Koss Corporation Form 10-Q Summary
Business Context and Reporting Period
Koss Corporation markets headphones, headsets, speaker-phones and related products, operating as one business segment. This unaudited Form 10-Q covers the three and six months ended December 31, 2012, the second quarter of fiscal 2013, with comparisons to the corresponding 2011 periods.
Financial Performance and Liquidity
| Metric | Three Months Ended Dec. 31, 2012 | Three Months Ended Dec. 31, 2011 | Six Months Ended Dec. 31, 2012 | Six Months Ended Dec. 31, 2011 |
|---|---|---|---|---|
| Net sales | $8.64 million | $9.99 million | $17.56 million | $18.75 million |
| Gross profit | $2.76 million | $3.80 million | $6.01 million | $7.13 million |
| Gross margin | 31.9% | 38.0% | 34.2% | 38.0% |
| Operating income | $566,463 | $1.34 million | $1.18 million | $1.84 million |
| Operating margin | 6.6% | 13.5% | 6.7% | 9.8% |
| Net income | $338,688 | $831,212 | $704,841 | $1.11 million |
| Diluted EPS | $0.05 | $0.11 | $0.10 | $0.15 |
- Second-quarter sales declined 13.5%; six-month sales declined 6.3%. Management attributed the decline primarily to weak European distributor sales, lower sales to a U.S. electronics retailer, the absence of a prior-year $407,000 Black Friday promotion, and approximately $240,000 of export orders delayed by a threatened dockworker strike.
- SG&A increased to $3.00 million for the quarter and $6.02 million for the six months, driven primarily by patent and trademark defense costs and higher deferred compensation expense.
- Unauthorized-transaction-related recoveries, net, benefited results by $812,344 in the quarter and $1.20 million for the six months. Current-year recoveries primarily reflected asset forfeitures and auction proceeds.
- Cash provided by operating activities was $929,664 for the six months, down from $1.44 million in the prior-year period. Cash used in investing activities was $657,473, while financing activities used $128,887.
- Cash and cash equivalents increased to $193,331 at December 31, 2012, from $50,027 at June 30, 2012.
- At December 31, 2012, current assets were $15.43 million versus current liabilities of $5.36 million. Inventory was $9.82 million, up from $9.40 million at June 30, 2012, while accounts receivable declined to $3.28 million from $5.33 million.
- The company had $1.20 million outstanding under its secured $8.0 million revolving credit facility, compared with no balance at June 30, 2012. The applicable interest rate was 3.25%; the facility expires July 31, 2014 and is secured by substantially all company assets.
- The quarterly dividend remained $0.06 per share. Management stated that regular quarterly dividends are expected to continue for the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Profitability deteriorated materially: quarterly gross margin fell 610 basis points, operating margin fell 690 basis points, and net income declined approximately 59%.
- Gross margin was pressured by $397,926 of software amortization in the quarter and $762,466 for the six-month period, together with an approximately $124,000 tooling write-off related to future Striva products. These effects were partly offset by lower product purchase costs and favorable customer pricing.
- Operating expenses benefited from lower legal costs related to unauthorized transactions because the derivative lawsuit, SEC investigation and class-action lawsuit had been resolved; however, higher SG&A offset part of that benefit.
- Operating cash flow declined because payments to contract manufacturers reduced accounts payable by approximately $2.20 million. Inventory and prepaid assets also increased to support Striva products and other programs.
- Investing cash usage decreased year over year because of lower equipment, life-insurance and capitalized software expenditures.
Outlook, Risks, Contingencies and Unusual Items
- Management described the long-term outlook as positive and stated that operating cash flow plus available credit capacity should fund operating needs, debt service, planned capital expenditures and dividends.
- The company budgeted $1.20 million for tooling and leasehold improvements during fiscal 2013 and expects to fund these expenditures through operations.
- Management anticipated a fiscal 2013 effective tax rate of approximately 20% to 31%, compared with 37.4% for the six months ended December 31, 2012, due to an expected reduction in unrecognized tax benefits.
- Unrecognized tax benefits were $1.15 million. During the following twelve months, the company believed these benefits and income tax expense could potentially decline by up to $500,000 as certain tax positions are expected to close.
- Capitalized product software is subject to impairment risk from technological obsolescence, competition, pricing and lower-than-expected product revenue. The company reviews the asset for impairment quarterly.
- Pending legal matters related to the unauthorized transactions involve American Express, Grant Thornton and Park Bank. Their ultimate resolution was not determinable from the filing.
- Other disclosed risks include consumer acceptance of new technologies and products, competition, pricing, third-party manufacturing, foreign sourcing and sales, borrowing costs, taxes, litigation and investigations.
- The company renewed a facility lease from its Chairman through June 30, 2018 at fixed annual rent of $380,000. Management reported no material changes in internal control over financial reporting and concluded disclosure controls were effective as of December 31, 2012.
Investor Verification Points
- Verify whether sales weakness in Europe and at the U.S. retailer persisted and whether delayed export orders were subsequently shipped.
- Assess the sustainability of gross margins after the continuing amortization of Striva software and the effect of any additional tooling or inventory write-offs.
- Track inventory levels, accounts payable, operating cash flow and reliance on the credit facility.
- Confirm the timing and amount of any tax benefit from the potential reduction in unrecognized tax benefits.
- Monitor recoveries and legal outcomes related to the unauthorized transactions, which materially affected reported operating results.
- Review the company’s ability to maintain dividends while funding product development, capital expenditures and secured debt obligations.