Business context and reporting period
Transcat, Inc. provides accredited calibration and compliance services and distributes professional-grade test, measurement and control instruments, with a focus on regulated industries. This Form 10-Q covers the second quarter and first six months of fiscal 2015, ended September 27, 2014; comparisons are to the periods ended September 28, 2013. Unless noted, amounts below are in millions of dollars.
Key financial results
| Metric | Second quarter FY2015 | Second quarter FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Revenue | $31.111 | $28.882 | $60.230 | $57.592 |
| Gross profit | $6.926 | $6.821 | $13.595 | $14.035 |
| Operating income | $1.516 | $1.281 | $2.275 | $2.433 |
| Net income | $0.859 | $0.771 | $1.304 | $1.492 |
| Diluted EPS | $0.12 | $0.10 | $0.18 | $0.20 |
- Revenue mix and growth: Second-quarter service revenue rose 9.8% to $12.595 million and distribution sales rose 6.4% to $18.516 million. For the six months, service revenue increased 6.6% to $24.733 million and distribution sales increased 3.2% to $35.497 million.
- Margins: Gross margin was 22.3% in the quarter versus 23.6% a year earlier, and 22.6% for the six months versus 24.4%. Quarterly service gross margin improved to 26.0% from 23.6%; distribution gross margin fell to 19.7% from 23.6%. Six-month operating margin was 3.8% versus 4.2%; net margin was 2.2% versus 2.6%.
- Cash flow: Six-month operating cash flow was $(0.411) million, compared with $0.234 million provided in the prior-year period. Investing used $8.513 million, including $6.681 million for the Ulrich acquisition and $1.854 million in capital spending. Financing provided $8.990 million, primarily from revolving-credit borrowings. Cash was $0.263 million at period end.
- Liquidity and debt: At September 27, current assets were $27.500 million and current liabilities were $11.688 million. Long-term debt was $16.327 million, up from $7.593 million at March 29, 2014. The revolving facility limit was amended to $30 million; the filing reports $16.3 million outstanding and $27.1 million “available” under the facility. The meaning of the reported availability figure is not clear from the filing text.
- Other balance-sheet items: Total assets rose to $63.154 million from $53.874 million, including increases in goodwill and intangible assets primarily related to the acquisition. Shareholders’ equity was $31.865 million.
Material changes versus the prior comparable period
- Second-quarter revenue growth and lower operating expenses lifted operating income to $1.516 million from $1.281 million; net income rose to $0.859 million from $0.771 million.
- For the six months, revenue increased but gross profit and net income declined. Management attributed the gross-margin reduction mainly to lower distribution vendor rebates; those rebates accounted for 170 basis points of the total margin decline. Quarter-specific distribution margin pressure also reflected increased customer price discounts and lower rebates.
- Service performance strengthened: quarterly service gross profit rose 20.8%, with management citing revenue growth and operating leverage from the segment’s relatively fixed cost structure. Distribution gross profit fell 11.2% in the quarter.
- On August 29, 2014, Transcat acquired Montreal-based Ulrich Metrology Inc. for approximately $6.7 million net of cash acquired. The preliminary allocation included $3.980 million of goodwill and $2.293 million of identifiable intangible assets; the goodwill and intangibles are not tax-deductible. Acquisition costs of $0.1 million were expensed. Pro forma six-month results assuming the acquisition from the start of the period were revenue of $61.901 million and net income of $1.408 million.
- The credit agreement amendment raised the revolving facility ceiling from $20 million to $30 million, increased acquisition borrowing capacity per fiscal year from $10 million to $15 million, and extended maturity to September 20, 2018. The company reported compliance with its loan covenants throughout the six-month period.
Outlook, management commentary, risks and unusual items
Management expected continued strength in Service and said its market positions and strategic acquisitions were expected to support meaningful growth. It expected strong consolidated operating-income growth for fiscal 2015. No numerical revenue or earnings guidance was provided.
- Service orders can fluctuate because of calibration timing, customer capital spending and outsourcing decisions; management considers trailing-twelve-month results a better indicator of the segment’s progress. It expects to outsource 10%–20% of Service revenue over the long term.
- Management cited reliance on a single significant inventory vendor, indebtedness, acquisition execution and integration, economic conditions, competition and cybersecurity among the risks that could affect results. Inventory and vendor rebates can also vary with purchase timing and product mix.
- Six-month days sales outstanding increased to 43 days from 40 days in the prior-year comparison, which management associated with extended payment terms at recently acquired businesses. Inventory increased to $7.513 million from $6.181 million at fiscal year-end.
- A 1% change in interest rates would change annual interest expense by approximately $0.2 million, assuming unchanged average borrowings. The company had no interest-rate hedging arrangements at quarter-end. More than 90% of revenue was denominated in U.S. dollars; a 10% Canadian-dollar movement would affect total revenue by less than 1%. A $7.5 million-notional foreign-exchange forward contract was outstanding.
- Disclosure controls were assessed as effective, and the company reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Clarify the filing’s stated $27.1 million of facility availability alongside a $30 million limit and $16.3 million outstanding; confirm actual unused borrowing capacity and any borrowing-base or letter-of-credit constraints.
- Track whether distribution margins and vendor rebates recover, and whether the competitive pricing strategy continues to support sales without further margin erosion.
- Assess Ulrich’s integration, contribution to service growth and profitability, and any revisions to the preliminary purchase-price allocation.
- Monitor operating cash conversion, working-capital needs, capital spending, leverage and compliance with credit covenants as acquisition activity continues.
- Compare subsequent performance with management’s qualitative expectation of strong fiscal-year operating-income growth; the filing provides no numerical guidance.