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TESS > SEC Filings for TESS > Form 10-Q on 7-Feb-2014All Recent SEC Filings

Show all filings for TESSCO TECHNOLOGIES INC

Form 10-Q for TESSCO TECHNOLOGIES INC


7-Feb-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. This commentary should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations from the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2013.

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.

We evaluate our business as one segment. However, to provide investors with increased visibility into the markets the we serves, we also report revenue and gross profit by the following market units: (1) public carriers, contractors and program managers; (2) private system operators and governments; (3) commercial dealers and resellers; (4) retailers, dealer agents and carriers, and (5) our Major 3PL relationship that was fully transitioned at the completion of fiscal 2013.

We offer a wide range of products that are classified into four product categories: base station infrastructure; network systems; installation, test and maintenance; and mobile device 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 device accessories products include cellular phone and data device accessories.

As previously discussed, our Major 3PL relationship with AT&T Mobility (AT&T) was fully transitioned during the fourth quarter of fiscal year 2013. This relationship produced large revenues, but at much lower gross margins than our other business generally. As a result of this transition, we experienced, a year over year decline in quarterly overall revenues. For the third quarter, we experienced a 29.1% decline in overall revenues. However, due to higher profit margins, year over year, gross profit only decreased by 7.3% for the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013. Revenue excluding the Major 3PL relationship was essentially flat as compared to last third quarter, while gross profit excluding this relationship increased by 1.5%. Total selling, general and administrative expenses decreased by 4.1% compared to the prior-year quarter. As a result, net income decreased by 18.1% and diluted earnings per share decreased by 18.5% compared to the prior-year quarter.

We believe that 2014 fiscal year to date revenue growth of 6.9% in our core business (which we define as our overall business excluding our recently transitioned Major 3PL retail store supply chain relationship) has been largely driven by the growth in consumer demand for wireless devices generally. That consumer demand translates into a need for faster networks with additional capacity. We expect this growth in consumer demand to continue and to drive opportunities for the sale of mobile device accessories, as well as to augment the demand for network build-outs. We have seen the impact of these build-outs, as evidenced by very strong growth in our public carriers, contractors & program managers market in the past year. 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 375 manufacturers, provide us with a significant competitive advantage over new entrants to the market.


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Results of Operations

Third Quarter of Fiscal Year 2014 Compared with Third Quarter of Fiscal Year 2013

Total Revenues. Revenues for the third quarter of fiscal 2014 decreased 29.1% as compared with the third quarter of fiscal 2013, largely due to the completed transition, prior to the beginning of the first quarter of fiscal 2014, of our Major 3PL retail store supply chain relationship. Excluding the transitioned 3PL relationship, our revenues decreased by 0.4% as compared to the third quarter of fiscal 2013. The public system operators, contractors and program managers market grew revenues by 15.3%. This growth was primarily driven by our customers' need to increase bandwidth and upgrade their infrastructure to accommodate increasing wireless traffic. Revenue within our commercial dealers and resellers market was essentially flat. Revenue within the private and government system operators markets declined 0.8% in part due to the temporary government shutdown. Revenues in our retailers, independent dealer agents and carriers market decreased in the third quarter of fiscal 2014 as compared to the same period last year by 11.3%, as a result of decreased sales to carriers, independent agents, and dealers, due in part to changes in the business models of the tier 1 retail carriers, who are now competing with us to sell to their customers.

Total Gross Profit. Gross profit for the third quarter of fiscal 2014 decreased by 7.3% as compared with the third quarter of fiscal 2013. This decrease reflects a reduction in gross profit due to our fully transitioned 3PL retail store supply chain relationship, which was partially offset by a 1.5% increase in gross profit in our other ongoing markets. This increase was primarily driven by a 15.3% increase in our public system operators, contractors, and program managers market as further discussed above, and to a much lesser extent by a 0.7% increase in our commercial dealers and resellers market partially offset by a 3.4% decrease in our private and government system operators market and a 2.7% decrease in our retailers, independent dealer agents and carriers market. Overall gross profit margin increased to 24.9%, compared to 19.1% for the same period last year, primarily driven by the absence of the lower margin sales related to the transitioned 3PL relationship and to a lesser extent by a 19.3% increase in sales of our Ventev proprietary products.

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. 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 and write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes. These expenses have been less than 1% of overall purchases of the last 2 years and for fiscal 2014 year to date.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by $1.3 million in the third quarter of fiscal 2014 as compared with the third quarter of fiscal 2013. Selling, general and administrative expenses as a percentage of revenues increased to 20.0% in the third quarter of fiscal 2014, from 14.8% in the third quarter of fiscal 2013, primarily as a result of the reduction in revenues related to the transitioned 3PL relationship.


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Compensation expense increased by $0.5 million in the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013, primarily due to growth in our business generation teams.

Pay for performance bonus expense (including both cash and equity plans) decreased by $0.7 million in the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013. 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 2013 than in fiscal 2014.

Marketing expense decreased by $0.8 million in the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013, primarily due to a decrease in 3PL market development expenses, which were completely variable to sales from the Major 3PL relationship, coupled with a decrease in direct marketing.

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. During the third quarter of fiscal year 2014 we experienced lower than normal bad debt expense mostly due to changes in estimates of amounts previously reserved. Accordingly, we recorded a provision for bad debts of ($132,400) and $209,300 for the third quarter ended December 29, 2013 and December 30, 2012, respectively.

Interest, Net. Net interest expense increased from $13,700 in the third quarter of fiscal 2013 to $37,800 in the third quarter of fiscal 2014.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate decreased slightly from 38.2% in the third quarter of fiscal 2013 to 38.0% in the third quarter of fiscal 2014. As a result of the factors discussed above, net income decreased 18.1% and diluted earnings per share decreased 18.5% for the third quarter of fiscal 2014 compared to the corresponding prior-year quarter.

First Nine Months of Fiscal Year 2014 Compared with First Nine Months of Fiscal Year 2013

Total Revenues. Revenues for the first nine months of fiscal 2014 decreased 26.7% as compared with the first nine months of fiscal 2013, largely due to the completed transition of our Major 3PL retail store supply chain relationship, prior to the beginning of the first quarter of fiscal 2014. Excluding the transitioned 3PL relationship, our revenues grew by 6.9% as compared to the first nine months of fiscal 2013. The public system operators, contractors and program managers market grew revenues by 47.8%. This growth was primarily driven by our customers' need 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 4.9%. Revenue within the private and government system operators markets declined 5.5% due to economic uncertainties as well as government spending cuts. Revenues in our retailers, independent dealer agents and carriers market decreased in the first nine months of fiscal 2014 as compared to the same period last year by 7.2%, as a result of decreased sales to carriers, independent agents, and dealers, due in part to changes in the business models of the tier 1 retail carriers, who are now competing with us to sell to their customers.


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Total Gross Profit. Gross profit for the first nine months of fiscal 2014 decreased by 4.4% as compared with the first nine months of fiscal 2013. This decrease reflects a reduction in gross profit due to our fully transitioned 3PL retail store supply chain relationship, which was partially offset by an 8.3% increase in gross profit in our other ongoing markets. This increase was primarily driven by a 46.4% increase in our public system operators, contractors, and program managers market, and to a much lesser extent by a 6.3% increase in our commercial dealers and resellers market, and a 0.6% increase in our retailers, independent dealer agents and carriers market partially offset by a 5.8% decrease in our private and government system operators market. Overall gross profit margin increased to 24.8%, compared to 19.0% for the same period last year, primarily driven by the absence of the lower margin sales related to the transitioned 3PL relationship.

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. 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 and write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes. These expenses have been less than 1% of overall purchases of the last 2 years and for fiscal 2014 year to date.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by $2.3 million in the first nine months of fiscal 2014 as compared with the first nine months of fiscal 2013. Selling, general and administrative expenses as a percentage of revenues increased to 19.8% in the first nine months of fiscal 2014, from 14.9% in the first nine months of fiscal 2013, primarily as a result of the reduction in revenues related to the transitioned 3PL relationship.

Compensation expense increased by $2.0 million in the first nine months of fiscal 2014 as compared to the first nine months of fiscal 2013, primarily due to growth in our business generation teams.

Pay for performance bonus expense (including both cash and equity plans) decreased by $1.8 million in the first nine months of fiscal 2014 as compared to the first nine months of fiscal 2013. 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 first nine months of fiscal 2013 than in fiscal 2014.

Marketing expense decreased by $2.4 million in the first nine months of fiscal 2014 as compared to the first nine months of fiscal 2013, primarily due to a decrease in 3PL market development expenses, which were completely variable to Major 3PL relationship sales, partially offset by an increase in direct marketing expenses.

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 $193,500 and $693,000 for the nine months ended December 29, 2013 and December 30, 2012, respectively. During the first nine months of fiscal year 2014, we experienced lower than normal bad debt expense due in part to changes in estimates of amounts previously reserved.


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Interest, Net. Net interest expense increased from $83,100 in the first nine months of fiscal 2013 to $159,400 in the first nine months of fiscal 2014.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate decreased from 38.9% in the first nine months of fiscal 2013 to 38.3% in the first nine months of fiscal 2014, primarily due to the expiration of a statute of limitations relating to an uncertain tax position. As a result of the factors discussed above, net income for the first nine months of fiscal 2014 decreased 10.6% and diluted earnings per share decreased 11.1%.

Liquidity and Capital Resources

The following table summarizes our cash flows provided by (used in) operating,
investing and financing activities for the nine months ended December 29, 2013
and December 30, 2012:

                                                                     Nine Months Ended
                                                         December 29, 2013       December 30, 2012
Cash flows provided by (used in) operating activities   $        11,643,600     $        (1,155,700 )
Cash flows used in investing activities                          (2,792,700 )            (4,234,900 )
Cash flows used in financing activities                          (5,037,500 )           (10,226,300 )
Net increase (decrease) in cash and cash equivalents    $         3,813,400     $       (15,616,900 )

We generated $11.6 million of net cash from operating activities in the first nine months of fiscal 2014 compared with $1.2 million used in the first nine months of fiscal 2013. In the first nine months of fiscal 2014, our cash generated by operating activities was primarily driven by net income (net of depreciation, amortization, and non-cash stock-based compensation expense) and a decrease in accounts receivable partially offset by decreases in accounts payable and payroll, benefits and tax liabilities. The decrease in accounts receivable was primarily due to lower December sales in fiscal 2014 than fiscal 2013. The decrease in accounts payable is related to the timing of inventory purchases and payments and the decrease in payroll, benefits and tax liabilities is due to the payment of our annual bonuses.

Net cash used in investing activities of $2.8 million in the first nine months of fiscal 2014 were down from expenditures of $4.2 million in the first nine months of fiscal 2013. Cash used in both periods were due to capital expenditures. In the first nine months of fiscal 2014 the capital expenditures were largely comprised of investments in information technology. In the first nine months of fiscal 2013 the capital expenditures were comprised of both investments in information technology and leasehold improvements.

Net cash used in financing activities was $5.0 million for the first nine months of fiscal 2014 compared to net cash used in financing activities of $10.2 million for the first nine months of fiscal 2013. For both the first nine months of fiscal 2014 and the first nine months of fiscal 2013, 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 stock-based compensation.


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We are party to an unsecured revolving credit facility with SunTrust Bank and Wells Fargo Bank, National Association, with interest payable monthly at the LIBOR rate plus an applicable margin. Borrowing availability under this facility is determined in accordance with a borrowing base, and the applicable credit agreement includes financial covenants, including a minimum tangible net worth, minimum cash flow coverage of debt service, and a maximum funded debt to EBITDA ratio. These financial covenants also apply to the separate but related term loan secured by our Hunt Valley, Maryland facility discussed below. The terms applicable to our revolving credit facility and term loan also limit our ability to engage in certain transactions or activities, including (but not limited to) investments and acquisitions, sales of assets, payment of dividends, issuance of additional debt and other matters. As of December 29, 2013, we had a zero balance on our $35.0 million revolving credit facility; therefore, we had $35.0 million available on our revolving line of credit facility, subject to the limitations imposed by the borrowing base and our continued compliance with the other applicable terms, including the covenants referenced above. We have entered into several modification agreements providing for term extensions and certain modifications to the provisions applicable to the credit facility. On November 30, 2012, we entered into a Seventh Modification Agreement to allow for a special dividend paid during fiscal 2013.

Most recently, during the third fiscal quarter, we entered into a Ninth Modification Agreement (the "Ninth Modification Agreement"), dated as of October 16, 2013, further modifying the Credit Agreement and related promissory note for the revolving credit facility discussed above. Pursuant to and in connection with the Ninth Modification Agreement, the term of the revolving credit facility was extended yet again from May 31, 2014 to October 1, 2016. In addition, the amount of the allowable dividend payments under the Credit Facility was increased from $6.25 million (the previous stated amount) to $8.0 million in any 12 month period, assuming continued compliance with the otherwise applicable terms. The Ninth Modification Agreement also provides for decreases in the applicable margins (from a range of 2.25% to 3.25% to a new range of 1.50% to 2.50%) and unused facility fees.

This revolving credit facility states that we may repurchase up to $30.0 million of our common stock (measured forward to the present date from the date of inception of the Credit Agreement, May 31, 2007). As of December 29, 2013, we had repurchased an aggregate of $13.7 million of common stock since May 31, 2007, leaving $16.3 million available for future repurchases, without the consent of our lenders or a further amendment to the terms of the facility.

We have a term loan in the original principal amount of $4.5 million from Wells Fargo Bank, National Association and SunTrust Bank, that is payable in monthly installments of principal and interest with the balance due at maturity. The note is secured by a first position deed of trust encumbering the Company-owned real property in Hunt Valley, Maryland. Effective July 1, 2011, we entered into a loan modification agreement with Wells Fargo Bank, National Association, and SunTrust Bank to extend the maturity date of the term loan to July 1, 2016. The key provisions of the loan otherwise remain the same, except that commencing July 1, 2011, the note bears interest at a floating rate of LIBOR plus 2.00%. As of December 29, 2013, we were in compliance with all loan covenants. The loan is subject to generally the same financial covenants as are applicable from time to time to our revolving credit facility, and had a balance of $2.4 million as of December 29, 2013.

On March 31, 2009, we entered into a term loan with the Baltimore County Economic Development Revolving Loan Fund for an aggregate principal amount of $250,000. The term loan is payable in equal monthly installments of principal and interest of $2,300, with the balance due at maturity on April 1, 2019. The term loan bears interest at 2.00% per annum and is secured by a subordinate position on our Hunt Valley, Maryland facility. At December 29, 2013, the principal balance of this term loan was $139,500.


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We have made quarterly dividend payments to holders of our common stock since the second quarter of fiscal 2010. Since then, a dividend has been paid quarterly at amounts which have increased from time to time. Our most recent quarterly cash dividend of $0.18 per share was paid in November 2013. On January 22, 2014, we declared a quarterly cash dividend in the amount of $0.20 per share, payable on February 19, 2014 to shareholders of record as of February 5, 2014. Any future declaration of dividends and the establishment of any corresponding record and payment dates remains subject to further determination from time to time by the Board of Directors.

We believe that our existing cash, payments from customers, and availability under our revolving credit facility will be sufficient to support our operations for at least the next twelve months. To minimize interest expense, our policy is to use excess available cash to pay down any balance on our revolving credit facility. We expect to meet short-term and long-term liquidity needs through operating cash flow, supplemented by our revolving credit facility. In doing so, the balance on our revolving credit facility could increase depending on our working capital and other cash needs. If we were to undertake an acquisition or other major capital purchases that require funds in excess of existing sources of liquidity, we would look to sources of funding from additional credit facilities, debt and/or equity issuances. As of December 29, 2013, we do not have any material capital expenditure commitments.

In addition, our liquidity could be negatively impacted by decreasing revenues and profits resulting from a decrease in demand for our products or a reduction in capital expenditures by our customers, or by the weakened financial conditions of our customers or suppliers, in each case as a result of the downturn in the global economy, among other factors.

Critical Accounting Policies and Estimates

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