TRANSCAT INC - Annual Report: 2004 (Form 10-K)

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FORM 10-K

Commission File Number: 000-3905

Transcat, Inc.

(585) 352-7777

Securities registered pursuant to section 12(b) of the Act:

Securities registered pursuant to section 12(g) of the Act:

Common Stock, $0.50 par value per share

     Indicate by check mark whether the registrant (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     þ     or     No     o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

      The aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant on September 27, 2003 (the last business day of the registrant’s most recently completed second quarter) was approximately $17,072,000. The market value calculation was determined using the closing sale price of the Registrant’s Common Stock on September 27, 2003, as reported on the NASDAQ SmallCap Market System.

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes     o     or     No     þ

      The number of shares of Common Stock of the Registrant outstanding as of June 16, 2004 was 6,237,465.

DOCUMENTS INCORPORATED BY REFERENCE

      The information required by Part III, Items 10, 11, 12, 13 and 14, of this Report, to the extent not set forth herein, is incorporated by reference from the Registrant’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on August 17, 2004, which definitive proxy statement will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.

TABLE OF CONTENTS

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PART I.

ITEM 1.     BUSINESS

     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.

     INTRODUCTION

      Transcat is a leading global 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. Our reportable business segments offer different products and services to the same customer base. We conduct our business through two segments: Distribution Products and Calibration Services.

      Through our distribution products segment, we market and distribute national and proprietary brand instruments to approximately 12,000 global customers. Our catalog (“Master Catalog”) offers access to more than 25,000 instruments, including: calibrators, deadweight testers, temperature devices, multimeters, oscilloscopes, pressure pumps, testers, recorders, and related accessories, from nearly 250 of the industry’s leading manufacturers including Fluke, Hart Scientific, Agilent, Ametek, and GE-Druck. In addition, we are the exclusive worldwide distributor for Altek and Transmation products. The majority of the instrumentation we sell requires expert calibration service to ensure that it maintains the most exacting measurements.

      Through our calibration services segment, we offer precise, reliable, fast calibration services through our ten Calibration Centers of Excellence strategically located across the United States and Canada to approximately 9,000 customers. To support our customers’ calibration service needs, we deliver the industry’s highest quality calibration services and repairs. Each of our calibration laboratories is ISO-9001:2000 registered with Underwriter’s Laboratories, Inc. and our scope of accreditation to ISO/ IEC 17025 is the widest in the industry for the market segments we serve. See “Calibration Services Segment – Quality” below in Item 1 for more information.

      CalTrak™, our proprietary documentation and asset management system, is used to manage the workflow at our Calibration Centers of Excellence. Additionally, CalTrak™ provides calibration certificates, calibration data, and access to other key documents required in the calibration process. CalTrak™ has been validated to 21CFR 820.75, which substantiates the validation of our process. This validation is especially significant in the life science industry, where federal regulations are especially stringent. See CalTrak™ below in Item 1 for more information.

      At Transcat, our attention to quality goes beyond the products and services we deliver. Our sales teams and customer service and support team stand ready to provide expert advice, application assistance and technical support wherever and whenever our customers need it.

      Our top 200 customers, representing approximately 34% of our consolidated sales are Fortune 500/ Global 500 companies, including Wyeth, Merck, DuPont, Exxon Mobil, AK Steel Holding, ConocoPhillips, Dow Chemical, and Duke Energy. We believe these customers do business with us because of our commitment to quality service, our CalTrak™ asset management system, and access to our product offering.

      Transcat has focused on the process and life science markets since its founding, 40 years ago. We are the leading seller of calibrators into the process industry. We believe that our broad product offering and our

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      Transcat’s Internet website address is www.transcat.com. The information contained on our website is not a part of this Form 10-K. On our investor relations internet web page, http://www.transcat.com/ AboutTranscat/InvestorRelations.asp, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”): annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings on our investor relations web page are available free of charge.

      An Ohio corporation founded in 1964, we are headquartered in Rochester, New York and employ more than 200 personnel. Our executive offices are located at 35 Vantage Point Drive, Rochester, New York 14624. Our telephone number is 585-352-7777.

      We are an accredited provider of calibration services and a distributor of test and measurement equipment. Our strategy is to focus on gaining business and market share in companies who value quality systems and/or operate in regulated environments. We will differentiate ourselves and build barriers to competitive entry by offering the best products and calibration services and integrating the two to benefit our customers’ operations and lower their cost.

      We service our customers through two business segments: Distribution Products and Calibration Services. We serve approximately 17,000 customers with no customer or controlled group of customers accounting for 10% or more of our consolidated net sales from fiscal year 2002 to 2004. We are not dependent on any single customer the loss of which would have a material adverse effect on our business, cash flows, balance sheet, or results of operations. Note 8 of our Consolidated Financial Statements in this Form 10-K presents financial information for these segments.

      We market and sell to our customers through multiple sales channels consisting of direct catalog marketing, a direct field sales organization, proactive outbound sales, and an inbound call center. Our direct field sales team, outbound sales team, and inbound sales team are each staffed with technically trained personnel. Our domestic and international sales organization covers territories in North America, Latin America, Europe, Africa, Asia, and the Middle East. We concentrate on attracting new customers and increasing product and calibration sales (North America only) to existing customers. Sales efforts are also focused on cross selling. Approximately 23% of our customers utilize both segments of our business, which provides us with an opportunity to increase our average revenue per customer, adding to our value as a single source supplier. Our sales to customers during the periods indicated were as follows (calculated on dollars in millions):

      We focus primarily on the process, life science, and manufacturing industries. Process manufacturing has been and continues to be the foundation of our core business competency. The process industry, in our definition, includes petroleum refining, chemical, water treatment, industrial power, steel, petrochemical, gas and pipeline, textile, pulp and paper, food and dairy, and utility companies. The life science industry, in our definition, includes

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      Summary. Our customers’ facilities in the process, life science, and manufacturing industries use test, measurement, and calibration equipment to calibrate and test their processes and ensure that their processes and/or end product(s) are within specification. Utilization of such diagnostic equipment also allows for continuous improvement processes to be in place, increasing the accuracies of their measurements. The industrial distribution products industry for test and measurement instrumentation, in the geographic markets in which we predominately operate, is characterized by national broad based distribution organizations and uniquely focused organizations such as Transcat.

      Most industrial customers find that maintaining an in-house inventory of back-up test, measurement, and calibration equipment is cost prohibitive due to the large number of stock keeping units. As a result, the distribution of test and measurement instrumentation has traditionally been characterized by frequent, small quantity orders combined with a need for rapid, reliable, and substantially complete order fulfillment. The purchasing decision is generally made by plant engineers, quality managers, or their purchasing function. Products are generally purchased from more than one distributor.

      The majority of our products are not consumables but are purchased as replacement, upgrades, or for expansion of manufacturing and research and development facilities. Our catalog and sales activities are designed to maintain a constant presence in front of the customer to ensure we write the order when they are ready. As a result, we evaluate sales trends over at least a four quarter period as any individual months’ sales can be impacted by any number of factors.

      We believe that a distribution product customer chooses a distributor based on a number of different criteria including the timing and accurate delivery of orders, consistent product quality, value added services, and price. Value added services include providing technical support to insure our customer receives the right product for his/her specific need through application knowledge and product compatibility. We also provide calibration of product purchases, on-line procurement, same day shipment of products for in-stock items, a variety of custom product offerings and training programs, and the operational efficiency of dealing with one distributor for our customer product needs.

      Our distribution products segment accounted for approximately 66% of our revenue in our fiscal year ended March 27, 2004, referred to as fiscal year 2004, which we anticipate declining as a percentage of total sales as a result of the targeted higher growth rates in calibration. Within the distribution products segment, our routine business is comprised of customers who place orders to acquire or to replace specific instruments, which typically average $950 per order.

      Marketing and Sales. Through our comprehensive Master Catalog, supplemental catalogs, opt-in email newsletter, and other direct sales and marketing programs, we offer our customers a broad selection of highly nationally recognized branded products at competitive prices. During fiscal year 2004, we distributed approximately 400,000 pieces of direct marketing materials including catalogs, flyers, supplements and other promotional materials to approximately 17,000 customers and 275,000 potential customers. The number of catalogs and other direct marketing materials received by each customer depends upon a number of factors, including purchase history.

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      Through our comprehensive catalogs and other direct marketing and sales promotions, we offer customers a broad product selection. Approximately 10,000 instruments account for the majority of our sales. The instruments typically range in price from $100 to over $5,000 for large calibration test systems and are sold and marketed to approximately 9,000 customers in the process, life science, and manufacturing markets.

      The majority of our product sales are derived from catalog marketing. Our Master Catalog consists of approximately 700 pages of products relevant to the process, life science, and manufacturing industries. We distribute our Master Catalog to approximately 75,000 existing and prospective customers in the United States and Canada approximately every 12 months. The Master Catalog provides standard make/model and related information and is also available in “CD” format upon request and on-line at our website: www.transcat.com. Our new customer acquisition program utilizes smaller catalog supplements targeting over 250,000 prospects, often featuring new products, promotions, or specific product categories are direct mailed at varying periods throughout the year.

      The approximate percentage of our distribution products business by industry segment for our largest customers is as follows:

      Competition. The markets we serve are highly competitive. Competition for sales in distribution products is quite fragmented and ranges from large, well-financed national distributors and manufacturers to small local distribution organizations and service providers. Key competitive factors typically include customer service and support, quality, turn around time, inventory availability, product brand name, and price. To address our customers’ needs for technical support and product application assistance, and to differentiate ourselves from competitors, we employ a staff of highly trained technical application specialists. To maintain our competitive position with respect to such products and services, we must continually demonstrate our commitment to our customers and continue to compete effectively in the areas described above.

      Suppliers and Purchasing. We believe that effective purchasing is a key element to maintaining and enhancing our position as a provider of high quality test and measurement equipment. We frequently evaluate our purchase requirements and suppliers’ price offerings to obtain products at the best possible cost. We obtain our products from about 250 suppliers of brand name and private labeled equipment. In fiscal year 2004 our top 10 vendors accounted for approximately 70% of our aggregate business.

      We plan our product mix, including stocked and non-stocked inventory items, to best serve the needs of our customers whose individual purchases vary in size. We can ship our customers our top selling products the same day they are ordered.

      Operations. Our distribution operations take place within an approximate 27,000 square foot facility located in Rochester, New York. This location is our headquarters and also houses the customer service, sales, and administrative functions. Approximately 35,000 product orders are shipped from this facility annually with an average order size in fiscal year 2004 of approximately $950 per order. This average is consistent with recent years.

      Distribution. We distribute our products in the United States and internationally from our distribution center in Rochester, New York. Customers in Canada are serviced from our New York location as well as a re-distribution center in Eastern Canada. We maintain appropriate inventory levels in order to satisfy customer demand for prompt delivery and complete order fulfillment of their product needs. These inventory levels are managed on a daily basis with the aid of our sophisticated purchasing and stock management information system. Our automated freight manifesting and laser bar code scanning facilitates prompt and accurate order fulfillment.

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      Distribution Agreement. 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 25, 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 extends through 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 year 2003 and 2002 met our commitment under the New Agreement and we expect that our purchases for calendar year 2004 will also meet the commitment. We believe that this commitment to future purchases is consistent with our business needs and plans. See “Divestitures” below in this Item 1 for more information.

      Backlog. 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, orders required to be shipped at a future date, and orders on credit hold/awaiting letters of credit.

      At the end of fiscal year 2004, the value of our unshippable product orders was approximately $1.7 million, compared to approximately $1.4 million and $1.3 million at the end of fiscal years 2003 and 2002, respectively. During fiscal year 2004, the level of unshippable product orders varied between a low of $0.9 million and a high of $2.1 million. This variation is due primarily to seasonality, the economy, supplier delivery schedules, and variations in customer ordering patterns.

      The following graph shows the increased level of unshippable product orders and backorders throughout fiscal year 2004, on a quarterly basis.

      Summary. Calibration is the act of comparing a unit or instrument of unknown value to a standard of known value and reporting the result in some rigorously defined form. After the act of calibration has been completed, a decision is made, again based on rigorously defined parameters, on what is to be done to the unit. The decision may be to adjust, optimize, repair, limit its use, range or rating, scrap the unit, or leave as is. The purpose of calibration is to significantly reduce the risk of product or process failures caused by inaccurate measurements.

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      Transcat’s calibration strategy encompasses either one of the two ways a company manages its calibration needs:

      In either case, we intend to have the broadest calibration offering to our targeted markets. This includes the broadest scope of accreditation, certification of our technicians to the American Society for Quality standards, complete calibration management encompassing the entire metrology function, and access to our products offering.

      The billion-dollar commercial calibration services industry is extremely fragmented with an estimated 750 companies participating, ranging from national accredited organizations such as Transcat to one-person organizations, in addition to companies that do not currently outsource their calibrations. Our typical customer is a technically based individual who is employed in a quality, engineering, or manufacturing engineering position.

      The calibration services industry has its origins in the military, and we estimate that approximately 60% of our calibration technicians and laboratory managers have calibration expertise with the military prior to joining Transcat.

      Sourcing decisions are based on quality, customer service, turn-around time, documentation, price, and a one-source solution.

      Our calibration services segment provides periodic calibration and repair services for our customers’ test, measurement, and diagnostic instruments. We perform over 100,000 calibrations annually. These are performed at one of our ten Calibration Centers of Excellence, or at the customer’s physical location. Calibration services accounted for approximately 34% of our total fiscal year 2004 revenue. We anticipate that calibration sales as a percentage of total sales will increase given the targeted higher growth rates in this segment.

      This segment of the market is critically aligned with our strategic focus on quality accreditations. Our calibration services are of the highest technical and quality levels, with broad ranges of accreditation and registration. Our quality systems are further detailed below in “Quality”.

      Marketing and Sales. Calibration allows for maximum productivity and efficiency by assuring accurate, reliable equipment and processes. Through our calibration services segment, we perform periodic calibrations on new and used equipment as well as repair services for our customers. Each of our ten Calibration Centers of Excellence provides accredited calibration in commonly used measurement parameters including electrical, physical, and dimensional.

      Our calibration services are provided to our customers with a strategic focus in the highly regulated industries including process, life science, and manufacturing. Our quality process and standards are designed to meet the needs of companies that are highly regulated (e.g., by the Food and Drug Administration, or FDA), and/or have a strong commitment to quality and a comprehensive calibration program.

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      The approximate percentage of our calibration services business by industry segments for our largest customers for the periods indicated was as follows:

      Competition. The calibration outsource industry is highly fragmented and is composed of companies ranging in size from non-accredited, sole proprietorships to internationally recognized and accredited corporations, such as Transcat, resulting in a tremendous range of service levels and capabilities. A large percentage of calibration companies are small businesses that provide only basic measurements and service markets in which quality requirements may not be as demanding as the markets that we strategically target. Very few of these companies are structured to compete on the same scale and level of quality as us.

      Quality. The accreditation process is the only system currently in existence that assures measurement competence. Each laboratory is audited and reviewed by outside accreditation bodies proficient in the technical aspects of calibration, metrology, and physics, ensuring that measurements are properly made. Accreditation also requires that all standards used for accredited measurements have a fully documented path; known as the traceability chain, either directly or through other accredited laboratories, back to the national or international standard for that measurement parameter. This ensures proper measurement techniques throughout the process.

      To ensure the quality and consistency of our calibrations to customers, we have sought and achieved several national levels of quality and accreditation. Our calibration laboratories are ISO 9001:2000 registered with Underwriters Laboratories, Inc. Our calibrations are also traceable to National Institute of Standards and Technology (“NIST”) or National Research Council of Canada (“NRC”) standards. Our laboratories are accredited by American Association for Laboratory Accreditation (“A2LA”) to ISO/ IEC 17025 and ANSI/ NCSL Z540-1-1994, who provides an objective, third party, and internationally accepted evaluation of the quality and consistency of our calibration process and competency.

      To provide the widest range of service to our customers in our target markets, our A2LA accreditations extend across a wide range of technical disciplines, each requiring and meeting separate and unique accreditation standards. The following table represents Transcat’s capabilities (accredited and/or non-accredited) for each Center of Excellence:

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      CalTrak™. CalTrak™ and CalTrak-Online is our proprietary metrology management system that provides a comprehensive calibration quality program. Many of our customers have unique calibration service requirements to which we have tailored specific services. CalTrak™ allows our customers to track calibration cycles via the Internet and provides the customer with safe and secure off-site archive of calibration records that can be accessed 24 hours a day. Access to records data is managed through our secure password protected web site. Calibration assets are tracked with records that are automatically cross-referenced to the equipment that was used to calibrate. CalTrak™ has also been validated to meet the most stringent requirements within the industry.

      Our breadth of distribution products and calibration services along with our strong commitment to customer sales, service, and support enable us to satisfy our customer needs through convenient selection and ordering, rapid, accurate, and complete order fulfillment and on-time delivery.

      A key element of our customer service approach is our technically trained direct field sales team, outbound sales team, inbound sales team, and customer service organization. Most customer orders are placed through our customer service organization who often provides technical assistance to our customers to facilitate the purchasing decision. To ensure the quality of service provided, we frequently monitor our customer service through customer surveys, interpersonal communication, and daily statistical reports.

      Customers may place orders by:

      Approximately 16% of our sales in fiscal year 2004, 2003, and approximately 17% in fiscal year 2002 resulted from sales to customers outside the United States (calculated on dollars in millions). Our percentage of foreign sales is impacted by the strength of the United States dollar in relation to other currencies. When the United States dollar is stronger than foreign currencies, we have historically had weaker foreign sales.

      In addition, our revenues are subject to the customary risks of operating in an international environment, including the potential imposition of trade or foreign exchange restrictions, tariff and other tax increases, fluctuations in exchange rates and unstable political situations, any one or more of which could have a material adverse effect on our business, cash flows, balance sheet or results of operations.

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      We utilize a basic software platform, Application Plus, to manage our business and operations segments. We also utilize a turnkey enterprise software solution. This software includes a suite of fully integrated modules to manage our business functions, including customer service, warehouse management, inventory management, financial management, customer management, and business intelligence. This solution is a fully mature business package with over 20 years of refinement and currently supports over 1,200 organizations to run their mission critical operations.

      During fiscal year 2002, we divested our Transmation Products Group (“TPG”) and the Measurement and Control (“MAC”) units (the “Divestitures”). Our strategic focus is now centered exclusively on our core competencies, which are the distribution of test, measurement, and calibration instrumentation and providing calibration services.

      In December 2001, we sold TPG to Fluke for $11.0 million. In connection with this agreement, we entered into a distribution agreement with Fluke that included an agreement to purchase a specific amount of inventory from Fluke. The distribution agreement was subsequently revised as of September 1, 2002, as previously noted above in “Distribution Products Segment – Distribution Agreement”. As a result of the terms of the distribution agreement, the gain on the sale of TPG of $1.5 million has been deferred (see “Deferred Gain on TPG” of Critical Accounting Policies and Estimates below in Item 7). As a result of the divestiture of TPG, we no longer incur R&D expense.

      In January 2002, we sold MAC to Hughes Corporation for $2.9 million and recorded a loss of $4.5 million on the sale in fiscal year 2002.

      We believe that our line of business has certain historical seasonal factors. Our fiscal second quarter is generally weaker and the fiscal fourth quarter historically stronger due to typical industrial operating cycles.

      We believe that compliance with federal, state, or local provisions relating to the protection of the environment will not have any material effect on our capital expenditures, earnings, or competitive position.

      At the end of fiscal year 2004, we had 213 employees, compared to 222 and 247 employees at the end of fiscal years 2003 and 2002, respectively. The decrease from fiscal year 2002 to 2003 was primarily the result of positions eliminated as a result of laboratory consolidations.

      The following table sets forth certain information regarding our executive officers and certain key employees as of March 27, 2004:

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ITEM 2.     PROPERTIES

      We lease the following properties:

      We also lease storage space in Chicago, Illinois and Toronto, Canada and office space in Shanghai, China. We believe that our properties are generally in good condition, are well maintained, and are generally suitable and adequate to carry on our business.

ITEM 3.     LEGAL PROCEEDINGS

      In May 2002, our former Vice President of Finance sued us in New York State Supreme Court, Monroe County, alleging, among other items, that we breached the terms of his employment agreement with us when his employment was terminated. In November 2003, we settled the lawsuit for $0.2 million in order to avoid further litigation expenses.

      No matters were submitted to a vote of our stockholders during the quarter ended March 27, 2004.

PART II.

ITEM 5.     MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

      Our Common Stock is traded on the NASDAQ SmallCap Market under the symbol “TRNS”. As of March 27, 2004, we had approximately 750 shareholders of record.

      The following table sets forth, on a per share basis, for the periods indicated, the high and low reported sales prices of our Common Stock as reported on the NASDAQ SmallCap Market System for each quarterly period in fiscal years 2004 and 2003.

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      We have not declared any cash dividends since our inception and do not intend to pay any dividends for the foreseeable future.

      The following table provides selected financial data for the current fiscal year and the previous four fiscal years (in thousands, except per share data): (See “Divestitures” in Item 1 for information regarding businesses divested in fiscal year 2002, which are included in the following table for fiscal years 2000 to 2002.)

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      Certain reclassifications of prior fiscal year financial information have been made to conform with current fiscal year presentation.

      Certain reclassifications of prior fiscal year quarter and prior fiscal year financial information have been made to conform with current fiscal year quarter and current fiscal year presentation.

      Operational Overview. We are a leading distributor of professional grade test, measurement, and calibration equipment and provider of nationally recognized and accredited calibration services across a wide array of measurement disciplines.

      We operate our business through two reportable business segments that offer different products and services to the same customer base. Those two segments are Distribution Products and Calibration Services.

      In our distribution segment, our Master Catalog is widely recognized by both original equipment manufacturers and customers as the ultimate source for test and measurement equipment. Additionally, because we specialize in test and measurement equipment, as opposed to a wide array of industrial products, our sales and customer service personnel can provide value added technical assistance to our customers to assist them in determining what product best meets their particular application requirements.

      Our strength in our calibration services segment is based upon our wide range of disciplines and our investment in the quality systems that are required in our targeted market segments. Our services range from the calibration of a single unit to managing a customer’s entire calibration program.

      Our revenue in our distribution products segment has been heavily impacted by the economic environment. As industrial customers curtailed capital and discretionary spending over much of the last eighteen months, our product sales were adversely impacted. Absent significant economic volatility, we do not see this segment of our business as high growth. The majority of our products are not consumables but our purchased as replacements, upgrades, or for expansion of manufacturing and research and development facilities. Year over year sales growth in any one month can be impacted by a number of factors.

      We believe our calibration services segment offers considerable growth opportunity and the potential for continuing revenue from established customers from what is typically an annual calibration cycle.

      We evaluate sales growth in both of our business segments against a four quarter trend analysis, not by analyzing any single quarter.

      Financial Overview. In fiscal year 2004, we were challenged early in the year with a difficult economic environment. We focused on controlling our costs, improving the productivity of our calibration laboratories and finding new ways to increase revenue. Our efforts were rewarded with improved performance throughout the year.

      Our gross margin overall improved by two points. Our products segment gross margin declined as we decided mid-year to enter new low margin market segments and to increase our promotional and pricing activity to increase revenue. The product revenue increase in the fiscal fourth quarter was directly impacted by those decisions. Although that revenue increase was achieved at a lower gross margin, we have increased our customer base and provided additional leads for our calibration services.

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      We are very pleased with our eleven point increase in our calibration services gross profit margin resulting from our focus on expense control and productivity improvements. Calibration sales growth offers significant leverage on gross profit due to the relatively fixed nature of a calibration laboratory cost structure.

      Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting principles or methods used in the preparation of financial statements. Note 1 of our Consolidated Financial Statements includes a complete discussion of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. A summary of our most critical accounting policies follows:

      Revenue Recognition. Sales are recorded when products are shipped or services are rendered to customers, as we generally have no significant post delivery obligations, the product price is fixed and determinable, collection of the resulting receivable is probable and product returns are reasonably estimated. Provisions for customer returns are provided for in the period the related sales are recorded based upon historical data. Our shipments are generally free on board (“FOB”) shipping point and our customers are generally invoiced for freight, shipping, and handling charges.

      Goodwill. On April 1, 2002, we adopted SFAS No. 142. Upon adopting SFAS 142, we were required to calculate the fair value of recorded goodwill. If the fair value of the goodwill does not exceed the carrying value of the goodwill, a write down of the remaining goodwill is necessitated. We evaluated the fair value of our goodwill and determined that a non-cash goodwill impairment of $6.5 million existed at April 1, 2002. Accordingly, in the first quarter of fiscal year 2003, we reported a $6.5 million charge as a cumulative effect of a change in accounting principle. We re-evaluated the fair value of our remaining goodwill, consistent with the provisions of SFAS No. 142, as of March 27, 2004 and March 31, 2003, and determined no further impairment existed. At March 27, 2004 and March 31, 2003 goodwill amounted to $2.5 million. A change in business could cause additional write-off or impairment.

      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, we may modify the period over which costs are recognized. In fiscal year 2002, we reduced our estimate of the productive life of our Master Catalog from 24 to 18 months, and recognized an additional $0.1 million in catalog related amortization expense. We amortize the cost of catalog supplements over a three month period. Total deferred catalog costs were $0.4 million at March 27, 2004. There were no deferred catalog costs at March 31, 2003.

      Deferred Gain on TPG. As a result of certain post divestiture commitments, according to GAAP, we are unable to recognize the gain of $1.5 million on the divestiture of TPG, which took place in fiscal year 2002, until those commitments expire in fiscal year 2007.

      Valuation Allowance on Deferred Tax Assets. A valuation allowance 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. A valuation allowance for the full amount of the net deferred tax asset was recorded at March 27, 2004 and March 31, 2003. Such valuation allowance increased by approximately $0.1 million, $1.1 million, and $2.4 million for the fiscal years 2004, 2003, and 2002, respectively.

      Stock Options. We follow the disclosure provisions of the Accounting Principle Board (“APB”) Opinion 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. SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123” requires pro forma disclosure of net income and earnings per share determined as of the fair value method of accounting for stock options had been applied in measuring compensation cost. If we had chosen to expense stock options, our stock-

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      Use of Estimates. We make significant estimates and assumptions for, but not limited to: allowance for doubtful accounts and returns, inventory valuation, depreciable lives of assets, economic lives of leased assets, useful life and impairment of goodwill, estimated lives of our catalogs, and tax valuation allowances. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. Our estimates 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. The following table summarizes the more significant charges that require management 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.

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

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      The following table sets forth, for the prior three fiscal years, the components of our Consolidated Statements of Operations (calculated on dollars in thousands). Fiscal year 2002 includes amounts from businesses divested in fiscal year 2002. See “Divestitures” above in Item 1 and our Pro Forma Statements of Operations below in Item 7.