Earnings Call Transcript - THR Q1 2025

Operator, Operator

Hello and welcome to the Thermon Q1 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. Instructions for the operator have been provided. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Ivonne Salem. Please go ahead, Ivonne.

Ivonne Salem, Corporate Secretary

Thank you, Diego. Good morning and thank you for joining Thermon's fiscal 2025 first quarter results conference call. Leading the call today are CEO, Bruce Thames; and Vice President and Corporate Controller, Greg Lucas. Earlier this morning, we issued an earnings press release, which has been filed with the SEC on Form 8-K and it's also available on the Investor Relations section of our website. Additionally, the slides for this conference call can be found in our IR website under News & Events IR Calendar Earnings Conference Call Q1 2025. 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 would like to remind you that, during this call, we might 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 might differ materially from those contemplated by these forward-looking statements and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future developments or otherwise, except as may be required by law. Today's call will begin with remarks from our CEO, Bruce Thames, who will provide a review of our recent business performance, including an update on the progress we have made on our strategic initiatives, followed by a financial update and review from our Vice President and Corporate Controller, Greg Lucas. Bruce will then wrap up our prepared remarks and update on our business outlook. At the conclusion of these prepared remarks, we will open the line for questions. With that, I'll turn the call over to Bruce.

Bruce Thames, CEO

Thank you, Ivonne, and good morning to everyone joining us on the call today. I'm extremely proud of the team's hard work and disciplined execution during the first quarter against the backdrop of a weaker global growth environment where we were able to deliver top line and adjusted EBITDA growth and strong cash flow. The quarter was highlighted by continued favorable momentum in our diversified end markets, the successful integration and positive contribution from our Vapor Power acquisition and disciplined financial management leading to solid free cash flow conversion. But most importantly, this quarter demonstrated our successful execution on a couple of our key strategic pillars, namely our focus on growing our installed base as well as diversifying our revenue and end market exposure. Starting at Slide 4, we generated nearly 8% revenue growth during the first quarter which was driven largely by the contribution from our Vapor Power acquisition. The integration of Vapor Power is on track and we're excited about the revenue synergies we have quickly identified that were not contemplated in our initial strategy. However, excluding Vapor Power, our revenues declined roughly 5% on an organic basis. While we're disappointed by the organic revenue decline, it's important to note that our organic revenues declined only modestly despite a 34% decline in our large project revenue during the quarter. This type of performance would not have been possible if not for our focus on diversifying our end market exposure and growing our installed base of customers. In addition, consistent with the trends noted during our last earnings call, our Canadian business grew 9% in the first quarter on a year-over-year basis after a weak second half of fiscal '24. The continued pressure on our large project revenue, which is generally tied to our customers' capital spending budgets, was somewhat offset by 22% growth in our point-in-time material sales and small project revenues which together we refer to as OpEx revenues which are generally tied to our customers' annual operating budgets. As we detail on Slide 5, our materials and small project revenues were $98 million during the first quarter. Revenues associated with OpEx spending represented nearly 85% of our total revenues, while our large project revenues were only 50% of the total compared to a 75% to 25% mix in the prior year. Excluding Vapor Power, our OpEx revenue increased 4% organically. We're proud of this result and believe this demonstrates the benefits of our deep installed base and recurring revenue exposure. Our current mix provides a more stable and predictable revenue stream as well as a more profitable mix, given our OpEx revenues consistently generate higher gross margins. In addition to benefiting from recurring revenues during the first quarter, we were also aided by our more diversified end market exposure. An important aspect of our strategy you've heard me discuss has been our goal to reduce exposure to the oil and gas market. We have a goal of getting our diversified end market revenue to at least 70% of the total and as a result of our efforts, together with the inclusion of Vapor Power, we've achieved our goal on a trailing 12-month basis which has been a positive driver to our results given the recent weakness in the oil and gas sector. While oil and gas is an important part of our business, it is no longer the key driver of our results that it once was. Our oil and gas revenues declined 7% during the first quarter, so we're very pleased we were able to generate solid financial results despite the weakness in these markets. We're very proud of the work we've accomplished to position our business to be more successful across the business cycle. We have built a business that we believe is more durable and one that is equipped to generate stable, more predictable operating results across a range of economic scenarios and spending cycles. All that said, the large project business is still an important driver to grow the installed base for Thermon and we are well positioned to benefit as large project spending trends improve. As we discussed in recent quarters, large capital projects have experienced extended sales cycles driven by customer uncertainty related to the macro environment, the upcoming elections, and the uncertain trajectory of interest rates. While we don't have a crystal ball and timing is difficult to predict, we do remain cautiously optimistic that large project spending will improve in the second half of our fiscal year as we get some clarity on the November elections and we hopefully start to see some Fed rate cuts in September as the market currently expects. We remain encouraged that our quoting activity continues to be robust, up almost 13% and our total bid pipeline is up 9%, both on a year-over-year basis. Unfortunately, project decisions have been delayed given the market uncertainty, but we believe we are very well positioned when normal spending patterns resume. Now turning to Slide 6 and our strategic pillars. I've already spent quite a bit of time on our focus on growing our installed base and diversifying our end market exposure. However, I do want to quickly give an update on decarbonization opportunities and our execution on our capital allocation priorities. We continue to see our sales pipeline of decarbonization opportunities grow to now over $320 million, representing roughly 30% of the total. During the quarter, we secured approximately $9 million in orders related to decarbonization or approximately 7% of the incoming orders in the quarter. As it relates to our capital allocation, Greg will provide more of the details but suffice it to say we are very pleased with our solid financial discipline which has enabled us to quickly delever following the Vapor Power acquisition. We're in a strong financial position with our leverage ratio of 1.1x, coming in nicely below our targeted range of 1.5 to 2x. We believe this provides us with more than sufficient capacity to pursue our growth objectives and capital allocation priorities. With that, I'll turn it over to Greg, who will provide a more detailed review of our first quarter results before I wrap up with some remarks on our financial outlook.

Greg Lucas, Vice President and Corporate Controller

Thank you, Bruce, and good morning, everyone. I will provide some additional details on the quarter and give an update on our working capital and free cash flow and conclude with a commentary on our balance sheet and liquidity. Moving now to Slide 7 and our first quarter performance. Revenue in the first quarter was $115 million, a year-over-year increase of 8%, primarily driven by the inclusion of Vapor Power which contributed $13.9 million of revenue during the first quarter. Excluding Vapor Power, first quarter organic sales decreased 5%, primarily related to the softness in large CapEx projects that Bruce has already discussed. Large project revenue was $18 million during the first quarter, down 34% from the same period last year as customers continue to delay decisions on large capital projects. The weakness was more pronounced in our oil and gas end markets but the weakness was broad-based. While large project spending was weak, our OpEx revenues were $98 million during the first quarter, an increase of over 20% compared to last year as our customers shifted their priorities to maintenance and repair spending. Excluding Vapor Power, our OpEx revenues increased 4%, demonstrating the benefits of our balanced revenue model and the strength of our long-term customer relationships and deep installed base. From a geographic perspective, we saw sales improved 9% year-over-year in Canada and 7% in APAC. While sales in our U.S.-LAM segment, excluding Vapor Power, declined 14% and sales in our EMEA region declined 19%. Adjusted EBITDA was $23.2 million during the first quarter, up from $22.1 million last year due to the contribution from Vapor Power. Adjusted EBITDA margin was 20.2% during the first quarter, slightly down from 20.7% in the same period last year. Our margins benefited from an increased mix of materials revenue during the quarter which generally carry higher gross margins. However, this was offset by certain contracts with higher labor content which diluted our margins as well as the continued investments we have made in our strategic initiatives. Last quarter, we discussed our manufacturing rooftop consolidation program which is a key component of our operational excellence strategy. This program includes the consolidation of our rail and transit production lines from Denver into our San Marcos facility. From this effort and a concurrent reduction in force, we incurred a charge of $2.3 million during the quarter and expect another $0.3 million to $0.5 million over the next few quarters as we complete this initiative. This effort is on track and we expect the cost to implement this reduction in force and facilities consolidation to be less than our original estimate. As a reminder, we are targeting $5.7 million in annualized savings. We continue to target just over $4 million in realized savings during fiscal 2025 and we saw the savings begin to benefit our results during the first quarter. Backlog was $198.5 million compared to backlog of $172.1 million as of the first quarter last year. Excluding backlog attributable to Vapor Power of $44.3 million, backlog declined 10% on an organic basis. Orders during the first quarter were $127.2 million compared to $114.1 million in the same period last year, an increase of 12%. On an organic basis, orders declined 5%. It is important to note that over 70% of our incoming orders in the quarter were from diverse end markets. Moving now to Slide 8 for an update on our balance sheet and liquidity. Net working capital was 31.4% of sales during the first quarter, down from 34.6% last year as we continue to optimize our supply chain while also improving lead times and on-time deliveries to our customers. CapEx was $3.9 million during the first quarter of 2025, up from $2.8 million last year. As a result of our sound working capital management, free cash flow was $8.8 million in the quarter, an improvement of nearly $11 million versus last year. We expect our continued focus on fiscal discipline, combined with our expectation of solid operating results to deliver another year of strong free cash flow conversion. We paid down roughly $3 million of term debt during the quarter, bringing our net debt balance to $120 million. Net leverage declined from 1.1x at the end of the first quarter, down from 1.2x at the end of the previous fiscal quarter and down from 1.5x immediately following the acquisition of Vapor Power. Our ability to quickly delever following the Vapor Power acquisition highlights the strong free cash flow capabilities of our business. Based on our total cash and available liquidity of $141.8 million, we remain well capitalized and have ample flexibility to continue to support our capital allocation priorities. Assuming no additional acquisitions, we expect to target incremental debt paydown of $20 million to $40 million during fiscal 2025. In summary, we are pleased with our financial execution during the quarter as we made further progress on operational excellence initiatives which should drive further margin benefits in the coming quarters and we continue our strict financial discipline, resulting in strong free cash flow performance. With that, I will turn the call back over to Bruce.

Bruce Thames, CEO

Thanks, Greg. Now if you'll turn to Slide 9, we'll wrap up with our outlook for fiscal 2025. While trends in the large project market remain depressed, so far, the year is tracking roughly in line with our expectations. Our OpEx revenues are benefiting from a shift in our customers' priorities to MRO spending and our more diverse end market exposure is helping us overcome the weakness in the oil and gas markets. We are continuing to execute on our operational excellence priorities, including our supply chain initiatives and manufacturing rationalization program. These efforts helped drive savings in the first quarter and we expect more progress from these and other operational efficiency programs over the balance of the year. As a result of these factors, we are maintaining our full year 2025 guidance that calls for revenue in the range of $527 million to $553 million, which includes expected revenue from Vapor Power of $55 million to $59 million, adjusted EBITDA in a range of $112 million to $120 million, and adjusted EPS in a range of $1.90 to $2.06 per share. Historically, the seasonality in our business has resulted in roughly 55% to 56% of our revenue being generated in the back half of the year. And given the expected ramp in our large project revenue through this fiscal year, we have communicated and anticipate revenue to be more heavily back-end weighted to around 57% to 59% in fiscal 2025. The team remains laser-focused on executing to achieve our FY '26 goals and objectives. Finally, just to wrap up things on Slide 10. We were pleased with our first quarter results which we think demonstrate the progress we've made in developing a business that is more stable, profitable, and durable across a cycle. We're not nearly as reliant on large projects or the CapEx cycles in the oil and gas markets. Our large and growing installed base of loyal customers provides us with a resilient aftermarket franchise which gives us access to a steady stream of predictable and highly profitable MRO revenues. We also remain well positioned to benefit from several powerful secular growth drivers. These include the energy transition and decarbonization, onshoring in North America, and infrastructure spending. While the recent macro uncertainty has delayed some of this spending, we don't think that anything has changed to impact these long-term drivers and we remain confident that this only serves to create pent-up demand when customer confidence improves. Lastly, we benefit from a high margin, low capital intensity business that yields significant cash flow. This enabled us to quickly delever following the Vapor acquisition and leaves us in a strong financial position. We have ample flexibility to pursue our capital allocation priorities which include investment in growth, both organic and through acquisition, capital returns, and debt paydown, all with a focus on creating long-term shareholder value. That completes our prepared remarks. We're now ready for the question-and-answer portion of our call.

Operator, Operator

Our first question today is coming from Brian Drab from William Blair.

Brian Drab, Analyst

Could we start off with you, Bruce, providing us with more detail about your insights on the project revenue recovering later this year? Are there specific projects you can see that will contribute to this? What needs to occur for that revenue to materialize?

Bruce Thames, CEO

Yes, it's a great question, Brian. So I'll start with our pipeline of sales and project opportunities. That's all the opportunities that are $100,000 and greater. That pipeline is over $1 billion in revenue opportunities and it's grown about 9% year-over-year. And so if I start there and then I'll look at our quoting activity, it's up 12% to 13% year-over-year. So that's been quite strong. And then I look to just our incoming order rates with the positive book-to-bill, which is the first positive book-to-bill we've had in a couple of quarters. So some of those trends are leading indicators. We'll need to continue to see book-to-bill being positive in Q2 but we feel like we have a solid pipeline of opportunities. The quote volume is there and our win rates are flat to improving. So we feel like we're very well positioned to capitalize on these opportunities as these projects move forward.

Brian Drab, Analyst

Okay, great. Can you help us reconcile the positive move of up 9% for the pipeline and up 13% in quoting activity with what you're actually seeing in the backlog?

Bruce Thames, CEO

Yes. Looking at our backlog, it decreased by 10% year-over-year but increased by 5% sequentially. I want to emphasize that when we refer to backlog, we are discussing our large projects. Our flow business and MRO business, which were mentioned in relation to OpEx spending, tend to fluctuate in and out of backlog quickly. The fact that 85% of our revenues in the first quarter were linked to these types of revenues highlights the flow and velocity, as it cycles through backlog within the period. There are two important points to note. First, the backlogs have improved sequentially due to a positive book-to-bill ratio. Second, there has been a shift towards more OpEx spending, which we are well-equipped to take advantage of given our extensive installed base. These two factors are crucial as we analyze backlog both year-over-year and sequentially.

Brian Drab, Analyst

Got it. So at the moment, when you have a mix like this, the backlog kind of becomes less relevant, it really does.

Bruce Thames, CEO

Yes. Particularly when we're talking about OpEx revenues.

Brian Drab, Analyst

Yes. Maybe just one more question for now. And I may have missed but did you mention what percentage of orders coming in or what percent of the backlog is tied to decarbonization and renewables and how is that trending?

Bruce Thames, CEO

Yes, it was $9 million in orders during the quarter and 7% of total bookings.

Brian Drab, Analyst

Got it. Okay. Okay...

Operator, Operator

Our next question is coming from Justin Ages from CJS Securities.

Justin Ages, Analyst

Can you unpack the diversified end markets a bit, good progress on that but I wanted to get your thoughts on food and beverage, transport, what trends you're seeing in those end markets?

Bruce Thames, CEO

Yes. The areas we've observed the most activity have been in chemical and petrochemical power, which has been very strong. Additionally, we see significant opportunities in infrastructure, rail, and transit as we look ahead. I also want to highlight the building pipeline of opportunities we have in decarbonization and electrification, which span a wide range of end markets.

Justin Ages, Analyst

I appreciate that color. Please continue.

Bruce Thames, CEO

Yes. One other thing to note, we do have a significant number of opportunities in the LNG liquefaction facilities, particularly in North America.

Justin Ages, Analyst

Okay. And then on capital allocation strategy, can you give us an update on what you're seeing in the M&A market, especially as it pertains to reaching that $600 million to $700 million kind of revenue target for fiscal '26?

Bruce Thames, CEO

Yes. First of all, we have a really healthy pipeline of M&A opportunities that we believe are actionable within the next 12 to 18 months. So I think that's very positive. Certainly, our balance sheet is in good shape. These things are binary. So certainly, it's a win or lose scenario but we think we're very well positioned and we see a number of opportunities that really fit squarely within our strategic initiatives.

Operator, Operator

Our next question is coming from Jon Braatz from Kansas City Capital.

Jon Braatz, Analyst

Bruce, regarding the big project and the potential for business in that area, if spending on the CapEx budgets starts to rise after the election along with some interest rate cuts, would you expect a reduction in the operating expense budgets? What kind of balance is there between those two budgets for your clients?

Bruce Thames, CEO

I really don't believe they're closely related. Operating expenditures are much less susceptible to economic cycles. And I really view those as being fairly stable. It's one of the reasons we've really focused on having that be a larger part of our incoming revenue stream. So I'd start there. As far as the CapEx, as I look at this, the customers that we've spoken with haven't had significant cuts in CapEx budgets. In fact, in most cases, they're flat. And in some cases, they're even projected to increase this year. But what we've seen, particularly in the last 2 quarters, our fourth quarter of '24 and into this quarter, we have seen a slowdown in decision-making. So we continue to see that pipeline of opportunities grow but the time between when that's quoted and when we actually receive orders has become more protracted. So our hope would be in the latter part of this year, we get through and maybe get some clarity from the Fed around interest rates as well as around the election that customers would feel more comfortable in moving forward with some of that spending.

Jon Braatz, Analyst

Sure. Any sense on your part that there was some catch-up in the maintenance spending by your clients?

Bruce Thames, CEO

No, that's long in the rearview mirror from like 2 years back.

Jon Braatz, Analyst

Yes. Yes. Okay. Okay. Good. And then on Vapor, I think that's going to be a very nice acquisition. Are you seeing things fall into place for Vapor as you expected? And secondly, maybe is there an expectation that Vapor will contribute more and growth at Vapor can accelerate a little bit because of these electrification trends that we're seeing?

Bruce Thames, CEO

So Vapor has strategically started to show even better marketplace opportunities, especially around electrification. I want to specifically point out the electrode boiler line and our resistance electric boilers. We are seeing a positive trend in shifting from hydrocarbon-fired heating and industrial processes to electric. Additionally, we've been pleasantly surprised by the increase in inquiries our sales team has received since adding Vapor to our offerings. This has enhanced our market coverage and created more opportunities for us. Currently, our main challenge is scaling capacity, and we are concentrating on implementing the Thermon Business System in Vapor Power operations at both Franklin Park and Morristown. Our teams are diligently working to unlock capacity, which would enable us to enhance our current plans. We acknowledge there is still work to do, and our teams are busy focusing on opportunities to improve both our supply chain and manufacturing capacity. Ideally, we hope to see some upside, if not this year, then in the coming years as we expand capacity in those operations.

Jon Braatz, Analyst

Would you envision an increase in your CapEx spending to support the growth at Vapor? A new facility or expanded facility beyond improving supply chain and other things?

Bruce Thames, CEO

We believe our current estimates for capital expenditures include funds to debottleneck and increase capacity within those operations. Looking ahead, as circumstances change, there may be a need for additional capital expenditures if demand grows faster than we initially anticipated.

Operator, Operator

We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Bruce Thames, CEO

Kevin, thank you. And again, I'd like to thank our Thermon employees around the globe for serving our customers with excellence each and every day. And I'd like to thank all of you for your time and interest in Thermon. If we don't speak during the quarter, we look forward to speaking to you again on our next quarterly call. Have a good day.

Greg Lucas, Vice President and Corporate Controller

Thanks, everyone.

Operator, Operator

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.