Q2 2019 Earnings 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 already Vito.

Director of Investor Relations Mr. Morabito, you may begin.

Thank you Joni and good morning, everyone. Thank you all for joining US today Youll hear prepared remarks from Mary Laschinger, Our chairman and Chief Executive Officer, and Steve Smith, Our Chief Financial Officer Afterward, we will take your questions.

Before we begin please note that some of the statements made in today's presentation regarding the intentions beliefs expectations and or predictions of the future by the company and or management are forward looking.

Actual results could differ in a material manner additional information that could cause results to differ from those in the forward looking statements is contained in the company's SEC filings.

This includes but is not limited to risk factors contained in our 20 Eightth annual report on Form 10-K and in the news release issued this morning, which is posted any investor relations section at Baird Corp. dotcom.

non-GAAP financial measures are included in our comments today and in the presentation slides. The reconciliation of these non-GAAP measures to the applicable U.S. GAAP measures are included at the end of the presentation slides and can also be found in the Investor Relations section of our website.

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

Thanks, Tom Good morning, everyone and thank you for joining US today as we review our second quarter 2019 financial results. We will also provide some thoughts on the important drivers of our expected full year 2019 performance.

Our second quarter results were highlighted by strong free cash flow and adjusted EBITDA improvements in three of our four segments.

However, consolidated revenues were below expectations and decline year over year, largely due to the ongoing structural decline in our print and publishing segment and general market softness in packaging.

Some of the revenue loss was planned as we made strategic choices in facility solutions and de risk the print customer portfolio in the quarter.

Consolidated reported net sales for the second quarter were $2 billion down about 10% compared to the prior year period with our core net sales decline at also at about 10%.

Our packaging core revenues were flat year over year, while our print facility solutions and publishing segments all experienced declines.

Consolidated adjusted EBITDA for the second quarter was $43 million down about 5% year over year.

The reduction in earnings was due to the volume declines in print.

And the negative earnings impact of certain financing leases being replaced by operating leases.

This is the last quarter in which these incremental lease cost will have a negative year over year impact on adjusted EBITDA.

Somewhat offsetting these pressures on earnings were margin improvements and lower cost.

Shifting now to review our performance by segment.

Packagings adjusted EBITDA came in as expected in the second quarter.

With core revenues flat year over year, but with improved margins.

Our U.S. packaging business is experiencing some softness we believe our results are roughly in line with the overall market.

The U.S. market has weakened from the second half of 2018 into the first half of 2019 with box shipments and sales of resin based products flat slightly down year to date.

However, our rigid packaging product line has experienced strong year over year growth and is up high single digits in both sales and earnings over the prior year quarter.

Packagings adjusted EBITDA increased about 2% in the second quarter.

The earnings increase was due to improved margins and lower delivery cost in our U.S. business, partially offset by increased storage costs.

For the full year of 2019, we expect packaging adjusted EBITDA margins to improve from last year and for revenue growth to be around GDP.

Rigid is packaging our product line is expecting high single digit growth, but the balance of the packaging business will likely not be as robust as 2018 due to less of a benefit from supplier price increases more modest growth with certain large customers and continued softness in parts of our U.S. business.

Our facility solutions segment saw a decline in the second quarter core revenues were up 6% year over year. This decrease was driven really driven principally by strategic choices.

Facility solutions adjusted EBITDA increased about 9% in the second quarter, driven by improved margins as well as lower operating and selling expenses.

We are repositioning this segment for success by continuing to make strategic customer choices in order to focus on our strengths and better aligned with market product and customer dynamics as well channels of distribution, particularly in the United States.

As we have said before these choices are resulting in facility solutions being smaller, but a more profitable business.

For full year 2019, we expect facility solutions revenue trends to be similar to that of the first half of 2019 due to the choices. Just mentioned however, we expect to see an improvement in year over year adjusted EBITDA led by a continuation of the key drivers experienced during the first half of the year as well as the further focus on core product offerings, including private label.

Switching to our print segment and favorable industry pressures continue to affect our <unk> our revenues.

Print core revenues declined nearly 22% for the second quarter, driven by continuing secular declines in market volumes, coupled with excessive inventory throughout the channel partially offset by increased the prices.

In addition, as we have mentioned on previous calls we are making choices to manage credit risk in our print segment, which has and may continue to have a negative impact on her volumes.

These choices have improved the quality of our accounts receivable portfolio and have reduced our bad debt charges.

The print segments adjusted EBITDA was down approximately 37% year over year due to the revenue decline and margin pressure, partially offset by lower expenses.

We expect secular industry trends will continue to negatively impact Prince revenue in the second half of 2019.

We could also experienced worsened market volume declines as we continue to make adjustments to our customer base and product offerings.

The print business model changes, we implemented in 2018 will only partially offset the earnings effect of the volume declines in 2019.

Taking all these factors into account.

We expect print adjusted EBITDA in 2019 to be significantly lower than the 2018 level.

The publishing segments core revenues decreased approximately 15% in the second quarter.

Similar to print publishing was impacted by the continued secular declines in the market volumes.

Adjusted EBITDA in this segment actually increased nearly 17% year over year due to improved margins from the stabilization of prices and effective cost management.

For the remainder of 2019, we are expecting a more stable environment for publishing with volume declines consistent with industry decline and prices moderating.

We expect earnings to be roughly at the same level as 2018.

As we have noted in the past this business can be impacted by changes in customer order patterns.

Turning now to our consolidated 2019 guidance.

We expect adjusted EBITDA to be in the range of $165 million to $180 million for 2019.

Key assumptions for reaching this range includes a GDP growth rate of about 2% and revenue declines in the print segment similar to our second quarter performance.

In the second quarter of 2019, we generated approximately $130 million in free cash flow compared to 18 million in the second quarter of 2018.

The increase was due to volume declines and post integration process improvements, which resulted in a lowering of accounts receivable and inventory.

Due to the strong cash flow results in the first half and a continued focus on post integration process improvement.

Somewhat offset by the seasonality of working capital in the second half. We are confident we can achieve free cash flow of at least 100, it at least $85 million in 2019.

Now I'll turn it over to Steve who can take you through the details of our second quarter financial performance.

Thank you Mary and good morning, everyone.

We will first review the overall results for the second quarter ending June 2019.

As we review those results. Please note that when we speak to coordinate sales were referencing the reported net sales performance, excluding the impact of foreign exchange and adjusting for any day count differences.

As it relates to the day count.

We have the same number of shipping days in the second quarter of 2019, as we had the second quarter of 2018.

As a reminder, we've had one less shipping day in the first quarter. So we will have one additional shipping day in the third quarter with the fourth quarter, having the same number of days in 2018.

Consequently, we will have the same number of shipping days through 2019, as we had in 2018, but the difference in day count will shift our already seasonal earnings pattern slightly more into the second half.

Consolidated net sales for the quarter were $2.0 billion down 9.8% from the prior year period with core net sales down 9.5% after adjusting for small impact from foreign currency.

Our cost of products sold for the quarter was approximately $1.6 billion.

Net sales less cost of product sold was $374 million.

Net sales less cost of products sold as a percentage of net sales was 19.1% up about 140 basis points from the prior year period, largely due to improvements in pricing and mix.

Consolidated adjusted EBITDA for the second quarter was $43.3 million down about $2 million or 4.6% versus the prior year period.

Adjusted EBITDA as a percentage of net sales for the second quarter was 2.2% up 10 basis points versus the prior year period.

While consolidated adjusted EBITDA declined approximately $2 million year over here.

The print segments earnings decline about $7 million versus the prior year quarter.

Consolidated adjusted EBITDA was negatively affected by about $3 million as a result of how our leases are treated from an accounting perspective.

Most of that incremental $3 million in expense was absorbed by the packaging segment.

Offsetting these pressures on earnings were margin improvements and lower costs.

Said differently, even with approximately $10 million and adjusted EBITDA headwinds for the print segment and the lease accounting changes our earnings declined only $2 million year over year as margin management the mix of products sold and reduced operating costs helped offset these headwinds.

Let's now move into the segment results for the second quarter.

Packagings net sales and core revenues were both flat and were negatively impacted by a slowdown in parts of our us business.

We believe we are performing roughly in line with the market.

Offsetting a portion of this revenue decline slowdown our Richard products line achieved revenue gains over the prior year quarter.

Packaging contributed 6.5 65.5 million and adjusted EBITDA up nearly 2% year over year.

Adjusted EBITDA as a percentage of net sales was 7.4% up 10 basis points or approximately $1 million from the prior year period.

The earnings increase was due to improved margins and lower delivery costs in our us business, partially offset by increased storage costs of approximately $3 million.

Facility solutions net sales decreased 6.8%.

Core revenues decreased 6%.

The revenue decline in this increasingly competitive segment was due to channel dynamics and the fact that we are making customer choices that align to our product and service capabilities.

Facility solutions contributed $8.3 million in adjusted EBITDA up 9.2% year over year.

Adjusted EBITDA as a percentage of net sales increased 40 basis points from the prior year period.

The in the earnings increase was primarily driven by improved margins as well as lower operating and selling expenses.

The print segment experienced a 22.2% decline in net sales and core revenues were down 21.9%.

The revenue decrease was driven by secular declines in market volumes, coupled with excessive inventories throughout the channel as well as choices, we're making to manage credit risk.

These declines were partially offset by increased market prices.

For the second quarter print contributed $12.3 million in adjusted EBITDA down 37% year over year.

The earnings impact of the sales decline and margin pressure was only partially offset by a reduction in supply chain and selling expenses.

Publishing's net sales in core revenues, both decreased 14.6% from the prior year quarter.

The revenue decline was due to a reduction in volumes, primarily driven by continued secular decline in the industry.

Publishing contributed $5.6 million in adjusted EBITDA.

Nearly 17% year over year.

The increase in adjusted EBITDA can be attributed to improved margins from the stabilization of prices and effective cost management.

For the entire company, we experienced $5.2 million of bad debt expense in the second quarter down from $6.8 million in the second quarter of 2018.

For the first time in three years, the print segment experienced a year over year reduction in bad debt expense.

Shifting now to our balance sheet and cash flow.

At the end of June we had borrowed approximately $757 million against the asset based lending facility and had available borrowing capacity of approximately $320 million.

As a reminder, the ABL facility is backed by the inventory and receivables of the business.

At the end of June our net debt to adjusted EBITDA leverage ratio was 4.0 times down from 4.8 times in the prior year period, and 4.7 times at the end of March 2019.

Taking our long term strategic goal continues to be a net leverage ratio of about three times.

Cash flow from operations for the second quarter was approximately $138 million.

Subtracting capital expenditures of about $7 million from cash flow from operations, we generated free cash flow of approximately $131 million.

If we add back the roughly $11 million of cash items due to acquisition integration and restructuring activities adjusted free cash flow for the quarter would've been approximately $142 million.

Our strong second quarter free cash flow was due to the lowering of both accounts receivable and inventory.

For 2019, our total capital expenditures are expected to be approximately $45 million.

That concludes our prepared remarks, Jodi, we're now ready to take questions.

At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad, we'll pause for just a moment to compile the Q and a roster.

And your first question comes from the line of John Babcock of Bank of America Merrill Lynch. Please go ahead. Your line is open.

Hey, good morning.

Good morning, John .

Hi, good morning, how are you.

A couple of questions I mean first of all you talked about kind of managing credit risk and some customer churn during the quarter across couple of your businesses and just wanted to first get a sense where were those customers.

Some of that churn did that help EBITDA during the quarter. So in other words were they on EBITDA drag on the company.

The the customer churn so let's talk about a couple of different topics in this within this context.

In our print business, we made choices around exiting specific customers because of bad credit risk.

So they they hurt us from the standpoint that it impacted our volume.

And so to read to respond to that we have to take out cost correspondingly and we're never sure precisely how much that isn't there is always a lag between losing the volume and getting the cost out.

So in that regard it did hurt our adjusted EBITDA, but on the flip side of that we had lower bad debt expense for the quarter than what we did prior year.

So it's a it's a combination of both positive and negative impact.

We also had as we alluded to in our facility solutions business.

Where we are making customer choices around specific channels that we want to support or certain types of customers that have service needs that don't necessarily match, our our supply chain capabilities are what we want our supply chain capabilities to be as we move forward.

As exiting those customers again had negative pressure on our revenues and volumes, which does put pressure on our cost structure, but we've been able to take out cost at least as fast or more.

As we've made those customer choices, so it actually improved our margins, which improved our adjusted EBITDA.

Yeah, Thanks for that.

And then obviously a lot of us have read kind of about.

You asked trying to trade dispute and I want to get a sense I guess first of all for how the new set of tariffs.

Set to go into effect on September Onest might impact Verity of and then also is there any incremental impact to guidance.

So we've had a minimal impact of the tariff situation until our business to date.

The biggest impact that we've had is with.

Products that were buying in Asia, specifically that we resell, obviously and weve to date been able to pass those incremental costs onto our customers.

We anticipate continuing to do that.

We also have had some impact with our outside U.S. business in particular in the Asian markets, where we support customers in that geography that have had to make choices to move manufacturing on China, specifically into other regions and that has had a short term impact on volumes.

And products going into those customers as they move to other parts of the world such as Mexico.

Indonesia, and Vietnam, and so there has been some short term impact on us as it relates to that we do not anticipate any impact on this tariff situation with regards to our outlook in terms of our guidance for adjusted EBITDA or cash flow.

Okay.

And on on this topic.

I mean, we've heard from some of our contacts that.

I guess some shipments that had initially with this kind of uncertainty in the market and what's going on between the U.S. in China. It sounds like some shipments have been moved into Fourq you that.

In prior years might have been.

In part because of ecommerce been put in Threeq, you and I guess I want to get a sense particular on the packaging side, whether you're seeing any change in the trajectory of shipments in the second half the year from Threeq to fourq or vice versa.

In the packaging space, we have not seen that at all to date.

What I would say is that we saw a change in shipments in the first half of the year of imports on the paper side as global demand and supply and demand has moved between Asia and the middle East and.

In other parts of the World that has that has actually push more imports into the us on the paper front in particular on the West coast.

But that's not it's.

It is somewhat related to tariff, but it's also related to other world issues.

That are happening in the middle East, but we have not seen an impact of the tariffs and in the packaging business, having said that.

What we would anticipate and are anticipating is pressure on pricing in the U.S. and in particular and packaging and boxes I'm just because of the fall off of demand in Asia and the impact it's having on linerboard supply the supply demand balance and linerboard, which could impact pricing going forward.

In that segment.

Okay and.

On that.

Actually kind of leads me to the next question is really just kind of talk about how declining container prices impact your results and.

If you can just kind of remind us of the flow through there that would be great.

Sure, we generally lag behind both price increases and price declines with an effort to try and stabilize our margin.

We do have us a percentage of our business it's.

Less than 30, that's tied to indices.

And so we would move with that when when the indices are posted but it's a relatively small percentage of our business.

And so you could expect because of the time lag we might have improving margins for a time period and then they would level out come back down generally we try to target them to be stable over the course of time.

Okay. Thanks, and last question before I turn it over just a it looks like you paid down some debt during the quarter.

Just want to get a sense for how you're thinking about leverage by the year end and also whether we should expect some pickup in debt.

Yes, particularly in Threeq given that.

You typically have more working capital uses during that time, but if you can just kind of.

Ken talked talking about Thats correct.

John we're very pleased with our first half free cash flow and we did use as you mentioned that excess cash flow to pay down debt, bringing it down to 4.0 times due to seasonality, we do expect our leverage to increase.

Because we will have free cash outflow in the third quarter and possibly in the fourth.

And so we would typically see an increase in leverage in the second half we would expect that for this for this year, although we're working hard to continue to reduce our working capital components and that should help us versus historical averages.

Yeah. Thanks Steven.

There are no further questions I will turn the call back over to Mary Laschinger.

Chairman and executive.

Sorry, Chief Executive Officer for closing remarks.

Thank you well everyone. Thank you for your questions to today I would just like to summarize our corridor with a few comments you know our optimization efforts are leading to significant improvements in our margins meaningful cost reductions and in general improved working capital. Despite the revenue headwinds we had in the print industry. Our second quarter results were highlighted by adjusted EBITDA improvements in three out of our four segments and very strong free cash flow, which has enabled us to significantly reduce our debt.

So again, we feel good about the corridor as well as the balance of the year. Thank you for taking the time to join US today and we look forward to speaking with you in November as we talk about our third quarter results have a great day.

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