Business Overview and Environment

TESSCO Technologies Incorporated (TESSCO, we, or the Company) architects and delivers innovative product and value chain solutions, at lower costs, to support wireless broadband systems. Although we sell products to customers in many countries, approximately 98% of our sales are made to customers in the United States. We have operations and office facilities in Hunt Valley, Maryland, Reno, Nevada and San Antonio, Texas.

The Company evaluates its business in two segments - commercial and retail. The commercial segment includes: (1) public carriers, contractors and program managers; (2) private system operators and governments; and (3) commercial dealers and resellers. The retail segment includes: (1) retailers, dealer agents and Tier 2 and 3 carriers and (2) Tier 1 carriers (including the Company's largest customer, AT&T).

We offer a wide range of products that are classified into four business categories: base station infrastructure; network systems; installation, test and maintenance; and mobile devices and accessories. Base station infrastructure products are used to build, repair and upgrade wireless telecommunications. Sales of traditional base station infrastructure products, such as base station radios, cable and transmission lines and antennas are in part dependent on capital spending in the wireless communications industry. Network systems products are used to build and upgrade computing and Internet networks. We have also been growing our offering of wireless broadband, network equipment, security and surveillance products, which are not as dependent on the overall capital spending of the industry. Installation, test and maintenance products are used to install, tune, and maintain wireless communications equipment. This category is made up of sophisticated analysis equipment and various frequency-, voltage- and power-measuring devices, replacement parts and components as well as an assortment of tools, hardware and supplies required by service technicians. Mobile devices and accessory products include cellular phone and data device accessories. Our customers generally have the ability to purchase any of our product categories, but base station infrastructure, network systems and installation, test and maintenance products are primarily sold into our commercial segment, while mobile device and accessories products are primarily sold into our retail segment.

Our largest customer relationship, primarily a third party logistics retail store supply chain relationship with AT&T, a Tier 1 cellular carrier, accounted for approximately 36% of our total revenues during fiscal 2012 and 33% of our total revenues for the first nine months of fiscal 2013. Beginning in October 2011, our business with AT&T expanded, resulting in dramatically increased revenues but significantly lower profit margin. In April 2012, we were notified by AT&T of their intention to transition their third party logistics retail store supply chain business away from us beginning in the second quarter of our fiscal 2013. We now anticipate that this business will be fully transitioned prior to the close of our fiscal 2013, which ends on March 31, 2013. This will result in a significant reduction in revenues but, because of the lower margins and our on-going cost reduction efforts, a lesser relative impact on overall profits in fiscal 2013. During and after the transition, we expect to continue to supply product to this customer's other programs and to supply proprietary Ventev® products to AT&T retail stores. Our AT&T revenue and gross profit in the third quarter of fiscal 2013 decreased significantly as compared to the third quarter of fiscal 2012, as a result of the continued AT&T transition. Our AT&T revenues increased in the third quarter by approximately 1% as compared to the second quarter of fiscal 2013; however, gross profit decreased. For the nine months ended December 30, 2012, revenues related to the transitioning business totaled approximately $186 million, with gross margins of less than 10%. The selling, general and administrative costs for this business vary but generally approximate 2% of revenue.

Sales of products purchased from our largest vendor, Otter Products, LLC (Otter) generated approximately 10% of our total revenues for the third quarter of fiscal 2013. Much of this concentration, however, is attributable to our mobile device accessory sales to AT&T, which in relation to Otter was fully transitioned from TESSCO to a third party logistics provider during the third quarter of fiscal 2013. The terms of our current business relationship with Otter were set to expire in March 2013 and as such, we had been engaged in discussions with them regarding revised terms of our relationship. Effective January 2013, Otter and TESSCO agreed on new terms for our business relationship, which continues for sales outside of the AT&T retail store supply chain relationship.

Excluding sales to our Tier 1 carriers, third quarter fiscal 2013 revenues increased by 17.9% as compared to the third quarter of fiscal 2012. This growth was offset by a 39.8% decrease in sales to our Tier 1 carriers (including AT&T), which resulted in a total third quarter revenue decrease of 9.6% compared to the third quarter of fiscal 2012. Excluding our Tier 1 carriers, gross profit increased by 18.1% in the third quarter of fiscal 2013 as compared to the third quarter of fiscal 2012 and gross profit from our Tier 1 carriers decreased by 54.8%. This resulted in an overall decrease in gross profits of 1.3% compared to the third quarter of the prior fiscal year. Selling, general and administrative expenses decreased by 4.3% over the prior year quarter. As a result, net income increased by 13.1% and diluted earnings per share increased by 10.1% over the prior-year quarter.

We believe that our recent revenue growth excluding sales to Tier 1 carriers has been, and we expect that it will continue to be, largely driven by the growth in consumer demand for wireless devices generally. We expect this to drive opportunities for the sale of mobile devices and accessories in our retail segment, and to augment the demand for network build outs, which we expect will have a positive impact on our commercial segment. We have begun to see the impact of these build-outs as evidenced by very strong growth in our public system operators and contractors and program managers market. We continue to see large enterprises, utilities, and governments increasing their use of wireless networks in their businesses and operations.

The wireless communications distribution industry is competitive and fragmented and is comprised of several national distributors. In addition, many manufacturers sell direct. Barriers to entry for distributors are relatively low, particularly in the mobile devices and accessories market, and the risk of new competitors entering the market is high. Consolidation of larger wireless carriers has and will most likely continue to impact our current and potential customer base. In addition, the agreements or arrangements with our customers or vendors looking to us for product and supply chain solutions are typically of limited duration and are terminable by either party upon several months, or otherwise short notice. Our ability to maintain these relationships is subject to competitive pressures and challenges. Because of the nature of our business, we have been affected from time to time in the past by the loss and changes in the business habits of significant customer and vendor relationships, and expect that we will continue to be so affected in the future. We believe, however, that our strength in service, the breadth and depth of our product offering, our information technology system, industry experience and knowledge, and our large customer base and purchasing relationships with approximately 390 manufacturers, provide us with a significant competitive advantage over new entrants to the market.

Results of Operations

Third Quarter of Fiscal Year 2013 Compared with Third Quarter of Fiscal Year 2012

Total Revenues. Revenues for the third quarter of fiscal 2013 decreased 9.6% as compared with the third quarter of fiscal 2012, largely due to a 25.8% decrease in our retail segment revenues. This is primarily driven by the continuation of the AT&T transition, resulting in a 39.8% decrease in revenue from Tier 1 customers. Excluding Tier 1 carrier customers, our retail segment revenues grew by 19.5% as compared to the third quarter of fiscal 2012. Commercial segment revenues increased by 17.2% compared to the third quarter of fiscal 2012, with a significant increase in sales to our public system operator, contractor and program manager market.

Total Gross Profit. Gross profit for the third quarter of fiscal 2013 decreased slightly by 1.3% as compared with the third quarter of fiscal 2012, due to a 24.2% decrease in our retail segment largely offset by a 17.4% increase in our commercial segment. Within the retail segment, our Tier 1 carrier market showed a considerable decrease in sales and corresponding gross margins, resulting in a 24.2% decrease in gross profit. This was primarily due to the continued transition of the AT&T business as discussed above. We expect that this business will be fully transitioned prior to the close of our fiscal 2013, which ends March 31, 2013. The increase in our commercial segment gross profit was driven by an increase in our public system operator, contractor and program manager markets. Overall gross profit margin increased to 19.1%, compared to 17.4% for the same period last year, primarily driven by the contracting, lower margin AT&T business.

Our ongoing ability to earn revenues and gross profits from customers and vendors looking to us for product and supply chain solutions depends upon a number of factors. The terms, and accordingly the factors, applicable to each relationship often differ. Among these factors are the strength of the customer's or vendor's business, the supply and demand for the product or service, including price stability, changing customer or vendor requirements, and our ability to support the customer or vendor and to continually demonstrate that we can improve the way they do business. In addition, the agreements or arrangements on which our customer and vendor relationships are based are typically of limited duration, typically do not include any obligation in respect of any specific product purchase or sale and are terminable by either party upon several months or otherwise relatively short notice. Because of the nature of our business, we have been affected from time to time in the past by the loss and changes in the business habits of significant customer and vendor relationships, and we may continue to be so affected in the future. In April 2012, we were notified by AT&T of their intention to transition their third party logistics supply chain business away from us and expect this transition to be completed prior to close of our fiscal 2013, which ends March 31, 2013. Our customer relationships could also be affected by wireless carrier consolidation or the overall global economic environment.

We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by $1.4 million or 4.3% in the third quarter of fiscal 2013 as compared with the third quarter of fiscal 2012. Selling, general and administrative expenses as a percentage of revenues increased slightly to 14.8% in the third quarter of fiscal 2013, from 14.0% in the third quarter of fiscal 2012, primarily as a result of the much lower AT&T revenues, but largely offset by decreases in performance bonus expense and AT&T related marketing expenses.

Pay for performance bonus expense (including both cash and equity plans) decreased by $1.5 million in the third quarter of fiscal 2013 as compared to the third quarter of fiscal 2012. Our bonus programs are all based on annual performance targets. The relationship between expected performance and actual performance led to higher bonus accruals in the third quarter of fiscal 2012 than in fiscal 2013.

As previously reported, effective November 27, 2012, David M. Young ceased to serve as TESSCO's Chief Financial Officer. In connection with his departure, Mr. Young was paid 1.65 times his base salary, or $499,125, and the sum of $102,424, as the prorated amount of any Value Share incentive compensation due for the current fiscal year. Additionally, in accordance with the terms of the applicable agreements, all of Mr. Young's earned but not yet vested PSU shares (30,563 shares) vested and were issued. The impact of these payouts and accelerated vesting, net of previously accrued bonus and PSU amortization that was reversed, was approximately $550,000.

Marketing expense decreased by $1.4 million in the third quarter of fiscal 2013 as compared to the third quarter of fiscal 2012, primarily due to a decrease in AT&T market development expenses, which are completely variable to sales.

The decreases in our bonus expense and marketing expense were partially offset by smaller increases in our freight costs, non AT&T marketing expenses and compensation and benefits costs.

We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve based on this evaluation. We also evaluate the credit worthiness of prospective and current customers and make decisions regarding extension of credit terms to such customers based on this evaluation. Accordingly, we recorded a provision for bad debts of $209,300 and $206,700 for the third quarter ended December 30, 2012 and December 25, 2011, respectively.

Interest, Net. Net interest expense decreased from $73,500 in the third quarter of fiscal 2012 to $13,700 in the third quarter of fiscal 2013, primarily due to decreased borrowings on our revolving line of credit facility.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate decreased slightly from 38.9% in the third quarter of fiscal 2012 to 38.2% in the third quarter of fiscal 2013, primarily due to a research and development tax credit. As a result of the factors discussed above, net income for the third quarter of fiscal 2013 increased 13.1% and diluted earnings per share increased 10.1% compared to the corresponding prior-year quarter.

Commercial Segment. Revenues in our commercial segment totaled $99.5 million in the third quarter of fiscal 2013, compared to $84.9 million in the prior year period, a 17.2% increase. Gross profit totaled $25.5 million, a 17.4% increase as compared to the third quarter last year. Within this segment, the public system operators, contractors and program managers market grew revenues by 75.3% and gross profits by 57.6%. This growth was primarily driven by a need by our customers to increase bandwidth and upgrade their infrastructure to accommodate increasing wireless traffic. The need for increased bandwidth was echoed in our commercial dealers and resellers market, with revenue growth of 12.4% and gross profit growth of 16.4%. Revenue within the private and government system operators markets declined 10.2% with a lesser decrease in gross profit of 1.8%. This decline was due in part to economic uncertainties, including potential government spending cuts.

Our direct expenses in this segment totaled $11.4 million, a 9.9% increase compared to the third quarter of fiscal 2012. Therefore, total segment net profit contribution was $14.1 million, a 24.2% increase over the prior year period.

Retail Segment. Revenues in our retail segment totaled $104.9 million in the third quarter of fiscal 2013, representing a 25.8% decrease from the prior year period. Gross profit totaled $13.4 million, a 24.2% decrease. Revenues in our retailer, dealer agent and Tier 2/3 carrier market increased in the third quarter of fiscal 2013 as compared to the same period last year, up 19.5%, with a 20.2% increase in gross profit, as a result of increased sales to independent agents and dealers. We experienced significantly lower sales to our Tier 1 carrier market, primarily AT&T, which showed a 39.8% revenue decrease and a 54.8% decrease in gross profit.

Our direct expenses in this segment totaled $7.4 million in the third quarter of fiscal 2013, a 14.5% decrease over the prior year period, primarily related to lower marketing costs associated with the AT&T relationship. Therefore, total segment net profit contribution was $6.0 million for the third quarter of fiscal 2013, a 33.5% decrease over the prior year period.

First Nine Months of Fiscal Year 2013 Compared with First Nine Months of Fiscal Year 2012

Total Revenues. Revenues for the first nine months of fiscal year 2013 compared with the first nine months of 2012 increased 10.3%, due to a 12.5% increase in commercial revenues and an 8.5% increase in retail segment revenues. Commercial revenue growth was driven by a significant increase in sales to the public system operator, contractor and program manager market, coupled with increases in our commercial dealer and reseller market. The retail sales growth was largely a result of a 21.3% increase in sales to our non-Tier 1 customers.

Total Gross Profit. Gross profit for the first nine months of fiscal year 2013 increased 2.2% as compared with the first nine months of fiscal year 2012, due to a 9.1% increase in our commercial segment partially offset by a 7.9% decrease in our retail segment. Overall gross profit margin decreased to 19.0%, compared to 20.5% for the same period last year, largely due to a decrease in gross margin from our AT&T relationship, but also due to a decrease in the non Tier 1 business, mostly associated with product mix and larger projects within the public system operator, contractor and program manager market.

We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by $0.8 million or 0.8% in the first nine months of fiscal year 2013 as compared with the first nine months of 2012. Selling, general and administrative expenses as a percentage of revenues decreased to 14.9% for the first nine months of fiscal year 2012, as compared to 16.6% in the first nine months of fiscal year 2012, resulting from an increase in revenues and a small decrease in selling, general and administrative expenses. The largest factors contributing to the overall decrease in total selling, general and administrative expenses were decreased pay for performance bonus expense and marketing expense, partially offset by increases in compensation and benefits, as well as information technology and corporate support expense.

Pay for performance bonus expense (including both cash and equity plans) decreased by $3.5 million in the first nine months of fiscal 2013 as compared to the first nine months of fiscal 2012. Our reward programs are performance based, and due to the exceptionally strong first and third quarters of fiscal 2012, our bonus expense in the first nine months of fiscal 2013 was lower compared to the first nine months of last year.

Marketing expense decreased by $1.2 million in the first nine months of fiscal 2013 as compared to the first nine months of fiscal 2012, primarily due to a decrease in AT&T market development expenses, which are completely variable to sales.

Corporate support expense increased approximately $0.8 million, or 15.8%, in the first nine months of fiscal 2013 as compared to the first nine months of fiscal 2012. This increase was primarily related to slightly higher bad debt expense in addition to higher new product development costs.

Information technology expense increased approximately $0.4 million in the first nine months of fiscal 2013 as compared to the first nine months of fiscal 2012. This increase was primarily related to investments in business generation technology tools.

Additionally, our compensation and benefits increased by $1.0 million, or 2.5% in the first nine months of fiscal 2013 as compared to 2012, primarily in our business generation teams.

We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve based on this evaluation. We also evaluate the credit worthiness of prospective and current customers and make decisions regarding extension of credit terms to such customers based on this evaluation. Accordingly, we recorded a provision for bad debts of $693,000 and $283,200 for the nine months ended December 30, 2012 and December 25, 2011, respectively. Bad debt expense in the first nine months of fiscal 2012 was unusually low due to significant bad debt recoveries, with the first nine months of fiscal 2013 being much more representative of our historical bad debt expense levels.

Interest, Net. Net interest expense decreased from $251,900 in the first nine months of fiscal 2012 to $83,100 in the first nine months of fiscal 2013, primarily due to decreased borrowings on our revolving line of credit facility.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased to 38.9% in the first nine months of fiscal year 2013 as compared to 38.6% in the first nine months of fiscal year 2012, due to the Company being subject to income tax in additional state taxing jurisdictions. As a result of the factors discussed above, net income for the first nine months of fiscal year 2013 increased 15.4% and diluted earnings per share increased 12.4% compared to the corresponding prior-year period.

Commercial Segment. Revenues in our commercial segment totaled $276.5 million in the first nine months of fiscal 2013, compared to $245.8 million in the prior year period, a 12.5% increase. Gross profit totaled $71.6 million, a 9.1% increase as compared to the first nine months of last year. Within this segment, the public system operators, contractors and program managers market grew revenues by 38.0% and gross profits by 30.3%. This growth was primarily driven by a need by our customers to increase bandwidth and upgrade their infrastructure to accommodate increasing wireless traffic. The need for increased bandwidth was echoed in our commercial dealers and resellers market, with revenue growth of 12.0% and gross profit growth of 11.3%. Revenue within the private and government system operators markets declined slightly by 2.2% with a decrease in gross profit of 3.4%. This decline was due to economic uncertainties as well as potential government spending cuts.

Our direct expenses in this segment totaled $32.2 million, a 4.9% increase compared to the first nine months of fiscal 2012. Therefore, total segment net profit contribution was $39.4 million, a 12.8% increase over the prior year period.

Retail Segment. Revenues in our retail segment totaled $317.6 million in the first nine months of fiscal 2013, representing an 8.5% increase from the prior year period. Gross profit totaled $41.5 million, a 7.9% decrease. Revenues in our retailer, dealer agent and Tier 2/3 carrier market increased in the first nine months of fiscal 2013 as compared to the same period last year, up 21.3%, with a 19.1% increase in gross profit, as a result of increased sales from independent agents and dealers. Sales were relatively flat in our Tier 1 carrier market, primarily AT&T, which showed a 2.9% revenue increase; however, due to the lower gross margin associated with this business, and the beginning of the business transition, gross profit decreased 28.0%.

Our direct expenses in this segment totaled $22.0 million in the first nine months of fiscal 2013, a 1.1% decrease over the prior year period. Therefore, total segment net profit contribution was $19.5 million for the first nine months of fiscal 2013, a 14.4% decrease over the prior year period.

Liquidity and Capital Resources

The following table summarizes our cash flows (used in) provided by operating,
investing and financing activities for the nine months ended December 30, 2012
and December 25, 2011:

                                                                     Nine Months Ended
                                                         December 30, 2012       December 25, 2011
Cash flows (used in) provided by operating activities   $        (1,155,700 )   $        14,611,300
Cash flows used in investing activities                          (4,234,900 )            (4,960,900 )
Cash flows used in financing activities                         (10,226,300 )            (3,377,300 )
Net (decrease) increase in cash and cash equivalents    $       (15,616,900 )   $         6,273,100

We used $1.2 million of net cash from operating activities in the first nine months of fiscal 2013 compared with $14.6 million generated in the first nine months of fiscal 2012. In the first nine months of fiscal 2013, our cash used in operating activities was primarily driven by net income (net of depreciation and amortization and non-cash stock-based compensation expense) plus an increase in trade accounts payable, offset by increases in trade accounts receivables and inventory and decreases in accrued payroll, benefits and taxes. The increase in accounts payable is largely due to the timing and credit terms of inventory receipts, including the significant increase in inventory during the first nine months of fiscal 2013. The increase in inventory is to improve service levels to support increased customer demand. The increase in trade accounts receivable is primarily due to an increase in receivables for our public systems operators, contractors and program managers and private and government system operators markets. The decrease in accrued payroll, benefits and taxes was primarily related to a lower bonus accrual rate as compared to fiscal 2012.

Capital expenditures of $4.2 million in the first nine months of fiscal 2013 were down from expenditures of $5.0 million in the first nine months of fiscal 2012. In the first nine months of fiscal year 2013, capital expenditures were largely comprised of $1.4 million for leasehold improvement expenditures related to our administrative offices and $1.6 million for investments in information technology. In the first nine months of fiscal year 2012, capital expenditures were largely comprised of $1.9 million for leasehold improvement expenditures related to our administrative offices and $1.7 million for investments in information technology. A portion of these leasehold improvements expenditures has been reimbursed to us by our landlord during our third fiscal quarter, pursuant to the applicable terms of our lease. These funds have been recorded as deferred rent and are being charged as an offset to rent expense over the remaining term of the lease.

Net cash used in financing activities was $10.2 million for the first nine months of fiscal 2013 compared with a net cash outflow from financing activities of $3.4 million for the first nine months of fiscal 2012. For the first nine months of fiscal 2013 and fiscal 2012, our cash outflow from financing activities was primarily due to cash dividends paid to shareholders as well as repurchases of stock from employees and directors for minimum tax withholdings related to equity compensation, partially offset by the excess tax benefit from . . .