Greetings, and welcome to the Thermon Group Holdings Inc. Second Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Sarah Alexander, General Counsel. Thank you, you may begin.

Thank you, Christine. Good morning, and thanks 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 www.thermon.com. A replay of today's call will also be available via webcast after the conclusion of this call. This broadcast is the property of Thermon. Any redistribution, retransmission or rebroadcast in any form without the expressed written consent of the company is prohibited. During this call, our comments may include forward-looking statements, which are subject to risks and uncertainties. We do not intend to update these statements unless they're required to do so under applicable securities laws, and our actual results may differ materially from the views expressed today. Some of these risks have been set forth in the press release and in our quarterly and annual reports filed with the SEC. We would also like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements may include among others, our outlook for future performance, revenue growth, profitability, leverage ratios, acquisitions, synergies and various other aspects of our business. 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. And now, it's my pleasure to turn the call over to Bruce Thames, our President and Chief Executive Officer.

Thank you, Sarah. Good morning, everyone, and thank you all for joining our conference call and for your continued interest in Thermon. Today, we have Jay Peterson, our CFO, joining me on the conference call. And Jay will follow me and present the financial details of our fiscal 2019 second quarter. Just to start. We continued to see the positive impacts of investments made during the industry downturn directly translate into improved operating results and market share. The positive momentum that we saw in the second half of fiscal 2018 has continued into fiscal 2019. We're now beginning to see the true potential for this business. On a trailing 12-month pro forma basis, we generated $83 million in adjusted EBITDA, a level not seen since fiscal 2015 when oil was $100 a barrel and there were very large oil sands projects underway. We've been able to accomplish this by expanding our addressable market, diversifying into adjacent markets and differentiating our offering. The integration of CCI Thermal Technologies, now called Thermon Heating Systems or THS, continues to progress well. Our production facility consolidation is complete, and now operating at full capacity and generating cost savings that meet or exceed the original plan. Our efforts to leverage market channels with an expanded solution are also beginning to generate sales synergies that were not originally included in the initial financial justification for the acquisition. The outcome of these efforts, combined with strong maintenance spending drove second quarter revenue growth that exceeded our expectations. Revenues of $90.2 million were up 46.4% year-over-year with organic growing 16.9%, excluding FX. Inorganically, we saw Thermon Heating Systems finish at $19.4 million in revenue, up 7.9% on a pro forma basis and on track with our base case for the acquisition. Margins declined by 540 basis points year-over-year…

Thank you, Bruce. Good morning. I will start off by discussing Q2 results and then turn to a review of our updated guidance for fiscal year '19. First off, revenue and orders. Our revenue this past quarter totaled $90.2 million and that's an increase of 46% over the prior year's quarter. Organic revenue in constant currency grew by 17%. FX decreased organic revenue by approximately 2%, and M&A revenue contributed 31.4%. And on a pro forma basis, our total revenue grew by 13%. In the quarter, we continued to experience positive signs of a recovery with our organic revenues, growing double digits for the fourth consecutive quarter. In addition, Thermon Heating Systems revenue increased 8% on a pro forma basis. Our organic MRO/UE mix for Q2 was 69% of revenues, whereas Greenfield totaled 31%. Total orders for the quarter totaled $96 million versus $73 million in the prior quarter for an increase of 32%. Organic orders grew 8%. And on a pro forma basis, THS orders declined by 15%, and this decline was due to a large transportation order in July of '17 that made for an especially difficult Q2 comp. Our backlog of orders ended September at $150 million versus $121 million as of September fiscal year '18, and that's an increase of 23%. Our organic backlog grew by 1%. And on a pro forma basis, the THS backlog declined by 16%. And our book-to-bill for the quarter was positive at 1.06. Moving on to gross margins. Total margins were 45% of revenue and grew by 30% on a GAAP basis. Against a very difficult prior year comp, our margins declined by 540 basis points. Our organic Greenfield margins declined due to a typical high mix of labor. And note that our MRO/UE margins declined slightly due to a…

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

I guess, the main question here probably is around gross margin. I think that you are pretty clear that for the first half of the year this 45% gross margin would be where you shake out at. It looks like the consensus was above that. But, I guess, the big question is, what do you expect for the balance of the year in terms of gross margin? What do you have in the backlog in terms of gross margin? And any guidance on gross margin, I think, is probably the most important thing we need to get clarity on, on this call?

Okay. Brian, just as we look at margins and backlog, we see those have been essentially flat year-over-year. So we haven't seen big shifts. We did see a high mix of projects that had a high labor content in this quarter. And as you know, just that mix and volatility can have - that mix can drive volatility in our overall margins. Looking forward, particularly in the second half of the year as we enter the heating season, we would expect that mix to improve. And we've also passed along price increases in the marketplace. And certainly, given all the dynamics those we have been accepted and we should start to see a greater impact of those in the second half of the year. So I really think through the price increases combined with our mix change through the heating season we should see margin improvement, particularly, in the third quarter.

Okay. Particularly in the third quarter even versus the fourth, is that what that last comment mean?

Well, I mean, typically, third quarter margins are the highest in any given fiscal year, and that's due to the heating season and the mix of products. And that really applies both on the traditional heat tracing business as well - it's even more pronounced on the Thermon Heating Systems business.

Okay. And then, I guess, Bruce, can you just - you said flat year-over-year, as you started to answer that question. What do you mean exactly by you are seeing flat year-over-year? Should - I guess, should I look at the second half of fiscal '18 and think the 45.5% margin that you did then is what we should expect in the second half of this year? Or something above that?

Yes, my comment around backlog - about margins being flat were margins in backlog were essentially flat year-over-year. That was my comment.

Okay. So I guess, can you get any more specific in terms of, is gross margin going to be up? And when you say up, are they better in the back half of the year? Is it up closer to 50 basis points or into the 47%, 48% range, which you've done in the second half of years in the past? I mean, any more granularity on what to expect there?

Well, again, mix can have a big impact. But what we have seen, particularly, as we look on a line item basis in our product lines and as we look at our quick turn business, which is really the best proxy for the MRO within the MRO/UE, we actually are seeing margin expansion. So I would expect that will be favorable in the second half of the year, particularly as the mix improves. But, again, timing on projects can influence that absolute number. But I would expect margins to increase in the second half relative to the first half of this fiscal year.

Okay, okay. And then you mentioned LTM order number, I think, it was $296 million, and I didn't catch whether you mentioned the growth rate on that level of orders?

I didn't provide it, and I don't have that at this time. But we use that really to take out the seasonality and the lumpiness in the projects as we look at our business. And just as we look at our forecast organically, it supports the revenue forecast that we've revised upward with this call.

Okay, okay. And then can you just - my last question, for now, would just be on the tariffs. What exactly is the cost impact? Like what items are you purchasing that you're seeing the cost impact on?

Yes, Brian. The biggest impact we have seen from a raw materials perspective is stainless. And, again, we have largely been able to pass those increases along to our customers. And when we do talk to our customers, they are readily aware of these increases and we are not getting any discernible pushback.

And just to be clear, Jay, are you saying that you're buying that stainless domestically, but the price is up just pressured by tariffs in general, you're not buying that from China?

It's the impact of tariffs. Yes.

On the domestic price, you're saying?

Right.

But not - you're not buying that - you're not sourcing stainless steel from China?

No, no.

Our next question comes from line of Charlie Brady with SunTrust.

I just want to circle back on, kind of, dovetail on Brian's question on the gross margin, particularly, on the MRO side of the business. I think I missed part of your comment, but it sounds like the margin in the MRO business was also down a little bit. I didn't really catch the reason why it was down? And I guess, along those lines, if I look at the gross margin and I know that the Greenfield had a much higher labor content, which skews it down. But even so the mix of MRO in the quarter at 69% relative to 55% in Q1 and 66% a year ago in Q2, you did have a meaningful shift in MRO, and the gross margin correspondingly didn't really improve on that, so and I just have the comps, but prior to the MRO business, I guess, what's going on with margins in that business?

Yes, Charlie, there's two dynamics and they somewhat mitigate each other. MRO/UE margins declined slightly due to a higher shift within MRO/UE to the upgrade and expansion category. However, mitigating that is in the maintenance aspect, the MRO component. At MRO/UE, we actually saw an increase in what we call the maintenance or quick turn component. And that was actually positive this last quarter. So it is - within MRO/UE, it is a higher mix towards UE, but fortunately that was largely mitigated by a 2% increase in MRO margins.

Can you put that mix of the MRO versus UE. Can you put that in context as to what it was even in first quarter or maybe even a year ago quarter just to get a sense of how that's moved?

Yes. We have that data. I'll have to take that offline with you, Charlie.

That's fine. And I guess, I want to go back on the pricing. If I heard correctly, it sounds like that the full impact of pricing was not embedded into the second quarter results, and that starting here in Q3, we are getting the full benefit. So that I'm thinking maybe the gross margin was also impacted by not fully realizing price in the second quarter, is that correct?

That's correct. We have not realized full impact of price increases during the second quarter. They were passed on late in the first quarter. We have a 30-day period with a lot of our channel partners. We also have business and backlog, obviously, that was booked at prior pricing. And so second half of this year, we should see a much better price realization in the margins.

And I would guess that given it's coming out of backlog and the backlog doesn't get repriced, then it probably is more heavily skewed to the fourth quarter versus third quarter as far as the price realization goes, is that fair?

Certainly on the project business. But on MRO, we would see that come through in the third quarter.

Got it. Yes, that makes sense. And then, just finally one from me on the operating expense number. That - it was down significantly, and I'm just trying - and despite, as you said, R&D being up, I'm trying to understand what's really driving kind of the SG&A expense down? And is this kind of a normalized run rate we should be assuming going forward?

Yes. So the big impact there is - I mean, we've made investments during the downturn and have really augmented the management structure, and we've invested in research and development. We're now in a position, as we get volume growth that we can begin to leverage that SG&A spend. And so our objectives are to continue to drive this down over the next couple of fiscal years to that 25% range, and then - and that's really consistent with growing our EBITDA margins as a percent of revenue back to that historical 24%, 25%.

[Operator Instructions]. Our next question comes from the line of Scott Graham with BMO Capital Markets.

Can you hear me okay?

Yes. Scott, good morning.

So Bruce, I'm hoping you could help me triangulate towards something here because we've said now for really the better part of the year that the gross margin in the backlog is higher on a year-over-year basis. And then we have this gross margin reported here today. Understanding, of course, that the year ago comparison is not appropriate because you had that sort of a non-repeatable jump, but why has the - why did the read through like this is down 500 basis points plus. Let's call that 200-ish or more of the comp, but it seems as if the - and I think this is kind of what Charlie was alluding to that the MRO gross margin really shifted more negative than, I think, some of the examples that you are providing here. So I'm just - I guess, I'm not really understanding that because certainly the quick turn is going to give you that swing factor on a specific quarter, as we've talked about. But you came into the quarter with gross margins in the backlog up year-over-year and there is a lot of Greenfield in there. So I guess, like others, I'm having trouble getting to why the margin was as low as it was?

Yes. And again, I go back to what Jay had said earlier and what he said in his script. Essentially, the Greenfield, we have a significant increase in the labor content during this quarter. Last year, we actually - we had a significantly less in total volume of Greenfield. The mix has changed, but those were largely design and supply projects and had very little to know of labor content. And that has a significant impact over the Greenfield margins. And so those were very - even though they were smaller as a percentage, the absolute value grew by 82% and the net impact to our margins was material and was 75% of the decline. So we did see a higher mix of UE within the MRO/UE segment. But, again, the positive signs we've seen on the margin front are in our MRO margins. And at a - by a product line basis, we are actually seeing margin expansion year-over-year. So it gives us some confidence that it is largely mix related. And as we said, we do expect to see more price realization in the second half as we get the full impact of the price increases that were passed on at the end of the first quarter. And so we should see the positive impact of that translate through the P&L in the second half of this year.

Okay. I think we're getting a little closer here, Bruce, that was really helpful. I think I heard you say that and, if I'm wrong please correct me, 75% of the declining year-over-year margin was because of the Greenfield labor content?

Correct.

Okay. See, that's huge. So the question then becomes, of course, is never one answer without another question, right. If the backlog was up coming into the quarter, and gross margin that is, and you shipped a lot of lower margin Greenfield, why would the backlog only - the standing backlog only be flat now? Shouldn't the backlog be up - the gross margin in the backlog be up?

Yes, I see your point. Certainly, if we have a significant shift, we should see a big swing. But our backlog margins, based on the visibility we have year-over-year, are essentially flat.

Fair enough. Okay. And that's fine. So we would expect then - I think what some are trying to get you here, including the number of e-mails that I've been getting, is that your gross margin in the second half of this year versus the second half of last year flat to up, would you say?

Yes. I would say flat to increasing.

Okay. Now as - but my extension here, and I - not that I've already have belabored this point, but would that suggest then that - I don't know what your bookings look like this quarter, but with a flat gross margin, I'm assuming that there was, obviously, a lot more on the Greenfield side. Can - if as we go into fiscal '20, if the MRO sort of base margins are up, pricing is better, should we - I know I'm asking you to project out here a little bit, but shouldn't we then the see gross margin flat to up in fiscal '20 as well or is that unanswerable?

It is early yet, Scott, and we haven't really begun to - we're just starting our planning for our fiscal '20. I would say overall, as we look at the markets, we are seeing positive momentum in our markets. We've seen that in order growth. We're seeing that in our volume. There is and will be a tipping point where - and I really feel like in this part of the recovery cycle, just some of the inflationary pressures had mitigated some of the margin expansion we would normally anticipate at this point. But there is a tipping point and we're getting closer to where a project's time becomes more and more important than price in many of these opportunities, and so we would expect to see some continued margin expansion as we enter our fiscal '20.

Our next question comes from the line of Jon Braatz with Kansas City Capital.

Earlier this month, up in Canada, the LNG Canada project was approved. And some people are suggesting that Canada is back open for business in the energy area, and there's going to be additional projects that get the go-ahead, even some other additional LNG projects. And I guess, I'm asking is, what kind of - do you see - do you - are you feeling the same thing about Canada? And what are the opportunities that may lie ahead of you over the next couple of years if the market really opens up in Canada?

Yes, so we are seeing - with the announcement on the Canadian LNG facility, we are seeing an increase in some of the gas activity. There have been some additions to rail takeaway capacity that have helped with some of the takeaway capacity constraints from the oil sands. But I would say, we are not seeing those investments in the oil sands. The Canadian crude is actually trading at a significant discount due to the lack of takeaway capacity, so some of these pipelines need to be constructed to really improve that. I think soon as we do see that, we'll see a significant increase in the overall activity in the oil side of Canada. So very positive on the gas side, and we are seeing that activity. There is still some work to be done around some of these pipelines to improve takeaway capacity from the oil sands and, ultimately, the rail is really limiting takeaway capacity. And so when we see that - those projects move forward, you'll see big increase in the overall opportunities for our Canadian business.

Okay, okay. Thank you. And Jay, one question on your tax rate. Assuming everything stays the same - I mean, assuming you don't get any benefits, will your tax rate remain the same around 35% for the remainder of the year?

No, no. We anticipate for the second half of the year it to be at 30%. And that assumes this GILTI tax is not able to be mitigated through some structural changes, for example, in our debt, whether we have the debt on the U.S. books or our subsidiary books.

We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

All right, thank you, Christine. I'd like to just take a moment to thank our Thermon employees around the globe for their commitment to serving our customers and creating shareholder value. They really are the Thermon difference. And with that, I'd also like to thank, everyone, for joining us on this call today and for your continued interest in Thermon. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. And have a wonderful day.