Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation develops and sells high-fidelity, wireless Bluetooth, computer, telecommunications, and active noise-canceling headphones and related speakers. It operates as one business segment. This unaudited report covers the three and nine months ended March 31, 2019, the company’s fiscal third quarter and first nine months of fiscal 2019. Prior periods were retrospectively adjusted for ASC 606 revenue recognition and lease accounting.
Financial performance and liquidity
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $4.86 million, up 10.7% | $16.06 million, down 1.9% |
| Gross profit | $1.66 million; 34.1% margin | $5.15 million; 32.1% margin |
| SG&A | $1.51 million; 31.0% of sales | $4.80 million; 29.9% of sales |
| Income before taxes | $149,286 | $350,843 |
| Net income | $172,306; $0.02 diluted EPS | $373,838; $0.05 diluted EPS |
| Cash provided by operating activities | Not provided for the quarter | $1.84 million |
Cash and cash equivalents were $2.72 million at March 31, 2019, compared with $1.08 million at June 30, 2018. Total current assets were $12.58 million versus current liabilities of $2.82 million. Inventory increased to $6.73 million from $6.14 million. Total liabilities were $8.04 million and stockholders’ equity was $14.92 million.
Investing activities used $241,723 during the nine-month period, primarily for equipment, leasehold improvements, and life insurance premiums. Financing activities provided $46,677 from stock-option exercises. The company had no borrowings under its $4.0 million secured revolving credit facility, which was scheduled to expire July 31, 2019, and stated that it was in compliance with applicable covenants. Management believed operating cash flow, cash reserves, and available borrowings would provide adequate liquidity for the next twelve months and the foreseeable future.
Material changes versus the prior comparable period
- Third-quarter sales increased $469,793, driven by higher domestic and export sales. Nine-month sales declined $309,057, primarily because of lower domestic mass-retail and distributor sales.
- Gross margin improved from 23.1% to 34.1% for the quarter and from 27.9% to 32.1% for the nine-month period. Management attributed the improvement to product, customer, and channel mix and the absence of prior-year excess and obsolete inventory charges.
- The company moved from a third-quarter net loss of $762,150 to net income of $172,306, and from a nine-month net loss of $3.68 million to net income of $373,838.
- SG&A decreased 15.0% for the quarter and 7.8% for the nine-month period, reflecting lower employee benefit, commission, engineering-testing, and professional-fee costs.
- Cash from operations increased from $1.52 million to $1.84 million for the nine-month period, supported by collections of accounts receivable, partially offset by higher inventory.
- Prior-year nine-month results included $3.05 million of income tax expense, including deferred-tax write-downs and a valuation allowance. Current-period tax expense was minimal and included a $22,995 tax benefit related to an AMT-credit refund.
Guidance, outlook, risks, contingencies, and unusual items
The company did not provide quantitative revenue or earnings guidance. It expected fiscal-year capital expenditures for tooling, leasehold improvements, and other capital items to be similar to the prior year and expected to fund them through operations or its credit facility.
Export sales increased, particularly to distributors in Europe, Asia, and the South Pacific, with wireless product introductions contributing to growth. Domestic sales for the nine-month period remained pressured by mass-retail product placement, a retailer experiencing financial difficulties, and competition in lower-priced products. Management raised prices on certain lower-margin products to improve margins.
A former celebrity endorser sued the company in July 2018, alleging unauthorized use of her name and image after termination of the endorsement agreement. The ultimate outcome was not determinable. The company also continued an intellectual-property enforcement program that could result in legal costs, licensing arrangements, lawsuits, royalties, or other proceeds, but the timing and amount of any proceeds were uncertain.
The company leases its Milwaukee facility from Koss Holdings, LLC, which is wholly owned by the former chairman. The operating lease had a reported liability of $2.91 million at March 31, 2019 and runs through June 30, 2023, with an option to renew for five additional years. Revenue is subject to estimates for product returns, rebates, volume incentives, and lifetime warranty obligations; changes in actual claims or customer activity could affect future results.
Other identified risks included consumer acceptance of new technologies and products, competition, customer orders and concentration, third-party manufacturing, foreign sourcing and sales, trade and importation matters, borrowing costs, tax changes, and litigation. Management concluded that disclosure controls were effective as of March 31, 2019, and reported no significant changes in internal control over financial reporting.
Investor verification points
- Confirm the March 31, 2019 reporting date and the retrospective effects of ASC 606 and lease adoption when comparing results.
- Assess whether improved gross margins are sustainable or primarily reflect temporary product, customer, and channel mix.
- Monitor domestic mass-retail and distributor demand, retailer financial issues, and the growth and durability of export and wireless-product sales.
- Review inventory levels, the $2.41 million obsolete-inventory allowance, and potential working-capital requirements.
- Verify renewal or replacement of the $4.0 million credit facility before its July 31, 2019 expiration.
- Track the celebrity-endorser litigation and costs and potential proceeds from the intellectual-property enforcement program.
- Evaluate related-party lease terms and the company’s reliance on cash flow and available secured borrowing capacity for liquidity.