Koss Corporation Form 10-Q Summary
Business Context and Reporting Period
Koss Corporation markets high-fidelity headphones, wireless Bluetooth speakers, computer and telecommunications headsets, active noise-canceling and wireless headphones, and Koss Classics recordings. The company operates as one business segment. This Form 10-Q covers the three and six months ended December 31, 2015, within fiscal 2016. The interim financial statements are unaudited.
Financial Performance
| Metric | Three Months Ended Dec. 31, 2015 | Three Months Ended Dec. 31, 2014 | Six Months Ended Dec. 31, 2015 | Six Months Ended Dec. 31, 2014 |
|---|---|---|---|---|
| Net sales | $7.23 million | $7.04 million | $12.76 million | $12.51 million |
| Gross profit | $2.66 million | $2.41 million | $4.31 million | $4.25 million |
| Gross margin | 36.8% | 34.2% | 33.8% | 34.0% |
| SG&A expense | $2.03 million | $2.09 million | $3.83 million | $4.09 million |
| Income before income tax | $635,477 | $307,081 | $473,273 | $153,980 |
| Net income | $386,632 | $165,586 | $285,828 | $70,588 |
| Diluted earnings per share | $0.05 | $0.02 | $0.04 | $0.01 |
Six-month EBITDA from operations, a non-GAAP measure used for performance tracking and credit covenant purposes, was $1.05 million, or 8.2% of sales, compared with $891,576, or 7.1% of sales, in the prior-year period. The reconciliation includes unauthorized-transaction-related costs of $74,950 for the six months.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash provided by operating activities was $1.52 million for the six months ended December 31, 2015, compared with cash used of $693,407 in the prior-year period.
- Investing cash outflow was $389,043, including $259,662 for equipment and leasehold improvements and $129,381 for life insurance premiums.
- Cash and cash equivalents increased to $2.13 million at December 31, 2015, from $1.00 million at June 30, 2015.
- Current assets were $14.07 million and current liabilities were $4.07 million at December 31, 2015. Inventory was $7.04 million, net of a $4.15 million obsolescence allowance.
- The company had no borrowings under its $5.0 million secured revolving credit facility at December 31, 2015. The facility expires July 31, 2016, and the company reported compliance with its covenants.
- Total liabilities were $6.34 million and stockholders’ equity was $16.88 million at December 31, 2015.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 2.7%; six-month sales increased 2.0%. Growth was driven primarily by certain export markets and one domestic mass retailer.
- Domestic sales declined because of lost drug-store-chain sales and lower online-retailer sales, partly offset by additional mass-retailer sales and new customers.
- Export sales benefited from improved activity at major distributors and a new Asian distributor, while Russia and Ukraine remained weak because of economic and geopolitical conditions.
- Quarterly gross margin improved 260 basis points, primarily because of sales mix and improved margins on newer products. Six-month gross margin declined 20 basis points.
- SG&A declined by $68,157 for the quarter and $256,421 for the six months, reflecting reduced headcount and lower stock-based compensation. The retirement of the former chairman reduced expenses by approximately $48,000 for the quarter and $87,000 for the six months.
- Net income increased substantially in both periods, supported by improved gross profit, lower SG&A and lower interest expense.
- Operating cash flow improved principally because the company received approximately $1.02 million of advance payments for shipments expected in the quarter ending March 31, 2016. The prior-year period included approximately $1.3 million of payments for returned product.
Guidance, Outlook, Risks and Unusual Items
- Management expects an effective income tax rate of approximately 38% to 40% for the fiscal year ending June 30, 2016.
- Planned fiscal 2016 expenditures for tooling, leasehold improvements and capital expenditures are estimated at approximately $500,000 to $600,000. Management expects operations and available credit to fund these expenditures.
- Management stated that operating cash flow, cash reserves and the credit facility should provide adequate liquidity for operating needs, debt service and planned capital expenditures for the next twelve months and thereafter for the foreseeable future.
- Key operating risks include consumer acceptance of new technologies and products, competition, pricing, customer orders, third-party production, foreign manufacturing and sales, import and trade matters, economic conditions, borrowing costs, taxes and litigation.
- The company remains involved in litigation concerning previously reported unauthorized transactions, including proceedings against American Express-related parties and Park Bank. The ultimate resolution was not determinable as of December 31, 2015.
- The company recorded $37,475 of unauthorized-transaction-related costs in the quarter and $74,950 for the six months. These costs are excluded from management’s non-GAAP EBITDA measure.
- The company leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The operating lease runs through June 30, 2018 at fixed annual rent of $380,000, plus normal property-related expenses.
- No dividend was declared for the quarter, and no shares were repurchased during the period. Disclosure controls were assessed as effective, and no material changes to internal control over financial reporting were reported.
Investor Verification Items
- Verify whether export-market growth and new distributor activity are sustainable, particularly given continued weakness in Russia and Ukraine.
- Assess the quality of operating cash flow, including the approximately $1.02 million of customer advance payments.
- Review inventory levels and the $4.15 million allowance for obsolete inventory.
- Monitor renewal, amendment or replacement of the secured credit facility before its July 31, 2016 expiration and continued covenant compliance.
- Track the resolution and potential financial impact of the pending unauthorized-transaction litigation.
- Confirm whether planned capital expenditures remain within the projected $500,000 to $600,000 range and whether the anticipated 38% to 40% tax rate is achieved.