KOSS CORP 10-Q

Item 2. 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, 2023 as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on August 25, 2023, 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, 2023, 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. Overview 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. The Company operates as one business segment, as its principal business line is the design, manufacture and sale of stereo headphones and related accessories. Financial Results The following table presents selected financial data for the three months ended September 30, 2023 and 2022: Three Months Ended September 30 Financial Performance Summary 2023 2022 Net sales $ 3,373,938 $ 3,364,129 Net sales increase (decrease) % from prior year period 0.3% (22.9)% Gross profit $ 1,067,690 $ 1,195,824 Gross profit as % of net sales 31.6% 35.5% Selling, general and administrative expenses $ 1,536,279 $ 23,680,196 Selling, general and administrative expenses as % of net sales 45.5% 703.9% Interest income $ 212,859 $ 27,056 Other income $ — $ 33,000,000 (Loss) income before income tax provision $ (255,730) $ 10,542,684 (Loss) income before income tax as % of net sales (7.6)% 313.4% Income tax provision $ 1,879 $ 597,941 Income tax provision as % of (loss) income before income tax (0.7)% 5.7% ‎ 15 Table of Contents Fiscal 2023 Period Results Compared with Fiscal 2022 Period (comments refer to the three-month periods ended September 30 unless otherwise noted) Net sales of $3,374,000 for the quarter ended September 30, 2023 were fairly consistent with sales for the same quarter in the prior year, an increase of $10,000. A reduction in direct-to-consumer (DTC) sales and sales to certain of our distributors in the domestic market were offset by an increase in sales to the European markets. Export net sales for the three months ended September 30, 2023 increased by $129,000, or 20.1%, compared to the three months ended September 30, 2022, related to an order from a distributor in Eastern Europe. A $66,000, or 41.7%, reduction in sales to our Asian distributor slightly dampened the overall increase. Given the perpetuation of the conflict in Eastern Europe and related export restrictions, sales to our Russian distributor have not resumed and there have been no sales to that country since April 2022. During the three months ended September 30, 2023, net sales to the domestic market declined by $119,000, or 4.4%, offsetting much of the increase in export sales. Net sales in the domestic market were approximately $2,603,000 compared to $2,722,000 in the three months ended September 30, 2022. A notable sale to a new customer did not outweigh the 28.6% drop in DTC sales as a general reduction in consumer confidence slowed spending. A 12.6% decline in net sales to certain of our domestic distributors, resulting from continued overstocked inventory levels of non-Koss items at these distributors, also contributed to the overall decline. Gross profit margin decreased to 31.6% for the three months ended September 30, 2023, compared to 35.5% for the three months ended September 30, 2022. A less favorable customer mix of sales, with a lower volume of higher margin DTC and distributor sales, coupled with the continued sell through of Company inventory received from suppliers with higher freight rates, adversely impacted the gross margin. An increase in inventory obsolescence also drove the reduction in margins. Favorability in fixed manufacturing expenses during the three months ended September 30, 2023 as a result of cost savings initiatives provided some positive impact compared to the same period in the prior year. Freight rates edged up slightly through the quarter ended September 30, 2023 and are expected to continue a slow rise during the next quarter. Given the current labor landscape and the recent settlement of threatened carrier strikes and labor disputes, along with rising energy prices, the Company is anticipating an increase in transportation costs. The Company’s partnership with a dedicated freight forwarder will help to stabilize contract rates to limit the impact. While the recent announcement by Yellow freight lines that it has declared bankruptcy may impact carrier availability and increase freight costs, the Company has had no material direct exposure to Yellow. Selling, general and administrative expenses declined by $22,144,000, or 93.5%, from $23,680,000 for the three months ended September 30, 2022 to $1,536,000 for the same three months in the current period. The decrease was predominantly driven by the $21,016,000 of legal fees and related expenses incurred during the first quarter in the prior year in support of the Company’s patent defense litigation. Also, expenses related to bonus and profit-sharing accruals of $381,000 and $576,000, respectively, were recorded during the quarter ended September 30, 2022 as a result of the increased net income before income taxes due mainly to the licensing proceeds received during that quarter, offset by the aforementioned legal fees. Lastly, the increase in the discount rates used to calculate the deferred compensation liability resulted in a decrease in the liability with a corresponding decrease to expense during the current quarter. No other income was recorded for the three months ended September 30, 2023. Other income for the same three months in the prior period consisted entirely of $33,000,000 in licensing proceeds received. Given the taxable loss for the first quarter of fiscal year 2024, no federal income tax expense was recorded. State income tax expense of approximately $1,900 was recorded reflecting the minimum required tax due. For the three months ended September 30, 2022, the utilization of net operating loss carryforwards significantly reduced the taxable income generated by the net licensing proceeds and income tax expense of $598,000, consisting of federal and state tax provisions of $449,000 and $149,000, respectively, was recorded. The effective tax rate was less than 1% in the three months ended September 30, 2023 and 5.7% in the three months ended September 30, 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, 2023. The Company’s remaining expected federal tax loss carryforward is expected to approximate $32,100,000 by the end of the fiscal year. The taxable loss for the quarter increased the net operating loss carryforward deferred tax asset to approximately $8,300,000 as of September 30, 2023, and the future realization of this continues to be uncertain. The valuation allowance was also increased to fully offset the net 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 tax loss occurred. As previously mentioned, 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 16 Table of Contents 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, the Company may owe all or a portion of any future proceeds arising from the enforcement program to third parties. The Company believes that its financial position remains strong. The Company had $2.0 million of cash and cash equivalents, $17.2 million of short-term investments and available credit facilities of $5.0 million on September 30, 2023. Recent Events Recent and ongoing macroeconomic and geopolitical conditions have impacted, and will continue to impact, our business. These include, the inflationary cost environment, reduced consumer confidence, disruption in our supply chain and trade tensions with China, the ongoing crisis in Eastern Europe, the crises in the Mideast, the possibility of a government shutdown in the U.S. and increased risk of cyberattacks. While the impact of these factors on our fiscal 2024 performance remains uncertain, we will continue to evaluate the extent to which these factors will impact our business, financial condition, or results of operations. These and other uncertainties with respect to these recent events could result in changes to our current expectations. Inflationary Cost Environment and Reduced Consumer Confidence - The Company continues to experience inflationary cost increases in our commodities, packaging materials, wages and higher energy and transportation costs, potentially impacting our ability to meet customer demand. These increases have been partially mitigated by pricing actions implemented in the third quarter of the prior fiscal year, as well as working with a dedicated freight forwarding partner to minimize freight rate increases. Inflation may impact customer demand for our products resulting from a slowdown in consumer spending as disposable income decreases due to rising interest rates, the price of essential items and dwindling savings. Other risk factors further exacerbated by inflation include supply chain disruptions, rising oil and energy costs, risks of international operations and the recruitment and retention of talent. Supply Chain Disruption and Trade Tensions with China - The Company relies on our third-party supply chain and distribution networks and the availability of necessary components to produce a significant number of our products. A reduction or interruption in supply, including interruptions due to a reoccurrence of the COVID-19 pandemic, geopolitical unrest, labor shortages or strikes, or a failure to procure adequate components, may lead to delays in manufacturing or increases in costs. The Company uses contract manufacturing facilities in the People’s Republic of China and Taiwan to produce a significant amount of our products. There has been increasing geopolitical tension between China and Taiwan that may affect future shipments from Taiwan and China-based suppliers. Any other adverse changes in the social, political, regulatory or economic conditions in the countries could materially increase the cost of the products we buy or delay shipments. There has also been increasing geopolitical tension between China and the United States. Sustained uncertainty about, or worsening of, economic relations and further escalation of trade tensions between the United States and China, or any other country in which the Company conducts business, could result in retaliatory trade restrictions that restrict our ability to source products from China or continue business in such other country. Any alterations to our business strategy or operations made in order to adapt to or comply with any such changes would be time-consuming and expensive, and the Company may not be able to pass along most increases in tariffs and freight charges to the Company’s customers, which would also directly affect profits. Our dependence on foreign suppliers for our products necessitates ordering products further in advance than we would if manufactured domestically, thus increasing investments in inventory. Delays in receiving and shipping products due to interruptions in its supply chain would pose a risk of lower sales to the Company and the potential for price volatility, negatively impacting profits. Recovery of a single facility through replacement of a supplier in the event of a disaster or suspension of supply could take an estimated six to twelve months. On July 25, 2023, United Parcel Service (UPS) and the International Brotherhood of Teamsters Union reached a tentative five-year contract deal that averted a nationwide strike. 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, there has been movement by some of the leading railroad companies to grant paid sick leave with continued negotiations between union leaders and railroad executives of each of the remaining railroads. In addition, Yellow freight lines recently announced their insolvency, however, the Company had no material direct exposure to Yellow in the current fiscal year. The Company continues to monitor these situations as the changes in the current labor landscape, the settlement of recent labor disputes, coupled with rising energy prices, could potentially exacerbate disruptions in the supply chain, delay product shipments and increase transportation costs. Russia’s Invasion of Ukraine - Financial and credit markets around the world experienced volatility following the invasion of Ukraine by Russia in February 2022. In response to the invasion, the United States, United Kingdom, and European Union, along with others, 17 Table of Contents imposed significant sanctions and export controls against Russia, Russian banks and certain Russian individuals and may implement additional sanctions or take further punitive actions in the future. In accordance with Executive Order 14071 signed on April 6, 2022, the Company suspended sales to Russia. Also, as a result of the humanitarian crisis in Ukraine created by the war and the population seeking refuge in other countries, sales to Ukraine have been impacted. During the three months ended September 30, 2023 and 2022, there were no sales to Russia. Cyberattacks - Cyberattacks are a growing geopolitical risk, becoming larger, more frequent, more intricate and more relentless. They are a significant threat to individual organizations and national security . We rely on accounting, financial, and operational management information systems to conduct our operations. Any disruption in these systems could adversely affect our ability to conduct our business. Furthermore, as part of our normal business activities, we collect and store common confidential information about customers, employees, vendors, and suppliers. This information is entitled to protection under a number of regulatory regimes. Any failure to maintain the security of the data, including the penetration of our network security and the misappropriation of confidential and personal information, could result in business disruption, damage to our reputation, financial obligations to third parties, fines, penalties, regulatory proceedings and private litigation with potentially large costs, and also result in deterioration in customers confidence in us and other competitive disadvantages, and thus could have a material adverse impact on our financial condition and results of operations . While we devote resources to security measures to protect our systems and data, these measures cannot provide absolute security and the insurance coverage we maintain may be inadequate to cover claims, costs, and liabilities relating to cybersecurity incidents. Liquidity and Capital Resources Cash Flows The following table summarizes cash flows from operating, investing and financing activities for the three months ended September 30, 2023 and 2022: Total cash (used in) provided by: 2023 2022 Operating activities $ (713,247) $ 11,692,114 Investing activities (393,536) (99,767) Financing activities — 70,440 Net (decrease) increase in cash and cash equivalents $ (1,106,783) $ 11,662,787 Operating Activities The cash used in operating activities during the three-month period ending September 30, 2023, was primarily payment of bonuses earned in the prior year, renewal of the annual general insurance policies and state income tax payments. The Company’s strict management of its inventory investment helped to retain cash in the first quarter. During the three months ended September 30, 2022, the majority of the cash provided by operating activities resulted from the licensing proceeds received, partially offset by the payment of related legal fees and expenses. The reduction in the Company’s investment in inventory also contributed to the cash provided by operating activities during that period. Investing Activities Cash used by investing activities for the three months ended September 30, 2023 was related to fixed asset expenditures, predominantly the replacement of a roof section of the building for approximately $300,000. The Company also paid the premiums on the company-owned life insurance policies on two of its executives. This is consistent with the investing activities for the three months ended September 30, 2022. During the first quarter of the current fiscal year, proceeds of $2,000,000 from the maturity of U.S. Treasury securities were received and were fully utilized to purchase another similar security. The Company believes that its available cash and its credit facility is sufficient to fund any necessary tooling, leasehold improvement and capital expenditures. Financing Activities As there were no stock option exercises during the first quarter of the current fiscal year, there was no impact on cash due to financing activities. In the same quarter in the prior year, cash provided by financing activities was due entirely to stock option exercises. 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 and the cash provided from these stock option exercises was approximately $70,000. As of September 30, 2023, the Company had no outstanding borrowings on its bank line of credit facility. 18 Table of Contents There were no purchases of common stock in the three months ended September 30, 2023 or September 30, 2022 under the stock repurchase program. Liquidity The Company believes its existing cash and cash equivalents, investments in short-term U.S. Treasury securities, cash provided by operating activities and borrowings under its credit facility, if any, will be sufficient to meet its anticipated working capital, and capital expenditure requirements during the next twelve months. There can be no assurance, however, that the Company’s business will continue to generate cash flow at current levels. If the Company is unable to generate sufficient cash flow from operations, then it may be required to sell assets, reduce capital expenditures, or draw on its credit facilities. 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 for 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 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. The Credit Agreement contains certain affirmative and negative covenants customary for financings of this type. 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, 2023, the Company was in compliance with all covenants related to the Credit Agreement. As of September 30, 2023 and June 30, 2023, there were no outstanding borrowings on the facility. Contractual Obligation The Company leases its 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 and includes current stockholders of the Company . 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 September 30, 2023, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. ‎ 19 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.