Summary of TRANSCAT INC - Yahoo! Finance

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements. This report and, in particular, the Management's Discussion and Analysis of Financial Condition and Results of Operations section of this report, contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These include statements concerning expectations, estimates, and projections about the industry, management beliefs and assumptions of Transcat, Inc. ("Transcat", "we", "us", or "our"). Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to forecast. Therefore, our actual results may materially differ from those expressed or forecasted in any such forward-looking statements. When considering these risks, uncertainties and assumptions, you should keep in mind the cautionary statements elsewhere in this report and in any documents incorporated herein by reference. New risks and uncertainties arise from time to time and we cannot predict those events or how they may affect us. For a more detailed discussion of the risks and uncertainties that may affect Transcat's operating and financial results and its ability to achieve its financial objectives, interested parties should review the "Risk Factors" sections in Transcat's reports filed with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended March 29, 2008. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES Accounts Receivable: Accounts receivable represent receivables from customers in the ordinary course of business. These amounts are recorded net of the allowance for doubtful accounts and returns in our Consolidated Balance Sheets. The allowance for doubtful accounts is based upon the expected collectibility of accounts receivable. We apply a specific formula to our accounts receivable aging, which may be adjusted on a specific account basis where the specific 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. The returns reserve is calculated based upon the historical rate of returns applied to sales over a specific timeframe. The returns reserve will increase or decrease as a result of changes in the level of sales and/or the historical rate of returns.
Stock-Based Compensation. In accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, we measure the cost of services received in exchange for all equity awards granted, including stock options, warrants and restricted stock, based on the fair market value of the award as of the grant date. We use the modified prospective application method to record compensation cost related to unvested stock awards as of March 25, 2006 by recognizing the unamortized grant date fair value of these awards over the remaining service periods of those awards with no change in historical reported earnings. Awards granted after March 25, 2006 are valued at fair value and are recognized on a straight line basis over the service periods of each award. Excess tax benefits from the exercise of stock awards are presented in the Consolidated Statements of Cash Flows as a financing activity. 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 have any stock-based compensation costs capitalized as part of an asset. We estimate forfeiture rates based on our historical experience.
Options generally vest over a period of up to four years and expire up to ten years from the date of grant. Beginning in the second quarter of fiscal year 2008, options granted to executive officers vest using a graded schedule of 0% in the first year, 20% in each of the second and third years, and 60% in the fourth year. Prior options granted to executive officers vested equally over three years. The expense relating to these executive officer options is recognized on a straight-line basis over the requisite service period for the entire award.
During the first six months of fiscal year 2009, we granted performance-based restricted stock awards in place of options as a primary component of executive compensation. The performance-based restricted stock awards vest after three years subject to certain cumulative diluted earnings per share growth over the eligible three-year period. During the second quarter of fiscal year 2009 and in conjunction with the acquisition of Westcon, we modified these awards by increasing the cumulative diluted earnings per share growth performance condition. The modification did not have an impact on our Consolidated Financial Statements.
Revenue Recognition. Product sales are recorded when a product's title and risk of loss transfers to the customer. We recognize the majority of our service revenue based upon when the calibration or repair activity is performed and then shipped and/or delivered to the customer. Some of our service revenue is generated from managing customers' calibration programs in which we recognize revenue in equal amounts at fixed intervals. We generally invoice our customers for freight, shipping, and handling charges. Provisions for customer returns are provided for in the period the related revenues are recorded based upon historical data.

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Reclassification of Amounts: Certain reclassifications of financial information for the prior fiscal year have been made to conform to the presentation for the current fiscal year.

RESULTS OF OPERATIONS
The following table sets forth, for the second quarter and the first six months
of fiscal years 2009 and 2008, the components of our Consolidated Statements of
Operations as a percentage of our net revenue (calculated on dollars in
thousands).

                                                            (Unaudited)                                  (Unaudited)
                                                        Second Quarter Ended                          Six Months Ended
                                                September 27,         September 29,          September 27,         September 29,
                                                     2008                  2007                  2008                   2007
As a Percentage of Net Revenue:

Product Sales                                           69.6 %                67.5 %                 69.3 %                67.5 %
Service Revenue                                         30.4 %                32.5 %                 30.7 %                32.5 %

Net Revenue                                            100.0 %               100.0 %                100.0 %               100.0 %


Product Gross Profit                                    26.1 %                27.9 %                 26.7 %                28.0 %
Service Gross Profit                                    21.0 %                20.6 %                 21.0 %                21.4 %
Total Gross Profit                                      24.6 %                25.5 %                 25.0 %                25.8 %

Selling, Marketing and Warehouse Expenses               11.4 %                12.1 %                 12.9 %                13.2 %
Administrative Expenses                                  9.2 %                 9.8 %                  8.9 %                 9.5 %

Total Operating Expenses                                20.6 %                21.9 %                 21.8 %                22.7 %


Operating Income                                         4.0 %                 3.6 %                  3.2 %                 3.1 %

Interest Expense                                         0.2 %                 0.2 %                  0.1 %                 0.2 %
Other Expense, net                                         -                   1.3 %                    -                   0.9 %

Total Other Expense                                      0.2 %                 1.5 %                  0.1 %                 1.1 %


Income Before Income Taxes                               3.8 %                 2.1 %                  3.1 %                 2.0 %
Provision for Income Taxes                               1.5 %                 1.0 %                  1.2 %                 0.8 %


Net Income                                               2.3 %                 1.1 %                  1.9 %                 1.2 %

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SECOND QUARTER ENDED SEPTEMBER 27, 2008 COMPARED TO SECOND QUARTER ENDED
SEPTEMBER 29, 2007
(dollars in thousands):
Revenue:

                                          Second Quarter Ended
                                   September 27,        September 29,
                                       2008                 2007
                Net Revenue:
                Product Sales     $        12,954      $        11,219
                Service Revenue             5,656                5,406

                Total             $        18,610      $        16,625

Net revenue increased $2.0 million, or 11.9%, from the second quarter of fiscal year 2008 to the second quarter of fiscal year 2009.
Our product net sales results accounted for 69.6% of our total net revenue in the second quarter of fiscal year 2009 and 67.5% of our total net revenue in the second quarter of fiscal year 2008. For the second quarter of fiscal year 2009, product sales increased $1.7 million or 15.5% from the second quarter of fiscal year 2008. Product sales by Westcon, since the date of the acquisition, accounted for $0.9 million of this increase. Exclusive of Westcon, our product sales increased 7.6% over the second quarter of fiscal year 2008. Our fiscal years 2009 and 2008 product sales growth in relation to prior fiscal year quarter comparisons is as follows:

FY 2009 FY 2008 Q2 Q1 Q4 Q3 Q2 Q1 Product Sales Growth (Decline) 15.5 % 12.7 % (2.4 %) 5.8 % 13.6 % 3.7 %

Our average product sales per business day increased to $206 in the second quarter of fiscal year 2009, compared with $178 in the second quarter of fiscal year 2008 primarily due to a combination of organic growth and the addition of Westcon in the second quarter of fiscal 2009. Our product sales per business day for each fiscal quarter during the fiscal years 2009 and 2008 are as follows:

FY 2009 FY 2008 Q2 Q1 Q4 Q3 Q2 Q1 Product Sales Per Business Day $ 206 $ 192 $ 197 $ 213 $ 178 $ 171

In the second quarter of fiscal year 2009, our direct distribution channel grew 5.6% year-over-year. The primary drivers of this growth were incremental sales associated with Westcon and increased international sales. Organic sales to our direct U.S. customers were relatively consistent year-over-year, while sales to Canadian customers declined. As a result of the changing geographical customer mix from more profitable Canadian customers to less profitable international customers, our direct distribution channel gross profit percentage decreased 120 basis points from the second quarter of fiscal year 2008 to the second quarter of fiscal year 2009. Within our reseller channel, sales increased 77.6% for the quarter with a slight improvement in gross profit percentage. Approximately 32.5% of the reseller sales dollar growth is attributable to Westcon. As for our organic growth, we believe resellers continue to utilize us for our extensive availability to provide a broad range of new and existing products from within our inventory. As the depth of our products increases, we anticipate continued growth within this channel. The following table reflects the percentage of net sales and the approximate gross profit percentage for significant distribution product channels for the second quarter of fiscal years 2009 and 2008:

                                                       FY 2009 Second Quarter                   FY 2008 Second Quarter
                                                  Percent of             Gross             Percent of             Gross
                                                  Net Sales           Profit % (1)         Net Sales           Profit % (1)
Direct                                                 77.6 %                25.8 %             84.9 %                27.0 %
Reseller                                               20.8 %                18.2 %             13.5 %                18.0 %
Freight Billed to Customers                             1.6 %                                    1.6 %

Total                                                 100.0 %                                  100.0 %

(1) Calculated as net sales less purchase costs divided by net sales.

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Customer product orders include orders for products that we routinely stock in our inventory, customized products, and other products ordered less frequently, which we do not stock. Pending product shipments are primarily backorders, but also include products that are requested to be calibrated in our calibration laboratories prior to shipment, orders required to be shipped complete, and orders required to be shipped at a future date. Our total pending product shipments for the second quarter of fiscal year 2009 decreased by approximately $0.3 million, or 17.2% from the second quarter of fiscal year 2008. This decrease is driven by a 21.1% decrease in the outstanding backorders balance, which can be attributed to a greater availability of products through our increased inventory levels. The following table reflects the percentage of total pending product shipments that are backorders at the end of the second quarter of fiscal year 2009 and our historical trend of total pending product shipments:

                                       FY 2009                                           FY 2008
                                 Q2               Q1              Q4               Q3               Q2               Q1
Total Pending Product
Shipments                     $ 1,398          $ 1,366         $ 1,419          $ 1,411          $ 1,689          $ 1,678

% of Pending Product
Shipments That are
Backorders                       70.7 %           74.7 %          81.5 %           78.1 %           74.1 %           81.0 %

Service revenue increased $0.3 million, or 4.6%, from the second quarter of fiscal year 2008 to the second quarter of fiscal year 2009. Westcon contributed $0.2 million in service revenue in the second quarter of fiscal year 2009. Organic service revenue was relatively flat in the second quarter of fiscal year 2009 compared with the same period of the prior fiscal year. Service revenue in the second quarter of fiscal year 2009 was negatively impacted by Hurricane Ike. In addition to the forced two week shutdown of our largest calibration laboratory and repair center in Houston during the storm and its aftermath, many of our customers in that area postponed or cancelled expected calibration service requests. Additionally, repair service requests, which can be unpredictable from quarter-to-quarter, were down 12.3% year-over-year. The timing of calibration orders and service segment expenses can vary on a quarter-to-quarter basis based on the nature of a customers' business and calibration requirements. In general, a trailing twelve month trend provides a better indication of the progress of this segment. Service revenue for the twelve months ended September 27, 2008 was $23.4 million, up 7.7% when compared with $21.8 million for the twelve months ended September 29, 2007. Our fiscal years 2009 and 2008 service revenue growth in relation to prior fiscal year quarter comparisons is as follows:

FY 2009 FY 2008 Q2 Q1 Q4 Q3 Q2 Q1 Service Revenue Growth 4.6 % 5.3 % 10.6 % 9.9 % 8.6 % 5.6 %

Within the calibration industry, there is a broad array of measurement disciplines making it costly and inefficient for any one provider to invest the needed capital for facilities, equipment and uniquely trained personnel necessary to perform all calibrations in-house. Our strategy has been to focus our investments in the core electrical, temperature, pressure and dimensional disciplines, and we have historically subcontracted 15% to 20% of our customers' equipment to outside vendors. In the second quarter of fiscal year 2009, 78.5% of service revenue was generated by our staff of technicians while 18.8% was subcontracted to outside vendors.

                                         FY 2009 Second              FY 2008 Second
                                             Quarter                     Quarter
                                                     % of                        % of
                                      Service      Service        Service      Service
                                      Segment      Segment        Segment      Segment
                                      Revenue      Revenue        Revenue      Revenue
        In-House                      $  4,441         78.5 %     $  4,266         78.9 %
        Outsourced                       1,065         18.8 %          995         18.4 %
        Freight Billed to Customers        150          2.7 %          145          2.7 %

        Total                         $  5,656        100.0 %     $  5,406        100.0 %

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Gross Profit:

                                        Second Quarter Ended
                                 September 27,         September 29,
                                     2008                  2007
                Gross Profit:
                Product         $         3,386       $         3,130
                Service                   1,188                 1,116

                Total           $         4,574       $         4,246

Total gross profit dollars increased 7.7% from the second quarter of fiscal year 2008 to the second quarter of fiscal year 2009. As a percentage of total net revenue, total gross profit declined 90 basis points for the same time period. Gross profit for our products segment may be influenced by a number of factors including market channel mix, product mix and discounts to customers. Product gross profit in the second quarter of fiscal year 2009 was $3.4 million, or 26.1% of total product sales, compared with $3.1 million, or 27.9% of total product sales, in the second quarter of fiscal year 2008. The reduction in gross profit percentage was attributable to higher international and reseller sales, which have lower profit margin potential, combined with lower sales to Canadian customers, which typically have higher profit margins. The following table reflects the quarterly historical trend of our product gross profit as a percent of total product sales:

                                        FY 2009                            FY 2008
                                     Q2         Q1           Q4         Q3         Q2         Q1
     Product Gross Profit % (1)     24.2 %     23.9 %       24.1 %     25.1 %     25.8 %     24.6 %
     Other Income % (2)              1.9 %      3.4 %        3.0 %      3.0 %      2.1 %      3.4 %

     Product Gross Profit %         26.1 %     27.3 %       27.1 %     28.1 %     27.9 %     28.0 %

(1) Calculated as net sales less purchase costs divided by net sales.

(2) Includes vendor rebates, cooperative advertising income, freight billed to customers, freight expenses, and direct shipping costs.

Service gross profit in the second quarter of fiscal year 2009 was $1.2 million, or 21.0% of total service revenue, compared with $1.1 million, or 20.6% of total service revenue, in the same period of the prior fiscal year. Cost control measures were implemented in the quarter to compensate for the lower than expected revenue growth, resulting in relatively flat service gross profit. In general, our gross profit percentage for calibration services fluctuates on a quarterly basis due to the seasonality of our revenues (our fiscal fourth quarter is generally our strongest) and the timing of operating costs associated with our calibration laboratory operations. The following table reflects our service gross profit growth in relation to prior fiscal year quarters:

                                                     FY 2009                           FY 2008
                                                 Q2         Q1            Q4         Q3        Q2        Q1
Service Gross Profit Dollar Growth (Decline)     6.5 %     (0.3 %)       32.5 %     14.0 %     5.0 %     3.8 %


Operating Expenses:

                                                  Second Quarter Ended
                                           September 27,         September 29,
                                               2008                  2007
       Operating Expenses:
       Selling, Marketing and Warehouse   $         2,122       $         2,018
       Administrative                               1,713                 1,634

       Total                              $         3,835       $         3,652

Operating expenses increased $0.2 million, or 5.0%, from the second quarter of fiscal year 2008 to the second quarter of fiscal year 2009. Operating expenses as a percent of total revenue decreased from 22.0% in the second quarter of fiscal year 2008 to 20.6% in the second quarter fiscal year 2009. Selling, Marketing and Warehouse expenses increased to $2.1 million

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in the second quarter of fiscal year 2009 compared with $2.0 million in the same period of the prior fiscal year, but were down from $2.6 million in the first quarter of fiscal year 2009. Administrative expenses were $1.7 million for the second quarter of fiscal year 2009, which included $0.1 million in expenses for Westcon, compared with $1.6 million for the second quarter of fiscal year 2008 and $1.5 million in the first quarter of fiscal year 2009. Reduced expenses related to variable and stock-based compensation had a positive impact on both selling and administrative expenses compared with the first quarter of fiscal year 2009.

Other Expense:

                                           Second Quarter Ended
                                   September 27,           September 29,
                                       2008                    2007
             Other Expense:
             Interest Expense     $            28         $            29
             Other Expense, net                 4                     209

             Total                $            32         $           238

Interest expense in the second quarter of fiscal year 2009 was consistent with the interest expense in the second quarter of fiscal year 2008. Other expenses, consisting primarily of foreign currency net losses, decreased due to a reduction in our intercompany balances.

Taxes:

                                                Second Quarter Ended
                                          September 27,      September 29,
                                              2008               2007
            Provision for Income Taxes     $      277         $       162

In the second quarter of fiscal year 2009, we recognized a $0.3 million provision for income taxes, compared to a $0.2 million provision in the second quarter of fiscal year 2008, as a result of an increase in income before income taxes. We continue to evaluate our tax provision on a quarterly basis and make adjustments, as deemed necessary, to our effective tax rate given changes in facts and circumstances expected for the entire fiscal year.

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SIX MONTHS ENDED SEPTEMBER 27, 2008 COMPARED TO SIX MONTHS ENDED SEPTEMBER 29,
2007
(dollars in thousands):
Revenue:

                                           Six Months Ended
                                   September 27,       September 29,
                                       2008                2007
                Net Revenue:
                Product Sales     $        25,265     $        22,146
                Service Revenue            11,198              10,669

                Total             $        36,463     $        32,815

Net revenue increased $3.6 million, or 11.1%, from the first six months of fiscal year 2008 to the first six months of fiscal year 2009.
Our product net sales, which accounted for 69.3% of our total net revenue in the first six months of fiscal year 2009 and 67.5% of our total net revenue in the first six months of fiscal year 2008, have increased 14.1%. Exclusive of Westcon, product sales in the first six months of fiscal year 2009 were $24.4 million, a 10.1% increase compared to the $22.1 million in product sales in the first six months of fiscal year 2008. Total sales within our direct distribution channel increased 7.7% in the first six months of fiscal year 2009, with organic sales contributing 5.0% of this increase. This increase in organic sales is a result of growth in sales to our U.S. and international customers, partially offset by a decline in sales to our Canadian customers. The decline in Canadian sales, our most profitable channel, and lower margin sales by Westcon have had a negative impact on our overall direct channel gross margin. Our direct channel's gross profit as a percent of product sales has declined 110 basis points from the first six months of fiscal year 2008 to the first six months of fiscal year 2009.
Within our reseller channel, we experienced a 52.5% increase in total sales and a 40.2% increase in organic sales during the first six months of fiscal year 2009. We attribute this growth to our ability to provide resellers an extensive availability to a broad range of new and existing products from within our inventory. Our reseller sales growth did not come at the expense of declining profit margins within the channel. We experienced a profit margin improvement of 100 basis points in the first six months of fiscal year 2009 compared to the first six months of fiscal year 2008. The following table provides the percentage of net sales and the approximate gross profit percentage for significant distribution product channels for the first six months of fiscal . . .