What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-12 compared with 2023-01-27 · 70 added, 72 removed, 90 unchanged (61% of the section changed)

9 unchanged sentences

Financial Results

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

The following table presents selected financial data for the three and nine months ended March 31, 2023, and 2022:

Three Months Ended

Six Months Ended

Nine Months Ended

Financial Performance Summary

Net sales (decrease) % from prior year period

Net sales (decrease) increase % from prior year period

Gross profit as % of net sales

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Fiscal 2023 Period Results Compared with Fiscal 2022 Period

(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.

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

Net sales for the quarter ended March 31, 2023 decreased by $1,265,000, or 27.3%, primarily due to reduced sales to certain of our distributors in the domestic market and online retailers, as well as lower sales in the European markets.

For the nine-month period ended March 31, 2023, net sales decreased by $3,420,000, or 25.5%, with over 50% of the reduction due to a slowdown in certain of our domestic distributor sales.

This was coupled with a continued decline in sales to our European and Asian markets.

Net sales in the domestic market were approximately $2,717,000 in the three months ended March 31, 2023, compared to approximately $3,735,000 in the prior year period, a decrease of $1,018,000, or 27.3%.

Domestic net sales for the nine months ended March 31, 2023 decreased from $9,781,000 in the prior year period to $7,589,000, a decline of $2,192,000, or 22.4%.

A weakness in consumer demand and bloated customer inventory levels have resulted in a 38% decrease in net sales to certain of our domestic distributors, representing approximately 85% of the drop in domestic net sales.

Growth in direct-to-consumer (DTC) sales of $214,000, or 8.7%, during the nine months ended March 31, 2023 over the same period in the prior year helped to slightly offset the decline.

Export net sales for the three months ended March 31, 2023 decreased by $247,000, or 27.5%, compared to the three months ended March 31, 2022, behind a decrease in sales to our distributors in Russia and Ukraine due to the continued discord in that region.

Export net sales were down $1,228,000, or 33.8%, in the nine months ended March 31, 2023 versus the same prior year period.

The decline in overall sales during fiscal year 2023 heightened the impact of the drop-off in sales to the two distributors in Russia and Ukraine, representing nearly 50% of the decrease in export sales for the current year.

The 12.4% and 34.7% reduction in sales to our European and Asian distributors, respectively, for the current nine-month period also contributed to the decline.

Gross profit margin decreased to 36.1% for the nine months ended March 31, 2023, compared to 38.0% for the nine months ended March 31, 2022.

As the Company sold off inventory brought in during the prior year at higher freight rates, the margins on those sales were adversely impacted.

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.

Favorability from lower freight costs during the current nine-month period, as a result of declining rates and a decreasing investment in inventory, provided some positive impact on the overall margin as a partial offset.

Freight rates remained constant through the quarter ended March 31, 2023 and are expected to continue as general container demand remains stable and the partnership with a dedicated freight forwarder is maintained.

Selling, general and administrative expenses for the three months ended March 31, 2023 were $1,746,000, a $180,000 or 11.5% increase over the same period in the prior year.

The decrease in the discount rates used to calculate the deferred compensation liability resulted in an increase in the liability with a corresponding increase to expense.

This, coupled with an increase in legal fees compared to the prior year, were the main factors for the increase.

For the nine months ended March 31, 2023, selling, general and administrative expenses increased by approximately $23,314,000 to $27,891,000 compared to the prior year period.

The significant increase was primarily a result of approximately $22,265,000 in legal fees and expenses incurred in support of the Company’s patent defense litigation.

Also, increased expense related to a bonus accrual of $381,000 and a second quarter profit-sharing payout of $576,000 were recorded as a result of the increased net income before income taxes for the first nine months of fiscal year 2023 due mainly to the licensing proceeds received during the quarter ended September 30, 2022, partially offset by the aforementioned legal fees and expenses.

A decrease of $108,000 in employer taxes on stock option exercises slightly offset the significant increase in expense for the current nine-month period.

Other income for the nine months ended March 31, 2023 consisted entirely of $33,000,000 in licensing proceeds received in the first quarter.

The Company received licensing proceeds of $100,000, which was also recorded as other income, in the first quarter of the prior year.

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

Total other income for the nine months ended March 31, 2022 was $362,000.

An income tax benefit of approximately $31,000 was recorded during the third quarter of fiscal year 2023 as a result of the taxable loss for the period.

Income tax expense for the nine months ended March 31, 2023 was approximately $464,000 and was comprised of the U.S.

federal statutory rate of 21% and the blended state income tax rate of approximately 3.8%, offset by an adjustment to the valuation allowance for deferred tax assets.

The utilization of net operating loss carryforwards significantly reduced the taxable income, resulting in federal and state tax provisions of $374,714 and $89,214, 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.

For the three and nine months ended March 31, 2022, a state tax provision of $3,575 and $5,638, respectively, was recorded.

The federal income tax expense was zero for the three and nine months ended March 31, 2022.

The effective tax rate was 5.1% in the nine months ended March 31, 2023 and less than 1% in the nine months ended March 31, 2022.

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 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.

In the nine months ended March 31, 2023, stock option exercises resulted in tax deductible compensation expense of approximately $332,000 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 $32,600,000 by the end of the fiscal year.

The quarterly adjustment to the estimated tax loss carryforward decreased the deferred tax asset to approximately $9,600,000 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 quarterly adjustment to the estimated tax loss carryforward decreased the deferred tax asset to approximately $9,800,000 as of March 31, 2023, and the future realization of this continues to be uncertain.

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 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.

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 $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.

The Company had $2.9 million of cash and cash equivalents, $12.0 million of short-term investments and available credit facilities of $5.0 million on March 31, 2023.

Recent Events

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As a result of the COVID-19 pandemic, uncertainty with respect to its economic effects has impacted not only our operating results but also the global economy.

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

Certain of the Company’s suppliers have been, and could continue to be, impacted by the COVID-19 pandemic, resulting in disruptions to 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.

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

Inflationary Cost Environment and Supply Chain Disruption - The Company continues to experience inflationary cost increases in our commodities, packaging materials, wages and higher energy and transportation costs.

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 at the beginning of the third quarter of the current fiscal year.

The Company also continues to work with a dedicated freight forwarding partner to minimize freight rate increases.

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

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.

The Company is aware that with the easing of COVID-19 restrictions in China, manufacturing operations and major ports could continue to 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:

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

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:

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

In April 2023, United Parcel Service (UPS) and the International Brotherhood of Teamsters Union started labor contract talks to negotiate better pay, no forced overtime and the elimination of a two tier pay system.

Members of the union have stated that they are prepared to walk off the job if UPS fails to deliver a deal before the current contract expires at midnight on July 31, 2023.

Also, since December 2022, when the U.S.

government abated a threatened railroad strike and implemented a labor agreement that prohibited the workers from striking, some union leaders and railroad executives have voluntarily reopened the conversation around paid sick leave in hopes of negotiating an improvement.

The Company continues to monitor both situations as ether strike in the U.S.

could potentially exacerbate disruptions 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 - 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.

The lack of sales to Russia and Ukraine during the nine months ended March 31, 2023 compared to net sales of approximately $600,000, or 4% of total net sales for the same period in the prior year.

The continuation of the conflict will have an impact on sales to the region in the future, however we are uncertain of what that impact will be on the results of operations.

Liquidity and Capital Resources

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

The following table summarizes cash flows from operating, investing and financing activities for the nine months ended March 31, 2023 and 2022:

Total cash provided by (used in):

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Operating Activities

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.

A majority of the cash provided by operating activities during the nine months ended March 31, 2023 is the result of the licensing proceeds received, partially offset by the payment of related legal fees and expenses as well as the profit-sharing payout in the second quarter.

Additionally, the continued reduction in inventory levels as the Company’s investment tapers off contributed to the cash provided by operating activities during the first nine months of the current fiscal year.

The use of cash in the same nine-month period in the prior year was related to the impact of the deliberate investment in inventory to ensure adequate stock levels to mitigate the impact of potential supply chain delays.

An increase in accounts payable and accrued liabilities as a result of the increased inventory investment and customer deposits from our European distributors provided cash from operating activities to partially offset the use.

Investing Activities

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.

Cash used by investing activities for the nine months ended March 31, 2023 was almost entirely related to the purchase of $17,300,000 of U.S.

Treasury securities at a discount.

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

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.

In the nine months ended March 31, 2023, an aggregate of 69,000 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 $137,000.

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.

During 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.

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

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.

As of March 31, 2023, 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 March 31, 2023 or March 31, 2022 under the stock repurchase program.

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

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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 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.

As of March 31, 2023, the Company was in compliance with all covenants related to the Credit Agreement.

As of March 31, 2023 and June 30, 2022, there were no outstanding borrowings on the facility.

Contractual Obligation

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Off-Balance Sheet Transactions

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

At March 31, 2023, 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