Koss Corporation 10-Q Summary
Business Context and Reporting Period
Koss Corporation markets headphones, headsets, speaker-phones, noise-canceling and wireless products, and Koss Classics recordings. It operates as one business segment. This unaudited Form 10-Q covers the three months ended September 30, 2014, the first quarter of fiscal 2015, with comparisons to the same quarter of fiscal 2014.
Key Financial Metrics
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $5.47 million | $6.82 million | Down 19.9% |
| Gross profit | $1.84 million | $2.31 million | Down 20.3% |
| Gross margin | 33.7% | 33.9% | Down 0.2 percentage points |
| SG&A expense | $1.94 million | $2.88 million | Down 32.8% |
| Operating income (loss) | $(148,768) | $135,880 | Turned to loss |
| Net income (loss) | $(94,998) | $79,402 | Turned to loss |
| Operating margin | (2.7%) | 2.0% | Down 4.7 percentage points |
| Basic and diluted EPS | $(0.01) | $0.01 | Declined |
| Non-GAAP EBITDA from operations | $227,964 | $174,052 | Up 31.0% |
| EBITDA margin | 4.2% | 2.6% | Up 1.6 percentage points |
Cash flow from operations was $(2.66) million, compared with $4.52 million of cash provided in the prior-year quarter. Investing cash outflow was $412,000, primarily for life insurance premiums and equipment. Financing activities provided $1.30 million from borrowings under the credit facility; no dividend was paid.
Cash and cash equivalents declined from $1.90 million at June 30, 2014 to $125,000 at September 30, 2014. Current assets were $14.02 million and current liabilities were $4.96 million. Inventory was $7.18 million, including a $4.80 million obsolescence allowance.
The secured revolving credit facility was reduced from $8.0 million to $5.0 million in July 2014. Borrowings were $1.30 million at September 30, 2014, versus zero at June 30, 2014. Management stated that the company was in compliance with all covenants and believed available cash flow, reserves and borrowing capacity were adequate for the next twelve months and the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because European export sales fell approximately 39%, including weakness in key European customers, Ukraine-related political unrest and inventory adjustments in the Czech Republic. U.S. sales declined approximately 8%.
- Gross margin decreased modestly because of lower export sales, pricing changes for a mass-retail customer and fixed manufacturing overhead absorption.
- SG&A decreased by approximately $945,000, reflecting lower STRIVA development spending, reduced legal and outside-service fees, lower 401(k) matching expense, lower commissions and charitable donations, and the closure of the Switzerland sales office.
- The company suspended Mexico operations at the end of July 2014, reducing manufacturing costs.
- The prior-year quarter benefited from $816,529 of unauthorized-transaction-related asset-forfeiture recoveries, while the current quarter recorded $52,492 of related legal costs.
- Cash flow worsened primarily because of approximately $1.30 million paid for returned products, inventory purchases for new products and promotions, export rebates, vendor payments and costs associated with suspending Mexico operations.
- Product software amortization was zero in the current quarter versus $364,539 in the prior-year quarter. The remaining capitalized software balance had been expensed in the quarter ended December 31, 2013 after management determined that a new architecture was required.
- Quarterly dividends were suspended until operations, earnings, sales and liquidity improve.
Guidance, Outlook, Risks and Unusual Items
- Management anticipated an effective tax rate of approximately 35% to 40% for fiscal 2015.
- Planned fiscal 2015 spending for tooling, leasehold improvements and capital expenditures was approximately $400,000 to $500,000. Management expected operating cash flow to fund these expenditures, although current-quarter operating cash flow was negative.
- Management expects to receive final forfeiture-related proceeds during fiscal 2015, but stated that remaining amounts are not expected to be significant.
- Key risks include weak European economies and customer inventory levels, geopolitical conditions in Ukraine, competitive pricing, product acceptance, foreign manufacturing and sales, borrowing costs, tax matters and pending litigation.
- Legal proceedings remain pending against parties associated with the 2009 unauthorized transactions and against Red Fusion Studios concerning termination of the STRIVA development agreement. The ultimate resolution was not determinable.
- The Federal income-tax return for fiscal 2013 was under examination. Unrecognized tax benefits were $175,000 at September 30, 2014.
- The company’s disclosure controls were assessed as effective, and no material changes to internal control over financial reporting were reported.
Important Facts for Investors to Verify
- Whether export and domestic sales recover and whether European customer inventory reductions persist.
- Liquidity trends, including the decline to $125,000 of cash, continued use of the credit facility and compliance with minimum EBITDA and tangible-net-worth covenants.
- Inventory levels, promotional demand and the adequacy of the $4.80 million obsolete-inventory allowance.
- Whether cost reductions from suspending Mexico operations and STRIVA development can offset lower revenue and pricing pressure.
- The timing and amount of any remaining unauthorized-transaction recoveries and the costs and outcomes of related litigation.
- Conditions required for resumption of quarterly dividends.
- The results of the pending federal tax examination and potential impact of unrecognized tax benefits.