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THR > SEC Filings for THR > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for THERMON GROUP HOLDINGS, INC.

Form 10-Q for THERMON GROUP HOLDINGS, INC.


13-Nov-2012

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction and Special Note Regarding Forward-Looking Statements Management's discussion and analysis of our financial condition and results of operations is provided as a supplement to the unaudited interim condensed consolidated financial statements and accompanying notes thereto for the three and six months ended September 30, 2012 and 2011 to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. In this quarterly report, we refer to the three and six month periods ended September 30, 2012 and 2011 as Interim 2013 and Interim 2012 and YTD 2013 and YTD 2012, respectively. The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, our condensed consolidated financial statements and related notes included above.
The discussion in this section includes forward-looking statements within the meaning of the U.S. federal securities laws in addition to historical information. These forward-looking statements include, without limitation, statements regarding our industry, business strategy, plans, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, liquidity and capital resources and other financial and operating information. When used in this discussion, the words "anticipate," "assume," "believe," "budget," "continue," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "project," "will," "future" and similar terms and phrases are intended to identify forward-looking statements in this quarterly report.
Forward-looking statements reflect our current expectations regarding future events, results or outcomes. These expectations may or may not be realized. Some of these expectations may be based upon assumptions, data or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control, which could result in our expectations not being realized or otherwise materially affect our financial condition, results of operations and cash flows. These forward-looking statements include but are not limited to statements regarding: (i) our plans to strategically pursue emerging growth opportunities in diverse regions and across industry sectors; (ii) our plans to secure more new facility, or Greenfield, project bids; (iii) our ability to generate more facility maintenance, repair and operations or upgrades or expansions, or MRO/UE, revenue from our existing and future installed base; (iv) our ability to timely deliver backlog; (v) our ability to respond to new market developments and technological advances;
(vi) our expectations regarding energy consumption and demand in the future and its impact on our future results of operations; (vii) our plans to develop strategic alliances with major customers and suppliers; (viii) our expectations that our revenues will continue to increase; and (ix) our belief in the sufficiency of our cash flows to meet our needs for the next year. Actual events, results and outcomes may differ materially from our expectations due to a variety of factors. Although it is not possible to identify all of these factors, they include, among others, (i) general economic conditions and cyclicality in the markets we serve; (ii) future growth of energy and chemical processing capital investments; (iii) changes in relevant currency exchange rates; (iv) our ability to comply with the complex and dynamic system of laws and regulations applicable to international operations; (v) a material disruption at any of our manufacturing facilities; (vi) our dependence on subcontractors and suppliers; (vii) our ability to obtain standby letters of credit, bank guarantees or performance bonds required to bid on or secure certain customer contracts; (viii) competition from various other sources providing similar heat tracing products and services, or other alternative technologies, to customers; (ix) our ability to attract and retain qualified management and employees, particularly in our overseas markets; (x) our ability to continue to generate sufficient cash flow to satisfy our liquidity needs;
(xi) the extent to which federal, state, local and foreign governmental regulation of energy, chemical processing and power generation products and services limits or prohibits the operation of our business; and (xii) other factors discussed in more detail under the caption "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012 filed with the SEC on June 8, 2012 and in any subsequent Quarterly Reports on Form 10-Q that we may file with the SEC. Any one of these factors or a combination of these factors could materially affect our future results of operations and could influence whether any forward-looking statements contained in this quarterly report ultimately prove to be accurate. Our forward-looking statements are not guarantees of future performance, and actual results and future performance may differ materially from those suggested in any forward-looking statements. We do not intend to update these statements unless we are required to do so under applicable securities laws. Overview
We are one of the largest providers of highly engineered thermal solutions for process industries. For over 50 years, we have served a diverse base of thousands of customers around the world in attractive and growing markets including energy, chemical processing and power generation. We are a global leader and one of the few thermal solutions providers with a global footprint and a full suite of products and services required to deliver comprehensive solutions to complex projects. We serve our customers locally through a global network of sales and service professionals and distributors in more than 30 countries and


through our four manufacturing facilities on three continents. These global capabilities and longstanding relationships with some of the largest multinational energy, chemical processing, power and engineering, procurement and construction companies in the world have enabled us to diversify our revenue streams and opportunistically access high growth markets worldwide. For Interim 2013 and YTD 2013, approximately 72% and 71% of our revenues were generated outside of the United States, respectively.
Revenue. Our revenues are derived from providing customers with a full suite of innovative and reliable heat tracing solutions, including electric and steam heat tracing, tubing bundles, control systems, design optimization, engineering services and installation services. Our sales are primarily to industrial customers for petroleum and chemical plants, oil and gas production facilities and power generation facilities. Demand for industrial heat tracing solutions falls into two categories: (i) new facility construction, which we refer to as Greenfield projects, and (ii) recurring maintenance, repair and operations and facility upgrades or expansions, which we refer to as MRO/UE. Greenfield construction projects often require comprehensive heat tracing solutions. We believe that Greenfield revenue consists of sales revenues by customer in excess of $1 million annually (excluding sales to agents, who typically resell our products to multiple customers), and typically includes most orders for projects related to facilities that are new or that are built independent of existing facilities. We refer to sales revenues by customer of less than $1 million annually, which we believe are typically derived from MRO/UE, as MRO/UE revenue. Based on our experience, we believe that $1 million in annual sales is an appropriate threshold for distinguishing between Greenfield revenue and MRO/UE revenue. However, we often sell our products to intermediaries or subcontract our services; accordingly, we have limited visibility into how our products or services may ultimately be used and can provide no assurance that our categorization may accurately reflect the sources of such revenue. Furthermore, our customers do not typically enter into long-term forward maintenance contracts with us. In any given year, certain of our smaller Greenfield projects may generate less than $1 million in annual sales, and certain of our larger plant expansions or upgrades may generate in excess of $1 million in annual sales, though we believe that such exceptions are few in number and insignificant to our overall results of operations.
We believe that our pipeline of planned projects, as evidenced by our backlog of signed purchase orders, provides us with strong visibility into our future revenue, as historically we have experienced few order cancellations, and the cancellations that have occurred in the past have not been material compared to our total contract volume or total backlog. The small number of order cancellations is attributable in part to the fact that a large portion of our solutions are ordered and installed toward the end of Greenfield project construction. Our backlog at September 30, 2012 was $112.9 million. The timing of recognition of revenue out of backlog is not always certain, as it is subject to a variety of factors that may cause delays, many of which are beyond our control (such as customers' delivery schedules and levels of capital and maintenance expenditures). When delays occur, the recognition of revenue associated with the delayed project is likewise deferred.
Cost of sales. Our cost of sales includes primarily the cost of raw material items used in the manufacture of our products, cost of ancillary products that are sourced from external suppliers and construction labor cost. Additional costs of sales include contract engineering cost directly associated with projects, direct labor cost, external sales commissions, and other costs associated with our manufacturing/fabrication operations. The other costs associated with our manufacturing/fabrication operations are mainly indirect production costs, including depreciation, indirect labor costs, and the costs of manufacturing support functions such as logistics and quality assurance. Key raw material costs include polymers, copper, stainless steel, insulating material, and other miscellaneous parts related to products manufactured or assembled as part of our heat tracing solutions. Historically, the costs of our primary raw materials have been stable and readily available from multiple suppliers, and we generally have been successful with passing along raw material cost increases to our customers. Therefore, increases in the cost of key raw materials of our products have not generally affected our gross margins. We cannot provide any assurance, however, that we may be able to pass along such cost increases to our customers in the future, and if we are unable to do so, our results of operations may be adversely affected.
Operating expenses. Our marketing, general and administrative and engineering expenses are primarily comprised of compensation and related costs for sales, marketing, pre-sales engineering and administrative personnel, as well as other sales related expenses and other costs related to research and development, insurance, professional fees, the global integrated business information system, provisions for bad debts and warranty.
Key drivers affecting our results of operations. Our results of operations and financial condition are affected by numerous factors, including those described under the caption "Risk Factors" in our Annual Report on Form 10-K filed with the SEC on June 8, 2012 and elsewhere in this quarterly report and those described below:

         Timing of Greenfield projects.  Our results of operations in recent
          years have been impacted by the various construction phases of large
          Greenfield projects. On very large projects, we are typically
          designated as the heat tracing provider of choice by the project owner.
          We then engage with multiple contractors to address incorporating
          various heat tracing solutions throughout the overall project. Our
          largest Greenfield projects may generate revenue for several quarters.
          In the early stages of a Greenfield project, our revenues are typically


realized from the provision of engineering services. In the middle stages, or the material requirements phase, we typically experience the greatest demand for our heat tracing cable, at which point our revenues tend to accelerate. Revenues tend to decrease gradually in the final stages of a project and are generally derived from installation services and demand for electrical panels and other miscellaneous electronic components used in the final installation of heat tracing cable, which we frequently outsource from third-party manufacturers. Therefore, we typically provide a mix of products and services during each phase of a Greenfield project, and our margins fluctuate accordingly.
Cyclicality of end-users' markets. Demand for our products and services depends in large part upon the level of capital and maintenance expenditures of our customers and end users, in particular those in the energy, chemical processing and power generation industries, and firms that design and construct facilities for these industries. These customers' expenditures historically have been cyclical in nature and vulnerable to economic downturns. Greenfield projects, and in particular large Greenfield projects (i.e., new facility construction projects generating in excess of $5 million in annual sales), have been a substantial source of revenue growth in recent years, and Greenfield revenues tend to be more cyclical than MRO/UE revenues. A sustained decrease in capital and maintenance spending or in new facility construction by our customers could have a material adverse effect on the demand for our products and services and our business, financial condition and results of operations.

         Impact of product mix.  Typically, both Greenfield and MRO/UE customers
          require our products as well as our engineering and construction
          services. The level of service and construction needs will affect the
          profit margin for each type of revenue. We tend to experience lower
          margins from our design optimization, engineering, installation and
          maintenance services than we do from sales of our heating cable, tubing
          bundle and control system products. We also tend to experience lower
          margins from our outsourced products, such as electrical switch gears
          and transformers, than we do from our manufactured products.
          Accordingly, our results of operations are impacted by our mix of
          products and services.

We estimate that Greenfield and MRO/UE have each made the following contribution as a percentage of revenue in the periods listed:

              Three Months Ended September 30,        Six Months Ended  September 30,
                 2012                   2011            2012                  2011
Greenfield         38 %                   36 %            39 %                  35 %
MRO/UE             62 %                   64 %            61 %                  65 %

We believe that our analysis of Greenfield and MRO/UE is an important measurement to explain the trends in our business to investors. Greenfield revenue is an indicator of both our ability to successfully compete for new contracts as well as the economic health of the industries we serve. Furthermore, Greenfield revenue is an indicator of potential MRO/UE revenue in future years.
For MRO/UE orders, the sale of our manufactured products typically represents a higher proportion of the overall revenues associated with such order than the provision of our services. Greenfield projects, on the other hand, require a higher level of our services than MRO/UE orders. Therefore, we typically realize higher margins from MRO/UE revenues than Greenfield revenues.
Large and growing installed base. Customers typically use the incumbent heat tracing provider for MRO/UE projects to avoid complications and compatibility problems associated with switching providers. Therefore, with the significant Greenfield activity we have experienced in recent years, our installed base has continued to grow, and we expect that such installed base will continue to generate ongoing high margin MRO/UE revenues. For Interim 2013, MRO/UE sales comprised approximately 62% of our consolidated revenues.

         Seasonality of MRO/UE revenues.  Revenues realized from MRO/UE orders
          tend to be less cyclical than Greenfield projects and more consistent
          quarter over quarter, although MRO/UE revenues are impacted by seasonal
          factors. MRO/UE revenues are typically highest during the second and
          third fiscal quarters, as most of our customers perform preventative
          maintenance prior to the winter season.

Results of Operations
The following table sets forth our statements of operations for the three months
ended September 30, 2012 and the

                                       35
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three months ended September 30, 2011 and indicates the amount of change and
percentage change between periods.
                                       Three Months Ended                   Increase/
                                         September 30,                      (Decrease)
                                      2012            2011              $               %
Consolidated Statements of
Operations Data:
Sales                            $     67,358     $    68,023     $      (665 )         (1.0 )%
Cost of sales                          34,719          36,072          (1,353 )         (3.8 )%
Gross profit                     $     32,639     $    31,951     $       688            2.2  %
Gross margin %                           48.5 %          47.0 %
Operating expenses:
Marketing, general and
administrative and engineering   $     14,158     $    14,615     $      (457 )         (3.1 )%
Stock compensation expense                336              57             279          489.5  %
Management fees                             -              15             (15 )       (100.0 )%
Amortization of intangible
assets                                  2,798           2,878             (80 )         (2.8 )%
Income (loss) from operations    $     15,347     $    14,386     $       961            6.7  %
Interest expense, net (1):
Interest income                            30              76             (46 )        (60.5 )%
Interest expense                       (2,969 )        (3,581 )           612          (17.1 )%
Acceleration of unamortized debt
cost                                   (1,447 )        (1,051 )          (396 )         37.7  %
Loss on retirement of debt                  -          (2,336 )         2,336         (100.0 )%
Amortization of debt costs               (277 )          (398 )           121          (30.4 )%
Interest expense, net                  (4,663 )        (7,290 )        (2,627 )         36.0  %
Other income/(expense)                     93          (1,173 )         1,266         (107.9 )%
Income before provision for
income taxes                     $     10,777     $     5,923     $     4,854           82.0  %
Income tax expense                      3,790           2,109           1,681           79.7  %
Net income                       $      6,987     $     3,814     $     3,173           83.2  %


__________________________________


(1) During the three months ended September 30, 2012, we negotiated a new revolving line of credit agreement. As a result, we wrote off $1.4 million of unamortized debt costs related to the terminated contract. During the three months ended September 30, 2011, we made redemption payments on our senior secured notes totaling $24.6 million. These payments resulted in accelerated amortization of deferred debt costs as well as premium payments on bond principal during Interim 2012 We have presented the breakdown of these charges in order to provide our expected interest and debt amortization cost in future periods.
Three Months Ended September 30, 2012 ("Interim 2013") Compared to the Three Months Ended September 30, 2011 ("Interim 2012") Revenues. Revenues for Interim 2013 were $67.4 million, compared to $68.0 million for Interim 2012, a decrease of $0.7 million or 1.0%. Revenues in Interim 2013 were negatively impacted by foreign currencies. Approximately 72% of our sales are to foreign customers. Due to the strengthening U.S. dollar, our foreign sales were converted at a lower rate than the prior period. We estimate the negative impact to revenue from the strengthening dollar to be approximately $3.3 million during Interim 2013. Revenue from Greenfield projects was slightly higher in Interim 2013, representing 38% of total sales as compared to 36% in Interim 2012. Both periods are in line with our historical mix of MRO/UE and Greenfield revenues.
Gross profit and margin. Gross profit totaled $32.6 million in Interim 2013, compared to $32.0 million in Interim 2012, an increase of $0.7 million or 2.2%. As a percentage of revenues, gross profit increased to 48.5% in Interim 2013 from 47.0% in Interim 2012. Our gross margins are impacted by the product mix between Greenfield projects and MRO/UE sales. Generally, Greenfield sales generate lower margins as compared to MRO/UE sales. Although we saw a greater percentage of Greenfield sales in Interim 2013 than in Interim 2012, our Interim 2013 Greenfield sales delivered higher margin than in Interim 2012 due to the product mix within our Greenfield sales. Greenfield sales include all of our product types including


design and installation services as well our manufactured products and those products that we outsource. Since we derive higher margins from our manufactured products than we do from outsourced products, design and installations, gross margins on our Greenfield sales will fluctuate accordingly. Gross margins on MRO/UE sales in Interim 2013 were also slightly higher than in Interim 2012. Marketing, general and administrative and engineering. Marketing, general and administrative and engineering costs (including stock compensation and management fee expenses) were $14.5 million for Interim 2013, compared to $14.7 million in Interim 2012, a decrease of $0.2 million or 1.4%. Marketing, general and administrative and engineering costs were 21.5% of total revenue in Interim 2013 as compared to 21.6% in Interim 2012.
Amortization of intangible assets. Amortization of intangible assets was $2.8 million in Interim 2013, compared to $2.9 million in Interim 2012, a decrease of $0.1 million. Intangible asset amortization is subject to foreign currency translation adjustments. We expect these amounts to be representative of our estimated quarterly expense for amortization of intangible assets for the foreseeable future.
Interest expense. Interest expense, net, was $4.7 million in Interim 2013, compared to $7.3 million in Interim 2012, a decrease of $2.6 million. In Interim 2013 we negotiated a new revolving line of credit agreement. As a result, we wrote off $1.4 million of unamortized debt costs related to the terminated contract, which is included in interest expense. In Interim 2012, we made partial redemptions of our senior secured notes with $24.6 million in aggregate principal amount being redeemed. In connection with these bond redemptions, we incurred deferred debt acceleration costs of $1.1 million and loss on retirement of debt of $2.3 million. There were no redemptions on the senior secured notes in Interim 2013. Interest expense on outstanding principal balances was $3.0 million and $3.6 million for Interim 2013 and Interim 2012, respectively. The decrease in interest expense is the result of a total of $91.9 million of our senior secured notes being redeemed, repurchased and retired since March 31, 2011.
Miscellaneous expense. Other income was $0.1 in Interim 2013 and $1.2 million of expense in Interim 2012. The $1.2 million expense in Interim 2012 is associated with foreign exchange transactions losses. During the prior year Interim 2012, there was significant volatility in currency rates, most notably the strengthening of the US Dollar. The foreign exchange losses that occurred in Interim 2012 were prior to the use of foreign currency forward contracts which minimized the foreign exchange transaction losses in Interim 2013. See "Item 3- Quantitative and Qualitative Disclosures About Market Risks" for further discussion of the foreign currency forward contracts.
Income taxes. We reported an income tax expense of $3.8 million in Interim 2013, compared to $2.1 million in Interim 2012, an increase of $1.7 million. The increase is attributable to higher income before tax in Interim 2013 which was $10.8 million compared to $5.9 million in Interim 2012. Our effective tax rates were 35.2% in Interim 2013 and 35.6% in Interim 2012. Our anticipated annual effective tax rate of approximately 35.0% has been applied to our consolidated pre-tax income in calculating the amount of the income tax expense for the three months ended September 30, 2012. This anticipated annual tax rate is established by estimating anticipated tax rates in each of the countries where we earn taxable income as adjusted for known differences, our expectations of earnings repatriations as well as our ability to apply any jurisdictional tax losses to prior or future periods. See Note 12, "Income Taxes", to our unaudited consolidated financial statements for the three months ended September 30, 2012, included elsewhere in this quarterly report, for further detail on income taxes. Net income (loss). Net income was $7.0 million in Interim 2013 as compared to $3.8 million in Interim 2012, an increase of $3.2 million. The increase in net income is the result of the reduction of interest expense of $2.6 million, the increased gross profit of $0.7 million, the reduction of marketing, general and administrative and engineering costs of $0.2 million and the reduction of losses from foreign exchange transactions of $1.3 million, which is included in miscellaneous expense. These were offset by increased tax expense of $1.7 million.
Results of Operations
The following table sets forth our statements of operations for the six months ended September 30, 2012 and the six months ended September 30, 2011 and indicates the amount of change and percentage change between periods.


                                       Six Months Ended                    Increase/
                                         September 30,                     (Decrease)
                                     2012            2011              $               %
Consolidated Statements of
Operations Data:
Sales                            $   134,571     $   132,641     $     1,930            1.5  %
Cost of sales                         68,593          68,701            (108 )         (0.2 )%
Gross profit                     $    65,978     $    63,940     $     2,038            3.2  %
Gross margin %                          49.0 %          48.2 %
Operating expenses:
Marketing, general and
administrative and engineering   $    30,115     $    29,784     $       331            1.1  %
Stock compensation expense               394           6,399          (6,005 )        (93.8 )%
Management fees, including
termination fees                           -           8,120          (8,120 )       (100.0 )%
Amortization of intangible
. . .
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