Thermon Group Holdings Inc (THR) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Thermon Earnings Conference Call Q3 2018. (Operator Instructions) As a reminder, this conference call may be recorded.

I would know like to introduce your host for today's conference, Ms. Sarah Alexander, General Counsel. Ms. Alexander, you may begin.

Thank you, Daniel. Good morning, and thank you all for joining today's 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 the call. This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast in any form without the expressed 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 quarterly and annual report filed with the SEC.

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, leverage ratios, acquisitions, acquisition 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 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.

And now it is my pleasure to turn the call over to Bruce Thames, our President and Chief Executive Officer.

Thank you, Sarah. Well, good morning, everyone, and thank you all for joining our conference call today and for your continued interest in Thermon. It's greatly appreciated.

Today, we have Jay Peterson, our CFO, joining me on the conference call. Jay will follow me and present the financial details of our fiscal 2018 third quarter.

To begin with an overview of the financials for the quarter, overall, we are very pleased with the operating performance in Q3. We saw a year-over-year growth in bookings, revenue, backlog and EBITDA in both the organic business and on the acquisition on a pro forma basis.

Focusing first on our organic business. We are seeing improved performance based upon cost reductions and process improvements implemented over the last year that we believe are sustainable going forward. We are also seeing improving in markets in our organic business that led to year-over-year revenue growth of 19% and backlog growth of 26%. We also saw organic margins expand by 100 basis points year-over-year and OpEx trend down on a percentage basis, excluding onetime expenses related to the acquisition.

Now turning to the recent acquisition of CCI Thermal Technologies, which we now call Thermon Heating Systems, or you'll hear referred to as THS. We are extremely pleased with the performance during the first 2 months as being part of Thermon. Our teams on both sides have successfully worked together to, first, stay focused on the customer; and second, make the integration as seamless as possible. Both revenues and profits from this business have thus far met or exceeded the business case during the first 2 months of operation.

The revenues of $16.1 million drove our year-over-year revenue growth to 44% in the quarter, and improved our EBITDA margins on an adjusted basis by 130 basis points.

Moving now to the combined businesses. We saw a book-to-bill of 114%, with organic at 115% and inorganic at 108%. The combined backlog of $168 million was up 26% organically year-over-year, with the new Thermon Heating Systems representing an additional $35 million of that increase. The organic backlog growth was largely attributable to petrochemical and power project bookings in the U.S. and Latin America.

Thermon Heating Systems also saw a 21% year-over-year backlog growth and 10% consecutively, both on a pro forma basis.

GAAP EPS finished at $0.02 a share versus the prior year of $0.16 per share. However, looking at our adjusted EPS provides a much better indicator of the true potential of these combined businesses and a positive impact to the operational improvements made over the last year. Excluding the onetime charges related to the acquisition in U.S. tax reform, adjusted EPS finished at $0.24 a share relative to $0.16 a share last year, representing a 50% increase over the prior year Q3.

In addition, strong cash flows and EBITDA growth reduced our net debt-to-EBITDA from 3.4 at the time of the acquisition to just 3.0 only 2 months later. Jay will cover the impact of the U.S. tax reform and onetime acquisition-related adjustments in more detail.

From a market perspective, the oil and gas sector continues to show early signs of a recovery with increased maintenance spending and moderate capital spending on smaller projects. The chemical and petrochemical sectors remain active with improved bookings in the U.S. and much better visibility for fiscal 2019. Combined cycle power projects remained steady. And looking geographically, revenue was up across all reporting segments with double-digit growth versus prior year in all, but the U.S.

Backlog conversion is improving in the Eastern Hemisphere as shipments began to materialize in Q3 and will continue in Q4.

After a very robust H1 in Canada, we were pleased to see that trend continue into Q3. Greenfield project activity in the U.S. and Latin America also increased as anticipated in Q3, and we saw a strong order growth as customers are beginning to release projects that have been slow to move.

With a positive book-to-bill of 163%, the outlook for the year in the U.S. and Latin America and visibility for fiscal 2019 has significantly improved.

Moving on to our project pipeline. The number of opportunities remain stable at over 800, while the total value within our pipeline has grown to approximately 1.1 billion. We're working to expand this to include the new acquisition. However, the pipeline does not yet include opportunities for Thermon Heating Systems.

Much of this project growth from the prior year is in midstream in chemical or petrochemical projects. We continue to invest in new product development to lead the industry with innovative solutions that create unique customer value and a differentiated position for the business. We'll have more new product announcements in the coming quarters.

The integration of Thermon Heating Systems is progressing as planned. We continue to be impressed with the caliber of the people, the quality of their products and the commitment to superior customer service. We remain on track to meet or exceed our financial objectives for this business. And from a strategic perspective, early feedback from the market has been very positive on that expanded solutions set and the potential revenue synergies, which were not included in the investment returns.

Our M&A pipeline remains robust, but our near-term capital allocation has shifted to debt reduction as the first priority.

Looking forward, the healthy backlog and improving end markets in North America, combined with the increased pace of project execution in the Eastern Hemisphere, provide line of sight to overachieve our organic revenue plans for the year. As a result, we are increasing our revenue guidance for the full year to a range of $258 million to $263 million. Inorganically, we reiterate our guidance of $38 million to $41 million in revenue at 24% to 26% EBITDA margins, bringing the combined total revenue guidance range for the year from $296 million to $304 million.

We're pleased with the improving results and remain cautiously optimistic on the positive signs of recovery we're seeing in many of our end markets. Under the current oil price environment, we see these trends continuing into fiscal 2019. This, in combination with the expanded addressable market represented by the Thermon Heating System acquisition, position the company well for success in fiscal 2019 and beyond.

Thank you again for joining us today. Jay Peterson, our CFO, will now address the details of our financial performance for Q3 fiscal 2018. Jay?

Thank you, Bruce. Good morning. I would like to start by discussing our Q3 financial results and then conclude with updated revenue guidance for the balance of fiscal year 2018.

Starting off with orders and revenue. Total orders for the quarter grew 9% year-on-year on a pro forma basis and 21% sequentially, and we experienced order growth in both our organic business with record orders of $88 million in Thermon Heating Systems. And going forward in this discussion, we will refer to Thermon Heating Systems as THS.

In aggregate on a GAAP basis, our revenue grew from $64.3 million to $92.7 million, and that's a growth of 44%. On a pro forma basis, total revenue grew by 19% with organic growing from $64.3 million to $76.6 million, with all 4 major geographies showing growth in the quarter. For the 2 months since the acquisition, THS grew revenue from $13.7 million to $16.1 million on a pro forma basis, and that's 17% revenue growth.

Our organic Greenfield mix for Q3 was 38% of revenues whereas MRO/UE totaled 62%. And Greenfield revenues increased by 38% over prior year quarter due to a step-up in capital spending, whereas MRO/UE increased by 10%. And FX currency translation positively impacted our revenue in the quarter by approximately $3 million.

Our total backlog grew to $168 million with both organic and THS achieving record backlogs. In addition, organic margins in our backlog are up 3% year-on-year. Our organic book-to-bill for the quarter was positive at 115%, and that's marking our fifth consecutive quarter with a positive book-to-bill. And also, THS had a positive book-to-bill for the quarter at 108%.

In terms of gross margins, our total gross margins increased by 110 basis points to 45.6%. Contributing to the improved margins this past quarter was an increase in higher margin electrical products mix, continued cost management and improved project execution.

Now moving to operating expenses. Operating expenses for the quarter, that is SG&A, and this excludes depreciation, amortization of intangibles and transaction-related expenses, totaled $21.6 million versus $19.9 million on a pro forma basis in the prior year quarter. Onetime transaction-related costs totaled $3.5 million. And in addition, reflected in other income expense, we took a noncash foreign exchange hedging charge of $3.3 million relating to a hedge placed to cover currency impact from the announcement of the transaction to the closure 30 days later, and a second noncash charge of $2.2 million or a currency hedge on the 5-year intercompany loan between our U.S. and Canadian entities. And our operating expense as a percent of revenue was 23%, and again this excludes D&A and transaction-related expenses.

Moving to taxes. Our tax rate for the quarter was 51.5%, and the effective rate was the result of low pretax income of $1.7 million due to transaction-related charges. And relative to U.S. tax reform, we are currently estimating to pay $6.8 million in cash taxes over the next 8 years and a net GAAP tax charge of 800k, and that 800k charge is incorporated in the 51.5% rate I previously mentioned.

Prior to U.S. tax reform, had we decided to repatriate our excess foreign cash, Thermon's tax rate would have been 35%. Post U.S. tax reform, we plan to repatriate excess foreign cash at an estimated tax rate of 26%.

Moving on to earnings. GAAP EPS for the quarter totaled $0.02 compared to a prior year of 16%. And excluding all transaction-related costs and the 2 FX charges, our adjusted EPS totaled $0.24, an increase over the prior year by 50%.

Our adjusted EBITDA grew by 72% in the quarter, and it totaled $21.7 million or 23% of revenue. Organic adjusted EBITDA as a percent of revenue improved to 22%, and that's much closer to our historical levels and what we anticipate to deliver in the future. Adjusted EBITDA for THS totaled $4.6 million or 29% of revenue, and it grew year-on-year by 12.2%. And please see the table in our press release for a detailed bridge from net income to adjusted EBITDA.

Next, the balance sheet and future capital allocation. Our cash balance ended at $52.2 million this past quarter versus $79 million 1 year ago, and the decrease was due to the acquisition of THS. At the time of the October acquisition, our net debt-to-EBITDA leverage was 3.4x, and it is currently at 3.0x. And we believe we can delever the business to a net 2.5x within the next 9 to 12 months, beating our previous October guidance by 1 whole year.

CapEx spending for the quarter totaled $1.3 million or 1% of revenue, and our EBITDA conversion ratio was 96% for the quarter. And based on our ongoing ability to generate cash and the benefit of recent U.S. tax reform, we anticipate making optional debt payments in the neighborhood of $30 million over the next year and an additional $30 million in fiscal year '20, and this will increase our EPS by approximately $0.04 a share in fiscal year '19 and $0.08 a share in fiscal year '20.

Lastly, summary in 2018 guidance. We are quite pleased with the financial performance of our organic business and the THS businesses. Both businesses grew orders, top line revenue and backlog and are well positioned to exit the year with continued momentum. We believe we will finish the year with total revenue in the $296 million to $304 million range, and we are maintaining our previously revenue guidance of $38 million to $41 million for THS. And we will be providing an update on the synergies and cost reductions relative to the THS acquisition during our next earnings conference call, along with guidance for fiscal 2019.

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

(Operator Instructions) And our first question comes from Brian Drab, William Blair.

Jay, I think that you may have just told me that you're not going to answer my first couple of questions, but I'm just going to see what you're willing to share now. So your previous targets for CCI for the last 12 months ended July 31, '18, was $29 million and then $29.3 million and then $31.4 million with the synergies. Has that changed? And did I -- I don't know if I heard you today say that there might be more than the originally planned synergies.

Yes. In terms of what we announced relative to synergies was that there would be $2 million worth of total synergies relating to the acquisition, and we are right in the middle of that as we speak. And we'll be able to provide additional guidance and an update on that at our next call. In terms of the revenue, we are holding to the revenue number that we mentioned back in October. And the range is still at $38 million to $41 million over the 5-month period.

So no update on any of that. Okay.

Brian, this is Bruce. Just real quickly, my comment around the revenue synergies, which were not included in the business case, it's very early. So any impact we might see from that would be significantly out in the future. So we'll keep you updated as we progress.

Okay. And then did you say what -- for the 3 months ended December, for the whole December quarter, what CCI grew? Or I guess I'm going to start calling THS, sorry.

Yes, we actually did, but it was only for the 2 months that they were part of our business. And that -- they grew 17% during that 2-month period.

Okay. And then the tax rate going forward with the new tax policy.

Tax rate going forward, and this assumes -- and we plan to repatriate foreign cash to pay down debt, 26%.

Okay. That's your consolidated -- regardless of repatriation or not, your consolidated effective tax rate going forward is 26%.

Correct.

Okay. And then maybe a question more for Bruce. But are you getting more visibility on some of these petrochem projects, better visibility than you had a few months ago and whether it's orders coming in or just discussions that you're having with some of the oil majors?

Yes, we are. In fact, the bookings in the U.S., which I referenced, the book-to-bill was 163%. The bookings in the U.S. represented 57% of bookings in the quarter -- 53% of bookings in the quarter. We had a very strong incoming order rate there, and much of that is related to these petrochemical projects that are coming in, in 2019 and beyond. So yes, visibility has improved dramatically.

Is that your fiscal 2019 that you're referring to or calendar '19?

Yes, fiscal '19.

Your fiscal 2019.

That's correct.

Okay. And then can you just give us any more detail about what's going on globally, where you're seeing the biggest -- the greatest growth rates or the biggest opportunities whether it's an update on Middle East or Eastern Europe, Russia? Just a little more detail on what you're seeing globally.

Yes. So in the Eastern Hemisphere, the biggest drivers we've seen there are the Middle East and Russia. And the good news there is we've had -- we've been carrying a record backlog in the Eastern Hemisphere this quarter. We really began to see those projects move from backlog to revenue. A lot of those projects had been in engineering for a protracted period of time, and now we're beginning to see that materialize. That had a significant impact on the Greenfield mix in the quarter, and we do expect that going forward. When we look at Western Hemisphere, we've seen a significant improvement in Canada. We think that's going to be somewhat limited by just the price of oil there in Canada, and so we do expect investments there to be more in infill development and SAGD and in infrastructure, some midstream spending. In the U.S., we're seeing a lot more spending in petrochemical and downstream processing so that looks pretty favorable going forward.

Okay. And then just the last one. Is there any reason why we would be more cautious or expect maybe a decline in gross margin sequentially going forward? Or the level we see here, what should we model?

No. If you look -- I would just say as you look forward to the balance of the year, I think, just in a year-over-year comp, we would have exposure of at least 200 basis point improvement in our gross margins in the organic business. So I think that's probably what you should look for. And we have seen stabilization in our margins and backlog at this level, so we should see -- going into 2019, we would expect the margin profile to be similar. And as you know, mix has a big impact on that.

Okay. So 200 basis points better. Just for the slightly finer point on that, 200 basis points better year-over-year is about 44. And you said that's only for the -- and it would be -- that's kind of the floor for the legacy business. And then how do we think about CCI -- sorry, THS blending that up or down?

So we've talked about that business being -- and our forecast there is at 24% to 26% EBITDA margins on that $38 million to $41 million in revenue. And that $38 million to $41 million is for the 5 months of ownership for the full year, so...

But does that mean that -- are you indicating that it blends up gross margin, Bruce?

It has a slight positive effect to gross margin.

And our next question comes from Scott Graham with BMO Capital Markets.

So it looks like the fourth quarter implied sales are organically slower than sort of just taking the midpoint sort of like mid-single-digit-ish kind of thing than they were this quarter. Is that a timing thing? Is that -- did you have such good execution out of the backlog where there was some pull-forward sales on that?

It wasn't pull-forward sales. I would say our revenues -- we'd had some pent-up projects that finally began to shift, and that was a positive impact. We do expect that to continue into the fourth quarter. I mean, as you know, there is some seasonality in the fourth quarter. We expect single -- we expect both our organic as well as the acquisition to show growth, but it may not be the double-digit growth. It's probably more in the single-digit range.

So that would suggest that your -- the guidance, which is truthfully, Bruce, runs a little counter to what you just said that the guidance is perhaps, conservative.

The guidance we gave was revenues to be flat to -- on the organic business to up about 8% in the fourth quarter, and so I think that's consistent with what I just said.

Okay. So the next question I have is on sort of price cost. What are you seeing in terms of materials inflation? And are you able to get -- have you been increasing your prices? And kind of where do you stand on that ratio?

We have seen some material price inflation, mainly in copper. It's the only one that has been of any significance, and we -- but it hasn't had a material impact to our margins, and we believe that we are -- we do have more pricing leverage and can pass that on in the marketplace.

Okay. Would it also be fair to say that with -- inflation in metals seemingly continuing to inflect upward that you guys are either increasing prices now or really kind of at the ready?

I would say more at the ready.

Okay. Two other questions for me. The organic orders in the quarter kind of -- they were, I think, about plus 5. And I know that there was currency in there as well. So again, kind of same tiger, different stripes. Is this a timing issue in the quarter? Is it a comp issue? It doesn't sound like you see -- so anything out there that is giving you more pause than last quarter at all. So what happened to the organic orders number this quarter?

Yes. So I guess one thing to note is this was a record organic booking quarters that -- so -- and last year was the second highest we'd had. This actually beat the prior record. So that's a pretty substantial bookings quarter. If you just look at the run rate on our organic business, we would expect around $70 million a quarter to come in and $88 million is significantly above that run rate. So we feel really strongly, and I'd say we believe that Q3 is actually building more momentum going forward. I think the other thing, the comment around FX goes back to the note that 53% of those bookings were in the U.S. And so on a percentage basis, a lot less of that was international. So the FX impact just, because of the mix, would be less, but I don't have that number for you. So -- but I think the more important factor is that this quarter has built confidence for us going into the balance of the year and in the fiscal '19.

Yes. Understood. Last question, and I think someone was trying to get to this in an earlier question. So your EBITDA margin in CCI was -- my calculation, have it at about 29% in the quarter, which is above the Thermon number. So you indicated that CCI's mix to gross margin was only -- is only a modest positive on a run rate basis. At least that's what I inferred. Would that suggest that the rest of that differential is in SG&A?

Yes. That is correct.

And our next question comes from Charley Brady with SunTrust Robinson Humphrey.

I want to first -- on the marketing G&A and engineering expense, I think you started touching on this just a second ago in response to Scott's question on the SG&A at THS. But that was unusually -- as a percentage of revenue, that was unusually low and a pretty big step down from Q2 into Q3. Was that skewed a lot because now the 2 months you had THS in there? And going forward, when we're trying to model that out as a percentage of the revenue number or even on a dollar value, I guess, should we be assuming that that's -- that percent of revenue ought to be coming down relative to what historically Thermon's done without THS embedded in that?

Yes. There were 2 positive factors. One is, as I just mentioned, THS certainly helps that ratio, that percentage. And also as we have grown the business, we are getting back to the organic OpEx as a percent of revenue that we saw 3 years ago or so when we were performing at record levels. So it's really a combination of the 2.

Okay. That's helpful. And then just on a go-forward basis, I know it's hard on the MRO/UE business to kind of gauge because the duration of that is shorter. But as you look at kind of the incoming orders and kind of what your expectation is, can you give us a sense of -- should we see any kind of meaningful shift in that mix or kind of assume kind of the normal mix we've been seeing? I guess I'm trying to understand because I think there's not anything there to skew it significantly towards Greenfield, but -- or is there?

This is Bruce. Timing on projects can have a significant impact within any specific quarter. And in Q2 of this year, we had less shipments, Greenfield shipments, project shipments. Q3, we saw those increase. If you're to average those out, they still fall around that, the 60-40 range, within a couple of points. So there's nothing going forward that we anticipate would change that significantly, but it's very hard to say with any given quarter just based upon project timing.

(Operator Instructions) And our next question comes from Jon Braatz with Kansas City Capital.

I would look -- going back looking at my notes and on CCI or THS, and THS has a more diversified customer base, I think, than Thermon organically. Are you seeing business improve in a sort of the non-oil and gas markets for Thermon Heating Systems, too?

Yes. It's been fairly broad-based.

Okay. How much -- if you can help me, how much of their business is oil and gas?

About 45%. But the one comment I would make there is they have a lot more exposure to midstream than natural gas, which we're -- we've been heavily focused historically on upstream, downstream and oil. So it does give us more diversification within energy.

Okay. Okay. And then Jay, looking forward, do you see any other -- any additional "onetime cost" that might -- we might see in subsequent quarters?

No, we don't. Nothing of any material nature. One thing I would mention though is as we delever the business, there will be some noncash charges for prior debt issuance costs that will be burned off you, if you will, on an accelerated basis as we accelerate the optional debt payments. Other than that, from this last transaction, we think we have incorporated 95% to 98% of them. Nothing of any materiality.

And I'm not showing any further questions at this time. I would now like to turn the call back over to Bruce Thames for any further remarks.

All right. Thank you again for everyone joining the call today. We appreciate your interest in Thermon. Have a very good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.