Greetings. And welcome to the Thermon Group Holdings Third Quarter Fiscal 2019 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Sarah Alexander, General Counsel for Thermon Group Holdings. Please go ahead, Sarah..

Thank you, Kevin. Good morning and thank you all for joining today's 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 the 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 which are subject to risks and uncertainties. We do not intend to update these statements unless we're required to do so under applicable securities laws, and our actual results may differ materially from the views expressed today.

Some of these risks have been set forth in the earnings press release and in our quarterly and annual reports filed with the SEC. We would also 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, 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 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 is 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 for 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 year 2019 third quarter.

To begin, we continue to see the positive impacts of investments made during the industry downturn directly translate into improved operating results and expanding market share. Despite a very warm start to the heating season, our team drove broad-based organic growth of the installed base across our business lines.

On a trailing 12-month basis, this business delivered $84.4 million in adjusted EBITDA, approaching the previous record set in fiscal year 2015 when oil was $100 a barrel and there were very large oil sands projects underway.

We've been able to accomplish this by expanding our addressable market, diversifying into adjacent markets and differentiating our offering. These efforts drove strong third quarter revenue growth in our Greenfield business, which is key to growing the installed base to capture future MRO/UE revenues.

An accelerated rate of project execution drove revenues of $119.4 million in the quarter, up 20% year-over-year on a pro forma basis with organic growing 28.6%, excluding FX.

Inorganically, we saw Thermon Heating Systems finish at $23.6 million in revenue, up 2.5% on a pro forma basis with EBITDA remaining on track with our base case for the acquisition. We saw an unusually high mix of Greenfield versus MRO/UE, up 45% to 55% as compared to a 38% versus 62% mix, respectively, in our Q3 of fiscal 2018.

This mix negatively impacted margins by 300- basis points over the prior year quarter as Greenfield volume grew by nearly 50%. MRO/UE revenues also grew by 11.2% year-over-year despite a warmer start to the heating season.

Project execution and price realization more than offset the impacts of tariffs during the quarter as project margins and electrical margins expanded by 80- basis points and 70- basis points, respectively, over the prior year.

The incremental volume drove strong adjusted EBITDA growth in the overall business at $26 million in the quarter, an increase of 20% over prior year. Operational improvements drove improved leverage on operating expenses in the quarter to achieve 21.8% EBITDA margins.

Most notably, we were able to achieve this leverage while simultaneously implementing an ERP and an HRIS system and increasing our investments in research and development. Our GAAP EPS of $0.29 per share compared to $0.02 a share in the third quarter of fiscal 2018. Adjusted EPS of $0.40 a share increased 14% over the prior year quarter.

Thermon Heating Systems contributed $0.08 a share in adjusted EPS in the quarter when fully burdened with the associated debt. We continue to generate positive cash flow and EBITDA growth to drive lower net debt-to-EBITDA. Since the acquisition, net debt-to-EBITDA has been reduced from 3.4x to 2.3x over a 14-month period.

Our first priority for capital allocation remains debt reduction to position the business to take advantage of future growth opportunities. Bookings for the quarter of $105.6 million were down 6% year-over-year on a pro forma basis. On a trailing 12-month basis, bookings are at $371 million.

The backlog of $136 million is also down 19% over prior year due to the strong shipments during the quarter. Looking forward, we saw a very large increase in quotations, which were up 82% over prior year. We also saw the project pipeline grow to a record level of $1.4 billion with over 1,300 active opportunities over the next 3 to 5 years.

From a market perspective, upstream activity in the shale plays have been steady. But there, we see some uncertainty with operators due to oil price volatility. The chemical and petrochemical sectors have shown continued strength, which has been instrumental in driving growth over the last 5 quarters.

Combined cycle power projects are showing steady single-digit growth as natural gas continues to be the fuel of choice for power generation. Midstream activity, particularly in LNG, is driving some very large project opportunities globally that should extend over the next several years. Transportation has been active in the U.S.

and Canada with a number of multiyear transit contracts being awarded that help moderate the seasonality in the energy sector. Turning now to look geographically, North America continues to show strength in fiscal 2019 that began in the second half of our fiscal 2018.

We're seeing growth continue to gain momentum in fiscal 2019 led by chemical and petrochemical spending. Pent-up demand in maintenance and upgrade expansions has led to robust spending across growth in North America and is anticipated to continue at this pace.

In the Eastern Hemisphere, we continue to see larger projects in backlog move forward through the first 3 quarters of fiscal 2019. We do expect growth to moderate in this hemisphere during Q4 and early fiscal '20. We continue to invest in our research and development capabilities to accelerate execution of our project and technology road maps.

During the quarter, we launched a new CompuTrace power management software module. This addition to our VisiTrace 3D software platform streamlines and automates the design of power distribution and electrical load management for heat tracing systems.

This new tool aids modular construction programs by automating the design process to ensure optimal designs that reduce material and design labor costs while improving project schedules. In the coming months, we will announce 3 more new product launches as promised at the beginning of this fiscal year.

Looking forward, we're pleased with the business performance through the first 3 quarters of this fiscal year. The sustained positive momentum and project activity over the last 5 quarters has led us to increase our full year guidance for the third consecutive quarter.

The new fiscal year 2019 revenue forecast will be increased to $396 million to $402 million, an increase of 28% to 30% over fiscal year 2018. No M&A is comprehended in these revenue projections. We are currently building our plans for fiscal year 2020, and we'll provide an update during the earnings call scheduled in May.

I'll now turn the call over to Jay Peterson, our CFO, to address the details of our Q1 fiscal 2019 financial performance.

Jay?.

Thank you, Bruce. Good morning. I will start by discussing our record Q3 results and then turn to a review of our updated guidance for this fiscal year. First off, revenue and orders. Our revenue was a record this past quarter and totaled $119 million. That's an increase of 29% over the prior year's quarter.

Organic revenue in constant currency totaled $98.5 million, and that grew by 28%. FX decreased our organic revenue by approximately 3%. And M&A revenue that is from the CCI acquisition, grew 47%. And on a pro forma basis, our total revenue grew by 20%. Organic Greenfield revenue grew by 49% over the prior year quarter and was 45% of the revenue mix.

The organic MRO/UE revenue grew by 11% and amounted to 55% of the organic revenue mix. And the above Greenfield mix was 5% higher than our typical historical performance. We continue to experience positive signs of a recovery with our organic revenues growing double digits for the fifth consecutive quarter.

And in addition, Thermon Heating Systems revenue increased slightly on a pro forma basis. Orders for the quarter totaled $106 million versus $105 million in the prior quarter, and our backlog of orders ended December at $136 million versus $168 million as of December of last year. And that's a decrease of 19%.

And FX negatively impacted our backlog by $5.3 million. Our book-to-bill for the quarter was negative at 0.89, and this was primarily due to the acceleration of Greenfield project revenues from Q4 into Q3. And moving on to gross margins and gross profit. Margins were 43% of revenue, and gross profit grew by 20% on a GAAP basis.

The organic mix shift to Greenfield contributed to the lower than typical corporate margins due to the higher content of engineering and construction labor and third-party buy-out items. Margins from Thermon Heating Systems were accretive to our corporate margins. And on a pro forma basis, gross profit dollars grew by 10.1%.

And while we have experienced cost increases attributable to the recent tariffs, we have been able to pass these increases along to our customers, and we have not seen any impact to our gross margins due to tariffs. Moving on to operating expenses.

Core operating expenses for the quarter that is SG&A, and this excludes depreciation and amortization of intangibles and any transaction-related expenses, totaled $25.8 million for the quarter versus $21.6 million in the prior year. And that's an increase of 19.6%. And on a pro forma basis, our core spending increased from $23.1 to $25.8 or 11.6%.

And that compares to a 20% increase in revenue. Our OpEx as a percent of revenue was 21.6%. And again, that excludes depreciation and amortization and any transaction-related expenses. And that's an improvement of 170 basis points from the prior year level of 23.3%.

And this spending improvement was concurrent with a 12% increase in organic research and development spending related to future project -- product offerings, a successful implementation of a corporate-wide HRIS system and the very tail-end of an organic ERP implementation. Now switching to earnings.

GAAP EPS for the quarter totaled $0.29 a share compared to the prior year quarter of $0.02, and that's an increase of $0.27 per share. Thermon Heating Systems contributed a gain of $0.04 a share to our GAAP EPS, and that is on a fully burdened basis, inclusive of all incremental interest expense.

Adjusted EPS -- and this is defined by GAAP EPS less amortization expenses and any one-time transaction-related charges -- totaled $0.40 a share relative to $0.35 a share in the prior year quarter.

And we will continue to communicate this adjusted EPS construct in the future due to the high level of non-cash amortization expense running through our income statement. And at present, we are expensing $5.5 million per quarter or $0.12 per share or approximately $0.48 a share on an annual basis for non-cash amortization.

EBITDA grew by 20% versus the comparison quarter, and EBITDA as a percent of revenue was 21.8%. EBITDA totaled $25.9 million this past quarter. And trailing 12-month EBITDA on a pro forma basis totaled a near record of $84.4 million. And that's an increase of 25% over the trailing 12-month as of December 2017.

And on to the balance sheet and capital allocation. Our cash and investments balance at the end of December improved to $33 million. The most significant use of cash for the quarter was the $20 million increase in our accounts receivable balance due to the high level of December shipments.

CapEx for the first 3 quarters of the year totaled $7.2 million or 2.4% of revenue. Recall our net debt-to-EBITDA ratio was 3.4x at the time of the October 17 CCI acquisition. Through continued growth in EBITDA and continued reduction in our net debt, we have delevered the business to 2.3x, all within a 14-month period.

And lastly, our capital allocation priority, and this is in the absence of any near-term M&A transactions, is to continue to reduce our debt through optional debt repayments. Taxes. Our tax rate for the third quarter was 29.9%. And we continue to work with our tax advisers on potential strategies to reduce our income tax exposure.

And finally, 2019 guidance. A couple of points I would like to mention. First off, we are planning top-line revenue to be in the $396 million to $402 million range in this fiscal year. And lastly, we expect to reduce our net debt-to-EBITDA leverage to approximately 2.0x over the balance of the year.

And I would now like to turn the call back over to Kevin to moderate our question-and-answer session.

Kevin?.

[Operator Instructions] Our first question is coming from Charley Brady from SunTrust. Your line is now live..

This is actually Patrick Wu standing in for Charley.

Can you hear me okay?.

Yes. Good morning, Patrick..

So, just on gross margin, I mean, I understand that the mix of Greenfield obviously is higher in the quarter but that skews it down a bit.

But can you provide some granularity on how your margin looks like now in the backlog relative to this point a year ago? And I guess, how -- you mentioned that the pricing is -- you guys were able to offset some of the tariffs. How are the pricing trends looking for the new projects coming in? And I guess, we can start with that then..

So, the gross margins in the backlog are essentially flat with what they were at the end of Q2. We have not seen any significant mix of the projects in the backlog and -- nor the inherent pricing, so it's essentially flat quarter-on-quarter..

I think you might have mentioned it in the very beginning of your commentary, and I may have missed the numbers. But in the past, you had given how gross margins for Greenfield and MRO/UE have moved within the quarter.

Can you shed a little bit of light on that or maybe just restate the numbers that you mentioned? And given the variability of Greenfield mix from quarter-to-quarter, this is -- this would be helpful to see how you guys think about gross margin on a forward basis..

Sure, Patrick. So in the past, the guidance we have provided and articulated on Greenfield gross margins was a range of 30% to 40%. And correspondingly, MRO/UE gross margins would be in a range of 50% to 60%.

In this past quarter, the main driver to our margin change year-on-year was not the specific gross margins, but it was really nearly a 5x differential in the growth rate of Greenfield relative to MRO/UE. I can say that for both Greenfield and MRO/UE, they were on the lower end of the range I just mentioned.

But for competitive reasons, we're not going to disclose the exact percentages..

Our next question is coming from Brian Drab from William Blair..

So, Jay, maybe just to clarify on the organic revenue growth. When you're saying organic and you made it clear in the press release, you're just saying it, let's take THS out of the calculation completely. And that's where you get the $95.8 million, and that compares to $76.6 million last year or thereabouts.

Is that right?.

Yes. The exact numbers for organic, I'd give it to you on a constant currency basis, $97.9 million versus $76.6 million, FX impacted that number by $2.2 million..

Right. So I got that. Okay. So when I'm thinking about organic, this is just like a housekeeping item really.

But can you tell us how much revenue THS would have recorded in terms of acquisition revenue in this quarter versus two months that are in the organic calculation?.

Yes. And actually, the way we've done this was to break it out, okay? So that might be....

I understand, yes, but I just want to do it the other way..

Okay. $23.6 million for the quarter for the 2 months in the prior period, $16.0 million. If we do a pro forma, 3 months in both quarters, it's $23.6 million versus $23 million or 3% growth for THS..

$23 million in third quarter of '18?.

That is correct, Brian..

And so for -- and so in this period, what was the revenue in THS in October? I guess, just to close the books on this..

I don't have that exact number for the month, Brian. Sorry..

Okay, okay.

And the only reason I'm asking is just because I'd like to know what revenue from THS I would put into my organic calculation versus?.

Yes. I can get that for you. Let me shoot you an e-mail with that..

Okay. So, maybe secondary, bigger picture. It sounds like some revenue was recognized earlier than expected or some pulled into third quarter from fourth quarter.

And, can you talk about that? And why the implied guidance -- I think, the big question today right is going to be, you did $119 million in the third quarter and your guidance implies around $102 million, $103 million for the fourth quarter, which is below the Street estimates, and why is that? What's going on there?.

Brian, this is Bruce. We did see a lot of -- we talked about this in prior calls, kind of the opportunity we saw coming into this fiscal year. And if you will recall, we've seen a very protracted kind of backlog materialization during the downturn, and we began to see that really begin to come in. And so we saw it as protracted as 18 months.

Historically, that backlog conversion has been more in the 12-month range. We're now seeing that normalize. And so when you look at timing of projects, we had seen customers delaying deferring, so that would affect the timing of revenue quarter-to-quarter.

We actually saw that really accelerate in the, really, the last couple of quarters, which has led to a much heavier Greenfield mix. So it's really just a project timing issue. We do continue to see this carrying over into next year -- next quarter, excuse me. And so we do see revenues, just tying the revenues being stronger in Q3 than in Q4.

Quite frankly, that's more in-line with our historical seasonality. And certainly, the MRO revenues based upon the weather, the heating season will positively or negatively impact those as well. But we feel very confident in the fourth quarter revenue forecast that we projected..

Okay. It seems like a bit -- I know there's seasonality here, but it seems like a pretty big step-down, like, if you hold MRO -- MRO was constant from third quarter to fourth quarter. You'd have to go from $51 million in Greenfield down to $34 million, and $34 million is kind of -- that's what you did in the first quarter or $33.5 million.

That's a -- and I know you didn't give these numbers for the fourth quarter.

I'm just wondering, would you -- does that even make sense that the fourth quarter given all the momentum in the building pipeline would be in line with first quarter Greenfield?.

No, I think you've mistaken. What we would expect is not the amount of Greenfield and it would be at the expense of the MRO/UE. We would expect revenues to be more normalized in that 60-40 range to our historical..

Yes, okay. So would you expect the MRO/UE steps down sequentially, then, I guess, what we're -- what that implies.

Is that -- why would that be?.

It's typically what we see in the seasonality of this business. Didn't necessarily occur exactly that way last year. But certainly, if you look over time, that's been what we've experienced..

Yes, okay. Yes, I see it. I know that. It just seems like a pretty big step-down given the momentum, again, given your comment that you got off to a slow start in the heating season in the third quarter. But I'm just trying to piece them together..

Certainly, the weather that we're seeing right now could have a very positive impact on that forecast..

Yes. I would think so. It's negative 50 windshield when I walked my dog this morning..

Yes. That really -- that can definitely have a very positive impact to the forecast that's been provided..

Our next question today is coming from Marty Malloy from Johnson Rice..

My first question is about Canada and with the curtailment for oil sands in Alberta.

How is that impacting what you're seeing from your customers, if at all?.

We've talked about this over the last several years. Certainly, the takeaway capacity in the oil sands has really negatively impacted the price of Alberta crude. It has been really at a $30 a barrel discount to West Texas Intermediate. Certainly, that varies, but -- so that has had a big impact to investment.

So essentially, what we've seen is we've been able to drive these business levels with really the lack of kind of those large capital projects that we saw in Canada during the early 2010 to 2015 time frame.

What we have seen is based on the installed base, our baseline MRO revenues in Canada have virtually doubled from, say, the mid 2000s, so in '05, '07 time frame. And that's really due to the much larger installed base there. So historically, you might look back and revenues would have been $25 million to $30 million in MRO/UE basis.

And now we're generating our revenues in kind of the mid-50s to $60 million range in our Canadian operations. So I guess, just that broadly characterizes what we've seen..

Okay. And then just with your -- the improvement that you're seeing in the net debt ratio.

Could you maybe speak to -- if you look out 6, 12 months, do you think you're going to be in a position to be more active in looking at acquisitions?.

Yes. Yes, we do. We have a pipeline of acquisitions, and the idea is to grow our business both organically and inorganically. And if we were to lever up again, we believe based on history now that we can delever in a rather rapid pace, assuming we were to do an acquisition in the next 12 months. So the answer is yes, Marty..

Our next question is coming from Scott Graham from BMO Capital Markets..

This is Katja on for Scott.

So, on the Greenfield, what is really driving the acceleration? Can you provide any more color on that?.

Again, I kind of go back to timing. What we have seen really is a lot of these projects particularly are petrochemical related. And as we saw the increase in oil prices, we saw some pretty big disparities between the price of, say, natural gas liquids, things like propane, ethane, things like that and naphtha as a feedstock.

And so that price differential has really made the economics pretty compelling. And even though we've seen crude prices come fall here from the mid-60s to low 50s, we're still seeing those are pretty compelling economically for these operators. So those have been -- they're really probably the largest driver behind just pace of execution..

And Bruce, if I'm not mistaken, you said that you expect this to continue, right, until next year?.

Yes. So -- and again, I go back to historically, we've seen kind of a backlog conversion in that 12-month range. It had been as protracted as 18 months. And we're now seeing that and more normalized..

So these are lower gross margin.

How should we look at gross margin in 4Q and then going forward? Can you provide any color on that?.

So the biggest -- I mean, one of the biggest impacts that we've seen to gross margins historically is really mix. And we have seen large project -- and I want to clarify that our backlog is largely projects. There's only 1 or 2 weeks of kind of MRO/UE sitting in that. So as we look at margins in backlog, they've been relatively flat.

And so really, it's the mix that we see in any given quarter that has the greatest impact on our absolute margins. I had noticed -- I had noted in my script that we have seen some improvement just in project execution. And as a result, we've been able to see about a 70-, 80- basis point improvement year-over-year in just our project margins.

And as we look within our product sales, we're seeing our electrical margins improve similarly. So those are some positive signs really on just the project execution as well as price realization to offset the negative effects we've seen from tariffs..

Just my last question.

Why have orders slowed? The growth?.

The order intake is lumpy because of these projects. Our baseline MRO business actually increased 11% year-over-year, which was a very positive sign. So it's kind of low double-digit growth year-over-year. It was just significantly overshadowed by the revenue growth we saw in Greenfield, which was up nearly 50% year-over-year.

So as we look forward, certainly, we watch this. We kind of look on a trailing 12. The good news that we've seen is our quote activity really rose significantly during the past quarter, and it was broad-based. And a lot of that, we're seeing some nice growth activity really in both hemispheres.

And as we look at our -- the project pipeline, which is really our opportunities that we're tracking that have process heating content over the next 3 to 5 years, we're actually seeing that grow to over $1.4 billion. And we've seen the number of projects grow to over 1,300, so that's a new record level for us.

One of the particular areas we've seen some very nice growth has been in LNG. And we do see some major projects on the horizon that would generate some significant opportunities to grow both Greenfield as well as growing the installed base over the next 3 years..

[Operator Instructions] Our next question is coming from Charley Brady, a follow-up from SunTrust. Your line is now live..

This is Patrick Wu again. So I just want to triangulate your comments on margins. And it sounds like, obviously, the backlog or the margins of the backlog are pretty similar to last year levels. Given the organic growth that you saw in the quarter, I would've imagined that the margins will be higher. I understand that Greenfield is a bigger mix.

Would you say it's fair to surmise, then, that labor cost is becoming a bigger impact into gross margin? And are you seeing any further strain in that regard moving out?.

Well, no, we don't see labor cost as being a strength. However, we are seeing more labor within our contracts. But as far as the labor cost eroding margins, that has not been the case..

Okay. And you gave some good color on the SG&A expenses in the quarter. That's a pretty significant drop-off in terms of as a percentage of sales versus even the prior quarter and the prior year.

Is this really a one-time thing for the quarter? Or are you seeing a broader -- was it more a broader function of your ability to integrate the adjusted better, reduce cost on a more permanent basis? How sustainable is this lower level of SG&A cost as a percent of the sales, at least?.

So one thing to call out, Patrick. And that is in the downturn, we purposefully made certain investments such that we could grow the business faster once the downturn ended and we saw an uptick. And that's exactly where we're at right now. And we believe, by and large, this level will be sustainable.

It will grow with revenue, but it will not grow near or anywhere near the rate of revenue increase in the future..

Our next question is a follow-up from Brian Drab from William Blair. Your line is now live. Brian perhaps your phone is on mute? If there are no further questions, I'll turn the floor back over to management for any further or closing comments..

All right. Thank you, Kevin. And I'd like to take this opportunity to thank our Thermon employees around the globe for their commitment to serving our customers and creating shareholder value. They truly really make the Thermon difference. And I'd also like to thank everyone for joining this call, for your interest in Thermon. Have a great day..

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time. And have a wonderful day. We thank you for your participation today..