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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

________________________________

FORM 10-Q

For the transition period from _______________ to _______________

Commission File Number: 000-03905

TRANSCAT, INC.
(Exact name of registrant as specified in its charter)

35 Vantage Point Drive, Rochester, New York 14624
(Address of principal executive offices) (Zip Code)

(585) 352-7777
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrantregistrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [✓] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [✓] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”filer,” “smaller reporting company” and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [✓]

The number of shares of common stock, par value $0.50 per share, of the registrant outstanding as of FebruaryAugust 2, 2017 was7,020,291. 7,129,632.

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

TRANSCAT, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)

See accompanying notes to consolidated financial statements.

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TRANSCAT, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements.

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TRANSCAT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

See accompanying notes to consolidated financial statements.

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TRANSCAT, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In Thousands, Except Par Value Amounts)
(Unaudited)

See accompanying notes to consolidated financial statements.

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TRANSCAT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Per Share and Per Unit Amounts)
(Unaudited)

NOTE 1 – GENERAL

Description of Business:Transcat, Inc. (“Transcat” or the “Company”) is a leading provider of accredited calibration and laboratory instrument services and a value-added distributor of professional grade test, measurement and control instrumentation. The Company is focused on providing services and products to highly regulated industries, particularly the life science industry, which includes pharmaceutical, biotechnology, medical device and other FDA-regulated businesses. Additional industries served include industrial manufacturing; energy and utilities, including oil and gas; chemical manufacturing; FAA-regulated businesses, including aerospace and defense;defense and other industries that require accuracy in their processes, confirmation of the capabilities of their equipment and for which the risk of failure is very costly.

Basis of Presentation:Transcat’s unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8-03 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 necessarily indicative of what the results will be 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, 201625, 2017 (“fiscal year 2016”2017”) contained in the Company’s 20162017 Annual Report on Form 10-K filed with the SEC.

Revenue Recognition:Distribution sales are recorded when an order’s title and risk of loss transfers to the customer. The Company recognizes the majority of its 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 the Company recognizes revenue in equal amounts at fixed intervals. The Company generally invoices its customers for freight, shipping, and handling charges. Provisions for customer returns are provided for in the period the related revenue is recorded based upon historical data. In 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09 to provide specific guidance on how entities should recognize revenue derived from contracts with customers. Transcat is required to adopt ASU 2014-09 in its fiscal year 2019, which begins April 1, 2018. The Company does not expect the adoption of this ASU to have a material impact on its Consolidated Financial Statements.

Fair Value of Financial Instruments:Transcat has determined the fair value of debt and other financial instruments using a valuation hierarchy. The hierarchy, which prioritizes the inputs used in measuring fair value, consists of three levels. Level 1 uses observable inputs such as quoted prices in active markets; Level 2 uses inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, which is defined as unobservable inputs in which little or no market data exists, and requires the Company to develop its own assumptions. The carrying amount of debt on the Consolidated Balance Sheets approximates fair value due to variable interest rate pricing, and the carrying amounts for cash, accounts receivable and accounts payable approximate fair value due to their short-term nature. Investment assets, which fund the Company’s non-qualified deferred compensation plan, consist of mutual funds and are valued based on Level 1 inputs. At DecemberJune 24, 20162017 and March 26, 2016,25, 2017, investment assets totaled $0.8 million and $0.7 million respectively, and are included as a component of other assets (non-current) on the Consolidated Balance Sheets.

Stock-Based Compensation:The Company measures the cost of services received in exchange for all equity awards granted, including stock options and restricted stock units, based on the fair market value of the award as of the grant date. The Company records compensation expense related to unvested equity awards by recognizing, on a straight-line basis, the unamortized grant date fair value over the remaining service period of each award. In 2016, FASB issued ASU 2016-09 to simplify certain aspects of the accounting for share-based payment transactions to employees. The Company elected to early adopt this ASU in the fourth quarter of fiscal year 2017. Upon adoption, excess tax benefits for share based award activity are reflected in the statement of income as a component of the provision for income taxes. Excess tax benefits are realized benefits from tax deductions for exercised awards in excess of the deferred tax asset attributable to stock-based compensation costs for such awards. The Company did not capitalize any stock-based compensation costs as part of an asset. The Company estimates forfeiture rates based on its historical experience. During the first nine monthsquarter of the fiscal year ending March 25, 201731, 2018 (“fiscal year 2017”2018”) and the first nine months of fiscal year 2016,2017, the Company recorded non-cash stock-based compensation expense of $0.3$0.5 million and $0.1 million, respectively, in the Consolidated Statements of Income.

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Foreign Currency Translation and Transactions:The accounts of Transcat Canada Inc., a wholly-owned subsidiary of the Company, are maintained in the local currency and have been translated to U.S. dollars. Accordingly, the amounts representing assets and liabilities have been translated at the period-end rates of exchange and related revenue and expense accounts have been translated at an average rate of exchange during the period. Gains and losses arising from translation of Transcat Canada Inc.’s financial statements into U.S. dollars are recorded directly to the accumulated other comprehensive loss component of shareholders’ equity.

Transcat records foreign currency gains and losses on its Canadian business transactions. The net foreign currency loss was less than $0.1 million duringin each of the first nine months of eachquarters of fiscal years 20172018 and 2016.2017. The Company continually utilizes short-term foreign exchange forward contracts to reduce the risk that its earnings will be adversely affected by changes in currency exchange rates. The Company does not apply hedge accounting and therefore the net change in the fair value of the contracts, which totaled a gainloss of $0.1 million during the first nine monthsquarter of each of the fiscal yearyears 2018 and 2017, and a gain of $0.4 million during the first nine months of fiscal year 2016, was recognized as a component of other expense in the Consolidated Statements of Income. The change in the fair value of the contracts is offset by the change in fair value on the underlying accounts receivables denominated in Canadian dollars being hedged. On DecemberJune 24, 2016,2017, the Company had a foreign exchange contract, which matured in JanuaryJuly 2017, outstanding in the notional amount of $5.9$5.6 million. The foreign exchange contract was renewed in JanuaryJuly 2017 and continues to be in place. The Company does not use hedging arrangements for speculative purposes.

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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 stock options and unvested restricted stock units using the treasury stock method in periods in which they have a dilutive effect. In computing the per share effect of assumed conversion, funds which would have been received from the exercise of options and unvested restricted stock units and the related tax benefits 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 each of the third quarters of fiscal years 20172018 and 2016,2017, the net additional common stock equivalents had no effect on the calculation of diluted earnings per share. For the first nine months of each of the fiscal years 2017 and 2016, the net additional common stock equivalents had a $0.01 effect on the calculation of diluteddilutive earnings per share. The average shares outstanding used to compute basic and diluted earnings per share are as follows:

Recently Issued Accounting Pronouncements:In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting, Compensation—Stock Compensation (Topic 718). This ASU provides clarity and reduces both diversity in practice and cost and complexity when applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. This ASU is effective for annual reporting periods beginning after December 15, 2017 and should be applied prospectively. Early adoption of this ASU is permitted. The Company does not expect adoption of this ASU to have a material impact on its Consolidated Financial Statements.

NOTE 2 – LONG-TERM DEBT

Description:Transcat,The Company, through its credit agreement, as amended (the “Credit Agreement”), which matures September 20, 2018, has a revolving credit facility that allows for maximum borrowings of $30.0 million (the “Revolving Credit Facility”) and a term loan. The Revolving Credit Facility is subject to a maximum borrowing restriction based on a 3.0 multiple of earnings before income taxes, depreciation and amortization, and non-cash stock-based compensation expense for the preceding four consecutive fiscal quarters. As of DecemberJune 24, 2016,2017, $30.0 million was available under the Revolving Credit Facility, of which $17.1$23.6 million was outstanding and included in long-term debt on the Consolidated Balance Sheets.Sheet.

Under Amendment 3 to the Credit Agreement (“Amendment 3”) set the limit of borrowings that may be used for business acquisitions at $20.0 million for fiscal year 2017 andare limited to $15.0 million for eachin fiscal year thereafter.years 2018 and 2019. During the first nine monthsquarter of fiscal year 2017, the Company2018, no borrowings were used $7.0 million of borrowings for business acquisitions and related payments.acquisitions.

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Amendment 3 also provided the Company with a $10.0 million term loan. As of DecemberJune 24, 2016, $9.02017, $8.3 million was outstanding on the term loan, of which $1.4 million was included in current liabilities on the Consolidated Balance Sheet with the remainder included in long-term debt on the Consolidated Balance Sheet.debt. The term loan requires principal repayments of $0.1 million per month plus interest. Total annual repayment amounts of $1.4 million are required in fiscal years 20172018 through 2021 with a $3.0 million repayment required in fiscal year 2022. Amendment 3 also increased the allowable leverage ratio to a maximum of 3.0 from 2.75.

Interest and Other Costs:Interest on the Revolving Credit Facility and term loan accrues, at Transcat’s election, at either the variable one-month London Interbank Offered Rate (“LIBOR”) or a fixed rate for a designated period at the LIBOR corresponding to such period, in each case, plus a margin. Commitment fees accrue based on the average daily amount of unused credit available on the Revolving Credit Facility. Interest rate margins and commitment fees are determined on a quarterly basis based upon the Company’s calculated leverage ratio, as defined in the Credit Agreement. The one-month LIBOR as of DecemberJune 24, 20162017 was 0.76%1.2%. The Company’s interest rate duringfor the first nine monthsquarter of fiscal year 20172018 ranged from 2.6%3.0% to 2.9%3.3%.

Covenants:The Credit Agreement has certain covenants with which the Company has tomust comply, including a fixed charge coverage ratio covenant and a leverage ratio covenant. The Company was in compliance with all loan covenants and requirements during the first nine monthsquarter of fiscal year 20172018.

Other Terms:The Company has pledged all of its U.S. tangible and expects to remain in compliance throughout fiscal year 2017.intangible personal property, the equity interests of its U.S.-based subsidiaries, and a majority of the common stock of Transcat Canada Inc. as collateral security for the loans made under the Revolving Credit Facility.

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NOTE 3 – STOCK-BASED COMPENSATION

The Transcat, Inc. 2003 Incentive Plan, as Amended and Restated (the “2003 Plan”), provides for, among other awards, grants of restricted stock units and stock options to directors, officers and key employees atoptions. At June 24, 2017, the fair market value at the datenumber of grant. At December 24, 2016, 1.3 million shares were available for future grant under the 2003 Plan.Plan totaled 1.1 million.

Restricted Stock Units:The Company grants 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 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, the Company records compensation cost based on the estimated level of achievement of the performance conditions.

The Company achieved 50% of the target level for the performance-based restricted stock units granted in the fiscal year ended March 29, 201428, 2015 and as a result, issued 5025 shares of common stock to executive officers and certain key employees during the first quarter of fiscal year 2017.2018. The following table summarizes the non-vested performance-based restricted stock units outstanding as of DecemberJune 24, 2016:2017:

				Total		Grant Date			Estimated
				Number		Fair			Level of
Date		Measurement		of Units		Value			Achievement at
Granted		Period		Granted		Per Unit			December 24, 2016
April 2014		April 2014 - March 2017		61		$	9.28		50% of target level
April 2015		April 2015 - March 2018		73		$	9.59		50% of target level
April 2016		April 2016 - March 2019		94		$	10.13		100% of target level

Total expense relating to performance-based restricted stock units, based on grant date fair value and the achievement criteria, was $0.2 million duringand $0.1 million in the first nine monthsquarter of both fiscal years 2018 and 2017, and 2016.respectively. As of DecemberJune 24, 2016,2017, unearned compensation, cost to be recognized over the grants’ respective service periods, totaled $0.8$1.5 million.

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

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The following table summarizes the Company’s options as of December 24, 2016 and for the first nine months of fiscal yearquarter ended June 24, 2017:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the thirdfirst quarter of fiscal year 20172018 and the exercise price, multiplied by the number of in-the-money stock options) that would have been received by the option holders had all holders exercised their options on DecemberJune 24, 2016.2017. The amount of aggregate intrinsic value will change based on the fair market value of the Company’s common stock.

Total expense related to stock options was less than$0.3 and $0.1 million during each of the first nine monthsquarter of fiscal years 2018 and 2017, and 2016.respectively. Total unrecognized compensation cost related to non-vested stock options as of DecemberJune 24, 20162017 was less than $0.1 million, which is expected to be recognized over a weighted average period of one year. The aggregate intrinsic value of stock options exercised in the first nine monthsquarter of fiscal year 20172018 was $0.1$0.4 million. Cash received from the exercise of options in the first nine monthsquarter of fiscal year 20172018 was $0.2$0.6 million.

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NOTE 4 – SEGMENT INFORMATION

Transcat has two reportable segments: Distribution and Service. The Company has no inter-segment sales. The following table presents segment information for the thirdfirst quarter and first nine months of fiscal years 20172018 and 2016:2017:

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NOTE 5 – BUSINESS ACQUISITIONS

Transcat completed one business acquisition during the first nine months ofDuring fiscal year 2017, Transcat acquired substantially all of the assets of Excalibur Engineering, Inc. (“Excalibur”), a California-based provider of calibration services, new and three business acquisitions during the first nine months of fiscal year 2016.used test equipment sales, and equipment rentals.

These transactions alignThis transaction aligned with the Company’s acquisition strategy of targeting businesses that expand the Company’s geographic reach and leverage its infrastructure while also increasing the depth and breadth of the Company’s service capabilities. In addition, Excalibur Engineering, Inc. (“Excalibur”), acquired in April 2016, provided an established equipment rental and used equipment business, which are complimentary offerings to the Company’s traditional Distribution segment sales.

The Company accounts for business acquisitions usingapplies the acquisition method of accounting. Goodwill, calculated asaccounting for business acquisitions. Under the excess ofacquisition method, the purchase price paid overof an acquisition is assigned to the underlying tangible and intangible assets acquired and liabilities assumed based on their respective fair values at the date of acquisition. The Company uses a valuation hierarchy, as further described under Fair Value of Financial Instruments in Note 1 above, and typically utilizes independent third-party valuation specialists to determine the fair value ofvalues used in this allocation. Purchase price allocations are subject to revision within the underlying net assets of the businesses acquired, generally represents expected future economic benefits arisingmeasurement period, not to exceed one year from the reputationdate of an acquired business,acquisition. Intangible assets related to the assembled workforce, expected synergies and other assets acquired that could not be individually identified and separately recognized. Other intangible assets, namely customer bases and covenants not to compete, represent an allocation of a portion of the purchase price to identifiable intangible assets of the acquired businesses. Excluding goodwill, intangible assetsExcalibur acquisition are being amortized for financial reporting purposes on an accelerated basis over anthe estimated useful life of up to 10 years. Amortization of goodwill related to the Excalibur acquisition is expected to beyears and are deductible for tax purposes.

Of the goodwill and other intangible assets relating to the Excalibur acquisition, $2.8 million was allocated to the Service segment and $2.8 million was allocated to the Distribution segment, based on quantitative and qualitative factors.

The total purchase price paid for the assets of Excalibur was approximately $7.6 million, net of less than $0.1 million cash acquired. The following is a summary of the preliminary purchase price allocation, in the aggregate, to the fair value, based on Level 3 inputs, of assets and liabilities acquired:

Acquisition costs of $0.1 million and $0.4 million were recorded as incurred as administrative expenses in the Consolidated Statements of Incomeacquired during the first nine months of fiscal years 2017 and 2016, respectively.period presented:

Certain of the Company’s acquisition agreements have included provisions for contingent consideration and other holdback amounts. The Company accrues for contingent consideration and holdback provisions based on their estimated fair value at the date of acquisition. As of DecemberJune 24, 2016, $0.5 million of2017 and March 25, 2017, no contingent consideration and $2.2 million ofor other holdback amounts were unpaid and reflected in current liabilitiesincluded on the Consolidated Balance Sheets. Subsequent to December 24, 2016, the entire outstanding contingent consideration and $1.8 million of other holdback amounts were paid. As of March 26, 2016, $0.8 million of contingent consideration and $1.6 million of other holdback amounts were unpaid and reflected in current liabilities on the Consolidated Balance Sheets. Included in the other holdback amounts at December 24, 2016 is $0.7 million related to the acquisition of Excalibur. This amount was included in the total $1.8 million of other holdback amounts paid subsequent to December 24, 2016. $0.3 million of contingent consideration and holdback amounts related to acquisitions completed in prior fiscal years were paid during the first nine months of fiscal year 2017.

The results of the acquired businesses are included in Transcat’s consolidated operating results as of the dates the businesses were acquired. The following unaudited pro forma information presents the Company’s results of operations as if the acquisitions made during fiscal years 2017 and 2016acquisition of Excalibur had occurred at the beginning of the respective fiscal years.year 2017. The pro forma results do not purport to represent what the Company’s results of operations actually would have been if the transactionstransaction had occurred at the beginning of eachthe period presented or what the Company’s operating results will be in future periods.

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During each of the first quarters of fiscal years 2018 and 2017, acquisition costs of less than $0.1 million were recorded as incurred as general and administrative expenses in the Consolidated Statements of Income.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements.This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations, estimates, beliefs, assumptions and predictions of future events and are identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “projects,” “intends,” “could,” “may”“may,” “intend” and other similar words. Forward-looking statements are not statements of historical fact and thus are subject to risks, uncertainties and other factors that could cause actual results to differ materially from historical results or those expressed in such forward-looking statements. You should evaluate forward-looking statements in light of important risk factors and uncertainties that may affect our operating and financial results and our ability to achieve our financial objectives. These factors include, but are not limited to, our reliance on one vendor to supply a significant amount of inventory purchases, the risks related to current and future indebtedness, the relatively low trading volume of our common stock, risks related to our acquisition strategy and the integration of the businesses we acquire, the impact of economic conditions, volatility in the oil and gas industry, the highly competitive nature of our two business segments, foreign currency rate fluctuations and cybersecurity risks. These risk factors and uncertainties are more fully described by us under the heading “Risk Factors” in our reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended March 26, 2016.25, 2017. You should not place undue reliance on our forward-looking statements. Except as required by law, we undertake no obligation to update correct or publicly announce any revisions to any of the forward-looking statements contained in this report, whether as a result of new information, future events or otherwise.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes to our critical accounting policies and estimates from the information provided in our Annual Report on Form 10-K for the fiscal year ended March 26, 2016.25, 2017.

RESULTS OF OPERATIONS

During our thirdOur first quarter of fiscal year 2017,2018 started off strong with 9.4% consolidated revenue growth driven by both of our operating segments. Our Service segment revenue improved 7.6% and our Distribution segment sales increased 11.4% compared with the prior fiscal year first quarter. First quarter revenue growth was purely organic as we achieved record quarterlygained market share and saw some upside from economic improvements in U.S. industrial markets.

First quarter gross profit improved 5.4% or $0.4 million as a result of increased volume. Gross margin was down 90 basis points from the same period in the prior year as short-term Service segment technical labor constraints impacted productivity and the mix of services sold.

Operating expenses increased $0.5 million when compared to the prior year first quarter, driven by increased general and administrative expenses, which reflected investments to advance the Company’s operating infrastructure and operational excellence initiatives as well as $0.3 million in one-off non-cash stock-based compensation expense within the quarter. As a percentage of total revenue, of $37.8 million. Total revenue increased $7.7 million or 25.4% overoperating expenses were 20.1%, down from 20.6% in the thirdfirst quarter of fiscal year 2016. Revenue growth in2017.

Net income for the quarter was the result of growth in both of our business segments and came from organic revenue growth and from revenue from acquired businesses.

Our Distribution segment produced its second sequential quarter of year-over-year sales growth with a 25.4% increase, demonstrating what management believes to be a rebound from challenging market conditions as strategic initiatives implemented in this segment continue to take hold. Year-over-year Distribution sales growth was primarily driven by growth in our traditional core customer base and was complemented by increased equipment rentals, increased demand from our customers in alternative energy markets and incremental sales from Excalibur’s used equipment and equipment rental businesses.

Our Service segment also exhibited strong growth in the third quarter, improving 25.4% when compared$0.9 million, comparable to the thirdfirst quarter of fiscal year 2016. Service segment revenue growth was driven by increased revenue from our traditional customer base and incremental sales from recent acquisitions.

Increased revenues along with higher Distribution segment vendor rebates helped to drive a 31.5% improvement in consolidated gross profit when compared to the third quarter of fiscal year 2016. On a consolidated basis, gross margin improved 110 basis points for the quarter to 23.6%. Gross profit improvements combined with management’s cost controls helped to offset increased operating expenses, resulting in a 39.9% increase in operating income in the third quarter of fiscal year 2017 compared to the third quarter of fiscal year 2016.2017.

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The following table presents, for the thirdfirst quarter and first nine months of fiscal years 20172018 and 2016,2017, the components of our Consolidated Statements of Income:

THIRDFIRST QUARTER ENDED DECEMBERJUNE 24, 20162017 COMPARED TO THIRDFIRST QUARTER ENDED DECEMBER 26, 2015JUNE 25, 2016 (dollars in thousands):

Revenue:

Total revenue increased $3.1 million, or 9.4%, in our fiscal year 2018 first quarter compared to the prior year first quarter. This year-over-year growth was purely organic.

Service revenue, which accounted for 46.2%50.9% and 51.8% of our total revenue in the third quarters of each of the fiscal years 2017 and 2016, increased 25.4% from the thirdfirst quarter of fiscal year 2016. This year-over-year increase in Service revenue wasyears 2018 and 2017, respectively, increased 7.6% from the result of a high single-digit organic growth rate with the remainder attributable to business acquisitions completed in the fourth quarter of fiscal year 2016 and first quarter of fiscal year 2017.2017 to the first quarter of fiscal year 2018. This year-over-year increase was experienced across various industries and resulted from a combination of customer retention and the addition of new customers.

Our fiscal years 20172018 and 20162017 Service revenue growth, in relation to prior fiscal year quarter comparisons, was as follows:

Fiscal year 2017 quarterly growth comparisons include organic and acquisition related growth while the first quarter of fiscal year 2018 included no acquisition related growth.

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Within any year, while we add new customers, we also have customers from the prior year whose service orders may not repeat for any number of factors. Among those factors are variations in the timing of periodic calibrations and other services, customer capital expenditures and customer outsourcing decisions. Because the timing of Service segment orders can vary on a quarter-to-quarter basis, we believe a trailing twelve-month trend provides a goodbetter indication of the progress of this segment. The following table presents the trailing twelve-month Service segment revenue for each quarter in fiscal years 20172018 and 20162017 as well as the trailing twelve-month revenue growth as a comparison to that of the prior fiscal year period:

Our strategy has been to focus our investments in the core electrical, temperature, pressure, physical/dimensional and radio frequency/microwave calibration disciplines. We expect to subcontract approximately 13% to 15% of our Service revenue to third-party vendors for calibration beyond our chosen scope of capabilities. We continually evaluate our outsourcing needs and make capital investments, as deemed necessary, to add more in-house capabilities and reduce the need for third-party vendors. Capability expansion through business acquisitions is another way that we seek to reduce the need for outsourcing. The following table presents the source of our Service revenue and the percentage of Service revenue derived from each source for each quarter during fiscal years 20172018 and 2016:2017:

Our Distribution sales accounted for 53.8%49.1% of our total revenue in the third quarters of each of the fiscal years 2017 and 2016. During the thirdfirst quarter of fiscal year 2017, organic2018 and 48.2% of our total revenue in the first quarter of fiscal year 2017. During the first quarter of fiscal year 2018, Distribution segment sales growth of $2.3 million was driven by increased demand from our traditional corethe Company’s end-user customer base, increasedparticularly within the industrial sector. Diversification efforts along with the growth of our equipment rental demandbusiness and increased demandincremental sales from alternative energy markets. Management believes that these improvements are a direct result of recently implemented strategic initiativesour business acquisitions, especially Excalibur, have helped to drive sales and mitigate the challenging macroeconomic conditions recently faced bybolster this segment particularly weakened demand from oil and gas industry and the negative impact of the strong U.S. dollar on industrial output. Initiatives implemented over the past several quarters to offset market conditions include diversification of product offerings, improved inventory management, e-commerce improvements on our U.S. and Canada websites, and investing in our organically grown equipment rental business. $1.8 million in third quarter revenue growth came from business acquisitions completedafter a downturn still evidenced in the fourth quarter of fiscal year 2016 and first quarterbeginning of fiscal year 2017, which was driven by challenging macro environment factors, including from Excalibur’s used equipmentvolatility in oil and equipment rental businesses. Spectrum Technologies, Inc. (“Spectrum”),gas and the assets of which were acquireddownturn in the fourth quarter of fiscal year 2016, had $.6 million of Distribution sales in the third quarter of fiscal year 2017.

related markets. Our fiscal years 20172018 and 20162017 Distribution sales growth (decline), in relation to prior fiscal year quarter comparisons, was as follows:

Fiscal year 2017 quarterly growth comparisons include organic and acquisition related growth while the first quarter of fiscal year 2018 included no acquisition related growth.

Distribution sales orders include orders for instruments that we routinely stock in our inventory, customized products, and other products ordered less frequently, which we do not stock. Pending product shipments are primarily backorders, but also include products that are requested to be calibrated in our service centers prior to shipment, orders required by the customer to be shipped complete or at a future date, and other orders awaiting final credit or management review prior to shipment. Our total pending product shipments at the end of the thirdfirst quarter of fiscal year 20172018 were $4.0$3.5 million, an increase of $0.6 million fromconsistent with the thirdfirst quarter of fiscal year 2016.2017. The following table presents our total pending product shipments and the percentage of total pending product shipments that were backorders at the end of each quarter of fiscal years 20172018 and 2016:2017:

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Gross Profit:

The year-over-year improvement in total gross profit was a direct result ofdriven by increased revenuevolume in both business segments.our Distribution segment. Total gross margin was 23.6%24.0% in the thirdfirst quarter of fiscal year 2017, a 110 basis point improvement2018, down from 24.9% in the thirdfirst quarter of fiscal year 2016.2017. This increaseyear-over-year decline was positively impacted by increased volume in both business segments, an improvedprimarily due to the mix of products and services sold and increased Distribution vendor rebates.expenses incurred within the period to address short-term Service segment labor constraints.

Service gross profit in the thirdfirst quarter of fiscal year 2017 increased $1.02018 decreased $0.1 million, or 31.6%2.0%, from the thirdfirst quarter of fiscal year 2016. This year-over-year improvement was primarily driven by2017. While the Service segment saw strong revenue growth in the first quarter of fiscal year 2018, a ramp-up in technical labor resources to meet ongoing revenue growth resulted in increased revenue oncosts and reduced productivity during the quarter. We expect this impact to productivity to be temporary and expect the ramp-up of resources to lay the ground work for improved productivity in the second-half of our relatively fixed cost structure in this segment.fiscal year 2018. The mix of services provided to customerssold during the first quarter also positively affected gross margins.impacted Service segment gross margin, was 24.7%as labor constraints resulted in the third quarter of fiscal year 2017, a 120 basis point improvement from the third quarter of fiscal year 2016.increased outsourcing, which generally yields lower profit margins.

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

Our Distribution gross margin includes net sales less the direct cost of inventory sold and the direct costs of equipment rental revenues, primarily depreciation expense for the fixed assets in our rental equipment pool, as well as the impact of rebates and cooperative advertising income we receive from vendors, freight billed to customers, freight expenses and direct shipping costs. In general, our Distribution gross margin can vary based upon the mix of products sold, price discounting, and the timing of periodic vendor rebates offered and cooperative advertising programs from suppliers.

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

Distribution segment gross margin improved 10080 basis points in the thirdfirst quarter of fiscal year 20172018 compared to the thirdfirst quarter of fiscal year 2016.2017. Improvements in gross margin were driven by increased sales in our higher-margin equipment rental business (including that of Excalibur), the used equipment business acquired from Excalibur, increased vendor rebates and an improved customer mix, which for us means a higher percentage of total sales to end user customers and reduction in sales to wholesale or intermediary reseller type customers.

Operating Expenses:

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Operating Expenses:

The year-over-year increase in operating expenses was primarily due to incremental selling, marketinggeneral and warehouseadministrative expenses associated with our recent business acquisitionsrelated to the Company’s operating infrastructure improvements and increased employee-related expenses. Total number of employees includedoperational excellence initiatives as well as $0.3 million in operatinga one-off non-cash stock-based compensation expense categories was 145 and 117 atincurred within the end of the third quarter of fiscal years 2017 and 2016, respectively. quarter.

As a percentage of total revenue, operating expenses were 17.4%20.1% in the thirdfirst quarter of fiscal year 20172018 and 16.9%20.6% in the thirdfirst quarter of fiscal year 2016.2017.

Income Taxes:

Our effective tax rates for the thirdfirst quarter of fiscal years 2018 and 2017 were 24.8% and 2016 were 40.9% and 34.1%28.7%, respectively. The year-over-year change in our effective tax ratedecrease largely reflects changes in the availability of federal and state research and development tax credits.benefit from stock-based compensation awards. 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.

Net Income:

Improved gross profit more than offset increases in operating expenses, resulting in a 19.9% improvement in net income in the third quarter of fiscal year 2017 when compared to the third quarter of fiscal year 2016. As a percentage of revenue, net income was 3.4% in the third quarter of fiscal year 2017, compared with 3.5% in the third quarter of fiscal year 2016.

NINE MONTHS ENDED DECEMBER 24, 2016 COMPARED TO NINE MONTHS ENDED DECEMBER 26, 2015 (dollars in thousands):

Revenue: