Greetings, and welcome to the Thermon Group Holdings, Inc. Second Quarter Fiscal 2021 Earnings Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host, Mr. Kevin Fox, Vice President, Corporate Development. Thank you sir. Please go ahead.

Thank you, Diana. Good morning, and thank you for joining today's fiscal 2021 second 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. I'd like to remind you that during this call we may make certain forward-looking statements regarding our company. Please refer to our annual report and most recent quarterly report filed with the SEC for more information regarding our forward-looking statements including the risks and uncertainties that could impact our future results. Our actual results may differ materially from those contemplated by these forward-looking statements and we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as maybe required by law. And now I'll ask Bruce Thames, our President and Chief Executive Officer for his opening comments.

Thank you, Kevin, and Good morning. We hope everyone listening is staying safe and in good health. We appreciate you joining our conference call and for your interest in Thermon. Jay Peterson, our CFO, is with me and will provide additional information on our Q2 financial performance following my remarks. Since our Q1 call, 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 remain open for business and have focused on supporting our customers around the globe. As we look across the world, our teams and our customers are adapting to the new normal. In many locations, we continue to suspend business travel, work from home where possible and follow the applicable local health protocols. I'd 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 this new way of working. I especially want to thank our front-line employees that have continued to be onsite, serving our customers each and every day throughout this pandemic. Their commitment to our core values of care, commitment and collaboration as well as our industry-leading safety performance is both admirable and appreciated. With the uncertainties surrounding this pandemic, our team has remained focused on value preservation and cash management. In Q1, the team took decisive action to reduce SG&A by $16 million in the fiscal year and just over $17 million on an annualized basis. During the second quarter, the team has further reduced expressed SG&A spending by an additional $9 million in the fiscal year, and we expect this reduction to continue on an annualized basis going forward. In addition,…

Thank you, Bruce. Good morning. In light of the protracted, depressed capital spend environment, our focus continues to be on value preservation in addition to funding specific strategic investments. During the quarter, we recorded $2 million of restructuring cost related to the Q2 cost. And we expect these cost-out actions, including the Q1 reduction in force, to reduce SG&A to approximately $34 to $35 million for the second half of this fiscal year. And we believe approximately 80% of these reductions are structural in nature and will provide incremental operating leverage when growth returns. And since May of this year, we have reduced our SG&A by approximately 24% from $100 million down to $76 to $77 million. Also during Q2, our Canadian subsidiaries qualified for and received a $1.4 million benefit from the Canadian Emergency Wage Subsidy program, and $400,000 of this benefit was recorded under cost of sales while the remainder impacted SG&A. While we have faced significant challenges in our P&L related to COVID-19 and the sustained decline in oil prices, our balance sheet remains strong. And our cash and investments balance at the end of September improved by $51.4 million. And we also paid down $4.4 million in debt and generated $7.2 million in free cash flow, and that marks our ninth consecutive quarter of positive free cash flow. Our CapEx spend for the second quarter totaled $2 million, net inclusive of both growth and maintenance capital. And we expect fiscal '21 CapEx to be approximately $4.6 million, and that's a year-on-year reduction of 54%. Our net debt EBITDA ratio was 2.9x at the end of Q2. And lastly, our capital allocation priority is to continue to reduce our debt through continued optional debt repayment, and we remain confident in our current liquidity and ability to generate…

[Operator Instructions]. Our first question is from Scott Graham of Rosenblatt Securities.

Very well done, very good execution.

Thank you.

I do have a couple of more 40,000-foot questions and then maybe a couple of 5,000-footers. As you look at the market right now and I'm certainly speaking largely oil and gas, and frankly even maybe even more specifically greenfield, it does look like Brent is sort of landlocked at this $40 level. What are your customers saying that, that means for their greenfield or capital spending, where it bottoms? In other words, right, so if it's down this year in the calendar year, but will it be down again next year because of that level?

Yes. Scott, this is Bruce. I'll tell you there is still a lot of uncertainty on capital spending with our customers. But as I mentioned in my script, what we're seeing is there are a number of customers that are much more impacted than others. And I think it's important to reinforce that if we look at the last downturn in the oil and gas sector, where Thermon prior to that downturn in 2014, 2015, Thermon really benefited from the investments in the oil sands. Since that time -- and at that time, upstream was a much larger percentage, probably 2.5x the percentage of our business that it is today. Today, we've repositioned the business much more -- we're much more exposed to gas. We're a lot more exposed to chemicals and petrochemicals and we were able to drive growth kind of in following that last downturn in those areas. It really wasn't in upstream spending. So I suspect the price of oil will continue to have a pretty significant impact on upstream operators as well as integrated oil companies. But as I mentioned, there are others pure chemical plays that chemical companies, they are less impacted, in fact, some of the -- in certain areas because of some other supply disruptions we saw in the Gulf Coast, particularly with the hurricanes that have hit Louisiana, we've actually seen prices spike. So in some of those areas, we expect them to be healthier, have better cash flows and capital investments to move ahead. So I guess that would be how I could characterize it. I don't really think I could necessarily quantify it.

That's fine. I think we're all grouping for that answer. If we were to look at your backlog right now, obviously, it's -- the number of looks good. But would you be able to quantify how much of the backlog, let's say, 6 months ago was expected to be shipped and it was not? Like how much of your backlog increase was not necessarily planned, right, so pushing out of shipments versus what do you expected?

Yes. Scott, a rather minor amount, okay, less than $5 million. And recall, we are very late cycle with our projects where the last oftentimes 1% or 2% or 3% of the activities needed to do the full commissioning. So a rather, rather minor amount and we have not seen a significant protraction in the execution of our backlog at this point in time.

Okay. So let me just connect those two dots, the question that Bruce answered and the question you just answered, Jay. Thank you. To this end, in the past, you guys have in greenfield been about 2 to 3 quarters, behind general purpose capital spending in oil and gas, again, on the greenfield side. And do you guys see anything different this cycle again notwithstanding when capital spending improves? But has that extended? Do you think that you will still be in that 2 to 3 quarter lag when CapEx bottoms?

Scott, this is Bruce again. I expect it to be similar. During the last downturn, we did see timelines move out. Normally, our backlog we execute in 12 months. Some of that could -- we saw that extend to as much as 18. As we look forward, I still expect us to lag by, I would say, 2 to 4 quarters the CapEx recovery just because of where we are in the cycle. I do, however, want to point to the fundamental difference in our business. When you look at the environmental and process heating products, which is about 25% of our revenues, those are about -- those are much earlier in the recovery. So we saw those turn down more quickly, and we expect those to rebound sooner. So that's an important shift to consider when you're kind of looking at the business on a go-forward basis.

Yes. Last question, and this is maybe for Jay. Jay, could you kind of give us the specific this quarter cost reductions? I think the numbers you gave for annualized, correct me if I'm wrong, right, for -- within SG&A and within cost of goods sold, what the specific benefits were this quarter. Do you have that?

Yes. For SG&A, we exited last year for SG&A approximately $100 million, slightly over $100 million. And in Q2, we discussed that the reduction would go down to $88 million, and we are now viewing somewhere between $76 million and $77 million for the year. So Q1 was $12 million and then add another $1 million-ish, maybe 2 million for this current quarter. In Q2, we've gone from $25 million to a pro forma basis of $19.9 million ex the Canadian Wage Subsidy and the restructuring charge.

So that would be the operative number in the second quarter, right, Jay, that 6 million?

Yes.

And then on the cost of sales side?

We have -- let me give you this fiscal year because a lot of these still need to blend in. We've identified $1.8 million worth of overhead-related cost reductions. On a future basis a 12 month basis, we believe that will be $3.8 million. So $3.8 million over the next 12 months, of which $1.8 million will be realized. And then Bruce talked about the strategic sourcing and the cost reduction initiatives, and that will be over and on top of the overhead cost reductions I just mentioned.

Our next question is coming from Joe Aiken of William Blair.

This is Joe on for Brian. So I guess I'll start. I'm curious if you could just talk in a little more detail about any large project activity you're seeing right now. You mentioned a couple of projects you're working on. Are there still some large projects being bid on in those markets or anything to highlight?

There is certainly a fewer number of capital projects out there. I mean we expected that coming into this year, and that's certainly been reflecting in our -- reflected in our incoming order rates. The larger projects that we see today tend to be in the Eastern Hemisphere. We see particularly weakness in the near term in the larger projects in the U.S. and Latin America and, to a lesser extent, in Canada. But -- so right now, the overall capital spending without question is down in the 25% to 30% range from what we had seen a year ago.

Okay. And can you just clarify for me kind of the order trends, how that trended through the quarter? I think in the first quarter call, you said it was down 33% in July. And did you say that ended up being down 18% for the full quarter? Is that right?

Yes, that's correct. So we saw improvement in the incoming order rate during the quarter sequentially. I think the really important thing to anchor on as we saw, we've been seeing improvement in our quick turn business, which is really the -- our MRO. It's a proxy for our MRO business, and it's the most profitable piece of our revenue on the installed base. So we are seeing some sequential improvements there, and that's certainly promising although they are still well below prior year levels.

Okay. And did you say what your incoming order rates on October order?

I have not mentioned it. I did say we expected to see some sequential improvements in our quick turn business, and that we have seen. But as I mentioned also during the script, we do expect headwinds in the capital projects in the back half of this year, particularly in the U.S. and Latin America.

Okay. So just to stick on that for a second. So sequential improvement, will that be compared with the full quarter incoming rate of down 18% sequential improvement from that?

You have to understand that's both maintenance, and capital, so that would not be a good way to look at it. It's -- I see a sequential improvement on our maintenance incoming order rates, and I see weakness in the capital.

Okay. And then just turning to margins, I think you said you would expect gross margin to improve 100 basis points or more in the second half of the year. Is that on a year-over-year basis? And would you expect -- given there is some moving pieces there with the cost reductions in the overhead reduction, would you expect to see more expansion in the fourth quarter compared to the third quarter?

Yes, that 100 bp improvement or more was on an annual basis.

Okay. Okay and okay. And would you expect more of that to come in the fourth quarter compared to third?

Yes. Yes, because some of these cost-out actions have to -- they take a little time. So -- and depending on how costs are rolled and such in manufacturing absorption, that doesn't all happen immediately.

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

Bruce, could you talk a little bit more about some of the alternative energy projects, biodiesel, biogas? I'm curious what type of content – heat-tracing content is on a project like that? How does that compare to a petrochemical plant or a refinery or what have you?

It certainly -- Jon, it certainly depends on the size of the processing facility, that certainly has great influence. But for example, I think it's important to note, historically, refineries have been heavily weighted towards steam. When you move towards things like biodiesel, they are almost exclusively electric. So that's a big shift or a transition from steam to electric that we see. And maybe for those of you, an update, it's around 48% steam, 52% electric when we look at the markets globally. A big part of that's been in refining. So as we look at, let's say, a biodiesel plant that I had mentioned, those may range from -- depending on the size and the scope of work, from $0.5 million to $2 million in total heat tracing content, and that's almost exclusively electric heat tracing. There are additional opportunities in the process of heating and temporary power, which are not included in the numbers I just shared.

Okay, okay. Any other alternative energy types of projects? A lot -- there's been a lot of talk about hydrogen, and I don't know if heat tracing's required for hydrogen. But anything beyond biodiesel, biogas?

There are other opportunities. The one that really is real today is concentrated solar power. Those are pretty significant when it comes to heat-tracing opportunities, and we've done a number of those projects around the globe. We don't play much in the photovoltaic solar today. Limited opportunities in wind. But those are at least a couple of examples. Hydrogen, it's a little early there. And certainly, that would be an area that we would continue to explore as that becomes a greater part of the overall energy mix. We think that's probably beyond the 5 to 10-year mark.

Sure, sure. Would you say concentrated solar power, do you mean utility-sized projects?

Absolutely.

Okay, okay. All right. Okay, that sounds good. And Jay, one sort of forward -- really forward-looking question. You've obviously taken a lot of costs out of the business. And when the revenues return, should they return to prior levels and so on? What do you think -- how do you think your margins could be relative to where they were in the past? They were up by -- up towards 20%-something like that. But given a return to "more normalized revenues" and then given the costs you've taken out, are we beyond that 20% in a better environment?

We are, we are. Recall back 4 or 5 years ago, when a lot of the upgraders in Canada were happening, and by the way, we are not planning for that to reoccur. We had EBITDA oftentimes at the 25% range going forward. We think it will be somewhere in the 22% to 25% range once we see upticks in volume.

EBITDA margins?

Correct.

Our final question today is coming from Andreas Nicholas [ph] of Evercore ISI.

So definitely understand where you're coming from on not providing new guidance for the remainder of fiscal year. There's just a lot of uncertainty out there and the recent resurgence of COVID in Europe, for example, is just one of many reasons that would give people pause. I guess this is more just a qualitative question for you. But as leadership of companies operating globally in the industrial and energy markets, what kind of things would you need to see take place in your markets or what you're seeing in your data order for you to feel confidence in providing and reinstating that near-term forward outlook?

Yes. I mean we are looking towards that in the coming quarters. Certainly, I mean, just one quarter later, our visibility is improving. But as you noted, there is still some uncertainty around some of the resurgence and things like that and how that may impact a whole host of things. But we would like to see just the rates under control and see a little more consistency in some of the demand environment that we are seeing with our end customers. And so I think COVID is -- and really getting that at least to manageable levels will be important for us to have better visibility for -- to provide forward guidance.

Okay. I hear you on that. If we move on to, let's say, some of the inroads that you've made in the digital area and some of your new products, how do you think about ensuring that you're able to capture some of that value that's being provided to the customer, whether in terms of greater efficiencies for them or savings? Or is that just increasingly viewed as table stakes in your sector these days? Just curious kind of how you can capture some of those?

I mean some of these technologies are available in other areas in the industry. But within our space, we're really out in front here. It's really -- we're seeing a significant amount of demand from our customers for these types of solutions, and we really have seen since COVID-19 it's accelerated the need for these types of technologies. As we look forward, we said this is our first subscription-based software. It's an operational software that our customers can use as -- to manage their asset base. It also sets up the opportunity to drive additional revenues on services on the installed base, whether that be online and virtual type of services around a predictive maintenance and troubleshooting, things like that, to even on stream, online and on-premise type of maintenance opportunities and really driving MRO sales. So I believe this is well beyond just a kind of a me-too and also needed. We're out in front here, and we see some really significant opportunities to drive additional revenues on the installed base. And there are real true value propositions when you look at the impact that can have on our customers and how they manage their assets.

At this time, I'd like to turn the floor back over to management for closing comments.

All right. Thank you, Donna. I would like to thank you all again for joining us today and appreciate your interest in Thermon, and enjoy the rest of your day. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time, and have a wonderful day.