Greetings, and welcome to the Thermon Group Holdings Second Quarter Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to our host, Ivonne Salem, Vice President, FP&A and Investor Relations. Thank you. You may begin.

Thank you, Diego. Good morning, and thank you for joining today's fiscal 2023 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 in our IR website under News & Events, IR Calendar Earnings Conference Call Q2 2023. During the call, we'll discuss some items that do not conform to generally accepted accounting principles. We have reconciled those items to the most comparable GAAP measures in the tables at the end of the earnings press release. These non-GAAP measures should be considered in addition to and not as a substitute for measures of financial performance reported in accordance with GAAP. I would like to remind you that during this call, we 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 statements, whether as a result of new information, future developments or otherwise, except as may be required by law. Now I would like to introduce Bruce Thames, our President and Chief Executive Officer, for his opening remarks.

Well, thank you, Ivonne, and good morning, everyone, and thank you for joining us today. I wanted to begin today by setting the stage with a quick overview of Thermon. As a 68-year-old company, we've been tested and proven resilient across many economic cycles. We're a world leader in providing safe, reliable and innovative mission-critical industrial process heating solutions to customers in 85 countries from facilities on four continents. Our over 1,300 employees have an industry-leading safety record and are dedicated to creating value for our customers by executing our strategic long-term plan, which I will discuss in more detail in the next few slides. I'd also like to thank and recognize our Canadian team for being an excellence awardee as one of Canada's safest employers in 2022. Thank you all for your commitment to safety. Turning now to Slide 4. You can see our strategic pillars. In order to create value for our shareholders over the long term, we're focused on three key areas. First, profitably growing our installed base. Second, diversification, digitization and developing markets. And third, disciplined capital allocation. We benefit from a very large global installed base, which provides significant opportunity to capture recurring revenues while driving growth across our traditional end market verticals. We're driving additional growth through diversification into attractive adjacencies, such as commercial, rail and transit, food and beverage and other end markets. Our solutions also help enable the long-term transition towards sustainable energy sources. We're expanding our solutions in the area of digitization with products that utilize the industrial Internet of Things and support customer demand for productivity, reliability, efficiency and safety enhancements. We're also seeing growth in the developing markets, driven by a rising middle class, and localization has become increasingly important, particularly with ongoing supply chain challenges to meet price…

Thank you, Bruce. Turning to revenue on Page 9. First, I would note that we are very pleased with our overall performance this quarter as the global Thermon team continued to drive profitable growth, while meeting strong customer demand. Revenue in the second quarter was $101 million, up 24% versus prior year and exceeding internal expectations. Sales growth in the Western Hemisphere was a result of continued deferred maintenance activity in upstream and downstream, oil and gas and chemical end markets and investments driven by sustained commodity prices and global demand. While maintenance spending in the oil and gas markets is growing considerably, we are still focused on executing against our long-term goal of market diversification. By the end of fiscal '26, we expect that at least 65% of total revenues will come from diversified markets other than oil and gas. We continue to see progress in those markets with rail and transit up 67% and food and beverage up 122% year-over-year. FX negatively impacted revenue by $3 million due to the stronger U.S. dollar, which we expect to continue to impact our business in the quarters ahead. Reported results also include the full quarter of Powerblanket financials worth $3 million in revenue. Thermon's revenue growth, excluding acquisitions and on a constant currency basis was 24% year-over-year. We are pleased that our integration of the Powerblanket acquisition is progressing smoothly with commercial integration activities completed on plan and in advance of the winter heating season. Point-in-time revenues grew 24% in the quarter and 29% in the trailing 12 months, which underscores the strength and maintenance spending across our global installed base. As a reminder, point-in-time revenues are aligned with our product or material sales, while overtime revenues, which were up 24% in the quarter and 34% on a TTM basis…

Kevin, thank you. I'd like you to now turn to Slide 13 and our long-term revenue goals. Our goals for fiscal year 2026 remain unchanged, and we're very pleased to be progressing well toward these objectives. This chart shows the impact of COVID-19 on the business in fiscal year '21, which is the base year of our five-year strategic plan. Subsequently, we saw growth in fiscal year '22 that was driven by the early stages of recovery in our end markets and successful execution of our strategic initiatives. With our strong performance in the first half of this fiscal year, we've revised our fiscal year '23 revenue estimate to $405 million to $420 million, which will put Thermon in line with our peak revenues established in fiscal year '19, and we believe puts us on track to achieve our fiscal year '26 growth objectives. We will continue to drive execution of organic growth, strategic initiatives and acquisitions across the entire enterprise to achieve our goals. We continue to place a high priority on diversifying our end market exposure, specifically targeting industrial markets outside of the oil and gas sectors to represent 65% to 70% of revenues by the end of our fiscal year '26. Last but not least, we expect operational excellence combined with leverage on our fixed costs to yield EBITDA margins in the low- to mid-20% range over that same period. Turning now to Slide 14 and our updated guidance for the fiscal year 2023. We are very pleased with Thermon's strong performance in the first half of this fiscal year. In spite of the number of areas of uncertainty in the current macro environment, the positive momentum we are seeing in quotations, bookings and backlog give us confidence to raise our fiscal year '23 full year revenue…

[Operator Instructions] Our first question comes from Brian Drab with William Blair.

Can we go back to Slide 5 just for a second and talk about these projects in the pipeline? First of all, can you just clarify, did you say how much revenue did you say that you generated and over what time period related to these categories?

I had noted the bookings in Slide 5. So I don't have a revenue number for this quarter. But I can say that...

If you could just repeat whatever you did say, I missed the number.

Yes, it was $16 million in bookings year-to-date. I can tell you that's roughly equivalent to what we booked in all of last fiscal year. So we are seeing a real growth here in these areas. And I think this slide is great and illustrative of all of the opportunities that we have to play in this emerging economy and this -- really the shift in our energy markets and the march toward decarbonization in 2050.

And just to clarify, you're saying 60 or 16, 1-6?

1-6, which is roughly 8% of bookings year-to-date are tied to these areas. And the other point is we've got over 150 opportunities in our pipeline now that's and growing.

Right. And I wanted to ask about that. It sounds like a very substantial pipeline. A couple of questions on that. Are some of those projects larger projects? And then do you expect to see the same type of -- the same competitors when you're bidding on these projects? And I'm just thinking typically, some of the larger projects globally, you see Thermon and nVent and that's pretty much it? And is that going to be the same kind of situation here? Or are there other competitors that are -- that you'll bump into in this space?

Well, it really depends on the opportunity. Certainly, when we think about certain product lines, nVent would be one of our larger -- is our largest competitor in our heat tracing business. But if you think about the breadth of our portfolio, whether that be process heating, emergent heating, environmental, tubing bundles, all of those things, our competitors do differ. And as you can see here, there's a pretty wide range of products and applications across all of these. So the competitive landscape will differ depending upon the opportunity. And Brian, I would add when you think about the size of the opportunities here, it runs the gamut. But I think I would tell you it skews towards the smaller side of things. And it's not your kind of large big heat tracing installs. I would kind of skew you more towards maybe the process heating engineered-type systems from a size standpoint. So hopefully, that helps give you a little bit of context there.

Yes, absolutely. And I guess one last question on the slide. Do you find that -- one of the things that kind of I think, revealed it tough on this slide is that you have a broad portfolio of solutions for these different categories. And is that a competitive advantage having the broad portfolio to offer for these different verticals?

Absolutely. It gives you an ability to really bring the right solution to solve the customer's problem. It gives you different touch points within the customer and the organization. So without question, it really gives us a real competitive advantage as we pursue and develop these types of opportunities.

Okay. Great. Yes, it's going to be interesting to see this develop. Just shifting to margins, correct me if I'm -- if I wrote it down wrong, but I think you said expectation for 300 to 400 basis points increase in EBITDA margin this year. If I got that right, can you talk about what you expect for the balance of the year in terms of gross margin? And for that 300 to 400, how much comes from gross margin versus OpEx leverage?

Yes, Brian, this is Kevin. I think when we think gross margins specifically for the back half, you've got the advantage of the heating season, which generally skews a little more towards the material side of things, which is higher margin. I think when we look at the backlog, margins and backlog for the projects, I think, are consistent with what we've seen in the first half of the year. So that's what's part of driving the uptick here that you're seeing year-over-year. And then we certainly don't have the headwind on the big contract that we had in backlog last year. So I think if you put all that together, it feels like we're going to have gross margins in the range of that kind of historical, call it, 45% where we've seen in the past. But there's obviously puts and takes with the mix, realization with projects. Do you get it in the year versus just out? So I think we feel pretty good about delivering that gross margin consistent with where we've seen it in the first half of the year and the back half.

Okay. The 45.7% that you did here in the second quarter is very strong gross margin, do you expect to come off of that level somewhat? Or that's what I was wondering is now we're going in the heating season, you just put up 45.7% does it kind of go up from there possibly?

Yes. Keep in mind, Q1 was a little bit lower. So when we kind of mix in the year-to-date gross margins, you're not near that 46% level. On a TTM basis, gross margins would be about 44%, if we exclude that labor project as well. So I think the team has certainly been able to demonstrate that we can get into those mid-40s. But certainly, as you know, the mix within the mix is a factor and certainly, the timing around that can skew the margins a little bit in the back half. So I think we feel pretty good about that mid-40s range for gross margins in the second half.

So can you give that number again just to make sure I got it. You said excluding the large project, gross margin was 44% over what period?

That's a TTM number, Brian. So that's 44.1% on a trailing 12 basis.

TTM, got it. Okay. And then can I just ask one more. Can you elaborate a little bit further on Europe because this is obviously, I think the first question I get on Thermon from investors at the moment going into the winter here and the gas situation, and can you just talk about the different dynamics there and how that connects potentially be a positive for Thermon? Or is it all risk? Or how do you look at that?

Yes. Brian, first of all, I think if we kind of -- let's look at short term and then more midterm opportunities. The really Europe's dependence upon Russia for oil and gas. There's a lot of work that has to be done to really shift their sources of supply and that creates opportunities for Thermon. And we are seeing that particularly in kind of natural gas, midstream and it's manifesting itself in LNG liquefaction as well as LNG tankers, things like that. So those are all positives. We are seeing just a higher energy costs in Europe, just having a pretty negative impact just on the operations there on the continent. So that's a headwind, that's all baked in and factored into the back half of our year forecast. So we feel like we've accounted for that risk in the forecast that's been provided. But certainly, we also see those higher energy costs in Europe, particularly are making other -- and I'm speaking more specifically around petrochemicals, chemicals and petrochemicals, they're making other lower energy cost geographies more competitive. The U.S. is actually benefiting from that. So there's some offset. And as part of the reason we believe we're seeing such strength in the U.S. kind of chemicals and petrochemical sector despite what they've seen is some margin pressure globally for various reasons. So there's overs and unders and there's certainly some positives in the mid to longer term, but we see just kind of near-term weakness with the higher energy costs and just the operations there on the European continent.

And our next question comes from Jon Braatz with Kansas City Capital.

Bruce, in your comments, you talked about how strong this year, the oil and gas market has been in a lot of deferred maintenance. What kind of legs does that have, by definition, it's deferred and they're going to get caught up? How long does that last?

Yes. So Jon, as I kind of look at this, I'm kind of looking at a few different things. And first and foremost, we saw just maintenance spending being deferred for a protracted period. And if we kind of go back to COVID-19, it's the first really economic downturn in which we've seen where we could not access customer facilities. So maintenance activities virtually stop. And then before that, we actually had a period really since 2014 and where a lot of the maintenance and underlying spending was, in my opinion, was fairly depressed. Then we also have a tighter supply environment here, which I think, independent of what we could see in a potential recession, I think we're still going to see tight supply. There's not been any -- when we look at the recovery, it's not in CapEx. It's really in the maintenance spending. And in it's really investments in kind of debottlenecking and improving productivity and reliability. I think these are fairly sustainable over a significant period of time, at least another 12 to potentially 24 months just in kind of catching up with a lot of this and also trying to get the most out of the assets that are in place because we're seeing capital allocation strategy really shift from big CapEx deployment by a lot of the oil and gas companies to more return to shareholders. And so a lot of what we're seeing here is investment in the current asset base to optimize throughput and ensure they're reliable going forward.

Okay. All right. Bruce, the Inflation Reduction Act and the Infrastructure Bill, we keep getting indications that there's going to be a tick up in spending in calendar 2023. We begin to see some benefits. Two questions. Number one, are you seeing or do you envision some benefit from maybe the spending that maybe is coming online in 2023? And then secondly, you, like everybody else, have supply chain challenges, and this is a broad question. If you have supply chain challenges now, and we're going to see increased spending from the Inflation Reduction Act and Infrastructure, why are these -- will the supply chain problems persist well into 2023? How do you look at that?

Well, it's a great question. First, let's start with just the opportunities. Yes, we do believe that some of these spending bills are going to create opportunities for our business. I mean I can look at power, particularly rail and transit. And those areas, certainly, we see some benefits. And those businesses are growing year-over-year as we look. And those are -- after we've had significant growth in the prior year. So power year-to-date is up 24% after a 200% growth last year and rail in transit is up almost 40%. So we see that kind of continued strength. As far as the supply chain challenges and disruptions, we are seeing it improve in a number of areas, but there are still kind of a couple of acute areas where we're still having to manage through. I guess the unpredictable part here is where supply chains are linked back to China, and we have the zero tolerance policies in place. Those shutdowns that occur really negatively impact those factories. They're hard to predict. And so I think just from a supply chain challenges, it's harder to sit here and prognosticate about what might happen. I think we've made a lot of adjustments in our supply chain to have redundancy and resiliency. And all of that is having a favorable impact. We did increase our inventory levels in certain areas where we see some challenges. So that helps us ensure security of supply for our customers. But it's a little harder, murkier to really predict how much of this will abate over the next, say, two to four quarters.

Thank you. There are no further questions at this time. I'll hand the floor back over to Bruce Thames for closing remarks.

All right. Diego, thank you. And thank you all for joining us on the call today. We appreciate your investment and interest in Thermon, and have a good day. Thank you.

Thank you. This concludes today's conference. All parties may disconnect. Have a great day.