What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-01-27 compared with 2022-10-28 · 89 added, 72 removed, 73 unchanged (69% of the section changed)

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

The following discussion and analysis supplements our management’s discussion and analysis for the year ended June 30, 2022 as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on August 26, 2022, and presumes that readers have read or have access to such discussion and analysis.

The following discussion and analysis should also be read together with the unaudited consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

This discussion contains forward-looking statements that reflect our plans and strategy for our business and involve risks and uncertainties.

You should review the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, as updated by subsequent filings with the Securities and Exchange Commission, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

You should carefully read “Cautionary Statement Regarding Forward-Looking Statements” in this Quarterly Report on Form 10-Q.

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

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Financial Results

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

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

Three Months Ended

Six Months Ended

Financial Performance Summary

Net sales (decrease) %

Net sales (decrease) % from prior year period

Gross profit as % of net sales

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Interest income

Income (loss) before income tax provision

Income (loss) before income tax as % of net sales

Income tax provision

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

(Loss) income before income tax (benefit) provision

(Loss) income before income tax as % of net sales

Income tax (benefit) provision

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

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.

(comments refer to the three and six-month periods ended December 31 unless otherwise noted)

Net sales for the quarter ended December 31, 2022 decreased by $1,144,000, or 25.9%, primarily due to reduced sales to certain of our distributors in the domestic market and lower sales to the Asian markets.

For the six-month period ended December 31, 2022, net sales decreased by $2,154,000, or 24.5%, due mainly to a decline in the European and Asian markets, and a slowdown in certain of our domestic distributor sales.

Growth in direct-to-consumer (DTC) sales of approximately $331,000, or 20.7%, partially offset the declines.

Net sales in the domestic market were approximately $2,146,000 in the three months ended December 31, 2022, compared to approximately $3,192,000 in the prior year period, a decrease of $1,046,000, or 32.8%.

Domestic net sales for the six months ended December 31, 2022 decreased from $6,004,000 in the prior year period to $4,873,000, a decline of $1,131,000, or 18.8%.

Net sales to certain of our domestic distributors decreased 62% from the prior year driven by weaker demand which appears to be due to over-stocked shelves as a result of the bullwhip effect triggered by the pandemic.

Net sales to the education market also decreased by over 50% mainly as a result of a delay in repeat orders.

The declines were partially offset by growth in DTC sales during the six months ended December 31, 2022 over the same period in the prior year.

Export net sales for the three months ended December 31, 2022 decreased by $99,000, or 8.1%, compared to the three months ended December 31, 2021, behind a decrease in sales to our Asian distributors due to the delay in recovery after the pandemic.

Export net sales were down $1,024,000, or 36.9%, in the six months ended December 31, 2022 versus the same prior year period.

The decrease was attributable to a 31.8% reduction in sales to European distributors, which reflects the lack of sales to Russia or Ukraine due to the ongoing conflict between the two countries, as well as a 39.3% decline in sales to our Asian distributors for the six-month period.

Gross profit margin decreased slightly to 34.9% for the six months ended December 31, 2022, compared to 35.7% for the six months ended December 31, 2021.

Margins were impacted by a less favorable market mix as higher margin sales to certain of our distributors, including custom headphones to healthcare and specialty customers, during the current six-month period declined by over 60%.

Growth of 23.3% in gross DTC sales, which generally bear a higher margin, for the six-month period helped to partially offset the aforementioned negative impacts on gross margin.

Margins were also negatively impacted by fixed manufacturing expenses that do not flex with sales volume.

The Company continued to benefit from lower freight rates during the quarter ended December 31, 2022 driven by general reduced container demand and the partnership with a dedicated freight forwarder.

Selling, general and administrative expenses for the three months ended December 31, 2022 were $2,474,000, approximately double that of the same period in the prior year.

The increase was driven mainly by a payment of $950,000 made to the Company’s external patent litigation team, and another $175,000 of legal expenses related to patent defense litigation resolved in the prior quarter, which were recorded as a change in estimate in the quarter ended December 31, 2022.

The year-over-year increase is also partly attributable to the prior year second quarter including the reversal of the deferred compensation liability for the Company’s founder who passed away in that quarter, resulting in an approximately $300,000 reduction to net expense for the prior quarter.

For the six months ended December 31, 2022, selling, general and administrative expenses increased by approximately $23,134,000 to $26,145,000 compared to the prior year period.

The increase was predominantly driven by approximately $22,196,000 in legal fees and expenses incurred as a result of the patent defense litigation referenced above.

A total of approximately $955,000 in bonus accruals and profit-sharing expense was recorded related to the increased net income before income taxes for the first six months of fiscal year 2022 due to licensing proceeds received during the quarter ended September 30, 2022, partially offset by the aforementioned legal fees and expenses.

A decrease of $116,000 in employer taxes on stock option exercises slightly offset the significant increase in expense for the current six-month period.

Other income for the six months ended December 31, 2022 consisted entirely of $33,000,000 in licensing proceeds received in the first quarter.

The Company received licensing proceeds of $100,000 in the prior year six-month period which was also recorded as other income.

In December 2021, the Company recognized other income on the proceeds from a company-owned life insurance policy on its founder, who passed away December 21, 2021.

Total other income for the three and six months ended December 31, 2021 was $256,000 and $356,000, respectively.

Income tax expense for the six months ended December 31, 2022 was approximately $495,000 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.

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.

The utilization of net operating loss carryforwards significantly reduced the taxable income, resulting in federal and state tax provisions of $374,714 and $120,125, respectively.

For the three and six months ended December 31, 2021, a state tax provision of $1,031 and $2,062, respectively, was recorded.

The federal income tax expense was zero for the three and six months ended December 31, 2021.

The effective tax rate was 5.3% in the six months ended December 31, 2022 and less than 1% in the six months ended December 31, 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, 2022.

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.

In the six months ended December 31, 2022, stock option exercises resulted in tax deductible compensation expense of approximately $208,000 and will offset some of the taxable 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 $32,500,000 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 quarterly adjustment to the estimated tax loss carryforward decreased the deferred tax asset to approximately $9,600,000 as of December 31, 2022, and the future realization of this continues to be uncertain.

The valuation allowance was also increased 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.

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.

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The Company believes that its financial position remains strong.

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

The Company had $4.8 million of cash and cash equivalents, $5.0 million of short-term investments and available credit facilities of $5.0 million on December 31, 2022.

Recent Events

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.

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

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

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These and other uncertainties with respect to these recent events could result in changes to our current expectations.

The Company has closely monitored the impact of COVID-19 (including the emergence of variants) to protect the health and safety of its employees and customers.

The Company continues to closely monitor the impact of COVID-19 (including the emergence of variants) to protect the health and safety of its employees and customers.

Business plans are being continuously updated and executed to maintain supply of the Company’s products to our customers throughout the world.

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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 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 recent easing of the strict zero-COVID policies that China has maintained for the past three years has resulted in a surge of COVID infections, with another spike expected during the upcoming Lunar New Year.

This potential increased spread of the virus could impact sales if it results 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 so long as 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.

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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.

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.

These measures include increased frequency of cleaning and disinfecting of facilities, and may also include, as necessary, social distancing practices, some remote working, restrictions on business travel, continuing to hold 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.

Inflationary Cost Environment and Supply Chain Disruption – The first half of fiscal 2022 brought continued inflationary cost increases in our commodities, packaging materials, wages and transportation costs.

Higher energy costs caused inflation to rise 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 the prior fiscal year, with another increase slated for the third quarter of the current fiscal year.

The Company is also working with a dedicated freight forwarding partner to minimize freight rate increases.

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

Since late fiscal year 2021, the Company has experienced issues related to the availability of containers and routings to move products in a cost effective and time efficient manner.

There have also been impacts to the movement of new product introductions and costs.

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

Delays throughout the supply chain continue as a result of the persistence of COVID-19 in all parts of the world, however, the Company does not believe that these continuing delays will be material to the Company as the cadence of specific customers’ bookings have become more consistent.

The Company is aware that with the recent easing of COVID-19 restrictions in China, manufacturing operations and major ports may be impacted by an increase in COVID-19 illness, which could result in supply chain delays.

As such, the Company continues to monitor the situation closely, and the supply chain team has modified business plans, which include, but are not limited to:

(1) being alert to potential short supply situations;

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

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.

In December 2022, the U.S.

government intervened in the rail strike that began in the prior month and implemented a labor agreement that prohibited the workers from striking.

Despite the U.S.

government’s intervention, the threat of a strike that could shut down a vital link in the nation’s supply chain continues to be a concern.

The Company continues to monitor the situation as 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, resulting in increased operating costs and delays in product shipments.

Russia’s Invasion of Ukraine:

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Liquidity and Capital Resources

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

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

Total cash provided by (used in):

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Financing activities

Net increase in cash and cash equivalents

Net (decrease) increase in cash and cash equivalents

Operating Activities

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.

A significant portion of the cash provided by operating activities during the six months ended December 31, 2022 is the result of the licensing proceeds received, partially offset by the payment of related legal fees and expenses and profit sharing.

The impact of the licensing fees was coupled with a reduction in inventory as the investment in inventory levels off, and a decline in accounts receivable resulting from lower sales.

Cash used by operating activities related to the decrease in accounts payable resulting from lower freight costs and fewer inventory purchases.

The driving factor for the use of cash in the same six-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, offset by a decline in accounts receivable.

Investing Activities

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.

Cash used by investing activities for the six months ended December 31, 2022 was almost entirely related to the purchase of $15,300,000 of U.S.

Treasury securities at a discount.

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

Financing Activities

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.

In the six months ended December 31, 2022, an aggregate of 42,000 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 $89,000.

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.

During the six months ended December 31, 2021, 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.

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

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.

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

There were no purchases of common stock in the three months ended December 31, 2022 or December 31, 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 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 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 or necessary tooling, leasehold and other 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.

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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.

On January 28, 2021, the Credit Agreement was amended to extend the expiration date 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 extended the expiration 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 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.

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

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

Contractual Obligation

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.

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 five 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.

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Off-Balance Sheet Transactions

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

At December 31, 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