Transcat Inc Q4 FY2025 Earnings Call

Greetings. Welcome to Transcat, Inc. Fourth Quarter and Full Year Financial Results Call for Fiscal Year 2025. This conference is being recorded. I am pleased to introduce your host, Tom Barbato, Chief Financial Officer. Thank you, Tom. Please proceed.

Thank you, Sherry, 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'll begin the call with some prepared remarks and then we'll open the call for questions. Our earnings release crossed the wire after market 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 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.

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. In fiscal 2025, consolidated revenue was up 7% to $278.4 million on continued consistent demand for both our Services and Products. Service revenue grew 7% to $181.4 million, driven by strength in our core calibration business. Distribution revenue grew 8% to $97 million on continued growth in our rental platform. Operating cash flow for the full fiscal 2025 year was a record $38.6 million, a year-over-year increase of 18%. Additionally, on December 9, we acquired the coveted Martin Calibration, the largest acquisition in Transcat's history. Martin is a very profitable, well-run company with over $25 million of mostly calibration service revenue. The Martin deal is highly synergistic and fulfills all three of our strategic acquisition drivers, including geographic expansion into the Minneapolis and Chicago regions of the Midwest, expanded capabilities and expertise, particularly on the dimensional and mechanical measuring side of the business. And finally, two bolt-on opportunities where we can leverage our current infrastructure in Southern California and Phoenix, Arizona. Turning to the fourth quarter results for our Service segment. Transcat's calibration services business continues to perform well and benefit from high levels of regulation and recurring revenue streams. In the fourth quarter, calibration services achieved double-digit revenue growth of 11%, of which organic growth was in the high-single digit range when normalized for the 53 week and excluding solutions. We reported a Service gross margin of 36.2% in the fourth quarter, which expanded 50 basis points versus the prior year. Margin expansion was driven by organic revenue growth and the associated inherent leverage in our calibration lab operating model, along with increased productivity from continued automation and process improvements. Turning to the fourth quarter results for our distribution segment. Distribution revenue grew 4%, driven by growth in the rental channel. It's important to note, our associated e-commerce platform continues to be an important component to lead generation for the Service segment. Transcat's distribution platform, including rentals, uniquely positions the company to achieve its consistent organic service growth. Barriers to entry in this respect have defended and we expect will continue to defend both our unique value proposition and strong brand across both operating segments. With that, I'll turn things over to Tom for a more detailed look at our Q4 and full year financial performance.

Thanks, Lee. I'll start on Slide 4 of the earnings deck, which provides details about our revenue on a consolidated basis and by segment for the fourth quarter and full year. The fourth quarter consolidated revenue was $77.1 million, reflecting a 9% increase from the previous year, driven by strength in the Service segment and growth in our distribution segment. Breaking it down by segment, Service revenue grew 11% to $52 million, which included $6.8 million from acquisitions during the quarter. As Lee noted, this growth was fueled by strong performance in our calibration business, with organic revenue growth in services in the high-single-digit range when adjusted for the 53rd week and excluding Transcat Solutions. In the distribution segment, revenue was $25.1 million, representing a 4% increase compared to last year, with continued growth seen in the rental channel. For the full year, total consolidated revenue amounted to $278.4 million, up 7% from the previous fiscal year. Our Service segment experienced consistent demand in the calibration business, leading to a year-over-year growth of 7%. For the full year, service revenue included a $10.4 million benefit from acquisitions. The distribution segment revenue grew 8%, propelled by rental activities. Moving to Slide 5, our consolidated gross profit for the fourth quarter was $25.9 million, which reflected an 8% increase from the prior year, although our gross margin declined by 30 basis points. Service gross margin improved by 50 basis points to 36.2%. This margin increase further showcased the leverage in our business model and our capability to harness higher automation levels and technician productivity. The gross margin for the distribution segment was 28.2%, down by 210 basis points. For the full year, consolidated gross profit rose by 7% to $89.5 million, while the gross margin decreased by 20 basis points to 32.1%. Service gross margins stood at 33.4%, a decline of 30 basis points year-over-year, while distribution segment gross margin improved by 20 basis points to 29.7%, benefiting from growth in the higher-margin rental channel. Moving to Slide 6, our Q4 net income was $4.5 million, a decrease from $6.9 million in the previous year, and diluted earnings per share fell to $0.48 from $0.77. The prior year’s net income included a non-cash profit increase of $2.4 million due to the amended NEXA earn-out agreement. We also report adjusted diluted earnings per share to normalize the impact of upfront and ongoing acquisition-related costs, reaching $0.64 for Q4. Furthermore, full year net income rose by 6% to $14.5 million. On Slide 7, we present our adjusted EBITDA and adjusted EBITDA margin, using adjusted EBITDA, which is non-GAAP, as a key indicator of our business performance and cash generation capability. This measure is especially crucial as we advance our acquisition strategy since it accounts for one-time transaction-related costs and the increased non-cash expenses reflected in our income statement due to acquisition purchase accounting. In this context, fourth quarter consolidated adjusted EBITDA was $12.7 million, a 9% increase from the same quarter last year, driven by a 16% increase in the Service segment. The Q4 EBITDA margin maintained at 16.5%, similar to last year. The full year EBITDA was $39.7 million, reflecting a 3% increase compared to the prior year, supported by strength in the calibration business. As always, a reconciliation of adjusted EBITDA to operating income and net income is available in the supplemental section of this presentation. Moving on to Slide 8, operating free cash flow improved by 31% to $25.4 million compared to the previous year. Full year capital expenditures remained consistent with the prior year, focusing on enhancing service segment capabilities, rental pool assets, technology, and future growth projects. This expenditure was in line with our expectations for fiscal year 2026, with net CapEx projected to be between $14 million and $16 million. Slide 9 showcases our robust balance sheet, with total net debt of $31 million and a leverage ratio of 0.7x at year-end. We had $49 million available from our credit facility at the end of the quarter. Lastly, we anticipate filing our 10-K on May 27. With that, I'll turn it back to you, Lee.

Thanks, Tom. Those of you who follow Transcat know we have consistently delivered strong results through various economic cycles over the past decade and a half. We have a proven track record of delivering profitable growth and being disciplined capital allocators. Our strategy is differentiated and our leadership team is poised to execute our plan and to drive excellent performance. While the macroeconomic backdrop, including tariffs, has become more uncertain since the beginning of the year, over time, Transcat's business, particularly our calibration services channel, has been resilient, as it continues to benefit from recurring revenue streams in highly regulated markets. Put simply, in the past, the business holds up well. It holds up well because our organic growth typically returns to growth levels more in line with the historical high-single digit growth range, as macro trends normalize. As we look at the landscape for strategic accretive acquisitions, we are excited by our current pipeline and our opportunity to drive both synergistic growth opportunities and strengthen our foundation for future growth. And as I mentioned, we are particularly excited with the recent Martin acquisition, which is both sizable and right down the fairway for Transcat. The early Martin integration activities are going very well and ahead of schedule. We continue to believe the Service segment has a substantial runway for growth, both organically and through acquisition. Our solutions business is making slow and steady progress towards the short-term goals we communicated over the last couple of quarters. We are now actively operating the proven Transcat sales playbook in the solutions channel. And as we integrate the solutions channel into our overall service platform, expectations are for improved results, stabilization, and ultimately growth, which will contribute to our overall organic service goals. I'll close by saying that our leadership team has never been stronger. Across the organization, we've invested in recruiting and developing a higher level of leadership in sales, technology, and operations. All commensurate with our ambitious long-term expectation for Transcat. It all starts with strong leadership and culture. And in our business space, we believe our leadership team is second to none. We intend to leverage these strengths as we create, communicate, and execute our strategy and vision for the future, a future we feel is incredibly exciting. And with that, operator, you can open the call for questions.

Thank you. Our first question is from Greg Palm with Craig-Hallum Capital Group. Please proceed.

Yeah. Good morning. Thanks for taking the questions and congrats on the results.

Thanks, Greg.

Thanks, Greg.

Can we start by discussing the cadence, particularly reflecting on December and the timing issues you faced? Back in late January, you mentioned a significant bounce back. How did the rest of the quarter progress? Also, more importantly, in the past four to six weeks, have there been any changes compared to what you observed in February and March?

I would characterize the fourth quarter, February, March, I would just include in my characterization as good, solid - kind of what we expected. We probably saw some of the pent-up demand from the December timeframe that I think you're referring to make its way into the fourth quarter and that helped contribute to the high-single digit organic growth. I don't think we saw at all and I think that will play out over time, that's a kind of interesting thing, I mean, given the backdrop we have and some of the volatility. I mean, this work has to be done and we're going to do it, but there is some flexibility in the short term for customers to kind of wiggle around certain dates and extend intervals when necessary. So I think it all plays out as we'll get the work, but from a quarter-to-quarter, month-to-month basis, it's hard to predict, particularly with the volatility. So, we're pleased with the high-single digit growth. We think there's probably more over time, but it's going to take a couple of quarters to get past the current volatility before we probably see it all.

Yeah, that makes sense. Last quarter, you mentioned several significant opportunities in the service business. Have any of those materialized, or are you indicating that there are still opportunities available and that the timing is just shifting?

We currently have a strong pipeline of new opportunities. Several new wins are contributing to what we believe will be momentum, particularly in the latter half of the year. However, it's important to acknowledge that assessing our business every 90 days can be challenging. Being in a regulated market, we find that if we deliver quality work and maintain customer satisfaction, we typically see repeat business. So, when looking beyond quarterly results to the entire year, we anticipate achieving our targets of high-single digit growth as we close this year and move into the next. The timeline for reaching these goals and the volatility observed in the first quarter are hard to predict given the current economic environment, but we have no concerns looking beyond that.

Fair enough. Okay. And then just on distribution, I'm just curious, just given some of the tariff announcements from a procurement standpoint, just remind us kind of where that sits? And maybe more importantly, are you seeing any kind of changes in behavior from customers? Are you seeing more demand for more interest in rentals versus buying outright? I'm just kind of curious to see what you're seeing in that segment as well.

Currently, the distribution aspect is performing quite well. We are receiving a good number of orders and volume, but it's challenging to discern any significant increase. It's also difficult to tell if this is a response to potential tariffs. Historically, distribution has been seen as an indicator of economic conditions; when performance is slow, it may signal economic struggles, while strong performance indicates the opposite. Given the ongoing discussions about tariffs, the usual indicators may not apply. The positive results we're observing could be a sign of good things to come, or they could simply reflect reactions to tariffs. We need more time to understand how this business will unfold this year and what the current stability means. At this moment, we’re handling things adequately but remain cautious due to the existing volatility.

And to be clear, when you're discussing the uptick, are you referring to the current quarter or quarter-to-date, or are you thinking of something more?

The current read is that distribution is holding up well.

Yeah. Okay. All right. I will leave it there. Thanks.

You got it. Thanks. Thanks, Greg.

Thanks, Greg.

Our next question is from Ted Jackson with Northland Securities. Please proceed.

Great. Thanks for taking my questions.

Hey, Ted.

Hey, Ted.

So my first question, you did a really nice job with regards to expense control on the OpEx side. And I was kind of curious, what were the levers you pulled in there? And how would we think about those line items as we put together our estimates for '26?

I think it's something that we focus on regularly, ensuring our costs are aligned with the revenue levels we're experiencing as well as the current economic backdrop. This includes delaying some hires and practicing good cost management, which we will continue. However, we can only delay hiring for so long because it's important to have the right teams in place to execute our long-term plan. We will continue to prioritize cost management and make sound decisions. Looking ahead, we anticipate some nominal increases and a return to more normal levels for certain items. For example, last year, we did not pay incentives at our usual levels due to our performance, but this year, with our expectations, we anticipate an increase in some of those areas. Nonetheless, we will remain focused on cost savings and maintaining a cost-conscious approach.

It was impressive. Next question. I'm going to go back to what Greg was hinting at. When I listened to the prepared remarks and the details in your slide deck about the expectation of high-single digit growth for services, with the note that this is contingent upon the macro-environment normalizing, is this just standard language? Are you being conservative because you feel you should be, or have you actually encountered some disruption or turmoil in the business that makes you hesitant? Since we've entered April and now May, it seems like things have been a bit more unstable. As you consider how to project that growth, do you anticipate that things will settle down and that the latter part of the fiscal year will show stronger performance than the early part?

Yes, this is Lee. I agree with a lot of what you've mentioned and the way you expressed it. Overall, while there is some short-term volatility and disruptions, including delays from some customers, we are focused on our value proposition, market approach, and the quality of our services, which remain strong. As we enter this year, our capability to sell calibration services is improving along with the data we're obtaining from our technology and our customer engagement strategies. We have been identifying process improvements not just as a statement, but as a real focus. I expect our company to enhance its performance and achieve stronger sales in the future compared to the past. While the next quarter or two could be uncertain, I am confident that our current strategies are beneficial for the business. Our value proposition is unmatched, and I am pleased with our leadership and sales initiatives. Our sales pipelines are looking promising, and I anticipate a good performance once we navigate through the current volatility. Nothing has fundamentally changed, and if anything, I see a brighter future ahead. I won't specify numbers, but I appreciate the direction we're heading and the identity we are building. I look beyond the next couple of quarters and I like what I see.

I'd be concerned if you didn't look longer than a quarter or two. I'm going to ask one more question. I do have more, but I'm going to let other people ask and then if they don't get asked, I'll circle back in. So the next question is just kind of on Transcat Solutions or the NEXA business. It's been an area that you've been repairing, rebuilding, if you would. Could you talk a little bit about where things stand with that portion of your world and kind of how to think about it for kind of the next 12 to 18 months?

Yeah. Sure. I will. And there were two goals with NEXA coming off of some of the problems. We call it solutions now. And the change from NEXA Solutions is important because it's a change in how we view the business. And so, there's two pieces to it. One is sales. So we have integrated. We are integrating. We put a lot of work into making sure that every salesperson in this company understands the value proposition around solutions and that every salesperson is capitalizing on the opportunities they encounter relative to the solutions channel. And that was not in place before. It doesn't happen overnight, but I think we get better every day. So I'm fairly pleased with the progress we've made in terms of the recognition of how to sell, when to sell and why to sell solutions. That I would not have said that a year ago, I don't think I would have said it six months ago. But I like the progress we've made. On the operations front, we see total integration where solutions is not only stands on its own two feet as a channel, small channel, but that it's a means to an end. And it's a means to an end. And we say a lot here at Transcat internally, all roads lead to calibration. When we're in front of a customer and we're trying to solve problems for them on their database, on their reliability, if you will, looking at their intervals, it all leads to a calibration discussion. And so we see it as a means to an end solution and in and of itself and it's an important distinction. Sales understands this. Operations understands this. This is an important part of making Transcat a better company. So I'm pleased with the progress. We'll continue to stabilize it and eventually, the growth that we see in that area will contribute to our overall organic growth in service.

Okay. I'm going to step aside and I might jump back in later. Thanks.

Thanks, Ted.

Our next question is from Scott Buck with H.C. Wainwright. Please proceed.

Hi. Good morning, guys. Thanks for taking my questions. Lee, I'm curious, you've been integrating automation now for a few quarters. How much juice is there left to squeeze out of that?

It's a great question. We began this journey about three to four years ago, stating that we were in the first inning. I appreciate your inquiry; it’s an important one. We are proud of the significant progress we’ve made, which has certainly contributed to some margin improvement. I would say that today, we are around the fourth or fifth inning. It feels like we are at the midpoint, perhaps slightly before, so I think the fourth inning is more accurate than the fifth. There's still a lot of work ahead of us. It’s a challenging, slow, and demanding process. However, once we complete it, it’s like coding—it has long-lasting effects, and we can move on to the next task. We've invested considerable time, effort, and money into this, and I think it sets us apart. When we aim for consistent mid-high single-digit growth and beyond, this effort is a crucial part of that progress. So, let’s say we’re in the fourth inning with one out.

That's helpful and great to hear there's some more room there. Second, can you remind us in a more challenging macro-environment, the mechanics of distribution? I mean, do you see customers put off sales and go the rental route instead to save some of their own CapEx or what are the mechanics on that side of the business in a more challenging macro-environment?

I believe the short answer is yes, we do see that. However, we are not observing it at the moment. The reason may not be definitive, but our instinct suggests we aren't seeing it due to the challenging environment. So why isn't distribution feeling more pressure? We think it could be related to people trying to get ahead of tariffs. They are placing orders for equipment now at price levels they expect to be lower than in the near future. Therefore, even though the long or mid-term outlook for distribution might not seem as favorable, in theory, we aren't seeing that because the impacts from tariffs are different from those caused by a more long-term recession. That's likely why we're not experiencing this pressure. Typically, you would expect distribution sales to be front and center and to decline, facing some headwinds that we aren't currently facing. However, this pressure might emerge once we get past the tariff situation, as orders have been placed and higher costs start impacting the market. Then we may notice a shift in distribution later in the year, but this is speculation based on our thoughts.

Great. I mean, that makes a ton of sense. And then last one, Lee, the business clearly looks fairly different than it did three or four years ago. Has the M&A criteria changed at all, just given the scale and scope of the business today versus maybe 2020 or 2021?

I think we've devoted significant effort to our M&A strategy. There are numerous small companies in a still fragmented industry. Generally, the narrative remains consistent. There is increasing private equity interest in our sector. As a public company, Transcat has demonstrated remarkable and consistent performance over time. We have a strong business model that naturally attracts private equity. While we've observed private equity acquiring various small companies, most of these were ones we opted to pass on for valid reasons. So, while acquisitions are occurring and the landscape is becoming slightly more compact, I believe there's still ample opportunity, particularly with desirable regional players like Martin. There remains enough fragmentation for us to follow through on our strategy, and I don't think our acquisition plan or expectations for achieving significant synergistic deals have fundamentally changed. I still see good potential for pursuing these opportunities.

Great. Well, I appreciate the added color, guys, and congrats on the quarter.

All right, Scott.

Thank you, Scott.

Thanks for the questions.

Our next question is a follow-up from Ted Jackson with Northland Securities. Please proceed.

Thank you. I have two follow-up questions. First, regarding the distribution and rental sectors, could you provide more insight into what you're observing in the rental market? Although you don't specify the size, it seems like we will continue to take a larger share of that line item moving forward. Given its increasing significance to your business, how do you anticipate rental will perform in a more challenging macroeconomic environment? I would think it could potentially thrive while the equipment distribution side might struggle, but the rental market could remain strong. That's my first question.

Yeah. I think, Ted, it ties back to Lee's earlier comment. In times of uncertainty like this, we would have anticipated a decline in core distribution and an increase in rentals due to limitations on capital expenditures. However, we haven't yet observed that decline in distribution. We are noticing a slight increase in rentals, and we expect that as long as this uncertain environment persists, it will be beneficial. Our expectations for the rental business continue to align with historical trends in the services sector, aiming for growth in the high-single digits. We are making the necessary investments to ensure that this growth continues, not only by enhancing our asset pool but also by investing in our team.

But in some ways, I mean, given that it's, you've targeted generally a better margin revenue stream than actual distribution, I mean, it could be a case to where, even though you might see some softness in distribution, you might pick it up at the gross profit level just with a big shift towards rentals. Is that a fair way to kind of think about it?

For sure. And I think as we look forward, I mean, assuming that it plays out the way you described, Ted, then I think we will definitely be in a position where we can or we should be in a position, I should say, where we can just consistently see distribution margins North of 30%.

And then my last question is actually one that's hopefully a little bit more fun, but I like the commentary with regards to the active automation, improving some of your margin structure and I know that you made that acquisition in Ireland and it was something that we used to talk about quite a bit. Added too much. So maybe a little discussion about what are some of the things you've done on the automation front that have allowed you to drive a return on your business and kind of where you see that going? Very open-ended. Thanks.

There are two main aspects to automation. The first is the technical side, which involves coding. This means taking a known standard with electronic outputs and writing code to enable communication with the unit being tested. It's fundamentally about the coding process itself. There isn't anything particularly magical about it; it's a matter of identifying opportunities and determining the resources and capital available for this initiative. As a public company, we need to maintain balance, ensuring we're moving in the right direction while managing expectations and funding for critical projects like automation. The second part is about utilizing the written code effectively. Once the code is developed, it’s essential to execute it properly. One key aspect of this execution is not only having automation in place but also integrating it across our operations, especially in North America, and we also have a lab in Ireland. It's crucial to ensure that every technician in every location is using the code because once they see its benefits, for instance, the potential to perform two calibrations simultaneously, that creates significant efficiency gains. So, I believe the process involves writing the code, identifying opportunities, and ensuring the code is consistently integrated into operations. This requires appropriate incentives, strong leadership, and effective day-to-day management. When executed well, this approach can lead to improved margins. In essence, we have two narratives unfolding simultaneously.

Okay. Thanks very much, guys.

Thanks, Ted.

I appreciate the question.

There are no further questions at this time. I would like to turn the call back over to Lee for closing comments.

Okay. Well, thank you all for joining us on the call today. We appreciate it. We will be attending the upcoming 22 Annual Craig-Hallum Institutional Investor Conference, which is in Minneapolis on the 28. So we hope to see you there. We appreciate everyone's continued interest in Transcat and feel free to check in with us really anytime. We look forward to talking to you guys again after the first quarter. So thanks again for participating.

Thank you. This will conclude today's conference. You may disconnect your lines at this time and thank you for your participation.