Thermon Group Holdings Inc (THR) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Thermon third-quarter 2013 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 be given at that time. (Operator Instructions). As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Ms. Sarah Alexander. You may begin.

Thank you, Ashley. 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 last year.

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 a substitute for, income from operations, net income, net income per share, and other measures of financial performance reported in accordance with GAAP.

And now it's my pleasure to turn the call over to Rodney Bingham, our President and Chief Executive Officer.

Thank you, Sarah. Good morning, everyone. Thank you for joining our conference call and your continued interest in Thermon.

Today we will have two of our senior vice presidents joining us on the call. Jay Peterson, our CFO, will follow me and present the financial details of our FY 2013 third-quarter and year-to-date results. George Alexander, our Executive Vice President of Global Sales, will assist in the Q&A session by answering questions that pertain to global market segments 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.

While Jay will discuss the financial details in a moment, I would like to touch on some of the highlights of the quarter. Our Q3 revenue was the highest in our history. Our operations, engineering, and construction personnel did an outstanding job of getting the work done in a quarter with two major holidays. We are very proud of this achievement.

Our revenue for Q3 was approximately $77 million, which is an increase of 11% over prior-year's Q3. Our revenue mix for the quarter was 42% greenfield projects and 58% MRO/UE business.

Our total gross profit was $35 million, which is another all-time high for Thermon. Margins were at 45.5% of sales, which compares to 48.7% of prior-year's Q3. While the margins were slightly lower than the previous two quarters, they're still consistent with our historical average of approximately 45% of sales.

Our Q3 backlog remains strong at $107 million versus prior-year's quarter of $102 million.

We have now completed our new control panel and skid fabrication facility in our San Marcos plant. We have also completed a move to our new office in Houston, Texas. This has more than doubled our engineering workspace. These two infrastructure build-outs, combined with the recently completed wire manufacturing facility in San Marcos, has put us in an excellent position to accommodate future growth.

Our global footprint continues to penetrate our targeted end markets, which are oil, gas, power and chemical, thus resulting in continued long-term organic growth.

We are very excited about our record breaking year. We have grown our business despite unfavorable foreign currency headwinds that Jay will touch on in a little bit.

Our management team would like to thank our employees throughout our global organization for their hard work and dedication. We would also like to thank our customers, investors, and advisors for their support and confidence.

Thank you again for joining us today. Jay Peterson, our Chief Financial Officer, will now address the details of the financial performance for Q3 and FY 2013 year to date.

Thank you, Rodney. Good morning.

Thermon set several records this past quarter, including top line revenue growth, gross margin dollars, net debt balances, and cash balances.

Let me first start off with revenue. Our revenue this past quarter grew to a record $76.8 million and, as Rodney mentioned, that was an 11% increase over the prior-year's quarter. Our year-to-date revenues totaled $212 million, or 5% growth over the prior year.

Note that the strong dollar has negatively impacted our year-to-date revenues by $7 million. Had we experienced constant currencies, that is relative to the prior year, we would have grown a total of 8%. Major currencies impacting our revenues this year are the euro and the Canadian dollar.

Orders for the quarter totaled $71 million and our trailing 12-month order activity totals $285 million. Our backlog of orders ended December at $107 million versus $102 million at the end of Q3 fiscal year '12, an increase of 5%, with both hemispheres showing growth. Our backlog did decline between September and December, and that was due to the spike in greenfield revenues.

Let me turn to gross margins. Margin dollars grew this past quarter to a record $35 million. On a relative basis our margins declined to 45.5% due to the high mix of greenfield revenues. Versus the prior-year quarter, our margins decreased by 320 basis points. Our MRO/UE mix for Q3 was 58% of revenues this quarter, whereas greenfield totaled 42%. Last year that mix was 65% MRO/UE and 35% greenfield.

Now let's discuss operating expense and our human resources. Total operating expense for the quarter, that is SG&A -- and this excludes amortization of intangibles and any transaction-related expenses -- totaled $16.9 million, an increase of $1.6 million from the prior year. And our operating expense as a percent of revenue this past quarter was a competitive 22%. And, again, that excludes amortization. Our return on equity on a Q3 annualized EBITDA basis was 35% this past quarter.

Also, the number of full-time employees at the end of December was 800, up from the 723 as of calendar December 2011. Over 90% of these additions were in production, sales, research and development and engineering and directly relate to managing our top-line growth.

In terms of earnings this past quarter, our GAAP net income for the quarter totaled $7.7 million compared to a prior year of $6.9 million. GAAP EPS was $0.24 a share versus $0.22 in the prior-year period. Year-to-date December our EPS was impacted negatively by approximately $0.02 a share from the combined effects of FX when considering both translation and transaction impacts.

Our EBITDA totaled $18.9 million this past quarter, up slightly from the prior-year performance of $18.7 million. And EBITDA as a percent of revenue was 25% this past quarter.

Now to the balance sheet and our cash flow. Our cash balance at the end of December was $28 million compared to $19.8 million in the prior-year period. And that's an increase of 43% year on year.

Our net debt position and leverage continues to decrease. One year ago December our net debt was $128 million and at the end of December '12 it was $90 million, or a 30% reduction. Regarding our net debt leverage, on a trailing 12-month basis our debt to EBITDA leverage was 1.2. And we believe that number will finish this year at approximately 1.

We generated just under $10 million in free cash flow -- and that's measured as cash flow from operations less capital investment -- this past quarter. And that's $0.30 a share in free cash flow earnings.

Our business continues to be highly capital efficient. Thus far this fiscal year our CapEx spending totaled $5.2 million, and that includes both sustaining and growth capital, and amounted to 2.5% of revenues.

In summary, we demonstrated another strong quarter in Q3 and we again set several financial records. However, certain of our geographies are experiencing a slowdown in orders and due to macroeconomic events.

With that as a backdrop, we are amending our fiscal '13 guidance to 5% to 7% revenue growth, or 7% to 9% adjusted for constant currencies. In addition, we anticipate strong greenfield invoicing activity in Q4 and, as a consequence, we expect Q4 margins on a relative basis to be similar to Q3's margins.

In terms of next fiscal year, we are in the middle of our budgeting process and look for fiscal '14 to be a growth year for THR. We will provide more specific guidance for fiscal year '14 during our next earnings conference call.

Thank you for your continued interest and support. We plan to announce our financial results for fiscal year '13 via a conference call and press release in June of this year.

I would now like to turn the call back over to Ashley to moderate our Q&A session.

Thank you. (Operator Instructions) Charley Brady; BMO Capital Markets.

Can you give a little more detail? In the press release you cited specific project circumstances and impacting the margin and also the product mix on the greenfield. Can you just give us a little more granularity on exactly what that means? And also, on your last comment about the certain geographies experiencing slowdown, can you just expand on that a little bit as to what geographies or specific end markets you're seeing that in and to what degree? Thanks.

Charley, this is George. I'm going to try to answer all those questions. There were several of them, though. First, on the question about the greenfield mix, it was stronger than the prior year in terms of the invoicing rate. We had a couple of strategic projects that invoiced during the quarter that had significant subcontract components. So that impacted product mix and margin.

The markets that are underperforming, based on our forecast are a little soft, are the US market and Europe market. Asia-Pacific is performing strong for us. The only exception there is Japan.

Jeff Hammond; KeyBanc Capital Markets.

Can you give us the order number in the quarter?

Yes. The orders for the quarter were $71 million.

Okay, perfect. And then, you mentioned, I think, US and Europe as the areas of weakness. What are you seeing specifically in the Oil Sands? We've heard some concerns about project delays and just kind of oil pricing differentials up there. I'm just wondering if that's having any impact on order or quoting activity there.

Jeff, this is George. Yes, we're seeing the same publications that you are relative to some possible delays as far as CapEx in the Oil Sands. Fortunately for us, we have a significant installed base in Canada. Plus, the cycle as far as heat tracing is concerned, being at the end of these greenfield projects, or towards the end of the greenfield projects, it hasn't affected us yet. And we really haven't seen yet a downturn in our early involvement. So we're on the lookout for that. We're cautious because of what we see in the press and so forth. But, honestly, we haven't seen any slowdown or indicators in our business yet.

Okay, great. And then, based on your mix and stuff, backing into kind of MRO growth rates, it looks like last quarter it was down kind of low-mid-single digits this year and this year may be flattish. I'm just wondering what's driving kind of flattening out in the MRO business. I had thought with some of the capacity additions, you'd be able to kind of accelerate growth there. Just talk about what you're seeing on the MRO side.

Yes, Jeff, George again. One of the things that definitely has an impact on MRO rates is weather, is the heating seasons. And we did have a very mild -- or have had a very mild heating season in the US as it relates to weather. And we also had a relatively tough comp last year because we were coming off of a pretty difficult winter, especially in the southern part of the US where a lot of exposed plants are.

So, again, our plant expansion is aimed at being able to take advantage of not only increased MRO, but also to pursue opportunities in adjacent markets. That is still ongoing. And so we're anticipating taking advantage of that increased capacity going forward, as well as being able to serve a larger installed base when some of the MRO starts kicking in as we move forward from the significant growth that we've seen over the last couple of years.

Okay. Thanks, guys. I'll get back in queue.

Tim Mulrooney; William Blair.

Did foreign currency have a negligible impact on revenue in the third quarter?

Yes, it did.

Okay.

The $7 million impact was almost entirely in Q1 and Q2, Tim.

Okay. And did you see any strength in any particular market this quarter? I know you talked about geographies. But in terms of market are you seeing power gen improve at all? Or is your growth still mainly driven by the oil and gas?

The oil and gas industry, both upstream and downstream, continues to be the biggest driver in our overall business. It is continuing to be the most active although in the Asia-Pacific region and the Middle East areas we are seeing an uptick in the chemical and petrochemical.

Great. Thank you.

Scott Graham; Jefferies.

Couple of questions. Charley asked a question earlier that I was just wondering if you could answer. The gross margin decline attributable to this project issue, could you kind of give us what that specifically was and the impact on the gross margin?

Scott, this is George. I can, again, talk about the impact of product mix in those projects. They included a significant component of subcontracts that were a drag on the margins overall. In terms of specifically how much they affected the overall gross margins, I'll turn that over to Jay. The downturn was due to mainly the product mix, but from a specific standpoint --

Approximately 50/50 between the two, and maybe 60/40 due to MRO and the other impact due to the strategic order was less than that.

Okay. Is that something that continues in the fourth quarter?

We mentioned that we do believe greenfield revenues will be strong in Q4, and we do believe margins will be very similar to what we're experiencing this year -- excuse me, this last quarter.

Okay. I guess where I'm going with this is that the -- if you're saying that the gross margin in the fourth quarter looks similar to the third quarter, you know, the third quarter down 300 basis points, including this specific project thing. Last year's fourth quarter was higher than last year's third quarter. So you're saying that the margin is going to be down in the 400 to 500 basis point territory for fourth-quarter gross margin?

On a relative basis we'll be -- believe it will be similar, Scott, to what we experienced in Q3. In Q3 it was 45.5%. And based on our understanding of the backlog, based on our understanding of the MRO mix, and based on our understanding of the large projects, we think we'll be similar to that.

Okay. Well, that's a pretty big swing. So my next question would be along the lines of SG&A. What are the plans there to perhaps curb the SG&A number, bring that number down on a year-over-year basis a little bit better than what you did in the third quarter? Can you do that? Because I think there's some expectations there for an earnings level that is not consistent with your gross margin guidance that you're offering here. So what do you on the SG&A line that maybe makes some of that up?

Well, we believe that next year, fiscal year '14, will be a growth year for Thermon. And we believe we need to prudently hire resources and talent now in order to execute that growth. So we don't appear -- we're not planning on any significant operating expense impact in Q4, in that the great majority of our expenses are people.

Okay. Could you also give us the orders for the year-ago period?

Yes. For the year-ago, trailing 12 month was $285 million. This last quarter was $71 million. The prior-year quarter, Scott, was $83 million and change, $83.7 million.

Okay. Thank you.

Andrew Gadlin; [CJ] Securities.

Could you talk a little bit in the composition of the backlog, whether that's more high-end greenfield type projects? Is it original cable or are you -- is it a lot of engineering work and kind of pass-through products?

This is George. The backlog is largely a reflection of our greenfield projects. Most of our backlog will burn off in a 12-month period. But it doesn't have a significant component of MRO business in it because our MRO business usually comes in and goes out in a matter of days or weeks.

I understand. I'm asking within greenfield you'll occasionally have different margin levels associated with different type of work. I'm trying to get a sense, as we look into the first half of next year, whether it's likely to be some of the higher margin greenfield, as it was this past quar- -- in Q2? Or is it going to be more similar to what we saw this quarter?

Our greenfield projects all contain a significant component of buyout products. And so, they don't necessarily all contain subcontract components. But it is something that, depending on when the higher margin mix shifts versus the buyouts, that will affect the gross margin for the quarter. So I can't answer your question specifically about the component of the backlog for FY14 as far as product mix, which ones contain subcontracts and so forth. But our projections going forward are that our margins on greenfield projects are based on the projections that we've made for the year. We don't see that changing significantly.

Okay. Thank you.

Jon Braatz; Kansas City Capital.

Couple questions -- we're hearing about some down the road, maybe beginning in late this year, about some maybe large petrochemical facilities being built, or planned. What is your role in those facilities? And I'm talking about domestically. How much exposure would you have to that market? Or is that a function of where these facilities might be constructed?

Jon, this is George. It's both. We're seeing the same thing, as far as the announcements. Some of that is related to ethylene crackers that are projected based on the significant shale gas availability. And we do have -- that gives us a lot of reason for promise there. That is, they do require heat tracing. If they're built on the Gulf Coast it's a little less intensive because of the freeze protection component. But all of them will require a significant amount of process tracing. So it's not entirely region-specific, but if it's in a freezing climate it does add the component of freeze protection to the overall scope.

And I assume, George, if actually some of these projects got under way in late 2013, 2014, your revenue on those projects are maybe in 2015, further down the road. Correct?

That's correct, Jon.

Okay. Jay, the other question I have is, is there -- I think there's an opportunity for you to retire or redeem some debt this year. Can you refresh my memory on that?

Yes, Jon. Actually, we have the ability, obviously, to go into the open market and repurchase our debt. It is rather thinly traded at a rather stout premium. Next year, in April of 2014, we have a call option where we can call all of it at 104.75.

Okay. For some reason, Jay, I was thinking it was this year. Okay.

Just a little over a year from now, Jon.

Okay. All right. Thank you very much.

(Operator Instructions) AJ [Grasser]; Cooper Creek Partners.

So just a couple of questions. On the guidance for the fiscal '13, just based on your 5% to 7% range it would imply revenue for Q4 I believe around $74 million or so. Maybe talk a little bit about what's causing this sequential decline from Q3 to Q4, based on that guidance.

The guidance actually -- I think that would be the low end of the guidance, if you do the math, AJ. It could be above that. And we could, in fact, possibly record yet another record quarter for Thermon. It really all comes down to our shipments typically in the last month, greenfield type activity, where we are somewhat or entirely at the beck and call of the customers on whether or not they will accept the shipments, or whether their schedule is working to the previous plan.

Do you expect Q4 MRO sales to be up or down year over year in Q4?

Expect them to be up. But we do also expect a strong greenfield mix.

Okay. And then my last question is on backlog. Should we be concerned? I think this is the first quarter where it was down sequentially in a while. How do you expect it to be trending? Just given your order flow to date in the quarter, how do you expect it to be trending for Q4?

Good question, AJ. One of the hard things to do is when you post really strong revenue growth, is also to post backlog growth. Those are two oftentimes difficult things to execute in the same quarter. If our backlog were to fall in Q4, I really don't think that's a real big impact to the Company, in that we believe, based on our ending backlog and our order activity for next year, we will be able to grow the business again next year.

So there's a fair amount of either mix issues or timing issues that will impact our backlog positively or negatively.

Okay. And then, I'm sorry, if I could just get one question in here. One of the kind of defendable parts of your story has been that you should be somewhat immune to the CapEx cycle in that you're a relatively small part of the build-out of these facilities. But you're talking about some softness here and I'm just trying to understand why would you see softness if you're a relatively small part of the build-out here and levered to what should be a strong secular trend.

Well, the part maybe -- we're not immune to the CapEx cycle. I mean, if CapEx overall starts to decline, I mean, eventually that would affect our greenfield business. But what we are saying is that in the CapEx cycle, in the build-out cycle, our invoicing occurs towards the end of the projects. So if the decline started today we wouldn't see it until a couple of years down the road. Did I answer your question?

Yes. I just wanted to make sure there's no change in tone from your customers or anything of that nature, or behavior.

Oh, actually, as I said before, in our growth markets we're still seeing very robust activity. Our quoting activity is strong. So we haven't seen that indication yet of any slowdowns coming.

Thank you again and thanks for taking my questions.

Jeff Hammond; KeyBanc Capital Markets.

I know you're not ready to give fiscal '14 guidance, but I just want to understand a little bit better this balancing growth and investing in the business on the SG&A side with some of this slowing order growth. And I think you say some growth -- I think you used the term it will be a growth year. But maybe give us a sense how you're balancing those two things. I mean, do we think about '14 as growing in line with kind of your long-term growth rate or growing below that with some of the choppiness in the orders?

Yes. How we look at that, Jeff, is we believe next year we'll be a growth business. That's certainly one way to offer value back to our shareholders. Also, our balance sheet will be much stronger next year. And that will give us the opportunity to continue to reinvesting back into our business. As you know, we also are looking at M&A. We don't have anything on the front burner, but that's always a constant component of our strategy.

Other ways we can use our cash and offer value to our shareholder is to continue to buy down our debt and increase earnings through that. We also, even though our float is relatively modest, we do have the ability to repurchase our securities. And we also have the ability, depending on our cash balance, to offer some sort of dividend program. So we've got a lot of different options at our disposal. But the number one option, or the number one emphasis, is that we're going to reinvest back into our business and to continue to grow our top line.

Okay, great. And then just on -- I mean, I understand the macro weakness on Europe. But do you think the US is more a function of kind of headline risk or weather or a little bit of both?

Jeff, it's George. It is a little bit of both. And, as I mentioned before, it's also -- our US organization in the prior year had a outstanding year. So we had a bit of a tough comp, but again, yes, I think the softness in the economy. But, like you say, like we talked about earlier, we're seeing some positive signs there as well because of the shale gas play and the potential for the chemical side to actually make a comeback.

Okay. Thanks, guys.

Charley Brady; BMO Capital Markets.

Yes. I just want to be clear, make sure I heard something correctly. Your net debt expected to be at end of the year at $90 million and net debt to EBITDA at 1 times?

No. The comment I meant was that our leverage would be at approximately 1 by the end of the year. And we believe we'll execute that by not reducing our debt, but by increasing our cash balance.

Okay. That's helpful. Thanks. And I guess with respect to the backlog and the gross margin, I guess I'm just trying to get a sense does the margin embedded in the backlog today, is it higher than what it has been previously? Or as we go into '14, I guess what I'm truly trying to get to is -- do you expect a greenfield margin improvement in '14 because of what you're (technical difficulty) and how you're booking today?

Difficult question to answer, Charley, for several reasons. One is our backlog is just at a point in time, and therefore the margins in that move around every day. Secondly, backlog is really only 40% of our business. So it certainly determines margins, but it's not the driver, the top line, or the number one driver that impacts our gross margins.

We're not forecasting -- our forecast is based on our greenfield margins remaining consistent with what they have been.

Okay, thanks, and then just one more. On M&A, could you talk about -- is that something you're actively pursuing or looking at? Or maybe an update on potential M&A opportunities. Thanks.

Charley, it's Rodney. M&A activity is something that's always on the forefront of our strategic planning. Typically -- I think we've said this in the past -- we are looking for, from an organic standpoint, companies that fit a geography and technology scenario for us. Looking for areas where we could acquire market share in markets or geographies we underperform in. And then perhaps even more importantly, technology -- purchasing companies that have technology that we don't have as it relates to the heat tracing business.

And then the other component of our M&A strategy is looking at adjacent and tangential markets that start to -- still connected, but slightly deviate from the standard core business that we have. And it is a significant component of our strategy. Has been in the past couple years and will probably take a more elevated role in the future.

Thank you. And I'm not showing any further questions in the queue. I'd like to turn the call back over to Management for any further remarks.

Rodney Bingham. Once again, thank all of you for your continued interest in Thermon. And we look forward to seeing you guys down the road and again in June for our next earnings call. Thank you very much.

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