Good evening. Welcome to the Transcat, Inc. Third Quarter Fiscal Year 2021 Financial Results Conference Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Craig Mychajluk, Investor Relations for Transcat. You may begin.

Yes. Thank you, and good morning, everyone. We certainly appreciate your time today and your interest in Transcat. With me here on the call today, we have our President, Chief Executive Officer, Lee Rudow; and our Chief Financial Officer, Mark Doheny. After formal remarks, we'll open the call for questions. If you don't have the news release across the wire after markets yesterday, you can find it at our website at 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 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 law. Please review our forward-looking statements in conjunction with these precautionary factors. I'd like to point out as well that 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 have 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?

Thanks, Craig. Good morning, everyone. Thank you for joining us on the call today. Some of you have already met with Mark, talked to Mark, but being that this is his first earnings call with Transcat, I'd like to introduce him before we move on to the third quarter results. Mark was named CFO in November, succeeding Mike Chitter, who retired at the end of the calendar year. The transition went very smoothly. Mark is well versed in our business and strategy and is an excellent addition to the executive team. We anticipate Mark's extensive background in M&A and operations will be of great value in the execution and acceleration of our strategic plan, including the continued investment in technology and technology-based infrastructure. Turning to our third quarter results. We are pleased by our performance, especially given the continued adverse conditions caused by the COVID-19 pandemic. The team's responsiveness and dedication throughout the pandemic has been impressive, and the business continues to effectively provide critical support and service to many essential businesses, including the research, manufacturing, and distribution of the COVID-19 vaccines. In the third quarter, we achieved consolidated top-line growth, driven by 12% growth in our service segment, 5.9% of which was organic. The growth represents our 47th consecutive quarter of year-over-year service growth. That's nearly 12 years. The business continues to demonstrate resiliency; our unique value proposition continues to resonate. Pipet.com, which we acquired in February last year, continues to perform well. And together with the recently acquired biotech services has strengthened our life science service portfolio and geographic footprint. It is our expectation that the two complementary businesses will be integrated quickly and achieve both sales and operational synergies over the next several quarters. Service segment continues to deliver outstanding margin performance. In the quarter, gross margin increased 590 basis points, and operating margin increased 570 basis points. The increase in service margin was primarily driven by higher technician productivity and operating leverage on organic service growth. Distribution revenue was down 8.6% versus the prior year. We anticipate that distribution will continue to be negatively impacted by the current pandemic. Focus will remain on capitalizing on our unique position in the market by leveraging every distribution interaction and every distribution lead to organically grow our service business. On the rental front, the channel performed very well, up 12% in the third quarter. Operating income for the third quarter exceeded expectations and increased by 20% over the same prior year period. To date in fiscal 2021, we have achieved outstanding cash generation of $15.6 million, driving the reduction of debt and supporting continued investment in technology, infrastructure, and growth opportunities. And with that, I'll turn things over to Mark.

Thanks, Lee, and good morning, everyone. It's great to be with you all today, and I hope you are keeping safe and doing well. I'm certainly excited to have joined the Transcat team at such an exciting time in the company's history, and I look forward to contributing to our continued growth and success. I will start on Slide 4 of the earnings deck, which provides detail regarding our revenue on a consolidated basis and by segment. Consolidated revenue of $44.1 million was up 2% from the prior year, and we showed growth for the first time this fiscal year, a notable achievement given the ongoing impact of the pandemic. Turning to the segment performance. As Lee mentioned, strong service segment growth of approximately 12% was one of the highlights of the quarter, with about half of that segment's growth coming organically and the other half from acquisition growth. With regard to the acquisition growth, about $1.3 million of revenue came from pipet.com and less than $1 million, about $1.1 million came from biotech, a little under $100,000. As you know, biotech closed toward the end of our fiscal quarter. I will mention that we are approaching the one-year anniversary of our acquisition of pipet.com, which was acquired on February 21 last year. This will, of course, impact the level of our year-over-year acquisition growth beginning in our fiscal fourth quarter. Turning to Distribution. Segment sales of $19.3 million were down approximately 9% from the prior year, in line with our expectations. As Lee mentioned in his opening remarks, this segment continues to be significantly impacted by the pandemic as certain end markets that we participate in continue to be soft. Turning to Slide 5. Our consolidated gross profit was up 13% from the prior year, and our gross margin expanded 250 basis points to 25.5%. Service was up an impressive 590 basis points to 27.9% on continued traction from our technician productivity initiatives, tight cost controls, operating leverage on our costs that are more fixed in nature, as well as strong performance at pipet.com, which has a higher-margin profile. Distribution segment gross margin was down 150 basis points from the prior year, which reflects the lower volume and reduced co-op advertising and rebate programs as vendors continue to look for ways to lower their costs. Turning to Slide 6 and our overall operating performance. Consolidated operating income of $2.5 million was up 20% from the prior year and exceeded our expectations. Service segment operating income increased over $1.5 million and 570 basis points as a significant portion of the gross profit increase fell through to operating income. Distribution operating income of $0.6 million was easily our best quarter of fiscal year 2021, but was still down $1 million from the prior year quarter, largely due to the lower gross profit. Turning over to Slide 7. Q3 net income increased 19%, and our diluted earnings per share of $0.23 were up $0.03 from the prior year, a result of our strong operating performance. Our effective tax rate was just north of 23%, and we continue to expect our fiscal year tax rate to range between 22% and 23%, which includes federal, various state, and Canadian income taxes. Slide 8, where we show our adjusted EBITDA and adjusted EBITDA margin. Among other measures, we use adjusted EBITDA, which is non-GAAP, to gauge the performance of our segments because we believe it is a good measure of our operating performance and our ability to generate cash. A reconciliation of adjusted EBITDA to operating income and net income can be found in the supplemental section of this presentation, which, as a reminder, is posted on our website. Consolidated adjusted EBITDA was up 12% in the quarter, and our adjusted EBITDA margin was 10.4%. And we were particularly pleased with the service segment's 80% increase in adjusted EBITDA to $3.4 million or 13.9% of sales. Moving to Slide 9, where we provide some detail regarding our cash flow. Year-to-date net cash provided by operations nearly doubled to $15.6 million and was a function of our improved EBITDA and reductions to working capital. Year-to-date capital expenditures were $4.3 million, and were largely focused on technology infrastructure, service segment capabilities, and rental pool assets. With regard to capital expenditures, we now believe our full fiscal year 2021 CapEx will be in the range of $6 million to $6.5 million, which is a more narrow band versus the $5.5 million to $6.5 million range we had communicated at the end of our fiscal second quarter. Slide 10 highlights our strong balance sheet. At quarter end, we had total net debt of $23.4 million, which was down $6.4 million from fiscal 2020 year-end. With this reduction, our leverage ratio also came down and was 1.24. This is calculated as the total debt at the period end divided by the trailing 12 months adjusted EBITDA, including giving credit for any acquired EBITDA. And finally, we had $26.8 million available under our revolving credit facility at the end of the quarter. Lastly, we do expect to file our Form 10-Q tonight after the market closes. And with that, I will turn it back over to you, Lee.

Okay. Thank you, Mark. As we progress through the fourth quarter and into fiscal 2022, we will continue to focus on the execution of our strategic plan. We expect the combination of mid- to high single-digit organic growth and acquired growth to drive overall double-digit service growth. Consistent with our strategy, we expect the bulk of our service growth to be generated in regulated industries, including life sciences, aerospace, and defense. Throughout fiscal 2021, operational excellence and technology have helped drive significant improvement in our service gross margin. We expect the margin expansion to continue over time as we increase the level of technology, including automation into our network of 42 calibration labs. We also expect emphasis to continue on the development and acquisition of talent across all levels of the organization to guide Transcat through our next phase of growth. And I will close with an update on our acquisition program. As anticipated, our M&A pipeline is very active. Our acquisition objectives are supported by a strong balance sheet and our ongoing investments in the development of integration tools. Both will enable us to execute and capitalize on an increased number of opportunities going forward. While we are seeing some upward trend in historical multiples, there is no shortage of opportunities that are within parameters we believe are competitive, accretive, and offer attractive internal return rates. As we stated in our earnings release, we expect consolidated operating income in the fourth quarter of fiscal 2021 to be similar to the fourth quarter of fiscal 2020. Our stability and strong performance in an environment that continues to be challenging reinforces our strong position in the markets we serve. Looking ahead, we believe the combination of our talented team, our strong balance sheet, and our demonstrated ability to execute our strategic plan positions Transcat to perform well as we drive hard to the finish line in fiscal 2021 and beyond. Operator, with that, we can open up the line for questions.

At this time, we will be conducting a question-and-answer session. Our first question is from Greg Palm with Craig Capital Group.

Mark, congrats on the good quarter here. So maybe we start with service segment and the return to organic growth. I'm curious if you can maybe go into a little bit more detail on the primary drivers of that? I mean is it outsized growth in life sciences? Is it just a continued recovery elsewhere? Maybe there's some share gains in that?

Yes, Greg, I think it's a combination of factors. We noticed some flow-through from pent-up demand. The first few quarters in service were relatively flat, but we knew we had a solid pipeline and were having productive conversations. This led to some of that flow-through. Overall sales activity has increased, and our organic pipeline is strong. So it’s not surprising that we're seeing growth this fiscal year. I believe this trend will continue in the next few quarters, and that’s how I would describe the situation.

Yes. Do you get the sense that there's still a decent chunk of pent-up demand out there? And I guess, what's your confidence level that you can sustain this kind of mid- to high single-digit organic growth rate, even in sort of a challenging and volatile end market scenario where we're still in?

Yes, I think it's relatively high. I mean the one thing that leads me to make that kind of comment is we've got a number of large opportunities that have been working their way through the pipeline throughout the pandemic. And while we won a number of them, there are still an interesting number of opportunities still out there. I think we're going to win our percentage of those, and we have a high confidence level. In addition to pent-up demand and in addition to just general levels of calibration picking up based upon pipeline activity, I think the combination of those three things drive our confidence level and make the statements we do around the organic growth.

We're nearly a year into the pandemic, and I'm interested in the long-term trends that are starting to show up in the service sector. I'm wondering if there's been an increase in delivery services compared to traditional on-site or in-house options. How many of these new trends do you think will persist, and what potential impacts could they have on profit and loss?

It's an interesting question. I'm not ready to comment on any long-term changes resulting from the pandemic. We've all adapted our businesses accordingly. There have been fewer on-site visits, less pickup for delivery, and more equipment being sent to us. I believe we will eventually return to normal rates. This year, we didn't see a continued growth trajectory in client-based labs (CBLs). We had a strong two-year period where we added a significant number of new CBLs. There are larger opportunities in the pipeline, but they came to a halt during the pandemic. I expect that they will resume in the near future. Other than that, I think the business will return to a normal state eventually, and I don't identify any long-term lasting effects at this time.

And our next question is from Kara Anderson with B. Riley Securities.

I jumped on a little bit late. So sorry if you already discussed this, but can you talk about the nature of the Biotech acquisition and how it seemed to be? Why you saw that small attractive calibration services when you wanted to own?

Right. Absolutely. So about a year ago, the best place to start is with pipet.com. about a year ago, we acquired pipet.com. Both companies, biotech and pipet.com do pipetting, almost not exclusively, but it's the lion's share of the work that they produce. The difference between them and why we were interested in biotech is because pipet.com is generally a Boston-based operation that does most of its work in the New England region and very little, if any, on-site work. So if people want to send pipets from anywhere in the country, they can send them, but most of their work comes from New England. Biotech is a small company, you are right. But the entire company is based on on-site services for pipetting. Combining the biotech on-site service with what we call the depot, New England based pipet.com, gives us a powerful combination. That's why we talk about sales synergies and getting to them quickly. There are even cost synergies in this one because we're going to combine these operations, and there are probably some redundancies in the administration of the combined business. So it was small. We never would have bought it as a standalone, but it's a bolt-on to pipet.com. It makes a lot of sense for us.

And are there any other technical capabilities that you are looking for, where you can kind of do these acquisitions where you just find other ones to build on and you kind of just build out a new category, if you will?

Well, one of our three drivers when we look at acquisitions in general is to increase our capabilities or bring on expertise we don't have today. That's a main driver in addition to expanding our geographic footprint and just in general, bolting on operations when they're close in vicinity to an infrastructure that we already have in place. Yes, there's a list, and it's not appropriate to go into the details on this call, but you've got disciplines and variables and parameters that we don't measure today that we actually outsource. We have about 85% to 90% of our own work, but we still outsource about 15% of that work. And all companies do that. Nobody does 100% because of the economies of scale and such. But yes, I would think that we always look at that list whether it's flow or different technologies that are new that come out; we always want to bring them on board and make them core. One way to do that is through acquisition when it makes sense.

Got it. And then just one last relatable question about kind of M&A. Are you seeing a change in the size of opportunities at all?

So a part of our pipeline, which I alluded to on the call, is very robust. Part of that pipeline, I would characterize as fitting sort of our core historic pipeline, our sweet spot, much of the same, if you will. I would also say that what makes this pipeline a little bit different is we are starting to see activity levels and opportunities present themselves at sort of the next level up in terms of size. So that is something we thought we would encounter, and in fact, we are. It's kind of a combination of the historic pipeline and some new, somewhat larger opportunities as well.

Yes. And just to add to that, I think adding Jim Jenkins four months ago to really dedicate a lot of his time to developing that pipeline and the relationships we need has really improved the pipeline in a lot of areas, even in the last 120 days since I've been here, Lee.

Good timing with the market, making that investment here.

And our next question is from Scott Buck with HC Wainwright.

Lee, you mentioned earlier in the call the kind of mix in the services segment between mail in and on site. Can you remind us what the margin differential is between some of those different components?

Let me address that. The most profitable aspect for us is our depot work, which we refer to as in-house. This involves customers sending their equipment to us, resulting in minimal additional costs. For example, if ten units come into the lab, there’s no need for extra capital or hiring; it simply translates to high incremental tech revenue. We also offer pickup and delivery services, where we collect equipment from the customer and bring it back to the lab. While this service shares a similar profitability profile to the in-house work, it does incur additional costs due to the pickup and delivery process. Additionally, we have on-site work, which entails sending a crew and various assets to the customer’s location. This can vary widely in terms of scale and expense. Client-based labs are slightly less profitable than on-site work but play a crucial role in our business with a high lifetime value. In my eight or nine years here, we have never lost a client-based lab that we established.

Great. That's very helpful. Second, how do you guys think about long-term margin targets in the services segment? I know you're undergoing some technology improvements and additional automation. Over the next 5 years, can margins in this segment get to mid-30s?

Yes, I think mid-30s is not an unreasonable target at this point. We started this campaign of margin improvement in technology back when we were, I want to say, at a 24% gross margin. We discussed a two to three-year journey to get closer to 30%. And so we're there, right? It won't be every quarter that we're at 30%. We did a little higher this past Q3, a little lower. But we're in that range. I think when we look at the business and the margin profile and what we have on top in terms of investments, I think we're thinking the same as you suggested. Mid-30s is not unreasonable. It's not going to happen overnight. It's not going to happen every single quarter. But I think we'll be up and to the right, heading to that range over the next couple of years, for sure.

And our next question is from Mitra Ramgopal with Sidoti.

First, I would like to understand, Lee, regarding the investments you're making in technology, how advanced are you in achieving your goals? Also, concerning the recruitment of technicians, how has the market been in terms of finding talent without needing to exceed budget expectations? Does this situation reflect your confidence in the business as you plan for the next few years while making these additions?

Well, from a technology perspective, Mitra, we've been on a three to four-year journey of starting from an infrastructure that lacked some of the technology advancements that we needed. We've been working hard to catch up, and I think the team has done a really good job. We've hired some great people who have a solid understanding of where we are, where we need to go, and how we're going to get there. But there's a lot still to do. Yes, we love the margin improvement and tools we've built for integration. If I were to use a baseball analogy, we might say we're probably in the fourth inning at best in technology. So there's a lot of upside there. Regarding technician availability, with flat organic growth for the first couple of quarters, we weren't aggressive about recruiting new technicians. We had the right number to service that work. The pipeline is healthy. We saw organic growth in the third quarter and anticipate continued organic growth. I think we will need to hire technicians at some point as part of our growth plan. I'm confident we will get it right.

Okay. And then quickly on the life science business. I was just wondering if you're seeing heightened interest or conversations because of the pandemic maybe driving developments for vaccines and other things. Just curious if you're getting any tailwind out of that.

It's difficult to tell because we were always life science oriented. We do business with most pharmaceutical companies and medical devices; that's always part of our normal business. I would say for the most part, the stable revenue this year has been due to our core life science business. No doubt we're dealing with pharmaceutical companies involved in vaccines. But I don't think it's been all that much in terms of incremental demand. I think it’s just the business we normally do. These companies have held stable and resilient, so we've been stable and resilient. I anticipate once we get beyond COVID, that will create upside for our business because the general industrial market will open back up. We've done very well in life sciences. Still, I think there's upside once the general market returns.

And I would just mention, too, that there are pockets within life sciences, like, for example, the pipet.com business, that have definitely been impacted favorably over the last 11 months since we've owned them. So we have pockets of it.

And our next question is from Dick Ryan with Colliers.

Switching to maybe distribution. Are you seeing any green shoot opportunities in that part of the business? I know oil and gas has been negatively impacted. Are you seeing any positive momentum emerging?

Yes, it's moderate at best. We experienced a significant number of back orders leaving the third quarter and extending into the fourth quarter. I believe that COVID-related supply chain slowdowns will improve in the fourth quarter. However, your question pertains to the overall environment. I think there will be some pent-up demand in the industrial sector for distribution, although we haven't seen much of it yet. We expect it to come. The business has been consistent; it is currently down single digits from last year, but it remains stable. As I mentioned in the earnings call, we will continue to leverage those interactions, which is our primary focus.

Okay. Maybe one for Mark's direction. OpEx, you probably had some savings early on with less travel and other pandemic limitations that you were able to realize. Are any of these costs kind of coming back into the fold? And maybe how should we look at OpEx going into fiscal '22?

Yes. And it's a great question, one we spend a lot of time understanding, especially the service gross margin. How much is sustainable and how much might change when we start traveling again? I would say there has been little of that going on; when we do begin traveling again, there'll be a slight uptick in some of those discretionary costs, travel probably being the largest. But it’s not something that I would highlight as a significant driver of some of our operating income and gross profit improvements.

Okay. Good. Congrats on the good execution. Thank you.

And our next question is from Chris Sakai with Singular Research.

Just had a question on distribution gross margin. I just wanted to know if you could shed some light on there when you guys might see some improvement?

Yes. That's a tough one to call. You've got a couple of things happening there. Of course, the lower volumes, which we talked about due to the market. Our vendors have reduced their co-op advertising and rebate programs. We're working closely with them. That’s really the main contributor to the decline in margins. Depending on how things progress with the pandemic, it's tough for us to plan for any significant bounce backs at this point. Our teams on the distribution side are working closely with the vendors to find opportunities to help the margins.

We have reached the end of the question-and-answer session. And I'll now turn the call over to management for closing remarks.

Okay. Well, thank you all for joining us on today's call. We appreciate your continued interest in Transcat. Feel free to check in at any time with me or with Mark. We look forward to talking to everybody again after the fourth quarter results come out. Again, thanks for participating.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.