Good day, ladies and gentlemen, and welcome to the Thermon Second Quarter 2016 Earnings Conference Call. [Operator Instructions] I would now like to introduce your first speaker for today, Sarah Alexander. You have the floor, ma'am. .

Thank you, Andrew. 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 also be available via webcast 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..

Please note that during this call, our comments may include forward-looking statements. These forward-looking statements are based upon limited information available today, which is subject to change. They are also subject to risks and uncertainties, and our actual results may differ materially from the views expressed on this call.

Some of these risks have been set forth in the press release and in our annual report on Form 10-K filed with the SEC in June..

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, revenue growth, profitability, forecasts, projections, estimates, leverage ratios, acquisitions, synergies 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, and not as a substitute for, 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, and thank you for joining our conference call and your continued interest in Thermon. Today, we have 2 of our management team members joining me on this earnings call.

Jay Peterson, our CFO, will present the financial details of our FY 2016 second quarter; and Bruce Thames, our Executive Vice President and Chief Operating Officer, will follow me in the presentation and assist in the Q&A session..

Now I'd like to touch on some of the highlights for our Q2. Our revenues were right at $70 million, and this include a negative FX impact of $6.4 million as the dollar strengthened against the euro, Russian and Canadian currencies. Acquisitions added $7.8 million of revenue in the quarter..

It is important to note that except for our Canadian operation, which is challenged by the price of oil, all 3 of our other geographic regions showed year-on-year revenue growth on an organic basis. This excludes the impact of currency and acquisitions. New orders were down year-over-year, but up sequentially over prior quarter.

Upstream opportunities in the Oil Sands region was the main contributing factor to this downward trend..

Our backlog of $82 million was down year-over-year, but up over prior quarter. The impact of FX accounted for 7.6 of this year-on-year decline. Our project pipeline of identified opportunities still remains strong at $1.1 billion, with the total number of projects actually increasing..

We successfully completed our third acquisition, Industrial Process Insulators. This addition expands our service capabilities in the U.S. Gulf Coast and enhances our ability to deliver complete thermal solutions to more of our customers in a robust market sector.

We plan to continue our strategic investment initiatives that will launch new products and design software that will enhance our value proposition to our customers. .

While we believe that our FY 2016 will be a profitable year of investment, our strategy is to have these new product and service platforms in place to position the company for future growth opportunities. We still believe that the global demand for energy, chemicals and power will increase over the next several decades.

We also believe that our customers will continue to make investments to support these future increases in demand for energy and petrochemicals..

While our revenue from the upstream sector continues to be challenged, lower oil and gas prices have helped to stimulate the construction of downstream processing plants and power generation facilities.

As we stated in the press release, the foreign currency headwinds and decline in opportunities in the Canadian Oil Sands have negatively impacted our business more than we initially anticipated.

We are therefore revising our fiscal 2016 revenue guidance to reflect the top line percentage decline of mid- to high single digits as compared to prior year. We are still actively managing costs while investing for future growth. We will experience some near-term pressure on EPS results in FY 2016..

We are continuing to pursue strategic acquisitions that strengthen our organic business model and increase our addressable market space. 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. And again, thank you for joining us today..

Now Bruce Thames, our Chief Executive Officer, will share some of his perspectives he has formed since joining Thermon. .

Thank you, Rodney. Since joining Thermon, I've spent the last 5 months listening to and learning from seasoned leadership, our employees and our customers.

My time has also been spent focusing on the integration of IPI, key initiatives to improve operating performance, positioning the company for future growth and managing costs, particularly in Canada in a difficult environment.

Although our end markets and financial results have been impacted by lower oil prices and a strong dollar, it is reassuring to see the timeless business model and proactive cost management delivered over 26% adjusted EBITDA margins and strong cash flows in the quarter despite lower revenues.

It's also reassuring to see that our business outside of Canada has performed well in a very difficult environment..

More importantly, the last 5 months have solidified my confidence in the longer-term viability of our business and growth opportunities in our end markets. Due to the commitment of our employees, the breadth of our product lines and global footprint, we operate from a position of strength in this space.

Long-term drivers for this business also remain intact, with the emerging middle class in developing countries continuing to drive demand growth for chemicals, power and energy. This, combined with tightening environmental regulations, continues to generate demand growth for electrical trace heating and environmental emissions monitoring solutions..

Without question, we're going to encounter choppy waters ahead as the impact of lower oil prices shake out across the industry. Recurring revenues from our installed base, the diversity of our end markets and geographic distribution of our customers provide a natural hedge and position us well to weather the storm.

In the interim, we will continue to invest in a promising product pipeline that fuel organic growth and expand our M&A activity consistent with our strategy while aggressively managing costs in underperforming units..

Now I'd like to hand it over to Jay Peterson, our CFO, to provide financial results for the quarter.

Jay?.

Thank you, Bruce. Good morning. This morning, I will discuss our second quarter results, starting off with top line revenue. Our revenue this past quarter totaled $69.9 million, and that's a decrease of 12% relative to the prior year's quarter. One point I'd like to make is a testimony to the continued strength of our business model.

Our adjusted EBITDA as a percent of revenue was a healthy 26% in a very difficult macro environment. This decline in revenue is attributable to the strong U.S. dollar and reduced capital spend in the Canadian Oil Sands.

It's important to note our organic revenue in constant currency totaled $68.6 million, and excluding Canada, our organic revenue would have actually grown 10% year-on-year. FX negatively impacted our revenue by $6.4 million. And for the quarter, M&A contributed $7.8 million in revenue.

Orders for the quarter grew 19% from $63.9 million in Q1 to $75.8 million. And our backlog of orders grew through to $82 million, and that's 8% higher than June of 2015, and our book-to-bill was a positive 1.08..

Note our backlog was negatively impacted by $8 million, that's on a year-on-year basis, due specifically to currency. And recall that, typically, only 40% of our orders are ever resident in our backlog. .

In terms of gross margins. Margin dollars this past quarter totaled $33.3 million. And compared to Q2 of fiscal year '15, our margins decreased 450 basis points to 47.7%. And this margin decrease was due to a relatively high mix of lower-margin construction revenue and a correspondingly lower mix of product sales.

Also, I'd like to note that the gross margin impact from the 3 acquired companies was a negative 1% in the first -- in the fiscal quarter. .

In terms of operating expense. Our total operating expenses for the quarter, that is SG&A excluding D&A and any transaction-related expenses, totaled $16.4 million, and that's down significantly from the prior year number of $19.2 million.

The majority of this spending reduction was in our Canadian affiliate, where we reduced our spending to be in alignment with anticipated revenue over the near future. These spending reductions on a worldwide basis will save approximately $5 million over the next 12 years.

And year-on-year, our organic spend decreased by 11%, and that excludes amortization and the lumpy incentive accrual..

The number of full-time employees at the end of September was 982. That's up 15% from the headcount of 1 year ago. And the driver of this increase was the 3 recently announced acquisitions. And parenthetically, excluding M&A, our headcount would have actually declined year-on-year by 2%..

In terms of interest and taxes. Our interest expense totaled 878k versus $1.1 million a year ago. That's a decrease of 18%, and that number will continue to decrease over the next 12 months. Our effective tax rate for the quarter was 30%, and we are estimating a rate of 29.6% for the fiscal year..

In terms of earnings. GAAP net income for the quarter totaled $7 million versus $11.7 million in Q2 of last year. Our GAAP EPS totaled $0.21 versus $0.36 in the prior year. The combined effects of FX translation and transaction impact reduced our EPS by $0.02 in this last quarter.

Our adjusted EPS amounted to $0.26 a share, and the $0.05 in adjustments relate to a $1.3 million in contingent consideration and earn-out, if you will, anticipated to be paid to the seller of the Sumac business, a 600k restructuring charge in the quarter and 300k in expense relating to our August refinancing of our term loan. .

Our adjusted EBITDA totaled $18.6 million this past quarter, below the prior year performance of $22 million. And as mentioned previously, EBITDA as a percent of revenue was a strong 26% in Q2..

Since March of this last year, we have closed 3 acquisitions, and all 3 were EPS accretive and added $0.03 in earnings over the first half of the year. Our cash balance was $62 million at the end of Q2. That's a year-on-year decrease of $20 million.

And this balance was after paying down approximately $14 million in debt and funding on a net basis $30 million for the purchase of the 3 acquired companies. Leverage at the end of September on a net-debt basis was near a historical low of 0.6x, and that's down from over 4% back in 2010..

CapEx amounted to a total of $2.9 million, and that's for both sustaining and expansion capital or approximately 4% of revenue. This percent is slightly higher than typical due to capital invested in our rental pool at Thermon power systems and the recent expansion of our warehouse and 2 bundle operation in San Marcos.

And lastly, our conversion ratio for the quarter was a robust 96%, consistent with fiscal year 2015's performance..

I would now like to turn the call back over to Andrew to moderate our Q&A session. .

[Operator Instructions] Our first question comes from the line of Kathryn Thompson from Thompson Research Group. .

This is Steven on for Kathryn. A couple questions here.

Would you expect Greenfield as a percentage of sales to stay below the 40% level through the remainder of 2016? And would you expect, because of that gross margin, to push up to the higher end of the historical range?.

Yes. We think if you look back through history through various cycles we've been in, the 60-40 number on a more protracted period of time is still a good number to model for our business going forward.

And could you repeat the second part of the question, please?.

If Greenfield were to stay kind of at a lower level, at least through 2016, would you expect gross margins to push towards the higher end of the historical range?.

Yes. There's a lot of contributors in that. In the -- everything else being constant. If we only had an MRO business, obviously, we would have higher much -- much higher gross margins. But I think what I would do is go back to our timeless business model, where we talk about the 60-40 split with our gross margins at 45%.

And as previously mentioned, we will endeavor to drive margins up above that 45% through cost management. So that's the guidance I'd give you at this time. .

Great. And then my last question. I guess, kind of 2 here on acquisitions.

How much of your backlog comes from acquisitions? And have the companies that you've acquired, have they seen sales growth year-over-year?.

Yes. In terms of the backlog question, it's a rather de minimis number for us. I believe it's about $2 million round numbers at present at the end of September. And yes, we do expect these businesses to grow. We are very happy with the performance of all 3 of them. Candidly, some are off to a little bit better start than others.

But right now, based on their EBITDA performance revenue profile and the fact that they're accretive, we're happy right where they're at, at this 5 minutes. .

Our next question comes from the line of Bhupender Bohra from Jefferies. .

So Jay, I just want to go through the core sales guidance. I mean, you guys actually lowered the guidance from up mid-single to now you're expecting that with total sales down mid- to high single. Can you talk about the competence which make that number? Let's talk about like acquisition and how much is FX of the total number here. .

Yes, let me give you a -- let's call it a hypothetical right now. Rodney mentioned mid- to high single-digit decline. And as you know, there's a -- things are pretty dynamic right now. We've got 3 new businesses. FX is obviously a big headwind and lastly, with oil prices.

But in terms of a hypothetical, let's say we were to take the midpoint of the mid- to high single-digit decline, one rough perspective on that is a 13% decline for organic in constant currency.

And having said that, I'd immediately like to call out that we are seeing ex Canada for the full year actually having growth, 2% growth on a constant currency basis. M&A will be in the 10% to 11% to 12% growth brackets. And FX at present, we see, let's say, a 6% to 7% decline.

And you do the math on that, Bhupender, and it's roughly a 7.5% decline which, again, is the midpoint of what Rodney mentioned. And again, that's hypothetical. There's... .

Right, right. So 7.5%, let's take the midpoint.

That actually includes your 10% to 11% acquisition assumption, right?.

Yes, it does, Bhupender. .

Right. And then you take out the FX, that gives you -- I believe the initial guidance was like about negative 2%. So this kind of -- it's a big delta, the organic. So now talk about like what actually moved the needle here. Like, I mean, we were definitely going into the quarter. Canada was weak like last quarter.

You did actually talk about the spending in Canada to be weaker. I think it was decline of like 40% to 50%. We are looking at project revenue this quarter down 20%. If you can just talk about what moved the needle here. .

Yes. This is Bruce. Bhupender, the biggest things here are as we came into the year and as we've gone through the first half, the things that have fallen short or been significantly greater impact from our original expectations have really been Canada and FX rates.

And so Canada has been softer and we expected to see a significant impact to the Greenfield, obviously, on the capital side. But we've also seen is, as you know, our MRO and our UE is actually a combination of our baseline business and smaller upgrades and expansions.

And we kind of differentiate that at the $1 million in -- orders of $1 million and below. What we're seeing is that UE component of Canada being very soft as well, and so that's impacting our incoming order rates. And that is much more flow business that's not typically reflected in backlog.

And so that's been the bigger part of the decline there, which we did not anticipate at this level. And then, of course, FX has continued and actually gotten worse since our last earnings call. So those 2 things are really the largest 2 drivers for the decline. .

Okay. And last question on SG&A line. The number actually moved from 18 point -- whatever it was, like $17 million to 16-point-something this quarter. You are taking costs down from -- in Canada.

And would that be a good run rate to assume in the back half of this year, fiscal year?.

Yes, it would. At the time being, that would be the guidance we would give on that, Bhupender. .

$16 million like in the back half of this year.

But are we taking costs down more than what we have seen this quarter in Canada?.

The majority of the expenses were realized -- expense reductions were realized in the quarter. It could go down slightly. But as Bruce mentioned, we're going to continue to monitor our order intake. And if we have to adjust expenses based on lower orders in the future, we will certainly do that. .

Okay.

And can you remind us like how big Canada right now is in terms of revenue for you guys?.

Rough number, it's $60 million. .

Okay. And one more follow-on, actually.

On the capital allocation now with the cash you have through your acquisitions and where the stock is today going into some revenue headwinds in this back half, how do you feel about like share repurchases here?.

Yes, Bhupender, this is Bruce. Just as a team, we're reviewing all of our options. But I'd like to reiterate, our first priority is to reinvest in the business. We still see opportunities within in and around our core markets and our core product lines. We are looking for the best way to deliver shareholder value.

I'd like to point to the acquisitions we've made thus far and say they've been a good use of capital, they've been accretive to earnings year-to-date and that would be our first and primary use, but we're definitely evaluating all options. .

Our next question comes from the line of Charley Brady from SunTrust Robinson Humphrey. .

In terms of the project pipeline, I don't know if you quantified. You said it was more projects in the pipeline.

Could you quantify number of projects in the pipeline now or what the delta is versus what it was?.

The last -- previous quarter, the number of projects was around -- was 680-something plus or minus a few. And now the -- as of the end of this quarter, it was about 715, 720, somewhere like that, so it was the increase in the number of the projects.

The total estimated amount of the opportunities would stay at $1.1 billion, which is pretty much flat from the prior quarter. .

Right, okay.

And I guess, just could you -- how much was Canada down in the quarter?.

In USD?.

Yes. .

68%. .

For the quarter, and this is inclusive of the acquired companies, it was down 55% in Q2. .

Including the acquisitions, correct? Is that... .

Yes, sir. .

And including FX headwinds on that?.

Yes, that would be a GAAP number as reported. .

Do you have it in constant -- constant Canadian currency, how much it was down?.

I do. Let me give you a call on that. .

Okay. I'll talk to you off-line on that. I guess, as I look out for the guidance was down, your hypothetical that you put out there, that was helpful, but let us assume the down 13% organic.

What's your expectation on how much of that -- you've got a backlog of -- how much that backlog is going to flow through the rest of this year? And really, how much of that backlog -- does any of it stretch out beyond 12 months? Or is it just a full 12-month backlog?.

Yes. History would tell us that we burn through the great majority of our backlog in 12 months. There could be some outliers that flow into a period beyond that. But the majority of that will burn off or invoice within the next 12 months, the great majority. .

Are you seeing projects -- did you take anything out of backlog this quarter?.

The project pipeline is a dynamic document. It was done on a weekly or semi-biweekly basis. So it's constantly moving, adding and subtracting as projects come on and off through our system. .

Our next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. .

So if you want maybe on the -- if you're saying organic, you're thinking it's down low double digits. Can you maybe speak -- bifurcate that to how you're thinking about MRO/UE versus Greenfield from a revenue decline? It seems like first quarter MRO was much more challenged and now Greenfield's stepped down. So maybe just give us a little more color.

Or within the guidance change, how much is Greenfield versus MRO/UE?.

For the balance of the year, I would go back with the 60-40 number. And recall that our orders and backlog have been up over the last quarter, and that gives us some perspective on getting back to the 60-40 split, MRO to Greenfield. .

Okay. So that would imply that MRO is under a lot more pressure in the back half to get to 60-40. Because you -- front half of the year, you've been running more like 64% last year. You're running 64% in the second half.

Is that the right way to think about it?.

Yes. To get back to the 60-40, yes. .

And then that puts a fair bit of pressure on the margins. .

Yes. One other component to talk about in there is the UE component resident in MRO. That has lower gross margins. So you kind of have a mix within a mix that will significantly impact our margins. .

Jeff, just the other thing that probably adds an additional nuances, we've seen a -- when you look at the Greenfield, the MRO/UE mix is we see higher amount of construction. I think we called that out. And that is also contributing to the lower margins within Greenfield.

So those are the dynamics that refer back to what Jay was referring to, the 60-40 model. .

Yes. So it seems like within all that, 45% -- kind of a step down to 45% seems more reasonable as we get into the back half. .

Yes. As we said, that would be -- let's call that the low watermark for guidance, and we're doing everything possible to drive that number up. .

Okay, great. And then I think you said you're thinking about 2% organic growth for ex Canada for the year. .

That is correct. On a full year basis. .

Yes.

How were you thinking about that 3 months ago?.

Well, Canada is worse today than we thought several months ago. And... .

Right, right. The 2% is ex Canada.

So has anything changed in that 2%? Have you seen weakening elsewhere?.

No. No, not really. .

Okay. Okay. And then just -- you mentioned the acquisitions, some going better than others.

Can you talk about the outliers to the good or bad and what's driving that?.

Not at this time, Jeff. Some of these companies we've had 2 months and some just a couple months more that -- more than that. So we really need a little more runway to better understand their performance and their capabilities. But I would tell you that on a margin basis, we are happy where they're at, at this point in time.

Their margin percentage relative to EBITDA is quite similar to the corporate average, maybe 3 or 4 points off. And we're happy with that at this point. .

Okay, great. And then just final one on MRO. It seems like all the weakness thus far in MRO has really been more on the upgrade expansion.

But what are you seeing on your strict MRO business? Are people destocking? Are people trying to -- as they do maintenance repair being more careful not to rip off the heat tracing? And maybe just how are you seeing things, the same or different in MRO?.

We are seeing actually and particularly in the U.S. and Europe, our MRO sales are up year-over-year. The real softness in MRO has largely been in Canada and it is the upgrade and expansion, the capital piece of that which we believe is most impacted. .

Our next question comes from the line of Jon Braatz from Kansas City Capital. .

Most of my questions have been answered. But Jay, you had mentioned that in your commentary that you reduced the Canadian spending, I guess, SG&A and -- by 11%, I think, year-over-year.

Is that correct?.

Yes.

Let me just get that exact number, okay?.

Yes.

And I guess what I'm asking, was that in local currency? Or is that GAAP -- a GAAP number?.

Yes. What the comment was, that, that is a GAAP number and that was an 11% reduction on an organic spend basis. So that would exclude the M&A component. .

Okay, okay.

Is -- assuming that Canada doesn't come back or stay soft for an extended period of time, what else might you be looking at in terms of further reducing costs and limiting the impact Canada is having? Is there anything more you can do?.

Yes. Yes, there is. But right now, we have 2 problems that the business is facing. One is Canada. We believe we have rightsized our spending to the opportunity over the next year. The second is FX. We are -- we're always looking to manage costs. And if we see a degradation in other geographies, we will manage costs in those geographies appropriately. .

Okay.

If -- I don't want you to be a currency prognosticator, but if you -- if the currency with the Canadian dollar, it would stabilize here at these levels over the next 6 months, does the currency headwind soften a little bit?.

Yes. .

Yes, it would. Yes, it would, Jon. .

Our next question comes from the line of Josh Berman from William Blair. .

First thing, could you comment on your outlook for some specific investments you've talked about in the past in terms of the new controller and some other opportunities?.

Yes. We do have a number of different new product developments in our pipeline, and we would expect those to be launched between the fourth quarter of fiscal 2016 through midyear of 2017. .

Great, okay. And then if you wouldn't mind just providing a little bit more color on the $5 million of savings, I think, you said from cutting OpEx in Canada.

Have all those actions already been executed? And is -- are we going to start to see the impact of that right away? Or is this going to take the full 12 months to realize all that savings?.

Yes, let me clarify. The $5 million was over the worldwide basis, not just Canada. The majority of those were in Canada. And it was people, discretionary spending, certain facilities that we decided to close. And all of that has been executed. It was executed in the second quarter.

You will see a small tail-on or tail of decreased expenses, but the majority of them were realized in Q2. .

[Operator Instructions] And that looks like all the questions that we have in the queue at this time. So I'd like to turn the call back over to management for closing remarks. .

Okay. Once again, I appreciate everybody's participation and interest in Thermon. And we look forward to seeing you on our next earnings call. Thank you. .

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program, and you may all disconnect your telephone lines at this time. Everyone, have a great day..