Greetings and welcome to the Thermon Group Holdings Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note that this conference is being recorded. I will now turn the conference over to our host, Kevin Fox, Chief Financial Officer for Thermon Group Holdings. Thank you. You may begin.

Thank you, Diego. Good morning and thank you for joining today's fiscal 2022 third 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 the IR website under News Events, IR Calendar Earnings Conference Call Q3 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 introduce 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 Q3 financial performance following my remarks. Before we get started, I'd like to take this opportunity to recognize Rene Van Der Salm, our Senior Vice President of Manufacturing for his 20 years of service. During his tenure, Rene has been an important part of Thermon and has played an instrumental role in many of the company's achievements. He will be stepping down as of February 15, but will assist in the transition through the end of April. At the same time, we are also excited to have Roberto Kuahara join the team as the new Senior Vice President of Manufacturing. Roberto brings a wealth of knowledge and experience in international manufacturing operations, Six Sigma, the Toyota Production system and operational excellence. Moving forward, he will be instrumental in expanding the capabilities and competencies within the senior leadership team that are needed to execute our strategy. I'd like to now turn to Slide 3 and the third quarter results. There are a lot of positive things we're seeing across the business this quarter highlighted by growth in the top-line, net income, bookings and backlog. We saw solid execution by the team in the third quarter with strong top-line growth, as we see end markets continuing to recover. Revenue for the quarter was $100.6 million, up 26.4% over prior year, with growth largely driven by North America. In the Eastern hemisphere, the market recovery is lagged in a more challenging business environment, particularly in Asia, due to COVID-19 restrictions in many countries. Net income of $11.3 million was up 82.3%…

Thank you, Bruce. We had another great quarter on the top-line on Page 6. Revenue was up 26% versus the prior year quarter and up 12% on a trailing 12-month basis. The current quarter's revenue includes less than $1 million of benefit from foreign exchange. Revenue growth was driven by both the U.S., Latin America and Canada regions with strong materials growth due to an increase in maintenance spending, concurrent with the easing of COVID restrictions. We continue to see companies in the U.S. Gulf Coast making investments to improve infrastructure, especially power infrastructure, after both the winter storm and hurricanes from the last year. The U.S. also benefited from the impact of the large one-time contract we mentioned last quarter with almost $9 million of revenue booked in the period. We will provide these revenue figures for comparability purposes, given the size and nature of the contracts. In the Eastern hemisphere, both EMEA and APAC declined due to the continuing impact from the pandemic and the slower recovery in certain countries. In both regions, our project business has been more impacted than material sales. On a TTM basis, revenues are up 12% as we pass the inflection point into year-over-year growth. We are realizing the impact of price increases put in place in the second half of 2021 and as a reminder; those are most applicable to our materials business. Pricing had a positive impact of about 200 basis points overall with the impact accelerating from the first half of the fiscal year, which is a trend we expect to continue in the fourth quarter. Reported gross margins in the quarter were 40.5% versus 46.4% in the prior year period. If we exclude the impact of the large one-time contract margins would have been 43%. So currently, the contract…

Thank you, Kevin. I'd like to turn now to Slide 10. Now the team is making progress in advancing our three strategic platforms to achieve our goal of $550 million in revenue by the end of fiscal 2026, while driving operational excellence to achieve EBITDA margins in the low to mid-20% range. Beginning with the developing markets, the team has built a detailed analysis by customer and end market identifying the specific needs by country or region. We've established an initial localization roadmap that would be instrumental in growing share in these emerging economies. On our next call, we will provide more of our plans for fiscal year 2023 to meet local requirements, market lead times and reasonable price points. While we have seen a delay in the overall market recovery in the Eastern Hemisphere, we believe there is pent-up demand that will return as economies emerge from COVID-19 restrictions. We continue to advance our diversification of end markets in the quarter as well. Recently, we have added a new business development manager for rail and transit and have launched a new Hovey Hellfire Blizzard Duty Rail Switch-heater that has been well received by our Class one rail customers. We've also launched our Zero Halogen Low Smoke commercial heat tracing cable that is gaining momentum, particularly in Europe. Based upon feedback from our channel partner, we expect sales to double in the coming year. During the quarter, we have secured wins in two data centers for our commercial products. And finally, we've launched the marketing campaign in food and beverage that is yielding early results with key wins in some new applications. As you prepare to watch the Superbowl next weekend, you may be interested to know that Thermon plays a role in providing those much needed Game Day essentials…

Thank you. And ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Jon Braatz with Kansas City Capital. Please state your question.

A couple of questions. Bruce, can you tell me what maybe the opportunity that may be in front of you in your eastern hemisphere Asian markets? I know the markets have been weak there. But how much maybe the pent-up demand new capital projects? How significant can that turn around be when it happens?

As I look at that Jon, I see it much the same as what we're now experiencing in the west. And I don't want you to walk away the impression that there's not additional lift that we can see in the western hemisphere as well in North America particularly. But yes, in the east, I would expect that recovery to look very similar. I'm certain the demand is the various pent-up demand there. We look at our business in Asia; it's even off a bit from last year. So when I look at kind of where we were previously, I see easily 15%, 20% opportunity dips in growth and recovery. In EMEA, in Europe, Middle East Africa, I would say it may be is more in the 10% to 15% range, but certainly some nice additional growth opportunities in the east. I also see additional running room here in the west as well.

Sure, sure. Okay, okay. And Kevin, how much of the -- that large project remains to be filled?

Yes, Jon. So I think we've done almost $12 million year-to-date. If you think a little under $9 million this quarter, it was a little under $3 million last. We think it's going to be probably north of $20 million for the year. So we're a little over halfway through that contract right now.

Okay. So still -- still some margin headwinds in the fourth quarter?

Yes, that's correct.

Okay. And then, obviously you do a very well -- very good job in terms of managing the SG&A expenses. Are there anything unusual in there that might come back a little bit? Or are these -- you view these, this ratio is sort of more permanent, and will be with us for some time?

Yes, Jon. I think more of the latter, if you think, maybe roll back the clock a year. So when we -- we obviously had to take some actions on the base cost. The intention was to get the business to a place that on a more permanent basis is starting to look like what it looks like today, essentially. There should be some operating leverage in the business as we continue to grow. But that SG&A as a percentage of sales, in the call it below 20s I think is a place where we can get to on a more permanent basis not there yet. On a year-to-date or trailing 12-months basis, but I think the future of SG&A as a percentage of sales is more representative today than what we spend six, 12, 18 months ago.

Thank you. Our next question comes from Brian Drab with William Blair. Please state your question.

Hi, thanks and congratulations on a continued recovery here and the execution. Just first, looking at Slide 6 I was wondering, and I think you just answered part of this question. But with these gross margin headwinds that you called out on Slide 6, the contract the supply chain emergency wage subsidy. Can we just talk a little bit about the duration of these headwinds? I guess that one-time contract is going to fall off after a couple more quarters. How are you looking at that?

Yes, Brian, this is Bruce. So the contract will largely will be completed with the bulk of it by the end of this fiscal year. So while it's accretive to EBITDA it is dilutive to gross margin. So that that will be falling off. When I look at some of the cost increases that we've incurred here in the supply chain and labor costs increases, as I've used some of these. I believe they're transitory. I think some of these are commodities. I think in other cases, there's been shortage of supply and there's been some price gouging, particularly in electronic components. I think, as supplies return those will normalize. So I think we'll see that come back. I do believe the labor costs are here to stay. And I think there's probably some of the material price increases that will get locked in as well. So I expect that to probably be middle of the calendar year. My glass ball is no better than yours. But I do expect to see some of that come back on. And as I said earlier, we have additional pricing realization we expect during the fourth quarter. And we're certainly evaluating our opportunities to selectively increase price going forward, where we see some of these residual cost landing and we need to get more price in the market.

Got it. So just kind of building on that, as if you look at -- look forward to the fourth quarter and next year? Can you give us any more like directional guidance around gross margin? This fiscal year, it's averaged. I know there's a lot of factors here. But it's average, like 38.5% for the first three quarters. And I guess directionally, I think you'd tell us it should be going up. Can you give us any sense for as we look forward to the next fiscal year what's the normalized level that you think you can shoot for it?

What I would expect, because of the some unusual one-time expenses and the dilution of this one-time project and some of the headwinds we've seen, I would expect margins to be in the low to mid 40% range in the coming year. And some of that will depend on obviously depend on mix and how strong the capital projects come back in the coming year and so that will have an influence. Obviously, my expectation that if it were on the lower end of that, we would see a stronger capital cycle, which would be positive for the top-line.

Got it. Okay. Thanks. And then, Kevin, you're talking about OpEx in terms of percentage of sales kind of longer-term. I just want to get a little help if I could on modeling this in the more near-term though. It's been -- the run rate for, we look at on adjusted OpEx basis so I hope my numbers kind of line-up with how you can think about it. But like $28 million was kind of the old run rate plus or minus. Now, we're like at $23 million last couple of quarters. Is this where you'd guide us to kind of -- is that sustainable for the -- through the next four or five quarters here that where we're going to be?

Yes, I guess, Brian, the first thing is kind of the jumping off point here is about; we've talked about the target around $80 million for this year that excludes the depreciation. I think that's probably the $2 million to $3 million a quarter on this delta between your $23 million and maybe your $20 million. But as we think about the base cost of the business, profitable growth, and operating leverage is the name of the game here. So we're going to be trying to calibrate those investments that we're making in the business, whether that's around our strategic initiatives. Clearly thinking about the labor force and making sure we've got qualified sales people who can be running the plants and everything around that nature. But we do expect there's significant operating leverage in the business. So if the top-line is growing by 5%, 10%, 15% we think the SG&A number is going to be growing at a rate that is below that to create that improved profitability in the business. So probably too early to talk about specific numbers for fiscal 2023. But we certainly expect that as the business is growing, that the energy transition is kind of taking a hold. We are going to have to invest in those strategic initiatives that is going to drive incremental costs. But the balance here is going to be to do that in a way where we're managing profitable growth at the same time. So don't really want to put $1 against that right now, we can probably come back to that when we talk about fiscal 2023 here in the next quarter. But that's generally the conversation we're having with the leaderships and board.

Got it. Okay. And then, what, I can't believe it's already been four years since you acquired CCI. And one of you could just talk about what, as you're seeing the recovery in your business. Are you seeing that in both, what, I guess would you call it Thermon heating systems and the legacy business or is one performing better than the other?

Yes, Brian this is Bruce. Actually, if you call that that business, the process and environmental heating product lines they actually lead heat tracing kind of in the recovery they did in the last. And we're seeing the same thing here. So we actually are seeing a stronger and earlier recovery in the process and environmental heating. And we expect the heat tracing business, it's the heat-based tracing business is recovering as well. But it's lagging by six months or so. So it's what has historically happened. It's what's happening now. So we feel good about that business and where it's going. And it's also a leading indicator what we can expect in the legacy business.

Right. And can you say anything relative to the margins are today in those businesses relative to one another?

Kevin, do you want to comment?

Yes, precisely, just like relative just like is one higher than the other. So --

Yes, I think Brian; I think relatively the THS business has always been viewed as slightly accretive versus the core. I think that trend has continued through the course of the acquisition. So I wouldn't say there's been any fundamental shift on the profile of the business between the two with the process heating being a little more attractive on the balance versus heat tracing.

It's more material sales than the project sales, which tend to be dilutive on the heat tracing side.

Okay. And then just last question, I'm just curious on the slide, where you showed that 16% of revenue from Upstream oil how does that break down these days between oil sands and non-oil sands?

The bulk of that, the bulk of those revenues are actually in Canada, and in Eurasia, in colder climates, it's not all but I would say, at least 80% or more.

Yes. And so that's still in the -- you're still generating revenue in the oil sands, oil sands not talked about as much, you don't really know, is that a lot of MRO business from previously?

No. It is a -- yes, it is a very solid recurring revenue stream in MRO/UE and it's, I could go back and it's $50 million a year, largely material sales in Canada that are linked to some of those end markets. They continue to operate and produce and they got to maintain those assets.

And that's still relatively higher margin business isn't it with self-heating --?

Very nice.

Self-regulated [indiscernible]?

Yes, absolutely.

Thank you. And ladies and gentlemen, there are no further questions at this time. I'll turn it back to Bruce Thames for our closing remarks.

Well, I'd like to thank everyone for their interest in Thermon and for joining. I'd also like to just take a moment and thank our employees around the globe that each and every day, serve our customers and our focus on creating value for our shareholders. Appreciate your interest. Enjoy the rest of your day.

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