Koss Corporation Form 10-Q Summary
Business Context and Reporting Period
Koss Corporation designs and markets high-fidelity, wireless Bluetooth, computer, telecommunications, and active noise-canceling headphones and related products. The company operates as one business segment. This unaudited Form 10-Q covers the three and six months ended December 31, 2018, within fiscal 2019.
Financial Performance and Position
| Metric | Three Months Ended December 31, 2018 | Three Months Ended December 31, 2017 | Six Months Ended December 31, 2018 | Six Months Ended December 31, 2017 |
|---|---|---|---|---|
| Net sales | $5.411 million | $5.891 million | $11.196 million | $11.975 million |
| Gross profit | $1.662 million | $1.877 million | $3.494 million | $3.561 million |
| Gross margin | 30.7% | 31.9% | 31.2% | 29.7% |
| SG&A expense | $1.531 million | $1.800 million | $3.264 million | $3.448 million |
| Income before taxes | $134,121 | $75,945 | $201,557 | $123,606 |
| Net income (loss) | $134,121 | $(2.941) million | $201,532 | $(2.919) million |
| Diluted EPS | $0.02 | $(0.40) | $0.03 | $(0.40) |
- Domestic sales were approximately $3.223 million for the quarter, down 19.6% year over year, and approximately $6.956 million for the six-month period. Declines were concentrated among mass retail customers and certain domestic distributors.
- Export sales increased to approximately $2.188 million for the quarter and $4.240 million for the six-month period, supported by distributors in Europe, Asia, and the South Pacific and by new wireless products.
- Six-month operating cash flow was $1.354 million versus $388,502 in the prior-year period. Investing cash use was $235,514, financing cash provided was $46,677, and cash increased by $1.165 million to $2.247 million.
- At December 31, 2018, total assets were $23.235 million, total liabilities were $8.589 million, and stockholders’ equity was $14.646 million.
- Net inventory increased to $7.186 million from $6.139 million at June 30, 2018. Accounts receivable declined to $3.010 million from $4.710 million.
- The company had no borrowings under its $4.0 million secured revolving credit facility and reported no interest expense in the current-year periods. The facility expires July 31, 2019 and is secured by substantially all company assets.
Material Changes Versus the Prior Comparable Period
- Quarterly sales declined 8.1%; six-month sales declined 6.5%.
- Quarterly gross margin decreased by 1.2 percentage points, while six-month gross margin increased by 1.5 percentage points. Management attributed the changes primarily to product, customer, and channel mix.
- SG&A declined by 15.0% for the quarter and 5.4% for the six-month period, primarily due to lower employee benefit costs, sales commissions, engineering testing costs, and legal fees.
- Net income improved substantially because the prior-year periods included $3.017 million and $3.042 million of income tax expense, respectively. The prior-year tax expense included a deferred-tax write-down and a valuation allowance related to the Tax Cuts and Jobs Act. Current-period tax expense was negligible.
- The company adopted revenue recognition Topic 606 using the full retrospective method and lease standard Topic 842 using the modified retrospective method effective July 1, 2018. These changes materially affected balance-sheet presentation but had an overall immaterial effect on reported income and cash flows.
Outlook, Risks, Contingencies, and Unusual Items
- Management expects capital expenditures for tooling, leasehold improvements, and other capital projects during fiscal 2019 to be similar to the prior fiscal year. It expects operating cash flow and available credit to fund these requirements.
- Management states that cash, operating cash generation, and borrowing capacity should provide adequate liquidity for the next twelve months and the foreseeable future, but the filing does not provide formal revenue or earnings guidance.
- Risks include continued weakness among domestic mass retailers and distributors, competition in lower-priced products, consumer acceptance of new technologies and product introductions, third-party manufacturing and foreign sourcing, trade and importation matters, and changing economic conditions.
- The company remains involved in litigation concerning unauthorized transactions and a Wisconsin Supreme Court appeal involving Park Bank. A separate lawsuit by a former celebrity endorser alleging unauthorized use of her name and image remained pending after the company’s motion to dismiss was denied on January 4, 2019. The ultimate resolution of these matters was not determinable.
- The Milwaukee facility is leased from Koss Holdings, LLC, which is wholly owned by the former chairman. The lease has fixed annual rent of $380,000, with a renewal option; recorded operating lease liabilities totaled $2.976 million at December 31, 2018.
- Unauthorized transaction-related costs were $28,602 for the six months, compared with a $16,180 recovery in the prior-year period. Stock-based compensation expense was $194,356 for the six months.
- Management concluded that disclosure controls were effective as of December 31, 2018, and reported no significant changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether domestic retail and distributor sales stabilize and whether export growth and wireless product introductions offset domestic weakness.
- Whether the higher inventory balance converts to sales without additional obsolescence charges; gross inventory included a $2.525 million obsolescence allowance.
- The renewal or replacement of the $4.0 million secured credit facility before its July 31, 2019 expiration.
- Potential financial and reputational effects of the Park Bank appeal and former endorser litigation.
- The sustainability of negligible tax expense, given the valuation allowance on deferred tax assets and the company’s ability to realize those assets.
- The effects of revenue-recognition estimates for product returns, rebates, warranties, and deferred revenue on future sales and margins.