Greetings and welcome to the Transcat, Inc. Second Quarter Fiscal Year 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operation Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Craig Mychajluk, Investor Relations.

Yes, thank you, and good morning, everyone. We certainly appreciate your time today and your interest in Transcat. With me here on the call, we have Transcat's President and CEO, Lee Rudow; and our CFO, Mike Tschiderer. After formal remarks, we'll open up 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 Web site, www.transcat.com. The slides that accompany today's discussion are also our Web site. If you would, please refer to Slide 2. 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 the Securities and Exchange Commission. You can find those on my Web site, where we regularly post information about the Company, as well as on the SEC's Web site 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. I would like to point out as well that during today's call, we'll 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 comparable GAAP measures in the tables accompanying the earnings release. So with that, let me turn the call over to Lee to begin the discussion. Lee?

Thank you, Craig. Good morning, everyone. Thank you for joining us today on the call. We'll follow the same format as we have in the past. I'll review some of the highlights for the quarter, Mike will provide a more in depth review of the financials, and I'll come back to wrap things up with an outlook for the back-half of the fiscal year and beyond. Second quarter results were strong across the board as both operating segments performed very well. Consolidated gross margin was up 80 basis points, to 23.5%, operating income increased 49% to $2.2 million, while operating margin was up 150 basis points to 5.6%. The increased profitability in both segments worked its way to our net income, which nearly doubled to $1.5 million. We generated strong cash flow from year-to-date operations of $4.9 million. Consistent with our plan, we expect to allocate the cash to foster organic and acquired service growth and longer-term technology investments to drive productivity gains. Looking specifically at Service, organic Service revenue growth was 7.6%. We're particularly pleased with the organic service growth in the U.S., which came in at a little over 9%. These numbers exclude the Angel's acquisition, which we acquired on August 31, 2018. While not included in our 9% organic growth in the U.S. Service, Angel's September results are included in our reported numbers. We have now achieved 38 consecutive quarters of year-over-year service growth. That's every quarter for nine-and-a-half years. We continue to take market share from the competition as well as in-house labs and OEMs. This is particularly true in the life science space, which is consistent with our growth trends over the past few years. The Service segment demonstrated operating leverage as segment operating income grew 42%, and operating margin improved 140 basis points. We…

Well, thanks, Lee, and good morning everyone. I'll start on slide five of the deck, where we provide some detail for our revenue for the second quarter of fiscal year 2019. That quarter ended on September 29, 2018. Our full fiscal year 2019 ends on March 30th of 2019. Consolidated revenue for the quarter was $38.9 million, up 8.2%. As Lee mentioned, we completed the Angel's Instrumentation acquisition effective after business close on August 31st. So our reported results include one month of the Angel's acquisition. Excluding the acquired September revenue of approximately $300,000, our consolidated organic revenue grew 7.4%. We had Service segment revenue growth of 9.1% to $19.9 million, which was driven by strong organic growth of 7.6% when excluding Angel's revenue. This organic growth rate was in line with our expected range of mid-to-high single digits, and we continue to expect to achieve our organic revenue growth goals for the full fiscal year of 2019. We're also pleased to see the gross margin expansion in Service too. In our Distribution segment, revenue increased 7.3% to $19 million. The increase reflects higher demand from core industrial customers, and includes rental revenue growth of 15% to $1 million or rental revenue for the quarter. In addition to providing an attractive margin profile, we believe rentals continue to differentiate us in the marketplace. Consolidated gross margin expanded 80 basis points. Total operating expenses were up $300,000 to $7 million, which reflected our continued investment in operating infrastructure and operational excellence initiatives. And expressed as a percentage of revenue, operating costs were down 70 basis points to 17.9%. As a result, as shown on slide six, operating income increased 49%, and operating margin expanded 150 basis points to 5.6%. You may recall there, fiscal 2018 second quarter gross and operating margins…

Okay. Thank you, Mike. I'll close by reviewing our three key strategic goals as we continue to build Transcat for the long-term. Number one, driving operational excellence and leveraging technology as a competitive advantage. Operational excellence remains at the forefront of everything we do as we fortify our infrastructure with technology, people and improved processes and systems. We continue to make progress towards longer term opportunities related to driving productivity, automation and ultimately higher margins in our service labs and throughout the organization. Number two, generating double-digit service growth through a blend of organic and acquired activity; and number three, leveraging the combined operation of our distribution and Service segments to provide a significant competitive advantage in the market. The combined operation is a differentiator that continues to strengthen our value proposition and make Transcat unique. All-in-all, we're energized by our vision and our plan as Transcat remains well-positioned to do great things in our industry. Operator, with that, we can open the line for questions.

At this time we will be conducting a question-and-answer session. [Operator Instructions] One moment please, while we hold for questions. Our first question comes from Matt Koranda, ROTH Capital Partners. Please proceed with your question.

Good morning.

Hey, morning, Matt.

Just wanted to start out with the service growth outlook in Lee's commentary and I think in the release it says that your goal is to drive double-digits Service segment revenue growth, which I think is a little higher than the usual commentary of high single-digits. So is that factoring in acquisitions or are you guys indicating any fundamental change in the organic growth outlook for this Service segment?

So when we made that statement, Matt, we were referring to the combined growth of organic and acquired. So we stick to the mid to high single-digits that remains the same, but we'll layer in acquisition activity in most recently Angel's. So yes, we typically talk about double-digit growth, it includes both.

Okay, perfect. And then in terms of Angel's, I think if you back into it, it contributed something like $300,000 in about a month. Is it safe to sort of drag that out times 12 to get to a rough annual contribution or is there any seasonality or things we need to take into account for modeling that on a go-forward basis?

Yes, Matt, you may remember when we announced the deal we said that they had annual revenue of about $4 million. So the $300,000 approximate for the month of September, a little bit of seasonality in there, so we still kind of expect it to be at that $4 million run rate.

Okay. And then margin contribution is - I would assume it's relatively similar to the Service segment, but anything to call out there in terms of the way we should think about that?

No, I guess, their margins probably would be a little bit higher than what we might report, but when you combine it with us - I focus more on kind of the bottom lines and maybe in EBITDA between what we paid, what the annual revenues are. It was within the range of what we disclosed that we buy companies for which is a 4x to 6x multiple kind of imply what the EBITDA would be and kind fill it in from there with some typical margin assumptions.

Okay. That's helpful. On the purchase agreement holdback, I just want to get a sense. What are the catalysts to, I guess, to get the holdbacks removed and over what timeframe is the additional million going to be paid out?

Sure. There's three different pieces Matt. One, and one is the $470,000 indemnification holdback, kind of typical breaches of reps and warranties and that one would be paid out within 30 days after the anniversary of the closing. The remainder - there's two separate ones. There was two kind of significant contracts that were coming up for renewal in October and they kind of had some different revenue profiles. So we'll be paying those out as the contracts are signed and as revenues actually build under those contracts. So it's going to be - probably one would be within 90 days of closing and then the other one would be after the end, so after the anniversary, so right, probably a year from now.

Okay. On the Distribution segment, I mean, gross margins and the incremental margins continue to look really solid there. Anything to call out this quarter in terms of additional lender rebates that swung things in an abnormal way and maybe you could also just talk about mix and price, because I think those are the kind of the three buckets that you guys typically fall out into the margin drivers there?

Right. Okay, Matt, so I think we were pretty pleased with the volume that the Distribution segment produced at 7.3%. So that was solid numbers. It continues to show stability and strength in that segment. From a margin perspective, we continue to drive optimization of pricing. Mix has been favorable. When I say that, I am referring to core end user business has been rock solid and that's where we will achieve higher margins. And the reseller business becomes a smaller and smaller part of our business by design. So, I think to a certain degree we are going to see - we hope to see we would expect that to continue. We haven't seen any indicators that would lead to us believe otherwise. I don't think you are going to see necessarily like I wouldn't model the continued growth in margins or growth rates above what you have seen. But I think we would expect distribution to perform well in like pattern to the first half of the year.

Yes, the last half of last year was pretty strong in distribution. So I kind of expect that quarter-over-quarter percentage growth to be less than the 7.3 we had here, but still solid. And to your question on rebates, there was a little bit of acceleration. Part of that was we were able to bring in some inventory ahead of price increases to obtain both some purchase and sales rebates because of the strong growth that we have had in that - in those products.

Okay. That puts to my next question relatively well, which is any additional headwinds that we should be factoring in, in terms of pricing from your vendors in distribution? Or, is that essentially pretty much all offset with pricing action on your part?

Yes, to-date it's been offset. So we had some price increases, some sort of inflationary price I think based upon the tariffs from certain key manufacturers. But we raise our prices in accordance with that and it's been passed along. It's been accepted by the market. So far, we really haven't had any headwind as a result.

Perfect. The last one on the rental business, any help there just in terms of total revenue expectations for the rest of this year? I mean what I am mainly interested in is that 15% growth rate that you had this quarter is sustainable through the rest of the year. I know you are - I mean you had some tough comps from last year, but can we sustain that 15% growth rate for the remainder of the year here?

Yes, we can. You are right. It kind of ramped up in the last half of the last year. Especially the third quarter of last year was positively impacted by the hurricanes we saw. Rental businesses go up especially in the eastern area because of that catastrophe. But I think 15% is still achievable.

Perfect. All right, guys. I will jump back in queue. Thank you.

Thank you, Matt.

Matt, take care.

Our next question comes from Dick Ryan, Dougherty & Company. Please proceed with your question.

Thank you. So Lee, last quarter you mentioned the high level of service wins. Can you talk what your experience was in Q2 and kind of the timing of how those wins flow through the process?

Sure. So, you are right. We did talk about the win level which in Q1 was strong. We expected it to play out into a favorable growth rate in Q2. We experienced that. And so to your direct question, I would say that wins in Q2 were steady and strong. And I would expect that as we play out through Q3 and 4, we'll hit our expectations. We would expect to achieve the mid-to-single high digit organic growth based upon current pipelines and current win. We feel pretty good about that.

Okay. And then when you look at like the second half of the year, typically distribution ramps or peeks in the Q3 timeframe and service the next quarter kind of peeks in Q4. Is that sort of seasonality still the right way to look at for this year?

Yes, I would expect, right. So, if you look back historically, Q3 is going to be - has been historically strong for distribution. I don't see any early indicators or indicators whatsoever at this point that would lead me to believe differently. And for over 30 years in the business, calendar year first quarter has been strong for service. And we talked in the past that's based upon lot of new equipment being bought at the end of the calendar year based on use it or lose it budgets. And that sort of plays out into a strong first calendar quarter in service. And I would expect that that would be true this year as well, Dick.

Okay.

Sorry, let me just also one thing just before your next question. Sorry, Dick. And I would just remember that, yes, we do expect them to be stronger. But as we have said before, you have to remember fiscal year '19 is a 52-week year compared to '18 which is a 53-week year.

Yes, that's right. Thanks Mike. You talk about the differentiator of having distribution and service. Have you started seeing the lead generation show up from distribution side over to the service slab?

Yes, I think we have. And I think we do. So, we talk about that as a differentiator because it is. And of the four national service companies, we are the only company that had that $85 million distribution sort of pipeline. This year the leads from that pipeline have set record level. Some of that is the macros international growth of the distribution and it's doing well. And some of it is based upon cumulative marketing activities and technology activities around trying to leverage these two segments together. We spend a lot of time and focus on that to maximize that potential. So I think we are doing well in that respect and so the leads are up. But I wouldn't want to suggest that there is a macro impact as well. Nevertheless, we would expect that to continue.

Okay, great. Thank you.

[Operator Instructions] Our next question comes from Chris Sakai, Singular Research. Please proceed with your question.

Hi, good morning. You guys had an operating margin expansion both in the service and Distribution segment. I just wanted to first see you know, what were the main factors that led to this expansion? And are they sustainable going forward?

So, this is Lee, Chris. I think we - we were pleased with the margin expansion. I think it's a variety of factors, and Mike chime in if I miss any of these. But some of the expansion in margins is based upon the inherent leverage in particular related to the service business. As volumes increase, we would expect more income to drop to the bottom line and for the bottom line to grow at faster rate. That's kind of general expectations around our service business. I think in the distribution business, we have done some really good work. We talk about systems and people and processes and trying to run a better business. And I think we have seen some of that. Some of the benefits of those campaign roll into pricing optimization which has helped margins on distribution. So, on go-forward basis, I would expect with the investments that we are making in technology and some of these are operational excellence areas, I would expect - and Mike and I talk about margins increasing over time. It won't be linear. We are in a 26% range now. And then we would expect it to be at 27, 28. And we feel comfortable that in a reasonable amount of time over the next couple years, I will say two to three, we should be in that 30% range for service. And again, there will be bumps along the way. And it won't necessarily show itself up. It increases every quarter. But over the longer haul, these operational excellence campaigns should drive service margins up. From a distribution perspective, you will see some of that, but nowhere near the gains that we expect in margin on the service pie. The margins are probably going to be similar to the way they are now. The growth in that business will be more GDP related. So, we are doing a lot of work in both segments, but I think the service margin arena is where you are going to see some of the gains over time.

Okay, great. And then as far as future acquisitions go, do you have a sense of will they be in service or distribution segment?

We focus our acquisition strategy primarily on the service segment. That's not to say that we wouldn't entertain or from time to time acquire company in the distribution space, but the majority almost to accompany with the exception maybe that pops into head are the last eight or nine have all been service related. And I think you are going to see that pattern continue in the future. That's our - service is our primary growth engine. And so, when we look at growth, we are going to look at both acquired and organic growth in the service business for that reason.

Okay, great. And then as far as future financing goes for acquisitions, can you comment on how these acquisitions will be paid for?

Sure, Chris. Yes, we historically use cash or our debt facility versus equity offerings. You may recall that we actually did do a $50 million shelf registration in December of last year. We don't have any plans to use that. But it's nice to know that it is there. But between the availability that we have on our debt facility as well as in equity, we think we have a strong balance sheet to do any acquisitions. Just a matter of how we want to fund them.

Okay, great. Thanks. That's all my questions.

Thanks, Chris.

Ladies and gentlemen, we have reached the end of the question-answer session, and I would like to turn the call back to management for closing remarks.