Xerium Technologies' (XRM) CEO Harold Bevis on Q2 2016 Results - Earnings Call Transcript

| About: Xerium Technologies, (XRM)

Xerium Technologies, Inc. (NYSE:XRM)

Q2 2016 Earnings Conference Call

August 2, 2016 4:30 PM ET

Executives

Harold Bevis – President and Chief Executive Officer

Cliff Pietrafitta – Executive Vice President and Chief Financial Officer

Analysts

Anthony Young - Macquarie

John Roles - Argonne Capital

Richard Kus - Jefferies

Operator

Ladies and gentlemen, welcome to the Xerium Technologies 2016 Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. At the request of Xerium Technologies, this conference call will be webcast and recorded.

I would now like to turn the conference over to Executive Vice President and Chief Financial Officer, Cliff Pietrafitta. Please go ahead.

Cliff Pietrafitta

Thank you, Glenn, and good afternoon everyone. I would like to remind everyone to please refer to the press release regarding our financial results for the second quarter 2016 filed on August 02, 2016 and our corresponding 10-Q with particular reference to, the Safe Harbor noticed contained in the text of the press release about our forward-looking statements; and two, the use of certain non-GAAP financial measures such as adjusted EBITDA and the associated reconciliation of such measures to GAAP under Regulation G.

Those same statements also apply to our remarks on this conference call. Our actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those described in the press release and in our SEC filings. For a full discussion, please refer to our earnings release as well as our SEC filings, including our June 30, 2016 10-Q.

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

Harold Bevis

Thank you, Cliff, good afternoon ladies and gentlemen. Thank you for joining us this afternoon to review Xerium's second quarter 2016 results. At this time I would like refer you to the business update slide deck that's attached to our webcast, I'd like to begin today's calls by detailing a few significant developments since our last report, then provide some highlights from the quarter and finished with the summary of our long-term strategy update.

Starting on page slide in the webcast deck, in the second quarter 2016 we had sales of 124 million up approximately 6% sequentially on a constant currency basis. Our rolls and service sales were up approximately 13% from the prior year as a result of the repositioning initiatives we have implemented which are starting to take traction, machine clothing sales of 6% from the prior year period as a result of lower machine clothing volume in South America and Asia primarily and the ongoing shift to product mix towards growth rate.

However our machine clothing repositioning projects were sequenced behind our rolls repositioning project and we expect this trend to mitigate itself, our core pipeline activities for filling these new capacity is very encouraging. Second quarter adjusted EBIDTA of 27.6 million was essentially flat to the prior year period and up sequentially 15% due to increase sales volume. During the quarter we realized 7.2 million of savings from our ongoing cost reduction programs, 2016 full year cost reduction programs results to be approximately 24 million which is similar to the prior three years.

We had free cash flow of approximately $1 million from the quarter which included a $10.7 million interest payment and a tax payment, this marks a $9.7 million increase compared to prior year due to the completion of repositioning investment, specifically our Kunshan China machine clothing repositioning project. We are pleased to have maintained our guidance for both 2016 full year adjusted EBIDTA and full year free cash flow. Additionally we have closed an acquisition of a specialty rolls maker Spencer Johnston and we refinance our senior notes and termed debt out to five years from now for August 2021.

We have eliminated refinancing risks and we will implement our plan of filling our new capacity with new sales and pay-off the material portion of our debt. We are also maintaining our forecasted 2016 pro forma outlook of 4.5 times of net debt by year end including the impact of our refinancing all in.

Moving to slide four, in the second quarter we continue to build on improvement we showed in the first quarter as we became operational and more efficient in the introduction of innovative high quality products have begun to take hold in the graphical and specialty grade markets, additionally during the quarter we introduced two new rolls cover product families and a new family of next generation shoe press felt [ph] technology. The development of new products continues to serve our customers evolving needs as well as fill our product gaps so that gearing with the full line supplier, especially to the board and packaging customers, tissue, non-woven, and fiber cement markets.

In our opinion the fourth quarter of 2016 marked a bottoming out in our end market exposure and since that time, we have seen stability in both graphical and specialty grade markets despite continued weakness in Asia and South America, similar to last quarter, the company saw sequential EBIDTA growth while revenue sequentially improved a percent in the quarter after the sequentially flat first quarter of 2016. The improvement is marked by three strategic repositioning actions we have undertaken, I would like to take a moment to provide an update on these initiatives that we have had a significant number of positive developments since we last spoke.

Beginning with our sales repositioning efforts in the second quarter we completed a significant plant upgrade in our Neenah, Wisconsin facility and we also began a critical step of field testing 14 new products to achieve sales growth in our targeted new areas. Second our new machine clothing products and seven our rolled products, field testing the product is an important step before formally introducing the product to market and generally speaking the products are 6 to 12 months away from customer shipment. Lastly we began the integration of Spencer Johnston and Xerium's new business.

Our 2016 CapEx will be approximately $20 million as we have previously have announced and the accelerated capital spending program is completed, looking ahead in our sales repositioning efforts, we have repositioned 50 million of our capacity into growth markets and growth trades and are now focused on selling that new capacity, the return of organic growth is our objective and our cost reduction and lean operations initiatives, we have realized savings of 7.2 million as I mentioned during the period and remain on track for the full year.

Additionally, we are taking roll machines from our Middle Town Virginia facility and we will outfit two new plants and two new growth markets, one in Chile and one in Southern China. This will enhance our rolls capabilities in emerging markets where demand is increasing. Additionally, we have implemented Lean Six Sigma program at all 30 plants globally, during the second year of this program projects will be aimed at waste reduction, lead time reduction and quality improvement, becoming operationally lean and efficient has been goal of ours and through Lean Six Sigma we will look to further enhance improvements we have made, looking ahead we anticipate cost take out to offset inflation.

Next, we generated positive free cash flow of $1 million in the quarter which I mentioned was approximately 10 million higher than the prior year, in the first half of 2016 the company has generated 11 million in free cash flow which is a $24 million improvement compared to the first half of 2016, the free cash flow was negative 13 million. For the full year of this year we expect almost a $50 million improvement versus last year in free cash flow.

As a reminder, the free cash flow burn in the first half of 2015 was in relation to the capital investment we were making in order to strongly reposition Xerium for future growth and with those now complete, we are seeing the operational benefit and CapEx spend returning to historical norms, the Spencer Johnston acquisition is immediately de-leveraging on a pro forma basis and adds to free cash flow and EBIDTA, starting in second quarter. Post synergies we expect the acquisition to provide an additional 6 million of EBIDTA and 6 million of free cash flow at full run rate which will occur in 2017. On an ongoing basis, there will be minimal CapEx investment required in this acquisition.

Turning to slide five, as we discussed in each of our quarters call, and specifically in last quarter's call, in the second half of last year, gearing along with these global competitors, reported a faster than expected deceleration in commodity end markets which impacted our medium term results as our repositioning projects have not sufficiently come online and ramped up to offset the decline that being said, the benefits of our repositioning efforts remain on plan and are providing a meaningful contribution to our consolidated profitability and as I mentioned earlier, we are seeing good market reaction to our new products, the repositioning strategy that we are implementing quite directly into the trend lines demonstrated in these end markets as our repositioning project has been designed to leverage Xerium expertise into high-growth geographies and pivot away from commodity [technical difficulty].

Before I turn the call back over to Cliff to provide a walkthrough of our financial, I want to reiterate the fact that we have completed the foundational spending requirements to reposition Xerium especially in the rolls business and it is encouraging to see the initial progress the company has made and that the investments we have taken hold and are generating profit returns. We look to return to organic growth with the introduction of new products, continued with our cost reduction programs and finally we intend to be just as aggressive in reducing the leverage of the company as we were in repositioning the company go-forward prospects.

With that, I will turn the call over to Cliff for a closer look at our financials, Cliff?

Cliff Pietrafitta

Thank you, Harold. Moving to our financials on slide six, revenue in the second quarter 2016 was 124 million compared to prior year quarter of 123.1 million.

On a constant currency basis, sales were up 0.4% compared to the second quarter of 2015. Sequentially, sales increased $9 million or 7.8% and were up 6.1% on a constant currency basis. This increase in sales was primarily attributable to higher rolls sales as a result of repositioning program and the Spencer Johnston acquisition, partially offset by lower machine clothing volumes in South America and Asia market and ongoing product mix shift towards growth grades.

By segment in our machine clothing segment net sales on a constant currency basis decreased 6.4% to 74.8 million in the second quarter of 2016, compared to 79.2 million in the second quarter of 2015, the decline was mainly attributable to volume declines in South America and Asia. Machine clothing gross margin excluding plant start-up costs declined to 42.2% in Q2 2016 from 43.8% in Q2 2015, the decline in gross profit is primarily due to the effect of ongoing shift in product mix towards growth rates partially offset by cost reduction initiatives, net of inflation and favorable currency effects.

Moving to our rolls segment, net sales for the second quarter 2016 increased 11.8% coming in at 49.2 million compared to the prior year level of 44 million, higher roll cover sales was the result of our repositioning efforts and the acquisition of Spencer Johnston. Roll gross margin excluding start-up costs declined to 34.9% in Q2 2016 from 36.1% in Q2 2015, the decline was primarily due to unfavorable currency effects and negative product mix. Second quarter 2016 consolidated gross profit was 48.2 million or 38.9% of net sales compared to 49.4 million or 40.2% of net sales in the second quarter 2015.

SG&A expenses were 30.7 million or 24.8% of net sales in Q2 2016 compared to 30.4 million the slight increase in SG&A expense is primarily attributable to the increase management incentive compensation partially offset by savings achieved in the company's cost down initiatives and favorable currency effects.

Moving to our taxes, cash taxes were 3.9 million in Q2 2016 for the full year, we expect the cash taxes will be approximately $14.9 million, cash taxes are primarily impacted by income and company earned in tax paying jurisdiction relative to income earned in non-tax paying jurisdiction primarily the United States.

Non-GAAP second quarter 2016 basic earnings per share were $0.31 per share compared to the second quarter non-GAAP 2015 basic income per share of $0.37 per share. On a GAAP basis, second quarter 2016 earnings per share were $0.13 compared to second quarter loss per share of $0.05.

Moving to slide seven, second quarter 2016 adjusted EBIDTA was 27.6 million or 22.3% of net sales compared to second quarter 2015 adjusted EBIDTA of 28 million or 22.7% of net sales, earlier returns from our repositioning investments offset legacy market issues, approximately 40% of our adjusted EBIDTA resulted from new sales and lower cost structure, further highlighting the positive impact, our repositioning strategy is having on our business.

Moving to the next slide, free cash flow was 26 million in the quarter compared to the second quarter 2015 free cash flow of negative 9.1 million. This increase is primarily resulted -- the result of a reduction in CapEx as our repositioning spending wind down in the quarter. Our net debt at the end of the second quarter was 499.5 million the increase in debt from second quarter 2015 is primarily due to the acquisition of Spencer Johnston. Our next debt leverage ratio was 4.9 times at June 30, 2016 and 4.7 times on a pro forma basis after factoring in the Spencer Johnston acquisition.

Turning to our outlook on slide 9 and consistent with the company's prior communications, we expect continuing sales growth volume in our rolls segment for the full year, the machine clothing segment, sales are expected to be slightly negative relative to the prior year as the company's brings on new volume from plant investments and new products to offset the impact of declining markets and grades. Despite the negative impact of currency changes since the beginning of the year, the company continues to expect 2016 adjusted EBIDTA to be in the range of 107 to 130 million and keep free cash flow in the range of 25 to 30 million.

I will now turn the call back over to Harold for final comments before we take your questions.

Harold Bevis

Thank you Cliff, although our end market pressure continued impact the business somewhat, we remain focused on what we control and are pleased to see continued improvement in the first half of 2016 and expect more in the second half of 2016, I would like to thank our shareholders and bond holders for their ongoing support and our employees for their dedication providing world class products and services to our customers.

Operator, I would like to open up the call for your questions.

Question-and-Answer Session

Operator

[Operator instructions] Your first question comes from Anthony Young from Macquarie. Your line is open.

Anthony Young

Hey, Harold and Cliff, thanks for taking the questions. I guess first just as far as the free cash flow goes and priorities, the acquisition of Spencer Johnston or J.J. Plank, looks to be a pretty good acquisition, I mean, do you guys think that you are finished with acquisitions for the time being and focus on paying down debt?

Harold Bevis

Yes, our priorities -- thank you, Anthony. Our priorities are absolutely on paying down debt, yes, and we are going to be very aggressive and vigilant just as we were determined to reposition to be in a better spot for go-forward sales. We are extremely focused on that. J.J. Plank, Spencer Johnston was a small process and we are not in pursuit of any acquisition ideas. We are very focused on our own repositioning. We have put in place a lot of new capacity now, and we have generated the pipeline, we need to fill it. And so, these priorities we have internally are not capital-intense. We are focused on products and trials and filling up that capacity. And we are very [indiscernible] plenty of cash flow here, and we are going to be paying down debt with it. That's our goal. Our goal is to pay down a ton of debt before that needs to be refinanced. So it's going to be a very aggressive debt pay down.

Anthony Young

Okay. Okay, that's good to hear. And then also just with respect to the repositioning, I think in the past you had talked about 20% of your exposure being in the print and write grades [ph], and with the transition here, has that changed at all or is that still a good number?

Harold Bevis

That 20% of our revenues in EBIDTA come from declining markets, newsprint, and printing and writing, and that number is still. That's still our number. That's our current number. And our outlook is that those markets will continue to decline around 2.5% a year. Those are the outlook that we and our public peers put out there and that we see in that back test for us over a multi-year period of time. So we have got that into what we call our net losses, and so, when we look forward with our projections what our new product tender capacity, we are more than offsetting that decline, but [indiscernible] how much for our business is in our actual trend down.

Anthony Young

Okay. That makes sense. I appreciate the question, guys.

Harold Bevis

Thank you, Anthony.

Operator

[Operator Instructions] The next question comes from the line of John Roles from Argonne Capital. Your line is open.

John Roles

Hey, guys. So I guess you bumped the free cash flow guidance up by $5 million on both the low and high end. And if I am not mistaken that's inclusive of I don't know let's say $3 million to $4 million of additional interest expense with the refinancing. So can you just draw down a little bit on the delta there, I mean is the restructuring expenses coming in lower than you expected? Is the EBITDA little stronger, I mean is there working capital management, what are sort of the components of that favorable delta to what you were expecting before?

Harold Bevis

Yes, sure. The free cash flow guidance we kept at the same as $25 million to $30 million the same we've last quarter. You are right the interest payment this year will be lower because of the timing of the debt refi. However, we have some currency offsets just to keep -- left that number in the same range.

John Roles

Okay. So I guess I am little confused. In the pres release you did say that the free cash guidance was 25 to 30, but then in the presentation on pages nine and three, it looks like you're saying that you are increasing the full year free cash flow guidance for 30 to 35.

Harold Bevis

No, it is -- the guidance is the same. Page three at the bottom of page three we are maintaining our full year guidance of 25 to 30 that was requirement. And then on page nine, we are running strong to the - we are running strong to our guidance. But we don't intend to change it to this one.

John Roles

Okay. I just, I don't know if there is a couple of versions of this presentation, but I just told one of your Web site which hasn't differ [ph].

Harold Bevis

You want to check.

Cliff Pietrafitta

You are picking up what Chris said. Our recent data is the bond refinancing.

John Roles

Right.

Harold Bevis

And specifically what happens with that is that an interest statement move from the second half of this year to first half of next year.

John Roles

Got it, okay, understood.

Harold Bevis

Yes.

John Roles

Okay, great.

Harold Bevis

Sorry, confusing on that one.

John Roles

No, that's okay. Thank you.

Harold Bevis

You're welcome.

Operator

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

Richard Kus

Hey guys. Good afternoon. So just a quick one for me on the roll cover side of the business you guys had a really strong quarter, can you talk a little bit about whether or not the type of sale that you are seeing out of this business basically established a new run rate and really where you think we go from this level?

Harold Bevis

Yes, that was new run rate Rich and fundamentally we had several plans that we are on good thoughts, but we are not full service level repair shops and we corrected that. So we've corrected the Ruston, Louisiana. We've corrected Griffin, Georgia, we've corrected and Neenah, Wisconsin, we've corrected Changzhou China, and that is a new run rate. We were physically limited with doing certain size rolls and certain types of services this particularly accountable services and certain type of roll covers needed for tissue. And another one is [indiscernible] rolls and that roll our current roll and repair of all those rolls and all the plants.

So we have now corrected that and we still have a couple white spots southern China and Chile. And our goal is to be one-stop-shop for all the premier machines for board packaging tissue and [indiscernible]. And we've -- so it is a new run rate, but we are also not done. So we are building the Chile plant right now, and we will build the [indiscernible] inclusive to our capital CapEx guidance is achieved because we already have the machines, if you will. So the rate will continue to increase, Rick, from our [indiscernible] so still on increase.

Richard Kus

Okay.

Harold Bevis

But it is generating a new higher level of sales expectations, yes.

Richard Kus

Good. SO you expect sales to be upfrom Q2 and Q3?

Harold Bevis

Yes.

Richard Kus

Okay. Great, thanks.

Harold Bevis

You're welcome.

Operator

I'll now turn the call back over to the presenters for closing remarks.

Harold Bevis

All right. Thank you for everyone calling in today and we are very pleased with the performance of the business. If you get any questions about orders or backlog about our business is very healthy. We are entering into a typical strong period for us already for it. We are completing it's a very important repositioning. The rolls business was repositioned first. You are seeing the benefit of that already in our numbers for machine clothing business second to quite Chile and it was an enabling and that's what we made with our China plant is ramping up nicely at the three page ramp up.

We are already preparing second phases of ramp up in the second half of this year ad we are happy with the performance of the business and we thankful for you guys hanging in with us heavy spending period is curtailing now. We are cash generative and we intend pay down debt aggressively just as aggressive as we want to reposition the business. And that that I would like thank for your participation today in the call,

Operator

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

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