Koss Corporation Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2016, with comparison to fiscal 2015. The source filing is an annual report for fiscal 2016, not a 2015 fourth-quarter filing.
Business Context
Koss designs, manufactures and sells stereo headphones and related accessories through retailers, distributors, e-commerce, specialty stores, OEM customers and international channels. The company operates as one reporting segment. Approximately 83% of fiscal 2016 sales were from music-listening headphones and 17% from communications, education and other applications.
Products are sold through approximately 16,000 domestic retail outlets and numerous international retailers. Koss sources products and materials from Asia and operates a manufacturing facility in Milwaukee. The company employed 54 non-union employees as of June 30, 2016.
Financial Performance
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Net sales | $26.00 million | $24.23 million | Up 7.3% |
| Gross profit | $8.94 million | $8.45 million | Up 5.8% |
| Gross margin | 34.4% | 34.9% | Down 0.5 percentage points |
| SG&A expense | $7.96 million | $7.90 million | Up 0.7% |
| Income before taxes | $2.26 million | $0.50 million | Up materially |
| Income tax provision | $0.87 million | $0.02 million | Up materially |
| Net income | $1.39 million | $0.48 million | Up 188% |
| Basic and diluted EPS | $0.19 | $0.07 | Up $0.12 |
Fiscal 2016 results included a $1.286 million net recovery related to unauthorized transactions, compared with $31,027 of net costs in fiscal 2015. The recovery primarily reflected a $3.0 million gross settlement with American Express, offset by $1.714 million of related legal fees and $75 of asset-forfeiture proceeds.
SG&A increased due mainly to higher deferred compensation, profit-based compensation, 401(k) matching contributions and travel. These increases were largely offset by lower stock-based compensation, former-chairman retirement costs, commissions and legal fees.
Revenue and Geographic Developments
- Export sales increased $3.05 million to $10.50 million, while U.S. sales declined $1.28 million to $15.50 million.
- Sales increased in Scandinavia, the Czech Republic and Asia, and benefited from a new African distributor and a new Asian OEM customer.
- The five largest customers represented approximately 47% of fiscal 2016 sales, compared with 45% in fiscal 2015. Tura Scandinavia represented approximately 17% and Wal-Mart approximately 11% of fiscal 2016 sales.
- Sales concentration and dependence on retailers and distributors remain significant risks.
Cash Flow, Liquidity and Capital Resources
| Cash flow metric | FY2016 | FY2015 |
|---|---|---|
| Cash provided by operating activities | $314,625 | $(340,590) |
| Cash used in investing activities | $(579,498) | $(558,555) |
| Cash provided by financing activities | None | None |
| Net decrease in cash | $(264,873) | $(899,145) |
| Cash and cash equivalents at year-end | $735,393 | $1.00 million |
Operating cash flow benefited from the American Express settlement but was reduced by a $735,388 increase in receivables and a $1.413 million increase in inventory. Inventory rose to $8.595 million from $7.182 million, partly due to a new mass-retailer product, manufacturing transfers and higher expected demand.
Koss had no borrowings outstanding under its secured $5.0 million revolving credit facility at June 30, 2016. The facility was amended in May 2016 to extend its expiration to July 31, 2018. The company stated that it was in compliance with all covenants and expects operating cash flow and available credit to fund operations, debt service and planned capital expenditures.
Management planned approximately $900,000 of tooling and leasehold improvements in fiscal 2017 to support new product introductions. No shares were repurchased in fiscal 2016 or 2015; $2.140 million remained available under the repurchase authorization at June 30, 2016.
Balance Sheet and Other Obligations
- Total assets were $24.12 million, compared with $22.43 million at June 30, 2015.
- Total liabilities were $5.93 million, compared with $6.07 million in the prior year.
- Stockholders’ equity increased to $18.19 million from $16.35 million.
- Deferred compensation liabilities totaled approximately $2.34 million, including current and long-term amounts.
- The Milwaukee facility is leased from Koss Holdings, LLC, which is wholly owned by the former chairman, at fixed annual rent of $380,000 through June 30, 2018.
Material Changes, Outlook and Risks
- Management expects fiscal 2017 research and development spending for Bluetooth and traditional wired headphones and plans several new product offerings.
- Management anticipates an effective tax rate of approximately 38% to 40% in fiscal 2017.
- Asset-forfeiture proceeds related to the unauthorized transactions are expected to be minimal, if any, in fiscal 2017; therefore, fiscal 2016’s recovery should not be viewed as a recurring operating benefit.
- Gross margin declined because of product and channel mix, with approximately $57,000 of additional costs related to shifting manufacturing among Chinese contract manufacturers.
- Key risks include consumer demand and confidence, competition from larger companies, retailer and distributor concentration, foreign exchange and trade restrictions, tariffs and freight costs, reliance on Asian suppliers, inventory obsolescence, product returns and warranty claims.
- The company’s top ten selling models represented approximately 61% of fiscal 2016 sales. A supplier disruption could take approximately 120 days to replace, and management estimated that restoring production of those models could take up to one year.
- Koss is appealing a court ruling dismissing its case against Park Bank relating to the unauthorized transactions. The ultimate resolution was not determinable as of June 30, 2016.
- Management concluded that disclosure controls and internal control over financial reporting were effective as of June 30, 2016. The independent auditor audited the financial statements but was not engaged to audit internal control over financial reporting.
Important Facts for Investors to Verify
- Separate recurring operating performance from the $1.286 million net unauthorized-transaction recovery recognized in fiscal 2016.
- Assess whether export growth and the new OEM relationship can offset declining U.S. sales and elevated customer concentration.
- Monitor inventory growth, receivables from the new OEM customer and the company’s ability to convert earnings into operating cash flow.
- Verify fiscal 2017 tooling and leasehold-improvement spending of approximately $900,000 and the expected tax rate of 38% to 40%.
- Review the Park Bank appeal, remaining legal costs and any potential recoveries or liabilities related to the unauthorized transactions.
- Evaluate supplier concentration, manufacturing-transfer execution, tariff exposure and warranty obligations, particularly because most products carry lifetime warranties.