Transcat, Inc. — Q3 FY2020 Form 10-Q
Reporting period: Third quarter and first nine months ended December 28, 2019; comparisons are to the periods ended December 29, 2018. Financial amounts below are in millions unless stated otherwise. Transcat provides calibration and laboratory services and distributes professional-grade test, measurement and control instruments.
Financial performance
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Revenue | $43.2 | $40.9 | $127.3 | $116.4 |
| Gross profit / margin | $9.9 / 23.0% | $9.5 / 23.4% | $30.4 / 23.9% | $27.8 / 23.9% |
| Operating income / margin | $2.1 / 4.8% | $2.4 / 5.9% | $7.1 / 5.6% | $6.6 / 5.7% |
| Net income | $1.5 | $1.6 | $5.6 | $4.5 |
| Diluted EPS | $0.20 | $0.21 | $0.75 | $0.60 |
| Adjusted EBITDA | $4.1 | $4.4 | $12.8 | $12.2 |
- Q3 revenue grew 5.7%: Service revenue increased 7.8% to $22.1 million and Distribution sales increased 3.5% to $21.1 million. Management attributed the quarter’s growth to organic activity, including life sciences and other regulated-sector demand.
- For the first nine months, revenue grew 9.4%, led by Service growth of 13.8%; Distribution sales rose 4.7%. Net income increased 24.3%, while Adjusted EBITDA rose 4.6% to $12.8 million. Adjusted EBITDA is a non-GAAP measure.
- Q3 gross margin declined 40 basis points and operating expenses rose 9.5%, causing operating income to fall 12.7% and net income to fall 5.9% year over year. Q3 Adjusted EBITDA margin was 9.4%, versus 10.7% a year earlier; nine-month margin was 10.0%, versus 10.5%.
- Nine-month operating cash flow was $8.2 million, compared with $7.2 million. Investing used $6.1 million, including $5.0 million of capital expenditures and acquisition-related payments; financing used $2.5 million. Cash decreased $0.6 million to $0.2 million.
- At December 28, current assets were $44.6 million and current liabilities $19.7 million. Debt totaled approximately $19.7 million: $6.6 million drawn on the revolving facility and $13.1 million outstanding on the term loan. The term loan carries a fixed 4.15% rate; revolving borrowings had rates of 3.0%–3.7% during the first nine months. The $30 million revolving facility matures October 2021. The company was covenant-compliant, with a defined leverage ratio of 1.07 versus 1.12 at fiscal year-end.
Material changes and notable items
- Management said a holiday-affected, slow December reduced activity in both segments and caused under-absorption of fixed Service costs. Distribution gross margin also fell 80 basis points year over year, reflecting product pricing and mix, including lower rental contribution than in recent quarters.
- Q3 operating expenses increased as the company continued investment in technology infrastructure and operational-excellence initiatives. Management cited a net increase of 37 technicians, or 12%, over the prior-year period.
- Adoption of lease accounting in fiscal 2020 added right-of-use assets and lease liabilities to the balance sheet; adoption did not materially affect reported income or cash flows. The balance sheet reports $9.0 million of right-of-use assets and $7.3 million of lease liabilities, with some lease obligations included in accrued liabilities.
- Transcat acquired Canadian calibration-software developer Infinite Integral Solutions in July 2019 for consideration of C$1.4 million, partly milestone-based; an additional C$0.4 million was paid in January 2020. The acquisition was immaterial to pre-acquisition revenue and expenses.
- Nine-month income tax provision fell to $0.8 million from $1.4 million. The effective tax rate was 12.0%, benefiting from $0.9 million in discrete share-based-compensation tax benefits, versus $0.1 million in the prior-year period.
Outlook, risks and liquidity
- Management said sales rebounded in January and early February after the slow December and that the company remained on track to achieve record fiscal 2020 results. It cited a healthy acquisition pipeline, expanded laboratory capacity, and potential for double-digit Service growth with improved profitability margins; these are forward-looking statements, not guarantees.
- Fiscal 2020 effective tax-rate outlook was reduced to approximately 17%–18%, from the prior 18%–19% range, due to share-based-award tax benefits. Capital expenditure guidance was lowered to $6.8–$7.1 million from $7.8–$8.2 million, primarily due to project timing and lower expected spending on Service lab replacement assets.
- The company expects cash from operations and borrowings to meet foreseeable liquidity needs. Key disclosed risks include competition, hiring and retaining skilled technicians, acquisition integration, customer-industry volatility, vendor and inventory availability, cybersecurity and IT disruption, indebtedness, foreign-exchange movements, and general economic conditions.
- Approximately 90% of revenue was denominated in U.S. dollars. A 10% move in the Canadian dollar was estimated to affect revenue by about 1%. The company had a $3.8 million-notional foreign-exchange forward contract at quarter-end, renewed in January 2020. It had no hedging arrangements for interest-rate increases; a 1% rate move was estimated to change annual interest expense by about $0.1 million on variable-rate borrowings.
Investor verification points
- Whether the January–February sales rebound continued and whether Service growth translated into improved margins after the December under-absorption.
- How much of reported earnings growth reflects sustainable operating performance versus discrete share-based-compensation tax benefits; compare GAAP results with the company’s non-GAAP Adjusted EBITDA reconciliation.
- Cash conversion, working-capital movements, and the effect of low quarter-end cash alongside capital spending, debt repayments, and share-related cash outflows.
- Progress against fiscal 2020 tax-rate and capital-expenditure outlook, and execution of the IIS acquisition and broader acquisition strategy.
- Debt levels, available revolving capacity, and ongoing compliance with credit-agreement covenants.