Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation designs, manufactures and sells stereo headphones, wireless headphones and speakers, computer and telecommunications headsets, active noise-canceling headphones and related accessories. It operates as one business segment. This unaudited Form 10-Q covers the three and six months ended December 31, 2021, the second quarter of fiscal 2022, with balance-sheet comparisons to June 30, 2021.
Financial results and key metrics
| Metric | Three months ended Dec. 31, 2021 | Three months ended Dec. 31, 2020 | Six months ended Dec. 31, 2021 | Six months ended Dec. 31, 2020 |
|---|---|---|---|---|
| Net sales | $4.416 million | $4.930 million | $8.781 million | $10.138 million |
| Gross profit | $1.550 million | $1.618 million | $3.132 million | $3.254 million |
| Gross margin | 35.1% | 32.8% | 35.7% | 32.1% |
| Income from operations | $320,399 | $2,073 | $121,439 | $132,529 |
| Net income | $578,969 | $508,890 | $479,610 | $635,819 |
| Diluted EPS | $0.06 | $0.07 | $0.05 | $0.09 |
- Quarterly SG&A declined 23.9% to $1.229 million, or 27.8% of sales, from $1.616 million, or 32.8% of sales. Six-month SG&A was $3.010 million, or 34.3% of sales, versus $3.122 million, or 30.8%.
- Other income was $255,975 in the quarter and $355,975 for six months, including approximately $256,000 of life-insurance proceeds related to the founder’s death and a $100,000 one-time patent license fee. Prior-year other income included $506,700 of forgiven PPP/SBA debt.
- Cash and cash equivalents were $7.789 million at December 31, 2021, versus $6.950 million at June 30, 2021. Total assets were $28.531 million and stockholders’ equity was $21.708 million.
- Six-month operating cash flow was negative $380,714, compared with positive $784,680 in the prior year, primarily because inventory increased by $1.845 million to support supply-chain needs.
- Investing cash outflow was $171,043, while financing cash inflow was $1.390 million from stock-option exercises. The resulting net increase in cash was $838,589.
- The company had no borrowings under its $5.0 million secured revolving credit facility and reported material compliance with its covenants. The facility expires October 31, 2022 and permits letters of credit up to $1.0 million.
- Net inventory was $7.746 million at December 31, 2021, up from $5.902 million at June 30, 2021. Current liabilities were $2.526 million.
Material changes versus the prior comparable period
- Sales declined 10.4% in the quarter and 13.4% for the six-month period, driven primarily by lower domestic sales. Domestic six-month sales fell to approximately $6.004 million from $7.599 million.
- Sales of communication headsets to education-related distributors did not repeat the prior-year surge. Sales also declined following the loss of a U.S. mass-retailer placement for a non-Koss-branded product, reducing sales by approximately $165,000 in the quarter and $892,000 year to date.
- Export sales decreased slightly in the quarter but increased to approximately $2.777 million for six months, supported primarily by European distributor sales and new products.
- Gross margin improved because of a more favorable product and channel mix, including reduced low-margin mass-retailer business and increased direct-to-consumer and higher-margin distributor sales.
- Quarterly operating income improved substantially despite lower sales, benefiting from lower SG&A and a $472,883 reversal of deferred compensation following the founder’s death. Six-month operating income declined modestly.
- Stock-option exercises increased shares outstanding to 9,147,795 at December 31, 2021 from 8,608,706 at June 30, 2021, and provided approximately $1.4 million of cash. The exercises generated approximately $8.0 million of tax-deductible compensation expense.
Outlook, risks, contingencies and unusual items
- Management believes cash from operations, cash reserves and available borrowings provide adequate liquidity for operating needs, debt service and planned capital expenditures for the next twelve months and the foreseeable future. No formal revenue or earnings guidance was provided.
- Supplier delays, container shortages, port and rail congestion, and elevated inbound freight costs are affecting the company’s primarily southern-China supply chain and are expected to pressure margins. Management is increasing inventory, securing critical components, using alternative sources and considering air freight.
- COVID-19-related retail disruption and the absence of the prior-year headset demand surge may continue to affect sales. The ultimate financial impact remains uncertain.
- The company estimates a federal tax-loss carryforward of approximately $39.8 million for fiscal 2022 and a deferred tax asset of approximately $12.0 million at December 31, 2021; the asset is fully offset by a valuation allowance because future realization is uncertain.
- Koss is pursuing patent-infringement claims against Apple, Bose, JLab, Plantronics/Polycom and Skullcandy. Potential recoveries are uncertain, and some or all monetary awards may be payable to third parties. The company also received notice of potential patent infringement claims from One E-Way; no lawsuit had been filed and served as of the filing.
- The company leases its Milwaukee facility from an entity owned by the former chairman’s revocable trust at fixed annual rent of $380,000 through June 30, 2023, with an option to renew through June 30, 2028.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes were reported to the risk factors in the prior Form 10-K.
Investor verification points
- Verify whether sales recovery, direct-to-consumer growth and European distributor demand offset continued domestic weakness.
- Track inventory levels, supplier reliability, freight costs and their effect on gross margin and operating cash flow.
- Assess liquidity after considering the negative operating cash flow and the October 31, 2022 credit-facility expiration.
- Evaluate the sustainability of earnings excluding the life-insurance proceeds, patent license fee, deferred-compensation reversal and prior-year PPP forgiveness.
- Monitor dilution and tax effects from stock-option exercises, including the uncertain realization of the deferred tax asset.
- Follow the patent litigation and potential obligations to third parties, as outcomes and recoveries are not determinable from the filing.