Koss Corporation 10-Q Summary
Business context and reporting period
Koss Corporation designs and markets high-fidelity, 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 months ended September 30, 2018, the first quarter of fiscal 2019, compared with the three months ended September 30, 2017.
Key financial metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $5.785 million | $6.084 million | Down 4.9% |
| Gross profit | $1.831 million | $1.684 million | Up 8.8% |
| Gross margin | 31.7% | 27.7% | Up 4.0 percentage points |
| SG&A expense | $1.733 million | $1.648 million | Up 5.2% |
| Income before tax | $67,436 | $47,661 | Up 41.5% |
| Net income | $67,411 | $21,969 | Up 206.8% |
| Basic and diluted EPS | $0.01 | Less than $0.01 as reported | Improved |
| Cash provided by operating activities | $707,789 | $96,843 | Up $610,946 |
Cash and cash equivalents were $1.698 million at September 30, 2018, compared with $1.082 million at June 30, 2018. Total current assets were $12.037 million and current liabilities were $2.859 million. Inventories, net, were $6.397 million, including a $2.566 million allowance for obsolete inventory.
Investing activities used $137,544, primarily for equipment and leasehold improvements and life insurance premiums. Financing activities provided $46,677 from stock-option exercises. The company ended the quarter with a $616,922 net increase in cash.
Koss had no outstanding borrowings under its secured $4.0 million revolving credit facility at September 30, 2018. The facility expires July 31, 2019, has a $2.0 million letter-of-credit sublimit, is secured by substantially all company assets, and had no financial covenant breaches reported. Total operating lease liabilities were $3.040 million.
Material changes versus the prior comparable period
- Sales declined $299,216, primarily because of lower sales to a domestic mass-retail customer. Domestic sales decreased approximately $428,000, partially offset by approximately $147,000 of higher export sales, driven by European and Australian distributors.
- Gross margin improved to 31.7% from 27.7%, primarily due to product, customer, and channel mix and lower obsolete-inventory-related charges.
- SG&A increased $85,188, reflecting lower income from the cash surrender value of life insurance and higher legal fees, partly offset by lower sales commissions.
- Unauthorized-transaction-related costs were $30,854, compared with a $14,409 recovery in the prior-year quarter. Current-quarter costs included $32,500 of legal fees, partly offset by $1,646 of restitution payments.
- Interest expense fell to zero from $2,692 because the company did not draw on its credit facility.
- Income tax expense decreased to $25 from $25,692. Management attributed the minimal current-quarter expense to an offsetting change in the valuation allowance for deferred tax assets.
- Operating cash flow increased substantially, principally from a $1.080 million reduction in accounts receivable, partly offset by higher inventory and lower accounts payable.
Guidance, outlook, risks, contingencies, and unusual items
Management expects fiscal 2019 expenditures for tooling, leasehold improvements, and capital expenditures to be similar to the prior fiscal year. Management believes operating cash flow, cash reserves, and available credit will provide adequate liquidity for operating requirements, debt service, and planned capital expenditures over the next twelve months and the foreseeable future. No quantitative revenue or earnings guidance was provided.
The company adopted the revenue-recognition standard in Topic 606 using the full retrospective method and adopted the lease standard in Topic 842 using the modified retrospective method, effective July 1, 2018. These changes materially affected balance-sheet presentation, including deferred revenue and operating lease assets and liabilities, but had no material overall impact on reported operating cash flows and did not affect the statements of operations for the lease adoption. The prior-year income statement was restated for revenue recognition, with an overall immaterial effect on net income.
Koss leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The lease runs through June 30, 2023, with an option to renew through June 30, 2028, at fixed annual rent of $380,000.
Pending legal matters include the company's litigation involving Park Bank and unauthorized transactions, which was pending before the Wisconsin Supreme Court, and a lawsuit by a former celebrity endorser alleging unauthorized post-termination use of her name and image. The ultimate resolution of these matters was not determinable.
Principal identified business risks include consumer acceptance of new technologies and products, competition, customer orders and concentration, pricing, third-party manufacturing, foreign sourcing and sales, trade and importation issues, borrowing costs, tax changes, and pending or threatened litigation. The company stated that its disclosure controls were effective as of September 30, 2018, and that no risk factors were separately reported as applicable in Part II, Item 1A.
Facts investors should verify
- Whether the decline in domestic mass-retail sales continues and whether export growth can offset it.
- Whether the improved gross margin is sustainable or primarily reflects temporary product, customer, and channel mix.
- The adequacy and aging of the $2.566 million obsolete-inventory allowance relative to $6.397 million of net inventory.
- The company's ability to fund operations and planned capital expenditures after the $4.0 million credit facility expires on July 31, 2019.
- The potential financial impact of the Park Bank appeal and former celebrity endorser litigation.
- The effects of deferred warranty revenue, product returns, rebates, and other variable-consideration estimates on future revenue.
- The related-party Milwaukee facility lease and the inclusion of the renewal option in lease-liability calculations.