Jan 25, 2016
Executives
Deborah Pawlowski - IR Lee Rudow - CEO John Zimmer - CFO Mike Tschiderer - VP of Finance
Analysts
Steven Stern - Stern Investment Advisory
Operator
Greetings, and welcome to the Transcat Third Quarter Fiscal Year 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode.
A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for Transcat. Thank you.
You may begin.
Deborah Pawlowski
Thank you, Christine, and good morning everyone. We certainly appreciate your time today and your interest in Transcat.
Hopefully those on the East Coast, they were able to get into their office. With me here on the call today, we have Transcat's President and Chief Executive Officer, Lee Rudow, who I will give you a heads-up on is suffering from the flu right now, so he brings his illness to come into talk; our Chief Financial Officer, John Zimmer; and Vice President of Finance, Mike Tschiderer.
Great to hear you, Mike. After formal remarks, we will open the call for questions.
If you don't have the news release across the wire before the market open today, it can be found on our Web site at www.transcat.com. You will also find there slides that accompany today's discussion.
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 Securities and Exchange Commission.
You can find those on our Web site where we regularly post information about the company, as well as on the SEC's Web site at sec.gov. So please review our forward-looking statements in conjunction with these precautionary factors.
With that, I'll turn the call over to Lee to begin the discussion. Lee?
Lee Rudow
Okay. Thank you, Debbie.
Good morning, everyone. Thank you for joining us on the call today.
Before I get started I want to take a moment to introduce Mike Tschiderer, who became Vice President of Finance last month, at the same time that we announced John Zimmer's decision to retire as CFO at the end of March. Mike will succeed John as CFO upon his retirement.
John has made many contributions to Transcat throughout his tenure as CFO. I'm personally very grateful for his counsel, dedication, and support in leading the company.
We greatly appreciate his outstanding service and flexibility, and planning his retirement to provide adequate time to transition his responsibilities to Mike. All the best, John, as you change course in life.
We're fortunate to have a financial executive of Mike's caliber and experience in place to become our next CFO. Over the course of his career, he served in several senior financial executive positions, including CFO in multiple industries, as well as having big four public accounting experience.
We're confident that his financial and business expertise and leadership capabilities will make a smooth transition as he steps into the CFO role.
Mike Tschiderer
Thanks Lee for that very nice introduction. Let me say that it is an honor for me to soon assume the position of CFO at Transcat at a time when we are in an active growth mode and expanding our position as an industry leader in calibration services.
It's an outstanding opportunity and I am very motivated and committed in doing my best for the company, our customers, and our investors. I am also looking forward to talking with the investment community as I take on the CFO role and having an active part in our investor relations activities.
Glad to be here; and back to you, Lee.
Lee Rudow
Okay. Thank you, Mike.
Turning to our quarterly results if you are looking at the slides, I'll generally be talking to Slide 3. Third quarter results were generally positive.
As we mentioned in our earnings release, we generated a 42% increase in service operating income, which drove our consolidated results. The segment delivered double-digit growth of 10.5%.
This represents 27 consecutive year-over-year revenue growth, quarters of year-over-year revenue growth for Transcat. From a consolidated revenue growth perspective, our double-digit service growth was offset by a decline in Distribution segment revenue resulting from a continued weakness in the industrial environment, particularly the direct and indirect impact from the weakness in oil and gas and the strength of the U.S.
dollar. All in all, a positive performance in this challenging environment can be highlighted by our 30% increase in net income and the strong growth in cash from operation as we generated $7.4 million year-to-date, up significantly from $1.2 million in the same period last year.
Let me walk you through our segment performances. Our Service segment continues to be our primary growth engine from a revenue and earnings perspective.
For the quarter, Service contributed a 46% of our total revenue. Service revenue was up nearly 11% to 13.9 million, a record third quarter for the segment.
Segment operating income increased 42%, and operating margin expanded 120 basis points. Strong operating leverage continues to have a very favorable effect on our overall profitability.
Despite a decline in industrial output, we continue to perform well on the organic sales front. Significant life science growth, both in pharmaceuticals and medical devices have offset service softness in the general industry sector, including markets related to oil and gas.
So we continue to execute the strategic plan and to grow our service business in particular driving revenue in the life science sector. On the acquisition front, we have done an outstanding job not only of acquiring companies, but acquiring the right companies at the right valuation.
Mostly recently, in fact last week, we increased our life science capabilities and expertise in Montreal with the acquisition of Dispersion Laboratory as we continue to fortify and grow our leading position in Canada. Dispersion is the only laboratory in Canada performing robotic mass calibrations, which we anticipate will be an important differentiator as we look to grow our life science revenue in Canada.
Spectrum Technologies, which closed after our quarter end and right at the end of December, increased our geographic footprint and capabilities as we now offer a full suite of biomed services throughout the United States. Spectrum brings annualized revenue of almost $6 million and operating income margins in the 20% range.
It is the largest acquisition we've made in several years, and we love the strategic fit as we drive the growth of our life science portfolio. Moving forward, the acquisition pipeline remains strong and we maintain the financial flexibility to move fast when we identify the right opportunities.
Moving on to Distribution, we all know the industrial macros have been a challenge over the past couple of quarters. About half of our year-over-year distribution decline relates to the turmoil in the oil and gas market.
Also, the strong U.S. dollar has certainly had a derivative effect on distribution revenues as well.
That said, we are encouraged that the rate of decline in Q3 slowed, and maybe nearing the bottom. Our consolidated performance in the phase of economic challenges can be highlighted by three major developments which give us cause for encouragement as we drive through Q4 and enter into fiscal 2017.
Number one, rapid deployment of web-oriented technology upgrades that allow our Distribution business to compete more effectively on the web, and our Service segment to strengthen its value proposition; number two, successful completion and transition of numerous strategic acquisitions; and three, a host of new diversified programs in both segments of our business, including SKU expansion, ensuring [ph] rentals and value-added options on many of our products, all of which have generated meaningful operating income. We believe that economic slowdowns are some of the best times to make our most significant strides, and we will continue to make progress in positioning the company for a strong future.
With that, I'm going to turn things over to John to discuss the quarterly results.
John Zimmer
Thank you, Lee, and good morning everyone. Before I begin my last earnings call, I want to say what a great experience it's been serving as the CFO and working with the investment community over the last ten years.
I've enjoyed working with Lee and rest of the Transcat team in building the company and positioning it to move to the next level of growth and success. Mike and I are working very closely, and I see a seamless transition when he steps in as CFO.
It is with great confidence in the company's future that I have looked forward to watching Transcat succeed as I turn my focus toward other life goals. Turning to our financial results; looking and Slide 4, consolidated revenue declined 2.9% in the third quarter to 30.2 million as revenue in our higher margin Service segment increased by double-digits offsetting much of the impact of the decrease in the Distribution segment sales.
Looking at the Service segment specifically, third quarter revenue was up by 10.5% to 13.9 million, and was comprised of both organic and acquisition-related growth. On a trailing 12-month basis, Segment revenue was also up the same 10.5% compared with the fiscal 2015 period.
Sales in the Distribution segment declined 2.2 million or 12% to 16.2 million in the quarter due to soft market conditions as Lee noted. The consolidated compound annual growth rate for Service segment sales since fiscal 2012 is over 12%.
Moving on to Slide 5; our Service segment continued to deliver strong operating income and operating margins. For the quarter, operating margins expanded 120 basis points to 5.7%.
Margins also improved in the Distribution segment with its gross margin increasing 40 basis points to 21.6% due to higher vendor rebates, and its operating margin expanding 100 basis points to 5.4% based on lower segment operating costs from operational efficiencies. As we said on our last earnings call, we do not expect vendor rebates to negatively impact fiscal '16, and as expected, we're seeing some upside.
We'll now move on to Slide 6, where we look at adjusted EBITDA and EBITA margin to gauge our performance. We used adjusted EBITDA because we believe it is a good measure of operating cash flow for each segment.
These are non-GAAP measures. So please review our reconciliations and related disclosures in our release and at the end of the slides.
Consolidated third quarter adjusted EBITDA was 2.6 million, a 12.5% improvement which reflected the robust revenue growth and strong operating leverage in the Service segment. Adjusted EBITDA for the Service segment increased 23% to $1.5 million, and segment margin increased 107 basis points to 11%.
In the Distribution segment, adjusted EBITDA was consistent at $1.1 million. The consolidated compound annual growth rate for adjusted EBITDA since fiscal 2012 was 6.1%, while it was more than 41% for the Service segment, which underscores the impressive earnings power of this segment.
On to Slide 7, where we have our bottom line performance; third quarter net income increased 31% to $1.1 million and diluted earnings per share increased 36% to $0.15. Our net income compound annual growth rate since fiscal 2012 is more than 8%.
Slide 8 provides detail regarding the strength and flexibility of our balance sheet. At the end of the third quarter, we had $19.5 million in availability under our credit facility, of which $12 million was available for acquisitions.
Some of this availability was used subsequent to quarter end for the acquisitions of Spectrum and Dispersion. CapEx was $3.8 million year-to-date, up from $2.7 million last year, and was primarily for expanded Service segment capabilities and acquisition of assets for our growing rental business.
As always, our strategy involves operating and investing with discipline. We expect total capital expenditures in the range of 4 million to 4.5 million in fiscal '16, which is a slightly higher estimate from last quarter.
More than half of the estimated CapEx will be focused on increasing our lab capabilities and capacity. With that, I'll turn it back to Lee.
Lee Rudow
Thank you, John. As we near the close of the fiscal year, we'll continue to perform well and execute our strategic plan despite headwinds.
Total company reported operating income growth is now likely to be flat or modest, but we are in a great position to drive future growth as industrial markets rebound. We expect double-digit revenue growth in our Service segment through a combination of acquisitions and consistent organic growth.
Our acquisition pipeline remains strong, and our position as a leading U.S. and Canadian provider of calibration services continues to strengthen.
Looking further out, our strategic plan is structured to enable growth to 175 million to 200 million in revenue within the next five years and more importantly to achieve double-digit EBITDA margins at that revenue level. So with that, operator, we can open the line for questions.
Operator
Thank you. [Operator instructions] It appears we have no question -- oh, I am sorry; we did get a question from Steven Stern with Stern Investment Advisory.
Please proceed with our question.
Steven Stern
Good morning, and congratulations on an excellent quarter you report, and congratulations to John Zimmer on your well-deserved retirement, and I have always enjoyed your commentary on these calls.
John Zimmer
Thank you.
Steven Stern
The net operating margin expansion is excellent, and in, as you say headwind environment, the bottom line growth is very, very good. In looking at the release, so much of the improvement or the final thrust of the improvement came from reduction of selling, marketing and warehousing expenses, and holding administrative expenses in line to a little down.
What types of things did you do to achieve that, and are they one-time adjustments, or those are adjustments that will carry forward into future quarters?
John Zimmer
Thank you, Steve, and this is John Zimmer. The types of adjustments that we had with decline in distribution, sales that we've had this year, we have been able to adjust expenses particularly on the distribution side of the business related to some of our marketing and other expenses related to warehousing and purchasing and other aspects of that side of the business, as well as, there is a little bit less in the year-to-date numbers for performance-based compensation, and particularly we in the third quarter, there is -- some of that impact of lower expenses is related to our performance-based comp.
So that's not necessarily going to be sustainable, and in fact as we said in the fourth quarter, we anticipate that the performance-based comps will be higher this year than last year.
Steven Stern
Okay, thank you. And then one financing question, the company seems to have excellent relation with its banks with the renewals and flexibilities on the financing of the lines of credit, any thought to possibly [indiscernible] in lower interest rates on the liability side with a public issue or a private issue [indiscernible] duration bond?
John Zimmer
We are always looking at the alternatives from a balance sheet perspective as far as how we are going to finance -- continue to finance the growth going forward, and I don't think that there is anything that's off the table, but I do think that we do have great relationships with our bank and we are looking at making sure of that, and we are confident that we'll have capacity going forward to continue to grow the business the way that we have in the trajectory that we've had in the past, but nothing specific as far as that goes.
Steven Stern
Okay, very good. Thank you very much.
John Zimmer
Thanks.
Operator
We have no further questions at this time. I would now like to turn floor back over to management for additional or closing comments.
Lee Rudow
So this is Lee, thank you, thank you all for joining us on the call. We certainly appreciate your continued interest and support.
John Zimmer
Thank you.
Operator
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time.
Thank you for your participation, and have a wonderful day.