Transcat, Inc. — Q1 FY2020 Form 10-Q
Reporting period: First quarter ended June 29, 2019; comparative quarter ended June 30, 2018. Amounts below are in U.S. dollars. Financial statement amounts are rounded to millions unless stated otherwise.
Business context
Transcat provides calibration and laboratory instrument services and distributes test, measurement and control equipment, primarily to regulated industries including life sciences. Its reportable segments are Service and Distribution.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Service revenue | $22.4 million | $19.3 million | +15.9% |
| Distribution sales | $20.0 million | $17.3 million | +15.4% |
| Total revenue | $42.4 million | $36.7 million | +15.7%; organic growth 13.1% |
| Gross profit / margin | $10.1 million / 23.7% | $9.1 million / 24.9% | Profit +10.3%; margin down 120 bps |
| Operating income / margin | $2.0 million / 4.6% | $2.0 million / 5.5% | Income down 3.3%; margin down 90 bps |
| Net income | $1.7 million | $1.4 million | +20.3% |
| Diluted EPS | $0.23 | $0.19 | + $0.04 |
| Adjusted EBITDA (non-GAAP) | $3.9 million; 9.3% of revenue | $3.8 million; 10.5% of revenue | +2.6%; margin down |
Service operating income fell to $0.7 million from $1.1 million, while Distribution operating income rose to $1.2 million from $1.0 million. Service gross margin decreased 150 bps to 24.0%, primarily due to hiring, onboarding, training and developing technicians. Distribution gross margin declined 80 bps to 23.4%, mainly from product and channel mix.
Net income growth was aided by a $0.5 million discrete tax benefit from share-based compensation; the prior-year benefit was $0.1 million. The quarterly effective tax rate was (2.7%) versus 20.7%.
Cash flow, liquidity and debt
- Operating cash flow was $0.9 million, down from $3.1 million. Inventory investment and timing of collections and payments contributed to working-capital movements.
- Investing cash outflow was $1.3 million, including $1.4 million of property and equipment purchases, partly offset by $0.2 million of sale proceeds. Financing cash flow was positive $0.4 million.
- Cash declined $0.2 million during the quarter to $0.6 million. Accounts receivable were $26.7 million; inventory was $15.9 million, up $1.6 million from fiscal year-end. Days sales outstanding were 53, versus 50 a year earlier.
- Total debt was approximately $22.4 million: $14.1 million on the term loan and $8.3 million on the revolving facility. The term loan bears fixed interest of 4.15%; revolver rates ranged from 3.6% to 3.7%. The company reported a 1.22 leverage ratio and compliance with loan covenants.
- The revolving facility is described as a $30.0 million facility, with $8.3 million outstanding. The filing also says $30.0 million was “available” while reporting that amount outstanding; the remaining availability is therefore not clearly stated in the filing text.
- Adoption of lease accounting added approximately $8 million of right-of-use assets and lease liabilities to the balance sheet. The June 29 balance sheet shows $7.8 million of right-of-use assets and $6.2 million of lease liabilities; a further $1.7 million of lease liabilities is included in accrued compensation and other liabilities.
Material changes, outlook and risks
- Revenue growth reflected both organic expansion and acquisitions. Service growth was supported by new life-sciences business and other regulated sectors; Distribution growth included alternative energy and used-equipment sales. Rental revenue increased 34% to $1.2 million.
- Pending product shipments rose to $4.1 million from $3.5 million a year earlier; 77.2% were backorders. Management noted that shipment timing and demand in certain Distribution channels can vary.
- Operating expenses increased 14.2%; they included a $0.2 million loss on sale of a Montana building no longer needed for operations. Gross-margin pressure and this unusual expense contributed to lower operating income.
- Management expects continued strength in Service revenue, citing recent contract wins and a robust pipeline. Productivity initiatives are expected to benefit margins, although management said benefits may be greater over the longer term. It cautioned that alternative-energy and used-equipment sales can fluctuate quarter to quarter.
- FY2020 outlook: expected effective tax rate of 21%–22%, reduced from the prior 22%–23% range; capital expenditures remain forecast at $7.8–$8.2 million. No specific revenue or earnings guidance was provided.
- Transcat acquired Gauge Repair Service assets effective April 1, 2019, expanding its Southern California service presence. Subsequent to quarter-end, it acquired Infinite Integral Solutions for C$1.4 million, partly subject to milestones; management expects its CalTree software to support calibration automation and operating efficiency.
- Risks identified include competition, technician recruitment and retention, acquisition execution and integration, customer and vendor demand or supply changes, cybersecurity and IT-system disruption, indebtedness and interest rates, foreign exchange, and general economic conditions. A 1% interest-rate move was estimated to change annual interest expense by about $0.1 million, assuming average borrowing levels were unchanged.
Important facts for investors to verify
- Confirm the revolving facility’s actual unused availability, given the filing’s inconsistent description of the $30.0 million facility and $8.3 million outstanding.
- Assess whether Service growth can continue while technician investment and lower Service gross margin weigh on profitability.
- Track cash conversion, receivables (53 days sales outstanding), inventory, and the elevated level of pending product shipments and backorders.
- Separate underlying earnings trends from the discrete share-based tax benefit and the building-sale loss; compare non-GAAP Adjusted EBITDA with GAAP results.
- Monitor acquisition integration, contingent consideration and holdbacks, leverage and covenant headroom, and delivery of the stated capital-spending and tax-rate outlook.