Transcat Q1 2025 Earnings Report

Transcat EPS Results

• Actual EPS: $0.48
• Consensus EPS: $0.28
• Beat/Miss: Beat by +$0.20
• One Year Ago EPS: $0.38

Transcat Revenue Results

• Actual Revenue: $66.70 million
• Expected Revenue: $69.35 million
• Beat/Miss: Missed by -$2.65 million
• YoY Revenue Growth: +10.10%

Transcat Announcement Details

• Quarter: Q1 2025
• Date: 7/29/2024
• Time: After Market Closes
• Conference Call Date: Tuesday, July 30, 2024
• Conference Call Time: 11:00AM ET

Transcat (NASDAQ:TRNS) (NASDAQ: TRNS) is a leading provider of calibration, laboratory, and metrology services in North America. Founded in 1964 and headquartered in Ronkonkoma, New York, the company specializes in ensuring the accuracy and compliance of measurement instruments across a wide range of industries. Transcat operates a network of ISO/IEC 17025–accredited laboratories and offers on-site field calibration, instrument repair, and preventive maintenance services.

In addition to its calibration services, Transcat distributes precision instrumentation and related software solutions from top manufacturers. The company’s offerings include temperature and humidity monitoring systems, pressure gauges, analytical balances, and data acquisition hardware. By combining equipment sales with technical support and training, Transcat helps clients optimize their quality-control processes and maintain regulatory compliance.

Transcat serves customers in pharmaceutical, biotech, medical device, aerospace, defense, food and beverage, and general manufacturing sectors. With operations throughout the United States and remote support capabilities, the company delivers responsive service tailored to each customer’s operational environment. Transcat’s commitment to accreditation, continuous improvement, and technical expertise underpins its reputation as a trusted partner in precision measurement.

Transcat Q1 2025 Earnings Call Transcript

Key Takeaways

• Positive Sentiment: Transcat delivered Q1 FY25 revenue of $66.7 M (up 10%), adjusted EBITDA of $10.2 M (up 20%), and expanded consolidated gross margin by 310 bps to 34%.
• Positive Sentiment: The service segment marked its 61st straight quarter of year-over-year growth with 10% revenue increase (6.4% organic) and achieved a 150 bps lift in gross margin to 34%, driven by automation, technician training, and process improvements.
• Positive Sentiment: Distribution & rentals gross margin widened by 620 bps, led by the high-margin rental business and smooth integrations of the Acxiom and Becknell acquisitions, with early synergy opportunities already identified.
• Positive Sentiment: A strong balance sheet features $19.1 M net cash, 0.1× leverage and $80 M available credit, supporting recent $50 M Becknell deal funded with stock and cash.
• Positive Sentiment: For FY25, management expects high single-digit to low double-digit organic service growth, continued margin expansion, and a robust acquisition pipeline to drive sustainable long-term value.

Presentation

[Operator]

.Greetings, and welcome to Transcat, Inc., First Quarter Fiscal Year 2025 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Tom Barbato, Chief Financial Officer. Thank you, Mr. Barbato. You may begin.

[Tom Barbato, SVP and CFO at Transcat Inc]

Thank you, operator, 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 will begin the call with some prepared remarks, and then we will open up the call for questions. Our earnings release crossed the wire after markets closed yesterday. Both the earnings release and the slides that will be referenced during our prepared remarks can be found on our website, transcat.com, in the Investor Relations section. If you would, please refer to slide number two. As you are aware, we may make forward-looking statements during the formal presentation and Q&A portion of this teleconference.

[Tom Barbato, SVP and CFO at Transcat Inc]

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.

[Tom Barbato, SVP and CFO at Transcat Inc]

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 comparable GAAP measures in the tables accompanying their earnings release. With that, I'll turn the call over to Lee.

[Lee Rudow, President and CEO at Transcat Inc]

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. Transcat delivered strong performance across our entire portfolio in the first quarter of fiscal 2025, as we continue to demonstrate our ability to effectively execute our strategy and to drive differentiation throughout our business platform. Consolidated revenue was up 10% to $66.7 million, driven by continued demand for our services, as well as strong rental performance. Consolidated gross margin expanded 310 basis points to 34% and was driven by significant margin expansion in both our service and distribution segments. Adjusted EBITDA in the quarter grew 20% from prior year to $10.2 million. Service continued to perform at a high level and recorded its 61st straight quarter of year-over-year revenue growth. That's more than 15 straight years.

[Lee Rudow, President and CEO at Transcat Inc]

In the first quarter of fiscal 2025, service revenue grew 10% overall and 6.4% organically. We continued to focus on recurring revenue streams with highly regulated industries that include life science and aerospace and defense. Internally, we rally around the theme of get bigger and get better. To that point, service gross margins in the first quarter grew 150 basis points versus prior year to 34%. Our consistent service gross margin improvement over time reflects our ability to drive continuous process improvement throughout our operation. Specific drivers of service gross margin improvement include increased productivity through higher levels of automation and technical training, as well as system and software enhancements. As we talked about in the past, the constant driver of service margin gain is the inherent leverage in the operating model as service revenue grows.

[Lee Rudow, President and CEO at Transcat Inc]

Turning to distribution and rentals, gross margins expanded 620 basis points from prior year, driven primarily by the higher-margin rental business, which now includes both Axiom, which we acquired in August, almost one year ago, and Becnel, acquired this past April at the start of our first quarter. The integration with Axiom has been excellent, and on the Becnel front, we're off to a strong start, making early, meaningful progress. In fact, in the first quarter since the acquisition of Becnel, we can already point to several synergistic service opportunities that we've encountered from the Becnel customers. While this was anticipated to occur at some point, the strong early start is great news. Becnel is a very well-run company that has cultivated a loyal customer base, most of which are heavy users of instrumentation and calibration services.

[Lee Rudow, President and CEO at Transcat Inc]

In addition to its rental platform, Becnel offers a very profitable, growing operator-based service model that we anticipate will contribute to service margin expansion over time. Overall, we're pleased with our start, our strong start across the business in fiscal 2025, the 10% growth we generated in consolidated revenue, the 310 basis point expansion in consolidated gross margin, and the 20% growth in adjusted EBITDA. It's all a testament to the strength of Transcat, our brand, and the uniqueness of our value proposition. Transcat continues to be recognized and rewarded for the delivery of our risk-mitigating services across high cost of failure manufacturing environments. Customer retention has been and continues to be a hallmark of Transcat, and a major contributor of our consistent top-line performance over time.

[Lee Rudow, President and CEO at Transcat Inc]

Lastly, the first quarter of fiscal 2025 was also benefited from the expansion of addressable markets, which contributed significantly to both revenue and margin growth. We ended the quarter with a strong balance sheet, and we are well-positioned to execute our growth initiatives, including the acquisition of companies that enhance our geographic footprint, expand our current capabilities, expertise, and markets. With that, I'll turn things over to Tom to provide additional detail on the first quarter financials.

[Tom Barbato, SVP and CFO at Transcat Inc]

Thanks, Lee. I'll start on slide 4 of the earnings deck posted on our website, which provides detail regarding our revenue on a consolidated basis and by segment for the first quarter of fiscal 2025. First quarter consolidated revenue of $66.7 million was up 10% versus prior year, as both segments experienced consistent demand. Looking at it by segment, service revenue growth remained solid at 10%, 6.4% of the growth coming organically, and the remainder from acquisition. Turning to distribution, revenue of $22.9 million grew 11%, as we continue to see strong performance in the higher-margin rental business. Turning to slide 5, our consolidated gross profit for the first quarter of $22.7 million was up 21% from the prior year, and our gross margin expanded 310 basis points to 34%.

[Tom Barbato, SVP and CFO at Transcat Inc]

As Lee mentioned, we are very pleased with our year-over-year service gross margin expansion of 150 basis points. The service margin increase further demonstrates the inherent leverage in our service model and our ability to drive higher levels of automation and technician productivity. Distribution segment gross margin of 33.9% was up 620 basis points, driven by strong rental performance. Turning to slide 6, Q1 net income of $4.4 million increased 49% from prior years, and our diluted earnings per share came in at $0.48, up $0.10 per share. Net income growth was driven by strong Q1 performance and the reduction of interest expense, as the majority of our debt was paid down in Q3 of last year, leveraging the proceeds from our secondary offering.

[Tom Barbato, SVP and CFO at Transcat Inc]

We report adjusted diluted earnings per share as well to normalize for the impact of upfront and ongoing acquisition-related costs. Q1 adjusted diluted earnings per share was $0.68, up from $0.52 per share in the prior year. A reconciliation of diluted earnings per share to adjusted diluted earnings per share can be found in the supplemental section of this presentation. Flipping to slide 7, where we show our adjusted EBITDA and adjusted EBITDA margin. We use adjusted EBITDA, which is non-GAAP, to gauge the performance of our business because we believe it is the best measure of our operating performance and ability to generate cash. As we continue to execute our acquisition strategy, this metric becomes even more important to highlight, as it does adjust for one-time deal-related transaction costs, as well as increased levels of non-cash expense that will hit our income statement from acquisition purchase accounting.

[Tom Barbato, SVP and CFO at Transcat Inc]

With that in mind, first quarter consolidated Adjusted EBITDA of $10.2 million was up 20% from the same quarter in the prior year, and Adjusted EBITDA margin expanded 130 basis points. Both segments had double-digit Adjusted EBITDA growth compared to last year. As always, a reconciliation of Adjusted EBITDA to operating income and net income can be found in the supplemental section of this presentation. Moving to slide 8. Operating cash flow improved from last year to $8.9 million for the quarter. Q1 capital expenditures were $900,000 higher than prior year and continued to be centered around service segment capabilities, rental pool assets, technology, and future growth projects. The spend was in line with expectations. Slide 9 highlights our strong balance sheet.

[Tom Barbato, SVP and CFO at Transcat Inc]

At quarter end, we had total net cash of $19.1 million, with a leverage ratio of 0.1x. We had $80 million available from our credit facility. As previously announced, we acquired Becnel Rental Tools for $50 million just after the end of the first fiscal year, paid in a combination of $32.5 million company stock and $17.5 million in cash. Lastly, we expect to file our Form 10-Q on August seventh. With that, I'll turn it back to you, Lee.

[Lee Rudow, President and CEO at Transcat Inc]

Thank you, Tom. Transcat has successfully delivered on the expectations we have set and communicated over a very long period of time. Expectations include consistent organic service revenue growth, gross margin expansion, and in recent years, solid free cash flow. We've also expanded our addressable markets and strengthened our industry-leading value proposition through a significant number of accretive acquisitions in our core and adjacent markets. And as always, effective and timely integration represents the key differentiator and has set Transcat apart. Throughout the remainder of 2025 and beyond, we are confident this will continue. Fiscal 2025, we expect organic service growth in the high single digit to low double-digit range when normalized for the extra week in fiscal 2024, and we expect gross margin expansion throughout our portfolio of businesses and business channels.

[Lee Rudow, President and CEO at Transcat Inc]

We have a robust and diverse acquisition pipeline that will enable opportunities to both expand our core services and addressable markets, and ultimately increase the trajectory of the business. Of course, the ultimate focus will continue to be on generating sustainable long-term value for our shareholders. As we look ahead, we remain excited about the direction Transcat is headed and our ability to execute what we believe is a differentiated and defendable strategic plan. With that, operator, we can open the line for questions.

[Operator]

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we pull for questions. The first question comes from the line of Greg Palm with Craig-Hallum Capital Group. Please go ahead.

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Hey, all. Good morning. Thanks for taking the questions here. Wanted to maybe dig into the segment-related results a little bit to start things off. So on services, the organic growth number was a little bit light of kind of your full year guide, certainly what we're accustomed to in, you know, over the past couple of years. So just can you dig into that a little bit? Was it timing? It, you know, it suggests that, you know, if you're going to get to high single digits, low double digits, it obviously accelerates from this level for the remainder of the year. So just a little bit more color there would be helpful to start.

[Lee Rudow, President and CEO at Transcat Inc]

Sure, Greg, this is Lee. I'll take that. No, I wouldn't read into the 6.4% organic growth too deeply. You know, service remains strong in terms of demand, and demand remains strong. There's going to be fluctuations in this business. We've always talked about that, fluctuations that aren't necessarily reflective of our expectations, particularly long term. So we didn't change our guidance because, you know, we still think that the pipeline and the demand is there, and, you know, we would expect to be in that range, you know, for, you know, for the fiscal year. So no, we're not... It's not something we think about too much as we look at 90-day increments of time. We've never really looked at the business that way, and, so, no, I'm not concerned.

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Yep. Any end markets, you know, within that segment that jumped out, either from a positive standpoint or maybe a little bit weaker than expected, at least for the quarter?

[Lee Rudow, President and CEO at Transcat Inc]

No, I think everything's pretty consistent with, with, you know, our expectations. You know, we, we see when you look at the business that was generated, the growth and the pipeline, it's, it's, it's pretty much in line with the, highly regulated industries that we serve. So you've got aerospace and defense in a big way, producing, and same with life sciences. So I think that's consistent with the past, and, and that's what we expect.

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Yep. Okay, good. And then shifting gears to distribution, you know, I—by our math, I think organic growth was negative, you know, and certainly the reported growth was driven by acquisition-related contribution. Can you just give us a little bit more sense on what's happening in distribution? And, you know, for rental specifically, how much is that at this point in terms of overall mix? Are you willing to give us kind of a ballpark number?

[Lee Rudow, President and CEO at Transcat Inc]

So generally speaking, you know, we have guided towards this and, you know, we look at distribution a little bit differently, obviously, than we did years ago. We have invested in our strategy to grow the rental business. We've done that organically and through acquisition. You do see acquired revenue, but you also see, on the rental side, organic growth, which has been pretty impressive. So we like where we are in distribution for that reason. Margins are up, profits are up. We did expect that core distribution over time may decrease and the mix may change, and the percentage of the business is going to increase towards rentals. We like that. That's strategic for us, and we'll keep that going.

[Lee Rudow, President and CEO at Transcat Inc]

We have low margin and what we used to call reseller business in the core distribution channel, and it's just not something that we spend a lot of time thinking about or investing in, and we expect that number to tweak its way down over time, but to be supplemented and substituted for the higher margin, higher growth rental business. We're going to continue down that path. We like it.

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Is it fair to say that you're maybe walking away from some of that business on purpose, that low margin business, or is it just more of a, "Hey, we're not really putting any resources focus on it," so it may just sort of dwindle over time?

[Lee Rudow, President and CEO at Transcat Inc]

Yeah, I think the latter. You know,

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Yeah. Okay.

[Lee Rudow, President and CEO at Transcat Inc]

We're not going to walk away from business. We never walk away from our customers when they have needs, but we're certainly not allocating additional incremental resources to low margin. Let's say, for example, like I just pointed out, resale business or channels that aren't as profitable. We're allocating resources towards that high margin rental business, and we don't lose much in terms of that ever important connection. In fact, we don't lose anything, in my opinion, in the connection between services, you know, in the rental business. Same customers, and we always want to get that crack in that door so that we can walk through and try to gain service business. So that, nothing has changed in that respect, Greg.

[Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group]

Understood. Okay, I will leave it there. Thanks for the time.

[Operator]

Thank you. Next question comes from the line of Ted Jackson with Northland Securities. Please go ahead.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Thanks very much. Good morning.

[Lee Rudow, President and CEO at Transcat Inc]

Hey, Ted.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

So I'm gonna just jump over into let's talk about services gross margins, because, I mean, it's a clear bright spot for Transcat, and, you know, something you should be proud of, and I know you are. Can you, you know, maybe flesh out what's driving a lot of the margin improvement? I mean, in the press release, you talked about, you know, productivity improvements, and you talked about automation, and maybe put some meat on the bones with regards to, you know, some of the projects and programs that you are using to drive that margin improvement and things in terms of projects and programs in the future that will continue to drive, drive it going forward. And then I think I have a follow-up after that. Thanks.

[Lee Rudow, President and CEO at Transcat Inc]

Yeah, this is Lee. I'll take a stab at this, and Tom can make sure I don't miss anything, because there are a lot of things in play here, and I'll try to capture and highlight some of the big ones. Automation is important. You know, we launched this initiative, I wanna say maybe 3, 4 years ago. At least that feels about right. You know, for the first couple of years, people would ask, you know, "How far along are you?" I'd say, "Well, we're in the first inning, second inning." I think today I would characterize that as, you know, we're in the fourth inning. We used to have automation in terms of percentage of our calibration.

[Lee Rudow, President and CEO at Transcat Inc]

We don't get into a lot of detail around that, but you know, mid-low single digits, and you know, now it's in the 20%+ range. And so there's a lot of automation that's taking place, and it's arduous, and it's difficult, and there's a lot of programming. But once you get it done, you know, you can capitalize on it over a long period of time, and that's kind of what we're doing. So there's still runway there that's significant, and we're steady progress. We're pleased with it, and you always want it to be faster than it is, but it's making a dent in the initiative, and we're increasing margin. There you know, it's an inflection point in this business, right?

[Lee Rudow, President and CEO at Transcat Inc]

So that operating leverage, and as you get organic revenue growth, you know, over time, aside from a step function investment here or there, you know, that's gonna improve your margins. So that's definitely playing a role. And, you know, we've done a lot of work. You know, we have a new Chief Operating Officer, and we've really dug into the labs and trying to make them more efficient, improve processes, and we've really made some gains in terms of how we get products through our lab, onto the bench, off the bench, build quicker, better turnaround times. These are all things that eventually lead their way to margin and also lead their way to stronger organic growth because you have a higher level of customer satisfaction with better turnaround times.

[Lee Rudow, President and CEO at Transcat Inc]

These are all things we're working on, and I think they all contribute. Tom, maybe-

[Tom Barbato, SVP and CFO at Transcat Inc]

You know, the other thing I would just add, right, is that, you know, when we talk about, you know, productivity and automation and the benefit that we see, you know, in margins, there's also another benefit that we get, right? It puts less dependency on, you know, additional resources to get the incremental work done, which, you know, I don't wanna lose sight of, right? Because, you know, technicians are, you know, our most important asset, and, you know, being able to do more work with the same number of people is extremely valuable. So I just wanna make that point as well.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Well, that's good, 'cause, you know, Tom, that's a great segue into my next question, and that has to go with, labor and, what your labor needs. And, you know, I think you might have gotten into it a bit, but, you know, as Transcat continues to get big, it, you know, clearly means that you need more technicians. I mean, it's always been an issue in terms of your ability to get in that kind of labor, and that's why you started your training program, so you could develop your own talent, you know, grow your own wood, if you would. You know, like, you know, where is that in terms of an issue for Transcat? You know, maybe an update with regards to, you know, some of your training programs and the technicians that you've put through it.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

You know, maybe, I don't know, maybe you kind of answered it already, but what, where do you see that in terms of your needs and choke points going forward?

[Lee Rudow, President and CEO at Transcat Inc]

So, Ted, you know, I've been in this business for coming up on 40 years. Labor, technical labor has always been an issue, and it always will be an issue. And you're right, that's why we started Transcat University. That's why we decided we have to train our own technicians, and if and when we do, and we are doing it, it'll be a differentiator because we'll have labor when and where we need it. Now, that's not always the case, and it's not as easy as I make it sound. But we're... You know, we try to position ourselves better than the competition so that we can compete better, and we can win more, and we can win the jobs that we want. So always a challenge, no question, but in there also lies the opportunity, right?

[Lee Rudow, President and CEO at Transcat Inc]

So if you can overcome it, and you can get this kind of training program going, and that—and I expect that program to get better and better over time, more efficient, more effective over time. Still relatively new, but I like the returns. We like the returns, and I see that as continuing. Now, there are other ways, too. You know, we talk about, as Tom mentioned, the more automation you do, the more, you know, you go kind of from tech to operator. I mean, one day it'll be more robotics, which takes you from operator to robots. I mean, there's all kind of things that you can do longer term.

[Lee Rudow, President and CEO at Transcat Inc]

We're focused on those things, but when you allocate resources, the best place is to make sure you have the labor where and when you need it, and that's what we're doing with Transcat University. I see that continuing.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Okay. And then my last question is, just on, you know, it's, it's a topic that used to get mentioned a lot, and it doesn't come up quite as often, but just on the customer base, you know, kind of labs, you know, can you give us an update on kind of like, you know, I don't know, how many, you know, CBLs you have at this point, what the pipeline looks like? You know, how, you know, kind of what's kind of going on with that in terms of a, of a growth driver for, service revenue for you over the, you know, coming, you know, you know, quarters, years? Thanks.

[Lee Rudow, President and CEO at Transcat Inc]

I would characterize our Client-Based Labs as steady. So you know, we still have in the mid- to upper 20s as a round number for the number of locations we're actually in, with embedded technicians, with an embedded lab. You know, at different times, that business sort of ebbs and flows, and it's usually a by-product of labor shortages and our customers' inability or their challenge that they have with finding the labor they need when they need it. So right now, we have a pipeline with a significant number of CBLs in them. But you know, when you look across our pipeline, our portfolio, we've got everything from transactional to core small, core medium, core large, strategic, and then CBL. So it's just one of the six service channels. They tend to be larger accounts.

[Lee Rudow, President and CEO at Transcat Inc]

But I think that I would say it's steady and stable is how I'd describe that. It's not on the uptick, but it's not declining either, so it's kind of in a steady state.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Okay. All right. Hey, thanks very much. Talk to you guys soon.

[Lee Rudow, President and CEO at Transcat Inc]

Okay.

[Tom Barbato, SVP and CFO at Transcat Inc]

Thanks, Ted.

[Operator]

Thank you. Next question comes from the line of Martin Yang with Oppenheimer & Co. Please go ahead.

[Martin Yang, Executive Director at Oppenheimer & Co]

Hey, thanks for taking my question. Lee, I want to ask you about your updated view on your addressable market. You know, in the past, you have updated numbers, such as $1.6 billion for U.S. calibration services. Now, with the bigger rental business as a management, as well as Becnel's decommissioning services, you know, how do you think about your, you know, service addressable market in the U.S.? You know, do you have an updated number for us?

[Lee Rudow, President and CEO at Transcat Inc]

Well, in terms of addressable markets, in general, first, let's make clear that when we expand our addressable markets, we're always going adjacent to what we do. We want to stay in pretty close proximity to our core business, which is calibration services. So, today, you know, we're always looking to, you know, expand where it makes sense for the business, where we get recurring revenue streams, where there's a demand, where there's regulation. You saw that with Becnel. You know, if there's a margin play, you know, you saw that with Axiom. And so with NEXA, you saw kind of a combination of, you know, value prop enhancers around calibration.

[Lee Rudow, President and CEO at Transcat Inc]

I think, Martin, there are opportunities to expand our addressable markets to the house next door, and sometimes maybe the house right next door to that. We're gonna stay disciplined. You know, we've always been disciplined around our acquisition strategy, and that's not gonna change. It's something that we talk to the board about, it's required from us, and our shareholders expect that. So there are more addressable markets. We expect to tap into them. They are likely to be the house next door because that's the way we approach it. And certainly, we look for all the attributes that are part of our acquisition strategy, geographic expansion, margin enhancers, adding expertise. These are some of the things that we'll continue to focus on when we look to expand our markets.

[Lee Rudow, President and CEO at Transcat Inc]

I hope, I hope that added some clarity for you.

[Martin Yang, Executive Director at Oppenheimer & Co]

Got it. Thank you. And my next question is about gross margins. So when you look at the two different segments, they are, you know, almost at parity now. And how do you think about, you know, the difference in margins or the convergence of gross margins between the two segments in the medium to longer term?

[Lee Rudow, President and CEO at Transcat Inc]

So, you know, Tom, help me out with this one. But, you know, we've guided towards service gross margins being in the mid- to upper 30s for now, right? We have pretty good sight lines, as Tom would say, to get to that range and to continue the improvement in margins over time. You know, I don't like to really talk about it quarter to quarter. There's some quarters where we have outstanding results like this one, and there's some where you may be flat and some where you may have 20 basis points. But over time, we can see. We see that continuing and because there's a lot of runway left on the initiatives around that. And then, of course, the inherent leverage that we talk about.

[Lee Rudow, President and CEO at Transcat Inc]

In distribution, you know, the margin increase is driven by rentals, and we know that, and we like it. If we go back to 2016, we didn't have that business, and distribution was a, you know, low 20s, 20% business. So that's changed drastically for the better. And, you know, it even surprises us to a certain degree. If you go back five or six years ago, would we have seen the, you know, the parity between the two margins? I would have not bet on that. But through creativity, through being, you know, allocating resources properly, getting the right leaders here, we've made something really significant out of that business, and it has scalability, which we like, and it's connected to service. So I think that margin will increase over time.

[Lee Rudow, President and CEO at Transcat Inc]

Also, as the percentage of rentals, it becomes higher within distribution, which we expect it to do. So, Tom-

[Tom Barbato, SVP and CFO at Transcat Inc]

No, I would agree with that. I would just, you know, we gotta keep in mind that, you know, in August, we'll kind of lap the Axiom acquisition, right? And, you know, so some of that lift that we're getting from, you know, last year's August Axiom acquisition will go away. But on a go-forward basis, I would expect that, you know, the two, you know, margins will kind of track, you know, in a similar fashion going forward.

[Martin Yang, Executive Director at Oppenheimer & Co]

Got it. Thanks, Tom. Thanks, Lee.

[Tom Barbato, SVP and CFO at Transcat Inc]

Yep.

[Operator]

Thank you. Next question comes from the line of Ted Jackson with Northland Securities. Please go ahead.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Oh, Ted, I just have a follow-up question driven by the last line of questioning. When you look at the historic, you know, trends of the business and the seasonality of it, typically, Transcat sees the second quarter margin, particularly as it relates to services revenue, stronger than the first quarter. Do we expect that to be the same this year?

[Lee Rudow, President and CEO at Transcat Inc]

How do you want to take that one or?

[Tom Barbato, SVP and CFO at Transcat Inc]

Yeah, we're not expecting, Ted, anything, you know, really significantly different in our from a seasonality standpoint. So I think it would be safe to assume that.

[Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities]

Okay. Okay, that was my one question. Thank you very much.

[Operator]

Thank you. A reminder to all the participants that you may press star one to ask a question. Ladies and gentlemen, there are no further questions at this time. I would now like to turn the floor over to Lee Rudow for closing comments.

[Lee Rudow, President and CEO at Transcat Inc]

Okay, well, thank you all for joining us on the call today. We certainly appreciate your interest, your continued interest in Transcat. We will be attending the Oppenheimer 27th Technology, Internet, and Communications Conference. It's gonna be on August 12th, so feel free to sign up to talk to us then and reach out. Otherwise, you know, you can really check in with Tom or me at any time. So if we don't hear from you, we look forward to talking to everybody again after our second quarter results. And, thank you again for participating. Take care.

[Operator]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Participants

Executives

• Lee Rudow, President and CEO
• Tom Barbato, SVP and CFO

Analysts

• Greg Palm, Senior Research Analyst at Craig-Hallum Capital Group
• Martin Yang, Executive Director at Oppenheimer & Co
• Ted Jackson, Managing Director and Senior Research Analyst at Northland Securities