Koss Corporation: Form 10-Q Summary
Business Context and Reporting Period
Koss designs, manufactures and sells stereo headphones, wireless headphones and speakers, computer and telecommunications headsets, and related accessories. The company operates as one business segment. This unaudited Form 10-Q covers the three months ended September 30, 2020, Koss’s fiscal first quarter of 2021, compared with the quarter ended September 30, 2019.
Key Financial Metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Net sales | $5.208 million | $5.411 million | Down 3.7% |
| Gross profit | $1.636 million | $1.347 million | Up 21.4% |
| Gross margin | 31.4% | 24.9% | Up 6.5 percentage points |
| SG&A expense | $1.506 million | $1.665 million | Down 9.5% |
| Operating income (loss) | $130,456 | $(317,146) | Improved by $447,602 |
| Net income (loss) | $126,928 | $(310,749) | Improved by $437,677 |
| Diluted EPS | $0.02 | $(0.04) | Improved |
| Cash flow from operations | $(180,900) | $(622,281) | Use decreased by $441,381 |
| Capital expenditures and other investing cash use | $(368,564) | $(276,514) | Use increased by $92,050 |
Income before taxes was $128,405, compared with a loss before taxes of $310,749 in the prior-year quarter. The income tax provision was $1,477; federal tax expense was reduced to zero by net operating loss carryforwards and a full valuation allowance against deferred tax assets. The company reported approximately $897,000 of federal net operating loss carryforwards.
Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $3.450 million at September 30, 2020, down from $3.999 million at June 30, 2020, but up from $1.329 million at September 30, 2019.
- Total assets were $23.283 million and stockholders’ equity was $15.436 million at September 30, 2020.
- Net inventories were $5.297 million, including a $1.618 million reserve for obsolete inventory.
- The company had no borrowings under its $5.0 million secured revolving credit facility, which expires May 14, 2021. The facility also supports letters of credit of up to $1.0 million and is secured by substantially all company assets.
- The company had a $506,700 Paycheck Protection Program loan outstanding at September 30, 2020. On November 3, 2020, after the reporting date, the full principal amount was forgiven.
- Management stated that cash reserves, operating cash flow and available borrowing capacity should provide adequate liquidity for operating needs, debt service and planned capital expenditures.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because of lower sales to a U.S. mass retailer, including the absence of a large, low-margin back-to-school promotion recorded in the prior-year quarter.
- U.S. sales declined to $3.952 million from $4.501 million, while export sales increased 38% to $1.257 million from $909,000.
- Online sales and sales of communication headsets increased as COVID-19 shifted work and education toward remote settings. Certain products experienced shortages and were expected to take several months to replenish.
- Gross margin improved substantially because of a more favorable product, customer and channel mix and the comparison with the prior-year low-margin promotion.
- SG&A decreased by approximately $159,000, primarily due to lower legal and professional fees and lower employee benefit costs.
- Operating cash use improved but remained negative, largely because of increased accounts receivable and prepaid assets. Investing cash use increased because of leasehold improvements and tooling for new product introductions.
Outlook, Risks and Unusual Items
- Management expects approximately $600,000 of tooling, leasehold improvements and other capital expenditures during fiscal 2021 and expects to fund them through operations, cash reserves or the credit facility.
- COVID-19 created demand for communication headphones but continued to disrupt retail businesses, consumer spending and portions of the supply chain. Management stated that the ultimate financial impact cannot reasonably be estimated.
- The supply chain is primarily located in southern China. Earlier disruptions had largely subsided, but the company continued to monitor potential shortages, delivery timing, alternative suppliers and air freight requirements.
- Koss filed patent-infringement complaints against Apple, Bose, JLab, Plantronics/Polycom and Skullcandy concerning wireless audio technology. Potential recoveries are uncertain, and portions of any monetary recovery may be payable to third parties.
- One E-Way notified Koss that certain wireless products may infringe its patents; no lawsuit had been filed and served as of September 30, 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.
- No off-balance-sheet arrangements were reported. Management concluded that disclosure controls were effective and that there were no significant changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether COVID-19-related demand for communication headsets and online sales persists after work and education patterns normalize.
- Product availability, inventory aging and the adequacy of the $1.618 million obsolete-inventory reserve.
- Renewal or refinancing of the $5.0 million secured credit facility before its May 2021 expiration.
- Accounting treatment and cash-flow effects of the $506,700 PPP loan forgiveness recognized after the reporting date.
- Progress, costs, third-party payment obligations and potential outcomes of the patent-enforcement program and the One E-Way allegations.
- Ability to generate positive operating cash flow while funding the planned approximately $600,000 of fiscal 2021 capital expenditures.