Transcat Inc (TRNS) 2019 Q2 法說會逐字稿

Greetings, and welcome to the Transcat, Inc.

Second Quarter Fiscal Year 2019 Financial Results Conference Call.

(Operator 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 website, transcat.com.

The slides that accompany today's discussion are also on our website.

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 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 laws.

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 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 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 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 9.5 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 enter our third quarter with strong pipelines both on the new business front as well as the acquisition front.

Let's turn to our Distribution segment.

Distribution delivered strong revenue, profits; and delivered on our stated goal of driving differentiation in the market and lead generation for our Service segment.

Distribution sales were up 7.3% in the quarter, which included a 15% increase in our rental business.

Distribution gross margins were up 110 basis points to 22.8%.

Distribution operating margins were up 170 basis points.

I'd like to take a moment to talk about some of the progress we've made on the acquisition integration front.

We continued to develop a tool set to more quickly integrate our acquisitions to our operating systems.

In parallel, we've made meaningful progress on the physical integration of the last 3 bolt-on acquisitions.

The map on Slide 4 details the physical integration of these last 3 bolt-on acquisitions.

We've fully executed the consolidation of Excalibur's Irvine, California facility with our LA lab, which is located in Fullerton, California.

Dispersion's life science business in Montréal has moved into our Canadian headquarters in Montréal.

And finally, NBS calibration in Phoenix has moved into our Phoenix facility.

I would also like to call your attention to the most recent acquisition of Angel's Instrumentation, represented by the green marker, in Northern Virginia.

With approximately $4 million in annual revenue, Angel's represents a geographic expansion for Transcat as well as expertise in the adjacent maritime calibration market.

We believe the integration of Angel's is on track.

And we're pleased to welcome Angel's employees to the Transcat team; and the Angel customers to our network of customers that recognize Transcat as a leading provider of products, services and solutions to the test, measurement and control market.

As we've mentioned in the past, there is ample opportunity to expand geographically as we look to expand into Florida, Georgia, Northern California, Minnesota, Maryland and Dallas, among some other areas.

So with that, let me turn things over to Mike to discuss the second quarter results.

And I'll come back and talk to our outlook.

Thanks, Lee.

And good morning, everyone.

I'll start on Slide 5 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 30, 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 31, so our reported results include 1 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 of 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 $0.3 million 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 6, operating income increased 49% and operating margin expanded 150 basis points to 5.6%.

You may recall that our fiscal 2018 second quarter gross and operating margins were negatively impacted by hurricanes Harvey and Maria, especially our Service segment.

As a reminder, we had estimated last year's hurricane impact to range between 40 and 90 basis points of Service segment operating margin for that prior year second quarter.

The operating leverage achieved in our Service segment more than made up for that impact, with segment operating margin expanding a total of 140 basis points to 5.7%.

So even with considering the estimated impact of the hurricanes on fiscal 2018 second quarter, Service operating margins would still have expanded by approximately 50 to 100 basis points.

Distribution segment operating margin expanded 170 basis points to 5.5%.

This includes a 110 basis point improvement in gross margin resulting from favorable customer mix, vendor rebates and certain pricing initiatives.

Slide 7 shows the net income on a trailing 12-month and quarterly basis.

Net income nearly doubled to $1.5 million in fiscal 2019 second quarter, which equates to earnings of $0.20 per diluted share, an increase of $0.09 per diluted share.

In addition to our improved operating results, the significant increase in net income in both the trailing 12 months and quarterly bases also reflects the positive impact from the U.S. federal Tax Cuts and Jobs Act that was enacted in December of 2017, which was in the third quarter of our fiscal year 2018.

The effective tax rate this quarter was 24.9% compared with 34.2% in the second quarter of last fiscal year.

Our effective tax rate includes U.S. federal taxes, various state taxes and taxes on our Canadian operating entity' income.

Our income tax rate for full fiscal year 2019 is still expected to be in the range of 25% to 27%.

On Slide 8, we show adjusted EBITDA and adjusted EBITDA margin.

Among other measures, we use adjusted EBITDA, which is a non-GAAP measure, to gauge the performance of our segments because we believe it is a good measure of our operating performance and is used by investors and others to evaluate and compare performance of core operations from period to period.

I do encourage you to look at the supplemental slides that provide a reconciliation of adjusted EBITDA to the closest GAAP measures, which for us are operating income and net income.

On a consolidated basis, quarterly adjusted EBITDA was up 22% to $4 million, while adjusted EBITDA margin expanded 110 basis points to 10.3%.

Both segments contributed to this increase, with Service up 17% and Distribution up 30%.

Slide 9 provides detail on our balance sheet and cash flow.

We generated cash from operations of $4.9 million to the first 6 months of the fiscal year, which was used in part for our acquisition of Angel's, to fund our growth-focused investments and to drive operational excellence initiatives.

As previously disclosed, we acquired substantially all the assets of Angel's for $4.7 million, before purchase agreement holdbacks of $1 million expected to be released over the next 12 months.

At the end of second quarter fiscal 2019, we had total debt of $25.3 million outstanding, with $17.7 million available under our revolving credit facility.

Our debt levels are up $2.4 million since the end of fiscal 2018 primarily due to the use of cash for Angel's acquisition.

Our fiscal 2019 second quarter leverage ratio is 1.34x.

We calculate this leverage ratio as the total debt on our balance sheet at period end, divided by the trailing 12 months adjusted EBITDA.

The trailing 12 months of pro forma EBITDA of acquired companies is used in the leverage ratio calculation as provided for in our revolving credit facility.

Other companies may calculate such a leverage metric differently.

Year-to-date capital expenditures were $3.7 million and primarily focused on customer-driven expansion of Service segment capabilities and acquiring assets for the rental business.

Our anticipated capital expenditure planned for fiscal 2019 remains in the $7 million to $7.5 million range.

And on Slide 10, we provide a breakout of the various focus areas for CapEx spend expected for full year fiscal 2019.

We continue to believe we have sufficient liquidity and a strong balance sheet to fund investments that meet our strategic criteria.

And lastly, we expect to timely file our Form 10-Q on or about November 6.

With that, I'll turn it back to you, Lee.

Okay, thank you, Mike.

I'll close by reviewing our 3 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.

(Operator Instructions) Our first question comes from Matt Koranda, Roth Capital Partners.

I 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-digit Service segment revenue growth, which I think is a little higher than the usual commentary of high single digit.

So is that factoring in acquisitions?

Or are you guys indicating any fundamental change in the organic growth outlook for the Service segment?

So when we made that statement, Matt, we're 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 and 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 it 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, I mean, is it -- I would assume it's relatively similar with 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'd focus more on kind of the bottom lines and maybe an EBITDA between what we paid, what the annual revenues are.

It was within the range of what we've disclosed that we buy companies for, which is a 4 to 6x multiple, and kind of imply what the EBITDA will be and kind of 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 time frame is the additional $1 million going to be paid out?

Sure, sure.

There's 3 different pieces, Matt.

One -- and one is a $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.

There is -- the remainder, there's 2 separate ones.

There was 2 kind of significant contracts that we -- 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 revenue is actually built onto 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 -- 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 vendor rebates that swung things in an abnormal way?

And maybe you could also just talk about mix and price since I think those are the kind of the 3 buckets that you guys typically call out in terms of margin drivers there.

Well, 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, solid numbers.

It continues to show stability and strength in that segment.

From a margin perspective, we continue to drive optimization in pricing.

Mix has been favorable.

When I say that, I'm referring to core end user business has been rock solid, and that's where we'll 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 you're going to see -- we hope to see we would expect that to continue.

We haven't seen any indicators that would lead us to believe otherwise.

I don't think you're going to see necessarily -- I wouldn't model in continued growth in margins or growth rates above what you've seen, but I think we would expect Distribution to continue to perform well and 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 it 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've had in that -- in those products.

Okay, that puts up 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've had some price increases, some sort of inflationary pricing, I think, based upon the tariffs from certain key manufacturers, but we raised our prices in accordance with that and it's been passed along.

It's been accepted by the market, so so far we really haven't had any headwinds as a result.

Perfect.

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'm mainly interested in is if that 15% growth rate that you hit this quarter sustainable through the rest of the year.

I know your -- 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, I think we can.

You are right.

It kind of ramped up in the last half of last year.

Especially, the third quarter of last year was positively impacted by the hurricanes.

We saw rental business go up, especially in the Houston area, because of that catastrophe, but I think 15% is still achievable.

Our next question comes from Dick Ryan, Dougherty & Company.

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're right.

We did talk about the win level, which in Q1 was strong.

We expected 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 wins, so I feel pretty good about that.

Okay.

And then when you look at like the second half of the year, typically Distribution ramps or peaks in the Q3 time frame.

And Service, the next quarter, kind of peaks in Q4.

Is that sort of seasonality still the right way to look at it for this year?

Yes, I would expect that, 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 a lot of new equipment being bought at the end of the calendar year based on users with looser 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.

And...

And just one thing is I think -- sorry.

Let me just say one thing just before your next question.

Sorry, Dick.

We'll just remember that, yes, we do expect them to be stronger, but as we've said before, you have to remember fiscal year '19 is a 52-week year compared to '18, which is a 53-week year.

That's right.

That's right.

You talk about the differentiator of having distribution in Service.

Have you started seeing the lead generation show up from Distribution side over to the Service labs?

Yes, I think we have, and I think we do.

So we talk about that as a differentiator because it is.

And of the 4 national service companies, we're the only company that has that $85 million distribution sort of pipeline.

We -- this year, the leads from that pipeline have set record levels.

Some of that's the macros and the natural growth of the Distribution business, and that's doing well.

And some of it is based upon cumulative marketing activities and technology activities around trying to leverage these 2 segments together.

We spend a lot of time and focus on that to maximize that potential, so I think we're doing well in that respect.

And so the leads are up, but I wouldn't want to suggest that this is a macro impact as well.

Nevertheless, we would expect that to continue.

(Operator Instructions) Our next question comes from Chris Sakai, Singular Research.

You guys had some operating margin expansions both in the Service and Distribution segments.

I just wanted to, first, see, what were the main factors that led to this expansion?

And are they sustainable going forward?

So this is Lee, Chris.

I think 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, to -- and for the bottom line to grow at a faster rate.

That's kind of general expectations around our Service business.

I think in the Distribution business we've done some really good work.

We talk about systems and people and processes and trying to run a better business.

And I think we've seen some of that, some of the benefits of those campaigns roll in through pricing optimization, which has helped margins on Distribution.

So on a go-forward basis, I would expect -- with the investments that we are making in technology and some of these operational excellence areas, I would expect and Mike and I talk about margins increasing over time.

It won't be linear.

We're in the 26% range now; and then we'd expect to be at 27%, 28%.

And we feel comfortable that, in a reasonable amount of time over the next couple years, let's say 2 to 3, we should be in that 30% range for Service.

And again, there'll be bumps along the way.

And it won't necessarily show itself up as increases every quarter, but over the longer haul, these operational excellence campaigns should drive Service margins up.

From a Distribution perspective, you'll see some of that but nowhere near the gains that we expect in margin on the Service side.

The margins are probably going to be similar to where they are now.

The growth in that business will be more GDP related.

So we're doing a lot of work in both segments, but I think the Service margin is -- Service margin arena is where you're 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 there be in the 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 a company in the Distribution space, but the majority [almost to a company], with the exception maybe of 1 that pops into my head out of the last 8 or 9, have all been Service related.

And I think you're 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're going to look at both acquired and organic growth on 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 used cash or our debt facility, so -- 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's 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.

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

Okay.

Well, this is Lee.

We appreciate you all being on the call today.

Thank you for joining us.

And we appreciate your interest in Transcat.

Feel free to reach out to us at any time.

Mike and I will certainly try to entertain all the calls that we get.

We look forward to talking with everybody after our third quarter results come out.

So have a nice day.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.