Thermon Group Holdings Inc (THR) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Thermon Second Quarter 2016 Earnings conference call. At this time, all participant lines are in a listen-only mode to reduce background noise. (Operator Instructions). I would now like to introduce your first speaker for today, Sarah Alexander. You have the floor, ma'am.

Thank you, Andrew. 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 also be available via webcast 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. Please note that during this call our comments may include forward-looking statements. These forward looking statements are based upon limited information available today which is subject to change. They are also subject to risks and uncertainties and our actual results may differ materially from the views expressed on this call. 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 in June.

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, revenue growth, profitability, forecast, projection, estimates, leverage ratios, acquisitions, synergies and various other aspects of our business.

During the call we will also discuss some items that do not conform to generally-accepted accounting principals. 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. 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. Thank you for joining our conference call and your continued interest in Thermon. Today we have two of our management team managers joining me on this earnings call. Jay Peterson, our CFO, will provide the financial details of our FY-2016 second quarter; and Bruce Thames, our Chief Operating Officer, will follow me in the presentation and assist in the Q&A session. Now I would like to touch on some of the highlights for our Q2. Our revenues were right at $70 million, and this includes a negative FX impact of $6.4 million as the dollar strengthened against the Euro, Russian, and Canadian currencies.

Acquisitions added $7.8 million of revenue in the quarter. It is important to note except for our Canadian operation, which is challenged by the price of oil, all three of our geographic regions showed year-on-year revenue growth on organic basis. This excludes the impact of currency and acquisitions. New orders were down year-over-year, but up sequentially over the prior quarter. Upstream opportunities in the oilsands region was the main contributing factor to this downward trend.

Our backlog of $82 million was down year-over-year, but up over prior quarter. The impact of FX accounted for $7.6 of this year-on-year decline. Our project pipeline of identified opportunities still remains strong at $1.1 billion, with the total number of projects actually increasing.

We successfully completed our third acquisition, Industrial Process Insulators. This addition expands our service capabilities in the U.S. Gulf Coast, and enhances our ability to deliver complete thermal solutions to more of our customers in a robust market sector. We plan to continue our strategic investment initiatives that will launch new products, and design software that will enhance our value prop session to our customers.

While we believe our FY-2016 will be a profitable year of investment, our strategy is to have these new product and service platforms in place to position the Company for future growth opportunities. We still believe the global demand for energy, chemicals, and power will increase over the next several decades. We also believe our customers will continue to make investments to support the future increases in demand for energy and petrochemicals.

While our revenue from the upstream sector continues to be challenged, lower oil and gas prices have helped to stimulate the construction of downstream processing plants and power generation facilities. As we stated in the press release, the foreign currency headwinds and the decline in opportunities and the Canadian oilsands have negatively impacted our business more than we initially anticipated.

We are therefore revising our fiscal 2016 revenue guidance to reflect a top line percentage decline of mid- to high-single digits as compared to prior year. We are still actively managing costs while investing for future growth. We will experience some near-term pressure on EPS results in FY-2016. We are continuing to pursue strategic acquisitions that strengthen our organic business model and increase our investful market space.

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 again thank you for joining us today. Now, Bruce Thames, our Chief Executive Officer will share some of the perspectives he has formed since joining Thermon.

Thank you, Rodney. Since joining Thermon, I have spent the last five months listening to, and learning from, seasoned leadership, our employees and our customers. My time has also been spent focusing on the integration of IPI, key initiatives to improve operating performance, positioning the Company for future growth; and managing costs, particularly in Canada, in a difficult environment. Although our end markets and financial results have been impacted by lower oil prices and a strong dollar, it is reassuring to see the timeless business model and proactive cost management delivered over 26% adjusted EBITDA margins and strong cash flows in the quarter despite lower revenues.

It is also reassuring to see that our business outside of Canada has performed well in a very difficult environment. More importantly, the last five months have solidified my confidence in the longer term viability of our business and growth opportunities in our end market. Due to the commitment of our employees, the breadth of our product lines, and global footprint; we operate from a position of strength in this space. Long-term drivers for this business also remain intact with the emerging middle class and developing countries, continuing to drive demand growth for chemicals, power, and energy.

This combined with tightening environmental regulations continues to generate demand growth for electrical trace heating and environmental emissions monitoring solutions. Without question, we are going to encounter choppy waters ahead at the impact as lower oil prices shake out across the industry. Recurring revenues from our install base, the diversity of end markets, and geographic distribution of our customers provide a natural hedge and position us well to weather this storm.

In the interim, we will continue to invest in a promising product pipeline to fuel organic growth and expand our M&A activity consistent with our strategy, while aggressively managing costs in under-performing units. Now, I would like to hand it over to Jay Peterson, our CFO, to provide financial results for the quarter. Jay?

Thank you, Bruce. Good morning. This morning I will discuss our second quarter results, starting off with top line revenue. Our revenue this past quarter totaled $69.9 million dollars, and that is a decrease of 12% relative to the prior year's quarter. One point I would like to make is a testimony to the continued strength of our business model. Our adjusted EBITDA as a percent of revenue was a healthy 26% in a very difficult macro environment.

This decline in revenue is attributable to the strong U.S. dollar and reduced capital spend in the Canadian oilsands. It is important to note our organic revenue and constant currency totaled $68.6 million, and excluding Canada, our organic revenue would have actually grown 10% year-on-year. FX negatively impacted our revenue by $6.4 million and for the quarter M&A contributed $7.8 million in revenue.

Orders for the quarter grew 19% from $63.9 million in Q1 to $75.8 million, and our backlog of orders grew to $82 million and that is 8% higher than June of 2015; and our book-to-bill was a positive 1.08%. Note our backlog was negatively impacted by $8 million. That is on a year-on-year basis, due specifically to currency.

And recall that typically only 40% of our orders are ever resident in our backlog. In terms of gross margins, the margin dollars this past quarter totaled $33.3 million, and compared to Q2 of fiscal year 2015, our margins decreased 450 basis points to 47.7%. And this margin decrease was due to a relatively high mix of lower margin construction revenue and a correspondingly lower mix of product sales.

Also I would like to note that the gross margin impact from the three acquired companies was a negative 1% in the first -- in the fiscal quarter. In terms of operating expense, our total operating expenses for the quarter, that is SG&A, excluding D&A and any transaction-related expenses, totaled $16.4 million. That is down significantly from the prior year number of $19.2 million. The majority of the spending reduction was in our Canadian affiliate, where we reduced our spending to be in alignment with anticipated revenue over the near future.

These spending reductions on a worldwide basis will save approximately $5 million over the next 12 years. And year-on-year, our organic spend decreased by 11%, and that excludes amortization and the lumpy incentive accrual. The number of full-time employees at the end of September was 982. That's up 15% from the head count of one year ago. And the driver of this increase was the three recently-announced acquisitions, and parenthetically excluding M&A, our head count would have actually declined year-on-year by 2%.

In terms of interest and taxes, our interest expense totaled $878,000 versus $1.1 million a year ago. That is a decrease of 18% and that number will continue to decrease over the next 12 months. Our effective tax rate for the quarter was 30%, and we are estimating a rate of 29.6% for the fiscal year. In terms of earnings, GAAP net income for the quarter totaled $7 million versus $11.7 in Q2 of last year. Our GAAP EPS totaled $0.21 versus $0.36 in the prior year. The combined of FX translation and transaction impact reduced our EPS by $0.02 in this last quarter.

Our adjusted EPS amounted to $0.26 a share and the $0.05 in adjustments relate to a $1.3 million in contingent consideration, and earn out if you will, and anticipated to be paid to the seller of the Sumac business. A $600,000 restructuring charge in the quarter and $300,000 in expense relating to our August refinancing of our term loan. Our adjusted EBITDA totaled $18.6 million this past quarter, below the prior year performance of $22 million. And as mentioned previously, EBITDA as a percent of revenue was a strong 26% in Q2.

Since March of the last year, we have closed three acquisitions and all three were EPS accretive and added $0.03 in earnings over the first half of the year. Our cash balance was $62 million at the end of Q2. That is a year-on-year decrease of $20 million. This balance was after paying down approximately $14 million in debt, and funding on a net basis; $30 million for the purchase of the three acquired companies.

Leverage at the end of September on a net debt basis was near a historical low of .6x, and that is down from over 4% back in 2010. CapEx amounted to a total of $2.9 million and that is for both sustaining and expansion capital, or approximately 4% of revenue. This percent is slightly higher than typical due to capital invested in our rental pool at Thermon Power Systems and the recent expansion of our warehouse and two-bundle operation in San Marcos.

And lastly our conversion ratio for the quarter was a robust 96%, consistent with fiscal year 2015's performance. I would now like to turn the call back over to Andrew to moderate our Q&A session.

(Operator Instructions). Our first question comes from the line of Katherine Thompson from Thompson Research Group. Your line is open.

Good morning, Katherine.

Katherine Thompson we are not getting audio from your line. Please check your mute button.

Hello, can you hear me now?

We can hear you now.

Great, thanks. This is Steven on for Katherine. A couple questions here. Would you expect Greenfield as a percentage of sales to stay below the 40% level through the remainder of 2016, and would you expect because of that gross margin to push up to the higher end of the historical range?

Yes, we think if you look back through history, through various cycles we have been in, the 60/40 number on a more protracted period of time is still a good number to model for our business going forward. And could you repeat the second part of the question please?

If Greenfield were to stay kind of at a lower level at least through 2016 would you expect gross margins to push towards the higher end of the historical range?

Yes. There are a lot of contributors in that. Everything else being constant if we only had an MRO business obviously we would have higher -- much higher gross margins, but I think what I would do is go back to our timeless business model where we talk about the 60/40 split with our gross margins at 45%. And as previously mentioned, we will endeavor to drive margins up above that 45% through cost management. That is the guidance I would give you at this time.

Great, thanks. And my last question I guess kind of, two here on acquisitions, how much of your backlog comes from acquisitions? And have the companies that you have acquired, have they seen sales growth year-over-year?

Yes, in terms of the backlog question it is a rather diminimis number for us. I believe it is about $2 million round numbers at present at the end of September. And yes, we do expect these businesses to grow. We are very happy with the performance of all three of them; and candidly some are off to a little bit better start than others, but right now based on their EBITDA performance, revenue profile, and the fact that they are accretive, we are happy right where they are at at this five minutes.

Great, thank you guys.

Thank you.

Our next question comes from the line of Bhupender Borha from Jeffreys. Your line is open.

Hey, good morning, guys.

Good morning.

So, Jay, I just want to go through the core sales guidance. You guys actually lowered the guidance from up mid-single to -- now you are expecting that total sales down mid- to high-single. Can you talk about the competence which makes that number, let us talk about acquisition and how much is FX of the total number here.

Yes, and let me give you -- let us call it a hypothetical right now. Rodney mentioned mid- to high-single digit decline. And as you know things are pretty dynamic right now. We have got three new businesses. FX is obviously a big headwind. And lastly, with oil prices.

But in terms of a hypothetical, let us say we were able to take the mid-point of the mid- to high-single digit decline, one rough perspective on that is a 13% decline for organic and constant currency. And having said that, I would like to immediately call out that we are seeing xCanada for the full year actually having growth -- 2% growth on a constant currency basis.

M&A will be in the 10% to 11% to 12% growth brackets. And FX at present we see, let us say a 6% to 7% decline, and you do the math on that, Bhupender, and it is roughly a 7.5% decline -- which, again, is the midpoint of what Rodney mentioned. And again, that is hypothetical, there is --

Right, right. So, 7.5% and let us take the midpoint and that includes your 10% to 11% acquisition assumption, right?

Yes it does, Bhupender.

Right. And then you take out the FX and that gives you -- you know, I believe the initial guidance is like about negative 2%. So this kind of, it is a big delta of organics. Now talk about like what actually moved the needle here. We were definitely going into the quarter; Canada was weak. Like last quarter, you did actually talk about the spending in Canada to be weak. It was a decline of 40% to 50%. We are looking at project revenue down 20% if you can just talk about what moved the needle here.

This is Bruce, Bhupender. The biggest things are, as we came into the year and as we have gone through the first half, the things that have fallen short or been significantly greater impact from our original expectations have really been Canada and FX rates. And so, Canada has been softer and we expected to see a significant impact to the Greenfield, obviously on the capital side. What we have also seen is, as you know, our MRO and our UE is actually a combination of our baseline business and smaller upgrades and expansions, and we differentiate that at the $1 million and orders of $1 million and below, what we are seeing is that UE component of Canada being very soft as well.

And so that is impacting our incoming order rates. And that is much more flow business that is not typically reflected in the backlog. And so, that has been the bigger part of the decline there which we did not anticipate at this level. And then of course, FX has continued and actually gotten worse since our last earnings call. So those two things are really the largest two drivers for the decline.

Okay, and you know, last question on SG&A line; we saw the number actually move from $18 million-point -- you know, what, it was like $17 million-point to million-point-something this quarter. You are taking calls down from in Canada. Would that be a good run rate to assume in the back half of this year, fiscal year?

Yes, it would. At the time being that would be the guidance we would give on that, Bhupender.

Then $16 million like in the back half of this year. Are we taking cost down more than what we have seen this quarter in Canada?

The majority of the expenses were realized -- expense reductions were realized in the quarter. It could go down slightly, but as Bruce mentioned, we are going to continue to monitor our order intake. And if we have to adjust expenses based on lower orders in the future, we will certainly do that.

Okay, and can you remind us how big Canada right now is in terms of revenue for you guys?

Rough number, it is $60 million.

Okay, and one more follow-up actually. On the capital allocation with the cash you have three acquisitions and where the stock is today going into some revenue headwinds in the back half, how do you feel about share repurchases here?

Bhupender, this is Bruce. Just, you know, as a team we are reviewing all of our options. I would like to reiterate our first priority is to reinvest in the business. We still see opportunities within, in, and around our core markets and our core product lines. We are looking for the best way to deliver shareholder value. I would like to point to the acquisitions we have made thus far, and say they have been a good use of capital. They have been accretive to earnings year-to-date, and that would be our first and primary use. But we are definitely evaluating all options.

Thank you, guys.

Thank you.

Thank you. Our next question comes from the line of Charlie Brady from SunTrust Robinson. Your line is open.

Hey, thanks. Morning, folks.

Good morning.

Just in terms of the project pipeline, I don't know if you quantified, you said there were more projects in the pipeline. Can you quantify number of projects in the pipeline now, or what that delta is versus what it was?

The previous quarter, the number of projects was around -- was 680-something, plus or minus a few. And now, as of the end of this quarter, it was about 715, 720 -- somewhere like that. That was the increase in the number of projects. The total estimated amount of the opportunities was $1.1 billion which pretty much flat from the prior quarter.

Right, okay, thanks. And I guess just could you -- how much was Canada down in the quarter?

In USD?

Yes.

68%.

For the quarter, and this is inclusive of the acquired companies, it was down 55% in Q2.

Including the acquisitions, correct, you said?

Yes, sir.

And including FX headwinds on that?

Yes, that would be a GAAP number as reported.

Do you have it in constant Canadian currency how much it was down?

I do. Let me give you a call on that.

Okay. I will talk to you offline on that. I guess as I look out for the guidance of down, your hypothetical that you put out there, was helpful, but let us assume the down 13 organic. What is your expectation on how much of that -- you have a backlog of -- how much that backlog is going to float through the rest of this year, and really how much of that backlog, does any of it stretch out beyond 12 months, or is it just a full 12-month backlog?

Yes, history would tell us that we burned through the great majority of our backlog in 12 months. There could be outliers that flow into a period beyond that. The majority of that will burn off, or invoice, within the next 12 months -- the great majority.

Are you seeing projects -- did you take anything out of backlog this quarter?

The project pipeline is a dynamic document. It is done on a weekly, or bi-weekly basis. So, it is constantly moving; adding and subtracting as projects come on and off through our system.

All right, fair enough. Thanks.

Thank you. Our next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Your line is open.

Hey, good morning, guys.

Good morning, Jeff.

So if you want maybe on the -- if you are saying organic you are thinking down low double digits, can you maybe speak, bifurcate that to how you are thinking about ERO/UE versus Greenfield from a revenue decline? It seems like first quarter MRO was much more challenged, and now Greenfield has stepped down, so maybe just give us a little more color? Or within the guidance change, how much is Greenfield versus MRO/UE?

For the balance of the year I would go back with the 60/40 number, and recall that our orders in backlog have been up over the last quarter, and that gives us some perspective on getting back to the 60/40 split, MRO to Greenfield.

So that would imply that MRO is under a lot more pressure in the back half to get to the 60/40? Because you know, the front half of the year you have been running more like 64%, and last year you were running 6% in the second half. Is that the right way to think about it?

To get back to the 60/40, yes.

And then that puts a fair bit of pressure on the margins.

Yes, one other component to talk about in there is the UE component resident in MRO. That has lower gross margins, so you have a mix within a mix that will significantly impact our margins.

Jeff -- the other thing that probably adds an additional nuance is, when you look at the Greenfield, a MRO/UE mix, we see a higher amount of construction. I think we called that out. That is also contributing to the lower margins within Greenfield. Those are the dynamics that refer back to what Jay was referring to, the 60/40 model.

So it seems like within all of that 45% -- kind of a step down to 45% -- seems more reasonable as we get into the back half?

Yes, and as we said that would be -- let us call that the low water mark for guidance. And we are doing everything possible to dry that number up.

Okay. Great. And then I think you said you are thinking about 2% organic growth for xCanada?

That is correct.

For the year?

On a full year basis.

How are you thinking about that three months ago?

Well Canada is worse today than we thought several months ago.

Right, the 2% is x Canada. So has anything changed in that 2%? Have you seen weakening elsewhere?

No, no not really.

Okay, and you mentioned the acquisitions, some going better than others. Can you talk about the outliers to the good or bad, and what is driving that?

Not at this time, Jeff. Some of these companies we have had two months, and some just a couple months more than that. So we really need a little more runway to better understand their performance and their capabilities. But, I would tell you that on a margin basis, we are happy where they are at, at this point in time. Their margin percentage relative to EBITDA is quite similar to the corporate average; maybe three or four points off. And we are happy with that at this point.

Okay, great. And final one on MRO. It seems like all of the weakness thus far in MRO has really been more on the upgrade expansion. But what are you seeing on your strict MRO business? Are people destocking? Are people trying to -- as they do -- maintenance repair and being more careful not to rip off the -- and maybe just, how are you seeing things the same or different in MRO?

We are seeing actually, particularly in the U.S. and Europe, our MRO sales are up year-over-year. The real softness in MRO has largely been this Canada, and it is the upgrade and expansion, the capital piece of that, which we believe is most impacted.

Okay. Thanks, guys.

All right. Thank you.

Thank you. Our next question comes from the line of Jon Braatz from Kansas City Capital. Your line is open.

Good morning, everyone.

Good morning.

Most of my questions have been answered, but Jay, you mentioned in your commentary that you reduced the Canadian spending -- I guess SG&A -- by 11%, I think year-over-year. Is that correct?

Yes, let me just get that exact number, okay?

And I guess what I am asking, was that in local currency, or was that GAAP -- a GAAP number?

Yes, what the comment was -- that is a GAAP number, and that was an 11% reduction on an organic spend basis. So that would exclude the M&A component.

Okay. Assuming that Canada does not come back, or stays soft for an extended period of time, what else might you be looking at in terms of further reducing costs and limiting the impact Canada is having? Is there anything more you can do?

Yes. Yes, there is. But right now we have two problems that the business is facing. One is Canada. We believe we have right-sized our spending to the opportunity over the next year. The second is FX. We are always looking to manage costs, and if we see a degradation in other geographies, we will manage costs in those geographies appropriately.

Okay. I do not want you to be a currency prognosticator, but if you -- if the currency -- if the Canadian dollar would stabilize here at these levels over the next six months, does the currency head wind soften a little bit?

Yes, it would -- yes, it would, Jon.

All right. Thank you very much.

Thank you.

Thank you. Our next question comes from the line of Josh Berman from William Blair. Your line is open.

Hi, good morning.

Good morning, Josh.

First thing, can you comment on your outlook for some specific investments you have talked about in the past in terms of the new controller and some other opportunities?

Yes. We do have a number of new product developments in our pipeline. And we would expect those to be launched between the fourth quarter of fiscal 2016 through midyear of 2017.

Great, okay, thanks. And then if you would not mind providing a little more color on the $5 million of savings I think you said from cutting OPX from Canada. Have all those -- have those actions already been executed, and are we going to start to see the impact of that right away? Or is this going to take the full 12 months to realize the savings?

Yes, let me clarify. The $5 million was over the worldwide basis, not just Canada. The majority of those were in Canada. And it was people, discretionary spending, certain facilities that we decided to close, and all of that has been executed. It was executed in the second quarter. You will see a small tale of decreased expenses, but the majority of them were realized in Q2.

Great, thank you.

Thanks, Josh.

Thank you. (Operator Instructions). And that looks like all of the questioners we have in the queue at this time. I would like to turn the call back over to management for closing remarks.

Okay. Once again we appreciate everybody's participation and interest in Thurmon, and we look forward to seeing you on our next earnings call. Thank you.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may all disconnect your telephone lines at this time. Everyone have a great day.