TRANSCAT INC (TRNS) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and related notes appearing elsewhere in this annual report. In addition to historical information, the following discussion and analysis includes forward looking statements that involve risks, uncertainties and assumptions. Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those discussed in “Risk Factors” and elsewhere in this annual report. See the discussion under “Forward Looking Statements” beginning on page 1 of this annual report

OVERVIEW

Operational Overview. We are a leading provider of accredited calibration services, enterprise asset management services, and value-added distributor of professional grade handheld test, measurement and control instrumentation.

We operate our business through two reportable business segments, Service and Distribution, which offer a comprehensive range of services and products to the same customer base.

Our strength in our Service segment is based upon our wide range of disciplines, our investment in quality systems and our ability to provide accredited calibrations to customers in highly-regulated targeted market segments. Our services range from the calibration and repair of a single unit to managing a customer’s entire calibration program. We believe our Service segment offers an opportunity for long-term growth and the potential for continuing revenue from established customers with regular calibration cycles and recurring laboratory instrument service requirements.

Our Service segment has shown consistent revenue growth over the past several years, ending fiscal year 2023 with its 56th consecutive quarter of year-over-year growth. This segment has benefited from both organic growth as well as acquisitions over those 56 quarters. The business acquisitions that we made have been heavily focused on expanding our service capabilities, increasing our geographic reach and leveraging our Calibration Service Centers and other infrastructure to create operational synergies.

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Our Service segment revenue growth was 18.8% for fiscal year 2023 from fiscal year 2022, and included a combination of organic growth and acquisition related revenue. The Service segment gross margin increased by 30 basis points. Service segment gross profit and gross margin increases were primarily due to improved productivity offset by increased start-up costs from new client-based lab implementations.

In our Distribution segment, we sell and offer for rent, professional grade handheld test and measurement instruments. Because we specialize in professional grade handheld test and measurement instruments, as opposed to a wide array of industrial products, our sales and customer service personnel can provide value-added technical assistance to our customers to aid them in determining what product best meets their particular application requirements. We have expertise in the procurement and sale of used equipment, furthering our ability to add value for our customers. We also have a higher-end electronic test and measurement equipment rental business that augments our organically grown test and measurement equipment rental business. Through our website and sales teams, customers can place orders for test and measurement instruments and can elect to have their purchased instruments calibrated and certified by our Calibration Service Centers before shipment as well as on regular post-purchase intervals. Pre-shipment calibration and certification allows our customers to place newly purchased instruments into service immediately upon receipt.

Sales in our Distribution segment are generally not consumable items but are instruments purchased as replacements, upgrades or for expansion of manufacturing or research and development facilities. As such, this segment can be heavily impacted by changes in the economic environment. As customers increase or decrease capital and discretionary spending, our Distribution sales will typically be directly impacted.

In fiscal year 2023, Distribution segment sales increased by 3.3%. This increase in sales primarily due to increased demand for rental orders.

The Distribution segment gross margin in fiscal year 2023 increased by 180 basis points. The increase in segment gross margin was primarily due to a favorable mix of products sold and strong demand for our higher-margin rentals business.

Initiatives implemented within this segment include adding new in-demand vendors and product lines, expanding the number of SKUs that we offer with and without pre-shipment calibration and offering equipment rental and used equipment options. Management believes this diversification strategy will mitigate the impact that any particular industry or sector will have on the overall performance of this segment as well as help to further differentiate us from our competitors going forward.

Financial Overview. In evaluating our results for fiscal year 2023, investors should consider that we operate on a 52/53-week fiscal year, ending the last Saturday in March. In a 52-week fiscal year, each of the four quarters is a 13-week period. In a 53-week fiscal year, the last quarter is a 14-week period. Fiscal years 2023 and 2022 each consisted of 52 weeks.

A discussion regarding our financial condition and results of operations for the fiscal year ended March 26, 2022 and year-to-year comparisons between fiscal year 2022 and fiscal year 2021, which are not included in this Form 10-K, can be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 26, 2022 and are incorporated by reference herein.

Total revenue for fiscal year 2023 was $230.6 million. This represented an increase of $25.6 million or 12.5% versus total revenue of $205.0 million for fiscal year 2022. Total revenue increased due to increases in both Service revenue and Distribution sales increases.

Service revenue was $144.9 million in fiscal year 2023, an increase of $22.9 million or 18.8%. Service revenue accounted for 62.8% of our total revenue during fiscal year 2023. Of our Service revenue in fiscal year 2023, 86.2% was generated by our Calibration Service Centers and enterprise asset management services while 12.6% was generated through subcontracted third-party vendors, compared with 84.0% and 14.5%, respectively, in fiscal year 2022. The remainder of our Service revenue in each period was derived from freight charges.

Distribution sales were $85.7 million in fiscal year 2023, an increase of $2.7 million or 3.3%.  Distribution sales accounted for 37.2% of our total revenue in fiscal year 2023.

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Sales to domestic customers comprised 92.1% of total Distribution sales in fiscal year 2023, while 6.6% were to Canadian customers and 1.3% were to customers in other international markets.

Total gross profit was $68.4 million in fiscal year 2023 compared to $58.4 million in fiscal year 2022, an increase of $9.9 million or 17.0%. Total gross margin was 29.6%, which is a 110 basis point increase versus fiscal year 2022. Service gross margin was 32.2% in fiscal year 2023 compared with 31.9% in fiscal year 2022, a 30 basis point increase. Distribution gross margin was 25.3% in fiscal year 2023 compared with 23.5% in fiscal year 2022, a 180 basis point increase. This increase in service gross margin in fiscal year 2023 was primarily the result of improved productivity offset by increased start-up costs from new client-based lab implementations.  The increase in Distribution segment gross margin was primarily due to a favorable mix of products sold and strong demand for our higher-margin rentals business.

Operating expenses were $52.1 million, or 22.6% of total revenue, in fiscal year 2023 compared with $44.3 million, or 21.6% of total revenue, in fiscal year 2022. Operating income was $16.2 million, or 7.0% of total revenue, in fiscal year 2023 compared with $14.1 million, or 6.9% of total revenue, in fiscal year 2022. The year-over-year increase in selling, marketing and warehouse expenses was due to increased expenses related to recent acquisitions, especially acquisition related amortization expense, and higher incentive-based employee costs due to higher sales. The year-over-year increase in general and administrative expenses was due to by incremental expenses from acquired businesses (including stock expense), increased payroll costs for new employees and continued investments in technology.

Net income for fiscal year 2023 was $10.7 million compared with $11.4 million in fiscal year 2022, a $0.7 million decrease. Diluted earnings per share for fiscal year 2023 was $1.40 compared with $1.50 for fiscal year 2022, a $0.10 per diluted share decrease.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Use of Estimates. The preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (“GAAP”) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for, but not limited to, allowance for doubtful accounts and returns, inventory reserves, estimated levels of achievement for performance-based restricted stock units, fair value of stock options, depreciable lives of fixed assets, estimated lives of major catalogs and intangible assets, and the valuation of assets acquired, liabilities assumed and consideration transferred in business acquisitions. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our Consolidated Financial Statements will change as new events occur, as more experience is acquired, as additional information is obtained, and as our operating environment changes. Our estimates are evaluated on an ongoing basis and are drawn from historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Such changes and refinements in estimation methodologies are reflected in reported results of operations in the period in which the changes are made and, if material, their effects are disclosed in the Notes to our Consolidated Financial Statements.

The following items in our Consolidated Financial Statements require significant estimation or judgment:

Accounts Receivable. Accounts receivable represent amounts due from customers in the ordinary course of business. These amounts are recorded net of the allowance for doubtful accounts and returns in the Consolidated Balance Sheets. The allowance for doubtful accounts is based upon the expected collectability of accounts receivable. We apply a specific formula to our accounts receivable aging, which may be adjusted on a specific account basis where the formula may not appropriately reserve for loss exposure. After all attempts to collect a receivable have failed, the receivable is written-off against the allowance for doubtful accounts. A returns reserve is calculated based upon the historical rate of returns applied to revenues over a specific timeframe. The returns reserve will increase or decrease as a result of changes in the level of revenues and/or the historical rate of returns. Management believes that the allowances are appropriate to cover anticipated losses under current conditions. However, unexpected changes or deterioration in economic conditions could materially change these expectations.

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Inventory. Inventory consists of products purchased for resale and is valued at the lower of cost or net realizable value. Costs are determined using the average cost method of inventory valuation. Inventory is reduced by a reserve for items not saleable at or above cost by applying a specific loss factor, based on historical experience and current demand, to specific categories of our inventory. Inventory is at risk of obsolescence if economic conditions change. Relevant economic conditions include changing consumer demand, customer preferences or increasing competition. We believe these risks are largely mitigated because our inventory typically turns several times per year. We evaluate the adequacy of the reserve on a quarterly basis.

Business Acquisitions. We apply the acquisition method of accounting for business acquisitions. Under the acquisition method, identifiable assets acquired, liabilities assumed and consideration transferred are measured at their acquisition-date fair value. We use a valuation hierarchy to determine the fair values used. Historically, we have relied, in part, upon the use of reports from third-party valuation specialists to assist in the estimation of fair values. Purchase price allocations are subject to revision within the measurement period, not to exceed one year from the date of acquisition.  The fair value of contingent consideration is determined at each reporting period with changes reflected in the statement of operations.  Administration costs to acquire a business may include, but are not limited to, fees for accounting, legal and valuation services and are recorded as incurred in our Consolidated Statement of Income.

Goodwill and Intangible Assets. Goodwill represents the excess of the purchase price over the values assigned to the underlying net assets of an acquired business and is not amortized. As of March 25, 2023, we had $69.4 million of recorded goodwill.

Intangible assets, namely customer base and covenants not to compete, represent an allocation of purchase price to identifiable intangible assets of an acquired business. These intangible assets are amortized over their estimated useful lives and are reviewed for impairment if and when indicators are present.

We test goodwill for impairment for each reporting unit on an annual basis during the fourth quarter of each fiscal year or immediately if conditions indicate that such impairment could exist.  We estimate the fair value of our reporting units using the fair market value measurement requirement.  We have the option to perform a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit has declined below its carrying value. This assessment considers various financial, macroeconomic, industry and segment specific qualitative factors.  Based on the results of our qualitative impairment testing, we have determined that it was more likely than not that the fair values exceeded the carrying values of goodwill for each reporting unit and there were no impairments as of each of March 25, 2023 and March 26, 2022.

Intangible assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable.  In the event a trigger is identified, the carrying value of the asset group is compared to the undiscounted cash flows from that asset group.   There were no intangible asset impairment indicators identified during the years ended March 25, 2023 or March 26, 2022.

Income Taxes. We record deferred income taxes for the effects of timing differences between financial and tax reporting. These differences relate primarily to accrued expenses, bad debt reserves, inventory reserves, operating leases, goodwill and intangible assets, depreciation and amortization and stock-based compensation. We base our deferred income taxes, accrued income taxes and provision for income taxes upon income, statutory tax rates, the legal structure of our Company, interpretation of tax laws and tax planning opportunities available to us in the various jurisdictions in which we operate. We file income tax returns in the U.S. federal jurisdiction, various states, Canada and Ireland. We are regularly audited by federal, state and foreign tax authorities, but a number of years may elapse before an uncertain tax position, for which we have unrecognized tax benefits, is audited and finally resolved. From time to time, these audits result in assessments of additional tax. If a loss is determined to be probable as a result of an audit, an accrual is established.

We apply a more-likely-than-not threshold to the recognition and derecognition of uncertain tax positions. Accordingly, we recognize the amount of tax benefit that has a greater than 50% likelihood of being ultimately realized upon settlement. Future changes in judgments and estimates related to the expected ultimate resolution of uncertain tax positions will affect income in the quarter of such change. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, we believe that our unrecognized tax benefits reflect the most likely outcome.

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Stock-Based Compensation. We measure the cost of services received in exchange for all equity awards granted, including stock options and restricted stock units, based on the fair market value of the award as of the grant date. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options granted. The application of this pricing model involves assumptions that require judgment and are sensitive in the determination of compensation expense. The fair market value of our common stock on the date of each option grant is determined based on the most recent closing price on our primary trading stock exchange, currently the NASDAQ Global Market.

We record compensation cost related to unvested equity awards by recognizing, on a straight-line basis, the unamortized grant date fair value over the remaining service period for awards expected to vest. In accordance with Accounting Standards Updates (“ASU”) 2016-09, excess tax benefits for share-based award activity are reflected in the Consolidated Statement of Income as a component of the provision for income taxes. Excess tax benefits are realized benefits from tax deductions for exercised awards in excess of the deferred tax asset attributable to stock-based compensation costs for such awards. We did not capitalize any stock-based compensation costs as part of an asset. We estimate forfeiture rates based on our historical experience.

We grant timed-based and performance-based restricted stock units as a component of executive and key employee compensation. These restricted stock units are either time vested or vest following the third fiscal year from the date of grant subject to cumulative diluted earnings per share growth targets over the eligible period. Compensation cost ultimately recognized for these restricted stock units will equal the grant-date fair market value of the unit that coincides with the actual outcome of the performance conditions. On an interim basis, we record compensation cost based on the expected level of achievement of the performance conditions. The expense relating to the time vested restricted stock units is recognized on a straight-line basis over the requisite service period for the entire award.

Stock options vest either immediately or over a period of up to five years using a straight-line basis, and expire either five years or ten years from the date of grant. The expense relating to options is recognized on a straight-line basis over the requisite service period for the entire award.

See Note 6 to our Consolidated Financial Statements for further disclosure regarding our stock-based compensation.

Post-retirement Health Care Plans. The Company has a defined benefit post-retirement health care plan which provides long-term care insurance benefits, medical and dental insurance benefits, and medical premium reimbursement benefits to eligible retired corporate officers and their eligible spouses.

For accounting purposes, the defined benefit post-retirement health care plan requires assumptions to estimate the projected and accumulated benefit obligations, including the following variables: discount rate; certain employee-related factors, such as retirement age and mortality; and health care cost trend rates. These and other assumptions affect the annual expense and obligations recognized for the underlying plans. Our assumptions reflect our historical experiences and management's best judgment regarding future expectations.

Increasing the assumed health care cost trend rate by one percentage point would increase the accumulated post-retirement benefit obligation and the annual net periodic post-retirement benefit cost by $0.1 million. A one percentage point decrease in the healthcare cost trend would decrease the accumulated post-retirement benefit obligation and the annual net periodic post-retirement benefit cost by $0.1 million.

Recently Issued Accounting Pronouncements. In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”) to determine the potential impact they may have on our consolidated financial statements.  For a discussion of the newly issued accounting pronouncements see “Recently Issued Accounting Pronouncements” under Note 1 to the Consolidated Financial Statements included in Item 8 of Part II of this report.

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RESULTS OF OPERATIONS

The following table sets forth, for fiscal years 2023 and 2022, the components of our Consolidated Statements of Income.

FISCAL YEAR ENDED March 25, 2023 COMPARED TO FISCAL YEAR ENDED March 26, 2022 (dollars in thousands):

Revenue:

Total revenue was $230.6 million in fiscal year 2023 compared to $205.0 million in fiscal year 2022, an increase of $25.6 million or 12.5%.

Service revenue, which accounted for 62.8% and 59.5% of our total revenue in fiscal years 2023 and 2022, respectively, increased $22.9 million, or 18.8% from fiscal year 2022 to fiscal year 2023. This year-over-year growth includes a combination of organic and acquisition-related revenue growth.

This year-over-year increase also reflected increased demand from the life sciences and other highly-regulated end markets in fiscal year 2023 and included $10.6 million of incremental revenue from acquisitions. Excluding acquired revenue of $10.6 million, the Service segment organic revenue increased by 10.0%.

Our fiscal years 2023 and 2022 Service revenue growth in relation to prior fiscal year quarter comparisons, was as follows:

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Within any year, while we add new customers, we also have customers from the prior year whose service orders may not repeat for any number of factors. Among those factors are variations in the timing of periodic calibrations and other services, customer capital expenditures and customer outsourcing decisions. Because the timing of Service segment orders can vary on a quarter-to-quarter basis, we believe a trailing twelve-month trend provides a better indication of the progress of this segment.

The growth in fiscal year 2023 and fiscal year 2022 reflected both organic growth and acquisitions. The growth in Service segment revenue in fiscal year 2023 includes revenue from Alliance, e2b and Complete Calibration. The growth in Service segment revenue in fiscal year 2022 includes revenue from NEXA and Tangent.

The following table presents the trailing twelve-month Service segment revenue for each quarter in fiscal years 2023 and 2022 as well as the trailing twelve-month revenue growth as a comparison to that of the prior fiscal year period:

Our strategy has been to focus our investments in the core electrical, temperature, pressure, physical/dimensional and radio frequency/microwave calibration disciplines. We expect to subcontract approximately 13% to 15% of our Service revenue to third-party vendors for calibration beyond our chosen scope of capabilities. We continually evaluate our outsourcing needs and make capital investments, as deemed necessary, to add more in-house capabilities and reduce the need for third-party vendors. Capability expansion through business acquisitions is another way that we seek to reduce the need for outsourcing. The following table presents the source of our Service revenue and the percentage of Service revenue derived from each source for each quarter during fiscal years 2023 and 2022:

Our Distribution sales accounted for 37.2% and 40.5% of our total revenue in fiscal years 2023 and 2022, respectively. Distribution sales increased $2.7 million, or 3.3% in fiscal year 2023 compared to fiscal year 2022. This increase in sales was primarily due to strong demand for rental orders.  The increase in sales in fiscal year 2023 were all organic. The change in fiscal year 2022 versus fiscal year 2021 reflected both organic and an easier comparison to fiscal year 2021, which was adversely impacted by the COVID-19 pandemic. Our fiscal years 2023 and 2022 Distribution sales growth in relation to prior fiscal year quarter comparisons were as follows:

Distribution sales orders include orders for instruments that we routinely stock in our inventory, customized products, and other products ordered less frequently, which we do not stock. Backorders are the total dollar value of orders received for which revenue has not yet been recognized. Pending product shipments are primarily backorders, but also include the total dollar value of products that are requested to be calibrated in our service centers prior to shipment, orders required by the customer to be shipped complete or at a future date, and other orders awaiting final credit or management review prior to shipment. Management uses pending product shipments and backorders as measures of our future business performance and financial performance within the distribution segment.

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Our total pending product shipments increased $0.4 million, or 4.6%, at the end of fiscal year 2023 compared to the end of fiscal year 2022. Backorders at the end of fiscal year 2023 were $6.9 million, compared to $6.4 million at the end of fiscal year 2022. The year-over-year increase in pending product shipments was a result of the disruption to the supply of products as well as increased orders.

The following table presents the percentage of total pending product shipments that were backorders at the end of each quarter in fiscal years 2023 and 2022 and our historical trend of total pending product shipments:

Gross Profit:

Total gross profit in fiscal year 2023 was $68.4 million compared to $58.4 million in fiscal year 2022, an increase of $9.9 million or 17.0%. As a percentage of total revenue, total gross margin was 29.6% in fiscal year 2023 compared to 28.5% in fiscal year 2022, a 110 basis point increase.

Service gross profit was $46.6 million, an increase of $7.7 million, or 19.8%, from fiscal year 2022 to fiscal year 2023. Our annual and quarterly Service segment gross margins are a function of several factors. Our organic Service revenue growth provides some incremental gross margin growth by leveraging certain fixed costs of this segment. The mix of services provided to customers may also affect gross margins in any given period. Service gross margin increased by 30 basis points in fiscal year 2023 versus fiscal year 2022. This increase in service gross margin in fiscal year 2023 was the result of improved productivity offset by increased start-up costs from new client-based lab implementations.

The following table presents the quarterly historical trend of our Service gross margin as a percent of Service revenue:

Our Distribution gross margin includes net sales less the direct cost of inventory sold and the direct costs of equipment rental revenues, primarily depreciation expense for the fixed assets in our rental equipment pool, as well as the impact of rebates and cooperative advertising income we receive from vendors, freight billed to customers, freight expenses and direct shipping costs. During fiscal year 2023, we saw a decrease in the rebates offered by our vendors. We recorded vendor rebates of $0.6 million and $1.0 million in fiscal years 2023 and 2022, respectively, as a reduction of cost of Distribution sales. In general, our Distribution gross margin can vary based upon the mix of products sold, price discounting, the timing of periodic vendor rebates offered and cooperative advertising programs from suppliers.

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The following table reflects the quarterly historical trend of our Distribution gross margin as a percent of Distribution sales:

Distribution segment gross margin increased 180 basis points in fiscal year 2023 compared to fiscal year 2022. The increase in segment gross margin was primarily due to a favorable mix of products sold, strong demand for our higher-margin products sold and rented.

Operating Expenses:

Total operating expenses were $52.1 million in fiscal year 2023 compared to $44.3 million in fiscal year 2022. This represented an increase of $7.8 million, or 17.6%, compared to fiscal year 2022. As a percentage of total revenue, operating expenses increased 100 basis points from 21.6% in fiscal year 2022 to 22.6% in fiscal year 2023. The year-over-year increase in selling, marketing and warehouse expenses is due to increased expenses related to recent acquisitions, especially acquisition related amortization expense, and higher incentive-based employee costs due to higher sales. The increase in general and administrative expenses includes incremental expenses related to acquired companies, increased payroll costs for new employees and continued investments in technology.

Provision for Income Taxes:

Our effective tax rate for fiscal years 2023 and 2022 was 20.8% and 13.7%, respectively. The increase in tax rate is due to the lower discrete tax benefits from share-based compensation activity. Our provision for income taxes is affected by discrete items that may occur in any given period but are not consistent from year to year. The discrete benefits related to share-based compensation activity in fiscal years 2023 and 2022 were $0.4 million and $1.4 million, respectively. We continue to evaluate our tax provision on a quarterly basis and adjust, as deemed necessary, our effective tax rate given changes in facts and circumstances expected in the future.

We expect to receive certain federal, state, Canadian and Irish tax credits in future years. We also expect to receive discrete tax benefits related to share-based compensation awards in fiscal year 2024. As such, we expect our effective tax rate in fiscal year 2024 to be between 21.0% and 23.0%.

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Net Income:

Net income for fiscal year 2023 decreased by $0.7 million or 6.1% compared to fiscal year 2022. As a percentage of revenue, net income was 4.6% in fiscal year 2023, down from 5.6% in fiscal year 2022. This year-over-year change reflects higher operating income discussed offset by higher interest expense and a higher provision for income taxes.

Adjusted EBITDA:

In addition to reporting net income, a GAAP measure, we present Adjusted EBITDA (earnings before interest, income taxes, depreciation and amortization, non-cash stock compensation expense, acquisition related transaction expenses, non-cash loss on sale of building, and restructuring expense), which is a non-GAAP measure. Our management believes Adjusted EBITDA is an important measure of our operating performance because it allows management, investors and others to evaluate and compare the performance of our core operations from period to period by removing the impact of the capital structure (interest), tangible and intangible asset base (depreciation and amortization), taxes, stock-based compensation expense and other items, which is not always commensurate with the reporting period in which it is included. As such, our management uses Adjusted EBITDA as a measure of performance when evaluating our business segments and as a basis for planning and forecasting. Adjusted EBITDA is also commonly used by rating agencies, lenders and other parties to evaluate our credit worthiness.

Adjusted EBITDA is not a measure of financial performance under GAAP and is not calculated through the application of GAAP. As such, it should not be considered as a substitute or alternative for the GAAP measure of net income and, therefore, should not be used in isolation of, but in conjunction with, the GAAP measure. Adjusted EBITDA, as presented, may produce results that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies.

During fiscal year 2023, Adjusted EBITDA was $30.4 million, an increase of $4.1 million or 15.6% compared to fiscal year 2022. As a percentage of revenue, Adjusted EBITDA was 13.2% during fiscal year 2023 versus 12.8% during fiscal year 2022, a 40 basis point increase. The increase in Adjusted EBITDA during fiscal year 2023 was primarily driven by the increase in operating income, depreciation and amortization expense and non-cash stock compensation expense.

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Adjusted Diluted Earnings Per Share:

In addition to reporting Diluted Earnings Per Share, a GAAP measure, we present Adjusted Diluted Earnings Per Share (net income plus acquisition related amortization expense, acquisition related transaction expenses, acquisition related stock-based compensation, acquisition amortization of backlog and restructuring expense, on a diluted per share basis), which is a non-GAAP measure. Our management believes Adjusted Diluted Earnings Per Share is an important measure of our operating performance because it provides a basis for comparison of our business operations between current, past and future periods by excluding items that we do not believe are indicative of our core operating performance.

Adjusted Diluted Earnings Per Share is not a measure of financial performance under GAAP and is not calculated through the application of GAAP. As such, it should not be considered as a substitute or alternative for the GAAP measure of Diluted Earnings Per Share and, therefore, should not be used in isolation of, but in conjunction with, the GAAP measure. Adjusted Diluted Earnings Per Share, as presented, may produce results that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies.

LIQUIDITY AND CAPITAL RESOURCES

We expect that foreseeable liquidity and capital resource requirements will be met through anticipated cash flows from operations and borrowings from our Revolving Credit Facility (as defined below).

On July 7, 2021, we entered into the Second Amended and Restated Credit Facility Agreement (the “2021 Credit Agreement”) with Manufacturers and Traders Trust Company (“M&T”), that amended and restated in its entirety the Company’s Amended and Restated Credit Facility Agreement dated as of October 30, 2017, as amended by Amended and Restated Credit Facility Agreement Amendment 1 dated December 10, 2018 and Amended and Restated Credit Facility Agreement Amendment 2 (“Amendment Two”) dated May 18, 2020 (as amended, the “Prior Credit Agreement”).

The 2021 Credit Agreement increased the revolving credit commitment (the “Revolving Credit Commitment”) from $40.0 million to $80.0 million, with a letter of credit subfacility increased from $2.0 million to $10.0 million, and extended the term of the Revolving Credit Commitment to June 2026. The 2021 Credit Agreement amended the definition of Applicable Margin (formerly Applicable Rate under the Prior Credit Agreement), which is based upon our then current leverage ratio and is used to determine interest charges on outstanding and unused borrowings under the revolving credit facility; the amendments reduced the Applicable Margins payable at the two highest leverage ratio levels. The 2021 Credit Agreement also amended the definition of Permitted Acquisitions, that is, acquisitions which are permitted under, and may be financed with proceeds of, the revolving credit facility, including increasing the aggregate purchase price for acquisitions consummated in any fiscal year from $1.0 million to $65.0 million during fiscal year 2022 and $50.0 million during fiscal year 2023 and any subsequent fiscal year, and adding an aggregate purchase price of $40.0 million for acquisitions consummated at any time during the term of the 2021 Credit Agreement related to businesses with a principal place of business located in the United Kingdom or the European Union.

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In addition, the 2021 Credit Agreement provides that, assuming no event of default, restricted payments up to $25.0 million (increased from $10.0 million in the Prior Credit Agreement) in the aggregate and $10.0 million (increased from $3.0 million in the Prior Credit Agreement) in any single fiscal year may be used by us to repurchase our shares and pay dividends. The 2021 Credit Agreement modified the leverage ratio and fixed charge coverage ratio covenants with which we are required to comply. The 2021 Credit Agreement also reduced the London Interbank Offered Rate ("LIBOR") floor from 1.0% to 0.25% and included a mechanism for adoption of a different benchmark rate upon the discontinuation of LIBOR. The 2021 Credit Agreement also reduced the fixed interest rate on our term loan in the amount of $15.0 million (the “2018 Term Loan”) from 4.15% to 3.90%.

The 2021 Credit Agreement superseded in its entirety, the Prior Credit Agreement. Amendment Two to the Prior Credit Agreement had previously extended the term of the revolving credit facility to October 20, 2022 and increased the revolving credit commitment to $40.0 million.

Amendment Two had modified the definition of the applicable rate used to determine interest charges on outstanding and unused borrowings under the revolving credit facility and it amended the definition of permitted acquisitions to amend borrowings available under the revolving credit facility for acquisitions. In addition, Amendment Two had amended the definition of restricted payments to exclude amounts up to $2.5 million during each fiscal year used to pay certain employee tax obligations associated with share-based payment and stock option activity, and modified certain restrictions to our ability to repurchase our shares and pay dividends. Amendment Two also had modified the leverage ratio and fixed charge coverage ratio covenants with which we were required to comply and limited capital expenditures to $5.5 million for fiscal year 2021. Amendment Two also had established a LIBOR floor of 1.0% and included a mechanism for adoption of a different benchmark rate in the event LIBOR was discontinued.

As of March 25, 2023, $80.0 million was available under the revolving credit facility, of which $42.7 million was outstanding and included in long-term debt on the Consolidated Balance Sheets. During fiscal year 2023 and 2022 we used $9.1 million and $29.8 million, respectively, for business acquisitions.

As of March 25, 2023, $6.4 million was outstanding on the 2018 Term Loan, of which $2.2 million was included in current liabilities on the Consolidated Balance Sheets with the remainder included in long-term debt. The 2018 Term Loan requires total repayments (principal plus interest) of $0.2 million per month through December 2025.

Pursuant to the Prior Credit Agreement, we were required to comply with a fixed charge ratio covenant and a leverage ratio covenant, which were modified by the 2021 Credit Agreement. The allowable leverage ratio under the Prior Credit Agreement for the first quarter of fiscal year 2022 was a maximum multiple of 4.0 of total debt outstanding compared to EBITDA and non-cash stock-based compensation expense for the preceding four consecutive fiscal quarters. The Prior Credit Agreement also had provided that the trailing twelve-month pro forma EBITDA of an acquired business was included in the allowable leverage calculation. After the first quarter of fiscal year 2022, pursuant to the 2021 Credit Agreement, the allowable leverage ratio is a maximum multiple of 3.0. We were in compliance with all loan covenants and requirements during fiscal years 2023 and 2022. Our leverage ratio, as defined in the 2021 Credit Agreement, was 1.60 at March 25, 2023, compared with 1.74 at March 26, 2022.

Interest on the revolving credit facility continues to accrue, at our election, at either the variable one-month LIBOR or a fixed rate for a designated period at the LIBOR corresponding to such period (subject to a 1.0% floor during the first quarter of fiscal year 2022 and a 0.25% floor for subsequent periods), in each case, plus a margin. Interest on outstanding borrowings under the 2018 Term Loan accrued at a fixed rate of 4.15% during the first quarter of fiscal year 2022 and accrued or will accrue at a fixed rate of 3.90% over the term of the loan for subsequent periods. Unused fees accrue based on the average daily amount of unused credit available on the revolving credit facility. Interest rate margins and unused fees are determined on a quarterly basis based upon our calculated leverage ratio.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was enacted. The CARES Act included a provision that allows the Company to defer the employer portion of social security payroll tax payments that would have been paid between the enactment date and December 31, 2020, with 50% payable by December 31, 2021 and 50% payable by December 31, 2022. During fiscal year 2021, the Company deferred $2.0 million of employer social security payroll taxes. The Company repaid $1.0 million of the deferred amounts and during each of fiscal year 2023 and fiscal year 2022.

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Cash Flows: The following table is a summary of our Consolidated Statements of Cash Flows (dollars in thousands):

Operating Activities: Net cash provided by operating activities was $17.0 million during fiscal year 2023 compared to $17.6 million during fiscal year 2022. The year-over-year decrease in cash provided by operations is primarily the result of changes in net working capital (defined as current assets less current liabilities). The significant working capital fluctuations were as follows:

Our inventory balance increased $4.2 million during fiscal year 2023. Our inventory balance increased $1.1 million during fiscal year 2022. The year-over-year change is a result of strategic inventory purchases during fiscal year 2023.

Accounts payable increased $1.7 million during fiscal year 2023, inclusive of $0.1 million of accounts payable acquired during the period.  Accounts payable increased by $1.9 million during fiscal year 2022. The variance is largely due to the timing of inventory and capital expenditure purchases and other payments in the respective periods.

During fiscal year 2023, accrued compensation and other liabilities decreased by $1.2 million, primarily due to reduced accrued incentives. During fiscal year 2022, accrued compensation and other liabilities increased by $1.0 million, inclusive of $0.5 million of accrued compensation and other liabilities acquired as part of three acquisitions completed during the period.

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Investing Activities: During fiscal year 2023, we invested $9.4 million in capital expenditures that was used primarily for customer-driven expansion of Service segment capabilities and capacity and our rental business.

During fiscal year 2022, we invested $10.2 million in capital expenditures that was used primarily for customer-driven expansion of Service segment capabilities and our rental business.

During fiscal year 2023, we used $9.1 million for business acquisitions. During fiscal year 2022, we used $29.8 million for business acquisitions.

During each of fiscal year 2023 and fiscal year 2022, no contingent consideration or other holdback amounts were paid related to a business acquisition.

Financing Activities: During fiscal year 2023, $2.8 million was borrowed from our revolving line of credit and $0.7 million in cash was generated from the issuance of common stock. In addition, we used $2.1 million for scheduled repayments of our term loan and $0.4 million for the “net” awarding of certain share awards to cover employee tax-withholding obligations for share award and stock option activity in fiscal year 2023, which is shown as a repurchase of shares of our common stock on our Consolidated Statements of Cash Flows.

During fiscal year 2022, $31.0 million was borrowed from the revolving line of credit and $1.5 million in cash was generated from the issuance of our common stock. In addition, we used $2.1 million for scheduled repayments of our term loan and $6.7 million for the “net” award of certain share awards to cover tax-withholding obligations for share award activity in the period which are shown as a repurchase of shares of our common stock on our Consolidated Statements of Cash Flows.

Recent Events

Effective March 27, 2023, we purchased all of the outstanding capital stock of TIC-MS, Inc. (“TIC-MS”), a Missouri based provider of calibration services. This transaction aligned with a key component of our acquisition strategy of targeting businesses that expand the depth and breadth of our Service capabilities. The total purchase price paid for TIC-MS was approximately $9.8 million, of which $2.9 million was paid in cash, including $0.5 million place in escrow for certain post-closing adjustments and indemnification claims, if any, and the issuance of 77,387 shares of our common stock valued at approximately $6.8 million. Pursuant to the purchase agreement, the purchase price will be subject to reduction by up to $0.5 million if a key customer relationship is not retained.

OUTLOOK

As we think ahead into fiscal year 2024, despite macroeconomic uncertainty that looms over the business world, we expect another year of growth and margin expansion across our Service channels. Our business continues to benefit from a predominately life science-oriented market, driven by high levels of regulation and recurring revenue streams, along with a growing rentals business that tends to perform well throughout various economic cycles including more challenged economic environments. In the year ahead, we expect organic Service revenue growth in the high single-digits and gross margin improvement to continue. We are investing in our high-growth NEXA business as well as new client-based labs, which will support additional organic revenue growth and margin expansion in the second half of the year but will temporarily weigh on year-over-year gross margin expansion in the first quarter of fiscal year 2024.

Accretive acquisitions that strengthen our fundamental value proposition will be a key component of our go-forward strategy. Our robust and diverse acquisition pipeline enables opportunities for us to expand addressable markets and increase our capabilities like we did with NEXA and the pipettes business.

We have generated consistent margin improvement over the past several years and we believe the improvement will continue. Automation of our calibration processes and overall process improvement will be key enablers to future margin expansion. We anticipate demonstrating more selling, general and administrative expense leverage in the second half of fiscal year 2024. We believe the Service segment has substantial runway ahead for growth, both organically and through acquisitions. We have a long history of generating sustainable value for our shareholders and providing a dynamic, rewarding workplace for our team.

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We expect our income tax rate to range between 21.0% and 23.0% in fiscal year 2024. This estimate includes Federal, various state, Canadian and Irish income taxes and reflects the discrete tax accounting associated with share-based payment awards.  Although the tax rate is consistent with recent years, there will be a difference in calendarization of the tax benefit from vesting of share-based payments in fiscal year 2024.   These benefits are normally realized in the first quarter, but in fiscal year 2024, we will see the benefit in the second quarter, due to a timing difference of when the awards were made.  In the first quarter of fiscal year 2023, this benefit positively impacted the tax rate by approximately 13% and we would expect a similar impact in second quarter of fiscal year 2024.