Transcat Inc (TRNS) 2015 Q3 法說會逐字稿

Greetings and welcome to the Transcat, Inc. third quarter fiscal year 2015 financial results conference call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Debra Pawlowski, with Investor Relations for Transcat. Thank you Debra, you may begin.

Thank you, Adam, and good morning, everyone. I hope you all aren't buried out in the snow there. We are doing fine up here in Western New York with a very clear, if cloudy day. With the weather report, I want to thank you for your time and your interest in Transcat. On the call with me are President and Chief Executive Officer, Lee Rudow, and our Chief Financial Officer, John Zimmer.

After formal remarks, we will open the call for questions. If you don't have the news release that crossed the wires after market yesterday, it can be found on our website at www.Transcat.com. There are also slides that accompany today's discussion, which you can find at the same location on the website.

If you would, please refer to slide 2. This is the Safe Harbor statement. Because as you are aware, we may make forward-looking statements during the formal presentation and the 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 actual results to differ materially from where we are today. These factors are outlined in the news release as well as documents filed by the Company with the 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.

So, please review our forward-looking statements in conjunction with these precautionary factors. With that, I would like to turn the call over to Lee to begin the discussion. Lee?

Okay, thanks, Deb. Good morning, everyone. Thanks for joining the call. Let me start by saying that, generally speaking, Q3 was a solid quarter, particularly as it relates to our service business. We continue to grow our top line in service -- the topline trend. We tripled our year-over-year service operating income, which is consistent with the message that we tried to convey and that we talk about. And our distribution segment continued to generate significant cash, which many of you know we use to foster the growth of our overall business and our strategic plan.

Before John walks through some of the financial data, let me take a couple minutes and highlight some of the activities within the third quarter I think you'd be interested in. We are about three months removed from the Ulrich acquisition up in Montreal, Canada, and the early read has been really positive. As we anticipated, Ulrich is delivering expanded capabilities up in the region and strong leadership right out of the gate after the acquisition was completed. In Q3 we signed a very significantly large deal with a major manufacturer up in Montreal.

It's not unusual, when we acquire companies, we often combine our resources right out of the gate and oftentimes, you have the one plus one equals three scenario, so that's kind of what took place in the early days of the integration of Ulrich. In addition to that, we continue to work the acquisition pipeline. We expect to continue to make deals that fir our strategic plan. The drivers are the same. The expansion of our geographic footprint is important. We look to expand capabilities and always expertise within the industry.

We are still the only company that we are aware of that are making acquisitions in the life science, the healthcare space. We remain very well-capitalized, and maybe the biggest differentiator of all on the acquisition front is that we have the leadership in place today that recognizes good opportunities that can negotiate deals and ultimately effectively integrate the opportunities that we do acquire. So, net-net on acquisition front, we think we are very well-positioned and will be well-positioned moving forward.

Shifting over for a minute to the organic service front, our new C3 metrology asset management software has gotten off to a good start; continues to be very well received with great early adoption rates. The idea behind the software, as a reminder, is to become more embedded, to become more intimate with our current large customers. That's exactly what it's doing, that's exactly what we're doing. The idea is also to foster enterprise-level growth opportunities as we look to sell our services to larger companies. The C3 metrology software we developed is a key differentiator for us.

For those of you who may be interested actually in looking at the software, there's a link on our website that will take you to the C3 software and you might find it interesting. In addition to that, in the quarter we located our LA lab about 30 minutes from its former location. This new facility is state of the art. It allows us to have expanded capacity which we need and expand capabilities. It's located right in the heart of the Southern -- what we consider the Southern California life science cluster. Moving forward with this new lab we expect to be more competitive in that region than we've been in the past. So that's a positive.

And finally, relative to services in the quarter, we made significant progress selling our expanded adjustable services -- into our expanded adjustable services, is the best way to put it. We closed two nice-sized organic deals in the analytical space servicing gas chromatograph, dissolution, and HPLCs. These are services that we acquired when we made the Anacor deal a couple of years ago. So it's good to see big wins in that relatively new space for us. Overall, our service -- our organic service pipeline is strong as we head into fiscal 2016.

Let me take a minute, and before John get started, let's move to distribution. We are engaged now -- well, I will get to it in a minute or two, but we are engaged in some new interesting activities. But just as a backdrop, as many of you know, the instrument market itself for the last several years has been kind of soft. There's been downward pressure on margins, but when we look back on our performance throughout, all in all, we think Transcat's performed pretty well in that kind of a market.

Back in Q3 in November, we launched our brand-new website that we worked on for at least six months prior to the launch. This new website puts us -- and this new platform puts us in a position to do some unique things that we have not been able to do in the past. So we are -- first off, we are piloting a new program. We call it a new instrument rental program, and it's gained -- we've been pretty impressed with early results and it's gained some early traction right out of the gate.

Now, this isn't a business that we think is going to move the topline needle all that much, but it does have with it outstanding intrinsic margins. And we will keep you posted as we move forward and continue to develop the business, but it's interesting. In addition to that, with the new service -- the new web platform, we are also going to launch a new SKU expansion project. So we are looking to add thousands of new items to our website that we have been unable to add in the past, at least in an efficient way, based upon old platform versus the new. So that initiative combined with the rentals should create some momentum.

We expect both of these programs to have -- provide some offset, if you will, for us on the margin pressure that we've been experiencing. The real story behind distribution in fiscal 2015, however, is about rebates. We are down $1.4 million year-over-year when it comes to rebates, and we will continue to fight this significant headwind through our fourth quarter. The good news is that that challenge will end with fiscal 2015. We will not have a rebate issue in fiscal 2016. It will be behind us, so kind of looking forward to that.

So we have new programs on the distribution front. We will fight through the rebate. All in all, relative to distribution, we feel like we are doing the right things that are going to maximize the impact from distribution. And we expect the cash generation -- the significant cash generation of the past will continue into the future. So with that, John, I will turn it over to you. We can walk through some of our performance data.

Thanks, Lee, and good morning, everyone.

Slide 4 is an overview of the quarter and the important advances we have made so far this year that will help drive our growth. Our service segment continues to deliver excellent results while our distribution segment provides solid cash generation for investments that support our organic and acquisition growth strategies.

Looking at slide 5, we continued our trend of topline growth, posting record third-quarter results on a consolidated basis and record third-quarter service segment revenue. We achieved $12.6 million in service revenue, a 9.4% increase driven by a combination of organic and acquired growth. This marks our 23rd consecutive quarter of year-over-year service segment revenue growth. The distribution segment saw a $500,000 or 2.9% decrease in sales. While the market in this segment remains highly competitive, we are executing multiple strategies, as we alluded to, to maintain and grow our market position.

Moving on to slide 6, as we have seen in previous quarters, our service segment delivered strong gross profit and operating margins. Gross margin for this segment improved 110 basis points to 24.5%, while operating income tripled to $600,000, with the operating margin expanding 320 basis points to 4.5%.

Distribution gross profit was down $500,000 to $3.9 million with gross margin declining to 21.2% from 23.4%. As Lee mentioned, the gross margin was primarily impacted by lower vendor rebates compared with the prior year period, which accounted for 190 basis points of the 220 basis point decline. We expect the negative impact to distribution segment gross margin from vendor rebates in the range of 200 to 300 basis points in the fourth quarter. On a consolidated basis, our operating income in the third quarter was $1.4 million, up 2.6% from the prior year's third quarter.

We will now move on to slides 7 and 8, where we look at both contribution margin and adjusted EBITDA to gauge our performance. Contribution margin by segment excludes corporate expenses and focuses on the operating performance of the segment. We use adjusted EBITDA because we believe it is a good measure of operating cash flow for each segment. These are non-GAAP measures, so please review our reconciliations and related disclosures in our release and at the end of these slides.

On slide 7, for the quarter consolidated contribution margin was $3.4 million compared with $3.5 million in the prior year period. For the service and distribution segments, contribution margin was $1.5 million and $1.9 million, respectively, or 12% and 11% of revenue for each segment, respectively.

On slide 8, consolidated adjusted EBITDA was $2.4 million compared with $2.2 million or a 5.8% increase over the third quarter of fiscal 2014. The service segment achieved adjusted EBITDA growth of $500,000 or 69% over the prior year period. On a trailing 12 months basis, service segment adjusted EBITDA increased 22% over the comparable period in fiscal 2014. And since fiscal 2011, that segment has achieved a 34% compound annual growth rate. On to slide 9. Our third-quarter net income was consistent with the prior year period at $800,000 or $0.11 per diluted share. Our net income compound annual growth rate since fiscal 2011 is nearly 9%.

Slide 10 provides detail regarding the strength of our balance sheet. As of the end of the third quarter of fiscal 2015, we have $14.8 million in long-term debt. The Ulrich Metrology acquisition, which Lee mentioned, used $6.7 million of borrowings available for acquisitions, leaving $8.3 million available for acquisitions for the remainder of the fiscal year. Our year-to-date CapEx was $2.7 million and focused primarily on additional service capabilities and information technology, including C-3 and our new website, which Lee discussed earlier. We expect full fiscal year 2015 CapEx to be approximately $3.5 million.

Slide 11 is an illustration of key investments and the impact to debt on a trailing 12 months basis, which demonstrates that we are generating cash to fund day-to-day operations and continue to make investments necessary to fund future growth. We believe that our balance sheet structure offers the financial flexibility to facilitate our acquisition strategy and satisfy working capital requirements and capital expenditure needs.

And lastly, slide 12 summarizes the key points we have discussed today. That concludes my remarks. Operator, we can now open the line for questions.

(Operator Instructions). Andrew Fleming, Heartland Advisors.

Congrats on a solid quarter, especially in the service side of the business.

Thanks, Andy.

I've been trying to get a better understanding of the gross profit margin profile in the distribution side as we move into fiscal 2016. So should we expect the gross profit margin to refer back to 2014 type of margins? Or that 21% to 22% that we've seen in this fiscal year? Is that a good run rate to think of going forward?

Yes, I think it's more accurate to say that will be the run rate to pick up going forward. We anticipate, Andy, continued pressure on the margins. To what exact degree it's hard to completely determine, but we are going into the year thinking there will be -- the run rate will continue, that there will be some marginal pressure. That's why we are doing some different activities to try to offset that and anticipate that that is going to happen. Now, if that doesn't happen, that's fantastic.

If there's some stabilization in the margins, that would be great for the business. But we will go in with the assumption that margin pressure will continue. Most of it is Internet-based, if you will, increased competition. But obviously at some point there's a bottom. People have to make money. Have we reached it? We don't know, but it's best to prepare for it to decline a bit and the pressure to continue and offset it with some good programs, and that's what we're doing.

Yes, and from a rebate perspective, we don't expect it to decline. There may be some small upside next year. I don't think we should expect to see it rebounding to the level that it was last year.

Okay. So more of the (multiple speakers). Okay, that sounds good. And then just trying to dig a little deeper on the service gross profit margins, so obviously great improvement year-over-year. I'm just trying to understand from Q to Q, from the second quarter to the third quarter, did this third quarter have a larger percentage of outsourced service revenue?

Not particularly. I think this -- every quarter is little bit different, and the mix of work that we do is different from the second quarter to the third quarter. And I think that's why it's more relevant. The work that we did this year in the third quarter, other than new business, would be similar to what we did last year in the third quarter, so it's really more of a mix. Sometimes the type of work that we do for a particular company, whether it's a big on-site or another might be at a lower margin in the third quarter than the work that we did for a different customer in the second quarter. So, those margins are going to fluctuate from quarter to quarter, but that's why we look at it year-over-year for the same quarter.

Okay. Great. And then with the Ulrich transition now being fully integrated, what percentage of revenue for the Company as a whole is from Canada at this point on an annualized basis?

So, you're talking -- just distribution or distribution and service as well?

Just total revenue.

You want to get that or you want me to get that?

I think on the service side of the business, our Canadian revenue is, in Canadian dollars, somewhere between CAD9 million and CAD10 million, roughly. And on the distribution side, it fluctuates on an annual basis, but it's in the CAD4 million to CAD5 million range.

Okay. And then on the service side, I assume we are naturally hedged and that the costs and revenues --.

Yes, that's correct. Right.

Okay.

It's in the 15% range, Andy, relative to services; a percentage of our overall service revenue.

Okay, great.

Yes, 20.

Okay, great. And then as we move into fiscal 2016 on the service side, we still think that 10% growth with the 50% incrementals should be the way to think about things going forward?

Yes. I think our revenue, as always, will be -- we haven't changed our plan so it's going to be a blend of organic activity and acquired activity. And we would absolutely look to see revenues grow in the double digits, but it's -- so we are on target with that.

That's great to see. Well, keep up the good work. If that comes to fruition, we should be close to a mid-teens ROIC, which is nice to see.

Exactly.

Yes.

Dave Rode, Stifel Nicolaus.

Yes, congrats on another record quarter. And I also noticed I think someone had sent me -- you guys relisted in the Forbes 100 Best Small Companies last fall. I think that was third quarter as well.

You are correct and that's -- Dave, that is something we are particularly proud of. We didn't see that coming or didn't know that we were being considered, but yes, that's always good news.

Yes. Some of my questions have already been answered. I would like to ask one question. I know you guys used to post the amount of your product sales that were Internet oriented. Are you not doing that anymore? Can you disclose that number or not?

We haven't been disclosing that number, David. It hasn't really changed much and so it wasn't really particularly interesting. It's still in the low double digits and continues to be pretty consistent on that basis. I think one of the things that may be more interesting as we go forward now that we've launched our new website is that there is a settling in period. When you do have a new website, where the spiders have to reindex from an SVO standpoint. So your traffic jobs a little bit initially and then it starts to pick up again.

So I think once it settles in at the rate that it's going to be more consistently -- from a traffic standpoint, it might be interesting for us to provide an update, maybe in the first or second quarter next year. But we're already seeing the traffic rebounding to the same levels it was at and actually beyond where it was when we launched the new website. So our expectation is the new website will generate more traffic and, more importantly, the conversion rate when somebody gets to our website will be increased.

Has there been any more thinking along the lines of analytics as far as marketing via the Internet yet?

Dave, we think about that all the time. We have a new VP of Marketing here that took the position in Q3 in fact. We have been really impressed with his aptitude, his ability, his energy level, all in all, his smarts. And I think that when we have marketing meetings now and Mike West steps to the front and lays out his thoughts and his strategy, it's a different atmosphere. And we are encouraged and I am looking forward to what he's thinking, what I think he's going to implement. So data becomes -- the analytics become more important.

We can now, with our new platform, we know who is looking at what when they visit our website. We know how long they spent in each area of our website, what their interests are, and we have the ability to chat with them online. We have the ability to follow up really quickly in a more effective way than we have in the past. From a data perspective specifically, addressing your question, we are getting better analytics. And so to the degree that we can capitalize on that, our success will be accelerated.

One thing I wanted to add to what John had said, we did some industry research, and when you launch a new website you have to go through that reindexing process. It takes X amount of time to do that and we planned and knew that that -- perhaps we would take one step back, so that we could take two steps forward in terms of traffic. But we have actually experienced a little bit of a different trend and we are recovering quicker than industry norms. We have even checked with Fluke and some of our manufacturers who went through a similar process. It takes 6 to 8 months to recover, and we look at we're recovering with an almost a quarter, so that's good news, too, as well.

That's great. I guess this would be for John. So, it looks like you've got what? $800,000 left in CapEx for the fourth quarter here, is that about it?

Yes.

Okay. And can you quantify at all -- I know we've talked about the rebates and the effect that they've had on things -- can you quantify at all any EPS or lack of that occurred because of that in the third quarter?

I don't have that number in front of me, Dave, but it was 190 basis points of margin, so we would have to calculate the dollars associated with that and tax effect it, because it really drops to the bottom line.

And just FYI, gosh, I look back 10 years with you guys and you have really done an outstanding job. I ran some numbers. Your shareholders' equity in the last 10 years quarter over quarter is a 773% increase.

Wow.

Your service revenues the last 10 years have increased 201% quarter over quarter. And the service revenues 10 years ago were 30%. They are now 41% of the overall picture. My question to Lee is, going forward, we don't have to go out 10 years into the future, but as we look forward, how do you want to see that mix with service and product sales on a long, long-term basis?

Longer-term, Dave, there's no question that our strategy is driving us towards growing service obviously at a faster rate than distribution. We want to see distribution grow, we want to add thousands of SKUs. We want to expand our product line on the distribution side, but the -- we're going to look to grow service, it's got the higher margins, it's got the recurring revenue streams.

The bottom line is the most important thing and service is going to drive that. And so looking at it -- I can't look out 10 years in a crystal ball, but I can say there's a lot of companies to acquire in our space throughout the country. If we acquire for the right reasons and the right companies, that's going to really aid growth. We have a very talented leadership team in place. We've recruited some of these folks from the competition from around the country.

We are well-positioned to grow this Company, and the strategy to grow service faster -- at a faster rate than distribution is a good one. I would expect distribution to grow, but it's going to be service that's going to get us to the promised land and really pop the bottom line. So the future looks bright. We always say we don't look quarter to quarter because there's a lot that can happen in a very short period of time, but the long-range plan is solid.

In your acquisition arena and strategy and to date you've done I think nine of them over the last seven years. Have they all been accretive?

I want to -- John, you may be able to answer that because I wasn't here for all of them.

Yes, I would say it's a really interesting question. I think on the surface it's sometimes hard to tell because we integrate quickly, and some of those acquisitions generate organic opportunities as well as the revenue that we've acquired. So I would say you have to really look at the aggregate of what we've done and the way that we've grown.

And I appreciate your pointing out the growth of the last 10 years. I can only take credit for the last 8 1/2 years. But I think when I started it was $19 million of service revenue and we were losing money and now we're north of $50 million. And a lot of that came through acquisitions, and we've seen the profitability and the increases in gross profit associated with that. So I think in the aggregate -- which is the way we really look at it, because they kind of are the one plus one equals three scenario -- they've been accretive.

Okay, great.

We haven't had any real dogs in that group, I can tell you that.

That's amazing. That's a good record. I guess my last question would be in the stock area. It seems as though when I've looked at the filings as far as who your holders are, you've attracted some purchasers over the last 12 months. Some of the names I recognize, some high-quality, long-term investors, both funds and institutions.

Heartland was on. I think Opus has bought. Grandeur Peak, Dalton, Punch, to name a few. Certainly have noticed presentation slides as well along the way posted on your website. I'm assuming that's part of your Investor Relations efforts. Can you comment on your commitment and plans at all for this going forward during, say, the next 12 months?

So we plan to continue to meet with investors on a quarterly basis, we will continue to do these conference calls. This is all part of our investor outreach. We do have a plan to go to the West Coast in a couple weeks. We're going to be there from the 9th through the 11th, and if anybody is on the call or listening to the call and is interested in meeting with us, then they should contact Debbie Pawlowski, and we can set up a one-on-one meeting.

We will be in San Francisco, LA, and San Diego during that time. And we plan to do that kind of thing quarterly. We will look at some conferences, as appropriate, and we've done some of that. So yes, you will probably see more of the same as what we've been doing over the last 12 months.

Okay, thank you.

(Operator Instructions). Donald Porter, DGHM.

So, what was the organic growth rate in the quarter?

We haven't been splitting out the organic growth. We integrate very quickly and we haven't -- and we don't typically break that out and we aren't -- we don't plan to. Because once we acquire these businesses, they become part of our network and some of the opportunities that Lee was talking about earlier are generated through that one plus one equals three scenario, where we have trouble putting it in a bucket, whether it's organic or acquired. It's not really meaningful to break it out.

Sure. And then can you quantify the -- you said with the Ulrich you won a contract. What's the size of that kind of contract?

Yes, I will just give you -- this is Lee, Donald. That's in the -- it's a six-figure contract. Let's call it mid- to low-six-figure contract range.

Okay, got you. And then the other two, you said you expanded service and you won two deals. Magnitude there?

Yes, so those deals on the analytical space, one is mid-six-figures and one is around low-six-figures, so there's -- they are both significant.

Okay, great. And just not to beat a dead horse on the rebates thing, but is this just an off year where it reverts every other year? Or is it more competitive just generally, and so it's more difficult to get margin there?

Sure. So last year, Donald, we had a really good year with Fluke in particular, and it drove a very high gross rebate for us. And the bar gets raised. It's based on growth, and so when you are coming off of a very, very good year, it's difficult to hit that threshold next year. It's possible but sometimes difficult. And so we've just had a challenge this year. Coming off of this year going into next, that's absolutely not going to be the case. So it's not completely cyclical and there are off years that are little bit -- there are anomalies in there, but generally you are coming off of a high year and that's the rental.

I think going forward, though, that the market is very competitive, and I don't think that the expectation is to see the level that we saw last year. I think no further declines, but we won't see -- we're not expecting to see the rebound. So the margin going forward may be similar to what we are seeing this fiscal year. And we are also getting an increased contribution of revenue from more variety of manufacturers and that spreads the revenue out, and I think that diversification is positive for the business in the long run.

Got you, great. And just on the M&A pipeline, how is that looking?

So we have a decent pipeline. It's something that we work pretty hard at, and we like the pipeline as it is today. We expect that will result in future deals that fit our strategic plan.

Got you. Okay, great. Thanks guys, appreciate it.

Steven Stern, Stern Investment Advisory.

Three quick, somewhat unrelated questions. In your release, you referred to cost discipline and distribution and reduced expenses related to performance-based compensation. I'm just curious, is that a sales commissions for the sales staff, or is that operating rewards for the distribution management?

It's more of the latter. We are a very performance-based -- our compensation throughout the Company is very performance-based and heavily levered that way. So, as we see something like the reduction in the gross profit year-over-year, that has an impact on everyone's compensation.

Very good. What are some of the parameters? Is it sales growth? Margin change? What are the parameters of -- what are the benchmarks by which they are measured?

The most important is our EPS. When we talk about our management performance-based compensation plan, EPS is the highest rated. And there are other factors, and all of that -- it's relatively complicated but all of that is outlined in our proxy statement, so if you go to the proxy you can see it. But for management it's based on the overall company performance and the most heavily weighted factor is EPS. And then we also have a plan that all employees share on, which is based on our success relative to our plan every year. And those are -- go ahead.

Do you have an ESOP plan?

No, we don't.

Very good. And then the third question, completely a change of pace. With the decline -- the drastic decline in oil prices, petroleum prices, what is our exposure to the refining industry or drilling, retailing? Any?

So Steve, this is Lee. There are -- such a drastic decline is likely to impact a lot of areas and a lot of companies. I don't think anything really significant on our end. We do have a certain portion of our distribution business that sells into the pipeline industry. We are pulling our own data within the last month or so to try to gauge the potential impact. It's not really all that material. Will we have some decline in that market? Of course, but it's not something that -- we are not concentrated on the distribution side relative to refinement of oil and so on and so forth.

On the service side, there's even going to be less impact. We've always talked about targeting the life science industry and that's where the bulk of our customers lie, not in the oil refining industry. We do some work at the utility level, but again, oil should have a minimal impact.

Very good. Okay, that's it. Keep up the good work.

Thank you. Ladies and gentlemen, there are no further questions at this time. I would now like to turn the floor back over to management for closing remarks.

Okay, so thank you, everyone, for joining us on the call. Certainly appreciate your interest and support. As John mentioned, we are going to be in California on February 9th through the 11th. I think we are stopping off in San Francisco, LA, San Diego. So if you are in that area, you ought to contact Deb and we will do everything we can to accommodate a meeting, if that's possible. Otherwise, I will keep you updated on our progress. We appreciate you all being on the call.

Ladies and gentlemen, this concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.