Thermon Group Holdings, Inc. (NYSE:THR) Q4 2019 Earnings Conference Call June 6, 2019 4:15 PM ET
Kevin Fox - Vice President, Corporate Development
Bruce Thames - President and Chief Executive Officer
Jay Peterson - Chief Financial Officer
Conference Call Participants
Brian Drab - William Blair
Greetings. And welcome to the Thermon Group Holdings Inc. Fourth Quarter Fiscal Year 2019 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to you, Kevin Fox. Thank you. Please begin.
Thank you, Roya. Good afternoon and thank you for joining today's conference call.
We issued an earnings press release this afternoon, which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our Web site at ir.thermon.com. A replay of today's call will also be available via webcast after the conclusion of the call. This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast in any form without the expressed written consent of the company is prohibited.
During this call, we will also discuss some items that do not conform to generally accepted accounting principles. We have reconciled those items to the most comparable GAAP measures and 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 would like to remind you that during this call we may make certain forward-looking statements regarding our company and business that are not historical facts, because forward-looking statements relate to the future they are subject to inherent uncertainties, risks and changes and circumstances that are difficult to predict.
Please refer to our annual report and most recent quarterly report filed with the SEC for ore 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. We caution you, therefore, against relying on any of these forward-looking statements. They are neither statements of historical facts nor guarantees or assurances of future performance.
Any forward-looking statement made by us during this call speak only as of the time at which it is made. Factors or events that could cause our actual results to differ may emerge from time to time. And it is not possible for us to predict all of them. 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.
And now it's my pleasure to turn the call over to Bruce Thames, our President and Chief Executive Officer. Bruce?
Well, thank you, Kevin, and good afternoon everyone. And thank you for joining our conference call and for your continued interest in Thermon. Today we have Jay Peterson, our CFO joining me on the conference call. And Jay will follow me to present the financial details of our fiscal year 2019 fourth quarter and full fiscal year.
To begin, I'd like to take just a moment to highlight some key accomplishments in our fiscal 2019. The increased investment in our research and development has resulted in a more robust pipeline of new products than at any time in the history of Thermon. These efforts yielded eight new product launches during the fiscal year that continued to differentiate our solutions in the marketplace to build and extend our leadership position.
These new introductions included the New Genesis control platform that has formed the basis for our IoT cloud-based solutions going forward. These new solutions will give customers more accurate and timely information to improve the reliability, safety and efficiency of their operations. Most recently, we introduced the TraceNet Triton wireless temperature transducer, the next generation Terminator Beacon Light System and the HTSX HT High Temperature Self-Regulating heater to provide the most advanced heat tracing system and accessories available on the market today.
We also launched new software platforms such as CompuTrace 6.1; CompuTrace power management and TraceNet Sync to improve our suite of design technology that creates greater value for customers starting with early design and continuing through installation and ongoing operations. Finally, we introduced the methane destruction module, which capitalizes on our Cata-Dyne Catalyst Technology by converting fugitive natural gas emissions to CO2 and water dramatically reducing greenhouse gas emissions for our customers.
During the year we continued to invest by adding key talent, upgrading equipment and enhancing processes to accelerate the pace while improving the overall success rate of these new product launches. During the year, we continued to invest in people, processes, systems and tools to build a scalable global business that improved operations, productivity and project execution as evidenced by the supplier of the year award we received from Bechtel for the execution of the world's largest ethylene unit now nearing completion.
We also successfully integrated Thermon heating systems by capitalizing on the identified cost synergies, while growing the business, increasing our addressable market, enhancing the solution set and creating an expanded platform for growth. All of these investments enabled organic growth above and beyond the market recovery to deliver a record $413 million in revenue and a record $83.5 million in adjusted EBITDA. This growth in revenue and EBITDA while successfully managing costs translated into GAAP EPS of $0.69 a share, an increase of 90% over prior year. Adjusted EPS finished at a $1.19 a share, an increase of 20% over prior year.
As we look back to fiscal 2018, we saw the early stages of recovery beginning to materialize in the second half of the year and this recovery was characterized by an increase in deferred maintenance spending, particularly in Canada, which drove strong gross margin expansion during that fiscal year.
During fiscal 2019, we saw greenfield project activity begin to accelerate as higher oil prices created improved economics particularly for petrochemical projects linked to natural gas feedstock. This acceleration in project activity drove a disproportional growth in greenfield projects during the year creating an unfavorable mix and weighing on gross margins. However, we believe firmly that our project wins and the resulting growth in the installed base positions Thermon well to capitalize on historically higher margin, recurring revenues in the future.
Turning now to our fourth quarter. We were very pleased with the revenue growth the team delivered in Q4. We saw revenues of $114 million, exceed our expectations for the quarter, an increased 11% year-over-year. Organically, this represented the sixth consecutive quarter of double-digit growth. The growth was largely driven by change orders and accelerating projects schedules, which shifted the mix to a record level of greenfield projects versus our MRO/UE business at 50% versus 50% respectively. While we expect this shift to have a positive impact over time due to the growth in the installed base and the higher margins associated with future recurring revenues, the higher mix of heat tracing greenfield at lower margins had a negative impact on gross margins in the quarter.
As a result, gross margins declined by 620 basis points. Despite the headwind from this mix shift, the business delivered adjusted EBITDA of $21.7 million in the quarter largely offsetting the gross margin mix pressure with base cost leverage. Adjusted EPS was $0.32 a share for the quarter down $0.02 a share year-over-year.
Bookings of $106 million in the quarter showed a solid 12% percent growth year-over-year after Q3 that was characterized by slower bookings, but increased quote activity. Although, we saw double-digit growth in incoming orders, the substantial overachieve number of revenues resulted in a 93% book to bill for the quarter.
As a result, the backlog finished the year at $120 million a year-over-year decline of 25%, margins and backlog improved by 100 basis points during the quarter.
Turning now to an overview of our markets and geographies. From a market perspective, upstream activity is stable. Both chemical and petrochemical sectors remain the most active as the project pipeline continues to improve. We see an expanding pipeline of LNG midstream projects that could be awarded in fiscal 2020, but will not begin to materialize into fiscal 2021 and beyond. We believe that this trend will create significant opportunities for growth through 2025 and beyond.
Combined cycle power projects are showing low single-digit growth particularly in the U.S. and Latin America. The transportation sector in North America continues to create opportunities to diversify end markets for Thermon. We anticipate several large infrastructure projects in Eastern Canada and the U.S. will contribute to bookings in our fiscal year 20.
Our installed base and associated approvals in the nuclear sector position as well to capitalize on a steady flow of refurbishments planned in the coming years.
Geographically, North America showed strength throughout fiscal year 2019 driven largely by the U.S. and Latin America geography. Going into 2020, we expect the rate of growth to slow. In the eastern hemisphere, we saw strength in Asia offset by weakness in Europe, Middle East and Africa that we expect will continue into fiscal 2020.
Overall, we're pleased with how well the business is positioned for future growth with a stream of new product introductions and the expansion of our addressable market. While there is uncertainty due to volatility in commodity markets and overall macro events like Brexit and the ongoing U.S. China trade discussions, we do see continued strength in the U.S. and Asian markets driven in large part by petrochemicals.
We also anticipate that the LNG midstream investments that would be made through 2025 will become a significant driver for our business in the coming years.
Looking ahead, our fiscal 2020 plans include globalization of the Thermon heating system business bound to drive growth above and beyond the market.
We also forecast the business returning to a more traditional mix of MRO/UE versus greenfield revenues in fiscal 2020, which should improve the gross margin profile. In addition, we expect to pass along price increases in the 3% to 4% range of which we anticipate approximately half will be realized during fiscal 2020.
We continue to see attractive organic investment opportunities and our expanded R&D capabilities expect to deliver another five new product launches in the coming year. We believe that these new product introductions will expand our capabilities across the portfolio of solutions. We anticipate R&D spending to be approximately 2% of revenues in the coming year.
Our M&A pipeline remains robust. Our cash flow generation and current EBITDA to net debt ratio positions the business attractively for the right strategic opportunity. As part of ongoing operational improvement projects, we have targeted cost reduction initiatives that we expect will net 1% of cost of goods sold savings during the fiscal year and approximately double that on an annualized basis.
We continue to execute on our plan to grow our addressable market by 2x to 3x by the end of fiscal 2021, our near-term goal is to reach $500 million in revenue and $125 million in EBITDA by the end of fiscal 2021. That will translate to double-digit compounded annual growth for our shareholders.
Looking forward, we're forecasting organic revenue growth of 2% to 4% for fiscal 2020. Given the strong Q4 shipments and seasonality of the business, we anticipate a slow start to the first half of the fiscal year.
I would like to take this opportunity to thank our Thermon employees around the globe for their commitment to serving our customers well and creating shareholder value in fiscal 2019.
I continue to look forward to seeing what this team is capable of delivering in fiscal 2020 and beyond.
Jay Peterson, our CFO will now address the details of our financial performance for Q4 and full year 2019. Jay?
Thank you, Bruce. Good afternoon.
I will start by discussing our record Q4 results then a recap of fiscal year 19 accomplishments, and then, conclude with our guidance for fiscal year 20.
First off, revenue and orders; our record revenue this past quarter totaled 114 million and that's an increase of 11% over the prior year's quarter. We saw a dramatic shift in the MRO/UE and greenfield mix in Q4 to 50:50. And this was the highest mix of greenfield revenue in at least the past nine years. And due to the strong U.S. dollar across the globe, FX decreased our Q4 revenue by approximately 3 percentage points.
The heat tracing greenfield revenue grew by 42% over the prior year quarter and the above greenfield mix was 10% higher than our typical historical performance and was negatively impactful to our gross margins. We continued to experience positive signs of recovery with our heat tracing revenues growing double digits for the sixth consecutive quarter. And orders for the quarter totaled 106 million and they grew by 12% versus the prior period.
Our backlog of orders ended March at $120 million versus $160 million as of March, Fiscal year 18 and that's a decrease of 25%. But as a reminder, only 30% to 40% of our orders are typically resident in our backlog due to the velocity of maintenance and standardized products flowing in and out of our backlog. FX negatively impacted our backlog by $4.2 million. In our book-to-bill for the quarter was negative at 0.93 primarily due to the acceleration of and somewhat unanticipated greenfield project revenue from Q1 into Q4.
Moving on to gross margins. Margins were 39.4% of revenue and gross profit declined by 620 basis points. The significant heat tracing revenue mix shift to greenfield was the main contributor to the lower than typical corporate margins and recall that greenfield margins are lower than MRO/UE due to the higher content of engineering and construction labor and third-party buyout items.
Margins from Thermon heating systems were accretive to our corporate margins in the quarter. And FX negatively impacted our gross margins by 97 basis points and gross profit by $1.2 million. And we have largely been able to pass along any cost increases attributable to the ongoing tariffs to our customers and we have seen minimal impact to our gross margins due to these tariffs.
Turning to operating expenses, core operating expenses for the quarter that is SG&A and this excludes depreciation and amortization of intangibles in any transaction-related expenses totaled $24.3 million in the quarter versus $25.3 million in the prior year. That's a decrease of 4%. And we have experienced significant leverage with our spending, which decreased again 4% relative to an 11% revenue increase.
Our operating expense as a percent of revenue was 21.3% again excluding D&A and this is an improvement of 350 basis points from the prior year level of 24.7. And this spending improvement was concurrent with a 19% increase in research and development spending related to future product offerings, a successful implementation of a corporate wide HRIS system and the tail end of a legacy ERP implementation.
And more specifically over the last five years, we have increased our research and development spending by 70% and have dramatically increased the number of new product introductions into the marketplace.
Moving to earnings, GAAP EPS for the quarter totaled $0.20 a share compared to the prior year quarter of $0.18, and that's an increase of $0.02 cents per share. FX negatively impacted our Q4 earnings by $0.01 a share. And Thermon heating systems contributed a gain of $0.02 a share to our GAAP EPS on a fully burdened basis including all incremental interest expense.
Adjusted EPS defined by GAAP EPS less amortization expense and any onetime charges totaled $0.32 a share relative to $0.34 a share in the prior year quarter. We will continue to communicate this adjusted EPS construct due to the high-level of non-cash amortization expense running through our income statement.
At present we are expensing $4.6 million per quarter or $0.10 a share or approximately $0.42 a share on an annual basis after tax for non-cash amortization. And note that the total Amortization expense will decrease in May of fiscal year 21 by approximately 43% to 10.5 million due to the roll off of certain assets related to the 2010 private equity acquisition of Thermon. EBITDA declined by 4% versus the comparison quarter and EBITDA as a percent of revenue was 19%. And EBITDA totaled $21.7 million this past quarter.
Next up the balance sheet and capital allocation. Our cash and investments balance at the end of March improved to 31.4 million and the most significant use of cash for the quarter was the $4 million increase in our accounts receivable balance due to the high level of March shipments. And in March in excess of 40% of our revenue occurred.
CapEx for the year totaled $10 million or 2.4% of revenue and our EBITDA conversion ratio ended the year at a healthy 88%. And lastly, our capital allocation priority in the absence of any near-term M&A transaction is to continue to reduce our net debt through ongoing cash generation and optional debt repayment.
Taxes, our tax rate for the fourth quarter was 30% and our tax rate was exposed upward this past year due to record profitability in our Latin American subsidiary with an effective tax rate of 32%.
In terms of Thermon heating systems return on invested capital, we continue to be on track for the TH business to exceed our weighted cost of capital by year three.
Turning to the financial highlights for the full year, revenue totaled 413 million that's a record high and grew by 34% over the prior year. EBITDA for 2019 totaled a new annual record of 83.5 million invested in our prior year EBITDA record set back in 2015. And our net debt-to-EBITDA ended the year at 2.2x. That's a decrease of 1.2x, since October of 2017.
Commenting on the material weakness, we received during our annual year-end audit a material weakness was identified relating to business controls over project accounting. The material weakness did not impact any of our previous SEC filings and we believe that our recently implemented ERP systems along with additional business controls as outlined in our 10-K will remedy this material weakness.
And finally, guidance for 2020. First off, we are planning top-line revenue to grow 2% to 4% in fiscal year 2020. And while we are not guiding to any M&A revenue at this time based on our acquisition pipeline and improving balance sheet M&A revenue is certainly possible.
We expect gross margins to increase in the coming year and the drivers behind this increase are an improved mix of MRO/UE recent pricing actions and run rate cost reductions of $4.5 million of which $2.5 million will be realized in fiscal year 20.
And lastly, we expect to reduce our net debt-to-EBITDA leverage to approximately 1.5x by the end of fiscal year 20.
I would now like to turn the call over to Roya to moderate our Q&A session. Roya?
Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Brian Drab with William Blair. Please proceed.
Hi Bruce. Hey Jay.
Hey, good afternoon, Brian.
Hey. I don't know if you want to add some color regarding the revenue recognition situation. But could you comment a little bit about what happened and how it was kind of a function of operating within an older ERP and the upgrade that you've gone through since. And I know there's a lot of information in that in the K around this. But on any detail, you've given and comfort you could give the investment community around to fix that is in place and kind of the root cause would be great.
Sure. There were six projects in our EMEA subsidiary that we were accounting for under our old ERP system. We have implemented a new ERP system and all new projects are under this new ERP system, which has greater visibility greater granularity and much more robust business controls to ensure accurate accounting and bookkeeping. So therefore, with this new system, we believe this issue along with some other business controls that we will be implementing including training and additional resource. We believe this issue is a thing of the past and fortunately the impact to Thermon in terms of any revenue adjustments was immaterial -- so immaterial that there were not any proposed changes to Q1, Q2 or Q3 of this current fiscal year.
Okay. Or any period?
Any period. Okay. All right. Thanks. And then, you commented on the midstream LNG. I just want to make sure I heard correctly. Did you say -- what did you say about the potential impact from some of these major projects this year?
Yes. Brian, I didn't quantify it. We would expect some of those key projects awards to occur this year. We don't expect revenues in the current fiscal year. And that's a piece of kind of our comments around -- last year was really a year of heavy greenfield projects. We really see going forward in more normalized mix and because we don't see the capital that some of the larger capital projects in this current fiscal year, we expect it to be more driven by baseline MRO/UE type growth in our installed base.
Okay. So, of the many of the major projects in that midstream LNG though none of those have been awarded yet, right? But you think that –
I can't say none of them, but certainly the ones that we're following have yet to be awarded.
I got you. And then, just the last one. R&D spending is up and what do we expect going forward in terms of the level of R&D spending. Is this a run rate or does it potentially step down slightly from here?
At this time, we really see that 2% of revenues being an appropriate level. As we look across the industry and it's not just looking at peers. But, as we look at the opportunities that we have in our product and technology roadmaps over the next three to five years, we believe that's an appropriate level of spending to drive the pace of development to ultimately lead with the solutions we provide to the industry.
Okay. Thanks very much.
Thank you. [Operator Instructions] It appears we have reached the end of our question-and-answer session. Allow me to hand the floor back over to management for closing remarks.
Roya, Thank you. Well, thank you all for listening in on this call. Thank you for your continued interest in Thermon and have a nice afternoon.
Thank you. This conclude today's conference. You may disconnect your lines at this time and thank you for your participation.