Xerium Technologies' (XRM) CEO Harold Bevis on Q1 2014 Results - Earnings Call Transcript

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Xerium Technologies, Inc. (NYSE:XRM) Q1 2014 Earnings Conference Call May 9, 2014 9:00 AM ET

Executives

Kevin McDougall - Executive Vice President and General Counsel

Harold Bevis - President and Chief Executive Officer

Cliff Pietrafitta - Executive Vice President and Chief Financial Officer

David Pretty - President, North America and Europe

Kevin McDougall - General Counsel

Analysts

Katja Jancic - Sidoti & Company

Adam Ritzer - Pressprich

Craig Hoagland - Anderson Hoagland & Company

Doug Weiss - DSW Investment

Richard Kus - Jefferies

John Koerber - Bennett Management

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2014 Xerium Technologies’ Earnings Conference Call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the call over to your host for today, Mr. Kevin McDougall, Executive Vice President and General Counsel. Please proceed.

Kevin McDougall - Executive Vice President and General Counsel

Thank you, and welcome to Xerium Technologies’ first quarter 2014 financial results conference call. Joining me this morning are Harold Bevis, CEO and President of Xerium Technologies; and Cliff Pietrafitta, Executive Vice President and Chief Financial Officer. Harold will start the discussion this morning and then we will provide further financial details with respect to the quarter results. Subsequently, we will open up the line for questions.

Xerium Technologies’ financial results for the quarter were made available with the filing of our 10-Q after the market close on Tuesday, May 8, 2014. And we are also announcing a press release issued after the filing of the 10-Q. Notification of this call was broadly disclosed and this conference call is being webcast using the link on the Investor Relations home page on our website at www.xerium.com.

I would also note that we will make comments today about future expectations, plans and prospects of the company such as our general expectations for 2014. These statements constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. 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 Thursday’s press release and in our SEC filings. These forward-looking statements represent our view as of today, May 9, 2014 and we specifically disclaim any obligation to update these forward-looking statements.

Lastly, on this call, we plan to discuss supplementary non-GAAP financial measures such as adjusted EBITDA that are key metrics for our credit facility and that we use internally to assess liquidity and financial performance and therefore believe will assist you in better understanding our company. Reconciliation of these measures to the comparable GAAP numbers, are available in our press release, which is posted in the Investor Relations section on our website at www.xerium.com.

With that, I’d like to turn the call over to Harold.

Harold Bevis - President and Chief Executive Officer

Thank you, Kevin and good morning ladies and gentlemen. Thank you for joining us this morning to review our first quarter results and talk about the full year as well. I’d like to start off with several significant highlights. Our first quarter roll sales were weaker than expected in North America and Europe and weather conditions had a market inventory correction and containerboard grow weaker than expected roll sales in the quarter for North America and Europe.

We expected and planned for sales to be weak. We have a good amount of visibility. I mean where we believe these market conditions were temporary and appears that they were. And our orders grew in this – in the quarter 5.8% and grew sequentially. Roll sales were in line with the rest of the world outside of North America and Europe. On a segment basis, our constant currency machine clothing sales declined year-over-year about 1%, while our adjusted EBITDA in that segment grew about $1 million.

If you look at our sales growth in cost reduction programs that we have underway, they are on track and deliver our expected results. Per our plan, they are somewhat back end loaded due to the timing of our capital equipment coming in and we are underway with a balanced program for sales growth and cost reduction. Our cost reduction programs are comprised of the plant repositioning program and operational excellence programs. The plant repositioning program will dramatically reposition our assets to be in the right places to mirror our full growth opportunities geographically and by product type and at the same time increase our competitiveness as we are taking cost as we do this repositioning effort. The plant repositioning program includes six plant closures, five of which are underway right now, none of which have been completed. 11 plant expansions, and all 11 are underway and two new Greenfield plants both of which are underway.

The operational excellence programs involve all 28 Xerium plants globally. And each plant has a site specific program to address the following initiatives, waste reduction, netting out procured items, implementing throughput best practices, installing the lower cost logistics network, implementing a new safety program and capital projects to lower our costs. These programs have been centrally organized in order to spread best practices uniformally across all regions. And implemented in parallel with these foundation molds is an equally size set of sales growth programs. The programs are comprised of new people, industry specialists with additive knowledge to our current legacy team and new R&D program, new R&D tools and new machines with capabilities the company has never had couple with a new product program that’s primarily centered around 11 specific programs.

In the first wave of new products coming out from these new programs are pretty exciting. And the first one is EnerVent, which is a brand new highly engineered and machined roll cover that’s optimized for tissue machines. The second is our continuation of our extremely successfully Smart Roll program called Smart 6.0. And it is the industry’s first load sensing roll cover for suction box applications. If you are not close to papermaking, this is an extremely big and important breakthrough in the industry and it is the first. The third is our Shoe press belt and the company has received its first order for a very innovative approach to this application, which has not been served by our company for several years. And the last is a very important product for the tissue industry and it’s our company’s first ever through air drying fabric for high-end tissue machine applications.

The company is shifting with the market. We have a smaller market in the global printing and writing segment. And that is now about 23% of the global pulp and paper market. And we a larger position in the growing markets for tissue, packaging papers, boxboard, fiber cement, non-woven belts, rolls for flexible packaging and rolls for film production. We continue to advance our position and increase our market share globally in these non-paper markets, such as fiber cement and non-wovens, with a dedicated team, allocated resources, and advanced product offerings. For instance, fiber cement demand in North America is growing 8.5% annually through 2017 driven by the gradual recovery in residential construction.

Global growth also is benefiting from a shift from asbestos-based production to fiber cement based building materials. On the non-wovens side, global demand continues to be forecasted to rise at least 5.4% annually and demand in developing countries is even more robust and at higher 7.2% annually. Xerium is small in both of these segments looking backwards, but looking forward, there is certainly areas where we intend to grow in a deliberate manner.

If you turn the attention to EBITDA, we are basically reconfirming our commitment to prior guidance that we gave to achieve full year adjusted EBITDA in the range of $116 million to $120 million. And we are on track for that. So, why would we have a range? The range really is dependent upon macroeconomic factors. All of our cost programs are on track. The only variable we have really is a macroeconomic environment, which has got the lot of play in market research. So with the stable demand, we are going to be on the $120 million side of this if we have fourth quarter softness, which has happened in the last two years have been closer to the $116 million kind of the number. But we are reducing our costs at the same time that we repositioned our commercial programs and capacities to mirror our growth opportunities geographically and by product. These plans are on track and they back end loaded and they have to get there. Why are they back-end loaded? It is dependent upon the lead times we have from machinery in order to enable these moves.

We see the same amount of upside and downside to that range. We can see conditions where we can beat $120 million and we see conditions where we could be slightly less. So, we think it’s a balance set of range of expectations for you. And as a management team, we are committed to deliver it. And furthermore, if you look at the cash flows associated with what we are doing here to fix the company, we will be cash generative in the second half of this year and we expect to pay down debt.

And our growth story remains the same, is unchanged in this conference call, we intend to grow in Asia, and in fact we are growing in Asia and we intend to grow in the Americas and in Europe, primarily in the non-paper areas and in the rolls and mechanical services areas. We are putting in place the machine capabilities and people to grow in those new product areas. And already mechanical services are about 10% of our sales and growing. It’s a very value added service biased and very specific. We have a range of services we offer and they are desired.

Our sales of non-paper products are already over $100 million of our sales profile. And we are investing heavily to increase that proportion and we are investing to deepen and expand the value we bring to the paper market. The declining printing & writing segment gets a lot of attention and has a tendency to both be exaggerated and extrapolated to the rest of the market. But that’s actually in air because approximately 77% of the pulp & paper market is just fine, healthy and growing.

We intend to remain a strong participant in those market segments over the long-term. And the first major investment program we made in our most popular products will begin in the second half of this year and it’s our $10 million – approximately $10 million expansion we did in our Gloggnitz, Austria press felt plant. Our press felts continue to be very popular because of the value that they provide on the machines that they go on to and its one of our strengths as a company. The primary machine for that product was ordered in the beginning of last year and its being installed now and it will – let’s say de-bottlenecking of capacity for us at our popular products and sales growth will benefit from it.

So we are going to have a specific company action that we will be countercyclical to seasonal softness in the fourth quarter. And sales growth in our markets is a long cycle. So, this is going to be typical of what you see happening over the next quarters from our company. You will see us announcing that machinery has been installed and sales growth has been enabled. We expect to achieve year-over-year sales growth in 2014 just as we did in 2013 and we expect sales growth in ‘15 and ‘16. In addition, we will be very cash generative going forward as we exit very expensive repositioning program and we will continue to pay down debt.

I will now turn the call over to Cliff for his insights into financial performance and after that we will go through question-and-answer with the crowd. Cliff?

Cliff Pietrafitta - Executive Vice President and Chief Financial Officer

Thank you, Harold. Q1 2014 sales were 4.6% below a very strong Q1 2013. As Harold mentioned constant currency roll sales lagged behind machine clothing sales declining 11.3%. This reduction was primarily driven by decreases in North America of 5% and Europe of 6%, due to weaker industry demand in both regions. Machine clothing sales declined 0.9% on a constant currency basis. Geographically, sales increased in South America by 4.4%, while sales declined in North America by 5%, Europe by 6% and Asia by 5%.

Operating income in Q1 2014 declined by $4.9 million, due to lower sales volume and higher restructuring costs, partially offset by decreased SG&A costs, increased gross margins and the impact of favorable foreign currency exchange rates. Reductions in SG&A costs and improved gross margins were largely a result of our restructuring initiatives. Adjusted EBITDA in Q1 2014 was $25.7 million, or 19.3% of sales, but was 11.7% below a very strong Q1 2013 adjusted EBITDA of $29.1 million, primarily due to lower sales volume.

Q1 2014 was a successful quarter related to cost-out actions. The company spent approximately $13 million of cash on capital expenditures and restructuring costs in Q1. For the full year we expect to spend $68 million or a similar amount to 2013, to generate approximately $25 million of cost reduction savings in 2014. In addition, we have more spending related to longer payback projects such as the China machine clothing plant, which will not result in incremental savings or earnings in 2014.

While cost-out and restructuring savings initiatives are the centerpiece of Xerium’s 2014 business plan, the company still expects the current market conditions, inflation and negative price mix will combine to limit growth in adjusted EBITDA to approximately $116 million to $120 million, assuming the current foreign exchange rate outlook and market demand. As of Q1 2014, we had an aggregate of $42.6 million available for additional borrowings under our credit facility and smaller lines of credit and our cash balances totaled $18 million.

Free cash flow in 2014 defined as cash flow from operations less capital expenditures declined to $7.7 million – negative $7.7 million from a positive $6.6 million as capital expenditures increased $6.8 million to $10.5 million and trade working capital increased due to an increase in sales late in the quarter and its impact on accounts receivables as well as temporary inventory builds in our machine clothing business. However, we expect our free cash flow to improve in the second half of the year, which will allow us to pay down approximately $6 million to $8 million of debt by year end.

Capital expenditures and cash restructuring payments in Q1 totaled $10.5 million and $2.6 million. Capital expenditures primarily related to longer term payback projects, such as the new plant in Ba Cheng, China, restructuring payments primarily related to headcount reductions, and the elimination of machine clothing production in Argentina.

Trade working capital increased to $149.1 million in Q1 2014 from $136.4 million in Q4 2013. This increase was primarily the result of an increase of $7.3 million in accounts receivable due to an increase in sales late in the quarter. Day sales outstanding, however, were slightly favorable compared to Q4 2013. In addition, inventory increased by $4.4 million due to increased levels of European produced machine clothing caused by lower sales volumes in Q1 2014 while accounts payable remained essentially the same from year end.

Net debt increased to $430.5 million in the first quarter from $417.4 million in Q4 2013 primarily as a result of increased trade working capital, higher capital expenditures, and the execution of a capital lease in our corporate headquarters. In addition, our net debt leverage increased to 4.15 times in Q1 2014 from 3.9 times in Q4 2013. Our effective income tax rate for the first quarter was 61.9% compared to 31.3% in the prior year’s first quarter. Excluding the effects of restructuring, our effective tax rate was 40%. This overall effective tax rate reflects the fact that we have losses in certain jurisdictions, where we receive no tax benefit, including losses related to restructuring.

We are off to a great start in our 2014 restructuring initiatives and are underway with a program to restructure our plant network. As part of this plan, we are in the final stages of four plant closures, in the middle of a fifth plant closure, and in process with a plant opening in China. This large scale restructuring effort is a multi-year endeavor and we see a continuous stream of operational improvement opportunities.

Harold Bevis - President and Chief Executive Officer

Thank you, Cliff. That concludes our prepared remarks and we are now ready for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Katja Jancic of Sidoti & Company. Please proceed.

Katja Jancic - Sidoti & Company

Good morning.

Harold Bevis

Good morning.

Katja Jancic - Sidoti & Company

You mentioned that you expect sales to grow in the next two years, could you provide a growth rate or a range that you anticipate is attainable?

Harold Bevis

Yes. Our internal grows are between 1% and 2% based upon on our specific actions we have taken to install equipment. So, it’s a bottoms-up natural mix that we are attempting to achieve with our customers and it adds ups to about 1% to 2% constant currency growth.

Katja Jancic - Sidoti & Company

For both years, or we are talking about ‘14 now?

Harold Bevis

This year it’s the same, it’s more where we are shooting at – a little higher than 1% and same for ‘15, same for ‘16.

Katja Jancic - Sidoti & Company

Okay. Could you also maybe provide more information as to how much of the first quarter sales derived from the non-paper market?

Cliff Pietrafitta

It’s up 9% of our sales, Katja.

Katja Jancic - Sidoti & Company

Okay, that’s very helpful. Thank you so much.

Harold Bevis

You are welcome. Thank you.

Operator

Your next question comes from the line of Adam Ritzer of Pressprich. Please proceed.

Adam Ritzer - Pressprich

Good morning guys. How are you?

Harold Bevis

Good morning, Adam.

Adam Ritzer - Pressprich

See couple of questions, can you talk about longer term what you think would be cost cutting and sales improvement you might be able to reach in terms of gross margins and EBITDA margins?

Harold Bevis

Well, we do have a long-term plan. We do have a public benchmark on gross margins. I think everyone knows that. We certainly think we can close the gap on gross margins and EBITDA that gets down to how much investment we do into SG&A. Our EBITDA percentage, I think is what you are asking, Adam. And we definitely believe that it can grow a couple of points from where it is and we have internal plans to do so.

Adam Ritzer - Pressprich

Okay. In terms of your CapEx, maybe can you give us kind of a future look at when the cost reduction spending is over and the plant expansion spending is over, what kind of normalized CapEx do you get, which I guess would be probably like 2016 range?

Harold Bevis

Okay. If we gave you a matrix on our CapEx spending, it’s very balanced between sales growth and cost out. If you look at our total cash expenditures on restructuring, it’s skewed more towards cost reduction due to severance. And if you look at the closures we have made, we have actually impacted a lot of our European colleagues and its lump-sum severance payment. So, if you look at our cash restructuring – our total cash out for cash CapEx, cash restructuring, a large component of it is severance and that’s going to go away. We are almost through that now. So, that’s going to completely go to a very small number from what they have been running, Cliff, what was last year.

Cliff Pietrafitta

They are running at $15 million to $20 million.

Harold Bevis

Well, $15 million to $20 million is going to de minimis. In terms of capital spending, there is obviously we are doing some foundational spending in Ba Cheng, China and other locales. So the other equipment we have ordered actually enables several years of growth. So, we have assumed a non-disruptive impact on the market and winning new positions in a value added way, we call, value results program. So, we are assuming a gentle fill of those assets. So, the machinery we are putting into places will last just a few years not just kind of a one year set.

If you look at the capital spending requirements in the out years, it will come down, but we are not finished fixing the company. If you look at why is our gross margin 40%, why is a public benchmark that we have 45%? We know why. And the lot of these things require investments into new machinery, that’s better and faster and easier to setup and easier to change and less waste. And so we still have to do that. We are still not where we want to be. We do want to close that gross profit gap and that’s going to take million to do it. What’s going to end up being? It’s going to be similar to what we are doing now. I think this year we will spend between $45 million and $50 million on CapEx would probably have a couple of more years of that, but the cash restructuring is going to almost stop, because we are through the layoffs we want, not that we had to go through. It’s going to be a very small number. And of course, the EBITDA is higher. So, if you do the free cash flow model, there you end up with quite a bit of free cash flow to pay debt down.

Adam Ritzer - Pressprich

Well, I guess if you back out the $15 million to $20 million restructuring costs, let’s say, that gets you down to that $50 million level, of that how much is being spent on equipment for your plant expansions in China?

Harold Bevis

The China project is going to cover several years and that the increment of that in this year’s number, Cliff.

Cliff Pietrafitta

It’s about $9 million this year. And I think it’s about another $14 million or so in ‘15 – in 2015.

Harold Bevis

Yes. It spans three calendar years, Adam.

Adam Ritzer - Pressprich

Okay. So, if you back that out again, when you get to a maintenance level, it looks like it’s short, $35 million, $40 million, is that a good number to use?

Harold Bevis

Look our payback projects, the projects that we obviously don’t have board approved plans for ‘15 and ‘16 today, but I am trying to answer your questions frankly. The maintenance level of CapEx of the company is probably around 30, but we see high payback projects that we would advocate doing to close the gap on gross profit and that gets us to a bigger number. That moves you up into the 45 or 50 range.

Adam Ritzer - Pressprich

Okay. So, those payback projects are obviously going to be incremental to EBITDA in growth beyond what the normal maintenance spending is?

Harold Bevis

Exactly, when I say maintenance, I mean maintenance is business not just fix and break.

Adam Ritzer – Pressprich

Right.

Harold Bevis

Yes. So maintenance of fix and break kind of CapEx, if you had to lean it out that’s maybe around 12 to 15. But we have to be more than that to win on contracts when they come up and go next generation. So there is a staying with the programs, staying with the market program that we have to do that puts us up at a little higher number than just fixing step to breaks. We still have a lot of good payback projects that are accretive, increase our EBITDA had great ROIs and trade paybacks. And we have a couple of years of it, so we have a nice set of opportunities to get better then to close that gap on gross profit. And that’s generally where we are headed, but we don’t – we don’t have multi-year guidance, we don’t have multi-year board approved plans, but hopefully that’s helpful enough, Adam.

Adam Ritzer - Pressprich

Well, you’ve kind of given us multi-year guidance in terms of revenue growth and in terms of paybacks and cost savings so you are kind of getting there without being specific, I appreciate it. And I will get back on the call? Thanks.

Harold Bevis

Thanks, Adam.

Operator

Your next question comes from the line Craig Hoagland of Anderson Hoagland & Company. Please proceed.

Craig Hoagland - Anderson Hoagland & Company

Hi, on the fourth quarter call you sort of called out the containerboard issue in North America, it sounds like things actually turned out to be difficult in Europe as well, can you sort of tell us what happen during the quarter…?

Harold Bevis

Yes. Containerboard, our situation was pretty much focused on rolls and rolls are a high ticket item and rolls appeal in the order as a PO. So the paper customers, this is a very paper specific situation and so when the paper – where paper producers have issues and slowdown, they do not place those orders, they don’t take those rolls and go through that expensive maintenance spend on their part. And they don’t have spare rolls for every position they have the spare rolls for the most important positions. And it’s subjective on when they can recover them and so it’s typical for – when a slow period for our customers especially our public customers who dominate the industry to put out by spending when they can and they did.

And it’s started in November, December, January, February and it picked up in March and it’s strong in April. And so Cliff mentioned that our trade working capital went up on an end point basis because of late breaking orders we got in March and that is true. So our payment terms are such that they were in AR at the quarter end point and that will flush through but rolls picked backup, containerboard looks fine on a sequential basis and on a year-over-year basis our clothing business was okay. We were flat quarter-to-quarter in clothing. We were down a little bit year-over-year in clothing. Rolls was the story, it’s a roll story and that’s a big ticket item and it’s the discretionary spend gets attention from our customers. And so those are little bit of pulling back to happen there, but we already see it releasing and we are having strength in orders, our orders were up a lot. And there is reasoning for it, so that’s a good mix for us too by the way, so we are having a good order situation, orders were up sequentially, our orders were up year-over-year. And so I think we are through that, that will slowdown and that story is collaborated by our other public peer. And if you listen to the earnings releases of our top customers it’s all consistent, there were lot of reporters yesterday and the day before and everyone said the same thing. So it’s a very consistent story and we felt it too as a top supplier to the industry.

Craig Hoagland - Anderson Hoagland & Company

Okay. And then flat 20% order growth is that for rolls, is that for the – that include clothing as well?

Cliff Pietrafitta

That includes clothing as well.

Craig Hoagland - Anderson Hoagland & Company

Okay. And that level of orders I am just curious how you get from there to expected revenue growth of closer to 1%?

Harold Bevis

Well, we have some specific actions also, one of the big ones, the (indiscernible) ramp up is it’s important to doing these numbers here, I mean that’s a big investment we have made and it’s unclogging a situation that’s a bottleneck for the company. And we will get an immediate release of a backlog there, if you will, I mean backorder. So, we are going to be fixing a jammed up situation and it will help our orders that we get to ship an invoice in ‘14.

Craig Hoagland - Anderson Hoagland & Company

So, you have brought down backlog. Okay, thank you.

Harold Bevis

You are welcome.

Operator

Your next question comes from the line of Doug Weiss of DSW Investment. Please proceed.

Doug Weiss - DSW Investment

Hi, good morning.

Harold Bevis

Good morning, Doug.

Doug Weiss - DSW Investment

And I guess this follows up in the prior question, you said at the $146 million of orders that’s for rolls and clothing?

Cliff Pietrafitta

Yes, it is. The split would be, we are going to be heavier on the PMC side, rolls would be a little bit lower, but that is the blend rate.

Doug Weiss - DSW Investment

And what’s the delivery period for that typically?

Harold Bevis

A roll, when we receive a roll, it’s an extremely important asset for our customers. And so when it shows up, they want it back. And the 60 days will be typical. It takes us, it’s not an easy job, sometimes 90 days for the more complicated rolls. There is a lot of inspection that has to happen to the shaft and all the metal components to look at the stress and the mountings and they have to be stripped down properly and built up from their base up and balanced. Many of our high-end working rolls have special drilling and grooving and balancing and coatings. So, it’s a complicated build. It’s a lot of skilled workmanship involved, 60 to 90 days and then they want it back, because it’s usually in a critical position in the machine. And those spares are needed. So, our customers have learned their lesson and not let them hang out in our plant and may go and stage them in their own plant. It’s their asset, they own it, and we recovered and service it and so 60 to 90 days.

On the clothing side, we get POs straight up that have a lead time ask on them. And then I would say maybe the majority of our business however is ongoing positions that we have and we work to min-maxes. There is usually between one and three pieces that we negotiate behind the position, because of how long they last, press out will last a certain, a very short amount of time, woven fabrics a little longer and dryers a lot longer, but based on the life of the product and the production schedule that the customer has, they will maybe request us on the min-max program and we abide by it and we monitor it and we replenish it and there is sunset clauses to those programs. So, if they haven’t consumed the parts over a certain period of time, we invoiced it anyway, but generally that does not happen due to the life of the product. So, the life on the machine is short for the clothing products that are popular that we make, very short. And it takes them longer to get it than it takes them to use it. So, we have to have this min-max program that we all abide by in the industry to, it’s not just us, no one in the industry could make a product inside of the neat cycle. So, it’s a min-max kind of setup for the industry.

Doug Weiss - DSW Investment

So, I mean, is it reasonable to think that, that order level would be largely delivered in the second quarter?

Harold Bevis

Yes, that’s reasonable. That’s certainly our expectation. I also saw the comments from our peer and I believe them too, which is orders are really a leading indicator, because the macroeconomic environment is going to dictate the amount of paper and board production that’s going to get made. And if they don’t run the machine and the part doesn’t get consumed that we make. So, there is business plans and indicators, but then there has to be actual use in production and we are directly linked to actual production. So, the tried and true statistic that we correlate to is paper and board production rates. And so backlog is something we monitor in the order rates, but it’s a leading indicator that’s correlated to our sales, a stronger one is paper and board production rates.

Doug Weiss - DSW Investment

And then I just wanted to clarify on the non-wovens and non-paper sales, you mentioned that you had a $100 million, it wasn’t clear to me exactly what that $100 million signified, you also said at the beginning to the first question, the 10% of your sales or roughly 10% was non-paper. So, I am just trying to square those two numbers right, because 10% will get you to about $13 million, not really at a $100 million run-rate. What does that – can you just square those numbers?

Harold Bevis

Yes. Let me give you a few more numbers. We have a business here internally that’s Steve Johnston is the leader of it and it’s focused upon revenue diversification outside of non-paper products. We are looking at industrial rolls, fiber cement, non-woven mechanical service pulping applications for paper and non-paper pulp. And that business unit is around $100 million in sales. And the specific question that Cliff answered had to do with a couple of the products. So, the non-woven and fiber cement markets are quite large and healthy and were not a big participant. We haven’t been the big participant looking back. We have never been a big participant. So, there is no change to that story. However, they fit our machineries very nicely and we are entering them more deliberately with product innovation and specific machinery geared at making those type of products. They do have to specifically be made. Those are estimates on these market sizes some estimates for fiber cement are around $50 million, some estimates on the market for non-wovens are around $100 million. So, you would say they are niche markets, but we are a small player and so they can be significant to us.

We have very small market shares. And if we just get a few points out of those that adds up give them the numbers here and we are shooting for 1% or 2% growth. And if you look at size 550 kind of top line, 1% to 2% do the math and then you just need to get a few million here or there. So, it’s a very specific focus for us. And mechanical services are growing and we are growing in non-paper products. So, it’s not a reporting segment, but it’s definitely a business segment and there is a business thrust and a strategic thrust. And we are having successful – and the products are right on our company average, for profit rate, no better, no worse.

Doug Weiss - DSW Investment

Okay. So – and then I guess you spoke last quarter and I think you alluded to at the beginning of the call some of the mix pressure on pricing from the changes in the declines in printing paper production. Do you have those same mix pressures on the roll side or is it really just on the clothing side?

Harold Bevis

Dave Pretty, you might be able to help me. You have been there longer than I. So wouldn’t you mind taking that question please?

David Pretty

Sure. I have no problem. As far as the mix impacts related to rolls, no, it’s really not – it’s not in the same order of magnitude that we would see in the clothing business, pricing between printing and writing bound paper grades on PMC. There is – there are issues we need to deal with there, but on the rolls business, no, not at all. It’s pretty consistent across the board.

Doug Weiss - DSW Investment

Yes. And then just I don’t know if you can answer this or not and this is my last question kind of a big picture question just looking at the overall industry structure. Do you think there is room in either of the segments or in both of the segments for more industry consolidation or do you think that the industry is consolidated to a point where that would cause the anti-trust issues?

Harold Bevis

No, I think there is room for consolidation. If you look at the decline in North America or Europe in paper and board production, then help me out here, Dave, over the last 10 years how much paper and board productions from that in North America, for instance. What is it? It’s around 20% of the market hang on with me here.

Doug Weiss - DSW Investment

Yes.

Harold Bevis

Yes, the March – I will just say in North America, the PMC market has declined about 25% in the last 10 years. And paper production declined about 20%. If you look at Europe, the market for our products has declined about 26% while paper production has also declined. But the real deal is how much capacity is out there for what we do. And then the people just go from three shifts, to two shifts but still have the capacity there of two shifts to one shifts or four shifts to three shifts. That gets down the plant closures now, right now at this point in time. We are probably doing more than anybody with our plant closures to correct the industry capacity. I don’t know see our competitors doing what we are doing at all. But be that as it may, I do think there is open capacity in the industry for what we do roll recovering and clothing making.

So for sure, our customers have open capacity in the segments but there is open capacity for our products of amongst our peers I believe that there are – there is room for capacity consolidation, yes. Now, what’s really going to happen I don’t know because the Tier 1 guys, us, Voith, Metso, Andritz, Albany, (indiscernible), AstenJohnson, the Tier 1 players who compete on value. We all have open capacity here or there and we have strong positions that are stronger than some of the one plant kind of competitors out there who planned to gain differently. In the case of the machine builders, they have very strong portfolios of machinery and components amongst our pure-play peers. It varies on product strengths and service strengths. So, I think there is consolidation that’s possible. As far as us, we are very focused on our own enterprise and making our enterprise more valuable and being very deliberate and not hasty with our growth actions and selling on value with innovative products. So it’s not a quickie kind of a deal, it’s kind of slow and so I would say consolidation you get into distressed, is anyone distressed kind of a deal.

So we need to be consolidated, there is not a lot of distress, you can see the free cash flow of our company and you can see wherever contribution margin or gross profits, everyone sees that. So it’s still a pretty profitable business for everybody and I don’t think the decline is such that we have distressed players. So then you get into do you want, if some want to go consolidate and pay a premium when they have open sassy themselves and then you get into those kind of decisions. So, it’s not a topic in the industry really, it’s really about getting oriented properly, staying value focused, delivering results for shareholders why you do it? It’s not a vibrant business development market. There are opportunities as far as us we are very focused on the matters that we discussed today and generally held there on those lines.

Doug Weiss - DSW Investment

Okay, alright. Well, thanks for answering all the questions.

Harold Bevis

You’re welcome.

Operator

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

Richard Kus - Jefferies

Hi, guys, good morning.

Harold Bevis

Hi, Richard.

Richard Kus - Jefferies

Just a quick one for me as most of my questions have been answered already. In terms of cost inflation you guys mentioned it briefly in the release, what have you seen where does it hits you most and have you been able to take price actions to offset this or have been more of a cost focus that you guys have used to offset the input cost inflation?

Harold Bevis

Cost inflation runs a little over $5 million a year and is mainly labor and is mainly statutory, most of our workforce is unionized and lot of our salaried employees are in countries with statutory costs of living increases. And we mimic that in the North America so that we don’t have differential treatment of our people. So that number ends up being a little over $5 million for wage and medical inflation. With regards to offsetting it, we have offsetting actions that we go through with headcount elimination as well as other aspiration excellence programs.

And if you look at our cost reductions broadly I know Richard that you have only about 20% of our cost reductions are based on these plant closures, the majority of our cost reductions in this year plan are based on operational excellence, improvements and they are sustainable and the whole game plan obviously is to offset our inflation, offset any negative price mix we have and increase our EBITDA on a net basis and we have that, that’s kind of muscled now, made not have been two years ago, but it’s the way we run the company now.

Richard Kus - Jefferies

Sure. We certainly see it in your results over the course of the past, call it, year and a half or so. So, anyway I appreciate it. Thank you.

Harold Bevis

Thank you, Richard.

Operator

Your next question comes from the line of John Koerber of Bennett Management. Please proceed.

John Koerber - Bennett Management

Good morning. I have several questions. One is as you talked about your in-roads in non-paper it seemed to be that you didn’t that when you give the 1% to 2% sales growth, you are really being conservative, because you have other pockets, where you think you might get greater sales growth. Is that a fair way of looking of it that the industry is going to go 1% to 2% and that’s all your forecasting, but you have other places, where you really think you are going to make more growth. You may beat that number on the top line?

Harold Bevis

That’s correct. We are being conservative and it would be pretty bold of us to assume that we are just going to march in and be successful when there is very good competitors in all of these slots. And we are not going to be fighting with price, we are going to be fighting with value. So, those wins come a little slower when you compete in that manner, but you are correct that there is upside to the numbers, but we are really looking at a global market environment that’s – if you look at resi or any of the industry data that the paper and board market itself is growing and it is around 2% growth. The printing and writing segment itself is declining about 3% and that’s about 23% of the total. But Asia is growing, tissue is growing, paper and board grades are growing with GDP and the GDP varies by country of course and with affluence. So, the underdeveloped countries as they grow, there is a direct correlation to how much paper and board they use as that happens with disposable diapers and tissues and paper towels and all this sort of thing. So, it’s a growing base market and we are in it and we are vibrant. And we are pursuing these non-paper markets. So, you are correct you did pickup that we are being conservative there, but it would be kind of bold to put a bigger number down. If when our results suggest that we can be stronger with our – with expectations, we will stay, but right now, we are just kind of looking for that 1% to 1.5% growth.

John Koerber - Bennett Management

Okay. Second question is I believe you commented that you will pay down a little debt this year? The way I run my numbers that implies you probably our breakeven that does on working capitals, in other words, you highlight yes, we have working capital investment. And in the first quarter just by the timing of late sales, but you probably will not be, I have any investment that year-over-year, is that true?

Harold Bevis

Yes. If you look at our – there is two things out, there is a rate, there is efficiency and then there is what are the dollar bills. So, if you look at our dollar bills in AR and in the components, they are inventory AP. And the total dollars invested as a percentage of working capital, we intend to take our working capital percentage down, we are not at this practice level yet, even but measuring ourselves again to ourselves. And to that end, we appointed a leader this year in charge of it, Theresa is our new leader, our new Treasurer and she is here with us. And she is in charge of driving that number to best practice levels in a sustainable manner. So, we do have improvement programs to increase our efficiency. The offset to that is increasing sales and your timing of it and we intend to grow in the fourth quarter due to our specific actions that we are taking in (indiscernible) and to get press out at the door. So, if you look at the timing of all of that, we are going to end up with some working capital that’s going out the year as a percentage of sales. Cliff, would you like to add any comment?

Cliff Pietrafitta

I will just say, John, your point is well taken and I would agree with it. We expect as Harold said the rate to come down, but we – the dollars we think from a year-to-year standpoint, the offset of the sales increase will be offset by actions we are taking, so the dollars will be relatively flat with the prior year. And so with that expectation is for the remainder of the year.

John Koerber - Bennett Management

And then my final question is you highlighted probably one of your first paragraphs that your clothing EBITDA was up year-over-year, which means your roll recovers is where you really suffered year-over-year, on an annual 2014 is that just going to be catch – are you going to be down in roll covers or will there be some catch up there?

Harold Bevis

Yes. That’s really getting caught up, and we are getting caught up as we speak the slowness that happened. This is an item you can put off but you can’t avoid. And so as production is picked up, so has our roll cover reordering and its actually strong right now, so we definitely intend that – over an annual basis that’s going to be very consistent. So definitely expecting that to be caught up and for the full year, Cliff did you have that number?

Cliff Pietrafitta

I would make a couple of points. One is if you compare quarter-to-quarter, the rolls in Q1 of ‘13 were very strong category for us and really drove a lot of the exceptional results we had last year. Rolls were actually weak even relative to our normal base this year, so you had kind of both ends of the spectrum you also had some mix issues within the North America results which were temporary. So we expect that the roll business will come back to normal levels for the remaining quarters of the year.

John Koerber - Bennett Management

Okay. And then my final question and I don’t know how much you will comment on it through the news story that somebody is trying to put a lawsuit on Directors on fiduciary actions, what is that about?

Harold Bevis

Yes. We saw that and Kevin, our General Counsel I would like him to make – to comment, please Kevin.

Kevin McDougall

John, this is Kevin McDougall we are aware of the investigation by the law firm it’s come to our attention and they may relate to CEO incentive compensation as the subject. The company believes that all of its compensation practices are lawful. The company and the Board will conduct the results appropriately on this issue and we have no further comment on this matter.

John Koerber - Bennett Management

Fair enough. Well, alright, thank you very much for all the guidance you have given for 2014 and I look forward to subsequent calls this year of all being positive. Thank you very much, gentlemen.

Harold Bevis

Thank you, John.

Operator

(Operator Instructions) Your next question comes from the line of Craig Hoagland of Anderson Hoagland & Company. Please proceed.

Craig Hoagland - Anderson Hoagland & Company

Hi, just a quick follow-up to your comments on market growth rates, if you look at the 77% of the markets that’s not printing and writing paper, what kind of growth rate do you put on that?

Harold Bevis

Well, the net growth for the markets around 123 and that’s quick math in my head, you are asking me to do a ratio, but I can’t right now.

Craig Hoagland - Anderson Hoagland & Company

Okay, I can do it. I guess this is…

Harold Bevis

Probably 3%.

Craig Hoagland - Anderson Hoagland & Company

Okay.

Harold Bevis

And if you look at the compound at 7 Asia is big, Asia is growing around 5 to 7. If you look at tissue, tissue is growing 5 to 7. Indonesia specifically within Asia and China are our fast growth. Paper and board are GDP specific to the country. And so there are some hotspots in GDP and then there are some countries not doing so well. And the U.S. is doing fine and we are doing fine. If you look at the clothing, our numbers are stronger as you have heard. In the rolls they are discretionary so they are going to get pushed and pulled based on health of our customers and their discretionary decision but over one year period they will be steady, it’s just something that has to be done. When the rolls need service the machine that is not running well at all and this is just a matter of time before it comes to us.

So we are growing nicely in Asia. We are – we are growing nicely in tissue. We are growing nicely in fiber cement and non-woven’s and so we have our personal strengths that are story specific and we try to be transparent about it. And we primarily are bottlenecked. If you look at the spending that we are doing and spin back to the fall of ‘12 when the board made a big strategic decision to advance the cost here, we were sold out and fiber cements sold out non-wovens. We were sold out in press sales. And I am talking globally here and these are very expensive gems to get out of. The Ba Cheng plant is a growth story to debottleneck our company in press sales. And the investments we are making in these expensive looms that are dialed in to make fiber or cement non-woven products, that’s an expensive endeavor as well.

So, we spend a lot of money to enable these growth activities to happen. And so we will have a story to ourselves, because we will debottleneck ourselves and then you have the natural market environment. So, we primarily see ourselves. We are working on the gem. It’s not like we were setting on open capacity. We had no capacity for most popular products that we make. And it just has taken a lot of time, because the machines themselves take over a year to get and then you have to build a building to put the machine in. So, we are trying to be free cash flow neutral as we go through this thing and we just have to be patient and we can’t get too crazy about it. So, we see a lot of upside potential here based on pace and timing of filling those machines, but we have been conservative and John picked that up. And it could be better if we have wins and it could be solar. So, we are pretty comfortable with the – we are trying to set expectations properly. And then you always want to have a management team, have stronger stretch goals than what they say and we do have that.

Craig Hoagland - Anderson Hoagland & Company

Thank you very much.

Harold Bevis

You are welcome, Craig.

Operator

At this time, there are no additional questions. And I would like to turn the conference back over to Harold Bevis for closing remarks. Please proceed sir.

Harold Bevis - President and Chief Executive Officer

Thanks. Thank you very much and thank you everyone for calling in today and everyone asked some good questions. I appreciate it. And we look forward to speaking on the next quarter. With that, we will end the call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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