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Feb. 5, 2021, 4:47 p.m. EST

10-Q: TESSCO TECHNOLOGIES INC

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(EDGAR Online via COMTEX) -- 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 29, 2020, filed with the SEC on June 5, 2020.

Business Overview and Environment

TESSCO architects and delivers innovative product and value chain solutions to support wireless systems. Although we sell products to customers in many countries, approximately 96% 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.

At a closing on December 2, 2020, we sold most of our retail inventory, the Ventev brand as it relates to mobile device accessory products, and certain other retail-related assets to Voice Comm, LLC (Voice Comm). Cash proceeds of $9.5 million were received at closing, which occurred during the third quarter of fiscal 2021. As part of the sale agreement, we are entitled to royalty payments, up to $3.0 million in the aggregate, on the sale of Ventev branded products by Voice Comm over a four-year period after closing. Additionally, some customer returns we receive may be resold to Voice Comm over a two-year period after closing. As a result of the disposal, the operating results of our former Retail segment have been included in Income (loss) from discontinued operations, net of taxes in the Consolidated Statements of (Loss) Income for all periods presented.

As a result of this sale and our exit from the Retail business during the third quarter of fiscal 2021, we now operate as one business segment.

We provide certain information within two key markets: (1) public carriers, which are generally responsible for building and maintaining the infrastructure system and provide airtime service to individual subscribers; and (2) value-added resellers and integrators, which includes value-added resellers, the government channel and private system operator markets.

We offer a wide range of products that can generally be sold to any customer.

Our ongoing ability to earn revenues and gross profits from customers and suppliers 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 supplier's business, the supply and demand for the product or service, including price stability, changing customer or supplier requirements, and our ability to support the customer or supplier and to continually demonstrate that we can improve the way they do business. In addition, the agreements or arrangements on which our customer and supplier 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 customers and suppliers, and expect that we will again be so affected from time to time in the future. Our customer and supplier relationships could also be affected by wireless carrier consolidation or the overall global economic environment, or other events beyond our control, including the COVID-19 pandemic.

The wireless communications distribution industry is competitive and fragmented and is comprised of several

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national distributors. In addition, many manufacturers sell direct. Barriers to entry for distributors are relatively low, and the risk of new competitors entering the marketplace 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 supplier 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 350 manufacturers, provide us with a significant competitive advantage over new entrants to the marketplace.

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Results of Continuing Operations

Third quarter of Fiscal Year 2021 Compared with Third quarter of Fiscal Year 2020

Total Revenues. Revenues for the third quarter of fiscal 2021 decreased 1.6% compared with the third quarter of fiscal 2020. Revenues in our value-added resellers and integrators market decreased 10.7%, partially offset by a 13.6% increase in revenue in our public carrier market. This increase in the public carrier market was due to gaining additional market share and increased purchases from two of our largest customers this quarter. This decline in revenues in our value-added resellers and integrators market was largely driven by a combination of continued headwinds from the economic downturn, and the impact of COVID-19.

Cost of Goods Sold. Cost of goods sold for the third quarter of fiscal 2021 increased 0.9% compared with the third quarter of fiscal 2020. Cost of goods sold in our public carrier market increased by 14.6%, and cost of goods sold in our value-added resellers and integrators market decreased by 8.6%, in each case for the third quarter year over year. These changes in cost of goods sold in both markets were largely driven by changes in revenue and customer mix, as discussed above.

As discussed above under the heading "Business Overview and Environment," our ongoing ability to earn revenues and gross profits from customers and suppliers depends upon a number of factors that 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 customers and suppliers, and expect that we will again be so affected from time to time in the future. Our customer and supplier relationships could also be affected by wireless carrier consolidation or the overall global economic environment, or other events beyond our control, including the COVID-19 pandemic.

Total Gross Profit. Gross profit for the third quarter of fiscal 2021 decreased by 11.9% compared to the third quarter of fiscal 2020. This decrease was primarily due to customer mix as the lower margin public carrier market made up a larger percentage of total revenue in this quarter as compared to the prior year quarter. Gross profit margin in our public carrier market decreased to 11.1% from 11.9% in the same quarter last year. Gross profit margin in our value-added resellers and integrators market decreased to 22.3% in the third quarter of fiscal 2021 from 24.0% in the same quarter last year. We experienced margin compression within our public carrier market primarily due to a change in customer mix, with increased sales going to larger customers with lower margins. As a result of these drivers on gross profit and change in the mix of overall revenues by market, gross profit margin decreased to 17.4% in the third quarter of fiscal 2021, compared to 19.5% in the third quarter of fiscal 2020.

Selling, General, Administrative and Goodwill Impairment Expenses. Total selling, general and administrative expenses increased by $1.6 million for the third quarter of fiscal 2021, compared to the third quarter of fiscal 2020. Selling, general and administrative expenses as a percentage of revenues increased from 21.8% for the third quarter of fiscal 2020, to 23.8% for the third quarter of fiscal 2021.

The increase in our selling, general and administrative expenses was primarily due to an increase of $3.3 million in corporate support expense, partially offset by a $1.3 million decrease in compensation and benefit expense during the third quarter of fiscal 2021 as compared to the third quarter of fiscal 2020. The increase in corporate support expense is primarily due to costs related to the Company's response to a consent solicitation initiated by a shareholder group just prior to the end of the second quarter and completed during the third quarter of

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fiscal 2021. The reduction in compensation and benefit expense was related to lower operations costs and reductions in health insurance costs.

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 had bad debt expense of $7,500 and $446,800, for the three months ended December 27, 2020 and December 29, 2019, respectively.

Interest, Net. Net interest expense decreased from $367,900 for the third quarter of fiscal 2020 to $151,200 for the third quarter of fiscal 2021. A decrease in the average amount outstanding resulted in decreased interest expense under our secured Revolving Credit Facility and 2020 Revolving Credit Facility in the 2021 third fiscal quarter (discussed in Note 6 to our Consolidated Financial Statements, included in this Quarterly Report on Form 10-Q). In addition, capitalized interest increased from $32,500 from the third quarter of fiscal 2020 to $145,300 for the third quarter of fiscal 2021.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate decreased from 23.6% for the third quarter of fiscal 2020 to 11.5% for the third quarter of fiscal 2021. The decrease in the effective tax rate resulted from changes in rates applicable to net operating loss carrybacks and valuation allowances. We expect the tax rate to be higher for the rest of the fiscal year. Net loss from continuing operations increased 174.9% and diluted loss per share from continuing operations increased from $(0.24) to ($0.66) for the third quarter of fiscal 2021, compared to the corresponding prior-year quarter.

Discontinued Operations. Net income from discontinued operations was $4.8 million for the third quarter of fiscal year 2021 compared to a loss of $2.9 million for the third quarter of fiscal year 2020. The increase in net income was due to a $3.0 million gain on the sale of inventory to Voice Comm as discussed above, as well as sales to higher margin customers and lower selling, general and administrative expenses due to the sale of Retail inventory and exit from the Retail business during the quarter. Additionally, the company recorded a goodwill impairment of $2.6 million related to the Retail business during the third quarter of fiscal year 2020. See footnote 12, "Discontinued Operations", for further discussion.

First Nine Months of Fiscal Year 2021 Compared with First Nine Months of Fiscal Year 2020

Total Revenues. Revenues for the first nine months of fiscal 2021 decreased 6.1% compared with the first nine months of fiscal 2020. Revenues in our value-added resellers and integrators market decreased 11.9%, partially offset by an increase of 3.9% in revenue in our public carrier market. The increase in the public carrier market is primarily due to gaining additional market share. The decline in our value-added resellers and integrators market was largely driven by a combination of continued headwinds from the economic downturn, and the impact of COVID-19.

Cost of Goods Sold. Cost of goods sold for the first nine months of fiscal 2021 decreased 3.9% compared with the first nine months of fiscal 2020. Cost of goods sold in our value-added resellers and integrators market for the first nine months of fiscal 2021 decreased by 10.5%, partially offset by a 6.1% increase in cost of goods sold in our public carrier market for the first nine months of fiscal 2021, in each case compared to the first nine months of the prior fiscal year. These changes in cost of goods sold in both markets were largely driven by changes in revenue and customer mix, as discussed above.

As discussed above under the heading "Business Overview and Environment," our ongoing ability to earn revenues and gross profits from customers and suppliers depends upon a number of factors that often differ for

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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 customers and suppliers, and expect that we will again be so affected from time to time in the future. Our customer and supplier relationships could also be affected by wireless carrier consolidation or the overall global economic environment, or other events beyond our control, including the COVID-19 pandemic.

Total Gross Profit. Gross profit for the first nine months of fiscal 2021 decreased by 15.3% compared to the first nine months of fiscal 2020. This decrease was largely due to lower sales volume. Gross profit margin in our public carrier market decreased to 10.5% in the first nine months of fiscal 2021 from 12.3% in the same period last year. Gross profit margin in our value-added resellers and integrators market decreased to 22.9% in the first nine months of fiscal 2021, from 24.1% in the first nine months of fiscal 2020. We experienced margin compression within our public carrier market primarily due to a change in customer mix, with increased sales going to larger customers with lower margins. As a result of these drivers on gross profit, gross profit margin decreased to 17.9% in the first nine months of fiscal 2021, compared to 19.8% in the first nine months of fiscal 2020.

Selling, General, Administrative and Restructuring Expenses. Total selling, general and administrative expenses decreased by $2.5 million for the first nine months of fiscal 2021, compared to the first nine months of fiscal 2020. Selling, general and administrative expenses as a percentage of revenues increased from 22.6% for the first nine months of fiscal 2020, to 23.2% for the first nine months of fiscal 2021.

The decrease in our selling, general and administrative expenses was primarily due to a decrease of $4.8 million in compensation and benefit expense, partially offset by a $2.9 million increase in corporate support expense during the first nine months of fiscal 2021 as compared to the first nine months of fiscal 2020. These changes are primarily due to costs related to the Consent Solicitation and lower operations costs.

We also incurred a $0.5 million restructuring charge related to severance expense for the first nine months of fiscal 2020. No such charges were incurred during fiscal 2021.

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 had bad debt recovery, net of expense of $780,600 and bad debt expense of $474,200 for the nine months ended December 27, 2020 and December 29, 2019, respectively.

Interest, Net. Net interest expense decreased from $911,700 for the first nine months of fiscal 2020 to $367,800 for the first nine months of fiscal 2021. Decreases in interest rates have resulted in decreased interest expense under our secured Revolving Credit Facility (discussed in Note 6 to our Consolidated Financial Statements, included in this Quarterly Report on Form 10-Q). In addition, capitalized interest increased from $37,500 for the first nine months of fiscal 2020 to $252,200 for the first nine months of fiscal 2021.

Income Taxes, Net Income and Diluted Earnings per Share. The effective tax rate decreased from 22.2% for the first nine months of fiscal 2020 to 12.2% for the first nine months of fiscal 2021. The decrease in the effective tax rate resulted from changes in rates applicable to net operating loss carrybacks and valuation allowances. We expect the tax rate to be higher for the rest of the fiscal year. Net loss from continuing operations increased 77.3% and diluted loss per share from continuing operations increased from $(0.90) to ($1.56) for the first nine months of fiscal 2021, compared to the first nine months of fiscal 2020.

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Discontinued Operations. Net income from discontinued operations was $7.7 million for the first nine months of fiscal year 2021 compared to $0.1 million for the first nine months of fiscal year 2020. The increase in net income was due to a gain of $3.0 million on the sale of inventory and other assets related to our Retail segment, lower selling costs due to lower revenue and shipments, as well as lower selling, general and administrative expenses due to the sale of these Retail assets and our exit from the Retail segment during the third quarter of fiscal year 2021. Additionally, the Company recorded a goodwill impairment of $2.6 million related to the Retail business during the third quarter of fiscal year 2020. See Note 12, "Discontinued Operations", for further discussion.

Liquidity and Capital Resources

The following table summarizes our cash flows provided by or used in operating, investing and financing activities for the nine months ended December 27, 2020 and December 29, 2019.







                                                                      Nine Months Ended
                                                           December 27, 2020      December 29, 2019
        Cash flow used in operating activities            $         (388,000)    $       (3,794,200)
        Cash flow provided by (used in) investing
        activities                                                    148,200            (6,036,300)
        Cash flow provided by financing activities                    424,000              9,801,000
        Net increase (decrease) in cash and cash
        equivalents                                       $           184,200    $          (29,500)
        


Net cash used in operating activities was $0.4 million for the first nine months of fiscal 2021, compared with net cash used in operating activities of $3.8 million for the first nine months of fiscal 2020. The fiscal 2021 outflow was due to the net loss, a decrease in accounts payable, and a gain on the sale of retail assets, partially offset by the decrease in accounts receivable and inventory.

Net cash provided by investing activities was $0.1 million for the first nine months of fiscal 2021, compared to $6.0 million used in the first nine months of fiscal 2020. The fiscal 2021 inflow was due to the cash proceeds received from the sale of our Retail inventory, partially offset by capital expenditures, largely comprised of investments in information technology. Cash used in fiscal 2020 was due to capital expenditures, largely comprised of investments in information technology.

Net cash provided by financing activities was $0.4 million for the first nine months of fiscal 2021, compared to net cash provided by financing activities of $9.8 million for the first nine months of fiscal 2020. We utilized our asset based secured Revolving Credit Facility during the first nine months of fiscal 2021, leading to a cash inflow of $0.4 million during this period. During the first nine months of fiscal 2020, we utilized our asset based secured Revolving Credit Facility, leading to a cash inflow of $15.0 million during this period. This inflow was partially offset by a cash outflow of $5.1 million during the first nine months of fiscal 2020 due to cash dividends paid to shareholders. No cash dividend was paid during the first nine months of fiscal 2021.

On October 29, 2020, we entered into a Credit Agreement (the "Credit Agreement") among the Company, the Company's primary operating subsidiaries as co-borrowers, the Lenders party thereto, and Wells Fargo Bank, National Association ("Wells"), as Administrative Agent, swingline lender and an issuing bank, and terminated our previous secured Revolving Credit Facility. The Credit Agreement provides for a senior secured asset based revolving credit facility of up to $75 million (the "2020 Revolving Credit Facility"), which matures in forty-two months, on April 29, 2024. As of December 27, 2020, borrowings under the secured 2020 Revolving Credit Facility totaled $26.0 million; therefore, we then had $49.0 million available, subject to the Borrowing Base limitations and compliance with the other applicable terms of the Credit Agreement, including the financial and

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other covenants discussed in Note 6 to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Borrowings under the Credit Agreement accrue interest at the rates, and the Company is required to pay a monthly commitment fee, as also discussed in Note 6 to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

We believe that our existing cash, payments from customers and availability under the secured 2020 Revolving Credit Facility will be sufficient to support our operations for at least the next twelve months. To minimize interest expense, our policy is to apply excess available cash to reduce the balance outstanding from time to time on our secured Revolving Credit Facility. Our increased focus over the past several years on business opportunities for sales to our public carrier customers led to the recent expansion of our borrowing limits, as now reflected in the 2020 secured Revolving Credit Facility, and has at times resulted in increased borrowings and dependence on that facility. We expect this trend to continue, although at present we have no plans for any further expansion of the current facility. If we were to undertake an acquisition or other major capital purchases that require funds in excess of existing sources of liquidity, we would look to sources of funding from additional credit facilities, debt and/or equity issuances. As of December 27, 2020, 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

A description of recently issued and adopted accounting pronouncements is contained in Note 2 to our Consolidated Financial Statements.

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 29, 2020, filed with the SEC on June 5, 2020.

Off-Balance Sheet Arrangements

We have no material off-balance sheet arrangements.

Forward-Looking Statements

This Quarterly Report on Form 10-Q 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," "intends," "projects," "plans," "should," "would," "could," and similar expressions, but the absence of these words or phrases does not necessarily mean that a statement is not forward looking.

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Forward looking statements involve a number of known and unknown risks and uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. 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 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: the impact and results of any new or continued activism activities by Robert B. Barnhill, Jr. and/or other activist investors; 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' demand for, or 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, or technological failures, 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; health epidemics or pandemics or other outbreaks or events, or national . . .

Feb 05, 2021

COMTEX_380280370/2041/2021-02-05T16:46:54

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