TESSCO Technologies 10-K 2005
Documents found in this filing:
Washington, D.C. 20549
For the transition period from to
Commission file number 0-24746
TESSCO Technologies Incorporated
(Exact name of registrant as specified in its charter)
11126 McCormick Road, Hunt Valley, Maryland 21031
(Address, including zip code, of principal executive offices)
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark if the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes o No ý
The aggregate market value of Common Stock, $.01 par value, held by non-affiliates of the registrant based on the closing sales price of the Common Stock as quoted on the NASDAQ Stock Market as of September 26, 2004, was $38,856,177.
The number of shares of the registrants Common Stock, $.01 par value, outstanding as of June 1, 2005, was 4,245,636.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the definitive Proxy Statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Shareholders scheduled to be held July 21, 2005, are incorporated by reference into Part III.
TABLE OF CONTENTS
TESSCO Technologies Incorporated (TESSCO, or the Company) is a leading provider of integrated product and supply chain solutions to the professionals that design, build, run, maintain and use wireless mobile, fixed and in-building systems.
We link customers with integrated product and supply chain solutions configured from product choices made by world-class manufacturers. While creating Your Total Source® opportunity for our customers to improve the way business is done, we present, market, sell, supply, and support manufacturers products as a part of a total customer solution, thus providing a cost-effective channel to a broad and diverse customer base.
Our operational platform, which we refer to as our Knowledge, Configuration, Delivery and Control System (KCDCTM), allows customers and manufacturers the opportunity to streamline the supply chain process and lower total inventories and costs by providing guaranteed availability and complete, on-time delivery to the point of use.
We began our total source operations in 1982, reincorporated as a Delaware corporation in 1987 and have been listed on the NASDAQ Stock Market (symbol: TESS) since 1994. Today, we operate 24 hours a day, seven days a week, under ISO 9001:2000 registration. Our Global Logistics Center in Hunt Valley, Maryland and Americas Sales & Logistics Center in Reno, Nevada, configure orders for complete, on-time delivery throughout the world. Our solution offering, consisting of over 31,000 items from approximately 350 manufacturers, falls within the broad business segment categories of network infrastructure, mobile devices and accessories, and installation, test and maintenance products.
We currently serve approximately 9,900 commercial customers and 36,100 consumers per month, including a diversified mix of carrier and public network operators, infrastructure site owners, program managers, contractors and integrators, industrial and enterprise self-maintained users, governments, manufacturers, repair centers, retailers, dealers and value-added resellers, affinity partners and consumers.
We identify, select, present, market, sell, supply, and support products and services required to design, build, run, maintain and use a wireless system. We principally offer competitively priced, manufacturer brand-name products, ranging from simple hardware items to sophisticated test equipment, with per item prices ranging from less than $1 to $90,000 and gross profit margins ranging from less than 5% to over 90%. During fiscal 2005, we offered over 31,000 stock keeping units (SKUs), classified into our three business segments: network infrastructure, mobile devices and accessories and installation, test and maintenance products, which accounted for approximately 25%, 62% and 13% of revenues, respectively. Network infrastructure products are used to build, repair and upgrade wireless telecommunications, computing and Internet networks, and generally complement radio frequency transmitting and switching equipment provided directly by original equipment manufacturers (OEMs). Products include base station antennas, cable and transmission lines, fixed broadband equipment, filtering systems, small towers, lightning protection devices, connectors and miscellaneous hardware. Our network infrastructure service offering includes connector installation, custom jumper assembly, filter product tuning, site kitting and logistics integration. Mobile devices and accessory products include cellular telephones and other data devices, pagers and two-way radios and related accessories, such as replacement batteries, cases, speakers, mobile amplifiers, power supplies, headsets, mounts, car antennas and various wireless data devices. Retail merchandising displays, promotional programs, customized order fulfillment services and affinity-marketing programs, such as providing outsourced call centers and private label Internet sites, complement our mobile devices and accessory product offering. 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, replacement and component parts and supplies required by service technicians. For more detailed financial information regarding our business segments, for each of the past three fiscal years, see Note 9 to the Consolidated Financial Statements included in Item 8 to this Annual Report on Form 10-K for the fiscal year ended March 27, 2005.
While we principally provide manufacturer brand-name products, a variety of products, which are primarily subscriber accessory products and infrastructure accessory components, are developed and offered under a TESSCO-owned brand, Wireless Solutions®. We have incurred no significant research and development expenditures in each of the last three fiscal years.
Our products are sold as part of our integrated product and supply chain solutions. Our supply chain services for all product areas are grouped under Knowledge, Configuration, Delivery and Control. Knowledge solutions include product choice comparison, with comprehensive specifications organized by product, not manufacturer, reinforced by engineering, sales and technical support staff and hands-on training programs. Configuration services are comprised of customized product kitting, logistics management and consumer and retail merchandising and marketing, allowing the products to be delivered ready for immediate use, installation or resale. Our delivery system allows the customer to select 1-, 3- or 5-day just-in-time delivery, to specific delivery locations, designed to eliminate the customers need for staging and warehousing. We guarantee on-time, complete and error-free delivery. Our services that increase customer control include predetermined monthly pricing levels, the ability to monitor multi-site purchasing with pre-approved, customized parameters indicating who is able to order how much of which specific products, order delivery tracking, product and usage tracking and history reporting and alternative financing options.
As part of our commitment to customer service, we typically allow customers to return a product for any reason, for credit, within 30 days of the date of purchase. Total returns and credits have been less than 5% of revenues in each of the past three fiscal years.
As of March 27, 2005, we offered products purchased from approximately 350 manufacturers. A substantial portion of our purchases are concentrated with a small number of vendors. In fiscal 2005, products, primarily comprised of handsets, purchased directly from T-Mobile USA (T-Mobile), our largest vendor, and sold only to customers reached through our affinity relationship with T-Mobile, generated approximately 41% of our revenue and 7% of our gross profit. Overall sales to customers reached through our affinity relationship with T-Mobile, including not only our sales of the handsets purchased directly from T-Mobile, but also sales of phone accessories purchased by us from third-party vendors, and other supply chain billings, totaled 44% of our revenues and 20% of our gross profits in fiscal 2005. Our next nine top vendors accounted for approximately 19% of our fiscal 2005 revenues and 17% of our gross profits, thus resulting in revenue and gross profit from sales of products purchased from our top ten vendors of approximately 60% and 24% of our total revenues and gross profits, respectively. Although we do not maintain long-term supply contracts with our vendors, including T-Mobile, we believe that, for other than those products purchased by us as part of this and other affinity relationships as described below, alternative sources of supply are available for many of the product types we carry. The agreements and arrangements on which most of our affinity relationships are based, are of limited duration and terminable by either party upon several months notice.
As previously disclosed, T-Mobile is planning to transition the TESSCO provided e-commerce marketing and sales system to their own in-house web solution and alternative third-party logistics provider. In October 2004, we reached agreement with T-Mobile to continue providing our system through July 2005. In April 2005, this agreement was amended and now runs through August 2005. Upon completion of this transition, revenues from this affinity relationship will cease.
We supply repair and replacement materials to authorized service centers for Nokia Inc. (Nokia) in the United States, Canada and Latin America. Sales of the Nokia repair and replacement materials, that we purchase from Nokia and sell to approximately 800 separate and distinct service centers each month, accounted for approximately 4% of our total revenues in fiscal 2005. This relationship is a complete supply chain relationship and, therefore, we have no alternative sources of supply, and our purchases, and ultimately our resale, of these products is dependent upon the continuation of the Nokia relationship. We also sell products other than Nokia repair and replacement materials to many of these customers. Absent this arrangement with Nokia, we would maintain the ability to sell these other products to these customers.
We are dedicated to superior performance and quality and consistency of service in an effort to maintain and expand these types of relationships, but there can be no assurance that we will continue to be successful in this regard in the future or that competitive pressures or other events beyond our control will not have a negative impact on our ability to maintain these relationships or to continue to derive revenue from these relationships.
Our customer base consists of commercial customers and consumers, which accounted for approximately 53% and 47%, respectively, of fiscal 2005 revenues. Commercial customers share the characteristic that they are organizations that design, install, operate, repair or sell some type of wireless communications system. Our commercial customers are categorized into two different markets: 1) public carriers and network operators and 2) self-maintained users (SMUs), governments and resellers, which accounted for approximately 28% and 72%, respectively, of fiscal 2005 commercial revenues. Public carriers and network operators are systems operators that are generally responsible for building and maintaining the infrastructure system and provide airtime service to individual subscribers. SMUs, government and reseller customers include:
SMUs and government customers include commercial entities such as major utilities and transportation companies, federal agencies and state and local governments, including public safety organizations. TESSCO holds three General Services Administration (GSA) contracts including IT Schedule 70 for state and local government agencies.
Resellers include dealers and resellers that sell, install and service cellular telephone, paging and two-way radio communications equipment primarily for the consumer and small business markets. These resellers include local and national proprietorships and retailers, as well as sales and installation centers operated by cellular and paging carriers.
Consumers place orders for wireless phones, data devices, and related accessories via telephone and the Internet primarily through our affinity-marketing programs. Under these programs, we collaborate with our affinity-marketing clients, including OEMs, wireless carriers and dealers, to market to their customers under their brands. In most cases, we act as the merchant on behalf of the affinity-marketing client, interfacing with the customer, accepting the order, shipping from our inventory and collecting payment. Our affinity-marketing programs create a high level of customer service and supplementary income for the client through revenue share payments. In addition to our affinity programs, we developed and maintain our own consumer website, YourWirelessSource.com, which offers handsets, phone activations, cellular phone accessories from OEMs and Wireless Solutions®, our own private brand, and other complimentary consumer wireless products.
Our largest customer relationship, sales to customers reached through the T-Mobile relationship, accounted for approximately 44% of our revenues and 20% of gross profits during fiscal 2005. Under this relationship, we sell and deliver wireless phones and accessories to consumers and other end-users. Sales to customers reached through the T-Mobile relationship include sales of items purchased directly from T-Mobile, primarily handsets, sales of additional phone accessories purchased from other third-party vendors, and other supply chain services billings. As previously disclosed, T-Mobile is planning to transition the TESSCO provided e-commerce marketing and sales system to their own in-house web solution and alternative third-party logistics provider. In October 2004, we reached agreement with T-Mobile to continue providing our system through July 2005. In April 2005, this agreement was amended and now runs through August 2005. Upon completion of this transition, revenues from this affinity relationship will cease. Our next nine largest customer relationships accounted for 9% of our total revenues and gross profits during fiscal year 2005, and therefore, our top ten customer relationships totaled 53% and 29% of our total revenues and gross profits, respectively.
Although we currently service customers in over 100 countries, approximately 98% of our sales have been made to customers in the United States during each of the past three years. Due to our diverse product segments and our wide customer base, our business is not significantly affected by seasonality.
We believe that we have developed a highly integrated, technologically advanced and efficient method of operation based on the following key tenets:
Understanding and anticipating customers needs and building solutions by cultivating lasting relationships;
Allowing customers to make the best decisions by delivering product knowledge, not just information, through our knowledge tools, including the Solutions Guide, a one-of-a-kind industry resource, and TESSCO.com®, our Internet-based Solution and Transaction System;
Responding to what we refer to as the moments of truth by providing customers with sales, service and technical support, 24 hours a day, seven days a week, 365 days a year;
Providing customers what they need, when and where they need it by delivering integrated product and supply chain solutions; and
Helping customers enhance their operations by providing real-time order tracking and performance measurement.
We operate as a team of teams structured to enhance marketing innovation, customer focus and operational excellence and consist of these integrated units:
Market Development and Sales: To meet the needs of a dynamic and diverse marketplace, sales and marketing activities are organized on an end-market basis. Sales teams are focused on three primary markets: public carrier and network operator (e.g., carriers, infrastructure site owners, program site managers, contractors and integrators); SMUs, governments and resellers (e.g., self-maintained users, governments, manufacturers, repair centers, retailers, dealers, value-added resellers); and consumers (e.g., affinity programs, Web store programs and fulfillment and consumer services). This organization allows for the development of unique product and solution offerings to meet the needs of our diverse customer base.
We attempt to understand and anticipate customers needs and to build solutions by cultivating lasting relationships. Our commercial customer database contains detailed information on approximately 150,000 existing and potential customers, including the names of key personnel, past contacts, inquiries, and buying and credit histories. This extensive customer database enables us to identify and target potential customers and to market specific products to these targeted customers. Potential customers are identified through their responses to TESSCO.com®, direct-marketing materials, advertisements in trade journals and industry trade shows, as well as through referrals from other TESSCO customers and vendors. Customer relationship representatives pursue these customer inquiries through distribution of our knowledge tools and through phone contact, electronic communications and field visits. The information technology system tracks potential customer identification from the initial marketing effort through the establishment and development of a purchasing relationship. Once a customer relationship is established, we carefully analyze purchasing patterns and identify opportunities to encourage customers to make more frequent purchases of a broader array of products. Scheduled contacts are made to each regularly purchasing customer for the purpose of information dissemination, order generation, database maintenance and the overall enhancement of the business relationship. The process aims at the attraction of prospects to TESSCO, the conversion of these prospects to buying customers, and the ultimate migration to loyal, total source monthly buyers.
Solutions Development and Marketing: We actively monitor advances in technologies and industry trends, both through market research and continual customer interaction, and continue to enhance our product offering as new wireless communications products and technologies are developed.
In addition to determining the product offering, our product and solutions development teams provide the technical foundation for both customers and our personnel. The Wireless Product Knowledge System (WPKS) is continually updated to add new products and additional technical information in response to manufacturer specification changes and customer inquiries. WPKS contains detailed information on each SKU offered, including full product descriptions, category classifications, technical specifications, illustrations, product cost, pricing and delivery information, alternative and associated products, and purchase and sales histories. This information is available on a real-time basis to all of our personnel for product development, procurement, technical support, cataloging and marketing.
We utilize our WPKS to develop both broad-based and customized product information materials. These materials are designed to encourage both existing and potential customers to realize the value we provide in their product and supply chain decisions. We are an important source of their product requirements and solutions. These knowledge tools are an integrated suite of informational print and electronic media. They include: the Solutions Guide, which is distributed annually to over 55,000 current and prospective buyers; The Wireless Journal®, which is distributed to over 100,000 individuals each quarter and is designed to introduce the reader to our capabilities and product offerings and contains information on significant industry trends and product reviews; Technical Application Notes and White Papers, which provide in-depth planning and installation instructions and diagrams; Tech Tips, which offer suggestions and ideas from TESSCO customers; and TESSCO.com®. In fiscal 2005, we added the new Wireless Networking Solutions Guide, featuring 16 configured applications of the latest broadband, security, and networking solutions; the Wireless Devices and Accessories Specialty Guide, designed specifically for retailers as a countertop tool and in-store accessories sales solution;
the Wireless Technicians Solutions Guide, offering the people who make wireless work an easy in-the-field selection of tools, test equipment, and training sessions; the Site Planning Guide, created for carriers and tower contractors as they plan their site builds and repairs; a new complete Solutions Guide on CD, allowing a more mobile access to our entire product offering; and a monthly electronic version of The Wireless Journal, which is e-mailed to over 50,000 different customers, and is uniquely produced for various portions of our customer base.
TESSCO.com® is our virtual, Internet-based commerce site as well as wireless information superstore. It offers online access to a real time system of Knowledge, Configuration, Delivery and Control of product and supply chain solutions. Intended for our commercial customers who design, build, run, maintain or use everything wireless, its feature-rich capabilities include:
An electronic version of our printed Solutions Guides and other knowledge tools;
Vital industry-focused information and in-depth product knowledge, including illustrations, detailed specifications and application information;
Order reservations and order history review;
Real-time product availability for over 31,000 SKUs from approximately 350 manufacturers of network infrastructure products, mobile devices and accessory products, as well as installation, test and maintenance products;
The ability to view invoices online and customer-specific pricing, based on our tiered pricing levels tied to a customers aggregate purchase volume;
Easy ordering capabilities, including a worksheet ordering tool which allows for the construction of a total source order and worksheets can be saved with or without protection, copied and shared;
Order confirmation, specifying the contents, order status, delivery date, tracking number and total cost of an order;
Multiple product search options;
Six-month order history review; and
Pre-configured base solutions that can be customized to a particular customers needs.
Our knowledge tools empower our customers to make better decisions by delivering product knowledge, rather than just information. These tools also provide our manufacturers the opportunity to develop their brands and to promote their products to a broad and diverse customer base.
Procurement and Inventory Management: Our product management and purchasing system aims to provide customers with a total source of broad and deep product availability, while maximizing our return on our inventory investment.
We use our information technology system to monitor and manage our inventory. Historical sales results, sales projections and information regarding vendor lead times are all used to determine appropriate inventory levels. The information technology system also provides early warning reports regarding upcoming inventory requirements. As of March 27, 2005 and March 28, 2004, we had an immaterial level of backlog orders. All backlog orders as of March 27, 2005, are expected to be filled within 90 days of fiscal year-end. For the fiscal years ended March 27, 2005 and March 28, 2004, inventory write-offs were 0.4% and 1.0% of total purchases, respectively. Generally, we have been able to return slow-moving inventory to our vendors pursuant to stock rotation agreements. Inventory turns for fiscal years 2005 and 2004 were 8.2 and 8.1, respectively.
Customer Support and Order Entry: The customer support teams are responsible for responding to what we refer to as the moments of truth by providing sales and customer support services by means of an effective and efficient transaction system. We also continually monitor our customer service performance through report cards included with each product delivery, customer surveys and regular interaction with customers. By combining our broad product offering with a commitment to superior customer service, we seek to reduce a customers overall procurement costs by enabling the customer to consolidate the number of suppliers from which it obtains products, while also reducing the customers need to maintain high inventory levels.
Our information technology system provides detailed information on every customer account, including recent inquiries, buying and credit histories, separate buying locations within a customer account and contact diaries for key personnel, as well as detailed product information, including technical, product availability and pricing information. The
information technology system increases sales productivity by enabling any customer support representative to provide any customer with personalized service and also allows non-technical personnel to provide a high level of technical product information and order assistance.
We believe that our commitment to providing prompt, friendly and efficient customer service before, during and after the sale enables us to maximize sales, customer satisfaction and retention. The average number of commercial customers per month has increased from 9,400 in fiscal 2004 to 9,900 in fiscal 2005. An average of 36,100 consumer end-users were served per month in fiscal 2005 as compared to 34,500 in fiscal 2004.
Fulfillment and Distribution: Orders are received at our Hunt Valley and Reno customer sales support centers. As orders are received, customer representatives have access to technical information, alternative and complementary product selections, product availability and pricing information, as well as customer purchasing and credit histories and recent inquiry summaries. An automated materials-handling system, which is integrated with the product planning and procurement system, allows us to ensure inventory control, minimize multiple product shipments to complete an order and limit inventory duplication. Bar-coded labels are applied to every product, allowing distribution center personnel to utilize radio frequency scanners to locate products, fill orders and update inventory records in real-time, thus reducing overhead associated with the distribution functions. Orders are delivered to customers by a variety of freight line and parcel transportation carriers with whom we contract. During fiscal 2005, we made a substantial investment in this system, which we now refer to as our Configuration, Fulfillment and Delivery technology system, at our Global Logistics Center. We expect to begin realizing productivity gains from this investment during fiscal year 2006. These planned productivity gains should include compensation savings at current order levels, increased accuracy on shipments and inventory counts, increased flexibility for business growth, and other technology driven productivity improvements. The same system will be implemented at our Americas Sales & Logistics Center during fiscal 2006.
Delivery charges are calculated on the basis of the weight of the products ordered and on the delivery service requested, not distance to the customer. We believe that this approach, combined with our Performance and Delivery Guarantee, which emphasizes on-time delivery instead of shipment dates, enables customers to minimize their inventories and reduce their overall procurement costs, thereby encouraging them to make us their total source supplier.
Information Technology: Critical to the success of our operations is our information technology system. We have made substantial investments in the development of this system, which integrates cataloging, marketing, sales, fulfillment, inventory control and purchasing, financial control and internal and external communications. The information technology system includes highly developed customer and product databases and is integrated with our distribution centers. The information contained in the system is available on a real-time basis to all of our employees and is utilized in every area of our operations. In fiscal 2005, we made an investment in our Configuration, Fulfillment and Delivery technology system at our Global Logistics Center as discussed above.
We develop, construct, maintain and host several Web sites for certain affinity partners. These sites include increased control capabilities, including partner branding, independent landing pages and URLs, product filtering and purchase authorization limits that allow us to seamlessly interact with the customer, fulfill online orders and provide required information to these affinity partners.
We believe that we have been successful to date in pursuing a highly integrated, technologically advanced and efficient method of operations; however, disruption to our day-to-day operations, including failure of our information technology system, distribution system, or freight carrier interruption, could impair our ability to receive and process orders or to ship product in a timely and cost-efficient manner.
The wireless communications distribution industry is competitive and fragmented, and is comprised of several national distributors, such as Hutton Communications, Cellstar, Brightpoint, Sprint North Supply, Anixter, Westcon, Comstor, Tech Data, Ingram Micro and Wincomm, as well as numerous regional distributors, including Talley Communications. In addition, many manufacturers sell and fulfill directly to customers. Barriers to entry for distributors are relatively low, particularly in the mobile devices and accessory market, and the risk of new competitors entering the market is high. In addition, the agreements or arrangements with our customers or vendors looking to us for product and supply chain solutions, are typically of limited duration and are terminable by either party upon several months notice.
Accordingly, our ability to maintain these relationships is subject to competitive pressures and challenges. We believe, however, that our strength in service, the breadth and depth of our product offering, our information technology system, our large customer base and purchasing relationships with approximately 350 manufacturers provide us with a significant competitive advantage over new entrants to the market. Some of our current competitors, particularly certain manufacturers, have substantially greater capital resources and sales and distribution capabilities. In response to competitive pressures from any of our current or future competitors, we may be required to lower selling prices in order to maintain or increase market share, and such measures could adversely affect our operating results.
Continuing changes in the wireless communications industry, including risks associated with conflicting technology, changes in technology, inventory obsolescence, and consolidation among wireless carriers, could adversely affect future operating results. In addition, we view the rapid expansion of Internet technology as a positive business opportunity; however, this technology and evolving Internet business models could also present additional competitive pressures and challenges.
We believe that the principal competitive factors in supplying products to the wireless communications industry are the quality and consistency of customer service, particularly timely delivery of complete orders, breadth and quality of products offered and total procurement costs to the customer. We believe that we compete favorably with respect to each of these factors. In particular, we believe we differentiate ourselves from our competitors based on the breadth of our product offering, our ability to quickly provide products and supply chain solutions in response to customer demand and technological advances, the level of our customer service and the reliability of our order fulfillment process.
We seek to protect our intellectual property through a combination of trademarks, service marks, confidentiality agreements, trade secret protection and, if and when appropriate, patent protection. Thus far, we have generally sought to protect our intellectual property, including our product data and information, customer information and information technology systems, through trademark filings and nondisclosure, confidentiality and trade secret agreements. We typically require our employees, consultants and others having access to our technology to sign confidentiality and nondisclosure agreements. There can be no assurance that these confidentiality and nondisclosure agreements will be honored, or whether they can be fully enforced, or that other entities may not independently develop systems, technologies or information similar to that on which we rely.
TESSCO Communications Incorporated, a wholly-owned subsidiary of TESSCO Technologies Incorporated, maintains a number of trade names and registered trademarks in connection with our business activities, including TESSCO®, Delivering What You Need When and Where You Need It®, Your Total Source®, Your Virtual Inventory®, Delivering Everything For Wireless®, The Wireless Journal®, Wireless Solutions®, The Vital Link to a Wireless World®, Transmitter®, T-Flash®, Techdirect®, and A Simple Way of Doing Business Better®. Our general policy is to file for trademark and service mark protection for each of our trademarks and trade names and to enforce our rights against any infringement.
Although we currently hold no patents, we intend, if and when appropriate, to seek patent protection for patentable technology. The ability to obtain patent protection involves complex legal and factual questions. Others may obtain patent protection for technologies that are important to our business, and as a result, our business may be adversely affected. In response to patents of others, we may need to license the right to use technology patented by others, or in the event that a license cannot be obtained, to design our systems around the patents of others.
We are subject to various laws and governmental regulations concerning environmental matters and employee safety and health in the United States. We are also subject to regulation by the Occupational Safety and Health Administration concerning employee safety and health matters. Compliance with these federal, state and local laws and regulations related to protection of the environment and employee safety and health has had no material effect on our business. There were no material capital expenditures for environmental projects in 2005 and there are no material expenditures planned for such purposes in 2006.
As of March 27, 2005, we had 592 full-time equivalent employees. Of our full-time equivalent employees, 289 were engaged in customer and vendor service, marketing, sales and product management, 221 were engaged in fulfillment and distribution operations and 82 were engaged in administration and technology systems services. No employees are covered by collective bargaining agreements. We consider our employee relations to be excellent.
Executive officers are appointed annually by the Board of Directors and serve at the discretion of the Board of Directors. Information regarding our executive officers is as follows:
Our corporate headquarters and primary distribution center, known as the Global Logistics Center (GLC), is located in a Company-owned 184,000 square-foot facility located north of Baltimore in Hunt Valley, Maryland. Our sales, marketing and administrative offices are located in leased office space near the GLC. This lease expires in May 2007, but can be terminated by us with twelve months written notice. Monthly rent payments range from $110,300 to $117,200 throughout the lease term. West Coast sales and fulfillment is facilitated by our Company-owned 115,000 square-foot Americas Sales & Logistics Center (ALC) located in Reno, Nevada. The ALC is used to configure and fulfill product and supply chain solutions, provide disaster backup for the GLC, and allow for future growth of staffing and increased fulfillment capabilities. The GLC is encumbered by a deed of trust as security for a term loan. See Note 7 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Each of our three business segments uses all of our properties for either sales or fulfillment purposes.
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 affect on our financial condition or results of operations.
Our common stock has been publicly traded on the NASDAQ Stock Market since September 28, 1994, under the symbol TESS. The quarterly range of prices per share during fiscal years 2004 and 2005 are as follows:
As of June 1, 2005, the number of stockholders of record of the Company was 67. We estimate that the number of beneficial owners as of that date was approximately 2,500.
We have never declared or paid any cash dividends on our common stock and do not expect to pay any cash dividends in the foreseeable future. Our revolving line of credit agreement prohibits the payment of cash dividends without the prior written consent of the lender.
During the first quarter of fiscal 2004, our Board of Directors established a stock buyback program and authorized the purchase of up to 450,000 shares. To date, we have repurchased 366,903 shares of our outstanding common stock pursuant to this program for $3,661,800 or an average price of $9.98 per share. Of the total shares repurchased, 254,003 shares were repurchased in fiscal 2005 at an average price of $11.45 per share and 112,900 shares were repurchased in fiscal 2004 at an average price of $6.68 per share. An aggregate of 83,097 shares remain available for repurchase under this program. No repurchases were made in any month during the fourth quarter of fiscal 2005, and no timetable has been set for the completion of this program.
The information required by Item 201(d) of Regulation S-K, pursuant to paragraph (a) of this Item 5, is incorporated by reference to the information set forth under the caption Equity Compensation Plan Information in the Companys Proxy Statement for the 2005 Annual Meeting of Stockholders, which is anticipated to be filed pursuant to Regulation 14A no later than one hundred twenty (120) days following the end of the fiscal year reported on.
Quarterly Results of Operations (Unaudited)
This Managements Discussion and Analysis (MD&A) should be read in conjunction with the other sections of this Annual Report on Form 10-K, including Part I, Item 1: Business, Part II, Item 6: Selected Financial Data, and Part II, Item 8: Financial Statements and Supplementary Data. The various sections of this MD&A contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the Additional Risks Factors section of this MD&A. Our actual results may differ materially from those described in any such forward-looking statement.
Business Overview and Environment
TESSCO Technologies Incorporated (TESSCO) is a leading provider of integrated product and supply chain solutions to the professionals that design, build, run, maintain and use wireless mobile, fixed and in-building systems. Although we sell products to customers in over 100 countries, approximately 98% of our sales are made to customers in the United States. We have operations and office facilities in both Hunt Valley, Maryland and Reno, Nevada. Due to the diversity in our business, we are not significantly affected by seasonality.
We offer a wide range of products that are classified into three business segments: network infrastructure, mobile devices and accessories, and installation, test and maintenance. Network infrastructure products, which are sold to our commercial customers, are used to build, repair and upgrade wireless telecommunications, computing and Internet networks. Sales of traditional network infrastructure products, such as cable, transmission lines and antennas are in part dependent on capital spending in the wireless communications industry. However, we have also been growing our offering of wireless broadband and in-building products, which are not as dependent on the overall capital spending of the industry. Mobile devices and accessory products include cellular telephones and other mobile devices, pagers and two-way radios and related accessories. Mobile devices and accessory products are widely sold to commercial customers and consumers. Commercial customers include retail stores, value-added resellers and dealers. Consumers are primarily reached through our affinity partnerships, where we offer services including customized order fulfillment, outsourced call centers, and building and maintaining private label Internet sites. Installation, test and maintenance products, which are sold to our commercial customers, are used to install, tune, maintain and repair wireless communications equipment. Approximately 40% of all of our installation test and maintenance sales are generated from the sales of replacement parts and materials for original equipment manufacturers such as Nokia, Inc. (Nokia). The remainder of this segment is made up of sophisticated analysis equipment and various frequency-, voltage- and power-measuring devices, as well as an assortment of tools, hardware and supplies required by service technicians. Both our repair and replacement parts sales and consumer sales through our affinity partnerships are reliant on relationships with a small number of vendors. We view our customer base in three major categories. Commercial public carriers and network operators are systems operators that are generally responsible for building and maintaining the infrastructure system and provide airtime service to individual subscribers. Commercial SMUs, government and reseller customers include:
SMUs and government customers include commercial entities such as major utilities and transportation companies, federal agencies and state and local governments, including public safety organizations. TESSCO holds three General Services Administration (GSA) contracts including IT Schedule 70 for state and local government agencies.
Resellers include dealers and resellers that sell, install and service cellular telephone, paging and two-way radio communications equipment primarily for the consumer and small business markets. These resellers include local and national proprietorships and retailers, as well as sales and installation centers operated by cellular and paging carriers.
Consumers are customers buying through one of our affinity partner relationships or directly from our consumer website, YourWirelessSource.com.
The wireless communications distribution industry is competitive and fragmented, and is comprised of several national distributors. In addition, many manufacturers sell direct. Barriers to entry for distributors are relatively low, particularly in the mobile devices and accessory market, and the risk of new competitors entering the market is high. The recent consolidation of larger wireless carriers has and will most likely continue to impact our current and potential customer base. In addition, the agreements or arrangements with our customers or vendors looking to us for product and
supply chain solutions are typically of limited duration and are terminable by either party upon several months notice. Our ability to maintain these relationships is subject to competitive pressures and challenges. We believe, however, that our strength in service, the breadth and depth of our product offering, our information technology system, our large customer base and purchasing relationships with approximately 350 manufacturers provide us with a significant competitive advantage over new entrants to the market.
As previously disclosed, T-Mobile USA (T-Mobile), our largest affinity relationship, is planning to transition the TESSCO provided e-commerce marketing and sales system to their own in-house web solution and alternative third-party logistics provider. In October 2004, we reached agreement with T-Mobile to continue providing our system through July 2005. In April 2005, this agreement was amended and now runs through August 2005. Upon completion of this transition, revenues from this affinity relationship will cease. Under the April 2005 amendment, we will provide standby services in August for a fee, which we believe will provide a net profit contribution for August at a level comparable to prior months, before profits generated by sales, if any. During fiscal 2005, sales from the T-Mobile relationship represented 44% of our revenues and 20% of our overall gross profit and included sales of items purchased directly from T-Mobile, primarily handsets, sales of additional phone accessories purchased by us from other third-party vendors, and supply chain service billings. The gross profit margin on these sales was approximately 8.5% in fiscal 2005, compared to gross profit margin on non-T-Mobile revenues of approximately 26.0% for the same period. The 8.5% T-Mobile gross profit margin is after product-material costs only, and does not include operating or indirect expenses necessary to support this business. These expenses are a significant portion of overall selling, general and administrative expenses and include: freight out and distribution supplies; compensation and benefit costs related to fulfillment and returns processing, in-bound call center, program management, and credit and collections; credit card fees and bad debt expenses related to cash collections directly from end users; and e-commerce expenses. Indirect expenses include executive involvement, depreciation of technology and operating assets, facilities, and other overhead costs.
Under the terms of our agreement with T-Mobile, we will continue servicing T-Mobile and its customers during the transition period. Unless we replace the lost T-Mobile business between now and then with new or additional business, the loss of T-Mobile as a customer will have a material adverse effect on our revenues, margins, and profits. However, management has been and will continue to be diligently focused on redeploying resources to new opportunities and reducing expenses in an effort to lessen the impact of the loss of the T-Mobile business. There can be no assurances about the extent to which we will be able to lessen the impact. Regardless of the impact, we do not believe the scheduled termination of the T-Mobile relationship will cause any material impairment of our assets.
Results of Operations
The following table summarizes the results of our operations for fiscal years 2005, 2004 and 2003:
NM not meaningful
Fiscal 2005 Compared to Fiscal 2004
Revenues. Revenues grew 46%, in fiscal 2005 over fiscal 2004 driven by growth in each of our three business segments and both our commercial and consumer markets. Total commercial sales grew 20%, while consumer sales grew 91%.
We experienced significant growth in both commercial and consumer sales of mobile devices and accessory products. The increase in consumer sales of mobile devices and accessories revenues was primarily due to strong growth in our affinity consumer-direct sales channel, primarily attributed to increased volumes from our ongoing T-Mobile affinity relationship. Handset and accessory revenues from this affinity relationship with T-Mobile collectively accounted for approximately 44% of total revenues in fiscal year 2005; however, gross profit generated through the T-Mobile relationship represents only 20% of our total gross profit. In fiscal 2005, aggregate sales of mobile devices and accessories through both our T-Mobile relationship and our other affinity consumer-direct sales channels represented 47% of our total revenues, but because a significant portion of these sales relate to lower margin handset sales as described below, gross profit from these sales represented only 29% of our total gross profit. Commercial revenues for mobile devices and accessories, which are sold primarily to SMUs, governments and resellers, but also to public carriers and network operators, increased 28% over the prior year, due in part to enhanced merchandising and packaging programs and an increase in data product sales.
The 13% increase in our network infrastructure sales is attributable to increases in sales of RF propagation products such as antennas and cable, as well as increased sales of broadband and in-building products. The market for RF propagation products continues to be challenging, but we believe that pent up demand for new technologies and increased spending in homeland security and public safety have contributed to our growth in this line of business. The market for broadband and in-building products continues to emerge and grow. During fiscal year 2005, we increased marketing efforts in this area, added several new vendors and improved inventory availability. These initiatives led to growth in broadband sales of approximately 20% this fiscal year. Substantially all of our growth in sales of network infrastructure product was in sales to SMUs, governments and resellers as we have focused on diversification beyond the traditional infrastructure carrier customer. Although we believe the market for both broadband and RF propagation products will continue to grow, there can be no assurance that these trends will continue.
The 25% increase in installation, test and maintenance revenues is primarily attributable to increased sales of high dollar test equipment and increased sales of repair and replacement parts under our relationships with several Original Equipment Manufacturers. We believe that the increased capital spending leading to our growth in network infrastructure sales has also contributed to the increase in installation, test and maintenance sales. Similarly, there can be no assurance that such trends will continue.
Gross Profit. Gross profit grew 22% in fiscal 2005 compared to fiscal 2004, driven by growth in each of our three business segments and both of our commercial and consumer markets. Total commercial gross profit grew 18%, while consumer gross profit grew 33%. Gross profit margin decreased to 18.5% in fiscal 2005 from 22.0% in fiscal 2004. Gross profit margin decreased to 23.5% from 24.9% in our network infrastructure segment and decreased to 26.5% from 26.7% in our installation, test and maintenance segment. Generally, our gross margins by product within these segments have been sustained and these minor variations are related to sales mix within the segment product offerings, including the sales growth of lower margin broadband products in our network infrastructure line of business. Gross profit margin in our mobile devices and accessories segment decreased to 14.8% from 19.0%. This decrease is wholly attributable to a decrease in gross profit margin for our consumer sales, and was minimally offset by an increase in gross profit margin for our commercial sales. The decrease in gross profit margin for our consumer sales, from 16.0% to 11.1% was due to significantly increased volume of lower margin handset sales attributable to our affinity relationship with T-Mobile. The minor increase in commercial gross profit margin, from 25.5% to 26.8% is attributable to sales mix within the product offering. We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.
Our on-going ability to earn revenues and gross profits from customers and vendors looking to us for product and supply chain solutions is dependent upon a number of factors. The terms, and accordingly the factors, applicable to each affinity relationship often differ. Among these factors are the strength of the customers or vendors 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 affinity relationships are based are typically of limited duration, and are terminable by either party upon several months or otherwise relatively short notice. These affinity relationships could also be affected by wireless carrier consolidation.
Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased by 15% in fiscal 2005 compared to fiscal 2004. Due to the increase in revenues and other factors discussed below, total selling, general and administrative expenses decreased as a percentage of revenues to 16.5% in fiscal 2005, from 20.8% in fiscal 2004.
The largest factor contributing to the increase in total selling, general and administrative expenses was increased fulfillment costs associated with the large growth in consumer revenue and to a lesser extent, the growth in commercial sales. Largely because of the continued success of our affinity relationships, the number of orders we delivered in fiscal 2005 grew 36% compared to fiscal 2004. During the fourth quarter of fiscal 2005, fulfillment costs and labor costs increased due to start-up issues associated with our new Configuration, Fulfillment and Delivery technology system that was initiated during the quarter. We expect only minor start-up costs relating to this system to continue into the first quarter of fiscal 2006.
Also contributing to the increase in total selling, general and administrative expenses are costs associated with our reward plans, including the expensing of stock options, expenses associated with Performance Stock Units (PSU), and
accrual of bonus and other cash reward payments. During fiscal 2005, we recognized stock compensation expense, primarily associated with the PSUs and the expensing of previously issued stock options, of $886,900.
Occupancy costs have also increased due to rent and related costs associated with our sales, marketing and administrative offices. Through May 2004, these occupancy obligations were reimbursed through insurance proceeds, and in June of fiscal 2005, we became solely responsible for these ongoing obligations. This leased space was originally used as temporary space during the October 2002 disaster. Following the disaster and during the subsequent rebuilding of our Global Logistics Center, we decided to continue using this facility. This rental expense increase was partially offset by rent expense savings related to a facility that was consolidated into our Global Logistics Center near the end of the third quarter of fiscal 2004, at which time we incurred a charge for the remaining lease payments for the consolidated facility, which run through March 2006.
Beginning in fiscal 2005, credit card and other banking and related fees were included in selling, general and administrative expenses; these fees had previously been classified as interest, fees and other expense, net on the Consolidated Statements of Income. Credit card and other banking and related fees for fiscal 2004 and 2003 have been reclassified to selling, general and other administrative expenses to conform to the current year presentation. These fees increased $518,100 from fiscal 2004 to fiscal 2005, primarily due to higher credit card fees associated with the increase in consumer sales.
We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve based on this evaluation. We also evaluate the credit worthiness of prospective customers and make decisions regarding extension of credit terms to such prospects based on this evaluation. Accordingly, we recorded a provision for bad debts of $1,227,000 and $999,000 for the years ended March 27, 2005 and March 28, 2004, respectively.
Interest, net. Net interest expense for fiscal 2005 was flat as compared with fiscal 2004 as we only took minor draws on our revolving line of credit in each year. Interest expense on our other debt instruments had only minor variances from year to year in total.
Income Taxes, Net Income and Diluted Earnings Per Share. The effective tax rates in fiscal 2005 and 2004 were 38.9% and 39.8%, respectively. The effective tax rate for fiscal 2005 decreased due to minor changes in the relationship between non-deductible expenses and taxable income. As a result of the factors discussed above driving growth in sales, gross profit and selling, general and administrative expenses, net income and diluted earnings per share for fiscal 2005 increased 110% and 114%, respectively, compared to fiscal 2004.
Fiscal 2004 Compared to Fiscal 2003
Revenues. Revenues increased by 29% in fiscal 2004 compared to fiscal 2003 driven by strong growth in sales of network infrastructure and mobile devices and accessories products. Total commercial sales grew 6% and consumer sales grew 109%.
In fiscal 2004, sales of mobile devices and accessories through our affinity consumer-direct sales channel represented 36% of our total revenues, but because a significant portion of these sales related to lower margin handset sales as described below, gross profit from this channel represented only 26% of our total gross profit. The increase in mobile devices and accessories revenues was primarily due to strong growth in our affinity consumer-direct sales channel, as well as growth in our commercial business. The significant increase in affinity consumer-direct revenues is attributed to increased volumes from our ongoing T-Mobile affinity relationship. Handset and accessory revenues from this affinity relationship with T-Mobile collectively accounted for approximately 31% of total revenues in fiscal year 2004; however, gross profit generated through the T-Mobile relationship represented only 13% our total gross profit. Commercial revenues for mobile devices and accessories increased 10% over the prior year, due in part to enhanced merchandising and packaging programs and an increase in data product sales.
We believe that pent up demand for improved mobile phone coverage and new broadband technologies led to increased capital spending compared to the prior year, which resulted in an 18% increase in sales of our network infrastructure products. We also believe that increased spending in homeland security and public safety at the federal, state and local levels have contributed to increased network infrastructure sales.
The 17% decline in installation, test and maintenance revenues in fiscal 2004 was primarily attributable to a significant decrease, driven by market conditions, in the selling prices of repair and replacement parts pursuant to our relationship with Nokia under which these materials were supplied to Nokias authorized service centers in the United States.
Gross Profit. Gross profit increased by 9% in fiscal 2004 compared to fiscal 2003. Gross profit margin decreased to 22.0% in fiscal 2004 from 26.0% in fiscal 2003. Total commercial gross profits increased 3%, while consumer gross profits increased 30%. Gross profit margin decreased to 24.9% from 25.9% in our network infrastructure segment and decreased to 26.7% from 27.5% in our installation, test and maintenance segment. Generally, our gross margins by product within these segments have been sustained and these minor variations are related to sales mix within the segment product offerings. Gross profit margin in our mobile devices and accessories segment decreased to 19.0% from 25.3%. This decrease was wholly attributable to a decrease in gross profit margin for our consumer sales, and was partially offset by an increase in gross profit margin for our commercial sales. The decrease in gross profit margin for our consumer sales was due to significantly increased volume of lower margin handset sales attributable to our affinity relationship with T-Mobile. The minor increase in commercial gross profit margin was attributable to sales mix within the product offering. We account for inventory at the lower of cost or market, and as a result, write-offs/write-downs occur due to damage, deterioration, obsolescence, changes in prices and other causes.
Selling, General and Administrative Expenses. Total selling, general and administrative expenses increased 9% in fiscal 2004 compared to fiscal 2003. Due to the increase in revenues and productivity gains discussed below, total selling, general and administrative expenses decreased as a percentage of revenues to 20.8% in fiscal 2004, from 24.6% in fiscal 2003.
The largest factor for the increase in total selling, general and administrative expenses was increased fulfillment costs associated with the large growth in consumer revenue. Primarily because of the continued success of our affinity relationships, the number of orders we delivered in fiscal 2004 grew 19% compared to fiscal 2003.
Marketing, sales promotion and compensation for commercial business generation also increased in fiscal 2004. Although our employee count declined slightly from fiscal 2003, the number of employees involved in business generation activities increased from 256 at the end of fiscal 2003 to 269 at the end of fiscal 2004. Increased compensation expenses are also attributable to approximately $510,000 of expense related to a stock option repurchase program completed on June 5, 2003.
Corporate expenses also increased as a result of increased insurance premiums and increased bad debt expense as noted below, which was primarily a result of increased consumer orders. We continually evaluate the credit worthiness of our existing customer receivable portfolio and provide an appropriate reserve, based on this evaluation. We also evaluate the credit worthiness of prospective customers and make decisions regarding extension of credit terms to such prospects based on this evaluation. Accordingly, we recorded a provision for bad debts of $999,000 and $616,100 for the years ended March 28, 2004 and March 30, 2003, respectively.
The increases in selling, general and administrative expenses were partially offset by the results of our productivity and profitability program, which was initiated at the beginning of the third quarter of fiscal 2004. This program was designed to improve profitability at then current revenue levels and to strengthen our foundation for future profitable growth, and included a restructuring of our organization, policies and processes, and a consolidation of facilities. Selling, general and administrative expense savings were primarily a result of a people count reduction, due to the termination of 21 employees, facility consolidation, and other productivity improvements.
Also related to the productivity program, we recorded $2.3 million in restructuring charges during the third quarter of fiscal 2004. This charge consisted of $164,000 in severance pay and other minor costs to implement the productivity and profitability program discussed above and a $2.1 million charge relating to the consolidation of our distribution facilities from three to two. The facility consolidation portion of the charge was based on then current assumptions, and represents exit costs, including asset write-offs, as well as the then present value of a continuing facility lease obligation. Due to real estate market conditions and the short remaining lease term, we did not expect to be able to sub-lease the vacated facility for significant amounts, the term for which expires in March 2006. Beginning in the fourth quarter of fiscal 2004, we realized selling, general and administrative expense savings of approximately $250,000 per quarter relating to this facility consolidation. However, beginning in June of fiscal 2005, these savings were offset by additional rent expense discussed in the following paragraph. Although the present value of the continuing facility obligation has already been
recognized as a restructuring charge, payment of the facility lease obligation continues to be paid monthly through March 2006, and has been and will continue to be funded from cash flow from operations, if available, or from our revolving credit facility.
Certain selling, general and administrative expenses were also affected by the October 12, 2002 disaster in which our primary office, distribution center and network operating center was flooded as a result of a malfunctioning public water main system. Depreciation expense increased slightly in fiscal 2004. Most of the assets destroyed in the disaster were replaced toward the end of the third quarter of fiscal 2004 as our Global Logistics Center rebuild was completed. This increased depreciation was partially offset by depreciation savings from assets destroyed in the disaster, which were written off and are no longer being depreciated. Depreciation also increased due to the opening of our Reno, Nevada facility in June 2003. Also, as a result of the October 12, 2002 disaster, we relocated our sales, marketing and administrative offices to a subleased location near our Global Logistics Center. Beginning in June of fiscal 2005, we began incurring approximately $500,000 per quarter in rent and related expenses associated with this leased facility, which is charged to operations. The rent for this facility was funded by insurance proceeds through May 2004, and therefore was not included in selling, general and administrative expenses in fiscal 2004.
Also relating to the disaster, we recorded a benefit from insurance proceeds during fiscal 2004 of $3.1 million, representing the final settlement of insurance claims. We recorded a benefit from insurance proceeds during fiscal 2003 of $1.2 million. Each of these benefits resulted in increased operating income as reported in our Consolidated Statements of Income for the applicable periods.
Interest, net. Net interest expense increased by 59% in fiscal 2004 compared to fiscal 2003. In fiscal 2003, approximately $150,000 of interest was capitalized relating to renovations performed at the Americas Sales and Logistics Center. Accordingly, interest increased in fiscal 2004, despite lower borrowings and interest rates.
Income Taxes, Net Income and Diluted Earnings Per Share. The effective tax rates in fiscal 2004 and 2003 were 39.8% and 38.5%, respectively. The effective tax rate for the fiscal year increased due to minor changes in the relationship between non-deductible expenses and taxable income. As a results of the factors discussed above, net income and diluted earnings per share for fiscal 2004 decreased 5% and 3%, respectively, compared to fiscal 2003.
Liquidity and Capital Resources
Working capital increased to $41.0 million as of March 27, 2005, from $37.3 million as of March 28, 2004. Stockholders equity increased to $60.8 million as of March 27, 2005, from $56.3 million as of March 28, 2004.
We generated $4.3 million of net cash from operating activities in fiscal 2005 compared to $5.6 million in fiscal 2004. In fiscal 2005, our cash flow from operations was driven largely by net income plus depreciation and amortization and a significant increase in trade accounts payable, partially offset by significant increases in both accounts receivable and product inventory. The large increase in accounts payable is largely a result of increased inventory purchases. These inventory purchases were necessary to support increased sales volumes and are related to all lines of business, but were primarily related to handsets and accessories in the consumer mobile devices and accessories business. In most cases, we have negotiated open payment terms with our vendors and manufacturers. We negotiate the duration of these payment terms when establishing and/or renewing relationships with vendors and manufacturers and attempt to balance the payment terms with other factors such as pricing, availability of competitive products and anticipated demand. The timing of payments related to past purchases and the amount of future inventory purchases will create periodic increases and decreases in the accounts payable balance. Trade accounts receivable grew significantly in fiscal 2005 due to increased sales to our customers, many of whom maintain accounts with open terms.
Capital expenditures totaled $4.4 million in fiscal 2005, primarily related to investments in information technology, including our new Configuration, Fulfillment and Delivery technology system. In fiscal 2004, capital expenditures totaled $5.0 million, comprised primarily of investments in information technology and the rebuilding of the Global Logistics Center. Also in fiscal 2004, insurance proceeds related to property and equipment totaled $7.2 million.
We used $2.8 million of net cash from financing activities in fiscal 2005 compared to a net usage of $0.9 million in fiscal 2004. The increase in cash used is primarily related to increased purchases of our common stock pursuant to our stock buyback program. Through the end of fiscal 2005, 366,903 shares of our outstanding common stock were purchased
for $3,661,800 or an average price of $9.98 per share. Of the total shares repurchased, 254,003 shares were repurchased in fiscal 2005 at an average price of $11.45 per share and 112,900 shares were repurchased in fiscal 2004 at an average price of $6.68 per share. The Board of Directors has authorized the purchase of up to 450,000 shares, leaving 83,097 shares still available for repurchase at fiscal year end 2005 under the program. We expect to fund any future purchases from working capital and/or our revolving credit facility.
Effective September 30, 2003, we established a $30 million revolving line of credit facility with Wachovia Bank, National Association and SunTrust Bank, replacing our previously existing $30 million revolving credit facility with another lender. This facility currently expires in September 2007, is unsecured and interest is payable monthly at the LIBOR rate plus an applicable margin, which ranges from 1.5% to 2.0%. The facility is subject to a borrowing base based on levels of trade accounts receivable and inventory, and is also subject to certain financial covenants, conditions and representations. We were in compliance with these covenants at March 27, 2005. There was no outstanding balance on our revolving line of credit facility at March 27, 2005, and we only took minimal draws throughout fiscal 2005.
Effective June 30, 2004, we refinanced our previously existing term loan with a bank. The new term loan in the original principal amount of $4,500,000 is with Wachovia Bank, National Association and SunTrust Bank and is payable in monthly installments of principal and interest with the balance due at maturity, June 30, 2011. The note bears interest at a floating rate of LIBOR plus 1.75%. The note is secured by a first position deed of trust encumbering the Company-owned real property in Hunt Valley, Maryland. The loan is subject to generally the same financial covenants as our revolving credit facility. This loan had a balance of $4,350,000 at March 27, 2005.
To minimize interest expense, our policy is to use excess available cash to pay down any balance on our revolving credit facility.
Unless we replace the lost T-Mobile business, the loss of T-Mobile as a customer will have a material adverse effect on our revenues, margins, profits and potentially cash flows. However, management has been and will continue to be diligently focused on redeploying resources to new opportunities and reducing expenses in an effort to lessen the impact of the loss of the T-Mobile business. There can be no assurances about the extent to which we will be able to lessen the impact. Regardless of the impact, we do not believe the scheduled termination of the T-Mobile relationship will cause any material impairment of our assets.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of our operations are based on our consolidated financial statements, which have been prepared in accordance U.S. generally accepted accounting principles. 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.
We have identified the policies below as critical to our business operations and the understanding of our results of operations.
Revenue Recognition. We record revenue when 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) our price to the buyer is fixed and determinable, and 4) collectibility is reasonably assured. Our revenue recognition policy includes evidence of arrangements for significant revenue transactions through either receipt of a customer purchase order or a web-based order. We record revenue when product is shipped to the customer and all shipments are made using FOB shipping terms. Our prices are always fixed at the time of sale. Historically, there have not been any material concessions provided to or by customers, future discounts, or other incentives subsequent to a sale. We sell under normal commercial terms and, therefore, we only record sales on transactions where collectibilty is reasonably assured.
Because our sales transactions meet the conditions set forth in Statement of Financial Accounting Standard (SFAS) No. 48 Revenue Recognition When Right of Return Exists, we recognize revenues from sales transactions containing sales returns provisions at the time of the sale. These conditions require that 1) our price be substantially fixed and
determinable at the date of sale, 2) the buyer is obligated to pay us, and such obligation is not contingent on their resale of the product, 3) the buyers obligation to us does not change in the event of theft or physical destruction or damage of the product, 4) the buyer has economic substance apart from us, 5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and 6) the amount of future returns can be reasonably estimated. Because our normal terms and conditions of sale are consistent with conditions 1-5 above, and we are able to perform condition 6, we make a reasonable estimate of product returns in sales transactions and accrue a sales return reserve based on this estimate.
Our current and potential customers are continuing to look for ways to reduce their inventories and lower their total costs, including distribution, order taking and fulfillment costs, while still providing their customers excellent service. Some of these companies have turned to us to implement supply chain solutions, including purchasing inventory, assisting in demand forecasting, configuring, packaging, kitting and delivering products and managing customer relations, from order taking through cash collections. In performing these solutions, we assume varying levels of involvement in the transactions and varying levels of credit and inventory risk. As our solutions offerings continually evolve to meet the needs of our customers, we constantly evaluate our revenue accounting based on the guidance set forth in accounting standards generally accepted in the United States. When applying this guidance in accordance with Emerging Issues Task Force (EITF) No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent, we look at the following indicators: whether we are the primary obligor in the transaction; whether we have general inventory risk; whether we have latitude in establishing price; the extent to which we change the product or perform part of the service; whether we have responsibility for supplier selection; whether we are involved in the determination of product and service specifications; whether we have physical inventory risk; whether we have credit risk; and whether the amount we earn is fixed. Each of our customer relationships is independently evaluated based on the above guidance and revenue is recorded on the appropriate basis. Based on a review of the factors above, in the majority of our sales relationships, we have concluded that we are the principal in the transaction and we record revenue based upon the gross amounts earned and booked. However, we do have several smaller relationships where we are not the principal and we record revenue on a net fee basis, regardless of amounts billed (less than 1% of our total revenue). If applying this revenue recognition guidance resulted in recording revenue on a different basis from which we have previously concluded, or if the factors above change significantly, revenues could increase or decrease; however, our gross profit and net income would remain constant.
Most of our sales arrangements do not contain multiple elements. However, when we enter into arrangements that do contain multiple elements, we follow the guidance under EITF No. 00-21, Revenue Arrangements with Multiple Deliverables. Therefore, at the inception of the arrangement, we determine if each deliverable under the arrangement represents a separate unit of accounting. We do this by determining whether the delivered items have value to the customer on a stand-alone basis (if it is sold separately by any other vendor or the customer could resell the delivered item on a stand-alone basis), if there is objective and reliable evidence of the fair value of the item, and whether the delivery or performance of the undelivered item is considered probable and substantially in our control (in cases where the arrangement includes a general right of return relative to the delivered item). Currently, we have one significant multiple element arrangement, which includes product configuration and distribution, web development, and web hosting/maintenance activities. All of the elements are delivered and billed based on output measures on a monthly basis. Fees and the billings for these elements are structured in a manner that reflects performance on the contract in accordance with the output measures; therefore, we recognize revenues based on the billing provisions in the contract.
Inventories. Inventories are stated at the lower of cost or market. Cost is based on our first-in, first-out (FIFO) method. Write-offs/write downs occur due to damage, deterioration, obsolescence, changes in prices and other causes. Inventory obsolescence reserves are maintained based on our estimates, historical experience and forecasted demand for our products. A material change in these estimates could adversely impact our results from operations.
Allowance for Doubtful Accounts. We use estimates to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable and unbilled receivables to their expected net realizable value. We estimate the amount of the required allowance by reviewing the status of past-due receivables and analyzing historical bad debt trends. Actual collection experience has not varied significantly from estimates, due primarily to credit policies, collection experience and our stability as it relates to its customer base. Typical payments from commercial customers are due 30 days from the date of the invoice. We charge-off receivables deemed to be uncollectible to the allowance for doubtful accounts. Accounts receivable balances are not collateralized. Although we believe that the current allowance is sufficient to cover existing exposures, there can be no assurance against the deterioration of a major customers credit worthiness, or
against defaults that are higher than what has been experienced historically. If our estimate of this allowance is understated, it could have an adverse impact on our results of operations.
Impairment of Long-Lived and Indefinite-Lived Assets. Our Consolidated Balance Sheets include goodwill of approximately $2.5 million. We periodically evaluate our goodwill, long-lived assets and intangible assets for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on estimated future cash flows, market conditions, operational performance and legal factors. Based on our valuations of goodwill completed during the fiscal year, we determined that goodwill was not impaired. Future events, such as significant changes in cash flow assumptions, could cause us to conclude that impairment indicators exist and that the net book value of goodwill, long-lived assets and other intangible assets is impaired. Had the determination been made that the goodwill asset was impaired, the value of this asset would have been reduced by an amount up to $2.5 million, which would have resulted in a charge to operations.
Income Taxes. We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability. This review is based on historical taxable income, projected future taxable income and the expected timing of the reversals of existing temporary differences. Based on this review, we have not established a valuation allowance. If we are unable to generate sufficient taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to establish a valuation allowance against all or a significant portion of our deferred tax assets, resulting in a substantial increase in our effective tax rate and a material adverse impact on our operating results.
Stock-based Compensation. Effective March 29, 2004, we adopted the fair value provisions of SFAS No. 123, Accounting for Stock-Based Compensation using the modified prospective method, as prescribed by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure. Accordingly, beginning in fiscal year 2005, we began recognizing stock compensation expense related to stock options and other equity instruments using fair-value methods. No compensation expense related to the grant of stock options under our stock compensation plans was reflected in net income for any periods ended on or before March 28, 2004, except as noted in Note 2 to the Consolidated Financial Statements included in Item 8 to this Annual Report on Form 10-K, because we accounted for grants in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and all stock options granted in those periods had an exercise price equal to the market value of the underlying common stock on the date of grant.
Also under SFAS No. 123, we record compensation expense on our PSUs over the vesting period, based on the number of shares management estimates will ultimately be issued. Accordingly, we determine the periodic financial statement compensation expense based upon the stock price at the PSU grant date; our projections of future EPS performance over the performance cycle; and the resulting amount of estimated share grants, net of actual forfeitures. Future changes in factors impacting the ultimate number of shares granted could cause these estimates to change in future periods.
Additional Risk Factors
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. In addition to risk elsewhere discussed in this Annual Report on Form 10-K, included among the risks that could lead to a materially adverse impact on our business or operating results are: the termination or non-renewal of limited duration agreements or arrangements with our vendors and affinity partners which are typically terminable by either party upon several months 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 the customers, vendors and affinity partners business; economic conditions that may impact customers ability to fund purchase of 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; failure of our information technology system or distribution system; 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 from competitors, including 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; 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; and inability to protect certain intellectual property, including systems and technologies on which we rely.
Summary Disclosures about Contractual Obligations and Commercial Commitments
The following tables reflect a summary of our contractual cash obligations and other commercial commitments as of March 27, 2005:
Other long-term liabilities include amounts owed under the deferred compensation plan and Supplemental Executive Retirement Plan.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, Share-Based Payment, a revision of SFAS No. 123, Accounting for Stock-Based Compensation and superseding APB Opinion No. 25, Accounting for Stock Issued to Employees. This statement requires companies to expense stock options and other equity compensation instruments using fair value methods. We had previously adopted the provisions of SFAS No. 123 on March 29, 2004 and accordingly, the adoption of SFAS No. 123R is not expected to have a material impact on our consolidated financial position or results of operations. SFAS No. 123R is effective for us beginning in the second quarter of fiscal 2006.
This Report contains a number of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, all of which are based on current expectations. These forward-looking statements may generally be identified by the use of the words may, will, believes, should, expects, anticipates, estimates, and similar expressions. Our future results of operations and other forward-looking statements contained in this report involve a number of risks and uncertainties, including those described throughout this Annual Report on Form 10-K and under the heading Additional Risk Factors above. For a variety of reasons, actual results may differ materially from those described in any such forward-looking statement. Consequently, the reader is cautioned to consider all forward-looking statements in light of the risks to which they are subject.