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 in Item 1A of Part II of this report and 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. 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 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 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. Compensation cost ultimately recognized for these awards will equal the grant-date fair market value of the award that coincides with the actual outcome of the performance condition. On an interim basis, we record compensation cost based on an assessment of the probability of achieving the performance condition.

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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.

RESULTS OF OPERATIONS
The following table sets forth, for the third quarter and the first nine 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)
                                                       Third Quarter Ended                           Nine Months Ended
                                                December 27,          December 29,           December 27,         December 29,
                                                    2008                  2007                   2008                 2007
As a Percentage of Net Revenue:

Product Sales                                            70.0 %                70.5 %                 69.5 %               68.6 %
Service Revenue                                          30.0 %                29.5 %                 30.5 %               31.4 %

Net Revenue                                             100.0 %               100.0 %                100.0 %              100.0 %


Product Gross Profit                                     24.7 %                28.1 %                 26.0 %               28.0 %
Service Gross Profit                                     21.4 %                19.5 %                 21.1 %               20.7 %
Total Gross Profit                                       23.7 %                25.6 %                 24.5 %               25.7 %

Selling, Marketing and Warehouse Expenses                13.0 %                12.5 %                 13.0 %               12.9 %
Administrative Expenses                                   7.5 %                 7.4 %                  8.4 %                8.7 %

Total Operating Expenses                                 20.5 %                19.9 %                 21.4 %               21.6 %


Operating Income                                          3.2 %                 5.7 %                  3.1 %                4.1 %

Interest Expense                                          0.2 %                 0.1 %                  0.1 %                0.2 %
Other Expense, net                                        0.3 %                 0.7 %                  0.1 %                0.8 %

Total Other Expense                                       0.5 %                 0.8 %                  0.2 %                1.0 %


Income Before Income Taxes                                2.7 %                 4.9 %                  2.9 %                3.1 %
Provision for (Benefit from) Income Taxes                 0.9 %                (1.7 )%                 1.1 %               (0.1 )%


Net Income                                                1.8 %                 6.6 %                  1.8 %                3.2 %

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

                                          Third Quarter Ended
                                    December 27,       December 29,
                                        2008               2007
                 Net Revenue:
                 Product Sales     $       13,986     $       13,005
                 Service Revenue            6,006              5,435

                 Total             $       19,992     $       18,440

Net revenue increased $1.6 million, or 8.4%, from the third quarter of fiscal year 2008 to the third quarter of fiscal year 2009.
Our product net sales results accounted for 70.0% of our total net revenue in the third quarter of fiscal year 2009 and 70.5% of our total net revenue in the third quarter of fiscal year 2008. For the third quarter of fiscal year 2009, product sales increased $1.0 million or 7.5% from the third quarter of fiscal year 2008. The Westcon acquisition contributed sales of $1.3 million, which more than offset the 2.1%, or $0.3 million, sales decline from the organic business. The decline in our organic sales was primarily attributed to the impact of the adverse economic conditions in November and December 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 Q3 Q2 Q1 Q4 Q3 Q2 Q1

Product Sales Growth (Decline) 7.5 % 15.5 % 12.7 % (2.4 %) 5.8 % 13.6 % 3.7 %

Our average product sales per business day increased to $226 in the third quarter of fiscal year 2009, compared with $213 in the third quarter of fiscal year 2008. This improvement was primarily due to the incremental sales associated with the acquisition of Westcon which occurred in the second quarter of fiscal year 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 Q3 Q2 Q1 Q4 Q3 Q2 Q1

Product Sales Per Business Day $ 226 $ 206 $ 192 $ 197 $ 213 $ 178 $ 171

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In the third quarter of fiscal year 2009, sales to our direct distribution channel remained relatively consistent with sales from the same time period the prior fiscal year. Sales growth associated with incremental Westcon sales was offset by a decline in organic sales to our direct customers, primarily as a result of the sluggish economy. Our organic sales decline was most prevalent in our U.S. and Canadian direct channels, while sales in our international channel declined less significantly. Canadian sales comparisons for the third quarter of fiscal year 2009 compared to the third quarter of fiscal year 2008 were also impacted by the exchange rate, as the Canadian dollar in relation to the U.S. dollar weakened by approximately 1,700 basis points. The mix of sales from more profitable U.S. and Canadian customers to less profitable international customers, as well as our extension of greater discounts to customers to remain competitive in the current economic conditions, reduced our direct distribution channel gross profit percentage by 230 basis points from the third quarter of fiscal year 2008 to the third quarter of fiscal year 2009. Within our reseller channel, sales increased 58.7% for the quarter with a slight improvement in gross profit percentage. Approximately 46.2% of the reseller sales dollar growth is attributable to Westcon. As for our organic growth, we believe resellers continue to utilize us for our ability to provide a broad range of new and existing products from within our inventory. As the depth of our products increase, 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 third quarters of fiscal years 2009 and 2008:

                                                       FY 2009 Third Quarter                   FY 2008 Third Quarter
                                                  Percent of             Gross            Percent of             Gross
                                                  Net Sales          Profit % (1)         Net Sales          Profit % (1)
Direct                                                 79.7 %               23.9 %             85.6 %               26.2 %
Reseller                                               19.1 %               18.1 %             13.0 %               17.7 %
Freight Billed to Customers                             1.2 %                                   1.4 %

Total                                                 100.0 %                                 100.0 %

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

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 third quarter of fiscal year 2009 increased by approximately $0.3 million, or 20.6% from the third quarter of fiscal year 2008. This was driven by a 29.9% increase in the outstanding backorders balance, a direct result of our integration of Westcon onto our order entry system. The following table reflects the percentage of total pending product shipments that are backorders at the end of the third quarter of fiscal year 2009 and our historical trend of total pending product shipments:

                                         FY 2009                                                 FY 2008
                           Q3              Q2              Q1              Q4              Q3              Q2              Q1

Total Pending
Product Shipments       $ 1,701         $ 1,398         $ 1,366         $ 1,419         $ 1,411         $ 1,689         $ 1,678

% of Pending
Product Shipments
That are
Backorders                 84.1 %          70.7 %          74.7 %          81.5 %          78.1 %          74.1 %          81.0 %

Service revenue increased $0.6 million, or 10.5%, from the third quarter of fiscal year 2008 to the third quarter of fiscal year 2009. Westcon contributed $0.4 million in service revenue in the third quarter of fiscal year 2009. Organic service revenue increased $0.2 million, or 3.8%, for the third quarter of fiscal year 2009 when compared to the third quarter of fiscal year 2008. Within our organic business, service segment revenue from the life sciences industry more than offset declines in demand from industrial and energy markets. Because the timing of calibration orders and segment expenses can vary on a quarter-to-quarter basis based on the nature of a customers' business and calibration requirements, we believe a trailing twelve month trend provides a better indication of the progress of this segment. Service revenue for the twelve months ended December 27, 2008 was $24.0 million, up 7.9% when compared with $22.3 million for the twelve months ended December 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 Q3 Q2 Q1 Q4 Q3 Q2 Q1

Service Revenue Growth 10.5 % 4.6 % 5.3 % 10.6 % 9.9 % 8.6 % 5.6 %

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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 historically 15% to 20% of our service segment revenue has been a result of subcontracting our customers' equipment to outside vendors. In the third quarter of fiscal year 2009, 78.3% of service revenue was generated by our staff of technicians while 18.2% was subcontracted to outside vendors.

                                          FY 2009 Third               FY 2008 Third
                                             Quarter                     Quarter
                                                     % of                        % of
                                      Service      Service        Service      Service
                                      Segment      Segment        Segment      Segment
                                      Revenue      Revenue        Revenue      Revenue
        In-House                      $  4,705         78.3 %     $  4,284         78.8 %
        Outsourced                       1,093         18.2 %        1,009         18.6 %
        Freight Billed to Customers        208          3.5 %          142          2.6 %

        Total                         $  6,006        100.0 %     $  5,435        100.0 %

Gross Profit:

                                         Third Quarter Ended
                                   December 27,        December 29,
                                       2008                2007
                  Gross Profit:
                  Product         $        3,448       $       3,654
                  Service                  1,283               1,059

                  Total           $        4,731       $       4,713

Total gross profit dollars in the third quarter of fiscal year 2009 were relatively consistent with the third quarter of fiscal year 2008. As a percentage of total net revenue, total gross profit declined 190 basis points for the same time period.
Gross profit for our Product segment may be influenced by a number of factors including market channel mix, product mix, foreign currency fluctuations and discounts to customers. Product gross profit in the third quarter of fiscal year 2009 was $3.4 million, or 24.7% of total product sales, compared with $3.7 million, or 28.1% of total product sales, in the third quarter of fiscal year 2008. The reduction in gross profit percentage was primarily attributable to a greater mix of reseller sales, which have lower profit margins, combined with lower sales to direct U.S. and Canadian customers, which typically have higher profit margins. Also impacting the product gross profit was approximately $0.1 million less in vendor rebates received in the third quarter of fiscal year 2009 compared to the third quarter of fiscal year 2008. The following table reflects the quarterly historical trend of our product gross profit as a percent of total product sales:

                                          FY 2009                                  FY 2008
                                  Q3         Q2         Q1           Q4         Q3         Q2         Q1

  Product Gross Profit % (1)     22.8 %     24.2 %     23.9 %       24.1 %     25.1 %     25.8 %     24.6 %
  Other Income % (2)              1.9 %      1.9 %      3.4 %        3.0 %      3.0 %      2.1 %      3.4 %

  Product Gross Profit %         24.7 %     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.

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Service gross profit in the third quarter of fiscal year 2009 was $1.3 million, or 21.4% of total service revenue, compared with $1.1 million, or 19.5% of total service revenue, in the same period of the prior fiscal year. In the third quarter of fiscal year 2009, we continued the cost control measures implemented in the second quarter of fiscal year 2009 in order to compensate for the lower than expected revenue growth, resulting in a 39.2% incremental margin from increased revenue. 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
                           Q3            Q2             Q1             Q4             Q3            Q2            Q1

Service Gross
Profit Dollar
(Decline) Growth          21.2 %         6.5 %         (0.3 %)        32.5 %         14.0 %         5.0 %         3.8 %


Operating Expenses:

                                                  Third Quarter Ended
                                            December 27,        December 29,
                                                2008                2007
        Operating Expenses:
        Selling, Marketing and Warehouse   $        2,606       $       2,304
        Administrative                              1,503               1,365

        Total                              $        4,109       $       3,669

Operating expenses increased $0.4 million, or 12.0%, from the third quarter of fiscal year 2008 to the third quarter of fiscal year 2009. Operating expenses as a percent of total revenue increased from 19.9% in the third quarter of fiscal year 2008 to 20.5% in the third quarter of fiscal year 2009. Included in the third quarter of fiscal year 2009 operating expenses were approximately $0.2 million in one-time integration expenses related to the acquisition of Westcon. Exclusive of these one-time expenses, Administrative expenses would have been relatively consistent year-over-year. Selling, Marketing and Warehouse expenses increased to $2.6 million in the third quarter of fiscal year 2009 compared with $2.3 million in the same period of the prior fiscal year, primarily related to increased cost associated with our acquisition of Westcon and strategic investments in our sales and marketing for the Service segment. Year-over-year operating expenses were positively impacted in the third quarter of fiscal year 2009 by reductions in management bonus and employee profit sharing expenses when compared with the third quarter of fiscal year 2008. Other Expense:

                                           Third Quarter Ended
                                    December 27,          December 29,
                                        2008                  2007
              Other Expense:
              Interest Expense     $           43         $          17
              Other Expense, net               56                   135

              Total                $           99         $         152

The increase in interest expense in the third quarter of fiscal year 2009 when compared with the third quarter of fiscal year 2008 was a result of higher debt levels due to the acquisition of Westcon. Other expenses decreased approximately $0.1 million due to reduced foreign exchange losses associated with changes in the exchange rate between the U.S. dollar and Canadian dollar. We have a program in place to hedge the majority of our risk to fluctuations in the value of the U.S. dollar relative to the Canadian dollar.

Taxes:

                                                        Third Quarter Ended
                                                  December 27,      December 29,
                                                      2008              2007

     Provision for (Benefit from) Income Taxes     $     181         $      (316 )

In the third quarter of fiscal year 2009, we recognized a $0.2 million provision for income taxes, compared to a $0.3 million benefit from income taxes in the third quarter of fiscal year 2008. The 2008 benefit was a result of a reversal of a $0.8 million deferred tax asset valuation allowance. We continue to evaluate our tax provision on a quarterly basis and make

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adjustments, as deemed necessary, to our effective tax rate given changes in facts and circumstances expected for the entire fiscal year.

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

                                           Nine Months Ended
                                    December 27,       December 29,
                                        2008               2007
                  Net Revenue:
                  Product Sales     $      39,251     $       35,151
                  Service Revenue          17,204             16,104

                  Total             $      56,455     $       51,255

Net revenue increased $5.2 million, or 10.1%, from the first nine months of fiscal year 2008 to the first nine months of fiscal year 2009.
Our product net sales, which accounted for 69.5% of our total net revenue for the first nine months of fiscal year 2009 and 68.6% of our total net revenue for the first nine months of fiscal year 2008, have increased $4.1 million, or 11.7%. Incremental sales as a result of the acquisition of Westcon accounted for $2.1 million of the increase. Organic product net sales increased $2.0 million, or 5.6%, for the first nine months of fiscal year 2009. Total sales within our . . .