Koss Corp. 10-Q Summary: Period Ended December 31, 2010
Business Context and Reporting Period
This Form 10-Q covers the quarterly and six-month periods ended December 31, 2010, for Koss Corporation, a Delaware corporation headquartered in Milwaukee, Wisconsin. The company designs, manufactures, and markets audio products. The filing is classified as a smaller reporting company. As of January 21, 2011, there were 7,382,706 shares of common stock outstanding.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2010 | Six Months Ended Dec 31, 2010 |
|---|---|---|
| Net Sales | $12,800,806 | $22,832,940 |
| Gross Profit | $5,210,963 (40.7% margin) | $9,572,572 (41.9% margin) |
| Operating Income | $2,417,298 | $3,407,959 |
| Net Income | $1,382,113 | $1,944,972 |
| Earnings Per Share (Diluted) | $0.18 | $0.26 |
| Cash and Equivalents | $214,340 (as of Dec 31, 2010) | |
| Working Capital | $7,428,576 (as of Dec 31, 2010) | |
| Debt (Line of Credit) | $2,500,000 outstanding | |
| Operating Cash Flow | $949,813 (Six months) |
Material Changes vs. Prior Period
- Profitability Turnaround: The company reported a net income of $1.38 million for the quarter and $1.94 million for the six months, a significant reversal from the net losses of $1.85 million and $3.44 million, respectively, in the prior year periods.
- Impact of Unauthorized Transactions: The primary driver for the improvement in operating income was the absence of "unauthorized transactions" in the current period. In the prior year, these transactions resulted in expenses of $4.96 million (quarter) and $10.29 million (six months).
- Revenue Trends: Net sales increased 4.8% in the quarter due to higher export sales to Europe and Scandinavia. However, for the six-month period, sales decreased 4.2% due to the loss of a large customer in the prior year and lower sales to distributors.
- Expense Management: Selling, general, and administrative (SG&A) expenses increased slightly due to higher profit-based compensation and legal fees, but were offset by lower provisions for doubtful accounts.
Guidance, Outlook, Risks, and Unusual Items
Unusual Items and Legal Matters: The financial results are heavily influenced by the aftermath of unauthorized transactions totaling approximately $31.5 million discovered in December 2009. The company incurred net legal costs of $204,900 (quarter) and $471,184 (six months) related to these transactions, partially offset by insurance recoveries of $575,825 and $938,962, respectively. The former Vice President of Finance was sentenced to 11 years in prison in November 2010.
Litigation: The company is involved in multiple legal proceedings, including a class action lawsuit, shareholder derivative suits, and an SEC investigation. The company has also initiated lawsuits against third parties, including American Express, Grant Thornton LLP, and various banks, alleging negligence and fraud.
Controls and Procedures: Management concluded that disclosure controls and procedures were not effective as of December 31, 2010, due to the inability to complete testing of remedial measures implemented following the fraud. A new internal audit function has been established to assist in testing.
Liquidity and Outlook: The company maintains an $8 million secured credit facility with JPMorgan Chase, with $2.5 million outstanding. Management believes cash from operations and available credit are sufficient to meet requirements. The company intends to continue paying regular quarterly dividends ($0.06 per share declared for the quarter).
Investor Verification Checklist
- Verify the status and potential financial impact of ongoing litigation, including the class action suit and lawsuits against third parties.
- Confirm the timeline for the completion of internal control testing and the subsequent declaration of effective disclosure controls.
- Monitor the resolution of the SEC investigation regarding the unauthorized transactions.
- Assess the sustainability of the gross margin improvement given the noted increase in freight costs and product mix changes.
- Review the company's ability to maintain compliance with financial covenants (current ratio, tangible net worth, leverage ratio) under the new JPMorgan Chase credit facility.