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, 2025 as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on August 29, 2025, 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, 2025, 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, 2025 and 2024: Three Months Ended Six Months Ended December 31 December 31 Financial Performance Summary 2025 2024 2025 2024 Net sales $ 2,861,379 $ 3,557,086 $ 6,932,157 $ 6,758,954 Net sales increase (decrease) % from prior year period (19.6)% 5.9% 2.6% 0.4% Gross profit $ 830,806 $ 1,404,957 $ 2,459,498 $ 2,577,883 Gross profit as % of net sales 29.0% 39.5% 35.5% 38.1% Selling, general and administrative expenses $ 1,845,384 $ 1,546,741 $ 3,520,116 $ 3,356,800 Selling, general and administrative expenses as % of net sales 64.5% 43.5% 50.8% 49.7% Interest income $ 202,484 $ 238,686 $ 495,612 $ 459,044 Other income $ 250,000 $ — $ 250,000 $ — Interest expense $ (553) $ — $ (1,152) $ — Income (loss) before income tax provision $ (562,647) $ 96,902 $ (316,158) $ (319,873) Income (loss) before income tax provision as % of net sales (19.7)% 2.7% (4.6)% (4.7)% Income tax provision $ 2,760 $ 2,760 $ 5,520 $ 5,520 Income tax provision as % of income (loss) before income tax provision (0.5)% 2.8% (1.7)% (1.7)% ‎ 16 Table of Contents Fiscal 2026 Period Results Compared with Fiscal 2025 Period (comments refer to the three and six-month periods ended December 31, 2025 and 2024 unless otherwise noted) Net sales for the three months ended December 31, 2025 totaled $2,861,000, a decrease of $696,000, or 19.6%, compared to $3,557,000 for the three months ended December 31, 2024. The decrease was almost entirely due to new product sales to the European market in the second three months of the prior year, which did not repeat at the same level in the current period. Gains in sales to certain of the Company’s domestic distributors and a slight increase in direct-to-consumer (DTC) sales slightly offset the declines. For the six months ended December 31, 2025, sales of $6,932,000 were $173,000, or 2.6%, ahead of the same period in the prior year as a result of a considerable sale of custom headphones to a customer in the Education segment, offset by deficits in sales to European distributors. Export sales of $612,000 for the three months ended December 31, 2025 were $763,000, or 55.5%, behind sales of $1,375,000 for the second quarter of the prior fiscal year. Sales to our largest distributors in central and northern Europe were down 69.0%, largely as a result of higher, continued restock shipments during the three months ended December 31, 2024 of the new products launched in the first quarter of that year. For the first half of fiscal year 2026, export sales were $1,361,000 compared to $2,410,000 for the same period in the prior year, a decrease of $1,049,000, or 43.5%. Significant new product sales in the prior year were the primary driver of lower current year sales. Strong sales to our Asian distributors, an increase of 115% compared to the prior year, helped to offset some of the decline. Sales to the domestic markets of $2,249,000 for the three months ended December 31, 2025 reflect a $68,000, or 3.1%, increase over sales of $2,181,000 in the three months ended December 31, 2024. Following a slowdown in orders, clear color headphone sales rose by nearly 31% as major domestic distributors restocked their inventory to meet shifting customer demand. A 5.3% rise in DTC sales versus the prior three-month period helped boost domestic sales growth, but a one-time custom sale made in the three months ended December 31, 2024 offset the majority of the total sales uplift. For the six months ended December 31, 2025, domestic market sales grew to $5,571,000 from $4,349,000 for the same six-month period in fiscal year 2025, a $1,222,000, or 28.1% increase. The sizable custom headphone sale in the Education market during the first quarter was the main driver for the overall sales improvement in the current fiscal year. Gross profit as a percentage of net sales for the three months ended December 31, 2025 was 29.0% against a gross profit percentage of 39.5% for the comparable period in the prior year, a decrease of 10.5%. For the six months ended December 31, 2025, gross margins were 35.5% versus 38.1% for the same six-month period in the prior year. The current year’s erosion in margins is predominantly a result of the impact of tariffs on inventory that was sold throughout the second quarter and entire first half of fiscal 2026, some of which was tariffed at 145%. A favorable customer mix, including higher sales of higher margin domestic distributor and DTC sales, offset some of the adverse impact of the tariffs. Freight costs increased modestly during the second quarter of fiscal 2026 as planned peak season surcharges came into effect. Despite this, overall rates remained low due to ample capacity and soft overall demand. Shipment costs are expected to decline slightly in the third quarter as the peak season surcharges fall off. The Company continues its relationship with a dedicated freight forwarder but will be ceasing its relationship with the bonded warehouse as tariff rates have stabilized at 20%. The inventory at the bonded warehouse will be strategically withdrawn as needed to fulfill orders throughout the remainder of fiscal year 2026. The Company is prepared for the additional unloading, storage and loading costs at the facility in exchange for deferred payments to the Custom Border Patrol for stored product until needed. Ongoing monitoring of developments will help the Company adapt and maintain product availability . Tariff policies have fluctuated over the last twelve months, particularly with respect to trade policies and tariffs applied to trade between China and the U.S. The Company is currently subject to certain tariff rates on products manufactured in China that are now lower than those previously imposed and should remain stable until November 2026, but future changes in trade policy could result in significantly higher duties. Federal courts have ruled that the broad tariffs imposed under the International Emergency Economic Powers Act (IEEPA) are illegal and exceeded the President’s statutory authority. The Supreme Court heard oral arguments on November 5, 2025 to consider the IEEPA tariffs in the consolidated case of Learning Resources v. Trump, and other companies have joined in the IEEPA tariff dispute. As of mid-January 2026, the U.S. Supreme Cout had not yet issued a decision. If the Supreme Court ultimately rules that the IEEPA tariffs were illegally imposed, importers could seek reliquidation and refunds, though the administration could turn to other statutes to support tariffs. 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 totaled $1,845,000 for the three months ended December 31, 2025, an increase of $298,000, or 19.3%, in comparison to $1,547,000 for the same period in the prior year. For the six months ended December 31, 2025, selling, general and administrative expenses were $3,520,000, an increase of $163,000, or 4.9%, versus $3,357,000 for the six-month period ended December 31, 2024. The increases for both the three- and six- month periods are due mostly to the $250,000 in legal fees and expenses incurred as a result of litigation related to patent defense that was resolved during the second quarter of fiscal year 2026. An increase in the deferred compensation expense year over year, due to declining interest rates used to calculate the related liability 17 Table of Contents and an increase in the annual payments under the plan given an additional year of service was completed, was mostly offset by a decline in other legal and professional fees unrelated to patent litigation. Other income for the three and six months ended December 31, 2025 consisted entirely of $250,000 in non-recurring licensing proceeds. There was no other income recorded for the three and six months ended December 31, 2024. State tax expense of $2,760 was recorded for each of the three months ended December 31, 2025 and 2024 and $5,520 was recorded for each of the six months ended December 31, 2025 and 2024, reflecting the minimum required state tax due. No federal income tax was recorded during the first half of fiscal year 2026 due to net operating loss (NOL) carryforwards available to offset most taxable income. The effective tax rate for the three and six months ended December 31, 2025 was less than 1% and 1.7%, respectively. The effective tax rate for the three and six months ended December 31, 2024 was 2.8% and 1.7%, 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 NOL carryforwards that existed as of June 30, 2025. The Company’s remaining expected federal tax loss carryforward approximates $34,760,000 at the end of the second quarter of fiscal year 2026, resulting in a deferred tax asset related to the Company's federal and state net operating loss carry forwards of roughly $8,877,000 as of December 31, 2025. The valuation allowance was adjusted accordingly to fully offset the net deferred tax asset as there is not sufficient positive evidence to support a reduction in 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, $13.0 million of short-term investments and available credit facilities of $5.0 million on December 31, 2025. The Company also had $4.0 million of long-term investments in U.S. treasury debt securities on December 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 tariff volatility and global trade tensions, persistent inflation pressures, a softening job market and rising long-term unemployment, still elevated borrowing costs, even after three quarter-point interest rate cuts in the first half of the Company’s fiscal year, steadily declining consumer confidence, disruption in our supply chain, the conflict in Eastern Europe and instability in the Middle East and increased risk of cyberattacks. While the impact of these factors on our fiscal 2026 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. Government Shutdown - The federal government shutdown on October 1, 2025 , when new appropriations or a continuing resolution failed to be passed. A continuing resolution was signed on November 12, 2025 to reopen the government with an agreement to provide temporary funding for most agencies through January 30, 2026. The economic impact was generally modest with expectations for growth recovery, however, there are lingering impacts such as lack of timely critical economic data making gauging inflation and labor trends difficult, a backlog of small business loans, delays in federal licenses and SEC approvals, and supply chain disruptions in certain sectors such as aerospace and defense. Since the current funding agreement is only temporary, there is some renewed uncertainty as the deadline approaches. The Company does provide product to the federal government and fulfillment of these orders was delayed as a direct result of the shutdown. Tariffs - In April 2025, the U.S. government imposed tariffs of up to 145% in certain imports from China, which significantly increased the Company’s expected duty cost for goods sourced from China. Since then, President Trump and his administration have implemented several temporary pauses to allow for trade negotiations. In May 2025, a 90-day tariff truce between the U.S. and China reduced reciprocal tariffs down to 10%, however, an additional 20% fentanyl-related tariff remained, resulting in a total 30% tariff on many Chinese goods. In August 2025, President Trump signed an executive order extending the tariff pause for another 90 days, with the suspension of additional reciprocal tariffs on Chinese goods remaining in effect until November 10, 2025 while trade negotiations continue. On November 10, 2025, the fentanyl-related tariffs were reduced by half to 10% following an Executive Order by President Trump, the existing 10% reciprocal tariff rate remained in place and tariff exclusions were extended to November 2026. The Company 18 Table of Contents continues to monitor the volatile tariff landscape to assess its impact on inflation and consumer sentiment which could impact 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 , sustained elevated interest rates and volatile energy costs continue. While the Federal Reserve cut its benchmark federal funds rate by 0.75 percentage points via three separate cuts since June 30, 2025, consumer confidence continued to decline steadily due to concerns over high prices, tariffs and a softening labor market. Consumers may still 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 in the coming quarter and 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 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 – The United States and global markets continue to experience volatility and disruption resulting from the ongoing conflict between Russia and Ukraine, which began following the invasion of Ukraine by Russia in February 2022. The significant sanctions and export controls imposed against Russia, certain Russian banks and Russian individuals by the U.S. and other countries remain unchanged. The Company suspended all sales to Russia in April 2022 in accordance with Executive Order 14071 and no sales were made to Russia since that time. 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 a Ukrainian distributor. During the three and six months ended December 31, 2024, there were nearly $39,000 in sales to this distributor. There were no sales to the Ukrainian distributor in the six months of fiscal year 2026, however, an order for approximately $30,000 was received and will ship out in the coming quarter. 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. Given connectivity through the internet, the Company can only be as strong as its weakest link, whether that is a financial service provider, third party distributor, reseller, transportation service provider, contract manufacturer, customer or consumer. ‎ 19 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, 2025 and 2024: Total cash (used in) provided by: 2025 2024 Operating activities $ 1,823 $ (50,419) Investing activities (361,092) (403,380) Financing activities 16,310 152,445 Net decrease in cash and cash equivalents $ (342,959) $ (301,354) Operating Activities The cash provided by operating activities during the six months ending December 31, 2025 was due to the $512,000 IRS refund received in the first quarter relating to employer payroll taxes incorrectly paid in prior years on the gains from the disqualifying dispositions of incentive stock options. This cash inflow was mostly offset by payments to the Custom Border Patrol for tariffs on inventory purchased from China and payment of the Company’s annual insurance premiums, which is made in advance at the beginning of the fiscal year and recorded in expense over the next twelve months. 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. Investing Activities Cash used by investing activities for the six months ended December 31, 2025 was due mostly to replacement of the third roof section of the building at $269,000, a sprinkler system valve replacement and various new product tooling purchases. The Company also paid premiums of $51,000 on the company-owned life insurance policies on two of its executives. Total proceeds of $3,000,000 were received during the first half of fiscal year 2026 from the redemption of U.S. Treasury securities and $2,998,000 of new U.S. Treasury securities were purchased at a net discount of $1,000 during that same period. 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 $346,000, and the payment of $71,000 in 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. Financing Activities Cash from the exercise of stock options during the six-month period ended December 31, 2025 provided the majority of the cash from financing activities. Principal payments on a finance lease for a new reach truck leased for the warehouse at the beginning of the year slightly offset cash provided. A total of 10,000 shares of common stock were issued as a result of employee stock option exercises under grants that were still outstanding from the Company’s 2012 Omnibus Incentive Plan. For the six months ended December 31, 2024, an aggregate of 76,000 shares of common stock were issued as a result of employee stock option exercises under grants outstanding from the Company’s 2012 Omnibus Incentive Plan. As of December 31, 2025 and June 30, 2025, the Company had no outstanding borrowings on its bank line of credit facility. There were no purchases of common stock in the six months ended December 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. 20 Table of Contents 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 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, 2025, the Company was in compliance with all covenants related to the Credit Agreement. As of December 31, 2025 and June 30, 2025, 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, 2025. Off-Balance Sheet Transactions At December 31, 2025, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. ‎ 21 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.