Koss Corporation — Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2018. The requested “2017 Q4” period does not match the filing, which is an annual report for fiscal 2018; the filing provides annual comparisons with fiscal 2017.
Business context
Koss designs, manufactures and sells stereo headphones, Bluetooth and wired headphones, speakers, headsets and related accessories through retailers, distributors, e-commerce, OEM customers and other channels. The Company reports one operating segment. Approximately 77% of fiscal 2018 sales came from music-listening headphones and 23% from communications, education, metal-detector, OEM and other applications.
Products are sold through approximately 12,000 domestic retail outlets and numerous international retailers. Wal-Mart represented approximately 20% of fiscal 2018 sales, compared with 14% in fiscal 2017; the five largest customers represented approximately 47% and 45%, respectively.
Financial performance and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $23.515 million | $24.054 million | Down 2.2% |
| Gross profit | $6.582 million | $6.895 million | Down $0.313 million |
| Gross margin | 28.0% | 28.7% | Down 0.7 percentage points |
| SG&A expense | $6.939 million | $7.600 million | Down $0.661 million |
| Loss before taxes | $0.343 million | $0.773 million | Improved by $0.430 million |
| Income tax provision | $3.043 million | $0.191 million | Increased $2.852 million |
| Net loss | $3.386 million | $0.964 million | Loss increased $2.422 million |
| Basic and diluted loss per share | $0.46 loss | $0.13 loss | Loss increased $0.33 per share |
| Cash flow from operations | $1.031 million | $0.234 million | Increased $0.797 million |
Fiscal 2018 operating cash flow benefited substantially from a $2.207 million reduction in inventory, partially offset by a $0.773 million increase in receivables and an $0.814 million reduction in accounts payable. Investing cash outflow was $0.382 million, including $0.251 million for equipment and leasehold improvements and $0.131 million for life insurance premiums. Net cash increased $0.649 million to $1.082 million.
At June 30, 2018, current assets were $12.169 million and current liabilities were $2.608 million. Inventory declined to $6.139 million from $8.345 million, while accounts receivable increased to $4.710 million from $3.932 million. Total liabilities were $5.158 million and stockholders’ equity was $14.518 million.
The Company had no outstanding borrowings under its secured $4.0 million revolving credit facility at June 30, 2018. The facility was extended to July 31, 2019, financial covenants were eliminated in 2017, and the Company stated that it was in compliance with applicable covenants. Planned fiscal 2019 tooling and leasehold-improvement expenditures were approximately $0.700 million.
Material changes versus fiscal 2017
- Domestic sales increased $0.600 million to $16.565 million, driven primarily by a $1.443 million increase in sales to a large mass retailer following placement of a new product.
- Export sales decreased $1.139 million to $6.951 million, including a $0.730 million decline in sales to an Asian OEM customer and the loss of orders from an Asian distributor.
- Scandinavian sales improved by approximately $0.380 million, and sales to the Czech Republic also increased.
- Gross margin declined because of product and channel mix and write-downs of excess and obsolete inventory.
- SG&A declined due to lower commissions, salaries, travel and marketing costs, partly offset by approximately $0.191 million of higher legal expense.
- The income tax provision increased sharply because of the Tax Cuts and Jobs Act, including a $0.714 million deferred-tax remeasurement charge and a $2.339 million increase in the valuation allowance. The Company recorded a full valuation allowance against deferred tax assets at year-end.
- Research and development expense increased to $0.427 million from $0.214 million, reflecting product-development activity.
Outlook, risks and unusual items
- Management planned additional Bluetooth and traditional wired headphone introductions in fiscal 2019 and expected related research and development and approximately $0.700 million of tooling and leasehold-improvement spending.
- Management expected a fiscal 2019 effective tax rate of approximately 25% to 27%, subject to the realizability of deferred tax assets and other tax factors.
- Key risks include dependence on major retailers and distributors, concentration in Wal-Mart and the five largest customers, intense competition, consumer confidence, product acceptance, foreign exchange movements, tariffs and trade restrictions.
- The Company relies on contract manufacturers in China and Taiwan and may face interruptions from natural disasters, war, disease, government intervention or trade restrictions. Management stated that replacing a supplier could take approximately 120 days; the top ten models represented approximately 67% of fiscal 2018 sales.
- Most products carry lifetime warranties, creating exposure to higher-than-expected warranty claims, product-quality issues and related costs. The warranty obligation was $0.376 million at June 30, 2018.
- The Company continues activities to recover losses related to previously reported unauthorized transactions. Fiscal 2018 included a net recovery of $18,765, compared with net costs of $67,548 in fiscal 2017.
- A Wisconsin Supreme Court matter concerning the unauthorized transactions remained pending. A former celebrity endorser also sued in July 2018 over alleged continued use of her name and image after termination of the endorsement agreement; the Company filed a motion to dismiss.
- The Milwaukee facility is leased 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.
- The Company adopted or planned to adopt new revenue and lease accounting standards beginning in fiscal 2019. Management expected an immaterial income-statement impact but a material balance-sheet impact from deferred revenue and right-of-use lease accounting.
Important facts for investors to verify
- Confirm the filing period: this Form 10-K covers the year ended June 30, 2018, not a standalone 2017 fourth quarter.
- Assess whether the $3.386 million net loss was primarily driven by the $3.043 million tax provision and whether deferred tax assets are likely to become realizable.
- Evaluate customer concentration, particularly Wal-Mart’s 20% sales contribution and the five largest customers’ 47% contribution.
- Review the sustainability of operating cash flow, given that fiscal 2018 cash generation benefited from inventory liquidation and reduced payables.
- Monitor export-market recovery, new product launches, gross-margin trends and the Company’s ability to absorb tariffs and freight increases.
- Review the pending legal matters, unauthorized-transaction recovery efforts and potential exposure from warranty and product-return obligations.
- Verify future liquidity after planned capital spending, the July 31, 2019 credit-facility expiration and the related-party facility lease.