Koss Corporation — Form 10-Q Summary
Business context and reporting period
Koss Corporation designs and markets headphones, wireless Bluetooth headphones and speakers, headsets, active noise-canceling headphones, and related products. The company operates as one business segment. This unaudited Form 10-Q covers the three months ended September 30, 2016, the first quarter of fiscal 2017, compared with the same period of fiscal 2016.
Financial results and key metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $6.349 million | $5.531 million | 14.8% increase |
| Gross profit | $1.942 million | $1.646 million | 18.0% increase |
| Gross margin | 30.6% | 29.8% | Up 0.8 percentage points |
| SG&A expense | $1.776 million | $1.766 million | Approximately $10,000 increase |
| Income before taxes | $128,142 | $(162,204) | Improved |
| Income tax provision/(benefit) | $43,931 | $(61,400) | Expense versus benefit |
| Net income/(loss) | $84,211 | $(100,804) | Returned to profitability |
| Basic and diluted EPS | $0.01 | $(0.01) | Improved |
| Operating cash flow | $62,445 | $(1.044) million | Improved |
Export sales increased to approximately $2.531 million from $1.631 million, primarily because of higher sales to an OEM customer in Asia. Domestic sales were approximately $3.818 million versus approximately $3.900 million. Income before tax margin was 2.0%, compared with negative 2.9% in the prior-year quarter.
At September 30, 2016, cash and cash equivalents were $459,921, total current assets were $12.222 million, and total current liabilities were $2.224 million. Inventory was $7.388 million, down from $8.595 million at June 30, 2016. Total liabilities were $4.585 million and stockholders’ equity was $18.359 million.
Net cash used in investing activities was $337,917, including $206,309 of equipment and leasehold-improvement purchases and $131,608 of life-insurance premiums. Cash decreased by $275,472 during the quarter, ending at $459,921. There were no financing cash flows during the quarter.
Material changes versus the prior comparable period
- Sales growth was driven principally by the Asian OEM customer and increased export activity.
- Gross margin improved because of changes in product, customer, and sales-channel mix.
- SG&A was broadly stable; higher 401(k) matching, product-testing, and deferred-compensation costs were largely offset by lower stock-based compensation expense and increased cash surrender value of life insurance.
- Operating cash flow improved substantially, supported by inventory and receivables reductions, although accounts payable also declined by $1.332 million.
- Interest expense declined to $846 from $5,318 because the company had limited borrowing on its credit facility.
- Unauthorized-transaction-related legal costs remained approximately $37,500 in the quarter.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects an effective income tax rate of approximately 38%–40% for fiscal 2017.
- Management expects approximately $700,000–$900,000 of tooling, leasehold-improvement, and other capital expenditures during fiscal 2017 and believes operating cash flow, cash reserves, and available credit will fund these needs.
- The secured revolving credit facility has a $5.0 million borrowing limit, subject to borrowing-base requirements, and expires July 31, 2018. No borrowings were outstanding at September 30, 2016, and the company reported compliance with all covenants.
- The facility is secured by substantially all company assets and includes customary affirmative, negative, and financial covenants.
- The company is appealing a March 2016 summary judgment dismissing its legal action against Park Bank concerning previously reported unauthorized transactions. The ultimate resolution is not determinable. Related legal costs continue.
- Key stated risks include consumer acceptance of new technologies and products, competition, customer orders, third-party manufacturing, foreign sourcing and sales, trade and import restrictions, borrowing costs, tax-rate changes, and pending or threatened litigation.
- The company leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The lease runs through June 30, 2018, at fixed annual rent of $380,000, plus related property expenses.
- Management concluded that disclosure controls were effective as of September 30, 2016, and reported no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the Asian OEM-driven export growth is recurring or concentrated in a limited number of orders or customers.
- The sustainability of the 30.6% gross margin and the effect of future product and channel mix.
- Inventory quality, including the $2.448 million allowance for obsolete inventory against gross inventory of $9.835 million.
- Cash conversion and working-capital needs, particularly the effect of falling accounts payable on future operating cash flow.
- Progress and potential financial impact of the Park Bank appeal and related unauthorized-transaction litigation.
- Actual fiscal 2017 capital expenditures versus the $700,000–$900,000 estimate and any resulting use of the credit facility.
- Reliance on the secured credit facility and continued compliance with its covenants.
- Potential dilution from outstanding options: 2.365 million shares were excluded from diluted EPS because they were anti-dilutive.