Thermon Group Holdings Inc (THR) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Thermon Group Holdings, Inc. second-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Sara Alexander, Director of Investor Relations.

Thank you, Javon. Good morning and thank you for joining us for today's earnings conference call. We issued an earnings press release this morning, which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our website at www.Thermon.com. A replay of today's call will be available on our website beginning two hours after the conclusion of this call. This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of the Company is strictly prohibited.

During this call, our comments may include forward-looking statements. These forward-looking statements are subject to risks and uncertainties and our actual results may differ materially from the views expressed today. Some of these risks have been set forth in the press release and in our Annual Report on Form 10-K filed with the SEC on June 20, 2011.

We also would like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements may include, among others, our outlook for future performance and revenue growth, leverage ratios, acquisitions 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, including adjusted EPS and adjusted EBITDA. We have reconciled those items to the most comparable GAAP measures in the earnings release. Adjusted EPS and adjusted EBITDA should be considered in addition to and not as substitutes for income from operations, net income or loss, net income or loss per share and other measures of financial performance reported in accordance with GAAP. And now it is my pleasure to turn the call over to Rodney Bingham, our President and Chief Executive Officer.

Thank you, Sarah. Good morning, everyone and thank you for your continued interest in Thermon. Today, we have two of our executive team leaders joining us on this call. Jay Peterson, our CFO, will follow me and present the financial details of FY 2012's second quarter. George Alexander, our Executive Vice President of Global Sales, will assist in the Q&A session by answering questions that pertain to global markets and industry trends.

For those of you who are not familiar with Thermon, we are a leading global provider of thermal solutions. We serve the oil, gas, chemical and power generation industries. Our heat tracing systems provide freeze protection and temperature control for piping, vessels and instrumentation. These mission-critical systems ensure the continuous and safe operation of industrial facilities.

In a little bit, Jay will cover the financial details, but I would like to give you a high-level perspective of some of our achievements for this quarter. Basically we had a strong quarter. We grew revenue over Q1 and prior-year Q2. We grew our backlog, we received a record level of new purchase orders. We achieved record EPS levels and we voluntarily reduced our long-term debt by another $24.6 million. Needless to say, these financial results support our belief that it is a good time to be in the heat tracing business.

We also believe there is upside to our previous revenue forecast of modest single-digit growth for 2012. At this time, we feel that our revenues could approach double-digit growth over prior-year 2011. We see the potential for some downward pressure on our gross margin percentages during the second half of this year as compared to the first half. This is due to product mix and timing on several large greenfield projects.

This lumpiness occurs or generally occurs when we have -- when we ship and invoice a significant amount of materials that we do not manufacture. We do this as an integrating service for our clients on these large projects. Margins on these buyout items are historically at lower levels than our own manufactured goods.

As the organic growth potential continues to be robust, we will continue to invest in our infrastructure that has made our business model so successful over the past several years. Assets are being added to reinforce our global footprint in key growth areas. Our planned expansion in San Marcos, Texas is on schedule to be completed and operational by the end of this fiscal year. Several new products and software upgrades will be launched in the near future. With that, I would like to again thank all of you for joining us on this call and I look forward to the Q&A session and now Jay Peterson will present our financials.

Thank you, Rodney. Good morning. Thermon had a very solid quarter in fiscal Q2 and we, again, set several financial records, including orders, revenues and earnings. In the following discussion, we will focus on the results of our core business and exclude those expenses relating to the bond redemptions that occurred earlier this year.

Let's start with revenue. Our revenue this past quarter grew to $68 million and that is a new record for Thermon and it is an increase of 7% over the prior-year quarter's level of $63.5 million. And at the halfpoint of our fiscal year, our revenues totaled $133 million and they are up 16% over the prior-year period.

The quarter was also a record for new orders, $73 million, eclipsing our previous record of $70 million. And note that our orders have grown 12% year-on-year. Our backlog of orders ended September at $87 million versus $85 million at the end of Q2 fiscal year '11, an increase of 2%. And also our backlog increased by $5 million, up from $82 million, from the end of June to the end of the September period.

Gross margins, margin's dollars grew this past quarter by 15% to $32 million and that is up from last year's level of $28 million and an increase of over $4 million. And on a relative basis, our margins last quarter were 47% versus 44% one year ago. And this increase, this relative increase was primarily due to product mix with a higher percent of our maintenance type revenues, MRO.

In terms of operating expenses, our core OpEx for the quarter, SG&A and this excludes depreciation and amortization of intangibles and also bond redemption expenses totaled $14.2 million versus $13 million in the prior-year period. And please refer to our press release for an analysis of those expenses relating to the redemption of our bonds. And due to the three recent redemptions in our bonds, our quarterly interest payments have been reduced from $5 million a quarter to less than $3.5 million a quarter and this equates to a quarterly increase in our EPS by $0.05 a share.

And I want to point out that our EPS is negatively impacted by $0.05 a quarter due to the non-cash amortization expense due to the acquisition of our company by CHS last calendar year. The number of our full-time employees at the end of September was 703 and this is up from the 630 as of calendar September 2010. And it is important to note that 70% of those additions were in production and engineering and relate to managing our growing backlog and growing top-line revenues.

Earnings on a GAAP net income basis, we set a new record this quarter with income of $3.8 million compared to prior year of a loss of $1.8 million. GAAP EPS increased to $0.12 a share versus a negative $0.07 in the prior-year period and adjusted EPS came in at $0.19 a share versus $0.02 one year ago. And again, these adjustments are expenses relating to the paydown of our debt and in the case for fiscal year '11, certain transaction-related expenses. Our earnings per share was negatively impacted by $0.01 a share from the combined effects of foreign exchange when considering both translation and transaction impacts.

In terms of balance sheet and cash flow, our cash balance at the end of September was at $13 million compared to $16 million in the prior-year period and this cash decrease was due to the optional redemptions of our long-term debt.

Our DSO improved to 62 days versus 77 days one year ago and our days in inventory at the end of September increased to 89 days and that compares to 70 days from the period one year ago and this growth in our inventory was planned and is due to the fact that we will be transitioning to a new production facility in the near future.

And lastly, in aggregate, our cash conversion cycle increased to 104 days versus 96 days and we believe that number will be exposed downward once we transition to our new facility.

From a debt perspective, at the end of September, our long-term debt has been reduced down to $143 million and you will recall that a year ago that number was $210 million. And note that all of the $67 million in debt reduction was due to optional redemptions enabled by our strong cash flows and IPO proceeds.

In addition, we purchased an additional $4 million in the open market last month and anticipate further optional redemptions in our debt in the coming months. In May of 2010, our debt leverage was approximately 4.2 and today it is approximately 2.

Our business continues to generate impressive returns on investment capital. For example, this past quarter, our maintenance CapEx amounted to well less than $0.5 million, or less than 1% of revenues. And this excludes the investment we are making in our new manufacturing facility.

In summary, we are performing at record levels, including order activity, top-line revenue, net income and EPS and all of these achievements were accomplished within the backdrop of an uncertain macroenvironment. We are prudently managing both our expenses and capital investments and we are reducing our debt leverage.

Looking into the future, we remain cautiously optimistic about our Company due to our current order activity and healthy backlog. And we have mentioned in the past the impact of mix on our gross margins. One caveat, due to product mix, we believe that our margins in the second half of the year have downward exposure relative to the margins we had experienced in the first half of the year. We plan to next announce our results for Q3 fiscal year '12 via a conference call and press release in February of next year. I would now like to turn the call back over to Jovan to moderate our Q&A session.

(Operator Instructions). Jeff Hammond, KeyBanc Capital Markets.

Hi, good morning, guys. Can you just give us the MRO versus OE mix this quarter and how you think it trends into the second half as you think of the lower gross margins?

Yes, for the quarter, we had 64% MRO, 36% greenfield and we believe that could move possibly a couple of points or so. It is very difficult to discern the actual movement at this point in time. However, our backlog does indicate we have got some large projects coming forward that will reduce our margins and increase the greenfield percentage.

Okay. And then you mentioned along with the capacity expansion new product introductions and software upgrades. Can you just run through, maybe in order of importance, what you think moves the needle the most, what you are most excited about on the new product front?

On the products we talked about, it is a combination of several products that make up a control system that monitors the status of the heat trace piping and the heat tracing system itself. It follows along a product upgrade of a product we currently have that brings several things updated and state-of-the-art from our current model and we look forward to bringing that out in the very near future.

In terms of the software upgrades, our main computer software for heat tracing design, that engine is being upgraded again to a state-of-the-art program and we will be releasing that again in the very near future.

Okay, thanks. I will get back in queue.

James West, Barclays Capital.

Hey, good morning, guys. Jay, just a quick question, first, on the margin side. I know you and Rodney both mentioned some margin degradation as we go through the year. I just want to make sure this isn't something that we should see that is out of the ordinary. I mean just getting -- are you talking about getting back to maybe that mid-40% gross margin level or is it going to be worse than that? Is there something that is going to drive that and make it look more negative?

Yes, recall, James, we have talked about our timeless business model in the past where our gross margins will be 45% and the operating expense, excluding D&A to drive those gross, would be 20%. And then on an EBITDA basis, we would be at 25%. I'm not exactly certain how this quarter will shake out. However, we believe it will be closer to these timeless numbers that we have talked about in the past.

Said a little differently, we had a very, very strong first half due to strong MRO mix and we now see some very large projects coming into the backlog that will turn into revenue in the coming months.

Okay, fair enough. And then maybe a bigger picture question for Rodney and maybe George as well. We have seen a lot of news flow here recently about the Arctic, a lot of exploration ongoing in the Arctic, a lot of CapEx being put towards development of the Arctic. It seems like that is an area of the world that would be perfect for your equipment. So maybe if you guys wouldn't mind just kind of letting us know how you are thinking about that area of the world and what you are doing to position yourself for that expansion if it occurs?

Thanks. This is George Alexander. Yes, that is heat tracing paradise in terms of the environment in the Arctic exploration areas, both offshore and onshore. So we are continuing to invest both in terms of our infrastructure as it relates to the resources necessary to pursue this business and to position Thermon to be able to aggressively go after it.

As you can imagine, when you are talking about installations in very remote areas, very harsh environments, it does create some demands that we haven't seen previously. But I think we are well on our way as far as product development, as far as the infrastructure necessary to go after this business with our key customer base. So it is very definitely on our radar screen. We are already active in it and we are excited about the possibilities.

And do you have products already that could participate in the Arctic now or is there a lengthy kind of R&D process that you might have to go through?

There is a little bit of both, but, yes, our current products are ideally suited for the applications in the Arctic environment. And we also do have some R&D activity in some related areas that will help our total integrated solution.

Okay, got it. All right, thanks, guys.

Brian Drab, William Blair.

Good morning. So with revenue up 16% year-to-date, you said you are now expecting to approach double-digit revenue growth, so you are suggesting or implying a stepdown from the second-quarter level in the back half of the year. I understand the mix is driving the reduction in the margins, but what is driving the modest pullback in revenue in terms of absolute revenue in the back half of the year?

This is George Alexander. We are expecting the second half of the year to continue to produce revenues at our previously forecasted level, but what we didn't forecast was the strength of the first half of the year. And so therefore that is where the approximate double-digit growth is coming from. We are not expecting -- we don't see any significant weaknesses in the second half of the year as far as revenue production or revenue generation. We think that it will be very near our targeted levels.

Okay, great. And then you put in the press release 27% growth in orders in the Eastern Hemisphere. Can you focus that a little bit for us in maybe specific projects or specific regions that are really driving that strong order growth?

Well, we are going to be a little bit careful about the information that we provide as it relates to specifics, but what we can say is that we have seen significant order activity that is associated with the emerging markets in the Eastern Hemisphere and this is according to our plan. That is where we have projected our growth to be. So the fact that it is growing is not something that is a surprise to us and we are very pleased to see that our participation in the emerging markets is according to plan.

Would that be -- could I just ask if it is within the Arctic Circle in the Eastern Hemisphere or is it more other regions?

It is in all geographies, but, yes, the Arctic environment is part of the participation, but not -- at this stage, not a dominant player. It is pretty much across the board in all of the emerging markets.

Okay, great. And then, if I could, just one more, on the commercial market opportunity, can you give us an update in terms of maybe how many customers you are serving there or beginning to partner with there and if you are shipping product now and what that opportunity looks like today.

Again, I am going to be a little careful about the specifics there, but, yes, we are shipping product today and in that area and we are confident about the opportunity for continuing to grow in that adjacent market. And I guess that is probably about all I need to say on that, but it is positive and we are shipping product and we are looking forward to continuing to grow our business there.

Okay, thanks, George. Thanks, guys and congrats on a good quarter.

Charley Brady, BMO Capital Markets.

Thanks, good morning, guys. Can you give any kind of granularity on the share repurchase you were talking -- bond repurchase rather into the open market you were talking about in coming months? And then a second question would be maybe some -- an update on kind of how the M&A outlook looks for you guys or prospects for that.

Yes, Charley, this is Jay. First off, in I believe it is the end of April or first part of May, we have the ability per our bond agreement to repurchase $21 million of our debt at 103 and that impact in and of itself will have a $0.06 a share in terms of accretion to earnings for the coming year.

We are also working with certain banks looking into the open market. However, when we started that process 30 days ago or so, we were able to acquire our debt at about 105 and it is now closer to 108 or 109. So we are just going to kind of wait that out, but we do have the cash to do that, but we want to do it at the most favorable rate that we possibly can. So right now, we are continuing to monitor it, but we -- I can't guarantee we will go and do the 10% in April/May, but I certainly think that is a viable possibility.

Have the debt levels subsequent to September 30 changed then?

Yes, they have. They are down I think it is $4.3 million since that point in time. That was effectuated in October.

Okay. As it relates -- I believe you asked about M&A activity. This is Rodney. We currently have a list of candidates for acquisition. They are in some degree of active status, each one of them. As we -- again, we are looking for a particular fit in terms of -- as it relates to geography and technology in terms of what our status is and going forward. But at this time, we have no impending agreements on the table that we need to disclose at this time. But we are active in pursuing it with again those two covenants in mind of technology and geography.

Great. Thanks very much.

Jon Braatz, Kansas City Capital.

Good morning, gentlemen. Jay, I notice on the P&L statement, there was a $1.2 million miscellaneous expense in the quarter. What was that?

Jon, that was -- if you recall earlier this quarter, the dollar strengthened considerably I believe in response to a lot of the chaos that was occurring in Europe and because of the strong dollar and certain intercompany payables, we had to essentially mark those to market and take that particular charge in the quarter.

That is not related to what you gad previously said about $0.01 foreign currency impact?

It actually is. What I did in the script is I combined both the transaction and the translation adjustment and those two knitted together had a negative impact of $0.01 a share.

Okay, okay. Perfect. And were there any additional costs, any costs associated with the construction accident in the quarter, anything that -- any manufacturing difficulties or anything that might be associated with that accident?

No.

And we remain on budget. Actually -- we remain on budget.

Okay, okay. And going back to the refinancing issue, I know we discussed this a little bit, you talked a little bit with me about the ROI of any refinancing plan versus the accretion. How do you look at -- how do you look at those issues, the ROI versus the potential accretion?

Yes, we continue to look at it. It would certainly help our EPS, but right now, the people we are talking to want about a 15% premium. So on $140 million, that is very significant. But we are continuing to look at it and if we can find in the market a reduction in the premium than I think it would be something that could be positive and have a positive IRR. But at this point in time, it is something we continue to look at.

Okay. Thank you very much, Jay.

[Bhupinder Bamrah], Jefferies & Co.

Good morning, guys. I am actually sitting in for Scott Graham. First question, on sales of $65 million, could you guys talk about your capacity overall? Like were there any capacity constraints this quarter? I mean you did like a slightly higher revenue number here.

In terms of capacity, we had no capacity restraints during the last quarter. We had obviously built our inventory up for the switchover from the current facility to the new one. And that related just to one-time heater cable. So we had plenty of inventory and still do to cover that and there were no capacity constraints in other areas of our operations on a global basis.

Okay. So basically you did like a higher revenue -- we had like -- I mean you did better than the numbers, so I was just checking like was there like overtime or you got like some kind of particular contracts during the quarter or was it like inventory build like you said it was kind of contributed to the revenue growth here?

Yes, we have been running at virtually full capacity on many of these lines, including certain operations are running 24 hours a day. However, we have not had an impact on our orders or lost orders or had to defer an order such that we ended up losing it to competition.

Okay. And the second question was if you guys can talk about your gross margin impact. Was there anything like -- I know you said you are running your facilities like 24 hours, any overtime, which could have impacted margins or is it purely like the mix issue?

It was mostly a mix issue. We had a good MRO quarter and our MRO revenues carried higher margins than our greenfield activity. And this is the time of year for Thermon or anybody in the heat tracing business where your MRO business or product-only sales is at a high level.

Okay. And the last one actually I just wanted to -- do you guys have any updates on your capacity expansion? Is that on track or anything --?

Yes, as I said earlier, we are on schedule for a completion in this fiscal year. That will be around March. You obviously can't see a picture of it, but all the steel is up, most all the main members are up and it is in full swing right now and we will be on the schedule that we last released and construction is going well.

Thanks a lot.

(Operator Instructions). Jeff Hammond, KeyBanc Capital.

Hey, guys. Can you give cash flow from operations and CapEx in the quarter? And how are you thinking about free cash flow for the year?

Why don't we start with free cash flow? Let's say we are on track to do -- and I am going to kind of give you some bracketed numbers here -- let's say $60 million to $65 million in EBITDA. In terms of -- and I am going to exclude the building here. The normal CapEx for us -- maintenance CapEx is about $2 million. We have already talked about the interest expense going forward. That should be somewhere in the range of $13 million to $14 million and that is exposed downward due to additional potential redemptions. Cash taxes, let's say $9 million plus or minus. So that is what we believe will happen this year.

In terms of the cash flow statement for this quarter, due to the increases in inventory, we did -- we did put more inventory on the balance sheet and that did in fact impact our cash during this quarter. And one other way of looking at it, due to the increase in our cash conversion cycle, if you were to strip out the effects of the IPO and the bond redemptions, we have essentially grown cash a very modest amount over the year and that is because of the dollars we are putting on the balance sheet in inventory and payables.

Okay, great. And then just on this news on this Keystone pipeline project, do you expect that to have any impact on just oil sand project activity? Are there larger projects that are kind of waiting for that to go through? Does that have any impact?

This is George again. Yes, I mean it is going to have some impact, yes, because that is a delivery system to the US refineries for the Canadian crude. But again it is not the only option that is available, so certainly the projects that are currently funded and that are underway right now, we don't foresee any slowdown or any pullback as a result of a delay in that Keystone pipeline. But longer term, it certainly does set a tone and it will be interesting to watch, but again it is not the only option available.

Sure. Okay, thanks, guys.

Bob Franklin, Prudential Financial.

Hi, I'm not sure if you mentioned this. How large an acquisition if you were going to make one would you be willing to make and what do you think you are comfortable with in terms of leverage?

I will let Jay handle the leverage question, but size is not an issue to us as much as the two things I mentioned earlier about trying to find a strategic fit for us from a technology aspect as it relates to industrial heat tracing or a specific geography in an emerging market where we believe we could increase our marketshare by such an acquisition. So it is not necessarily an issue over the amount of the acquisition and Jay, why don't you cover the part on leverage.

Yes, in terms of leverage, when we were acquired by CHS back in 2010, we were in the range of 4. We were very comfortable at that level. I certainly wouldn't want us to see any leverage above that number. And let's say we do $65 million in EBITDA next year, so if you take the multiple at 4, that would be the high end of the range.

Okay, terrific. Thank you.

Charley Brady, BMO Capital Markets.

I think I may have missed your answer on the cash from operations during the second quarter and then the CapEx actually expended during Q2.

The CapEx in Q2 was about I want to say a little over $2 million and that includes the building -- the great majority of that was for the building. In terms of the cash flow statement, let me see if I have that in front of me. Charley, I am going to have to defer that question to another time. I apologize. I can give you a call on that.

Okay. I will follow up with you offline. Thanks.

At this time, I would like to turn it over to our speakers for any closing remarks.

Again, thank you very much for attending the earnings call. We do appreciate your interest, both investors and potential investors. Always a good call when things are going well and we look forward to speaking with you again in February. Thank you very much. We hope everybody has a safe and wonderful holiday season.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.