Transcat, Inc. (TRNS) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Transcat Third Quarter Fiscal Year 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your hosts, Deborah Pawlowski, Investor Relations for Transcat. Thank you. You may begin.

Thank you, Christine, and good morning, everyone. We certainly appreciate your time today and your interest in Transcat. With me here on the call today we have Transcat’s President and CEO, Lee Rudow and our Chief Financial Officer, Mike Tschiderer. After formal remarks, we will open the call for questions. If you don’t have the news release that crossed the Wire after markets closed yesterday, it can be found on our website at www.transcat.com. The slides that accompany today’s discussion are also on our website. If you would, please refer to slide two. As you are aware we may make some forward-looking statements, during the formal presentation and Q&A portion of this teleconference. Those 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 with documents filed by the Company with Securities and Exchange Commission. 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. Please review our forward-looking statements in conjunction with these precautionary factors. I would like to point out as well during today’s call; we will discuss non-GAAP measures, which we believe will be useful in evaluating our performance. You should not consider the presentation and of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release. So, with that, I’ll turn the call over to Lee to begin. Lee?

Okay. Thank you, Deb. Good morning. Thank you all for joining us. Deb I am going to go a little slower than that. As we stated in our release we’re certainly pleased with our third quarter results. As you can see from the release, we’re making good progress on the road to our longer-term revenue objective of $175 million to $200 million. We're demonstrating the impact of strong execution of our strategy, and we continue to like the long view of both in Transcat’s vision and our position in the market. I’ll start with an overview of some highlights for the quarter and then turn it over to Mike for more in-depth review of the financials before I get back on to talk about some outlook for the rest of the year. The third quarter results were strong for both of our operating segments. And it represented our second consecutive quarter of record consolidated revenue. Consolidated revenue in the third quarter was just shy of $38 million up 25% from the same quarter in fiscal 2016. Higher revenue and gross profit resulted in operating income growth of 40%. Operating margin increased 60 basis points to 6.2% and our adjusted EBITDA margin expanded 150 basis points to double-digit 10.3%. The Service segment achieved it’s 31st consecutive quarter of year-over-year growth. The growth was driven by both solid organic activity along with incremental revenue from our recent acquisitions. We continue to drive both cost and sales synergies from our recent acquisitions, and we expect margins to continue to expand as we continue to go down the integration path. From an organic perspective the combined organization has done a particularly nice job of taking market share in the targeted life science space. We ended the quarter with a strong backlog of what we refer to as work in progress and we believe the fourth quarter is setting up nicely. Moving on to Distribution, the business has performed well over the last two quarters and similar to our Service segment revenue has been driven both by organic as well as acquisition related growth. We've seen an increase in overall activity levels across the board, which includes quotes, leads, traffic to our website, and to our cost centers. From a margin perspective, our Distribution business achieved volume-based rebates, which drove expanded margins along with the incremental revenue from the higher margin rental and used equipment businesses. In the third quarter, we also launched a new Canadian website that immediately generated positive results, we expect that to continue. Turning to acquisitions for a minute. Our interest in finding good acquisitions, remains as high as ever and opportunities are numerous. Of course we continue to be both selective and disciplined in our approach. Our recent deals have enhanced our strategic position and strengthened our value proposition. In addition we've driven diversification through both segments of the business and diversification particularly in Distribution has become a real strength and a true differentiator. And with that I'll turn things over to Mike, to discuss the results and I’ll come back and take a look at the outlook.

Thanks Lee and good morning everyone. I will be going through the results of the third quarter of our fiscal year 2017 that ended on December 24, 2016, when considering the year-over-year comparison, the results of this fiscal year’s third quarter included the acquisitions of Spectrum Technologies and Dispersion Laboratory in January 2016, and Excalibur Engineering in April 2016 which are not included in third quarter fiscal 2016 numbers. Calibration Technologies acquired in June 2015 and Anmar Meteorology acquired in September 2015 are included in both third quarters of fiscals 2017and 2016, but only partially in fiscal 2017 for the nine-month period comparisons. Referring to the posted slide presentation, on Slide 4, our record quarter was driven by significant growth in both our Service and Distribution segments. In fact both were up 25%. Service segment revenue was $17.5 million, which was driven by a combination of high single-digit organic growth and the impact of the acquisitions I just mentioned. On a trailing 12-month basis, which is indicative of the long-term progress of the Service segment, revenue was up nearly 23%. As we discussed we are very encouraged by the progress in the growth of the Distribution segment. As this was the second consecutive quarter of solid year-over-year double-digit improvement in sales. In the quarter, higher core products sales were supported by incremental sales from Excalibur’s rental business and used equipment sales combined with strong orders from our alternative energy sector customers. Moving on to Slide 5, please. Consolidated operating income increased 40% to $2.4 million, while our operating margin expanded 60 basis points. The Service segment gross margin improved 120 basis points from the leverage we achieved by more activities from the organic revenue growth in our cost controls. Service operating margin was slightly impacted by a higher allocation of general and administrative expense to that segment versus the Distribution segment. At the beginning of each fiscal year, we adjust the allocation of G&A expense between our two segments based on the mix of prior year revenue of those segments. For fiscal year 2017, this meant that the service segment received an allocation of approximately $140,000 more in G&A expense per quarter than it did in the prior year. Without the incremental G&A allocation, Services third quarter operating margin would have expanded 50 basis points compared with last year. Distribution margins expanded because of the higher sales activity earned us more volume related vendor rebates and we had a more favorable mix of business with an increase in our high margin rentals and used equipment sales. Gross margin in Distribution was up 100 basis points and operating margin increased 150 points. The reduction in the allocation of G&A expenses to distribution helped the operating margin by 60 basis points for the quarter. On Slide 6, we show adjusted EBITDA and adjusted EBITDA margins. Among other measures, we do use adjusted EBITDA, which is a non-GAAP measure to gauge the performance of our Service and Distribution segments because we believe it is a good measure of operating performance and is used by investors and others to evaluate and compare performance of core operations from period to period. I encourage you to look at the reconciliation of adjusted EBITDA to the closest GAAP measures, operating income and net income that we have provided. Adjusted EBITDA growth was strong for both segments in the quarter. For Service it increased 35% to $2.1 million and as a percentage of segment sales it was 11.8% up 80 basis points. In the Distribution segment adjusted EBITDA was $1.8 million, up 64%. And as a percentage of segment sales it improved 210 basis point to 9.0%. On Slide 7, our strong performance in the quarter led to an increase in third quarter net income of 20% almost $1.3 million. Diluted earnings per share increased $0.03 to $0.18 per share. We now expect our income tax rate to range between 36% and 38% in fiscal 2017. As we will earn less research and development tax credits in the U.S. and Canada based on the type and the amount of software and other development work that we will do this year. Slide 8, provides detail regarding the strength and the flexibility of our balance sheet. Our trailing 12-month ROIC or return on invested capital was 7.7%. We do expect our ROIC to increase as we get the full benefit of operational and sales synergies from our recent acquisitions. As a reminder ROIC is considered non-GAAP calculation. We should not consider this information in isolation or as a substitute for results prepared in accordance with GAAP. Also for us ROIC is calculated as the average trailing 12-month total debt in equity divided by the trailing 12-months net operating income after income taxes. Other companies may calculate ROIC using differing methodologies. CapEx was $4.1 million year to-date and was primarily for assets, for our rental business expansion and expanded service segment capabilities. We continue to expect our capital expenditure range for the year, will be between $5 million and $5.5 million. At the end of the third quarter, we had approximately $26 million in total outstanding borrowings on our credit facility. With $12.9 million in borrowing available to us, our leverage ratio at the end of the third quarter was 1.89. That calculates as our total debt divided by the trailing 12-months adjusted EBITDA. We continue to have sufficient liquidity for our operations. And believe we have ample dry powder for any acquisitions that meet our strategic criteria. With that, I’ll turn it back to Lee.

Okay, thank you Mike. Let’s close with a quick look at fiscal 2017 as we progress through the fourth quarter. Amidst an uncertain, macro environment we continue to be impressed with the team and what we've been able to accomplish. We've seen strong execution of our plan and we expect to finish the quarter and the year with solid results. While we've done a good job managing the growth of the business, I think we can do even better. As we mentioned in our press release Transcat recently added a Vice President of Operational Excellence as we look to accomplish two things. First is to improve processes for the delivery of unmatched of what we’re internally calling epic service to our customers. And secondly to focus on speed and efficiency with the integration of our current and future acquisitions. From a Service revenue perspective, we’ll continue to expect double-digit growth in our Service segment. The growth will continue to be a blend of organic and acquired revenue we expect to continue to be a calibration leader particularly in the life science space. Looking at the outlook for Distribution, we expect to finish fiscal 2017 year strong, the business has been diversified and is performing well. We're seeing positive results and organic growth from a variety of initiatives, which include the higher margin rental business. The Excalibur acquisition has provided the Distribution segment higher margin rental and used equipment sales. And similar to Service we have a solid back log in Distribution. And we expect a strong fourth quarter and strong full year results. So with that I'll turn things back ever to the operator, we can take some questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from line of Bill Nicklin with Circle N Advisors, please proceed with your question.

Hey good morning.

Good morning

Good morning Bill.

Hey Bill.

I think your numbers speak for themselves, so I am going to ask maybe a somewhat of a broader question. How – if we look back to the percentage of your business you had and that’s energy related but what was that may be 5-years ago and what is it today? If you can answer that without looking at a lot of numbers?

So I think Bill, this is Lee and. You know I would say if I look back at energy, generally speaking, I don't have the specifics to dive into numbers. I will say that from an alternative energy perspective what we've seen in the last several years is a pick up on alternative energy both from solar and wind and I think some of that is driven by the production tax credit that you see kind of ebb and flow. We’re in an environment now, where there's been an extension to that agreement. And so you know some of the - both of our segments, both segments of our business are impacted in a positive way when that extension gets done. So that's one thing that comes to mind. I wouldn’t …

Well let me kind of follow on that, for what I've seen in the wind, where there are a lot of areas of offshore at East Coast that have now been approved for wind farms. Though it would appear that – and if a foreign company is actually coming in and funding a lot it, so it appear to me that there shouldn't be any slowdown in that area there could actually be a pickup is that kind of – is that what you are looking at or is that too granular of a view to have an impact on your business.

I would agree with that sentiment and we stay pretty – we've got pretty close relationships with all the major manufacturers particularly on the wind side. And we're looking at that momentum, some plans for production that that should keep the business strong in the foreseeable future.

Adding on to that, used to have power generation at big central plants and then there was Distribution and now we're coming along with wind, solar and what have you, and it appears that there is going to be a significant addition of storage, would the requirements of storage if you've looked at it have some want of a similar effect as the wind and solar, and if you look at the storage it seems to me that you're going to need higher levels of the performance assurance, that are certainly different technology that many different points in the head in the past. So again I hope I am not getting too granular or way often to the woods in place but does that make sense as you look at your business.

So Bill it does, and I would add – my reply is very similar to my former reply and that is that I agree with you. We see the same thing to the degree that regulation drives, the testing at all the points that ultimately would be impacted. That will be good for our business. With and without regulation there's always going to be a play when you're transmitting energy. And we do a lot of work now in that respect, I see that continuing and the real question is will it be incremental as this new technology develops and is stored and I would anticipate that there's going to be some incremental play there. And I will say that if and when that occurs or is occurring we're well positioned to take advantage of it.

And I have one more question if I could.

Sure

There is a lot of discussion these days about import and export, domestic international and as we’ve seen the Company grow over the years it's been pretty much fully domestic. Do you have any numbers on that as a percentage of your business as far as a revenue source.

It's still the same today Bill as it was we’re focused domestically. There is ultimately an indirect input or derivative sort of effect from exports. We follow the manufacturing curve, industrial output is a important part of the numbers and the data we look at as output increases our business benefits. And export, our exports increase certainly the output will benefit from that. So we have a derived output based on exports but not direct and it's hard to figure out, when you sell to a Boeing or a Caterpillar or any major manufacturer it's hard to determine whether the end result of that is going to be exported or not. So I don't have good data around it other than to say that it does impact us but we’ve been doing and selling domestically like we always have and that hasn't changed much.

And Bill this is Mike and I'll just add one thing as it relates specifically to distribution. As part of our diversification we have this year especially and even last year had reduced the number of resellers that we actually sold to who would sell more to the international markets than we would directly. So the mix of reseller versus end-users has changed dramatically to more of the end-users, to any impact of terrorists or any problems with exports leaving here. We've kind of couched that already by the mix of end users that’s going through reseller channel customers.

How about the sourcing that go through your Distribution system, can you see any impact on that. I would imagine that a good chunk of the instruments that your are filling probably have been manufactured outside of the country.

There is, there is and we continue to watch that with our supply chain folks. There's still quite a bit that is U.S. manufactured because customers need it to be manufactured especially in regulated industries. But there has been an – unexpectedly move some factories to China and other countries. So love to continue to watch that to see what they're going to do, if they're going to change where the sourcing comes from.

Al right I appreciate it. That is it from me that very much.

Thanks Bill.

Thanks Bill.

Our next question comes from the line of Dean Trudeau a Private Investor. Please proceed with your question.

Hey guys nice quarter and congratulations on executing your strategy over the years. It's good to see. My question relates to the used and rental equipment. I'm just trying to get a sense of the materiality on the Distribution side. Are you able to provide any numbers or any context to that?

At this point we haven't provided detail information and I will say that from a revenue perspective it hasn't moved the needle all that much because I think the segment is in the $70 million range and we could, we're talking of something 10% or under in terms of volume and revenue. However what's interesting about this business and what's attractive about this business is the margins are significantly larger. And so, even though it might not move the on the top end in the short-run, we have felt the impact in margins and on the earnings volume. So that’s about what we're able to provide at this point we’ll add more color as the business develops

Yeah it is growing. We certainly compare it to any SEC requirements on segment reporting. It doesn't meet any of the criteria both for qualitative or quantitative but we'll continue to evaluate it as it grows both those segments.

Okay, that's great, that's all the questions I have. Thanks guys.

Thanks Dean.

Thank you. We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Okay, this is Lee thank you all for joining us on the call today as always we appreciate your interest and support. As Transcat grows and continues to demonstrate our operating leverage in the business, we're seeing more and more interest in the Company and that's a good thing. As a result we're looking to meet with more investors, were scheduled to be at the ROTH Conference March 13 to the 15. And at the Sidoti Spring Conference on March 29. Once we have our reported results for fiscal 2017, we plan on participating as well in the IDEAS Conference, which is in Boston on May 17 through the 18. So we welcome the opportunity to meet anyone. Please feel free to get in touch with us if you'd like to have a an one-on-one. And again thanks for participating on the call today. We appreciate it.

Ladies and gentlemen this does conclude today teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.