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TRNS > SEC Filings for TRNS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for TRANSCAT INC


9-Nov-2012

Quarterly Report


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 and outcomes 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 contained 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 31, 2012. 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 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 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 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 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.

Stock-Based Compensation: We measure the cost of services received in exchange for all equity awards granted, including stock options and restricted stock, based on the fair market value of the award as of the grant date. We record compensation cost related to unvested stock awards by recognizing, on a straight-line basis, the unamortized grant date fair value over the remaining service period 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 capitalize any stock-based compensation costs as part of an asset. We estimate forfeiture rates based on our historical experience.

We grant performance-based restricted stock units as a primary component of executive compensation. The units generally vest following the third fiscal year from the date of grant subject to certain cumulative diluted earnings per share growth targets over the eligible period. Compensation cost ultimately recognized for these performance-based 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 an assessment of the probability of achieving the performance conditions. We achieved 75% of the target level for the performance-based restricted stock units granted in fiscal year 2010 and as a result, issued 52 thousand shares of common stock to executive officers and certain key employees during the first quarter of fiscal year 2013. At September 29, 2012, we estimated the probability of achievement for the units granted in fiscal years 2013 and 2012 to be 100% of the target levels and 75% of the target level for the units granted in fiscal year 2011.

Revenue Recognition: Product sales are recorded when a product's title and risk of loss transfer to the customer. We recognize the majority of our service revenue based upon when the calibration or other activity is performed and then shipped and/or delivered to the customer. Some 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 presents, for the second quarter and first six months of
fiscal years 2013 and 2012, the components of our Consolidated Statements of
Operations.

                                                                (Unaudited)                              (Unaudited)
                                                           Second Quarter Ended                       Six Months Ended
                                                    September 29,         September 24,       September 29,       September 24,
                                                        2012                  2011                2012                2011
Gross Margin:
Product Gross Margin                                          22.0 %                25.4 %              23.8 %              25.1 %
Service Gross Margin                                          23.9 %                22.4 %              23.4 %              23.3 %
Total Gross Margin                                            22.7 %                24.4 %              23.7 %              24.5 %

As a Percentage of Total Revenue:
Product Sales                                                 63.3 %                67.4 %              64.2 %              67.2 %
Service Revenue                                               36.7 %                32.6 %              35.8 %              32.8 %
Total Revenue                                                100.0 %               100.0 %             100.0 %             100.0 %

Selling, Marketing and Warehouse Expenses                     11.1 %                12.1 %              12.3 %              13.1 %
Administrative Expenses                                        7.2 %                 7.4 %               8.0 %               7.8 %
Total Operating Expenses                                      18.3 %                19.5 %              20.3 %              20.9 %

Operating Income                                               4.4 %                 4.9 %               3.4 %               3.6 %

Interest and Other Expense, net                                0.2 %                 0.1 %               0.2 %               0.2 %

Income Before Income Taxes                                     4.2 %                 4.8 %               3.2 %               3.4 %
Provision for Income Taxes                                     1.4 %                 1.8 %               1.1 %               1.3 %

Net Income                                                     2.8 %                 3.0 %               2.1 %               2.1 %

SECOND QUARTER ENDED SEPTEMBER 29, 2012 COMPARED TO SECOND QUARTER ENDED
SEPTEMBER 24, 2011 (dollars in thousands):

Revenue:
                          Second Quarter Ended
                   September 29,        September 24,
                       2012                 2011
Revenue:
Product Sales     $        16,948      $        16,969
Service Revenue             9,840                8,214
Total Revenue     $        26,788      $        25,183

Total revenue increased $1.6 million, or 6.4%, from the second quarter of fiscal year 2012 to the second quarter of fiscal year 2013.

Our product sales accounted for 63.3% of our total revenue in the second quarter of fiscal year 2013 and 67.4% of our total revenue in the second quarter of fiscal year 2012. Product segment sales were $16.9 million in the second quarter of fiscal year 2013, consistent with the prior-year period. In the prior-year period, sales were strengthened by one-time opportunistic orders. Excluding those orders, product segment sales increased by 3.6%. Our fiscal years 2013 and 2012 product sales (decline) growth in relation to prior fiscal year quarter comparisons is as follows:


                                      FY 2013                            FY 2012
                                     Q2          Q1          Q4         Q3         Q2         Q1
Product Sales (Decline) Growth     (0.1 %)     (4.8 %)     19.2 %     17.0 %     26.0 %     32.4 %

Our average product sales per business day were unchanged at $269 in the second quarter of fiscal years 2013 and 2012. Our product sales per business day for each fiscal quarter during the fiscal years 2013 and 2012 are as follows:

FY 2013 FY 2012
Q2 Q1 Q4 Q3 Q2 Q1
Product Sales Per Business Day $ 269 $ 260 $ 295 $ 308 $ 269 $ 268

Customer product 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. Pending product shipments are primarily backorders, but also include products that are requested to be calibrated in our laboratories prior to shipment, orders required to be shipped complete or at a future date, and other orders awaiting final credit or management review prior to shipment. Our total pending product shipments for the second quarter of fiscal year 2013 decreased by $1.0 million, or 29.8%, from the second quarter of fiscal year 2012. This decrease was primarily driven by a decline in backorders. Overall, variations in pending product shipments can be impacted by several factors, including the timing of when product orders are placed in relation to the end of the fiscal period, specialized product orders that are not stocked, or production issues experienced by manufacturers. The following table presents the percentage of total pending product shipments that were backorders at the end of the second quarter of fiscal year 2013 and our historical trend of total pending product shipments:

                                         FY 2013                             FY 2012
                                        Q2          Q1          Q4          Q3          Q2          Q1
Total Pending Product Shipments    $ 2,365     $ 2,806     $ 2,670     $ 3,572     $ 3,368     $ 3,002
% of Pending Product Shipments
that are Backorders                   68.6 %      68.8 %      70.9 %      65.6 %      73.6 %      67.9 %

Service revenue increased to $9.8 million in the second quarter of fiscal year 2013, a $1.6 million, or 19.8% increase, when compared to $8.2 million in the second quarter of fiscal year 2012. The growth can be attributed to expansion of our existing customer base and incremental revenue associated with our recent business acquisitions, partially offset by the loss of $0.3 million in low margin revenue from services we were outsourcing for a customer. Also, within any year, while we add new customers, we also have customers from the prior year whose calibrations may not repeat for any number of reasons. Among those reasons are variations in the timing of customer periodic calibrations on instruments and other services, customer capital expenditures and customer outsourcing decisions. Because the timing of calibration orders and segment expenses 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. Service segment revenue for the twelve months ended September 29, 2012 was $38.3 million, up 16.7% when compared with $32.9 million for the twelve months ended September 24, 2011. Our fiscal years 2013 and 2012 service revenue growth in relation to prior fiscal year quarter comparisons is as follows:

                             FY 2013                          FY 2012
                             Q2        Q1         Q4         Q3         Q2         Q1
Service Revenue Growth     19.8 %     3.7 %     20.1 %     24.0 %     10.3 %     10.1 %

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 address all measurement disciplines with in-house calibration capabilities. Our strategy has been to focus our investments in the core electrical, temperature, pressure and dimensional disciplines. Accordingly, over the long-term, we expect to outsource 15% to 20% of Service segment revenue to third party vendors for calibration beyond our chosen scope of capabilities. During any individual quarter, we could fluctuate beyond these percentages. We will continue to evaluate the need for capital investments that could provide more in-house capabilities for our staff of technicians and reduce the need for third party vendors in certain instances. The following table presents the source of our Service segment revenue and the percent of Service segment revenue for each quarter during fiscal years 2013 and 2012:


                                    FY 2013                             FY 2012
                                   Q2          Q1          Q4          Q3          Q2          Q1
Percent of Service Revenue:
Depot/Onsite                     82.6 %      79.1 %      80.5 %      77.9 %      79.0 %      77.7 %
Outsourced                       14.9 %      18.3 %      16.7 %      19.7 %      18.5 %      19.8 %
Freight Billed to Customers       2.5 %       2.6 %       2.8 %       2.4 %       2.5 %       2.5 %
                                100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %

Gross Profit:

                        Second Quarter Ended
                 September 29,         September 24,
                     2012                  2011
Gross Profit:
Product         $         3,723       $         4,311
Service                   2,355                 1,842
Total           $         6,078       $         6,153

Total gross profit in the second quarter of fiscal year 2013 decreased $0.1 million, or 1.2%, from the second quarter of fiscal year 2012. Total gross margin in the second quarter of fiscal year 2013 decreased 170 basis points from the second quarter of fiscal year 2012.

We evaluate product gross profit from two perspectives. Channel gross profit includes net sales less the direct cost of inventory sold. Our total product gross profit includes channel gross profit as well as the impact of vendor rebates, cooperative advertising income, freight billed to customers, freight expenses and direct shipping costs. In general, our product gross margin can vary based upon the mix of products sold, price discounting and the timing of periodic vendor rebates and cooperative advertising income received from suppliers.

Product segment gross profit declined $0.6 million, or 13.6%, in the second quarter of fiscal year 2013 compared to the second quarter of fiscal year 2012. As a percentage of product sales, gross profit decreased to 22.0% in the second quarter of fiscal year 2013 compared with 25.4% in the second quarter of fiscal year 2012. Our product gross profit includes a point-of-sale rebate program with a key vendor that is based on Product segment sales growth on a calendar year-over-year basis. We experienced a decrease in our annual rebates which caused declines in our Product segment gross profit and gross margin. The following table reflects the quarterly historical trend of our product gross margin:

                                      FY 2013                          FY 2012
                                     Q2         Q1         Q4         Q3         Q2         Q1
Channel Gross Margin (1)           21.5 %     22.7 %     23.3 %     22.5 %     23.1 %     23.0 %
Total Product Gross Margin (2)     22.0 %     25.7 %     24.7 %     25.6 %     25.4 %     24.8 %

(1) Channel gross margin is 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 segment gross profit increased $0.5 million, or 27.9%, from the second quarter of fiscal year 2012 to the second quarter of fiscal year 2013. Service segment gross margin increased 150 basis points over the same time period as a result of strong organic revenue growth combined with incremental revenue from acquired businesses. Because the timing of calibration orders and segment expenses 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. Service segment gross profit for the twelve months ended September 29, 2012 was $9.1 million, up 11.1% when compared with $8.2 million for the twelve months ended September 24, 2011. Service segment gross margin was 23.7% and 24.9% for the twelve months ended September 29, 2012 and September 24, 2011, respectively. The following table reflects the quarterly historical trend of our calibration services gross margin as a percent of service revenues:


                            FY 2013                          FY 2012
                           Q2         Q1         Q4         Q3         Q2         Q1
Service Gross Margin     23.9 %     22.9 %     27.3 %     20.1 %     22.4 %     24.1 %



Operating Expenses:

                                           Second Quarter Ended
                                    September 29,         September 24,
                                        2012                  2011
Operating Expenses:
Selling, Marketing and Warehouse   $         2,959       $         3,042
Administrative                               1,939                 1,870
Total                              $         4,898       $         4,912

Operating expenses in the second quarter of fiscal year 2013 were consistent with the second quarter of fiscal year 2012. As a percentage of total revenue, operating expenses were 18.3% and 19.5% in the second quarter of fiscal years 2013 and 2012, respectively.

Taxes:

                                    Second Quarter Ended
                              September 29,      September 24,
                                  2012               2011
Provision for Income Taxes   $        384       $         457

Our effective tax rates for the second quarter of fiscal years 2013 and 2012 were 34.0% and 38.0%, respectively. 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.

SIX MONTHS ENDED SEPTEMBER 29, 2012 COMPARED TO SIX MONTHS ENDED SEPTEMBER 24,
2011 (dollars in thousands):

Revenue:

                           Six Months Ended
                   September 29,       September 24,
                       2012                2011
Revenue:
Product Sales     $        33,313     $        34,151
Service Revenue            18,572              16,637
Total Revenue     $        51,885     $        50,788

Total revenue increased $1.1 million, or 2.2%, from the first six months of fiscal year 2012 to the first six months of fiscal year 2013. Revenue increases in the Service segment were partially offset by lower sales in the Product segment.

Our product sales accounted for 64.2% and 67.2% of our total revenue in the first six months of fiscal years 2013 and 2012, respectively. For the first six months of fiscal year 2013, product sales decreased $0.8 million, or 2.5%, compared with the first six months of fiscal year 2012. Sales to both direct and reseller customers declined, reflecting economic conditions and unusually strong product sales, due to opportunistic orders, in the first half of fiscal year 2012.

Service revenue increased $1.9 million, or 11.6%, from the first six months of fiscal year 2012 to the first six months of fiscal year 2013. The growth is attributed to higher organic revenue combined with incremental revenue from recent acquisitions, partially offset by the loss of $0.6 million in low margin revenue from services that we were outsourcing for a customer.


Gross Profit:

                         Six Months Ended
                 September 29,       September 24,
                     2012                2011
Gross Profit:
Product         $         7,933     $         8,579
Service                   4,352               3,872
Total           $        12,285     $        12,451

Total gross profit in the first six months of fiscal year 2013 decreased $0.2 million, or 1.3%, from the first six months of fiscal year 2012. Total gross margin declined 80 basis points in the first six months of fiscal year 2013 compared to the same time period in the previous fiscal year.

Product gross margin in the first six months of fiscal year 2013 was 23.8% and declined 130 basis points when compared with 25.1% in the first six months of fiscal year 2012. Product gross profit decreased $0.6 million in the first six months of fiscal year 2013 compared to the first six months of fiscal year 2012, as a result of a decline in manufacturer rebates as well as increased price discounts extended to customers, partially offset by an increase in cooperative advertising income.

Service segment gross profit increased $0.5 million, or 12.4%, from the first six months of fiscal year 2012 to the first six months of fiscal year 2013. Service segment gross margin increased 10 basis points over the same time period to 23.4%. Revenue growth in the Service segment reflected incremental revenue from acquisitions, which provided limited margin expansion opportunity.

Operating Expenses:

                                            Six Months Ended
                                    September 29,       September 24,
                                        2012                2011
Operating Expenses:
Selling, Marketing and Warehouse   $         6,400     $         6,668
Administrative                               4,111               3,972
Total                              $        10,511     $        10,640

Operating expenses declined $0.1 million from the first six months of fiscal year 2012 to the first six months of fiscal year 2013. As a percentage of total revenue, operating expenses during the first six month of fiscal year 2013 were 20.3%, down from 20.9% in the first six months of fiscal year 2012 reflecting lower performance-based compensation and acquisition-related expenses, partially offset by a one-time Service segment sales organization restructuring charge and increased investments in sales and marketing activities.

Taxes:

                                       Six Months Ended
                              September 29,         September 24,
                                  2012                  2011
Provision for Income Taxes   $           570       $           657

Our effective tax rates for the first six months of fiscal years 2013 and 2012 were 34.0% and 38.0%, respectively. 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.

LIQUIDITY AND CAPITAL RESOURCES

On September 20, 2012, we entered into a new three-year revolving credit facility in the amount of $20.0 million. We believe that amounts available under our new credit facility and our cash on hand are sufficient to satisfy our expected working capital and capital expenditure needs as well as our lease commitments for the foreseeable future.


Cash Flows: The following table is a summary of our Consolidated Statements of Cash Flows:

                                       Six Months Ended
                               September 29,       September 24,
                                   2012                2011
Cash Provided by (Used in):
Operating Activities          $           654     $           892
Investing Activities                   (4,475 )            (4,022 )
Financing Activities                    3,987               3,158

Operating Activities: Net cash provided by operations was $0.7 million for the first six months of fiscal year 2013 compared to $0.9 million in the first six months of fiscal year 2012. Significant working capital fluctuations were as follows:

Accounts Receivable: The higher accounts receivable balance as of September 29, 2012 compared to the balance as of September 24, 2011 is reflective of an increase in quarterly revenues. In addition, our quarter-end days sales outstanding reflects improved collections. The following table illustrates our days sales outstanding for the fiscal quarters ended September 29, 2012 and September 24, 2011:

                                             September 29,       September 24,
                                                 2012                2011
Net Sales, for the last two fiscal months   $        19,340     $        18,065
Accounts Receivable, net                    $        12,466     $        11,988
Days Sales Outstanding                                   39                  40

Inventory/Accounts Payable: Our inventory balance at September 29, 2012 was $7.1 million, an increase of $0.7 million when compared to $6.4 million on-hand at March 31, 2012. Our inventory strategy includes making appropriate larger quantity, higher dollar based purchases with key manufacturers for various reasons, including maximizing on-hand availability of key products, reducing backorders for those products with long lead times and optimizing . . .

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