In 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which established principles to provide specific guidance on how entities should recognizereport useful information to financial statement users about the nature, timing and uncertainty of revenue derived from contracts with customers. ASU No. 2014-09 along with various related amendments comprise Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“Topic 606”), and provide guidance that is applicable to all contracts with customers regardless of industry-specific or transaction-specific fact patterns. Transcat is required to adopt ASU 2014-09 inadopted the new standard for its fiscal year ending March 30, 2019 (“fiscal year 2019”). This new standard supercedes previous guidance, which began April 1, 2018 using the modified retrospective approach to each prior reporting period presented. Based on revenue recognition and requiresour analysis, the use of more estimates and judgments than the present standards. It also requires additional disclosures. We are continuing to evaluate certain contracts to determine their treatment under ASU 2014—09. The Company does not expectconcluded that the adoption of this ASU tothe amended guidance did not have a material impact on its net revenue recognition. The cumulative effect adjustment upon adoption of the Consolidated Financial Statements.ASU in the first quarter of fiscal year 2019 was immaterial.

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, 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 December 23, 2017each of June 30, 2018 and March 25, 2017,31, 2018, 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.

Table of Contents

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, excessExcess 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 31, 2018 (“fiscal year 2018”)2019 and fiscal year 2017,2018, the Company recorded non-cash stock-based compensation expense of $1.1$0.3 million and $0.3$0.5 million, respectively, in the Consolidated Statements of Income.

Table of Contents

Foreign Currency Translation and Transactions:The accounts of Transcat Canada Inc., a wholly-owned subsidiary of the Company, are maintained in the local currency (Canadian dollars) 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 20182019 and 2017.2018. 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 loss of $0.1 million during the first nine monthsquarter of each of fiscal yearyears 2019 and 2018, and a gain of $0.1 million during the first nine months of fiscal year 2017, 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 December 23, 2017,June 30, 2018, the Company had a foreign exchange contract, which matured in JanuaryJuly 2018, outstanding in the notional amount of $5.4$4.9 million. The foreign exchange contract was renewed in JanuaryJuly 2018 and continues to be in place. The Company does not use hedging arrangements for speculative purposes.

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 thirdfirst quarter of fiscal year 20182019, the net additional common stock equivalents had a $0.01 effect on the calculation of diluted earnings per share. For the thirdfirst quarter of fiscal year 2017,2018, the net additional common stock equivalents had no effect on the calculation of dilutive earnings per share. For each of the first nine months of fiscal year 2018 and fiscal year 2017, the net additional common stock equivalents had a $0.01 effect on the calculation of diluted 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,June 2018, the FASB issued ASU 2017-09, Scope of Modification Accounting, Compensation—2018-07, Compensation – Stock Compensation, (Topic 718). Thiswhich simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under this ASU, provides clarity and reduces both diversity in practice and cost and complexity when applyingmost of the guidance in Topic 718on such payments to a changenonemployees would be aligned with the requirements for share-based payments granted to the terms or conditions of a share-based payment award.employees. This ASU is effective for annual reporting periods beginning after December 15, 2017 and should be applied prospectively.2018. 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.

Table of Contents

In February 2016, the FASB issued ASU No. 2016-02, Leases (ASC Topic 842), which requires lessees to recognize substantially all leases on-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right of use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.

The new standard is effective for annual and interim periods beginning after December 15, 2018. ASU 2016-02 requires entities to adopt a modified retrospective transition method for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements.

The Company continues to evaluate the impact that adopting ASU 2016-02 will have on its financial statements, but the most significant impact will be to increase assets and liabilities on the consolidated balance sheet by the present value of the Company’s leasing obligations, which are primarily related to facility and vehicle leases, as well as additional disclosures required.

NOTE 2 – LONG-TERM DEBT

Description:On October 30, 2017, the Company entered into an Amended and Restated Credit Agreement (the “2017“Credit Agreement”), which amended and restated our prior credit facility agreement. The 2017Credit Agreement extended the term of the Company’s $30.0 million revolving credit facility (the “Revolving Credit Facility”) to October 29, 2021. As of December 23, 2017,June 30, 2018, $30.0 million was available under the Revolving Credit Facility, of which $11.6$8.0 million was outstanding and included in long-term debt on the Consolidated Balance Sheet.Sheets. The 2017Credit Agreement also increased the amount of the Company’s outstanding term loan to $15.0 million (the “2017 Term Loan”), replacing the previous term loan. As of December 23, 2017, $14.6June 30, 2018, $13.6 million was outstanding on the 2017 Term Loan, of which $2.1 million was included in current liabilities on the Consolidated Balance SheetSheets with the remainder included in long-term debt. The 2017 Term Loan requires principal repayments of $0.2 million per month plus interest through September 2022 with a $4.3 million repayment required on October 29, 2022. Under the 2017Credit Agreement, borrowings that may be used for business acquisitions are limited to $20.0 million per fiscal year. During the first nine months of fiscal year 2018, no borrowings were used for business acquisitions.

Table of Contents

The allowable leverage ratio under the 2017Credit Agreement remains at a maximum multiple of 3.0 of total debt outstanding compared to earnings before income taxes, depreciation and amortization, and non-cash stock-based compensation expense for the preceding four consecutive fiscal quarters. The excess funds of the 2017 Term Loan over the previous term loan were used to repay amounts outstanding under the Revolving Credit Facility.

Previously, on March 31, 2016, the Company entered into Amendment 3 (“Amendment 3”) to the prior credit agreement. Under Amendment 3, borrowings that could be used for business acquisitions were limited to $15.0 million in fiscal years 2018 and 2019. Amendment 3 also provided the Company with a $10.0 million term loan. The term loan required principal repayments of $0.1 million per month plus interest. Total annual repayment amounts of $1.4 million were required in fiscal years 2017 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. As described above, in the third quarter of fiscal year 2018, we entered into the 2017 Agreement that amended and restated the prior credit agreement, including Amendment 3.

Interest and Other Costs:Interest on outstanding borrowings of the Revolving Credit Facility and term loan accrue,2017 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 2017Credit Agreement. The one-month LIBOR at December 23, 2017as of June 30, 2018 was 1.6%2.1%. The Company’s interest rate for the first nine monthsquarter of fiscal year 20182019 ranged from 3.2% to 3.4%3.6%.

Covenants:The 2017Credit 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 thirdfirst quarter of fiscal year 2019. Our leverage ratio, as defined in the Credit Agreement, was 1.28 at June 30, 2018, compared with 1.40 at the end of fiscal year 2018.

Other Terms:The Company has pledged all of its U.S. tangible and 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.

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 at the fair market value at the date of grant. At December 23, 2017, 1.1 millionJune 30, 2018, the number of shares were available for future grant under the 2003 Plan.Plan totaled 1.1 million.

Table of Contents

Restricted Stock Units:The Company generally grants performance-based restricted stock units as a primary component of executive compensation. TheIn previous fiscal years, the units generally vestvested following the third fiscal year from the date of grant subject to certain cumulative diluted earnings per share growth targets over the eligible period. The restricted stock units granted in June 2017 and April 2018 were time vested. Beginning with the restricted stock units granted in May 2018, 50% of the units will vest subject to certain cumulative diluted earnings per share growth targets over the eligible period and 50% of the restricted stock units will be time vested over a three-year 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 expense relating to the time vested restricted stock units is recognized on a straight-line basis over the requisite service period for the entire award.

The Company achieved 50% of the target level for the performance-based restricted stock units granted in the fiscal year ended March 28, 201526, 2016 and as a result, issued 2532 shares of common stock to executive officers and certain key employees during the first quarter of fiscal year 2018.2019. The following table summarizes the non-vested performance-based restricted stock units outstanding as of December 23, 2017:June 30, 2018:

Table of Contents

Total expense relating to performance-based restricted stock units, based on grant date fair value and the achievement criteria, was $0.6 million and $0.2 million respectively in each of the first nine monthsquarter of fiscal years 2018year 2019 and 2017. Total expense relating to time vested restricted stock units was less than $0.1 million for the first nine months of fiscal year 2018. As of December 23, 2017,June 30, 2018, unearned compensation, to be recognized over the grants’ respective service periods, totaled $1.2$1.7 million.

Stock Options:Options vest either immediately or over a period of up to four years using a straight-line basis and expire either five years or 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.

The following table summarizes the Company’s options as of and for the first nine months of fiscal yearquarter ended June 30, 2018:

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 20182019 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 December 23, 2017.June 30, 2018. The amount of aggregate intrinsic value will change based on the fair market value of the Company’s common stock.

Table of Contents

There was no expense related to stock options during the first quarter of fiscal year 2019. Total expense related to stock options was $0.4 million and $0.1$0.3 million during each of the first nine monthsquarter of fiscal years 2018 and 2017, respectively.year 2018. There was no unrecognized compensation cost related to non-vested stock options as of December 23, 2017. The aggregate intrinsic value ofJune 30, 2018. There were no stock options exercised induring the first nine monthsquarter of fiscal year 2018 was $0.6 million. Cash received from the exercise of options in the first nine months of fiscal year 2018 was $0.6 million.2019.

Table of Contents

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 2018year 2019 and 2017:fiscal year 2018:

NOTE 5 – BUSINESS ACQUISITIONSASSET PURCHASE

During the first quarter of fiscal year 2017,2019, Transcat acquired substantially all of the assets of Excalibur Engineering,NBS Calibration, Inc. (“Excalibur”NBS”), a California-basedan Arizona-based provider of calibration services, new and used test equipment sales, and equipment rentals.

services. This 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 provided an established equipment rental and used equipment business, which are complimentaryDue to the Company’s traditional Distribution segment sales.

The Company applies the acquisition methodimmaterial amount of accounting for business acquisitions. Under the acquisition method, the purchase price of an acquisition is assigned to the underlying tangible and intangibleNBS 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 values used in this allocation. Purchase price allocations are subject to revision within the measurement period, not to exceed one year from the date of acquisition. Intangible assets related to the Excalibur acquisition are being amortized for financial reporting purposes on an accelerated basis over the estimated useful life of up to 10 years and are deductible for tax purposes.

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 purchase price allocation,it has been included in the aggregate, topurchases of property and equipment, net in the fair value, basedconsolidated statement of cash flows.

As of June 30, 2018 and March 31, 2018, no contingent consideration or other holdback amounts were unpaid and included on Level 3 inputs, of assets and liabilities acquired during the period presented:Consolidated Balance Sheets.

Table of Contents

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 atthe date of acquisition. As of December 23, 2017 and March 25, 2017, no contingent consideration or other holdback amounts were outstanding.

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 acquisition of Excalibur had occurred at the beginning of fiscal year 2017. The pro forma results do not purport to represent what the Company’s results of operations actually would have been if the transaction had occurred at the beginning of the period presented or what the Company’s operating results will be in future periods.

During each of the first nine months 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.

NOTE 6 – INCOME TAXES

On December 22, 2017, the Tax Cuts and Jobs Act (H.R. 1), the tax reform bill (the "Act"), was signed into law. The Act includes numerous changes to existing tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%. Since the Company is a fiscal year taxpayer, the lower corporate income tax rate will be phased in and the U.S. federal tax rate recorded is a blended rate of the old rates and the new rates for fiscal year 2018. The result was a $0.1 million reduction of the Company’s provision for income taxes in the third quarter of fiscal year 2018.

The Company has concluded that the Act will cause the Company’s U.S. deferred tax assets and liabilities to be revalued. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported basis in the financial statements that will result in taxable or deductible amounts in future years. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are revalued and any change is adjusted through the provision for income tax expense in the reporting period of the enactment. The Act required the Company to do such a revaluation and record a reduction in its net deferred tax liability of approximately $0.2 million, which reduced the provision for income taxes during the third quarter of fiscal year 2018.

In addition, the Act provides for a one-time “deemed repatriation” of accumulated foreign earnings. The Company has estimated the additional provision for income tax expense on the repatriation to be less than $0.1 million. The Company will pay any amounts owed over eight years.

The reduction in the Company’s provision for income taxes due to the Act in the third quarter of fiscal year 2018 was approximately $0.3 million or $0.04 per share.

The impact of the Act may differ from this estimate, possibly materially, due to, among other things, changes in interpretations and assumptions the Company has made, guidance that may be issued and actions the Company may take as a result of the Act.

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,” 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, risks related to the accuracy of the estimates and assumptions we use to revalue our U.S. deferred tax assets and liabilities in accordance with the Tax Cuts and Jobs Act of 2017, 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 25, 2017.31, 2018. You should not place undue reliance on our forward-looking statements. Except as required by law, we undertake no obligation to update 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.

Table of Contents

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 25, 2017.31, 2018.

RESULTS OF OPERATIONS

We achieved recordDuring our first quarter of fiscal year 2019, we had consolidated revenue of $40.5$36.7 million. This represented an increase of $2.7$0.4 million or 7.1%1.0% versus the thirdfirst quarter of fiscal year 2017.2018. Revenue growth was led bydue to our Service segment, which increased 7.5%4.6% to $18.8$19.3 million. Sales growthThere was a 2.6% sales decline in our Distribution segment was 6.7% to $21.7 million, a record quarter for that segment.$17.3 million. The sales growth achieved in both segmentsthe Service segment was all organic.

GrossFirst quarter gross profit was $9.7improved 4.9% or $0.4 million an increase of $0.8 million or 8.8% versus the thirdfirst quarter of fiscal year 2017.2018. Gross margin increased 40was 24.9%, an increase of 90 basis points, versus the first quarter of fiscal year 2018. This increase was due to improved productivity in the Service segment and changes in the Distribution segment sales mix with more rental revenues and opportunistic strategic pricing being applied to our core industrial customer base.in the Distribution segment.

Operating expenses were $7.0decreased $0.2 million an increase of $0.5 million or 7.4% aswhen compared to the thirdprior year first quarter, of fiscal year 2017. Generaldriven by decreased general and administrative expenses increased as we continued to invest in our technology infrastructure and operational excellence initiatives. This was partially offset byfiscal year 2018 first quarter included a decrease in selling, marketing and warehouse expenses which was a result of reduced acquired customer amortization$0.3 million one-off non-cash stock-based compensation expense. Operating expenses asAs a percentage of total revenue, operating expenses were 17.4%19.3%, the same asdown from 20.1% in the thirdfirst quarter of fiscal year 2017.2018. As a result of the gross margin improvement and cost discipline, operating income grew 43.5% or $0.6 million and operating margin expanded by 160 basis points.

Net income was $1.8$1.4 million for the thirdfirst quarter of fiscal year 20182019 for the reasons stated above, up from $1.3$0.9 million in the thirdfirst quarter of fiscal year 2017.2018. The Company also benefitted from reduced provision for income taxes of $0.3 milliontax rates due to the Act.Tax Cuts and Jobs Act of 2017 (the “Tax Act”).

Table of Contents

The following table presents, for the thirdfirst quarter and first nine months of fiscal yearsyear 2019 and fiscal year 2018, and 2017, the components of our Consolidated Statements of Income:

Table of Contents

THIRDFIRST QUARTER ENDED DECEMBER 23, 2017JUNE 30, 2018 COMPARED TO THIRDFIRST QUARTER ENDED DECEMBERJUNE 24, 20162017(dollars in thousands):

Revenue:

Total revenue was $40.5 million, an increase of $2.7increased $0.4 million, or 7.1%1.0%, in our fiscal year 2018 third2019 first quarter compared to the prior year thirdfirst quarter. This year-over-year growth was purely organic.

Service revenue, which accounted for 46.4%52.7% and 46.2%50.9% of our total revenue in the thirdfirst quarter of fiscal years 20182019 and 2017,2018, respectively, increased 7.5%4.6% from the thirdfirst quarter of fiscal year 20172018 to the thirdfirst quarter of fiscal year 2018.2019. This year-over-year increase in Service revenue was comprisedthe result of new business from the life sciencesciences market and growth in general industrial manufacturing customers, which includes the defense and aerospace market.manufacturing.

Our fiscal years 20182019 and 2017 quarterly2018 Service revenue growth, in relation to prior fiscal year quarter comparisons, was as follows: