Earnings Call Transcript - THR Q1 2021

Operator, Operator

Greetings and welcome to the First Quarter Fiscal 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Kevin Fox, Vice President, Corporate Development. Thank you. You may begin.

Kevin Fox, VP, Corporate Development

Thank you, Maria and good morning, and thank you for joining today's fiscal 2021 first 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. 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. Before I turn this call over to Bruce, 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 recently filed Quarterly Report 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. With that said, I'll ask Bruce Thames, our President and CEO, to begin with his opening remarks.

Bruce Thames, President and CEO

Kevin, thank you and good morning. We hope everyone listening is staying safe and in good health. We appreciate you joining our conference call today and for your interest in Thermon. Jay Peterson, our CFO, is with me and will provide additional information on our financial performance following my remarks. Since our last update in June, the Thermon team has remained focused on the safety and security of our employees, customers, suppliers, and the communities in which we live. As a supplier to critical infrastructure, we have remained open for business and have continued to focus on supporting our global customers. We have experienced temporary facility closures due to local or regional restrictions in locations such as India and Russia during the quarter, although both of these locations have begun to see an easing in restrictions and are now operational. As we look across the globe, many of our teams in Asia where the virus first struck have begun to resume more normalized business activities where the virus has been controlled. We view this as a positive sign of what we may expect in the West as the virus is contained. In many of our other locations, we continue to suspend business travel, work-from-home where possible, and follow the applicable WHO and CDC protocols. I would like to thank our Thermon employees around the globe for their commitment to our customers and our shareholders through these challenging times. Our employees are incredibly resilient and have quickly adapted to a new way of working. I especially want to thank our frontline employees that have continued to be on-site serving our customers each and every day throughout this pandemic. Their demonstration of our core values of care, commitment, and collaboration as well as our industry-leading safety performance is both admirable and appreciated. With the uncertainty surrounding this pandemic, our team has remained focused on value preservation and cash management. The team took decisive actions to reduce SG&A by $16 million in the fiscal year and just over $17 million on an annualized basis. Over 75% of these reductions are structural and will provide added leverage to the business when we emerge from this crisis. In addition, we have performed extensive modeling to project cash flows and understand debt covenants through a wide range of scenarios. This has given us confidence that we will be able to generate cash and manage the balance sheet with an approximately 40% decline in revenue using very conservative margin and working capital assumptions. As we progress through the year, we will continue to manage our cost structure to align with the level of incoming business. I would like to turn now to our first-quarter results. Our Q1 results with $56.8 million of revenue and $1.4 million of EBITDA were in line with our expectations for the quarter. Revenue was down 35% on a constant currency basis, while adjusted EBITDA was down 88%. Gross margins for the quarter were 42.4%, an improvement of 190 basis points over prior year and in line with our prior quarter. We benefited from the receipt of Canadian Wage Subsidies, which we anticipate will continue through December as an offset to volume variances in our Canadian manufacturing operations GAAP and adjusted EPS were negative $0.18 and negative $0.11 during the quarter driven by lower volumes attributed to the COVID-19 lockdowns around the globe and the OPEC+ dispute between Saudi and Russia that have led to an unprecedented oversupply of oil globally. Our bookings for the quarter were $61 million, which were down 27% from prior year, but our book-to-bill of 1.07 was positive for the second quarter in a row. During the quarter, we saw destocking in the channel with our distributors and representatives that was above and beyond our normal seasonality. We also saw weakness in our MRO business due to safety measures our customers have implemented in an effort to prevent the spread of the virus. Many have suspended project-based maintenance activities to limit the number of contractors on-site and manage cash. We've also seen deferrals and turnarounds that were originally planned for this fiscal year. We anticipate this will result in pent-up demand for these products and services similar to what we experienced in fiscal year 2018 following the last downturn in fiscal year 2016. April was the weakest month in our quick turn business and we saw modest sequential improvements in both May and June. Backlog of $110 million was down 1.5% from prior year, but grew sequentially 4%. We saw backlog growth of 19% in our environmental and process heating product lines driven by a multiyear transit project and globalization efforts in the Eastern Hemisphere. We were pleased with our cash from operating activities of $3.4 million during the quarter, which was essentially flat over prior year and we see additional opportunities to generate cash from the balance sheet going forward. Geographically, we see bright spots in Asia that are more than offset by weakness in Europe and North America due to COVID-19 restrictions currently in place. Turning now to a discussion of our end markets, our current end market exposure to oil and gas is approximately 55% to 60%. Since the last downturn in fiscal year 2016, we have repositioned the business such that upstream represents approximately 14% of fiscal year 2020 revenues, about half the percentage we saw in fiscal year 2015. In addition – with the addition of the environmental and process heating product lines, we have much greater exposure to natural gas and downstream petrochemical than in the past. In response to this dual black swan event resulting from the pandemic and the OPEC oversupply of the oil market, we are seeing capital budgets being cut by 20% to 30% or more, with the bulk of those cuts by independent oil companies focused on upstream investments. The downstream capital budgets have been less impacted, but we are seeing numerous projects being delayed, or indefinitely postponed. We anticipate that this will directly translate into lower greenfield bookings in the coming quarters. We are seeing some signs of stabilization in the oil market. After May futures contracts went negative, prices have rebounded to around $40 a barrel. EIA reports show a global inventory build through April and May that fell below initial projections. In June, there was an inventory drawdown due to improving demand, adherence to OPEC curtailments and falling U.S. production. Looking forward, the EIA is forecasting global inventories to steadily decline to more normalized levels by the second half of calendar 2021. Although, there are many factors on both the supply and demand side of this equation, this scenario would result in a tightening market with oil prices forecasted to average in the $50 a barrel range during the next calendar year. In contrast to oil, natural gas demand has been less impacted by COVID-19 lockdowns. A sharp decline in industrial demand related to plant shutdowns has been the biggest driver during the quarter. This demand, combined with a warm winter has led to higher global inventories. However, the market is anticipated to recover more quickly than oil with the EIA forecasting global demand in calendar 2021 to be at or near 2019 levels. Demand growth during 2025 – or up to 2025 is anticipated at a 1.5% compounded annual growth rate, driven in large part by Asia and industrial demand growth. Downstream refining and petrochemical is our largest end market at 42% of revenues in fiscal year 2020. Refining has been most impacted in this sector due to the sharp decline in transportation fuel demand beginning in March. April appears to have been the bottom, followed by a slow recovery in demand in May and June. With the outbreaks of COVID-19 around the globe, recovery in demand will be slow and protracted, particularly in jet fuels. Demand for petrochemicals has been less impacted and continues to have a positive mid-term outlook for growth through 2025. As restrictions are lifted and demand recovers, we expect budgets to be released and deferred spending to follow, with maintenance budgets recovering first and capital spending emerging later. We anticipate the petrochemical markets to recover more quickly as the overall economy rebounds. Looking now at the midstream sector, it is much better positioned to weather the current economic environment with a number of LNG projects in various stages of planning and execution. LNG demand is anticipated to grow at a 5.8% compounded annual growth rate through 2025, due to demand growth in Asia. The chemical market, representing 21% of our revenues has experienced a slowdown in maintenance spending due to COVID-19 restrictions. These end markets are wide-ranging and include agriculture, paint, polymers, etc., which are expected to recover more quickly as restrictions are lifted. Forecasts show these markets growing at a 3.5% compounded annual growth rate through 2025. Power and renewables markets, which represent approximately 6% of revenues have suffered a short-term impact and should continue to offer steady opportunities in the mid-term as industrial demand recovers post-pandemic. And while much of the coal-to-gas conversion has occurred in the West, Asia is now in the process of making this transition. Transportation, representing 3% of revenues in fiscal year 2020 continues to offer an opportunity to diversify end markets. After securing a large order in light rail in Q4, we secured another large transit order representing a multiyear opportunity that we will expand the installed base in the U.S. and Canada. Turning now to our investments in research and development, since 2015, Thermon has more than doubled our annual investments in research and development, and we anticipating spending at approximately 2% of revenue per year going forward. We have invested more than $25 million in our R&D efforts since 2015, and those solutions have generated an estimated $41 million in gross profit over the last three years. Recent investment dollars have been focused on extending our industry-leading performance in heat trace, developing enhanced software and control solutions; and finally, reducing product costs to improve margins. Looking forward, we expect to announce a major release in the coming months that will extend our technology lead and connected controls. This new solution will enable our customers to monitor operations in real time, improve safety and reduce costs through data analytics. These solutions come at a time when the world and our customers are looking for smart solutions to evolve how they operate in a post-COVID-19 environment. Given the backdrop and near-term uncertainty in our end markets, we are focused on managing those things that are within our control. First, a primary concern is the safety of our employees and customers. Second, we are committed to actively managing our cost structure to the level of incoming business. Some of these controls are temporary. However, the greater percentage are structural and will provide operating leverage when demand recovers. Third, we're committed to our continuous improvement program to drive a 1% reduction in the cost of goods sold on an annual basis going forward. This fiscal year, our initiatives have targeted $3.9 million in savings to be realized during the fiscal year. While these savings will be instrumental in offsetting volume variances this year, they will offer opportunities to grow gross margins in the future. Fourth, we will manage our cash to ensure a healthy balance sheet and a near-term focus on debt repayment. We have significant opportunities on the balance sheet to continue to generate cash this year and beyond. In fact, our ability to generate cash during these unprecedented times is one of the great strengths of this business. Fifth, we will continue to fund opportunities for organic growth through the introduction of new products, capitalizing on our installed base and globalizing our environmental and process heating product lines. Executing on these five priorities will position the business to perform during this downturn, and more importantly, profitably grow as our end markets recover. Now looking forward, given the current level of uncertainty, we do not intend to reinstate formal guidance for fiscal 2021 at this time. We do believe that Q1 represents the low watermark for the year due to COVID-19 restrictions that were in place combined with the normal seasonality of our business. With July bookings down 33% from prior year, we believe that there should be a modest improvement in Q2 with revenues that will be in line with this incoming order rate. It is important to note that Q2 of our fiscal year 2020 was a record revenue quarter, and would be a difficult comparison under any circumstances. During the quarter, the cost-out actions we have executed will begin to moderate the impact of lower volume on adjusted EBITDA margins and we anticipate that our reduced CapEx budget will also contribute to a positive free cash flow for the year. We will continue to monitor the overall business environment and provide updates as markets evolve and visibility improves. As we look ahead, I want to emphasize the strength of this business model and our ability to generate cash through the cycle. We have a talented team that remains committed to serving our customers and creating value for our shareholders. By focusing on the priorities outlined, Thermon is well positioned to control cost, manage the balance sheet while generating cash, driving continuous improvement and investing in organic growth opportunities. We will emerge a stronger, more profitable business as our end markets adjust to the next normal. I'd like to pause here, and hand it over to Jay, for a more detailed review of the financials.

Jay Peterson, CFO

Thank you, Bruce. Good morning. As we highlighted in our last call, as we face the challenges presented by the COVID virus and the disruption in the global oil market, our focus has been on value preservation. And during the quarter, we recorded $2.9 million of severance cost related to the cost-out actions outlined in June. This reduction in force, among other cost reductions, will reduce SG&A by $16 million in the fiscal year. And we believe approximately 75% of these reductions are structural in nature and will provide incremental operating leverage as growth returns. Also during Q1, our Canadian subsidiaries qualified for and received a $2.4 million benefit from the Canadian Emergency Wage Subsidy program. And approximately $1.7 million of this benefit was recorded under cost of sales while the remainder impacted SG&A. And while we face significant challenges in our P&L related to COVID-19 and the decline in oil prices, our balance sheet remains strong and our cash and investments balance at the end of June improved to $48.2 million. And also, we generated $1.3 million in free cash flow during the quarter. And we have access to a $60 million revolver line of credit, subject to a consolidated leverage ratio of 4.5:1 that steps down to 3.75:1 in December of this year. In June, we were able to amend our revolver credit agreement from a gross debt basis to a net debt basis, providing measurement credit for all cash on hand in excess of $20 million, affording us additional liquidity as we manage through these difficult times. Our CapEx spend, for the first quarter, totaled $2.1 million inclusive of both growth and maintenance capital. We expect fiscal 2021 CapEx to be $4.0 million. Our net debt to EBITDA ratio is currently at 2.5x. And lastly, our capital allocation priority, in the absence of any near-term M&A transaction, is to continue to reduce our debt through continued optional debt repayment. And we remain confident in our current liquidity and ability to generate cash during the fiscal year. In terms of revenue and orders, our revenue this past quarter totaled $56.8 million and that's a decline of 38% against the prior year record quarter, and in line with our expectations for the fiscal quarter. And note that, Q1 is typically our low revenue quarter from a seasonality perspective. The legacy revenue mix between MRO/UE and Greenfield was 68% and 32% respectively versus a 51% and 49% in Q1 of fiscal year 2020. FX decreased total revenue by $2.4 million and in constant currency, our revenue declined by 36%. Orders for the quarter totaled $60.6 million versus $82.8 million in the prior year quarter for a decline of 27%. And our backlog of orders ended June at $109.9 million, that's up 4% sequentially and versus $111.5 million, as of June fiscal year 2020, essentially flat with the prior year. And our book-to-bill for the quarter was positive at 1.07, marking the second consecutive quarter of a positive book-to-bill. Turning to gross margins, margins were 42.4%, a 190 basis point improvement versus the comp period. Gross margins were positively impacted by 299 basis points by the Canadian Wage Subsidy. And gross profit declined by $13 million in the quarter and that is due to the double-digit revenue decline or by 35% versus the comp period. In terms of operating expenses, operating expenses for the quarter excluding depreciation and amortization of intangibles totaled $25.2 million versus $25.3 million in the prior year. And SG&A expenses included $2.9 million of severance cost. And on a go-forward basis, which includes the impact of recent cost actions, we expect our annualized SG&A run rate to be in the $88 million range and from a cash perspective, albeit $700,000 of the $2.9 million in severance has been paid out. In terms of earnings, GAAP EPS for the quarter totaled minus $0.18 a share and as compared to the prior year quarter of $0.04 a share and that's a decline of $0.22 per share. And adjusted EPS as defined by GAAP EPS less amortization expense and any one-time charges totaled minus $0.11 a share relative to $0.15 a share in the prior year quarter. Adjusted EBITDA declined by 89% versus the comparison quarter and adjusted EBITDA as a percent of revenue was 2.4% and that's a decline of 773 basis points versus the comp period. Adjusted EBITDA totaled $1.4 million this last quarter. And free cash flow was positive for the quarter by $1.3 million and we remain confident in our ability to generate cash and service our debt going forward. Our effective tax rate for the quarter was 29% and that reflects a worldwide rate of 31% less any discrete stock compensation-related items. And in late July last month, the U.S. Treasury issued final rules regarding the global intangible low tax income or GILTI tax and this revised tax code will benefit Thermon. And while we are studying the exact impact of the revised tax code, we do expect to see a lower tax rate for the balance of fiscal year 2021. Next the balance sheet. Cash grew $5 million in the quarter to $48.2 million and we generated $7.7 million in cash from working capital management and our net debt-to-EBITDA was essentially flat with last year at 2.5x. And finally, in conclusion, given the continued uncertainty surround the impact of COVID-19, we will not be providing any formal guidance at this time but we will continue to evaluate as the year unfolds. And I would like to reiterate that we will continue to manage what we have control over including operating expenses, continuous improvement initiatives, and the management of working capital. And as Bruce just mentioned, we will adjust our spending consistent with the incoming order rate and overall business activity.

Operator, Operator

At this time, we will hold a question-and-answer session. Our first question is from Scott Graham with Rosenblatt Securities. Please go ahead with your question.

Scott Graham, Analyst

Good morning everyone. Thank you for the detailed information. I have two main questions. Looking back at the last call from five years ago, and considering the rapid changes in the oil, gas, and chemical markets, it seems the order rate comparison from that period shows that the first half of last year was relatively equal to the first quarter of last year. With July bookings down 33, which is worse than the first quarter, I’m curious why that is the case. Even though the minus 33 figure is an improvement from what we just observed, when compared over five years, it appears to be slightly worse. I would like to understand what that indicates.

Bruce Thames, President and CEO

Yes. Scott, this is Bruce. This is what we've observed in the month. I mean, let's face it bookings are lumpy, but we have also seen this second wave of COVID-19 outbreak. And what we haven't seen is that recovery as maybe quickly as we might have originally anticipated. So we still see really limited access to facilities and things like that. And we do believe that is slowing or having a negative impact on the sequential improvements we might have otherwise expected.

Scott Graham, Analyst

The July bookings are weaker on a year-over-year basis compared to the first quarter. I'm looking for more information about this. Bruce, you mentioned you were anticipating some sequential weakness in oil and gas. You talked about various factors affecting your end markets. Could the weaker July bookings be related to the item you mentioned?

Bruce Thames, President and CEO

No, not really necessarily. I think my comments around both the first quarter we started out really low in April and May. We saw some improvements. We did see some nice actually greenfield orders that landed in the quarter that contributed to the overall bookings rate and the impact year-over-year. And, I mean, we did have a fairly strong bookings quarter last year in Q2. So I do think it's got to do overall with the impact we're seeing due to the COVID-19, as well as what we're seeing in our end markets in oil certainly and the impact that's then had on our customers. And then I think also it's relative to prior year comparisons that were fairly robust overall. First half of our last year was record.

Scott Graham, Analyst

Got it. Okay. Understood. So the other question is about SG&A, which has two parts. First, I assume that when Jay mentioned the $88 million as the new run rate, it excludes depreciation and upbeat. What will trigger the restoration of the 25% SG&A that you plan to bring back in orders? Is it based on having one quarter of orders up year-over-year, or does it require two quarters? Can you provide more details on the trigger for that?

Jay Peterson, CFO

Yes. To answer your first question, it is exclusive of depreciation and amortization. And was your question relating to when the leverage will occur or…?

Scott Graham, Analyst

No, no. You talked about the $16 million this year, you talked about a full run rate of $17 million next year. What I'm wondering is you said that you're going to bring 75% of them are structural out of the $17 million. And so that does suggest that 25% is sort of more variable and will be brought back on to the books. And I'm wondering what the order rate trigger is for that to begin.

Bruce Thames, President and CEO

Yes. Scott, this is Bruce. We would need to see some stabilization in the end markets and some sequential improvements and improved overall visibility before we would consider bringing back some of those temporary cost reductions.

Scott Graham, Analyst

That's great. Thank you.

Jay Peterson, CFO

Hey, Scott, let me just clarify one thing before you ask this in a following question. Our revolver is $60 million and the amendment that we were able to garner gives us measurement credit for all cash on the balance sheet in excess of $20 million. I think I might have said $60 million and $60 million, but it should have been $20 million and in excess of cash on the balance sheet at that level.

Scott Graham, Analyst

Yes. Thank you.

Operator, Operator

Our next question is from Brian Drab with William Blair. Please proceed with your question.

Brian Drab, Analyst

Hi. Good morning. Thanks for taking my questions. First one is just the…

Bruce Thames, President and CEO

Good morning, Brian.

Brian Drab, Analyst

Hi. Good morning. Jay, in the last call you mentioned that in a scenario analysis, if revenue were to decline by 35% to 40%, that would be the point at which you'd reach cash flow breakeven. Is that still your expectation? Do you have any updated thoughts on that? I'm also trying to recall if that accounts for all the cost-cutting measures that have been considered.

Jay Peterson, CFO

It does. But one thing I would like to clarify that 35% to 40% revenue reduction has kind of double conservatism in that. It has rather depressed gross margins and rather depressed working capital management assumptions in that. So we think that's a very conservative number for us to be free cash flow breakeven.

Brian Drab, Analyst

Understood. So that's just a worst-case scenario and all it is a scenario just for frame of reference of course.

Jay Peterson, CFO

Exactly.

Brian Drab, Analyst

Yes. To clarify, Bruce, you mentioned that the orders fell by 33% in July. Is it correct to use that figure as a likely indicator of the revenue decline for the September quarter? I understand this isn't guidance, but I wanted to confirm.

Bruce Thames, President and CEO

Yes, it's not guidance but that's what we're seeing in the incoming order rate. We would expect our revenues to be in line with the incoming order rate for the quarter.

Brian Drab, Analyst

Okay. And in those orders and in the backlog, can you talk a little bit more about what you're seeing in terms of the margins and whether you expect the first quarter gross margin level to be the trough for margins as well as the trough for revenue?

Bruce Thames, President and CEO

Yes. So the revenue question, we think sequentially revenue will improve and the worst is behind us, also due to the volume increase. We think we'll have a positive impact on fixed cost absorption. And also, to clarify that the costs that were taken out we really only had one full month of the costs that were taken out of the impact to gross margins. And then we have the favorable seasonality. In terms of the backlog, we do see backlog margins typically lower than typical right now but they really vary from month to month depending on what projects are in the backlog.

Brian Drab, Analyst

Okay. Jay, can I ask you a follow-up regarding what is considered lower than typical? Are they lower than what you experienced in the first quarter?

Jay Peterson, CFO

They are.

Brian Drab, Analyst

In terms of what's the reported margin in the first quarter.

Jay Peterson, CFO

So I would estimate that it's probably closer to 300 basis points lower, but that can change literally every week or every month.

Brian Drab, Analyst

Okay. Good. I'm kind of walking away with the impression that maybe gross margin steps down before it comes back up then.

Jay Peterson, CFO

No not necessarily. For projects possibly. But again, it's all predicated on timing. And with some of the cost actions, with some of the cost absorption due to increased volumes and the seasonality aspect is typically relating to maintenance. Those would all be accretive to market.

Brian Drab, Analyst

Yes. And everything in the backlog or most of what's in the backlog is the greenfield obviously and...

Jay Peterson, CFO

Correct.

Operator, Operator

Our next question is that it seems there are no further inquiries at this moment. I would like to hand the discussion back to Bruce Thames, President and CEO.

Bruce Thames, President and CEO

Maria, thank you. Again, I would like to thank all of you for joining us on our call today and enjoy the rest of your days. Thank you.

Operator, Operator

Before we conclude I do have one more question.

Bruce Thames, President and CEO

Okay. We're happy to take it.

Operator, Operator

Okay. It does look like they have been disconnected. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.