TRNS - NASDAQ

Greetings, and welcome to Transcat, Inc. First Quarter 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Barbato at Transcat, Inc. Please go ahead, sir.

Thank you, operator, 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 will begin the call with some prepared remarks, and then we'll open up the call for questions. Our earnings release crossed the wire after market closed yesterday and can be found on our website, transcat.com in the Investor Relations section along with the earnings presentation slides that we will be referencing this morning. If you would please refer to Slide number 2. As you are aware, we 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.

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. Yesterday, we announced strong first quarter financial results, reporting significant year-over-year gains in revenue, margin and earnings across our entire business platform. We also announced exciting organizational changes that better position the company to execute our day-to-day operating objectives and at the same time, achieve our strategic long-term growth vision. I'll talk to both our results and our organizational changes. But first, I'll start with our first quarter year-over-year financial highlights. Consolidated revenue was up 14% to $54.7 million as demand for our products and services remain strong. Consolidated gross margin expanded 100 basis points to 29.3% and was driven by margin expansion in both our Service and Distribution segments. Service revenue grew 23%. Organic service revenue grew 9%. Service gross margin increased 20 basis points to 32%. Adjusted EBITDA, which is a very important metric for Transcat given our level of acquisitive growth, grew 20% to $7.3 million. The 23% growth in our Service business represented the 53rd straight quarter of year-over-year growth. Demand for our services continues to be strong, and we continue to capture market share from third-party service providers, OEMs and in-house calibration labs. The NEXA acquisition is proving to be a significant differentiator and a great addition to our unique value proposition that is resonating very well throughout our target markets. The NEXA platform enables Transcat to cross-sell what we are now calling single-source solutions. Examples include computerized maintenance management systems to optimize calibration asset and data flow, reliability, validation and various compliance services that are critical to the calibration ecosystem. We believe the single-source solution platform that I'm referring to creates a competitive edge for Transcat as we execute our service growth strategy. On the service gross margin front, margin gains were primarily a function of organic volume growth and strong acquisition performance, offset somewhat by start-up costs at recently won client-based labs. We are also benefiting from the opening of our new technician training center in Houston this past November. The concept of establishing our own training school has been in the works for years. The hard-working and dedicated technical leadership team brought this important differentiator to fruition. Moving on to Distribution. Revenue grew 3% to $20.8 million despite extended vendor lead times and supply chain shortages that delayed the conversion of open customer orders. Demand, however, continues to be strong as back orders were up 17% from the beginning of the quarter. Year-over-year, distribution margin increased 150 basis points or 25%. The margin expansion was primarily driven by a favorable mix and the continued growth of our rental business, which is within the distribution platform. Overall, we're pretty pleased with the fiscal 2023 first quarter results. The strong performance is a great way to start our new fiscal year. Turning to acquisitions. In the first quarter, we closed the Cincinnati-based Alliance Calibration acquisition, which we anticipate will be a great bolt-on to our Dayton operation. Integration is underway and we expect the acquired team, which is very talented, to work closely with Transcat to drive the anticipated synergies and capture market share in this important region. Entering the second quarter, our acquisition pipeline remains robust, and our balance sheet remains strong with a leverage ratio of just over 1.8x. Now let's move on to the organizational changes that we announced in yesterday's press release. There are 2 role changes, both enhance our organizational structure at what we believe is a unique time of opportunity for Transcat. In fiscal 2022, we surpassed $200 million in annual revenue. This is an important milestone, growth milestone for the company. But what is more important is our strong belief that we're just getting started. To that point, Mark Doheny, our current CFO, will be assuming the role of Chief Operating Officer; and Tom Barbato, our current Senior VP of Finance, will be promoted to Chief Financial Officer. This is a great time to appoint Mark in the COO role to oversee the day-to-day operations of the business. Mark is a talented executive with large company experience, and in 2 years with Transcat, he has demonstrated the acumen, instincts and drive that we believe is a perfect operational fit for the anticipated growth of the company. Moving Mark to the COO position will allow me to spend more time with large customers, M&A opportunities, recruiting and developing talent and perhaps more important than anything else, leveraging our unique value proposition, which now includes the next asset management systems across a range of targeted end markets for Transcat. The move with Mark was made possible by our ability to recruit Tom Barbato to the organization a little over 6 months ago. Tom is an experienced public company, operational CFO and has already made significant contributions to our financial leadership team and the entire organization for that matter. His roll up your sleeves and get things done. His "roll up your sleeves and get things done" attitude is a great approach and a perfect fit for Transcat's culture. Congratulations to both guys as we position Transcat to achieve the long-term growth objectives that we've set for ourselves. And with that, I'll turn things over to Mark Doheny for some comments on his new role, and then we'll turn it over to Tom Barbato for a deeper look into our first quarter financial results.

Thanks, Lee. While I have really enjoyed my first 2 years at Transcat in the CFO role, I couldn't be more excited about the opportunity to lead our day-to-day operations across the company. In fact, with Tom on board since January, I've been able to spend more and more time with the various operational teams recently. It really is a talented and dedicated team and one that I would put up against any in the industry. We have been experiencing accelerated organic and acquisitive growth recently. And as Lee mentioned, we believe this is only the beginning. In my new role, I look forward to ensuring this growth continues over the long term, and we do it profitably with focus on needle-moving key initiatives such as automation, process improvement in our network of labs and achieving synergies from our acquired companies. With regard to acquisitions. As we also mentioned, we closed on Cincinnati-based Alliance Calibration at the beginning of June, and it is clear there is excitement on both sides. One relevant item to share is that the prior owner of Alliance told us it is very apparent that Transcat has done this before as the communication and integration activities have gone amazingly well. I mentioned this as it is a testament to the maturity level of Transcat's acquisition and integration program. We identify quality companies to acquire and then we integrate them in a very timely and disciplined fashion, following a playbook that has been developed and refined for years. We also closely track their financial performance versus our original evaluation model assumptions to ensure we are meeting or exceeding sales and earnings projections and overall rates of return approved by our Board of Directors. In fact, for 2 years post acquisition, we update our Board every quarter on not only the acquired company's financial performance but also on synergies achieved as well as how the overall integration is progressing. This is difficult work, but we have some of our most talented individuals leading these efforts, and this gives us confidence that we can continue to successfully execute on our acquisition strategy going forward. With that, I'll turn it over to Tom to go through our first quarter financial results in a little more detail.

Thanks, Mark. I'll start on Slide 4 of the earnings deck posted on our website, which provides detail regarding our revenue on a consolidated basis and by segment for the first quarter. First quarter consolidated revenue of $54.7 million was up 14% as we continue to see strong demand for both our services and products. Looking at it by segment, service revenue growth was very strong at 23% with approximately 9% of the growth organically and the other 14% from acquisition. We continue to see robust demand across our highly regulated end markets. The NEXA business continues to perform very well, and the Tangent acquisition, which closed in fiscal Q4 2022, maintained a strong start. Turning to Distribution. Revenue of $20.8 million was up 3% despite global supply chain conditions remaining very challenged and some vendor lead times continuing to be extended. We continue to see good demand levels, which is reflected in our backlog being up 17% from the end of the prior fiscal quarter to a record high of $9 million. Turning to Slide 5. Our consolidated gross profit for the first quarter of $16 million was up 19% from the prior year, and our gross margin expanded 100 basis points to 29.3%. Q4 service gross margin was 32% and expanded 20 basis points from the prior year. Distribution segment gross margins of 25% were up 140 basis points from prior year and was driven by strength at our high-margin rentals business and a favorable sales mix. Turning to Slide 6. Q1 net income of $3.1 million decreased 16% from prior year, and our diluted earnings per share came in at $0.40. Both net income and earnings per share were negatively impacted by increased acquisition accounting costs as well as higher tax rate compared to the prior year. As a reminder, in the prior fiscal year first quarter, we had a significant impact from a favorable discrete tax benefit due to tax accounting associated with share-based awards and stock option activity, which resulted in negative tax expense for the quarter. In the current fiscal quarter, we saw a similar type of benefit but not to the magnitude of the prior year. The tax rate for the current quarter was approximately 10.9% compared to negative 5.6% in the prior year. The increase in tax rate had an unfavorable impact of $0.08 per diluted earnings per share. We continue to expect the full year fiscal 2023 tax rate to be in the range of 22% to 24%. Acquisitions will continue to be an important part of our go-forward strategy. So with this in mind, in our Q4 2022 earnings call, we introduced an adjusted diluted earnings per share metric, which normalizes for the impact of upfront and ongoing acquisition-related costs. First quarter adjusted diluted earnings per share was $0.54, which represents a 2% decrease compared to Q1 of the prior fiscal year. Keep in mind that the adjusted diluted earnings per share was also still impacted by the $0.08 per share due to the year-over-year decrease in the discrete tax benefit that I spoke to earlier. A reconciliation of our Q1 2023 adjusted diluted earnings per share to diluted earnings per share and net income can be found in the supplemental section of this presentation. Turning to Slide 7, 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 one of the best measures of our operating performance and ability to generate cash. First quarter consolidated adjusted EBITDA of $7.3 million was up 20% from the same quarter in the prior fiscal year. We saw strong growth in both our Service and Distribution segments during the first quarter. 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 8. Cash flow from operations reflects the impact of increased inventory as a result of opportunistic buys we have made to counter the effects of extended lead times and price increases. Capital expenditures were $2.4 million in the quarter and continued to be centered around Service segment capabilities, including automation, rental pool assets and investments to support future growth. Turning to Slide 9 and the balance sheet. At the end -- at quarter end, we had a total net debt of $51.3 million with a leverage ratio of 1.83x. We had $36.3 million available from our credit facility at the end of the quarter. And as previously announced, we acquired Alliance Calibration for $4.7 million at the beginning of June, which was largely funded from the revolving credit facility. Lastly, we expect to file our 10-Q on or around August 8. With that, I'll turn it back to Lee.

Okay. Thank you, Tom. As I alluded to earlier, we're well positioned for profitable growth, and we believe our value proposition has never been stronger. Of course, driving execution will be the key. While there's a bit of uncertainty in the current economic climate, the Transcat business model is positioned to perform well. Our service revenue is anchored by recurring revenue streams in highly regulated markets, and we maintain a demonstrated track record of sustained growth through various economic cycles. We are confident and expect this will continue. Strong organic growth remains at the heart of our strategy. We expect organic growth to be in the high single-digit range for the balance of fiscal 2023 year. We will continue to identify and pursue acquisition opportunities that expand our addressable markets, geographical footprint and capabilities. Acquisitions remain an important part -- an important component of our growth strategy and increase the trajectory of our business. We have a strong balance sheet to support the conversion of our active M&A pipeline. And we will continue to drive continuous process improvement and automation to generate sustainable service margin improvements into the future. And with that, operator, we can open the line for questions.

[Operator Instructions] We have a first question from the line of Greg Palm with Craig-Hallum Capital Group.

Yes. Congrats to both Mark and Tom, and congrats on the good quarter here. Lee, I'm curious, just what are some of the near-term priorities given this change. You laid out some of that, but in terms of the day to day, but I wanted to give you the chance to into some of this a little bit deeper, if you can.

Well, Greg, I specifically mentioned the words unique time of opportunity for Transcat. And I think that is absolutely the case. And so when I think about that and what it means in reference to your question, I think the M&A pipeline is active, and there's a -- with NEXA on board, our value proposition as strong as it is, I would just think we have to execute super well. We've done well in the past, and it's really an opportunity to kind of take it to the next level. And having Mark take on the COO role and -- it's definitely going to give me the time and opportunity to get out to the field and to make sure that what makes us unique is understood by every employee that we have, every salesperson is conveying our value prop, every customer that needs to hear it. And so, well, I'm kind of looking forward to that. It's more of my roots by nature. I like getting out into the field, and this is really just the best opportunity to do that from a time perspective. So that's really what it's all about.

Okay. Makes sense. In terms of the Service margins, if I heard you right -- well, I guess, even before that, maybe update us on CBLs. But I think if I heard you right, it sounded like there were some start-up costs associated with the opening of a CBL or multiple. I guess I missed exactly what it was, but maybe go into that a little bit deeper. And then can you quantify what that impact was specifically?

Right. So in the first quarter, coming out of the -- what we'll call an intense COVID period, where things just subsiding a bit, we were able to get back on track with what we would call a more normalized pipeline for client-based labs and actual wins for us. So we had several sizable wins in the first quarter, and we actually just started those jobs midway through the quarter. So if you recall in our past, just in 2019 just before COVID, whenever we have 2 or 3 new CBLs in a quarter or even for that matter in a year, 4, 5 perhaps, there's always a natural drag at the beginning. You got to send a lot of people. The upstarts are kind of complex and take some time. But remember, CBLs, client-based labs have a high lifetime value. They're very sticky, very profitable and they're absolutely part of our growth strategy. But in the short term, whenever you land, let's say, 2 or 3 or 4 in a quarter, you're going to have a short-term drag on margin. It usually takes about a quarter or 2, depending on how large it is or the complexity of each individual client-based lab, but it's a couple of quarters before you kind of get out of that initial phase and into what is a more -- with a more normalized profitability. So we definitely experienced some of that. The impact in the first quarter, I'm not going to put an exact number on it. We've got some general ideas. And it definitely impacted the quarter. Yet, we still were able to increase margin, which is the good news. So we'll benefit down the road from the CBLs from a margin perspective.

Can you say whether those were new or existing customers? And then is it fair to assume, based on your pipeline that you'll likely open up new sites as we progress throughout the year?

I will say with complete clarity that every CBL that's been new was completely new to us, all new logos, which is really good news, because we always have the opportunity to expand our current customer base, and we will do that. But the first quarter wins were all new.

Got it. And more to come throughout the year or not necessarily?

Yes. I mean the pipeline certainly supports that possibility.

We have the next question from the line of Scott Buck with H.C. Wainwright.

Just a little more on the CBLs. Lee, could you tell us how many active CBLs you guys have now? And then, I guess, what is the average revenue of a CBL once it's up and running? And how many more opportunities are out there like this?

So we probably have in the low 20s now in terms of numbers of CBLs. From a size perspective, they can run anywhere from 500,000 on the low end, 400,000, 500,000 to couple of million today in our current platform. And the pipeline for CBL beyond what we've already won in the first quarter is, I would call healthy.

Okay. Appreciate that color. And I saw the -- nice shout-out on the rental business in the release and in the commentary here. Are you seeing folks opt for rentals over purchases based on inflationary pressures on pricing? Or what's driving the strength in rentals?

Yes. Scott, this is Tom Barbato. I think the supply chain issues that we're struggling with, our customers are struggling with as well. And rentals is a good option for them to get the product when they need it to support their activities. So I think that's probably having as much of an impact as anything right now.

Okay. I appreciate that, Tom. And then last one for me. Maybe just a reminder on where your comfort level is around leverage given kind of the M&A conversations that we've heard on the call so far.

So typically, I think our banking covenants call for around 3x. But we've always been comfortable. We've always been a little underlevered, but we've had it up to 2.5, 2.6. And we're kind of comfortable in that range. We'll probably get comfortable at 3, but our more normalized comfort level is around 2.5-ish.

We have the next question from the line of Gerry Sweeney with ROTH Capital.

Just I had a question on organic growth and maybe you could give a little bit more detail or nuance. Obviously, very solid organic growth. I always thought the NEXA acquisition on the asset management side is a differentiator, CBLs makes sense, bringing them in-house. But maybe just describe what's driving some of this growth. It sounds as though you're taking share. Are you hitting just size and scale on a national basis, driving additional clients towards you versus competitors? Just want to understand more what's going on, on that front.

I think the number 1 contributor to organic growth is the strength of our value proposition. And that doesn't happen overnight. I mean we have worked literally a decade on this. It started with our orientation towards life sciences at a time when others weren't doing it, and it was kind of a unique approach to the market. It's understanding the high cost of failure and how to communicate, how we mitigate that and how we add value to that process from a compliance perspective. And then it kind of evolves into formulating our sales team so that they can properly convey those benefits. And so that takes time and that takes years. So when you get to an environment that we're in now, we've got size, we've got scope. All these investments that we've made in terms of assets and people are all out in the market, creating a differentiated service solution. Now we're calling it a single-source solution. And a big part of the single-source solution, Gerry, is NEXA. So we go to the customer that we saw for calibration services, too. And now we offer everything that's adjacent to calibration services in addition. And so we can go to a client that used to spend $1 million, while maybe one of our competitors are in-house and say, "Hey, we can show you how to get your cost down to $800,000, save them 20%." You'll do this discrete step and that discrete step, and this will yield the results that you're looking for. And we can express that, I think, like no other, and we have this value proposition that supports it. That's going to be the driver for strong organic growth. I mean not every single quarter necessarily, but over time, that's a winning value proposition. It's taken us a long time to get there. We had gradual improvements along the way, but that's the driver. It's going to be the value proposition well communicated. And then of course, you have to execute.

Sure. And then just talking about NEXA, is there another "NEXA" out there that could increase your value proposition even more in this scenario that you're thinking about looking at as you continue to go forward?

Great. It's actually a great question. Acquiring NEXA showed us and proved to us that we can do well in expanded adjacent markets to our core calibration. But what it also did and probably even more important is it shows us that this is an area that can be expanded. So the growth on the core calibration business is X and the growth on the NEXA consulting single-source solutions is Y. And so we're trying to get our arms around exactly what the growth potential is. But it is real and it is significant and it is additive and incremental to what we used to do. So we're kind of putting that all together. Remember, it's only been 9, 10 months. It hasn't been a year for NEXA. And their business has doubled. And so that's a good indication for us that we're heading down the right path.

This may sound a little bit off topic, but I think is important to the discussion. But how many discrete customers -- or how many discrete customers do you have? Because I look at that as almost a channel that you can leverage with additional sort of ancillary businesses or services.

On the service side, it's probably in the range of 35,000 to 40,000.

Okay. There's a big channel that you can sort of mine for -- if you bring in additional adjacent services.

There is. Correct. That's how we see it.

Got it. I appreciate it. Congrats on a great quarter.

Thank you, Gerry.

[Operator Instructions] Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the call back to Lee Rudow for closing remarks. Over to you, sir.

Okay. Thank you all for joining us on the call today. We certainly appreciate your continued interest in Transcat. Transcat will be presenting at the up-and-coming Oppenheimer Conference. That's on August 10. Feel free to sign up for a one-on-one with us, the management team or you can just log in to our presentation. Otherwise, we'll check back with everybody after our next quarter results. Take care. Thank you for joining us.