Q1 2022 Thermon Group Holdings Inc Earnings Call
[music].
Greetings and welcome to the Therm on group Holdings first quarter of fiscal 'twenty 'twenty 2 earnings conference call.
At this time all participants are in a listen only mode of <unk>.
On an answer session will follow the formal presentation.
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As a reminder, this conference is being recorded.
I would now like the turn the conference over to your host Kevin Fox Chief Financial Officer. Please go ahead.
Thank you Bruce good morning, and thank you for joining today's fiscal 2022 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. Additionally, the slides for this conference call can be found under our IR web.
Site at news events IR calendar earnings Conference call Q1.2022.
During the call we will discuss some items that do not conform to generally accepted accounting principles. We've 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.
You that during this call we may make certain forward looking statements regarding our company. Please refer to our annual report on 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 with that we will turn to the opening comments from Bruce <unk>, our president and Chief Executive.
Sure.
Thank you Kevin and good morning, we hope everyone listening is staying safe and in good health and we appreciate you joining our conference call and for your interest in Therm on Kevin Fox. Our CFO is here to provide additional details on our Q1 financial performance following my remarks.
Turning now to the first quarter results overall, we're very pleased with the first quarter results. The team delivered to start the fiscal year, we were particularly pleased with the strong order growth of 19% year over year in the quarter, which was reflected in the top line growth of over 25% over Q1 fiscal year.
2021, we're also pleased to see the results of our efforts to realign the cost structure to the incoming level of business with SG&A down 16% on an adjusted basis in the quarter and 22% on a trailing 12 month basis.
Gross margin in the quarter fell below expectations for a number of reasons first.
We've seen the labor shortages and supply chain disruptions negatively impact volume and absorption in the quarter. Secondly, we are seeing higher costs due to material price inflation and material <unk> supplier of substitution as the team has tactfully managed in a dynamic and often unpredictable environment.
These issues combined to negatively impact gross margins by approximately 390 basis points in the quarter.
As a positive note we've seen real progress on the labor front and have put supply chain strategies in place to address the disruptions, we've seen and can anticipate.
We believe these actions combined with price increases that were enacted in late Q1, we will begin to have a material impact late in Q2 and fully offset these costs in the second half of this year.
Despite the lower gross margins of the team delivered $9.7 million on adjusted EBITDA up almost 600% from prior year on $71.2 million in revenue demonstrating very strong operating leverage in the quarter. Adjusted EPS was <unk> 17 per share in the quarter up 18.
Since a share or 164% from the prior year quarter, just as a note here we continue to invest in our strategic initiatives to drive growth I'll cover this in more detail later in the presentation.
Turning now to a discussion of our end markets. We are seeing positive momentum in our end markets that began late in Q4 of fiscal year 'twenty, 1 and is cause for cautious optimism, while we have not yet returned to pre COVID-19 levels of activity, we experienced a solid 35% improvement.
And our Q1 quick turn business over the prior year quarter as maintenance spending is showing positive signs of recovery, particularly in North America.
As we look to the chart on page 4 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 sector.
Greater than 55% of our end markets are tied to the chemical petrochemical natural gas and power markets.
With natural gas as a bridge fuel the chemical petrochemical and power market is being driven by the emergence of the middle class in developing economies the growth outlook across the sectors is much more robust than upstream oil, which now represents just 16% of our revenues while expectations for cash.
<unk> spending this fiscal year have been the low we are seeing positive quotation activity with a number of capital projects moving toward final investment decisions, particularly in the downstream and petrochemical sectors.
With numerous projects in various stages of planning and execution. We are also well positioned to capitalize on a downstream shift to biofuels as evidenced by over $4 million in capital project projects currently in our backlog.
In addition, we see significant opportunities and more diverse end markets with favorable growth potential such as rail and transit commercial and food and beverage in the coming years.
At this time approximately 13% of our backlog is related to multi year transit projects in North America, We expect the infrastructure Bill currently in Congress if passed to create a tailwind in this sector.
Moving on to slide 5 of the presentation.
While down 14% from the prior year period on a trailing 12 month basis, we have reached an inflection point with orders up 19% in the quarter over the prior year period, and a positive book to bill, resulting in backlog growth of 5% year over year as of note. We have had a positive book to bill.
And 5 of the last 6 quarters.
Increases in quotation activity, particularly in larger capital projects is a very positive sign that of capital cycle could be building that will likely translate into bookings later in the fiscal year with execution beginning in fiscal year 'twenty 3.
We are also seeing some positive effects falling winter storm here in Texas, and along the Gulf Coast as customers in the power and natural gas sectors move beyond the initial emergency repairs and begin to address winter innovation in advance of the next heating season with the passage of state of Texas State Senate Bill 3.
Into law now mandating winner of <unk> of the state power and natural gas infrastructure, we expect the positive impact of maintenance activities. This fall and for years to come I.
I would also.
I would like to hand, it over to Kevin Fox, our CFO to provide a more detailed review of the quarter and for the year financial results Kevin.
Thanks, Bruce revenue in the first quarter was $71.2 million, an increase of 25% versus the previous year FX was the tailwind in revenues were up 17% on a constant currency basis.
I'm on revenue was $291 million on a trailing 12 month basis and with the increase we are seeing in customer spending we expect to continue to see quarterly growth through the year.
Trends in Canada are the most positive among our regions with increases in both project and maintenance, while maintenance spending in the U S land region got off to a great start in Q1. We believe this is driven by an uptick in deferred maintenance finally, starting to kick in some countries in APAC, particularly India continue to be impacted by Covid.
Striction, which led to lower volumes of business in Q1.
Last but certainly not least we continue to make progress on larger projects in EMEA, albeit delivering relatively lower margin content in the quarter.
Our business typically pass along pricing changes during the summer and this year is no exception those increases have been announced and why we didn't see any benefit in the first fiscal quarter, we expect them to start to impact our results late in Q2 and for the remainder of the year. We believe the price increases should offset rising costs that we're seeing in our supply.
Train and manufacturing facilities.
While there is still uncertainty around current or future COVID-19 variance in the impact that may have on the global economy. We view this as a promising start to the year for revenues commodity prices are stabilizing around historically investable levels and our customer spending appears to be following suit.
Gross margin this quarter were 39, 6% of decrease versus last year's 42, 4% as Bruce previously mentioned the decrease was driven by manufacturing cost increases due to 1 material shortages to having to procure higher cost raw materials to compensate for shortages or inbound shipping delay.
And 3 challenges securing hourly labor in certain locations all 3 factors led to lower utilization in under absorbed manufacturing overhead on.
The positive side, we continue to see improving growth in our quick turn business, although not yet back to fiscal 2020 levels quick turn margins remained stable and attractive and as a reminder, quick turn of the material sales that book and ship in less than 2 weeks and are accretive to overall gross margin rates.
From a mixed perspective MRO versus Greenfield in our legacy business was <unk> 65 versus 35 as compared to the previous year's mix of $68.32, which is also of a slight headwind for the business.
This is because of within greenfield or larger projects made up a higher portion of project revenue in the period and larger contracts typically have a lower profitability rate than smaller projects due to scope.
Typically in this quarter, the larger projects or time and materials based not fixed price and represent approximately 175 basis points of headwind in the quarter.
This is an example of the mix within the mix that we have previously mentioned, but more broadly I want to reemphasize that continuing to build our global installed base is a strategic imperative for the company.
In response to the impact of inflation and the congested global supply chain on our business. We have taken the following actions 1 price increases were rolled out earlier this quarter factoring and rising input costs for both us and our suppliers.
Feedback from the field indicates our current planned increases were within customer expectations.
We've proactively secured supply of some key raw materials to minimize downtime in our manufacturing plants and third we've reviewed labor rates versus the market in certain jurisdictions and adjusted where appropriate. So that we can continue to attract the talent needed to maintain our quality and safety standards.
Last but not least our annual continuous improvement targets for this year are approximately $2 million and we believe we remain on track.
For SG&A, we've cleaned up the account presentations in the 10-Q Youll see later today changing the previously named marketing general and administrative and engineering expenses to now be referred to as selling general and administrative and our SEC reported figures.
Going forward, we will also present any expense or benefit from the nonqualified deferred compensation line separately given the volatility from its nature as the mark to market account that is offset below the line ultimately we deduct depreciation from the SEC SG&A to get to the presentation. We have on this slide.
In Q1, 'twenty, 2 SG&A was $18.3 million of 16% reduction from the comparison period on.
On a TTM basis, you can see the year over year cost out execution of approximately $21 million or 22%.
We previously indicated that we believe SG&A will average about $20 million per quarter for the year. So we are a little ahead out of the gate, which was expected we plan for cost to increase slightly through the year, primarily driven by more travel as economies reopen and as we execute on planned investments in our strategic initiatives we will.
Continue to closely monitor expenses to ensure our business is positioned to drive improved profitability and cash flow as volumes increase.
Adjusted EBITDA is on the right side of the page with Q1, 'twenty 2 coming in at $9.7 million or almost 14% of sales adjusted EBITDA. In Q1 has average to 12, 5% from fiscal 2018 through fiscal 'twenty..1. So we are slightly ahead of that historical average to start this year.
Even despite the weaker gross margins the combination of improving topline growth and disciplined cost management has resulted in significant operating leverage incremental adjusted EBITDA margins were 59% in the quarter as we move through the year, we expect that TTM adjusted EBITDA dollars will quickly turn from declines to increases.
Due to the improved business performance and we expect the associated profitability margins to continue expanding.
Not on the page, but we wanted to highlight GAAP EPS was <unk> <unk> per share in the quarter with adjusted EPS of <unk> <unk> per share.
Reconciliation tables were provided in the press release for us.
A couple of quick highlights on the balance sheet for the first quarter cash ended at $41 million down year over year, but up just a bit over a year and we made no optional debt repayments in the quarter of Q1 is typically our weakest period for cash flow due to seasonality and post year end outflows.
The inventory management continues to be top of mind, and we are flat versus March of $64 million.
As a reminder, we generally build inventory in advance of the heating season. So we would expect this to increase slightly next quarter before again, reducing in the second half of the year.
Total debt as of $148 million, a significant reduction versus this point last year due to our optional debt paydowns over the last 12 months net debt to adjusted EBITDA is now at 2.4 times down from the year end at 3.0 times due to the sequential improvement in adjusted EBITDA, We expect the business to continue to Delever.
In fiscal 'twenty, 2 as the recovery takes hold and as a reminder, we believe we should be operating 1 and a half to 2 times range under normal conditions.
Capex was less than $1 million in the quarter as we continue to balance investments in future growth with annual maintenance.
Free cash flow was positive in the quarter $1.6 million and was our <unk> consecutive quarter of positive free cash flow.
From a capital allocation standpoint, we continue to evaluate potential inorganic opportunities for the business, we will monitor the pace of our deleveraging through the year vis vis timing for any potential inorganic activity.
Optional debt Paydown remains the top priority in the interim and in any permutation. We continue to believe in the importance of maintaining a strong balance sheet.
Overall, a positive start to the year and illustrative of the opportunity ahead of us to drive shareholder value customer spending is returning we are proactively managing our cost base and we continue to believe there is significant operating leverage within the business over the next 2 to 3 years.
Now I'll turn it back to Bruce for an update on long term goals on our strategic initiatives.
Yeah.
Alright, Thank you Kevin.
With the recent events and the accelerated pace at which the globe is moving toward de carbonization the.
Board and management of revised our strategy to capitalize on some of the major transitions underway.
As a result, <unk> is highly focused on the electrification of industry and is positioned to lead this effort as evidenced by a recent paper presented on the topic at the PCI see Europe Conference. This June.
Turning now to slide 9.
As we move forward. In addition to core growth, we see developing markets diversification of end markets and technology enabled maintenance as key drivers for growth moving forward on.
Our goals are the double our business over the next 5 years, while diversifying our end markets such that greater than 60% of revenues are generated outside of the oil and gas sector.
To achieve these objectives, we remain committed to investments in new product development that include connected and smart control solutions advanced heating technologies and materials science we're.
We're excited to announce we have received the first order for the Genesis network 1 of our 9 new product introductions in fiscal year 'twenty..1. In addition to this order we are seeing of growing quotation log of opportunities with this new platform.
With Iot capabilities. This new network significantly enhances situational awareness for our customers to increase safety reliability and efficiency, while creating opportunities for recurring revenues from software as well as troubleshooting and predictive maintenance the.
<unk> solutions further strengthen the relationship with our customers and improve our abilities to capture recurring revenues from the installed base.
The diversification of our end markets is the second area identified is of significant growth driver going forward.
Examples of other sectors with promising growth that we have touched historically include commercial rail and transit as well as food and beverage.
Here are 2 new heat tracing products targeting commercial applications with a 120.
120 volt heating and of low smoke zero halogen solution for the EU market, we believe the commercial space and heat tracing alone will significantly expand our addressable market by $750 million annually.
Looking forward for the remainder of fiscal year 'twenty 2.
Going forward, we're pleased with the realignment of the business and are well positioned to capitalize on a recovery that appears to be underway. We will maintain a laser focus on driving price increases and operational improvements to further improve the overall profitability of the business to offset the inflationary pressures.
We are now experiencing.
We are committed to delivering $2 million in cost savings through continuous improvement while holding the line on SG&A expenses to drive meaningful EBITDA margin expansion in this fiscal year.
While the Delta and Gamma COVID-19 variance created on an ongoing level of uncertainty visibility is improving across the business and we are seeing solid demand growth. As a result, we are raising revenue guidance for fiscal year 'twenty 2 from a range of $278 million to $2.95 million to a range of.
293 million to $308 million for the full year.
In conclusion, we're pleased with the direction of the business and the improvements we're seeing in our end markets, our proven business model combined with our unique and longstanding customer relationship.
Continues to demonstrate our ability to generate strong cash flow through the cycle. We have a very talented team that remains committed to serving our customers. While repositioning this business to capitalize on growing in markets to create long term value for our shareholders.
By focusing on both our operational and strategic initiatives Fairmont is well positioned to profitably grow as our customers and end markets emerge from this pandemic.
I would like to now turn.
In turn this back over to Brock our moderator for the Q&A portion of the call.
Thank you at this time, we will be conducting the question and answer session.
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Our first question today is from Scott Graham of Rosenblatt Securities. Please proceed with your question.
Yes, Hey, good morning can you hear me okay.
Yes, good morning, Scott, Great well, congrats on a real nice quarter nice printing with the.
The pivot upward in both sales and orders.
Couple of questions.
On the margins so.
1 of the things you said at the top Bruce was that gross margin was impacted by the labor shortages.
Supply chain disruption materials inflation on.
Obviously, you Didnt mentioned in the air mix, but I was just wondering if either you or Kevin can kind of unpack that a little bit on tell us.
We are the worst.
Can tell us the basis point impact of the 3 of 4 issues that hit the gross margin.
Or at least tell us which are the largest of at least.
Yes, Scott this is Kevin maybe I can start off with some of the quant and if we want to sell on the blanks for some color we can.
If you think about the COVID-19.
The call it the supply chain on the manufacturing challenges I think Bruce highlighted about 400.390 basis points related to those factors.
Between that I wouldn't necessarily think there is anything thats more material than the others of what we highlighted.
But also on the mix standpoint, when I cited about 175 basis points of headwind that was really driven by the largest projects that we have and just looking at those year over year.
So theres, probably actually a little bit more headwind, if you think about the relative mix as well while total that's about 600 points.
Between the year over year in the.
The other thing Thats may be worthwhile, highlighting as we look forward instead of back margins and backlog continue to increase sequentially as well. So I think quantitatively hopefully that gives you a little bit of the color of maybe how you get from the <unk> 39 reported of something that looks more consistent with historical standards.
So you Wouldnt of Bruce is -390, <unk> call out anything I mean, the old kind of equal whether it was labor or whether it was supply chain of materials inflation all about the same and the same.
What I meant.
They're pretty evenly I'd say labor shortages were probably 1 of the larger contributing factors in the first quarters second would be material shortages that stopped disrupted production.
Okay. Thank you.
And within that Labor shortages, Bruce you also mean sort of what the seems to be a little bit of a reset in PE.
On that there was sort of labor inflation, there as well or is that separate.
But that's really separate us really basically addressed some of the labor shortages and attracting the Cal.
Caliber of talent, we need we need for our manufacturing operations.
Got it and then going back to your long term goals here.
Interesting I just wanted to ask if the.
These long term goals impact you are.
Focus on getting to like I think you want to get to a 22.
At least the 22% EBITDA margin in 2023.
<unk>.
<unk>.
I've said I think I've given the right number of B do these new long term value creation factors impact that.
Well first AUR correct that is our goal for fiscal year 'twenty 3.
And those would be incorporated into our longer term objectives in my comments I did mentioned.
A couple of times on really looking to.
Get.
Better leverage on the business EBITDA margin expansion and so thats embedded in those goals and objectives.
We'll be sharing more detail on this next quarter and I really look for it to putting some more of the pieces in place to really clearly show the path from from where we are today to where we want to take the business.
By of fiscal year 2026.
That's great. Thank you both.
Thank you Scott.
The next question is from Brian Drab of William Blair. Please proceed with your question.
Hi, Good morning, Thanks for taking my questions first just on gross margin.
Just to be.
Specific Inc, and clear here there was the I think you said Bruce that 390 basis point headwind related to these temporary.
Issues in the first quarter.
And then those will alleviate in the back half of the year. So should we model the essentially at least the 400 basis points.
Improvement from the first quarter for the second half of the fiscal year.
Directionally that's accurate.
Okay.
Okay. Thanks, and then.
I was wondering if you could we've been trying to find more information about this.
The legislation in Texas can you elaborate on the Texas.
Texas Winters Nation law on how you expect that to drive demand for the reminder, in the near term.
Our long term.
Yes, so yes, the I've mentioned the Senate Bill 3 was passed into law, which actually requires it mandates the when organizations of the Texas natural gas and power infrastructure.
And there are a number of elements to the bill there's aspects of funding.
There is also.
The <unk> also mandated with the public Utilities Commission in Railroad Commission that they define on.
All of the rules and regulations that's currently underway.
And the early drafts look to be of.
Very.
Positive to be able to drive.
Requirements and so the the new law of essentially mandates the winner of <unk> has to occur and we'll set.
Standards for doing so.
And in order to sell into the grid and then.
While it's early draft. It also provides some incentives for higher levels of winner of <unk> to kind of.
The lower probability cases, so overall, we're pleased with the direction. We think it will really do a lot to improve the reliability of the of the Texas natural gas and power infrastructure.
Should we encounter future future weather events similar to what we saw this February.
Is there some legislation then the in draft form and some of that has passed or is it all in draft form.
The law is passed so but what has been mandated from the law mandates. The public Utilities Commission of the Railroad Commission established the rules and regulations governing winter Ization and so that is in draft form those should be done by say the latter part of this film.
<unk> year of the law has passed the rules and regs have not.
I got it and so which products are you thinking it would be most in demand here I mean is this a more.
The heat.
Heating elements or is it the heat tracing cable or is it some of them.
More recently acquired technologies.
It's.
Really all of the above it it will be heavily weighted towards heat tracing however.
A lot of the other environmental heating products and our.
And our cat of dine or norseman.
And in rough net heating lines will be will be required as well for not only personnel, but equipment and instrumentation, particularly.
So those are it's really a really a broad.
Swath of our of our solutions that we will need to be employed to really winterize. These assets for.
For the future significant weather event.
Got it and then.
Can you.
And I don't think that you did say this the other I'm sorry, if you did but the <unk>.
Tell us what was the growth or decline in revenue in the major geographies for the the quarter.
Yes, Brian let me get that here so from a quarterly basis, you guys will see the Q later today.
<unk>, plus 21, Canada, plus 32, Europe, plus 58, and APAC was actually a decline of approximately <unk> 14.
Okay. Thanks very much.
Yes, no problem.
As a reminder, if you would like to ask a question. Please press star 1 on your telephone keypad.
The next question is from Scott Graham of Rosenblatt Securities. Please proceed with your question.
Hi, guys. If no 1 else is there so I was going to ask it would be a couple of more if you don't mind.
What was the problems.
Percentage of what was the FX impact in the quarter for on sales.
It was about 8 points. So you went from 25 reported Scott the 17 on a constant currency basis.
Okay. Thank you and then.
I guess the comment the Bruce that you may 2.
Brian's question about sort of.
Taking what we didn't get in the first quarter and throwing it into the second half.
I think they'll come back to you on.
Just wondering why you would want to.
No.
So kind of put yourself out there that.
The supply chain disruptions and what have you that are a lot of the stuff from a lot of.
The journey of the stuff is out of your control, what why that would sort of cure in what's.
The 3 months time as we enter the second half is it may be more reasonable to assume that that spreads out a little bit more.
Of the reason I made the comment is 1 is of feel like we've largely addressed the labor issues, which were a significant factor in Q1.
You are right that some of the supply chain disruptions are unpredictable and so those are things that are really beyond our control, but my comment there was the price increases will take effect and they should.
Offset or even more than offset.
Any any future disruptions, we have in the back half of the year that could negatively impact our cost basis.
Got it.
And then Kevin maybe 1 last 1 for you so with the gross margin in the backlog seemingly up each of the last I think couple of quarters.
As we start to ship.
Greenfields out of that backlog need perhaps at higher margins, even if they are smaller projects should.
Should the.
It would seem to me that the impact of.
Of the.
The switch to Greenfield on the as a percentage of total starts to get reduced but I do know that there are the whole margin and the margin, saying, so maybe just give us an idea of.
Is there a is the margin on the margin.
Issue offset that or should that GAAP in gross margin actually shrink if all of them.
On it.
So I think I'm following you, but I think he might have also answered your own question too when you think about the mix within the mix and as that changes on a quarter to quarter of year over year basis, but.
I think philosophically youre on the right path as we look to those margins in the backlog if they are higher than they've been before at some point theyre going to accrete in if it's larger projects they might be executed over a longer time period. If it's some smaller projects maybe they would they would kind of filter in over a quicker time period.
As we've talked about a lot before really really difficult to kind of get forward and project those margins from an external standpoint, so we try to concentrate on that mix within the mix and kind of give as much color as we can but ultimately as we think about the I think the P&L on the margins through the year.
We should be infecting positive with the mix of some of those larger projects get closer towards the end of the execution phase and so ultimately I think for of a belief that it's a tailwind, but I think as your other question alluded to there is there still of lot of uncertainty within the supply chain specifically around timing.
And that's just.
The other another factor that we and others are all dealing with at the moment.
Yep got here's maybe my last 1 so you guys have been very hard on work internally just trying to protect your earnings in the.
Not just the tough downturn, but maybe even a little bit extended particularly on the MRO side now that you're starting to see a little bit more daylight.
Kind of what do we get back to start of rebuilding the acquisition pipeline because I'm sure that that was now of.
Backburner a priority.
Do we start to rebuild the M&A pipeline now and.
Or are you or have you already kept up with that in your M&A.
On the M&A has bubbled up from your.
From.
From your business managers.
During this process kind of where do you stand there.
Yes, Scott that's of Great question, absolutely as we see delevering throughout this year, we recognize the balance sheet is going to be in a fundamentally different place at the end of this fiscal year.
We've been actively.
Engaged in and really looking at that Emma.
M&A pipeline, particularly in light of some of the.
Our strategic initiatives around diversification of our end markets and so we are really looking at that and recognizing that our position is going to be fundamentally the.
The different in the back half of this year and we will be much more able to.
Execute on some of our inorganic growth opportunities.
Got it.
Build on that as well as of we think about the the market process heating not just heat tracing theres a lot of fragmentation out there there are certainly opportunities for us to execute and I think the balance sheet was more of the limiting factor, we've always kind of kept up with relationships and what's going on so.
We're certainly engaged in the conversations and as Bruce said and hopefully that balance sheet becomes more of an enabler in the future.
Hey, Thank you both for answering all my questions I appreciate it.
Thanks Scott.
There are no additional questions at this time I would like to turn the call back the Bruce <unk> for closing remarks.
Thank you Bob and thank you all for joining the call today, we appreciate your interest and support of Therm on Pla.
Enjoy the rest of your day.
Yeah.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
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