NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)
1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The condensed consolidated balance sheet of Koss Corporation (the "Company") as of
June 30, 2018
, has been derived from audited financial statements. The unaudited condensed consolidated financial statements presented herein are based on interim amounts. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The operating results for the
nine months ended March 31, 2019
, are not necessarily indicative of the operating results that may be experienced for the full fiscal year ending
June 30, 2019
.
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended
June 30, 2018
.
The Company has restated certain prior period amounts related to revenue and leases to conform to the current period presentation based on its adoption of the new accounting standards for those items.
2.
SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION — In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 (Topic 606), Revenue from Contracts with Customers. This new standard supersedes nearly all existing revenue recognition guidance and provides a five-step analysis to determine when and how revenue is recognized. The underlying principle is to recognize revenue when promised goods or services transfer to the customer. The amount of revenue recognized is to reflect the consideration expected to be received for those goods or services.
The Company adopted the requirements of the new standard on July 1, 2018 using the full retrospective transition method. Prior period consolidated financial statements were restated to reflect full retrospective adoption beginning with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2018.
Revenues from product sales are recognized when the customer obtains control of the product, which typically occurs upon shipment from the Company's facility. There are a very limited number of customers for which control does not pass until they have received the products at their facility. Revenue from product sales is adjusted for estimated warranty obligations and variable consideration, which are detailed below.
Warranties -
The Company offers a lifetime warranty to consumers in the United States and certain other countries. This lifetime warranty creates a future performance obligation. There are also certain foreign distributors that receive warranty repair parts and replacement headphones to satisfy warranty obligations in those countries. The Company defers revenue to recognize the future obligations related to these warranties. The deferred revenue is based on historical analysis of warranty claims relative to sales. This deferred revenue reflects the Company's best estimates of the amount of warranty returns and repairs it will experience during those future periods. If future warranty activity varies from the estimates, the Company will adjust the estimated deferred revenue, which would affect net sales and operating results in the period that such adjustment becomes known.
Reserves for Variable Consideration -
Revenue from product sales is recorded at the net sales price, which includes estimates of variable consideration for which reserves are established and which result from returns, rebates, and co-pay assistance that are offered within contracts between the Company and its customers. Overall, these reserves reflect the Company's best estimates of the amount of consideration to which it is entitled based on the terms of the contract. If actual results in the future vary from the estimates, the Company will adjust these estimates, which would affect net sales and operating results in the period such variances become known.
Product Returns -
The Company generally offers customers a limited right of return. The Company estimates the amount of product sales that may be returned by its customers and records the estimate as a reduction of revenue in the period the related product revenue is recognized. Product return liabilities are estimated using historical sales and returns information. If actual
results in the future vary from the estimates, the Company will adjust these estimates, which would affect net sales and operating results in the period such variances become known.
Volume Rebates -
The Company offers volume rebates to certain customers in the United Sates and certain foreign distributors. These volume rebates are tied to sales volume within specified periods.
The amount of revenue is reduced for variable consideration related to customer rebates, which are calculated using expected values and is based on program specific factors such as expected rebate percentages and expected volumes. Changes in such accruals may be required if actual sales volume differs from estimated sales volume, which would affect net sales and operating results in the period such variances become known.
LEASES — In February 2016, the FASB issued ASU 2016-02 (Topic 842), Leases. This new standard revises existing lease guidance and requires all operating leases to be recorded on a company's balance sheet as right-of-use ("ROU") assets and lease liabilities. The new guidance also requires additional disclosures about leases. The Company adopted the requirements of the new standard on July 1, 2018 using the modified retrospective transition method. Prior period consolidated financial statements were restated to reflect modified retrospective adoption beginning with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2018.
The Company determines if a contract is a lease at the date of inception. The Company leases its facility in Milwaukee, Wisconsin from Koss Holdings, LLC, which is wholly-owned by the former chairman, and has determined that the lease is an operating lease.
Operating leases are reported on the Company's condensed consolidated balance sheets as operating lease ROU assets and operating lease liabilities. Operating lease ROU assets and liabilities are valued at the present value of the future lease payment obligations.
INCOME PER COMMON SHARE - Basic income per share is computed based on the weighted-average number of common shares outstanding. Diluted income per common share is computed by dividing net income by the weighted-average number of common shares outstanding assuming dilution. The difference between basic and diluted income per share is the result of the dilutive effect of outstanding stock options. For the
nine months ended March 31, 2019 and 2018
, there were
2,521,827
and
2,395,000
shares of common stock underlying options and warrants, respectively, excluded due to these instruments being anti-dilutive.
3.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
REVENUE RECOGNITION — In May 2014, the FASB issued ASU 2014-09 (Topic 606), Revenue from Contracts with Customers. The Company adopted the new standard effective July 1, 2018, using the full retrospective method. Adoption of the new revenue recognition standard required the Company to restate its previously reported results for the prior year comparative period and had a material impact on the consolidated balance sheets but an overall immaterial impact on its consolidated statements of income and cash flows and related disclosures. The impact on the Company's consolidated balance sheets was a result of the adjustment to defer revenue from prior years and a corresponding adjustment to retained earnings.
LEASES — In February 2016, the FASB issued ASU 2016-02 (Topic 842), Leases. The Company elected to early adopt the standard effective July 1, 2018, concurrent with the adoption of the new standard related to revenue recognition. The adoption of the new lease standard had a material impact on the consolidated balance sheets but did not have an impact on the consolidated statements of operations. The impact on the Company's consolidated balance sheets was a result of recording the right-of-use asset and corresponding lease liability. Adoption of the new standard also required the Company to restate its previously reported results to include the recognition of right-of-use assets and lease liabilities for the prior year comparative period.
IMPACTS TO PREVIOUSLY REPORTED RESULTS — Adoption of the standard related to revenue recognition impacted the Company's previously reported results as follows:
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New
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As
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Revenue
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Balance Sheets
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Previously
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Standard
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As
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June 30, 2018
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Reported
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Adjustment
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Adjusted
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Current liabilities:
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Accrued liabilities
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$
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1,178,571
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$
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(389,610
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)
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$
|
788,961
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Deferred revenue
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—
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690,905
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690,905
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Long-term liabilities:
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Other liabilities
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155,702
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(155,702
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)
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—
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Deferred revenue
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—
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168,465
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168,465
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Equity:
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Retained earnings
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8,728,628
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(314,058
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)
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8,414,570
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New
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As
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Revenue
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Statements of Income
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Previously
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Standard
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As
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Three Months Ended March 31, 2018
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Reported
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Adjustment
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Adjusted
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Net sales
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$
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4,326,674
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$
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63,780
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$
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4,390,454
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Cost of goods sold
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3,363,121
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13,914
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3,377,035
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Income tax provision
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5,126
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(852
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)
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4,274
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Net (loss)
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(812,868
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)
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50,718
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(762,150
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)
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(Loss) per common share:
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Basic
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$
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(0.11
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)
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$
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0.01
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$
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(0.10
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)
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Diluted
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(0.11
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)
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0.01
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(0.10
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)
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New
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As
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Revenue
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Statements of Income
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Previously
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Standard
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As
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Nine Months Ended March 31, 2018
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Reported
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Adjustment
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Adjusted
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Net sales
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$
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16,277,181
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$
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88,189
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$
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16,365,370
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Cost of goods sold
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11,753,719
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37,578
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|
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11,791,297
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Income tax provision
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3,048,208
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(852
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)
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3,047,356
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Net (loss)
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(3,733,089
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)
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51,463
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(3,681,626
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)
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(Loss) per common share:
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Basic
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$
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(0.51
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)
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$
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0.01
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$
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(0.50
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)
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Diluted
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(0.51
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)
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0.01
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(0.50
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)
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Adoption of the standard related to leases impacted the Company's previously reported results by adding the following line items to the Company's balance sheets:
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Balance Sheets
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As
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June 30, 2018
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Adjusted
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Assets:
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Operating lease right-of-use asset
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$
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3,102,263
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Current liabilities:
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Operating lease liability
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254,418
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Long-term liabilities:
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Operating lease liability
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2,847,845
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Adoption of the standards related to revenue recognition and leases had no impact on total cash provided by operating activities on the consolidated statements of cash flows.
4.
INVENTORIES
The components of inventories were as follows:
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March 31, 2019
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June 30, 2018*
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Raw materials
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$
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2,676,550
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$
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2,717,862
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Finished goods
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6,463,112
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6,057,703
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9,139,662
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8,775,565
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Allowance for obsolete inventory
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(2,409,996
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)
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(2,636,886
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)
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Inventories, net
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$
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6,729,666
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$
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6,138,679
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5.
INCOME TAXES
The Company files income tax returns in the United States federal jurisdiction and in several state jurisdictions. The statute of limitations for the Company’s federal tax returns for tax years beginning July 1, 2014 or later are open. For states in which the Company files state income tax returns, the statute of limitations is generally open for tax years ended June 30, 2014 or later.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“the Tax Act”) was signed. The Tax Act significantly changed the income tax environment for US corporations, including the reduction of the US federal corporate tax rate from 35% to 21%. For the
three and nine months ended March 31, 2019
, the Company recorded an income tax benefit of
$23,020
and
$22,995
, respectively, due to refund of the AMT credits not recognized in prior years. This compare to income tax expense of
$4,274
and
$3,047,356
for the
three and nine months ended March 31, 2018
. There was no tax expense in the
three months ended March 31, 2019
, related to the federal statutory tax rate of 21% due to tax net operating loss carryforwards being utilized. The income tax expense for the
nine months ended March 31, 2018
includes
$713,826
for the write down of deferred income taxes due to the change in federal statutory rate as a result of the passage of the Tax Act and
$2,429,235
related to the recording of a valuation allowance for all deferred taxes. The valuation allowance was recorded due to uncertainty of the ability to realize the deferred tax assets.
The Company does not believe it has any unrecognized tax benefits as of
March 31, 2019
or
June 30, 2018
. Any changes to the Company’s unrecognized tax benefits as of
March 31, 2019
, if recognized, would impact the effective tax rate.
6.
CREDIT FACILITY
On May 12, 2010, the Company entered into a secured credit facility (“Credit Agreement”) with JPMorgan Chase Bank, N.A. (“Lender”). The Credit Agreement provided for an
$8,000,000
revolving secured credit facility with interest rates either ranging from
0.0%
to
0.75%
over the Lender’s most recently publicly announced prime rate or
2.0%
to
3.0%
over LIBOR, depending on the Company’s leverage ratio. The Company pays a fee of
0.3%
to
0.45%
for unused amounts committed in the credit facility. On June 29, 2017, the Credit Agreement was amended to reduce the facility to
$4,000,000
and to eliminate the financial covenants. On May 9, 2018, the Credit Agreement was amended to extend the expiration to July 31, 2019. In addition to the revolving loans, the Credit Agreement also provides that the Company may, from time to time, request the Lender to issue letters of credit for the benefit of the Company of up to a sublimit of
$2,000,000
and subject to certain other limitations. The loan may be used only for general corporate purposes of the Company. The Company and the Lender also entered into the Pledge and Security Agreement dated May 12, 2010, under which the Company granted the Lender a security interest in substantially all of the Company’s assets in connection with the Company’s obligations under the Credit Agreement. The Company is currently in compliance with all covenants related to the Credit Agreement. As of
March 31, 2019
and
June 30, 2018
, there were no outstanding borrowings on the facility.
The Company incurs interest expense primarily related to its secured credit facility. Interest expense was
$0
and
$5,218
for the
three and nine months ended March 31, 2018
, respectively. There was no interest expense in the
three and nine months ended March 31, 2019
.
7.
ACCRUED LIABILITIES
Accrued liabilities were as follows:
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March 31, 2019
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June 30, 2018*
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Cooperative advertising and promotion allowances
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$
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190,923
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$
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292,873
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Customer credit balances
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126,663
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53,365
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Current deferred compensation
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150,000
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150,000
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Employee benefits
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59,708
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60,739
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Legal and professional fees
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90,300
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81,000
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Profit-sharing
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21,578
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17,975
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Sales commissions and bonuses
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64,342
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74,078
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Other
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37,612
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58,931
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Total accrued liabilities
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$
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741,126
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$
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788,961
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*As adjusted for retrospective adoption of ASC 606
8.
STOCK OPTIONS
The Company recognizes stock-based compensation expense for options granted under both the 1990 Flexible Incentive Plan and the 2012 Omnibus Incentive Plan ("2012 Plan"). The stock-based compensation relates to stock options granted to employees and non-employee directors. In the
nine months ended March 31, 2019
, options to purchase
585,000
shares were granted under the 2012 Plan at a weighted average exercise price of
$2.79
. In the
nine months ended March 31, 2018
, options to purchase
490,000
shares were granted under the 2012 Plan at a weighted average exercise price of
$1.89
. Stock-based compensation expense during the
three and nine months ended March 31, 2019
was
$97,830
and
$292,186
. Stock-based compensation expense during the
three and nine months ended March 31, 2018
was
$82,792
and
$248,624
.
9.
ADDITIONAL CASH FLOW INFORMATION
The net changes in cash as a result of changes in operating assets and liabilities consist of the following:
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Nine Months Ended
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March 31
|
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2019
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2018*
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Accounts receivable
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$
|
1,893,559
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$
|
919,927
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Inventories
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(590,987
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)
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1,988,887
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Prepaid expenses and other current assets
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(68,539
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)
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(123,671
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)
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Income taxes receivable
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(9,776
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)
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5,951
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|
|
Accounts payable
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(222,292
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)
|
|
(1,414,569
|
)
|
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Accrued liabilities
|
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(47,835
|
)
|
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411,527
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Net change
|
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$
|
954,130
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|
|
$
|
1,788,052
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Net cash paid during the period for:
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|
|
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Income taxes
|
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$
|
1,678
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|
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$
|
3,182
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|
|
Interest
|
|
$
|
—
|
|
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$
|
5,218
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*As adjusted for retrospective adoption of ASC 606
10.
DEFERRED REVENUE
Deferred revenue relates primarily to consumer and customer warranties. These constitute future performance obligations and the Company defers revenue to recognize these future performance obligations. Changes in unearned revenue were as follows:
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Beginning
Balance
|
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Deferral
of Revenue
|
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Recognition
of Deferred
Revenue
|
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Ending
Balance
|
|
Nine Months Ended March 31, 2019
|
|
$
|
859,370
|
|
|
$
|
368,087
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|
|
$
|
(464,205
|
)
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$
|
763,252
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11.
LEASES
The Company leases its facility in Milwaukee, Wisconsin from Koss Holdings, LLC, which is wholly-owned by the former Chairman. On January 5, 2017, the lease was renewed for a period of
five
years, ending June 30, 2023, and is being accounted for as an operating lease. The lease extension maintained the rent at a fixed rate of
$380,000
per year and included an option to renew at the same rate for an additional five years ending
June 30, 2028
. The Company is responsible for all property maintenance, insurance, taxes and other normal expenses related to ownership.
The Company used its incremental borrowing rate as of July 1, 2017, the retrospective date of adoption of ASU 2016-02 (Topic 842) Leases, to calculate the net present value of the operating lease ROU asset and liability. The five year renewal option was included in the calculation of the ROU asset and liability as the Company believes it is more likely than not to exercise its right to renew. The non-lease components of the agreement related to common area maintenance charges are accounted for separately.
Supplemental information related to lease expense and valuation of the ROU asset and liability was as follows:
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Nine Months Ended
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March 31
|
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|
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2019
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2018
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Operating lease cost
|
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$
|
285,000
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|
|
$
|
285,000
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Cash paid for amounts included in the measurement of lease liabilities:
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Operating cash flows from operating leases
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$
|
285,000
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|
$
|
285,000
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|
Weighted-average remaining lease term (in years)
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9.25
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|
10.25
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Weighted-average discount rate
|
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4.25
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%
|
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4.25
|
%
|
The maturity schedule of future minimum lease payments and reconciliation to the operating lease liabilities reported on the consolidated balance sheets is as follows:
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Year ending June 30,
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2019 (excluding the nine months ended March 31, 2019)
|
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$
|
95,000
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2020
|
|
380,000
|
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|
2021
|
|
380,000
|
|
|
2022
|
|
380,000
|
|
|
2023
|
|
380,000
|
|
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Thereafter
|
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1,900,000
|
|
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Total lease payments
|
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3,515,000
|
|
|
Present value adjustment
|
|
(602,534
|
)
|
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Total lease liabilities
|
|
$
|
2,912,466
|
|
12.
LEGAL MATTERS
As of
March 31, 2019
, the Company is party to the matters described below:
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•
|
On or around July 13, 2018, the Company was served with a lawsuit by a former celebrity endorser of certain products alleging that the Company used her name and image to market and sell the products after the termination of their agreement without her consent. This case remains pending. The ultimate resolution of this matter is not determinable at this time.
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•
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The Company has launched a program focused on enforcing its intellectual property and, in particular, certain of its patent portfolio. The Company has incurred costs and will continue to incur costs related to enforcing this program. These costs primarily relate to legal fees and other costs involved with the underlying efforts to enforce this portfolio. Depending on the response to and the underlying results of the enforcement program, the Company may enter into licensing arrangements or initiate lawsuits as part of the Company’s efforts to enforce this program.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (the “Act”) (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the Securities Exchange Commission, press releases, or otherwise. Statements contained in this Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Act. Forward-looking statements may include, but are not limited to, projections of revenue, income or loss and capital expenditures, statements regarding future operations, anticipated financing needs, compliance with financial covenants in loan agreements, plans for acquisitions or sales of assets or businesses, plans relating to products or services of the Company, assessments of materiality, predictions of future events, the effects of pending and possible litigation and assumptions relating to the foregoing. In addition, when used in this Form 10-Q, the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “may,” “will,” “should,” “forecasts,” “predicts,” “potential,” “continue” and variations thereof and similar expressions are intended to identify forward-looking statements.
Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified based on current expectations. Consequently, future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements contained in this Form 10-Q, or in other Company filings, press releases, or otherwise. In addition to the factors discussed in this Form 10-Q, other factors that could contribute to or cause such differences include, but are not limited to, developments in any one or more of the following areas: future fluctuations in economic conditions, the receptivity of consumers to new consumer electronics technologies, the rate and consumer acceptance of new product introductions, competition, pricing, the number and nature of customers and their product orders, production by third party vendors, foreign manufacturing, sourcing, and sales (including foreign government regulation, trade and importation concerns), borrowing costs, changes in tax rates, pending or threatened litigation and investigations, and other risk factors which may be detailed from time to time in the Company’s Securities and Exchange Commission filings.
Readers are cautioned not to place undue reliance on any forward-looking statements contained herein, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect new information.