Greetings and welcome to the Thermon Group Holdings Third Quarter 2021 Earnings 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.

I will now turn the conference over to our host, Kevin Fox, Vice President, Corporate Development. Thank you, you may begin..

Thank you, Diego. Good morning and thank you for joining today's fiscal 2021 third 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 may be required by law. With that, we will turn to the opening comments from Bruce Thames, our President and Chief Executive Officer..

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.

As we review the results of this quarter, it'll become evident that our efforts in each of these areas are yielding positive results in the business. In Q3, the cost reduction actions which included reductions in force, facility closures, consolidation of legal entities and the divestiture of the South African business have been largely completed.

These efforts will reduce SG&A expenses from FY 2020 by over $22 million in the current fiscal year, and approximately $23 million in Fiscal Year '22. In addition, our continuous improvement programs have yielded $3.8 million in projected savings within the fiscal year versus the target of $3.9 million outlined in our Q1 call.

This continuous improvement program is an integral part of our operational discipline and will serve to both preserve and expand gross margins going forward.

We believe that cost reductions implemented this year, 80% of which are structural, have fundamentally repositioned the business to be more profitable during the downturn and generate substantial operating leverage during the recovery.

It is important to note, that these cost reductions were made while preserving investments in key areas that will help drive future growth, such as frontline sales, resources to globalize the process and environmental heating, product lines and new product development. I would like to turn now to our Q3 results.

Overall, I'm very pleased with the strong operating performance and execution by our team. As we stated last quarter, we believe our first quarter represented a quarterly bottom in terms of both revenue and EBITDA. Our second quarter showed a sequential improvement in both of these metrics when adjusted for seasonality.

The third quarter continued this trend with revenues of $79.6 million, down 21% from prior year, but up 20% sequentially. Adjusted EBITDA of $18.5 million was down 11.2% from prior year, but up 77% from Q2 on higher volume and cost reduction actions.

Gross margins of 46.4% for the quarter expanded by 310 basis points from prior year and 285 basis points sequentially on a flat mix of MRO/UE versus Greenfield at 62% and 38%, respectively. We continue to benefit from the receipt of the Canadian Emergency Waste Subsidies which have been excluded from the adjusted numbers.

Adjusted EPS was $0.30 a share for the quarter and $0.02 over prior year on 21% lower volume. We're very pleased to be reporting growth in adjusted earnings, demonstrating the positive impact of continuous improvement and cost reduction efforts in the current environment.

Bookings for the quarter ended at $71 million which were down 28% from prior year, and 6% sequentially. For the first time in four quarters our book-to-bill of 89% was below 1. Backlog grew by 7% over prior year, but declined 7% sequentially.

These booking levels are consistent with our forecast of a weaker capital environment in the second half of this fiscal year. However, as anticipated, we did see a sequential 19% improvement in our Q3 quick turn business when adjusted for typical seasonality as we entered the winter heating season.

We continue to believe the deferral of maintenance is building pent up demand that will create incremental opportunities for MRO/UE as COVID-19 restrictions ease.

We expect capital spending to be weaker in the fourth quarter of this fiscal year and into fiscal year '22, particularly in the US and Latin America, representing a near-term headwind, that should be somewhat offset by increased maintenance spending at higher gross margins.

Just as a reminder, the gross profit impact of $1 of MRO/UE revenue is worth approximately $2 in Greenfield revenue due to the difference in the margin profile of these two revenue streams.

We continue to generate positive cash flows from our operation of $2.9 million during the third quarter, which enabled $5.6 million in debt repayment, leaving $49.6 million in cash on hand at the end of the quarter.

We see further opportunities to continue improving working capital, helping to steadily reduce our net debt to EBITDA over the next several quarters. Turning now to a discussion of our end markets. We're beginning to see some signs of improvement in our end markets that are cause for cautious optimism.

We have seen sequential improvements in maintenance activity that are above and beyond normal seasonality despite the lockdowns late in Q3. We've also seen a substantial uptick in quotation activity late in the year. Some of the areas that show the greatest promise are in chemicals and petrochemicals, power and natural gas opportunities.

Chemical and petrochemical companies have seen much less decline in demand and commodity pricing has been more resilient. As we look forward, Thermon has technologies that are well positioned to help enable the energy transition and decarbonization movement. Our solutions contribute to this transition in a number of ways.

First, the transition from steam to electric heating technology has been underway for decades, and Thermon's electric heating solutions reduce on-site emissions, while improving efficiency, control and safety.

We see this electrification and process facilities accelerating in the coming years, increasing demand for our heat tracing, process heating and environmental heating solutions, where steam is the best solution Thermon system's lower initial capital costs and improve overall operating efficiencies.

In some cases, gas fired blowers are being converted to electric to reduce on-site emissions and improve control. We also have several technologies that contribute to monitoring or reducing emissions of the process industries we serve.

Our tubing bundle solutions enable sampling from industrial processes to monitor and control the environmental emissions. A number of our solutions are employed in processes like sulfur recovery units, which require high temperature processing to reduce the sulfur content to create cleaner burning transportation fuels.

Many of these same technologies are used in production and processing of renewables, such as biodiesel and ethanol. Finally, we have a new patent pending technology being beta tested that converts fugitive natural gas emissions to CO2 and water, thereby reducing the greenhouse gas effect by over 20 times.

With Thermon's expanded portfolio of solutions that now include process and environmental heating, we see additional opportunities to grow our presence in less cyclical end markets where we have traditionally participated. Some of these markets include, food and beverage, commercial, transportation and materials processing.

The transportation sector only represented 3% of revenues in fiscal year 2020. But is a growing segment of our business, representing over 15% of our backlog at the end of Q3. We continue to see large transit opportunities that will expand the installed base in the US and Canada to generate stable recurring revenues going forward.

Turning now to our investments in research and development. We remain committed to investments in new product development that include connected and smart control solutions, advanced heating technologies and material science.

Innovations across these and other technologies are creating value for our customers by lowering maintenance and total installed costs, while improving efficiencies, reducing emissions and increasing safety.

The new Genesis Network which extends our leadership position in smart connected control solutions has been received very positively by our customers. We will be announcing additional new product launches in the coming quarters to build on this and other capabilities.

While the level of uncertainty in our current environment remains high with the current infection rates globally, we are reinstating formal guidance for the fourth quarter of fiscal 2021 to a projected $69 million to $76 million in revenue for the quarter.

We believe that Q3 represented the bottom in terms of trailing 12-month adjusted EBITDA and that Q4 will be in an inflection point due to lower cost structure and improve gross margin profile of the business. Going forward, we maintain a laser focus on driving operational improvements to positively impact the overall profitability of the business.

We are building plans to deliver an additional 200 basis points to 300 basis points in FY '22 EBITDA margins over fiscal year '21 and further expanding adjusted EBITDA margins to 22% or more in fiscal year '23 as the global economy emerges from the pandemic, and our end markets recover.

We also remain committed to our strategic initiatives and driving growth in the business going forward. We see four key opportunities for growth over the next several years.

They include, globalization of the process and environmental business, diversification of end markets, growth in developing economies and technology-enabled maintenance for our installed base. We'll share more about these opportunities and the associated investments in the next earnings call when we communicate our fiscal year '22 plan.

In conclusion, I believe this quarter is illustrative of the strength and resilience of our business model and our ability to drive profitability and generate cash through the cycle. We have a talented team that remains committed to serving our customers and creating a long-term value for our shareholders.

By focusing on our operational and strategic initiatives, Thermon is well positioned to emerge a stronger, more profitable business as our customers and end markets adapt to the next normal. I would like to pause here and hand it over to Jay and Kevin, for a more detailed review of the financials.

Jay?.

Bruce, thank you for the kind words. Good morning. Given the currently depressed capital spending in our end markets, our focus continues to be on valued preservation. And during the quarter, we recorded a $3.8 million restructuring charge on a pre-tax basis related to the Q3 cost out actions.

We expect these cost out actions, including the reduction in force in the first half of this year to reduce our SG&A to less than $79 million in the fiscal year. And we believe approximately 80% of these reductions are structural in nature, and will provide incremental operating leverage when growth returns.

Also during Q3, our Canadian subsidiaries qualified for and received a $1.7 million pre-tax benefit from the Canadian Wage Subsidy program. And $1.4 million of this benefit was recorded under cost of sales, while the remainder impacted SG&A. Moving on to revenue and orders. Our revenue this past quarter totaled $79.6 million.

That's down by 21% against the prior year quarter and in line with our expectations for the quarter, and revenues were up sequentially by 20%. The legacy revenue mix between MRO/UE and Greenfield was 62% and 38%, respectively and this is the same split as in fiscal year '20. And foreign exchange decreased total revenue by $200,000.

And in constant currency, our revenue declined by the same 21%. Orders for the quarter totaled $71 million and relative to the prior year quarter, our orders declined by 28%. Our trailing 12-month order rate currently sits at $298 million and that is down 22% versus the equivalent metric from the prior year.

Our backlog of orders ended December at $110 million, which is $8 million or 7% higher than at December 31st of 2019. And our book-to-build for the quarter was negative at 0.89 and this is the first quarterly decline in our book-to-bill in the last four quarters. Moving on to gross margins.

Margins were a robust 46.4%, up 310 basis points versus the prior year comparison period, and they were up sequentially by 285 basis points. Gross margins were positively impacted by both continuous improvement efforts and the recent cost out actions.

Margins were also positively impacted by 177 basis points by the Canadian Emergency Wage Subsidy program. Gross profit declined by $6.5 million and that's attributable to the volume and revenue decline of 21% and decremental margins were only 31%. Moving on to operating expenses.

OpEx for the quarter, that is, SG&A and this excludes depreciation and amortization of intangibles, totaled $21.8 million versus $23.9 million in the prior year period.

And SG&A expenses include $3.7 million of restructuring costs and normalized for the Canadian Wage Subsidy and the restructuring charge, our SG&A for the quarter, and this is on a pro forma basis, totaled $18.4 million. And as mentioned previously, we expect our fiscal year '21 SG&A to be less than $79 million.

That's inclusive of the recent spending actions. And going into next year, we would anticipate incremental spending in travel and other expenses to return, but to be offset by the full year impact of previously announced cost reductions.

And lastly, it is notable that our investment in research and development is 2x, what it was in fiscal year '15, demonstrating our commitment to our Genesis solutions, connected controls and polymer and other heating technologies. Lastly, EPS.

GAAP EPS for the quarter totaled $0.18 per share, compared to the prior year quarter of $0.20 and that's a decline of $0.02 per share.

Adjusted EPS, and this is defined as GAAP EPS, less amortization expense and any one-time charges, totaled $0.30 per share, relative to $0.28 a share in the prior year quarter or growth of 7%, and versus the prior year comparison period, adjusted EBITDA declined by 11% and adjusted EBITDA as a percent of revenue improved to 23%, and that's an increase of 250 basis points versus the prior year quarter.

And adjusted EBITDA margins grew 750 basis points sequentially and adjusted EBITDA totaled $18.5 million this past quarter and grew by 77% over the sequential quarter. The tax rate for the third quarter was 28.2% after accounting for the net impact of certain one-time tax items, and the going forward, our tax rate is expected to be approximately 27%.

And cash taxes for the year are expected to be approximately $6 million. Now I'd like to turn the call over to Kevin to discuss our balance sheet and capital allocation.

Kevin?.

Thank you, Jay. Our balance sheet remains strong, and we paid down $5.6 million in debt and generated $2.3 million in free cash flow, marking our 10th consecutive quarter of positive free cash flow. Our cash balance ended just under $50 million and our net debt to adjusted EBITDA ratio was 3.0 times at the end of the quarter.

Our revolver remains undrawn, and we have over $55 million in total capacity available. As a reminder, the net debt to adjusted EBITDA covenant on the revolver debt stepped down to 3.75 times as of December 31st. As we believe this quarter represents a trough of trailing 12-months EBITDA, we feel confident in our current position versus that metric.

Bruce and Jay both mentioned the South Africa disposition, and I wanted to briefly comment on that transaction. As part of our restructuring analysis, we determined Thermon's ownership was limiting the entities' potential and sold the operations in December to a local consortium led by the existing General Manager.

We signed a long-term distribution agreement for Thermon Solutions and believe this new structure will better allow that entity to serve its customers and provide incremental opportunity for future growth. We booked a restructuring charge of approximately $2.2 million which includes a currency translation adjustment of $0.8 million.

Quickly on CapEx, our spend for the third quarter totaled $0.6 million inclusive of both growth and maintenance capital. We now expect fiscal '21 CapEx to be approximately $6 million which includes $1.5 million for new equipment necessary to complete confirmed orders for upcoming turnarounds in Canada.

We are still on track to hit our core budget number of approximately $4.5 million. Our capital allocation priority is to continue to reduce our debt through optional debt repayments. 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 Q4.

Regarding M&A, we continue to evaluate options for future acquisitions and would expect inorganic growth to become a higher priority once we get closer to our target of 2.0 times leverage or less.

In closing, I would like to reiterate that we believe this quarter is representative of the resilience of our business model and our employees' ability to execute for customers and shareholders. Despite lower volumes, we delivered 23% adjusted EBITDA margins, year-over-year adjusted EPS growth and positive cash flow in the quarter.

However, I still see additional opportunities to focus on working capital and improve profitability over time. As Bruce noted, we'll have a more fulsome update on strategy and fiscal '22 guidance during our next call. Before we hand it over to the operator, I want to pause and recognize Jay for his contributions to Thermon over the last decade.

He's recruited a talented and global team, guided the business through multiple cycles and helped build the foundation for our future success. I'm personally thankful for his expertise, dedication and thoughtfulness during this transition period. Jay, all the best to you and Laura, and thank you very much.

And I'd like to turn the call over to Diego to moderate our Q&A..

Thank you. Ladies and gentlemen, at this time, we will conduct our question-and-answer session. [Operator Instructions] Thank you. Our first question comes from Brian Drab with William Blair. Please state your question..

Good morning. Thanks for taking my questions. And Jay, yeah, it's been good working with you. And we'll see if Kevin can match your sense of humor going forward, we're going to miss working with you..

Hey, thank you, Brian. It's been a treat. Thank you..

So back to business here. So you know, the gross margin, I'm wondering if you could give a little more color just to help model in the near-term.

Do you expect that the, and sorry, if I missed this, but that gross margin should be up sequentially in the fourth quarter or not? And then can you talk a little bit more about how it should trend from there? You know, especially I guess, given the cost cutting, you said that there should be some upside to gross margin as we get into fiscal '22? But any more specific color there would be helpful..

Yeah, Brian, this is Kevin. I don't think we're going to comment on gross margins going forward. But what I'd direct you and others back to is, if we think about this sequence of the margin evolution through the year, we certainly expected and even have delivered on that improvement.

If you think about the mix, that's always the biggest factor when we look at gross margins. But really, it's focused on the continuous improvement efforts, we targeted $3.9 million in savings, we've achieved, I believe $3.8 million of that, will be achieved in the current fiscal year.

And certainly with the cost reductions we've made structurally in certain regions, we do expect those gross margin improvements to be sustainable. The questions are going to be around the relative mix over time.

So overall, I think the execution leads us to believe we're in a good spot, but not going to be providing any comments on the specifics going forward..

Okay, excellent. All right.

You know what, one thing that I'm curious about, and this might you know not be the question you're expecting, but the tubing bundles business and, you know, if I'm just, you know, if I look back in my notes over the years with Thermon, this was, you know, 10% to 15% of revenue, you know, really benefiting from increased focus on pollution control, you know, these like the heat, right, the heating systems that are keeping the analyzers that are detecting you know pollution of the smokestacks, you know, keep - keeping those operational.

I'm wondering is that something, you know, a business that could perform better potentially under the new administration? And, you know, how sizeable is that and what kind of growth are you seeing in that business today and going forward?.

Yeah, Brian this is Bruce. Yeah, that's exactly what I was referencing in my comments around end markets, tubing bundles..

Okay -.

Are one of the solution sets that are relevant to, you know, that benefit from stricter environmental regulations. You know, that business, roughly $40 million, you know, kind of in a more of a normal year, but certainly opportunities to grow.

This year will be significantly off of that just due to a lot of the capital deferrals and some of the maintenance deferrals and things like that, but still a nice segment of our business with a very healthy margin profile..

Okay. And then just in terms of the large projects that are out there. I know some things are being pushed out.

But any really, you know, important projects on the horizon that you could talk about that you're bidding on or you know, might be coming up for bid that could, you know, help revenue materially?.

For us on the project, you know, as we look at our pipeline going forward, we have seen an increase in overall quote activity, I'll tell you, the type of projects, you know, would not be classified in, you know, as we might have said - we might have characterized in the past as mega projects, things of $10 million or greater.

We see the project - the types of projects we're quoting today are more, you know, $1 million to $5 million is more common. So I don't see any big mega projects in the next 12 months. But we are seeing some activity in quotations in kind of more of those smaller to midsized projects.

And so we do expect the capital environment to be challenged, particularly in the fourth quarter and into next year. But we do believe that we start - should start seeing some of those projects being lit. And as you know, we're fairly late cycle. So I would expect to see some backlog growth in the coming fiscal year.

And then see that converted to revenue, maybe late in the fourth quarter, but probably more likely in fiscal '23 and beyond..

Okay, thanks very much. I might have a couple more questions, but I'll get back in line. Thank you..

No problem. Thank you..

Thank you. [Operator Instructions] Thank you. Our next question comes from Brian Drab with William Blair. Please state your question..

Yeah, well I was polite and I guess I'm back. So -.

The floor is yours..

I'm gathering that. Hey, I'm just curious, you know, the CCI, you know, business has historically been, you know, pretty cyclical I guess and exposed to industrial trends and coming out of the pandemic.

I'm just wondering, you know, this is a material part of your business that I imagine is rebound, it has the potential to rebound quite nicely and have some benefit from operating leverage as well.

Is that fair? And can you just talk a little bit about, you know, what you're seeing specifically for CCI?.

Yeah. And absolutely, Brian, this business, I think a couple of things to note, it turns down more quickly. So it's earlier cycle. And so we saw that business actually began to slow really in Q3 of fiscal year '20 and then really obviously declined with the pandemic. But historically, what we see is that, it recovers more quickly.

It also gives us a better ability to provide a solution set to some of these other end markets that we've touched in the past, but we've never really focused on you know, and I would say, commercial, food and beverage, the transportation sector that I noted, there are several others that with this now, this complete solution set that, you know, those products, those environmental and process heating products really give us the ability to have more critical mass in some of these end markets and we see that as opportunities for growth going forward.

You know, as to your question around leverage, yeah, absolutely that is a very high margin business and with some of the cost out actions, it's really delivering very attractive overall gross margins and EBITDA margins for the business. And so we see that as being part of the operating leverage story going forward..

And, Brian, I would just add as we look forward to the future, we've talked about globalizing that business in the past, having those resources now sitting in the eastern hemisphere, having those dialogues with customers, the process heating conversations happened earlier than generally the electric heat tracing as well.

So as Bruce talked about that solution, that's an opportunity for us to have a different, more wholesome, but also an earlier dialogue with our customers. So it does give us insight into the heat tracing upcoming business as well. And we still see plenty of opportunity to globalize that business.

And as demand shifts to the eastern hemisphere, we feel like we're pretty well positioned to take advantage of that in the coming years..

Got it. Okay, all right. Well thanks very much for answering my question..

Thank you..

Thanks, Brian..

Our next question comes from Jon Braatz with Kansas City Capital. Please state your question..

Good morning, everyone and, Jay, I want to wish you the best of luck too in your retirement. It's been great working with you and nothing but the best..

Hey, Jon, thank you. I really enjoyed working with you over the last 10 plus years..

Well, thank you very much.

Bruce, when you look at your, let's say, your core customers, your legacy customers, legacy clients, when you chat with them about or when it's time to, when will it be time to unleash their - unleash your capital spending programs is, what's really - what might be the tipping point of those clients when they begin to spend again? Is there some type of macro factor that they're looking at that might call them to open up their wallets?.

Jon, I've tried to communicate this in the last couple of calls. And the reality is, when we look at our traditional end markets and end customers, you know, they're not all seeing the same types of, really, the impact of the pandemic, and certainly the energy downturn is not impacting them all the same.

So when we look at integrated oil companies, you know, I think what we've seen is just the stabilization in commodity pricing has certainly helped, but there's still a number of them that that are still, you know, running net operating losses.

And so I think some stability in the price of oil and some increase there, you know, I see, you know, high $50, $60 a barrel as being kind of an inflection point for spending.

Clearly, many of them are significantly reducing costs and overhead and are positioning themselves for a different environment going forward, I would suspect that will lower that overall price level going forward. At what point that will be, I'm not certain.

When we look at other end markets, you know, and the chemicals, petrochemicals, we actually see a very different situation. You know, with the pandemic, certainly the impact to demand has been less. But - and we see a really pretty healthy growth over the next 5 years to 10 years in many of those end markets.

We've also seen really - resin prices being really more buoyant. And we believe that that will translate into more spending when we see some of the case counts come down a little more stabilization and just the global infection rates associated with COVID-19. So I think that's another example of the end markets' power.

Power markets, we expect to have strong growth over the next 20 years, we've actually benefited from quite a lot of that power transition from coal to natural gas. We're going to benefit less from the move to renewables, but the reality is, is natural gas as a bridge fuel, a lot of power plants are going to be built in Asia and other geographies.

And so we think that's actually a pretty positive momentum even now and going forward. You know, some of that demand growth is industrial. So certainly as industry recovers, that's going to drive more need for increased power supply and should - we should see these capital projects move ahead. But those are kind of our three key end markets..

Okay. Thank you.

Kevin, do you or Jay, do you expect the Canadian - Wage Subsidy to continue into 2022?.

Jon, fiscal '22 or calendar '22?.

Fiscal 2022..

We'd have to double check. But when we go through our planning with items like that, we generally don't consider that something like ongoing obviously, it's a government program. And you know, I think we all hope it will have an end date, I can get back to you on when exactly it's supposed to.

But we certainly don't count on those types of programs that continue. As a reminder, we adjust them out of the results as well..

Yeah, yeah.

Do you expect it - do you expect some benefit in the fourth quarter here?.

I believe we do expect some results in the fourth quarter. But I don't want to quantify that, we can probably look at past four quarters is prevalent for what it might look like though..

Okay. And then one final question, Kevin, your stock compensation expense was materially less than that what it has been.

Is - it will remain at that level or something unusual in this quarter?.

There was a one-timer related to some prior year PSUs that were adjusted out. So I think there's a special event in the quarter, the quantum of that, I can get back to you on but that was the driver for the difference between prior quarters..

Okay, all right. Thank you very much..

Hey, Jon, if memory serves, it was in the 600k range or so..

Okay..

Certain prior grants that will not be in the money, if you will..

Okay, all right. Thank you, Jay..

Thank you, Jon. Appreciate it..

Thank you. There are no further questions at this time. I'll turn it back to management for closing remarks..

Thank you, Diego. I'd like to thank everyone today for joining our call. Thank you for your interest in Thermon and enjoy the rest of your day..

Thank you. This concludes today's conference. All parties may disconnect. Have a great day..