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TESS > SEC Filings for TESS > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for TESSCO TECHNOLOGIES INC

Form 10-Q for TESSCO TECHNOLOGIES INC


8-Aug-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 30, 2014.

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 serve, 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, and (4) retailers, dealer agents and carriers.

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, distributed antennas systems (DAS), 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.

Our first quarter revenue increased by 6.1% compared to the first quarter of fiscal year 2014. We experienced growth across all markets. We believe this growth is largely driven by growth in consumer demand for wireless devices generally. That consumer demand translates into a need for faster networks with additional capacity. As such, our sales of network systems products increased by 60.2% in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014. 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 strong growth in our public carriers, contractors & program managers market, 10.8%, over the prior year quarter. We continue to see large enterprises, utilities, and governments increasing their use of wireless networks in their businesses and operations.

Our first quarter gross profits declined slightly by 0.5% compared to the first quarter of fiscal year 2014. The decline in gross profit was primarily the result of a change in product mix, as we experienced increased sales of lower-margin DAS equipment. Total selling, general and administrative expenses increased by 2.5% compared to the prior-year quarter primarily due to increased expenses associated with our investments in talent and technology. As a result, net income decreased by 14.5% and diluted earnings per share decreased by 13.7% compared to the prior-year quarter.

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 380 manufacturers, provide us with a significant competitive advantage over new entrants to the market.


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Results of Operations

First Quarter of Fiscal Year 2015 Compared with First Quarter of Fiscal Year 2014

Total Revenues. Revenues for the first quarter of fiscal 2015 increased 6.1% as compared with the first quarter of fiscal 2014. The public system operators, contractors and program managers market grew revenues by 10.8%. 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 increased by 6.2%. Revenue within the private and government system operators markets increased 4.0%. Revenues in our retailers, independent dealer agents and carriers market increased in the first quarter of fiscal 2015 as compared to the same period last year by 3.4%.

Total Gross Profit. Gross profit for the first quarter of fiscal 2015 decreased by 0.5% as compared with the first quarter of fiscal 2014. This decrease reflects a reduction in gross profit in our public system operators, contractors, and program managers market of 8.9% due to a shift within this market from traditional network build-outs to lower margin DAS builds. This decrease was largely offset by an increase in gross profit in our commercial dealers and resellers market of 3.8%. Gross profit in our retailers, independent dealer agents and carriers market was flat and our private and government system operators market increased by 1.4%. Overall gross profit margin decreased to 23.0%, compared to 24.6% for the same period last year, primarily driven by the change in product mix mentioned above partially offset by a 5.6% increase in sales of our higher margin 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 two fiscal years and for fiscal 2015 year to date.

Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by $0.7 million in the first quarter of fiscal 2015 as compared with the first quarter of fiscal 2014. Selling, general and administrative expenses as a percentage of revenues decreased from 19.8% in the first quarter of fiscal 2014, to 19.1% in the first quarter of fiscal 2015.

Compensation expense increased by $0.6 million in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014, primarily due to growth in our business generation teams.

Pay for performance bonus expense (including both cash and equity plans) decreased by $0.8 million in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014. 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 quarter of fiscal 2014 than in fiscal 2015.


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Information technology expense increased by $0.3 million in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014, due to an increase in consulting expenses as well as an increase in software depreciation expense.

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. We incurred bad debt expense of $234,900 and $144,000 for the first quarter ended June 29, 2014 and June 30, 2013, respectively.

Interest, Net. Net interest expense decreased from $54,600 in the first quarter of fiscal 2014 to $28,400 in the first quarter of fiscal 2015.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased from 37.9% in the first quarter of fiscal 2014 to 39.3% in the first quarter of fiscal 2015. This increase is primarily the result of an expiration of a statute of limitations regarding an uncertain tax position that occurred in the first quarter of fiscal 2014. As a result of the factors discussed above, net income decreased 14.5% and diluted earnings per share decreased 13.7% for the first quarter of fiscal 2015 compared to the corresponding prior-year quarter.

Liquidity and Capital Resources

The following table summarizes our cash flows used in operating, investing and
financing activities for the three months ended June 29, 2014 and June 30, 2013:

                                                                Three Months Ended
                                                         June 29, 2014      June 30, 2013
Cash flows used in operating activities                 $    (2,780,900 )   $  (10,418,800 )
Cash flows used in investing activities                        (490,900 )         (902,500 )
Cash flows (used in) provided by financing activities        (1,959,900 )        7,231,000
Net decrease in cash and cash equivalents               $    (5,231,700 )   $   (4,090,300 )

We used $2.8 million of net cash from operating activities in the first three months of fiscal 2015 compared with $10.4 million used in the first three months of fiscal 2014. We typically have negative cash flows from operations in the first quarter because of the payout of pay for performance bonuses earned in the prior fiscal year. In addition to the bonus payment, our cash used by operating activities during the first three months of fiscal 2015 was driven by increases in accounts receivable, inventory, and accounts payable. The increase in accounts receivable was primarily due to higher June sales in fiscal 2015 than in March of fiscal 2014. The increase in inventory was primarily due to an increase in orders from customers in preparation for the peak build season. The increase in accounts payable is related to the timing of inventory purchases.

Net cash used in investing activities of $0.5 million in the first three months of fiscal 2015 were down from expenditures of $0.9 million in the first three months of fiscal 2014. Cash used in both periods were due to capital expenditures. In the first three months of both fiscal 2015 and 2014, the capital expenditures were largely comprised of investments in information technology.


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Net cash used in financing activities was $2.0 million for the first three months of fiscal 2015 compared to net cash provided by financing activities of $7.2 million for the first three months of fiscal 2014. During both the first three months of fiscal 2015 and the first three months of fiscal 2014, we had cash outflows 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. During the first three months of fiscal 2014, we had net borrowings of $9.1 million on our revolving line of credit causing the cash flows from financing to be a net inflow.

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 June 29, 2014, 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 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. Currently the term for the credit facility goes through October 1, 2016, and the amount of allowable dividend payments under the credit facility is $8.0 million in any 12 month period, assuming continued compliance with the otherwise applicable terms.

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 June 29, 2014, 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. The maturity date of the term loan in July 1, 2016, and the note currently bears interest at a floating rate of LIBOR plus 2.00%. As of June 29, 2014, 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 $2.3 million as of June 29, 2014.

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 June 29, 2014, the principal balance of this term loan was $127,100.


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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 $0.20 per share was paid in June 2014. On July 23, 2014, we declared a quarterly cash dividend in the amount of $0.20 per share, payable on August 20, 2014 to shareholders of record as of August 6, 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 June 29, 2014, 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.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers. This guidance will supersede Topic 605, Revenue Recognition, in addition to other industry-specific guidance, once effective. The new standard requires a company to recognize revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services. The accounting standard is effective for annual periods beginning after December 15, 2016. The Company is currently in the process of assessing what impact this new standard may have on our ongoing financial reporting and determining what transition method will be used.

In June 2014, the FASB issue Accounting Standards Update No. 2014-12, Compensation - Stock Compensation. This pronouncement provides guidance on accounting for share-based awards where the performance target could be achieved after an employee completes the requisite service period. The Company currently does not have any share based arrangements of this type; therefore, this guidance is not expected to have an impact on the Company's results of operations or financial condition. Refer to Note 3 for details of the Company's stock based compensation.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

For a detailed discussion on our critical accounting policies, please refer to our Annual Report on Form 10-K for the fiscal year ended March 30, 2014.


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Off-Balance Sheet Arrangements

We have no material off-balance sheet arrangements.

Forward-Looking Statements

This Report may contain forward-looking statements. These forward-looking statements may generally be identified by the use of the words "may," "will," "expects," "anticipates," "believes," "estimates," and similar expressions, but the absence of these words or phrases does not necessarily mean that a statement is not forward looking. Forward looking statements involve a number of risks and uncertainties. Our actual results may differ materially from those described in or contemplated by any such forward-looking statement for a variety of reasons, including those risks identified in our most recent Annual Report on Form 10-K and other periodic reports filed with the SEC, under the heading "Risk Factors" and otherwise. Consequently, the reader is cautioned to consider all forward-looking statements in light of the risks to which they are subject.

We are not able to identify or control all circumstances that could occur in the future that may adversely affect our business and operating results. Without limiting the risks that we describe in our periodic reports and elsewhere, among the risks that could lead to a materially adverse impact on our business or operating results are the following: termination or non-renewal of limited duration agreements or arrangements with our vendors and affinity partners that are typically terminable by either party upon several months or otherwise relatively short notice; loss of significant customers or relationships, including affinity relationships; loss of customers as a result of consolidation among the wireless communications industry; the strength of our customers', vendors' and affinity partners' business; economic conditions that may impact customers' ability to fund or pay for our products and services; changes in customer and product mix that affects gross margin; effect of "conflict minerals" regulations on the supply and cost of certain of our products; failure of our information technology system or distribution system; system security or data protection breaches; technology changes in the wireless communications industry; third-party freight carrier interruption; increased competition; our relative bargaining power and inability to negotiate favorable terms with our vendors and customers; our inability to access capital and obtain financing as and when needed; claims against us for breach of the intellectual property rights of third parties; product liability claims; and the possibility that, for unforeseen reasons, we may be delayed in entering into or performing, or may fail to enter into or perform, anticipated contracts or may otherwise be delayed in realizing or fail to realize anticipated revenues or anticipated savings.

Available Information

Our Internet Website address is: www.tessco.com. We make available free of charge through our Website, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Exchange Act as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the Securities and Exchange Commission. Also available on our Website is our Code of Business Conduct and Ethics.

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