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EX-32.1.1 - EX-32.1.1 - TESSCO TECHNOLOGIES INCtess-20160925ex3211f4667.htm
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EX-31.2.1 - EX-31.2.1 - TESSCO TECHNOLOGIES INCtess-20160925ex3121a1b08.htm
EX-31.1.1 - EX-31.1.1 - TESSCO TECHNOLOGIES INCtess-20160925ex3111ee460.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the quarterly period ended September 25, 2016

 

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: 001-33938

TESSCO Technologies Incorporated

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

52-0729657

(State or other jurisdiction of

incorporation or organization)

(I.R.S Employer

Identification No.)

 

 

 

 

11126 McCormick Road, Hunt Valley, Maryland

21031

(Address of principal executive offices)

(Zip Code)

 

 

(410) 229-1000

(Registrant’s telephone number, including area code)

 

 

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 ☑       No ☐

 

Indicate by check mark whether the registrant submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑       No ☐

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

 

Large accelerated filer ☐

Accelerated filer ☑

Non-accelerated filer ☐

Smaller reporting company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐       No ☑

 

The number of shares of the registrant’s Common Stock, $0.01 par value per share, outstanding as of October 28, 2016, was 8,332,089.

 

 

 

 


 

TESSCO Technologies Incorporated

Index to Form 10-Q

 

 

 

 

 

2


 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

TESSCO Technologies Incorporated

Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

 

    

September 25,

    

March 27,

 

 

 

 

2016

 

2016

 

 

 

 

(unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

10,754,800

 

$

16,882,800

 

 

Trade accounts receivable, net of allowance for doubtful accounts of $928,200 and $841,400, respectively

 

 

70,595,000

 

 

58,315,700

 

 

Product inventory, net

 

 

72,251,900

 

 

53,903,900

 

 

Prepaid expenses and other current assets

 

 

5,594,700

 

 

5,917,100

 

 

Total current assets

 

 

159,196,400

 

 

135,019,500

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

18,810,400

 

 

19,895,400

 

 

Goodwill, net

 

 

11,684,700

 

 

11,684,700

 

 

Deferred tax assets

 

 

 —

 

 

 —

 

 

Other long-term assets

 

 

2,969,400

 

 

2,816,400

 

 

Total assets

 

$

192,660,900

 

$

169,416,000

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Trade accounts payable

 

$

69,843,600

 

$

41,986,000

 

 

Payroll, benefits and taxes

 

 

5,094,400

 

 

4,927,900

 

 

Income and sales tax liabilities

 

 

1,187,200

 

 

1,456,800

 

 

Accrued expenses and other current liabilities

 

 

3,659,300

 

 

3,874,100

 

 

Revolving line of credit

 

 

 

 

 

 

Current portion of long-term debt

 

 

26,500

 

 

251,100

 

 

Total current liabilities

 

 

79,811,000

 

 

52,495,900

 

 

 

 

 

 

 

 

 

 

 

Deferred tax liabilities

 

 

364,900

 

 

379,400

 

 

Long-term debt, net of current portion

 

 

43,000

 

 

1,706,500

 

 

Other long-term liabilities

 

 

1,990,700

 

 

2,306,900

 

 

Total liabilities

 

 

82,209,600

 

 

56,888,700

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value, 500,000 shares authorized and no shares issued and outstanding

 

 

 —

 

 

 

 

Common stock $0.01 par value, 15,000,000 shares authorized, 14,027,934 shares issued and 8,317,551 shares outstanding as of  September 25, 2016, and 13,970,394 shares issued and 8,272,124 shares outstanding as of March 27, 2016

 

 

98,200

 

 

97,600

 

 

Additional paid-in capital

 

 

58,473,800

 

 

58,113,800

 

 

Treasury stock, at cost,  5,710,383 shares outstanding as of September 25, 2016 and 5,698,270 shares outstanding as of March 27, 2016

 

 

(57,432,800)

 

 

(57,245,200)

 

 

Retained earnings

 

 

109,312,100

 

 

111,561,100

 

 

Total shareholders’ equity

 

 

110,451,300

 

 

112,527,300

 

 

Total liabilities and shareholders’ equity

 

$

192,660,900

 

$

169,416,000

 

 

 

See accompanying notes.

 

3


 

TESSCO Technologies Incorporated

Unaudited Consolidated Statements of Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Quarters Ended

 

Six Months Ended

 

 

    

September 25, 2016

    

September 27, 2015

 

September 25, 2016

    

September 27, 2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

134,633,800

 

$

142,353,300

 

$

263,493,800

 

$

277,017,300

 

Cost of goods sold

 

 

105,878,200

 

 

111,841,600

 

 

207,632,200

 

 

217,523,700

 

Gross profit

 

 

28,755,600

 

 

30,511,700

 

 

55,861,600

 

 

59,493,600

 

Selling, general and administrative expenses

 

 

26,709,500

 

 

25,865,400

 

 

53,665,200

 

 

51,987,800

 

Income from operations

 

 

2,046,100

 

 

4,646,300

 

 

2,196,400

 

 

7,505,800

 

Interest expense, net

 

 

17,200

 

 

47,100

 

 

28,600

 

 

93,400

 

Income before provision for income taxes

 

 

2,028,900

 

 

4,599,200

 

 

2,167,800

 

 

7,412,400

 

Provision for income taxes

 

 

1,034,700

 

 

1,850,900

 

 

1,093,100

 

 

2,968,800

 

Net income

 

$

994,200

 

$

2,748,300

 

$

1,074,700

 

$

4,443,600

 

Basic earnings per share

 

$

0.12

 

$

0.33

 

$

0.13

 

$

0.54

 

Diluted earnings per share

 

$

0.12

 

$

0.33

 

$

0.13

 

$

0.54

 

Basic weighted-average common shares outstanding

 

 

8,310,300

 

 

8,238,065

 

 

8,300,000

 

 

8,218,905

 

Effect of dilutive options

 

 

13,900

 

 

32,130

 

 

20,900

 

 

40,573

 

Diluted weighted-average common shares outstanding

 

 

8,324,200

 

 

8,270,195

 

 

8,320,900

 

 

8,259,478

 

Cash dividends declared per common share

 

$

0.20

 

$

0.20

 

$

0.40

 

$

0.40

 

 

See accompanying notes.

4


 

TESSCO Technologies Incorporated

Unaudited Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

September 25, 2016

 

September 27, 2015

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

    

 

    

    

 

    

 

Net income

 

$

1,074,700

 

$

4,443,600

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

2,275,600

 

 

2,338,500

 

Non-cash stock-based compensation expense

 

 

192,400

 

 

399,700

 

Deferred income taxes and other

 

 

(370,300)

 

 

(287,500)

 

Change in trade accounts receivable

 

 

(12,279,300)

 

 

(6,592,600)

 

Change in product inventory

 

 

(18,348,000)

 

 

(2,736,100)

 

Change in prepaid expenses and other current assets

 

 

322,400

 

 

4,000,400

 

Change in trade accounts payable

 

 

27,857,600

 

 

4,644,800

 

Change in payroll, benefits and taxes

 

 

166,500

 

 

633,300

 

Change in income and sales tax liabilities

 

 

(338,800)

 

 

384,700

 

Change in accrued expenses and other current liabilities

 

 

(45,700)

 

 

(3,365,500)

 

Net cash provided by operating activities

 

 

507,100

 

 

3,863,300

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(1,190,600)

 

 

(1,753,800)

 

Net cash used in investing activities

 

 

(1,190,600)

 

 

(1,753,800)

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

Payments of debt issuance costs

 

 

(113,400)

 

 

 —

 

Payments on long-term debt

 

 

(1,888,100)

 

 

(125,400)

 

Proceeds from issuance of stock

 

 

68,300

 

 

81,200

 

Cash dividends paid

 

 

(3,323,700)

 

 

(3,306,100)

 

Purchases of treasury stock and repurchases of common stock from employees and directors for minimum tax withholdings

 

 

(187,600)

 

 

(826,900)

 

Excess tax benefit from stock-based compensation

 

 

 —

 

 

510,400

 

Net cash used in financing activities

 

 

(5,444,500)

 

 

(3,666,800)

 

 

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

 

(6,128,000)

 

 

(1,557,300)

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, beginning of period

 

 

16,882,800

 

 

7,524,000

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

10,754,800

 

$

5,966,700

 

 

See accompanying notes.

5


 

TESSCO Technologies Incorporated 

Notes to Unaudited Consolidated Financial Statements

 

Note 1. Description of Business and Basis of Presentation

 

TESSCO Technologies Incorporated, a Delaware corporation (TESSCO, we, our, or the Company), architects and delivers innovative product and value chain solutions to support wireless broadband systems. The Company provides marketing and sales services, knowledge and supply chain management, product-solution delivery and control systems, utilizing extensive internet and information technology. Approximately 98% of the Company’s sales are made to customers in the United States. The Company takes orders in several ways, including phone, fax, online and through electronic data interchange. Almost all of the Company’s sales are made in United States Dollars.

 

In management’s opinion, the accompanying interim consolidated 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 United States Securities and Exchange Commission (“SEC”). 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 consolidated 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 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 27, 2016.

 

 

Note 2. Reclassification of Items in Statement of Income and Supplemental Results Summary

 

The accompanying unaudited Consolidated Statements of Income for the fiscal quarter and six months ended September 27, 2015, along with the supplemental financial information provided in Note 10, have been adjusted to correct an immaterial error in the classification of indirect inventory costs in the income statement.  Prior to the third quarter of fiscal 2016, the Company classified indirect costs relieved from inventory upon a sale as selling, general and administrative expenses, as opposed to cost of goods sold. The income statements and supplemental financial information presented here correctly reflect indirect costs relieved from inventory as cost of goods sold for all periods.  This resulted in an increase in cost of goods sold, and a corresponding decrease in selling, general and administrative expenses of $3.3 million and $6.6 million for the fiscal quarter and six months ended September 27, 2015, respectively. These corrections have no impact on previously reported revenues, operating margin, net income, earnings per share, or on previously reported Consolidated Balance Sheets or Consolidated Statements of Cash Flows.

 

 

Note 3. Recently Issued Accounting Pronouncements

 

In August 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. The new standard will change the classification of certain cash payments and receipts within the cash flow statement. Specifically, payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest, will now be classified as financing activities. Previously, these payments were classified as operating expenses. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15,

6


 

2019, with early adoption permitted, and will be applied retrospectively. The Company does not expect that the adoption of this new standard will have a material impact on its Consolidated Financial Statements.  

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases. This ASU requires lessees to recognize most leases on their balance sheets related to the rights and obligations created by those leases. The ASU also requires additional qualitative and quantitative disclosures related to the nature, timing and uncertainty of cash flows arising from leases. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this new standard will have on its Consolidated Financial Statements.

 

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation – Stock Compensation. The new standard will modify several aspects of the accounting and reporting for employee share-based payments and related tax accounting impacts, including the presentation in the statements of operations and cash flows of certain tax benefits or deficiencies and employee tax withholdings, as well as the accounting for award forfeitures over the vesting period. The new standard is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this new standard will have on its Consolidated Financial Statements.

 

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Income Taxes. Current GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. The new standard simplifies the presentation of deferred tax assets and liabilities and requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015, with early adoption permitted. This ASU affected our disclosures relating to deferred tax assets and liabilities. The Company has applied this guidance retrospectively and it did not have a material impact on the consolidated balance sheets.

 

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.  In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, as a revision to ASU 2014-09, which revised the effective date to fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted but not prior to periods beginning after December 15, 2016 (i.e. the original adoption date per ASU 2014-09). In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations, which clarifies certain aspects of the principal-versus-agent guidance, including how an entity should identify the unit of accounting for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements, such as service transactions. The amendments also reframe the indicators to focus on evidence that an entity is acting as a principal rather than as an agent. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies how an entity should evaluate the nature of its promise in granting a license of intellectual property, which will determine whether it recognizes revenue over time or at a point in time. The amendments also clarify when a promised good or service is separately identifiable (i.e., distinct within the context of the contract) and allow entities to disregard items that are immaterial in the context of a contract. We are currently in the process of assessing the

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impact this new standard may have on our ongoing financial reporting and determining what transition method will be used. 

 

 

Note 4. Stock-Based Compensation

 

The Company’s selling, general and administrative expenses for the fiscal quarter and six months ended September 25, 2016 includes $76,600 and $192,400, respectively, of non-cash stock-based compensation expense. The Company’s selling, general and administrative expenses for the fiscal quarter and six months ended September 27, 2015 include $268,000 and $399,700, respectively, of non-cash stock-based compensation expense. Stock-based compensation expense is primarily related to our Performance Stock Units (PSUs), Restricted Stock Units, and Stock Options. In addition, the Company recorded an excess tax benefit directly to shareholders’ equity of $510,400, primarily related to the PSUs which vested during the six months ended September 27, 2015. No excess tax benefit related to PSU vesting was recorded during the six months ended September 25, 2016.

 

On July 26, 2016, the Company’s shareholders approved the Third Amended and Restated 1994 Stock and Incentive Plan (the Amended and Restated 1994 Plan), which amended and restated the Company’s Second Amended and Restated 1994 Stock and Incentive Plan, as previously amended (the 1994 Plan), in its entirety.  The material amendments to the 1994 Plan reflected by the Amended and Restated 1994 Plan are as follows:

 

·

Extension of Plan Term. The date through which awards may be granted was extended to July 21, 2021. Prior to this extension, the 1994 Plan was scheduled to expire on July 21, 2016.

·

Increase in Aggregate Share Limit. The Amended and Restated 1994 Plan increased the number of shares available for awards by 650,000 shares. The 1994 Plan had previously limited the aggregate number of shares of the Company's common stock that may have been delivered pursuant to all awards granted under the 1994 Plan to 3,553,125 shares. The Amended and Restated 1994 Plan increased the number of shares available for awards to 4,203,125 shares.

·

Elimination of Liberal Share Recycling. The Amended and Restated 1994 Plan, at Section 5(a)(iii), now prohibits liberal share recycling in respect of shares tendered by participants in payment of the exercise price for awards, or for payroll tax withholding obligations, and provides that such tendered shares shall not be available for purposes of the Amended and Restated 1994 Plan. Although the 1994 Plan could have been construed to permit it, the Company has not historically included such tendered shares as shares available for awards under the 1994 Plan.

 

On September 1, 2016, the Company appointed Murray Wright to serve as the Company’s President and Chief Executive Officer. In connection with Mr. Wright’s appointment, he was granted a stock option to purchase 250,000 shares of the Company’s common stock and 10,000 PSUs with a fiscal 2017 measurement year. The disclosures below for PSUs and stock options include these grants.

 

8


 

Performance Stock Units: The following table summarizes the activity under the Company’s PSU program for the first six months of fiscal 2017:

 

 

 

 

 

 

 

 

 

 

    

Six Months

    

Weighted

 

 

 

 

Ended 

 

Average Fair

 

 

 

 

September 25,

 

Value at Grant

 

 

 

 

2016

 

Date (per unit)

 

 

Unvested shares available for issue under outstanding PSUs, beginning of period

 

138,925

 

$

21.46

 

 

PSU’s Granted

 

207,000

 

 

10.77

 

 

PSU’s Vested

 

(26,736)

 

 

19.40

 

 

PSU’s Forfeited/Cancelled

 

(107,000)

 

 

21.72

 

 

Unvested shares available for issue under outstanding PSUs, end of period

 

212,189

 

$

11.16

 

 

 

Of the 212,189 unvested shares available for issue under outstanding PSUs as of September 25, 2016, 9,189 shares were previously earned in respect of the applicable measurement year, and will vest and be issued on or about May 1, 2017, assuming the respective participants remain employed by or associated with the Company on this date.

 

During fiscal 2017, the Compensation Committee of the Board of Directors with concurrence of the full Board of Directors, granted PSUs to select key employees, providing them with the opportunity to earn up to 207,000 shares of the Company’s common stock in the aggregate, depending upon whether and to the extent which certain earnings per share targets and other Company and individual performance metrics are met. These not-yet-earned PSUs have a one year measurement period (fiscal 2017), and assuming the performance metrics are met to a sufficient extent, any shares earned at the end of fiscal 2017 will vest and be issued ratably on or about May 1 of 2017, 2018, 2019 and 2020, provided that the respective employees remain employed by or associated with the Company on each date. Due to employee departures, 4,000 of these shares were subsequently canceled, leaving 203,000 unvested shares available for issue under PSUs granted in the current year, as of September 25, 2016.

 

The PSUs cancelled during fiscal 2017 related primarily to the fiscal 2016 grant of PSUs, which had a one year measurement period (fiscal 2016). The PSUs were cancelled because the applicable fiscal 2016 performance targets were not attained to any extent. Per the provisions of the 1994 Plan, the shares related to these forfeited and cancelled PSUs were added back to the 1994 Plan and became available for future issuance, now under the Amended and Restated 1994 Plan.

 

If the entire number of PSUs granted in fiscal 2017 is assumed to be earned on account of the applicable performance metrics being fully met, total unrecognized compensation costs on these PSUs and all earned but unvested PSUs, net of estimated forfeitures, would be approximately $2.2 million, as of September 25, 2016, and would be expensed through fiscal 2020. To the extent the actual forfeiture rate is different from what is anticipated or the maximum number of PSUs granted in fiscal 2017 is not earned, stock-based compensation related to these awards will differ from this amount.

 

Restricted Stock Units: The Company has over recent years made annual restricted stock unit (RSU) awards to its non-employee directors. On May 11, 2016, the Compensation Committee, with the concurrence of the full Board of Directors, awarded an aggregate of 10,000 RSUs, ratably to the non-employee directors of the Company. These awards provide for the issuance of shares of the Company’s common stock in accordance with a four year annual vesting schedule, following from the date of grant, provided that the director remains associated with the Company (or meets other criteria as prescribed in the applicable award agreement) on each such anniversary date.  As of September 25, 2016, there was approximately $0.4 million of total unrecognized compensation cost, net of estimated forfeitures, related to all outstanding restricted stock unit awards, including

9


 

the May 11, 2016 grant. Unrecognized compensation costs are expected to be recognized ratably over a weighted average period of approximately two years.

 

PSUs and RSUs are expensed based on the grant date fair value, calculated as the closing price of TESSCO common stock as reported by NASDAQ on the date of grant minus the present value of dividends expected to be paid on the common stock before the award vests, because dividends or dividend-equivalent amounts do not accrue and are not paid on unvested PSUs and RSUs.

 

To the extent the actual forfeiture rates are different from what is estimated, stock-based compensation related to the restricted awards will be different from the Company’s expectations.

 

Stock Options: As of September 25, 2016, there are 330,000 stock options outstanding. As of September 25, 2016, there was approximately $0.6 million of total unrecognized compensation cost, net of estimated forfeitures, related to all outstanding stock options. As of September 25, 2016, 17,500 of the outstanding stock options were vested.

 

 

Note 5. Borrowings Under Revolving Credit Facility

 

On June 24, 2016, the Company and its primary operating subsidiaries entered into a Credit Agreement (the “Credit Agreement”) with SunTrust Bank, as Administrative Agent. The Credit Agreement provides for a senior asset based revolving credit facility of up to $35 million (the “Revolving Credit Facility”), and replaces the Company’s previously existing $35 million unsecured revolving credit facility with both SunTrust Bank and Wells Fargo Bank, National Association, and which had no outstanding principal balance at the time of replacement. The new Revolving Credit Facility matures in five years, on June 24, 2021, and includes a $5.0 million sublimit for the issuance of standby letters of credit and a $10.0 million sublimit for swingline loans. The Credit Agreement also includes a provision permitting the Company, subject to certain conditions and approval of the Lenders, to increase the aggregate amount of the commitments under the Revolving Credit Facility to up to $50 million with optional additional commitments from existing Lenders or new commitments from additional lenders, although no Lender is obligated to increase its commitment. Borrowing availability is determined in part in accordance with a borrowing base, which is generally 85% of eligible receivables minus reserves. The Credit Agreement also contains financial covenants, including a fixed charge coverage ratio that must be maintained at any time during which the borrowing availability is otherwise less than $10 million. The Credit Agreement also may limit our ability to engage in specified transactions or activities, including (but not limited to) investments and acquisitions, sales of assets, payment of dividends, issuance of additional debt and other matters.

 

Borrowings initially accrue interest from the applicable borrowing date, generally the Eurodollar rate plus an applicable margin ranging from 1.5% to 1.75%.  Under certain circumstances, the applicable interest rate is subject to change from the Eurodollar rate plus the applicable margin to the base rate plus the applicable margin. Borrowings under the Revolving Credit Facility may be used for working capital and other general corporate purposes, and as further provided in, and subject to the applicable terms of, the Credit Agreement. As of September 25, 2016, we had a zero balance on the Revolving Credit Facility; therefore we had $35 million available, subject to the borrowing base limitation and compliance with the other applicable terms of the Credit Agreement including the covenants referenced above.

 

Pursuant to a related Guaranty and Security Agreement, by and among the Company, the other borrowers under the Credit Agreement and the other subsidiaries of the Company (collectively, the “Loan Parties”), and SunTrust Bank, as Administrative Agent, the Loan Parties’ obligations, which include the obligations under the

10


 

Credit Agreement, are guaranteed by the Loan Parties not otherwise borrowers, and secured by continuing first priority security interests in the Company’s and the other Loan Parties’ (including both borrowers and guarantors) inventory, accounts receivable, and deposit accounts, and on all documents, instruments, general intangibles, letter of credit rights, and chattel paper, in each case to the extent relating to inventory and accounts, and to all proceeds of the foregoing. The security interests are granted in favor of the Administrative Agent, for the benefit of the Lenders party to the Credit Agreement from time to time.  The obligations secured also include certain other obligations of the Loan Parties to the Lenders and their affiliates arising from time to time, relating to swaps, hedges and cash management and other bank products. 

 

 

Note 6. Extinguishment of Debt

 

Simultaneously with entering into the senior asset based Revolving Credit Facility described in Note 5, the Company terminated its $35 million unsecured revolving credit facility with SunTrust Bank and Wells Fargo Bank, National Association, which had no outstanding principal balance at the time of termination.

 

The Company also repaid in full its obligations under its Term Loan in the original principal amount of $4.5 million from Wells Fargo Bank, National Association and SunTrust Bank. The Term Loan was secured by a first position deed of trust encumbering Company-owned real property in Hunt Valley, Maryland and had an outstanding principal balance of $1.9 million at the time of repayment.

 

 

Note 7. Fair Value Disclosure

 

Assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

 

·

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.

·

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets, and quoted prices for identical or similar assets or liabilities in markets that are not active.

·

Level 3: Unobservable inputs for the asset or liability that reflect the reporting entity’s own assumptions about the inputs used in pricing the asset or liability.

 

The Company had no assets or liabilities required to be measured at fair value as of September 25, 2016 or as of March 27, 2016.

 

The carrying amounts of cash and cash equivalents, trade accounts receivable, trade accounts payable, accrued expenses and other current liabilities approximate their fair values as of September 25, 2016 and March 27, 2016 due to their short term nature. 

 

11


 

Fair value of long-term debt is calculated using current market interest rates, which we consider to be a Level 2 input as described in the fair value accounting guidance on fair value measurements, and future principle payments, as of September 25, 2016 and March 27, 2016 is estimated as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 25, 2016

 

March 27, 2016

 

 

 

 

Carrying

 

Fair 

 

Carrying

 

Fair 

 

 

 

 

Amount

 

Value

 

Amount

 

Value

 

 

Note payable to Baltimore County

 

$

69,500

 

$

66,700

 

$

82,600

 

$

78,700

 

 

 

 

Note 8. Income Taxes

 

As of September 25, 2016, the Company had a gross amount of unrecognized tax benefits of $291,700 ($192,500 net of federal benefit).  As of March 27, 2016, the Company had a gross amount of unrecognized tax benefits of $290,400 ($188,800 net of federal benefit).

 

The Company’s accounting policy with respect to interest and penalties related to tax uncertainties is to classify these amounts as part of the provision for income taxes. The total amount of interest and penalties related to tax uncertainties recognized in the consolidated statement of income for the first six months of fiscal 2017 was $27,000 (net of federal benefit). The cumulative amount included in the consolidated balance sheet as of September 25, 2016 was $364,000 (net of federal benefit). The total amount of interest and penalties related to tax uncertainties recognized in the consolidated statement of income for the first six months of fiscal 2016 was $31,800 (net of federal benefit). The cumulative amount of interest and penalties included in the consolidated balance sheet as of March 27, 2016 was $339,800 (net of federal benefit).

 

A reconciliation of the changes in the gross balance of unrecognized tax benefits, excluding interest is as follows:

 

 

 

 

 

 

 

    

 

    

 

Beginning balance at March 27, 2016 of unrecognized tax benefit

 

$

290,400

 

Increases related to current period tax positions

 

 

1,300

 

Reductions as a result of a lapse in the applicable statute of limitations

 

 

 —

 

Ending balance at September 25, 2016 of unrecognized tax benefits

 

$

291,700

 

 

 

Note 9. Earnings Per Share

 

The Company calculates earnings per share considering the Accounting Standard Codification No. 260 regarding accounting for participating securities, which requires the Company to use the two-class method to calculate earnings per share. Under the two-class method, earnings per common share is computed by dividing the sum of the distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the weighted average shares outstanding during the period. As of September 25, 2016 the Company had no participating securities outstanding and no distributed or undistributed earnings allocated to nonvested stock. As of September 27, 2015, the Company had 32,130 shares that qualified as participating securities. As such, the following table presents the calculation of basic and diluted earnings per common share for the fiscal quarter and six months ended September 27, 2015:

12


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal Quarter Ended

 

Six Months Ended

 

 

Amounts in thousands, except per share amounts

 

 

September 27, 2015

 

September 27, 2015

 

 

Earnings per share – Basic:

    

    

 

    

 

 

    

 

 

Net earnings

 

 

$

2,748

 

$

4,444

 

 

Less: Distributed and undistributed earnings allocated to nonvested stock

 

 

 

(7)

 

 

(12)

 

 

Earnings available to common shareholders – Basic

 

 

$

2,741

 

$

4,432

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding – Basic

 

 

 

8,238

 

 

8,219

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share – Basic

 

 

$

0.33

 

$

0.54

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share – Diluted:

 

 

 

 

 

 

 

 

 

Net earnings

 

 

$

2,748

 

$

4,444

 

 

Less: Distributed and undistributed earnings allocated to nonvested stock

 

 

 

(7)

 

 

(8)

 

 

Earnings available to common shareholders – Diluted

 

 

$

2,741

 

$

4,436

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding – Basic

 

 

 

8,238

 

 

8,219

 

 

Effect of dilutive options

 

 

 

32

 

 

41

 

 

Weighted average common shares outstanding – Diluted

 

 

 

8,270

 

 

8,260

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share – Diluted

 

 

$

0.33

 

$

0.54

 

 

 

 

 

 

 

 

 

 

 

 

Anti-dilutive equity awards not included above

 

 

 

80

 

 

80

 

 

 

 

At September 25, 2016, stock options with respect to 330,000 shares of common stock were outstanding, all of which were anti-dilutive. At September 27, 2015, stock options with respect to 80,000 shares of common stock were outstanding, all of which were anti-dilutive. There were no anti-dilutive PSUs or RSUs outstanding as of September 25, 2016 or September 27, 2015 respectively.

13


 

Note 10. Business Segments

 

The Company evaluates its business as one segment, as the chief operating decision maker assesses performance and allocates resources on a consolidated basis. However, to provide investors with increased visibility into the markets it serves, the Company also reports revenue and gross profit by the following customer market units:  (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) government system operators including federal agencies and state and local governments that run wireless networks for their own use;  (3) private system operators including commercial entities such as enterprise customers, major utilities and transportation companies; (4) 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; and (5) retailers, independent dealer agents and carriers.

 

To provide investors with better visibility, the Company also discloses revenue and gross profit by its four product categories:

 

·

Base station infrastructure products are used to build, repair and upgrade wireless telecommunications systems. Products include base station antennas, cable and transmission lines, small towers, lightning protection devices, connectors, power systems, miscellaneous hardware, and mobile antennas. Our base station infrastructure service offering includes connector installation, custom jumper assembly, site kitting and logistics integration.

 

·

Network systems products are used to build and upgrade computing and internet networks.  Products include fixed and mobile broadband equipment, distributed antenna systems (DAS), wireless networking, filtering systems, two-way radios and security and surveillance products.  This product category also includes training classes, technical support and engineering design services. 

 

·

Installation, test and maintenance products are used to install, tune, maintain and repair wireless communications equipment. Products include sophisticated analysis equipment and various

frequency-, voltage- and power-measuring devices, as well as an assortment of tools, hardware, GPS, safety and replacement and component parts and supplies required by service technicians.  

 

·

Mobile device accessories include cellular phone and data device accessories such as replacement batteries, cases, speakers, mobile amplifiers, power supplies, headsets, mounts, car antennas, music accessories and data and memory cards. Retail merchandising displays, promotional programs, customized order fulfillment services and affinity-marketing programs, including private label internet sites, complement our mobile devices and accessory product offering.

 

The Company evaluates revenue, gross profit, and income before provision for income taxes at a consolidated level.  Certain cost of sales and other applicable expenses have been allocated to each market unit or product type based on a percentage of revenues and/or gross profit, where appropriate.

14


 

Market unit activity for the second quarter and first six months of fiscal years 2017 and 2016 are as follows1 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

September 25, 2016

 

September 27, 2015

 

Revenues

    

 

    

    

 

    

 

Public Carriers, Contractors & Program Managers

 

$

18,532

 

$

25,803

 

Government System Operators

 

 

8,990

 

 

8,782

 

Private System Operators

 

 

23,735

 

 

23,056

 

Commercial Dealers & Resellers

 

 

32,256

 

 

34,055

 

Retailer, Independent Dealer Agents & Carriers

 

 

51,121

 

 

50,657

 

Total revenues

 

$

134,634

 

$

142,353

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

 

 

 

 

Public Carriers, Contractors & Program Managers

 

$

3,236

 

$

4,393

 

Government System Operators

 

 

2,092

 

 

2,093

 

Private System Operators

 

 

5,429

 

 

5,541

 

Commercial Dealers & Resellers

 

 

8,924

 

 

8,812

 

Retailer, Independent Dealer Agents & Carriers

 

 

9,075

 

 

9,673

 

Total gross profit

 

$

28,756

 

$

30,512

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

September 25, 2016

 

September 27, 2015

 

 

 

Revenues

    

 

    

    

 

    

 

 

 

Public Carriers, Contractors & Program Managers

 

$

35,110

 

$

50,954

 

 

 

Government System Operators

 

 

18,842

 

 

16,665

 

 

 

Private System Operators

 

 

45,250

 

 

45,078

 

 

 

Commercial Dealers & Resellers

 

 

65,686

 

 

67,543

 

 

 

Retailer, Independent Dealer Agents & Carriers

 

 

98,606

 

 

96,777

 

 

 

Total revenues

 

$

263,494

 

$

277,017

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

 

 

 

 

 

 

Public Carriers, Contractors & Program Managers

 

$

6,253

 

$

8,807

 

 

 

Government System Operators

 

 

4,232

 

 

4,040

 

 

 

Private System Operators

 

 

10,393

 

 

11,200

 

 

 

Commercial Dealers & Resellers

 

 

17,907

 

 

17,583

 

 

 

Retailer, Independent Dealer Agents & Carriers

 

 

17,077

 

 

17,864

 

 

 

Total gross profit

 

$

55,862

 

$

59,494

 

 

 

 


1 See Note 2 for a discussion of the reclassification of indirect inventory costs from selling, general, and administrative expenses to cost of goods sold, as it relates to the fiscal quarter and six months ended September 27, 2015. The financial information presented above in this Note 10 reflects such reclassification.

15


 

 

 

Supplemental revenue and gross profit information by product category for the second quarter and first six months of fiscal years 2017 and 2016 are as follows2 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

    

Three months ended

    

Three months ended

 

 

 

 

September 25, 2016

 

September 27, 2015

 

 

Revenues

 

 

 

 

 

 

 

 

Base station infrastructure

 

$

52,502

 

$

56,275

 

 

Network systems

 

 

21,461

 

 

22,425

 

 

Installation, test and maintenance

 

 

6,881

 

 

9,012

 

 

Mobile device accessories

 

 

53,790

 

 

54,641

 

 

Total revenues

 

$

134,634

 

$

142,353

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

 

 

 

 

 

Base station infrastructure

 

$

13,453

 

$

13,662

 

 

Network systems

 

 

3,421

 

 

3,372

 

 

Installation, test and maintenance

 

 

1,376

 

 

1,867

 

 

Mobile device accessories

 

 

10,506

 

 

11,611

 

 

Total gross profit

 

$

28,756

 

$

30,512

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Six months ended

    

Six months ended

 

 

 

 

September 25, 2016

 

September 27, 2015

 

 

Revenues

 

 

 

 

 

 

 

 

Base station infrastructure

 

$

104,897

 

$

110,098

 

 

Network systems

 

 

39,891

 

 

43,619

 

 

Installation, test and maintenance

 

 

15,636

 

 

17,630

 

 

Mobile device accessories

 

 

103,070

 

 

105,670

 

 

Total revenues

 

$

263,494

 

$

277,017

 

 

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

 

 

 

 

 

Base station infrastructure

 

$

26,881

 

$

27,758

 

 

Network systems

 

 

6,319

 

 

6,483

 

 

Installation, test and maintenance

 

 

2,944

 

 

3,497

 

 

Mobile device accessories

 

 

19,718

 

 

21,756

 

 

Total gross profit

 

$

55,862

 

$

59,494

 

 

 

 


2 See Note 2 for a discussion of the reclassification of indirect inventory costs from selling, general, and administrative expenses to cost of goods sold, as it relates to the fiscal quarter and six months ended September 27, 2015. The financial information presented above in this Note 10 reflects such reclassification.

 

 

Note 11. Stock Buyback

 

On April 23, 2014, the Board of Directors expanded the Company’s then existing stock buyback program and authorized the purchase on a non-accelerated basis of up to $10.0 million of the Company’s stock over a 24-

16


 

month period, which ended in April 2016. No shares were purchased during the first six months of fiscal year 2017 and the stock buyback program has now expired.

 

The Company also withholds shares from its employees and directors at their request, equal to the minimum federal and state tax withholdings related to vested performance stock units, stock option exercises and restricted stock awards. For the six months ended September 25, 2016 and September 27, 2015, the allocated value of the shares withheld totaled $187,600 and $827,000, respectively.

 

 

 

Note 12. Concentration of Risk

 

The Company’s future results could be negatively impacted by the loss of certain customer and/or vendor relationships.

 

For the fiscal quarter and six months ended September 25, 2016 and September 27, 2015, no customer accounted for more than 10.0% of total consolidated revenues.

 

For the fiscal quarter ended September 25, 2016, sales of Otter Products LLC and CommScope Incorporated products accounted for 10.1% and 9.4% of consolidated revenue, respectively. For the six months ended September 25, 2016, sales of Otter Products LLC and CommScope Incorporated products accounted for 11.2% and 9.8% of consolidated revenue, respectively. For the fiscal quarter ended September 27, 2015, sales of Otter Products LLC and CommScope Incorporated products accounted for 15.4% and 11.9% of consolidated revenue, respectively.  For the six months ended September 27, 2015, sales of Otter Products LLC and CommScope Incorporated products accounted for 14.7% and 11.4% of consolidated revenue, respectively.

 

 

Note 13. Subsequent Events

 

On October 11, 2016, Samsung Electronics Co. Ltd. announced the discontinuation and recall of its Galaxy Note 7 phone. The Company has not distributed this phone, but until recently distributed mobile device accessories related to it.  The Company’s inventory of these accessory products, which consists primarily of OEM inventory, but also includes some of the Company’s proprietary Ventev product, has been rendered largely obsolete on account of this discontinuation and recall.  Based on discussions with Samsung and the Company’s other primary vendors and customers for these accessory products, and after consideration of the Company’s investment in this inventory and assessment of its vendor return and reimbursement rights, the Company currently believes that, after accounting for anticipated vendor reimbursement, the net write-off related to this inventory will not be material.  These discussions and the Company’s assessment is continuing, however, and no assurances are offered that, even where the Company has return and reimbursement rights, those rights will be honored in a timely manner or at all, and the Company’s current belief is qualified accordingly. 

 

 

 

 

17


 

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 27, 2016.

 

Business Overview and Environment

 

TESSCO Technologies Incorporated (TESSCO, we, or the Company) architects and delivers innovative product and value chain solutions 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 we serve, we also report revenue and gross profit by the following market units: (1) public carriers, contractors and program managers; (2) government system operators; (3) private system operators; (4) commercial dealers and resellers, and (5) retailers, independent 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 telecommunication systems. 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 second quarter fiscal year 2017 revenue decreased by 5.4% compared to the second quarter of fiscal year 2016. We experienced second quarter fiscal 2017 revenue growth within our government system operators market of 2.4%, compared to the same quarter last year, primarily due to increased spending by our government contractor customers. We also experienced second quarter fiscal year 2017 revenue growth in our private systems operators market of 2.9%, as compared to the same quarter last year, related to increased sales from our utilities customers. The revenue growth in these markets for the second quarter of fiscal 2017 was more than offset by a revenue decline of 28.2% and 5.3% in our public carriers, contractors and program managers and commercial dealers and resellers markets, respectively, as many of our carrier customers continue to delay network deployments. However, we have seen sequential growth in our public carriers, contractors, and program managers market, with revenue increasing 11.8% in the second quarter of fiscal year 2017 as compared to the first quarter of fiscal year 2017. On the product side, revenue decreased in our installation, test and maintenance category and our base station infrastructure category by 23.6% and 6.7%, respectively, for the second quarter of fiscal year 2017, compared to the same quarter last year.

 

Our second quarter fiscal year 2017 gross profit decreased by 5.8%, compared to the second quarter of fiscal year 2016. The decrease in gross profit was primarily the result of the decreases in revenue discussed above. Total selling, general and administrative expenses increased by 3.3% compared to the prior-year quarter. As a result, net income decreased by 63.8% and diluted earnings per share decreased by 63.6% compared to the prior-year quarter.

18


 

 

On October 11, 2016, Samsung Electronics Co. Ltd. announced the discontinuation and recall of its Galaxy Note 7 phone. We have not distributed this phone, but until recently distributed mobile device accessories related to it. Our inventory of these accessory products is now largely obsolete.  Based on continuing discussions with Samsung and our other primary vendors and customers for these accessory products, and after consideration of our investment in this inventory and assessment of our vendor return and reimbursement rights, we currently believe that, after accounting for anticipated vendor reimbursement, the net write-off related to this inventory will not be material. These discussions and our assessment is continuing, however, and we do not offer any assurances that, even where we have return and reimbursement rights, those rights will be honored in a timely manner or at all, and our current belief is qualified accordingly.

 

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.

 

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. Our ability to maintain customer and vendor 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, industry experience and knowledge, and our large customer base and purchasing relationships with approximately 400 manufacturers, provide us with a significant competitive advantage over new entrants to the market.

 

The financial results presented herein for the fiscal quarter and six months ended September 27, 2015 have been adjusted to correct an immaterial error in the classification of indirect inventory costs in the income statement.  Prior to the third quarter of fiscal year 2016, the Company classified indirect costs relieved from inventory upon a sale as selling, general and administrative expenses, as opposed to cost of goods sold. The income statements presented here correctly reflects indirect costs relieved from inventory as cost of goods sold for all periods.  This resulted in an increase in cost of goods sold, and a corresponding decrease in selling, general and administrative expenses of $3.3 million and $6.6 million for the fiscal quarter and six month period ended September 27, 2015.  These corrections have no impact on previously reported revenues, operating margin, net income, earnings per share, or on previously reported Consolidated Balance Sheets or Consolidated Statements of Cash Flows.

19


 

Results of Operations

 

Second Quarter of Fiscal Year 2017 Compared with Second Quarter of Fiscal Year 2016

 

Total Revenues. Revenues for the second quarter of fiscal 2017 decreased 5.4% compared with the second quarter of fiscal 2016. Revenues in our government system operators market increased by 2.4%, compared to the same quarter last year, primarily due to increased spending by our government contractor customers. Revenues in our retailers, independent dealer agents and carriers market were relatively flat with a 0.9% increase for the second quarter of fiscal 2017, compared to the same period last year. Revenues in our private system operators market increased by 2.9% for the second quarter of fiscal 2017, compared to the same period last year, primarily due to increased sales from our utilities customers. This revenue growth was largely offset by a reduction in spending from Tier 1 carriers, and from customers working with and for these Tier 1 carriers. Revenues decreased in our public carrier, contractors and program managers market and our commercial dealer and resellers market by 28.2% and 5.3%, respectively, compared to the same quarter last year primarily due to this reduction in spending.

 

Total Gross Profit. Gross profit for the second quarter of fiscal 2017 decreased by 5.8% compared to the second quarter of fiscal 2016. Gross profit in our commercial dealers and resellers market increased by 1.3%. Gross profit in our government systems operator market remained flat, while gross profit in our retailers, independent dealer agents and carriers market decreased by 6.2% primarily due to a change in customer mix. Gross profit in our public carriers, contractors and program managers market decreased by 26.3%. Overall gross profit margin was flat at 21.4% for the second quarter of fiscal 2016 and fiscal 2017.

 

As discussed above under the heading “Business Overview and Environment,” our ongoing ability to earn revenues and gross profits from customers and vendors depends upon a number of factors which often differ for each relationship. Agreements or arrangements on which these relationships are based typically do not include any obligation in respect of any specific product purchase or sale, are of limited duration, and are terminable by either party upon relatively short notice. 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.  

 

Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by $0.8 million for the second quarter of fiscal 2017, compared to the second quarter of fiscal 2016. Selling, general and administrative expenses as a percentage of revenues increased from 18.2% for the second quarter of fiscal 2016, to 19.8% for the second quarter of fiscal 2017.

 

Compensation and benefit expenses and recruiting expenses increased by $0.5 million and $0.2 million, respectively, for the first quarter of fiscal 2017, compared to the first quarter of fiscal 2016. These increases are primarily due to continued investments related to our sales and marketing initiatives, as well as the appointment of our new President and Chief Executive Officer.

 

Pay for performance bonus expense (including both cash and equity plans) decreased by $0.3 million for the second quarter of fiscal 2017, compared to the second quarter of fiscal 2016. Our bonus programs are primarily based on achieving annual performance targets. The relationship between expected performance and actual performance led to lower bonus accruals for the second quarter of fiscal 2017 than for the comparable quarter of fiscal 2016. 

 

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

20


 

customers and make decisions regarding extension of credit terms to such customers based on this evaluation. We incurred bad debt expense of $214,800 and $186,600 for the fiscal quarter ended September 25, 2016 and September 27, 2015, respectively. 

 

Interest, Net. Net interest expense decreased from $47,100 for the second quarter of fiscal 2016 to $17,200 for the second quarter of fiscal 2017, due to the extinguishment of our term loan as discussed in Note 6.

 

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased from 40.2% for the second quarter of fiscal 2016 to 51.0% for the second quarter of fiscal 2017. The effective tax rate for the second quarter of fiscal 2017 was higher due to a higher ratio of permanent differences related to our projected pre-tax income. Our provision for income taxes decreased by 44.1% compared to the prior year quarter, primarily as a result of lower income before provision for income taxes. As a result of the factors discussed above, net income decreased 63.8% and diluted earnings per share decreased 63.6% for the second quarter of fiscal 2017, compared to the corresponding prior-year quarter.

 

First Six Months of Fiscal Year 2017 Compared with First Six Months of Fiscal Year 2016

 

Total Revenues. Revenues for the first six months of fiscal 2017 decreased 4.9% compared with the first six months of fiscal 2016. Revenues in our government system operators market increased by 13.1%, compared to the same period last year, primarily due to increased spending for network buildouts by state and local government customers, as well as government contract customers. Revenues in our retailers, independent dealer agents and carriers market increased by 1.9% for the first six months of fiscal 2017, compared to the same period last year. Revenues decreased in our public carriers, contractors and program managers market and our commercial dealers and resellers market by 31.1% and 2.7%, respectively, compared to the same period last year primarily due to a reduction in spending from Tier 1 carriers, and from customers working with and for these Tier 1 carriers. Revenue in our private system operators market remained flat from the first six months of fiscal 2017 compared to the first six months of fiscal 2016.

 

Total Gross Profit. Gross profit for the first six months of fiscal 2017 decreased by 6.1% compared to the first six months of fiscal 2016. Gross profits in our government system operators market and our commercial dealers and resellers market increased by 4.8% and 1.8%, respectively. However, this growth was more than offset by a reduction in our public carriers, contractors and program manager market and our private system operators market of 29.0% and 7.2%, respectively. Overall gross profit margin declined slightly to 21.2% for the first six months of fiscal 2017, compared to 21.5% for the same period last year.

 

As discussed above under the heading “Business Overview and Environment,” our ongoing ability to earn revenues and gross profits from customers and vendors depends upon a number of factors which often differ for each relationship. Agreements or arrangements on which these relationships are based typically do not include any obligation in respect of any specific product purchase or sale, are of limited duration, and are terminable by either party upon relatively short notice. 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.  

 

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 for the last two fiscal years and for fiscal 2017 year to date.

 

Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by $1.7 million for the first six months of fiscal 2017, compared to the first six months of fiscal 2016. Selling,

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general and administrative expenses as a percentage of revenues increased from 18.8% for the first six months of fiscal 2016, to 20.4% for the first six months of fiscal 2017.

 

Compensation and benefit expenses and recruiting expenses increased by $0.7 million and $0.8 million, respectively, for the first six months of fiscal 2017, compared to the first six month of fiscal 2016. These increases are primarily due to continued investments related to our sales and marketing initiatives, as well as the appointment of our new President and Chief Executive Officer.

 

Pay for performance bonus expense (including both cash and equity plans) decreased by $0.4 million for the first six months of fiscal 2017, compared to the first six months of fiscal 2016. Our bonus programs are primarily based on achieving annual performance targets. The relationship between expected performance and actual performance led to lower bonus accruals for the first six months of fiscal 2017 than for the comparable period of fiscal 2016. 

 

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 $530,200 and $657,800 for the six month ended September 25, 2016 and September 27, 2015, respectively. 

 

Interest, Net. Net interest expense decreased from $93,400 for the first six months of fiscal 2016 to $28,600 for the first six months of fiscal 2017, due to the extinguishment of our term loan, as discussed in Note 6.

 

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate increased from 40.1% for the first six months of fiscal 2016 to 50.4% for the first six months of fiscal 2017. The effective tax rate for the first six months of fiscal 2017 was higher due to a higher ratio of permanent differences related to our projected re-tax income. Our provision for income taxes decreased by 63.2% compared to the first six months of fiscal 2016, primarily as a result of lower income before provision for income taxes. As a result of the factors discussed above, net income decreased 75.8% and diluted earnings per share decreased 75.9% for the first six months of fiscal 2017, compared to the corresponding prior-year period.

 

Liquidity and Capital Resources

 

The following table summarizes our cash flows used in operating, investing and financing activities for the six months ended September 25, 2016 and September 27, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

    

September 25, 2016

    

September 27, 2015

    

 

Cash flow provided by operating activities

 

$

507,100

 

$

3,863,300

 

 

Cash flow used in investing activities

 

 

(1,190,600)

 

 

(1,753,800)

 

 

Cash flow used in financing activities

 

 

(5,444,500)

 

 

(3,666,800)

 

 

Net decrease in cash and cash equivalents

 

$

(6,128,000)

 

$

(1,557,300)

 

 

 

We generated $0.5 million of net cash from operating activities for the first six months of fiscal 2017, compared with net cash provided by operating activities of $3.9 million for the first six months of fiscal 2016. This fiscal 2017 inflow was driven by net income coupled with an increase in accounts payable, partially offset by increases in accounts receivable and product inventory. The increase in accounts payable was driven by the increase and timing of product inventory purchases. Our higher inventory levels are due to our higher quarter over quarter sales, as well as inventory procured for the iPhone 7 launch and the retail holiday season. The increase in accounts receivable is related to an increase in sales volume.

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Net cash used in investing activities of $1.2 million for the first six months of fiscal 2017 was down from expenditures of $1.8 million for the first six months of fiscal 2016. Cash used in both periods was due to capital expenditures largely comprised of investments in information technology.

 

Net cash used in financing activities was $5.4 million for the first six months of fiscal 2017, compared to $3.7 million for the first six months of fiscal 2016. During the first six months of both fiscal 2017 and fiscal 2016, we had cash outflows due to cash dividends paid to shareholders. Additionally, during the first six months of fiscal 2017, we had a cash outflow relating to the repayment of our term loan of $1.9 million. During the first six months of fiscal 2016, we had cash outflows due to stock repurchased 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 quarter of fiscal 2017 we entered into a senior asset based revolving credit facility of up to $35 million with SunTrust Bank, as Administrative Agent. The revolving credit facility is secured by our and our primary operating subsidiaries’ inventory, accounts receivable, and deposit accounts, and replaces our previously existing unsecured revolving credit facility with SunTrust Bank and Wells Fargo Bank, National Association. Interest on borrowings is payable monthly, generally at the Eurodollar rate plus an applicable margin ranging from 1.5% to 1.75%.  Under certain circumstances, the applicable interest rate is subject to change from the Eurodollar rate plus the applicable margin to the base rate plus an applicable margin. Borrowing availability is determined in part in accordance with a borrowing base, which is generally 85% of eligible receivables minus reserves. The credit agreement also contains financial covenants, including a fixed charge coverage ratio that must be maintained at any time during which the borrowing availability is otherwise less than $10 million. The credit agreement also may limit our ability to engage in specified transactions or activities, including (but not limited to) investments and acquisitions, sales of assets, payment of dividends, issuance of additional debt and other matters. The revolving credit facility has a five year term and expires on June 24, 2021. As of September 25, 2016, we had a zero balance on the revolving credit facility; therefore we had $35 million available, subject to the borrowing base limitation and compliance with the other applicable terms of the credit agreement, including the covenants referenced above.

 

In conjunction with entering into the new revolving credit facility noted above we repaid our term loan with an original principal amount of $4.5 million, from Wells Fargo Bank, National Association, and SunTrust Bank. At the time of repayment the loan had a balance of $1.9 million.

 

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 September 25, 2016, the principal balance of this term loan was $69,500.

 

We have made quarterly dividend payments to holders of our common stock since the third quarter of fiscal 2010. Our most recent quarterly cash dividend of $0.20 per share was paid in August 2016. On October 27, 2016, we declared a quarterly cash dividend in the amount of $0.20 per share, payable on November 23, 2016 to shareholders of record as of November 9, 2016. 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,

23


 

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 September 25, 2016, 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 a downturn in the global economy, among other factors.

 

Recent Accounting Pronouncements 

 

In August 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. The new standard will change the classification of certain cash payments and receipts within the cash flow statement. Specifically, payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest, will now be classified as financing activities. Previously, these payments were classified as operating expenses. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019, with early adoption permitted, and will be applied retrospectively. The Company does not expect that the adoption of this new standard will have a material impact on its Consolidated Financial Statements.  

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases. This ASU requires lessees to recognize most leases on their balance sheets related to the rights and obligations created by those leases. The ASU also requires additional qualitative and quantitative disclosures related to the nature, timing and uncertainty of cash flows arising from leases. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this new standard will have on its Consolidated Financial Statements.

 

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation – Stock Compensation. The new standard will modify several aspects of the accounting and reporting for employee share-based payments and related tax accounting impacts, including the presentation in the statements of operations and cash flows of certain tax benefits or deficiencies and employee tax withholdings, as well as the accounting for award forfeitures over the vesting period. The new standard is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this new standard will have on its Consolidated Financial Statements.

 

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Income Taxes. Current GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. The new standard simplifies the presentation of deferred tax assets and liabilities and requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015, with early adoption permitted. This ASU affected our disclosures relating to deferred

24


 

tax assets and liabilities. The Company has applied this guidance retrospectively and it did not have a material impact on the consolidated balance sheets.

 

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.  In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, as a revision to ASU 2014-09, which revised the effective date to fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted but not prior to periods beginning after December 15, 2016 (i.e. the original adoption date per ASU 2014-09). In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations, which clarifies certain aspects of the principal-versus-agent guidance, including how an entity should identify the unit of accounting for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements, such as service transactions. The amendments also reframe the indicators to focus on evidence that an entity is acting as a principal rather than as an agent. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies how an entity should evaluate the nature of its promise in granting a license of intellectual property, which will determine whether it recognizes revenue over time or at a point in time. The amendments also clarify when a promised good or service is separately identifiable (i.e., distinct within the context of the contract) and allow entities to disregard items that are immaterial in the context of a contract. We are currently in the process of assessing the impact this new standard may have on our ongoing financial reporting and determining what transition method will be used. 

 

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 27, 2016.

 

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, this Quarterly Report

25


 

on Form 10-Q, 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 either directly or indirectly as a result of consolidation among large wireless service carriers and others within the wireless communications industry; the strength of our customers', vendors' and affinity partners' business; increasingly negative or prolonged adverse economic conditions, including those adversely affecting consumer confidence or consumer or business spending, or otherwise adversely affecting our vendors or customers, including their access to capital or liquidity or our customers’ ability to fund or pay for our products and services; 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; 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, which could lead to significant inventory obsolescence and/or our inability to offer key products that our customers demand; third-party freight carrier interruption; increased competition, including from manufacturers or national and regional distributors of the products we sell and the absence of significant barriers to entry which could result in pricing and other pressures on profitability and market share; 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; our inability to protect certain intellectual property, including systems and technologies on which we rely; our inability to hire or retain our key professionals, management and staff; 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.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Interest Rate Risk:

 

We are exposed to an immaterial level of market risk from changes in interest rates. We have from time to time previously used interest rate swap agreements to modify variable rate obligations to fixed rate obligations, thereby reducing our exposure to interest rate fluctuations. We had no variable rate debt obligations as of September 25, 2016. Based on September 25, 2016 borrowing levels, a 1.0% increase or decrease in current market interest rates would have no effect on our statement of income.

26


 

Foreign Currency Exchange Rate Risk:

 

We are exposed to an immaterial level of market risk from changes in foreign currency rates.  Almost all of our sales are made in U.S. Dollars so we have an immaterial amount of foreign currency risk.  Those sales not made in U.S. Dollars are made in Canadian Dollars.

 

Item 4. Controls and Procedures.

 

The Company’s management, with the participation of the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)) as of the end of the period covered by this quarterly report. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Based on the evaluation of these controls and procedures required by Rules 13a-15(b) or 15d-15(b) of the Exchange Act, the Company’s management, including the CEO and CFO, have concluded that, as of the end of the period covered by this quarterly report, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to the Company’s management, including the Company’s CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. During the period covered by this quarterly report, there have been no changes to the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

27


 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Lawsuits and claims are filed against us 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 effect on our financial condition or results of operations. In addition, from time to time, we are also subject to review from federal and state taxing authorities in order to validate the amounts of income, sales and/or use taxes which have been claimed and remitted.

 

Item 1A. Risk Factors.

 

The following risk factors represent updates and additions to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended March 27, 2016. The risk factors listed below and the others described in the Annual Report on Form 10-K should be considered in connection with evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q.  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. Additional risks and uncertainties that management is not aware of or focused on, or that management currently deems immaterial may also adversely affect our business, financial position and results of operations.

 

We require substantial capital to operate, and the inability to obtain financing on favorable terms will adversely impact our business, financial position and results of operations. 

   

Our business requires substantial capital to operate and to finance accounts receivable and product inventory that are not financed by trade creditors. We have historically relied upon cash generated from operations, revolving credit facilities and trade credit from our vendors to satisfy our capital needs and finance growth. As the financial markets change and new regulations come into effect, the cost of acquiring financing and the methods of financing may change. Changes in our credit rating or other market factors may increase our interest expense or other costs of capital, or capital may not be available to us on competitive terms to fund our working capital needs. Our existing secured revolving credit facility contains various financial and other covenants that may limit our ability to borrow or limit our flexibility in responding to business conditions. The inability to maintain or when necessary obtain adequate sources of financing could have an adverse effect on our business. Our secured revolving credit facility involves variable rate debt, thus exposing us to risk of fluctuations in interest rates. Such fluctuations in interest rates could have an adverse effect on our business, financial position and results of operations. We may in the future use interest rate swaps in an effort to achieve a desired proportion of fixed and variable rate debt. We would utilize these derivative financial instruments to enhance our ability to manage risk, including interest rate exposures that exist as part of our ongoing business operations. However, our use of these instruments may not effectively limit or eliminate our exposure to a decline in operating results due to changes in interest rates.

   

Our ability to maintain and borrow under our revolving credit agreement could be constrained by the level of eligible receivables and by any failure to meet certain financial and other covenants in our revolving credit agreement.

   

Our borrowing availability under our secured revolving credit facility is determined in part by a borrowing base and is limited to certain amounts of eligible accounts receivable.  If the value of these accounts receivable were to decrease significantly, the amount available for borrowing under the facility would decrease and our ability to borrow under the facility could be significantly impacted. Borrowing under the facility is also

28


 

conditioned upon compliance with financial and other covenants included in the revolving credit agreement and a related guaranty and security agreement. Among these is a covenant to maintain a fixed charge coverage ratio at any time during which the borrowing availability is otherwise less than $10 million. There are no assurances that we will be able to comply with all applicable covenants in these agreements, and in the event that we do not, our ability to borrow under our secured revolving credit facility could be limited or suspended, or could terminate. 

 

If we fail to meet our payment or other obligations under our secured revolving credit facility, our lenders could foreclose on, and acquire control of, a significant portion of our assets.

 

Indebtedness under our secured revolving credit facility is secured by continuing first priority security interests in our inventory, accounts receivable, and deposit accounts, and on all documents, instruments, general intangibles, letter of credit rights, and chattel paper relating to inventory and accounts, and to all proceeds of the foregoing.  If we fail to meet our payment or other obligations under our secured revolving credit facility, our lenders could foreclose on these assets, which would have a material adverse effect on our business, results of operations and financial condition. 

 

We may not be able to continue to pay dividends on our common stock in the future, which could impair the value of our common stock.

 

We have paid a quarterly dividend on our common stock since the second quarter of fiscal year 2010. Any future declaration of dividends remains subject to further determination from time to time by our Board of Directors. Our ability to pay dividends in the future will depend on our financial results, liquidity and financial condition. Under Delaware law, dividends to shareholders may be made only from the surplus of a company, or, in certain situations, from the net profits for the current fiscal year or the fiscal year before which the dividend is declared.  Our secured revolving credit facility restricts our ability to pay cash dividends upon a default, and when our borrowing availability is below $12 million, subject to certain exceptions, and contains other financial covenants and ratios that could restrict future dividend payments. There is no assurance that we will be able to pay dividends in the future, or if we are able to, that our Board of Directors will continue to declare dividends in the future, at current rates or at all.  If we discontinue or reduce the amount or frequency of dividends, the value of our common stock may be impaired.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.  

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

Item 5. Other Information.

 

None.

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Item 6. Exhibits.  

 

(a)

Exhibits:

 

 

 

 

 

 

10.1.1

 

Employment Agreement, dated as of August 29, 2016, by and between the Company and Murray Wright (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 1, 2016).

10.2.2

 

Form of Stock Option to Murray Wright (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 1, 2016).

31.1.1*

  

Certification of Chief Executive Officer required by Rule 13a–14(a) or 15d–14(a) of the Securities Exchange Act of 1934, as amended pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2.1*

 

Certification of Chief Financial Officer required by Rule 13a–14(a) or 15d–14(a) of the Securities Exchange Act of 1934, as amended pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1.1*

 

Certification of periodic report by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2.1*

 

Certification of periodic report by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.1*