KOSS CORP annual report, FY2014

Koss Corporation Form 10-K Summary

Reporting period: Fiscal year ended June 30, 2014, compared with fiscal 2013. The source filing is an annual report for fiscal 2014, not a quarterly filing for 2013 Q4. Koss designs, manufactures and sells stereo headphones and related accessories through domestic and international retail, distributor and direct channels. The company reports one operating segment.

Financial Performance and Position

Metric	FY2014	FY2013
Net sales	$23.84 million	$35.76 million
Gross profit (loss)	$(0.28) million	$13.41 million
Gross margin	(1.2%)	37.5%
SG&A expense	$10.47 million	$13.35 million
Income (loss) from operations	$(10.00) million	$7.64 million
Net income (loss)	$(5.55) million	$5.43 million
Basic and diluted EPS	$(0.75)	$0.74
Cash provided by operating activities	$3.59 million	$3.50 million

FY2014 net sales declined 33.3%, driven principally by lower export sales, distributor inventory overstock, increased competition, political turmoil in certain markets and reduced U.S. retail product placement.
Gross profit was reduced by a $6.31 million impairment charge covering capitalized software, inventory, product design costs and tooling. The company also incurred approximately $1.52 million of expenses related to underutilized Mexico operations.
SG&A decreased $2.88 million, primarily due to lower profit-based compensation, reduced product-development spending and cost-reduction efforts.
Unauthorized-transaction-related recoveries were $1.13 million in FY2014 versus $10.19 million in FY2013, which included an $8.50 million lawsuit settlement. Net unauthorized-transaction-related costs and recoveries were benefits of $0.75 million and $7.59 million, respectively.
Cash and cash equivalents were $1.90 million at June 30, 2014, compared with $0.86 million at June 30, 2013. Accounts receivable declined to $3.16 million from $12.19 million, largely reflecting collection of the prior-year lawsuit settlement receivable and lower sales.
Total assets were $24.39 million and stockholders’ equity was $15.24 million at June 30, 2014, compared with $35.23 million and $21.39 million, respectively, at June 30, 2013.
The company had no borrowings under its credit facility at June 30, 2014. The facility was amended in July 2014, reducing total availability from $8.0 million to $5.0 million and revising financial covenants. Availability was approximately $5.0 million as of July 31, 2014.
Operating cash flow exceeded capital expenditures and dividends, producing a $1.04 million increase in cash during FY2014. Investing cash outflows were $0.78 million, and financing cash outflows were $1.77 million, all related to dividends paid.

Material Changes and Unusual Items

The company concluded that the Striva Wi-Fi product software required replacement with a new architecture and wrote off the remaining $2.31 million of capitalized software. Additional inventory, design-cost and tooling impairments resulted in the total $6.31 million charge.
Research and development expense declined to $1.02 million from $1.44 million. Wi-Fi development was temporarily suspended until the base business returns to more profitable levels, while traditional wired-headphone development continues.
Manufacturing at the Juarez, Mexico facility was temporarily suspended after lower export sales prevented an adequate return on the investment. Management stated that the facility may resume production if economic conditions improve.
The company did not declare the quarterly dividend for the quarter ended June 30, 2014. Dividends declared declined to $0.18 per share for FY2014 from $0.24 per share in FY2013, although $1.77 million of dividends were paid in each year.
No shares were repurchased under the authorized repurchase program during FY2014 or FY2013. Approximately $2.14 million remained available under the program at June 30, 2014.

Guidance, Outlook, Risks and Contingencies

Management expected FY2015 effective income tax rate of approximately 37% and budgeted approximately $0.60 million for tooling and leasehold improvements.
Management expects continued spending on traditional wired-headphone research and development and planned several new product offerings for FY2015. Wi-Fi-related spending was expected to remain substantially lower.
Management’s liquidity plan focuses on improving export and overall sales, reducing capital expenditures, increasing operating cash flow and restoring profitability. Future dividends depend on financial condition, liquidity, sales improvement and earnings; future dividend payments are not assured.
Customer concentration remains material: the five largest customers represented approximately 37% of FY2014 sales, while one Scandinavian distributor represented approximately 10% and one U.S. customer approximately 9%.
Foreign sales declined to $9.62 million from $19.39 million. Risks include foreign competition, political and economic instability, currency fluctuations, tariffs, trade restrictions and dependence on overseas distributors and contract manufacturers.
The company relies on suppliers in China, Taiwan and South Korea and maintains inventory intended to cover approximately 90 days of demand. Management estimates that replacing a disrupted supplier could take up to 120 days.
Pending legal matters include claims related to the previously reported unauthorized transactions and litigation involving the termination of a Striva technology vendor contract. The ultimate resolution was not determinable from the filing.
The Milwaukee facility is leased from an entity wholly owned by the company’s Chairman at $380,000 annually through June 30, 2018, creating a related-party lease obligation.
The independent auditor stated that the financial statements fairly presented the company’s financial position and results under U.S. GAAP. Management concluded that disclosure controls and internal control over financial reporting were effective; the auditor was not engaged to opine on internal control effectiveness.

Key Facts for Investors to Verify

Whether sales and margins recover after the FY2014 export and retail-channel declines.
The status, cost and potential value of restarting the Mexico facility and resuming the revised Wi-Fi product platform.
Compliance with the amended $5.0 million secured credit facility’s minimum EBITDA and tangible-net-worth covenants.
The sustainability of positive operating cash flow given the FY2014 net loss and reliance on working-capital changes.
Whether quarterly dividends resume and the amount of any future distributions.
Potential liabilities, recoveries or legal costs associated with the unauthorized-transaction and vendor-contract proceedings.
Inventory quality and the adequacy of reserves, including the substantial increase in the obsolete-inventory reserve to $4.87 million from $1.21 million.
Customer concentration, overseas distributor inventory levels and supply-chain exposure to foreign manufacturing and trade restrictions.