Transcat, Inc. (NASDAQ:TRNS) Q3 2023 Earnings Call Transcript

Transcat, Inc. (NASDAQ:TRNS) Q3 2023 Earnings Call Transcript January 31, 2023

Operator: Greetings, and welcome to the Transcat Third Quarter Fiscal Year 2023 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Tom Barbato, Chief Financial Officer for Transcat. Thank you. You may begin.

Tom Barbato: Thank you, Melissa, and good morning everyone. We appreciate your time and your interest in Transcat. With me here on the call today is our President and CEO, Lee Rudow; and our Chief Operating Officer, Mark Doheny. We’ll begin the call with some prepared remarks and then we will open up the call for questions. Our earnings release crossed the wire after markets closed yesterday. Both the earnings release and the slides that we will reference during our prepared remarks can be found on our website transcat.com in the Investor Relations section. If you would please refer to Slide two, as you are aware, we may make forward-looking statements during the formal presentation and Q&A portion of this teleconference. These statements apply to future events, which are subject to risks and uncertainties, as well as other factors that could cause the actual results to differ materially from where we are today.

These factors are outlined in the news release, as well as in the documents filed by the company with the SEC. You can find those on our website where we regularly post information about the company, as well as on the SEC’s website at sec.gov. We undertake no obligation to publicly update or correct any of the forward-looking statements contained in this call, whether as a result of new information, future events or otherwise, except as required by law. Please review our forward-looking statements in conjunction with these precautionary factors. Additionally, during today’s call we will discuss certain non-GAAP measures which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP.

We’ve provided reconciliations of non-GAAP to compared GAAP measures in the tables accompanying the earnings release. With that, I’ll turn the call over to Lee.

Lee Rudow: Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. Yesterday, Transcat announced excellent financial results for our fiscal third quarter. We experienced broad based strength across our portfolio of services that drove 19% service revenue growth, expanded gross margins and provided strong EBITDA growth of more than 20%. We are particularly pleased with our organic service growth of 12%. Organic growth has now been in the high single digits or better for the last eight quarters, despite COVID related impacts, inflationary pressure and economic uncertainty. This consistent performance demonstrates the resiliency of our business model, which inherently performs well through various economic cycles.

We continue to execute well in the highly regulated life science space, as well as the aerospace and defense markets where the cost of failure is high and the revenue streams are recurring when we meet the rigorous and ongoing needs of our customers. In the third quarter, consolidated revenue increased 13% to $57.4 million. Consolidated gross margin expanded 180 basis points to 28.6% and was driven by margin expansion in both our distribution and service segments. Adjusted EBITDA, a very important metric for us given our level of acquisitive growth, as I just mentioned, grew 20% from the prior year third quarter to $6.6 million. Our service segment continues to perform at a high level and recorded its 55th straight quarter of year-over-year revenue growth.

Expanding our addressable markets has been an instrumental driver of our consistent growth. We continue to make proactive investments to drive differentiation and position Transcat to make meaningful share gains in the regulated markets we serve. A great example of this is the NEXA Enterprise Asset Management. NEXA’s suite of services, which includes asset and data analytics, computerized maintenance management, compliance, quality and validation now positions Transcat in both the U.S. and Ireland to service mission critical global manufacturers. Revenue synergies between NEXA and Transcat continues to be outstanding and reinforces our sustainable longer term competitive advantage. From a margin perspective in the third quarter, we reported service gross margins of 30% which is up 30 basis points from the third quarter of fiscal 2022.

Moving on to our distribution segment, demand remained strong as revenue grew 4% to $21.4 million despite extended vendor lead times driven by high end electronic chip shortages that continue to make it challenging to convert some open customer orders. Distribution gross margin expanded 370 basis points year-over-year to 26.2% as we continue to see growth in our high margin rental business and to benefit from the strategic buys that we executed earlier in the year. Acquisitions are an important part of Transcat’s long term growth strategy and we acquired two companies at the beginning of the third quarter. E2B calibration located in Cleveland, Ohio specializes in calibration services related to the aviation industry. We believe that we can leverage Transcat’s current infrastructure and significant geographic footprint to further accelerate the growth in E2B’s capabilities across North America.

Photo by Ries Bosch on Unsplash

In addition, we are nicely positioned to capitalize on the life science market in the Greater Cleveland area. In the first quarter, since the acquisition, performance and integration activities have gone very well and we expect this to continue. Complete Calibrations established our first calibration footprint in Ireland. Complete Calibrations is a small but strategic acquisition for Transcat. The acquisition establishes a local presence in Ireland, a country with a robust life science market. Secondly, Complete Calibration offers Transcat foray into calibration robotics, that we believe over the longer term will be another differentiator for Transcat. All in all, our third quarter — our third quarter results were strong across our portfolio of businesses and channels.

Our balance sheet remains strong and supportive of our acquisition strategy with a leverage ratio of 1.66 times. In the third quarter year-to-date, we generated $6.8 million of free cash flow. And with that, I’ll turn things over to Tom Barbato for a deeper look into the third quarter financial performance. Tom?

Tom Barbato: Thanks, Lee. I’ll start on Slide four of the earnings deck, which provides detail regarding our revenue on a consolidated basis and by segment for the third quarter. Consolidated revenue of $57.4 million was up 12% versus the prior year, driven primarily by strength in our services segment. Service segment revenue growth remained very strong at 19% with 12% of the growth coming organically and the other roughly 7% from acquisition. Turning to distribution, revenue of $21.4 million was up 3.7% versus the prior year. We continue to see strong demand for our products, which is reflected in our open order backlog of $9.5 million, which is up 7% versus the third quarter of the prior year. Turning to Slide five. Our consolidated gross profit of $16.4 million was up 20% from the prior year and our gross margin expanded 180 basis points to 28.6%.

Service gross margin improved 30 basis points from the prior year. Distribution segment gross margin of 26.2% was up 370 basis points from the prior year and continued strength in our rental business and a favorable sales mix. Turning to Slide six, Q3 net income of $1.6 million was flat to prior year and our diluted earnings per share of $0.21 and adjusted diluted earnings per share of $0.35 were also essentially flat. When comparing diluted earnings per share and adjusted diluted earnings per share to the third quarter of the prior year, it is important to note that increased interest expense negatively impacted both EPS metrics by approximately $0.05 per share. We expect our full year fiscal 2023 tax rate to be in the range of 21% to 23%.

Flipping to Slide seven, where we show our adjusted EBITDA and adjusted EBITDA margin, we use adjusted EBITDA, which is a non GAAP measure to gauge the performance of our segments because, we believe it is the best measure of our operating performance and ability to generate cash. Additionally, as we continue to execute in our acquisition strategy, this metric becomes even more important to highlight as it does adjust for onetime deal related transaction costs, as well as the increased level of noncash expenses that will hit our income statement from acquisition purchase accounting. With that in mind, consolidated adjusted EBITDA of $6.6 million was up 20% from the prior year. As always, a reconciliation of adjusted EBITDA to operating income and net income can be found in the supplemental section of this presentation.

Moving to Slide eight. Cash flow from operations was in line with expectations for the quarter. Year to date capital expenditures through the end of the third quarter were $7.1 million compared to $5.9 million year to date in the prior year. And continued to be centered around service segment capabilities and technology, including automation and future growth projects. Slide nine highlights our strong balance sheet. At quarter end, we had total debt of $49.2 million with a leverage ratio of 1.66 times. We had $37.8 million available from our revolving credit facility. Lastly, we expect to file our 10-Q after the market closes tomorrow. With that, I’ll turn it back to you Lee.

Lee Rudow: Thank you, Tom. Turning to the fourth quarter and the fiscal 2024 year ahead, we are well positioned for continued revenue and margin growth. We also expect the strength of our value proposition to increase as we further develop our recently expanded addressable markets. In fiscal 2023, we continued to make great progress in that respect as both NEXA and our Pipettes business have performed very well. Serving highly regulated end markets with our unique differentiated value proposition makes our business model inherently durable and we expect demand for our services to remain strong despite the economic uncertainty that lies ahead. In fact differentiation is the key to our strategy. Along with strong execution, differentiation will secure our competitive advantage and foster our ability to gain market share in the industries we serve.

Strong organic growth remains at the heart of our strategy and in the year ahead we expect growth to remain in the high single digit range. We continue to identify and pursue strategic acquisition opportunities that will expand our addressable markets and geographic footprint, as well as leverage our current infrastructure with bolt-on opportunities. Ultimately, all these drivers are designed to increase the trajectory of our business. Our balance sheet remains strong and is supportive of our very active M&A pipeline. We’ll continue to leverage continuous process improvement, automation, and now robotics with the addition of Complete Calibration in Ireland to generate sustainable margin improvement in the future. We believe Transcat’s future looks bright and that we will continue to outperform in the years ahead.

And with that, operator, we can open the line for questions.

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Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and answer session. Our first question comes from the line of Greg Palm with Craig-Hallum Capital Group. Please proceed with your question.

Greg Palm: Hey, good morning, everyone. Thanks for taking the questions here.

Lee Rudow: Good morning, Greg.

Mark Doheny: Hey, Greg.

Greg Palm: I wanted to start with service growth. You saw a nice acceleration, they were up 12% on an organic basis and I’m curious if you can maybe pinpoint, I don’t know, areas of outperformance relative to prior quarters, whether that’s end market standpoint, maybe its increased synergy contribution from NEXA and other that’s lapped a year plus. Just want to get some broader thoughts on that?

Lee Rudow: Hey, Greg. Basically it’s a combination of all those things and probably some others as well. We did lap the year with NEXA. So their growth, which has been impressive is kind of towards our organic numbers, but across our channels and our businesses, really the company as we as we said in our stated remarks, performed well across the board. So that was encouraging. We saw strong retention, we saw growth in different businesses, including NEXA. So really kind of broad based strength in the quarter.

Greg Palm: Okay, good. I didn’t hear much in the way of CBLs, and I’m wondering if you can give us an update there on pipeline. What some of the recent activity. And I’m also curious if there’s any way you can quantify the gross margin headwind associated with that just for us to compare that on a year-over-year basis?

Lee Rudow: Yes, I would say that, when we look at our growth, CBLs has for many years saved the COVID years, it’s been a contributing factor. We did land some CBLs in the beginning of the year that were new, that were incremental coming out of COVID, which is good to see. And we anticipate it will always be a part, a factor in our growth. But nothing out of as the usual no high percentage of concentration of our growth would attribute to CBLs. As far as the CBLs, the two or three that we has sort of mentioned and guided towards in the beginning of the year, they take a couple of quarters to normalize and during that period of time when you land several in one quarter, there’s a bit of a drag and that drag did exist and we’re probably — we’ll probably see ourselves coming out of that a little bit more in the fourth quarter and as we enter the first quarter.

So that’s normal. We’re not going to guide towards exactly what the number of associated sort of basis points would be, but it’s a typical two to three quarter drag and you should see us starting to come out of the ones at least that we landed in the first quarter as we close out the year. Yes. So I appreciate the question.

Greg Palm: Okay. It makes sense. And then I guess just last one, distribution margin was strong. It sounded like some or most of that is attributable to rental, maybe mix as well. But can you give us an update on where rental is from a contribution standpoint grow, just be curious to get a little bit more detail on the strength there?

Tom Barbato: Yes. I would just say, Greg, I would characterize it as rentals and the impact of the strategic buys that Lee referenced kind of probably contributed fairly equally to the performance in the quarter. As I mentioned on the last call, those strategic buys are going to kind of dry up on us at some point here in the — as we approach the end of the year and into early fiscal 2024, but we expect that the growth in rental business will continue to offset those impacts. So I view the margin in the quarter is kind of on a robust side and we would see that normalize a little bit going forward.