The following discussion and analysis supplements our management's discussion
and analysis for the year ended June 30, 2022 as contained in our Annual Report
on Form 10-K filed with the Securities and Exchange Commission on August 26,
2022, 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, 2022, 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, 2022, and 2021:
Three Months Ended Six Months Ended
December 31 December 31
Financial Performance Summary 2022 2021 2022 2021
Net sales $ 3,271,931 $ 4,415,886 $ 6,626,460 $ 8,780,953
Net sales (decrease) % from prior year
period (25.9)% (10.4)% (24.5)% (13.4)%
Gross profit $ 1,126,162 $ 1,549,693 $ 2,312,386 $ 3,131,530
Gross profit as % of net sales 34.4% 35.1% 34.9% 35.7%
Selling, general and administrative
expenses $ 2,473,975 $ 1,229,294 $ 26,144,571 $ 3,010,091
Selling, general and administrative
expenses as % of net sales 75.6% 27.8% 394.5% 34.3%
Interest income $ 97,832 $ 3,626 $ 124,888 $ 4,258
Other income $ - $ 255,975 $ 33,000,000 $ 355,975
(Loss) income before income tax
(benefit) provision $ (1,249,981) $ 580,000 $ 9,292,703 $ 481,672
(Loss) income before income tax as %
of net sales (38.2)% 13.1% 140.2% 5.5%
Income tax (benefit) provision $ (103,102) $ 1,031 $ 494,839 $ 2,062
Income tax (benefit) provision as % of
(loss) income before income tax
8.2% 0.2% 5.3% 0.4%
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Fiscal 2023 Period Results Compared with Fiscal 2022 Period
(comments refer to the three and six-month periods ended December 31 unless
otherwise noted)
Net sales for the quarter ended December 31, 2022 decreased by $1,144,000, or
25.9%, primarily due to reduced sales to certain of our distributors in the
domestic market and lower sales to the Asian markets. For the six-month period
ended December 31, 2022, net sales decreased by $2,154,000, or 24.5%, due mainly
to a decline in the European and Asian markets, and a slowdown in certain of our
domestic distributor sales. Growth in direct-to-consumer (DTC) sales of
approximately $331,000, or 20.7%, partially offset the declines.
Net sales in the domestic market were approximately $2,146,000 in the three
months ended December 31, 2022, compared to approximately $3,192,000 in the
prior year period, a decrease of $1,046,000, or 32.8%. Domestic net sales for
the six months ended December 31, 2022 decreased from $6,004,000 in the prior
year period to $4,873,000, a decline of $1,131,000, or 18.8%. Net sales to
certain of our domestic distributors decreased 62% from the prior year driven by
weaker demand which appears to be due to over-stocked shelves as a result of the
bullwhip effect triggered by the pandemic. Net sales to the education market
also decreased by over 50% mainly as a result of a delay in repeat orders. The
declines were partially offset by growth in DTC sales during the six months
ended December 31, 2022 over the same period in the prior year.
Export net sales for the three months ended December 31, 2022 decreased by
$99,000, or 8.1%, compared to the three months ended December 31, 2021, behind a
decrease in sales to our Asian distributors due to the delay in recovery after
the pandemic. Export net sales were down $1,024,000, or 36.9%, in the six months
ended December 31, 2022 versus the same prior year period. The decrease was
attributable to a 31.8% reduction in sales to European distributors, which
reflects the lack of sales to Russia or Ukraine due to the ongoing conflict
between the two countries, as well as a 39.3% decline in sales to our Asian
distributors for the six-month period.
Gross profit margin decreased slightly to 34.9% for the six months ended
December 31, 2022, compared to 35.7% for the six months ended December 31, 2021.
Margins were impacted by a less favorable market mix as higher margin sales to
certain of our distributors, including custom headphones to healthcare and
specialty customers, during the current six-month period declined by over 60%.
Growth of 23.3% in gross DTC sales, which generally bear a higher margin, for
the six-month period helped to partially offset the aforementioned negative
impacts on gross margin. Margins were also negatively impacted by fixed
manufacturing expenses that do not flex with sales volume.
The Company continued to benefit from lower freight rates during the quarter
ended December 31, 2022 driven by general reduced container demand and the
partnership with a dedicated freight forwarder.
Selling, general and administrative expenses for the three months ended December
31, 2022 were $2,474,000, approximately double that of the same period in the
prior year. The increase was driven mainly by a payment of $950,000 made to the
Company's external patent litigation team, and another $175,000 of legal
expenses related to patent defense litigation resolved in the prior quarter,
which were recorded as a change in estimate in the quarter ended December 31,
2022. The year-over-year increase is also partly attributable to the prior year
second quarter including the reversal of the deferred compensation liability for
the Company's founder who passed away in that quarter, resulting in an
approximately $300,000 reduction to net expense for the prior quarter. For the
six months ended December 31, 2022, selling, general and administrative expenses
increased by approximately $23,134,000 to $26,145,000 compared to the prior year
period. The increase was predominantly driven by approximately $22,196,000 in
legal fees and expenses incurred as a result of the patent defense litigation
referenced above. A total of approximately $955,000 in bonus accruals and
profit-sharing expense was recorded related to the increased net income before
income taxes for the first six months of fiscal year 2022 due to licensing
proceeds received during the quarter ended September 30, 2022, partially offset
by the aforementioned legal fees and expenses. A decrease of $116,000 in
employer taxes on stock option exercises slightly offset the significant
increase in expense for the current six-month period.
Other income for the six months ended December 31, 2022 consisted entirely of
$33,000,000 in licensing proceeds received in the first quarter. The Company
received licensing proceeds of $100,000 in the prior year six-month period which
was also recorded as other income. In December 2021, the Company recognized
other income on the proceeds from a company-owned life insurance policy on its
founder, who passed away December 21, 2021. Total other income for the three and
six months ended December 31, 2021 was $256,000 and $356,000, respectively.
Income tax expense for the six months ended December 31, 2022 was approximately
$495,000 and was comprised of the U.S. federal statutory rate of 21% and the
blended state income tax rate of approximately 3.7%, offset by an adjustment to
the valuation allowance for deferred tax assets. The utilization of net
operating loss carryforwards significantly reduced the taxable income, resulting
in federal and state tax provisions of $374,714 and $120,125, respectively. For
the three and six months ended December 31, 2021, a state tax provision
of $1,031 and $2,062, respectively, was recorded. The federal income tax expense
was zero for the three and six months ended December 31, 2021. The effective tax
rate was 5.3% in the six months ended December 31, 2022 and less than 1% in the
six months ended December 31, 2021. It is anticipated that the effective rate in
the current year and future years will be reduced by utilization of a portion or
all of the federal net operating loss carryforwards that existed as of June 30,
2022.
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In the six months ended December 31, 2022, stock option exercises resulted in
tax deductible compensation expense of approximately $208,000 and will offset
some of the taxable income generated by the net licensing proceeds. Net
operating loss carryforwards were utilized to reduce the taxable income and, as
such, the remaining expected federal tax loss carryforward is expected to
approximate $32,500,000 by the end of the fiscal year. The quarterly adjustment
to the estimated tax loss carryforward decreased the deferred tax asset to
approximately $9,600,000 as of December 31, 2022, and the future realization of
this continues to be uncertain. The valuation allowance was also increased to
fully offset the 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 net loss is expected.
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, all or portions of monetary
awards or judgments received by the Company in connection with these complaints,
will be due to third parties.
The Company believes that its financial position remains strong. The Company had
$4.8 million of cash and cash equivalents, $5.0 million of short-term
investments and available credit facilities of $5.0 million on December 31,
2022.
Recent Events
Recent events continuing to impact our business include COVID-19, the
inflationary cost environment, disruption in our supply chain, the ongoing
crisis in Eastern Europe, and the threatened rail strike in the U.S. As more
fully described below, we expect each of these factors will impact our fiscal
2023 performance.
While the impact of these factors 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.
COVID-19: The Company continues to closely monitor the impact of COVID-19
(including the emergence of variants) to protect the health and safety of its
employees and customers. Business plans are being continuously updated and
executed to maintain supply of the Company's products to our customers
throughout the world. While we expect the impacts of COVID-19 on our business to
moderate, there still remains uncertainty around the pandemic. As a result of
the COVID-19 pandemic, uncertainty with respect to its economic effects has
impacted not only our operating results but also the global economy. The extent
and nature of government actions to ease restrictions are varied based upon the
current extent and severity of the COVID-19 pandemic within their respective
countries and localities. The recent easing of the strict zero-COVID policies
that China has maintained for the past three years has resulted in a surge of
COVID infections, with another spike expected during the upcoming Lunar New
Year. This potential increased spread of the virus could impact sales if it
results in disruptions of inventory replenishment. The Company expects the
negative sales impacts caused by governmental responses to COVID-19, and the
disruption in certain retail businesses to continue so long as new variants of
the virus continue to emerge and spread.
The ultimate magnitude of the COVID-19 pandemic, including the extent of its
impact on the Company's business, financial position, results of operations or
liquidity, cannot be reasonably estimated at this time due to the rapid
development and fluidity of the situation. The Company's future
results will be determined by the effectiveness of vaccines, rollout of vaccine
boosters, the duration of governmental pandemic restrictions, the impact of
variants, geographic spread, further business disruptions and the overall impact
on the economy throughout the world.
To protect the safety, health and well-being of employees, customers, and
suppliers, the Company continues to maintain several preventive measures while
also meeting the needs of global customers. These measures include increased
frequency of cleaning and disinfecting of facilities, and may also include, as
necessary, social distancing practices, some remote working, restrictions on
business travel, continuing to hold certain events virtually and limitations on
visitor access to facilities.
The Company is committed to executing these plans and will remain in close
contact with its supply chain to monitor future possible implications,
especially on production facilities.
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Inflationary Cost Environment and Supply Chain Disruption - The first half of
fiscal 2022 brought continued inflationary cost increases in our commodities,
packaging materials, wages and transportation costs. Higher energy costs caused
inflation to rise in the back half of the prior fiscal year and has continued
into the current fiscal year. These increases have been partially mitigated by
pricing actions implemented by the Company in the third quarter of the prior
fiscal year, with another increase slated for the third quarter of the current
fiscal year. The Company is also working with a dedicated freight forwarding
partner to minimize freight rate increases.
The Company's supply chain is primarily in southern China. Delays throughout the
supply chain continue as a result of the persistence of COVID-19 in all parts of
the world, however, the Company does not believe that these continuing delays
will be material to the Company as the cadence of specific customers' bookings
have become more consistent. The Company is aware that with the recent easing of
COVID-19 restrictions in China, manufacturing operations and major ports may be
impacted by an increase in COVID-19 illness, which could result in supply chain
delays. As such, the Company continues to monitor the situation closely, and the
supply chain team has modified business plans, which include, but are not
limited to: (1) being alert to potential short supply situations; (2) assisting
suppliers with acquisition of critical components; and (3) utilizing alternative
sources and/or air freight.
In December 2022, the U.S. government intervened in the rail strike that began
in the prior month and implemented a labor agreement that prohibited the workers
from striking. Despite the U.S. government's intervention, the threat of a
strike that could shut down a vital link in the nation's supply chain continues
to be a concern. The Company continues to monitor the situation as a rail strike
in the U.S. could potentially exacerbate the existing disruption in the supply
chain and impact product shipments from suppliers and to customers, resulting in
increased operating costs and delays in product shipments.
Russia's Invasion of Ukraine: The ongoing Russia-Ukraine conflict and the
sanctions imposed in response to this conflict have increased global economic
and political uncertainty. In accordance with the Executive Order declared on
April 6, 2022, the Company suspended sales into Russia. Also, given the
continued humanitarian crisis in Ukraine as a result of the conflict, and the
population seeking refuge in other countries, sales to Ukraine have also ceased.
Neither Russia nor Ukraine constitutes a significant portion of the business,
combining for less than 5% of net sales for the three months ended March 31,
2022, the last quarter prior to the Executive Order. As a result, there was not
a material impact on sales in the current quarter. We are uncertain, however, of
the impact it will have on our results of operations in the future if the
conflict continues.
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, 2022 and 2021:
Total cash provided by (used in): 2022 2021
Operating activities $ 10,538,583 $ (380,714)
Investing activities (15,023,416) (171,043)
Financing activities 88,940 1,390,346
Net (decrease) increase in cash and cash equivalents $ (4,395,893) $ 838,589
Operating Activities
A significant portion of the cash provided by operating activities during the
six months ended December 31, 2022 is the result of the licensing proceeds
received, partially offset by the payment of related legal fees and expenses and
profit sharing. The impact of the licensing fees was coupled with a reduction in
inventory as the investment in inventory levels off, and a decline in accounts
receivable resulting from lower sales. Cash used by operating activities related
to the decrease in accounts payable resulting from lower freight costs and fewer
inventory purchases. The driving factor for the use of cash in the same
six-month period in the prior year was the investment in inventory made to
ensure availability and to provide better inventory positions on key products to
mitigate the continued impacts of supply chain disruptions, offset by a decline
in accounts receivable.
Investing Activities
Cash used by investing activities for the six months ended December 31, 2022 was
almost entirely related to the purchase of $15,300,000 of U.S. Treasury
securities at a discount. The Company believes that its cash flow from
operations and available cash and its credit facility is sufficient to fund any
necessary tooling, leasehold improvement and capital expenditures.
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Financing Activities
Cash provided by financing activities is due entirely to stock option exercises.
In the six months ended December 31, 2022, an aggregate of 42,000 shares of
common stock were issued as a result of employee stock option exercises under
the Company's 2012 Omnibus Incentive Plan. The cash provided from these stock
option exercises was approximately $89,000. During the six months ended December
31, 2021, an aggregate of 539,089 shares of common stock were issued as a result
of employee stock option exercises under the Company's 2012 Omnibus Incentive
Plan. The cash provided from these stock option exercises was approximately
$1,390,000.
As of December 31, 2022, the Company had no outstanding borrowings on its bank
line of credit facility.
There were no purchases of common stock in the three months ended December 31,
2022 or December 31, 2021 under the stock repurchase program.
Liquidity
The Company's capital expenditures are primarily for leasehold improvements
and tooling. In addition, it has interest payments on its borrowings when it
uses its line of credit facility. The Company believes that cash generated from
operations, together with healthy cash reserves and available borrowings,
provide it with adequate liquidity to meet operating requirements, debt service
requirements and planned or necessary tooling, leasehold and other capital
expenditures for the next twelve months following the date of this Quarterly
Report on Form 10-Q and thereafter for the foreseeable future. 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 letters of credit for the benefit
of the Company of up to a sublimit of $1,000,000. There are no unused line fees
in the credit facility. On January 28, 2021, the Credit Agreement was amended to
extend the expiration date to October 31, 2022, and to change the interest rate
to Wall Street Journal Prime less 1.50%. A Third Amendment to the Credit
Agreement effective October 30, 2022 extended the expiration date to October 31,
2024. The Company and the Lender also entered into a General Business Security
Agreement dated May 14, 2019 under which the Company granted the Lender a
security interest in substantially all of the Company's assets in connection
with the Company's obligations under the Credit Agreement. The Credit Agreement
contains certain affirmative and negative covenants customary for financings of
this type. The negative covenants include restrictions on other indebtedness,
liens, fundamental changes, certain investments, disposition of assets, mergers
and liquidations, among other restrictions. As of December 31, 2022, the Company
was in compliance with all covenants related to the Credit Agreement. As of
December 31, 2022 and June 30, 2022, there were no outstanding borrowings on the
facility.
Contractual Obligation
The Company leases the 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. On May 24, 2022, the lease
was renewed for a period of five years, ending June 30, 2028, and is being
accounted for as an operating lease. The lease extension maintained the rent at
a fixed rate of $380,000 per year. The Company has the option to renew the lease
for an additional five years beginning July 1, 2028 and ending June 30, 2033
under the same terms and conditions except that the annual rent will increase to
$397,000. The negotiated increase in rent slated for 2028 will be the first
increase in rent since 1996. The Company is responsible for all property
maintenance, insurance, taxes and other normal expenses related to ownership.
The facility is in good repair and, in the opinion of management, is suitable
and adequate for the Company's business purposes.
Off-Balance Sheet Transactions
At December 31, 2022, the Company did not have any transactions, obligations or
relationships that could be considered off-balance sheet arrangements.
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