THERMON: MANAGEMENT REPORT AND ANALYSIS OF THE FINANCIAL POSITION AND OPERATING RESULTS (Form 10-K)
The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, Item 6, "Selected Financial Data" and our consolidated financial statements and related notes included elsewhere in this annual report. The discussions in this section contain forward-looking statements that involve risks and uncertainties, including, but not limited to, those described in Item 1A, "Risk Factors." Actual results could differ materially from those discussed below. Please refer to the section entitled "Forward-Looking Statements."
For a complete overview of our business, please see section 1. “Business” disclosed in this document.
Revenue. Our revenues are derived from providing customers with a full suite of innovative and reliable process heating solutions, including electric and steam heat tracing, tubing bundles, control systems, design optimization, engineering services, installation services, portable power solutions and software. Additionally, THS offers a complementary suite of advanced heating and filtration solutions for industrial and hazardous area applications. Historically, our sales are primarily to industrial customers for petroleum and chemical plants, oil and gas production facilities and power generation facilities. While our petroleum customers represent an important portion of our business, we have been successful broadening our customer base by earning business from numerous other industries, including chemical processing, power generation, transportation, food and beverage, commercial, pharmaceutical, and mineral processing. 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 revenue by customer in excess of
$1 millionannually (excluding sales to resellers), 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 revenue by customer of less than $1 millionannually, which we believe are typically derived from MRO/UE, as MRO/UE revenue. Based on our experience, we believe that $1 millionin 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 millionin annual sales, and certain of our larger plant expansions or upgrades may generate in excess of $1 millionin annual sales, though we believe that such exceptions are few in number and insignificant to interpreting our overall results of operations. THS has been excluded from the Greenfield and MRO/UE calculations. Most of THS's revenue would be classified as MRO/UE under these definitions. We believe that our pipeline of planned projects, in addition to our backlog of signed purchase orders, provides us with visibility into our future revenue. 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 March 31, 2021was $114.2 millionas compared to $105.4 millionat March 31, 2020. 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 revenue include contract engineering cost directly associated to projects, direct labor cost, shipping and handling costs, and other costs associated with our manufacturing/fabrication operations. The other costs associated with our manufacturing/fabrication operations are primarily indirect production costs, including depreciation, indirect labor costs, and the costs of 25 -------------------------------------------------------------------------------- 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, our primary raw materials have been readily available from multiple suppliers and raw material costs have been stable, and we have been generally 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 that we may be able to pass along such cost increases, including the potential impacts of tariffs, 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, 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 expense. Key drivers affecting our results of operations. Our results of operations and financial condition are affected by numerous factors, including those described above under Item 1A, "Risk Factors" and elsewhere in this annual 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 more than one year. 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 especially large Greenfield projects (i.e., new facility construction projects generating in excess of $5 millionin annual sales), historically have been a substantial source of revenue growth, 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. Acquisition strategy. In recent years, we have begun executing on a strategy to grow the Company through the acquisition of businesses that are either in the heat tracing solutions industry or that provide complementary products and solutions for the markets and customers we serve. We actively pursue both organic and inorganic growth initiatives that serve to advance our corporate strategy. 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 units, 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 / EU each made the following contribution as a percentage of revenue during the periods listed:
Fiscal Year Ended March 31,* 2021 2020 2019 Greenfield 35 % 40 % 49 % MRO/UE 65 % 60 % 51 %
* THS has been excluded from the above table. Most THS income would be classified as MRO / EU according to current definitions.
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 revenue 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, and often require us to purchase materials from third party vendors. 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 revenue. For fiscal 2021, MRO/UE sales comprised approximately 65% of our consolidated revenues (excluding THS). Seasonality of MRO/UE revenues. MRO/UE revenues for the heat tracing business are typically highest during the second and third fiscal quarters, as most of our customers perform preventative maintenance prior to the winter season. However, revenues from Greenfield projects are not seasonal and depend on the capital spending environment and project timing. Recent Developments - COVID-19 Pandemic. The recent COVID-19 pandemic and the measures being taken to address and limit the spread of the virus have adversely affected the economies and financial markets of many countries, resulting in an economic downturn that has negatively impacted, and may continue to negatively impact, global demand for our products and services. See part Item 1A, "Risk Factors" above, for further discussion. The Company has taken the following precautionary measures in light of current macroeconomic uncertainty resulting from the COVID-19 pandemic: •Reduced discretionary spending across the organization by approximately
$6.3 millionin the fiscal year ending March 31, 2021by curtailing consulting fees and travel expenses and consolidating our global operating footprint; •Decreased payroll expense, including temporarily decreasing salaries for certain officers and implementing a reduction in force initiative that reduced ongoing personnel cost by approximately $15.9 millionin the fiscal year ending March 31, 2021; •Reduced capital expenditures in the fiscal year ending March 31, 2021to approximately $8.1 million, which includes approximately $1.0 millionyear over year increase in strategic spending on our Thermon Power Solutions ("TPS") product line (based on market demand), a reduction of approximately $2.8 millionas compared to fiscal 2020; and •Reduced manufacturing expense across the organization by approximately $1.8 millionin the fiscal year ending March 31, 2021by consolidating our manufacturing footprint. Results of Operations The following table sets forth data from our statements of operations for the periods indicated. 27 --------------------------------------------------------------------------------
Fiscal Year Ended March 31, 2021 2020 2019 (dollars in thousands) Consolidated Statements of Operations Data: Sales
$ 276,181100 % $ 383,486100 % $ 412,642100 % Cost of sales 158,938 58 221,848 58 236,702 57 Gross profit $ 117,24342 % $ 161,63842 % $ 175,94043 %
Marketing, general, administrative, and engineering 91,398 33 111,202 29 106,660 26 Amortization of intangible assets 9,445 3 17,773 5 20,771 5 Restructuring and other charges/(income) 8,623 3 - - - - Income from operations
$ 7,7773 % $ 32,6639 % $ 48,50912 % Interest income 76 - 252 - 238 - Interest expense (10,261) (4) (14,279) (4) (15,714) (4) Other income/(expense) 2,135 1 (1,558) - 109 - Income/(expense) before provision for income taxes $ (273)- % $ 17,0784 % $ 33,1428 % Income tax expense/(benefit) (1,438) (1) 5,142 1 9,973 2 Net income/(loss) $ 1,165- % $ 11,9363 % $ 23,1696 % Income/(loss) attributable to non-controlling interest(1) - - (2) - 413 - Net income/(loss) available to Thermon Group Holdings, Inc. $ 1,165- % $ 11,9383 % $ 22,7566 % (1) Represents income attributable to the non-controlling equity interest in the Thermon Power Solutions ("TPS") business that was retained by sellers in the TPS transaction. Between July 20, 2018and August 1, 2019, income attributable to non-controlling equity interest represented 12.5%. Subsequent to August 1, 2019, income attributable to non-controlling equity interest represents 0%. See Note 12. "Related Party Transactions" to our consolidated financial statements included in Item 8 of this annual report for further discussion.
End of year
Revenue. Revenue for fiscal 2021 was
$276.2 million, compared to $383.5 millionfor fiscal 2020, a decrease of $107.3 million, or 28%. Our sales mix (excluding THS) in fiscal 2021 was 35% Greenfield and 65% MRO/UE, as compared to 40% Greenfield and 60% MRO/UE in fiscal 2020. Greenfield revenue is historically at or near 40% of our total revenue. In fiscal 2021 as compared to fiscal 2020, US-LAM reportable segment revenue decreased $60.0 millionor 38.6%, Canadarevenue decreased $37.5 millionor 29.2%, APAC revenue decreased $10.2 millionor 22.2%, and EMEA revenue increased $0.5 millionor 0.9%. The decreases in our US-LAM, Canada, and APAC segments were primarily related to a decline in demand for our products and services in both Greenfield and MRO/UE business activity as a result of the COVID-19 driven economic downturn. Decreases in EMEA's segment revenue related to the COVID-19 driven economic downturn were more than offset by an increase in over time, project-related revenue within the region. Gross profit and margin. Gross profit totaled $117.2 millionin fiscal 2021, compared to $161.6 millionin fiscal 2020, a decrease of $44.4 million, or 27%. Gross margins were 42.5% and 42.1% in fiscal 2021 and fiscal 2020, respectively. The lower gross profit in fiscal 2021 is primarily attributable to lower overall sales in connection with the depressed market conditions due to COVID-19. Although lower sales produced a lower gross profit in fiscal 2021, our margin percentage increased due to a greater mix of MRO/UE business relative to Greenfield plus overall cost reduction efforts described above and operational efficiencies in fiscal 2021. Additionally, the Canadian Emergency Wage Subsidy, through which we received subsidies with respect to our Canadian manufacturing operations, positively impacted our margins by $4.7 millionin fiscal 2021. Please see Note 1, "Basis of Presentation and Accounting Policy Information" in our financial statements for more information on the Canadian Emergency Wage Subsidy. Marketing, general, administrative, and engineering. Marketing, general, administrative and engineering costs were $91.4 millionin fiscal 2021, compared to $111.2 millionin fiscal 2020, a decrease of $19.8 million, or 17.8%. As a percentage 28 -------------------------------------------------------------------------------- of total revenue, marketing, general, administrative, and engineering costs were 33.1% and 29.0% in fiscal 2021 and fiscal 2020, respectively. The decrease in fiscal 2021 marketing, general, administrative, and engineering costs is attributable to intentional decreases in response to the COVID-19 pandemic. Specifically, we undertook a reduction in force initiative to reduce costs throughout fiscal 2021. At this time, we believe we are substantially complete with the reduction in force cost measures. In addition, our Marketing, general, administrative and engineering costs were positively impacted by the Canadian Emergency Wage Subsidy in the amount of $2.2 million, through which we received government subsidies with respect to our Canadian manufacturing operations. These favorable costs reductions were partly offset by $0.7 millionrelated to a specific customer past due account and an increase in compensation costs associated with the Company's non-qualified deferred compensation plan. To note, these specific compensation plan costs are fully offset in other income/(expense) where the Company experienced market gains of $1.6 millionon the related investment assets. Amortization of intangible assets. Amortization of intangible assets was $9.4 millionin fiscal 2021 and $17.8 millionin fiscal 2020. The decrease in amortization expense is attributable to certain intangible assets that became fully amortized during fiscal 2020.
Restructuring and other charges / (income). Restructuring and other charges / (income) was
Interest expense, net. Interest expense, net totaled
$10.2 millionin fiscal 2021, compared to $14.0 millionin fiscal 2020, a decrease of $3.8 million. The decrease in interest expense is due to substantial principal prepayments during fiscal 2021 on both the revolving credit facility and the term loan B credit facility (see Note 11, "Long-Term Debt," to our consolidated financial statements included below in Item 8 of this annual report for further discussion). We paid a total of $25 millionof principal above and in advance of our contractual obligation. Other income/(expense). Other income was $2.1 millionin fiscal 2021, compared to other expense of $1.6 millionin fiscal 2020, a comparative decrease of expense of $3.7 million. The decrease in other expense primarily relates to transactional foreign exchange gains as well as market-related gains on underlying investments associated with our deferred compensation plan for certain high-level employees. The gains were partially offset by related compensation expense, included in Marketing, general, administrative and engineering costs as discussed above. Income taxes. Income tax (benefit) was $(1.4) millionin fiscal 2021, on pre-tax net loss of $(0.3) millioncompared to income tax expense of $5.1 millionin fiscal 2020 on pre-tax net income of $17.1 million, a decrease of $6.5 million. The income tax (benefit) in the current period was primarily due to a pre-tax loss and the impact from the U.S.(global intangible low-taxed income) or "GILTI Tax". During fiscal 2021, tax law changes provided a $1.9 millionrecovery of previously incurred GILTI Tax expense. See Note 18, "Income Taxes," to our audited consolidated financial statements included elsewhere in this annual report, for further detail on income taxes. Net income/(loss) available to Thermon Group Holdings, Inc.Net income available to the Company, after non-controlling interest, was $1.2 millionin fiscal 2021 as compared to income of $11.9 millionin fiscal 2020, a decrease of $10.7 millionor 89.9%. The decrease in fiscal 2021 net income is primarily due to lower revenue, lower gross profit as a result, and restructuring and other charges/(income), as described above.
End of year
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended
March 31, 2020filed with the SECon June 1, 2020for a discussion of the results of operations in fiscal 2020 as compared to fiscal 2019.
We are involved in various legal and administrative proceedings that arise from time to time in the ordinary course of doing business. Some of these proceedings may result in fines, penalties or judgments being assessed against us, which may adversely affect our financial results. In addition, from time to time, we are involved in various disputes, which may or may not be settled prior to legal proceedings being instituted and which may result in losses in excess of accrued liabilities, if any, relating to such unresolved disputes. As of
March 31, 2021, management believes that adequate reserves have been established for any probable and reasonably estimable losses. Expenses related to litigation reduce operating income. We do not believe 29 --------------------------------------------------------------------------------
that the outcome of any of these proceedings or disputes would have a material adverse effect on our financial condition, long-term results of operations or cash flows. However, it is possible that the charges related to these matters could be material to our results of operations or cash flows in a single accounting period.
For more information on legal proceedings, see Note 15 “Commitments and contingencies” to our consolidated financial statements included elsewhere in this annual report, which is hereby incorporated by reference into this point 7.
To bid on or secure certain contracts, we are required at times to provide a performance guaranty to our customers in the form of a surety bond, standby letter of credit or foreign bank guaranty. On
March 31, 2021, we had in place standby letters of credit, bank guarantees and performance bonds totaling $10.0 millionto back our various customer contracts. Our Indian subsidiary also has $4.9 millionin customs bonds outstanding.
Liquidity and capital resources
Our primary sources of liquidity are cash flows from operations and funds available under our revolving credit facility and other revolving lines of credit. Our primary liquidity needs are to finance our working capital, capital expenditures, debt service needs and potential future acquisitions. In
October 2017, we entered into a new credit agreement that provides for (i) a seven-year $250.0 millionvariable rate senior secured term loan B facility and (ii) a five-year $60.0 millionsenior secured revolving credit facility. At March 31, 2021, outstanding principal under the term loan B facility was $148.5 millionand we had no outstanding borrowings under our revolving credit facility. Cash and cash equivalents. At March 31, 2021, we had $40.1 millionin cash and cash equivalents. We maintain cash and cash equivalents at various financial institutions located in many countries throughout the world. Approximately $10.0 million, or 25%, of these amounts were held in domestic accounts with various institutions and approximately $30.1 million, or 75%, of these amounts were held in accounts outside of the United Stateswith various financial institutions. Senior secured credit facility. See Note 11, "Long-Term Debt-Senior Secured Credit Facility" to our consolidated financial statements and accompanying notes thereto included in Item 8 of this annual report for additional information on our senior secured term loan and revolving credit facilities, which is hereby incorporated by reference into this Item 7 . At March 31, 2021, we had no outstanding borrowings under our revolving credit facility and $56.7 millionof available capacity thereunder, after taking into account the borrowing base and letters of credit outstanding, which totaled $3.3 million. From time to time, we may choose to utilize our revolving credit facility to fund operations, acquisitions or other investments, despite having cash available within our consolidated group in light of the cost, timing and other business considerations. As of March 31, 2021, we had $148.5 millionof outstanding principal on our term loan B facility. We are required to make quarterly principal payments of the term loan of $0.6 millionthrough July 31, 2024. Thereafter, the remaining principal balance will be settled with a lump-sum payment of $139.8 milliondue at maturity of the term loan in October 2024. During the fiscal year ended March 31, 2021, we made voluntary debt prepayments of principal on the term loan B facility of $25.0 million. From time to time, we may choose to make unscheduled and additional prepayments of principal on the term loan B based on available cash flows. Guarantees; security. The term loan is guaranteed by the Company and all of the Company's current and future wholly owned domestic material subsidiaries (the " U.S.Subsidiary Guarantors"), subject to certain exceptions. Obligations of the Company under the revolving credit facility are guaranteed by the Company and the U.S.Subsidiary Guarantors. The obligations of Thermon Canada Inc.(the "Canadian Borrower") under the revolving credit facility are guaranteed by the Company, Thermon Holding Corp.(the " U.S.Borrower"), the U.S.Subsidiary Guarantors and each of the wholly owned Canadian material subsidiaries of the Canadian Borrower, subject to certain exceptions. The term loan and the obligations of the U.S.Borrower under the revolving credit facility are secured by a first lien on all of the Company's assets and the assets of the U.S.Subsidiary Guarantors, including 100% of the capital stock of the U.S.Subsidiary Guarantors and 65% of the capital stock of the first tier material foreign subsidiaries of the Company, the U.S.Borrower and the U.S.Subsidiary Guarantors, subject to certain exceptions. The obligations of the Canadian Borrower under the revolving credit facility are secured by a first lien on all of the Company's assets, the U.S.Subsidiary Guarantors' assets, the Canadian Borrower's assets and the assets of the material Canadian subsidiaries of the Canadian Borrower, including 100% of the capital stock of the Canadian Borrower's material Canadian subsidiaries. Financial covenants. The term loan is not subject to any financial covenants. The revolving credit facility requires the Company, on a consolidated basis, to maintain certain financial covenant ratios. The Company must maintain a consolidated leverage ratio of 3.75:1.0 as measured on the last day of any fiscal quarter. In addition, on the last day of any period of four fiscal quarters, the Company must maintain a consolidated fixed charge coverage ratio of not less than 1.25:1.0. As of March 31, 2021, we were in compliance with all financial covenants of the credit facility. 30 -------------------------------------------------------------------------------- Restrictive covenants. The credit agreement governing our credit facility contains various restrictive covenants that, among other things, restrict or limit our ability to (subject to certain negotiated exceptions): incur additional indebtedness; grant liens; make fundamental changes; sell assets; make restricted payments including cash dividends to shareholders; enter into sales and leaseback transactions; make investments; prepay certain indebtedness; enter into certain transactions with affiliates; and enter into restrictive agreements. Repatriation considerations. Given the significant changes and potential opportunities under the U.S.Tax Cuts and Jobs Act of 2017 (the "Tax Act") to repatriate cash tax free, we have reevaluated our current indefinite assertions. Beginning with fiscal 2018, we no longer assert a permanent reinvestment position in most of our foreign subsidiaries. We expect to repatriate certain earnings which will be subject to withholding taxes. These additional withholding taxes are being recorded as an additional deferred tax liability associated with the basis difference in such jurisdictions. Any changes made by foreign jurisdictions to their respective withholding rates could impact future tax expense and cash flow. Future capital requirements. Our future capital requirements will depend on a number of factors. We believe that, based on our current level of operations, cash flow from operations and available cash, together with available borrowings under our revolving credit facility, will be adequate to meet our liquidity needs for the next 12 months. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to service our indebtedness, including our credit facility borrowings, or to fund our other liquidity needs. In addition, upon the occurrence of certain events, such as a change of control, we could be required to repay or refinance our indebtedness. We cannot assure you that we will be able to refinance any of our indebtedness, including our credit facility, on commercially reasonable terms or at all. In fiscal 2021, we invested $8.1 millionin capital expenditures. TPS purchased $4.6 millionin property, plant and equipment, primarily related to leased equipment. We invested $3.1 millionin our US-LAM segment primarily related to building improvements, leased equipment, and further investments in technology, furniture and fixture replacements, and capital maintenance.
End of year
Net cash provided by operating activities totaled
$30.3 millionfor fiscal 2021 compared to $70.7 millionfor fiscal 2020, a decrease of $40.4 million. The decrease was primarily attributable to a $19.7 milliondecrease in cash provided by working capital accounts, a decrease of $10.8 millionin net income, and $9.9 milliondecrease in cash provided from non-cash reconciling items. Our working capital assets in accounts receivable, inventory, contract assets, and other current assets represented a source of cash of $17.6 millionand $20.2 millionin fiscal 2021 and fiscal 2020 respectively, a decrease in the source of cash of $2.6 millionin fiscal 2021. During fiscal 2021, as compared to fiscal 2020 accounts receivable decreased on lower sales volume, representing a source of cash of $22.9 millionand a source of cash of $9.4 million, respectively. Contract assets represented a use of cash of $2.7 millionand a source of cash of $12.2 millionin fiscal 2021 and fiscal 2020, respectively, which is primarily attributed to timing of billings on our projects. In fiscal 2021, our inventory balance increased slightly as compared to fiscal 2020 due to lower inventory turnover, representing a use of cash of $0.5 millionfor fiscal 2021 and a source of cash of $1.4 millionin fiscal 2020. Our combined balance of accounts payable, accrued liabilities and other non-current liabilities represented a use of cash of $6.3 millionand source of cash of $3.1 millionin fiscal 2021 and fiscal 2020, respectively, a total decrease of $9.4 million. The increase in the use of cash in fiscal 2021 is primarily due to decreased overall activity as well as the timing of vendor payments. Changes in our income taxes payable and receivable balances represented a use of cash of $6.8 millionin fiscal 2021 and a source of cash of $0.9 millionin fiscal 2020. Net cash used in investing activities totaled $7.8 millionfor fiscal 2021 compared to $10.0 millionfor fiscal 2020, a decrease of $2.2 millionin the use of cash. Net cash used in investing activities relates to the purchase of capital assets primarily to maintain the existing operations of the business; it also includes purchases and sales of equipment in our rental business. Capital expenditures in fiscal 2021 were curtailed due to our response to the economic downturn associated with the COVID-19 pandemic. Net cash used in financing activities totaled $28.2 millionin fiscal 2021, compared to $46.5 millionfor fiscal 2020, a comparative decrease of $18.3 millioncash used in financing activities which is primarily attributable to increased principal prepayments on our credit facilities during fiscal 2020 as compared to fiscal 2021. Cash proceeds in financing activities are 31 --------------------------------------------------------------------------------
mainly short-term borrowings and cash used in financing activities come from contractual and voluntary principal repayments on our unpaid long-term debt.
End of year
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended
March 31, 2020filed with the SECon June 1, 2020for a discussion of net cash provided by operating activities, net cash used in investing activities and net cash provided by (used in) financing activities in fiscal 2020 as compared to fiscal 2019.
Off-balance sheet arrangements
We do not have off-balance sheet arrangements. In addition, we have no interest in entities known as variable interest entities, which include special purpose entities and other structured finance entities.
Effect of inflation
While inflationary increases in certain input costs, such as wages, have an impact on our operating results, inflation has had minimal net impact on our operating results during the last three years, as overall inflation has been offset by lower commodity prices for our core production materials. We cannot assure you, however, that we will not be affected by general inflation in the future. Seasonality Demand for our products depends in large part upon the level of capital and maintenance expenditures by many of our customers and end-users, in particular those customers in the oil and gas, refining, chemical processing and transportation markets. These customers' expenditures historically have been cyclical in nature and vulnerable to economic downturns. In addition, quarterly revenues for the heat tracing business are impacted by the level and timing of large Greenfield projects that may be occurring at any given time. Our operating expenses remain relatively consistent with some variability related to overall headcount of the Company. Our quarterly operating results may fluctuate based on the cyclical pattern of industries to which we provide heat tracing solutions and the seasonality of MRO/UE demand for our heat tracing products. Most of our heat tracing customers perform preventative maintenance prior to the winter season, typically making our second and third fiscal quarters the largest for MRO/UE revenue. However, revenues from Greenfield projects are not seasonal and depend on the capital spending environment and project timing.
THS generally experiences a more pronounced seasonality than our previous heat-tracing business, with a noticeable increase in revenue and profitability starting in the third fiscal quarter and continuing through the winter months until the end of the fourth fiscal quarter.
Accounting policies and critical estimates
The preparation of our financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. Our critical accounting policies are those that materially affect our financial statements and involve difficult, subjective or complex judgments by management. Our most significant financial statement estimates include revenue recognition, estimating allowances, specifically the allowance for doubtful accounts and the adjustment for excess and obsolete inventories, valuation of long-lived assets, goodwill, and other intangible assets, accounting for income taxes, loss contingencies, and stock-based compensation expense. Although these estimates are based on management's best knowledge of current events and actions that may impact the company in the future, actual results may be materially different from the estimates. Revenue recognition. Please refer to Note 4 "Revenue from Contracts with Customers" of our consolidated financial statements included below in Item 8 of this annual report for further discussion, including the impact the adoption had on our consolidated financial statements. 32 -------------------------------------------------------------------------------- Estimating allowances, specifically the allowance for doubtful accounts and the adjustment for excess and obsolete inventories. The Company's receivables are recorded at cost when earned and represent claims against third parties that will be settled in cash. The carrying value of the Company's receivables, net of allowance for doubtful accounts, represents their estimated net realizable value. If events or changes in circumstances indicate specific receivable balances may be impaired, further consideration is given to the Company's ability to collect those balances and the allowance is adjusted accordingly. The Company has established an allowance for doubtful accounts based upon an analysis of aged receivables. Past-due receivable balances are written-off when the Company's internal collection efforts have been unsuccessful in collecting the amounts due. The major end markets that drive demand for process heating include chemical and petrochemical, up-, mid- and downstream oil and gas, power generation, commercial, and rail and transit. From time to time, the Company has experienced significant credit losses with respect to individual customers; however, historically, these credit losses have been isolated to specific customers rather than across an industry and have been infrequent. The Company's foreign receivables are not concentrated within any one geographic segment nor are they subject to any current economic conditions that would subject the Company to unusual risk. The Company does not generally require collateral or other security from customers. We perform credit evaluations of new customers and sometimes require deposits, prepayments or use of trade letters of credit to mitigate our credit risk. Allowance for doubtful account balances were
$2.1 millionand $0.8 millionas of March 31, 2021and 2020, respectively. Although we have fully provided for these balances, we continue to pursue collection of these receivables. We write down our inventory for estimated excess or obsolete inventory equal to the difference between the cost of inventory and estimated net realizable value based on assumptions of future demand and market conditions. Net realizable value is determined quarterly by comparing inventory levels of individual products and components to historical usage rates, current backlog and estimated future sales and by analyzing the age and potential applications of inventory, in order to identify specific products and components of inventory that are judged unlikely to be sold. Our finished goods inventory consists primarily of completed electrical cable that has been manufactured for various heat tracing solutions. Most of our manufactured product offerings are built to industry standard specifications that have general purpose applications and therefore are sold to a variety of customers in various industries. Some of our products, such as custom orders and ancillary components outsourced from third-party manufacturers, have more specific applications and therefore may be at a higher risk of inventory obsolescence. Inventory is written-off in the period in which the disposal occurs. Actual future write-offs of inventory for salability and obsolescence reasons may differ from estimates and calculations used to determine valuation allowances due to changes in customer demand, customer negotiations, product application, technology shifts and other factors. Our allowance for excess and obsolete inventories was $1.8 millionand $2.0 millionat March 31, 2021and 2020, respectively. Historically, inventory obsolescence and potential excess cost adjustments have been within our expectations, and management does not believe that there is a reasonable likelihood that there will be a material change in future estimates or assumptions used to calculate the inventory valuation reserves. Significant judgments and estimates must be made and used in connection with establishing these allowances. If our assumptions used to calculate these allowances do not agree with our future ability to collect outstanding receivables, or the actual demand for our inventory, additional provisions may be needed and our future results of operations could be adversely affected. Valuation of long-lived, goodwill and other intangible assets. We conduct a required annual review of goodwill for potential impairment in the fourth quarter, or sooner if events or changes in circumstances indicate that the fair value of a reporting unit is below its carrying value. Our reporting units are our operating segments: US-LAM, Canada, EMEA, and APAC. We have the option to perform a qualitative assessment to satisfy the annual test requirement if we believe that it is more likely than not that we do not have an impairment in any one of our reporting units. If the carrying value of a reporting unit that includes goodwill exceeds its fair value, which is determined using both the income approach and market approach, goodwill is considered impaired. The income approach determines fair value based on discounted cash flow model derived from a reporting unit's long-term forecasted cash flows. The market approach determines fair value based on the application of earnings multiples of comparable companies to projected earnings of the reporting unit. The amount of impairment loss is measured as the difference between the carrying value and the fair value of a reporting unit but is limited to the total amount of goodwill allocated to the reporting unit. In performing the fair value analysis, management makes various judgments, estimates and assumptions, the most significant of which is the assumption related to revenue growth rates. The factors we considered in developing our estimates and projections for cash flows include, but are not limited to, the following: (i) macroeconomic conditions; (ii) industry and market considerations; (iii) costs, such as increases in raw materials, labor, or other costs; (iv) our overall financial performance; and, (v) other relevant entity-specific events that impact our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in the 33 -------------------------------------------------------------------------------- assumptions underlying the approach used to determine the estimated fair values of our reporting units. We believe that the estimates and assumptions used in our impairment assessment are reasonable; however, these assumptions are judgmental and variations in any assumptions could result in materially different calculations of fair value. We will continue to evaluate goodwill on an annual basis in our fourth quarter, and whenever events or changes in circumstances, such as significant adverse changes in operating results, market conditions, or changes in management's business strategy indicate that there may be a probable indicator of impairment. It is possible that the assumptions used by management related to the evaluation may change or that actual results may vary significantly from management's estimates. In fiscal 2021, 2020 and 2019, the Company determined that no impairment of goodwill existed. Other intangible assets include indefinite lived intangible assets for which we must also perform an annual test of impairment. The Company's indefinite lived intangible assets consist primarily of trademarks. The fair value of the Company's trademarks is calculated using a "relief from royalty payments" methodology. This approach involves first estimating reasonable royalty rates for each trademark then applying these royalty rates to a net sales stream and discounting the resulting cash flows to determine the fair value. The royalty rate is estimated using both a market and income approach. The market approach relies on the existence of identifiable transactions in the marketplace involving the licensing of trademarks similar to those owned by the Company. The income approach uses a projected pretax profitability rate relevant to the licensed income stream. We believe the use of multiple valuation techniques results in a more accurate indicator of the fair value of each trademark. This fair value is then compared with the carrying value of each trademark. The results of this test during the fourth quarter of our fiscal year indicated that there was no impairment of our indefinite life intangible assets during fiscal 2021, 2020 and 2019. Accounting for income taxes. We account for income taxes under the asset and liability method that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations or effective tax rate. Significant judgment is required in determining our worldwide income tax provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of revenue sharing and cost reimbursement arrangements among related entities, the process of identifying items of revenue and expense that qualify for preferential tax treatment, and segregation of foreign and domestic earnings and expenses to avoid double taxation. Although we believe that our estimates are reasonable, the final tax outcome of these matters could be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision and net income in the period in which such determination is made. In estimating future tax consequences, all expected future events are considered other than enactments of changes in tax laws or rates. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized. We consider future growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, historical earnings, taxable income in prior years, if carryback is permitted under the law, and prudent and feasible tax planning strategies in determining the need for a valuation allowance. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets valuation allowance would be charged to earnings in the period in which we make such a determination, or goodwill would be adjusted at our final determination of the valuation allowance related to an acquisition within the measurement period. If we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance as an adjustment to earnings at such time. The amount of income tax we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Our estimate of the potential outcome for any uncertain tax issue is highly judgmental. We account for these uncertain tax issues pursuant to ASC 740, Income Taxes, which contains a two-step approach to recognizing and measuring uncertain tax positions taken or expected to be taken in a tax return. The first step is to determine if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given with respect to the final outcome of these matters. We adjust reserves for our uncertain tax positions due to changing facts and circumstances, such as the closing of a tax audit, judicial rulings, refinement of estimates or realization of earnings or deductions that differ from our estimates. To the extent that the final outcome of these matters is different than the amounts recorded, such differences generally will impact our provision for income taxes in the period in which such a determination is made. Our provisions for income taxes include the impact of reserve provisions and changes to reserves that are considered appropriate and also include the related interest and penalties. 34 --------------------------------------------------------------------------------
We plan to repatriate some foreign income from jurisdictions subject to withholding taxes. These additional withholding taxes are recorded as an additional deferred tax liability associated with the base difference in these jurisdictions.
Loss contingencies. We accrue for probable losses from contingencies including legal defense costs, on an undiscounted basis, when such costs are considered probable of being incurred and are reasonably estimable. We periodically evaluate available information, both internal and external, relative to such contingencies and adjust this accrual as necessary. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss.
Stock-based compensation costs. We account for share-based payments to employees in accordance with ASC 718, Compensation-Stock Compensation, which requires that share-based payments (to the extent that they are compensatory) be recognized in our Consolidated Statements of Operations and Operations. overall result. on the basis of their fair values.
As required by ASC 718, we record a stock-based compensation expense for share-based payments that are expected to vest. To determine whether an award should vest, we account for lapses as they occur, rather than estimating expected lapses.
We are also required to determine the fair value of stock-based awards at the grant date. For option awards that are subject to service conditions and/or performance conditions, we estimate the fair values of employee stock options using a Black-Scholes-Merton valuation model. Some of our option grants and awards included a market condition for which we used a
Monte Carlopricing model to establish grant date fair value. These determinations require judgment, including estimating expected volatility. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be impacted.
Non-GAAP financial measures
Disclosure in this annual report of "Adjusted EPS," "Adjusted EBITDA," "Adjusted Net Income," and "Free Cash Flow," which are "non-GAAP financial measures" as defined under the rules of the
Securities and Exchange Commission(the "SEC"), are intended as supplemental measures of our financial performance that are not required by, or presented in accordance with, U.S.generally accepted accounting principles ("GAAP"). "Adjusted Net Income" and "Adjusted fully diluted earnings per share" (or "Adjusted EPS") represents net income attributable to Thermon before costs related to the consolidation of our operating footprint in Canada, acceleration of unamortized debt costs, the tax benefit from income tax rate reductions in certain foreign jurisdictions, amortization of intangible assets, the income tax effect on any non-tax adjustments, costs associated with our restructuring and other income/(charges), and income related to the Canadian Emergency Wage Subsidy, per fully-diluted common share in the case of Adjusted EPS. "Adjusted EBITDA" represents net income attributable to Thermon before interest expense (net of interest income), income tax expense, depreciation and amortization expense, stock-based compensation expense, income attributable to non-controlling interests, costs related to the consolidation of our operating footprint in Canada, costs associated with our restructuring and other income/(charges), and income related to the Canadian Emergency Wage Subsidy. "Free cash flow" represents cash provided by operating activities less cash used for the purchase of property, plant and equipment, net of sales of rental equipment and proceeds from sales of land and buildings. We believe these non-GAAP financial measures are meaningful to our investors to enhance their understanding of our financial performance and are frequently used by securities analysts, investors and other interested parties to compare our performance with the performance of other companies that report Adjusted EPS, Adjusted EBITDA, or Adjusted Net Income. Adjusted EPS, Adjusted EBITDA, and Adjusted Net Income should be considered in addition to, not as substitutes for, income from operations, net income, net income per share, and other measures of financial performance reported in accordance with GAAP. We provide Free cash flow as a measure of our liquidity. Note that our calculation of Adjusted EPS, Adjusted EBITDA, Adjusted Net Income, and Free cash flow may not be comparable to similarly titled measures reported by other companies. 35 -------------------------------------------------------------------------------- The following table reconciles net income to Adjusted EBITDA for the periods presented: Year Ended March 31, 2021 2020 2019 Net income available to Thermon Group Holdings, Inc. $ 1,165 $ 11,938 $ 22,756Interest expense, net 10,185 14,027 15,476 Income tax expense/(benefit) (1,438) 5,142 9,973 Depreciation and amortization 20,722 28,275 29,965 EBITDA (non-GAAP) $ 30,634 $ 59,382 $ 78,170Stock-based compensation 3,728 4,960 4,148 Income/(loss) attributable to non-controlling interest - (2) 413 Consolidation of operating footprint in Canada - - 757 Restructuring and other charges/(income) 8,623 - - Canadian Emergency Wage Subsidy (6,412) - - Adjusted EBITDA (non-GAAP) $ 36,573 $ 64,340 $ 83,488
The following table reconciles net income to adjusted net income and adjusted EPS for the periods presented:
2021 2020 2019 Net income available to Thermon Group Holdings, Inc.
$ 1,165 $ 11,938 $ 22,756Consolidation of operating footprint in Canada - - 757 Acceleration of unamortized debt costs 510 756 394
Tax charge / (benefit) for the impact of the rate reduction in foreign jurisdictions
332 (1,231) - Amortization of intangible assets 9,445 17,773 20,771 Restructuring and other charges/(income) 8,623 - - Canadian Emergency Wage Subsidy (6,412) - - Tax effect of financial adjustments (2,450) (4,447) (5,499) Adjusted net income (non-GAAP) $
Adjusted-fully diluted earnings per common share (non-GAAP) $
Fully-diluted common shares - non-GAAP basis (thousands) 33,341 33,149 33,054
The following table reconciles cash from operating activities and free cash flow for the periods presented:
2021 2020 2019
Cash from operating activities
$ 23,227Less: Purchases of property, plant and equipment, net of rental equipment sales (8,132) (10,855) (12,036) Plus: Sales of rental equipment 300 603 981 Plus: Proceeds from sales of land and buildings - 242 33 Free cash flow provided $ 22,457 $ 60,716 $ 12,20536
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