customer. What I said was is that, we're expecting less growth -- less aggressive growth in large national account. Because as you can imagine that when you're bringing on large accounts, they can be lumpy. So we anticipate a growth in that part of our business, but not to the same degree and pace that we saw in '17. So it wasn't based on a specific customer.

My comments on International, I didn't reference Europe. Most of our International businesses comes out of our support for U.S. customers operating in Asia. A lot of those are very specially designed projects that we do. And we had some real strength in our International business in Asia this past year. And we see that, again, tapering off slightly, just not as robust, but we will still have continued growth.

Again, if you look at that, those are projects that come and go over the course of time. We're constantly working on new ones, but there is some lumpiness in that part of our business. In terms of price. We do -- we experienced several price increases, in particular, in corrugated throughout the year in 2017, and prices started to tip up as well as in resins at the end of 2017. Our expectation in corrugated, in particular, in '18 is that, it won't be as aggressive as well as we have a layering-in effect of those price increases that went into effect already in '17, s it reduces the percent growth. So we're anticipating fewer price increases in corrugated. At this point in time, we can't predict that precisely. And on the resin front, again, we started experiencing price increases in the fourth quarter already. We're anticipating that there will be some more of that just not at the same rate. There's anticipated ongoing capacity improvements in that space.

Okay, great, thanks. And I think you also referenced an issue collecting receivables from small Print and Publishing customers last quarter. Have you resolved those issues or is there still some uncertainty in terms of what you're expecting from collecting receivables from those customers in 2018?

I would characterize that, that situation has not gotten worse and we're starting to see some modest improvement and believe we'll continue to make progress. And certainly, there is risk in that space just because of the market dynamics. But I believe that it will moderate more as we go into 2018.

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

So first of all, in 2018, is there any risk of cost overruns, as you continue to integrate the systems in DCs or you think that you have that largely behind you now?

First of all, it's not largely behind us. In terms of cost overruns, we have planned for, I would say, less productivity improvement as a result of the integration. I would say, if there is risk, it's going to lie more on our need for third-party freight, which is something that we can't control as much. So I think it's going to be similar to what we saw in 2017, in general. But again I want to clarify, we are not through our warehouse consolidations yet. But we think we've got pretty good handle on it. Obviously, there are some things we can't control around fuel and some third-party freight in which we do need every once in a while. But those would be the big drivers of that.

Got it., okay. And then for Facility Solutions in '18, you said GDP growth, but that you are also going to prune some high-risk accounts and you mentioned retail. So what sort of growth rate would you expect then? I guess, sort of quantify the retail risk there in the pruning.

We would expect low single-digit growth in that space, as we look at some of the risk profile of some customers, in particular, around credit.

Okay. So even with some pruning, you still expect positive growth?

That is correct.

Okay. And then just lastly, you sort of walked through this, Steve walked through this. But can you just explain or put a fine point on why in 2017 EBITDA margin is up in Publishing, but down in Print? The core revenue declines were fairly similar, just what's sort of the difference?

Yes. The difference is that the Publishing business is a brokerage business model. And so they have more than 70% of their total cost structure is completely variable. And so it flexes with the trends in the business greater. Plus, as we've gone through integration of systems and other capabilities in that business, we've been able to get at selling expense as well. So it's a combination of a high variable cost structure, a very high variable cost structure, products do not flow through the warehouses, as well as great management of selling expense. Whereas when you look at the Print business, I would characterize almost everything in our business as variable; not everything, but most things. And it takes longer to adjust to lower demand in that space just because of the nature of it flowing through the warehouses.

Makes sense, okay thanks for that.

And the pricing pressures were a little bit worse in the Print space, more competition than what we experienced in Publishing.

(Operator Instructions) Your next question comes from the line of Scott Gaffner with Barclays.

Mary, when you mentioned fewer or lower price increases in the corrugated segment in -- or corrugated industry in 2018, are you assuming that the March 1 price increase is effective or because if that's the case I would have thought that would be very similar 2018 versus 2017. What are you thinking there?

Yes. So there were 2 price increases last year. And right now, there is another one announced for here in the first quarter, which will probably go into effect probably in the second quarter. So there -- and it's hard to predict what might be on that, but recognize there's a lot of other capacity coming online. And so we're just not sure at this time. So it's actually double the amount of price increases in '17 versus what's currently expected in '18. Plus we've got the year-over-year comparisons, when those price increases of '17 came into play, is sometime in the second quarter.

Okay. So you are assuming now that the March 1st price increase is effective in your commentary?

Yes. We believe that it will. Yes.

Okay, all right, fair enough. Steve, when I look at the $30 million of free cash flow, I just want to clarify if that's free cash flow or adjusted free cash flow, which metric are we using there?

The former, the free cash flow. So cash flow from operations less CapEx.

Okay, all right. And then, if you look at, Mary, the business over time, we've obviously got a little bit of inflationary environment going on here. You mentioned some on the resin side. But the business definitely relies heavily on trucking, and I don't know how much of your fleet is company-owned versus how much is outsourced. Can you walk us through that and the sort of underlying impact on the business and how much of that cost you can pass through to the end customer?

Yes. So on inflation of raw materials, we generally will be able to pass that through. Sometimes we have lags and there may be dynamics periodically where some markets may be more competitive, especially when we are trying to renew large corporate contracts and those kinds of things. But generally speaking, we try to stay up with price increases that we're receiving from manufacturers due to inflation. It's not going to be perfect. There is often times lags and so on.

As it relates to inflation, in particular, in the trucking industry, the majority of what we do haul is our own internal fleet. We have our -- we have roughly about 1,000 power units and 1,500 trailers. So where we experience inflation, as I mentioned with third-party freights is when we cannot use our fleet. For example, as we're doing warehouse consolidation or sometimes we do have some customer demands that calling us for third-party freight. And so that's the area that we have less influence on, to the extent that we have fuel increases that would impact us though.

Okay. And then just lastly, on your working capital, Steve, I think, what's the exact assumption for working capital source versus use in 2018?

We're assuming a slightly positive source of cash from changes in working capital, Scott, in '18, which would be reversal of trend, which no doubt you figured out in 2017.

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

I just wanted to follow up on Scott's point about the free cash flow. If I'm -- can maybe just get a bridge? If you're increasing the EBITDA by at the mid-$10 million and then EBIT, I might have misheard, but I thought you said there wasn't much of an increase or benefit year-over-year from cash taxes. Working capital is, as you just said, supposed to be slightly positive, maybe assume $5 million. And I think CapEx at the mid is supposed to be up slightly. So how do you get to the $30 million of free cash flow? What am I missing here?

You are really close. Let me just add a few more points. The $180 million to $190 million adjusted EBITDA range, if you take the midpoint, you'll see that, that would generate roughly breakeven net income plus or minus or small amount. So let's just assume it's 0 to start. DNA last few years has been running right around mid-50s, so let's call it $55 million as an add back. Then we have other noncash items, let's use that 2017's figures representative of '18 at plus $10 million. And then the midpoint of the CapEx is about $40 million. We've guided $30 million to $50 million of the 2 different types. So before we get to working capital, you'd have total cash flow of about $25 million. And as we just spoke with Scott, we think that there is potential for slight positive in net working capital in '18, so that would take us to the $30 million or greater figure.

Okay. And going back to the comment that synergies from the integration are now largely complete, are they expecting no material benefits from operating system conversion, either -- now that, that's mostly in place? Any derived benefits from that or further warehouse consolidations, nothing we necessarily see as a particular improvement in 2018 over 2017?

So we're still finishing all of that work and it carries us through into the fourth quarter of 2018. We would characterize that the synergy capture is complete in terms of this first round. And as we stabilize our network, stabilize our information systems, that then takes us into the optimization phase of the company where we can begin to drive process improvement and operational excellence.

So there will be some benefit from all the work that's been done. But we don't characterize it as synergies. That wasn't part of our original plan, when we launched this initial effort.

Okay. So I guess, just thinking about 2018, you'd have further costs from the system conversion and warehouse consolidation this year and then looking ahead, into 2019, as you get more into the optimization program, you'll start seeing the benefit pretty much starting in 2019.

That's a fair characterization, yes.

Okay. And jumping around a little bit here about the Facility Solutions, you talked earlier about the growth profile on the revenue side. But with the pruning of some of the I guess lower-margin customers or higher-risk customers, what's the expected growth in the margin profile for 2018 and beyond? Do you have a particular target or goal that you think that segment gets to?

For 2018, I would characterize that that's going to be relatively flat, primarily driven by the fact that we are still finishing integration. We would expect over the course of time, in all of our segments, as we get through this, that we would see a trend toward a better margins across the entire system as a result of completing the integration and moving the company into optimization. But stable for the year.

Okay. And then just one last one, and I'll turn it over. You previously called out breaking out the -- a new segment that services offerings that you already have. Is that still expected to happen this year? And, I guess, where have you seen the progress in 2017? Do you see it adding a considerable amount of growth looking ahead?

Yes. So we still feel very strongly about the value creation that will come with services. We have begun the work of separating the existing services in the company into its own unit. We won't start reporting on that until 2019, and do see some value there. We've not given any estimates on growth. I will say that currently those segments of our business are growing, but they are embedded currently in the core business. And it's not -- and because of the size it is today, it's not having material impact on the core. And so we're learning more and more every day about and putting the strategies in place and the capabilities in place to accelerate that growth. But we still feel confident that there is significant opportunity there. But we haven't characterized that specifically.

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

I wanted to dig in, if I could, on just a couple of components there within the free cash flow. Steve, when you said working capital modest health, should I think it's something that's in the 0 to $10 million range, is that kind of what's you're implying?

Yes, correct, Chris.

Okay, that's helpful. And I wanted to ask about kind of some of the debt cost or assumptions or thoughts there. Do you have a -- I think last year your interest costs were about $31 million. I know that we've had interest rates move up a chunk, they're mostly variable on the EBL. Is there -- and pardon me not going all the way through, I'm sure you filed some of the debt agreement in components through time. But did you have any LIBOR floors or things or should we assume -- how should we think about interest cost for 2018?

Interest costs will be slightly [off] from 2017 due to the acquisition of AAC in August. So our absolute level of borrowings would be up, all things being equal, by the $145 million net purchase price. With rates rising in 2018, at least as expected by most of the market, there will be some use of cash for that incremental interest expense but would be measured in the order of magnitude to $5 million, not $15 million.

Okay, that's helpful. So LIBOR floors or things in there that you're insulated in the first 50 basis points of the move or something like that?

We do not. LIBOR strips can be stretched out to -- for temporarily fixing of rates, but we do not have any floors or ceilings that would protect us from rate movement. We have a cap that is currently at 3% out of the money, but we're a distance from hitting that at this time.

Okay, that's helpful. Last question, I did notice in the cash flow segment, you had an adjustment here for acquisition and integration expenses that was like $41 million for the year. You did just mention you paid $145 million. That seems like a really big number, almost 1/3 of purchase price for integration cost. Could you maybe give us a little color there as to what was happening or what's behind that?

So are you referring to a $40.5 million figure?

Yes, $40.6 million, right, cash payments for acquisition and integration.

Okay. So the cash payments for integration acquisitions is a combination of factors, if I'm looking at the same figures you're looking at.

I mean, just in relation to it being $145 million as a purchase price. It seems like a really, really big number, maybe it's related to...

Chris, let me clarify, the $41 million is not integration cost for AAC. We've not really integrated AAC. If that what's your question is.

Okay. So, this is something that's totally different. That was something I was trying to understand.

Yes.

Yes.

I thought it was related to the acquisition?

No, no. There are more items in there. So we have not spent any real money on integrating AAC at this point. So that is not the cost of integration.

Okay, that's helpful. And then last question is thoughts for '18. As you think about M&A markets, things of that nature, do you have any -- I guess, it may be challenging to add a bunch in, given where you are sitting today with leverage. But do you have opportunities for any swaps, say, add some small pieces, anything that you think about deleting within the portfolio to kind of fund that? Thoughts there?

Well, Chris, as you can imagine, as the owners of the business, in terms of what we're trying to do that, we're constantly evaluating the strategy for the company to continue to accelerate its growth. To your point, our debt-to-EBITDA came down considerably from when we closed the transaction in third quarter to today. But right now, I would characterize that we're trying to focus on paying down that -- [bad] debt. Opportunities do remain. We'll have to see how they play out over time, but there is nothing specific to comment at this time.

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

Did you reference in your commentary that you're bad debt reserves increased for a particular segment or was that across-the-board in 4Q '17? And with that, has your methodology for assessing bad debt changed over the course of 2017, and if so can you explain how?

Sure. So we did not reference specific figures on bad debt by segment, but we're glad to give you a bit more detail today and then we can talk to methodology change that occurred during '17, but had a small impact on the bad debt expense. So first of all, during 2017, the incremental bad debt expense year-over-year was about $14 million, from around $2 million in '16 to around $16 million in '17. Of that variance of $14 million, the vast majority, more than half, was related to our Print segment. And then it was evenly split, the incremental effort or cost, between the other segments.

As it relates to methodology, we did take a look at different [stratos] of exposure on bad debt, meaning different time experiences, 0 to $30 million, $60 million to $90 million, above $180 million. And we did put in place some different rate reserves given length of exposure in our Print segment. We did put aside a little bit different dollar figure as a result of that methodology change, but it was small relative to the overall $14 million increase year-over-year.

I would also add to clarify, Steve commented that year-over-year from '16 to '17 it was an incremental $14 million, but the $16 million was a relatively low number. And so on average you wouldn't see that kind of a delta -- that $16 million was just a historically low number for bad debt.

Okay. So $16 million is probably close to what your average has been over time, is that fair?

No, I would say about half that.

Okay, great. And then I think also you indicated that the cash impact from the Tax Act will be immaterial in '18. Do given expectation of what or if it will materially contribute to your cash flow in 2019?

We don't yet have that perspective. We're working through it, Jason. It may be in the future quarter-end call, we can share that with you.

Okay. And then lastly, we've heard from some other distribution businesses that there has been a shortage of drivers in the back half of '17. Have you experienced any issues attracting the appropriate amount of drivers or increasing cost associated with the drivers over the last six months?

So, for the last year or more, we've been challenged like other companies with a shortage of drivers. And so that continues to be a challenge for all companies that are shipping freight, frankly. And so we've been dealing with that over the course of the last couple of years actually. We do have the added benefit with our drivers that they get to go home every night and so our dynamics can be a little bit different, but that doesn't suggest that we don't have challenges, but it's been out there for quite some time, Jason.

There are no further questions in queue at this time.

Well, thank you, everyone, for your questions. As -- when I think about 2017, it was a challenging year for Veritiv. But I believe and am absolutely committed that we've got a bright future for Veritiv. Our growth segments and packaging and Facility Solutions continue to perform well, and the growth of these segments is now offsetting the secular declines in Print and Publishing. Over time, the higher growth higher-margin Packaging and Facility Solutions businesses will make up a larger percentage of the overall business. And over the past few quarters, we've already seen this long-term strategy play out. While the investments in our growth segments impacted our 2017 earnings, I believe they are vital to our long-term success for the company. In terms of our integration, we made significant progress in 2017, and we're pleased that we're getting closer to its completion. The entire Veritiv team should be proud of all we've accomplished in nearly 4 years since a very big merger. A great deal of work remains in 2018. But as we move through this year, we'll be well positioned to transition to the optimization element of our strategy. So thank you, again, for joining us today, and we'll look forward to talking to you in May, when we share our first quarter 2018 results. Have a great day.

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