Greetings. Welcome to Thermon Group Holdings Incorporated Second Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded.

I would now turn the conference over to your host, Kevin Fox, Vice President, Corporate Development. Mr. Fox, you may begin..

Thank you, Omer. Good morning and thank you 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 ir.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 and any redistribution, retransmission or rebroadcast in any form without the expressed written consent of the company is prohibited.

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 gap 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.

Before I turn this call over to Bruce, I'd like to remind you that during this call we may make certain forward-looking statements regarding our company and business that are not historical facts because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict.

Please refer to our annual report and most recent quarterly report filed with the SEC for more information regarding our forward-looking statements including the risks and uncertainties that could impact our future results. Our actual results may differ materially from those contemplated by these forward-looking statements.

We caution you therefore against relying on any of these forward-looking statements. They are neither statements of historical facts nor guarantees or assurances of future performance. Any forward-looking statement made by us during this call speak only as of the time at which it is made.

Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement whether as a result of new information, future developments or otherwise except as may be required by law.

And now, it's my pleasure to introduce Bruce Thames, our President and Chief Executive Officer for his opening remarks..

Thank you, Kevin. Good morning and thank you for joining our conference call, and for your continued interest in Thermon. Joining me today on the conference call today is Jay Peterson, our CFO, who will follow me and present the financial details of our fiscal year 2020 second quarter.

I'm going to begin by talking about the trends we're seeing with our customers and in the end markets where we choose to compete. We're seeing a weakening overall macro environment as supported by the most recent IMF growth forecasts that has resulted in a more cautious approach to capital deployment by many of our customers.

While questions persist regarding a number of factors impacting the global economy, we believe that execution of our strategy has positioned Thermon well to continue to grow in spite of the economic uncertainty.

As a reminder, the heat tracing market of our legacy business was roughly $1.5 billion, when we expanded into process heating capabilities two years ago with the purchase of CCI Thermal Technologies, now Thermon Heating Systems. We now believe our total addressable market is at least twice as large.

It's our intent to continue to grow that addressable market and our share via geographic growth, expansion into new verticals as well as potential future acquisitions.

From a capital investment standpoint, we see CapEx estimates for the next 12 months growing in the Middle East, Africa and India, moderate to neutral spending growth in North America and Asia and Europe continuing to be a very challenging and competitive economic environment.

Despite the varying levels of growth across the world, Thermon delivered top line growth for the eighth consecutive quarter over the comp period with three of the four geographic segments growing revenue in Q2 at least 15% over the prior year quarter.

Even in an environment with limited GDP growth, we see opportunities to create value for our customers and shareholders by selectively pursuing new business and expanding the installed base that has been built over the last several decades. Now, moving to our end markets where we're seeing mixed signals.

The outlook in upstream continues to weaken due to the softening of global demand leading to excess capacity and lower commodity prices. Downstream is also showing some weakness with slowing demand growth for transportation fuels.

Capital projects in this sector have been largely driven by tightening environmental regulations for lower sulfur content in fuels. However, in other areas, we're seeing significant growth opportunities tied to natural gas and petrochemicals. In midstream, we continue to be well-positioned to capitalize on an LNG investment cycle.

We've been awarded a major LNG project in North America that is not yet reflected in backlog or bookings for this quarter. We anticipate this project will begin to impact financials in fiscal year 2021 and continue for the next two to three years thereafter.

We believe this LNG investment trend will provide a significant tailwind through 2025 and beyond. Both chemical and petrochemical sectors remain the most robust of our end markets tied to demand for plastics as a global outlook for consumer spending remains positive.

There are a number of capital projects planned for the US Gulf Coast, Canada and across the Middle East and Asia. We're also seeing a shift in investments toward all the chemical projects as demand for transportation fuel weakens.

Combined cycle power projects are trending positively showing single digit growth particularly in the US and Latin America. Demand for mass transportation in growing population centers continue to create large multiyear project opportunities in rail and transit.

We anticipate revenue growth in Q3 as projects now in production begin to contribute to the top line. We're also seeing MRO opportunities in track and switch products as maintenance dollars are released before year-end. In nuclear, the majority of opportunities are tied to MRO/UE spending within existing facilities.

We have seen an increase in MRO opportunities during the first half which was anticipated following the completion of major nuclear plant upgrades in Eastern Canada that we expect will begin to translate into revenues in the second half of this fiscal year.

Even with these mixed signals from the market, our quotation activity and project pipeline are growing. We've recently had an attractive win with the award of a key THS process heating system in a Southeast Asian refinery. We continue to see the globalization of the THS platform as a key growth opportunity going forward.

Moving onto our financials, Jay, our CFO, will speak to the detailed financial results, but revenue has been a positive story for the past few quarters and this quarter continued that trend.

Total Thermon revenue was up 14% in a mixed market and we were able to drive a sequential 360 basis point margin expansion through price realization, expanded margins from new products and continuous improvement efforts related to our manufacturing costs.

More notable, our margins of 44.1% approached our historical average on a very heavy mix of Greenfield and MRO/UE revenues at 47% and 53% respectively. Throughout the year, we will continue to execute on our cost reduction plans while also focusing on new product development that will further enhance our margin profile over time.

I'd like to shift focus to cash which was a good story this quarter. As we mentioned on our last call, we felt there was an opportunity to increase the efficiency of our balance sheet and we improved our cash conversion cycle by over 25 days versus last quarter.

With a focused effort on all three drivers, we were able to generate over $26 million in operating cash flow during the quarter. With our low capital intensity business model, as a reminder, we typically spend slightly over 2% of revenue on CapEx.

Staying focused on our working capital will help consistently generate the cash needed to continue to pay down debt or pursue additional inorganic opportunities. From the M&A standpoint, two years ago, we purchased the business line now known as Thermon Heating Systems.

We were pleased with our progress since then and we will continue to be disciplined as we evaluate potential deals. We will prioritize bolt-on acquisitions that help build upon our leadership position in key technologies, globalize the THS platform or expand our addressable markets.

We continue to evaluate transactions each quarter and in the absence of attractive M&A, we will prioritize debt reduction. In this quarter alone, the savings from debt reduction and associated interest expense will translate to $0.03 a share in EPS on an annualized basis.

Alternatively from an organic growth perspective, we are continuing to invest in technology that positions Thermon to win in the market.

For example, recently completed investments in our research and development lab now give us the capability to rapidly iterate and test new material compositions that will enhance performance, improve quality and expand the range of applications for our heating solutions.

We've also incorporated THS' new product development ideas into our stage-gate process providing an enterprise wide view into future revenue opportunities. Last but certainly not least, we continue to invest in our software team as they develop modern solutions to enhance our customers' productivity, safety and performance.

As I look into the second half of the year, we see a tougher set of comparisons due to strong growth we achieved in the second half of our fiscal 2019 especially Q3. However, we feel confident in our plan for the remainder of the year and we are maintaining our annual revenue forecast of 2% to 4% organic growth for fiscal 2020.

I also wanted to highlight that Thermon celebrated its 65th anniversary last week. The company was founded in 1954, and Thermon has been an innovator in the market ever since.

To the Thermon employees around the globe, thank you for all you contribute in making this company what we are today, and I look forward to what we will accomplish together in the years ahead. Now, I'll turn it over to Jay Peterson, our CFO who will address the details of our financial performance for the second quarter.

Jay?.

Thank you, Bruce. Good morning. I will start by discussing our Q2 results and then finish with guidance and a discussion on margin enhancements for fiscal year 2020. First off, revenue and orders. Our revenue this past quarter totaled $102.9 million and that's an increase of 14% over the prior year's quarter.

The legacy revenue mix between MRO/UE and Greenfield was 53% and 47% respectively with the Greenfield mix significantly higher than in the past. FX decreased total revenue by approximately 1.5%, and in constant currency, our revenue grew by 16%. And this last quarter marks the eighth consecutive quarter that our business revenues have grown.

Orders for the quarter totaled $92.6 million versus $95.8 million in the prior quarter or a decline of 2%. Our backlog of orders ended September at a $102.3 million versus $149.6 million as of September of fiscal year 2019, and that is a decrease of 32%.

Margins in our backlog improved by 200 basis points over the last 90 days and 400 basis points over the last three quarters, and our book-to-bill for the quarter was 0.9. Moving on to gross margins, margins were 44% of revenue, and we're at the highest level in the last three fiscal quarters.

Although gross margins declined by 70 basis points versus the comp period, it is noteworthy that we were able to maintain 44% margins in spite of a substantial increase in the mix of Greenfield project revenues and consecutive quarter margins improved by 360 basis points, gained by 600 basis points over the last two quarters.

And in the quarter, gross profit grew by $5 million or 12% versus the comp period. While we have experienced cost increases attributable to the recent tariffs, we have largely been able to pass these increases along to our customers and we have not seen any material impact to our gross margins due to tariffs and to OpEx.

Core operating expenses for the quarter that is SG&A, and this excludes depreciation and amortization of intangibles totaled $25.4 million versus $23.9 million in the prior year. And that's an increase of 6.2% relative to a 14% increase in revenue.

And comprehended in this modest operating expense increase is a 52% growth in research and development spending and other costs specific to achieving our fiscal year 2020 strategic initiatives.

And our operating expense as a percent of revenue for the quarter was 24.7%, again this excludes depreciation and amortization and that's a decrease of 180 bps from the prior year level of 26.5%.

Now to earnings, GAAP EPS for the quarter totaled $0.21, compared to the prior year quarter of $0.10, an increase of $0.11 per share and note that EPS more than doubled on 14% revenue growth due to gross profit growth and continued expense management.

Adjusted EPS as defined by GAAP EPS less amortization expense and any one-time charges totaled $0.29 a share relative to $0.22 a share in the prior year order. And I'd like to call out that we are currently expensing $4.5 million per quarter or $0.10 per share or approximately $0.40 a share on an annual basis after tax for non-cash amortization.

And note that the total amortization expense will decrease in May of fiscal year 2021 to approximately $9.9 million per year due to roll-off of certain assets related to the 2010 private equity acquisition of Thermon.

In the quarter, EBITDA grew by 18% versus the comparison quarter, and EBITDA as a percent of revenue was 20.5%, and that's an improvement of 60 basis points versus the comparison period. EBITDA totaled $21.1 million this last quarter. Now moving on to the balance sheet and future capital allocation.

Our cash and investments balance at the end of September improved to $39 million, and we generated $24.5 million in free cash flow this quarter. And we were able to pay down $15.6 million in debt with additional debt paid down done this current quarter.

And this Thermon foregoing interest expense will be accretive to our earnings by $0.03 a share over the next 12 months. And that's an after tax number. Our Pac CapEx spend for the second quarter totaled $2.1 million that's inclusive of both sustaining and maintenance capital and came in at 2% of revenue.

Recall, our net debt to EBITDA was 3.4x at the time of the October 2017 CCI acquisition and it is presently at 2.0x with additional de-levering anticipated this fiscal year. And lastly, our capital allocation priority in the absence of any near term M&A transaction is to continue to reduce our debt through optional debt repayment.

Taxes, our tax rate for the second quarter was 21%, and tax expense for the quarter reflects a reduction of taxes totaling $784,000 for the impact of a 4% tax rate reduction in Alberta Canada.

And while this rate will be phased in over three years, accounting guidance requires that we adjust the respective tax accounts at the time the law becomes known and we continue to work with our tax advisers on various strategies to optimize our income tax structure and at the conclusion of this analysis, it is possible our tax rate will be exposed downward later this fiscal year.

And finally on to 2020 guidance, there are several guidance points I would like to mention.

We are holding to our previous revenue guidance of 2% to 4% growth and relative to our current margin performance various activities are in process to improve our margins including $4.5 million in cost reductions with an anticipated realization of $2.6 million in savings this current fiscal year, and we announced price list increases earlier this year for our maintenance related products.

And in Q2, we realized a 130 basis points due to price with an expectation of a total 200 bps for the fiscal year. And recent planned product announcements that we anticipate will yield accretive margins this year. And lastly, as we head into the heating season, we typically see a seasonal uptick in margins due to the increased mix of MRO activity.

And in conclusion, due to growth in cash and EBITDA and continued reduction in our debt, we expect to improve our net debt to EBITDA leverage to approximately 1.5x at the end of the year and this is excluding any M&A transaction. And I would now like to turn the call over to Omer to moderate our Q&A session.

Omer?.

At this time, we'll be conducting a question-and-answer session. Our first question is from Brian Drab, William Blair. Please proceed with your question..

The large projects in Canada, I guess, congratulations, I guess you only said North America, but can we say whether that's Canada LNG?.

Right now, we have a non-disclosure agreement and we're not at liberty to discuss that further..

Okay..

It is a very large North American project that will yield revenues for the next two to three years though. We're very pleased to....

Is there any chance that you can talk about what type of gross margin you'd expect on that project overall, and maybe just directionally, like would it be better than 45% or below 45%?.

It would be similar to our margin profiles for our Greenfield mix of projects..

Okay. Okay. So, I guess that's clearly below 45s45 on that business, that were below your average, if it's Greenfield....

It is, it would be an average Greenfield project margins..

Got it. Okay..

Obviously, the opportunity there is on the 20-year or 30-year annuity that would follow..

Right. And then, Bruce, is there any update on any of the other large projects that you're bidding on in the pipeline and I know there is another big project out, the Arctic LNG projects out there, there are some other big projects.

And any update on at least qualitatively even your optimism about winning some of these larger projects?.

What I will say is that the overall environment for LNG midstream is really promising and we see a number of these large projects moving forward beyond just FID, but through design and awards. So, we're very pleased with the current win we have and we also see additional opportunities in our quotes in our pipeline..

And then you beat the Street expectations for the second quarter and maintained guidance, so that implies one of two things either the Street was just too low for the second quarter or year, I guess maybe more likely implying a slower second half to the year..

Yes. I think the....

Is that right?.

Yes. Slower second half, we had a really strong H2 last year that was a heavy mix of Greenfield. And we just looking at our current backlog and the makeup of our backlog, we don't see a strong Greenfield in the second half. I think conversely we do see some significant opportunity for gross margin expansion in H2 relative to the prior year..

And then in between just kind of splitting up the quarters, the third quarter and the fourth quarter, I think you said on the call that you expect growth year-over-year in the third quarter.

But I guess that would that mean obviously then a decline in the fourth quarter is that the takeaway?.

No. My comment was really that Q3sQ3 would be a difficult comp and that we were in fact a difficult comp in the second half and that we were maintaining our 2% to 4% revenue growth projections for the year, and we really don't give quarterly guidance just due to the volatility of projects moving in or out of a quarter..

Okay. I'm just looking at the - if the revenue was flat for the next two quarters year-over-year that gets you to about the high end of the guidance. But should it imply that you have to either we've got relatively conservative guidance or we should be modeling down I guess year-over-year at the midpoint.

I just want to give you an opportunity to tell me, I'm doing the math wrong or is that's kind of....

That's the expectation we would see flat to slightly down revenues in H2 relative to the prior year..

And then just one last one.

Can you elaborate on the THS win in terms of maybe timing size, geography end market?.

Yes, it was Southeast Asia which I noted it's in a refinery..

Yes..

And it's a real nice process heating package that we've been awarded. We should see that land generate revenue in late Q4 or Q1 of fiscal 2021..

Okay. All right thanks very much..

I think that the thing we're excited about there is it's illustrative of the opportunities we have to globalize this business. That's what's exciting about it..

Our next question is from Jon Braatz, Kansas City Capital. Please proceed with your question..

Bruce, you mentioned that you're seeing some headwinds in the some of your end markets activity slowing a little bit, and I don't know if you can quantify these things. But as you look forward, if these headwinds persist, how much of a headwind is that for Thermon.

And I assume it's mostly in the Greenfield area as opposed to the MRO operations?.

Yes. Jon, that's correct.

Where we see more some challenges going forward are really more and really a more cautious approach to capital deployment in with some of our customers and a couple of the areas I noted particularly upstream which has been weak, so we and we don't benefit from upstream as much like in the shale plays as maybe some other businesses, so that that's been less impactful areas that we do best upstream have been Canada which has not recovered since the downturn.

So that really hasn't had a huge impact on us because it hasn't worsened. And then, the other area where we do quite a bit of business upstream has been in Russia. The other area I noted was really in refining and just the slow growth in demand for transportation fuels has certainly not required the level of capital investment.

However, there is we have benefited from are really investments in projects to reduce the sulfur, for it to produce lower sulfur. And so those have really created additional opportunities in spite of the fact that there hasn't - the demand growth has been fairly weak in that sector..

Are you seeing are you seeing any - is there any reason to believe that these trends could worsen or is it too early to tell?.

I would say at this time it's too early to tell. We're just you know - we're just watching it. We are seeing mixed signals because we see some really positive signs in other areas of our end markets..

This concludes the question answer session. Now, I'll now turn the floor back over to Bruce Thames for closing remarks..

All right, thank you. And thank you all for joining on the call today. We do appreciate your interest in Thermon. Enjoy the rest of your day..

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..