Koss Corporation Form 10-Q Summary
Business context and reporting period
Koss Corporation designs and markets high-fidelity, wireless Bluetooth, computer, telecommunications and active noise-canceling headphones and related products. It operates as one business segment. This unaudited report covers the three and six months ended December 31, 2017, the second quarter of fiscal 2018, compared with the corresponding periods in fiscal 2017.
Financial results and liquidity
| Metric | Three months ended December 31, 2017 | Three months ended December 31, 2016 | Six months ended December 31, 2017 | Six months ended December 31, 2016 |
|---|---|---|---|---|
| Net sales | $5.884 million | $6.688 million | $11.951 million | $13.037 million |
| Gross profit | $1.886 million | $2.207 million | $3.560 million | $4.149 million |
| Gross margin | 32.1% | 33.0% | 29.8% | 31.8% |
| SG&A | $1.800 million | $1.987 million | $3.448 million | $3.763 million |
| Income before taxes | $84,896 | $222,606 | $122,861 | $350,748 |
| Net income (loss) | $(2.938) million | $140,112 | $(2.920) million | $224,323 |
| Diluted EPS | $(0.40) | $0.02 | $(0.40) | $0.03 |
- Net sales declined 12.0% in the quarter and 8.3% for the six-month period. Export sales, including sales to an Asian OEM customer and distributors in Europe and Asia, were the principal weakness.
- Domestic sales were approximately $3.968 million in the quarter, down from approximately $4.297 million, but increased to approximately $8.246 million for the six-month period from approximately $8.178 million.
- Gross margin declined because of changes in product, customer and sales-channel mix.
- SG&A decreased primarily because of lower sales commissions, employment-related costs, incentive compensation, new-product testing, travel and 401(k) matching expenses.
- Cash provided by operating activities was $388,502 for the six months, compared with $539,666 in the prior-year period. Investing cash outflows were $361,018, resulting in a $27,484 net increase in cash.
- Cash and cash equivalents totaled $459,767 at December 31, 2017, compared with $432,283 at June 30, 2017. Current assets were $11.889 million and current liabilities were $2.306 million.
- Inventory declined to $7.435 million from $8.345 million at June 30, 2017. The balance included a $2.408 million allowance for obsolete inventory.
- The company had no borrowings under its secured revolving credit facility. The facility was reduced to $4.0 million in June 2017, expires July 31, 2018, and is secured by substantially all company assets. The company stated that it was in compliance with applicable covenants.
Material changes versus the prior comparable period
- Revenue fell by $803,920 in the quarter and $1.086 million for the six-month period.
- Six-month gross profit decreased by $589,061, and six-month gross margin fell 2.0 percentage points.
- Despite lower operating expenses, income before taxes declined to $122,861 from $350,748 for the six-month period.
- The company reported a net loss primarily because income tax expense increased to $3.043 million from $126,425. The increase included a $713,826 deferred-tax write-down resulting from the Tax Cuts and Jobs Act and a $2.241 million valuation allowance against all deferred tax assets.
- Unauthorized-transaction-related activity produced a $16,180 net recovery in the first six months of fiscal 2018, compared with $34,096 of net costs in the prior-year period.
- Total assets declined to $19.592 million from $23.424 million, primarily reflecting the elimination of a $3.042 million deferred-tax asset and lower working-capital balances.
Outlook, risks, contingencies and unusual items
- Management expects total fiscal 2018 expenditures for tooling, leasehold improvements and capital expenditures to be similar to the prior fiscal year and expects operating cash flow or the credit facility to fund them.
- Management believes cash from operations, cash reserves and available credit provide adequate liquidity for operating needs, debt service and planned capital expenditures for the next twelve months and the foreseeable future.
- The company renewed its Milwaukee facility lease through June 30, 2023, at fixed annual rent of $380,000. The property is leased from Koss Holdings, LLC, which is wholly owned by the former chairman.
- The company’s petition for review by the Wisconsin Supreme Court remains pending in litigation against Park Bank concerning previously reported unauthorized transactions. The Wisconsin Court of Appeals affirmed dismissal of the company’s claim in December 2017, and the ultimate resolution remains undeterminable.
- Key operating risks include consumer acceptance of new technologies and products, competition, customer orders and concentration, third-party manufacturing, foreign sourcing and sales, trade and import concerns, borrowing costs, tax changes and litigation.
- The company plans to adopt the new revenue standard in the first quarter of fiscal 2019 and preliminarily expects an immaterial financial-statement impact. It also plans to early adopt the new lease standard in fiscal 2019 and expects a material balance-sheet impact from recognizing right-of-use assets and lease liabilities.
- Management concluded that disclosure controls and procedures were effective as of December 31, 2017, and reported no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether declining export and OEM sales represent a temporary order-timing issue or a sustained deterioration in demand.
- The composition, aging and realizability of the $7.435 million inventory balance and the adequacy of the $2.408 million obsolescence allowance.
- The recoverability of deferred tax assets following the $2.241 million valuation allowance and the effect of future tax rates on reported earnings.
- The renewal or replacement terms of the $4.0 million secured credit facility before its July 31, 2018 expiration.
- The potential financial and timing effects of the pending Wisconsin Supreme Court petition and related unauthorized-transaction litigation.
- The effect of the expected fiscal 2019 lease-accounting adoption on reported assets, liabilities and leverage.