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, 2024 as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on August 30, 2024, 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, 2024, 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 and six months ended December 31, 2024 and 2023: Three Months Ended Six Months Ended December 31 December 31 Financial Performance Summary 2024 2023 2024 2023 Net sales $ 3,557,086 $ 3,360,124 $ 6,758,954 $ 6,734,062 Net sales increase % from prior year period 5.9% 2.4% 0.4% 1.3% Gross profit $ 1,404,957 $ 1,108,440 $ 2,577,883 $ 2,176,130 Gross profit as % of net sales 39.5% 33.0% 38.1% 32.3% Selling, general and administrative expenses $ 1,546,741 $ 1,584,523 $ 3,356,800 $ 3,120,802 Selling, general and administrative expenses as % of net sales 43.5% 47.2% 49.7% 46.3% Interest income $ 238,686 $ 208,809 $ 459,044 $ 421,668 Income (loss) before income tax provision $ 96,902 $ (267,274) $ (319,873) $ (523,004) Income (loss) before income tax provision as % of net sales 2.7% (8.0)% (4.7)% (7.8)% Income tax provision $ 2,760 $ 1,879 $ 5,520 $ 3,758 Income tax provision as % of income (loss) before income tax provision 2.8% (0.7)% (1.7)% (0.7)% ‎ 13 Table of Contents Fiscal 2025 Period Results Compared with Fiscal 2024 Period (comments refer to the three and six-month periods ended December 31, 2024 unless otherwise noted) Net sales of $3,557,000 for the three months ended December 31, 2024 were $197,000, or 5.9%, ahead of sales for the same three-month period in the prior year. A significant increase in sales to certain of our European distributors, along with a sizable custom headphone order from a new customer, was partially offset by shortfalls in sales to customers in the education segment, domestic distributors and e-tailers. For the six months ended December 31, 2024, sales of $6,759,000 were just slightly ahead compared to $6,734,000 of sales for the first half of the prior fiscal year, driven by the same variances as sales to Europe and custom orders were offset by lower distribution, education and e-tailer sales. Sales to the export markets for the three months ended December 31, 2024 were $1,376,000 compared to $693,000 for the same period in the prior year due almost entirely to increased sales to two of our largest European distributors. New product sales to these European distributors exceeded our expectations, resulting in an over 90% increase in sales compared to the same period in the prior year. Export sales for the six months ended December 31, 2024 was $2,410,000, a $947,000, or 64.7%, increase over the same period in the prior year. Similar to the second quarter, sales to the two largest European distributors were 111% above the prior year, driven by the success of new product sales. Overall sales to Europe grew by $1,241,000, or 61%, while sales to our Asian and Canadian markets rose by $95,000, or 30.1%. There were no sales to our Russian distributor during the current fiscal year, nor have there been any since April 2022. Domestic market sales declined by $486,000, or 18.2%, year over year for the three-month period ended December 31, 2024. Sales to the largest customer in the company’s education segment were down by $338,000 and sales to a provider of therapeutic listening tools were down $110,000 compared to the prior year, both due to timing of repeat orders. A $262,000 custom headphones order and a near 20% increase in direct-to-consumer (DTC) sales helped to offset the decline. For the six months ended December 31, 2024, domestic sales were $4,349,000, down $922,000, or 17.5%, from sales of $5,271,000 for the first two quarters of the prior fiscal year. Lower sales to the education market segment, domestic distributors and e-tailers were only partially offset by an approximately 19% increase in DTC sales for the six months ended December 31, 2024 compared to the same period in the prior year. Gross profit as a percentage of net sales for the three months ended December 31, 2024 was 39.5%, compared to 33.0% for the three months ended December 31, 2023, an increase of 650 basis points. Margins for the second quarter of the prior year were negatively impacted by working through the inventory investment made while freight costs were higher, along with an increase in the reserve for excess and obsolete inventory. During the second quarter of the current fiscal year, inventory levels remained fairly constant, having little impact on margins as lower freight costs were capitalized into inventory. Significant new product sales to Europe at higher margins combined with a higher volume of higher margin DTC sales also contributed to the increased gross margins for the three months ending December 31, 2024. For the six months ended December 31, 2024, the gross margin was 38.1%, an increase of 580 basis points over the gross margin of 32.3% for the first half of the prior year. A more favorable customer mix of sales, including increased higher margin DTC sales, new product sales to our European distributors at higher margins and a higher volume of higher margin sales to certain domestic distributors, drove the higher gross margin in the first half of fiscal year 2025. This combined with the prior year’s adverse impact of the sell-through of inventory brought in at higher freight costs and resulted in the gap in margins year over year for the six months ended December 31, 2024. While shipment costs slightly increased during the six months ended December 31, 2024, the Company expects them to increase more in the coming quarters due to general rate increases received at the end of December and into January. Transit times increased as a result of labor disputes and other delays in the supply chain. The Company’s partnership with a dedicated freight forwarder continues to help stabilize contract rates to limit the impact. Selling, general and administrative expenses decreased only slightly year over year for the three months ended December 31, 2024, from $1,585,000 to $1,547,000, a decrease of $38,000, or 2.4%. Income generated by the decrease in the deferred compensation liability as a result of the increase in the discount rates used to calculate the liability was mostly offset by an increase in legal expense during the second quarter of the current fiscal year as the result of the Company’s continued patent defense litigation, along with higher online advertising spend related to the new product launch in fiscal year 2025. For the six months ended December 31, 2024, selling, general and administrative expenses of $3,357,000 were higher by $236,000, or 7.6%, compared to $3,121,000 for the six months ended December 31, 2023. Increases in online advertising spend and new product certification testing related to new product development and launches, coupled with an increase in legal expense were somewhat offset by the reduction in stock based compensation expense as the remaining unvested stock options granted as part of the Koss Corporation 2012 Omnibus Incentive Plan (the “2012 Plan”) are nearly fully vested. Also, an increase in the deferred compensation liability as of December 31, 2024, due mostly to the annual increase in the future payments earned under the arrangement due to an additional year of service completed, resulted in a corresponding increase to expense compared to the prior year. As a result of minimal or no taxable income after utilization of the Company’s available net operating loss carryforwards (“NOLs”), no federal income tax expense was recorded for any of the three and six-month periods ended December 31, 2024 and 2023. State income tax expense of $2,760 and $1,879 was recorded for the three months ended December 31, 2024 and 2023, respectively, and 14 Table of Contents $5,520 and $3,758 was recorded for the six months ended December 31, 2024 and 2023, respectively, reflecting the minimum required state tax due plus estimated tax due on negligible net taxable income after state NOL deductions. The effective tax rate was 2.8% and 1.7% in the three and six months ended December 31, 2024, respectively. The effective tax rate was less than 1% for the three and six months ended December 31, 2023. It is anticipated that the effective rate in the current year and future years will continue to be reduced by utilization of a portion or all of the available federal and state net operating loss carryforwards that existed as of June 30, 2024. The Company’s remaining expected federal tax loss carryforward approximates $32,900,000 at the end of the second quarter. The small taxable gain for the first quarter of fiscal year 2025 decreased the net operating loss carryforward deferred tax asset by approximately $3,000 and the taxable loss in the second quarter increased it by approximately $14,000, resulting in a deferred tax asset of approximately $8,500,000 as of December 31, 2024. The valuation allowance was adjusted accordingly 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 has occurred. 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. 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 $2.5 million of cash and cash equivalents, $7.2 million of short-term investments and available credit facilities of $5.0 million on December 31, 2024. Recent Trends Recent and ongoing macroeconomic and geopolitical conditions have impacted, and will continue to impact, our business. These include economic uncertainty from unexpected job growth, elevated inflation and interest rates, reduced consumer confidence, disruption in our supply chain and trade tensions with China, the ongoing crises in Eastern Europe, the continued conflict in the Middle East and increased risk of cyberattacks. While the impact of these factors on our fiscal 2025 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. Job Market and Inflationary Cost Environment and the Impact on Consumer Confidence - Inflation , higher interest rates and higher energy costs continue to impact consumers’ discretionary spending and, in turn, the Company’s sales volumes. The U.S. economy added 256,000 jobs in December 2024, surpassing expectations and marking the largest increase since March 2024. The data indicates that, although consumers feel more optimistic about the economy, the increase in confidence is not reflected in their intent to spend. Intent to spend, which measures whether consumers expect to spend on various products and services, held steady or decreased across most essential, discretionary, and semi-discretionary categories compared with last quarter, despite the holiday shopping season. The current consumer landscape presents a paradox in which rising optimism coexists with restrained spending. This trend highlights a collective shift toward financial prudence, reflecting a broader desire for economic security amid lingering uncertainties, though it could also reflect a shift among consumers toward more mindful consumption patterns. While inflation rates have consistently decreased over the last few months, the Company is still experiencing higher costs for commodities, packaging materials, and wages, along with higher energy and transportation costs. The Company continues to monitor costs and will react with pricing actions as it deems necessary. T he Company continues to work with a dedicated freight forwarding partner to minimize freight rate increases. Other risk factors further exacerbated by inflation include supply chain disruptions, increased 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, primarily in southern China, and distribution networks and the availability of necessary components to produce a considerable number of our products. A reduction or interruption in supply, including interruptions due to pandemic related restrictions, geopolitical unrest, labor shortages or strikes, or a failure to procure adequate components, may lead to delays in manufacturing or increases in costs. Many of the Company’s products are sourced from contract manufacturing facilities in the People’s Republic of China and Taiwan. There continues to be geopolitical tension between China and the United States, as well as geopolitical tension between China and Taiwan that may affect future shipments from Taiwan-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 from our foreign suppliers or delay shipments of products. Sustained uncertainty about, or worsening of, economic relations and further escalation of trade tensions 15 Table of Contents 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. President-elect Donald Trump intends to direct a good portion of his tariff escalation on products sourced from China. Broad tariffs on Chinese exports encourage shifting supply chains out of China to other global regions and the Americas, however, before the shift, tariffs could cause inflation to rise, potentially impacting the Company’s costs and consumer demand. The Company will continue to monitor the situation and others that may arise 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. A potential crisis at United States East and Gulf Coast ports has been averted as the International Longshoremen’s Association (the “ILA”) and the United States Maritime Alliance reached a tentative six-year labor agreement, preventing what would have been the second strike in four months. The agreement came just days before the January 15 deadline, when a temporary contract extension was set to expire. 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, 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. While there is a humanitarian crisis in Ukraine created by the war and the population continues to seek refuge in other countries, the Company did receive orders from their Ukrainian distributor in the first half of both fiscal year 2025 and 2024 with potential for more in the current year. During the three and six months ended December 31, 2024 and 2023, there were no sales to Russia. Cyberattacks - Cyberattacks are a growing geopolitical risk, becoming larger, more frequent, more sophisticated and more relentless as technology has evolved, resulting in privacy, security, and compliance concerns. They are a significant threat to individual organizations and national security. High-profile security breaches at other companies and in government agencies have increased in recent years, and security industry experts and government officials have warned about the risks of hackers and cyberattacks targeting businesses. 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 there is a risk that these types of attacks could impact the entire supply and distribution chain for the Company’s product line. In a world that runs on the internet, the Company can only be as strong as its weakest link, whether as a financial service provider, third party distributor, reseller, transportation service provider, contract manufacturer, customer or consumer. ‎ 16 Table of Contents Liquidity and Capital Resources Cash Flows The following table summarizes cash flows from operating, investing and financing activities for the six months ended December 31, 2024 and 2023: Total cash (used in) provided by: 2024 2023 Operating activities $ (50,419) $ (345,185) Investing activities (403,380) (257,423) Financing activities 152,445 35,800 Net decrease in cash and cash equivalents $ (301,354) $ (566,808) Operating Activities The cash used in operating activities during the six months ending December 31, 2024 was driven primarily by the net operating loss for the first half of the year, offset by improvements in working capital and the receipt of a partial refund of the employee and employer payroll taxes inappropriately withheld related to the gains from the disqualifying dispositions of incentive stock options. During the six months ended December 31, 2023, the cash used in operating activities was primarily the payment of bonuses earned in the prior year and general insurance premiums. Investing Activities Cash used by investing activities for the six months ended December 31, 2024 was related mostly to fixed asset expenditures, namely the replacement of a second roof section of the building for approximately $346,000, and the payment of the premiums on the company-owned life insurance policies on two of its executives. Proceeds of $7,085,000 received during the six months ended December 31, 2024 from the maturity of U.S. Treasury securities were mostly reinvested to purchase $7,059,000 of similar securities at a $61,000 discount. Cash used by investing activities for the six months ended December 31, 2023 was also related to fixed asset expenditures, predominantly the replacement of the first 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. Proceeds of $7,223,000 from the maturity of U.S. Treasury securities were received and utilized to purchase $7,177,000 of similar securities at a discount of $180,000. Financing Activities Cash from the exercise of stock options during the six months ended December 31, 2024 provided the only cash from financing activities. An aggregate of 76,000 shares of common stock were issued as a result of employee stock option exercises under grants still outstanding from the Company’s 2012 Omnibus Incentive Plan. Employee stock option exercises provided the only cash from financing activities during the six months ended December 31, 2023. An aggregate of 20,000 shares of common stock were issued as a result. As of December 31, 2024 and June 30, 2024, the Company had no outstanding borrowings on its bank line of credit facility. There were no purchases of common stock in the three and six months ended December 31, 2024 or 2023 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 17 Table of Contents to change the interest rate to Wall Street Journal Prime less 1.50%. An amendment to the Credit Agreement effective October 30, 2024, extended the maturity date to October 31, 2026, and removed one of the covenants requiring submission of annual financial performance projections to the Lender. 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 December 31, 2024, the Company was in compliance with all covenants related to the Credit Agreement. As of December 31, 2024 and June 30, 2024, 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. Critical Accounting Policies and Estimates There have been no significant changes in our critical accounting policies and estimates from the information we provided in our Annual Report on Form 10-K for the fiscal year ended June 30, 2024. Off-Balance Sheet Transactions At December 31, 2024, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. ‎ 18 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.