The purpose of this discussion and analysis is to enhance the understanding and evaluation of the financial position, results of operations, cash flows, indebtedness and other key financial information of the Company for fiscal years 2021 and 2020. Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.





                                    Overview


The Company developed stereo headphones in 1958 and has been a leader in the industry ever since. We market a complete line of high-fidelity headphones, wireless Bluetooth® headphones, wireless Bluetooth® speakers, computer headsets, telecommunications headsets, and active noise canceling headphones. Koss operates as one business segment, as its only business line is the design, manufacture and sale of stereo headphones and related accessories.

The Company's products are sold domestically and internationally through a variety of retailers and distributors, as well as directly to other manufacturers for including with their own products. Changes in sales volume are driven primarily by the addition or loss of customers, a customer adding or removing a product from its inventory, or changes in economic conditions. They are relatively less impacted by seasonality or the traditional holiday shopping season.

Although certain of the Company's products could be viewed as essential by consumers for use with mobile phones and other portable electronic devices, other products are more of a discretionary spend. The results of the Company's operations are therefore susceptible to consumer confidence and macroeconomic factors.





                            Fiscal Year 2021 Summary


?Net sales increased 6.7% to $19,546,008 on increases in U.S. distributor, export market and direct-to-consumer ("DTC") sales. Export sales increased 67% while domestic sales fell 6%.

?Gross profit as a percent of sales increased 3.5% to 34.4%. The increase was primarily due to a US mass retailer dropping a lower margin product as well as a change in the mix of sales by product and by channel.

?Selling, general and administrative expense was higher as a result of employer taxes on stock option exercises and deferred compensation expense.

?Tax expense for the year ended June 30, 2021 was minimal due to an offsetting change in the valuation allowance for deferred tax assets.






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                              Consolidated Results


The following table presents selected consolidated financial data for each of the past two fiscal years:



Consolidated Performance Summary                           2021            2020
Net sales                                              $  19,546,008   $  18,311,830
Net sales increase (decrease) %                                 6.7%         (16.2)%
Gross profit                                           $   6,732,135   $   5,662,608
Gross profit as % of net sales                                 34.4%           30.9%
Selling, general and administrative expenses           $   7,122,627   $   6,146,650
Selling, general and administrative expenses as % of           36.4%           33.6%
net sales
Interest income                                        $       2,706   $      20,185
Other income                                           $     885,505   $           -

Income (loss) before income tax provision (benefit) $ 497,719 $ (463,857) Income (loss) before income tax provision as % of

               2.5%          (2.5)%
net sales
Income tax provision                                   $       4,125   $       1,740
Income tax provision as % of income (loss) before               0.8%          (0.4)%
taxes






                 2021 Results of Operations Compared with 2020


Net sales for 2021 increased primarily due to increased sales in the Company's export markets. Domestic sales reflected mixed results among markets but, overall, declined 5.7% compared to 2020.

Export net sales increased by $2,097,131 or 66.6% to $5,247,650. Export distributors had strong volumes especially in the Czech Republic, Scandinavia and Russia. These have historically been key markets and led the resurgence in sales volumes. These markets were strong despite the restrictions through the COVID-19 pandemic. The Company expects to see continued growth as restrictions are eased.

For the year ended June 30, 2021, domestic net sales decreased 5.7% from $15,161,311 to $14,298,358. There was a significant shift in sales to distributors and DTC from mass retail with a US mass retailer dropping their branded products from their planogram. The business has become much more oriented to distributors and DTC along with certain OEM products. Sales into the education marketplace decreased due to large shipments late in the year ended June 30, 2020 that were not repeated this year as those customers re-establish their testing services.

Gross profit increased to 34.4% for the year ended June 30, 2021, compared to 30.9% for the prior fiscal year. The margin rates are very dependent on mix of sales by customer, product and sales channel. The lower sales to a US-based mass retailer, which has discontinued the product supplied by the Company, improved margin rates. Improved sales in the U.S. through distributors, DTC market and the export markets improved the margin rates. Early in the year ended June 30, 2021, freight costs were higher than normal as product was shipped by air to meet customer delivery schedules. Late in the fiscal year, cargo-freight costs began to rise as cargo carriers significantly increased pricing. The Company expects high freight costs to continue into the fiscal year ended June 30, 2022 and negatively impact margins.

Selling, general and administrative expenses for the year ended June 30, 2021, increased 15.9% or approximately $976,000 to approximately $7,123,000. The primary factor was employer taxes on stock option exercises of approximately $571,000 in the current year. There was also increased deferred compensation expenses. These costs were partially offset by a reduction in the 401k company match. Deferred compensation expense increased by approximately $244,000 due to changes in the assumptions on life expectancy, discount rates, and a higher payout based on years of service and earnings. The 401k company match decreased approximately $172,000 as the percentage match was decreased.

As previously reported, the Company has launched 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. The Company has recovered certain of the fees and costs that were involved with the underlying efforts to enforce this portfolio, as further described in the notes to the financial statements included in this Annual Report on Form 10-K. If the program is successful, the Company may receive royalties, offers to purchase its intellectual property, or other remedies advantageous to its competitive position; however, there is no guarantee of a positive outcome from these efforts, which could ultimately be time consuming and unsuccessful.





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Income tax expense for the year ended June 30, 2021, was comprised of the U.S. federal statutory rate of 21%, and the effect of state income taxes, offset by an adjustment to the valuation allowance for deferred tax assets until it is more likely than not that the Company will be able to use the net operating loss carryforwards at which time the valuation allowance will be removed. The effective tax rate was approximately 0% in the fiscal year ended June 30, 2021. It is anticipated that the effective rate in future years will be reduced by utilization of a portion or all of the approximately $31,310,000 of federal net operating loss carryforwards.

The Company has been closely monitoring the COVID-19 situation 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.

The Company continued to see strong demand in the year ended June 30, 2021 for specific communication headphones as people continued to work from home and studied online due to COVID-19 related directives. However, certain retail businesses throughout the Company's markets, particularly in certain European markets, have seen continued disruption. The Company expects sporadic negative sales impacts to continue until markets reopen fully and consumer spending returns to normal.

The ultimate magnitude of the COVID-19 pandemic, including the extent of its impact on the Company's business, financial position, results of operations and 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 heavily determined by timely rollout of the vaccines, effectiveness of the vaccines, the duration of the pandemic, impact of the variants, its geographic spread, further business disruptions and the overall impact on the global economy. Many European countries continued to have lockdowns in the year ended June 30, 2021, which negatively impacted sales into those countries.

The Company's supply chain is primarily in southern China. This portion of the Company's supply chain was disrupted early in the quarter ended March 31, 2020. Until recently, these disruptions had little on-going impact. In the past six to nine months, the Company began experiencing issues related to the availability of containers and routing to move products in a time efficient manner. There have also been impacts to the movement of new product introductions and costs. The Company is monitoring the situation closely and the supply chain team has modified business plans, which include, but are not limited to: (1) increasing the investment in inventory; (2) being alert to potential short supply situations; (3) assisting suppliers with acquisition of critical components; and (4) utilizing alternative sources and/or air freight.

To protect the safety, health and well-being of employees, customers, and suppliers, the Company continues to implement several preventive measures while also meeting the needs of global customers. They include increased frequency of cleaning and disinfecting of facilities, social distancing practices, remote working when possible, restrictions on business travel, holding certain events virtually and limitations on visitor access to facilities. The Company is committed to continuing to execute these plans.

The Company had $6,950,215 of cash and available credit facilities of $5,000,000 on June 30, 2021, which the Company expects to be sufficient to fund its operations beyond the next twelve months from the date of filing this Form 10-K.





                        Liquidity and Capital Resources



Cash Flows


The following table summarizes our cash flows from operating, investing and financing activities for each of the past two fiscal years:





Total cash provided by (used in):             2021         2020
Operating activities                       $   348,740  $ 1,801,702
Investing activities                         (704,206)    (537,275)
Financing activities                         3,306,272      506,700

Net increase in cash and cash equivalents $ 2,950,806 $ 1,771,127









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Operating Activities


The Company generated less cash from operations despite having an improvement in net income of $959,101. Changes in operating assets and liabilities used $500,565 of cash in the year ended June 30, 2021 compared to generating $1,597,977 in cash during the year ended June 30, 2020. The movement of working capital in the year ended June 30, 2021 is more representative of the business in a year of growth and with sales shifting to export distributors. The Company is very focused on working capital, especially inventory levels, to adjust to changes in the business and the impacts of shipping delays on lead times from China.





Investing Activities



Cash used in investing activities was higher for 2021 as the Company increased spending on leasehold improvements and the implementation of a new ERP system. The Company is planning approximately $600,000 for tooling and leasehold improvements in the year ending June 30, 2022. The tooling expenditures are to support new product introductions. The Company expects to generate sufficient funds through operations to fund these expenditures.





Financing Activities


The cash generated from financing activities in the year ended June 30, 2021 was driven by stock option exercises. In the year ended June 30, 2020, the $506,700 cash generated from financing activities was the unsecured loan the Company entered into under the Small Business Administration Paycheck Protection Program of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") through Town Bank. As of June 30, 2021, the Company had no outstanding borrowings on its bank line of credit facility under the Credit Agreement (described below under "Credit Facility").

There were no purchases of common stock in 2021 or 2020 under the stock repurchase program. In the year ended June 30, 2021, there were stock option exercises of 1,203,875 shares generating $3,306,272 of cash.





Liquidity


In addition to capital expenditures, the Company has interest payments when it uses its line of credit facility. The Company believes that cash generated from operations, together with borrowings available under its credit facility, should provide it with adequate liquidity to meet operating requirements, debt service requirements, and capital expenditures. Management is focusing on increasing sales, especially in the export markets, increasing new product introductions, increasing the generation of cash from operations, and improving the Company's overall earnings to help improve the Company's liquidity. 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") for a two-year term expiring on May 14, 2021. The Credit Agreement provides for a $5,000,000 revolving secured credit facility with an interest rate of 1.50% over LIBOR. The Credit Agreement also provides 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 extend the expiration to October 31, 2022, and to change the interest rate to Wall Street Journal Prime less 1.50%. 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. The Company is currently in compliance with all covenants related to the Credit Agreement. As of June 30, 2021, and June 30, 2020, there were no outstanding borrowings on the facility.






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Stock Repurchase Program


In April 1995, the Board of Directors approved a stock repurchase program authorizing the Company to purchase, from time to time, up to $2,000,000 of its common stock for its own account. Subsequently, the Board of Directors periodically has approved increases of between $1,000,000 to $5,000,000 in the stock repurchase program. As of June 30, 2021, the most recently approved increase was for additional purchases of $2,000,000, which occurred in October 2006, for an aggregate maximum of $45,500,000, of which $43,360,247 had been expended through June 30, 2021.

There were no stock repurchases under the program in fiscal year 2021 or 2020. As of June 30, 2021, the Board of Directors has authorized the repurchase by the Company of up to $2,139,753 in Company common stock at the discretion of the Chief Executive Officer of the Company. Future stock purchases under this program are dependent on management's assessment of value versus market price, may occur either on the open market or through privately negotiated transactions and may be financed through the Company's cash flow or by borrowing.





Contractual Obligation


The Company leases the 126,000 square foot facility from Koss Holdings, LLC, which is wholly-owned by the Company's former chairman. On January 5, 2017, the lease was renewed for a period of five years, ending June 30, 2023, 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 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


Our discussion and analysis of financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates and judgments, including those related to doubtful accounts, product returns, excess inventories, warranties, impairment of long-lived assets, deferred compensation, income taxes and other contingencies. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.

The extent to which COVID-19 impacts the Company's business and financial results will depend on numerous evolving factors including, but not limited to: the magnitude and duration of COVID-19, the impact of COVID variants, the extent to which it will impact worldwide macroeconomic conditions, the speed of the anticipated recovery, access to capital markets, and governmental and business reactions to the pandemic. The Company assessed certain accounting matters that generally require consideration of forecasted financial information in context with the information reasonably available to the Company and the unknown future impacts of COVID-19 as of June 30, 2021 and through the date of the filing of this Annual Report on Form 10-K. The accounting matters assessed included, but were not limited to estimates related to revenue, the accounting for potential liabilities and accrued expenses, the assumptions utilized in valuing stock-based compensation issued for services, the realization of deferred tax assets, the inventory valuation reserve, and assessments of impairment related to long-lived assets. The Company's future assessment of the magnitude and duration of COVID-19, as well as other factors, could result in additional material impacts to the Company's consolidated financial statements in future reporting periods.

Despite the Company's efforts to evaluate the extent to which COVID-19 will impact the Company's business and financial results, the ultimate impact of COVID-19 depends on factors beyond the Company's knowledge or control, including the duration and severity of the outbreak, as well as third-party actions taken to contain its spread and mitigate its public health effects. As a result, the Company is unable to estimate the full extent to which COVID-19 will negatively impact its financial results or liquidity.





Revenue Recognition


Revenues from product sales are recognized when the customer obtains control of the product, which typically occurs upon shipment from the Company's facility. There are a very limited number of customers for which control does not pass until they have received the products at their facility. Revenue from product sales is adjusted for estimated warranty obligations and variable consideration, which are detailed below. The Company adopted the Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") 2014-09 (Topic 606), Revenue from Contracts with Customers. This standard superseded nearly all existing revenue recognition guidance and provides a five-step analysis to determine when and how revenue is recognized. The underlying principle is to recognize revenue when promised goods or services transfer to the customer. The amount of revenue recognized is to reflect the consideration expected to be received for those goods or services. See Note 3 to the Consolidated Financial Statements for additional information on revenue recognition.



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Accounts Receivable


The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by the review of the customer's current credit information. The Company continuously monitors collections and payments from customers and maintains an allowance for estimated credit losses. Accounts receivable are stated net of an allowance for doubtful accounts. The allowance is calculated based upon the Company's evaluation of specific customer accounts where the Company has information that the customer may have an inability to meet its financial obligations. In these cases, management uses its judgment, based on the best available facts and circumstances, and records a specific reserve for that customer against amounts due to reduce the receivable to the amount that is expected to be collected. These specific reserves are re-evaluated and adjusted as additional information is received that impacts the amount reserved. However, the ultimate collectibility of the unsecured receivable is dependent upon the financial condition of an individual customer, which could change rapidly and without warning.





Inventories


The Company values its inventories using standard cost which approximates the lower of first in first out ("FIFO") cost or net realizable value. Valuing inventories at the lower of cost or market requires the use of estimates and judgment. The Company continues to use the same techniques to value inventories that it has in the past. Our customers may cancel their orders or change purchase volumes. This, or certain additional actions or market developments, could create excess inventory levels, which would impact the valuation of our inventories. Any actions taken by our customers or market developments that could impact the value of our inventory are considered when determining the lower of cost or market valuations. The Company regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on historical and projected usage and production requirements. If the Company is not able to achieve its expectations of the net realizable value of the inventory at its current value, the Company would have to adjust its reserves accordingly. When a reserve is established, it creates a new cost basis, which is not increased in the future.

Product Warranty Obligations

The Company offers a lifetime warranty to consumers in the United States and certain other countries. This lifetime warranty creates a future performance obligation. There are also certain foreign distributors that receive warranty repair parts and replacement headphones to satisfy warranty obligations in those countries. The Company defers revenue to recognize the future obligations related to these warranties. The deferred revenue is based on historical analysis of warranty claims relative to sales. This deferred revenue reflects the Company's best estimates of the amount of warranty returns and repairs it will experience during those future periods. If future warranty activity varies from the estimates, the Company will adjust the estimated deferred revenue, which would affect net sales and operating results in the period that such adjustment becomes known.





Deferred Compensation


The Company's deferred compensation liabilities are for a current and former officer and are calculated based on compensation, years of service, discount rates and mortality tables. The related expense is calculated using the net present value of the expected payments and is included in selling, general and administrative expenses in the Consolidated Statements of Operations. Management makes estimates of life expectancy and discount rates using information available from several sources. In addition, management estimates the expected retirement date for the current officer as that impacts the timing for expected future payments. See Note 9 for additional information on deferred compensation.





Stock-Based Compensation



The Company has a stock-based employee compensation plan, which is described more fully in Note 11. The Company accounts for stock-based compensation in accordance with ASC 718 "Compensation - Stock Compensation". Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. The expected term of the options and volatility are estimated using historical experience for the options by vesting period. The risk-free interest rate is calculated based on the expected life of the options. The Company does not estimate forfeitures as they are recognized when they occur.





Income Taxes


We estimate a provision for income taxes based on the effective tax rate expected to be applicable for the fiscal year. If the actual results are different from these estimates, adjustments to the effective tax rate may be required in the period such determination is made. Additionally, discrete items are treated separately from the effective rate analysis and are recorded separately as an income tax provision or benefit at the time they are recognized.



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Deferred income taxes are accounted for under the asset and liability method whereby deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using statutory tax rates. Deferred income tax provisions are based on changes in the deferred tax assets and liabilities from period to period. Additionally, we analyze our ability to recognize the net deferred income tax assets created in each jurisdiction in which we operate to determine if valuation allowances are necessary based on the "more likely than not" criteria.





New Accounting Pronouncements


Applicable new accounting pronouncements are set forth under Item 15 of this annual report and are incorporated herein by reference.

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