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Edited Transcript of THR earnings conference call or presentation 6-Feb-20 4:00pm GMT

Q3 2020 Thermon Group Holdings Inc Earnings Call

SAN MARCOS Feb 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Thermon Group Holdings Inc earnings conference call or presentation Thursday, February 6, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce A. Thames

Thermon Group Holdings, Inc. - President, CEO & Director

* Jay C. Peterson

Thermon Group Holdings, Inc. - CFO, Senior VP of Finance, Assistant Secretary & Assistant Treasurer

* Kevin Fox

Thermon Group Holdings, Inc. - VP of Corporate Development

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Conference Call Participants

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* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* Joseph John Hanzlik

Confluence Investment Management LLC - Senior VP & Equity Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to the Thermon Group Holdings Third Quarter Fiscal Year 2020 Earnings Call. (Operator Instructions) Please note, this conference is being recorded. I will now turn the conference over to our host, Kevin Fox, Vice President, Corporate Development. Thank you. You may begin.

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Kevin Fox, Thermon Group Holdings, Inc. - VP of Corporate Development [2]

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Thank you, Diego. Good morning, and thank you for joining today's conference call. We issued an earnings press release this morning which has been filed with the SEC on Form 8-K and is also available on the Investor Relations section of our website at ir.thermon.com. A replay of today's call will also be available via webcast after the conclusion of the call. This broadcast is the property of Thermon, and any redistribution, retransmission or rebroadcast in any form without the expressed written consent of the company is prohibited.

During the call, we will also 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.

Before I turn this call over to Bruce, I'd like to remind you that during this call, we may make certain forward-looking statements regarding our company and business that are not historical facts. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. 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. We caution you, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. Any forward-looking statement made by us during this call speak only as of which the time it is made. Facts or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. 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.

And now, I'd like to introduce Bruce Thames, our President and Chief Executive Officer, for his opening comments.

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [3]

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All right. Thank you, Kevin, and good morning. And thank you all for joining our conference call and for your continued interest in Thermon.

Joining me on the call today is Jay Peterson, our CFO, who will follow me and present the financial details of our fiscal year 2020 third quarter.

Starting off, results in Q3 fell short of expectations and a record prior year Q3, primarily driven by weaker year-end discretionary spending and other factors during the quarter. While we projected weakness in capital projects, we expected to see stronger demand in MRO/UE as the heating season began and as customers release the last of fiscal budgets. This year, we saw neither materialize, which negatively impacted both mix and volume in the quarter. After 2 consecutive quarters of double-digit order growth, the weakening in our end markets we noted last quarter has now led to 2 consecutive quarters of single-digit order contraction.

I'd like to take a moment to discuss the trends we are seeing with our customers and in our end markets. From a capital investment standpoint, we see CapEx estimates for the next 12 months growing in the Middle East, Africa and India; moderate to neutral spending growth in North America and Asia; and Europe continuing to be a very challenging and competitive market.

Geographically, the U.S. and Latin America and Europe, Middle East, Africa, both contributed to the shortfall relative to expectations in prior year in the quarter.

In the U.S. and Latin America, we anticipated the weaker capital environment as some large ethane crackers are coming online and the next wave of projects are in early planning and engineering stages. However, we expected stronger year-end discretionary spending that occurred in the quarter, and we saw several new projects move to the right.

In Europe, Middle East, Africa, we have highlighted challenging market conditions for several quarters that continue to persist. Our Canadian and Asia Pacific geographies were both up low double digits over prior year.

We continue to see mixed signals in our end markets as well. The outlook in upstream remains weak due to excess capacity and lower commodity prices. This has certainly begun to weigh on capital deployment by integrated oil companies across other sectors of the industry. We also believe this contributed to the weaker year-end spending we saw this quarter.

Downstream is also showing some weakness with slowing demand growth for transportation fuels. Capital projects in this sector continue to be driven by tightening environmental regulations for lower sulfur content in fuels and efficiency improvements.

However, in other areas, we are seeing significant growth opportunities tied to natural gas and petrochemicals. In midstream, we continue to be well positioned to capitalize on an LNG investment cycle. We have been awarded a large Canadian LNG project that will begin to show in both bookings and backlog in Q4. We anticipate this project will positively impact financials in fiscal year 2021 and continue for the next 2 to 3 years thereafter.

With a warmer winter in Asia and European LNG storage near capacity, weaker demand could influence timing of final investment decisions for a number of planned projects. However, we continue to believe that global LNG investments will provide a tailwind for our business over the next several years.

Both chemical and petrochemical sectors remain the most robust of our end markets tied to cheap natural gas liquids and feedstock, particularly in the U.S. We're seeing a gap in this sector in the second half of fiscal year '20 as large capital projects are in various stages of planning and execution for the U.S. Gulf Coast, Canada and across the Middle East and Asia. We anticipate backlog growth as these projects move to award over the next several quarters. We're also seeing a few capital projects in renewables with biofuel processing plants over the next 24 months that create additional revenue opportunities.

Combined cycle power projects remained steady, particularly in the U.S. and Latin America.

Demand for mass transportation and growing population centers continue to create large multiyear project opportunities in rail and transit. We were awarded a multimillion dollar, multiyear transit project in Q3 that will be reflected in bookings and backlog in Q4. Awards of this nature helped balance the seasonality of the business through the continued diversification of our end markets.

In the nuclear segment, the majority of Thermon's opportunities are tied to MRO/UE spending within existing Canadian nuclear power facilities. We saw an increase in MRO activity in Q3, and we anticipate these activities to continue to generate revenue through late fiscal year '21.

Even with these mixed signals from the market, our project pipeline continues to grow, and we continue to see the globalization of the process heating platform as a key growth opportunity moving forward.

Moving on to financials. After 8 consecutive quarters of revenue growth, we saw a contraction in Q3 against a record quarter. Total Thermon revenue was down 16% from the prior year quarter on weaker capital projects, year-end discretionary spend and a slow start to the heating season.

Margins expanded 65 basis points over the prior year, but were down 80 basis points sequentially. We anticipated stronger margin expansion due to our continuous improvement efforts and an improving mix, but several factors had a negative impact in the quarter.

First, mix improved to a more historical average of 62% MRO/UE versus 38% greenfield, but less than anticipated due to the weaker discretionary spending in the quarter. Second, onetime charges and volume variances negatively impacted margins by about 225 basis points in the quarter.

We are continuing to execute on our planned cost reduction initiatives, while also investing in new product development that will further enhance our margin profile over time. We also take efforts -- we'll take efforts to rightsize our business, where warranted, while continuing to invest for growth.

Turning now to bookings. Bookings of $99 million for the quarter were down 6% from prior year, and backlog was essentially flat sequentially. On a positive note, globalization efforts resulted in solid bookings for our process heating products, up 4% year-over-year and 42% sequentially.

In addition, in a region that has been challenged for the last several quarters, we have secured a sizable project in Europe, Middle East, Africa that contributed to order and backlog growth during the quarter against an otherwise flat incoming order rate.

I want to shift now to focus to cash, which has been a good story this year. With a concerted effort on working capital, combined with a low capital intensity business model, we've been able to generate $19.9 million in free cash flow during the quarter and $46.3 million year-to-date. As a result, we were able to pay down an additional $23 million in debt during the quarter. At this time, our net debt to trailing 12-month adjusted EBITDA stands at 1.9x.

From an M&A standpoint, we continue to evaluate transactions each quarter, and the strength of our balance sheet positions us well for the right opportunity. We will prioritize bolt-on acquisitions that help build upon our leadership position in key technologies, globalize the process and environmental heating platform or expand our addressable markets. In the absence of attractive M&A, we will prioritize debt reduction. The savings from the year-to-date debt reduction and associated interest expense will translate to $0.04 a share in EPS on an annualized basis.

Additionally, from an organic growth perspective, we are continuing to invest in technology that positions Thermon to win in the market. We have several projects nearing completion in the new product development pipeline that will be announced in the coming quarters. These new industry-leading solutions will provide connectivity and enhanced performance while increasing safety and reliability.

Based upon the second consecutive quarter of weaker -- of our weaker incoming orders and the movement in project schedules, we are lowering our fiscal year 2020 forecast to $383 million to $390 million for the year. While China only represents 2% of revenue and our supply chain has limited exposure, we have included additional uncertainty in the range to account for the timing of shipments in the quarter. While the near-term environment remains choppy, Thermon is well positioned within our market space. The key market drivers for growth remain intact, as evidenced by our growing pipeline of opportunities. We see the emerging middle class in developing nations creating demand for chemicals and petrochemicals, tightening environmental regulations and natural gas as a bridge fuel, all creating opportunities to grow and service our installed base.

Thermon's resilient business model, in-market diversity, global footprint, decades of engineering design expertise and pipeline of new product and technology, all support our competitive position in this space. We will provide you guidance on our fiscal year 2021 during our next earnings call.

To the Thermon employees around the globe, thank you for all that you do for our customers each and every day. You are truly the Thermon difference.

With that, I'd like to now turn it over to Jay Peterson, our CFO, who will address the details of our financial performance for the third quarter. Jay?

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Jay C. Peterson, Thermon Group Holdings, Inc. - CFO, Senior VP of Finance, Assistant Secretary & Assistant Treasurer [4]

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Thank you, Bruce. Good morning. I will start by discussing our Q3 results, including our cash generation and debt paydown, and then finish with guidance and a discussion on margin enhancements for fiscal year 2020.

First off, our revenue this past quarter totaled $100.5 million, and that's a decline of 16% against the prior quarter, which was an all-time record high for Thermon. On a year-to-date basis, the majority of our revenue decline is attributable to the performance of our European business, which has been negatively impacted by the macro European economy, among other factors.

The legacy revenue mix between MRO/UE and Greenfield was 62% and 38%, respectively, versus a 35% and 45% mix in Q3 of fiscal year '19. FX nominally decreased total revenue by approximately $200,000. And in constant currency, our revenue declined by 16%.

Orders for the quarter totaled $99 million versus $105.7 million in the prior year quarter for a decline of 6%, and this was due to weaker-than-expected year-end spending and a warmer start to the annual heating season.

Our backlog of orders ended December at $102.5 million versus $135.9 million as of December fiscal year '19, and that is a decrease of 25%. And as Bruce mentioned, there are several large greenfield projects that have been recently awarded to Thermon, and we anticipate booking them into our backlog in the next 90 to 120 days. And our book-to-bill for the quarter was essentially flat at 0.99.

Moving on to gross margins. Margins were 43.3% for the quarter, and that's a 65 basis point improvement versus the comp period. Sequentially, margins were down by 80 basis points, and that was attributable to closeout costs for a large greenfield project and certain cost variances due to lower volumes.

Gross profit declined by $7.4 million due to the double-digit revenue decline or by 14.5% versus the comp period, which was also an all-time record high for Thermon.

Cost increases due to tariffs have been relatively minor, and we have largely been able to pass these cost increases along to our customers without any significant impact to our GMs.

Moving to OpEx. Core operating expenses for the quarter, and this excludes depreciation and amortization, totaled $23.9 million versus $25.8 million in the prior year. And that's a reduction of 7.4%, and that is due to lower personnel costs. In addition, comprehended in this OpEx decline is a 12% growth in research and development spending. And our operating expense as a percent of revenue was 24%, again, excluding depreciation and amortization, and that's an increase of 200 bps from the prior year level of 22%. And note that we have executed cost reduction actions in Europe in the month of January to better align our expenses with our incoming European order rate.

Now to earnings. GAAP EPS for the quarter totaled $0.20 compared to the prior year quarter of $0.29, and that's a decline of $0.09 per share. And with the adjusted EPS construct, as defined by GAAP EPS plus amortization expense and any onetime charges, totaled $0.28 a share relative to $0.40 a share in the prior year quarter. And we are currently expensing $4.5 million per quarter or $0.10 per share, or approximately $0.40 a share on an annual basis after tax for noncash amortization. And note that this total amortization expense will decrease in May of this year by $8.3 million annually due to the full amortization of certain assets related to the 2010 private equity acquisition of Thermon. And the impact of this will be an increase to our GAAP EPS on an after-tax basis of $0.19 per share for fiscal year '21.

And EBITDA declined by 19.7% versus the comparison quarter, and EBITDA as a percent of revenue was 21%. And this was a decline of 100 basis points versus the comparison period. And EBITDA this past quarter totaled $21 million.

Turning to the balance sheet and capital allocation. This last quarter, we were able to both grow our cash balance and pay down debt. Our cash and investments balance at the end of December grew to $37.1 million, and we generated $19.9 million in free cash flow this quarter, and we were able to pay down $23.1 million in debt with additional debt paydown this current fiscal quarter.

On a year-to-date basis, we have generated $46.3 million in free cash flow and paid down $33 million in debt. And the debt paydown will reduce our interest expense at next fiscal year by $0.04 a share on an after-tax basis. The reduction in amort expense, coupled with the interest expense savings, will be accretive to our fiscal year '21 earnings per share by $0.23, again, on an after-tax basis, with additional interest expense savings forthcoming.

Our CapEx spend for the third quarter totaled $2.1 million, and that is inclusive of both growth and maintenance capital and amounted to 2.1% of revenue. And our net debt-to-EBITDA ratio was 3.4x at the time of the October 2017 CCI acquisition and has since improved to 1.9x, with additional delevering planned for this current fiscal year. And our EBITDA conversion ratio, as defined as EBITDA less CapEx divided by EBITDA, for the last 12 months, was a healthy 89%, an improvement versus 87% in the prior year-to-date period. And lastly, our capital allocation, in the absence of any near-term M&A transaction, is to continue to reduce our debt through continued optional debt repayment.

Taxes. The tax rate for the third quarter was 27% and tax expense in Q3 2020 reflects a reduction of taxes totaling $447,000 for the impact of a 4% tax rate reduction in the Netherlands. And while this rate will be phased in over 3 years, accounting guidance requires that we adjust the respective tax accounts at the time the tax law becomes known.

And we continue to reduce -- continue to work with our tax advisers on potential strategies to optimize our income tax structure. And at the conclusion of this analysis, it is possible that our tax rate will be exposed downward in fiscal year '21.

And finally, guidance. There are several points I'd like to call out. Due to the higher-than-expected deceleration of capital projects and a weaker start to the heating season, and although small, impact of the coronavirus, we are revising our previous guidance to a 5% to 7% revenue decline over the prior year. And relative to our current margin performance, various activities are in process to improve our margins, including the following: $4.5 million in cost reductions, with an anticipated realization of approximately $2 million in savings this current fiscal year and with additional cost reductions planned for next year; and we announced price list increases earlier this year for our maintenance-related products, and that has partially offset margin impact due to negative volume impact; and recent and planned product announcements that we anticipate will yield accretive margins.

In conclusion, due to growth in cash, our TTM EBITDA projection and reduction in our debt, we expect our net debt-to-EBITDA leverage to decline to 1.7 to 1.8x at the end of this current year, excluding any M&A transaction.

I would now like to turn the call back over to Diego to moderate our Q&A session.

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Questions and Answers

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Operator [1]

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Ladies and gentlemen, at this time, we will conduct our question-and-answer session. (Operator Instructions) Our first question comes from Brian Drab with William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [2]

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Did you say what THS revenue was in the third quarter?

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Jay C. Peterson, Thermon Group Holdings, Inc. - CFO, Senior VP of Finance, Assistant Secretary & Assistant Treasurer [3]

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No. No, we did not. I've got that here. We will be talking about that both this quarter and the next quarter. But going into next fiscal year, due to the finalization of the integration into the legacy business, we will -- it will be unlikely that we will be discussing that going forward. This current year, it was just under $22 million, $21.9 million for the quarter.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [4]

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$21.9 million for the quarter. Okay. All right. So that business is down somewhat from last year, but not really any different from the decline that you saw in the core business, I guess?

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Jay C. Peterson, Thermon Group Holdings, Inc. - CFO, Senior VP of Finance, Assistant Secretary & Assistant Treasurer [5]

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Correct. That's correct.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [6]

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Okay, okay. And then can you talk about the margins that you're seeing in greenfield now that had been under pressure somewhat. Are those dynamics that are putting greenfield margins under pressure still in place, or what do you see there?

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [7]

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Yes. We haven't seen a material change in the greenfield margins. They're still running in the upper 20% range for the year, and that will vary a little bit on the type of project and geography. But the average is in that range and has been for the last 2 or 3 years.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [8]

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And then are the margins in your backlog then, I guess, is it safe to assume that those margins are about in that range as well?

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Jay C. Peterson, Thermon Group Holdings, Inc. - CFO, Senior VP of Finance, Assistant Secretary & Assistant Treasurer [9]

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Yes. We see the margins, they're a little dynamic based on which certain projects are in near term versus the out term. And at present, the margins are essentially flat with the prior quarter down modestly.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [10]

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Okay. Okay. And then on the last call, you talked about a couple of major project wins. Can you update at all on those projects? And I guess what I'm wondering is, Bruce, I think you said that some projects have been pushed out. Does that include some of these larger projects that we talked about last quarter?

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [11]

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Yes. So that's a great question. First of all, we take a pretty conservative approach to how we book projects in backlog. And so we've received a number of awards that -- sizable awards that are not reflected in our bookings and backlog. My reference to those projects that could move are not the ones that are -- that have been committed. The ones that are more in question around movement have yet to clear FID. And then we did see some in -- particularly in the Gulf Coast, but we saw some other project movement to the right by about 6 months. And that's -- there's various reasons that are driving some of that timing. But Brian, to answer your question, no, there is no impact to the timing of those projects. We just get firm builds of material and hard POs before we enter those into bookings and backlog. I do know, for the large Canadian LNG project that we've mentioned previously, this fourth quarter, that will begin to impact backlog -- bookings and backlog. And those will be led with a multiple purchase orders over the next 2 to 3 years. So it won't just be one big number, it will be bookings throughout the year at multiple quarters for multiple packages. So that's kind of what you should expect going forward.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [12]

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So the Canada LNG project has not really shown up in the numbers yet. That will start in the fourth quarter?

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [13]

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That's correct. They have not shown up in the numbers at all, so.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [14]

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Okay, at all? Okay, okay. I wasn't sure if there's any like early engineering work or something that hit. But it -- so it will start in the fourth quarter. I got it.

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [15]

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Correct.

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Operator [16]

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(Operator Instructions) Our next question comes from Joe Hanzlik with Confluence Investment Management.

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Joseph John Hanzlik, Confluence Investment Management LLC - Senior VP & Equity Analyst [17]

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Just looking at backlog over the last 2 years, it's steadily decreased over the last 8 quarters from $167 million down to about $102 million. What's that expectation for backlog going forward, sort of with the LNG and sort of without the LNG?

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [18]

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Yes. So Joe, thanks for your question. What we expect, we expected in the second half this year to really begin to see some backlog build and see a positive book-to-bill in the business for a couple of reasons. We've yet to see that materialize. Some of that is we have seen movement in project timing. And some of that is just as we've secured these commitments, moving through the engineering phases to get to firm bills and material, those have yet to be let with firm POs to hit our backlog. So our expectation, excluding the large LNG project, would be that we would begin to see some backlog build. And we did see that in Europe, which has been particularly weak and is largely responsible for the backlog decline you had referenced. Our Asia Pacific backlog remains strong. Canada has been fairly flat. And we've seen a drawdown in backlog from this time last year in the U.S. and Latin America as we've kind of completed some large ethane crackers. But there are a whole another wave of projects online in various stages of planning and execution that we believe we are well positioned to win and we believe should hit -- begin to hit backlog in the next several quarters.

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Operator [19]

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Ladies and gentlemen, there are no further questions at this time. I'll turn it back to management for closing remarks.

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Bruce A. Thames, Thermon Group Holdings, Inc. - President, CEO & Director [20]

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Thank you, Diego. And thank you, again, for joining this conference call today. We appreciate your interest and support for Thermon, enjoy the rest of your day.

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Operator [21]

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