What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-10-28 compared with 2022-05-06 · 83 added, 88 removed, 62 unchanged (73% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Company developed stereo headphones in 1958 and has been recognized as a leader in the industry ever since.

The Company initially developed stereo headphones in 1958 and has been recognized as a leader in the industry ever since.

Koss markets a complete line of high-fidelity headphones, wireless Bluetooth® headphones, wireless Bluetooth® speakers, computer headsets, telecommunications headsets, and active noise canceling headphones.

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Financial Results

The following table presents selected financial data for the three and nine months ended March 31, 2022, and 2021:

The following table presents selected financial data for the three months ended September 30, 2022, and 2021:

Three Months Ended

Nine Months Ended

Financial Performance Summary

Net sales increase (decrease) %

Net sales (decrease) %

Gross profit as % of net sales

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Income tax provision as % of income (loss) before income tax

2022 Results Compared with 2021

(comments refer to both the three and nine month periods ended March 31 unless otherwise noted)

Net sales for the quarter ended March 31, 2022 increased 16.2% behind better than expected direct-to-consumer (DTC) sales and sales to our distributor market class.

For the nine months ended March 31, 2022, net sales declined by 5% driven primarily by declines in sales to certain of our distributors and minimal sales to mass retailers.

Net sales in the domestic market were approximately $3,735,000 in the three months ended March 31, 2022, compared to approximately $2,693,000 in the prior year period.

Domestic net sales for the nine months ended March 31, 2022 were $9,781,000 compared to $10,292,000 for the same period in the prior year, a decrease of 5%.

Net sales to our largest distributor were down as a result of a prior year surge in demand for communication headsets in the education market that did not continue at the same level in the current fiscal period.

Also, the loss of sales to a mass retailer in the U.S.

for a non-Koss branded product impacted sales by $188,000 and $1,080,000 for the three and nine months ended March 31, 2022, respectively.

The final shipment of this product was during the quarter ended March 31, 2021.

These net sales were at lower than average margins.

These declines were mostly offset by growth in DTC sales.

Export net sales decreased to approximately $899,000 for the three months ended March 31, 2022, compared to approximately $1,294,000 for the same period last year due to an overall reduction in sales to Europe distributors.

Export net sales for the nine months ended March 31, 2022 also declined, to approximately $3,634,000 in the current fiscal year as compared to approximately $3,834,000 in the prior year period.

The continuing decline in sales to distributors in Asia was the primary driver for the nine month decrease.

Gross profit increased to 38.0% for the nine months ended March 31, 2022, compared to 33.1% for the nine months ended March 31, 2021.

Sales in the current year continue to reflect a more favorable mix in both markets and products.

Increased, higher margin sales to DTC and the distributors class translated to higher gross profit margins.

Lost placement at a U.S.

based mass retailer, which was low margin business, contributed as well.

The delays throughout the supply chain that began late last fiscal year as a result of the persistence of COVID-19 in all parts of the world, and presently due in part to the recent conflict in Eastern Europe, continue to affect the Company.

Chinese New Year added to the delays in product shipments from suppliers in Asia.

The ongoing disruption in ocean freight and congestion at the ports on the U.S.

west coast resulting in delivery delays have resulted in increased inbound shipping costs.

While rising shipping costs are expected to linger and negatively impact margins in the foreseeable future, the Company did see lower freight rates on inbound shipments during the quarter ended March 31, 2022, due in part to a dedicated freight forwarding partner.

Selling, general and administrative expenses for the three months ended March 31, 2022 decreased 31.0%, or approximately $705,000, to approximately $1,566,000.

The decrease was primarily driven by a drop in employer taxes on stock option exercises which were approximately $536,000 during the prior year’s third quarter and zero in the current quarter.

For the nine months ended March 31, 2022, selling, general and administrative expenses dropped $817,000, or 15.1%, compared to the same period in the prior year.

The primary factors were the reversal of the deferred compensation liability of $473,000 for the Company’s founder who passed away in December 2021 and lower employer taxes on fewer stock option exercises during the nine months ended March 31, 2022.

Other income for the three and nine months ended March 31, 2022 was $6,000 and $362,000, respectively, compared to $379,000 and $886,000 during the same three and nine month periods in the prior year.

In fiscal year 2022, the Company recognized $262,000 of other income related to the proceeds from a company-owned life insurance policy on its founder, who passed away in December 2021.

Also, in July 2021, the Company recorded a one-time license fee of $100,000 related to a license agreement entered into with a headphone manufacturer whereby the manufacturer licensed the use of certain patents in certain of their headphones.

A related payment of $100,000 to a third party was charged to legal expense.

For the nine months ended March 31, 2021, other income includes $507,000 related to the forgiveness of the Company’s unsecured loan under the Small Business Administration Paycheck Protection Program of the CARES Act as well as $379,000 received from a director in disgorgement of short-swing profits under Section 16(b) of the Exchange Act.

Income tax expense for the three and nine months ended March 31, 2022 was comprised of the U.S.

Fiscal 2023 Period Results Compared with Fiscal 2022 Period

(comments refer to the three-month period ended September 30 unless otherwise noted)

Net sales for the quarter ended September 30, 2022 decreased 23.2%.

The approximately $1,011,000 decrease in net sales was driven by declines in the European market and sales to certain of our distributors, partially offset by 73% growth in direct-to-consumer (DTC) sales.

Net sales in the domestic market were approximately $2,713,000 in the three months ended September 30, 2022, compared to approximately $2,788,000 in the prior year period.

While net sales to our largest distributor increased 85% over the same period in the prior year, certain other distributors were down nearly $600,000, or 66%, as a result of tighter inventory management and a reduction in the level of COVID-19 stimulus disbursements.

The growth in DTC sales mostly offset these declines.

Export net sales for the three months ended September 30, 2022 were down significantly versus the prior year period.

The decrease of $936,000, or 59%, was almost entirely attributable to an overall reduction in sales to European distributors.

There were no sales to Russia or Ukraine during the three months ended September 30, 2022 due to the ongoing conflict between the two countries, resulting in a decrease of $263,000 in export sales year over year.

Gross profit margin decreased slightly to 35.4% for the three months ended September 30, 2022, compared to 36.2% for the three months ended September 30, 2021.

While sales in the current year reflect a more favorable mix due to increased, higher margin sales to the distributor class and DTC, as well as decreased lower margin sales to Europe distributors, the resulting higher gross profit margins were partially offset by the impact of working through the inventory investment made while freight costs were higher.

Margins were also negatively impacted by increased product compliance testing that occurred during the first three months of the current fiscal year.

The Company experienced lower freight rates during the quarter ended September 30, 2022 driven by reduced container demand.

Delays throughout the supply chain continue as a result of the persistence of COVID-19 in all parts of the world, however, the delays were not overly impactful to the Company as bookings have continued without incident.

The threat of a rail strike during the current quarter was initially tempered due to bargaining sessions held as a result of direct intervention by President Biden.

Unfortunately, a tentative agreement has since been rejected, renewing the threat that there could be a strike that shuts down a vital link in the nation’s already struggling supply chain.

The Company continues to monitor the situation as a rail strike would negatively impact the Company with increased operating costs and delays in product shipments.

Selling, general and administrative expenses for the three months ended September 30, 2022 increased approximately $21,890,000 to $23,671,000.

The increase was predominantly driven by approximately $21,016,000 in legal fees and expenses incurred as a result of litigation related to patent defense that was resolved during the quarter.

A total of approximately $979,000 in bonus and profit-sharing accruals were recorded related to the increased net income before income taxes for the quarter due to licensing proceeds received during the three months ended September 30, 2022, partially offset by the aforementioned legal fees and expenses.

A decrease of $118,000 in employer taxes on stock option exercises slightly offset the significant increase in expense for the current three-month period.

Other income for the three months ended September 30, 2022 consisted entirely of $33,000,000 in licensing proceeds.

These proceeds are similar to the $100,000 licensing fee received in the prior year three-month period.

Income tax expense for the three months ended September 30, 2022 was approximately $600,000 and was comprised of the U.S.

federal statutory rate of 21% and the blended state income tax rate of approximately 3.7%, offset by an adjustment to the valuation allowance for deferred tax assets.

The effective tax rate was less than 1% in the three and nine months ended March 31, 2022 and 2021.

It is anticipated that the effective rate in the current year and future years will be reduced by utilization of a portion or all of the federal net operating loss carryforwards that existed as of June 30, 2021, plus the additional federal net operating loss carryforward generated by the deductible compensation expense on stock option exercises for the nine months ended March 31, 2022.

In the nine months ended March 31, 2022, stock option exercises resulted in tax deductible compensation expense of approximately $8,000,000.

The deduction of this stock option exercise compensation expense will cause a tax loss in the year ended June 30, 2022, which will be carried forward to future tax years.

The expected federal tax loss carryforward, including the stock-based compensation expense deductions in the nine months ended March 31, 2022, will be approximately $39,000,000.

The quarterly adjustment to the estimated tax loss carryforward decreased the deferred tax asset to approximately $11,800,000 as of March 31, 2022, and the future realization of this is uncertain.

The valuation allowance was also decreased to fully offset the deferred tax asset.

On December 22, 2017,the Tax Cuts and Jobs Act (TCJA) was enacted which changed the rules for deducting net operating losses (NOLs).

Before 2017, NOLs were fully deductible and could be carried back two years and carried forward 20 years.

For NOLs arising in tax years beginning after December 31, 2017, the TCJA limits the NOL deduction to 80 percent of taxable income.

As such, the utilization of the Company’s net operating loss carryforwards from fiscal years after 2018 were limited to 80 percent of the resulting net income.

The Company’s NOL carryforwards from fiscal 2017 and 2018 could be utilized to offset net income at 100 percent.

The effective tax rate was 5.6% in the three months ended September 30, 2022 and less than 1% in the three months ended September 30, 2021.

In the three months ended September 30, 2022, stock option exercises resulted in tax deductible compensation expense of approximately $179,000 and will offset some of the income generated by the net licensing proceeds.

Net operating loss carryforwards were utilized to reduce the taxable income and, as such, th e remaining expected federal tax loss carryforward is expected to approximate $30,500,000 by the end of the fiscal year.

The quarterly adjustment to the estimated tax loss carryforward decreased the deferred tax asset to approximately $9,300,000 as of September 30, 2022, and the future realization of this continues to be uncertain.

The valuation allowance was also decreased to fully offset the deferred tax asset as there is sufficient negative evidence to support the maintaining of a full valuation allowance as, excluding unusual, infrequent items, a three-year cumulative net loss is expected.

As previously reported, the Company maintains a program focused on enforcing its intellectual property and, in particular, certain of its patent portfolio.

The Company has enforced its intellectual property by filing complaints against certain parties alleging infringement on the Company’s patents relating to its wireless headphone technology.

If the program is successful, the Company may receive royalties, offers to purchase its intellectual property, or other remedies advantageous to its competitive position; however, there is no guarantee of a positive outcome from these efforts, which could ultimately be time consuming and unsuccessful.

Additionally, in the event that a monetary award or judgment is received by the Company in connection with these complaints, all or portions of such amounts will be due to third parties.

If efforts are successful, the Company may receive royalties, offers to purchase its intellectual property, or other remedies advantageous to its competitive position from time to time; however, there is no guarantee of a positive outcome from these efforts in the future, which could ultimately be time consuming and unsuccessful.

Additionally, all or portions of monetary awards or judgments received by the Company in connection with these complaints, will be due to third parties.

The Company believes that its financial position remains strong.

The Company had $9.5 million of cash and cash equivalents and available credit facilities of $5.0 million on March 31, 2022.

The Company had $20.9 million of cash and cash equivalents and available credit facilities of $5.0 million on September 30, 2022.

Recent Events

Recent events continuing to impact our business include COVID-19, the inflationary cost environment, disruption in our supply chain, and Russia’s invasion of Ukraine.

Recent events continuing to impact our business include COVID-19, the inflationary cost environment, disruption in our supply chain, and most recently the threatened rail strike in the U.S., and the ongoing crisis in Eastern Europe.

As more fully described below, we expect each of these factors will impact our fiscal 2023 performance.

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The extent and nature of government actions to ease restrictions are varied based upon the current extent and severity of the COVID-19 pandemic within their respective countries and localities.

The Company saw a surge in the sale of specific communication headsets in the nine months ended March 31, 2021 that did not repeat in the same period in the current year.

Also, certain retail businesses throughout the Company’s markets, particularly in certain European markets due to the spread of the Omicron subvariant BA.2, have seen continued disruption.

The Company expects the negative sales impacts caused by this disruption to continue until markets more fully re-open and consumer spending returns to normal.

The sweeping COVID -19 restrictions enacted in China to strictly prevent the spread of the virus could potentially impact sales if they result in disruptions of inventory replenishment.

The Company expects the negative sales impacts caused by governmental responses to COVID-19, and the disruption in certain retail businesses to continue while new variants of the virus continue to emerge and spread.

The ultimate magnitude of the COVID-19 pandemic, including the extent of its impact on the Company’s business, financial position, results of operations or liquidity, cannot be reasonably estimated at this time due to the rapid development and fluidity of the situation.

The Company's future results will be determined by the effectiveness of vaccines, rollout of vaccine boosters, the duration of the pandemic, impact of variants, its geographic spread, further business disruptions and the overall impact on the economy throughout the globe.

The Company's future results will be determined by the effectiveness of vaccines, rollout of vaccine boosters, the duration of governmental pandemic restrictions, the impact of variants, geographic spread, further business disruptions and the overall impact on the economy throughout the world.

To protect the safety, health and well-being of employees, customers, and suppliers, the Company continues to maintain several preventive measures while also meeting the needs of global customers.

They include increased frequency of cleaning and disinfecting of facilities, social distancing practices, remote working when possible, restrictions on business travel, holding certain events virtually and limitations on visitor access to facilities.

The Company is committed to continuing to execute these plans and will remain in close contact with its supply chain to monitor future possible implications, especially on production facilities.

Inflationary Cost Environment and Supply Chain Disruption – During fiscal 2022, we have experienced inflationary cost increases in our commodities, packaging materials and transportation costs.

These increases have been partially mitigated by pricing actions implemented in the third quarter of the current fiscal year, as well as working with a dedicated freight forwarding partner to minimize freight rate increases.

These measures include increased frequency of cleaning and disinfecting of facilities, and may also include, as necessary, social distancing practices, remote working, restrictions on business travel, holding certain events virtually and limitations on visitor access to facilities.

The Company is committed to executing these plans and will remain in close contact with its supply chain to monitor future possible implications, especially on production facilities.

Inflationary Cost Environment and Supply Chain Disruption – During the first half of fiscal 2022, we began experiencing inflationary cost increases in our commodities, packaging materials, wages and transportation costs.

Higher energy costs caused inflation to rise further in the back half of the prior fiscal year and has continued into the current fiscal year.

These increases have been partially mitigated by pricing actions implemented by the Company in the third quarter of last year, with another planned for the third quarter of the current fiscal year, as well as working with a dedicated freight forwarding partner to minimize freight rate increases.

The Company’s supply chain is primarily in southern China.

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The Company is monitoring the situation closely and the supply chain team has modified business plans, which include, but are not limited to:

(1) increasing the investment in inventory;

(1) being alert to potential short supply situations;

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and (3) utilizing alternative sources and/or air freight.

The latest COVID-19 resurgence resulted in another shut-down of several major ports in China, thus impacting manufacturing of our products and shipments from our suppliers.

Additionally, the threat of a rail strike in the U.S.

could potentially exacerbate the existing disruption in the supply chain and impact product shipments from suppliers and to customers.

Russia’s Invasion of Ukraine:

The invasion of Ukraine by Russia and the sanctions imposed in response to this conflict have increased global economic and political uncertainty.

In accordance with the recent Executive Order declared on April 6, 2022, the Company has suspended sales into Russia.

Also, given the current humanitarian crisis in Ukraine and the population seeking refuge in other countries, sales to Ukraine have been impacted.

Neither Russia nor Ukraine constitutes a significant portion of the business, less than 5% of net sales for the three months ended March 31, 2022, so there was not a material impact on the current quarter.

We are uncertain, however, of the impact it will have on our results of operations for the future.

The ongoing Russia-Ukraine conflict and the sanctions imposed in response to this conflict have increased global economic and political uncertainty.

In accordance with the Executive Order declared on April 6, 2022, the Company suspended sales into Russia.

Also, given the continued humanitarian crisis in Ukraine as a result of the conflict, and the population seeking refuge in other countries, sales to Ukraine have also ceased.

Neither Russia nor Ukraine constitutes a significant portion of the business, combining for less than 5% of net sales for the three months ended March 31, 2022, the last quarter prior to the Executive Order.

As a result, there was not a material impact on sales in the current quarter.

We are uncertain, however, of the impact it will have on our results of operations in the future if the conflict continues.

Liquidity and Capital Resources

The following table summarizes cash flows from operating, investing and financing activities for the nine months ended March 31, 2022 and 2021:

The following table summarizes cash flows from operating, investing and financing activities for the three months ended September 30, 2022 and 2021:

Total cash provided by (used in):

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Operating Activities

The investment in inventories was the driving factor for the increase in cash used by operating activities during the nine months ended March 31, 2022.

The Company increased the investment in inventory to ensure availability and to provide better inventory positions on key products to mitigate the continued impacts of supply chain disruptions.

The impact of the investment in inventory was partially offset by increased accounts payable and accrued liabilities related to the inventory investment and an increase in customer deposits from certain of our export customers.

The cash used by operating activities in the nine months ended March 31, 2022 also included a net gain of $262,000 on a life insurance policy held on the Company’s founder, who passed away in December 2021.

The cash provided by operating activities during the three months ended September 30, 2022 is almost entirely the result of licensing proceeds received, coupled with the increase in income tax, bonus and profit-sharing accruals that are a direct result of the increased net income.

The impact of the licensing fees was partially offset by an increase in prepaid expenses due to the annual premiums paid for insurance renewal and the decrease in accounts payable as investment in inventories normalizes.

The driving factor for the use of cash in the same three-month period in the prior year was the investment in inventory made to ensure availability and to provide better inventory positions on key products to mitigate the continued impacts of supply chain disruptions.

Investing Activities

Cash provided by investing activities for the nine months ended March 31, 2022 was related to the receipt of $2,014,000 of proceeds on company-owned life insurance policies on the Company’s founder who passed away in December 2021.

This was slightly offset by premiums paid for company-owned life insurance policies on other executives.

In the prior year, the Company had increased expenditures for a new operating system and leasehold improvements.

The Company expects to generate sufficient cash flow from operations or from the use of its available cash and its credit facility to fund any necessary tooling, leasehold improvement and capital expenditures.

Consistent with the prior year, cash used by investing activities for the three months ended September 30, 2022 was related to the premiums paid for company-owned life insurance policies on two of the Company’s executives as well as some minor fixed asset expenditures.

The Company currently has sufficient cash flow from operations and available cash and its credit facility to fund any necessary tooling, leasehold improvement and capital expenditures.

Financing Activities

In the nine months ended March 31, 2022, an aggregate of 539,089 shares of common stock were issued as a result of employee stock option exercises under the Company’s 2012 Omnibus Incentive Plan.

Cash provided by financing activities is due entirely to stock option exercises.

In the three months ended September 30, 2022, an aggregate of 32,000 shares of common stock were issued as a result of employee stock option exercises under the Company’s 2012 Omnibus Incentive Plan.

The cash provided from these stock option exercises was approximately $70,000.

An aggregate of 1,111,992 shares of common stock were issued as a result of employee stock option exercises under the Company’s 2012 Omnibus Incentive Plan in the nine months ended March 31, 2021.

An aggregate of 529,089 shares of common stock were issued as a result of employee stock option exercises under the Company’s 2012 Omnibus Incentive Plan in the three months ended September 30, 2021.

The cash provided from these stock option exercises was approximately $1,390,000.

As of March 31, 2022, the Company had no outstanding borrowings on its bank line of credit facility.

There were no purchases of common stock in the quarters ended March 31, 2022 or 2021 under the stock repurchase program.

As of September 30, 2022, the Company had no outstanding borrowings on its bank line of credit facility.

There were no purchases of common stock in the quarters ended September 30, 2022 or September 30, 2021 under the stock repurchase program.

The Company's capital expenditures are primarily for leasehold improvements and tooling.

In addition, it has interest payments on its borrowings when it uses its line of credit facility.

The Company believes that cash generated from operations, together with cash reserves and available borrowings, provide it with adequate liquidity to meet operating requirements, debt service requirements and planned capital expenditures for the next twelve months following the date of this Quarterly Report on Form 10-Q and thereafter for the foreseeable future.

The Company believes that cash generated from operations, together with healthy cash reserves and available borrowings, provide it with adequate liquidity to meet operating requirements, debt service requirements and planned capital expenditures for the next twelve months following the date of this Quarterly Report on Form 10-Q and thereafter for the foreseeable future.

The Company regularly evaluates new product offerings, inventory levels and capital expenditures to ensure that it is effectively allocating resources in line with current market conditions.

Credit Facility

On May 14, 2019, the Company entered into a secured credit facility ("Credit Agreement") with Town Bank (“Lender”).

The Credit Agreement provides for a $5,000,000 revolving secured credit facility with an interest rate of 1.50% over LIBOR.

The Credit Agreement also provides for letters of credit for the benefit of the Company of up to a sublimit of $1,000,000.

On May 14, 2019, the Company entered into a secured credit facility (“Credit Agreement”) with Town Bank (“Lender”).

The Credit Agreement provides for a $5,000,000 revolving secured credit facility letters of credit for the benefit of the Company of up to a sublimit of $1,000,000.

There are no unused line fees in the credit facility.

On January 28, 2021, the Credit Agreement was amended to extend the expiration to October 31, 2022, and to change the interest rate to Wall Street Journal Prime less 1.50%.

A Third Amendment to the Credit Agreement effective October 30, 2022 extends the maturity date to October 31, 2024.

The Company and the Lender also entered into a General Business Security Agreement dated May 14, 2019 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.

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The negative covenants include restrictions on other indebtedness, liens, fundamental changes, certain investments, disposition of assets, mergers and liquidations, among other restrictions.

As of March 31, 2022, the Company was in material compliance with all covenants related to the Credit Agreement.

As of March 31, 2022, and June 30, 2021, there were no outstanding borrowings on the facility.

As of September 30, 2022, the Company was in compliance with all covenants related to the Credit Agreement.

As of September 30, 2022, and June 30, 2022, there were no outstanding borrowings on the facility.

Contractual Obligation

The Company leases its facility in Milwaukee, Wisconsin from Koss Holdings, LLC, which is wholly owned by the Company’s former Chairman’s revocable trust.

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 leases the 126,000 square foot facility from Koss Holdings, LLC, which is controlled by five equal ownership interests in trusts held by the 5 beneficiaries of a former Chairman’s revocable trust.

On May 24, 2022, the lease was renewed for a period of five years, ending June 30, 2028, and is being accounted for as an operating lease.

The lease extension maintained the rent at a fixed rate of $380,000 per year.

The Company has the option to renew the lease for an additional five years beginning July 1, 2028 and ending June 30, 2033 under the same terms and conditions except that the annual rent will increase to $397,000.

The negotiated increase in rent slated for 2028 will be the first increase in rent since 1996.

The Company is responsible for all property maintenance, insurance, taxes and other normal expenses related to ownership.

The facility is in good repair and, in the opinion of management, is suitable and adequate for the Company’s business purposes.

Off-Balance Sheet Transactions

At March 31, 2022, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

At September 30, 2022, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

Quantitative and Qualitative Disclosures About Market Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis