Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation, a consumer audio products company, filed its unaudited Form 10-Q for the quarter and six months ended December 31, 2011. The company reported lower sales to several European distributors and a large U.S. mass retailer. Koss remains focused on new product development and planned product launches beginning in the quarter ending March 31, 2012.
Financial performance and position
| Metric | Three months ended Dec. 31, 2011 | Three months ended Dec. 31, 2010 | Six months ended Dec. 31, 2011 | Six months ended Dec. 31, 2010 |
|---|---|---|---|---|
| Net sales | $10.0 million | $12.8 million | $18.7 million | $22.8 million |
| Gross profit | $3.8 million | $5.2 million | $7.1 million | $9.6 million |
| Gross margin | 38.0% | 40.7% | 38.0% | 41.9% |
| Operating income | $1.3 million | $2.4 million | $1.8 million | $3.4 million |
| Net income | $0.8 million | $1.4 million | $1.1 million | $1.9 million |
| Diluted EPS | $0.11 | $0.18 | $0.15 | $0.26 |
For the quarter, sales declined 22.0%; for the six-month period, sales declined 17.9%. Operating income excluding unauthorized-transaction-related costs and recoveries was $874,772, or 8.8% of sales, in the quarter and $1,317,828, or 7.0% of sales, for six months, compared with 20.5% and 17.0%, respectively, in the prior-year periods.
Six-month operating cash flow was $1.4 million, compared with $0.9 million in the prior year. Investing cash flow was negative $1.4 million, including $713,202 of product software development expenditures, $370,437 of equipment and leasehold improvements, and $347,914 of life insurance premiums. Financing cash flow was $14,075 after $900,000 of credit-facility borrowings and $885,925 of dividend payments.
At December 31, 2011, cash and cash equivalents were $182,058, accounts receivable were $4.4 million, and inventory was $9.6 million. Inventory increased $1.7 million from June 30, 2011, partly because of lower sales and planned stocking for new product introductions. Working capital was $9.1 million.
The secured revolving credit facility provides capacity of up to $8.0 million and expires July 31, 2013. Outstanding borrowings were $2.3 million at December 31, 2011, compared with $1.4 million at June 30, 2011. The weighted-average interest rate on outstanding borrowings was 2.63%. The facility is secured by substantially all company assets and includes financial covenants.
Material changes versus the prior comparable period
- Sales fell primarily because of weaker European distributor demand, a difficult European economy, lower sales to a large U.S. mass retailer, increased competition, and product-placement issues.
- Gross margin declined because of higher costs from Chinese suppliers following wage increases. The company reported approximately $309,000 of related cost increases in the quarter and $587,000 for six months.
- Selling, general and administrative expense increased to $2.9 million for the quarter and $5.8 million for six months, principally due to new product development and trade-show preparation.
- Unauthorized-transaction-related items changed from a net cost of $204,900 in the prior-year quarter and $471,184 in the prior-year six months to net recoveries of $469,519 and $519,933, respectively, including insurance recoveries and a $242,419 bonus repayment by Michael J. Koss.
- Despite lower net income, operating cash flow improved because of smaller working-capital cash usage and deferred-tax effects.
- The Koss Classics Ltd. subsidiary was dissolved during the six months ended December 31, 2011.
Guidance, outlook, risks, contingencies, and unusual items
No formal quantitative revenue or earnings guidance was provided. Management expects to introduce new products in the second half of fiscal 2012 and is pursuing lower-cost sourcing, selective price increases, and product introductions to offset supplier cost inflation. Management stated that cash from operations and available credit are expected to provide adequate liquidity for operating needs, debt service, capital expenditures, and planned quarterly dividends.
- Sales declines may continue, and management stated that new customers and products may not offset lost distributor and retailer volume.
- As of December 31, 2011, the company had approximately $1.1 million of open commitments for software and new product development.
- Unauthorized transactions totaling approximately $31.5 million from fiscal 2005 through December 2009 continue to affect legal, insurance, restitution, and litigation matters.
- A shareholder class-action settlement in principle requires a $1.0 million payment funded by the company’s insurer, subject to court approval.
- The SEC matter was settled without admission or denial; Michael J. Koss reimbursed the company 160,000 options and $242,419 in cash, in addition to a prior $208,895 reimbursement.
- The company expects additional restitution proceeds from seized assets, including proceeds from auctions and other forfeiture efforts. It received $509,970 from Ms. Sachdeva’s 401(k) plan in November 2011.
- Management concluded that disclosure controls and procedures were not effective as of December 31, 2011 because testing of remedial measures and a new business system had not been completed. The company stated that the new system was implemented in the quarter ended September 30, 2011.
- Additional risks include reliance on foreign manufacturing and sales, competition, consumer acceptance of new products, borrowing costs, tax matters, litigation, investigations, and compliance with credit-facility covenants.
Important facts for investors to verify
- Whether new product launches and customer additions reverse the sales decline.
- Inventory levels, sell-through, and potential overstock resulting from weaker demand.
- Whether Chinese supplier-cost inflation persists and whether pricing or sourcing actions restore gross margins.
- Availability under and covenant compliance with the secured $8.0 million credit facility.
- Final court approval and insurance funding of the $1.0 million shareholder settlement.
- Future recoveries from restitution, litigation, and insurance, which are unusual and not necessarily recurring.
- Completion and effectiveness testing of remedial disclosure and financial-reporting controls.
- The company’s ability to fund product-development commitments, capital expenditures, debt service, and regular dividends from operating cash flow and borrowings.