Greetings. Welcome to the Thermon Earnings Conference Call for Quarter two of 2022. [Operator Instructions] And please note that this conference is being recorded. I will now turn the conference over to your host, Kevin Fox, Chief Financial Officer. You may begin.

Thank you, John. Good morning. And thank you for joining today's fiscal 2020 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. Additionally, the slides for this conference call can be found on our IR website under News Events, IR Calendar Earnings Conference Call Q2 2022. 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 may be required by law. Now I'd like to turn the call over to Bruce Thames, our President and Chief Executive Officer, for his opening remarks.

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. Kevin Fox, our CFO, is here to provide additional details on our Q2 financial performance following my remarks. Turning now to the second quarter results. Overall, we're very pleased with the momentum that is building in the market through the first two quarters of the year. We were particularly pleased with the sharp increase in quotations, up 63% over prior year, followed by robust order growth of 59% year-over-year a historical record, which included a large onetime labor and third-party material contract booking in excess of $20 million. Revenues were up 18% over the prior year period on a constant currency basis. Backlog at quarter end was $155 million, up 31% over prior year and 34% sequentially. As a result, we are raising guidance for the second consecutive quarter this year. The team has also continued to be disciplined around cost management with SG&A at 25% of sales and in line with annual spending projections. As we continue to invest in our strategic initiatives, we are seeing a growing quotation log for our new Genesis network and have secured our second order. Just as a reminder, this is an IIoT-enabled wireless, self-healing mesh network and supervisory software that provides real-time situational awareness to operators. It is a key part of the technology-enabled maintenance strategic platform. Other strategic platforms include developing markets and diversification of end markets. All 3 of these strategic initiatives will be addressed later in this call. Our efforts to address labor shortages and overcome supply chain challenges resulted in a sequential improvement in productivity and utilization over the first quarter, which were masked by $1.2 million in…

Thank you, Bruce. Revenue growth was again strong this quarter, plus 22% versus the prior year quarter and down 2% on a trailing 12-month basis. Current quarter includes a $2 million tailwind from FX. Revenues were up in 3 of our 4 regions with the U.S. Latin America, Canada and EMEA regions, all greater than 25% above prior year, while our smallest region in APAC contracted by 13% due to the continued impact from COVID-related government lockdowns in India and lower project volume. We booked a contract worth over $20 million in the quarter with a large multinational chemicals customer for labor and third-party materials. This onetime project contributed over $3 million of revenue in the current period. We will continue to provide revenue figures until the contract is complete to ensure appropriate year-over-year comparisons, both this year and next. While margins for these types of contracts are typically on the lower end of our desired range. We have already secured incremental materials and maintenance work on site, and this is another example of how Thermon's broad offering grows a value-added relationship. When viewed in the aggregate, relationships like these enhance our installed base and drive profitable growth for the company. On a TTM basis, revenues are down 2% as we start to emerge from the COVID induced trough. Pricing increases went into effect in our fiscal second quarter, but typically takes 60 days to implement within our network. So we expect to see the impact of that hit in our second half. While we are happy to see the business inflecting off last year's lows, we are not yet back to pre-COVID levels and still have plenty of room to run in this recovery. We are seeing the beginning of customer spending in Texas related to Winter Storm Uri…

Thank you, Kevin. I'd like you to now turn to Slide 10. As we move forward, in addition to growth in our base business, we see developing markets, diversification of end markets and technology-enabled maintenance as strategic platforms to grow -- to drive growth above and beyond that of our traditional end markets. Looking at developing markets. Developing countries are projected to grow at a rate 3x greater than that of developed countries over the next 10 years. To capitalize on this opportunity, we plan on leveraging our geographic footprint augmented by localization to compress lead times and achieve regional price points while meeting any local content requirements. The second opportunity, diversification of end markets is potentially the most important of our 3 strategic platforms. The addition of process and environmental heating to our solution set to complement heat tracing has created opportunities to build meaningful positions in more diverse end markets. The three markets we are initially targeting are commercial, food and beverage and rail and transit. While we have participated in these markets historically, we are expanding our market channels, enhancing our product portfolio and building sales tools and training to grow our share. Technology enabled maintenance leverages our digital Genesis network and control platform, providing real-time situational awareness to streamline maintenance while improving the safety, productivity and reliability of customer assets. We see additional revenue opportunities from the sale of hardware, subscription-based software and online services, enhancing our abilities to capture the full value of MRO opportunities. Above and beyond these three strategic initiative growth platforms, our operational excellence program is targeted to drive an incremental 1.5% to 2% in productivity gains on an annual basis. While we also anticipate leveraging SG&A to grow at half the rate of the top line to expand EBITDA margins over…

Thank you. [Operator Instructions] Our first question comes from the line of Brian Drab with William Blair. You may proceed with your question.

Hi, Bruce and Kevin. Thanks for taking my question.

Good morning.

Morning. Can you maybe just elaborate on what some of the products you have for the renewables market? What some of those specific applications of your products are? Obviously, that's great that you touched on it today. I'd just like to hear a little bit more about the outlook there. And when does that start to - that market start to really generate meaningful revenue? I mean, it sounds like it already is beginning to.

Yeah. So I spoke specifically to biofuels. And we really - it's many of our traditional products. Even though you're processing organic matter, you're converting that into biodiesel is one of the most common products there. And so the production processes are very similar. So we use really the same types of products we would use in a typical, say, refining applications. So certainly, heat tracing, as well as immersion heaters, and then in some cases, depending on the location of the facilities and the climate we might also provide environmental heating. So that would be kind of biofuels. If we're looking at other renewables, particularly around wind, those would tend to be immersion heaters as well as well as forced air heaters for typically warming the oil in the sum for the nasal for wind and then also warming - heating the nasal cell itself. So those would be kind of the two applications in wind and solar applications tend to be less.

Okay. And hydrogen plant? Is that some of the same like...

Yeah. So hydrogen, we actually use a lot of immersion heating for those processes to basically split the water molecule into its component parts, hydrogen and oxygen. So - And those are used pretty extensively in that process.

And in those end markets, do you typically bump into the, I guess, the same competitors that you would in your traditional markets as well?

That's correct.

Okay. You mentioned the $20 million order, congratulations on that. And it sounds like that $3 million was recognized. What is the timing of the balance recognition of the balance of that revenue? And is there potentially more beyond that? And what's the overall gross margin do you think for that opportunity?

Yeah. So we've projected $15 million to $20 million within the fiscal year. There are definitely additional opportunities above and beyond that. And we would expect those to be at a better margin profile. Just to note, we actually have already supplied all the direct materials, heat tracing, panels and all of that to this customer. This is just kind of some final work around installation, but we see opportunities in pre-commissioning and really during the commissioning process and then post start-up for additional revenues. The margin profile on labor and material is on the lower end of our expected range in projects.

And Brian, this is Kevin. Maybe just to round out on the timing between 3Q and 4Q, maybe half and half, I don't think there's a bias either way between the balance of the year. The maybe it could be a little more in 3Q versus not, but it's on the margins.

So just to make sure I understand, so the materials have been delivered, but it's just that you're going to recognize revenue as it's installed? Is that -- or is there...

We sold the material outright. We sold the material outright, that was recognized 3 years -- 2 or 3 years ago. So this is just final stages pre-commissioning - of construction, pre-commissioning at start-up.

So this is service and installation revenue that you're recognizing now? Maybe that's…

Correct. Correct.

And so when you say lower end of the range is like lower end of the greenfield range, like this could be like 25%, 30% gross margin-type revenue?

Brian, when we think of the range of the spectrum, there's probably even a lower end of that where some projects get done and especially with the content here not having any of the materials, you should think the lower end of the range.

I got you. I got you. Right. It's a lot of service here in installation. Right. I understand. And then -- yes, And then -- right, I wasn't thinking about it correctly for a second, but I got you. So the end markets, I just wanted to see if you could give any more granularity on this. And could I ask it this way, could you kind of rank order the impact like the strength of the end markets that you saw in the quarter, including petrochem, as much granularity as you can give with petrochem, midstream, downstream, oil and gas, et cetera?

Yeah. So the - when I kind of rank it chemical - petrochemical, by far, the strongest. We've seen -- There's a tightness in supply, resin prices are -- literally have doubled. So we're really starting to see those facilities really return to more pre-COVID levels of maintenance activity. And we're also seeing capital projects that had been shelved for some period of time now being pulled down and being advanced. So that's been really the strongest. And I would rank, second would be power. We've also seen some pretty strong maintenance spending and recovering power. Some of that's related to here in North America and Texas, particularly related to the winter storm last year. but also just overall strong demand in the power sector. And certainly, if we look at power more broadly, we see significant opportunities in the Eastern Hemisphere as power demand growth is expected to grow pretty significantly over the next several years. I think beneath that, we would -- I would look to kind of natural gas midstream and LNG opportunities. Those also are kind of being resurrected as we're seeing more demand for natural gas. I think it actually is actually up above pre-COVID levels, and that's actually driving requirements for more liquefaction and gasification of LNG in order to meet kind of global demand. So those would be kind of the top markets as far as where we see the strongest opportunities. I noted rail and transit renewables, those actually have some really nice opportunities. It's small, but certainly growing, part of our business. And then I would say, upstream is probably the weakest sector, although we are seeing some maintenance, not much in the way of CapEx.

Great. Thank you. And I'm just going to ask one more. Gross margin, big headwind right now from a number of factors, but how - can - and I know you commented that, I just want to make sure that I have all the details understood correctly. But can you just forecast, as much granularity as you're willing, to give what you're expecting for gross margin next couple of quarters and even into next year as things normalize, hopefully?

Yes, Brian, this is Kevin. I think on margins, you've seen the pieces. We've got 150 basis points on the charge in the quarter. That kind of gets you back above the 40% range. And then we outlined I think roughly 600 basis points, 200 there due to the large projects, another 400-ish due to the supply chain. We think pricing is going to have an impact on the supply chain side of things in the second half. So we certainly think there's a path back to those traditional historical 45% type of margins. But I think as we spoke to the large contract, that's going to be a drag on margins here. just given the structure of that. So there's a little bit of pluses from a supply chain being offset by pricing. Having more volume should increase productivity, but you've got a little bit of a drag back here in the next 2 quarters or so on the large projects. I would say longer term, I think we remain confident that this is a business that structurally can generate margins, on average, above 45%. And if you think about where SG&A is trending to date, we think about that kind of low 20s percent EBITDA, we think we're on a path there. And certainly, the business is not there today. So we think there's some pretty strong operating leverage here, not just in the next 6 months, but the next 18, 24, 36 months as the business continues to grow. So - without getting into specifics on gross margins, again, I think you can kind of work your way through some of the supply chain challenges with pricing. But we'll have a little bit of a lag here in the next 2 quarters just due to the -- that large onetime project as that gets completed.

Got it. So I'll let you go after I just make sure I -- what I just heard in my mind, I'm hearing like maybe mid like 45-ish is doable with price increases, but maybe a couple of hundred basis point headwind related to the large project or projects in the second half. And then beyond that 45% is the obtainable 45-plus even longer term? Is that...

You're in the right gift drag, Brian? Yes, absolutely that’s the catch.

Okay. Thank you.

[Operator Instructions] Our next question comes from the line of Jon Braatz with Kansas City Capital. You may proceed with your question.

Good morning, Bruce, Kevin.

Morning, Jon.

Returning to the gross margin and the sort of the 400 basis point drag because of supply chain issues and pricing and so on, would - everything else being equal, nothing gets worse. Would you think by the end of this fiscal year that you're back to fully recovering that 400 basis points? Or will the -- do you need more time, so to speak?

Yeah. John, I guess, embedded in the question, if I kind of think about it more broadly, is a little bit of a call on how transitory inflation actually is. But I think when we look at the vast majority of that 400, I think we feel really good about pricing in the market right now. There's a ton of demand out there. And I think when we look at the ability to meet it maybe it's three quarter of the way, maybe a little bit more gets home, related to pricing in the second half. I certainly don't want to be making a call on inflation when others aren't able to do that at the Fed and other experts in the field, if you will. But I think we feel pretty good on pricing ability in the second half to mitigate that. And ultimately, that's going to drive some of the recovery in the second half of the year.

Okay. And did you say, Kevin, that in the second half, there will be a small charge related to the project that's been causing some difficulty?

So we took the charge in this current quarter, Jon. That's roughly $1.2 million. What I was alluding to is we're going to have immaterial corrections in prior periods. So that will be Q4 '21, that's roughly $400,000. And then Q1 of '22, that was another $1.2 million. Yes. So no future charges that we expect at this time related to that project.

All right. All right. And Bruce, in terms of renewable and green energy, is there - and there's been a lot of talk about carbon capture, carbon sequestration and so on. Is there opportunity in that area for Thermon?

Yeah, there is. There certainly is applications of our technology there. And we are we are connected to those customers and those opportunities. Also, you heard Kevin mention about our methane destruction unit. It's actually one of the kind of myriad of solutions that are out there, but it really has a great application in kind of oil and gas gathering fields and where carbon capture is really not a viable solution. And it converts natural gas, methane, it converts that to CO2 and water. So that's actually even another opportunity when we start looking at carbon capture and reduction.

Okay. All right. Okay. Very good. And Bruce, you think -- I know you talked -- you made reference to it, but do you think there will be anything coming on the regulations regarding the Texas State bill that will begin to impact Thermon to any significant degree as -- Or are there big changes on the horizon as a result of that bill?

Yes. We already are seeing -- part of our order growth this year was directly related to improvements in the infrastructure to winterize assets. So we're already seeing the impact of that in our business.

Okay, all right. Thanks very much. Appreciate it.

Thank you, Jon.

At this time, we have reached the end of the question-and-answer session. And I will now turn the call back over to Bruce for any closing remarks.

All right. Thank you, John, and thank you all for joining here today. I appreciate your interest in Thermon, and enjoy the rest of your day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.+