Q3 2024 Transcat Inc Earnings Call
Participants
Tom Barbato; CFO; Transcat Inc
Lee Rudow; President & CEO; Transcat Inc
Greg Palme; Analyst; Craig Hallum
Scott Buck; Analyst; H.C. Wainwright & Co., LLC
Martin Yang; Analyst; Oppenheimer & Co., Inc.
Presentation
Operator
Greetings, and welcome to Transcat Inc. third quarter fiscal year 2024 financial results. At this time, all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded, and it is now my pleasure to introduce Tom Barbato, Chief Financial. You may begin.
Tom Barbato
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, Mark Heaney, and we'll begin the call with some prepared remarks, and then we'll open the call up for questions.
Our earnings release crossed the wire after markets closed yesterday, both the earnings release and the slides that we will reference 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 in 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 provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release.
With that, I'll turn the call over to Lee.
Lee Rudow
Thank you, Tom. Good morning, everyone. Transcat continues to make excellent progress on key initiatives across our entire business portfolio. The operating results for the first three quarters of fiscal 2024 have been outstanding.
Turning specifically to the third quarter, consolidated revenue grew 14% to $65.2 million, driven by strong demand for our broad suite of services. Consolidated gross margin expanded 350 basis points to 32.1% and was driven by margin expansion in both our service and distribution segments. Adjusted EBITDA grew 39% from prior year to $9.1 million and let me spend a few minutes on each of our operating segments will start with service. Consistent revenue growth continues to be fostered by recurring revenue streams in highly regulated markets, strong customer retention and a differentiated value proposition. Transco has built a very strong reputation for execution and delivering services that consistently meet the needs of our demanding customers. We continue to reside with the cost of failure is high and our services are critical component of our customers' processes. To today, approximately 60% of our service business comes from the highly regulated life science sector because of the criticality of our services. This is not an easy place to be, but it's where we want to be. It's where our tag line calibrated by Transcat resonates the most in the third quarter. We grew overall service revenue by 15%, 9% was organic growth. This represents the 59th straight quarter of year-over-year service revenue growth we have grown in the high single digits or better for each of the last two years, and we anticipate doing the same in fiscal 2024.
In addition to revenue growth, we continue to focus on margin expansion. Strategically, we focus on operational excellence, which includes increased levels of automation, robotics and process improvements. In the third quarter, service gross margin increased 250 basis points versus prior year to 32.5%. And as always, margin gains are supported by strong organic growth and the associated operating leverage. That's inherent in our service segments.
Turning to distribution, the growth of our rental business further accelerated by the Axiom acquisition drove gross margin expansion of 530 basis points from prior year third quarter. In fact, the transformation of our distribution segment by growth in rentals has driven approximately 1,000 basis points of gross margin expansion since 2016 and a continued mix change towards rentals provides further opportunities to improve distribution margins as we enter fiscal 2025 and beyond. Internally, we say all roads lead to calibration and our distribution and rental businesses continue to be an important generator of leads for our calibration services business. Overall, as we mentioned in the earnings release, we are extremely pleased with our performance in the third quarter of fiscal 2024, our adjusted EBITDA increase of 39% highlights Transcom's ability to deliver on the high expectations our shareholders have for consistent revenue and margin growth. Furthermore, the strong performance of recent acquisitions demonstrates the effective allocation of capital. We have successfully identified, acquired and integrated dynamic companies that align with our strategy and our disciplined approach drives differentiation. Our integration process enables new acquisitions such as such as the recent deal with Axiom to very quickly be accretive to the overall company. We ended the third quarter well positioned financially with strong operating cash flow generation and balance sheet capacity, both of which allow us to actively pursue the M&A opportunities that comprise our current robust acquisition pipeline and with that, I'll turn things over to Tom for more detailed review of our third quarter financials.
Tom Barbato
Thankfully, 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 third quarter of fiscal 2024. In the third quarter, consolidated revenue of $65.2 million was up 14% versus prior year on service segment strength and growth in our distribution business.
Looking at it by segment, service revenue growth remained very strong at 15% with 9% of the growth coming organically and the other 6% from acquisitions.
As Lee mentioned, demand remained strong in the services segment as our differentiated value proposition continues to resonate well with our customers.
Turning to distribution, revenue of $23.7 million grew 10% from the prior year. We continue to see growth in the higher-margin rental business which also benefited from the Axiom test equipment acquisition.
Turning to Slide 5. Our consolidated gross profit for the third quarter of $20.9 million was up 28% from the prior year and our gross margin expanded 350 basis points in the third quarter. Service gross margin expanded 250 basis points. The service margin increased further reflects our ability to leverage organic service growth, higher levels of technician productivity and our differentiated value proposition.
Distribution segment gross margin of 31.5% was up 530 basis points, driven by a larger mix of higher margin rental revenue, including impacts from the previously mentioned equity acquisition.
Turning to slide 6, Q3 net income of $3.3 million increased 109% from prior year, driven by strong operational performance and also benefited from a material reduction in interest expense. As a reminder, early in the third quarter, we completed what we believe to be a successful secondary offering, which allowed us to pay down our revolving credit facility in full, which drove a significant reduction in interest expense. Diluted earnings per share came in at $0.38, up 81% versus the same period in the prior year. We report adjusted diluted earnings per share as well to normalized for the impacts of upfront and ongoing acquisition related costs.
Q3 adjusted diluted earnings per share of $0.56 increased $0.21 or 60% from the prior year.
Flipping to Slide 7, where we show our adjusted EBITDA and adjusted EBITDA margin. We use adjusted EBITDA, which is a non-GAAP, 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 on our acquisition strategy. This metric becomes even more important to highlight as it does adjust for one-time deal related transaction costs as well as increased levels of noncash expenses that will hit our income statement from acquisition purchase accounting. With that in mind, third quarter consolidated EBITDA of $9.1 million was up 39% from the same quarter in the prior year and adjusted EBITDA margin expanded 250 basis points. Both segments had 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 free cash flow significantly improved from last year as cash from operations was $12.9 million higher than prior year. Third quarter capital expenditures were $800,000 higher than prior year and continued to be centered around service segment capabilities and technology, including automation investments in our rental asset pool and further growth projects.
Slide 9 highlights our strong balance sheet. At quarter end, we had total net cash of $30.5 million with a leverage ratio of 0.12 times and the full $80 million available under our credit facility. Lastly, we expect to file our Form 10 Q on January 31st with that, I'll turn it back to you leave.
Lee Rudow
Thanks, Tom. The future remains bright for Transcat. Transcat portfolio of services is both deep and broad and positions Transcat as a true leader in the highly regulated industries we serve. Our focus on the customer experience is a top priority as we strive to increase our long-term competitive advantage as we work our way through the fourth quarter of fiscal 2024, we continue to be positioned to deliver high single digit to low double digit organic service growth for the full fiscal year over time, we also expect continued and sustainable gross margin expansion. We believe the Service segment has a substantial runway ahead for growth, both organically and through acquisitions. Our active and diverse acquisition pipeline enables strategic accretive acquisitions that drive synergistic growth opportunities and will be a key component of our go forward strategy.
As I close last quarter's earnings call by saying at Transcat we expect to get bigger and we expect to get better. That's the Transcat way.
And with that, we can open the call for questions. Operator?
Question and Answer Session
Operator
Thank you. Ladies and gentlemen, at this time, we'll be conducting a question and answer session. If you'd like to ask a question, you may press star one on your telephone keypad. Confirmation tone will indicate your line is in the question queue. You may press star two. If you would like to remove your questions For participants using speaker equipment, it may be necessary to pick up your hands for pressing the star.
Our first question comes from the line of Greg Palm with Craig-Hallum. Please proceed with your question.
Greg Palme
Hey, hi, morning, everyone. Thanks for taking the questions. And congrats on the results here thinking.
Operator
Hey, thanks, Greg.
Greg Palme
I wanted to start with gross margins, particularly in distribution. Can you quantify maybe the mix tailwind from from rentals? And also trying to get a sense for what the positive impact was from, whether it's exiting or deemphasizing some of the lower-margin reseller sales as well. So I don't know if you can quantify either of those or talk about that a little bit more detail?
Lee Rudow
Yes, Greg.
Tom Barbato
I mean, we're not Tim. We're not prepared to go into that level of detail. What we will say though, is that that the focus on rentals continues to to pay returns for us and the acquisition of axiom that we did back in August, some has really gone well. The integration has gone well, and I think we're kind of, I guess, ahead of the integration curve on that one a bit. But as mix continues to change going forward and mix continues to shift more towards rentals. We'll expect to see margins continue to move up and to the right in the distribution segment.
Lee Rudow
Okay.
Greg Palme
I mean, any reason not to extrapolate what you saw this previous quarter and what you expect going forward? I mean that that distribution margin was obviously well ahead of kind of what you had expected, but I'm not sure if there's anything one-time in there or if it's just sort of the benefit of everything that you've been maybe sort of working for over the past couple of quarters?
Lee Rudow
Yes, Greg, I don't I wouldn't characterize as any one-time event that drove it. I mean, when we think about rentals, you think about mix and on in any given quarter in your 90 day increment of time, you're going to have a positive or sometimes have a bit a bit of drag based upon that mix. So we had a positive mix this past quarter we may have a positive mix the next quarter. But I think I think Tom's point is over time as much as the rental mix becomes a higher percentage of our overall distribution, we expect margins to continue to expand, and that's what we expect quarter to quarter. You may see another quarter like this one, we may be closer to 30%, but I think the bigger most important more important pictures, overtime rentals will continue to drive margins up as that becomes a greater part of our distribution mix. And just for lot of new shareholders. We have I mean, the strength of our brand is really an anchor for all of this. And when we started the rental business back in 2016, I mentioned 1,000 points again on margins. But we had we had the perfect infrastructure. We had the perfect position in the marketplace, and it was sort of the co-location of all these factors that help us helped us launch and drive this business. Now it's a more mature business and we understand it and there's acquisition opportunity. So you've got the combination of organic and inorganic. So I think we're positive for our outlook. But the quarter-to-quarter timing on we want to get too specific. We just don't have that kind of insight.
Greg Palme
Understood. Makes sense. And as it relates to M&A, can you talk about how the pipeline has evolved over the last a few years? And I'm really curious if your appetite around the type the kind of acquisitions the size, has that changed meaningfully recently, maybe the last couple of quarters and I think that's an accurate way to look at it.
Lee Rudow
We guided the market a few years ago, softly, we hired a vice president of business development to be more aggressive looking for these types of opportunities that would be strategically a good fit for the business we have integration teams in place due diligence teams in place. And so we're geared up and ready to kind of pick up the pace. And even the size of deals we showed that a little bit with Axiom. I think the pipeline that exists today also reflects that sort of an outlook. So I would expect the potential there as we go into the future to see bigger deals. But, you know, this is not something that should be a surprise. And this is something we've been talking about, I think for years of building up to the point where we are today, I think time will tell.
Tom Barbato
But I would just emphasize at least said that we've got it. We've got a really good process right and we make good decisions, and we've demonstrated that consistently over time. And our intent is to continue to stick to our process and the deals will happen when the deals happen Yes.
Lee Rudow
Okay.
Greg Palme
I will leave it there and best of luck going forward.
Lee Rudow
Thanks, Greg.
Operator
Our next question comes from the line of Scott Buck with H.C. Wainwright. Please proceed with your question.
Thank you.
Scott Buck
Good morning, guys. Appreciate the time, Lee, a little bit more on M&A. I'm curious what you're seeing in terms of pricing when you guys talk to folks and maybe what you're seeing from competitors in the market? Are they getting more aggressive on the acquisition front as well?
Lee Rudow
Right. We, you know, Scott, we have seen in the last couple of years more activity on the PE. side in terms of outreach to potential acquisitions. But literally, I think I'm comfortable saying this to date, it's very hard for us to point towards an acquisition that we wanted to make that we weren't able to make, whether it be price or some other factor on PE. is in this space. But we understand this is all we do, right? So we're intimate with these companies. We know the owners. We know the process, I think is very differentiated, which is what I tried to allude to in my earnings call. So so far, it hasn't had an impact on any company that we can point to that we wanted to acquire. So I don't see it changing anytime soon. There are some companies that have been acquired in this space, but they're ones that we've left behind because they can meet the criteria of our disciplined process.
Scott Buck
Great. That's helpful.
And then my second one, could you talk a little bit about what drives customers to the rental business versus your acquiring equipment and whether or not you know how sustainable that really is or whether we're just kind of in a peak macro environment that drives people to make that decision rather than another right was some of the factors include And I'd say, first and foremost, an urgent unexpected need.
Lee Rudow
When you think about rentals, you're thinking about someone needs equipment, but right now and didn't necessarily see it coming. So they turn to the rental market that would that would be a primary mover on. You also have the difference between CapEx and OpEx. And as you go through different economics, economic cycles, the macros are also the single cycle in and out as well a little bit, but those two sometimes balance each other off. I think the third factor is on the way we market rentals. I mean, we are we have become over the last I'm going to say, half a decade, last three to five years on. We're really adept at marketing, getting into the digital world with our brand with our offerings with our diverse value proposition and rentals as part of it. So I think rentals connects to service service connects to rentals distributions in between both that combination. A unique combination that we bring to market did we factor all three isn't the macros, the urgent unexpected need and the way we go about trying to grow our rental business. There's three factors, and I see that I don't see any major changes on the horizon that would change. We are we are thinking in terms of the consistency of that business.
Scott Buck
Great. I appreciate that. That's it for me, guys. Congrats again on the quarter.
Lee Rudow
Okay. Thanks, Vasco.
Operator
Our next question comes from the line of Martin Yang with Oppenheimer. Please proceed with your question.
Greg Palme
Good morning.
Martin Yang
Thank you for taking the question. I have First on CapEx. You referenced it the need to increase for rental of assets. And so the CapEx in speaking to a pickup quarter on quarter, is that associated with our expansion on the rental business? And then do we see should we see that as the goal for run rate or another step-up a more normalized CapEx after the acquisition?
Tom Barbato
Yes, I think I think, Martin, you know, some some of that I was specifically referencing the year-over-year increase that we saw in Q three and certainly rentals played a role in that as we continue to grow the rental business from, we'll continue to see an additional investment required in that space. It's just the nature of that that business, right. You've got to have the assets in order to grow the business, but it will be done in a very well-thought-out kind of methodical way and with a focus on assets that are going to drive the highest returns.
Martin Yang
Got it. Thank you, Tom.
My next question is on the lead generation potential between rental and distribution is one more effective than the other are, for example, has rental business a better lead gen tool than distribution.
Lee Rudow
I wouldn't characterize it that way, Martin, and I'm not sure we're prepared to rank the two. I would clearly with distribution. People are buying test equipment at some point. We'll have a need to have that test equipment service. So there's just such a natural connection there and some of them need the calibration done right upfront in order to put into service. So that's hard to get better than that. But with us with our rental customers to the degree that we're picking up test equipment users that we wouldn't otherwise have as a customer if we didn't have a rental program?
Yes, that will be incremental to the degree that our rental customers are a byproduct of our distribution customers, our installed base, then then it would be not incremental and I'm not sure it's any better than our core distribution. So I think they're both important, but you just got to love the connection between distribution and there's a really close connection from distribution to rentals.
Martin Yang
And Kelly, just a quick follow-up. So the for both rental and distribution are the equipment in both services recalibrating before you deliver to your customers?
Lee Rudow
Yes. One of the things that makes us unique in our rental program is when we get equipment in from our rental customers, we calibrate everything, of course, and that's easy for us to do. And I think it's easier than other in some of our competitors. But yet all equipments checked calibrated before it goes out to next customer. And in some cases, our customers who are renting equipment need need equipment that that is accredited. So we go through the uncertainty calculations as well. So that would all be part of our service done, frankly, that's off a mix.
Martin Yang
Okay. Appreciate it.
Operator
There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.
Lee Rudow
So this is Lee and I thank you all for joining us on the call today. We appreciate your continued interest in Transcat. Feel free to check in with us really at any time. Otherwise, we'll talk to everyone after we sent out the quarter results. Thanks again for participating.
Operator
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines.
At this time and have a wonderful day.
