Koss Corporation Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2014, compared with the corresponding periods ended March 31, 2013. The request metadata identifies “2013 Q3,” but the filing is for the third quarter of fiscal 2014.
Business Context and Reporting Period
Koss markets headphones, headsets, speaker-phones, noise-canceling and wireless products, and Koss Classics recordings. It operates as one business segment. The filing is unaudited and states that nine-month results are not necessarily indicative of the full fiscal year.
Financial Results and Liquidity
| Metric | Three Months Ended March 31, 2014 | Three Months Ended March 31, 2013 | Nine Months Ended March 31, 2014 | Nine Months Ended March 31, 2013 |
|---|---|---|---|---|
| Net sales | $4.30 million | $8.30 million | $17.65 million | $25.86 million |
| Gross profit | $1.09 million | $3.30 million | $0.79 million | $9.31 million |
| Gross margin | 25.4% | 39.8% | 4.5% | 36.0% |
| Operating income (loss) | $(1.03) million | $0.04 million | $(6.31) million | $1.22 million |
| Net income (loss) | $(0.03) million | $0.12 million | $(3.40) million | $0.82 million |
| Operating cash flow | Not separately provided | Not separately provided | $3.94 million | $2.54 million |
- Quarterly sales declined 48.2%; nine-month sales declined 31.7%.
- Quarterly operating margin was negative 23.9%, compared with positive 0.5% in the prior-year quarter. Nine-month operating margin was negative 35.7%, compared with positive 4.7%.
- Nine-month results included a $4.54 million impairment charge for capitalized software, inventory, product design costs, assumed liabilities and tooling. Excluding the impairment, nine-month gross margin was 30.2%.
- Cash and cash equivalents were $2.75 million at March 31, 2014, compared with $0.86 million at June 30, 2013.
- Current assets were $16.75 million versus current liabilities of $6.32 million, producing a current ratio of approximately 2.7x.
- Accounts receivable declined to $2.35 million from $12.19 million at June 30, 2013, primarily contributing to operating cash generation.
- Inventory was $9.67 million, including a $3.02 million obsolescence allowance, compared with $10.50 million at June 30, 2013.
- Total liabilities were $8.94 million and stockholders’ equity was $17.19 million at March 31, 2014.
- The company had no borrowings outstanding under its $8.0 million secured revolving credit facility. The facility also provides for up to $2.0 million of letters of credit and expires July 31, 2015.
- Nine-month investing cash outflow was $0.72 million, and financing cash outflow was $1.33 million, consisting of dividends paid.
Material Changes Versus the Prior Comparable Period
- Export sales decreased approximately 61% for the quarter and 50% for the nine-month period. Management attributed the decline to weak European economies, political unrest affecting customers in Ukraine and Russia, and lower volume for an Asian specialty product.
- U.S. sales declined approximately 30% for the quarter and 11% for the nine-month period. Lost retail space, a large anticipated customer return and lower shipments to certain new retail customers were partially offset by the Fit Series product line and new customer additions.
- Gross margin was pressured by lower sales over fixed manufacturing costs, Mexico manufacturing start-up costs and the anticipated customer return. Management stated that quarterly gross margin would have been 33.1% excluding Mexico manufacturing overhead.
- Selling, general and administrative expense declined to $2.35 million from $3.11 million for the quarter and to $7.93 million from $9.13 million for nine months, primarily due to lower software development, deferred compensation, commissions and charitable contributions.
- The company fully impaired its existing capitalized software technology after determining it would be replaced by a new architecture. Certain inventory, product design costs and tooling were also impaired.
- Unauthorized transaction-related costs and recoveries produced a net recovery of $0.23 million in the quarter and $0.83 million for nine months, compared with a net cost of $0.15 million and a net recovery of $1.04 million, respectively, in the prior-year periods.
- Nine-month operating cash flow benefited from an $8.5 million gross settlement with the company’s former auditors, or $6.38 million net of associated legal fees, received in July 2013.
- The company declared a $0.06-per-share dividend for the quarter ended March 31, 2014, but the board decided not to declare a dividend for the quarter ending June 30, 2014.
Guidance, Outlook, Risks and Unusual Items
- Management anticipated a fiscal 2014 effective tax rate of approximately 40% to 50%. The nine-month effective tax rate was approximately 45.1%, including the effect of reduced unrecognized tax benefits.
- The company expected approximately $0.8 million of fiscal-year spending for tooling, leasehold improvements and Mexico manufacturing equipment, funded through operating cash flow, cash reserves and available borrowings.
- Management expected to continue developing revised WiFi-based products, but future software development costs will be expensed as incurred rather than capitalized.
- Management stated that liquidity was adequate for operating requirements, debt service and planned capital expenditures for the next twelve months and the foreseeable future, but future dividends depend on financial condition, sales improvement, operating cash generation and earnings.
- Key risks include weak export and retail demand, consumer acceptance of new products, competition, pricing, foreign manufacturing and sourcing, political and economic conditions, tax matters, borrowing costs and pending litigation.
- Legal matters include claims against parties related to prior unauthorized transactions and litigation with Red Fusion Studios regarding termination of a Striva Technology development agreement. The ultimate resolution was not determinable.
- The company’s disclosure controls and procedures were assessed as effective as of March 31, 2014, with no reported material changes in internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether export and U.S. retail sales stabilize after the significant year-over-year declines.
- Whether Mexico manufacturing reaches sufficient scale to reduce gross-margin pressure.
- The timing, cost and commercial acceptance of the replacement WiFi product architecture and new headphone products.
- Whether the $4.54 million impairment fully captures obsolete software, inventory and tooling exposure.
- The sustainability of operating cash flow after the former-auditor settlement proceeds are no longer available.
- Whether the company can maintain adequate liquidity while funding capital expenditures and operating losses without drawing on its secured credit facility.
- The effect of suspending the June 30, 2014 dividend and the conditions required for future dividend resumption.
- The potential financial impact of pending litigation, tax matters and remaining unauthorized-transaction-related recoveries.