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TESS > SEC Filings for TESS > Form 10-K on 29-May-2014All Recent SEC Filings

Show all filings for TESSCO TECHNOLOGIES INC

Form 10-K for TESSCO TECHNOLOGIES INC


29-May-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This Management's Discussion and Analysis of Results of Operations and Financial Condition (MD&A) should be read in conjunction with the other sections of this Annual Report on Form 10-K, including Part I, "Item 1: Business," Part II, "Item 6: Selected Financial Data," and Part II, "Item 8: Financial Statements and Supplementary Data." The various sections of this MD&A contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing, including Part I, "Item 1A: Risk Factors." Our actual results may differ materially from those described in any such forward-looking statement.

Business Overview and Environment

TESSCO Technologies Incorporated (TESSCO, we, or the Company) architects and delivers innovative product and value chain solutions to support wireless systems. Although we sell products to customers in over 100 countries, approximately 98% of our sales are 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 and customer base as one segment. This segment includes the following markets: (1) public carriers, contractors, and program managers that are generally responsible for building and maintaining the infrastructure system and provide airtime service to individual subscribers; (2) private system operators and governments including commercial entities such as major utilities and transportation companies, federal agencies and state and local governments that run wireless networks for their own use; (3) commercial dealers and resellers that sell, install and/or service cellular telephone, wireless networking, broadband and two-way radio communications equipment primarily for the enterprise market; (4) retailers, dealer agents and carriers; and (5) our Major 3PL Relationship with AT&T, that was fully transitioned at the end of fiscal 2013.

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 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.

In April 2012, we were notified by AT&T, a Tier 1 cellular carrier then purchasing phone accessories from us, of their intention to transition their third party logistics, or 3PL, retail store supply chain business, which, at that time, made up the vast majority of our AT&T revenues, away from us beginning in the second quarter of our fiscal 2013. As this transition continued toward completion, revenues from this relationship for the fourth quarter of fiscal 2013 declined significantly, although this transition resulted in a lesser relative impact on overall profits. This reduction in revenue for the second half of fiscal 2013 was more than fully offset by an increase over fiscal 2012 in our non-AT&T revenues. While there was no revenue in 2014 for the transitioned 3PL business, we have continued to supply product to this customer's other programs and to supply proprietary Ventev® products to AT&T retail stores. Due to the loss of this 3PL relationship, which generated $213.5 million in revenues during fiscal 2013, we experienced a significant decline (25.6%) in overall revenues in fiscal 2014, however, gross profit declined only 6.0% in fiscal 2014.


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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 accessory 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. We believe, however, that our strength in service, the breadth and depth of our product offering, our information technology system, our large customer base and our purchasing relationships with approximately 380 manufacturers provide us with a significant competitive advantage over new entrants to the market.

Results of Operations

The following tables summarize the results of our operations for fiscal years 2014, 2013 and 2012:

(Dollars in
thousands,
except per
share data)                                       2013 to 2014                                 2012 to 2013
                  2014          2013         $ Change       % Change         2012        $ Change       % Change
Market
Revenues
Public
Carriers,
Contractors &
Program
Managers        $ 149,196     $ 111,146     $   38,050           34.2 %    $  73,824     $  37,322           50.6 %
Private &
Government
System
Operators         115,316       121,313         (5,997 )         (4.9 %)     129,129        (7,816 )         (6.1 %)
Commercial
Dealers &
Resellers         140,552       138,737          1,815            1.3 %      125,431        13,306           10.6 %
Retailers,
Independent
Dealer Agents
& Carriers        155,023       167,895        (12,872 )         (7.7 %)     153,803        14,092            9.2 %
Revenues,
excluding
Major 3PL
relationship      560,087       539,091         20,996            3.9 %      482,187        56,904           11.8 %
Major 3PL
relationship           --       213,474       (213,474 )       (100.0 %)     251,203       (37,729 )        (15.0 %)
Total                                                                 %)
Revenues        $ 560,087     $ 752,565     $ (192,478 )        (25.6      $ 733,390     $  19,175            2.6 %




(Dollars in
thousands,
except per
share data)                                        2013 to 2014                                2012 to 2013
                   2014          2013        $ Change       % Change         2012        $ Change       % Change
Market Gross
Profit
Public
Carriers,
Contractors &
Program
Managers         $  31,013     $  24,183     $   6,830           28.2 %    $  17,101     $   7,082           41.4 %
Private &
Government
System
Operators           31,607        33,596        (1,989 )         (5.9 %)      35,860        (2,264 )         (6.3 %)
Commercial
Dealers &
Resellers           39,396        38,345         1,051            2.7 %       35,393         2,952            8.3 %
Retailers,
Independent
Dealer Agents
& Carriers          36,142        35,903           239            0.7 %       33,421         2,482            7.4 %
Gross Profit,
excluding
Major 3PL
relationship       138,158       132,027         6,131            4.6 %      121,775        10,252            8.4 %
Major 3PL
relationship            --        15,012       (15,012 )       (100.0 %)      26,881       (11,869 )        (44.2 %)

Total Gross
Profit             138,158       147,039        (8,881 )         (6.0 %)     148,656        (1,617 )         (1.1 %)

Selling,
general and
administrative
expenses           111,668       117,821        (6,153 )         (5.2 %)     121,652        (3,831 )         (3.1 %)
Income from
operations          26,490        29,218        (2,728 )         (9.3 %)      27,004         2,214            8.2 %
Interest, net          178           224           (46 )        (20.7 %)         293           (69 )        (23.5 %)
Income before
provision for
income taxes        26,312        28,994        (2,682 )         (9.3 %)      26,711         2,283            8.5 %
Provision for
income taxes        10,063        11,200        (1,137 )        (10.2 %)      10,274           926            9.0 %
Net income       $  16,249     $  17,794     $  (1,545 )         (8.7 %)   $  16,437     $   1,357            8.3 %

Diluted
earnings per
share            $    1.94     $    2.15     $   (0.21 )         (9.7 %)   $    2.03     $    0.12            5.9 %


Table of Contents
Fiscal Year 2014 Compared to Fiscal Year 2013

Revenues. Revenues for fiscal year 2014 decreased 25.6% as compared to fiscal year 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 Major 3PL relationship, our revenues grew by 3.9% as compared to fiscal 2013. Revenue from the public carriers, contractors and program managers market grew by 34.2%. 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 1.3%. Revenue within the private and government system operators markets declined 4.9%, which we attributed to economic uncertainties as well as government spending cuts. Revenues in our retailers, independent dealer agents and carriers market decreased 7.7%, as a result of decreased sales to carriers, independent agents and dealers, due in part to changes in the business models of tier 1 retail carriers, many of which are now competing with us to sell to their customers. As noted above, in April 2012, we were notified by AT&T of their intention to transition their 3PL retail store supply chain business, which accounted for the vast majority of our historical AT&T revenues, away from us beginning in the second quarter of our fiscal 2013. This transition was completed by the close of our fiscal 2013 and, therefore, there were no Major 3PL revenues in fiscal 2014.

Gross Profit. Gross profit decreased 6.0% in fiscal year 2014 compared to fiscal year 2013. This reflects a reduction in gross profit due to our fully transitioned 3PL retail store supply chain relationship which was partially offset by a 4.6% increase in gross profit in our other ongoing markets. This increase was primarily driven by a 28.2% increase in our public carriers, contractors, and program managers market, and to a march lesser extent by a 2.7% increase in our commercial dealers and resellers market, and a 0.7% increase in our retailers, independent dealer agents and carriers market partially offset by a 5.9% decrease in our private and government system operators market. Overall gross profit margin increased to 24.7%, compared to 19.5% in fiscal year 2013, primarily driven by the absence of the lower margin sales related to the transitioned Major 3PL relationship.

Our ongoing ability to earn revenues and gross profits from customers and vendors looking to us for product and supply chain solutions is dependent 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 short notice. Our customer relationships could also be affected by wireless carrier consolidation or the global financial crisis.

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. These expenses have been less than 1% of overall purchases of the last 3 fiscal years.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by 5.2% during fiscal year 2014 as compared to fiscal year 2013. Total selling, general and administrative expenses as a percentage of revenues increased from 15.7% in fiscal year 2013 to 19.9% in fiscal year 2014, primarily as a result of the reduction in revenues related to the transitioned 3PL relationship.


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The largest factors contributing to the overall decrease in total selling, general and administrative expenses were decreased AT&T market development expenses, decreased pay for performance bonus expense, and lower corporate support expenses, partially offset by increased compensation.

Marketing expenses decreased by $2.1 million, or 38.1%, in fiscal year 2014 as compared to fiscal year 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 advertising and other direct marketing expenses.

Pay for performance bonus expense (including both cash and equity plans) decreased by $4.7 million in fiscal year 2014 as compared to fiscal year 2013. Our bonus programs are all based on annual performance targets. The relationship between targeted performance and actual performance led to lower bonus accruals in fiscal 2014 than in fiscal 2013.

Corporate support expense decreased approximately $1.4 million, or 17.0%, in fiscal year 2014 as compared to the fiscal year 2013. This decrease was primarily related to lower bad debt expense in addition to lower new product development costs.

Compensation expense increased by $2.2 million, or 4.8%, in fiscal year 2014 as compared to fiscal year 2013, primarily due to growth 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 $202,000 and $1,197,300 for fiscal year 2014 and fiscal year 2013, respectively. During fiscal 2014, we experienced lower than normal bad debt expense due in part to changes in estimates of amounts previously reserved.

Interest, Net. Net interest expense decreased from $224,200 in fiscal year 2013 to $177,700 in fiscal year 2014, primarily due to decreased average borrowings on our revolving credit facility, as well as a decrease in the interest rate on our revolving credit facility, which occurred in the third quarter of fiscal year 2014.

Income Taxes, Net Income and Diluted Earnings Per Share. The effective tax rates in fiscal year 2014 and 2013 were 38.2% and 38.6%, respectively. As a result of the factors discussed above, net income and diluted earnings per share for fiscal year 2014 decreased 8.7% and 9.8%, respectively, compared with fiscal year 2013.

Fiscal Year 2013 Compared to Fiscal Year 2012

Revenues. Revenues for fiscal year 2013 increased 2.6% as compared to fiscal year 2012. The public carrier, contractor and program manager market grew revenues by 50.6%. 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 10.6%. We continue to see strong opportunities for our proprietary and customized solutions in this market, as these customers continue to build and enhance their own private wireless applications. The private and government system operators market revenue declined 6.1%, which we attribute primarily to economic uncertainties and government spending cuts. The retailers, independent dealer agents, and carriers market grew revenues by 9.2%. Our Major 3PL relationship completed its transition in the fourth quarter of fiscal 2013, and as a result, revenues from this relationship decreased by 15.0% in fiscal 2013 compared to 2012.


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Gross Profit. Gross profit decreased 1.1% in fiscal year 2013 compared to fiscal year 2012. Our Major 3PL relationship market showed a decrease in sales, with a larger decrease of 44.2% in gross profit due to the transition of the AT&T third party logistics retail supply chain business. Additionally, our private and government system operators market experienced a 6.3% decline in gross profit. This decrease in gross profit was partially offset by a 7.4% increase in the retailers, independent dealer agents and carriers market, a 41.4% increase in our public carrier, contractor and program manager market, and an 8.3% increase in our commercial dealers and resellers market. Overall gross profit margin decreased to 19.5%, compared to 20.3% in fiscal year 2012, primarily driven by the continued decline in AT&T gross margin. Excluding our Major 3PL relationship, gross profit margin decreased from 25.4% in fiscal year 2012 to 24.5% in fiscal year 2013, due in part to higher dollar, lower margin public carrier, contractor and program manager market sales.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses decreased by 3.1% during fiscal year 2013 as compared to fiscal year 2012. Total selling, general and administrative expenses as a percentage of revenues decreased from 16.6% in fiscal year 2012 to 15.7% in fiscal year 2013, due to a decrease in selling, general and administrative expenses, partially offset by the slight increase of revenues as discussed above.

The largest factors contributing to the overall decrease in total selling, general and administrative expenses were decreased AT&T market development expenses and decreased pay for performance bonus expense, partially offset by increased corporate support expenses.

Marketing expenses decreased by $2.7 million, or 32.7%, in fiscal year 2013 as compared to fiscal year 2012, primarily related to a decrease in AT&T market development expenses, which are completely variable to sales units.

Pay for performance bonus expense (including both cash and equity plans) decreased by $5.1 million in fiscal year 2013 as compared to fiscal year 2012. Our bonus programs are all based on annual performance targets. The relationship between expected performance and actual performance led to lower bonus accruals in fiscal 2013 than in fiscal 2012.

As previously reported, in connection with his departure effective November 27, 2012, our previous Chief Financial Officer 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 his 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.

Corporate support expense increased approximately $1.4 million, or 21.5%, in fiscal year 2013 as compared to the fiscal year 2012. This increase was primarily related to slightly higher bad debt expense in addition to higher new product development costs related to our proprietary power product line.

We recorded a provision for bad debts of $1,197,300 and $458,700 for fiscal year 2013 and fiscal year 2012, respectively. Bad debt expense during fiscal year 2012 was unusually low due to significant bad debt recoveries, with fiscal year 2013 being much more representative of our historical bad debt expense levels.

Interest, Net. Net interest expense decreased from $292,900 in fiscal year 2012 to $224,200 in fiscal year 2013, primarily due to decreased average borrowings on our revolving credit facility as well as the repayment in full of a loan from the Maryland Economic Development Corporation.

Income Taxes, Net Income and Diluted Earnings Per Share. The effective tax rates in fiscal year 2013 and 2012 were 38.6% and 38.5%, respectively. As a result of the factors discussed above, net income and diluted earnings per share for fiscal year 2013 increased 8.3% and 5.9%, respectively, compared with fiscal year 2012.


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Liquidity and Capital Resources

In summary, our cash flows were as follows:

                                                  2014             2013              2012
Cash flow provided by operating activities    $ 18,665,400     $   3,352,400     $ 21,745,500
Cash flow used in investing activities          (4,715,500 )      (5,354,000 )     (6,513,700 )
Cash flow used in financing activities          (6,950,000 )     (11,742,000 )     (5,198,400 )
Net increase (decrease) in cash and cash
equivalents                                   $  6,999,900     $ (13,743,600 )   $ 10,033,400

We generated $18.7 million of net cash from operating activities in fiscal year 2014. Our cash inflow from operating activities was driven by net income (net of depreciation and amortization and non-cash stock compensation expense) and a decrease in accounts receivable, partially offset by a decrease in trade accounts payable and accrued payroll, benefits, and taxes. The decrease in accounts receivable is related to the AT&T transition. The decrease in trade accounts payable was caused by the timing of inventory purchases in the fourth quarter. The decrease in accrued payroll, benefits, and taxes was driven by higher bonus accruals in fiscal 2013 (and their subsequent payouts in fiscal 2014) compared to bonus accruals in fiscal 2014.

In fiscal year 2013 our cash inflow from operating activities was driven by net income (net of depreciation and amortization and non-cash stock compensation expense) and a decrease in accounts receivable, partially offset by an increase in product inventory and decreases in trade accounts payable and accrued payroll, benefits and taxes. The decrease in accounts receivable was related to the transition of our Major 3PL relationship. The increase in inventory is intended to improve service levels to support increased customer demand and improve availability. The decrease in trade accounts payable is related to this transition, causing lower AT&T inventory purchases and lower accruals related to AT&T market development funds, partially offset by higher non-AT&T inventory purchases. The decrease in accrued payroll, benefits and taxes was driven by higher bonus accruals in fiscal 2012 (and their subsequent payouts in fiscal 2013) compared to bonus accruals in fiscal 2013.

In fiscal year 2012, our cash inflow from operating activities was driven by net income (net of depreciation and amortization and non-cash stock compensation expense), as well as an increase in trade accounts payable, partially offset by an increase in trade accounts receivables and product inventory. The increase in trade accounts payable was largely due to the timing and credit terms of inventory receipts, including those related to an expansion of our AT&T relationship during the third and fourth quarters of fiscal year 2012. The increase in trade accounts receivable was primarily due to the timing of sales and collections, as well as the fact that we have granted extended payment terms to certain large customers. The increased inventory levels were to support growing sales, including the significant increase in sales to AT&T during the third and fourth quarters of fiscal year 2012, and to improve our inventory availability for our other customers.

Capital expenditures of $4.7 million in fiscal year 2014 were down from $5.4 million in fiscal year 2013. In fiscal year 2014 capital expenditures were largely comprised of $4.3 million for investments in information technology. Fiscal year 2013 capital expenditures were largely comprised of $1.6 million for leasehold improvement and $1.0 million for furniture and fixtures expenditures, related to a build-out and reorganization of our administrative offices and $2.2 million for investments in information technology. Fiscal year 2012 capital expenditures primarily consisted of $2.3 million for leasehold improvement and $1.4 million for furniture and fixtures expenditures, related to a build-out and reorganization of our administrative offices, and $2.0 million for investments in information technology. A portion of the leasehold improvement expenditures for both 2012 and 2013 were reimbursed to us by our landlord during the respective fiscal year, pursuant to the applicable terms of our lease. We received payments of $0.6 million and $1.2 million in fiscal 2013 and fiscal 2012, respectively, for tenant improvement.

Cash flows used in financing activities were primarily related to cash dividends paid to shareholders and purchases 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 and proceeds from issuance of stock. The significant increase in cash used in financing activities during fiscal 2013 was caused primarily by the payment of a special dividend of $0.75 per share of common stock on December 27, 2012.


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In the first quarter of fiscal year 2004 we commenced a stock buyback program, though no shares were purchased during fiscal 2014, 2013 or 2012. From the beginning of our stock buyback program (the first quarter of fiscal year 2004), through the end of fiscal year 2011, a total of 3,505,187 shares have been purchased under this program for approximately $30.7 million, or an average price of $8.76 per share. Our Board of Directors had authorized the purchase of up to 3,593,350 shares in the aggregate, and therefore, 88,163 shares remained available to be purchased as of the end of fiscal year 2014. On April 23, 2014, however, our Board of Directors expanded our stock buyback program and authorized the purchase on a non-accelerated basis of up to $10 million of the Company's stock over a 24-month period, ending in April 2016. Our Board of Directors believes that the repurchase of our shares, when appropriate, is an excellent use of funds to enhance long-term shareholder value. Shares may be purchased from time to time in the open market, by block purchase, or through negotiated transactions, or possibly other transactions managed by broker-dealers. Any purchases will be funded from working capital and/or our revolving credit facility. The actual number of shares to be repurchased remains . . .
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