Transcat, Inc.

Greetings and welcome to Transcat Incorporated third quarter fiscal year 2025 financial results. At this time all participants are on 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. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Tom Barbato. Thank you, you may begin.

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 Rudeau, and our Chief Operating Officer, Mike West. We will begin the call with some prepared remarks and then we'll open it up to call for questions. Our earnings release crossed the wire after markets 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 subjects 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.

Thank you, Tom. Good morning, everyone. Thank you for joining us. Fiscal 2025 Third Quarter consolidated revenue was up 2% to $66.8 million. However, organic service revenue declined 4% from prior year Third Quarter. Last quarter, we talked about the Next to Solutions channel and that our expectations were that softness in that channel would continue through the current fiscal year. This continues to be our view, and the team is focused on pipeline development and getting new solution deals across the finish line. What we did not anticipate in the Third Quarter was the December decline in core calibration service demand following in October and November, which was largely in line with expectations. We discovered that the midweek Christmas holiday drove extended manufacturing closures in the back half of the month. Essentially, this affected the incoming calibration service work in two ways. In the front end of December, many of our customers ramped up manufacturing to meet demand up to and through the holiday shutdowns. The intensified production makes it difficult to send in equipment for calibration. The back end of December, extended holiday facility closures and reduced staffing levels contributed to a reduced volume of incoming equipment through the end of the calendar year. So, timing contributed to the December service shortfall. As one would expect, service revenue picked up significantly in January as a result of pent-up demand from December. Stepping away for a moment from the quarterly performance, on December 10th, we acquired Martin calibration. We're very excited to get this deal done as Martin satisfies all of our strategic acquisition requirements. With annual revenues more than $25 million, Martin gives Transcat a strong presence in the Midwest, including Minneapolis, Chicago, and Milwaukee, as well as Tempe, Arizona, and Los Angeles, California. Martin's flagship lab is in Minneapolis, an area rich in medical device and life science. This is a region that relies heavily on quality calibrations and related services and solutions. From a bolt-on perspective, we anticipate the ability to leverage our current operational infrastructure by combining our Arizona and LA labs with the Martin facilities that are in very close proximity. From a capabilities perspective, the two companies are very complementary. Martin brings a higher level of expertise on the mechanical and dimensional side and represents an ideal match with Transcat's advanced capabilities on the temperature, pressure, and electrical side of the business. So in addition to the cost synergies you would expect over time with bolt-on acquisitions, we expect to drive service growth by leveraging the expanded combined capabilities of both Martin and Transcat. The integration process is off to a great start, and we work to maximize the early returns on this exciting coveted opportunity. Turning to distribution, revenue grew 7% in the quarter, in the third quarter. In December, however, due to the extended closure of many of our customers, our rental channel experienced a similar decline in demand as our core calibration services channel. The rental revenue decline in December resulted in a distribution segment mix change that negatively impacted distribution service margins. And before I turn things over to Tom, I want to point out that the Transcat team has consistently delivered excellent results over an extended period. We have a demonstrated track record of driving growth and productivity. Our team is working to overcome the near-term challenges we've encountered in the last couple of quarters, and this primarily pertains to the -over-year softness of the solutions channel. From a traditional calibration services channel perspective, we currently have a very strong pipeline of new high-probability opportunities. And as we close out fiscal 2025, we are prepared for a strong fiscal 2026. So with that, I'll turn things over to Tom for a more detailed look at the third quarter financial results.

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 third quarter of fiscal 2025. Third quarter consolidated revenue of $66.8 million was up 2% from versus prior year, driven by growth and distribution. Looking at it by segment, service revenue grew slightly. .8% organic decline was offset by growth from acquisitions. As Lee mentioned, service revenue was negatively impacted by the unexpected extended December holiday closures at our customer sites, as well as the anticipated -over-year decline in the Transcat Nexa solutions channel. Turning to distribution, revenue of $25.2 million grew 7% driven by strong product sales and rental growth. Turning to slide five, our consolidated gross profit for the second quarter of $19.7 million was down 6% from prior year. Service gross profit declined 8% versus prior year. Continued leverage from higher levels of technician productivity could not offset the headwinds caused by lower organic revenue levels. Distribution segment gross profit of $7.3 million was down 2% as margins were pressured in the third quarter due to mix. Turning to slide six, Q3 net income of $2.4 million was down $1 million versus prior year. Deluted earnings per share came in at $0.25, down $0.13. We report adjusted diluted earnings per share as well to normalize for the impacts of upfront and ongoing acquisition related costs. Q3 adjusted diluted earnings per share was $0.45. 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 best measures 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 transaction costs as well as the increased level of non-cash expenses that will hit our income statement from acquisition purchase accounting. The third quarter consolidated adjusted EBITDA of $7.9 million was down 13% from the same quarter in the prior year. As extended December holiday closures and the expected solutions revenue softness negatively impacted third quarter EBITDA. 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 cash flow and operating free cash flow were both higher year over year. Q3 capital expenditures were $1.4 million higher than prior year and continue to center around service segment capabilities, rental pool assets, technology and future growth projects. The spend was in line with expectations. Slide nine highlights our strong balance sheet. At quarter end we had total net debt of $40.8 million with a leverage ratio of .97x. We had $39.5 million available from our credit facility as previously announced. We acquired modern calibration for $79 million in fiscal Q3. Paid in combination of $69 million in cash and $10 million in company stock. Lastly, we expect to file our Form 10Q on February 5th. With that, I'll turn it back to you, Lee.

Okay, thanks, Tom. As we wind down the fourth quarter, we expect fiscal 2025 organic service revenue to be low to mid single digits once adjusted for the 53rd week in fiscal 2024. Of course, that is below our expectations and as I mentioned earlier, it's driven by the softness, primarily driven by the softness in our solutions channel that negatively impacted our organic growth rates in fiscal 2025. We're certainly looking forward to improve solutions performance in the year ahead. Relative to our core calibration business, we have a strong pipeline and momentum. Both are building as we get ready to embark on fiscal 2026. We believe organic service growth in fiscal 2026 will be more in line with our historical performance. We will continue to focus on the full integration of Martin calibration. Working together, we expect to capitalize on the numerous opportunities we have for both service growth and productivity gains. I shared my vision for the company over the years, which includes strong organic service growth and industry-leading value proposition, inherent service operating leverage, lower cost of goods sold and SG&A over time driven by process improvement, automation and other productivity improving initiatives, strong operating cash flow, and sensible expansion of addressable markets. We still believe in our vision, our goals, and our ability to achieve them. We're excited for the fiscal year ahead. And with that, Rob, you can open the line for questions.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll

for questions. Our first question comes from Greg Palm

with Craig Hallam. Please proceed with your question.

Yeah, good morning. Thanks for taking the questions here. I wanted to start, I guess, with the near-term outlook. So, you know, understand some of the timing around the holidays. You still, and it sounds like things picked up in January, but you still took down the full year guide. So I'm just curious if it was timing, just things slipping from December to January, you know, you wouldn't expect that guide to come down, but it did. So is there sort of more of a deferral? I guess what's kind of the incremental weakness here relative to, you know, what we were talking about three months ago?

So this is Lee. I'll start and maybe Tom can add some color as well. Yeah, so we had the slowness in December. We spoke to many of our customers during and after the slowdown. So we kind of confirmed that that was taking, that took place and impacted the numbers. The business has generally gotten very busy in January, so we made some of that back. You know, just looking at the full year, looking at the solutions impact, continued impact. You know, we're just, you know, we're confident that we'll be in the, you know, the -single-digit range for organic growth, generally speaking. And, you know, there's been, you know, there has been some relative delays and some orders and you know, things with high probability that we expected to close in Q3. Some will close at the back end of Q4, maybe even early into the fiscal year in April, but we just, you know, being conservative in the guidance.

Yep, okay. And can you maybe just give us a little bit more color on the visibility in the pipeline and really tie this back into kind of expectations for next year? Last quarter, I think you were kind of confidently talking about returning to -single-digit organic growth. I think the commentary is a little bit more vague, understandably so, but, you know, just any comments on visibility pipeline, you know, timing around some of the closures, you know, that'd be pretty helpful.

Yeah, right now, our core calibration pipeline is very strong. So it's about as strong as I probably have ever seen it, which is good. There's a couple of big opportunities, you know, for example, where, you know, we've gotten verbal confirmation, yes, you know, we're going to go with Transcat. We're going to proceed according to these terms and this timing. And some of those have been delayed, which has affected, you know, some of our softer guidance, trying to get our arms around exactly when some of these jobs are going to start. There's a variety of reasons why you have delays like this. You know, we can get into some of them if you'd like, but generally speaking, the pipeline is very strong. I think that's the most important point. And for us, it's a matter, you know, they have to come to fruition, of course, and that doesn't always happen. But we feel pretty good about where we stand going into the year, into the timing. And I think when we talk about, we're a little vague for Q4, but when we talk about next year, you know, particularly in the back half, Greg, as some of these things come to fruition, we're feeling pretty good about, you know, the level of activity that we're seeing. So not a lot has changed. And I think when we look at the solutions business improving, you know, throughout next year, and we combine that with, you know, with the pipeline activities, the macros appear to be pretty strong. And there's no reason to believe that we shouldn't get back to more historic, you know, levels in terms of sales.

Got it. Okay. And that was going to be kind of my next question or sort of final on this level of thinking, just making sure that nothing structural has changed, whether it's large numbers or something else. But, you know, historically, we've demonstrated and you've talked about this high single digit, low double digit organic growth profile for the service business. And, you know, understand a couple of hiccups recently. But anything as you look ahead over the next, you know, handful of years, there's nothing that gives you hesitancy and your ability to sort of match those targets?

Absolutely not. I mean, yeah, we have to keep things in perspective. You know, we've had a lot of growth over a very, very long time, quarter after quarter after quarter. Nothing has changed. Still, we have recurring revenue streams. Still the business is driven by regulation. There hasn't been any competition that we've noticed that's been able to that, you know, is taking market share or doing anything differently. We're still in a really good position. And when you just take a little bit of a broader perspective on the sales engine, which from our perspective continues to get better, there's always tweaks that you can make. There's always technology that you can implement to make the sales process and other processes better. You know, we're working on all those things and to have a couple of quarters that, you know, you're in the mid single digit growth as opposed to high or even low double digits. That's to be expected. You can't win every game the same way. But we are a really good team, a really good plan. The fundamentals are the same. And we expect that, you know, over the long term and even the midterm, we expect strong performance from this company. I can't point to anything today that would stop me from believing that. So we expect a good year and the pipeline going into the year supports it. So, you know, we'll see. You never know 100 percent. But but I like the fundamentals. Nothing's changed. And we just got to get over, you know, a couple of quarters of softness. And we for the most part that we have identified, you know, the areas that need to be addressed. So we feel pretty good about the upcoming year.

Thanks, Lee. Yeah,

no problem. Great. Thanks. Thanks, Greg.

Our next question is from Ted Jackson with Northland Securities. Please proceed with your question.

Thanks very much. Good morning. I got a list of questions. Let's start with kind of the next Transcat services and maybe get an update with regards to kind of the actions that you've taken so far and kind of the actions that are left to kind of put that business back where you want it

to be. Yeah. So from a solutions perspective, it's something we're talking a lot about. There's two ways to look at the solutions business. You know, one is as a standalone business that offers, you know, five or six service tracks in the in the ecosystem for calibration. And that business has to be profitable and that business has to grow. That those are our expectations. There's also, Ted, the benefit that you get from the solutions business in terms of organic growth for our calibration services business, because they also sit at the table with us literally and figuratively, you know, when we're trying to win new business. They're a differentiator. Their suite of services make our calibration business in some cases more affordable and, you know, helps our customers accomplish and complete their goals. So we like the business. We just need to have better pipeline development and a different way to sell it. Needed our marketing team involved. We're doing all these things. Unfortunately, the nature of that business is you're just not going to turn it around in a quarter or two. It takes a few quarters. So we think we're doing all the right things. The pipeline is better today. That's a fact that it was when we kind of discovered that we needed to work on it. And I think we'll get it to be an improved business, stable and growth in time. I'm not overly concerned with it. It's still a relatively small business, but we expect that it will be, I'm going to say, back on track next fiscal year and earlier the better.

OK, thanks. Then just kind of shifting over to more to some model questions. You know, like service gross margins, the lowest it was since, you know, third quarter of twenty three. And I know volume was a big impact there, but, you know, we're expecting to see a rebound in the fourth quarter and carry forward into twenty six. Can you give us some kind of view on what you would expect your service margins to be next quarter and how we would think about that for next fiscal year?

Yeah, I think, Ted, you know, as we've as we've talked and kind of gone through, you know, Q4 to be, you know, kind of more in line to be kind of flat year over year and then, you know, continue to grow as we look into, you know, fiscal twenty six and beyond.

And then shifting over to distribution, you did see, you know, I know you said it was a lot, but it was a little bit of recovery from last quarter. How do we think about that? Twenty five and twenty four, twenty five, twenty six. And then can you provide some kind of, you know, I mean, like, did we get the recovery out of Becknell that we expected with regards to some of the rental stuff? Maybe an update on that front. Yeah.

Yeah. So let me let me take that in pieces. Right. So, you know, from a margin standpoint, you know, certainly we've talked in the past about being consistently above 30 percent on the distribution side and in growing from there as the mix towards rentals continues. Right. I think if we, you know, we certainly would have been there if we didn't see the slowdown and in rentals that Lee referenced in the, you know, in the back half of December. And then, you know, as we look ahead, you know, that certainly that that that 30 percent threshold is one that, you know, we're we feel that we should be able to achieve. And then, as I said, as we as we see a better a bigger mix towards towards rentals, you know, we should see some growth from there. But now it was certainly better sequentially, you know, in Q3 versus Q2. And we expect it to be better in Q4 sequentially as than than Q3.

OK. And then. I lost my train of thought. I wanted to hit something else on when your earlier answer on the margin. I'll come back and maybe I'll come into my head. How about just on pro forma earnings? How should we think about, you know, you've just done a pretty large size acquisition. How should we think about, you know, the amortization of intangible assets within your pro forma earnings and also acquisition deal costs for fourth quarter in FY26?

Why don't I follow up with you on that? That I don't I don't have the numbers in front of me right now, but you know, I know when we when we talked about the model after the acquisition, I think we we had done that update, but I could follow up with you via email. Yeah, I'm just double

checking. Then shifting over to working capital. You know, your receivables are up, inventories are down, payables are up. You know, the turns all followed all that kind of stuff. You know, can you give us kind of a view on what's going on with some of those working capital levers? And now you see them playing out for the next two quarters.

Well, I think I think we should see a move kind of consistent with, you know, the growth. Growth and revenue. You know, we've had we've been focused on inventory levels all year, and I think you've seen, you know, the improvements we've made, you know, since the beginning of the year from an inventory standpoint. I mean, accounts receivable part of the growth, right, is just bringing on a business. And as we bring on these bigger businesses, right, we're bringing on the accounts receivable that goes along with that. So you saw that addition, you know, coming from the Martin acquisition in December. But, you know, I think we've we've over time, you know, we've seen those working capital numbers, you know, kind of flex accordingly, you know, based on, you know, the inorganic and organic growth that we've experienced.

OK, that's it for me. Thank you very much.

As a reminder, if you'd like to ask a question, please press star one on your telephone. One moment, please,

while we follow up for questions. Our next question comes from Martin Yang with Oppenheimer. Please proceed

with your question.

Hi, thank you for taking my question. First question on distribution. Would you attribute the witnessing distribution this quarter to the same reason you described for services? And how uniform are those two segments performing based on those seasonal seasonal patterns?

What we refer to Martin in the earnings cost script was the rental business as part of the rental channel, as part of the distribution that was impacted the same way that the calibration services. So that is to say that we saw a decrease in demand throughout the month, particularly in the back half. That's what we're referring to. And, of course, as you have that, as rentals becomes as rentals was lowered in the quarter, that changes the mix, the overall mix to heavy early. It's way heavier towards core distribution, which has lower margins. So it has both an impact on margin, which is significant, but also in volume. So that's what that's the effect that you saw in distribution. And yes, so it was similar to service in the month of December rentals, that is.

And then when we look at overall distribution on a year of year basis, can you tell us about a respective

growth rate for a rental versus non rental? So, you know,

I think Martin, what we've said, what we've kind of said historically, and it's still, you know, kind of plays out here is that, you know, we expect kind of our core distribution, you know, to decline slowly over time. And then, you know, we expect the rental business to grow at a similar rate to service. Right. And what we've seen historically with service, you know, like high single digits, you know, that's the that's kind of the goal. And that's what we've the trajectory we've been on, you know, over the past couple of years.

You got it. My next question is regarding your comment on what happened in December. Is there any other seasonal patterns every quarter or other certain time of year that could give you surprises like the past December?

Not really. You know, there are certain patterns in the business, you know, typically volume for services is higher in our fourth quarter, which is January through March. And typically distribution, core distribution, not rentals, is a little bit stronger in our third quarter. I mean, there are some patterns that seem to repeat Martin year over year. I think what happened this year, again, you know, when you have a holiday on a Wednesday, you never know exactly how people react. It just for whatever reason, which I don't think we saw as much in the past. So maybe it's an anomaly. Maybe it's a pattern. Don't know yet. But but being having a holiday land on a Wednesday, people shut down that week. And then, you know, things extend to 10 days and so on and so forth. So I don't know of, you know, we've been doing this a long time. And typically there aren't patterns like that. I'm not sure this is a pattern or a one off. But either way, it caught us a little bit off guard, you know, in terms of modeling and forecasting. So I guess that's the best way to answer.

Got it. Thank you, Lee. That's it for me. OK, thanks, Martin.

We have reached the end of the question and answer session. I'd now like to turn the call back over to management for closing comments.

OK, this is Lee. And thank you all for joining us on the call today. We appreciate your continued interest in Transcap. We will be attending the Oppenheimer 10th Annual Emerging Growth Conference, which is February 26. So for those of you who are attending a conference, feel free to call on us, check in on us and maybe sign up for a meeting time. Otherwise, you're free to contact us any time after that conference. And we'll be speaking to everybody again after our Q4 results. So thank you. Thanks again for joining us. Take care.

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.