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Edited Transcript of XRM earnings conference call or presentation 30-Oct-17 9:00pm GMT

Q3 2017 Xerium Technologies Inc Earnings Call

YOUNGSVILLE Nov 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Xerium Technologies Inc earnings conference call or presentation Monday, October 30, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Clifford E. Pietrafitta

Xerium Technologies, Inc. - CFO, EVP and Treasurer

* Mark Staton

Xerium Technologies, Inc. - CEO, President and Director

* Phillip B. Kennedy

Xerium Technologies, Inc. - General Counsel, VP and Secretary

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Conference Call Participants

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* James Martin Clement

Macquarie Research - Analyst

* Richard E. Kus

Jefferies LLC, Fixed Income Research - Analyst

* William Mastoris

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Xerium Technologies 2017 Third Quarter Financial Results Conference Call. (Operator Instructions) At the request of Xerium Technologies, this conference call will be webcast and recorded.

I would now like to turn the conference call over to Xerium's General Counsel, Phillip Kennedy.

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Phillip B. Kennedy, Xerium Technologies, Inc. - General Counsel, VP and Secretary [2]

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Thank you, and welcome to Xerium Technologies 2017 Third Quarter Financial Results Conference Call. Joining me this evening are Mark Staton, CEO and President of Xerium Technologies; and Cliff Pietrafitta, Executive Vice President and Chief Financial Officer. Mark will lead the discussion, and Cliff will discuss our Q3 2017 financial results. Then, we will open up the lines for questions.

I would like to remind everyone that our discussions during this conference call will include forward-looking statements that are subject to risks and uncertainties that would cause -- that could cause actual results to differ materially from those indicated and that those statements speak only as of the date of this call. We undertake no obligation to update or revise those statements.

Discussions on this call also will include financial measures not prepared in accordance with generally accepted accounting principles. Those measures are not and should not be viewed as substitutes for GAAP financial measures. For a full discussion of these matters, please refer to our press release regarding our financial results for the third quarter of 2017 issued this afternoon and our 10-Q filed today as well as our other SEC filings, including our December 31, 2016, 10-K, all of which can be found on our website.

Now I will turn the call over to Mark Staton, our President and Chief Executive Officer, who will provide the opening remarks. Mark?

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [3]

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Thank you, Phillip. Good afternoon, everyone, listening in. I'll begin today by highlighting our financial results and round numbers from the third quarter, before touching on some company initiatives that we've implemented. I'll then pass the call over to Cliff for a closer look at our numbers before I finish off with some comments on our outlook for the fourth quarter.

Results in the third quarter were in line with our expectations, as we continued to offset end-market pressure with higher sales and new products. We are focused on using all the tools available to us to find increased market penetration in sales growth areas and are having success doing so. We're pleased to see growing volumes in our pulp fabrics in the regions where pulp production is growing. Our Opticel fabric has seen additional advances. We also continue to grow our presence and reputation in shoe press belts. Our unique polyurethane roll covers technology is being bound to deliver excellent track resistance with a stable surface quality. This is being coupled with our Rezolve program, thereby increasing press efficiency.

Also, we have the recent introduction of Maximus, which is a new portfolio of unique patented press felt technology, specifically designed with the steady-state performance over its entire lifetime. This product reduces break-in periods and bounces performance at containerboard, packaging, and graphical paper grades, and also the lowest cost-per-ton.

Turning to financials for the third quarter. Total sales were $119 million, was slightly behind the prior year performance. The sales line had a favorable impact from currency of $1.6 million, but had some volume reductions from recent hurricanes affecting the south-eastern Texas during the period. While it is difficult to pinpoint the impact weather-related events caused, we can share the recent storms affected sales volume and produced a headwind that estimated to be approximately $1 million. Although we expect customer facilities to resume typical ordering patterns in the fourth quarter, we do not expect to benefit a catch-up of this volume in 2017, as at this time, then they do not expect it to regain the lost days. Excluding these discrete events, consolidated revenue was driven by a nice improvement in our Latin America Machine Clothing business, offset by softer sales in our roll covers in North America and Europe, and price pressure in our Asia Machine Clothing business. Adjusted EBITDA in the third quarter improved 2.3% on a constant currency basis, $23.8 million, compared to the prior year period of $23.3 million. The increase in adjusted EBITDA was the result of improved gross margins, lower overhead cost, partly impacted by lower sales and price pressure.

So far in 2017 and with an eye into 2018, we are working hard to drive EBITDA performance and generate cash flow. This includes several strategic actions we have begun to implement. On the sales side, we've implemented a demand-based product development pipeline to partner Xerium directly with our customers to address complex uptime and efficiency challenges. This is a different product development philosophy that Xerium has traditionally brought a wide range of new products to the market with a mix of performance outcomes. By partnering with our customers, we expect to reduce the total number of products under development, while substantially improving our success rate.

Secondly, during the quarter, we are implementing a revised sales force incentive plan that is designed to better align employee compensation with the needs of our customers and shareholders. This program revision will better reward those individuals directly involved in generating sales at new positions. Therefore, it should be viewed more as pay for current performance as opposed to an annuity system.

On the operations side. We are restructuring our senior team, adding a lead for the European market. Currently, we have one lead for both the U.S. and European markets. But we expect this added support to broaden our reach and focus, improve execution, keep decision-makers closer to the geographies they serve. I'm pleased to report that this process is at an advanced stage and would expect a conclusion in the quarter with an individual in place for the early 2018.

Secondly, we have taken some additional actions to further improve efficiency in 2018 and offset expected inflation headwinds. To that end, today, we announced a cost out initiative which reduced headcounts in North America and Europe by 46 people. Coupled with our refined compensation structure, these steps are intended to improve efficiency across our sales platform.

In total, we expect this to generate approximately $6 million in annual savings beginning in quarter 4 2017.

Now turning to our cash flow. We are pleased with the operating environment in cash flow during the quarter. Tying it together and taking a longer-term view, our stated mandate caused regressive action to strive EBITDA performance and cash flow with a primary goal of debt repayment. To help articulate our current cash requirements, please consider that our cash uses include $50 million in cash interest and about $15 million a year in CapEx.

Going forward, we expect $1 million to $2 million per year in cash restructuring. Cash taxes are currently in the $10 million range. And while we expect some moderation in 2018, it's a little too early to put a number around it. Cash generated over these requirements will be available for debt reduction.

With that, I'd now like to turn it over to Cliff to review our financials.

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Clifford E. Pietrafitta, Xerium Technologies, Inc. - CFO, EVP and Treasurer [4]

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Thanks, Mark. Referring to Page 3 of the slide deck, consolidated revenue in the third quarter of 2017 declined to $118.5 million compared to the prior year level of $119.2 million. Third quarter 2017 gross profit was $44.3 million or 37.4% of net sales compared to $43.8 million or 36.8% of net sales in the third quarter of 2016.

Let's turn on Page 4. Machine Clothing net sales increased to $72.6 in the third quarter of 2017 compared to $71 million in the third quarter of 2016. The increase in Machine Clothing sales was due to improved performance in Latin America.

Rolls & Service net sales were $45.8 million in the third quarter of 2017 compared to $48.2 million in the third quarter of 2016, primarily as a result of weaker roll sales in North America and Europe.

Machine Clothing gross margin as depicted on Page 5 improved to 39.2% in the third quarter of 2017 from 38% in the prior year. The increase in gross margin was primarily due to production efficiencies and favorable product mix, partially offset by competitive pricing pressure in certain regions.

Rolls & Service gross margin declined 20 basis points to 34.7% in Q3 2017 from gross margins of 34.9% in the prior year's quarter.

SG&A expenses were $28.9 million or 24.4% of net sales in Q3 2017 versus $30.2 million or 25.4% of net sales in Q3 2016. The decrease is due to cost-reduction initiatives and lower stock-based compensations.

Cash taxes were $3.5 million in Q3 2017 compared to $4.9 million in the prior year's third quarter. Cash taxes are primarily impacted by income the company earns in taxpaying jurisdictions relative to income it earns in nontaxpaying jurisdictions, primarily in the United States.

On a GAAP basis, third quarter of 2017 earnings per share was $0.07 per share compared to third quarter 2016 loss per share of $0.83. The increase is due primarily to Q3 2016 debt extinguishments costs and improved income from operations in Q3 2017, partially offset by higher income taxes and higher interest in the current year's Q3.

On Page 6 and 7, third quarter 2017 adjusted EBITDA was $23.8 million or 20.1% of net sales compared to the third quarter of 2016 adjusted EBITDA of $23.3 million or 19.5% of sales. The increase was driven by improved gross margins and lower overhead costs.

Moving to Page 8. Net cash used in operating activities during the third quarter of 2017 was negative $4 million, and free cash flow was negative $6.3 million. Free cash flow is expected to improve substantially in the fourth quarter of 2017, as we see lower cash interest, working capital reductions and lower CapEx. Net debt was $527.9 million at the end of the third quarter of 2017 compared to $511.7 million at the end of Q4 2016. Our debt -- our net debt leverage ratio is 5.4x.

Now I'll hand over the call back over to Mark for some summary comments.

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [5]

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Thanks, Cliff. Now for a few comments on our full year outlook. The full year, we expect adjusted EBITDA to be at least $97 million or at least $2 million above 2016 results. This is due in part with the continued efforts to diversify our sales mix towards improving growth areas, particularly in tissue and paperboard, while shifting away from declining commodity products. We will continue to relay the focus on improving efficiency in our business, serving customer needs and expanding the sales footprint. Our focus on these objectives will help us to drive aggressive debt repayments and continue to improve our leverage ratios and lower our debts.

By our fourth quarter call, we anticipate in providing greater color to the outlook fiscal 2018, providing additional business updates. So at this time, we'd like to open up the call to any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jamie Clement of Macquarie.

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James Martin Clement, Macquarie Research - Analyst [2]

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So just first off, Ba Cheng's full year free cash flow guidance back to trailing 9 months, just back of the envelope, it looks like working capital for the first 9 months has gone against you by like $30 million, which is pretty substantial. So presumably some of that's going to unwind. But can you give us just a little bit more color on kind of what went on in the first 9 months? How things are reversing? What specifically is going on in the business? And what are some longer-term opportunities to kind of put some more working capital back in the company's pocket?

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Clifford E. Pietrafitta, Xerium Technologies, Inc. - CFO, EVP and Treasurer [3]

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Sure. There's a couple of things going on, Jamie. If you look -- if you think about the -- when we did the refinancing last year in August, our interest payment dates changed from second and fourth quarter to first and third quarter. So when we compare the cash flow for this year, you've gotten an $11 million use of cash in September that you didn't have at the end of December. So you've got a timing difference for $11 million of cash interest. Secondly, there is some noncash reductions of about $4 million in net accounts payable accrued expense reduction line. The next piece is really a timing issue in our working capital, and when we've talked about the fact that we had a build of inventory last year to rectify some supply issues in North America. We expect it to have a net reduction inventory by the end of this year. We now expect that, that inventory would be back down to prior year level. So we do have some more work to do to get those numbers down.

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James Martin Clement, Macquarie Research - Analyst [4]

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So -- and so Cliff, prior year, so end of year roughly equal with the end of 2016, is that what you're saying?

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Clifford E. Pietrafitta, Xerium Technologies, Inc. - CFO, EVP and Treasurer [5]

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That's correct. And the same goes -- we had some timing issues related to receivables and payables, which we also expect to come back in line by the end of this year. So net-net, there's about a working capital -- trade working capital improvement of about $4 million to $5 million, that would be expected.

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James Martin Clement, Macquarie Research - Analyst [6]

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Okay, great. That's -- and Mark, if I could just turn to you. In terms of big picture end market fundamentals and the last 3 months. As you look at sort of tissue and board on one side and the more commoditized stuff on the other side, any discernible change in market conditions of either one since your last earnings conference call?

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [7]

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Not particularly, Jamie. I think there is a lot of capacity being added in the tissue market, and we will need to see demand increase commensurate with that other activity that's going in, in terms of new capacity. I think paperboard impacting pretty much remain in line with where we were in the last quarter. And as far as newsprints and the declining rates, they continue in that direction. But I think the tissue is the one that I see a lot of capacity coming in now in the next 2 or 3 years. It'll be interesting to see how that shakes out in terms of demand.

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Operator [8]

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Your next question comes from the line of Richard Kus of Jefferies.

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Richard E. Kus, Jefferies LLC, Fixed Income Research - Analyst [9]

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So two quick ones for me. The first one is, over in Asia. Can you talk a little bit about what you're seeing from a competitive standpoint over there? I'm curious how prices are shaping up across your product line?

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [10]

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Well, we're seeing increased activity on the pricing front, especially on Machine Clothing in Asia. The dynamics are such that there is a lot of capacity down there. And although there is new capacity being brought on a mill level, it has to work its way out, and the capacity is both traditional, top tier capacity. And in forming fabrics, we see second tier, which is performing very well as well. So it's an ongoing issue. I think it will eventually plateau out, but now it's certainly ahead headwind for us, Richard.

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Richard E. Kus, Jefferies LLC, Fixed Income Research - Analyst [11]

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Okay. Understood. And then you talked about all the capacity coming in the tissue market. Are you guys stronger on some of that TAD capacity? Or is it -- is your position really better in conventional? Is there any kind of a mix issue within tissue for you?

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [12]

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No. We are probably better in the conventional area versus the TAD. We have product development oriented in target towards some TAD applications. But our sweet spot of the moment would be a conventional tissue.

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Operator [13]

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(Operator Instructions) Your next question comes from the line of Bill Mastoris of Baird.

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William Mastoris, [14]

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First an administrative question. Cliff, how much availability did you have under your ABL at quarter end?

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Clifford E. Pietrafitta, Xerium Technologies, Inc. - CFO, EVP and Treasurer [15]

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It's about $23 million on the main revolver that we have.

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William Mastoris, [16]

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Okay. And Mark, question for you. The press release as well as some of your commentary refers to a lot of the new products, which you briefly touched on. I wonder if you could maybe do a slightly deeper dive on some of those new products. And if you have any figures, all right, that could help us get a little bit more traction, that would be greatly appreciated.

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [17]

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On the latter, now I'm unable to provide the figures for the call. But let me just talk a little bit more about the process, if I can, Bill. The process -- I think partnerships with new products involves establishing a much great relationship of trust with our customers, where they've got to have confidence in the new product trial. I mean, they don't just put it on for nothing. We have to have that confidence in it. And any result in the opportunity if we enhance their operations through better product performance. So what we're very focused on is making sure we increase the life of the product and improve productivity for our customers. And a couple of examples of this is what, today I was trying to think about customers and new product development. And the time it takes to bring a product to market, obviously, varies by product complexity, development time and trial periods. This can take as little as a month or it could take as long as a year to get the beginning of selling your product. So specific customer issues require solutions that are tailored to them, which is why we changed the trust of our product development to be very much in partnership on a customer-by-customer basis.

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William Mastoris, [18]

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Okay. In Latin America, if you were going to break down your backlog by region, and specific to Latin America, how would that backlog be broken out by region, if you have that data available?

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Clifford E. Pietrafitta, Xerium Technologies, Inc. - CFO, EVP and Treasurer [19]

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Yes, it's a -- the lead times in Latin America are actually much shorter, so the backlog there is -- it's not proportional to the sales. So it's much lower relative to the other regions. However, aside from Latin America, I'd say that the backlogs generally follow our breakout sales.

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Operator [20]

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There are no further questions in the queue at this time. I will turn the call back over to Mr. Mark Staton, CEO, for final remarks.

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Mark Staton, Xerium Technologies, Inc. - CEO, President and Director [21]

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Okay, well, thank you very much for listening in to our call for quarter 3. We look forward to talking to you all regarding our quarter 4 results sometime early in January or February. Thank you, all.

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Operator [22]

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

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