Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation markets headphones, headsets, speaker-phones and related audio products as one business segment. This unaudited Form 10-Q covers the quarter and six months ended December 31, 2013, within fiscal 2014. The company had 7,382,706 common shares outstanding at February 7, 2014.
Financial performance and condition
| Metric | Three months ended December 31, 2013 | Three months ended December 31, 2012 | Six months ended December 31, 2013 | Six months ended December 31, 2012 |
|---|---|---|---|---|
| Net sales | $6.52 million | $8.64 million | $13.35 million | $17.56 million |
| Gross profit (loss) | $(2.55) million | $2.76 million | $(0.30) million | $6.01 million |
| Gross margin | (39.2%) | 31.9% | (2.3%) | 34.2% |
| Operating income (loss) | $(5.41) million | $0.57 million | $(5.28) million | $1.18 million |
| Net income (loss) | $(3.45) million | $0.34 million | $(3.37) million | $0.70 million |
| Diluted earnings (loss) per share | $(0.47) | $0.05 | $(0.46) | $0.10 |
Six-month operating cash flow was $3.60 million, compared with $0.93 million in the prior-year period. Investing cash outflow was $0.68 million and financing cash outflow was $0.89 million, primarily reflecting dividends. Cash increased by $2.03 million to $2.89 million at December 31, 2013.
At December 31, 2013, current assets were $18.63 million versus current liabilities of $7.18 million. Total assets were $27.55 million and stockholders’ equity was $17.49 million. The $8.0 million secured revolving credit facility had no outstanding borrowings; it expires July 31, 2015 and includes a $2.0 million letter-of-credit sublimit.
The company declared quarterly dividends of $0.06 per share, or $0.12 per share for the six-month period. The filing reports no share repurchases during the quarter.
Material changes versus the prior comparable period
- Quarterly sales declined 24.5%; six-month sales declined 24.0%, primarily because of lower export sales. Export sales fell approximately 33% for the quarter and 44% for the six-month period.
- The company recorded a $4.54 million impairment charge for capitalized software, obsolete or excess inventory, product design costs, assumed liabilities and tooling. The charge drove reported quarterly and six-month gross losses.
- Excluding the impairment, quarterly gross margin was 30.4%, down from 31.9% in the prior-year quarter. Management attributed the reduction to startup costs for the Mexico manufacturing facility and fixed manufacturing costs spread over a lower sales base.
- SG&A declined to $2.75 million for the quarter and $5.57 million for the six-month period, although SG&A as a percentage of sales increased because of lower revenue.
- Unauthorized-transaction-related recoveries were lower than in the prior year. The quarter recorded $112,171 of net costs versus an $812,344 net recovery in the prior-year quarter; the six-month period recorded a $596,545 net recovery versus a $1.20 million recovery.
- Operating cash flow benefited materially from an $8.5 million gross settlement received in July 2013, or $6.38 million net of related legal fees.
Guidance, outlook, risks and unusual items
Management expects to launch new products using a revised software architecture for STRIVA WiFi-based headphones and other WiFi products. Future software development costs for the replacement technology will be expensed as incurred. New products were introduced during the fiscal year and additional products were shown at the January 2014 Consumer Electronics Show.
The company expects approximately $800,000 of fiscal-year capital expenditures for tooling, leasehold improvements and Mexico manufacturing equipment, and believes operating cash flow, cash reserves and available borrowings will fund planned needs. Management stated that the long-term outlook remains positive, but emphasized the importance of improved sales, particularly in export markets, higher operating cash generation and reduced capital expenditures.
Future dividends will be determined quarterly based on liquidity, sales, operating cash flow and earnings. Management intended to pay the regular $0.06 per-share dividend for the quarter ending March 31, 2014, but did not commit to future dividends beyond that assessment.
Key risks include weak European and Asian demand, customer inventory levels, retailer space and customer concentration, acceptance of new products, competition, foreign manufacturing and sourcing, technology obsolescence, inventory excesses, tax matters and pending litigation related to unauthorized transactions. The company expects its fiscal 2014 effective tax rate to be approximately 40% to 50%. Federal and state audit resolutions could reduce unrecognized tax benefits and income tax expense by up to $550,000.
The company remains involved in claims against American Express-related parties and Park Bank arising from the unauthorized transactions; ultimate resolution was not determinable. Management concluded that disclosure controls were effective as of December 31, 2013, with no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether export demand and U.S. retailer placements improve after the December-quarter sales decline.
- Whether the revised WiFi product architecture launches successfully and generates sufficient revenue to support future development spending.
- The sustainability of operating cash flow after excluding the one-time lawsuit settlement proceeds.
- The extent of additional inventory write-downs, software development expense and Mexico manufacturing startup costs.
- Whether the company can maintain quarterly dividends while funding capital expenditures and product development.
- The outcome and timing of pending unauthorized-transaction litigation and related recoveries.
- The final effective tax rate and any reduction in unrecognized tax benefits from tax audits or statute expirations.