Koss Corporation Form 10-Q Summary
Business Context and Reporting Period
Koss Corporation markets high-fidelity headphones, wireless speakers, computer and telecommunications headsets, noise-canceling and wireless headphones, and Koss Classics recordings. The company operates as one business segment. This unaudited report covers the three months ended September 30, 2015, the first quarter of fiscal 2016, compared with the same quarter of fiscal 2015.
Financial Performance and Position
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $5.531 million | $5.469 million |
| Gross profit | $1.646 million | $1.843 million |
| Gross margin | 29.8% | 33.7% |
| SG&A expense | $1.803 million | $1.991 million |
| Loss before income tax | $162,204 | $153,101 |
| Net loss | $100,804 | $94,998 |
| Basic and diluted loss per share | $0.01 | $0.01 |
| EBITDA from operations | $120,098 | $227,964 |
| EBITDA margin | 2.2% | 4.2% |
- Net sales increased 1.1%, or $61,776, primarily from certain export markets, a new headphone sold through a domestic mass retailer, and new customers.
- Gross profit declined 10.7%, and gross margin fell 390 basis points, primarily because the sales mix shifted toward a lower-margin product and away from distribution sales.
- SG&A declined 9.5%, reflecting lower stock-based compensation and reduced headcount, including savings associated with the former chairman's retirement and other position reductions.
- Interest expense was $5,318, compared with $4,333. The income tax benefit was $61,400, producing an effective tax rate of 37.9% on the pretax loss.
- Operating cash flow was negative $1.044 million, an improvement from negative $2.662 million in the prior-year quarter. Investing cash flow was negative $176,000, and financing activities provided $400,000.
- Cash and cash equivalents fell from $1.000 million at June 30, 2015 to $181,000 at September 30, 2015. Inventories were $6.918 million, accounts receivable were $2.912 million, and total current assets were $12.699 million.
- The company had $400,000 outstanding under its secured revolving credit facility, versus no borrowings at June 30, 2015. The facility was amended in July 2015, has a $5.000 million revolving commitment subject to borrowing-base requirements, and expires July 31, 2016. Management stated that all covenants were met.
Material Changes Versus the Prior Comparable Period
- Sales modestly improved, but profitability weakened because of lower gross margins.
- Net loss increased by $5,806 despite lower SG&A.
- Non-GAAP EBITDA declined by $107,866, or approximately 47%, primarily due to the gross-margin deterioration.
- Operating cash usage improved substantially because the prior-year period included approximately $1.3 million of payments related to returned products.
- Investing cash usage decreased because of lower tooling and capital expenditures and lower life-insurance premiums.
- The company granted options for 390,000 shares at a weighted-average exercise price of $2.76, compared with grants for 445,000 shares at $3.19 in the prior-year quarter.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expects an effective tax rate of approximately 37% to 39% for fiscal 2016.
- Expected fiscal 2016 expenditures for tooling, leasehold improvements, and capital expenditures are approximately $300,000 to $400,000. Management expects operations, cash reserves, and the credit facility to fund these needs and other requirements.
- Management identified risks involving consumer acceptance of new technologies and products, competition, customer orders, third-party production, foreign manufacturing and sourcing, currency fluctuations, borrowing costs, taxes, and litigation.
- The company continues to pursue litigation involving American Express and related parties concerning unauthorized transactions, and litigation involving Park Bank. The ultimate resolution was not determinable from the filing.
- Reported EBITDA from operations excludes $37,475 of unauthorized-transaction-related costs, net, in the current quarter and $52,492 in the prior-year quarter. EBITDA is a non-GAAP measure and should not be viewed as a substitute for net income or operating cash flow.
- The company leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The operating lease is fixed at $380,000 annually through June 30, 2018.
- No dividends, share repurchases, or stock-option exercises occurred during the quarter. Management stated that disclosure controls were effective and that no material changes occurred in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the lower-margin mass-retailer product and customer mix shift are temporary or likely to persist.
- Whether sales growth in export markets and new domestic customers can offset distributor and non-retail customer declines.
- Available borrowing capacity under the $5.0 million facility after applying borrowing-base limitations, and continued compliance with minimum EBITDA and tangible-net-worth covenants.
- Cash conversion, inventory levels, and the company's ability to fund operations while cash balances remain low.
- The potential financial impact and timing of the pending unauthorized-transaction litigation.
- The sustainability of the tax benefit and the projected 37% to 39% fiscal-year effective tax rate.
- The impact of outstanding and newly granted stock options, including the 2.335 million options excluded from diluted share calculations as anti-dilutive.