Transcat Inc

NASDAQ:TRNS

Earnings Call Analysis

Strong Revenue and Margin Growth with Strategic Acquisitions

Transcat Inc. delivered a strong performance in Q1 of fiscal 2025, with revenue increasing by 10% to $66.7 million, driven by robust service demand and rental performance. The gross margin expanded by 310 basis points to 34%. Net income rose by 49% to $4.4 million, and adjusted EBITDA grew 20% to $10.2 million. The service segment grew 10%, 6.4% organically. The company’s strategic acquisitions, including Axiom and Becnel Rental, significantly boosted rental and overall performance. Transcat expects organic service growth in high single-digit to low double-digit range for fiscal 2025 and further gross margin improvements.

Remarkable Growth in Revenue

Transcat, Inc. reported a robust performance in the first quarter of fiscal 2025, with consolidated revenue reaching $66.7 million, which reflects a 10% increase compared to the prior year. This growth is attributed to steady demand across both service and distribution segments, highlighting the company's strong position in its market. Specifically, service revenue grew 10% overall, with 6.4% coming from organic growth, signifying a healthy underlying business performance.

Enhanced Profitability with Margin Expansion

Consolidated gross profit improved significantly, rising 21% year-over-year to $22.7 million. This growth led to an impressive gross margin increase of 310 basis points, bringing it to 34%. The service segment alone saw gross margins grow by 150 basis points, demonstrating the company's effective operations and investment in automation and technician productivity. Additionally, the distribution segment's gross margin rose 620 basis points to 33.9%, attributed to strong performance in the higher-margin rental business.

Strong Earnings Growth

The company closed the quarter with net income soaring to $4.4 million, reflecting a considerable 49% increase from the previous year. Diluted earnings per share rose to $0.48, up $0.10 per share, indicating robust profitability. Adjusted diluted earnings per share also improved, climbing to $0.68 from $0.52, normalizing for acquisition-related costs. These results underscore Transcat's successful efforts to enhance its earnings capacity.

Consistent Cash Flow and Strong Balance Sheet

Operating cash flow improved to $8.9 million for the quarter, underscoring the company's effective cash generation capabilities. With a total net cash position of $19.1 million and a leverage ratio of just 0.1x, Transcat's balance sheet remains strong, providing a solid foundation for future growth initiatives. The company also had $80 million available from its credit facility, enabling potential acquisitions and operational investments.

Focus on Service and Strategic Acquisitions

Transcat emphasizes its commitment to the service sector, particularly targeting highly regulated industries like life sciences and aerospace & defense. As part of its growth strategy, the company has successfully integrated recent acquisitions, including Axiom and Becnel, which have already shown promise in creating synergistic opportunities. The expansion into rentals is seen as a strategic pivot, moving away from lower-margin distribution to focus on higher-margin rental services.

Guidance for Future Performance

Looking ahead, Transcat has set optimistic targets for fiscal 2025, forecasting organic service growth in the high single-digit to low double-digit range, excluding an extra week in fiscal 2024. The company anticipates continued gross margin expansion across its operations, supported by a diverse acquisition pipeline that aims to fortify its market position and deliver long-term shareholder value.

Conclusion: A Promising Outlook

In summary, Transcat's first quarter results illustrate a company in a strong position with solid growth, increasing margins, and a clear path forward driven by strategic acquisitions and a focus on high-margin services. Investors should take note of the company's commitment to operational excellence and improving profitability, backed by a robust balance sheet that supports future initiatives.

Earnings Call Transcript 2025-Q1

[Operator]

Greetings, and welcome to Transcat, Inc. First Quarter Fiscal Year 2025 Financial Results Conference Call. [Operator Instructions].

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Tom Barbato, Chief Financial Officer. Thank you, Mr. Barbato. You may begin.

[Thomas Barbato, executive]

Thank you, operator, and good morning, everyone. We appreciate your time and your interest in Transcat. With me here on the call today is our President and CEO, Lee Rudow; and our Chief Operating Officer, Mike West. We will begin the call with some prepared remarks, and then we will open up the call for questions. Our earnings release crossed the wire after markets closed yesterday, both the earnings release in the slides that will be referenced during our prepared remarks can be found on our website, transcat.com in the Investor Relations section.

If you would, please refer to Slide #2. As you are aware, we may make forward-looking statements during the formal presentation and Q&A portion of this teleconference. These statements apply to future events, which are 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 the documents filed by the company with the SEC.

You can find those on our website where we regularly post information about the company as well as on the SEC's website at sec.gov. We undertake no obligation to publicly update or correct any of the forward-looking statements contained in this call, whether as a result of new information, future events or otherwise, except as required by law. Please review our forward-looking statements in conjunction with these precautionary factors.

Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We've provided reconciliations of non-GAAP to compared GAAP measures in the tables accompanying the earnings release.

With that, I'll turn the call over to Lee.

[Lee Rudow, executive]

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. Transcat delivered strong performance across our entire portfolio in the first quarter of fiscal 2025 as we continue to demonstrate our ability to effectively execute our strategy and to drive differentiation throughout our business platform. Consolidated revenue was up 10% to $66.7 million, driven by continued demand for our services as well as strong rental performance.

Consolidated gross margin expanded 310 basis points to 34% and was driven by significant margin expansion in both our Service and Distribution segments. Adjusted EBITDA in the quarter grew 20% from prior year to $10.2 million. Service continued to perform at a high level and recorded its 61st straight quarter of year-over-year revenue growth as more than 15 straight years.

In the first quarter of fiscal 2025, Service revenue grew 10% overall and 6.4% organically. We continue to focus recurring revenue streams with highly regulated industries that include life science and aerospace and defense. And internally, we rally around the theme of get bigger and get better. To that point, service gross margins in the first quarter grew 150 basis points versus prior year to 34%. Our consistent service gross margin improvement over time reflects our ability to drive continuous process improvement throughout our operation.

Specific drivers of service gross margin improvement include increased productivity through higher levels of automation and technical training as well as system and software enhancements. As we talked about in the past, the constant driver of service margin gain is the inherent leverage in the operating model as service revenue grows. Turning to distribution and rentals. Gross margins expanded 620 basis points from prior year driven primarily by the higher margin rental business, which now includes both Axiom, which we acquired in August, almost 1 year ago and Becnel acquired this past April at the start of our first quarter. The integration with Axiom has been excellent.

And on the Becnel front, we're off to a strong start, making early, meaningful progress. In fact, in the first quarter, since the acquisition of Becnel, we can already point to several synergistic service opportunities that we've encountered from the Becnel customers. While this was anticipated to occur at some point, the strong early start is great news. Becnel is a very well-run company that has cultivated a loyal customer base. most of which are heavy users of instrumentation and calibration services. In addition to its rental platform, Becnel offers a very profitable growing operator-based service model that we anticipate will contribute to service margin expansion over time.

Overall, we're pleased with our start, our strong start across the business in fiscal 2025, the 10% growth we generated in consolidated revenue, a 310 basis point expansion in consolidated gross margin and a 20% growth in adjusted EBITDA. It's all a testament to the strength of Transcat, our brand and the uniqueness of our value proposition. Transcat continues to be recognized and rewarded for the delivery of our risk mitigating services across high cost of failure manufacturing environments.

Customer retention has been and continues to be a hallmark of Transcat and a major contributor of our consistent top line performance over time. Lastly, the first quarter fiscal 2025 was also benefited from the expansion of addressable markets, which contributed significantly to both revenue and margin growth. We ended the quarter with a strong balance sheet, and we are well positioned to execute our growth initiatives, including the acquisition of companies that enhance our geographic footprint, expand our current capabilities, expertise and markets.

With that, I'll turn things over to Tom to provide additional detail on the first quarter financials.

[Thomas Barbato, executive]

Thanks, Lee. I'll start on Slide 4 of the earnings deck posted on our website, which provides detail regarding our revenue on a consolidated basis and by segment for the first quarter of fiscal 2025. First quarter consolidated revenue of $66.7 million was up 10% versus prior year as both segments experienced consistent demand.

Looking at it by segment, Service revenue growth remained solid at 10%, 6.4% of the growth coming organically and the remainder from acquisition. Turning to distribution, revenue of $22.9 million grew 11% as we continue to see strong performance in the higher-margin rental business. Turning to Slide 5. Our consolidated gross profit for the first quarter of $22.7 million, was up 21% from the prior year, and our gross margin expanded 310 basis points to 34%.

As Lee mentioned, we are very pleased with our year-over-year service gross margin expansion of 150 basis points. The service margin increase further demonstrates the inherent leverage in our service model and our ability to drive higher levels of automation and technician productivity. Distribution segment gross margin of 33.9%, was up 620 basis points driven by strong rental performance.

Turning to Slide 6. Q1 net income of $4.4 million increased 49% from prior year, and our diluted earnings per share came in at $0.48, up $0.10 per share. Net income growth was driven by strong Q1 performance and the reduction of interest expense as the majority of our debt was paid down in Q3 of last year, leveraging the proceeds from our secondary offering. We report adjusted diluted earnings per share as well to normalize for the impact of upfront and ongoing acquisition-related costs. Q1 adjusted diluted earnings per share was $0.68, up from $0.52 per share in the prior year.

A reconciliation of diluted earnings per share to adjusted diluted earnings per share can be found in the supplemental section of this presentation. Flipping to Slide 7, where we show our adjusted EBITDA and adjusted EBITDA margin. We use adjusted EBITDA, which is non-GAAP to gauge the performance of our business because we believe it is the best measure of our operating performance and ability to generate cash. As we continue to execute our acquisition strategy, this metric becomes even more important to highlight as it does adjust for onetime deal-related transaction costs as well as increased levels of noncash expense that will hit our income statement from acquisition purchase accounting.

With that in mind, first quarter consolidated adjusted EBITDA of $10.2 million, was up 20% from the same quarter in the prior year, and adjusted EBITDA margin expanded 130 basis points. Both segments had double-digit adjusted EBITDA growth compared to last year. As always, a reconciliation of adjusted EBITDA to operating income and net income can be found in the supplemental section of this presentation.

Moving to Slide 8. Operating cash flow improved from last year to $8.9 million for the quarter. Q1 capital expenditures were $900,000 higher than prior year and continued to be centered around Service segment capabilities, rental pool assets, technology and future growth projects. The spend was in line with expectations. Slide 9 highlights our strong balance sheet. At quarter end, we had total net cash of $19.1 million, with a leverage ratio of 0.1x. We had $80 million available from our credit facility. As previously announced, we acquired Becnel Rental tools for $50 million just after the end of the first fiscal year, paid in a combination of 32.5 million company stock and $17.5 million in cash. Lastly, we expect to file our Form 10-Q on August 1. With that, I'll turn it back to you, Lee.

[Lee Rudow, executive]

Thank you, Tom. Transcat has successfully delivered on the expectations we have set and communicated over a very long period of time. Expectations include consistent organic service revenue growth, gross margin expansion and in recent year's solid free cash flow. We've also expanded our addressable markets and strengthened our industry-leading value proposition through a significant number of accretive acquisitions in our core and adjacent markets.

And as always, effective and timely integration represents the key differentiator and has set Transcat apart. Throughout the remainder of 2025 and beyond, we are confident this will continue. Fiscal 2025, we expect organic service growth in the high single-digit to low double-digit range when normalized for the extra week in fiscal 2024, and we expect gross margin expansion throughout our portfolio of businesses and business channels. We have a robust and diverse acquisition pipeline that will enable opportunities to both expand our core services and addressable markets and ultimately increase the trajectory of the business. Of course, the ultimate focus will continue to be on generating sustainable long-term value for our shareholders.

As we look ahead, we remain excited about the direction Transcat is headed and our ability to execute what we believe is a differentiated and defendable strategic plan.

And with that, operator, we can open the line for questions.

[Operator]

[Operator Instructions] The first question comes from the line of Greg Palm with Craig-Hallum Capital Group.

[Greg Palm, analyst]

I wanted to maybe dig into the segment-related results a little bit to start things off. So on Services, the organic growth number was a little bit light of kind of your full year guide, certainly, what we're accustomed to over the past couple of years. So just can you dig into that a little bit? Was it timing? I suggest that if you're going to get to high single digits, low double digits, it obviously accelerates from this level for the remainder of the year. So just a little bit more color there would be helpful to start.

[Lee Rudow, executive]

Sure, Greg. This is Lee. I'll take that. No, I wouldn't read into the 6.4% organic growth too deeply. Service remains strong in terms of demand. The demand remains strong. There's going to be fluctuations in this business. We've always talked about that, fluctuations that aren't necessarily reflective of our expectations, particularly long term.

So we didn't change our guidance because we still think that the pipeline and the demand is there, and we would expect to be in that range for the fiscal year. So no, we're not -- it's not something we think about too much as we look at 90-day increments of time. We've never really looked at the business that way. And so no, I'm not concerned.

[Greg Palm, analyst]

Yes. Any end markets within that segment that jumped out either from a positive standpoint or maybe a little bit weaker than expected, at least for the quarter?

[Lee Rudow, executive]

I think everything is pretty consistent with our expectations. We see -- when you look at the business that was generated, the growth and the pipeline, it's pretty much in line with the highly regulated industries that we serve. So you've got aerospace and defense in a big way, producing and same with life sciences. So I think that's consistent with the past, and that's what we expect.

[Greg Palm, analyst]

Yes. Okay. Good. And then shifting gears to distribution. By our math, I think organic growth was negative, and certainly, the reported growth was driven by acquisitions-related contribution. Can you just give us a little bit more sense on what's happening in distribution? And for rental specifically, how much is that at this point in terms of overall mix? Are you willing to give us kind of a ballpark number?

[Lee Rudow, executive]

So generally speaking, we have guided towards this, and we look at distribution a little bit differently, obviously, than we did years ago. We have invested in our strategy to grow the rental business. We've done that organically and through acquisition. You do see acquired revenue, but you also see on the rental side, organic growth, which has been pretty impressive. So we like where we are in distribution for that reason. Margins are up, profits are up.

We did expect that core distribution over time may decrease and the mix may change and a percentage of the business is going to increase towards rentals. We like that. That's strategic for us, and we'll keep that going. We have low margin and what we used to call reseller business in the core distribution channel, and it's just not something that we spend a lot of time thinking about or investing in, and we expect that number to tweak its way down over time, but to be supplemented and substituted for the higher margin, higher growth rental business. We're going to continue down that path. We like it.

[Greg Palm, analyst]

Is it fair to say that you're maybe walking away from some of that business on purpose that low-margin business? Or is it just more of a, hey, we're not really putting any resources focused on it. So it may just sort of doing the longer time.

[Lee Rudow, executive]

Yes, I think the latter. We're not going to walk away from business. We never walk away from our customers when they have needs, but we're certainly not allocating additional incremental resources to low margin, let's say, for example, like I just pointed out, resale business or channels that aren't as profitable. We're allocating resources towards a high-margin rental business. And we don't lose much in terms of that ever important connection. In fact, we don't lose anything, in my opinion, and the connection between services, on the rental business, same customers, and we always going to get that crack in that door so that we can walk through and try to gain service business. So that -- nothing has changed in that respect, Greg.

[Operator]

Next question comes from the line of Ted Jackson with Northland Securities.

[Edward Jackson, analyst]

So I'm going to just jump over into let's talk about services gross margins because I mean it's a clear bright spot for Transcat and something you should be proud of and I know you are. Can you maybe flesh out what's driving a lot of the margin improvement. I mean, in the press release, you talked about productivity improvements and you talked about automation and maybe put some meat on the bones with regards to some of the projects and programs that you are using to drive that margin improvement and things in terms of projects and programs in the future that will continue to drive it going forward. And then I think I have a follow-up after that.

[Lee Rudow, executive]

Yes. This is Lee. I'll take a stab at this, and Tom can make sure I don't miss anything because there are a lot of things in play here, and I'll try to capture and highlight some of the big ones. Automation is important. We launched this initiative, I want to say, maybe 3, 4 years ago, at least that feels about right. For the first couple of years, people had asked how far along are you? I'd say, "Well, we're in the first inning, second inning". I think today, I would characterize that as we're in the fourth inning. We used to have automation in terms of percentage of our calibration. We don't get into a lot of detail around that, but mid low single digits. And now it's in the 20% plus range. And so there's a lot of automation that has taken place, and it's arduous, and it's difficult. There's a lot of programming. But once you get it done, you can capitalize on it over a long period of time. And that's kind of what we're doing.

so there's still runway there that's significant, and we're steady progress. We're pleased with it. And you always want it to be faster than it is, but it's making a dent in the initiative and we're increasing margin. It's an inflection point in this business, right? So that operating leverage. And as you get organic revenue growth, over time, aside from a step-function investment here or there, that's going to improve your margins. So that's definitely playing a role. And we've done a lot of work. We have a new Chief Operating Officer, and we've really dug into -- to the labs and trying to make them more efficient, improve processes, and we've really made some gains in terms of how we get products through our lab, onto the bench, off the bench, build quicker, better turnaround times. These are all things that eventually lead their way to margin and also lead their way to strong organic growth because you have a higher level of customer satisfaction with better turnaround times. These are all the things we're working on. And I think they all contribute, Tom, maybe...

[Thomas Barbato, executive]

The other thing I would just add, right, is that, when we talk about productivity and automation and the benefit that we see in margins, there's also another benefit that we get, right, as it puts less dependency on additional resources to get the incremental work done, which I don't want to lose sight of, right, because technicians are our most important asset and being able to do more work with the same number of people is extremely valuable. So I just want to make that point as well.

[Edward Jackson, analyst]

Well, that's good because you know Tom, that's a great segue into my next question. and that has to go with labor and your labor needs. And I think you might have gotten into it a bit. But as Transcat continues to get big, it clearly means that you need more technicians. I mean there's always been an issue in terms of your ability to get in that kind of labor, and that's why you started your training program, so you could develop your own talent, grow your own wood, if you would. Like where is that in terms of an issue for Transcat, maybe an update with regards to some of your training programs and the technicians that you put through it. And maybe -- I don't mean maybe you kind of answered it already, but what -- where do you see that in terms of your needs and choke points going forward?

[Lee Rudow, executive]

So Ted, I've been in this business for coming up about 40 years. Labor, technical labor has always been an issue. It always will be an issue. And you're right, that's why we started Transcat University. That's why we decided we have to train our own technicians. And if and when we do, and we are doing it, it will be a differentiator because we'll have labor when and where we need it. Now that's not always the case. It's not as easy as I make it sound.

But we're -- we try to position ourselves better than the competition so that we can compete better and we can win more and we can win the jobs that we want. So always a challenge, no question. But in there also lies the opportunity, right? So if you can overcome it, and you can get this kind of training program going and I expect that program to get better and better over time, more efficient, more effective over time. still relatively new, but I like the returns. We like the returns, and I see that is continuing. Now there are other ways, too. We talk about, as Tom mentioned, the more automation you do, the more you go kind of from tech to operator. I mean 1 day, there will be more robotics, which takes you from operator to robots. I mean, there's all kind of things that you can do longer term. We're focused on those things. But when you allocate resources, the best place is to make sure you have the labor where and when you need it. And that's what we're doing in Transcat University. I see that continuing.

[Edward Jackson, analyst]

Okay. And then my last question is just on -- it's a topic that used to get mentioned a lot, it doesn't be come up quite as often. But just on the customer based kind of labs, can you give us an update on kind of like, I don't know, how many CBLs you have at this point. What the pipeline looks like, kind of what's kind of going on with that in terms of a growth driver for service revenue for you over the coming quarters and years?

[Lee Rudow, executive]

I would characterize our client-based labs as steady. So we still have in the mid- to upper 20s as a round number for the number of locations we're actually in with embedded technicians with an embedded lab. Different times, that business sort of ebbs and flows, and it's usually a byproduct of labor shortages and our customers' inability or their challenges that they have with finding the labor they need when they need it.

So right now, we have a pipeline with a significant number of CBLs in them. But when you look across our pipeline, our portfolio, we've got everything from transactional to core small, core medium, core large, strategic and then CBL. So it's just 1 of the 6 service channels. They tend to be larger accounts. But I think that I would say it's steady and stable is how I describe that. It's not on the uptick, but it's not declining either. So it's kind of in a steady state.

[Operator]

Next question comes from the line of Martin Yang with Oppenheimer & Co.

[Martin Yang, analyst]

Lee, I wanted to ask you about your updated view on your addressable market. In the past, you have updated numbers such as $1.6 billion for U.S. calibration services. Now with the bigger rental business, asset management as well as Becnel's decommissioning services. How do you think about your service addressable market in the U.S.? Do you have an updated number for us?

[Lee Rudow, executive]

Well, in terms of addressable markets, in general, first, let's make clear that when we -- when we expand our addressable markets, we're always going adjacent to what we do. We want to stay in pretty close proximity to our core business which is calibration services. So today, we're always looking to expand where it makes sense for the business where we get recurring revenue streams where there's a demand, where there's regulation, you saw that with Becnel. If there's a margin play, you saw that with Axiom. And so with NEXA, you saw kind of a combination of value prop enhancers around calibration. I think Martin, there are opportunities to expand our addressable markets to the house next door and sometimes maybe the house right next door to that. We're going to stay disciplined. We've always been disciplined around our acquisition strategy.

And that's not going to change. It's something that we talk to the board about. It's required from us and our shareholders expect that. So there are more addressable markets -- we expect to tap into them. They are likely to be the house next door because that's the way we approach it. And certainly, we look for all the attributes that are part of our acquisition strategy, geographic expansion, margin enhancers, adding expertise. These are some of the things that we'll continue to focus on when we look to expand our markets. I hope that added some clarity for you.

[Martin Yang, analyst]

Got it. And my next question is about gross margins. So when you look at the 2 different segments, they are almost at parity now. And how do you think about the difference in margins are? The convergence of gross margins between 2 segments in the medium to longer term.

[Lee Rudow, executive]

So Tom, help me out with this one. But we've guided towards service gross margins being in the mid to upper 30s for now, right? We have pretty good sight lines, as Tom would say, to get to that range and continue the improvement in margins over time. I don't like to really talk about it quarter-to-quarter.

There are some quarters where we have outstanding results like this one. And there's some where you may be flat and somewhere you may have 20 basis points. But over time, we can see -- we see that continuing because there's a lot of runway left on the initiatives around that. And then, of course, the inherent leverage that we talk about. In distribution, the margin increase is driven by rentals. And we know that and we like it, and we go back to 2016, we didn't have that business.

And distribution was a low 20s, 20% business. So that's changed drastically for the better. And it even surprises us to a certain degree. If you go back 5 or 6 years ago, would we have seen the parity between the 2 margins, I would have not bet on that. But through creativity, through being allocating resources properly, getting the right leaders here, we've made something really significant out of that business.

And it has scalability, which we like, and it's connected to service. So I think that margin will increase over time also as the percentage of rentals, it becomes higher within distribution, which we expected to do. So Tom...

[Thomas Barbato, executive]

No, I would agree with that. I would just we got to keep in mind that in August, we'll kind of lap the Axiom acquisition, right? And so some of that lift that we're getting from last year's August Axiom acquisition will go away. But on a go-forward basis, I would expect that the 2 margins will kind of track in a similar fashion going forward.

[Operator]

Next question comes from the line of Ted Jackson with Northland Securities.

[Edward Jackson, analyst]

I just have a follow-up question driven by the last line of questioning. When you look at the historic trends of the business and the seasonality of that typically Transcat sees the second quarter margin, particularly as it relates to services revenue stronger than the first quarter. Do we expect that to be the same this year?

[Lee Rudow, executive]

Do you want to take that one or?

[Thomas Barbato, executive]

Yes. We're not expecting, Ted, anything really significantly different in our -- from a seasonality standpoint. So I think it would be safe to assume that.

[Operator]

[Operator Instructions] Ladies and gentlemen, there are no further questions at this time. I would now like to turn the floor over to Lee Rudow for closing comments.

[Lee Rudow, executive]

Okay. Well, thank you all for joining us on the call today. We certainly appreciate your interest, your continued interest in Transcat. We will be attending the Oppenheimer 27th Technology Internet and Communications Conference, it's going to be on August 12. So feel free to sign up to talk to us then and reach out. Otherwise, you can really check in with Tom or me at any time. So we will hear from you. We look forward to talking to everybody again after our second quarter results. And thank you again for participating. Take care.

[Operator]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.