Transcat, Inc.

Q2 2024 Earnings Conference Call

10/31/2023

spk00: Greetings. Welcome to TransCal Inc. Second Quarter Fiscal 2024 Financial Results. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to Tom Barbato, CFO. Thank you. You may begin.
spk05: 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 the market closed yesterday. Both the earnings release and the slides that we'll 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 compare GAAP measures in the tables accompanying the earnings release. With that, I'll turn the call over to Lee.
spk01: Okay, thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. TransCat delivered strong performance across our entire business portfolio, again, in the second quarter of fiscal 2024. Consolidated revenue was up 11% to $62.8 million as demand for TransCat services continued to be strong. Consolidated gross margin expanded 230 basis points to 32%. as margins expanded in both our service and distribution segments. Adjusted EBITDA, a key metric for us given our successful acquisition strategy, grew 24% from the prior year to $9.3 million. Operating cash flow in the second quarter was $8.5 million and $16 million year-to-date. Turning to our second quarter service segment performance, Our differentiated suite of services continued to support performance at a very high level. We recorded our 58th straight quarter of year-over-year service revenue growth. Service revenue grew 17%, including double-digit organic service growth of 10%. Recurring revenue streams and a differentiated, defendable value proposition continue to foster durability and resiliency in our service growth model. And we continue to benefit from strong demand throughout multiple regulated service industries that include pharmaceutical, medical device, biomedical, and as well aerospace and defense. Service gross margin was 34% in the second quarter, which represents 140 basis point increase over prior year. Margin expansion was primarily driven by leverage on double digit organic growth increased productivity from automation, and significant process improvements throughout our network of calibration labs. Turning to distribution for the second quarter, gross margins expanded 340 basis points from prior year, driven by growth and an increase in mix of our high-margin rental business. Both core distribution and rentals continue to drive a significant number of leads and opportunities into our service segment, supporting consistent, strong organic growth. The combination of products, rentals, along with calibration and Nexus cost control and optimization services remains unique. We've executed well expanding our addressable markets and our value proposition has never been stronger. Overall strong performance for Transcat in the second quarter of fiscal 2024. The 24% increase in EBITDA is due in part to our ability to achieve our revenue and cost synergy objectives on the companies we acquire. We start by identifying and acquiring companies that are a good strategic fit for TransCap, but those are only the first two steps. Whether we acquire an adjacent company to expand our markets, a geographic footprint addition, or a classic bolt-on to our core calibration services, it is through integration that TransCap drives differentiation. And we're very proud of the work our team has done on this front. You can see it, you can see it in the results, the results of their work as margins and profits increase. And of course, acquisitions will continue to be an important part of our overall growth strategy. In the second quarter, we acquired Axiom Test Equipment Rentals, the largest acquisition in TransCAT's history, and SteriQual, a life science service company specializing in commissioning, qualification, and validation services. Axiom is a great synergistic fit with Transcat's traditional rental business that was launched organically in 2015. Growth synergies between Axiom and Transcat's traditional rental business include go-to-market selling and marketing strategies with complimentary inventories and customer base. We expect the combined rental business to perform well as we capitalize on what we consider a one plus one equals three opportunity. Steriqua expands our adjustable market within the NEXA cost control and optimization space. Steriqua also fortifies NEXA's differentiated single source solutions model, NS3. In addition to the two acquisitions in the second quarter fiscal 2024, perhaps what stands out most is the completion of a public offering of our common stock, which was used to repay our credit facility. The highly successful offering displayed robust demand for Transcat stock among institutional investors who recognize, understand, and value our long-term demonstrated track record of profitable revenue growth, expansion of addressable markets, and sustainable margin improvement. And with that, I'll turn things over to Tom for a more detailed view of our fiscal 2023 second quarter results.
spk05: Thanks, Lee. I'll start on slide four of the earnings deck. posted on our website, which provides detail regarding our revenue on a consolidated basis and by segment for the second quarter of fiscal 2024. Second quarter consolidated revenue of $62.8 million was up 11% versus prior year on service segment strength and slight growth in our distribution business. Looking at it by segment, service segment revenue growth remained very strong at 17%, with 10% of the growth coming organically, and the other 7% from acquisitions. As Lee mentioned, we continue to see high levels of demand in our services business. Turning to distribution, revenue of $21.4 million grew 1% from the prior year. We continue to see growth in the higher margin rental business, which also benefited from the Axiom test equipment acquisition, which closed in mid-second quarter. Turning to slide five, our consolidated gross profit for the first quarter of $20.1 million was up 20% from the prior year, and our gross margin expanded 230 basis points in the second quarter. Service gross margin expanded 140 basis points. The service margin increase further demonstrates our ability to benefit from the inherent leverage in our operating model as well as higher levels of technician productivity supported by continuous improvement initiatives like automation and process streamlining within our networks of labs. Distribution segment gross margin of 28.3 percent was up 340 basis points from the prior year, driven by a larger mix of higher margin rental revenue. Turning to slide six, Q2 net income of half a million dollars decreased from the prior year due to a non-recurring, non-cash charge of $2.8 million for the previously disclosed amended NEXA earn-out. The NEXA earn-out agreement was amended to recognize the expanded scope of the NEXA portfolio, which includes the acquisition of SteriQL And this change is based on current expectations of future business performance. Diluted earnings per share came in at $0.06. The one-time earn-out charge reduced earnings per share by $0.35. We report adjusted diluted earnings per share as well to normalize for the impacts of upfront and ongoing acquisition-related costs. Q2 adjusted diluted earnings per share of $0.60 increased $0.16, or 36 percent, from the prior year. A reconciliation of adjusted diluted earnings per share to diluted earnings per share can be found in the supplemental sections of this presentation. Flipping to slide seven, where we show our adjusted EBITDA and adjusted EBITDA margin, we use adjusted EBITDA, which is non-GAAP, to gauge the performance of our business because we believe it is the best measure of our operating performance and ability to generate cash. As we continue to execute on our acquisition strategy, this metric becomes even more important to highlight. as it does adjust for one-time deal-related transactions costs, as well as the increased level of non-cash expense that will hit our income statement from acquisition purchase accounting. With that in mind, second quarter consolidated adjusted EBITDA of $9.3 million was up 24% from the same quarter in the prior year, and adjusted EBITDA margin expanded 160 basis points. Both segments had adjusted EBITDA growth compared to last 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, operating free cash flow significantly improved up $10 million versus the prior year. We've generated $16 million in operating cash flow in the first half of the fiscal year. Q2 capital expenditures were $600,000 higher than prior year and continued to be centered around service segment capabilities. technology, including automation, and future growth projects. Slide nine highlights our strong balance sheet. At the end of the quarter, we had a total net debt of $52 million, with a leverage ratio of 1.37x, and $32 million available from our credit facility. Subsequent to the end of the quarter, the revolving credit facility was paid off using the funds from the secondary offering, which closed early in the third quarter. Lastly, we expect to file our 10-Q on November 1st. And with that, I'll turn it back to you, Lee.
spk01: Thanks, Tom. Transca has consistently delivered exceptional results throughout the past decade and through various economic cycles. We expect profitable growth and sustainable margin improvement to continue as we increase shareholder value. We expect our successful and unique acquisition strategy to drive synergistic growth opportunities and expand our addressable markets. We expect to leverage continuous process improvement and automation, including robotics, which we're in the very early stages of developing, as key enablers to future margin expansion. In other words, we expect to get bigger and we expect to get better. That's the TransCat way. As we work our way through the third quarter of fiscal 2024, we are still expecting high single-digit to low double-digit organic service growth for the full fiscal year, and we expect gross margin expansion as well. Perhaps most importantly, we expect to develop, recruit, and retain superior management and leadership throughout our organization. It's the people at TransCat that continue to move the needle and push the company to new heights. We expect to continue that as we journey into the future. And with that, operator, please open the line for questions.
spk00: Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For a participant using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Greg Palm with Craig Hallam Capital Group. Please proceed.
spk02: Yeah, thanks. Good morning, everyone. I wanted to start with Service gross margin on an absolute basis was really strong, and I think the improvement on a year-over-year basis was the highest in some time. So I guess it's kind of a continuation of what you've been seeing over the years, but in terms of kind of the greatest positive impacts – You know, where are you seeing that, and should we assume that level of year-over-year improvements for the remainder of the year, or was there something kind of one time in nature that drove some of that strength specifically in the quarter?
spk01: Okay, well, I'll take that call, that question, Greg. You know, it's a combination of things that we alluded to. No surprise that strong organic growth is going to always help our margins. You know, there's inherent leverage in this business model. We've talked about that through the years, and I think volume helps. volume would continue to help. So to the degree that we continue to grow organically at the rates that we have, you'll see margins improve from that. So also automation. You know, we are now probably in our third or fourth year of focusing on automation. We introduced it some years back, and we're picking up some momentum as well. There's no question in our minds as we track the data that that's a contributing factor, and that will also continue to contribute as, you know, we're certainly not at the end of – you know, our opportunities there. And process improvement in general. We've done a lot of work leaning out these labs, working on our processes from, you know, the moment the product comes into our facility to the moment it leaves. And I just think that when we look at these processes and some of the improvements we've made, they're contributing factors. So when you look forward, and most of those things are going to continue, but, you know, I'm always hesitant to guide quarter by quarter on margins because there's different factors. You know, you've got CBLs that can start up and have a short-term drag. There's other factors as well. So yes, margins will continue to improve. We expect that over time and over the next few years, and it will be pretty consistent. I don't want to get into a quarter-by-quarter guidance on that, but much of what you've seen in the past, I think you'll see in the near future.
spk02: Yep. Okay, fair enough. And then if I could just switch gears to distribution and talk a little bit about Axiom and you know, what kind of overlap is there? Maybe you can dive into a little bit of the potential, you know, revenue synergies that could, could play out. And then just in terms of, you know, rentals as a mix of, of total distribution revenue, where does that get you now? And maybe you can just remind us, you know, um, of the margin structure of rental versus equipment sale.
spk01: Well, I'll start off. I'll let Tom talk about, um, Axiom as a percent of, uh, total distribution revenue, but I'll talk to the synergies, Greg. So there's some really great synergies with this deal, and that's why we were excited from the outset. We've got inventories of potential rental equipment on their side of the business that very much will help us with our core customer base, and it goes both ways. Our inventory and their inventory, there's some overlap, but not a lot. And so we expect to sell our respective inventories to each other's customer base, and that's a big one. The way we go to market, Transcat is more driven by, our sales are driven by marketing, robust marketing plans, you know, domain authority on the web, link equities that we have, where people recognize us from a digital world. They do a lot of traditional selling. So again, this is a synergy because we're going to use our marketing expertise to help them grow their business, and they're going to be using their feet on the street, so to speak, salespeople to help us with ours. So two great synergies. And the customer bases themselves are different. And so we like this deal for all those reasons. As far as you want to address, Tom?
spk05: Yeah, so I think, Greg, I mean, if you think of the combined distribution business now, you know, the rentals is, you know, 20 to 25% of the combined distribution now when, you know, we take what we had and add the Axiom business to it.
spk02: And just remind us on the margin structure of rentals versus an equipment sale.
spk05: Yeah, I mean, when we had acquired Axiom, we had kind of disclosed that the margins were 55% or better on the rental business, the combined rental business.
spk02: Okay, great. All right, I will leave it there. Thanks. Best of luck.
spk05: Thanks, Greg.
spk00: Our next question is from Ted Jackson with Northland Securities. Please proceed.
spk03: Thank you very much, and congrats on a very, very solid quarter.
spk05: Okay, thanks, Ted. Thanks, Ted.
spk03: I'm going to go into some weeds. Sorry about that, but I always do. With the transaction closing and the money that you raised, I mean, it clearly wasn't in the current quarter. You're paying off the credit facility. So how much money did actually come in with the deal? I mean, I think it was supposed to be $65 million or so. And then the last quarter, the credit facility was at $42 million, $43 million. So when I look at your balance sheet, as we kind of think about that, how much cash is on your balance sheet? And am I correct? Would I just call it $65 million and subtract out $43 million? I'm going with this, and your debt's down by 43, and then the differentials in cash on your balance sheet?
spk05: Yes, so Ted, it's Tom, right? So the net proceeds were about $75 million, right? Because we did the initial deal at $70 million.
spk03: Oh, yeah, that's right.
spk05: And then another $10.5 million under the green shoe that was done, right? So we netted about $75 million. I'm going to talk round numbers. Fifty of that went to pay off our credit facility loan. And we've got about $25 million net, you know, cash, you know, subsequent to the revolver being paid off. We've got about $4.5 to $5 million of term debt that remains and roughly, you know, 4% interest. You know, so that'll be the only interest expense we have until we kind of tap into that cash balance.
spk03: Okay. That was very helpful. Any chance you can give me just kind of the breakdown in services between service, third party, and freight, at least on a percentage basis, just to let me clean up my model?
spk05: Yeah, it's in the queue, which we'll be filing tomorrow. I don't have that off the top of my head, Ted. I apologize.
spk03: That's OK. Then with regards to going back into the margins, because margins were really were fabulous. I mean, are we when we went, you know, when when I think about, you know, in particular on the distribution side of margins and, you know, the strength you had there, is it just fair to say that, you know, with the new mix in the rental business, that that's kind of the new baseline for, you know, rent for a distribution margin on the go forward basis?
spk05: Yeah, I mean, when we did the acquisition of Axiom, and we said that we expected to go forward, you know, once we got kind of in the steady state, that the distribution margins would be in the 28 to 30 percent range. So, we're kind of already at the low end of that range, and we still feel comfortable with that range for distribution in total.
spk03: And then on OPEX, I mean, you actually had a little better leverage in there than I expected just in terms of, you know, with the different acquisitions and everything that's happened as of late. You know, how should we think about OPEX with regards to, you know, at least, you know, kind of like a step up from Q's second quarter to third quarter and, you know, like kind of how should we think about how that scales out as we go forward?
spk05: Yeah, I mean, I think we should expect, you know, some continued investments. You know, we've talked about, you know, some of the heavy lifting being behind us, but I think, you know, we're, you know, we should expect some moderate increases, you know, going forward. You know, we continue to invest in sales. We continue to make some investments in IT and cybersecurity, which, you know, you just need to do. But, you know, we believe a lot of the heavy lifting is behind us. with the increases that we saw in last year and the year before. Okay.
spk03: And then one last question, and then I'll get out of line. On the customer-based lab front, can you talk a little bit about pipeline and activity on that front?
spk01: Yeah, I'll take that one, Ted. This is Lee. Yeah, the CBL pipeline is pretty solid. In fact, I would say it's very solid, as solid as it's ever been. We expect that to continue. I mean, as long as the labor market's tight, And, you know, I'm not going to suggest we're the only company that services CBLs, but it's certainly we have an expertise level in that that is different than our competition. I think we're really well positioned to do well in that space. So I would expect throughout the remainder of this year and into next that the pipeline we have will support strong growth there.
spk03: Okay. I'll get out of line. Again, congrats on the quarter. Thanks for taking my question. Thank you, Ted.
spk05: Thank you, Ted.
spk00: As a reminder to star one on your telephone keypad if you would like to ask a question. Our next question is from Martin Yang with Oppenheimer and Company. Please proceed. Good morning.
spk04: Thank you for taking my question, Lee and Tom. Can you maybe talk about next, you know, give a sense of, you know, how the business has grown by itself and what are the synergies, especially revenue synergies you have seen between Nexa and your calibration and distribution business thus far? And finally, maybe the outlook for the Nexa combined with SteroCoral, how that overall consulting business can grow in the longer term? Thanks.
spk01: Okay, so we acquired Nexa, it seems like, about two and a half years ago, roughly. So the business has done really well. We acquired at the time a business that... has since doubled in size, more than doubled in size in that period of time. And we think it's performing very well. There's a lot of synergies, Martin, that we've been able to leverage, take advantage of between TransCat and Nexa. Mostly, there's two avenues of synergies that we've performed well. And one is we've given Nexa access to our customer base. And some of that growth, since they've more than doubled, comes from TransCat traditional customers who are interested in in Nexus services. And that's been very clear and evident. That's been a clear and evident synergy for us. The second one has been when Transcat goes to the table and is trying to win a new opportunity, whether it be a CBL or a traditional onsite or a traditional body of work, we have Nexus sitting at the table with us often. And so not only are we talking about winning an opportunity that we currently don't have, that our competition has, or an in-house lab is running, And with Nexa sitting by our side, we're able to strengthen our value proposition. Our chances of winning increase significantly. We've won deals that we would have otherwise not won on the traditional TransCat side because Nexa partnered with us in our proposal. So I think it goes both ways, the synergies, and we've done a really nice job. And I see that continuing and maybe even improving as we go forward and get to know how to work with each other better, get to know each other's companies. This is just the early read, and the early read's been strong. STERAQUAL folds up really nicely under the NEXA suite because NEXA didn't offer commissioning services, and now they can. And they do validation as well, which is something that NEXA did offer, but it advances that value proposition. Working together, we expect growth to obviously be at a higher rate since we have more to offer. And we're not going to guide beyond that at this point other than to say that the outlook you know, with Nexa and SteriCall together is stronger than just Nexa by itself because the suite of services has expanded. And SteriCall is a really nice, small, boutique company. I think we can help them with some of the traditional ways we run and grow a business. It would be beneficial to them, and it's also been beneficial to Nexa. So we expect that trend to continue for those reasons as well.
spk06: Does that answer your question, Martin?
spk04: Yes. Sorry, I was on mute. Thanks, Lee. So one more question from me is on gross margin Axiom. Can you talk about the positive benefit on gross margin due to Axiom's integration last quarter? And then do you expect a meaningful contribution or gross margin update from the full integration of Axiom in fiscal 3Q?
spk05: Yeah. So, Martin, the impact, you know, the impact in this past quarter was was not significant. We only had seven weeks in the quarter, so it did positively impact distribution margins, but we'll see more of a full quarter impact in this upcoming quarter. But our intent is not to really talk about the specifics of margin in distribution and break it down into the individual pieces on a go-forward basis. You know, we expect, as we've said before, that, you know, going forward, we expect distribution margins in total to be in, you know, that 28 to 30% range, and we're already in the low end of that range. So I think you can kind of take it from there.
spk06: Thank you, Tom. That's all for me.
spk00: And our final question is a follow-up question from Ted Jackson with Northland Securities. Please proceed.
spk03: Great. Thanks. Hey, I just wanted to touch base on both automation and kind of what's going on within Ireland, you know, with kind of the acquisitions you had in that front. You brought up automation as one of the drivers for margin. I know it's been an area that you've been focused on and you kind of, you know, You've been kind of slow and methodical with it, so maybe kind of an update on kinds of things that you're automating and kind of where things stand with regards to that effort, and then behind that kind of a progress report with regards to the penetration of the Irish market. Thanks. Thanks.
spk01: Okay, first let's talk about automation and a small subset of that will be robotics. So automation is a very difficult initiative to execute. We knew that going in, but we also knew that once we did it and for each, you know, when we made progress, each element of progress that we make would
spk06: slow going and arduous.
spk01: But the results in the last few quarters, you can just see the margins and we can track it back to the number of technicians that we have, how efficient they are. We have productivity ratings for each technician. How often are they on the bench? How effective are they when they're on the bench? How much automation are they using? How many calibrations are they doing that are redundant to the time they're spent doing an automated cal? These are the type of KPIs we're tracking. So we know it's working and will continue to work. What inning are we in? If I had to characterize it, I used to say we're in the first, second inning. We're probably in the fifth inning of that game that we've progressed from the first, second, third inning to the fifth inning. There's still plenty of work to do. Robotics is a subset of that. The Irish company we bought is a robotics company, and we are now doing mass calibrations, for example. In Philadelphia and our LA labs, we have two robots in each lab. In Ireland, that robotics team, they're now working on digital multimeters. And I think on deck is temperature and pressure after that. So again, not a fast process, but robotics is actually faster than traditional automation. And like I said, we've already got robots running. And so these are things that are going to help us get to that high 30s from the mid 30s and beyond. And that's our ultimate goal. So we're pleased with that progress. The Irish market itself, as far as developing it for the calibration business, we bought that very, very small company. We've got some interesting plans in the works to try to grow that organically. It's really early for us to get into too many details on that, but we intend on growing our calibration business in the Irish market and really kind of exclusively in the Irish market as far as Europe goes. That's where our Cal Lab is. That's where we'll do work, and that's where we'll grow organically. Unlike the NEXA business that's more scalable throughout Europe because it's just easier to go to that business and to follow our customers throughout the European footprint, calibration will be in Ireland. And, you know, it's the early days there, but we intend on growing it organically for sure.
spk06: I hope that's helpful, Ted. It was. Thanks very much.
spk00: There are no more questions in the queue. I would like to turn the conference back over to management for closing comments.
spk01: Okay, well, this is Lee, and thank you all for joining us on the call today. We appreciate your continued interest in TransCat, as always. We'll be participating in the Roth and the Craig Hellam Conferences in New York City on November 15th and November 16th, so feel free to check in on us there. If not, you're always welcome to check in on us at any time. We look forward to talking to everybody. And if we don't hear from you, we'll talk to everybody after we have our third quarter results. Thanks again for participating in today's call.
spk00: Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
Disclaimer

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