Transcat - 10-Q quarterly report FY

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In Thousands, Except Per Share Amounts)

CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Amounts)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In Thousands)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Share and Per Share Amounts)

Description of Business: Transcat, Inc. (“Transcat” or “the Company”) is a leading distributor of professional grade test, measurement, and calibration instruments and a provider of calibration and repair services, primarily throughout the process, life science, and manufacturing industries.

Basis of Presentation: Transcat’s unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, the Consolidated Financial Statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of the Company’s management, all adjustments considered necessary for a fair presentation (consisting of normal recurring adjustments) have been included. The results for the interim periods are not indicative of the results to be expected for the fiscal year. The accompanying Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements as of and for the fiscal year ended March 26, 2005 contained in the Company’s 2005 Annual Report on Form 10-K filed with the SEC.

Principles of Consolidation: The Consolidated Financial Statements of Transcat include the accounts of Transcat, Inc. and all of the Company’s wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

Use of Estimates: The preparation of Transcat’s Consolidated Financial Statements in accordance with GAAP requires that the Company make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as 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, depreciable lives of assets, estimated lives of major catalogs (“Master Catalog”), and tax valuation allowances. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Consolidated Financial Statements will change as new events occur, as more experience is acquired, as additional information is obtained, and as the operating environment changes. Actual results could differ from those estimates.

Changes in Estimates: In the ordinary course of accounting for items discussed above, Transcat makes changes in estimates as appropriate, and as the Company becomes aware of circumstances surrounding 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 the Consolidated Financial Statements.

Fiscal Year: We operate on a 52/53 week fiscal year, ending the last Saturday in March. In a 52-week fiscal year, each of our four quarters is a 13-week period, and the final month of each quarter is a 5-week period.

Revenue Recognition: Sales are recorded when products are shipped or services are rendered to customers, as the Company generally has no significant post delivery obligations. The Company’s prices are fixed and determinable, collection of the resulting receivable is probable, and returns are reasonably estimated. Provisions for customer returns are provided for in the period the related sales are recorded based upon historical data. The Company recognizes the majority of service revenue based upon when the calibration or repair activity is performed then shipped and/or delivered to the customer. Some of the service revenue is generated from managing customers’ calibration programs in which the Company recognizes revenue in equal amounts at fixed intervals. Shipments are generally free on board shipping point and customers are generally invoiced for freight, shipping, and handling charges.

Shipping and Handling Costs: Freight expense and direct shipping costs are included in cost of sales. Direct handling costs, which primarily represent direct compensation of employees who pick, pack, and otherwise prepare, if necessary, merchandise for shipment to customers are reflected in selling, marketing, and warehouse expenses.

Rebates: Rebates are based on a specified cumulative level of purchases and are recorded as a reduction of cost of sales as the milestone is achieved.

Cooperative Advertising Income: Transcat follows the provisions of the Emerging Issues Task Force (“EITF”) Issue No. 02-16, “Accounting by a Reseller for Cash Consideration Received from a Vendor” which provides that cash consideration received from a vendor by a reseller be reported as a reduction of cost of sales as the related inventory is sold.

Comprehensive Income: Transcat reports comprehensive income under Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income”. Other comprehensive income is comprised of net income (loss) and currency translation adjustments.

Currency Translation Adjustment: The accounts of Transcat’s Canadian subsidiary are maintained in the local currency and have been translated to United States dollars in accordance with SFAS No. 52, “Foreign Currency Translation”. Accordingly, the amounts representing assets and liabilities, except for long-term intercompany and equity, have been translated at the period-end rates of exchange and related revenue and expense accounts have been translated at average rates of exchange during the period. Gains and losses arising from translation of the Company’s subsidiary balance sheets into United States dollars are recorded directly to the accumulated other comprehensive income component of stockholders’ equity.

Currency gains and losses on business transactions are included in other expense on the Consolidated Statements of Operations.

Earnings Per Share: Basic earnings per share of Common Stock are computed based on the weighted average number of shares of Common Stock outstanding during the period. Diluted earnings per share of Common Stock reflect the assumed conversion of dilutive stock options, warrants, and non-vested restricted stock awards. In computing the per share effect of assumed conversion, funds which would have been received from the exercise of options, warrants, and non-vested restricted stock are considered to have been used to purchase shares of Common Stock at the average market prices during the period, and the resulting net additional shares of Common Stock are included in the calculation of average shares of Common Stock outstanding.

For the first quarter of fiscal year 2006, the net additional Common Stock equivalents had a $0.01 per share effect on the calculation of dilutive earnings per share. For the first quarter of fiscal year 2005, there were no dilutive shares. The total number of dilutive and anti-dilutive Common Stock equivalents resulting from stock options, warrants, and non-vested restricted stock are summarized as follows (shares in thousands, except per share amounts):

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 the Consolidated Balance Sheets. The allowance for doubtful accounts is based upon the expected collectibility of accounts receivable. Transcat applies a specific formula to its 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.

Inventory: Inventory consists of finished goods and is valued at the lower of cost or market. Costs are determined using the average cost method of inventory valuation. Inventory is reduced by a reserve for items not saleable at or above standard cost. Transcat reserves specifically for certain items of inventory and, for other items, the Company applies a specific loss factor, based on historical experience, to specific categories of inventory. The Company evaluates the adequacy of the reserve on a regular basis.

Properties, Depreciation, and Amortization: Properties are stated at cost. Depreciation and amortization is computed primarily under the straight-line method with useful lives of 3 to 10 years for the following major classifications: machinery, equipment, software, and furniture and fixtures. Properties determined to have no value are written off at their then remaining net book value. Transcat accounts for software costs in accordance with Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”. Leasehold improvements are amortized under the straight-line method over the estimated useful life or the lease term, whichever is shorter. Maintenance and repairs are expensed as incurred.

Goodwill: Transcat estimates the fair value of the Company’s reporting units in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, using the fair market value measurement requirement, rather than the undiscounted cash flows approach. The Company tests goodwill for impairment on an annual basis, or immediately if conditions indicate that such impairment could exist.

Deferred Catalog Costs: Transcat amortizes the cost of each Master Catalog mailed over such catalog’s estimated productive life. The Company reviews response results from catalog mailings on a continuous basis; and if warranted, modifies the period over which costs are recognized. The Company amortizes the cost of each Master Catalog over an eighteen month period and amortizes the cost of each catalog supplement over a three month period.

Deferred Compensation: Previously, some of Transcat’s directors had elected to defer receipt of their non-discretionary awards of shares of Common Stock under the Amended and Restated Directors’ Stock Plan. Deferred shares were expensed at the market value of Common Stock at the date of award, and the associated liability is adjusted quarterly based on the quarter end market price of Common Stock. Directors voluntarily elected to cease deferring shares as of April 1, 2003.

In addition, the Company provides an annual benefit to a former president’s spouse and former executive under the terms of a deferred compensation agreement.

Deferred Gain on TPG: As a result of certain post divestiture commitments, Transcat was unable to recognize the gain of $1.5 million on the divestiture of Transmation Products Group (“TPG”), which took place in fiscal year 2002, until those commitments expire in fiscal year 2007. See Note 5 of the Consolidated Financial Statements for further disclosure.

Deferred Taxes: Transcat accounts for certain income and expense items differently for financial reporting purposes than for income tax reporting purposes. Deferred taxes are provided in recognition of these temporary differences. A valuation allowance on net deferred tax assets is provided for items for which it is more likely than not that the benefit of such items will not be realized, in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes”. SFAS No. 109 requires an assessment of both positive and negative evidence when measuring the need for a deferred tax valuation allowance.

Fair Value of Financial Instruments: Transcat has determined the fair value of debt and other financial instruments using available market information and appropriate valuation methodologies as follows:

Stock Options: Transcat follows the provisions of Accounting Practice Board No. 25, “Accounting for Stock Issued to Employees”, which does not require compensation costs related to stock options to be recorded in net income, as all options granted under the stock option plan had exercise prices equal to the market value of the underlying Common Stock at grant date.

Pro forma amounts are as follows (in thousands, except per share amounts):

Reclassification of Amounts: Certain reclassifications of prior fiscal periods’ financial information have been made to conform with current fiscal periods’ presentation.

Description. On November 13, 2002, Transcat entered into a Revolving Credit and Loan Agreement (the “Credit Agreement”) with GMAC Business Credit, LLC (“GMAC”). The Credit Agreement consisted of a term loan, a revolving line of credit (“LOC”), and certain material terms of which are as set forth below.

The Credit Agreement was amended on April 11, 2003 to address certain non-material post closing conditions.

The Credit Agreement was further amended on July 22, 2004 to waive compliance with an EBITDA (earnings before interest, income taxes, depreciation and amortization) covenant for the first quarter of fiscal year 2005, permanently waive a requirement relating to an inactive subsidiary that the Company had committed to dissolve by a specific date (that has been subsequently dissolved), and increase the Credit Agreement restriction on Master Catalog spending.

Transcat amended the Credit Agreement again on November 1, 2004 (“Third Amendment”). The Third Amendment consists of two term notes, a LOC, a capital expenditure loan if certain conditions are met, and certain material terms of which are as set forth below. The Third Amendment also waived compliance with the Company’s EBITDA covenant for the second quarter of fiscal year 2005 and extended the Credit Agreement expiration from November 13, 2005 to October 31, 2007.

Term Loans. Under the Third Amendment, the Company made two term loans, Term Loan A and Term Loan B, in the amounts of $1.5 million and $0.5 million, respectively. These term notes require annual payments of $0.5 million and $0.2 million, respectively, payable over three years in equal monthly installments, commencing on December 1, 2004. The Company is further required to reduce the term loans on an annual basis by a percentage of excess cash flow, as defined in the Third Amendment. Term Loan B will be reduced by the lesser of the balance owed on Term Loan B or 50% of the Company’s excess cash flow payable in three monthly installments. Once Term Loan B has been repaid, the excess cash flow payment required against Term Loan A is 20% of the Company’s excess cash flow, not to exceed $0.2 million, annually. As of June 25, 2005, the Third Amendment requires the Company to make the following principal payments on combined term loans, after giving effect to any excess cash flow payments to be made (in thousands):

(1)  On the Consolidated Balance Sheets as of June 25, 2005, the $0.8 million current portion of term loan consists of $0.5 million from principal term loan payments for the remaining nine months of fiscal year 2006, $0.2 million from term loan payments for the first three months of fiscal year 2007, and $0.1 million from excess cash flow payments.

LOC. Under the Third Amendment, the maximum amount available under the LOC portion is $9.0 million. As of June 25, 2005, the Company was eligible to borrow up to $8.1 million based on assets and borrowed $5.9 million. Availability under the LOC is determined by a formula based on eligible accounts receivable (85%) and inventory (50%).

The Credit Agreement contains both a subjective acceleration clause and a requirement to maintain a lock-box arrangement. These conditions resulted in a short-term classification of the LOC in accordance with EITF No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include both a Subjective Acceleration Clause and a Lock-Box Arrangement.”

Interest. Interest on the term loans and LOC is adjusted on a quarterly basis based upon the Company’s calculated Fixed Charge Coverage Ratio, as defined in the Third Amendment (see chart below). The prime rate and the 30-day London Interbank Offered Rate (“LIBOR”) as of June 25, 2005 were 6.01% and 3.34%, respectively.

Covenants. The Credit Agreement has certain covenants with which the Company has to comply, including a minimum EBITDA covenant, as well as restrictions on capital expenditures and Master Catalog spending. The Third Amendment includes a revised EBITDA covenant, a fixed charge coverage ratio covenant as well as revised restrictions on capital expenditures and Master Catalog spending. The Company was in compliance with all loan covenants and requirements for the first quarter of fiscal year 2006.

Loan Costs. In accordance with EITF 98-14, “Debtor’s Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements,” any fees paid to GMAC, third party costs associated with the LOC of the Third Amendment, and unamortized costs remaining under the Credit Agreement, are amortized over the term of the Third Amendment.

Other Terms. The Third Amendment requires an increase in the Company’s borrowing rate of two percentage points should an event of default occur and a termination premium of 2% of the advance limit in year one, 1% in year two, and 0.5% in the third year, as defined in the Credit Agreement, will be incurred if the Credit Agreement is terminated prior to its expiration date of October 31, 2007.

Additionally, the Company has pledged certain property and fixtures in favor of GMAC, including inventory, equipment, and accounts receivable as collateral security for the loans made under the Credit Agreement.

The Third Amendment also provides for a capital expenditure loan (“Cap-x Loan”). The Company has achieved an EBITDA, as defined in the agreement, of $2.4 million on a trailing twelve months basis in the required time frame specified in the Credit Agreement and therefore may make a Cap-x Loan of up to $1.0 million for qualifying capital expenditures. As of June 25, 2005, the Company has not borrowed any additional monies. The Cap-x Loan would be payable in equal monthly payments over a 36 month period with any residual balance resulting in a balloon payment at October 31, 2007. Interest is adjusted on a quarterly basis based upon the Company’s calculated Fixed Charge Coverage Ratio with the same terms as Term Loan A (see chart above).

Transcat has two reportable segments: Distribution Products (“Product”) and Calibration Services (“Service”). The accounting policies of the reportable segments are the same as those described above in Note 2 of the Consolidated Financial Statements. The Company has no inter-segment sales. The following table presents segment and geographic data for the first quarter of fiscal years 2006 and 2005:

Unconditional Purchase Obligation: In fiscal year 2002, the Company entered into a distribution agreement (the “Distribution Agreement”) with Fluke Electronics Corporation (“Fluke”) to be the exclusive worldwide distributor of TPG products until December 31, 2006. Under the Distribution Agreement, the Company also agreed to purchase a pre-determined amount of inventory from Fluke.

On October 31, 2002, with an effective date of September 1, 2002, the Company entered into a new distribution agreement (the “New Agreement”) with Fluke, which replaced the Distribution Agreement. The New Agreement ends on December 31, 2006. Under the terms of the New Agreement, among other items, the Company agreed to purchase a larger, pre-determined amount of inventory across a broader array of products and brands during each calendar year. The Company’s purchases for calendar years 2004 and 2003 exceeded the commitment under the New Agreement. The Company believes that this commitment to future purchases is consistent with Transcat’s business needs and plans.

Approximately 30% of Transcat’s product purchases on an annual basis are from Fluke, which is not believed to be inconsistent with Fluke’s share of the markets the Company services.

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 forecast in any such forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Reclassification of Amounts. Certain reclassifications of prior fiscal periods’ financial information have been made to conform with current fiscal periods’ presentation.

Rounding. Certain percentages may vary depending on the basis used for the calculation, such as dollars in thousands and dollars in millions.

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, as well as 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, depreciable lives of assets, estimated lives of our major catalogs (“Master Catalog”), and tax valuation allowances. 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. Actual results could differ from those estimates.

Changes in Estimates: In the ordinary course of accounting for items discussed above, we make changes in estimates as appropriate, and as we become aware of circumstances surrounding 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.

Revenue Recognition: Sales are recorded when products are shipped or services are rendered to customers, as we generally have no significant post delivery obligations. Our prices are fixed and determinable, collection of the resulting receivable is probable, and returns are reasonably estimated. Provisions for customer returns are provided for in the period the related sales are recorded based upon historical data. We recognize the majority of our service revenue based upon when the calibration or repair activity is performed 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. Our shipments are generally free on board shipping point and our customers are generally invoiced for freight, shipping, and handling charges.

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 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 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.

Inventory: Inventory consists of finished goods and is valued at the lower of cost or market. Costs are determined using the average cost method of inventory valuation. Inventory is reduced by a reserve for items not saleable at or above standard cost. We reserve specifically for certain items of our inventory and, for other items, we apply a specific loss factor, based on historical experience, to specific categories of our inventory. We evaluate the adequacy of the reserve on a regular basis.

Properties, Depreciation, and Amortization: Properties are stated at cost. Depreciation and amortization is computed primarily under the straight-line method with useful lives of 3 to 10 years for the following major classifications: machinery, equipment, software, and furniture and fixtures. Properties determined to have no value are written off at their then remaining net book value. We account for software costs in accordance with Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”. Leasehold improvements are amortized under the straight-line method over the estimated useful life or the lease term, whichever is shorter. Maintenance and repairs are expensed as incurred.

Goodwill: We estimate the fair value of our reporting units in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, using the fair market value measurement requirement, rather than the undiscounted cash flows approach. We test our goodwill for impairment on an annual basis, or immediately if conditions indicate that such impairment could exist.

Deferred Catalog Costs: We amortize the cost of each Master Catalog mailed over such catalog’s estimated productive life. We review response results from catalog mailings on a continuous basis; and if warranted, modify the period over which costs are recognized. We amortize the cost of each Master Catalog over an eighteen month period and amortize the cost of each catalog supplement over a three month period.

Deferred Gain on TPG: As a result of certain post divestiture commitments, we are unable to recognize the gain of $1.5 million on the divestiture of Transmation Products Group (“TPG”), which took place in fiscal year 2002, until those commitments expire in fiscal year 2007. See Note 5 of our Consolidated Financial Statements for further disclosure.

Deferred Taxes: We account for certain income and expense items differently for financial reporting purposes than for income tax reporting purposes. Deferred taxes are provided in recognition of these temporary differences. A valuation allowance on net deferred tax assets is provided for items for which it is more likely than not that the benefit of such items will not be realized, in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes”. SFAS No. 109 requires an assessment of both positive and negative evidence when measuring the need for a deferred tax valuation allowance.

Stock Options: We follow the provisions of Accounting Practice Board No. 25, “Accounting for Stock Issued to Employees”, which does not require compensation costs related to stock options to be recorded in net income, as all options granted under the stock option plan had exercise prices equal to the market value of the underlying Common Stock at grant date.

Off-Balance Sheet Arrangements: We do not maintain any off-balance sheet arrangements.

The following table sets forth, for the first quarter of fiscal years 2006 and 2005, the components of our Consolidated Statements of Operations (calculated on dollars in thousands).

Net sales increased $0.8 million, or 6.0% (calculated on dollars in millions) from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006.

Our product sales results, which accounted for 66.7% of our sales in the first quarter of fiscal year 2006 and 67.0 % of our sales in the first quarter of fiscal year 2005 (calculated on dollars in thousands), reflect improved year over year customer response to our marketing activities. Our first quarter of fiscal year 2006 and fiscal year 2005 product sales in relation to prior fiscal year quarter comparisons, is as follows (calculated on dollars in millions):

The following table provides the percent of net sales and the approximate gross profit percentage for significant product distribution channels for the first quarter of fiscal years 2006 and 2005 (calculated on dollars in thousands):

Customer product orders include orders for products that we routinely stock in our inventory, as well as customized products and other products ordered less frequently, which we do not stock. Unshippable product orders 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 unshippable orders for the first quarter of fiscal year 2006 were consistent with the first quarter of fiscal year 2005. The following table reflects our historical trend of product orders that are unshippable at the end of each fiscal quarter and the percentage of these orders that are backorders (calculated on dollars in millions):

Calibration services sales increased $0.3 million, or 6.8% (calculated on dollars in millions), from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006. This increase is attributable to both new customer acquisition and customer service efforts to retain existing customers. In addition, within any quarter, there is typically a netting of new customers against existing customers whose calibrations may not repeat for any number of factors. Among those factors are the timing of customer periodic calibrations on equipment as well as repair services, customer capital expenditure budgets, and customer outsourcing decisions. Our first quarter of fiscal year 2006 and fiscal year 2005 calibration service sales in relation to prior fiscal year quarter comparisons, is as follows (calculated on dollars in millions):

Gross profit increased as a percent of net sales from 23.6% in the first quarter of fiscal year 2005 to 25.6% in the first quarter of fiscal year 2006 (calculated on dollars in thousands).

Product gross profit increased $0.3 million, or 1.1 points (calculated on dollars in thousands) as a percent of net product sales from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006 primarily as a result of improved gross profit margins on international product sales reflecting the results of efforts to reduce discounts.

Our product gross profit can be impacted by a number of factors that can impact quarterly comparisons. Among those factors are sales to certain channels that do not support the margins of our core customer base discussed above, periodic rebates on purchases, and cooperative advertising received from suppliers reported as a reduction of cost of sales in accordance with Emerging Issues Task Force 02-16 (see Note 2 to our Consolidated Financial Statements). The following table reflects the quarterly historical trend of our product gross profit as a percent of net sales (calculated on dollars in millions):

Calibration service gross profit increased $0.2 million, or 3.9 points (calculated on dollars in thousands) from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006. This increase is a result of a 6.8% (calculated on dollars in million) increase in service sales and improving laboratory efficiency in a segment of our business where fixed costs are more effectively leveraged by an increase in sales. The following table reflects the quarterly historical trend of our calibration service gross profit as a percent of net sales (calculated on dollars in millions):

Operating expenses decreased $0.1 million, or 2.9% (calculated on dollars in millions), from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006. While selling, marketing, and warehouse expenses were relatively consistent from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006, administrative expenses decreased $0.1 primarily as a result of lower expense associated with stock previously issued to certain officers.

Interest expense was relatively consistent from the first quarter of fiscal year 2005 to the first quarter of fiscal year 2006 resulting from higher interest rates applied to lower average debt. The decrease in other expense in the first quarter of fiscal year 2006 was primarily attributable to less net losses in Canadian currency transactions in comparison to the first quarter of fiscal year 2005.

We have not recognized any provision (benefit) for income taxes in the first quarter of fiscal year 2006 and 2005 as pretax income (loss) was offset by a reduction (increase) in our deferred tax asset valuation reserve. When calculating income tax expense or benefit, we recognize valuation allowances for deferred tax assets, which may not be realized using a “more likely than not” approach, as is more fully described in Note 2 to our Consolidated Financial Statements.

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

Operating Activities: Cash used in operating activities for the first quarter of fiscal year 2006 was $0.1 million and decreased $1.0 million when compared to the $0.9 million of cash provided by operating activities in the first quarter of fiscal year 2005. This decrease was the result of a decrease in cash provided by working capital of $1.5 million, a decrease in non-cash charges of $0.1 million, offset by, an increase in net income of $0.6 million. Significant working capital fluctuations were as follows:

Investing Activities: The $0.3 million and $0.2 million of cash used in investing activities in the first quarter of fiscal years 2006 and 2005, respectively, resulted from capital expenditures, primarily for our calibration laboratories.

Financing Activities: Our debt was relatively consistent from June 26, 2004 to June 25, 2005. As the table below illustrates, our debt increased by $1.5 million more in the first quarter of fiscal year 2006 than in the first quarter of fiscal year 2005 (in millions). This increase is primarily the result of the relative decrease in cash provided by operating activities. See Note 3 to our Consolidated Financial Statements for further information regarding our debt.

Debt. Our third amendment of our Revolving Credit and Loan Agreement (“Credit Agreement”) with GMAC Business Credit, LLC consists of two term notes, a revolving line of credit, a capital expenditure loan option, and certain material terms of which are disclosed in Note 3 of our Consolidated Financial Statements.

The table below indicates our excess (shortage) EBITDA (earnings before interest, income taxes, depreciation and amortization) percentage for the periods indicated. The second and third amendment to the Credit Agreement waived compliance with the EBITDA covenant for the first and second quarters of fiscal year 2005, respectively. The third amendment also reduced the EBITDA requirement for the third and fourth quarters of fiscal year 2005. We met our EBITDA covenant for the first quarter of fiscal year 2006 and expect to meet the covenant on an on-going basis.

See Note 3 of our Consolidated Financial Statements for more information on our debt. See Item 3 for a discussion of interest rates on our debt.

Unconditional Purchase Obligation. In fiscal year 2002, we entered into a distribution agreement (the “Distribution Agreement”) with Fluke Electronics Corporation (“Fluke”) to be the exclusive worldwide distributor of TPG products until December 31, 2006. Under the Distribution Agreement, we also agreed to purchase a pre-determined amount of inventory from Fluke.

On October 31, 2002, with an effective date of September 1, 2002, we entered into a new distribution agreement (the “New Agreement”) with Fluke, which replaced the Distribution Agreement. The New Agreement ends on December 31, 2006. Under the terms of the New Agreement, among other items, we agreed to purchase a larger, pre-determined amount of inventory across a broader array of products and brands during each calendar year. Our purchases for calendar years 2004 and 2003 exceeded the commitment under the New Agreement. We believe that this commitment to future purchases is consistent with our business needs and plans.

In addition, in accordance with GAAP, we will be unable to recognize a gain of $1.5 million on the sale of TPG until the New Agreement expires on December 31, 2006.

We expect to continue to experience positive growth in both sales and earnings throughout fiscal year 2006. We expect revenue growth to be in the high single digits, with gross margin improvement driven by increased volume. We expect operating expenses to grow in line with sales. We have planned to increase investment in the following areas: marketing for prospecting and promotion, including employee training for new products; and infrastructure investments, including information technology.

We expect operating earnings to increase as a result of gross margin improvement and we expect them to increase as a percentage of sales. Our planned manpower increases and capital expenditures will be devoted primarily to calibration services and we expect them to be tied to increased volume or replacement/improvement of equipment.

We expect that distribution products will grow in the low single digits in a stable economy. Our growth in any quarter could be higher as a result of our sales of new product lines added in late fiscal year 2005 and early fiscal year 2006.

We expect that calibration services revenues will grow in the high single digits as more companies outsource their total calibration management to Transcat. Growth in any quarter could be higher or lower based on the timing and size of new business.

As previously disclosed, we have had a valuation allowance on our net deferred tax assets providing for items for which it is more likely than not that the benefit of such items will not be realized, in accordance with the provisions of SFAS No. 109. SFAS No. 109 requires an assessment of both positive and negative evidence when measuring the need for a deferred tax valuation allowance. The existence of cumulative losses in the most recent three-year fiscal period ending June 25, 2005 is sufficient negative evidence to maintain the valuation allowance under the provisions of SFAS No. 109. Our results over the most recent three-year period were heavily affected by such charges as severance, restructuring, litigation, and directors’ compensation expenses. Although we believe that the Company today is much stronger, more profitable, and focused on operating a sound, profitable business model, we must maintain a valuation allowance until sufficient positive evidence exists to support its reduction or reversal. We continue to evaluate that evidence on an ongoing basis.

Our exposure to changes in interest rates results from borrowing activities. In the event interest rates were to move by 1%, our yearly interest expense would increase or decrease by less than $0.1 million assuming our average-borrowing levels remained constant. On June 25, 2005 and June 26, 2004, we had no hedging arrangements in place to limit our exposure to upward movements in interest rates.

Under the third amendment described in Note 3 of our Consolidated Financial Statements, interest on the term loans and revolving line of credit is adjusted on a quarterly basis based upon our calculated Fixed Charge Coverage Ratio, as defined in the third amendment (see chart below). The prime rate and the 30-day London Interbank Offered Rate (“LIBOR”) as of June 25, 2005 were 6.01% and 3.34%, respectively.

Our interest rate for the first quarter of fiscal year 2006 was at Tier 3 and will continue to be at Tier 3 for the second quarter of fiscal year 2006.

Approximately 91% of our sales were denominated in United States dollars with the remainder denominated in Canadian dollars for the first quarter of fiscal years 2006 and 2005. A 10% change in the value of the Canadian dollar to the United States dollar would impact our revenues by less than 1%. We monitor the relationship between the United States and Canadian currencies on a continuous basis and adjust sales prices for products and services sold in Canadian dollars as we believe to be appropriate. On June 25, 2005 and June 26, 2004, we had no hedging arrangements in place to limit our exposure to foreign currency fluctuations.

You should consider carefully the following risks and all other information included in this quarterly report on Form 10-Q. The risks and uncertainties described below and elsewhere in this quarterly report on Form 10-Q are not the only ones facing our business. If any of the following risks were to actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall and you could lose all or part of your investment.

General Economic Conditions May Have A Material Adverse Effect On Our Operating Results, Financial Condition, Or Our Ability To Meet Our Commitments. The electronic instrumentation distribution industry is affected by changes in economic conditions, which are outside our control. Economic slowdowns, adverse economic conditions or cyclical trends in certain customer markets may have a material adverse effect on our operating results, financial condition, or our ability to meet our commitments.

We Depend On Manufacturers To Supply Our Inventory And Rely On One Vendor Group To Supply A Significant Amount Of Our Inventory Purchases. If They Fail To Provide Desired Products To Us, Increase Prices, Or Fail To Timely Deliver Products, Our Sales Could Suffer. A significant amount of our inventory purchases are made from one vendor group. Our reliance on this vendor group leaves us vulnerable to having an inadequate supply of required products, price increases, late deliveries, and poor product quality. Like other distributors in our industry, we occasionally experience supply shortages and are unable to purchase our desired volume of products. If we are unable to enter into and maintain satisfactory distribution arrangements with leading manufacturers, if we are unable to maintain an adequate supply of products, or if manufacturers do not regularly invest in, introduce

to us, and/or make available to us for distribution new products, our sales could suffer considerably. Finally, we cannot provide any assurance that particular products, or product lines, will be available to us, or available in quantities sufficient to meet customer demand. This is of particular significance to our business because the products we sell are often only available from one source. Any limits to product access could materially and adversely affect our business.

Indebtedness. In November 2004, we entered into a third amendment to our existing agreement with our secured credit facility. This amendment resulted in two additional term loans, in addition to our revolving line of credit. As of June 25, 2005, we owed $7.5 million to our secured creditor. We are required to meet financial tests on a quarterly basis and comply with other covenants customary in secured financings. Although we believe that we will continue to be in compliance with such covenants, if we do not remain in compliance with such covenants, our lenders may demand immediate repayment of amounts outstanding. Changes in interest rates may have a significant effect on our monthly payment obligations and operating results. Furthermore, we are dependent on credit from manufacturers of our products to fund our inventory purchases. If our debt burden increases to high levels, such manufacturers may restrict our credit. Our cash requirements will depend on numerous factors, including the rate of growth of our sales, the timing and levels of products purchased, payment terms, and credit limits from manufacturers, the timing and level of our accounts receivable collections and our ability to manage our business profitably. Our ability to satisfy our existing obligations, whether or not under our secured credit facility, will depend upon our future operating performance, which may be impacted by prevailing economic conditions and financial, business, and other factors described in this quarterly report on Form 10-Q, many of which are beyond our control.

If Existing Shareholders Sell Large Numbers Of Shares Of Our Common Stock, Our Stock Price Could Decline. The market price of our Common Stock could decline as a result of sales by our existing shareholders or holders of stock options of a large number of shares of our Common Stock in the public market or the perception that these sales could occur.

Our Stock Price Has Been, And May Continue To Be, Volatile. The stock market, from time to time, has experienced significant price and volume fluctuations that are both related and unrelated to the operating performance of companies. As our stock may be affected by market volatility, and by our own performance, the following factors, among others, may have a significant effect on the market price of our Common Stock:

We Expect That Our Quarterly Results Of Operations Will Fluctuate. Such Fluctuation Could Cause Our Stock Price To Decline. A large portion of our expenses for calibration services, including expenses for facilities, equipment and personnel, are relatively fixed, as is our commitment to purchase a predetermined amount of inventory. Accordingly, if revenues decline or do not grow as we anticipate, we may not be able to correspondingly reduce our operating expenses in any particular quarter. Our quarterly revenue and operating results have fluctuated in the past and are likely to do so in the future. If our operating results in some quarters fail to meet the expectations of stock market analysts and investors, our stock price would likely decline. Some of the factors that could cause our revenue and operating results to fluctuate include:

If We Fail To Attract And Retain Qualified Personnel, We May Not Be Able To Achieve Our Stated Corporate Objectives. Our ability to manage our anticipated growth, if realized, effectively depends on our ability to attract and retain highly qualified executive officers and technical personnel. If we fail to attract and retain qualified individuals, we will not be able to achieve our stated corporate objectives.

(a) Evaluation of Disclosure Controls and Procedures. Our Chairman, President, and Chief Executive Officer (our principal executive officer) and our Chief Operating Officer, Vice President of Finance, and Chief Financial Officer (our principal financial officer) evaluated our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report. Based on this evaluation, our Chairman, President, and Chief Executive Officer and our Chief Operating Officer, Vice President of Finance, and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of such date.

(b) Changes in Internal Controls over Financial Reporting. There has been no change in our internal control over financial reporting that occurred during the last fiscal quarter covered by this quarterly report (our first fiscal quarter) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

See Index to Exhibits.

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.