Koss Corporation Form 10-Q Summary
Business Context and Reporting Period
Koss Corporation designs and markets high-fidelity, Bluetooth, noise-canceling, computer, telecommunications and other headphones and speakers, operating as one business segment. This unaudited Form 10-Q covers the three and six months ended December 31, 2016, the second quarter of fiscal 2017, compared with the corresponding periods ended December 31, 2015.
Key Financial Metrics
| Metric | Three Months 2016 | Three Months 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Net sales | $6.688 million | $7.229 million | $13.037 million | $12.761 million |
| Gross profit | $2.207 million | $2.663 million | $4.149 million | $4.309 million |
| Gross margin | 33.0% | 36.8% | 31.8% | 33.8% |
| SG&A expense | $1.987 million | $1.989 million | $3.763 million | $3.755 million |
| Income before taxes | $0.223 million | $0.635 million | $0.351 million | $0.473 million |
| Net income | $0.140 million | $0.387 million | $0.224 million | $0.286 million |
| Diluted EPS | $0.02 | $0.05 | $0.03 | $0.04 |
Six-month operating cash flow was $539,666, compared with $1.520 million in the prior-year period. Investing cash outflow was $467,150, including $335,381 of equipment and leasehold-improvement purchases and $131,769 of life-insurance premiums. Net cash increased $72,516 to $807,909 at December 31, 2016.
At December 31, 2016, current assets were $13.407 million and current liabilities were $3.167 million. Inventory was $7.980 million, net of a $2.476 million obsolescence allowance. Total assets were $24.118 million and total liabilities were $5.531 million.
The company had no borrowings under its $5.0 million secured revolving credit facility and was in compliance with all covenants. The facility expires July 31, 2018 and is secured by substantially all company assets. Letters of credit are permitted subject to a $2.0 million sublimit.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales declined 7.5%, primarily because of lower distributor sales in Scandinavia and Asia. Six-month sales increased 2.2%, driven by higher Asian OEM sales and improved domestic distributor sales.
- Domestic sales increased to approximately $4.083 million in the quarter and $7.906 million for the six months. Export sales declined in the quarter to approximately $2.604 million but increased for the six months to approximately $5.131 million.
- Gross margin declined 380 basis points in the quarter and 200 basis points for the six months. Management attributed the decline primarily to product, customer and channel mix, including a greater proportion of lower-margin OEM sales.
- SG&A was essentially unchanged in dollars, although SG&A increased to 29.7% of quarterly sales from 27.5%.
- Quarterly net income declined 64% and six-month net income declined 22%. Lower gross profit was the primary driver.
- Operating cash flow declined by $980,522. Management attributed approximately $800,000 of the decrease to advance customer payments received in the prior-year period for products shipped in the subsequent quarter.
- Unauthorized-transaction-related costs declined to a $3,404 recovery in the quarter and $34,096 of net costs for the six months, compared with $37,475 and $74,950, respectively, in the prior-year periods.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2017 capital expenditures for tooling, leasehold improvements and other capital items of approximately $700,000 to $900,000, funded through operating cash flow or the credit facility.
- Management believes cash reserves, operating cash flow and available borrowing capacity provide adequate liquidity for operating needs, debt service and planned capital expenditures for the next twelve months and the foreseeable future.
- The anticipated effective income tax rate for the fiscal year ending June 30, 2017 is approximately 38% to 40%.
- Distributors in Scandinavia and Asia reportedly held excess inventory, which reduced purchases. The company remains exposed to consumer acceptance of new technologies, competition, pricing, product introductions, third-party manufacturing, foreign sourcing and sales, trade restrictions, tax changes and litigation.
- The company is appealing a March 2016 summary judgment dismissing its case against Park Bank related to prior unauthorized transactions. The ultimate resolution is not determinable from the filing.
- On January 5, 2017, the company renewed its related-party Milwaukee facility lease through June 30, 2023 at fixed annual rent of $380,000. The lessor is wholly owned by the former chairman.
- Management concluded that disclosure controls were effective as of December 31, 2016 and reported no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the sales decline among Scandinavian and Asian distributors persists and whether Asian OEM growth offsets that weakness.
- Whether product and channel mix continues to pressure gross margins.
- Inventory levels, the $2.476 million obsolescence allowance and the company’s ability to convert inventory into cash.
- Operating cash flow performance after the prior-year advance customer payment comparison normalizes.
- Actual fiscal 2017 tooling and capital expenditures relative to the $700,000-$900,000 estimate.
- Compliance with covenants and continued availability of the secured credit facility.
- The outcome and potential financial impact of the Park Bank appeal and other legal claims.
- The economic terms and governance implications of the related-party facility lease renewal.