Thermon Group Holdings Inc (THR) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Thermon Group second-quarter 2015 earnings results conference call.

(Operator Instructions).

As a reminder this conference call is being recorded. I would now like to turn the conference over to Sarah Alexander, General Counsel. You may begin.

Thank you, Latoya. 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 after the conclusion of this call.

This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast in any form without the express written consent of the Company is 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 10K filed with the SEC in May.

We would also 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 in 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. 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.

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. Thank you for joining our conference call and your continued interest in Thermon. Today we have two of our senior vice presidents joining me on this earnings call. Jay Peterson, our CFO, will follow me and present the financial details of FY15 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 market segments and industry trends.

While Jay will discuss our financial details in a moment, I would like to touch on some of the highlights of our second quarter of 2015. First of all, let me begin by saying that we are off to a good start for this fiscal year. Q1 was good, Q2 was better.

Our revenue grew 9% over the prior year. Our revenue mix for the quarter was 62% MRO, 38% greenfield. The resulting product mix produced gross margins that were 52% of sales. This strong margin quarter was driven by the favorable product mix, mostly in revenue from the United States and the Asia-Pacific business units.

Our EPS grew to $0.36 per share which is up 22% year on year. Our backlog grew to almost $106 million. This was an increase of $8 million over the prior quarter, and a $14 million increase over the prior year's Q2.

Purchase orders received were up $14.6 million over prior year. And this was primarily due to the increase in the USA and Asia-Pacific regions.

Quotation activity was robust with particularly strong performances in Europe and Canada. Thermon's updated pipeline of future projects increased to 587 identified opportunities for heat tracing, with an estimated total value of $1.15 billion. Foreign exchange rates negatively impacted our revenue, and this was primarily attributable to the depreciation of the Canadian dollar.

Based on the positive momentum stemming from our first-half results, we believe there is some moderate upward exposure to our previous guidance of mid single-digit revenue growth. Our global footprint continues to be a key component of our strategy to provide value to our customers worldwide and penetrate our targeted end markets. We are continuing to benefit from a rebound in the chemical, petrochemical and power generation sectors that are related to the shale oil and gas developments in the United States.

Our Canadian business unit continues to do well even after the completion of several mega projects. Smaller, more profitable projects have increased MRO/UE sales, and have helped fill most of the void associated with these mega project completions.

We're continuing to monitor the geopolitical situation in Russia and the potential impact to our business. Currently we are seeing some delays in the capital investments in the energy sector in Russia. We have continued to look for opportunities where we can leverage our leadership position in providing thermal solutions to the global energy and industrial markets.

Over the past several months we have begun investing more time and resources into researching inorganic growth opportunities. As a result, our M&A pipeline is building and we are evaluating several attractive opportunities.

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. And once again, thank you very much for joining us today. And now I'd like to turn this over to Jay Peterson, our CFO.

Thank you, Rodney. Good morning. Today I will discuss our second-quarter results starting with orders in revenue.

Orders for the quarter totaled $87 million. That's a growth of 20% relative to Q2 of last year, and that's following a 29% increase in Q1. Our revenue this past quarter grew to $79 million. That's an increase of 9% relative to the prior year's quarter with growth in all of our four major geographic segments. And note that both orders and revenue achieved record highs this past quarter.

During the quarter, our greenfield revenues grew by 8% and MRO/UE grew by 9%. And on a pro forma basis, after excluding revenue from our largest greenfield project, total revenue grew by 17%, and greenfield revenue grew by 25%. And both of those comparisons are relative to Q2 of 2014. Note that our revenue was negatively impacted by foreign exchange in the amount of $1.2 million, primarily due to the weakness in the Canadian dollar.

Our backlog of confirmed orders grew to $106 million. That is an increase of 15% versus September of the prior year. And our book to bill for this last quarter ended at 1.1.

Turning to gross margins, margin dollars this quarter grew to $41.2 million. And relative to Q2 of last year our margins increased by 360 basis points to 52.2%. This margin increase was due to the high mix of MRO/UE at 62% of revenues, whereas greenfield revenue totaled 38%. Margins were 47% for greenfield and 56% for MRO/UE this past quarter.

Core operating expenses for the quarter -- that is SG&A excluding D&A -- totaled $19.2 million, an increase of 10% year on year. Our OpEx as a percent of revenue this past quarter was a competitive 24%, again ex-D&A.

The number of full-time employees at the end of September was 856, up from the 854 as of one year ago. And note that over 90% of these additions were in production, sales, R&D and engineering, and directly relate to managing our growing backlog.

Now, turning to interest expense and taxes, due to our continued EBITDA growth and the recent refinancing of our term loan, the interest rate on our term loan will decrease to 3.12% in Q3, this current quarter. And that's a 50 bps reduction, and approximately $0.02 a share in incremental annual pretax earnings.

Our tax rate for the fiscal year is estimated at 28.5%. And that's up slightly over the prior year. And this is due to the increased profitability in the United States.

Earnings -- GAAP net income for the quarter totaled $11.7 million. And our GAAP EPS for the quarter totaled $0.36 a share, and that's up $0.03 a share from the prior year.

Our adjusted EBITDA totaled $22 million this past quarter, a growth of 20% from the prior-year performance of $18.3 million. And EBITDA as a percent of revenue came in at a healthy 28% this past quarter.

And finally the balance sheet, our cash balance grew to $82.1 million. That's an increase of $28.7 million over the last 12 months. And debt ended at the end of September at $115 million.

Our business continues to be highly capital efficient. Over the last six months our CapEx -- and this includes both maintenance and growth capital -- amounted to a total of $1.7 million, or approximately 1% of first-half revenue. And for the first half of this year, our conversion ratio was 99%.

And, finally, leverage at the end of September -- and this is on a net debt basis -- was of low of 0.4. And our future uses of cash continue to be as follows -- number one, reinvest back into our growing business; number two, funding our active M&A program; and, number three, debt reduction.

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

(Operator Instructions)

Charley Brady, BMO Capital Markets.

Thanks. Good morning, guys. On the orders, could you give us the break down greenfield/MRO, how much they were up on the order side?

Yes, Charlie. This is George. On the greenfield orders, the orders in Q2 on the greenfield side were up 7.5% and on the MRO side they were up 9.3%.

Thanks. And on the gross margin, in the prepared remarks you gave the breakdown between greenfield and MRO. I don't know if I've heard that before, but could you give us what it was for the quarter last year?

I do have that, Charley. Let me send that you in an e-mail. I don't have it right in front of me.

Will do. And then just one more on the M&A. You talked a little bit about it last quarter. You talked about maybe something imminent within six months. We're halfway through that now. Is the timetable still -- has it changed any there or has the opportunity set changed?

This is Rodney. We're still on target and nothing has changed from our previous comments.

Great. Thanks.

Brian Drab, William Blair.

Good morning, Rodney, George, Jay. Can you talk a little bit about your expectation for gross margin the balance for the year? This was, I think, an all-time record, as far as my model shows. What do you think you can do in terms of holding that level of gross margin?

It is a long-term record for us. We do not anticipate protracted levels at this performance level. We expect further growth in greenfield in the second half of the year.

As you know, there are significant buyout items with a greenfield installation. Therefore, we believe there are gross margin degradation, if you will, or lower gross margins, in the second half of the year, especially relative to what we saw in this current quarter.

I don't mean to press you too much but can you be any more specific, Jay, on that? Because we were introduced to this company a few years ago as 44%, 45% gross margin, then it ticked up and we got comfortable with the high 40%s, now 52%. Does degradation mean potentially back to 45% or does that mean back to 50%?

Brian, this is Rodney. Our gross margin as a percent of sales, they've outperformed our expectations mainly due to the fact that the gross margin within the greenfield projects themselves, which is jobs over $1 million, have performed more than our expectations, mainly because of the flexible heater cable content of the overall purchase order.

And, so, when we look at our timeless business model that we did introduce you to at like 45%, that was based on the data that showed a certain component of flexible heater cable sales. That component has increased, as well as some of our other products that have increased several points in margin.

For us to go back to 45%, it is possible if we have a quarter of all greenfield and literally no MRO. But we have not had that scenario develop in the last year and a half. A couple turns downward would be expected from us as we come into a quarter that could be heavily laden with greenfield revenues.

Also, I might mention that we are performing now in an environment without much contribution from mega projects which also tend to be at lower margins. I think going forward we do hope that we will incorporate mega projects again at some point in time, but right now they're pretty much absent from our revenue.

Okay. Great. And just to clarify, Rodney, I think you said a couple of turns downward would be reasonable to expect? Is that the same as saying a couple of percentage points down from the 52% level?

Somewhere in that area, yes.

Yes.

Thanks. And then can you give any color around the growth that you saw in the different geographic regions in revenue in the period? And specifically in the Middle East, as well?

We saw growth in the quarter in all four of the major geographic regions. The US, Latin America and Europe were all double-digit growth. Asia-Pacific and Canada were single-digit growth. The Middle East is a key market for us. We are active in the business opportunities there, not only from indigenous opportunities from the Middle East, but we're also very active with the EPCs around the world, and with orders that don't originate from the Middle East but ultimately that's where the install base is.

Okay. And then, last, if I could, what price of oil would you expect to see the SAGB projects in the oil sands potentially slow down? And clearly your results are indicating that you're not seeing any sign of any slow down there but can you talk a little bit about the potential impact of this pull back on the price of oil on that business?

Yes. As you pointed out, we aren't seeing any slowdown in the SAGB projects as a result of the oil price. In fact, we are currently looking at this as primarily a short-term issue because it's mainly a supply-and-demand balance at this point. We still see the demand for energy in the longer term as being strong. So, we're still very bullish on the opportunities that we see in the oil producing areas.

Would you say, George, that those projects are around, what is it? -- $70 a barrel plus or minus, where they're still economical? Or even lower than that?

Yes. You guys read the same information that we do. $70 a barrel seems to be a threshold. But, again, I think there's also, it's been pointed out in the press, that there's a lot of value put on long-term investments, diversity in terms of where the investments are. So, again, we don't see that softening at this point.

Okay. Thanks for answering my questions.

Scott Graham, Jefferies.

Good morning. Just a couple of things in terms of comments you guys have made. Jay, the plus 17% revenue, is that largely the rolloff of the Kearl being excluded from that number?

Exactly.

Okay. Great. And then, George, when we asked, I think it was Charley, answered his question about orders, I thought that the orders are up 20. And maybe I missed heard you, George, but I thought I heard you say greenfield up 8% and MRO up 9%.

You're correct. I made an error there. I was referring to revenue. When I answered Charlie's question, I was answering it based on revenue. Revenue for greenfield was up 7.5% and revenue for MRO was up 9.3%. That was not orders. My mistake.

Right. Are you able to answer that question or is that something you would rather not?

We generally don't break down orders by greenfield and MRO. But our backlog, as noted, is up quarter over prior year. So, we are seeing, I think, an increase in greenfield MROs.

Got it. My last question, because there have been a number of questions -- you guys did a great job also on outlining what happened here. My last question is simply, as alluded to earlier, there's been quite a gap down in the price of oil. And you alluded to, Rodney, that you are seeing some delivery delays with respect to Russia, more seemingly because of geopolitical unrest there.

Are you seeing -- it sounds to me like you're not -- but are you seeing any one react in any way, even outside of Canada, which I think you talked about already, in any kind of knee-jerk fashion here, particularly on the smaller projects which are easier to move around, or even on the larger projects which are fairly easy to push out? Anything that you're seeing that suggests that your customers' tone of ordering has been impacted by the decline in the price of oil?

I will let George address Russia, if you like, and as it relates to their capital investments and the sanctions. But in other areas we have not seen any knee-jerk reaction to the heat tracing business flow.

Scott, again, as it relates to the price of oil, we don't believe that is something that is going to be affected in the short term. This would have to be an extended -- we think anyway -- would have to be an extended period of time where oil would have to be in the $70 or below category. And even then, it would only affect the upstream activity, and, in fact, would probably further enhance the downstream activity.

As it relates to Russia, we have seen some pushback, if you will. The sanctions have caused us some additional hassles, as an example, in terms of getting material into the country, from our importing materials into the country. But, again, it's mainly due to capital projects for state-owned enterprises where financing is an issue, because the sanctions certainly have had an impact on the Russian companies' ability to gain access to financing.

We've seen some of that. But, again, our business in Russia, based on the install base that we have, is ongoing and we're still very active there. And at some point in time we think that's going to turn around once our leaders get on the same page.

Got it. Thanks very much.

Jon Braatz, Kansas City Capital.

Rodney, most of my questions have been answered. But just going back to the gross margins, obviously they've improved, and you talk about the mix changing and so on as a driver. But internally, in terms of manufacturing productivity, are you driving, are you seeing much improvement in, let's say, the manufacturing margins, and having a favorable impact on the overall gross margins?

Yes, we are seeing that.

When we look at our overhead rates, for example, today versus a couple of years ago, yes, we are seeing improvements.

And do you think there's more to come on that front?

Nothing of any large magnitude at this present time.

Nothing more than what the volume does as you amortize indirect costs. But we are highly efficient in our manufacturing operations, specifically as it relates to our flexible heater cable operations here in San Marcos. But we have seen an improvement since we've built the plant several years ago in workflow process improvements, and so on.

All right. Rodney, thank you very much.

(Operator Instructions)

Jeff Hammond, KeyBanc Capital Markets.

Good morning, guys. Just wanted to revisit your guidance comment about the bias upwards, maybe give us a little finer tune. And then with that, it looks like year to date your MRO revenues up low double digits, and your greenfields down slightly. And as we go into the back half it seems like comps get much tougher for MRO and much easier for OE. So, I'm just wondering how to think about mix into the second half, or maybe parsing those growth rates between MRO and greenfield.

Jeff, this is George. Our year-to-date greenfield business is up 9%, and our year-to-date MRO/UE is up 4.2%. And, again, going forward we believe that we're going to average close to the 60-40 split that is our historical number. Again, Q3 is going into the heating season so normally we would expect certainly an uptick in MRO/UE revenue in Q3 because of the effects of the heating season. But we also have a strong backlog so we think we are going to hang in there close to that 60-40 number.

Okay. In those year-to-date growth rates, are you excluding Kearl?

No, I'm not.

Because first quarter you had a much higher mix of MRO year on year, and even 2Q you had a larger mix of MRO slightly.

Yes. When we look at, for example, Q2, we look at the prior 12-months' performance -- but just for Q2. So, we look at all the customers that have built in excess of $1 million over the prior 12 months, and then look at that portion within the Q2 quarter. Year to date we do that same thing, but it is not additive, Q2 is not additive to our prior published Q1.

Okay. That's helpful. And then just back to the gross margin, I think the thing that stuck out to me is just how high the margins were in greenfield. If I recall, the trend historically had been low to mid-30%s. As we go forward and we have these absence of megaprojects and maybe the smaller greenfield projects, do we trend closer to the 47% this quarter or closer to that low to mid-30%s that you've historically had?

I think if we have significant megaprojects down the road similar to what we had, for example with Kearl, we will see a downward exposure. What we're seeing right now is a lot of these smaller greenfields that had more heater cable content. And that is obviously benefiting our margins of late. And in terms of the outlook over the next year, we do not have any Kearl-like projects in the outlook or at least anything of the significant level that Kearl invoiced.

Okay. And how much visibility do you have on what mix of heater cables is in the backlog and what might ship?

We have line-item detail by customer, by product. So, it's pretty good detail. And also we have a CRM process where we look at what we anticipate to book over the next year or two. So, very good visibility, from our perspective.

Okay. So your perspective -- no megaprojects and a pretty good mix of heater cables continues?

Yes.

Okay. Thanks, guys.

Scott Graham, Jefferies.

Hi. I did actually think of a question while you were answering me, George. I just wanted to see from a marketing standpoint -- I know that midstream pipelines have really not been a large business for you guys yet. A lot of projects do seem to be lining up in oil and gas in the midstream.

Just wondering what marketing efforts are going to be toward that opportunity going forward? It seems like it's an opportunity that you can avail yourselves of. Or I'm wrong on that and hopefully you'll tell me and answer both questions.

Yes, that's right. Midstream transportation is not typically one of the areas that is a significant contributor for us. But, again, there is more and more attention given today to heating solutions as a means to provide the pumpability of fluids in pipelines.

So the number of opportunities in that particular market sector is actually increasing. There's been a lot of information published about the availability of some of the other options like (inaudible) its availability. So, we are focusing on that. There's a lot of terminals activity, plans for building terminals around the world that have significant heat tracing opportunities. So, we are looking to those sectors as more significant contributors going forward.

Very good. Thank you.

Maddie Everett, Johnson Rice.

Hi. Good morning. Can you give us some more color as to why gross profit margins were up significantly during the quarter relative to the modest increase in MRO/UE as a percentage of total revenue?

Yes. The big driver there was when we look at the performance of greenfield. Historically our greenfield margins had been in, let's say, the mid-30%s to high 30%s. This last quarter they were at 47%. I think that's due to the mix of the product within greenfield, and also something that we haven't touched on yet in this call. Over the last two years we have made a concerted effort in investing in project managers, to make certain that we have people driving the performance of those projects at or above the quoted gross margin. And I think we've seen some success in that over the last quarter or two.

Okay. And also can you talk about where the new awards are during the first half of FY15 are coming from? I'm just trying to get a sense of the geographic locations and industries. And are there any larger awards included or is it just a mix of smaller and mid-size awards?

From an order perspective, if we look at where we are at in the half, we have three of our four geographies growing in total orders year on year, with the greatest amount of growth coming from the Americas.

And some from Asia Pacific, as well -- of the two top performers.

Okay. And are these larger awards included or is there a mix of smaller and mid-sized awards?

In the Americas, it's largely being driven by smaller projects and MRO/UE. Again, the impact of cheap gas as it relates to the downstream activities for polypropylene, polyethylene type process plants has been significant. We're also seeing quite a bit of activity in the power industry as it relates to existing facilities getting ready for the upcoming heating season, for the winterization process.

The Americas has been active and it's mainly, again, smaller projects and MRO/UE. That's usually more profitable business so that's also something that's helping keep our margins a little higher than what would be considered normal.

Okay. Great. Thanks so much.

Charley Brady, BMO Capital Markets.

Thanks. I didn't want to beat this to death but I'm going to anyway. On the gross margin, I understand what you're saying about the greenfield being elevated relative to historical levels, but in the release you called out the impact of manufactured heating cable. Does that apply to the MRO side of the business?

To both.

Okay. It just seems like your margin expectation seems conservative, even if you go back to a 60-40 split. Are you expecting 200 basis point margin decline in both sides of the greenfield and the MRO business? Or am I missing something here, because it seems --?

Historically, if you look at our business over the last decade, even over the last several years, there will be pockets, quarters, if you will, where we will hit down in the mid 40%s range. I think two years ago we even hit 44% for a quarter. So, that is entirely possible. Again, it is predicated on the mix of heater cable versus, for example, buyout items for construction or engineering in that overall mix in that particular quarter.

It also is impacted on where the projects are located. It's nice to think about that projects are created equal across the globe, but that's just not the case. Pricing and margins are driven by the demand and availability of manpower and so forth. And, so, it also depends on what geographies are contributing to the growth.

In terms of that answer, does the US tend to be on the upper end of the margin spectrum or lower or mid?

Mid to upper end.

Great. Thanks, guys. I appreciate it.

Thank you. There are no further questions in queue at this time. I would like to turn the call back over for closing remarks.

Again, thanks, everyone, for your interest in Thermon, and joining us on the call today. And we look forward to seeing you in about 90 days.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.