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 nine months ended March 31, 2026 and 2025: Three Months Ended Nine Months Ended March 31 March 31 Financial Performance Summary 2026 2025 2026 2025 Net sales $ 2,824,763 $ 2,781,006 $ 9,756,920 $ 9,539,960 Net sales increase % from prior year period 1.6% 5.4% 2.3% 1.8% Gross profit $ 1,002,761 $ 1,084,672 $ 3,462,259 $ 3,662,555 Gross profit as % of net sales 35.5% 39.0% 35.5% 38.4% Selling, general and administrative expenses $ 1,721,892 $ 1,603,678 $ 5,242,008 $ 4,960,478 Selling, general and administrative expenses as % of net sales 61.0% 57.7% 53.7% 52.0% Interest income $ 174,875 $ 208,175 $ 670,487 $ 667,219 Other income $ — $ — $ 250,000 $ — Interest expense $ (506) $ — $ (1,658) $ — Loss before income tax provision $ (544,762) $ (310,831) $ (860,920) $ (630,704) Loss before income tax provision as % of net sales (19.3)% (11.2)% (8.8)% (6.6)% Income tax provision $ 1,825 $ 5,911 $ 7,345 $ 11,431 Income tax provision as % of loss before income tax provision (0.3)% (1.9)% (0.9)% (1.8)% ‎ 18 Table of Contents Fiscal 2026 Period Results Compared with Fiscal 2025 Period (comments refer to the three- and nine-month periods ended March 31, 2026 and 2025 unless otherwise noted) Net sales for the three months ended March 31, 2026 were $2,825,000, a slight increase of $44,000, or 1.6%, compared to $2,781,000 for the three months ended March 31, 2025. The increase resulted from a 40% increase in domestic distributor orders, coupled with a 23% increase in direct-to-consumer (DTC) shipments, offset mostly by lower sales in our European and Asian markets. Sales of $9,757,000 for the nine months ended March 31, 2026 exceeded sales of $9,540,000 for the same period in the prior year by $217,000, or 2.3% due mainly to a significant sales of custom headphones to the Education segment plus a 16% increase in DTC sales, offset by a considerable decline in sales to our largest European distributors. Export sales of $381,000 for the three months ended March 31, 2026 were down $230,000, or 37.7%, compared to sales of $612,000 for the three months ended March 31, 2025. A near 70% reduction in sales to Asia versus the same prior year period and a 77% drop off in sales into Canada drove the decline. The Asia shortfall was a result of repeat orders that came earlier in the fiscal year, and our largest Canadian distributor that will not buy U.S. products at this time for political reasons. For the nine months ended March 31, 2026, export sales totaled $1,742,000, a marked decrease of $1,279,000, or 42.3%, against the nine-month period ended March 31, 2025. Sales to our largest distributors in central and northern Europe were down close to 60% largely as a result of delays in stock replenishment. Year-to-date sales to Asia, however, exceeded sales during the first nine months of the prior year by 19%, compensated for some of the decline. For the three months ended March 31, 2026, sales to the domestic markets totaled $2,444,000, representing an increase of $274,000, or 12.6%, compared to sales of $2,169,000 for the same period in the prior year. The higher sales figures reflect increased demand within the domestic distributor market and a continued effort to drive more DTC sales through marketing campaigns and other social media initiatives. Sales to the domestic markets during the nine months ended March 31, 2026 were $8,014,000, a rather significant year-over-year increase of $1,496,000, or 23.0%, as compared to sales of $6,518,000 for the nine months ended March 31, 2025. As noted above, a sizable order by a customer in the Education market boosted sales for the period, along with an approximately 50% increase in sales to a particular segment of the domestic distribution market driven by general inventory restocks and a continued demand for clear colored headphones. A 16% increase in DTC sales also contributed to the favorable sales, partially offset by two prior year custom orders that are expected to repeat in the fourth quarter potentially at a lower level . Gross profit as a percentage of net sales for the three months ended March 31, 2026 was 35.5% against a gross profit percentage of 39.0% for the comparable period in the prior year, a decrease of 350 basis points. For the nine months ended March 31, 2026, gross margins were 35.5%, a decrease of 290 basis points from the margin of 38.4% for the same nine-month period in the prior year. The adverse impact of significant International Emergency Economic Powers Act (IEEPA) and reciprocal tariffs, some as high as 145%, on inventory brought in and sold throughout the year, along with sales of inventory brought in at higher freight rates, were the main reasons for the margin erosion for both periods. A favorable mix of higher margin domestic distributor and DTC sales, coupled with sales of some obsolete and excess reserved inventory, helped to partially offset some of the negative impacts. During the third quarter of fiscal 2026, freight rates decreased. Peak season surcharges dropped off and a confluence of vessel overcapacity, weakened global demand, as well as the failure of the typical pre-Chinese New Year demand surge to materialize all contributed to lower shipping costs. The Company does, however, expect an increase in ocean rates during the fourth quarter due to another peak season surcharge that will come into effect. The Company continues its relationship with a dedicated freight forwarder and renewed the contract at the end of April. Given the elimination of IEEPA and reciprocal tariffs and anticipated lower rates in the future, the Company has decided to cease its relationship with the bonded warehouse. The inventory at the bonded warehouse will be completely withdrawn by the end of fiscal year 2026. Ongoing monitoring of supply chain and tariff developments will help the Company adapt and maintain product availability . Over the past nine months, U.S. tariff policy on China-produced goods has remained a significant factor affecting the Company’s cost structure and supply chain decisions. 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 fairly stable throughout the fiscal year. Future changes in trade policy, however, could result in significantly higher duties. On February 20, 2026, the federal courts ruled that the broad tariffs imposed under IEEPA were illegal and exceeded the President’s statutory authority. Soon after, President Trump invoked a 10% global tariff using Section 122 of the Trade Act of 1974. Also following the invalidation of the IEEPA and reciprocal tariffs, the Court of International Trade (CIT) ruled that the duties paid are unlawful and initiated a massive refund process. The Company may seek reliquidation and refunds via claims made in the Custom Border Patrol’s (CBP) new Consolidated Administration and Processing of Entries (CAPE) portal as soon as it is ready to begin accepting claims. While refunds are expected, they are not guaranteed and timing of the refund is currently expected to take 60-90 days. The government can appeal or cause delays, with full restitution potentially taking months or years. As such, the Company has not recorded any receivables related to the potential refunds amid the uncertainty. 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. 19 Table of Contents Selling, general, and administrative expenses of $1,722,000 for the three months ended March 31, 2026 increased $118,000, or 7.4%, in comparison to $1,604,000 for the same period in the prior year. The primary reasons for the increase were higher legal fees, increased commissions on larger sales turnover, and additional salary and a bonus accrual for a new headcount. For the nine months ended March 31, 2026, selling, general and administrative expenses were $5,242,000 versus $4,960,000 for the nine-month period ended March 31, 2025, an increase of $282,000, or 5.7%. The primary cause of the increase is $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 and directly offset by non-recurring licensing proceeds as noted below. A decrease in other legal fees was offset by higher sales commissions in addition to an increase in the deferred compensation expense year over year, as a result of both declining interest rates used to calculate the related liability and an increase in the annual payments under the plan given an additional year of service was completed. Other income for the nine months ended March 31, 2026 consisted entirely of $250,000 in non-recurring licensing proceeds. There was no other income recorded for the three months ended March 31, 2026 or the three- and nine-month periods ended March 31, 2025. State tax expense of $1,825 and $7,345 was recorded for the three and nine months ended March 31, 2026, respectively, and $5,204 and $10,724 for the three and nine months ended March 31, 2025, reflecting the minimum required state tax due. Aside from a $707 amount due and paid during the three months ended March 31, 2025 related to a prior-period tax return amendment, no federal income taxes were recorded during the first nine months of either fiscal year as a result of the net operating loss (NOL) carryforwards available to offset most taxable income. The effective tax rate for the three and nine months ended March 31, 2026 was less than 1%. The effective tax rate for the three and nine months ended March 31, 2025 was 1.9% and 1.8%, 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 approximated $35,290,000 at the end of the third quarter of fiscal year 2026. The current fiscal year to date adjustment to the net operating loss carryforward increased the deferred tax asset related to the Company’s federal and state net operating loss carry forwards to approximately $9,006,000 as of March 31, 2026. 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. In the third quarter of fiscal year 2026, the final lawsuit among a series of legal actions initiated by the Company since 2020 was dismissed. The Company is, however, appealing that decision. 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 $1.9 million of cash and cash equivalents, $16.9 million of short-term investments and available credit facilities of $5.0 million on March 31, 2026. 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, moderate, uneven growth in the labor market and steady unemployment, still elevated borrowing costs, continually declining consumer confidence, disruption in our supply chain, the conflict in Eastern Europe and instability and escalation 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. Tariffs - On February 20, 2026, in Learning Resources, Inc. v. Trump, the Supreme Court ruled that the IEEPA does not authorize the president to impose tariffs , declaring them unconstitutional and invalidating previous punitive tariffs on Chinese goods. Shortly after the ruling, President Trump announced a temporary 10% global tariff on imports under Section 122 of the Trade Act, which he has threatened to raise to 15%. These tariffs can be imposed for up to 150 days and are designed to address the U.S. trade deficit and related imbalances. As a result of the determination that IEEPA and reciprocal tariffs were unlawful, the Company is legally entitled and is expected to receive refunds of those tariffs. The Company continues to monitor the status of the claims process as it is currently under development and the refunds face significant legal and operational hurdles. These dynamics have contributed to variability in input costs and required the Company to actively manage supplier relationships, pricing strategies, and inventory planning. The 20 Table of Contents Company continues to monitor trade policy developments and evaluate mitigation strategies to assess the impact on inflation and consumer sentiment which, in turn, could impact operations, planning, and financial conditions. United States and Israel War with Iran – Escalating conflict between the United States and Iran poses material risks to global crude oil and refined fuel markets, as disruptions to Middle Eastern supply routes, including the Strait of Hormuz, could result in sharp and sustained increases in fuel prices and uncertainty in the financial markets. Our business operations and supply chain are exposed to such geopolitical volatility, and a prolonged conflict could compound inflationary pressures and dampen broader U.S. business activity in ways that may materially and adversely affect our financial condition and results of operations. Inflationary Cost Environment and the Impact on Consumer Confidence – Global inflation has been persistent despite earlier declines, particularly affecting input costs. While the Federal Reserve has initiated rate cuts during the fiscal year, elevated inflation from tariffs may restrict the ability to significantly lower interest rates, resulting in a higher-for-longer environment. In addition, the conflicts in the Middle East have contributed to sustained elevated interest rates and volatile energy costs. Consumer confidence continued to decline steadily due to concerns over high prices, increased energy costs, 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. The Company will continue to experience higher costs for commodities and packaging materials due to the tariffs, albeit at lower rates, 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 U.S.-China tariff war has 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. Any 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 nine months ended March 31, 2026 and 2025, sales of $31,000 and $80,000, respectively, were made to this distributor. 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. The U.S. Iran conflict has also significantly intensified cyber threats, characterized by Iran-linked hackers conducting high-volume, often low-impact, disruption attacks against U.S. critical infrastructure, including defense contractors, data centers and water systems. 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 21 Table of Contents 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. ‎ 22 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, 2026 and 2025: Total cash (used in) provided by: 2026 2025 Operating activities $ (580,822) $ 319,989 Investing activities (339,355) (374,623) Financing activities 13,846 152,445 Net increase (decrease) in cash and cash equivalents $ (906,331) $ 97,811 Operating Activities The cash used in operating activities during the nine months ending March 31, 2026 was primarily driven by the net loss from operations, somewhat offset by improvements in working capital. Payments to the Custom Border Patrol for tariffs on inventory purchased from Chinese suppliers plus payment of the Company’s annual insurance premiums at the beginning of the fiscal year were partially offset by a $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. The cash provided by operating activities during the nine months ending March 31, 2025 was a result of $344,000 in customer deposits for orders that shipped in the following quarter. Investing Activities Fixed asset additions of $316,000 during the nine months ended March 31, 2026 consisted of replacement of the third roof section of the Company’s building at a cost of $269,000, a sprinkler system valve replacement and various new product tooling and was the driving factor behind cash used by investing activities. The Company also paid premiums of $51,000 on the company-owned life insurance policies on two of its executives. Total proceeds of $9,035,000 were received during the first nine months of fiscal year 2026 from the redemption of U.S. Treasury securities and $8,998,000 of new U.S. Treasury securities were purchased at a net premium of $8,600 during that same period. Cash used by investing activities for the nine months ended March 31, 2025 was also 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 $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 $60,000 discount. Financing Activities Cash from the exercise of stock options during the nine-month period ended March 31, 2026 provided the majority of the cash from financing activities, offset slightly by principal payments on a finance lease for a new reach truck leased for the warehouse at the beginning of the year. 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 nine months ended March 31, 2025, 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 March 31, 2026 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 nine months ended March 31, 2026 or 2025 under the Company’s stock repurchase program. Liquidity During the three months ended March 31, 2026, the Company reclassified its debt securities with an amortized cost of $16,994,043 from held-to-maturity to available-for-sale in order to provide increased flexibility in managing its liquidity and capital resources. The reclassification was made in light of the Company’s updated strategy of diversification via acquisition and the related funding requirements of potential acquisition opportunities. Following the transfer, the securities remain highly liquid and available to support working capital needs, strategic initiatives, and other general corporate purposes. The transfer did not impact the Company’s cash position or results of operations, other than the recognition of an unrealized loss in other comprehensive loss related to marking the securities to fair value. 23 Table of Contents Management believes existing cash, cash equivalents, investments in short-term U.S. Treasury securities, cash generated from operations and available borrowings under its credit facility will be sufficient to meet the Company’s anticipated operating and capital expenditure requirements for at least the next twelve months and the foreseeable future. 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 March 31, 2026, the Company was in compliance with all covenants related to the Credit Agreement. As of March 31, 2026 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 March 31, 2026, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements. ‎ 24 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.