Thermon Group Holdings Inc (THR) 2022 Q3 法說會逐字稿

Greetings, and welcome to the Thermon Group Holdings Third Quarter 2022 Earnings Call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn the conference over to our host, Kevin Fox, Chief Financial Officer for Thermon Group Holdings. Thank you. You may begin.

Thank you, Diego. Good morning, and thank you for joining today's fiscal 2022 third quarter conference call. Earlier this morning, we issued an earnings press release, which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our website. Additionally, the slides for this conference call can be found on the IR website under News Events, IR Calendar, Earnings Conference Call Q3 2022.

During the call, we will 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.

I'd like to remind you that during this call, we may make certain forward-looking statements regarding our company. Please refer to our Annual Report and most recent quarterly report filed with the SEC for more information regarding our forward-looking statements, including the risks and uncertainties that could impact our future results. Our actual results may differ materially from those contemplated by these forward-looking statements, and we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

Now I'd like to introduce Bruce Thames, our President and Chief Executive Officer, for his opening remarks.

Thank you, Kevin, and Good morning. We hope everyone listening is staying safe and in good health. We appreciate you joining our conference call and for your interest in Thermon. Kevin Fox, our CFO, is here to provide additional details on our Q3 financial performance following my remarks.

Before we get started, I'd like to take this opportunity to recognize Rene van der Salm, our Senior Vice President of Manufacturing for his 20 years of service. During his tenure, Rene has been an important part of Thermon, and has played an instrumental role in many of the Company's achievements. He will be stepping down, as of February 15th, but will assist in the transition through the end of April.

At the same time, we are also excited to have Roberto Kuahara join the team as the new Senior Vice President of Manufacturing. Roberto brings a wealth of knowledge and experience in international manufacturing operations, 6 Sigma, the Toyota production system and operational excellence. Moving forward, he will be instrumental in expanding the capabilities and competencies within the senior leadership team that are needed to execute our strategy.

I'd like to now turn to Slide 3 and the third quarter results. There are a lot of positive things we're seeing across the business this quarter, highlighted by growth in the top line, net income, bookings and backlog. We saw solid execution by the team in the third quarter with strong top line growth, as we see end markets continuing to recover.

Revenue for the quarter was $100.6 million, up 26.4% over prior year, with growth largely driven by North America. In the Eastern Hemisphere, the market recovery has lagged in a more challenging business environment, particularly in Asia due to COVID-19 restrictions in many countries.

Net income of $11.3 million was up 82.3% over the prior year quarter, also showed strong growth. Adjusted EBITDA of $20.6 million was up 11% over prior year, as supply chain challenges persisted contributing to higher input costs. With gross margins finishing at 40.5%, a large onetime project was dilutive in the quarter by approximately 250 basis points. Prices had a positive impact of 200 basis points, and we anticipate further price realization in the fourth quarter of this year.

Inflation was a 300 basis point headwind as both labor and material costs continue to rise. The team has been very adept at navigating supply chain disruptions, which we believe have peaked in Q3 and appeared to be improving in Q4. However, we see continued risk in both the availability of labor and material through the middle of the calendar year. The team has also done an excellent job around managing costs with SG&A at 19.2% of sales for the quarter and trending below the projected run rate for the year.

GAAP EPS and adjusted EPS were $0.33 per share and $0.37 per share, respectively, with adjusted EPS up 23.3% from the prior year quarter. Our commitment to investing in our 3 long-term strategic platforms remains steadfast, and I will address these in more detail later in our call. We continue to see a strong broad-based recovery in our end markets. As a result, for the third consecutive quarter, we are raising full year revenue guidance to $342 million to $350 million.

Turning now to the external environment and our end markets on Page 4. As we look across our geographies and end markets, we see activity in certain areas approaching pre-COVID levels, but we also see additional room for further recovery in Q4 and throughout fiscal year '23 as other areas lag. As we look on the chart on this page of the presentation, I would like to reinforce a couple of key points. First, roughly 52% of our end markets are outside of the oil and gas sectors. Second, greater than 55% of our end markets are tied to chemical, petrochemical, natural gas and power. With natural gas as a bridge fuel and the chemical, petrochemical and power markets being driven by the emergence of the middle class and developing economies, the growth outlook across these sectors is much more robust than upstream oil, which now represents just 16% of our revenues.

The chemical and petrochemical sector has shown a nice recovery in maintenance spending year-to-date, and we are seeing capital projects that had been shelved now moving forward. In the power sector, bookings were up 60% over prior year, led by activity in the Texas Gulf Coast following Winter Storm, Yuri. We continue to win business in the rail and transit sector with bookings up 20% over the prior year quarter. We also have a line of sight to several multimillion-dollar transit opportunities in this space.

As we look to strategic adjacencies, Thermon is well positioned to play a key role in the energy transition. From wind power to biofuels to hydrogen power, our solutions are critical to safe, efficient and reliable operation. While nascent, hydrogen power is particularly exciting with many opportunities for both blue and green hydrogen processing in our pipeline today.

Moving on to Slide 5 of the presentation. On a trailing 12-month basis, orders finished at $360 million, a level not seen since Q4 of FY '20. During the current quarter, orders of $90.2 million grew 27% over the prior year period, but were down 25% sequentially due to a large onetime project secured in Q2. Backlog is up 32% year-over-year, and book-to-bill finished the quarter just above 1% when adjusting for the impact of the onetime project. As a note, we have had a positive book-to-bill in 6 of the last 8 quarters.

I'd like to now hand it over to Kevin Fox, our CFO, to provide a more detailed review of the third quarter and year-to-date financial results. Kevin?

Thank you, Bruce. We had another great quarter on the top line on Page 6. Revenue was up 26% versus the prior year quarter and up 12% on a trailing 12-month basis. The current quarter's revenue includes less than $1 million of benefit from foreign exchange. Revenue growth was driven by both the U.S., Latin America and Canada regions, with strong materials growth due to an increase in maintenance spending, concurrent with the easing of COVID restrictions. We continue to see companies in the U.S. Gulf Coast making investments to improve infrastructure, especially power infrastructure after both the winter storm and hurricanes from the last year. The U.S. also benefited from the impact of the large onetime contract we mentioned last quarter with almost $9 million of revenue booked in the period. We will provide these revenue figures for comparability purposes, given the size and nature of the contract.

In the Eastern Hemisphere, both EMEA and APAC declined due to the continuing impact from the pandemic and the slower recovery in certain countries. In both regions, our project business has been more impacted than material sales. On a TTM basis, revenues are up 12% as we pass the inflection point into year-over-year growth. We are realizing the impact of price increases put in place in the second half of 2021. And as a reminder, those are most applicable to our materials business. Pricing had a positive impact of about 200 basis points overall, with the impact accelerating from the first half of the fiscal year, which is a trend we expect to continue in the fourth quarter.

Reported gross margins in the quarter were 40.5% versus 46.4% in the prior year period. If we exclude the impact of the large onetime contract, margins would have been 43%. So currently, the contract is about 250 basis points dilutive. Pricing was a positive impact of 200 basis points on gross margins, and we expect the accretive impact from pricing actions to continue through the year.

The global supply chain challenges continue to impact our business through higher input costs, extended lead times or limited availability of raw materials and inconsistent labor availability. The cumulative impact of those factors on manufacturing productivity was approximately 350 basis points in Q3, slightly higher than anticipated as those headwinds persist.

Finally, we have the combination of a significantly decreased benefit from the Canadian emergency wage subsidy that was reported in COGS this year versus last, plus the different margin mix within projects revenue that had an impact of approximately 200 basis points versus prior year. The team continues to diligently work with our customers and suppliers to navigate the challenging environment in our industry. While we expect certain input cost headwinds and the availability of qualified labor to continue to pose challenges, the pricing actions we've taken will help offset that impact in the P&L.

Now on Page 7. I'll continue to focus on the over time versus point-in-time revenues and once you confirm we will no longer be disclosing the MRO/UE 12:14 framework in fiscal '23. As a reminder, the new metric includes 100% of our revenues, whereas the previous construct only incorporated the legacy heat tracing business. We believe this is a more accurate representation of the 2 unique revenue streams and since it is derivative from GAAP revenue recognition standards is also a more robust framework than the previous MRO/UE disclosure. Historical information remains available in our SEC filings for comparability.

Revenues recognized over time are generally represented of project work, where we have engineering and installation services, whereas point-in-time revenues are more aligned with product or material only sales. Over time, our project revenues represented 41% of total revenue this quarter versus point-in-time or material revenues of 59%. Excluding the large onetime contract, this split was 36-64 versus 35-65 than the previous year.

Point-in-time revenues grew 25% in the quarter and 29% on a year-to-date basis, which again highlights the strong increases of our customer maintenance spending and viewed over the longer term is a representative of the value of the global installed base of our business. We will continue to provide the greenfield versus MRO/UE mix through the end of the year, which was 39% greenfield and 61% MRO/UE versus 36% and 64%, respectively, in the prior year.

On Page 8, for this SG&A metric, we deduct depreciation from the SEC reported selling, general and administrative expenses. In the quarter, SG&A was $19.3 million or 19% of revenues. On a run rate basis, we are below our target of approximately $80 million that we projected at the start of the year. The team continues to execute on our investment plans, while managing controllable spend. We started the process of funding our strategic initiatives for diversification, technology-enabled maintenance and developing markets, and we will continue to build our product development road maps for the heat tracing and process heating lines.

Adjusted EBITDA was $20.6 million or 20.5% of sales. This includes a deduction for our Canadian Emergency Wage subsidy of $200,000, and we do not believe we will have any additional benefits from this program. Adjusted EBITDA is up $2.1 million from the prior year due to increased volume and pricing, but offset by the items we've previously mentioned that impacts the cost of sales. GAAP EPS was $0.33 per share, an increase versus prior year of $0.18 and adjusted EPS was $0.37 per share versus last year's $0.30.

On Page 9, the balance sheet continues to trend in the right direction, as we manage the growth of our business. Cash is down $17 million year-over-year as we've paid down debt and improved our global cash management processes. You can see the impact on our total debt with a 22% reduction versus prior year, resulting in net debt to adjusted EBITDA of 2.2x. We expect this to further decline to approximately 1.5x by the end of the fiscal year, excluding the impact of any potential acquisitions. The M&A pipeline remains robust, and we have ample capacity under our new debt agreement to execute when attractive opportunities are available.

Net working capital is down $4 million year-over-year or 6 points as a percentage of revenue. The cash conversion cycle is down to 130 days, a year-over-year improvement of over 60 days. This is a great result given the external environment, especially around suppliers, and we're focused on continuing to improve the cash flow of our business.

We continue to generate positive quarterly cash flows with free cash flow of $2.6 million in the quarter, as we invested in the net working capital, along with the growth of our top line. CapEx was only $700,000 and predominantly focused on maintenance, and we will likely see incremental investments in our strategic initiatives in the quarters ahead. Overall, another good quarter of financial results, as we continue to grow the business. I'm pleased with the top line performance and expect we will continue to see price realization in our fourth quarter. The global team continues to respond to rising input and transportation costs, while keeping our facilities operating safely and delivering for our customers.

Our balance sheet is strong, our technology is winning in the market and our people make a difference every day. I want to say a special thank you to our employees across the globe for their commitment, and all the fantastic work they are doing for our customers and shareholders.

And with that, I'll turn it back over to Bruce for an update on the progress we're making with our strategic initiatives.

Thank you, Kevin. I'd like to turn now to Slide 10. The team is making progress in advancing our 3 strategic platforms to achieve our goal of $550 million in revenue by the end of fiscal 2026, while driving operational excellence to achieve EBITDA margins in the low to mid-20% range.

Beginning with the developing markets, the team has built a detailed analysis by customer and end market identifying the specific needs by country or region. We've established an initial localization road map that would be instrumental in growing share in these emerging economies. On our next call, we'll provide more on our plans for fiscal year '23 to meet local requirements, market lead times and regional price points.

While we have seen a delay in the overall market recovery in the Eastern Hemisphere, we believe there is pent-up demand that will return as economies emerge from COVID restrictions. We continue to advance our diversification of end markets in the quarter as well. Recently, we have added a new business development manager for rail and transit and have launched a new Hovey Hellfire Blizzard Duty rail switch heater that has been well received by our Class I rail customers.

We've also launched our zero halogen, low-smoke commercial heat tracing cable that is gaining momentum, particularly in Europe. Based upon the feedback from our channel partner, we expect sales to double in the coming year. During the quarter, we have secured wins in 2 data centers for our commercial products. And finally, we've launched the marketing campaign in food and beverage that is yielding early results with key wins in some new applications. As you prepare to watch the Super Bowl next weekend, you may be interested to know that Thermon plays a role in providing those much-needed game day essentials with 1.1 million in orders for potato chip, dressing and food oils and brewing production operations.

Our third strategic platform, technology-enabled maintenance continues to gain momentum in the marketplace. The Genesis Network, a self-healing mesh network that enables centralized control, has been successful in early customer pilot programs. The quote backlog is growing and early adopters are seeking to expand the installations across their operations. We also have new product introductions to augment this solution set that will be announced during the first half of fiscal year '23.

Looking forward to -- on Page 11, we are very pleased with the continued momentum we are seeing in our business. The Thermon team has done an excellent job in positioning this business for success during the recovery and in the energy transition that is underway. Thermon solutions are mission-critical in the majority of the adverse end markets we serve. We see additional recovery in our traditional end markets in Q4 and throughout fiscal year '23 that will be augmented by our efforts to grow and expand our addressable markets. As a result, for the third consecutive quarter, we are raising our full year revenue guidance to $342 million to $350 million from $330 million to $345 million, representing 24% to 27% year-over-year top line growth.

While input costs continue to be a headwind on EBITDA margins, we anticipate some of these costs to be transitory and that our operational excellence programs will drive productivity gains combined with price increases to mitigate the residual impact over the next several quarters to further expand EBITDA margins. I'm personally excited about the opportunities that lie ahead. We have a resilient business model that generates strong cash flow at attractive margins. a very capable team, a sound strategy and recovering end markets that position us well to create shareholder value over time.

With that, I would like to hand it back over to our moderator for the Q&A portion of our call.

(Operator Instructions) Our first question comes from Jon Braatz with Kansas City Capital.

A couple of questions. Bruce, can you tell me what may be the opportunity that may be in front of you in your Eastern Hemisphere Asian markets? I know the markets have been weak there, but how much maybe the pent-up demand, new capital projects, how significant can that turnaround be when it happens?

As I look at that, Jon, I see it much the same as what we're now experiencing in the West. And I don't want to -- I don't want you to walk away the impression that there's no -- not additional lift that we can see in the Western Hemisphere, as well in North America, particularly. But yes, in the East, I would expect that recovery to look very similar. I'm certain the demand is -- there is pent-up demand there. We look at our business in Asia. It's even off a bit from last year.

So when I look at kind of where we were previously, I see easily 15%, 20% opportunity just in growth and recovery. In EMEA, in Europe, Middle East, Africa, I would say it maybe is more in the 10% to 15% range, but certainly some nice additional growth opportunities in the East. I also see additional running room here in the West as well.

Sure. Sure. Okay. Okay. And Kevin, how much of the -- that large project remains to be filled?

Yes, Jon. So I think we've done almost $12 million year-to-date, if you think, a little under $9 million this quarter and it was a little under $3 million last. We think it's going to be probably north of $20 million for the year. So we're a little over halfway through that contract right now.

Okay. Still so -- still some margin headwinds in the fourth quarter?

Yes, sir, correct.

Okay. And then, obviously, you did a very well -- very good job in terms of managing the SG&A expenses. Are there anything unusual in there that might come back a little bit? Or are these -- you view these -- this ratio sort of more permanent and will be with us for some time?

Yes. Jon, I think more of the latter, if you think maybe roll back the clock a year or so when we -- we obviously had to take some actions on the base cost, the intention was to get the business to a place that on a more permanent basis is starting to look like what it looks like today essentially. There should be some operating leverage in the business, as we continue to grow. But that SG&A as a percentage of sales in the, call it, the low 20s, I think, is a place where we can get to on a more permanent basis. Not there yet on a year-to-date or trailing 12-months basis. But I think the future of SG&A, as a percentage of sales is more representative of today than what it's been 6 months, 12 months, 18 months ago.

Our next question comes from Brian Drab with William Blair.

Congratulations on the continued recovery here and the execution. Just first, looking at Slide 6, I was wondering -- and I think you just answered part of this question, but with these gross margin headwinds that you called out on Slide 6, the contract, the supply chain, emergency wage subsidy. Can we just talk a little bit about the duration of these headwinds? I guess the onetime contract is going to fall off after a couple of more quarters? And how are you looking at that?

Yes. Brian, this is Bruce. So the contract will largely -- will be completed with the bulk of it by the end of this fiscal year. So while it's accretive to EBITDA, it is dilutive to gross margin. So that will be falling off. When I look at some of the cost increases that we've incurred here in the supply chain and the labor cost increases, as I've used some of these, I believe they're transitory. I think some of these are commodities. I think in other cases, there's been a shortage of supply, and there's been some price gouging, particularly in electronic components. I think as supplies return, those will normalize. So I think we'll -- we'll see that come back.

I do believe the labor costs are here to stay, and I think there's probably some of the material price increases that will get locked in as well. So I expect that to probably be middle of the calendar year. My glass ball is no better than yours, but -- but I do expect to see some of that come back in line. And -- and as I said earlier, we have additional pricing realization we expect during the fourth quarter, and we're certainly evaluating our opportunities to selectively increase price going forward, where we see some of these residual cost landing and we need to get more price in the market.

Got it. So just kind of building on that, as you look at -- to the fourth quarter and next year, can you give us any more like directional guidance around gross margin. This fiscal year, it's averaged -- I know there's a lot of factors here, but it's averaged like 38.5% for the first 3 quarters. And I guess, directionally, I think you tell us it should be going up. Can you give us any sense for -- as we look forward to the next fiscal year? What's the normalized level that you think you can shoot for?

Yes. What I would expect, because of the -- some unusual onetime expenses and the dilution of this onetime project and some of the headwinds we've seen, I would expect margins to be in the low to mid-40% range in the coming year. And some of that will depend on -- obviously, depend on mix and how strong the capital projects come back in the coming year. And so that will have an influence. Obviously, my expectation that if it we're on the lower end of that, we would see a stronger capital cycle, which would be positive for the top line.

Got it. Okay. And then, Kevin, you talk -- talking about OpEx in terms of percentage of sales kind of longer term, I just want to get a little help, if I could, on modeling this in the more near term, though. It's been -- the run rate for -- we look at it on an adjusted OpEx basis. So I hope my numbers kind of line up with how you can think about it. But I think $28 million was kind of the old run rate, plus or minus. Now we're like at $23 million last couple of quarters. Is this where you'd guide us to kind of -- is that sustainable for the -- through the next 4 quarters or 5 quarters here? Is that where we're going to be?

So yes, I guess, Brian, the first thing is kind of the jumping off point here of about -- we've talked about the target of around $80 million for this year. That excludes the depreciation. I think that's probably the $2 million to $3 million a quarter. That's the delta between your $23 million and maybe our $20 million. But as we think about the base cost of the business, profitable growth and operating leverage is the name of the game here. So we're going to be trying to calibrate those investments that we're making in the business, whether that's around our strategic initiatives, clearly thinking about the labor force and making sure we've got qualified safe people, who can be running the plants and everything around that nature. But we do expect there's significant operating leverage in the business.

So if the top line is growing by 5%, 10%, 15%, we think the SG&A number is going to be growing at a rate that is below that to create that improved profitability in the business. So probably too early to talk about specific numbers for fiscal '23, but we certainly expect that as the business is growing, that the energy transition is kind of taking a hold, we are going to have to invest in those strategic initiatives that is going to drive incremental cost, but the balance here is going to be to do that in a way, where we're managing profitable growth at the same time. So I don't really want to put a dollar against it right now. We can probably come back to that when we talk about fiscal '23 here in the next quarter. But that's generally the conversation we're having with the leadership team and the Board.

Got it. Okay. And then -- and what -- I can't believe it's already been 4 years since you acquired CCI. And I was wondering if you could just talk about -- what -- as you're seeing the recovery in your business, are you seeing that in both the, you know, what -- I guess, what you call, Thermon Heating Systems and the legacy business? Or is one performing better than the other?

Yes. Brian, this is Bruce. Actually, if you'll recall, that business, the process and environmental heating product lines, they actually -- they actually lead heat tracing kind of in the recovery they did in the last, and we're seeing the same thing here. So we actually are seeing a stronger and earlier recovery in the process and environmental heating, and we expect the heat tracing business -- it's -- the heat-based tracing business is recovering as well, but it's lagging by 6 months or so. So it's what has historically happened. It's what's happening now. So we feel good about that business and where it's going. And it's also a leading indicator of what we can expect in the legacy business.

Right. And can you say anything about what the margins are today in those businesses relative to one another?

Kevin, do you want to comment on that?

Yes. Precisely, just like relative, just like, it's one higher than the others, so...

Yes. Brian, I think relatively, the THS business has always been viewed as slightly accretive versus the core. I think that trend has continued through the course of the acquisition. So I wouldn't say there's been any fundamental shift on the profile of the business between the 2 with the process heating being a little more attractive on the balance versus heat tracing.

Yes. It's more material sales than the project sales, which tend to be dilutive on the heat tracing side.

Okay. And then just last question, I'm just curious on the slide, where you showed that 16% of revenue from upstream oil. How does that break down these days between oil sands and nonoil sands?

The bulk of that...

If you can (inaudible), yes.

The bulk of those revenues are actually in Canada and Eurasia, in colder climates. It's not all, but I would say at least 80% or more.

Yes. And then -- and so that's still -- I mean you're still generating revenue in the oil sands. The oil sands not talked about as much anymore really. Is that a lot of MRO business from previous [assets].

It is a -- yes, it is a very solid recurring revenue stream in MRO/UE. And it's -- I could go back and it's $50 million a year, largely material sales in Canada that are linked to some of those end markets. They continue to operate and produce and they've got to maintain those assets.

And that's still relatively higher-margin business, isn't it, with the...

Yes, very nice...

Self-healing cable -- self-regulating cable?

Absolutely.

Thank you. And ladies and gentlemen, there are no further questions at this time. I'll turn it back to Bruce Thames for closing remarks.

Well, I'd like to thank everyone for their interest in Thermon and for joining. I'd also like to just take a moment and thank our employees around the globe that each and every day serve our customers and are focused on creating value for our shareholders. I appreciate your interest. Enjoy the rest of your day.

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.