Good day, ladies and gentlemen, and welcome to the Thermon Fourth Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Sarah Alexander, General Counsel. Please go ahead. .

Thank you, Jonathan. 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 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 and in our annual report on Form 10-K to be filed with the SEC by the end of the month. 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 provision of the Private Securities Litigation Reform Act of 1995.

These statements may include, among others, our outlook for future performance, revenue growth, profitability, leverage ratios, acquisitions, acquisition 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 have 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 Bruce Thames, 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 Jay Peterson, our CFO, joining me on the conference call. Jay will follow me and present the financial details of our fiscal 2016 fourth quarter and full year.

However, to start, revenue and earnings were largely as expected for the fourth quarter with the exceptions of gross margins, which were below expectations due to mix, price and volume. Jay will cover this in more detail during the financial results. .

the low price of oil and the strong U.S. dollar. Fortunately, we have begun to see some stabilization in the price of oil in the mid-$40 per barrel range over the last few weeks. In addition, the FX headwinds have begun to moderate, although a Fed increase in the interest rate could lead to further strengthening of the U.S. dollar. .

oil and gas, chemical and power. Despite the increase and stabilization in oil prices, we continue to see customers delay projects and maintenance spending. By far, upstream projects are the most heavily impacted. We do see some downstream projects proceeding, driven by emissions requirements, changing feedstock and modernization. .

While the chemical sector has been robust, we have begun to see the increase in supply from the shale plays beginning to drive margin compression, leading to project delays in this sector. Projects that are currently under way are proceeding, albeit at a slower pace.

Power projects continue to remain strong, driven by conversion of coal to cleaner natural gas-fired plants as well as increases in emissions monitoring that is favorable to our tubing bundle product line. .

Geographically, we see 2 very different stories. The U.S. and Europe, Middle East, Africa both delivered record years in fiscal 2016. Conversely, our Canadian business was down by 54% and $53.3 million in revenue from fiscal 2015, driven by a seizure in both capital and maintenance spending there.

Going forward, we will continue to tightly manage cost commensurate with the level of incoming business and selectively invest where we see growth opportunities. .

Over the last several months, our management team and the Board of Directors have been working closely together to build our strategy for the next 5 years and beyond. The goal has been to expand the addressable market while leveraging our core competencies to provide double-digit shareholder returns in spite of the low oil price environment.

Following a disciplined process, we have identified areas for growth that will expand the addressable market by 2 to 3x over the next 5 years. We are currently building plans to grow the business organically through the introduction of new products, services and geographic expansion.

We will also leverage our strong balance sheet and debt capacity to grow inorganically via our M&A pipeline. .

We continue to focus on new product development to differentiate our offerings in the marketplace by providing more comprehensive solutions to customers. In April, we announced the release of our new TraceNet command software.

This new offering provides customers a comprehensive communications and control platform to more cost-effectively manage very large, complex facilities. In addition, 3 significant product introductions are planned throughout the balance of the year.

Consistent with our growth strategy, we will continue to invest in new product development and other strategic growth initiatives throughout fiscal 2017 to be well positioned when our end markets recover. .

We are also pleased to announce that Jim Pribble just joined our organization as Senior Vice President of Corporate Development. In this role, Jim will lead strategy execution to drive both organic and inorganic growth opportunities. .

Looking forward, our core business model remains resilient, our balance sheet remains strong and our cash conversion allow us to operate from a position of strength. In the near term, we anticipate the Canadian business to decline an additional $5 million to $8 million during fiscal 2017.

This contraction in our organic business will be offset by revenue growth in other geographies and the full year revenue contribution from Industrial Process Insulators, our most recent acquisition. We also anticipate margin pressure to continue due to an unfavorable mix, lower volumes and pricing pressures. .

Our revenue guidance for fiscal 2017 is flat to low single-digit growth over the prior year. To support this projection, the higher quote activity noted in Q3 has translated into 5% backlog growth year-over-year and a favorable book-to-bill in Q4.

Thermon's updated pipeline of future projects remain healthy with over 800 identified opportunities for heat tracing with an estimated total value of over $1.1 billion over the next 3 to 5 years. .

We continue to believe the near-term challenges are cyclical and not structural in nature. The reduced maintenance spending currently seen across the industry cannot continue indefinitely and is likely creating pent-up demand for a recovery cycle in the future.

An increase in this area will improve the mix and has historically positively impacted gross margins. Our management team would like to thank our employees throughout our global organization for their hard work and dedication. We'd also like to thank our customers, shareowners and advisers for their support and confidence. .

Thank you again for joining us today. Jay Peterson, our CFO, will now address the details of our financial performance for Q4 and fiscal 2016.

Jay?.

Thank you, Bruce. Good morning. I'd like to start off by discussing our Q4 results, then turn to our fiscal year results, and then conclude with some high-level guidance for fiscal year 2017. .

First off, revenue this past quarter totaled $72.3 million. And that's a decrease of 3% over the prior year's quarter. Relative to the prior year quarter, our organic revenue declined by $7.1 million or 9.5%. FX currency fluctuations impacted revenue by a negative $2.3 million or negative 3%.

And M&A revenue contributed $7 million for the quarter or a positive growth of 9.3%. In the quarter, we continued to experience erosion with our Canadian business, which was down 34% year-on-year on a constant currency basis. Our MRO/UE mix for Q4 was 60% of revenues this quarter whereas Greenfield totaled 40%. .

Orders for the quarter totaled $73 million versus $52 million in the prior quarter or a growth of 39%. And we saw double-digit order growth in the United States, Asia Pacific and Europe. Our backlog of orders ended March at $81 million versus $76 million at the end of Q4 fiscal year '16. And that's an increase of 7%.

And foreign currency fluctuations negatively impacted our backlog by $1.2 million. In terms of gross margins, margin dollars this past quarter totaled $32 million or 44.4% of revenue.

Versus the prior year quarter, our margins decreased by 150 basis points due to several factors, including a decline in MRO/UE margins due to lower sales to our agents, product mix, volume contraction and an increase of lower margin construction business. .

Operating expense that is core operating expense for the quarter, and this excludes depreciation, amortization and transaction-related expenses, totaled $18.7 million. And that's an increase of 4% from prior year. This increase in spending was related to managing our growing backlog and the double-digit order growth we experienced in the quarter.

Our operating expense as a percent of revenue was a competitive 26%, again excluding depreciation and amortization. The number of full-time employees at the end of March was 1,021. And that's up from 894 as of calendar March 2015.

130 of these additions were related to our recent acquisitions with our year-on-year headcount essentially flat in our organic business. .

Turning to earnings. GAAP EPS for the quarter totaled $0.10 compared to a prior year $0.33. After adjusting for a $1.8 million escrow settlement to the predecessor owners of our Sumac business and a $1.7 million impairment of certain assets related to our Unitemp acquisition, our adjusted EPS this quarter was $0.20 versus $0.28 in the prior year.

FX fluctuations negatively impacted our EPS by $0.01 and our free cash flow EPS significantly outstripped GAAP EPS for the quarter and totaled $0.32 a share. Our adjusted EBITDA totaled $14.4 million in the quarter and adjusted EBITDA as a percent of revenue was 20% this past quarter.

From a balance sheet perspective, our cash grew to $84.6 million this past quarter. And on a net debt-to-EBITDA basis, this ratio ended the quarter at 0.2. And we anticipate to be debt-free on a net debt basis this fiscal year. .

Turning to the full year 2016 performance. As a recap, we accomplished the following this last year. 3 of our 4 major geographies grew top line this past year on a constant currency basis. We completed 3 acquisitions, 2 of which generated positive return on invested capital.

We were able to hold gross margins at 46.6% for the year in a very difficult, competitive and macro environment. We generated free cash flow EPS of $1.16 a share versus adjusted EPS of $0.89 a share. And lastly, we reduced our debt balance to $94 million, a reduction of $13 million over the last 12 months. .

Now turning to fiscal 2017 guidance, several points I would like to offer. First off, we are planning top line revenue to be in the flat to low single-digit growth for the fiscal year. Gross margins are estimated to be in the mid-40% range. And that's consistent with our past guidance.

As Bruce mentioned, fiscal year '17 is going to be an investment year for Thermon. And we expect operating expense growth to outpace revenue growth. However, if we see our order rates decline, our flexible cost structure will enable us to tighten spending as necessary.

And lastly, our planned CapEx for this year will total $8.5 million or 3% of revenue. And that's down from $10.4 million in CapEx in fiscal year '16. .

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

Jonathan?.

[Operator Instructions] Our first question comes from the line of Jeff Hammond from KeyBanc Capital Markets. .

So just on the guidance of flat to low single-digit growth, you gave some good color on Canada. Maybe just give us some color on how you're thinking about the different -- the other regions within growth. .

Yes, Scott -- I mean, Jeff, this is Bruce. Real quickly looking at the various regions, we do see it's fairly broad-based both, and the U.S. is really we see as the strongest market. We see growth opportunities in Latin America as well after a pretty soft year.

And then some -- probably fairly flat in Europe, Middle East, Africa and some growth opportunities in Asia Pacific. .

Okay. And then you mentioned in your remarks some pricing pressure. Can you speak to where you're seeing that? And I think you said it's likely to persist. Do you see it kind of stabilizing at this lower level? Or do you see more risk for pricing pressure going forward? Maybe just a comment there. .

The pricing pressure we've historically felt in Greenfield. Because there's less work being released, it's even more competitive, so we see it there. We also see pricing pressure in our MRO business. Certainly, we would expect -- based on the current environment, we don't see it improving.

So we’d expect margins in this level to continue through the balance of fiscal '17. .

So when you say kind of margins continuing, in the range that you saw closer in the fourth quarter versus the full year?.

Yes, I would say thereabouts. But I don't think we will continue to repeat what we had in the fourth quarter. So I would look more to what we had for the balance of the year. But we could have a specific quarter if we had a large Greenfield project built in that quarter that was very competitively bid, we could see margins as we experienced in Q4. .

Yes, we would like to kind of go back to that 45% range that we've historically generated. Certainly in 2015, we had margins significantly higher. But we believe the 45% range is what we would expect in this current environment. .

Okay.

And then just lastly, within that kind of low or flat to low single digits, are you thinking about MRO and Greenfield much differently?.

No, we don't see big swings in that. We think the 60-40 mix is what we would expect going forward. .

Our next question comes from the line of Scott Graham from BMO. .

This is Katja for Scott Graham.

Can you talk a little bit what is behind the strong orders?.

Yes, the orders were fairly broad-based. We have had a number of sizable chemical, petrochemical projects that have contributed to that. But it's generally broad-based ex Canada. .

Okay.

Now what is your expectation for tax rate in fiscal '17?.

29%. We had a couple of adjustments this last quarter. The significant adjustment was related to a European affiliate that had a one-time structural change for fiscal year '17 -- excuse me, fiscal year '16. But we don't expect that to continue. For '17, we're modeling 29%. .

Okay. Just one more question.

What were sales by region in the quarter?.

We -- in the quarter, the revenue for Canada came in at $11.5 million; Europe, $17.4 million; the U.S., $28.1 million; Asia Pac, $8.1 million; Latin America, 300k. And then the 3 acquisitions, they totaled $7 million for the quarter. .

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

So Jay, a question for you. Over the last 2 quarters, we have been -- you guys have been talking about some improvement, kind of a mix shift towards chemical and power projects.

And when I look at the orders and the backlog, could you give us some color? And with respect to your guidance for the next year, is that something which will become a little bit more dominant in terms of top line growth? As we continue to see oil and gas capital spending still kind of weak, right? So your customers are not going to spend like the next year.

And so just give us some color about chemical and the power markets here. .

Yes, we continue to see a favorable trend in our U.S. business, which has a significant component of power and chemical. We also believe that even though in this last quarter we had a dip in agent sales that often ultimately end up in chemical and power, we see that to have a resurgence this coming year.

So it's possible we will have yet another record year in the U.S. going forward. .

Okay. And when I look at -- I mean, the next question for Bruce here on M&A. If I remember correctly, Bruce, we spoke before about like your venture in -- you had mentioned about like going into steam tracing. That could be one of the growth avenues going forward.

And with IPI under your belt, there could be some leverage you could pull off like on the steam tracing side.

Can you give us some color like which growth area, especially when you mention geographically, you want to do some expansion with respect to that, if you can talk about like the steam tracing market and the growth avenues over there?.

Yes. Well, Thermon began in steam tracing, so it's nothing new to the business. We have been winning some nice opportunities in steam tracing. IPI, that acquisition has given us the capabilities to execute on the field service and construction aspect of those projects as well, which has helped us win.

We will continue to look at that space as an opportunity to really continue to grow our business in industrial process heating. Geographically, we do see ex kind of U.S. and Canada, we see opportunities, particularly in Eurasia and in Asia, to geographically grow our business. So those are some of the areas we see opportunities for growth. .

Okay. And lastly, Jay, if you can give us the growth rates for the geographical. I think you gave the dollar numbers here for U.S., Canada. Do you have the growth numbers like Canada declined by x? So just... .

Yes. Canada was down 41%. Europe was down 25%. The U.S. in the quarter, which is an anomaly because they had growth for the year, was down 5.4%. Asia Pac for the quarter was down 19%. And that excludes the acquisition-related revenue. Oh, I'm sorry, I said Europe was down. I think it was up 25%, I apologize. .

Our next question comes from the line of Brian Drab from William Blair. .

I wanted to start by asking about Canada. Obviously, there's major events up there with the fires. And first and foremost, I was happy to hear that it sounds like everyone on the team is safe, although starting to hear some people lost some property.

But I'm wondering as we look at your first -- fiscal first quarter with Canada obviously down a lot but still about close to 20% of revenue, how is that affecting -- how were those fires affecting the activity for you? And also maybe just kind of like what you're seeing with respect to the industry in general up there right now. .

Well, Brian, this is Bruce. We have been out of our facilities for a couple of weeks now. And certainly, a number of those operations have been idled. Just recently, they've announced the startup of a couple of the major operations, so we would expect that to begin to resume.

But certainly, our quick-turn sales have been softer, given the idling of a lot of these facilities. So near term, we would expect, where we are seeing a slowdown there that will impact us in the first quarter, we don't believe that, that will have a significant impact over the course of the year as these facilities start up and get to running. .

Is that a big enough issue to where we should be modeling a downtick in revenue or a blip in the first quarter that then recovers as we move through the year?.

What we see, typically our first quarter is the softest quarter of our year. And so I would reiterate that. And then I would also say that looking at timing of backlog, we do see that scheduled out across the year. .

Okay. So yes, the seasonality in the first quarter is understood.

I'm just wondering, is it -- just to be clear, is the seasonality or is that weakness in the first quarter going to be more severe than typical, given the fires?.

We would expect it to have an impact to our first quarter revenue, yes. .

Okay, all right. And then Bruce, maybe you could talk a little bit about the plan to expand the addressable market over the next 5 years.

Can you tell us, give us any clue as to what measures you're taking or specific measures you're taking to expand it 2 to 3x?.

Yes. We are looking at adjacencies in and around what we provide to the industry. And our focus is on industrial process heating with heat tracing being that core offering but building around that.

And then also we see opportunities to really go beyond that and leverage our core competencies into some other areas of industrial process heating, where we can really deliver an engineered solution in hazardous environments that create value for our customers. .

Are you thinking about anything outside of petrochem, power gen, oil and gas?.

Well, our focus really is on our end markets, which are oil and gas, the chemical and power. Some of the opportunities could give us -- depending on the end markets, could give us more diversification outside of oil and gas. .

Okay. And maybe just 2 more quick ones.

Breakdown of your revenue currently or in this most recent quarter in terms of oil and gas, petrochem and power gen?.

We don't have that. Actually, we only do that on an annual basis. And we're in the process of doing those calculations. We'll have those available... .

Within a week or so. .

Within a week. .

Okay. And then I just want to be clear.

So with the revenue guidance and what you said about margins and OpEx outpacing revenue growth, is it fair for us to model EBITDA down in fiscal '17 then?.

Yes, but it will be down modestly, okay? We're not looking at significant reductions in EBITDA year-on-year. .

Modestly I would interpret as kind of mid-single digits. .

I would say it's going to be more like -- not to get too specific, but we ended $65 million for the year, $65.3 million. And it's going to be in that neighborhood with a modest reduction. .

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

This is actually Patrick Wu standing in for Charley. Just wanted to talk about -- I think you guys mentioned obviously pricing is a big thing for you guys in both MRO and Greenfield. And I think mixed more on the MRO side. So I just want to touch on that a little bit.

In terms of the projects that you guys are seeing in your backlog and obviously with the competitive pricing and usually these projects are longer term in nature, how long do you think the drag will be to your margins as you work down this backlog? And then on the MRO side, is service -- what is the mix of service within MRO/UE for this quarter? Because we would imagine that's generally on the lower end of the margins so that's why the mix has been dragged down.

Is that correct to say that?.

Yes, in terms of your first question, the backlog margins, that's a very difficult question for us to answer in that the MRO has significant velocity to it. It comes and goes very quickly. And whether we bill or not bill a certain Greenfield project in a given quarter will impact our margins. But the guidance is this 60-40 split going forward.

And we don't have any evidence that, that will change due to the current dynamics that we see in the backlog. .

And I guess how about the second part, which is the service portion of the MRO/UE? Was that -- what was the mix on that?.

That's something that we have not in the past disclosed. But we believe that will trend upward this year due to several initiatives and investments we are making in our services business. .

Okay, that's fair. And I think last quarter, you guys mentioned that fiscal year '16, you guys expected acquisitions to comprise around $30 million. And I think you came in around $26 million.

I guess over the past few months, what have you seen that's shifted in terms of dynamics for that, I guess, shortfall in the $4 million? Is that something you guys can maybe provide more color on?.

Yes, the main driver of that -- and it's actually very good news when you look out over the next several years. And that is our temporary power business that we acquired had started a rental program just about the time we acquired them. And we made a certain assumption in terms of revenue mix for purchases versus rentals.

And they significantly outstripped the rental mix that we anticipated. And even though we saw them not hitting their revenue target, they did hit and actually slightly exceeded their earnings target, their EBITDA target, due to this margin-rich, profit-rich revenue business that will -- rental business that will continue into fiscal year '17.

So that's the biggest reason we did not hit that $30 million number. .

Okay. And if I can add one more, orders obviously was very strong this quarter. And I think last quarter, you guys mentioned quoting activity was up, but that was not necessarily translated to bookings. I wanted to see if you guys can quantify how much of the increase in orders this quarter, what maybe like pushed back into this current quarter.

And how much of that is the sort of a slightly improved view on the macro environment? Well, at least with oil prices being up inching closer to $50, how would you classify the dynamics between those 2?.

Yes, they're both favorable trends, especially the oil number and the quotes, obviously. And there is a lag or a delay between the time we quote business to the time that we win the order. But both were favorable. .

[Operator Instructions] Our next question is a follow-up from the line of Jeff Hammond from KeyBanc Capital Markets. .

I don't know if I missed this.

But within like the flat to low single-digit growth, what's kind of the acquisition contribution versus FX headwind?.

Jeff, what we see is the acquisitions will contribute an additional $6 million to $8 million in revenue during the fiscal year. And then the balance would be what we see in our organic business. .

Okay.

And FX is neutral?.

I think for the current quarter, it's going to be a magnitude of maybe, and I'm guessing here, $0.5 million negative. .

Okay.

And then it would be pretty neutral?.

Yes. .

Yes. We're seeing some favorable trends with the euro. The CAD is coming close to parity. .

Okay.

And then on new product spend, do we -- do you see incremental growth in spending? Or has it just continued to stay at the high level you had in '16?.

Yes. We do see some incremental growth in spending in the range of about $3 million. And we're investing in not only new product development but some other organic growth initiatives. So we do see that, some growth in those areas.

And Jeff, we've got plans for growing organically our new products introduction so that by fiscal 2021, we would expect an incremental $40 million annually from these new product offerings. .

Okay. And then you mentioned the one new product, and then you had 3 more rolling out.

Is there anything you could talk about on the 3 new?.

We'll share that as they're released throughout the course of the year. .

Our next question is a follow-up from the line of Bhupender Bohra from Jefferies. .

Just on new products again, could you give us a sense like which end products markets these new products are rolling out into?.

They're fairly broad-based. So these are platforms that really can be utilized in any of our end markets in applications for industrial process heating. .

Okay. And just wanted to get a sense of when I look at a pie chart from an end market perspective, I believe about like 25% of your channel, kind of distribution-based.

What are you hearing through your distribution channel? What kind of a growth we had in the quarter? And if you want to talk about that for fiscal '17, how do we see that?.

Well, yes. So we actually saw that fairly weak in the fourth quarter. And that was part of the margin decline in MRO sales that Jay had noted in the financial reporting. So we have continued to see some softness there.

But as I spoke about, we see that the maintenance spending in some of the smaller projects, the UE piece of our MRO, those small upgrades and expansions, we would expect that a lot of that spending is being deferred. Much of it is related to critical maintenance or some of it even driven by regulatory requirements. So we do anticipate a return.

Predicting that timing is difficult. And as I said, as we begin to see that spending increase, that has historically been favorable to our margin mix. .

Okay.

And lastly, on one of the geographies, like Asia Pacific, especially the Middle East, what you saw in the quarter and how should we think about that like going into fiscal '17 here? Any changes from last year or like worse or better?.

Middle East is actually one of our bright spots in Europe. There's a couple of areas that are positive. Eurasia has actually been strong as well. And we have a very strong backlog in the Middle East, although the mix of business, the margins are not as favorable. But we have a very strong backlog going into the fiscal year. .

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Bruce Thames for any further remarks. .

Again, I'd like to thank everyone for your interest in Thermon. Thank you for joining us today, and we appreciate your support. .

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..