Thermon Group Holdings' (THR) CEO Bruce Thames on Q3 2017 Results - Earnings Call Transcript

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Thermon Group Holdings, Inc. (NYSE:THR) Q3 2017 Earnings Conference Call February 8, 2017 11:00 AM ET

Executives

Sarah Alexander - General Counsel

Bruce Thames - President and Chief Executive Officer

Jay Peterson - Chief Financial Officer

Analysts

Jeff Hammond – KeyBanc Capital Markets

Scott Graham – BMO Capital Markets

Bhupender Bohra – Jefferies

Brian Drab – William Blair

Charlie Brady – SunTrust Robinson Humphrey

Jon Braatz – Kansas City Capital

Martin Malloy - Johnson Rice

Operator

Good day ladies and gentlemen, and thank you for standing by. Welcome to the Thermon Earnings Conference Cal. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. And as a reminder this conference is being recorded. I would now like to hand the floor over to Sarah Alexander, General Counsel. Please go ahead.

Sarah Alexander

Thank you, Karen. Good morning everyone and thank you for joining us for today's earnings 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. These forward-looking statements are subject to risks and uncertainties 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 annual report filed on Form 10-K filed with the SEC last May. We also would 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, acquisition 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.

Bruce Thames

Thank you, Sarah. Good morning everyone. Thank you 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. Jay will follow me and present the financial details of our fiscal 2017 third quarter. To begin with an overview of the financials, after a soft quarter of bookings in Q2, revenue was $64.3 million, fell short of our expectations for the quarter and was down 14% year-over-year and 6% sequentially.

We continue to see MRO deferrals, winter arrived late and unlike most years, customers held on to those remaining capital dollars at calendar year end. Despite the revenue shortfall we did see a number of positives in our financial results for the quarter.

First, margins improved for the second consecutive quarter by 250 basis points to 44.5% as we have projected in the last earnings call. Second, we had a positive book-to-bill of 130% and the second highest bookings quarter in the history of the company at $84 million. These strong bookings levels drove backlog growth of 30% to $105 million for the quarter. This is the highest backlog the company have seen since Q2 of fiscal 2015 which if you’ll recall was a record year of revenue for the company.

The greatest growth was in EMEA and Asia with both geographies reaching record backlog levels. The mix of projects ranges across all of our key market sectors with power and downstream refining projects having the greatest impacts. The cost out measures noted in the last earnings call are on track to realize approximately $3 million of savings in fiscal 2017.

The combination of improved margins and better cost controls resulted in $0.16 adjusted EPS for the quarter, or up $0.06 over the prior quarter but down $0.09 year-over-year.

We will continue to balance the need to manage cost in underperforming businesses while making strategic investments where we see growth opportunity. In the near term, additional resources will be required in both project management and engineering to respond to the growing backlog understanding these costs, lead material sales on Greenfield opportunities.

From a market perspective, the overall oil and gas upstream sector remains the weakest, while the midstream and downstream sectors have shown more resilience. The chemical and petrochemical sectors remain active although there are signs of the overall pace slowing. There are some positive signs we are beginning to see from upstream operators including Canada SAGD and Eurasia.

Combined cycle power projects have also been strong, particularly in the US, although margins in this sector have historically been lower. Geographically, Europe, Middle East, Africa continues to be on pace to deliver a record year in both revenue and operating income. In Q3, revenue was up 18.6% over the prior year, and is up 7.6% compared to a record year in fiscal 2016.

After a quarter of growth, Canada revenues were down by 43% year-over-year, but effective cost management delivered 27.2% adjusted EBITDA for the quarter. Asia Pacific Q3 revenue was down 23.6% from prior year due to project timing and is flat through the first three quarters of this year.

Backlog growth has improved visibility for numerous projects across this region with several additions for the Middle East and Caspian. The US business continues to underperform in the current fiscal year with difficult comps to a record year in fiscal 2016. In Q3, revenues were down 10.8% from the prior year and are down 6.9% year-to-date.

Although timing continues to shift, our project pipeline remains stable with over 800 identified opportunities, representing approximately $1.1 billion in potential revenues over the next three to five years. While the number of opportunities have increased, we see the average size of projects remains lower than the historical average due to the lack of very large upstream projects on the horizon.

Although the pace has moderated, we continue to push forward with investments in new product developments to provide highly differentiated products and services to our customers. A two channel controllers, the TraceNet TCM2 was launched in January and it’s the latest addition to our comprehensive control and communications platform.

The TraceNet family provides customers a comprehensive suite of hardware and software solutions to improve the efficiency and reliability while lowering overall maintenance cost of customers’ operations.

In addition, we are on track to announce 200 new product introductions within the coming months. We are also pleased to announce that David Buntin has joined the leadership team as Senior Vice President of Research and Development. David brings over 20 years of experience with controls and communications in hazardous environments and has had a strong history of success in both new product development and commercialization.

We look forward to his contributions in accelerating our abilities to bring differentiated solutions to markets. We are also strengthening our presence in Eurasia with a new manufacturing location in Russia. Growth in the region has been a significant contributor to the success we have experienced in EMEA this year.

The facility has already begun production of accessories and we have began to produce trace heating cables to better serve a growing customer base in the region in Q1 of fiscal 2018. Moving on, our M&A pipeline remains active and we continue to pursue opportunities that align with our strategy.

Of the list of over 50 potential targets we mentioned in the last quarter, we have a heightened focus on roughly 10 high priority opportunities representing $500 million in revenue and $100 million in EBITDA.

We continue to build and refine plans to grow our addressable markets by two to three times by the end of fiscal 2021. Although now considered organic, the three acquisitions made in fiscal 2015 and 2016 were up in revenues by 4.1% year-to-date over prior and generated 22% in adjusted EBITDA.

Looking forward, we are pleased to see the backlog growth, but do not anticipate an impact to our forecast in the current fiscal year. We are tightening our guidance of mid-single-digit revenue decline to 7% decline subject to project shipments at quarter end.

Given the environment, we anticipate margin pressure to continue for the next several quarters, due to an unfavorable Greenfield mix and competitive pressures. We have begun the budgeting process for 2018 and we will provide an update and business outlook on the next earnings call.

Thank you again for joining us today. Jay Peterson our CFO will now address the details of our financial performance for Q3 fiscal 2017. Jay?

Jay Peterson

Thank you, Bruce, good morning. I would like to start off by discussing our Q3 financial results and then conclude with revenue guidance for the balance of fiscal year 2017. First off orders and revenues.

Orders for the quarter totaled a robust $84 million versus $73 million in the prior quarter for growth of 15% and marking our second largest bookings quarter ever. This bookings growth was led by EMEA with 111% growth followed by Asia Pac at 60% growth. And as mentioned during our last conference call, we expected our book-to-bill to be positive and we delivered a 1.3 book-to-bill.

Our revenue totaled $64.3 million and that’s a decrease of 14% over the prior year’s quarter. The decline was led by continued contraction in Canada with a revenue reduction of 43% and this was somewhat offset by EMEA with growth of 19%. Our MRO/UE mix for the quarter was 67% of revenues whereas Greenfield totaled 33%.

Greenfield revenues declined by 25% in the quarter whereas MRO/UE declined by 7% due to a double-digit decline in the US specific to the continued to delay in maintenance spending. Our backlog of orders ended December at $105 million versus $81 million at the end of December 2015 and that’s an increase of 30%. Both EMEA and Asia ended the quarter with record backlogs.

As mentioned last quarter, we are experiencing a protraction in the turns in our backlog. Several years back, our backlog would typically turn within 12 months. And at present, construction cycles continue to be protracted and our turns have increased to 18 months or so.

Gross margins, margins improved over the last 90 days by 250 BPS and by 330 BPS over the last 180 days. And this increase was due to the higher mix of MRO/UE revenue versus these previous quarters. Versus the prior year quarter, our margins decreased by 270 basis points with Greenfield margins declining by 8% due to continued competitive pressures in the Greenfield marketplace. Note that MRO/UE margins were essentially flat at 51%.

Core operating expenses for the quarter that is SG&A excluding depreciation and amortization of intangibles totaled $16.9 million versus $17.6 million in the prior year quarter for a decline of 4%. Normalizing for the lumpy incentive accruals, our operating expense grew by 4% and this incentive expense is specifically related to those geographies that are achieving their financial goals this year.

Also we incurred approximately $500,000 in the quarter due to severance costs as we reduced our workforce to align with current revenue levels. Note that this level of operating expense comprehends the continued investments we are making in new product development for products that will be released later this year.

Over the last two quarters, we have taken actions that will decrease our expenses in fiscal year 2018 by $3 million. These actions include a reduction in headcount, program spending and general corporate expenses.

Lastly, we have taken various actions that will decrease our cost of goods sold by approximately $3.4 million in the next fiscal year. Our operating expense as a percent of revenue was 26%, again ex D&A. The number of full-time employees at the end of December was 939 versus 976 as of calendar December 2015.

Turning to earnings, GAAP EPS for the quarter totaled $0.16 compared to $0.11 in Q2 and $0.08 in Q1. Free cash flow EPS outstripped GAAP for the quarter coming in at $0.27. Relative to the prior year, earnings were down by $0.10 or 38%. Our EBITDA totaled $12.6 million this last quarter, and EBITDA as a percent of revenue was 20%, our best performance of the fiscal year, but below our historical levels.

In terms of our balance sheet, our cash and investments totaled $79 million this past quarter, and in the last 12 months we increased our liquidity by $14 million. Capital expense on a year-to-date basis totaled $5.1 million or 2.5% of revenue and this is inclusive of both sustaining and expansion capital. And on a net debt-to-EBITDA basis, we ended the quarter at 0.1, and we anticipate to be net debt free this fiscal year.

Lastly, guidance for 2017, we are refining our guidance of a 7% revenue decline for this fiscal year and we’ll be providing guidance for fiscal year 2018 during our next earnings call.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Jeff Hammond from KeyBanc Capital Markets.

Jeff Hammond

Hey, good morning guys.

Bruce Thames

Good morning, Jeff.

Jay Peterson

Good morning.

Jeff Hammond

So, can you just give a little more detail on what kind of projects are falling into these EMEA and Asia that’s driving the strength in the orders? And then just maybe speak about the quoting activity that would suggest that either that the strength continues or doesn’t continues?

Bruce Thames

Yes, so, this is Bruce. Looking at the order growth, I noted a lot of our order growth has really been in power and downstream refining. If we look at EMEA and Asia Pacific, a lot of that growth has been in downstream refining, particularly in the Middle East and Europe and in Eurasia. And then Asia Pacific, a lot of that has also been in downstream activity although we have won a very substantial upstream project that – out of Asia that will be executed there, but will be destined for the Caspian. So, that kind of gives you an overview of the type of projects we are winning there in the eastern hemisphere. Looking forward, our quote activity remains active and has been consistent to say, I don’t know we’ll continue to book at these levels, but certainly we are seeing a sustained level of quote activity going forward.

Jeff Hammond

Okay, that’s very helpful. And then, I think you mentioned, kind of into the end of the year, people didn’t spend their CapEx OpEx dollars and you continue to see deferrals of MRO, we are starting to hear, I guess, with the turn in pricing a little bit more optimism, a little bit more discussion about downstream turnarounds normalizing. Just give us your view on what you are – why you don’t think you saw it in the fourth or in the December quarter? And what the tone is as we move into calendar 2017? Thanks.

Bruce Thames

The general feeling is that, customers, most of them have a calendar fiscal year, so most of them held on to those capital dollars at year-end for cash flow reasons. Typically, we would see the opposite. You would see a flurry of spending trying to get projects completed and buying of materials right at year end and that really just did not materialized this year.

So, looking forward, we’d like to see at some point, we have seen at least two years of deferred MRO spending. We’d like to see that recover. I guess, the good news that we’ve seen is our margins in our MRO has really remained stable and you can see that business recovers, it’s been very positive to the overall margin profile of the business. And that’s consistent with the history of the company.

Jeff Hammond

Okay, great, thanks guys.

Bruce Thames

Thank you.

Operator

Thank you. And our next question comes from the line of Scott Graham from BMO Capital Markets.

Jay Peterson

Good morning, Scott.

Scott Graham

Hi, good morning. How are you doing? So, I have several questions for you. One of them kind of jumped out when Bruce, you indicated that you are expecting gross margin pressure to continue for the next several quarters. Can you be a little bit more specifically you mean by that, is that a year-over-year thing, is that a sequential thing or are we looking at margins staying 43 and below? Give us an idea.

Bruce Thames

Let me speak to that. So, margins and backlog is really what I am referring to and here is the good news is, margins and backlog has stabilized and we are seeing them at least for the last two quarters, they’ve been down but have not declined further. What we have seen, Scott, is they are down about seven points from, let’s say, levels two years ago.

If you look at that backlog, just by the nature of how we measure backlog, that’s largely Greenfield work. And you can see in our margins, our MRO has actually held up. So that Greenfield is down about seven points understanding that 40% of the mix is around 280 basis points weight on margins compared to, let’s say margins two years ago.

And we actually saw that almost perfectly quarter-over-quarter when we looked at our performance in Q3 of this year versus fiscal 2016. So when we talk about that, that’s what we are seeing margins and backlog largely related to Greenfield.

Scott Graham

Right. I guess, what I wanted maybe tack on to that is, so when you say margins down 200 plus versus two years ago, margins two years ago were 50%, total gross margin. So, are you saying that margins will be in the 45% to 50% range? But I am not - I just checking a little clarity on this?

Bruce Thames

No, and so, yes the margins were 50% and I mean, you know this very well, that had a big – the biggest impact to that was the – particularly we look at two years ago, Q3 of fiscal 2015 was a record year in MRO sales and so that really drove. So the mix drove that less, when I speak of margins, two years ago, I am talking about margins and backlogs and it’s largely Greenfield.

The margins you are talking about comprehensively for the business were more related to mix at that period of time and we had another seven points of margin in our Greenfield project that did sit in backlog. Does that…

Scott Graham

That’s fine. That makes a lot more sense. And Jay, just to bring this full circle, you are expecting gross margin in fiscal 2018 to be up or just the low level of 2017, right?

Jay Peterson

Yes, it’s a little premature to make that statement. We were literally right in the middle of our budgeting cycle. One thing I would like to reiterate is that the gross margin that Bruce has mentioned in our backlog we have seen those gross margin levels since Q1 of fiscal year 2017 and some of that has already burned off into – for example, the revenue we realized this last quarter.

Scott Graham

Got you. That’s no problem. And I do understand you are in the middle of your planning process. So, interest can be limited. Let me also understand a little bit more of a comment that you made, Bruce, you said that given the size of the backlog now, you need more resources and I guess what I am saying, what I am thinking here is that, your MG&A has been running down the last couple quarters, but in fact, not down or at least this quarter, not down as much as sales.

Bruce Thames

Right.

Scott Graham

So, would it be particularly given that, the timing of these things continues to push out, is it not maybe a little bit premature to be adding resources to the business given those two factors?

Bruce Thames

The resources will be driven by timing for our engineering deliverables. So we will make sure that as we do add resources, it will be commensurate with the requirements for deliverables on projects and backlogs.

Scott Graham

That’s great. Thank you for that. And the last question is this, I know you are looking at a $1 billion to $1.5 billion addressable market way back when you initially came to market publicly. What is your addressable market right now? And your desires to increase kind of – just give us the baseline now versus where you expect it to be out several years?

Bruce Thames

So, today, our addressable market is roughly $1.5 billion. Our goal is to – again, grow it three times. So that would be in the $3 billion to $4.5 billion range. We’ve identified three key periods for growth. They are all potentially with our core customer base. So we don’t have a lot of customer risk and they complement the solutions that we bring to the market today.

Scott Graham

That’s great. Thanks a lot.

Bruce Thames

Thank you.

Jay Peterson

Thanks, Scott.

Operator

Thank you. And our next question comes from the line of Bhupender Bohra from Jefferies.

Bhupender Bohra

Hey, good morning guys.

Jay Peterson

Good morning Bhupender.

Bruce Thames

Good morning.

Bhupender Bohra

So, Jay, just a housekeeping question here on the orders. Can you give us the core number on that 14% or 15% number?

Jay Peterson

I am sorry, Bhupender I did not fully hear the question.

Bhupender Bohra

On the orders, can you give us the organic orders number, gross number?

Jay Peterson

Yes, it’s a little hard to do that right now, because we have now melded or in a process of melding specific entities together. Let me see if I can double check the records. I just don’t – it might take a little digging.

Bhupender Bohra

Did it have any FX impact during the quarter? Like, I mean, if you have the dollar numbers for FX, I can do that.

Jay Peterson

Very, very nominal. The revenue impact for Q3 was a little over $500,000 negative, $530,000.

Bhupender Bohra

Okay, got it.

Jay Peterson

So I guessing the order impact is somewhere in that same range.

Bhupender Bohra

Okay, got it. So the other question for Bruce here, overall, you again – your press release again talked about project delays and deferrals of CapEx and the maintenance CapEx. From a geographic standpoint, can you give us a sense like and from the end-market perspective like, where do you see within your backlog, those kind of things are happening, but Canadian oil sands or is that EMEA or Asia Pacific or the US chemical, petrochem? Anymore color on that? Thanks.

Bruce Thames

Yes, year-to-date we’ve really seen a slowdown in the US and it’s, we’ve really seen two things. Revenues have been down year-over-year and we’ve seen more margin compression in the US and a lot of that has to do with the mix of Greenfield work we are doing there and higher labor on it of that work. Canada, as we saw some growth last quarter was actually down substantially.

The good news there is they’ve done a very good job in cost management and so we are seeing – we are still seeing good profitability on that business despite the lower top-line. The US has been probably year-over-year has represented about 75% of the shortfall and we see that in the type of projects we are getting and just a slowdown when I speak to the chemical, petrochemical beginning to slow, we see some of that activity moderating.

Eastern hemisphere has really been the biggest growth and a lot of that is really related, some of its related to independents, but a lot of it is related to state owned entities and some continued spending in investments, particularly in the Middle East, but also in Eurasia and other parts of the Eastern Hemisphere. So, it kind of gives you at least a look at – that the state owned entities are continuing to - just independent of the cycle whereas we haven’t seen the capital spending return in more of the public sector.

Bhupender Bohra

Okay, and within the Canadian oil sands, has things stabilized over there? Like, in terms of I think your commentary mentioned about some activity in the SAGD side of your customers?

Bruce Thames

We are cautiously optimistic there. We have seen some renewed quote activity and some plans with a number of SAGD operators. So that’s certainly positive. We don’t foresee any spending in the large major projects for big mining and upgrading, which can be very large expenditures. We don’t see that in the foreseeable future.

But we have seen a lot of improvements in efficiencies and cost there in the Canadian oil sands, particularly as it relates to SAGD and we think with the rising price of oil and some of the efficiencies gained we will see some investments. The real question is timing, will that happen in fiscal 2018 or will that be beyond, so.

Bhupender Bohra

Okay, and lastly on the pricing, I think over the last few quarters, some of your conference calls you did mentioned that pricing has been weak. Has anything changed or have you seen stability within the pricing environment?

Bruce Thames

We don’t see it eroding further. I guess, that’s the good news. We haven’t seen it really improved. The positive sign here that it’s largely isolated to our Greenfield opportunities and the opportunity here is obviously to grow the installed base and then the MRO margins has held up and by growing that installed base we can capture those recurring revenues. And so we’ve been purposeful in doing that during the cycle.

Bhupender Bohra

Okay, got it. Just one more here. On the backlog, when you look backlog today versus historical, what would you say in terms of size of the project would be? I think you did mentioned that the size of the projects have come down, especially within your opportunity of like $1.1 billion which you see on your dashboard. Can you give us a sense like, the size of the projects have come down, I don’t know, like 25%, 30% like, is there a number?

Bruce Thames

When the Canadian oil sands were growing quite strong, I mean, the projects could be in the 20 plus million dollar range, even greater. We really don’t have one project in backlog that is above $10 million. We did book several projects during the quarter that were in the $5 million to $10 million range. Unfortunately, Bhupender, I don’t have the exact statistics or like the median or average project size. All I can tell you is kind of, what we’ve – more anecdotally, what we’ve seen as far as is bookings.

Bhupender Bohra

Okay, got it. Thank you.

Jay Peterson

Thanks, Bhupender.

Bruce Thames

Thank you.

Operator

Thank you. And our next question comes from the line of Brian Drab from William Blair.

Brian Drab

Hey, Bruce, hey, Jay.

Bruce Thames

Good morning, Brian.

Brian Drab

Hey, good morning. Thanks for taking the questions. So back to gross margin if I could just for a second, and maybe just kind of focusing specifically on the fourth quarter, if you look at what happened in the second quarter and third quarter, the revenue levels about the same, the mix of Greenfield and MRO is about the same and you had this big step-up in gross margin of 250 basis points from second quarter to third quarter.

What can you tell us about the mix and what you are seeing, you are almost half way through the fourth quarter in terms of the direction that gross margin goes in the fourth quarter and then maybe the magnitude of the change?

Bruce Thames

Yes, it’s a little preliminary, but what we are seeing is consistent more so what we have seen in Q3 than in the prior quarters. And – but lot of that is going to be predicated on the mix of MRO/UE.

Brian Drab

Okay. Got it. And then, this was discussed somewhat earlier on the call, but as you look out to fiscal 2018, and you are going to be entering that year it looks like with pretty solid backlog, Bruce you just mentioned some good projects coming in, in the $5 million to $10 million range.

Does that potentially skew the mix more toward Greenfield and potentially put maybe a cap or some pressure on gross margin as you enter 2018 relative to 2017 and I know Jay, you are going to say it’s pretty much sure, but is that – at least a thought that that makes sense?

Jay Peterson

So, yes, Brian let take this one. So, looking forward, I guess, as you know this will all be dependent upon what happens with MRO and maintenance spending. And so, because mix has such a big impact on the margin profile of the business and so, it’s really hard to predict. You know, at some point, we have to see some level of recovery in MRO spend.

Now, we haven’t finalized our plans for fiscal 2018. So, really not prepared to tell you what we anticipate those spending levels to be and how that will impact mix. But we would expect Greenfield margins to continue at the level we have seen in the last two quarters in fiscal 2018 based upon our current backlog and the length of time it we’re seeing it takes to execute these projects.

Brian Drab

Okay. Got it, thanks. And then, can you just may be this is a question for Jay, but talk specifics about the restructuring. I think you said in the past to reduce spending by $6 million or $7 million in fiscal 2018. Where are you again in terms of completing those restructuring actions and is this OpEx level that we saw in the third quarter representative of what we see going forward? Or is it – does it step down in terms of dollars from here as we move forward?

Bruce Thames

Yes, the total we talked about was $6.4 million and roughly half of that was SG&A and half of that was cost of goods sold. Some of that has – actually most of the SG&A has gone through the P&L and the same with the cost, but I think the comment that Bruce made were we are going to manage our spending based on the level of activity is really the prudent point here.

And that, if the business starts growing, there will be additional people required to execute that backlog and we will be able to provide some more comment and guidance on this once we finalize our budgeting plans for this upcoming fiscal year.

Brian Drab

Okay. Got it. And then, the last one and that something I’ve discussed with Sarah quite a bit offline, but can you comment on the recent activity regarding the pipelines, more news about Dakota pipeline today and Keystone and how what the opportunity is? And it sounds like it’s modest if anything on the pipeline itself, but what that does for your business upstream and downstream potentially?

Bruce Thames

Yes, Brian it’s Bruce. So, there are some opportunities on the pipelines and sales particularly around the pump stations and any type of terminals, things like that. But the real opportunity is really on either ends, both in upstream, downstream as that all comes down into the Gulf Coast, the opportunity is around capacity expansions or maybe some shifts in refining capacity to handle the heavier crude and the same would be true in the oil sands and really giving them access to market lowering the breakeven point for their production. They are particularly in Alberta and that will create opportunities for us either – on either end of those pipelines.

Brian Drab

Okay. Thanks very much.

Bruce Thames

Thank you.

Jay Peterson

Thanks, Brian.

Operator

Thank you. And our next question comes from the line of Charlie Brady from SunTrust Robinson Humphrey.

Charlie Brady

Hey, thanks. Good morning guys.

A - Bruce Thames

Morning, Charlie.

Charlie Brady

Just want to go back on the incremental expense or the adding additional resources question, I understand that this is going to be tied to working off the backlog and getting resources in, but, there is generally going to be a lag, and I guess, I am trying to understand the lag time, you’d have to bring people in, engineers in, to in fact effect those orders and the time before you recognize revenue and the profits on it, or is it strictly all kind of percentage of completion would be kind of an immediate offset to that?

Bruce Thames

Yes, it’s kind of a difficult question to pinpoint an answer on Charlie and that some of the engineering expense could precede revenue and we would put that expense on the balance sheet until we incur the revenue. So there wouldn’t be a significant jump in spending followed two quarters later by the revenues.

Charlie Brady

Okay. I guess, that’s the point I was trying to get to is really understand the dynamics of how that worked and it sounds like it’s pretty straightforward. If you look at the $105 million impact, while you talked about the duration of that backlog stretching out versus what it used to be, how much of that $105 million do you think ships over the next 12 months?

Bruce Thames

90% to 95% of it. For example, when we look at how much it’s been protracted, the great majority of the orders have been booked in the last 12 months and let’s say 10% or so preceded that. So, assuming we continue to see the delays that we’ve seen over the last year it will primarily all of it will ship between the next 15 to 18 months. But it’s not skewed to the 18 month mark. I guess, that’s the point I would try to make.

Charlie Brady

Got it. Now that’s what I was trying to understand. That’s very helpful. Just your comment on the revenue guidance, down 7% depending on the timing of orders and we all understand how this stuff looks around.

But I guess, can you give us a sense of the downside risk? I mean, is there – it sounds like there is not a whole lot of really large orders that could really skew it one way or the other right at the end of the year, but I guess, I am trying to understand the potential downside from the 7% if stuffs slips out a few weeks or a month or something like that?

Bruce Thames

It would be relatively small. I mean, a lot of this will depend around revenue recognition terms and the ability to ship partial. So, it would be within $1 million of revenue. We are not talking about $5 million. So it would be within $1 million of revenue.

Charlie Brady

Perfect. Helpful. And then just one more for me, your commentary on the holding back of CapEx at the end of the year which is unusual, have you seen those dollars released at all? Are they still kind of holding on to it? It sounds like they are probably still holding on to it?

Bruce Thames

That’s what we’ve seen thus far. We haven’t seen them being released. We did – if you go back, I am just talking more about the – less about spend, but more around orders. We had such a weak bookings quarter in Q2 of this year.

The good news is we saw them release those order in Q3 and so, but we have not seen the spending that year end spending we suspect that, that we are now in a new fiscal year for most of those customers and we would expect this to be a new capital plan for the year and we will watch what happens to overall capital spending in calendar 2018 and our fiscal 2018.

Charlie Brady

Great. Thanks a lot. That’s all for me.

Bruce Thames

Thank you.

Operator

Thank you and our next question comes from the line of Jon Braatz from Kansas City Capital.

Jon Braatz

Good morning, Bruce, Jay.

Bruce Thames

Good morning, Jon.

Jon Braatz

Have a few questions about your Russian expansion. How big initially are you – is that operation going to be? And should we – two other questions, should we consider the revenue opportunity an incremental opportunity? And then secondly, will there be any significant start-up costs associated with that expansion in the Russia?

Bruce Thames

Yes, Jon, so, we’ve seen significant growth in EMEA this year and a lot of – a significant piece of that is related to not only in the Middle East but Eurasia. Our investments there in Russia, we will start-up this plant in the Moscow region are really to support the customer base in that region. It gives us a lot closer proximity. It gives us local content. It gives us a cost basis in the ruble.

And so, all of those things really position us much better to continue to win and grow our presence in the region. Russia is really a significant producer or probably the second largest producer globally. If you look with roughly 10 million barrels of oil equivalent daily produced there, so, we see a lot of opportunities, cold climate, all of the things that are conducive to being a very heavy heat tracing intensive market.

So, as far as start-up cost, we have incurred some of that is been in the spending, but largely the capital expenditures are up on the balance sheet will be, will flow through once we have completed the plant start-up, we are adding staff now. We have already begun a very small levels of production and are producing some assemblies there. But we will begin full production in – by the end of the first quarter in fiscal 2018.

Jon Braatz

Okay, okay. And secondly, Bruce, there has been a lot of talk about oil and gas opportunities, sort of infrastructure spending in Mexico as they denationalized the industry. And – are the Mexican, assuming money is spent on there, but are there opportunities for you if indeed that unfolds the way some people think it might?

Bruce Thames

Yes, we believe there are opportunities over the mid to long-term right now. We just have to see where all of this goes and how it moves. Right now, I’ll tell you those – the spending in Latin America in the oil and gas sector has been extremely low and, but we are beginning to see some signs, particularly in Mexico of some spending that maybe forthcoming.

Jon Braatz

Okay, okay.

Bruce Thames

Although certainly not at historical levels.

Jon Braatz

Yes, sure. Absolutely. Okay, all right. Thank you.

Bruce Thames

Thank you.

Operator

Thank you. And our next question comes from the line of Martin Malloy from Johnson Rice.

Martin Malloy

Good morning.

Bruce Thames

Good morning, Mart.

Martin Malloy

Just looking at the schedule of number of ethane crackers expected to come online this year through 2019, along the Gulf Coast and derivative petrochemical pipes, are there potential opportunities for orders for those plants out in the front of you? Or have lot of those orders already been placed?

Bruce Thames

A lot of those orders are currently in backlog and we are in the process of executing them. We have three major ethane units that we are currently working on. Some have begun to deliver. Others will be delivered over the next 18 months.

Martin Malloy

Okay. And then, on the maintenance side, it’s been some time that we’ve seen lower maintenance spending here. Can you maybe talk about practically speaking and looking back your – the history as a company, how long can the customers defer spending maintenance or maintain it at a very low level? Is there some point that, just the corrosion of the pipes and valves that they are going to need to catch up?

Bruce Thames

That’s a general belief. So, right now, what we’ve seen is, when there have been issues, customers are doing kind of the minimal required to maintain a sustained operation. So, we do believe at some point that there are safety issues, regulatory issues, those are things that will demand and require that maintenance to occur.

I mean, there is – there have been a lot of deferrals of turnarounds, particularly in the Gulf Coast. You are beginning to see and hear that based upon crack spreads, refined product inventories, things like that, that these end-users are now beginning to plan and execute those turnarounds. So, based upon that, they’ve got to repair rotating equipment, flanges, valves all types of things like that.

Lot of those are then heat traced and so it will create some opportunities for us coming forward or going forward. Again, I’d love to be able to predict exactly when that will occur and to what levels. But conventional wisdom says yes, that spending needs, you will to return at some point.

Martin Malloy

Okay, thank you.

Bruce Thames

Thank you.

Operator

Thank you. And our next question comes from the line of Charlie Brady from SunTrust Robinson Humphrey.

Charlie Brady

Yes, just a quick follow-up, one housekeeping one. Expectations for tax rate in Q4?

Jay Peterson

For tax for Q4, Charlie, we are expecting a little over 24% - 24.2% based on projected revenues.

Charlie Brady

Great, thanks.

Operator

Thank you. And I also show another follow-up from the line of Bhupender Bohra from Jefferies.

Bhupender Bohra

Just a follow-up on the Russian manufacturing here, can you give us the size of the revenue capacity for that manufacturing facility? Like, over time, as you start producing and delivering products or how should we think about that?

Bruce Thames

We would expect the revenue – the production capacity to be, maybe in the $7 million to $10 million range within the first year and then that would grow over time.

Bhupender Bohra

Okay, got it. And the other question, somebody did on the call previously talked about regulation, now we have seen some of the regulation-driven businesses like the power business which you have, any issues or anything you have heard in terms of as we hear more about deferred regulation with EPA and with the Trump administration, kind of doing some sorts of things or changes which could delay regulations. Anything which you think would be of any significant impact to you going forward or no?

Bruce Thames

Yes, I guess, the biggest area around – is around environmental regulations. We see that impact our business in a couple of areas, particularly around the move on cogen facilities and the need to have reduced emissions and monitor those stacks that drives our tubing bundle business and creates really opportunities for those and those facilities we’ve seen that today. The other area is just the tightening of fuel regulations.

There is going to new CAFÉ standards in the US are going to drive a whole round of investment in downstream refining. We are also seeing the tightening regulations in Europe drives the need for lower sulfur, cleaner fuels, a lot of the – if you look at the Middle East, the clean fields project is all-time related to that.

We are seeing a lot of the downstream spending in Russia is tied to that as well. We also see the new standards on marine fuels and moving to a lower sulfur content that’s going to drive a lot of investment and lower – and sulfur recovery units and things like that over the next three to five years. So, environmental probably is the biggest regulatory driver that impacts our business really in many areas.

Bhupender Bohra

Okay, and that would be, could you remind like how much of you revenue would be tied to that kind of…

Bruce Thames

No, unfortunately, I don’t have that number.

Bhupender Bohra

Okay. No problems. Thank you.

Bruce Thames

Thank you.

Operator

Thank you. And that concludes our question and answer session for today. I’d like to turn the conference back over to Thermon for any closing comments.

Bruce Thames

All right. Well, thank you all very much. We appreciate your continued interest in Thermon. Thank you for joining us today.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.

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