Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation designs, manufactures and sells stereo headphones, 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, 2020, the second quarter of fiscal 2021, compared with the corresponding fiscal 2020 periods.
Key financial metrics
| Metric | Three months ended Dec. 31, 2020 | Three months ended Dec. 31, 2019 | Six months ended Dec. 31, 2020 | Six months ended Dec. 31, 2019 |
|---|---|---|---|---|
| Net sales | $4.93 million | $4.16 million | $10.14 million | $9.57 million |
| Gross profit | $1.62 million | $1.36 million | $3.25 million | $2.71 million |
| Gross margin | 32.8% | 32.8% | 32.1% | 28.3% |
| Operating income (loss) | $2,073 | $(222,618) | $132,529 | $(539,764) |
| Net income (loss) | $508,890 | $(215,713) | $635,819 | $(526,462) |
| Basic and diluted EPS | $0.07 | $(0.03) | $0.09 | $(0.07) |
Six-month net sales increased 5.9%, while second-quarter sales increased 18.4%. Selling, general and administrative expense was $1.62 million in the quarter, up 1.8%, and $3.12 million for the six months, down 4.0%. The six-month improvement in net income included $506,700 of other income from forgiveness of the company’s SBA Paycheck Protection Program loan; excluding this item, reported profitability would have been materially lower.
Cash provided by operating activities was $784,680 for the six months, compared with $352,988 in the prior-year period. Investing cash outflow was $478,288, including $374,558 of equipment and leasehold-improvement purchases and $103,730 of life-insurance premiums. Financing cash inflow was $88,918 from stock-option exercises. Cash increased by $395,310 to $4.39 million at December 31, 2020.
At December 31, 2020, total assets were $23.94 million, current assets were $13.15 million, and total liabilities were $7.75 million. Inventories were $5.80 million, up from $5.54 million at June 30, 2020. The company had no outstanding borrowings under its $5.0 million secured revolving credit facility and was in compliance with its covenants. The facility also permits letters of credit up to a $1.0 million sublimit.
Material changes versus the prior comparable period
- Sales growth was driven by increased online sales, certain U.S. distributors, and European distributors. Online sales increased approximately 2.5 times year over year for both the quarter and six-month period.
- U.S. sales increased in the quarter but were approximately flat for the six months, as online and distributor growth offset declines in mass retail and educational channels.
- Export sales increased 20.4% in the quarter and rose to approximately $2.54 million for the six months from $1.93 million, primarily due to European distributor demand and new products.
- Six-month gross margin improved to 32.1% from 28.3%, principally because of a more favorable product and market mix and the absence of the prior-year low-margin back-to-school promotion.
- Operating results improved from losses in the prior-year periods, although second-quarter operating income was only $2,073. Net income was significantly aided by the $506,700 SBA loan forgiveness.
- Cash generation improved, but inventories, accounts receivable, and prepaid assets increased as the company prepared for supply-chain constraints and higher demand.
Guidance, outlook, risks and unusual items
Management stated that cash from operations, cash reserves, and available borrowings should provide adequate liquidity for operating needs, debt service, and planned capital expenditures. The company expects approximately $600,000 of fiscal 2021 spending for tooling, leasehold improvements, and other capital expenditures.
COVID-19 increased demand for communication headphones used for remote work and study, but also caused retail disruption, product shortages, extended lead times, component shortages, higher costs, and delays in new-product introductions. Koss is increasing inventory investment, monitoring short supplies, assisting suppliers with critical components, using alternative sources, and employing air freight when necessary. Management stated that the duration and ultimate financial impact of the pandemic cannot reasonably be estimated.
On January 28, 2021, after the reporting date, the revolving credit agreement was amended to extend its expiration from May 14, 2021 to October 31, 2022 and to change the interest rate from 1.50% over LIBOR to Wall Street Journal Prime less 1.50%.
The company filed patent-infringement complaints against Apple, Bose, JLab Audio, Plantronics, Polycom, and Skullcandy concerning wireless-audio technology. Potential recoveries, licensing arrangements, or other outcomes are uncertain, and any monetary recovery may be owed in whole or in part to third parties. One E-Way also alleged that certain Koss wireless products may infringe its patents; no lawsuit had been filed and served as of December 31, 2020.
The company leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The lease runs through June 30, 2023 at fixed annual rent of $380,000, with an option to renew through June 30, 2028. Management reported no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.
Important facts for investors to verify
- Reconcile operating profitability with reported net income by separately evaluating the nonrecurring $506,700 SBA loan-forgiveness gain.
- Assess whether COVID-related demand for remote-work products is sustainable and whether shortages or supply-chain costs could constrain sales or margins.
- Monitor inventory growth, the $1.63 million obsolete-inventory reserve, and future working-capital requirements.
- Confirm the terms and availability of the amended $5.0 million credit facility, including the revised prime-based interest rate and covenant compliance.
- Track the patent-enforcement lawsuits and the potential for recoveries, licensing income, third-party claims, or litigation costs.
- Evaluate the company’s planned approximately $600,000 of fiscal 2021 capital expenditures against operating cash flow and liquidity.