Koss Corporation 2019 Form 10-K Summary
Business Context and Reporting Period
Koss Corporation designs, manufactures and sells stereo headphones and related accessories through retailers, distributors, OEM customers, specialty stores and direct-to-consumer channels. The company reports one operating segment. This filing covers the fiscal year ended June 30, 2019; the provided request metadata refers to 2018 Q4, but the filing itself is a fiscal 2019 annual report.
Approximately 81% of fiscal 2019 sales came from music-listening stereo headphones and 19% from communications, education, metal-detector, OEM and other applications. Products are sourced from Asia and manufactured at the Milwaukee facility and through contract manufacturers in China and Taiwan.
Financial Performance and Position
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Net sales | $21.84 million | $23.52 million | Down 7.1% |
| Gross profit | $6.82 million | $6.56 million | Up $0.26 million |
| Gross margin | 31.2% | 27.9% | Up 3.3 percentage points |
| SG&A | $6.42 million | $6.92 million | Down $0.50 million |
| Income from operations | $0.40 million | $(0.36) million | Improved |
| Net income (loss) | $0.43 million | $(3.41) million | Improved $3.85 million |
| Basic and diluted EPS | $0.06 | $(0.46) | Improved |
| Operating cash flow | $1.41 million | $1.03 million | Up $0.38 million |
Revenue declined primarily because of lower mass-retail and U.S. distributor sales and a $628,014 decline in sales to an Asian OEM customer whose contract ended during fiscal 2019. Export sales decreased to $6.59 million from $6.94 million, while domestic sales decreased to $15.26 million from $16.58 million.
Gross margin benefited from product and channel mix, approximately $121,000 from a freight class-action settlement, and the absence of fiscal 2018 excess and obsolete inventory charges. SG&A reductions reflected lower benefit costs, commissions, engineering testing and professional fees, partly offset by increased intellectual-property enforcement expenses.
Cash and cash equivalents were $2.23 million at June 30, 2019, compared with $1.08 million at June 30, 2018. Total current assets were $12.91 million and total current liabilities were $3.00 million. Inventories increased to $6.85 million from $6.14 million, while accounts receivable decreased to $3.66 million from $4.71 million.
Total assets were $23.24 million and stockholders’ equity was $15.07 million at fiscal year-end. The balance sheet includes a $2.85 million operating lease right-of-use asset and $2.85 million of long-term operating lease liability following early adoption of ASC 842.
Debt, Liquidity and Capital Allocation
Koss had no borrowings outstanding at June 30, 2019. The JPMorgan facility was terminated on May 14, 2019 and replaced with a secured $5.0 million revolving facility from Town Bank, expiring May 14, 2021, with interest at LIBOR plus 1.50% and a $1.0 million letter-of-credit sublimit. The company stated that it was in compliance with all covenants.
Investing cash outflows were $0.31 million, including $0.19 million for equipment and leasehold improvements and $0.12 million for life-insurance premiums. Management planned approximately $0.9 million of fiscal 2020 spending for tooling and leasehold improvements and expected operations to fund these expenditures.
No dividends or share repurchases occurred during fiscal 2019 or 2018. Approximately $2.14 million remained available under the authorized repurchase program at June 30, 2019. Stock-option exercises generated $46,677 of financing cash flow.
Material Changes Versus the Prior Comparable Period
- Sales decreased 7.1%, with declines concentrated in U.S. mass retail, certain distributors and an Asian OEM customer.
- Gross margin expanded to 31.2% from 27.9%, more than offsetting the revenue decline at the gross-profit level.
- The company returned to operating profitability and net profitability after fiscal 2018 operating and net losses.
- Operating cash flow increased to $1.41 million, and year-end cash more than doubled.
- Wal-Mart represented approximately 18% of fiscal 2019 sales, down from 21%; the five largest customers represented 45%, down from 47%.
- The company adopted ASC 606 retrospectively and ASC 842 using modified retrospective treatment. These changes materially affected balance-sheet presentation; ASC 606 had an overall immaterial effect on the previously reported statements of income and cash flows.
- Inventory accounting changed from LIFO to FIFO effective June 30, 2019. The filing states that the change did not affect reported inventory values or fiscal 2018 or 2019 results because the LIFO reserve was zero.
Outlook, Commentary, Risks and Unusual Items
Management expected fiscal 2020 research and development spending for new Bluetooth and wired headphone products and planned approximately $900,000 of tooling and leasehold-improvement expenditures. Management also anticipated an effective tax rate below 25%, partly from using approximately $630,000 of federal net operating loss carryforwards.
The company is pursuing intellectual-property enforcement and may enter licensing arrangements or initiate litigation. Successful enforcement could produce material royalties or other proceeds, but the timing and outcome are uncertain. Legal expenses increased as a result of this program.
Key operating risks include customer concentration, competitive pressure, consumer demand, dependence on retailers and distributors, foreign exchange and economic conditions, tariffs and freight costs, and reliance on Asian contract manufacturers. One Chinese vendor represented approximately 75% of contract-manufacturing costs. Management stated that replacing a supplier after a major disruption could take six to twelve months.
A lawsuit by a former celebrity endorser alleging unauthorized use of her name and image remained pending as of June 30, 2019. Management believed other ordinary-course claims were not expected to have a material adverse effect, but stated that legal outcomes are inherently uncertain.
The Milwaukee facility is leased from Koss Holdings, LLC, which is wholly owned by the former chairman, at fixed annual rent of $380,000 through June 30, 2023, with a renewal option. The company also has deferred compensation obligations to a former and a current officer totaling approximately $2.42 million at year-end.
Management concluded that disclosure controls and internal control over financial reporting were effective as of June 30, 2019. The auditor issued an unqualified opinion on the fiscal 2019 consolidated financial statements and did not audit the effectiveness of internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether sales stabilize after the loss or completion of certain mass-retail, distributor and OEM business, particularly the Asian OEM contract.
- Whether the 31.2% gross margin is sustainable or was materially supported by favorable mix, the freight settlement and the absence of prior-year inventory charges.
- Inventory composition, aging and reserve adequacy, given the $6.85 million inventory balance and reliance on approximately 90 days of finished-goods supply.
- Customer concentration and credit exposure, including Wal-Mart’s 18% share of sales and approximately 33% share of trade receivables.
- Execution and returns from planned product introductions, Bluetooth investments and approximately $900,000 of fiscal 2020 capital spending.
- Terms, collateral and covenant requirements of the new $5.0 million secured Town Bank facility.
- Potential costs or proceeds from intellectual-property enforcement and the status and potential exposure of the former-endorser lawsuit.
- Related-party lease and deferred-compensation obligations, as well as the company’s ability to maintain liquidity without borrowing.