Greetings, and welcome to the Thermon Group Holdings, Inc. Second Quarter Fiscal 2021 Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Mr. Kevin Fox, Vice President, Corporate Development. Thank you sir. Please go ahead..

Thank you, Diana. Good morning, and thank you for joining today's fiscal 2021 second quarter conference call. Earlier, this morning we issued an earnings press release, which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our website.

During the call, we will 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. I'd like to remind you that during this call we may make certain forward-looking statements regarding our company.

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 and we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as maybe required by law.

And now I'll ask Bruce Thames, our President and Chief Executive Officer for his opening comments..

first, the safety of our employees and customers; second, aligning cost structure to the level of incoming business; third, driving continuous improvement programs to achieve the targeted $3.9 million in savings during the fiscal year; fourth, cash management; and fifth, investing for future growth.

Executing on these 5 priorities will position the business to perform during this downturn and more importantly profitably grow as our end markets recover. Looking forward, given the current level of uncertainty, we do not intend to provide formal guidance for fiscal 2021 at this time.

We do believe that Q1 represented the quarterly bottom in terms of revenue and earnings due to COVID-19 restrictions that were in place, combined with the normal seasonality of our business. With Q2 revenues down 35% from prior year and bookings down 18%, we expect the revenue shortfall to prior year to begin to moderate in Q3 and Q4.

We also expect the cost reductions to begin to have a meaningful impact to bottom line performance in the back half of the year with decremental margins in the 25% to 30% range. As a result, we anticipate a small stepdown in trailing 12-month EBITDA in Q3, representing a bottom with trailing 12-month EBITDA expansion in Q4 on lower volume.

The actions we have taken this year have positioned the business to deliver a 100 basis points or more of EBITDA margin expansion during a downturn, and the team is hard at work to build a path to deliver similar or greater margin expansion in the subsequent year.

We continue to actively manage the business while remaining focused on executing on our strategic, operational and financial plans. As we look ahead, I want to emphasize the strength and resilience of our business model and our ability to drive EBITDA and generate cash through the cycle.

We have a talented team that remains committed to serving our customers and creating value for our shareholders. By focusing on the priorities outlined, Thermon is well positioned to emerge a stronger, more profitable business as our customers and end markets adapt to the next normal.

With that, I'd like to pause here and hand it over to Jay for a more detailed review of the financials.

Jay?.

Thank you, Bruce. Good morning. In light of the protracted, depressed capital spend environment, our focus continues to be on value preservation in addition to funding specific strategic investments. During the quarter, we recorded $2 million of restructuring cost related to the Q2 cost.

And we expect these cost-out actions, including the Q1 reduction in force, to reduce SG&A to approximately $34 to $35 million for the second half of this fiscal year. And we believe approximately 80% of these reductions are structural in nature and will provide incremental operating leverage when growth returns.

And since May of this year, we have reduced our SG&A by approximately 24% from $100 million down to $76 to $77 million.

Also during Q2, our Canadian subsidiaries qualified for and received a $1.4 million benefit from the Canadian Emergency Wage Subsidy program, and $400,000 of this benefit was recorded under cost of sales while the remainder impacted SG&A.

While we have faced significant challenges in our P&L related to COVID-19 and the sustained decline in oil prices, our balance sheet remains strong. And our cash and investments balance at the end of September improved by $51.4 million.

And we also paid down $4.4 million in debt and generated $7.2 million in free cash flow, and that marks our ninth consecutive quarter of positive free cash flow. Our CapEx spend for the second quarter totaled $2 million, net inclusive of both growth and maintenance capital.

And we expect fiscal '21 CapEx to be approximately $4.6 million, and that's a year-on-year reduction of 54%. Our net debt EBITDA ratio was 2.9x at the end of Q2.

And lastly, our capital allocation priority is to continue to reduce our debt through continued optional debt repayment, and we remain confident in our current liquidity and ability to generate cash during this fiscal year. And we plan to pay down additional debt in the second half of this year. And regarding M&A, our pipeline remains strong.

However, due to our current leverage position, we do not anticipate any acquisitions in the near term. Now turning to revenue and orders. Our revenue this past quarter totaled $66.4 million, and that's up sequentially by 17% and down by 35% against the prior year quarter and was in line with our expectations for Q2.

Our legacy revenue mix between MRO/UE and greenfield was 64% and 36%, respectively, versus 53% and 47% in Q2 of fiscal year '20, and FX decreased total revenue by $1.1 million in the quarter. And in constant currency, our revenue declined by 34%. Orders for the quarter totaled $75.7 million, up sequentially by 25%.

And relative to the prior year quarter, our orders declined by 18%, and that's an improvement from the Q1 decrease of 27%. And our backlog of orders ended September at $118.7 million, and that's the highest level in the last 18 months albeit under depressed revenues and due to cost-out actions and higher margin projects.

We have seen our backlog margins improve to 33.4%, and that's a 420 basis point improvement on a sequential basis. Our book to bill for the quarter was positive at 1.14, and that marks the third consecutive quarter of a positive book to bill. In terms of gross margins, margins were 43.6%.

And although they were down by 57 basis points versus the prior year comp period, they were up sequentially by 114 basis points, and gross margins were positively impacted by 63 bps due to the Canadian Emergency Wage Subsidy program.

Gross profit in the quarter declined by $16.5 million, and that's attributable to the volume and revenue decline of 35%.

And looking forward to the second half of this fiscal year, we expect gross margins to improve by 100 basis points or more due to the benefits of cost reductions even in light of the anticipated reduction in year-on-year volumes and an increase in the mix of our high margin on both a gross and net construct maintenance business. Moving on to OpEx.

Operating expenses for the quarter, that is SG&A and this excludes depreciation and amortization of intangibles, totaled $21 million versus $25.4 million in the prior year. And SG&A expenses included $2 million of restructuring cost.

Normalized for the Canadian Wage Subsidy program and the restructuring charge, our SG&A on a pro forma basis totaled $19.9 million. And as mentioned earlier, we expect our second half SG&A to be in the $34 to $35 million range, inclusive of the recent spending reduction actions.

And going forward, we would anticipate incremental spending in travel and other expenses to grow as volume returns. GAAP EPS for the quarter totaled $0.06 a share compared to the prior year quarter of $0.21, and that's a decline of $0.15 a share.

Adjusted EPS, as defined by GAAP less amortization expenses and any onetime charges, totaled $0.12 a share relative to $0.29 a share in the prior year quarter.

And versus the prior year comparison period, adjusted EBITDA declined by 50% and adjusted EBITDA as a percent of revenue improved to 16%, and that's an increase of 1,300 basis points versus the prior sequential quarter. And adjusted EBITDA totaled $10.5 million this past quarter.

Free cash flow was positive for the quarter by $7.2 million and, as I said before, our ninth consecutive quarter of positive free cash flow, and we remain confident in our ability to generate cash and service debt going forward.

For Q2 of 2021, we generated pretax income of $1.2 million and recorded a tax benefit of $627,000, and this benefit was due to U.S. Treasury regulations that provided updated guidance to the tax reform law of 2017 and the associated GILTI tax rules. And as a result, we reversed $1.4 million previously recorded GILTI tax.

And for the remainder of fiscal year '21 and the outyears, we expect our tax rate to be 26% on a consolidated basis. In the quarter, cash grew by $3.1 million to $51.4 million, and we generated $9.2 million from working capital. And over the last 12 months, we have paid down $30.3 million in debt.

And finally, given the continued impact of COVID-19 to our end markets, we will not be providing formal top line guidance at this time.

And I would like to reiterate that we will continue to manage what we have control over, including our operating expenses, cost reduction efforts, continuous improvement initiatives and the continued management of our working capital. I would now like to turn the call back over to Donna to moderate our Q&A session.

Donna?.

[Operator Instructions]. Our first question is from Scott Graham of Rosenblatt Securities..

Very well done, very good execution..

Thank you..

I do have a couple of more 40,000-foot questions and then maybe a couple of 5,000-footers. As you look at the market right now and I'm certainly speaking largely oil and gas, and frankly even maybe even more specifically greenfield, it does look like Brent is sort of landlocked at this $40 level.

What are your customers saying that, that means for their greenfield or capital spending, where it bottoms? In other words, right, so if it's down this year in the calendar year, but will it be down again next year because of that level?.

Yes. Scott, this is Bruce. I'll tell you there is still a lot of uncertainty on capital spending with our customers. But as I mentioned in my script, what we're seeing is there are a number of customers that are much more impacted than others.

And I think it's important to reinforce that if we look at the last downturn in the oil and gas sector, where Thermon prior to that downturn in 2014, 2015, Thermon really benefited from the investments in the oil sands.

Since that time -- and at that time, upstream was a much larger percentage, probably 2.5x the percentage of our business that it is today. Today, we've repositioned the business much more -- we're much more exposed to gas.

We're a lot more exposed to chemicals and petrochemicals and we were able to drive growth kind of in following that last downturn in those areas. It really wasn't in upstream spending. So I suspect the price of oil will continue to have a pretty significant impact on upstream operators as well as integrated oil companies.

But as I mentioned, there are others pure chemical plays that chemical companies, they are less impacted, in fact, some of the -- in certain areas because of some other supply disruptions we saw in the Gulf Coast, particularly with the hurricanes that have hit Louisiana, we've actually seen prices spike.

So in some of those areas, we expect them to be healthier, have better cash flows and capital investments to move ahead. So I guess that would be how I could characterize it. I don't really think I could necessarily quantify it..

That's fine. I think we're all grouping for that answer. If we were to look at your backlog right now, obviously, it's -- the number of looks good.

But would you be able to quantify how much of the backlog, let's say, 6 months ago was expected to be shipped and it was not? Like how much of your backlog increase was not necessarily planned, right, so pushing out of shipments versus what do you expected?.

Yes. Scott, a rather minor amount, okay, less than $5 million. And recall, we are very late cycle with our projects where the last oftentimes 1% or 2% or 3% of the activities needed to do the full commissioning. So a rather, rather minor amount and we have not seen a significant protraction in the execution of our backlog at this point in time..

Okay. So let me just connect those two dots, the question that Bruce answered and the question you just answered, Jay. Thank you. To this end, in the past, you guys have in greenfield been about 2 to 3 quarters, behind general purpose capital spending in oil and gas, again, on the greenfield side.

And do you guys see anything different this cycle again notwithstanding when capital spending improves? But has that extended? Do you think that you will still be in that 2 to 3 quarter lag when CapEx bottoms?.

Scott, this is Bruce again. I expect it to be similar. During the last downturn, we did see timelines move out. Normally, our backlog we execute in 12 months. Some of that could -- we saw that extend to as much as 18.

As we look forward, I still expect us to lag by, I would say, 2 to 4 quarters the CapEx recovery just because of where we are in the cycle. I do, however, want to point to the fundamental difference in our business.

When you look at the environmental and process heating products, which is about 25% of our revenues, those are about -- those are much earlier in the recovery. So we saw those turn down more quickly, and we expect those to rebound sooner. So that's an important shift to consider when you're kind of looking at the business on a go-forward basis..

Yes. Last question, and this is maybe for Jay. Jay, could you kind of give us the specific this quarter cost reductions? I think the numbers you gave for annualized, correct me if I'm wrong, right, for -- within SG&A and within cost of goods sold, what the specific benefits were this quarter.

Do you have that?.

Yes. For SG&A, we exited last year for SG&A approximately $100 million, slightly over $100 million. And in Q2, we discussed that the reduction would go down to $88 million, and we are now viewing somewhere between $76 million and $77 million for the year.

So Q1 was $12 million and then add another $1 million-ish, maybe 2 million for this current quarter. In Q2, we've gone from $25 million to a pro forma basis of $19.9 million ex the Canadian Wage Subsidy and the restructuring charge..

So that would be the operative number in the second quarter, right, Jay, that 6 million?.

Yes..

And then on the cost of sales side?.

We have -- let me give you this fiscal year because a lot of these still need to blend in. We've identified $1.8 million worth of overhead-related cost reductions. On a future basis a 12 month basis, we believe that will be $3.8 million. So $3.8 million over the next 12 months, of which $1.8 million will be realized.

And then Bruce talked about the strategic sourcing and the cost reduction initiatives, and that will be over and on top of the overhead cost reductions I just mentioned..

Our next question is coming from Joe Aiken of William Blair..

This is Joe on for Brian. So I guess I'll start. I'm curious if you could just talk in a little more detail about any large project activity you're seeing right now. You mentioned a couple of projects you're working on.

Are there still some large projects being bid on in those markets or anything to highlight?.

There is certainly a fewer number of capital projects out there. I mean we expected that coming into this year, and that's certainly been reflecting in our -- reflected in our incoming order rates. The larger projects that we see today tend to be in the Eastern Hemisphere. We see particularly weakness in the near term in the larger projects in the U.S.

and Latin America and, to a lesser extent, in Canada. But -- so right now, the overall capital spending without question is down in the 25% to 30% range from what we had seen a year ago..

Okay. And can you just clarify for me kind of the order trends, how that trended through the quarter? I think in the first quarter call, you said it was down 33% in July.

And did you say that ended up being down 18% for the full quarter? Is that right?.

Yes, that's correct. So we saw improvement in the incoming order rate during the quarter sequentially. I think the really important thing to anchor on as we saw, we've been seeing improvement in our quick turn business, which is really the -- our MRO.

It's a proxy for our MRO business, and it's the most profitable piece of our revenue on the installed base. So we are seeing some sequential improvements there, and that's certainly promising although they are still well below prior year levels..

Okay.

And did you say what your incoming order rates on October order?.

I have not mentioned it. I did say we expected to see some sequential improvements in our quick turn business, and that we have seen. But as I mentioned also during the script, we do expect headwinds in the capital projects in the back half of this year, particularly in the U.S. and Latin America..

Okay. So just to stick on that for a second.

So sequential improvement, will that be compared with the full quarter incoming rate of down 18% sequential improvement from that?.

You have to understand that's both maintenance, and capital, so that would not be a good way to look at it. It's -- I see a sequential improvement on our maintenance incoming order rates, and I see weakness in the capital..

Okay. And then just turning to margins, I think you said you would expect gross margin to improve 100 basis points or more in the second half of the year.

Is that on a year-over-year basis? And would you expect -- given there is some moving pieces there with the cost reductions in the overhead reduction, would you expect to see more expansion in the fourth quarter compared to the third quarter?.

Yes, that 100 bp improvement or more was on an annual basis..

Okay. Okay and okay.

And would you expect more of that to come in the fourth quarter compared to third?.

Yes. Yes, because some of these cost-out actions have to -- they take a little time. So -- and depending on how costs are rolled and such in manufacturing absorption, that doesn't all happen immediately..

Our next question is coming from Jon Braatz of Kansas City Capital..

Bruce, could you talk a little bit more about some of the alternative energy projects, biodiesel, biogas? I'm curious what type of content – heat-tracing content is on a project like that? How does that compare to a petrochemical plant or a refinery or what have you?.

It certainly -- Jon, it certainly depends on the size of the processing facility, that certainly has great influence. But for example, I think it's important to note, historically, refineries have been heavily weighted towards steam. When you move towards things like biodiesel, they are almost exclusively electric.

So that's a big shift or a transition from steam to electric that we see. And maybe for those of you, an update, it's around 48% steam, 52% electric when we look at the markets globally. A big part of that's been in refining.

So as we look at, let's say, a biodiesel plant that I had mentioned, those may range from -- depending on the size and the scope of work, from $0.5 million to $2 million in total heat tracing content, and that's almost exclusively electric heat tracing.

There are additional opportunities in the process of heating and temporary power, which are not included in the numbers I just shared..

Okay, okay. Any other alternative energy types of projects? A lot -- there's been a lot of talk about hydrogen, and I don't know if heat tracing's required for hydrogen.

But anything beyond biodiesel, biogas?.

There are other opportunities. The one that really is real today is concentrated solar power. Those are pretty significant when it comes to heat-tracing opportunities, and we've done a number of those projects around the globe. We don't play much in the photovoltaic solar today. Limited opportunities in wind. But those are at least a couple of examples.

Hydrogen, it's a little early there. And certainly, that would be an area that we would continue to explore as that becomes a greater part of the overall energy mix. We think that's probably beyond the 5 to 10-year mark..

Sure, sure.

Would you say concentrated solar power, do you mean utility-sized projects?.

Absolutely..

Okay, okay. All right. Okay, that sounds good. And Jay, one sort of forward -- really forward-looking question. You've obviously taken a lot of costs out of the business.

And when the revenues return, should they return to prior levels and so on? What do you think -- how do you think your margins could be relative to where they were in the past? They were up by -- up towards 20%-something like that.

But given a return to "more normalized revenues" and then given the costs you've taken out, are we beyond that 20% in a better environment?.

We are, we are. Recall back 4 or 5 years ago, when a lot of the upgraders in Canada were happening, and by the way, we are not planning for that to reoccur. We had EBITDA oftentimes at the 25% range going forward. We think it will be somewhere in the 22% to 25% range once we see upticks in volume..

EBITDA margins?.

Correct..

Our final question today is coming from Andreas Nicholas [ph] of Evercore ISI..

So definitely understand where you're coming from on not providing new guidance for the remainder of fiscal year. There's just a lot of uncertainty out there and the recent resurgence of COVID in Europe, for example, is just one of many reasons that would give people pause. I guess this is more just a qualitative question for you.

But as leadership of companies operating globally in the industrial and energy markets, what kind of things would you need to see take place in your markets or what you're seeing in your data order for you to feel confidence in providing and reinstating that near-term forward outlook?.

Yes. I mean we are looking towards that in the coming quarters. Certainly, I mean, just one quarter later, our visibility is improving. But as you noted, there is still some uncertainty around some of the resurgence and things like that and how that may impact a whole host of things.

But we would like to see just the rates under control and see a little more consistency in some of the demand environment that we are seeing with our end customers. And so I think COVID is -- and really getting that at least to manageable levels will be important for us to have better visibility for -- to provide forward guidance..

Okay. I hear you on that.

If we move on to, let's say, some of the inroads that you've made in the digital area and some of your new products, how do you think about ensuring that you're able to capture some of that value that's being provided to the customer, whether in terms of greater efficiencies for them or savings? Or is that just increasingly viewed as table stakes in your sector these days? Just curious kind of how you can capture some of those?.

I mean some of these technologies are available in other areas in the industry. But within our space, we're really out in front here. It's really -- we're seeing a significant amount of demand from our customers for these types of solutions, and we really have seen since COVID-19 it's accelerated the need for these types of technologies.

As we look forward, we said this is our first subscription-based software. It's an operational software that our customers can use as -- to manage their asset base.

It also sets up the opportunity to drive additional revenues on services on the installed base, whether that be online and virtual type of services around a predictive maintenance and troubleshooting, things like that, to even on stream, online and on-premise type of maintenance opportunities and really driving MRO sales.

So I believe this is well beyond just a kind of a me-too and also needed. We're out in front here, and we see some really significant opportunities to drive additional revenues on the installed base. And there are real true value propositions when you look at the impact that can have on our customers and how they manage their assets..

At this time, I'd like to turn the floor back over to management for closing comments..

All right. Thank you, Donna. I would like to thank you all again for joining us today and appreciate your interest in Thermon, and enjoy the rest of your day. Thank you..

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and have a wonderful day..