Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation designs, manufactures and sells stereo headphones and related accessories, including wireless Bluetooth headphones and speakers, computer and telecommunications headsets, and active noise-canceling headphones. The company operates as one business segment. This unaudited Form 10-Q covers the three and six months ended December 31, 2022, representing the second quarter and first half of fiscal 2023, compared with the same periods of fiscal 2022.
Key financial metrics
| Metric | Three months ended Dec. 31, 2022 | Three months ended Dec. 31, 2021 | Six months ended Dec. 31, 2022 | Six months ended Dec. 31, 2021 |
|---|---|---|---|---|
| Net sales | $3.27 million | $4.42 million | $6.63 million | $8.78 million |
| Gross profit | $1.13 million | $1.55 million | $2.31 million | $3.13 million |
| Gross margin | 34.4% | 35.1% | 34.9% | 35.7% |
| SG&A expense | $2.47 million | $1.23 million | $26.14 million | $3.01 million |
| Operating income (loss) | $(1.35) million | $0.32 million | $(23.83) million | $0.12 million |
| Other income | None | $0.26 million | $33.00 million | $0.36 million |
| Net income (loss) | $(1.15) million | $0.58 million | $8.80 million | $0.48 million |
| Diluted earnings (loss) per share | $(0.12) | $0.06 | $0.90 | $0.05 |
Six-month operating cash flow was $10.54 million, compared with cash used in operations of $0.38 million in the prior-year period. Investing cash outflow was $15.02 million, primarily reflecting purchases of U.S. Treasury securities. Financing cash inflow was $0.09 million from stock-option exercises. Cash and cash equivalents declined to $4.81 million from $9.21 million at June 30, 2022.
At December 31, 2022, the company held $5.01 million of short-term investments and $9.89 million of long-term investments, consisting primarily of held-to-maturity U.S. Treasury securities. Total assets were $39.41 million, compared with $29.96 million at June 30, 2022. Stockholders’ equity was $31.75 million, and total liabilities were $7.65 million.
The company had no outstanding borrowings under its $5.0 million secured revolving credit facility and was in compliance with its covenants. The facility maturity was extended to October 31, 2024. Management stated that cash from operations, cash reserves and available borrowings should provide adequate liquidity for the next twelve months and the foreseeable future.
Material changes versus the prior comparable period
- Quarterly sales decreased 25.9%; six-month sales decreased 24.5%. Domestic sales declined 32.8% in the quarter and 18.8% year to date, while six-month export sales declined 36.9%.
- Management attributed the sales decline primarily to weaker distributor demand, overstocked retail shelves following pandemic-related inventory effects, delayed education-market orders, reduced European and Asian sales, and the cessation of sales to Russia and Ukraine.
- Direct-to-consumer sales increased approximately 20.7% in the six-month period and partially offset distributor weakness.
- Gross margin declined 80 basis points for the six-month period, reflecting unfavorable product mix, lower higher-margin specialty sales and fixed manufacturing costs on lower volume. Lower freight rates provided some offset.
- SG&A increased by approximately $23.1 million for the six-month period, primarily due to $22.2 million of patent-enforcement legal fees and related expenses. Quarterly SG&A also included a $950,000 payment to external patent litigation counsel and $175,000 of related legal expense recorded as a change in estimate.
- Six-month net income was driven by $33.0 million of licensing proceeds recognized as other income during the first quarter. The prior-year period included $100,000 of licensing proceeds and approximately $256,000 of life-insurance-related income.
- Inventory declined to $7.83 million from $8.63 million at June 30, 2022, while the inventory obsolescence reserve increased modestly to $1.91 million.
Guidance, outlook, risks and unusual items
The filing does not provide formal numerical revenue or earnings guidance. Management expects fiscal 2023 results to continue being affected by COVID-19 and its variants, inflation in commodities, packaging, wages and transportation, supply-chain disruption, potential shipping delays, and the Russia-Ukraine conflict. The company implemented pricing actions and continues to pursue freight, sourcing and supply-chain mitigation measures.
The intellectual-property enforcement program remains a significant unusual item and source of uncertainty. Koss has pending patent infringement litigation involving Bose, PEAG/jLab, Plantronics and Polycom, and Skullcandy; the Apple litigation was dismissed in July 2022 following resolution. Future legal fees, settlements, awards or licensing outcomes are uncertain, and portions of any monetary recovery may be payable to third parties.
The company recorded a full valuation allowance against deferred tax assets. Remaining federal tax-loss carryforwards were expected to be approximately $32.5 million, while realization of the approximately $9.6 million deferred tax asset remained uncertain. A separate patent matter involving One-E-Way had an estimated accrued resolution cost of approximately $41,000.
Other risks include customer concentration, dependence on third-party manufacturing and suppliers, changing consumer demand, competition, foreign-market and trade risks, and potential effects from inflation and geopolitical events. Management stated that disclosure controls were effective as of December 31, 2022, with no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether licensing income is recurring; the filing does not indicate that the $33.0 million licensing receipt is recurring.
- The expected magnitude, timing and third-party sharing of future patent-litigation costs or recoveries.
- Whether distributor destocking and weak European and Asian demand reverse, and whether direct-to-consumer growth continues.
- The company’s ability to maintain gross margins despite lower volumes, fixed manufacturing costs and inflationary pressures.
- Cash requirements after the $15.0 million investment outflow and the availability and covenant terms of the secured credit facility.
- The realization prospects for deferred tax assets despite the full valuation allowance and expected tax-loss carryforwards.
- Concentration and credit risk among the four largest accounts receivable customers, which represented approximately 59% of trade receivables at December 31, 2022.