Koss Corporation 10-Q Summary
Business Context and Reporting Period
Koss Corporation designs and markets high-fidelity 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 months ended September 30, 2019, the first quarter of fiscal 2020, compared with the three months ended September 30, 2018.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $5.411 million | $5.785 million | Down 6.5% |
| Gross profit | $1.347 million | $1.831 million | Down 26.4% |
| Gross margin | 24.9% | 31.7% | Down 6.8 percentage points |
| SG&A expense | $1.665 million | $1.790 million | Down 7.0% |
| Operating income (loss) | $(0.317) million | $0.042 million | Declined |
| Net income (loss) | $(0.311) million | $0.042 million | Declined |
| Basic and diluted EPS | $(0.04) | $0.01 | Declined |
| Cash flow from operations | $(0.622) million | $0.708 million | Declined |
Domestic sales increased to approximately $4.504 million from $3.771 million, while export sales declined to approximately $0.907 million from $2.014 million. The company recorded $6,397 of interest income and no income tax provision in the quarter. The tax result reflected net operating loss carryforwards, bonus depreciation, and a full valuation allowance against deferred tax assets.
Cash and cash equivalents were $1.329 million at September 30, 2019, down from $2.228 million at June 30, 2019. Total current assets were $11.599 million, compared with $12.914 million at fiscal year-end. Inventory was $6.859 million, substantially unchanged from June 30, 2019. Total liabilities were $7.269 million, including $5.100 million of long-term liabilities, primarily deferred compensation and operating lease liabilities.
Koss had no borrowings under its secured $5.0 million revolving credit facility at September 30, 2019. The facility expires May 14, 2021, bears interest at 1.50% over LIBOR, permits up to $1.0 million of letters of credit, and is secured by substantially all company assets. The company reported compliance with all covenants.
Material Changes Versus the Prior Comparable Period
- Sales decreased 6.5%, primarily because export sales fell approximately $1.107 million. The prior-year quarter included approximately $653,000 from a contract that ended in December 2018, and Scandinavian distributor sales declined approximately $376,000.
- Domestic sales increased approximately $733,000, supported by back-to-school mass-retail promotions and higher direct-to-consumer sales. These sales carried lower margins, contributing to the gross-margin decline.
- Gross margin fell to 24.9% from 31.7%, primarily due to product, customer, and channel mix.
- SG&A decreased approximately $125,000. The decrease was aided by approximately $120,000 of additional income from the cash surrender value of life insurance and approximately $40,000 less bad-debt expense, partly offset by approximately $42,000 of higher legal fees related to intellectual-property enforcement.
- Operating cash flow shifted from $0.708 million provided to $0.622 million used. Management attributed the change mainly to the operating loss and payments for inventory received from China before June 30, 2019, reflected in lower accounts payable.
- Investing cash outflows increased to $0.277 million from $0.138 million, primarily due to leasehold improvements and tooling for new product introductions.
- The company adopted a new stock-based compensation method, recording expense ratably over the vesting period and recognizing forfeitures when they occur. Prior periods were adjusted retrospectively; Q1 FY2019 net income was reduced by $25,841 to $41,570.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management expects fiscal 2020 spending for tooling, leasehold improvements, and capital expenditures of approximately $750,000 to $900,000. It believes operating cash flow, cash reserves, and available credit will fund operating needs, debt service, and planned capital expenditures for the next twelve months and the foreseeable future. No revenue or earnings guidance was provided.
The company launched a program to enforce its intellectual-property portfolio. Related legal costs are expected to continue. Depending on results, Koss may enter licensing arrangements or initiate lawsuits; potential royalties, intellectual-property sales, or other proceeds could materially affect results, but no amount or timing is provided.
Key risks include weak or changing consumer demand for electronics, product-introduction and technology-acceptance risk, competition and pricing pressure, customer concentration and order variability, third-party manufacturing and foreign sourcing, foreign-exchange and trade matters, borrowing costs, tax changes, and litigation or investigations. The company is also subject to ordinary-course legal claims, which management does not currently expect to have a material adverse effect.
The Milwaukee facility is leased from Koss Holdings, LLC, wholly owned by the former chairman, at a fixed annual rent of $380,000 through June 30, 2023, with an option to renew for five additional years. Disclosure controls were deemed effective, and no significant changes in internal control over financial reporting were reported.
Investor Verification Points
- Verify whether export-market weakness, particularly in Scandinavia, persists and whether domestic promotional sales can be sustained without further margin compression.
- Assess inventory levels, the $1.595 million obsolete-inventory reserve, and the effect of sourcing and payment timing on operating cash flow.
- Monitor liquidity against planned capital expenditures of $750,000 to $900,000 and the availability and covenant requirements of the secured credit facility.
- Review the financial impact, legal costs, and potential proceeds associated with the intellectual-property enforcement program.
- Confirm the effects of the retrospective stock-based compensation accounting change on comparability and future expense recognition.
- Evaluate related-party lease terms and the company’s exposure to ordinary-course litigation and other contingencies.