Sarah Alexander Rodney Lynn Bingham - Chief Executive Officer, President and Director Jay C. Peterson - Chief Financial Officer, Chief Accounting Officer, Senior Vice President of Finance and Secretary George P. Alexander - Executive Vice President of Global Sales.

Charles D. Brady - BMO Capital Markets U.S. R. Scott Graham - Jefferies LLC, Research Division James Picariello - KeyBanc Capital Markets Inc., Research Division Thomas L. Hayes - Thompson Research Group, LLC Brian Drab - William Blair & Company L.L.C., Research Division.

Good day, ladies and gentlemen, and welcome to the Thermon Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Sarah Alexander, Director of Investor Relations. Please go ahead..

Thank you, Danielle. Good morning, and thank you for joining us for today's earnings conference call. We issued an earnings press release this morning, which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our website at www.thermon.com.

A replay of today's call will be available on our website after the conclusion of this call. This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast in any form without the expressed written consent of the company is prohibited. During this call, our comments may include forward-looking statements.

These forward-looking statements are subject to risks and uncertainties, and our actual results may differ materially from the views expressed today. Some of these risks have been set forth in the press release, in our quarterly reports on Form 10-Q and on our annual report on Form 10-K filed with the SEC.

We also would like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements may include, among others, our outlook for future performance and revenue growth, leverage ratios, acquisitions and various other aspects of our business. During the call, we will also discuss some items that do not conform to Generally Accepted Accounting Principles.

We've reconciled those items to the most comparable GAAP measures in the tables at the end of the earnings press release. These non-GAAP measures should be considered in addition to, not as substitute for, income from operations, net income, net income per share and other measures of financial performance reported in accordance with GAAP.

And now it's my pleasure to turn the call over to Rodney Bingham, our President and Chief Executive Officer..

Thank you, Sarah. Good morning, everyone. Thank you for joining our conference call and your continued interest in Thermon. Today, we have 2 of our Senior Vice Presidents joining me on this earnings call. Jay Peterson, our CFO, will follow me and present the financial details of our FY 2014 second quarter.

George Alexander, our Executive Vice President of Global Sales, will assist in the Q&A session by answering questions that pertain to global market segments and our industry trends. For those of you who are not familiar with Thermon, we are a leading global provider of thermal solutions. We serve the oil, gas, chemical and power generation industries.

Our heat tracing systems provide freeze protection and temperature control for piping, vessels and instrumentation. These mission-critical systems ensure the continuous and safe operation of industrial facilities. As stated earlier, Jay will discuss the financial details, but the first, I'd like to touch on a few highlights.

Q2 was a very good quarter for Thermon. Revenue was almost $73 million. That's our second highest quarter ever. Gross profit exceeded $35 million, and that was an all-time record for Thermon. EPS came in at $0.33, which was another historical record for Thermon.

Gross margin percentage for the quarter was over 48%, which is a very strong performance for the company. Our revenues were split 61% MRO/UE, 39% Greenfield. Sales in the U.S. and Canada continued to grow, and Europe rebounded with a strong quarter. Our backlog remained robust at $92 million.

Again, it was a very strong quarter for us to build on as we enter the heating season and plan to grow our business for a fourth consecutive year. Our global footprint continues to be a key component of our strategy to provide value to our international customers and penetrate our targeted end markets, which are oil, gas, chemical and power.

In addition to the ongoing capital investment in emerging markets, we are also seeing a rebound in the petrochemical and power generation sectors that are related to the shale oil and gas developments in the United States.

Our revenue for -- our revenue from Canadian oil sands continues to show growth for this year, even in the face of a slowdown in capital spending for some of the large upgraders. Unconventional methods of extraction, such as SAGD, remain very active as well as MRO sales that are associated with the aftermarket potential of these megaprojects.

Thermon's pipeline is still robust by identifying over 540 project opportunities and over $880 million in estimated value. We are also anticipating increased MRO revenue this fiscal year due to our larger installed base. Our management team would like to thank our employees throughout our global organization for their hard work and dedication.

We would also like to thank our customers, investors and advisors for their support and confidence. As a follow-up to our last call, we have added a Senior Vice President to our management team. Geoff DeMartino will be responsible for corporate development with a focus on M&A opportunities. Again, thank you for joining us today.

I will now turn the call over to Jay Peterson, our CFO, who will discuss the financial performance of Q2.

Jay?.

Thank you, Rodney. Good morning. Today, I will discuss our second quarter results, starting with orders and top line revenue. Orders for the quarter totaled $72 million, a growth of 14% relative to Q2 of last year. Our revenue this past quarter grew to $72.8 million, an increase of 7% relative to the prior year's quarter.

And during this quarter, our Greenfield revenue grew by 11%, and MRO/UE grew by 5%. Our fastest-growing geographies in the quarter were the U.S. and Canada, growing 25% and 9%, respectively. Note that our revenue was negatively impacted by FX in the amount of $1.1 million primarily due to the weakness in the Canadian dollar.

Our backlog of confirmed orders ended September at $92 million, essentially flat with June of 2013. In terms of gross margins, margin dollars this past quarter totaled a record $35.4 million. And relative to Q2 of fiscal year '13, our margins increased by 50 basis points to 48.6%.

This margin increase was due to the high mix of MRO/UE at 61% of revenues, whereas Greenfield totaled 39%. And margins were 39% for Greenfield and 55% for MRO/UE this past quarter. Turning to OpEx and headcount.

Our core operating expenses for the quarter, that is SG&A, and this excludes D&A and any transaction-related expenses, totaled $17.4 million, an increase of 25% year-on-year.

One of the drivers of our expense growth is attributable to our incentive accrual in Q2, a calculation that is based primarily on our performance against certain financial metrics. Our OpEx, as a percent of revenue this past quarter, was a competitive 24%, again, excluding depreciation and amortization.

The number of full-time employees at the end of September was 828, up from the 777 as of 1 year ago. And note that over 89% of these additions were in production, sales, R&D and engineering and directly relate to managing our growing business.

In terms of interest expense and taxes for the quarter, recall that earlier this year, we refinanced our 9.5% long-term bonds with a banknote currently with an interest rate of 3.6%. This refinancing will add in excess of $0.15 a share in earnings over the next 12 months. The rate will vary depending on our leverage ratios.

However, the rate will not fluctuate with any movement in LIBOR. As previously disclosed, we were able to declare a permanent reinvestment position with the earnings from our foreign affiliates, reducing our tax rate from the mid-30s down to the mid-20s. And this will save the company in excess of $1 million a year.

In terms of earnings, our GAAP net income for the quarter totaled a record $10.6 million, and our GAAP EPS for the quarter totaled a record $0.33 a share and $0.30 a share after a onetime favorable tax adjustment. This 3% adjustment to earnings relates to a tax credit dating back to the 2010 CHS acquisition of Thermon.

An explanation of this adjustment can be found in our earnings press release and our 10-Q. Note that our GAAP EPS was negatively impacted by $0.02 a share this past quarter due to the combined effects of FX translation and transaction impacts.

Our adjusted EBITDA totaled $18.3 million this past quarter, down from the prior year performance of $19.6 million. And EBITDA as a percent of revenue was a healthy 25% in Q2. Turning to balance sheet. Our cash balance grew to a record level of $53 million the end of Q2, and that's an increase of $37 million in the last 12 months.

Our leverage at the end of September on a net debt basis was a record low of 1.1, down from approximately 4x in 2010. And we are positioned to end this year below 1. Lastly, our business continues to be highly capital-efficient.

Over the last 6 months, CapEx, and this includes both sustaining and expansion capital, amounted to a total of $1.5 million or approximately 1% of first half revenue. I would now like turn the call back over to Danielle to moderate our Q&A session.

Danielle?.

[Operator Instructions] And our first question comes from Charley Brady from BMO Capital Markets..

On the -- your comment on the European market, in the press release, you kind of used stabilization in your verbal comments, you said -- you seemed a little more optimistic on that.

Can you just square that up with your thoughts?.

The stabilization impact related to our first half performance, the growth statement related specifically to our second quarter performance..

Right, okay. And just on the mix, I mean, it sounds -- I mean, obviously, the mix was a bit, I guess, stronger than anticipated on the MRO side.

When you look at kind of the quoting activity out there, as you look towards the back half of your year, do you see any -- where do you see kind of the mix going? Do you see it kind of staying in maybe an elevated level relative to what you previously thought it would be?.

Charley, this is George. In the second half of the year, we do still anticipate a significant contribution from MRO because it is our seasonal part of the year. As we've said in the past, the Greenfield mix is significantly affected by the schedule of -- the construction schedule of the projects.

But we do think -- we still -- we do still believe that as it relates to the overall performance in the second half of the year, that it's going to be -- remain at the 60-40 split. And we also think that we're going to have a strong second half of the year because of the seasonality and because of the project scheduling..

So that sort of implies that the gross margin level the back half of the year ought to kind of stay right around where you saw in second quarter then?.

Yes, one thing I would like to accentuate, Charley, our margins of late over the last several years have been very stout. We've had very strong MRO mix, and our mix within MRO has also been rather elevated.

However, we are not changing our long-term guidance in that if you look over a protracted period of time, our margins of late are well above our margins over the last decade or so. So we will see peaks and valleys in our margin performance. And could we hit even a number below 45% in a given quarter? Absolutely.

So there will be -- there will continue to be variability with our margins as we go forward..

Right.

But clearly, on the -- in the near term, for the second half, given your visibility, that's not something you would anticipate, correct?.

Yes, it's a possibility that they're exposed upward. But again, if we look at this over a very protracted period of time, we could have margins well below what we're currently experiencing..

Yes. No, fair enough.

Did you -- on the Greenfield side, are you seeing on timing of projects any kind of shift as far as pushout of projects or any kind of change to the pipeline there?.

Not anything that's abnormal. I mean, we always do experience slippage and -- on project schedules and so forth. And it's most of the time, when it happens, it's to the right. It doesn't happen a lot coming to the left. But it's not anything that's -- there's nothing happening at this point other than some of the pushouts on the upgraders in Canada.

But there's nothing else happening at this time that's unusual..

And our next question comes from Scott Graham from Jefferies..

So the question that I would have -- one of the 2 questions I have would be the orders number, that was a good number.

Is that the beginning, you think, of not just an improvement in the end markets that you alluded to on the call, but kind of leveraging the expanded capabilities that you have with the facility? Is it a combination of both? Or haven't we seen the facility, its ability to do more things for you? Have we not seen that yet?.

Well, it's certainly a part of the reason why we can't -- that we are -- why we are pursuing and realizing some gain from the adjacent markets. Without the expansion, we couldn't have done that.

But I mean, we have the ability to react to any sort of uptick in business that is caused by -- that would be caused by harsher-than-projected weather in any given part of the world. We're -- we'd like harsh winters.

And so when that happens and we get an unexpected uptick in demand, the expanded capacity gives us the ability to respond to that, take advantage of it. Without that added capacity, we would be under a significant strain to be able to take advantage of it. So yes, it is important. Yes, it -- we could use some help from Mother Nature..

Got you.

Could you, Jay, talk about the -- just a little bit more on the accrual? Could you tell us what the dollars were on the incentive accrual within SG&A and then what to expect for the rest of the year? Are you kind of good to go for the rest of the year or there'll a little bit more expense accruals required for that?.

Yes, I don't want to say Q2 was necessarily an anomaly, but the impact in Q2 was pronounced due to the fact that we had a very strong quarter, coupled with the fact, in Q2 of last year, we had a rather weak quarter. Therefore, when you put those things on top of each other, our expense growth was dominated, if you will, by those impacts.

In the second half of the year, I don't believe we will have both of those dynamics occurring in either Q3 or Q4..

Okay. So my first read of your SG&A was that obviously, there was something going on there. But my second read was that you're investing, just taking some of those gross income dollar that perhaps you weren't expecting and reinvesting them in the business, be it international infrastructure or otherwise.

Could you tell us what -- is that a fair statement? Is there some additional investing that you did outside of what you -- your normal scope because the gross margin was so strong this quarter?.

Yes, absolutely, that's a good point. We're up 51 people year-on-year, and all of those people are targeted to grow orders in the future, manage our growing business to manage our backlog. So it's not exclusively the impact of the incentive accrual. I did not want to give that impression.

So there's really 2 drivers there, one of which really is an anomaly, if you will, for the impacts of incentive. But also, a fair share of that expense growth was due to hiring additional people to manage our growing business..

Understood. So if I could just maybe frame this for us -- and I just asked Jay to answer as much as you can, whatever you're comfortable with. If we had a 400 basis point increase on a year-over-year basis in SG&A, well, I mean -- and that's all loaded in with some of the other things.

All I'm saying is would you say that half of that was the accrual, half was the internal spend? Or could you give us a feel?.

Rough number, 60-40 accrual to growing the business..

All right.

And so we should see some additional growth in the second half of the year, but not that exacerbated impact we saw in the second quarter?.

Correct..

And our next question comes from Jeffrey Hammond from KeyBanc..

This is James Picariello filling in for Jeff. So I have a question on project timing. How can we think about your upside with regard to -- say, recent announcements suggest some course, Fort Hills or Shell's Carmon Creek.

Are you going after this business already? I'm just trying to figure out how we could think about the timing of potential contract wins like these? Any color there will be helpful..

Yes, we are pursuing those projects. The fact that they are moving forward is positive news as it relates to the general -- overall general investment environment. And they're not likely to -- those projects like that are not like -- will not impact results for this fiscal year..

Got you.

And then just your thoughts on your current capital allocation strategy weighing buybacks, dividends and possible M&A?.

Yes, a good question. First off, we will continue to reinvest back into our operations. That will always be paramount in our thought process. In addition to that, we will continue to pay down debt. We do have an amortization feature in our term loan where we paid down 10% of the balance each year.

Also, with Geoff DeMartino onboard, our M&A activities will certainly heighten this coming fiscal year relative to what we have done in the past.

And then assuming on a lot of different factors, including our stock performance, general economic conditions, how well we're performing, we would be in a position possibly to reinvest -- or excuse me, to do either a share repurchase program or some sort of sustained dividend.

However, candidly, those first 3 activities I mentioned are really at the top of the list..

And our next question comes from Tom Hayes from Thompson Research..

I guess first question is, in the call last quarter, you mentioned you were looking at possible capacity expansion plans. Just wondering if there's any update on that..

Yes, we are moving forward, as we have received board approval, to expand capacity in one of our product lines and our warehouse facilities. Our specific -- this will be focused on our instrument product line that deals with process automation and emissions control.

So we see that as a growing sector for us, and we will begin that expansion in the next few months..

Great. And then maybe just as a follow-up, you had mentioned in -- with some of your end markets where you're seeing lesser growth, maybe you can provide maybe a little bit more detail on what you're seeing maybe on the petrochemical and the power gen, thoughts kind of on the back half of the year..

Yes, we -- we're continuing to see significant activity in the power industry, specifically the combined-cycle power generation construction activity.

As Rodney made reference to, that particular industry does have significant requirements for emissions monitoring equipment, which is funneling a lot of the -- or fueling, I'm sorry, a lot of the growth that we're experiencing in that particular product line. The petrochem area is one that, again, is rebounding globally actually.

I mean, the activity is robust globally, but significantly more so in the U.S. than it has been in the past. So that's good news because the petrochemical industry is increasing..

Good. And maybe just one more if I could. I just kind of wanted to get your thoughts on the pace of the MRO work. Some of our contacts have talked about the less or a reduced number of the large turnarounds at the refineries and the chemical processing plants and kind of moving towards almost a continuous project mode.

Are you seeing any of that across your spectrum of end users?.

Well, with heat tracing, we do -- you're correct. We do get involved in both types of MRO activities, which the scheduled shutdowns or the scheduled turnarounds certainly are a focus for us.

But again, because our product, our applications are seasonal to some extent, particularly as it relates to the heating season, their preventive maintenance is something that's routine. Or at least, we promote it as necessary to ensure the operation of the facility through the heating season.

So currently, we are -- our sales force is very active in reminding our customers of the importance of doing audits, doing heat tracing audits, making sure that the all-day heat tracing systems are being maintained properly. And that's not part of the scheduled shutdowns. That's part of the heating season..

And our next question comes from Brian Drab from William Blair..

So, Rodney, when is it not a good time to be in the heat tracing business?.

Before I started 42 years ago..

So you talked about the strength in the U.S.

and petrochem emissions monitoring, if you can parse that out a little bit, with a little bit more granularity in terms of which end markets were -- maybe rank order, where did you see the most strength in the U.S.?.

The -- we say it again. The petrochem and the power industry in the U.S. and -- has grown or the activities increased significantly. But not to forget or be overshadowed with the fact that we are -- we have been seeing increased activity for a few months now in the shale oil, shale gas development, particularly in the northern area of the U.S.

So it's up across the board, but the part that's encouraging for us, because it's -- it is heat tracing-intensive, is the increased activity in the petrochem..

Okay.

And in the power gen market, is it a combination of heat tracing and emissions monitoring?.

Yes, it is, about....

Okay.

And how big -- sorry?.

About 50-50, yes..

Okay, great.

And how big is that emissions monitoring business today?.

The emissions monitoring, which may be, we can say, the instrumentation part of our business, is roughly about 10% of our business or revenue..

10% of total revenue?.

Yes..

Okay. And in the -- I guess in the petrochem business in the U.S.

and then the emissions monitoring business, are those gross -- can you talk about those gross margins in general relative to the corporate average?.

They are consistent with our business model. They certainly pummel down our business model and our targets..

Okay.

So not significantly above or below? Is that how I -- another way of saying that?.

Yes..

Okay, okay. And then just 2 more quick ones. Jay, maybe the -- some tax rate guidance for the second half of '14? I may have missed that.

And then also, could you give the -- an update on the pipeline number which I believe was $930 million when we heard from you last in August?.

Yes, the -- I think the previous guidance on the tax rate, Brian, was in the mid-upper 20s. Right now, based on our projected profitability of our affiliates, which will in fact influence tax rate, we see more in the 27%, 26% range, somewhere in that -- in those brackets..

Okay. And then if you wouldn't mind, the pipeline update..

The pipeline is down from last report, which was over a little over $900 million as part of it is still scrubbing from the datas we've talked earlier -- on earlier calls and investor events. We're now with an online real-time system that I think is helping our data get cleaner.

But a part of it is a drop in the overall project identification, and it's reflected in that 880 number that we just gave you..

And I'm not showing any further questions at this time. I would like to now turn the call back to Rodney Bingham for any further remarks..

Well, thank -- first of all, thank all of our participants in the call today. And Brian stole my favorite line, but anyway, just so -- as you all know, this is still a good time to be in the heat tracing business. And so thank you very much. Have a nice day..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day..