TESSCO TECHNOLOGIES INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____

Commission file number 0-24746

TESSCO TECHNOLOGIES INCORPORATED
(Exact name of registrant as specified in charter)

Delaware 52-0729657
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

11126 McCormick Road, Hunt Valley, Maryland 21031
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (410) 229-1000

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|

The number of shares of the registrant's Common Stock, $ .01 par value per
share, outstanding as of August 2, 2002 was 4,513,747.

TESSCO TECHNOLOGIES INCORPORATED
INDEX TO FORM 10-Q

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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS

TESSCO TECHNOLOGIES INCORPORATED
CONSOLIDATED BALANCE SHEETS

See accompanying notes.

3

TESSCO TECHNOLOGIES INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes.

4

TESSCO TECHNOLOGIES INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

5

TESSCO TECHNOLOGIES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)

Note 1. Description of Business and Basis of Presentation
- --------------------------------------------------------------------------------

TESSCO Technologies Incorporated, a Delaware corporation (the Company), is a
leading provider of integrated product plus supply chain solutions to the
professionals that design, build, run, maintain and use wireless voice, data,
messaging, tracking and Internet systems. TESSCO is in the VitalLink(R)
position between buyers and manufacturers. While creating Your Total
Source(R) opportunity for its customers to improve the way business is done,
TESSCO presents, markets, sells and supports manufacturers' products as a
part of a total customer solution, thus providing a cost-effective channel to
a broad and diverse customer base. Approximately 95% of the Company's sales
are made to customers in the United States. Although the Company conducts
business selling various products to different customer groups, these
products and customers all fall within the telecommunications industry;
therefore, the Company reports operating results as one reportable segment.

In management's opinion, the accompanying interim financial statements of the
Company include all adjustments, consisting only of normal, recurring
adjustments, necessary for a fair presentation of the Company's financial
position for the interim periods presented. These statements are presented in
accordance with the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
the Company's annual financial statements have been omitted from these
statements, as permitted under the applicable rules and regulations. The results
of operations presented in the accompanying interim financial statements are not
necessarily representative of operations for an entire year. The information
included in this Form 10-Q should be read in conjunction with the financial
statements and notes thereto included in the Company's Form 10-K for the fiscal
year ended March 31, 2002.

Note 2. Earnings Per Share
- --------------------------------------------------------------------------------

The dilutive effect of all options outstanding has been determined by using the
treasury stock method. The weighted average shares outstanding is calculated as
follows:

Options to purchase 891,995 shares of common stock at a weighted average
exercise price of $21.64 per share were outstanding as of June 30, 2002, but the
common equivalent shares were not included in the computation of diluted
earnings per share because the options' exercise prices were greater than the
average market price of the common shares and, therefore, the effect of
including such shares would be antidilutive.

Note 3. Recent Accounting Pronouncements
- --------------------------------------------------------------------------------

In June 2001, the Financial Accounting Standards Board approved Statement of
Financial Accounting Standard ("FAS") No. 141, BUSINESS COMBINATIONS, and FAS
No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. FAS No. 141 prospectively
prohibits the pooling of interest method of accounting for business
combinations initiated after June 30, 2001. FAS No. 142 requires companies to
cease amortizing goodwill and certain other intangible

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assets. FAS No. 142 also establishes a new method of testing goodwill and
intangible assets for impairment on an annual basis or on an interim basis if
an event occurs or circumstances change that would reduce the fair value of a
reporting unit below its carrying value. The adoption of FAS No. 142 resulted
in discontinuation of amortization of our goodwill commencing April 1, 2002;
however, we are required to test goodwill and intangible assets for
impairment under the new standard during fiscal 2003.

The following table presents the impact of FAS 142 on net income and earnings
per share had FAS 142 been in effect for the quarter ended July 1, 2001:

In August 2001, FASB issued FAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and supersedes
FAS No. 121 and ABP Opinion No. 30. This statement retains the fundamental
provisions of Statement 121 that requires testing of long-lived assets for
impairment using undiscounted cash flows; however, the statement eliminates the
requirement to allocate goodwill to these long-lived assets. The statement also
requires that long-lived assets to be disposed of by a sale must be recorded at
the lower of the carrying amount or the fair value, less the cost to sell the
asset and depreciation should cease to be recorded on such assets. Any loss
resulting from the write-down of the assets will be recognized in income from
continuing operations. Additionally, long-lived assets to be disposed of other
than by sale may no longer be classified as discontinued until they are disposed
of. The provisions of this statement are effective for financial statements
issued for fiscal years beginning after December 15, 2001. Adoption of this
statement had no impact on the financial statements.

Note 4. Related Party Transactions
- --------------------------------------------------------------------------------

In August 2001, the Company guaranteed a personal revolving line of credit to
the Company's chief executive officer from a commercial bank in the principal
amount of $2,500,000. In connection therewith, the Company's chief executive
officer and his spouse entered into a Reimbursement and Security Agreement,
which obligates them to reimburse the Company for any amounts paid by the
Company under its guaranty. These obligations to the Company under the
Reimbursement and Security Agreement are secured by certain assets of the
chief executive officer and represent full recourse obligations to the chief
executive officer and his spouse.

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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
Form 10-K for the fiscal year ended March 31, 2002.

First Quarter of Fiscal 2003 Compared to First Quarter of Fiscal 2002
- --------------------------------------------------------------------------------

Revenues increased by $9.2 million, or 15%, to $69.1 million for the first
quarter of fiscal 2003 compared to $59.9 million for the first quarter of fiscal
2002. Revenues from mobile devices and accessories increased 38% and revenues
from test and maintenance products increased 30%, while revenues from network
infrastructure products decreased 8%. Network infrastructure, mobile devices and
accessories and test and maintenance products accounted for approximately 36%,
39% and 25%, respectively, of revenues during the first quarter of fiscal 2003,
as compared to 45%, 33% and 22%, respectively, of revenues during the first
quarter of fiscal 2002. We experienced revenue growth in the dealers and
resellers, and consumer market categories, partially offset by a decrease in our
systems operators and international categories. Systems operators, dealers and
resellers, consumer services and international users accounted for approximately
43%, 39%, 16% and 2%, respectively, of revenues during the first quarter of
fiscal 2003, compared to 52%, 36%, 7% and 5%, respectively, of revenues during
the first quarter of fiscal 2002.

The significant increase in revenues from mobile devices and accessories is
attributed to increased volumes from an existing customer relationship. This
relationship is an e-commerce, complete supply-chain relationship with a
wireless service provider. We sell and deliver wireless telephones and
accessories to consumers and other end-users. We purchase the telephones and
accessories, accept orders, and then serialize, package and kit the
telephones and accessories for delivery to the end-user.

The significant increase in test and maintenance revenues is a result of
increased volumes from an existing supply chain relationship with an Original
Equipment Manufacturer (OEM). We take orders from the OEM's authorized
service centers for repair and replacement parts, and then we configure, kit
and deliver the parts to these customers.

The decline in revenues of network infrastructure products can be attributed
to the continued tight capital markets. Many of our customers are
experiencing difficulty in obtaining consistent and continuing access to
capital to finance their growth and, correspondingly, to finance the purchase
of our products.

Our on-going ability to earn sales from customers 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 business, the supply
and demand for the product or service, and our ability to support the
customer and to continually demonstrate that we can improve the way they do
business. Moreover, we believe that in order to achieve our stated goal of
increasing market share, we must focus on: achieving a higher share of
current product categories purchased by our customers, both large and small;
expanding the product categories purchased by these customers; and
continuing to acquire and sell more customers, on a monthly basis.

Gross profit increased by $2.4 million, or 15%, to $18.6 million for the
first quarter of fiscal 2003 compared to $16.2 million for the first quarter
of fiscal 2002, due to revenue growth. The gross profit margin percent
decreased to 26.9% for the first quarter of fiscal 2003 compared to 27.0% for
the first quarter of fiscal 2002. Gross profit margin percent for network
infrastructure increased, while mobile devices and accessories and test and
maintenance products decreased. The decrease in gross profit margin percent
for mobile devices and accessories and test and maintenance products was
attributable to the expansion of the two relationships discussed above, both
of which operate at slightly lower than historical gross profit margin
percents. However, the effect of these lower margin percents was partially
offset by changes in product mix and the increase in network infrastructure
gross profit margin percent. 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.

Total selling, general and administrative expenses increased by $1.1 million, or
7%, to $16.4 million for the first quarter of fiscal 2003 compared to $15.3
million for the first quarter of fiscal 2002. The increase in these expenses

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is primarily attributable to continued investment in personnel; costs related
to our Vendor Symposium, a major marketing initiative intended to build a
higher level of collaboration with our suppliers; and expenses related to a
proposed acquisition that did not occur during the first quarter and is not
likely to occur in the near future. The total expenses relating to the Vendor
Symposium and proposed acquisition, which were fully expensed in this
quarter, were approximately $575,000. 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 customers and make decisions regarding extension of
credit terms to such prospects based on this evaluation. Accordingly, we
recorded a provision for bad debts of $79,300 and $233,800 for the quarters
ended June 30, 2002 and July 1, 2001, respectively. Total selling, general
and administrative expenses decreased as a percentage of revenues to 23.7%
for the first quarter of fiscal 2003 from 25.5% for the first quarter of
fiscal 2002.

Income from operations increased by $1.2 million, or 136%, to $2.2 million for
the first quarter of fiscal 2003 compared to $914,200 for the first quarter of
fiscal 2002. The operating income margin increased to 3.1% for the first quarter
of fiscal 2003 compared to 1.5% for the first quarter of fiscal 2002.

Net interest and other expense decreased by $141,400, or 31%, to $315,900 for
the first quarter of fiscal 2003 compared to $457,300 for the first quarter of
fiscal 2002. This decrease is due to lower interest rates and a reduction in
borrowings on our revolving credit facility, partially offset by an increase in
credit card fees.

Income before provision for income taxes increased by $1.4 million or 303%, to
$1.8 million for the first quarter of fiscal 2003 compared to $456,900 for the
first quarter of fiscal 2002. The effective tax rates in the first quarter for
fiscal years 2003 and 2002 were 38.5% and 38.0%, respectively. Net income and
earnings per share (diluted) for the first quarter of fiscal 2003 increased 300%
and 317%, respectively, compared to the first quarter of fiscal 2002.

Liquidity and Capital Resources
- --------------------------------------------------------------------------------

Net cash provided by operating activities was $5.7 million for the first quarter
of fiscal 2003 compared to $6.4 million for the first quarter of fiscal 2002.
This decrease was primarily the result of a smaller increase in accounts payable
and a larger increase in accounts receivable compared to fiscal 2002, partially
offset by a decrease in inventory and an increase in net income. Net cash used
in investing activities increased to $1.1 million for the first quarter of
fiscal 2003 compared to $813,500 for the first quarter of fiscal 2002, as a
result of increased fixed asset purchases. Net cash used by financing activities
was $5.1 million for the first quarter of fiscal 2003 and fiscal 2002. During
the first quarter of fiscal 2003, our revolving credit facility balance
decreased from $5.4 million at March 31, 2002 to $332,000 at June 30, 2002.

Our revolving credit facility with a bank provides for a maximum borrowing
capacity of $30.0 million and has a term expiring in September 2003. This
agreement contains certain conditions, covenants and representations, all of
which were complied with as of June 30, 2002.

To minimize interest expense, our policy is to use excess available cash to pay
down the balance on our revolving credit facility.

Critical Accounting Policies and Estimates
- --------------------------------------------------------------------------------

Our discussion and analysis of our financial condition and results of our
operations are based on our 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. On an on-going basis, we evaluate our estimates, including those
related to bad debts, slow-moving inventory, income taxes, property and
equipment and intangible assets. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the

9

results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.

We have identified the policies below as critical to our business operations and
the understanding of our results of operations. For a detailed discussion on the
application of these and other accounting policies, see the Notes to the
Consolidated Financial Statements in our Form 10-K for the fiscal year ended
March 31, 2002.

REVENUE RECOGNITION. We record revenue when product is shipped to the customer
or when services are provided. Other than subscriber accessory sales relating to
our private brand, Wireless Solutions(R), we offer no product warranties in
excess of original equipment manufacturers' warranties. Warranty expense is
estimated and accrued at the time of sale. Warranty expense was immaterial for
the fiscal quarters ended June 30, 2002 and July 1, 2001.

Our current and potential customers are continuing to look for ways to reduce
their inventories and lower their total costs, including distribution, order
taking and fulfillment costs, while still providing their customers excellent
service. Some of these companies have turned to us to implement supply-chain
solutions, including purchasing inventory, assisting in demand forecasting,
configuring, packaging, kitting and delivering products and managing customer
relations, from order taking through cash collections. In performing these
solutions, we assume varying levels of involvement in the transactions and
varying levels of credit and inventory risk. As our solutions offerings
continually evolve to meet the needs of our customers, and in order to assure
that we properly reflect our financial performance, we constantly evaluate
our revenue accounting based on the guidance set forth in accounting
standards generally accepted in the United States. When applying this
guidance, we look at the following indicators: whether we are the primary
obligor in the transaction; whether we have general inventory risk; whether
we have latitude in establishing price; the extent to which we change the
product or perform part of the service; whether we have supplier selection;
whether we are involved in the determination of product and service
specifications; whether we have physical inventory risk; whether we have
credit risk; and whether the amount we earn is fixed. Each of our customer
relationships is evaluated based on the above guidance and revenue is
recorded on the appropriate basis.

ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain an allowance for doubtful accounts
for estimated losses resulting from the inability of our customers to make
required payments. If the economy and/or the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make their payments, additional allowances may be required.

EXCESS AND SLOW-MOVING INVENTORY. 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.

VALUATION OF GOODWILL, LONG-LIVED ASSETS AND INTANGIBLE ASSETS. We periodically
evaluate our goodwill, long-lived assets and intangible assets for potential
impairment indicators. Our judgments regarding the existence of impairment
indicators are based on estimated future cash flows, market conditions,
operational performance and legal factors. Future events could cause us to
conclude that impairment indicators exist and that the net book value of
long-lived assets and intangible assets is impaired. Any resulting impairment
loss could have a material adverse impact on our financial condition and results
of operations.

INCOME TAXES. We recognize deferred tax assets and liabilities based on the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. We annually review our deferred tax assets for
recoverability and establish a valuation allowance based on historical taxable
income, projected future taxable income and the expected timing of the reversals
of existing temporary differences. If we are unable to generate sufficient
taxable income, or if there is a material change in the actual effective tax
rates or time period within which the underlying temporary differences become
taxable or deductible, we could be required to establish a valuation allowance
against all or a significant portion of our deferred tax assets, resulting in a
substantial increase in our effective tax rate and a material adverse impact on
our operating results.

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Summary Disclosures about Contractual Obligations and Commercial Commitments
- --------------------------------------------------------------------------------

The following table reflects a summary of our contractual cash obligations and
other commercial commitments as of June 30, 2002:

Forward-Looking Statements
- --------------------------------------------------------------------------------

This Report contains a number of forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, all of which are based
on current expectations. These forward-looking statements may generally be
identified by the use of the words "may," "will," "believes," "should,"
"expects," "anticipates," "estimates," and similar expressions. Our future
results of operations and other forward-looking statements contained in this
report involve a number of risks and uncertainties. For a variety of reasons,
actual results may differ materially from those described in any such
forward-looking statement. Such factors include, but are not limited to, the
following: our dependence on a relatively small number of suppliers and vendors,
which could hamper our ability to maintain appropriate inventory levels and meet
customer demand; the effect that the loss of certain customers or vendors could
have on our net profits; economic conditions that may impact customers' ability
to fund purchases of our products and services; the possibility that unforeseen
events could impair our ability to service customers promptly and efficiently,
if at all; 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; existing competition from national
and regional distributors and the absence of significant barriers to entry which
could result in pricing and other pressures on profitability and market share;
and continuing changes in the wireless communications industry, including risks
associated with conflicting technologies, changes in technologies, inventory
obsolescence and evolving Internet business models and the resulting
competition. Consequently, the reader is cautioned to consider all
forward-looking statements in light of the risks to which they are subject.

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have not used derivative financial instruments. We believe our exposure to
market risks, including exchange rate risk, interest rate risk and commodity
price risk, is not material at the present time.

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PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

Lawsuits and claims are filed against the Company from time to time in the
ordinary course of business. We do not believe that any lawsuits or claims
currently pending against the Company, individually or in the aggregate, are
material, or will have a material adverse affect on our financial condition or
results of operations.

ITEM 2 - CHANGES IN SECURITIES

None

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its Annual Meeting of Shareholders at the Company's corporate
headquarters on July 25, 2002. At the meeting, the shareholders were asked to
vote on the election of directors and the ratification of the appointment of the
Company's independent public accountants. Each of these proposals was described
in the Company's Definitive Proxy Statement filed with the Commission on
June 21, 2002.

ELECTION OF DIRECTORS. At the meeting, the shareholders re-elected Robert B.
Barnhill, Jr. and Benn R. Konsynski, Ph.D. for a three-year term expiring at the
Company's 2005 Annual Meeting of Shareholders. The votes cast for Mr. Barnhill,
Jr. and Mr. Konsynski were as follows:

Robert B. Barnhill, Jr. 3,893,747 For
385,719 Withheld

Benn Konsynski, Ph.D. 4,261,047 For
18,419 Withheld

John D. Beletic and Morton F. Zifferer, Jr. currently serve as directors of the
Company. Their term expires at the 2003 Annual Meeting of Shareholders and until
their successors are elected and qualify. Jerome C. Eppler and Dennis J.
Shaughnessy also serve as directors of the Company. Their term expires at the
2004 Annual Meeting of Shareholders and until their successors are elected and
qualify.

INDEPENDENT AUDITORS. At the meeting, the shareholders ratified the appointment
of Ernst & Young LLP to serve as the independent public accountants of the
Company for the fiscal year ending March 30, 2003. The number of votes for was
4,272,666, the number of votes against or withheld was 5,375, and the number of
abstentions was 1,425.

ITEM 5 - OTHER INFORMATION

None

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ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS:

99.1 Robert B. Barnhill, Jr., Chief Executive Officer, Certification Pursuant to
18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

99.2 Robert C. Singer, Chief Financial Officer, Certification Pursuant to 18
U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

(b) REPORTS ON FORM 8-K
We filed current report on Form 8-K on June 4, 2002, reporting our change
of auditors from Arthur Andersen LLP to Ernst & Young LLP.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

TESSCO TECHNOLOGIES INCORPORATED

Date: August 14, 2002 By: /s/ ROBERT C. SINGER
-------------------------------
Robert C. Singer
Senior Vice President and Chief Financial
Officer
(principal financial and accounting officer)

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