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 nine months ended March 31, 2025 and 2024: Three Months Ended Nine Months Ended March 31 March 31 Financial Performance Summary 2025 2024 2025 2024 Net sales $ 2,781,006 $ 2,637,606 $ 9,539,960 $ 9,371,668 Net sales increase (decrease) % from prior year period 5.4% (22.0)% 1.8% (6.5)% Gross profit $ 1,084,672 $ 841,523 $ 3,662,555 $ 3,017,653 Gross profit as % of net sales 39.0% 31.9% 38.4% 32.2% Selling, general and administrative expenses $ 1,603,678 $ 1,451,247 $ 4,960,478 $ 4,572,049 Selling, general and administrative expenses as % of net sales 57.7% 55.0% 52.0% 48.8% Interest income $ 208,175 $ 214,814 $ 667,219 $ 636,482 Loss before income tax provision (benefit) $ (310,831) $ (394,910) $ (630,704) $ (917,914) Loss before income tax provision (benefit) as % of net sales (11.2)% (15.0)% (6.6)% (9.8)% Income tax provision (benefit) $ 5,911 $ (81,130) $ 11,431 $ (77,372) Income tax provision (benefit) as % of loss before income tax provision (benefit) (1.9)% 20.5% (1.8)% 8.4% ‎ 13 Table of Contents Fiscal 2025 Period Results Compared with Fiscal 2024 Period (comments refer to the three and nine-month periods ended March 31, 2025 unless otherwise noted) Net sales for the three months ended March 31, 2025 were $2,781,000 compared to $2,638,000 for the same three-month period in the prior year, an increase of $143,000, or 5.4%. Increased sales to a certain segment of our domestic distributors, along with recurring orders from two of our custom OEM customers, were partially offset by lower sales from the other domestic distributors. Sales of $9,540,000 for the nine months ended March 31, 2025 were ahead by $168,000, or 1.8%, compared to sales of $9,372,000 for the nine months ended March 31, 2024. Higher sales to our European and Asian distributors, along with a custom headphone order to a new customer and a year-over-year increase in direct-to-consumer (“DTC”) sales were mostly offset by lower sales in the other market segments. Sales to the export markets were $612,000 for the three months ended March 31, 2025, a slight increase of $30,000, or 5.1%, over sales of $582,000 for the same period in the prior year behind higher sales to our Asian distributors. A decrease in sales to our European distributors offset most of that favorability and was due mainly to timing of expected reorders being pushed back to the fourth quarter of the fiscal year. Export sales for the nine months ended March 31, 2025 were $3,022,000, a $976,000, or 47.7%, increase over sales of $2,045,000 for the same period in the prior year. Sales to European distributors were up 41% over the prior year, due to the continued success of new product sales as well as overall inventory restocking. Sales to the Asian markets were up $182,000, or 67.0%, compared to last year driven by sales of headphones used in metal detecting units. There were no sales to our Russian distributor during the current fiscal year, nor have there been any since April 2022. For the three months ended March 31, 2025, sales to the domestic markets increased by $114,000, or 5.5%, as compared to the same period in the prior year. Sales of custom therapeutic listening headphones to one OEM customer and custom elements to another OEM customer were the biggest driver, while increased sales to a particular domestic distributor segment and DTC sales were offset by declines in other domestic distributor sales and sales to e-tailers. Sales for the nine months ended March 31, 2025 were $6,518,000, down $808,000, or 11.0%, compared to $7,326,000 for the nine months ended March 31,2024. A 57% decline in sales to the education markets, mainly due to timing, along with lower sales to domestic distributors, the music and books sector and e-tailers, was slightly offset by a 16.2% increase in DTC sales and a $262,000 custom headphones order. As a percentage of net sales for the three months ended March 31, 2025, gross margin was 39.0%, which compares favorably to a gross margin of 31.9% for the same three months in the prior year, an increase of 710 basis points. Margin improvement for the third quarter of the current fiscal year was largely due to the adverse impact in the prior year of the sell-through of inventory investment made while freight costs were higher. Margins were positively impacted in the three months ended March 31, 2025 due to a decrease in the reserve for excess and obsolete inventory compared to the same period in the prior year. A more favorable customer mix also contributed to the improved margins. For the nine months ended March 31, 2025, the gross margin was 38.4%, an increase of 620 basis points over the gross margin of 32.2% for the same nine-month period in the prior year. In the prior year, the adverse impact related to the sell-through of inventory brought in at higher freight costs drove the improvement in margins for the first nine months of the current year. The write-off of some obsolete inventory partially offset those gains. Despite a slowdown in the increase in freight rates, due to increased competition, post-Lunar New Year demand lull and capacity growth, shipment costs remain elevated and are expected to increase in the next quarter due to disruptions in key shipping routes, capacity issues, market volatility and general rate increases. Transit times decreased over the last quarter. The Company will sign a new contract with its dedicated freight forwarder in May but does not expect significant changes regarding freight costs or available services. With the recent tariff announcements, the Company expects to pay significantly more in duties going forward for product manufactured in China. Given the volatility of the tariff landscape and the substantial amount of product coming from China, the Company continues to closely monitor the latest updates and their impact on operations, planning efforts and financial conditions. Selling, general and administrative expenses of $1,604,000 for the three months ended March 31, 2025 increased $152,000, or 10.5%, from $1,451,000 for the same three-month period in the prior year. The increase was due mainly to new product certification and compliance testing, along with higher online advertising spend. For the nine months ended March 31, 2025, selling, general and administrative expenses of $4,960,000 were higher by $388,000, or 8.5%, compared to $4,572,000 for the nine months ended March 31, 2024. Increased spend related to certification, compliance and online advertising was also the primary driver of the year over year nine-month period overall increase, coupled with expenditures related to contract resources utilized to modify existing NetSuite functionality to incorporate necessary security and user rights. The reduction in stock-based compensation expense during the current year partially offset the increases as the remaining unvested stock options granted as part of the Koss Corporation 2012 Omnibus Incentive Plan (the “2012 Plan”) are nearly fully vested. An immaterial federal income tax expense was booked during the three and nine months ended March 31, 2025 due to the amendment of the 2022 fiscal year tax return as a result of adjustments for employer payroll taxes inappropriately paid in that year related to the gains from the disqualifying dispositions of incentive stock options. No federal income tax expense was recorded for the same periods 14 Table of Contents in the prior year, however, as a result of the Return-to-Provision (RTP) adjustment recorded during the third quarter of fiscal year 2024, a federal income tax benefit of $82,652 was recorded for both the three and nine months ended March 31, 2024. State income tax expense of $5,203 and $1,522 was recorded for the three months ended March 31, 2025 and 2024, respectively, and $10,724 and $5,281 was recorded for the nine months ended March 31, 2025 and 2024, respectively, reflecting the minimum required state tax due. The effective tax rate for the three and nine months ended March 31, 2025 was 1.9% and 1.8%, respectively. For the three and nine months ended March 31, 2024, the effective tax rate was 20.5% and 8.4%, respectively. It is anticipated that the effective rate in future years will continue to be reduced by utilization of a portion or all of the available federal and state net operating loss (NOL) carryforwards that existed as of June 30, 2024. The Company’s remaining expected federal tax loss carryforward approximates $33,600,000 at the end of the third quarter. The taxable loss for the initial nine months of the fiscal year increased the deferred tax asset by approximately $190,000, leading to a deferred tax asset related to the Company's net operating loss carry forwards of roughly $8,600,000 as of March 31, 2025. 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 $2.9 million of cash and cash equivalents, $10.1 million of short-term investments and available credit facilities of $5.0 million on March 31, 2025. 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, recently enacted tariffs and the global trade war, elevated inflation and interest rates, reduced consumer confidence, disruption in our supply chain, the ongoing crises in Eastern Europe and 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. Tariffs - As of April 2025, U.S. tariff policy has undergone significant changes under President Donald Trump's administration, leading to heightened global trade tensions and economic repercussions. The tariff announcements have significantly increased the Company's expected duty costs for products manufactured in China to as high as 145%. The new tariffs are also expected to increase inflation in the short term, which could result in a decline in consumer sentiment. The Company continues to monitor the volatile tariff landscape to assess its impact on operations, planning, and financial conditions. Inflationary Cost Environment and the Impact on Consumer Confidence – In addition to the expected inflation as a result of the newly imposed tariffs , higher interest rates and higher energy costs continue. A pervasive sense of uncertainty is evident, and consumer sentiment is waning. Consumers may put off making purchase decisions and cut back on overall spending, which could impact the Company’s sales volumes. As noted, the Company will experience higher costs for commodities and packaging materials due to the recently enacted tariffs 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 faces significant risks due to reliance on third-party supply chains, primarily in southern China and Taiwan, distribution networks and the availability of necessary components to produce a considerable number of our products . Issues such as pandemic restrictions, geopolitical unrest, labor shortages, strikes, and component procurement failures could delay manufacturing and increase costs. The escalating U.S.-China tariff war has severely disrupted supply chains, impacting both domestic industries and global trade dynamics. Continued geopolitical tensions between China and Taiwan may affect future shipments from Taiwan-based suppliers. Adverse changes in social, political, regulatory, or economic conditions could increase product costs or delay shipments. The escalation of trade tensions might lead to retaliatory trade restrictions, potentially 15 Table of Contents affecting the Company's ability to source products from China or conduct business internationally. 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, with limited ability to pass increased tariffs and freight costs onto customers. Broad tariffs may shift supply chains out of China, which could cause inflation to rise, impacting costs and consumer demand. The Company will continue to monitor the evolving situation and others that may arise as the changes in the current labor landscape, coupled with rising inflation and 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, imposed significant sanctions and export controls against Russia, Russian banks and certain Russian individuals and these sanctions remain unchanged. 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 continues to receive orders from their Ukrainian distributor in the first half of both fiscal years 2025 and 2024 with potential for more in the current year. During the three and nine months ended March 31, 2025 and 2024, 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 nine months ended March 31, 2025 and 2024: Total cash (used in) provided by: 2025 2024 Operating activities $ 319,989 $ (16,558) Investing activities (374,623) (197,625) Financing activities 152,445 35,800 Net increase (decrease) in cash and cash equivalents $ 97,811 $ (178,383) Operating Activities The cash provided by operating activities during the nine months ending March 31, 2025 was mainly driven by customer deposits of approximately $334,000 for orders that will ship in the next quarter. Cash used in operating activities during the nine months ended March 31, 2024 was primarily a result of the payment of bonuses earned in the year previous. Cash provided by improvements in cash flow related to working capital, namely the reduction of inventory levels, offset the majority of outflow. Investing Activities Cash used by investing activities for the nine months ended March 31, 2025 was related mostly to fixed asset expenditures, namely the replacement of a second roof section of the Company’s facility for approximately $346,000 and other leasehold improvements. Payments of approximately $70,000 were also made for the premiums on the Company-owned life insurance policies on two of its executives. Proceeds of $9,179,000 received during the nine months ended March 31, 2025 from the maturity of U.S. Treasury securities were mostly reinvested to purchase $9,059,000 of similar securities at a net discount of $60,000. Cash used by investing activities for the nine months ended March 31, 2024 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 $82,000 in premiums on the Company-owned life insurance policies on two of its executives. Proceeds of $14,331,000 from the maturity of U.S. Treasury securities were received and utilized to purchase $14,286,000 of similar securities at a $300,000 discount. Financing Activities Cash from the exercise of stock options during the nine months ended March 31, 2025 and 2024 provided the only cash from financing activities. An aggregate of 76,000 and 20,000 shares of common stock, respectively, were issued as a result of employee stock option exercises under grants still outstanding from the Company’s 2012 Omnibus Incentive Plan for those periods. As of March 31, 2025 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 nine months ended March 31, 2025 or 2024 under the Company’s 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 available 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 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 17 Table of Contents 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 March 31, 2025, the Company was in compliance with all covenants related to the Credit Agreement. As of March 31, 2025 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 March 31, 2025, 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.