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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-K/A**

 

**Amendment No. 1**

 

**x****   ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thefiscal year ended June 30, 2009**

** **

**OR**

** **

**o****     TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**COMMISSION FILE NUMBER 0-3295**

 

**KOSS CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **39-1168275**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **4129 North Port Washington Avenue, Milwaukee, Wisconsin**     | ** ** | **53212**                             |
| (Address  of principal executive offices                        |       | (Zip  Code)                           |

 

Registrant’stelephone number, including area code: **(414)964-5000**

 

Securities registeredpursuant to Section 12(b) of the Act:

 

| **Title of Each Class** | ** ** | **Name of Each Exchange on Which Registered** |
|----------------------------------------|------------|-----------------------------------------------------------------------------|
| Common  Stock $0.005 par value         |       | The  Nasdaq Stock Market LLC                                                |

 

**NONE**

(Titleof class)

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  Yes o  No x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act.  Yes o  No x

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o  No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K/A or any amendment to thisForm 10-K/A.  x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  

 

|         | Large  accelerated filer o                |   | Accelerated  filer o         |
|--------------|------------------------------------------------|--------|-----------------------------------|
|         |                                           |   |                              |
|         | Non-accelerated  filer o                  |   | Smaller  reporting company x |
| (Check one): | (Do  not check if a smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

The aggregate market valueof the common voting stock held by nonaffiliates of the registrant as ofDecember 31, 2008 was approximately $10,718,152****(based on the $4.65 per share closing price of the Company’scommon stock as reported on the NASDAQ Stock Market on December 31, 2008,as adjusted for the stock split on December 1, 2009).

 

On August 1, 2009 andon June 30, 2010, 7,382,706 shares of voting common stock were outstanding asadjusted for the stock split on December 1, 2009.

 

Documents Incorporated by Reference

 

Part III of thisForm 10-K/A incorporates by reference information from Koss Corporation’sProxy Statement for its 2009 Annual Meeting of Stockholders filed with theCommission under Regulation 14A within 120 days of the end of the fiscal yearcovered by this Form 10-K/A.

 

 

 

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KOSS CORPORATION AND SUBSIDIARY

FORM 10-K/A

JUNE 30, 2009

 

INDEX

 
| ** **       | ** **                                                                                  | ** ** | **Page** |
|------------------|---------------------------------------------------------------------------------------------|------------|----------|
|             |                                                                                        |       |     |
| **PART I**  |                                                                                        |       |     |
| Item 1.          | Business                                                                                    |       | 9        |
| Item 1A.         | Risk Factors                                                                                |       | 13       |
| **PART II** |                                                                                        |       |     |
| Item 6.          | Selected  Financial Data                                                                    |       | 19       |
| Item 7.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       | 19       |
| Item 8.          | Financial  Statements and Supplementary Data                                                |       | 25       |
| Item 9.          | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure       |       | 25       |
| Item 9A          | Controls and  Procedures                                                                    |       | 26       |
| **PART IV** |                                                                                        |       |     |
| Item 15.         | Exhibits  and Financial Statement Schedules                                                 |       | 29       |

 

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**EXPLANATORY NOTE**

 

ThisAnnual Report on Form 10-K/A for the year ended June 30, 2009includes our restated consolidated balance sheets as of June 30, 2009 and2008, and the related restated consolidated statements of operations, cashflows and stockholders’ equity for the years then ended.

 

KossCorporation and its consolidated wholly-owned subsidiary (the “Company”) isrestating its previously issued consolidated financial statements and relatednotes to the consolidated financial statements primarily to reflect adjustmentsrelating to the unauthorized transactions previously disclosed in Form 8-KCurrent Reports filed on December 21 and 24, 2009 and January 4, 7,11 and 20, 2010.  These adjustments aremore fully described in Note 2 to the restated consolidated financialstatements included in this Form 10-K/A.

 

*UnauthorizedTransactions* — On December 18, 2009, the Company learned ofcertain unauthorized transactions made by Sujata Sachdeva, its former VicePresident of Finance and Principal Accounting Officer.  The Company subsequently learned that Ms. Sachdevacolluded with two other employees of the accounting department in themisappropriation and circumvention of the Company’s existing internal controlsand established operating procedures.  Incarrying out the unauthorized transactions, these three former employees failedto adhere to the Company’s existing procedures for processing payments andconcealed the misappropriations from management, including the directors andremaining officers of the Company.  Ms. Sachdevaand these other former employees were terminated shortly after the Companylearned of the unauthorized transactions. On January 20, 2010, Ms. Sachdevawas indicted in connection with these misappropriations from the Company.

 

Aspreviously disclosed, approximately $31,500,000 was misappropriated from fiscalyear 2005 through December 2009. Approximately $30,900,000 or 98.1% of the total $31,500,000 of theunauthorized transactions was misappropriated by circumventing the Company’sinternal controls and other operating procedures for the payment of Companyexpenditures by using wire transfers or cashier’s checks to pay for Ms. Sachdeva’spersonal expenditures.  Of the$30,900,000, approximately $8,500,000 and $5,100,000 was misappropriated by useof these means during 2009 and 2008, respectively.  Misappropriations by use of wire transfers orcashier’s checks totaled $10,300,000 during fiscal year 2010.  The balance of the misappropriations ofapproximately $600,000, or 1.9% from the total amount of $31,500,000 fromfiscal year 2005 through December 2009, was carried out by circumventingthe Company’s internal controls and other operating procedures involving theCompany’s petty cash system, manual check system and traveler’s checkspolicy.  Out of the estimated $600,000 ofthese types of transactions, approximately $91,000 and $110,000 occurred duringyears 2009 and 2008, respectively. Approximately $107,000 of misappropriations involving the use of theCompany’s petty cash system, manual check system and traveler’s checks policyoccurred during 2010.

 

*Company’sActions**and Other Events* — The followingsummarizes the Company’s key actions and other significant events since theCompany learned of the unauthorized transactions:

 

·                                          On December 18, 2009,the Company appointed a committee of independent directors (“IndependentCommittee”), which thereafter engaged independent counsel and forensicaccountants to conduct an internal investigation of the unauthorizedtransactions (“Independent Investigation”).

 

·                                          On December 21, 2009,at the Company’s request, NASDAQ halted trading of the Company’s common stock.

 

·                                          Ms. Sachdeva wassuspended on December 21, 2009.  On December 23,2009, the Company terminated Ms. Sachdeva. On January 4, 2010, the Company terminated the two other members ofits accounting department.

 

·                                          On December 24, 2009and January 4, 2010, the Company announced that its previously issuedfinancial statements since fiscal year 2006 should not be relied upon.

 

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·                                          On January 4, 2010, theCompany announced that, upon a recommendation from the Audit Committee andapproval by the Board of Directors, it dismissed Grant Thornton, LLP as itsindependent auditor effective December 31, 2009.

 

·                                          On January 5, 2010, theCompany, upon a recommendation from the Audit Committee and approval by theBoard of Directors, appointed Baker Tilly Virchow Krause, LLP (“Baker Tilly”)as its independent auditor.

 

·                                          On January 11, 2010,the Company released preliminary and unaudited estimates (subsequently updated,as shown below) of the unauthorized transactions since fiscal year 2005 asfollows:

 
| · |   | FY  2005:    |   | $ | 2,257,079 |   |
|--------|--------|--------------|--------|---|-----------|--------|
| · |   | FY  2006:    |   | $ | 2,284,124 |   |
| · |   | FY  2007:    |   | $ | 3,509,861 |   |
| · |   | FY  2008:    |   | $ | 5,099,900 |   |
| · |   | FY  2009:    |   | $ | 8,498,434 |   |
| · |   | Q1  FY 2010: |   | $ | 5,324,164 |   |
| · |   | Q2  FY 2010: |   | $ | 4,962,824 |   |

 

·                                          On January 11, 2010,NASDAQ resumed trading of the Company’s common stock.

 

·                                          On January 18, 2010,the Company announced the appointment of David D. Smith as Executive VicePresident, Chief Financial Officer and Principal Accounting Officer and thatMichael Koss stepped down as Chief Financial Officer effective upon Mr. Smith’sappointment.

 

·                                          In February 2010, theCompany strengthened its accounting staff by recruiting an experiencedController and an experienced Credit Manager.

 

·                                          The Company’s remedialactions taken beginning in late December 2009 following the discovery ofthe unauthorized transactions include:

 

·                  Changed the Company’sbanking procedures and certain other internal policies and procedures;

 

·                  Enhanced the Company’sinternal controls by increasing documentation of the Company’s controls,improving the account reconciliation processes and implementing additionalreview and approval processes;

 

·                  Recruited new personnel inthe accounting department, which has improved the segregation of dutiesregarding the initiation, approval, recording and reconciliation of cashtransactions, including wire transfers;

 

·                  Increased supervision overcash through improved monitoring, reconciling and reporting to management;

 

·                  Engaged a consulting firm tosupport management’s review and implementation of an improved system ofinternal controls;

 

·                  Established Michael Koss asthe CEO or John Koss, Jr. as the Vice President of Sales as the onlyapproved signatories on the Company’s bank accounts;

 

·                  Reinforced the Company’sCode of Conduct, Code of Ethics and Whistleblower Policy to all of itsemployees, officers and directors.

 

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·                                          The Company has consultedwith the Independent Committee conducting the Independent Investigation and theIndependent Committee has concurred with the remedial actions taken by theCompany.

 

·                                          The Company continues tocooperate with law enforcement, the SEC, and the Independent Committee in theirongoing investigations of and related to the unauthorized transactions.

 

*Restatement* — Baker Tillywas engaged to perform audits of the Company’s restated consolidated financialstatements as of June 30, 2009 and 2008 and for the years then ended.  The Company’s previously filed annual reportson Form 10-K, quarterly reports on Form 10-Q, earnings releases andother similar communications prior to the restated periods, the consolidatedfinancial statements, reports of the previous independent registered publicaccounting firm and related financial information contained in such previouslyfiled reports should not be relied upon.

 

The restated consolidatedfinancial statements included in this Form 10-K/A, correct errors in amajority of the financial statement line items in the previously issuedconsolidated financial statements for all periods presented.  The errors resulted from falsifications bythe terminated employees including Ms. Sachdeva to conceal themisappropriations from management.  SeeNote 2 of the Notes to the Consolidated Financial Statements.  The most significant errors (by dollaramount) consist of the following:

 

·                                          The unauthorizedtransactions were not properly accounted for as losses and disclosed as aseparate line item on the income statement as an expense.

 

·                                          Net sales were understatedin all years because of journal entries made to conceal certainmisappropriations.

 

·                                          Cost of sales was overstatedas a result journal entries made to conceal certain misappropriations.

 

·                                          Administrative expenses wereoverstated as a result of journal entries made to conceal certainmisappropriations.

 

·                                          Accounts receivable wasoverstated due to delayed posting of cash, as a method used to conceal certainmisappropriations, and failing to provide for an allowance for certain doubtfulaccounts that was also used to conceal certain misappropriations.

 

·                                          Cash was not properlyreconciled and was overstated due to the unauthorized transactions at June 30,2009 and 2008.

 

·                                          Disposals of equipment andleasehold improvements were not properly recorded and assets no longer used inthe business were not properly removed from the financial records.

 

·                                          Other assets were improperlystated due to errors in applying accounting principles generally accepted inthe United States of America (“GAAP”).

 

·                                          Accounts payable wasunderstated at June 30, 2009 and 2008 due to an erroneous transaction thatwas posted to accounts payable in 2009 and improper cutoff of transactions inboth years.

 

·                                          Other accrued liabilities,including product warranty obligations and deferred compensation, have beenadjusted to properly apply GAAP or to correct the estimates used to prepare thepreviously filed consolidated financial statements.

 

*RelatedLitigation and Inquiries/Investigations* — Since learning of the unauthorizedtransactions in December 2009, the Company has been named in the mattersdescribed below and has incurred significant increased costs related to thesematters, its remediation efforts and the Independent Investigation.  In addition to pursuing 

 

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reimbursementof applicable expenses under its available insurance policies and tax refunds,the Company has also initiated certain actions against third parties, which arealso described below, and may bring additional claims against other thirdparties.

 

·                  On January 11, 2010, the Companyreceived a letter from a law firm stating that it represented a shareholder anddemanding that the Company’s Board of Directors investigate and take legalaction against all responsible parties to ensure compensation for the Company’slosses stemming from the unauthorized transactions.  The Company’s legal counsel has respondedpreliminarily to the letter indicating that the Board of Directors willdetermine the appropriate course of action after the Independent Investigationis completed.

 

·                  OnJanuary 15, 2010, a class action complaint was filed in federal court inWisconsin against the Company, Michael Koss and Sujata Sachdeva.  The suit alleges violations ofSection 10(b), Rule 10b-5 and Section 20(a) of the ExchangeAct relating to the unauthorized transactions and requests an award ofcompensatory damages in an amount to be proven at trial.  See *David A. Puskala v. KossCorporation, et al.*, United States District Court, Eastern Districtof Wisconsin, Case No. 2:2010cv00041.

 

·                  On January 26, 2010, the SEC’s Divisionof Enforcement advised the Company that it obtained a formal order ofinvestigation in connection with the unauthorized transactions. The Companyvoluntarily brought the unauthorized transactions to the SEC staff’s attentionwhen they were discovered in December 2009, and is cooperating with theongoing SEC investigation.

 

·                      On February 16and 18, 2010, separate shareholder derivative suits were filed in MilwaukeeCounty Circuit Court in connection with the previously disclosed unauthorizedtransactions. The first suit names as defendants Michael Koss, John Koss Sr.,the other Koss directors, Sujata Sachdeva, Grant Thornton, LLP, and KossCorporation (as a nominal defendant); the second suit names the same partiesexcept Grant Thornton, LLP. Among other things, both suits allege variousbreaches of fiduciary and other duties, and seek recovery of unspecifieddamages and other relief. See *Ruiz**v. Koss, et al.*, Circuit Court, Milwaukee County, Wisconsin,No. 10CV002422 (February 16, 2010) and *Mentkowskiv. Koss, et al*., Circuit Court, Milwaukee County, Wisconsin, No. 10CV002290(February 18, 2010).  These twoshareholder derivative suits have been consolidated under Master File No. 10CV002422.

 

·                      On February 18,2010, the Company filed an action against American Express Company, AmericanExpress Travel Related Services Company, Inc., AMEX Card Services Company,Decision Science, and Pamela S. Hopkins in Superior Court of Maricopa County,Arizona, case no. CV2010-006631, alleging various claims of aiding and abettingbreach of fiduciary duty, aiding and abetting fraud, conversion, and negligencerelating to the unauthorized transactions.

 

·                      On June 24,2010, the Company filed an action against its former independent auditor, GrantThornton, LLP, and Ms. Sachdeva, in Circuit Court of Cook County, Illinois,alleging various claims of accounting malpractice, negligent misrepresentation,and fraud relating to the unauthorized transactions.

 

Through the date of issuance of this 10-K/A, theCompany has received $1,400,000 from its insurance company.

 

*QuarterlyInformation* — On February 19, 2010 and June 3, 2010,the Company received notice from Nasdaq that because the Company’s QuarterlyReports on Form 10-Q for the three months ended December 31, 2009 andMarch 31, 2010, respectively, did not contain financial statements, theywere incomplete and did not comply with Listing Rule 5250(c)(1), which requiresthe timely filing of periodic financial statements.  In each case, the financial statements weredelayed because of the restatements required as a result of the unauthorizedtransactions.  Nasdaq granted the Companyuntil June 30, 2010 to amend these filings with the required financialstatements.  On June 30, 2010, theCompany amended its Quarterly Reports on Form 10-Q/A for the three 

 

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monthsended December 31, 2009 and March 31, 2010 to include consolidatedfinancial statements.  The Company hasalso restated the consolidated financial information in the Quarterly Reportson Form 10-Q/A for the three months ended September 30, 2009 toreflect the effect of the unauthorized transactions.  This Annual Report on Form 10-K/A shouldbe read in conjunction with those filings on Form 10-Q/A.

 

*StockSplit* - On September 10, 2009, NASDAQ notified the Company that it nolonger met the minimum 750,000 publicly held shares requirement under Listing Rule 5450(b)(1)(B).  The Company remedied its noncompliance withListing Rule 5450(b)(1)(B) by completing a two-for-one forward stocksplit on December 1, 2009.  TheCompany notes that all share and per-share data in the consolidated financialstatements included in this Form 10-K/A have been adjusted to give effectto the stock split, but that the Company has not amended other information inthis Form 10-K/A, such as the market information on the Company’s commonstock required by Part II, Item 5 (Market for Registrant’s CommonEquity), that was affected solely by the effects of the stock split.

 

*Index* — Thefollowing items of the Form 10-K have been modified or revised in thisAmendment No. 1 to Form 10-K/A to reflect these restatements:

 
| Part I, Item  1.   |   | Business                                                                                    |
|------------------------------|--------|---------------------------------------------------------------------------------------------|
|                         |   |                                                                                        |
| Part I, Item  1A.  |   | Risk  Factors                                                                               |
|                         |   |                                                                                        |
| Part II, Item  6.  |   | Selected  Financial Data                                                                    |
|                         |   |                                                                                        |
| Part II, Item  7.  |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                         |   |                                                                                        |
| Part II, Item  8.  |   | Financial  Statements and Supplementary Data                                                |
|                         |   |                                                                                        |
| Part II, Item  9.  |   | Changes  in and Disagreements with Auditors on Accounting and Financial Disclosure          |
|                         |   |                                                                                        |
| Part II, Item  9A. |   | Controls  and Procedures                                                                    |
|                         |   |                                                                                        |
| Part IV, Item  15. |   | Exhibits  and Financial Statement Schedules                                                 |

 

In addition to theamendments described above, the Company has corrected its reporting status bychecking the “smaller reporting company” box on the cover page of this Form 10-K/A.

 

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**CAUTIONARYSTATEMENT REGARDING FORWARD-LOOKING STATEMENTS**

 

This Annual Report onForm 10-K/A contains forward-looking statements within the meaning of thatterm in the Private Securities Litigation Reform Act of 1995 (the “Act”)(Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934). Additional written or oral forward-looking statements may be made by theCompany from time to time in filings with the Securities Exchange Commission,press releases, or otherwise.  Statementscontained in this Form 10-K/A that are not historical facts are forward-lookingstatements made pursuant to the safe harbor provisions of the Act.  Forward-looking statements may include, butare not limited to, projections of revenue, income or loss and capitalexpenditures, statements regarding future operations, anticipated financingneeds, compliance with financial covenants in loan agreements, plans foracquisitions or sales of assets or businesses, plans relating to products orservices of the Company, assessments of materiality, predictions of futureevents, the effects of pending and possible litigation and assumptions relatingto the foregoing.  In addition, when usedin this Form 10-K/A, the words “anticipates,” “believes,” “estimates,” “expects,”“intends,” “plans” and variations thereof and similar expressions are intendedto identify forward-looking statements.

 

Forward-looking statementsare inherently subject to risks and uncertainties, some of which cannot bepredicted or quantified based on current expectations.  Consequently, future events and actualresults could differ materially from those set forth in, contemplated by, orunderlying the forward-looking statements contained in this Form 10-K/A,or in other Company filings, press releases, or otherwise.  In addition to the factors discussed in thisForm 10-K/A, other factors that could contribute to or cause suchdifferences include, but are not limited to, developments in any one or more ofthe following areas: future fluctuations in economic conditions, thereceptivity of consumers to new consumer electronics technologies, the rate andconsumer acceptance of new product introductions, competition, pricing, thenumber and nature of customers and their product orders, production by thirdparty vendors, foreign manufacturing, sourcing, and sales (including foreigngovernment regulation, trade and importation concerns), borrowing costs,changes in tax rates, pending or threatened litigation and investigations, andother risk factors which may be detailed from time to time in the Company’sSecurities and Exchange Commission filings.

 

Readers are cautioned not toplace undue reliance on any forward-looking statements contained herein, whichspeak only as of the date hereof.  TheCompany undertakes no obligation to publicly release the result of anyrevisions to these forward-looking statements that may be made to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunexpected events.

 

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**PART I**

 

**ITEM 1.                  BUSINESS.**

 

**GENERAL**

 

As used herein, the term “Company”means Koss Corporation and its consolidated wholly-owned subsidiary, KossClassics Ltd. (“Koss Classics”), unless the context otherwise requires.  The Company was incorporated in Delaware in1971.

 

The Company operates in theaudio/video industry segment of the home entertainment industry through itsdesign, manufacture and sale of stereo headphones and related accessoryproducts.  The Company reports itsresults as a single reporting segment, as the Company’s principal business lineis the design, manufacture and sale of stereo headphones and relatedaccessories.

 

The Company’s products aresold through national retailers, international distributors, audio specialtystores, the Internet, direct mail catalogs, regional department store chains,discount department stores, military exchanges and prisons under the “Koss”name.  The Company also sells products todistributors for resale to school systems, and directly to other manufacturesfor inclusion with their own products. The Company has more than 250 domestic dealers and its products arecarried in approximately 17,000 domestic retail outlets and numerous retailersworldwide.  International markets areserved by domestic sales representatives and a sales office in Switzerlandwhich utilizes independent distributors in several foreign countries.  The Company has one subsidiary, KossClassics.

 

Ninety-nine percent of theCompany’s products are stereo headphones for listening to music.  The products are not significantlydifferentiated by their retail sales channel or application with the exceptionof products sold to school systems and prisons. There are no other product line differentiations other than the qualityof the sound produced by the stereo headphone itself, which is highlysubjective.  The business could also beclassified by distribution channel.

 

The Company sources completeheadphones manufactured to its specifications from various manufacturers inAsia as well as raw materials used to produce headphones at its plant inMilwaukee.  Management believes that ithas sources of complete headphones and raw materials that are adequate for itsneeds.

 

There are no employment orcompensation commitments between the Company and its dealers.  The Company has several independentmanufacturer’s representatives as part of its distribution efforts.  The Company typically signs one yearcontracts with these manufacturer’s representatives.  These agreements are seldom renewed inwriting, but continue from year to year. The Company has a manufacturer’s representative agreement with a firm inDetroit to work exclusively in the automotive arena.  The automotive representative is paid 2% forall business in this area. The Company’s remaining agreements withdistributors, past or present, pertain to distribution arrangements in foreigncountries.  The arrangements with foreigndistributors do not contemplate that the Company pays any compensation otherthan any profit the distributors make upon their sale of the Company’sproducts.  The Company has the right toterminate these agreements with foreign distributors without cause.

 

**INTELLECTUALPROPERTY**

 

John C. Koss is recognizedfor creating the stereophone industry with the first SP3 stereophone in1958.  The Company regularly applies forregistration of its trademarks in many countries around the world in which itdoes business, and over the years the Company has had numerous trademarksregistered and patents issued in countries in North America, South America,Asia, Europe, Africa, and Australia.  TheCompany currently has 369 trademarks registered in 85 countries around theworld and patents in 26 countries.  TheCompany has trademarks to protect the brand name, Koss, and its logo on itsproducts.  These trademarks aremaintained throughout the countries in which the Company sells itsproducts.  The Company also holds manydesign patents that protect the unique visual appearance of some of itsproducts.  These trademarks and patentsare important to differentiate the 

 

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Company from itscompetitors.  Certain of the Company’strademarks are of material value and importance to the conduct of itsbusiness.  The Company considersprotection of its proprietary developments important; however, the Company’sbusiness is not, in the opinion of management, materially dependent upon anysingle trademark or patent.  During theyear ended June 30, 2009, the Company took steps to update and monitor itspatents and trademarks to protect its intellectual property around the world.

 

See Part II, Item7 - “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS” herein for information relating to the Company’s licenseagreements.

 

**SEASONALITY**

 

Although retail sales ofconsumer electronics have typically been higher during the holiday season,stereophones have also seen increased interest as gift items over theyears.  Management of the Companybelieves that its business and industry segment are no longer seasonal as evidencedby the fact that 56% of net sales occurred in the first six months of the yearended June 30, 2009, and 44% of net sales occurred in the latter sixmonths of the year.  Management believesthat the reason for this level performance of sales to retailers is related tothe fact that stereo headphones have become replacement items for portableelectronic products.  Therefore, upgradesand replacements appear to have as much interest over the course of the year asgifts of stereophones during the holiday season.

 

**WORKINGCAPITAL AND BACKLOG**

 

The Company’s workingcapital needs do not differ substantially from those of its competitors in theindustry and generally reflect the need to carry significant amounts ofinventory to meet delivery requirements of its customers.  From time to time, although rarely, theCompany may extend payment terms to its dealers for a special promotion.  For instance, the Company has in the pastoffered a 90-120 day payment period for certain customers, such as computerretailers and office supply stores. Based on historical trends, management does not expect these practicesto have any material effect on net sales or net income.  The Company’s backlog of orders as ofJune 30, 2009 is not considered material in relation to net sales during2009 or anticipated 2010 net sales.

 

**CUSTOMERS**

 

The Company markets a lineof products used by consumers to listen to music, DVD’s in vehicles, soundbytes on computer systems, and other audio related media.  The Company distributes these productsthrough retail channels in the U.S. and independent distributors throughout therest of the world.  The Company marketsits products to approximately 17,000 domestic retailers and numerous retailersworldwide.  During 2009, the Company’ssales to its largest single customer, Wal-Mart Stores, Inc., wereapproximately 22% of net sales and sales to an independent distributor inScandinavia accounted for 17% of 2009 net sales.  The Company is dependent upon its ability toretain a base of retailers and distributors to sell the Company’s line of products.  Loss of retailers and distributors means lossof product placement.  The Company hasbroad distribution across many channels including specialty stores, massmerchants, electronics stores, and computer retailers.  Management believes that any loss of revenueswould be partially offset by a corresponding decrease, on a percentage basis,in expenses; thereby partially reducing the impact on the Company’s operatingincome.  The five largest customers ofthe Company (including Wal-Mart Stores, Inc. and the Scandinaviandistributor) accounted for approximately 54% and 50% of total net sales in 2009and 2008, respectively.

 

**COMPETITION**

 

The Company focuses on thestereo headphone industry.  In thestereophone market, the Company competes directly with approximately five majorcompetitors, several of which are large and diversified and have greater totalassets and resources than the Company. The Company’s single product focus is unique in the marketplace.  The extent to which retailers view theCompany as an innovative vendor of high quality headphone products, and aprovider of excellent after sales customer service, is the extent to which theCompany maintains a competitive 

 

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advantage.  The Company relies upon its unique sound,quality workmanship, brand identification, engineering skills, and customerservice to maintain its competitive position.

 

**RESEARCHAND DEVELOPMENT**

 

The amount expensed onengineering and research activities relating to the development of new productsor the improvement of existing products was approximately $1,559,000 during2009 as compared with $726,000 during 2008. These activities were conducted byboth Company personnel and outside consultants.

 

**ENVIRONMENTALMATTERS**

 

The Company believes that ithas materially complied with all currently existing federal, state and localstatutes and regulations regarding environmental standards and occupationalsafety and health matters to which it is subject.  During the years 2009 and 2008, the amountsincurred in complying with federal, state and local statutes and regulationspertaining to environmental standards and occupational safety and health lawsand regulations did not materially affect the Company’s earnings or financialcondition.

 

**EMPLOYEES**

 

As of June 30, 2009,the Company employed 72 people, who are all non-union.  The Company also utilizes temporarypersonnel.

 

**FOREIGNSALES**

 

The Company’s competitiveposition and risks relating to the conduct of its business in such markets arecomparable to the domestic market.  Inaddition, the governments of foreign nations may elect to erect trade barrierson imports.  The creation of additional barrierswould reduce the Company’s net sales and profit.  In addition, any fluctuations in currencyexchange rates could affect the pricing of the Company’s products and divertcustomers who might choose to purchase lower-priced, less profitable products,and could affect overall demand for the Company’s products.  For further information, see Part II, Item7 and Note 14 to the consolidated financial statements accompanying thisForm 10-K/A.

 

The Company has a smallsales office in Switzerland to service the international exportmarketplace.  The Company is aware of nomaterial risks in maintaining this operation. Loss of this office would result in a transfer of sales and marketingresponsibility.  The Company sells itsproducts to independent distributors in countries and regions outside theUnited States, including Europe, the Middle East, Africa, Asia, South America,Latin America, the Caribbean, and Mexico. The Company sells products in the Canadian market through a distributorwho services smaller specialty accounts. During the last two years, net sales of all Koss products, weredistributed as follows:

 
| ** **          | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|---------------------|------------|------------|------------|------------|------------|
| U.S.                |       | $          | 24,222,039 |       | $          | 29,962,809 |   |
| Europe              |       | 15,744,430 |       | 16,870,177 |       |
| All other countries |       | 1,750,645  |       | 2,251,335  |       |
| Net sales           |       | $          | 41,717,114 |       | $          | 49,084,321 |   |

 

In addition to amanufacturing facility in the United States, the Company uses contractmanufacturing facilities in the People’s Republic of China, Taiwan and SouthKorea.  These independent supplierentities are distant from the Company, which means that we are at risk ofbusiness interruptions due to natural disasters, war, disease and governmentintervention through tariffs or trade restrictions that are of less concerndomestically.  The Company maintainsfinished goods inventory in its U.S. facility to mitigate this risk.  The Company’s goal is to stock finished goodsinventory at an average of approximately 90 days demand per item.  Recovery of a single facility throughreplacement of a supplier in the event of a disaster or suspension of supplycould take 120 days.  The Companybelieves that it could restore production of its top ten selling models (whichrepresent 70% of the 

 

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Company’s sales revenue)within one year.  The Company is also atrisk if the trade restrictions are introduced on its products based uponcountry of origin.  In addition, mostincreases in tariffs and freight charges would not be acceptable to pass alongto the Company’s customers and would directly impact the Company’sprofits.  Finally, an additional area ofconcern for the Company is with the continuing “War on Terror” and the mostrecent developments in North Korea and Iran. Three of the Company’s largest distributors outside the U.S. havealready experienced a general tightening of the availability of credit.

 

**AVAILABLEINFORMATION**

 

The Company’s internetwebsite is http://www.koss.com.  TheCompany makes available free of charge through its internet website the Company’sannual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K, proxy statements and all amendments to those reportsas soon as reasonably practicable after they are electronically filed with (orfurnished to) the SEC.  These reports andother information regarding the Company are also available on the SEC’sinternet website at http://www.sec.gov.

 

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**ITEM 1A.               RISK FACTORS.**

 

Investing in the Company’scommon stock involves a high degree of risk. Any of the following risks couldhave a material adverse effect on the Company’s financial condition, liquidityand results of operations or prospects, financial or otherwise.

 

**REDUCTIONIN PRESENT LEVELS OF CASH FLOW COULD ADVERSELY AFFECT THE COMPANY’S BUSINESS**

 

The Company’s primary sourceof liquidity over the past 12 months has been operating cash flows.  The Company’s future cash flows fromoperations (on both a short term and long term basis) are dependent upon, butnot limited to:

 
| · | the Company’s ability to  attract new customers that will sell the Company’s products and pay for them;                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | the Company’s ability to  retain the Company’s existing customers at the level of sales previously  produced;                                                                 |
| · | the volume of sales for  these customers;                                                                                                                                               |
| · | the loss of business of  one or more primary customers;                                                                                                                                 |
| · | changes in types of  products that the customers purchase in their sales mix;                                                                                                           |
| · | the Company’s ability to  negotiate favorable royalty arrangements in the future as the one license  agreement that it had in 2009 terminated during the fourth quarter;           |
| · | poor or deteriorating  economic conditions which would directly impact the ability of the Company’s  customers to remain in business and pay for their products on a timely basis; |
| · | Management’s ability to  minimize the impact of requests for increases in material or labor cost  increases; and                                                                   |
| · | the ability to collect in  full and in a timely manner amounts due to the Company.                                                                                                      |

 

In addition, as noted above,the Company’s cash flow is also dependent, to some extent, upon the ability tomaintain operating margins. The continuing general downturn in economic conditionsor other events that caused the Company’s customers to turn to lower-priced,lower-margin products, could cause the Company’s cash flow and profitability tobe materially and adversely affected.

 

**FAILURE TOATTRACT AND RETAIN CUSTOMERS TO SELL THE COMPANY’S PRODUCTS COULD ADVERSELYAFFECT SALES VOLUME AND FUTURE PROFITABILITY**

 

The Company markets a lineof products used by consumers to listen to music.  The Company distributes these productsthrough retail channels in the U.S. and independent distributors throughout therest of the world.  The Company isdependent upon its ability to retain an existing base of customers to sell theCompany’s line of products.  Loss ofcustomers means loss of product placement. The Company has broad distribution across many channels includingspecialty stores, mass merchants, electronics stores and computerretailers.  Any loss of a customerdirectly translates into a reduction in sales volume which can only be replacedby adding a similar number of representative retail outlets.  The inability of the Company’s sales andmarketing staff to obtain new distribution outlets translates into a lack offuture growth and possibly a setback in sales volumes when loss of currentcustomers occur.  For example, the lossof a customer representing 10% of the Company’s business would translate into areduction in revenues of up to 10% based upon the point through the year thatthe customer was lost.  Attracting a newcustomer during the course of a year could have a positive impact or simplyreplace an account which has been lost. In addition, a customer can decide to make a change in the models thatit decides to offer for sale.  Suchchanges can take place arbitrarily throughout the course of a year which cancause reductions in sales revenues in proportion to the number of retailoutlets that the store represents in the market.  The Company may not be able to maintaincustomers or model selections and therefore experience a reduction in its salesrevenue until a model is restored to the mix or a customer is replaced by a newcustomer.  A reduction in sales volumewould cause a reduction in profitability. The Company’s failure to retain existing customers, obtain new customersor develop new product lines that customers would choose to offer to consumerscould 

 

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significantly affect theCompany’s future profitability.  The lossof business of one or more principal customers or a change in the sales volumefrom a particular customer could have a material adverse effect on the Company’ssales volume and profitability.

 

**SHIFT INCUSTOMER SPECIFICATIONS TO LOWER PRICED ITEMS CAN REDUCE PROFIT MARGINSNEGATIVELY IMPACTING PROFITABILITY**

 

The Company sells a line ofproducts with a suggested retail price ranging from less than $10 up to$1,000.  The gross margin for each ofthese models is unique in terms of percentages. The price range of the products also produces a different level ofactual dollar contribution per unit.  Forexample, a product with a gross margin contribution of 50% might yield a $5contribution for one item, while another item may feature a 30% gross marginwhich could yield $50.  The Company findsthe low priced portion of the market most competitive and therefore mostsubject to pressure on gross margin percentages, which tends to lower profitcontributions.  Retail preference forlower priced items can reduce profit margins and contributions.  The risk is that a shift in retail customerspecifications toward lower priced items can lead to lower gross margins andlower profit contributions per unit of sale. Due to the range of products that the Company sells, the product salesmix can produce a variation in terms of a range of profit margins.  Some customers sell a limited range ofproducts that yield lower profit margins than others.  Most notably, the budget priced headphonesegment of the market below $10 retail, which is distributed through computerstores, office supply stores and mass market retailers, tend to yield thelowest gross margins.  An increase inbusiness with these types of accounts, if coupled with a simultaneous reductionin sales to customers with higher gross margins, would reduce profit marginsand profitability.

 

**POORECONOMIC CONDITIONS CAN RESTRICT OR LIMIT PRODUCT PLACEMENT, SALES ANDREPLENISHMENT WHICH COULD DECREASE PROFITS**

 

Deteriorating or weakeconomic conditions, or a forecast for the same, can trigger changes ininventory stocking at retail customers. This may in turn lead to a reduction in model offerings and/or out ofstock situations.  If a retail customerof the Company does not have adequate supply of the Company’s products to offerfor sale in a retail store, consumers may choose another competitive modelinstead.  Customers operating retailstores anticipate future sales demands and stock inventory accordingly.  Whenever a general economic slowdown occurs,at both the domestic and/or foreign level, sales volume levels and re-ordervolume levels change.  These changesdirectly impact the Company’s sales and profitability.  The Company is not in a position to determinehow it will be affected by these circumstances, how extensive the effects maybe, or for how long the Company may be impacted by these circumstances.  The Company’s customers respond to changes ineconomic conditions and any adverse changes in economic conditions cantherefore restrict product placement, availability, sales, replenishment andultimately profitability.  Theseconditions exist domestically and internationally.

 

**MANAGEMENTIS SUBJECT TO DECISIONS MADE OUTSIDE ITS CONTROL WHICH COULD DIRECTLY AFFECTFUTURE PROFITABILITY**

 

Retail customers determinewhich products they will stock for resale. The Company competes with other manufacturers to secure shelf space inretail stores for the Company’s products. During the course of a year, changes in the customers’ managementpersonnel can ultimately lead to changes in the stock assortment offered toconsumers.  These changes are oftenarbitrary.  In addition to changes inpersonnel within the Company’s customers, it is also possible that a strategicdecision can be made by a retail customer to consolidate vendors, or to discontinuecertain product categories altogether. In these instances, the Company’s management team may not be able toconvince customers to reverse such decisions. The Company’s management team is also engaged in the effectiveprocurement, assembly and manufacture of products.  The ability to negotiate with suppliers,maintain productivity and hold the line on cost increases can be subjected topressures outside the control of management. For example, increases in fuel costs can increase freight rates.  Increases of this nature can seldom beavoided and the Company may not be able to pass such increases along to itscustomers.  Management’s effectivecontrol of the manufacturing processes will have a direct impact on the Company’sfuture profitability.  The Companyregularly makes decisions that affect production schedules, shipping schedules,employee levels 

 

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and inventory levels.  The Company’s ability to make effectivedecisions in managing these areas has a direct effect on future profitability.

 

**ACCOUNTSRECEIVABLE AMOUNTS DUE FROM OUR CUSTOMERS CAN BE LOST AS A RESULT OF CUSTOMERBANKRUPTCY, OPERATIONAL DIFFICULTY, OR FAILURE TO PAY, NEGATIVELY IMPACTINGFUTURE PROFITABILITY**

 

The Company has significantaccounts receivable or other amounts due from the Company’s customers.  The outstanding accounts receivable, net ofallowance for doubtful accounts, at the end of the last four quarters averagedapproximately $5,500,000.  Terms ofpayment for customers generally range from cash in advance of delivery to net120 day credit terms.  These creditarrangements are negotiated at unspecified and irregular intervals.  The largest customers generate the largestreceivable balances.  If a customerdevelops operational difficulty it is not uncommon to temporarily suspendpayment to vendors.  The Company issubject to this risk in the retail marketplace. From time to time a customer may develop severe operating losses whichcan lead to a bankruptcy.  In thesecases, the Company may lose most of the outstanding balance due.  Occasionally, the Company has been currentwith a customer at the time such an event occurs.  The more material risk is that of losing therevenue of the customer which might be more onerous than losing the currentoutstanding accounts receivable.  Inaddition, many companies that will typically insure accounts receivables willnot do so for the Company’s largest mass market customers.  The risk is that the Company derives most ofthe Company’s sales revenue and profits from selling products to retailers forresale to consumers.  The failure of theCompany’s customers to pay in full amounts due to the Company could negativelyaffect future profitability.

 

**COMPANYPROFITS CAN SUFFER FROM INTERRUPTIONS IN SUPPLY CHAIN**

 

The Company uses contractmanufacturing facilities in the People’s Republic of China, Taiwan and SouthKorea.  These independent supplierentities are distant from the Company which means that the Company is at riskof business interruptions due to natural disaster, war, disease and governmentintervention through tariffs or trade restrictions that are of less concerndomestically.  An additional area ofconcern for the Company is with the continuing “War on Terror” and the mostrecent developments in North Korea and Iran. Three of the Company’s largest distributors outside the U.S. havealready experienced a general tightening of the availability of credit inrecent months, which we believe to be partly a result of certain of theseexternal concerns.  Therefore, if thereare any interruptions in the supply chain for any of these reasons, this coulddirectly impact the Company’s profits in a negative way.  The Company is also at risk if traderestrictions are imposed on the Company’s products based upon country oforigin.  In addition, any increase intariffs and freight charges may not be acceptable to pass along to the Company’scustomers and could directly impact the Company’s profits.

 

**FLUCTUATIONSIN CURRENCY EXCHANGE RATES COULD AFFECT PRICING OF PRODUCTS AND CAUSE CUSTOMERSTO PURCHASE LOWER-PRICED, LESS PROFITABLE PRODUCTS AND COULD AFFECT OVERALLDEMAND FOR THE COMPANY’S PRODUCTS**

 

The Company receives amaterial portion of its sales and profits from business in Europe.  To the extent that value of the U.S. dollarincreases relative to currencies in those jurisdictions, it increases the costof the Company’s products in those jurisdictions, which could create negativepressure on the overall demand for the Company’s products.  The Company gets paid by its internationalcustomers in U.S. dollars.  To the extentthat increased prices arising from currency fluctuations decrease the overalldemand for the Company’s products and the Company’s sales or motivate customersto purchase lower-priced, lower profit products, the Company’s sales, profitsand cash flows could be adversely affected.

 

**COMPANYPROFITS CAN SUFFER FROM INCREASING MANUFACTURING COSTS IN CHINA AS A RESULT OFINCREASED WAGES AND WAGE TAXES**

 

The Company uses contractmanufacturing facilities in the People’s Republic of China.  An increase in the cost of labor or taxes onwages in China may lead to an increase in the cost of goods manufactured inChina.  The cost of labor and wage taxeshave increased in China which means that the Company is at risk of highermanufacturing 

 

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costs associated with goodsmanufactured in China.  Significantincreases in wages or wage taxes paid by contract manufacturing facilities mayincrease the cost of goods manufactured in China which could have a materialadverse effect on the Company’s profit margins and profitability.

 

**THE COMPANYUSES THIRD PARTY CARRIERS TO SHIP ITS PRODUCTS WHICH MAY PASS ON INCREASESIN TRANSPORTATION-RELATED FUEL COST TO THE COMPANY WHICH CAN REDUCE PROFITMARGINS NEGATIVELY IMPACTING PROFITABILITY**

 

The Company uses numerousthird party carriers to ship product, both domestically andinternationally.  If the price of fuelincreases and the carriers choose to pass on the increase to the Company,freight costs may increase.  As a result,the Company’s freight cost is impacted by changes in fuel prices.  Fuel prices affect freight costs to bothcustomer’s location and the Company’s distribution center.  Increases in fuel prices and surcharges andother factors have increased and may continue to increase freight costs in thefuture.  This inflationary pressure ofhigher fuel costs and continued increase in transportation-related costs couldhave a material adverse effect on the Company’s profit margins andprofitability.

 

**CONSISTENCYOF THE COMPANY’S BUSINESS WITH SEVERAL U.S. RETAILERS**

 

The Company is particularlyconcerned about the consistency of business with several U.S. retailers.  The recent tightening of credit availabilityworldwide caused all retailers to sharply curtail inventory increases.  The Company has already seen someconsolidation in product lines and item elimination, or reductions at severalbig box retailers.  The Company alsorecognizes the struggle that many of the Company’s automobile customers havebeen reporting in the news and the potential impact that a reduction inautomobile unit sales might have upon the Company’s rear seat entertainmentproducts for the automotive market in the coming year.

 

**THECOMPANY IS CURRENTLY UNABLE TO ASSESS THE AMOUNTS THAT MAY BE RECOVERED THROUGHTHE PROCEEDS FROM THE SALE OF ITEMS SEIZED BY LAW ENFORCEMENT, INSURANCE,POTENTIAL CLAIMS AGAINST THIRD PARTIES OR TAX REFUNDS*.***

 

TheCompany has estimated that the amount of the unauthorized transactions isapproximately $31,500,000 since fiscal year 2005 through December 31,2009.  Over 25,000 items have been seizedby law enforcement authorities. Although the Company intends to pursue proceedsfrom the sale of items seized by law enforcement authorities, as well as frominsurance coverage, potential claims against third parties and tax refunds, theCompany cannot reasonably assess the amounts or timing of such recoveries.  Through the date of issuance of this 10-K/A,the Company has received $1,400,000 from its insurance company.  The Company’s inability to recover its lossescould have a significant and adverse effect on its future financial condition.

 

**LEGALPROCEEDINGS RELATED TO THE UNAUTHORIZED TRANSACTIONS MAY ADVERSELY AFFECTTHE COMPANY’S RESULTS OF OPERATIONS, CASH FLOWS AND FINANCIAL CONDITION.**

 

As further described in the Explanatory Note, theCompany is currently addressing several legal matters related to theunauthorized transactions. The Company is unable at this time to quantifyits exposure, if any.  The costs ofdealing with these matters and any penalties and awards that may be assessedagainst the Company could be substantial and may adversely affect the Company’sfuture results of operations, cash flows and financial condition.

 

**THECOMPANY’S STOCK PRICE MAY FLUCTUATE AS A RESULT OF THE UNAUTHORIZEDTRANSACTIONS AND BECAUSE OF THE UNCERTAINTIES ABOUT THEIR EFFECT ON THE COMPANY’SFINANCIAL CONDITION.**

 

Uncertaintiesabout the effect of the unauthorized transactions and significant developmentsrelated to the unauthorized transactions, such as the results of therestatements of the Company’s previously issued consolidated 

 

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financialstatements, the legal matters described above or the results andrecommendations of the Independent Investigation could cause fluctuation in theCompany’s stock price.  The Company’s common stock could also besubject to wide fluctuations in response to additional business factors such asthe following:

 
| · | the  sale or availability for sale of substantial amounts of the Company’s common  stock;                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                 |
| · | actual  or anticipated fluctuations in the Company’s operating results or its  competitors’ operating results;                                                             |
|   |                                                                                                                                                                                 |
| · | announcements  by the Company or its competitors of new products;                                                                                                                    |
|   |                                                                                                                                                                                 |
| · | capacity  changes, significant contracts, acquisitions or strategic investments;                                                                                                     |
|   |                                                                                                                                                                                 |
| · | the  Company’s growth rate and its competitors’ growth rates;                                                                                                              |
|   |                                                                                                                                                                                 |
| · | changes  in stock market analyst recommendations regarding the Company, its competitors  or the industry generally, or lack of analyst coverage of the Company’s  common stock; |
|   |                                                                                                                                                                                 |
| · | sales  of the Company’s common stock by its executive officers, directors and  significant stockholders or sales of substantial amounts of common stock; and                    |
|   |                                                                                                                                                                                 |
| · | changes  in accounting principles.                                                                                                                                                   |

 

**ANY FUTURE INABILITY OF THECOMPANY TO COMPLY WITH NASDAQ’S LISTING RULES COULD RESULT IN A LOSS OFLIQUIDITY FOR THE COMPANY’S COMMON STOCK IF ITS SHARES ARE DELISTED BY NASDAQ.**

 

On September 10, 2009,NASDAQ notified the Company that it no longer met the minimum 750,000 publiclyheld shares requirement under Listing Rule 5450(b)(1)(B).  The Company remedied its noncompliance withListing Rule 5450(b)(1)(B) by implementing a two-for-one forwardstock split on December 1, 2009.  OnFebruary 16, 2010 and on May 17, 2010, as a result of effects of theunauthorized transactions, the Company filed incomplete Form 10-Q’s forthe periods ended December 31, 2009 and March 31, 2010, respectivelythat did not include quarterly consolidated financial statements.  NASDAQ Listing Rule 5250(c)(1) requiresthe timely filing of consolidated financial statements in periodic reportsfiled with the SEC.  On June 30,2010, the Company filed amended Form 10-Q/A’s for both quarters that includethe required unaudited quarterly consolidated financial statements.  Although the filing of the Form 10-Q/A’sshould remedy the Company’s noncompliance with NASDAQ Listing Rule 5250(c)(1) theCompany cannot be certain of NASDAQ’s concurrence or that the Company will notviolate NASDAQ’s listing rules in the future, which could result in thedelisting of the Company’s common stock from the NASDAQ Stock Exchange.

 

**THE COMPANY’S INTERNAL CONTROLOVER FINANCIAL REPORTING FAILED TO TIMELY DETECT AND PREVENT THE UNAUTHORIZEDTRANSACTIONS AND IT IS POSSIBLE THAT WE HAVE NOT IMPLEMENTED EFFECTIVE REMEDIALMEASURES.**

 

The Company’s internalcontrols as of June 30, 2009 were not effective in that they failed totimely detect and prevent the circumvention of the internal controls andprocedures relating to the unauthorized transactions.  Management has implemented remedial measuresto address the issues identified, but there is no assurance that thesedeficiencies have been adequately addressed or that the Company has discoveredall of the deficiencies that may exist in the internal control over financialreporting.  The Independent Investigationis ongoing and it is possible that the Company and/or the Independent Committeemay identify additional deficiencies regarding the Company’s internal controlover financial reporting.

 

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**THE COMPANY’S DETERMINATION THATPREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS SHOULD NO LONGER BE RELIEDUPON AND THE RESTATEMENT OF THE COMPANY’S CONSOLIDATED FINANCIAL STATEMENTS HASSUBJECTED THE COMPANY TO INCREASED COSTS FOR ACCOUNTING AND LEGAL FEES.**

 

As previously disclosed inForms 8-K filed December 24, 2009 and January 4, 2010 and asdiscussed elsewhere in this Form 10-K/A and in Note 2 to the restatedconsolidated financial statements, the Company determined that its previouslyissued consolidated financial statements for all prior years and interimperiods dating back to fiscal year ended 2005 should no longer be relied uponbecause of errors in such consolidated financial statements. The Companyfurther determined to issue in this report its restated and auditedconsolidated balance sheets as of June 30, 2009 and June 30, 2008,and related consolidated statements of operations, cash flows and stockholders’equity for the years then ended.  Thisrestatement has subjected the Company to significant costs in the form ofaccounting, legal fees and similar professional fees, in addition to thesubstantial diversion of time and attention of the Company’s Chief FinancialOfficer and members of its accounting department in preparing therestatement.  Although the restatement iscomplete, no assurance can be given that the Company will not incur additionalcosts associated with the restatement.

 

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**PART II**

 

**ITEM 6.****                                                 ****SELECTED FINANCIAL DATA.**

 

Not applicable.

 

**ITEM 7.****                                                 ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS.**

 

*The following discussion should be read in conjunction withthe Restated Consolidated Financial Statements and relatednotes.  References made to years are for fiscal year periods. All share and per-share data have been adjusted to give effect to the stocksplit on December 1, 2009.*

 

*The purpose of this discussion and analysis is to enhancethe understanding and evaluation of the results of operations, financialposition, cash flows, indebtedness and other key financial information of theCompany for fiscal years 2009 and 2008.  For a more completeunderstanding of this discussion, please read the Notes to ConsolidatedFinancial Statements included in this report.*

 

*This discussion and analysis has been updated to address theresults of the restatement described in the Explanatory Note to this report.*

 

**Overview**

 

TheCompany developed stereo headphones in 1958 and has been a leader in theindustry.  We market a complete line ofhigh-fidelity stereophones, speaker-phones, computer headsets,telecommunications headsets, active noise canceling stereophones, wirelessstereophones and compact disc recordings of American Symphony Orchestras on theKoss Classics label. We operate as one business segment.

 

***Unauthorized Transactions and Restatement*** — In December 2009,the Company discovered significant unauthorized transactions made by Ms. Sachdevawhich totaled approximately $31,500,000 from fiscal 2005 through December 2009.  The volume of these unauthorized transactionsincreased significantly over time, from $5,099,900 in 2008, to $8,498,434 in2009, to $10,286,988 from July 1, 2009 until the unauthorized transactionswere discovered in December 2009**. **The Company subsequently learnedthat Ms. Sachdeva colluded with two other employees of the accountingdepartment in the misappropriation and circumvention of the Company’s existinginternal controls and established operating procedures.  In carrying out the unauthorizedtransactions, these three former employees failed to adhere to the Company’sexisting procedures for processing payments and concealed the misappropriationsfrom management, including the directors and remaining officers of theCompany.  Various accounting methods andaccounting entries were used to conceal the unauthorized transactions.  As a result of these unauthorizedtransactions, we are restating our consolidated financial statements in thisannual report on Form 10-K/A.  Seethe Explanatory Note to this Form 10-K/A and Note 2 to the ConsolidatedFinancial Statements for additional discussion of the unauthorized transactionsand restatement.

 

***Operations*** — Net sales declined to $41,717,114 in 2009compared with $49,084,321 in 2008.  This $7,367,207 decrease in netsales was primarily driven by soft retail sales in the United States andEurope.  Including the unauthorizedtransactions as an expense, the Company had an operating loss of $340,094 in2009, compared to operating income of $5,663,325 in 2008.  Thedecrease in operating income was primarily driven by the lower sales volume andthe unauthorized transactions.  In 2009and 2008, the losses related to the unauthorized transactions, exclusive ofcorrections for accounting errors, were $8,498,434 and $5,099,900,respectively, resulting in an increase of $3,398,534 in 2009.  Operating income, excluding the unauthorizedtransactions, was $8,158,340 in 2009 or 19.6% of net sales compared to$10,763,225 or 22.0% of net sales in 2008.

 

***Restatement*** —The restatedconsolidated financial statements included in this Form 10-K/A, correcterrors in a majority of the financial statement line items in the previouslyissued consolidated financial statements for all 

 

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periods presented.  The errors resulted from falsifications bythe terminated employees including Ms. Sachdeva to conceal themisappropriations from management.  Themost significant errors (by dollar amount) consist of the following:

 

·                                          The unauthorized transactionswere not properly accounted for as losses and disclosed as a separate line itemon the income statement as an expense.

 

·                                          Net sales were understatedin all years because of journal entries made to conceal certainmisappropriations.

 

·                                          Cost of sales was overstatedas a result journal entries made to conceal certain misappropriations.

 

·                                          Administrative expenses wereoverstated as a result of journal entries made to conceal certainmisappropriations.

 

·                                          Accounts receivable wasoverstated due to delayed posting of cash, as a method used to conceal certainmisappropriations, and failing to provide for an allowance for certain doubtfulaccounts that was also used to conceal certain misappropriations.

 

·                                          Cash was not properlyreconciled and was overstated due to the unauthorized transactions at June 30,2009 and 2008.

 

·                                          Disposals of equipment andleasehold improvements were not properly recorded and assets no longer used inthe business were not properly removed from the financial records.

 

·                                          Other assets were improperlystated due to errors in applying accounting principles generally accepted inthe United States of America (“GAAP”).

 

·                                          Accounts payable wasunderstated at June 30, 2009 and 2008 due to an erroneous transaction thatwas posted to accounts payable in 2009 and improper cutoff of transactions inboth years.

 

·                                          Other accruedliabilities, including product warranty obligations and deferred compensation,have been adjusted to properly apply GAAP or to correct the estimates used toprepare the previously filed consolidated financial statements.

 

Since the discovery of theunauthorized transactions in December 2009, the Company has incurredsignificant increased costs due to the Independent Investigation and therestatement of its consolidated financial statements as a result of theunauthorized transactions and the Company is pursuing reimbursement ofapplicable expenses based on its available insurance coverage.  See the Explanatory Note to this Form 10-K/Afor additional discussion of these costs.

 

**2009 Resultsof Operations Compared with 2008**

 

***Sales and Gross Profit***

 

Netsales for 2009 totaled $41,717,114, compared with $49,084,321 in2008.  This $7,367,207 or 15.0% decrease in net sales was driven bysoft retail sales in the United States and Europe.  The majority of the decline came in theUnited States as export sales were off just 8.5% from a record year in2008.  The majority of the sales declinecame later in 2009 as the economic conditions worsened for consumers, retailersand distributors.  Sales of certain nicheproducts such as the PortaPro have held up very well during these difficulteconomic times and mitigated some of the overall sales decline.

 

Grossprofit in 2009 was $18,548,692 or 44.5% of net sales compared to $20,940,292 or42.7% of net sales in 2008.  Thisincreased gross margin percentage was driven by a more favorable product mix,lower material costs 

 

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andreduced overhead spending.  Material, asa percentage of gross sales, declined by approximately 1% from 2008 to2009.  Overhead costs were reduced assales declined and certain costs related to individual markets were eliminated.

 

***Selling, General and Administrative Expenses***

 

Selling,general and administrative expenses for 2009 were $10,390,352, as compared to$10,177,067 for 2008.  The increase in selling, general and administrativeexpenses was the result of increased new product development spending,additional dealer show expense and a gain in 2008 for the sale of Bi-Audiointangible assets.  New productdevelopment expenditures increased from approximately $726,000 in 2008 toapproximately $1,559,000 in 2009 as we focus on expanding the product line inhigh-end stereo headphones and expand consumers’ listening options with newproducts.  In 2008, the Company soldcertain intangible assets of its Bi-Audio division for $700,000 and recorded again of $151,133 which was credited to selling, general and administrativeexpenses.  In addition, 2008 costsincluded costs of $350,000 related to the Susan G. Komen Foundation for thecreation and sale of two pink stereophone models to raise awareness and researchdollars to find a cure for cancer. These increases were partially offset bydecreased spending on commissions, resulting from the lower sales, and reducedspending on employee profit-sharing and management bonuses driven by the lowerprofit in 2009 compared to 2008.

 

***Unauthorized Transactions***

 

In2009, the unauthorized transactions totaled $8,498,434 compared to $5,099,900in 2008.

 

***Operating Income***

 

2009had an operating loss including the unauthorized transactions of $340,094compared to operating income of $5,663,325 in 2008.  The decrease inoperating income was the result of lower volume, increased unauthorizedtransactions and increased spending on new product development and dealershows.  Operating income, excluding theunauthorized transactions, was $8,158,340 or 19.6% of net sales in 2009compared to $10,763,225 or 22.0% of net sales in 2008.

 

***Provision for Income Taxes***

 

Incometax benefit for 2009 was $75,434 as compared to $2,533,505 of income taxprovision in 2008.  The effective income tax rate was 22.7% in 2009and 42.3% in 2008.  The main variance in effective tax rate for 2009compared to the combined federal and state statutory rate of 37% was the impactof permanent tax differences in a year that was close to breakevenearnings.  For 2008, the higher effectivetax rate is driven by a higher state rate and the unfavorable impact ofpermanent tax differences.

 

**Liquidityand Capital Resources**

 

***Operating Activities***

 

Wecurrently use cash generated from operations and underlying working capital asfinancial measurements to evaluate the performance of our operations and ourability to meet our financial obligations.  We require workingcapital investment to maintain our position as a leading developer andmanufacturer of high quality stereophones. The primary drivers of these requirements are production costs,distribution costs and finished goods inventories to support our customers’requirements for short lead time.  As part of our continuousimprovement of purchasing and manufacturing processes, we continue to strivefor alignment of inventory levels with customer demand and current productionschedules.

 

During2009, cash provided by operations was $2,646,146, and during 2008, cashprovided by operations was $5,428,106. Working capital was $6,308,239 at June 30, 2009 and $12,210,161 atJune 30, 2008.  The net decrease inworking capital of $5,901,922 from June 30, 2008 to June 30, 2009represents primarily the net change in accounts receivable and cash and cashequivalents.  The decrease in accountsreceivable reflects the 

 

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declinein sales for the fourth quarter of 2009 compared to the fourth quarter of2008.  Depreciation charges totaled $728,054and $852,215 in years 2009 and 2008, respectively.

 

***Investing Activities***

 

Cashused in investing activities for 2009 was $2,345,298 as compared to $922,340used in investing activities for 2008.  Cash used in investingactivities for 2009 was driven by $2,071,795 of capital expenditures, mainlyconsisting of product software development expenditures and tooling to supportproduction.  Cash used in investingactivities in 2008 was primarily due to $1,298,837 of capital expenditures,including product software development expenditures.  These expenditures were partially offset by$700,000 received from the sale of certain Bi-Audio assets.  Budgeted capital expenditures for equipmentand product software for year 2010 are approximately $2,000,000.  The Company expects to generate sufficientfunds through operations to fund these expenditures.

 

***Financing Activities***

 

Netcash used in financing activities declined from $5,462,051 in 2008 to$1,964,205 in 2009.  Dividends paid tostockholders declined from $5,592,511 in 2008, which included a one-timespecial dividend, to $1,920,585 in 2009. Dividends paid in 2009 were at the Company’s normal rate of $0.26 pershare.  The Company intends to continueits regular quarterly dividends for the foreseeable future.

 

In2008, the Company purchased $244,409 of common stock under the stock repurchaseprogram.  2008 also included approximately$1,039,000 of non-cash transactions related to the stock repurchase program. Commonstock purchases in 2009 were only $43,620 under the stock repurchaseprogram.  The Company would intend torepurchase stock when appropriate given the market price for the stock and theCompany’s cash position.  In 2008,proceeds of $374,869 from stock option exercises were received.  No stock options were exercised in 2009.

 

*CreditFacilities -*On February 16, 2009, the Company entered intoa credit facility with Harris N.A. for an unsecured line of credit for up to amaximum of $10,000,000 up to and including January 29, 2010.  On October 9, 2009 the credit facilitywas extended to December 31, 2010. The credit facility replaced the Company’s previous credit facility,which was terminated and contained substantially the same terms as the Company’snew credit facility.  The Company coulduse the credit facility for working capital, to refinance existingindebtedness, for stock repurchase and for general corporate purposes.  Borrowings under the credit facility boreinterest at either the bank’s most recently publicly announced prime rate or ata London Interbank Offered Rate (“LIBOR”) based rate plus 1.25% determined inaccordance with the loan agreement.  Thecredit facility included certain financial covenants that required the Companyto maintain a minimum tangible net worth, liabilities to tangible net worthratios and interest coverage ratios. The tangible net worth of the Company mustnot fall below $10,000,000 at any time. The maximum leverage of the Company,which consists of the ratio of its consolidated liabilities to its consolidatedtangible net worth, must not exceed 1.5 to 1.0. The interest coverage of the Company, which consists of the ratio of itsearnings before interest, income taxes, depreciation, amortization and othernon-cash charges to its consolidated interest charges, must not be less than2.0 to 1.0.  The Company has been and iswell within these requirements.  TheCompany used its credit facility from time to time, although there was noutilization of this credit facility at June 30, 2009 or June 30,2008.

 

On May 12, 2010, theCompany entered into a new secured credit facility with JPMorgan Chase Bank,N.A. (“Lender”).  The Credit Agreementdated May 12, 2010 between the Company and the Lender (“Credit Agreement”)provides for an $8,000,000 revolving secured credit facility and for letters ofcredit for the benefit of the Company of up to a sublimit of $2,000,000.  The Credit Agreement expires on July 31,2013.  The Company and the Lender alsoentered into the Pledge and Security Agreement dated May 12, 2010 underwhich the Company granted the Lender a security interest in substantially allof the Company’s assets in connection with the Company’s obligations under theCredit Agreement.  As described in theCompany’s partial 10-Q for the period March 31, 2010 that was filed on May 17,2010, the Company’s credit facility with Harris N.A. was terminated on May 12,2010 and the outstanding balance of $5,863,349 as of that date was fullyrepaid.

 

*StockRepurchase Program* - In April 1995, the Board of Directorsapproved a stock repurchase program authorizing the Company to purchase fromtime to time up to $2,000,000 of its common stock for its own account.  Subsequently, the Board of Directorsperiodically has approved increases of between $1,000,000 to 

 

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$5,000,000in the stock repurchase program.  As ofJune 30, 2009, the most recently approved increase was for additionalpurchases of $2,000,000, which occurred in October 2006, for an aggregatemaximum of $45,500,000, of which $43,360,247 had been expended throughJune 30, 2009.  The Company intendsto effect all stock purchases either on the open market or through privatelynegotiated transactions and intends to finance all stock purchases through itsown cash flow or by borrowing for such purchases.

 

During2009, the Company purchased 7,996 shares of its common stock at an average netprice of $5.46 per share, for a total purchase price of $43,620.  As of June 30, 2009, the Board ofDirectors has authorized the repurchase by the Company of up to $2,139,753 inCompany common stock at the discretion of the Chief Executive Officer of theCompany.

 

***Off-Balance Sheet Arrangements***

 

TheCompany has no off-balance sheet arrangements other than the lease for thefacility in Milwaukee, Wisconsin, which it leases from its Chairman, John C.Koss.  On August 15, 2007, the leasewas renewed for a period of five years, ending June 30, 2013, and is beingaccounted for as an operating lease.  Thelease extension maintained the rent at a fixed rate of $380,000 per year.  Management believes the lease is on terms noless favorable to the Company than those that could be obtained from anindependent party.  The Company isresponsible for all property maintenance, insurance, taxes and other normalexpenses related to ownership.  Thefacility is in good repair and, in the opinion of management, is suitable andadequate for the Company’s business purposes.

 

**Critical AccountingPolicies**

 

Ourdiscussion and analysis of financial condition and results of operations isbased upon our Consolidated Financial Statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of these Consolidated Financial Statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  We continually evaluate ourestimates and judgments, including those related to doubtful accounts, productreturns, excess inventories, warranties, impairment of long-lived assets,deferred compensation, income taxes and other contingencies.  We baseour estimates on historical experience and assumptions that we believe to bereasonable under the circumstances.  Actual results may differ fromthese estimates.

 

***Revenue Recognition***

 

The Company recognizes revenue when all of thefollowing criteria are met: persuasive evidence of an arrangement exists;delivery has occurred; the seller’s price to the buyer is fixed anddeterminable; and collectibility is reasonably assured.  When these criteria are generally satisfied,the Company recognizes revenue.  TheCompany also offers certain customers the right to return products that do notmeet the standards agreed with the customer. The Company continuously monitors such product returns, and while suchreturns have historically been minimal, the Company cannot guarantee that theywill continue to experience the same return rates that they have experienced inthe past.  Any significant increase inproduct quality failure rates and the resulting credit returns could have amaterial adverse impact on the Company’s operating results for the period orperiods in which such returns materialize.

 

The Company provides for certain salesincentives.  The Company records aprovision for estimated incentives based upon the incentives offered tocustomers on product related sales in the same period as the related revenuesare recorded.  The provision is recordedas a reduction of sales.  The Companyalso records a provision for estimated sales returns and allowances on productrelated sales in the same period as the related revenues are recorded.  These estimates are based on historical salesreturns, analysis of credit memo data and other known factors.  If the historical data the Company uses tocalculate these estimates does not properly reflect future returns, adjustmentsmay be required in future periods.

 

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***Royalty Income***

 

The Company’s operations are affected by the levelsof royalty income generated in any given period.  Royalty income is recognized when earnedunder the terms of the Company’s license agreements.  Royalty payments are calculated based uponpredetermined percentages of net sales of the licensed products or based uponminimum quarterly royalty payments. Royalty income is booked monthly, on an accrual basis and the amount theCompany accrues is the monthly equivalent of the minimum royalty payment.  When the royalty payments are received eachquarter, the Company then reduces the account receivable accordingly.  The Company had one royalty agreement thatterminated in the fourth quarter of 2009. As of June 30, 2009, the Company had no license agreements ineffect that would provide for royalty payments.

 

***Accounts Receivable***

 

TheCompany performs ongoing credit evaluations of its customers and adjusts creditlimits 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 collectionsand payments from customers and maintains a provision for estimated creditlosses based upon the Company’s historical experience and any specific customercollection issues that have been identified. The Company values accounts receivable net of an allowance for doubtfulaccounts.  The allowance is calculatedbased upon the Company’s evaluation of specific customer accounts where theCompany has information that the customer may have an inability to meet itsfinancial obligations (bankruptcy, etc.). In these cases, the Company uses its judgment, based on the bestavailable facts and circumstances and records a specific reserve for thatcustomer against amounts due to reduce the receivable to the amount that isexpected to be collected.  These specificreserves are re-evaluated and adjusted as additional information is receivedthat impacts the amount reserved. However, the ultimate collectability of the unsecured receivable isdependent upon the financial condition of an individual customer, which couldchange rapidly and without warning.

 

***Inventories***

 

TheCompany values its inventories at the lower of cost or market.  Cost is determined using the last-in,first-out (“LIFO”) method.  As ofJune 30, 2009, 100% of the Company’s inventory was valued using LIFO.  Valuing inventories at the lower of cost ormarket requires the use of estimates and judgment.  The Company continues to use the sametechniques to value inventory as have been used in the past.  Our customers may cancel their orders orchange purchase volumes.  This, orcertain additional actions, could create excess inventory levels, which wouldimpact the valuation of our inventories. Any actions taken by our customers that could impact the value of ourinventory are considered when determining the lower of cost or marketvaluations.  The Company regularlyreviews inventory quantities on hand and records a provision for excess andobsolete inventory based primarily on our estimated forecast of product demandand production requirements for the next twelve months.  If the Company is not able to achieve itsexpectations of the net realizable value of the inventory at its current value,the Company would have to adjust its reserves accordingly.

 

***Product Software Development Costs***

 

Productsoftware development costs consist of costs incurred by outside parties for thedevelopment of software used to support new products.  These assets have been evaluated to ensurethat the capitalized costs do not exceed the estimated net realizable value ofthe related products.  As part of the impairment analysis, we use adiscounted cash flow model based on estimated sales to be derived in the futureuse of the asset and other estimated costs directly related to theproduct.  No amortization was recorded in 2009 or 2008 as the relatedproducts have not yet been introduced. The Company expects the products to be introduced during fiscal year2011.

 

Thediscounted cash flow model involves many assumptions, including operatingresults forecasts and discount rates.  Inherent in the operatingresults forecasts are certain assumptions regarding revenue growth rates,projected cost saving initiatives and projected long-term growthrates.  The Company performed impairment testing as of June 30,2009 and 2008 and no impairment was identified.

 

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***Product Warranty Obligations***

 

Productssold are generally covered by a lifetime warranty.  We record accruals for potential warrantyclaims based on prior product returns experience.  Warranty costs areaccrued at the time revenue is recognized.  These warranty costs arebased upon management’s assessment of past claims and currentexperience.  However, actual claims could be higher or lower thanamounts estimated, as the amount and value of warranty claims are subject tovariation as a result of many factors that cannot be predicted with certainty.

 

***Income Taxes***

 

Weestimate the effective tax rate expected to be applicable for the full fiscalyear.  If the actual results are different from these estimates,adjustments to the effective tax rate may be required in the period suchdetermination is made.  Additionally, discrete items are treatedseparately from the effective rate analysis and are recorded separately as anincome tax provision or benefit at the time they are recognized.

 

Deferredincome taxes are accounted for under the asset and liability method wherebydeferred income tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.  Deferred income tax assets and liabilities are measured usingstatutory tax rates.  Deferred income tax provisions are based onchanges in the deferred tax assets and liabilities from period toperiod.  Additionally, we analyze our ability to recognize the netdeferred income tax assets created in each jurisdiction in which we operate todetermine if valuation allowances are necessary based on the “more likely thannot” criteria.

 

**NewAccounting Pronouncements**

 

Applicablenew accounting pronouncements are set forth under Item 15 of this annual reportand are incorporated herein by reference.

 

**ITEM 8.****                                               ****FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

 

See the ConsolidatedFinancial Statements attached hereto.

 

**ITEM 9.****                                               ****CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIALDISCLOSURE.**

 

On January 4, 2010, theCompany announced that, upon a recommendation from the Audit Committee andapproval by the Board of Directors, it dismissed Grant Thornton, LLP as itsindependent auditor effective December 31, 2009.  On January 5, 2010, the Company, upon arecommendation from its Audit Committee and approval by the Board of Directors,appointed Baker Tilly as its independent auditor.  Baker Tilly has performed audits of the 2009and 2008 restated consolidated financial statements.

 

The audit reports of GrantThornton, LLP on our Consolidated Financial Statements as of and for the yearsended June 30, 2005 through 2009 did not contain an adverse opinion or adisclaimer of opinion and were not qualified or modified as to uncertainty,audit scope or accounting principles. During the years ended June 30, 2005 through 2009 and subsequentinterim period ended September 30, 2009 there were (1) nodisagreements with Grant Thornton, LLP on any matter of accounting principlesor practices, financial statement disclosure, or auditing scope or procedure,which disagreements, if not resolved to the satisfaction of Grant Thornton,LLP, would have caused it to make reference to the subject matter of thedisagreement in connection with its reports and (2) no “reportable events” asdefined in Item 304(a)(1)(v) of Regulation S-K.

 

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**ITEM 9A.****                                         ****CONTROLS AND PROCEDURES.**

 

**DisclosureControls and Procedures****.**

 

Disclosure controls andprocedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) ofthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) aredesigned to ensure that (1) information required to be disclosed in reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in SEC rules and forms; and(2) that such information is accumulated and communicated to management,including the principal executive officer and principal financial officer, toallow timely decisions regarding required disclosures.  There are inherent limitations to theeffectiveness of any system of disclosure controls and procedures, includingthe possibility of human error, the circumvention or overriding of controls andprocedures and collusion to circumvent and conceal the overriding of controlsand procedures.  Accordingly, eveneffective disclosure controls and procedures can only provide reasonableassurance of achieving their control objectives.

 

In connection with its postremedial measures, the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of the Company’s disclosure controls and procedures asof June 30, 2009, and management has concluded that the Company’sdisclosure controls and procedures were not sufficiently effective in that theyfailed to timely detect the circumvention of the internal controls and proceduresrelated to the processing and recording of the unauthorized transactions.  The failure to timely detect thecircumvention of the Company’s disclosure controls and procedures has resultedin the restatement of the Company’s consolidated financial statements for theperiods covered by this filing.

 

Notwithstanding thisconclusion, the Company’s management believes that the restatement of theconsolidated financial statements in this Annual Report on Form 10-K/Afairly presents, in all material respects, our financial position and resultsof operations and cash flows as of the dates and for the periods presented, inconformity with GAAP.  Such belief isbased on a number of factors, including the Company’s own internal review thatidentified restatements to its previously issued financial statements, theCompany’s efforts to reconcile certain account balances independent of theinternal controls, the Company’s utilization of third party consultingpersonnel to supplement this process, the Company’s efforts to remediate andstrengthen the existing internal controls over assets and financial reporting,and the performance of additional procedures by the Company’s managementdesigned to ensure the reliability of financial reporting.

 

The Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, continues toevaluate the effectiveness of the Company’s disclosure controls and proceduresto identify any enhancements that may provide greater comfort that the Company’sdisclosure controls and procedures are effective to provide reasonableassurance that information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is accumulated andcommunicated to the Company’s management, including its Chief Executive Officerand Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure and are effective to provide reasonable assurance that suchinformation is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms.

 

**Management’sAnnual Report on Internal Controls over Financial Reporting***.*

 

The Company’s management,including its Chief Executive Officer and Chief Financial Officer, isresponsible for establishing and maintaining adequate internal control offinancial reporting (as defined in Exchange Act Rules 13(a)-15(f) and15(d)-15(f)) and designing such internal controls to provide reasonableassurances regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with accountingprinciples generally accepted in the United States of America.  Because of inherent limitations, a system ofinternal control over financial reporting may not prevent or detectmisstatements.  Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate due to change in conditions, or that the degreeof compliance with the policies or procedures may deteriorate.

 

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Management conducted itsevaluation of the effectiveness of its internal control over financialreporting based on the framework in “Internal Control-Integrated Framework”issued by the Committee of Sponsoring Organizations of the Treadway Commission(“COSO”).  Based on this assessment, theCompany’s management, including its Chief Executive Officer and Chief FinancialOfficer, has concluded that the Company’s internal controls and operatingprocedures were circumvented and the circumvention was concealed fromManagement.  As a result, Managementbelieves that the Company’s internal controls contained material weaknesses bynot timely detecting the circumvention of internal controls related to theprocessing and recording of the unauthorized transactions.

 

Changes in Internal Controls

 

The Company has identifiedhow its controls over financial reporting were circumvented and how it isaddressing these matters below.

 

·                        *Auditor review*.  The circumvention of the Company’s internalcontrols and procedures was not detected as part of the Company’s annual auditsand quarterly reviews by its former independent auditor, Grant Thornton,LLP.  As described in the Explanatory Notesection above, on June 24, 2010, the Company filed an action against GrantThornton, LLP and Ms. Sachdeva.

 

·                        *Wire transfers and cashier’schecks.*  Approximately $30,900,000 or98.1% of the total $31,500,000 of unauthorized transactions from fiscal year2005 through December 2009 was misappropriated by circumventing theCompany’s internal controls and other operating procedures for the payment ofCompany expenditures by using wire transfers or cashier’s checks from theCompany’s bank accounts to pay for personal expenditures.  Of the $30,900,000, approximately $8,500,000and $5,100,000 was misappropriated by use of these means during 2009 and 2008,respectively.  Misappropriations by useof wire transfers or cashier’s checks totaled $10,300,000 during 2010.  These unauthorized transactions wereprocessed by circumventing the Company’s policy that all invoices over $5,000were required to be submitted and approved by Michael Koss as the CEO, and allaccounts payable checks generated from the Company’s accounts payable systemwere signed by the CEO.  Moreover, wiretransfers were to be used only for authorized transactions including certaininventory purchases and transfers of funds between the Company’s bankaccounts.  Wire transfers for inventorypurchases and the recurring expense items required the approval by severalemployees including authorized Vice Presidents, while the wire transfersbetween the Company’s bank accounts were processed and approved by Ms. Sachdevaand one of the other terminated employees in the accounting department.  Ms. Sachdeva, by herself and/or bydirecting other employees in the accounting department, ordered cashier’schecks from the Company’s bank accounts to pay for personal expendituresdirectly, thereby circumventing the internal controls and procedures asdescribed above so that these payments would not be submitted through theCompany’s normal accounts payable system. Ms. Sachdeva, by herself and/or by directing others in theaccounting department, processed wire transfers from the Company’s bankaccounts to pay for personal expenditures directly, thereby circumventing theinternal controls and procedures as described above so that these paymentswould not be submitted through the Company’s normal accounts payablesystem.  This has been remediated by: (1) disallowingthe use of any cashier’s checks; (2) enforcing that all wire transfers areinitiated within the financial function and electronically approved by the CEO;and (3) performing an enhanced review, reconciliation and reporting ofcash activities.

 

·                        *Petty cash, manual checks andtraveler’s checks*.  Theremaining misappropriations of approximately $600,000 or 1.9% from the totalamount of $31,500,000 from fiscal year 2005 through December 2009 werecarried out by circumventing the Company’s internal controls and other standardoperating procedures involving the Company’s petty cash system, manual checksystem and policy for using traveler’s checks. In doing so, the Company’s policy requiring that all expense reports besubmitted and approved by the CEO was circumvented.  Out of the estimated $600,000 of these typesof transactions, approximately $91,000 and $110,000 occurred during 2009 and2008, respectively.  

 

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Approximately $107,000 of misappropriationsinvolving the use of the Company’s petty cash system, manual check system andtraveler’s checks policy occurred during 2010. Remediation of these issues has been accomplished by: (1) eliminatingthe petty cash fund so all reimbursements run through normal controlledaccounts payable channels; (2) eliminating the use of manual checks so allcheck disbursements are generated from the Company’s accounts payable systemcheck run; and (3) eliminating the use of traveler’s checks.

 

·                        *Recording of unauthorizedtransactions.*  Ms. Sachdevaand one of the other terminated employees concealed the unauthorizedtransactions by recording numerous erroneous accounting entries in variousaccounts to hide the true nature of the transactions.  The Company has subsequently improved thecontrols and procedures related to journal entries and account reconciliationsto include improved segregation of duties, review and approval of reconciliations,and approval of all manual journal entries.

 

·                        *Performance and review of accountreconciliations. *The Company’sinternal controls and procedures included the performance and review of keyaccount reconciliations, including cash, by the accounting department employeesincluding Ms. Sachdeva, who collectively had over 50 years of experienceat the Company.  Ms. Sachdeva andone of the other terminated employees further concealed the unauthorizedtransactions by failing to properly perform and review these key accountreconciliations on a regular basis, and failing to properly perform the Company’speriod end financial close and reporting processes that were designed toaccurately report the Company’s financial information.  The account reconciliation process has beenimproved and includes proper segregation of duties as well as review andapproval by another person in the financial function.

 

·                        *Corporate standards andwhistleblower policy.*  Thethree terminated employees, including Ms. Sachdeva, failed to comply withthe Company’s established standards of integrity, ethical values and its Codeof Conduct, Code of Ethics and Whistleblower policy.  The Company has taken steps to reinforcethese policies with all of its employees, officers and directors.

 

·                        *Application of GAAP.*  The terminated employees, including Ms. Sachdeva,as the principal accounting officer in charge of financial reporting failed toproperly apply the Company’s established accounting policies and adherence withGAAP.  As a result, certain establishedaccounting policies were not applied correctly and resulted in inaccuracies,both from the fraudulent activity directed by Ms. Sachdeva and themisapplication of GAAP.  The affectedaccounts include equipment and leasehold improvements, cash surrender value oflife insurance, accrued deferred compensation, accrued product warrantyobligations and income taxes payable.  Aspart of the restatement of the consolidated financial statements, the accountswere reviewed in detail and reconciled. Integral to the reconciliation process was a review of all criticalaccounting estimates.

 

·                        *Information Technology.*  The Company’s internal controls andprocedures relating to the Company’s computer system for processing financialtransactions were manipulated to conceal the unauthorized transactions.  As the Company continues to evaluate itsinternal controls, the Company plans to implement a new computer system thatwill be used to improve its processing financial transactions and overallsegregation of duties.

 

The undetected circumventionof internal controls required the restatement of the previously reportedconsolidated financial statements and other related financial disclosuresincluded in this Annual Report on Form 10-K/A.

 

We believe the subsequentchanges to our system of internal controls resulting from these efforts willenhance the Company’s control over financial reporting.  We continue to diligently and vigorouslyreview our financial and reporting controls and procedures.  As we continue to evaluate and work to improveour internal control over financial reporting, we may take additional measuresto address any additional control deficiencies we may identify.

 

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**PART IV**

 

**ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.**

 

The following documents arefiled as part of this report:

 

1.                                       ConsolidatedFinancial Statements

 

Thefollowing consolidated financial statements of Koss Corporation and Subsidiary areset forth on pages 27 to 61:

 
| Report  of Independent Registered Public Accounting Firm                                               | 30 |
|--------------------------------------------------------------------------------------------------------|----|
| Consolidated  Statements of Operations for the Years Ended June 30, 2009 and 2008                 | 31 |
| Consolidated  Balance Sheets as of June 30, 2009 and 2008                                         | 32 |
| Consolidated  Statements of Cash Flows for the Years Ended June 30, 2009 and 2008                 | 33 |
| Consolidated  Statements of Stockholders’ Equity for the Years Ended June 30, 2009 and  2008 | 34 |
| Notes to Consolidated Financial Statements                                                             | 35 |

 

2.                                       FinancialStatement Schedules

 

All schedules have beenomitted because the information is not applicable, is not material or becausethe information required is included in the consolidated financial statementsor the notes thereto.

 

3.                                       Exhibits Filed

 

SeeExhibit Index attached hereto.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Tothe Board of Directors

KossCorporation

Milwaukee,Wisconsin

 

Wehave audited the accompanying consolidated balance sheets of Koss Corporationand Subsidiary (the “Company”) as of June 30, 2009 and 2008, and therelated consolidated statements of operations, stockholders’ equity and cashflows for the years then ended. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  TheCompany is not required to have, nor were we engaged to perform, an audit ofits internal control over financial reporting. Our audits included consideration of its internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the consolidated financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement as well as evaluating the overall consolidated financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above present fairly,in all material respects, the financial position of Koss Corporation andSubsidiary as of June 30, 2009 and 2008 and the results of theiroperations and their cash flows for each of the two years in the period ended June 30,2009, in conformity with U.S. generally accepted accounting principles.

 

Asdiscussed in Note 2 to the consolidated financial statements, the Company hasrestated its previously issued consolidated balance sheets as of June 30,2009 and 2008, and its related consolidated statements of operations,stockholders’ equity and cash flows for the years then ended.

 

Asdiscussed in Note 17 to the consolidated financial statements, the Company hasbeen named in several legal matters.  Inaddition, the Company has also initiated certain legal actions against thirdparties.

 

/s/Baker Tilly Virchow Krause, LLP

 

Milwaukee,Wisconsin

June 30,2010

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENTS OFOPERATIONS

 
| **Years Ended June 30,**              | ** ** | **2009**                   | ** ** | **2008**                   | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                           | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
| Net sales                                            |       | $                          | 41,717,114 |                       | $          | 49,084,321 |   |
| Cost of goods sold                                   |       | 23,168,422                 |       | 28,144,029                 |       |
| Gross profit                                         |       | 18,548,692                 |       | 20,940,292                 |       |
|                                                 |       |                       |       |                       |       |
| Operating Expenses:                                  |       |                       |       |                       |       |
| Selling, general and administrative expenses         |       | 10,390,352                 |       | 10,177,067                 |       |
| Unauthorized transactions                            |       | 8,498,434                  |       | 5,099,900                  |       |
| Total Operating Expenses                             |       | 18,888,786                 |       | 15,276,967                 |       |
|                                                 |       |                       |       |                       |       |
| (Loss) income from operations                        |       | (340,094                   | )          | 5,663,325                  |       |
|                                                 |       |                       |       |                       |       |
| Other Income (Expense):                              |       |                       |       |                       |       |
| Royalty income                                       |       | 208,750                    |       | 349,374                    |       |
| Interest income                                      |       | 15,503                     |       | 119,464                    |       |
| Interest expense                                     |       | (216,751                   | )          | (145,009                   | )          |
| Total Other Income, net                              |       | 7,502                      |       | 323,829                    |       |
|                                                 |       |                       |       |                       |       |
| (Loss) income before income tax (benefit)  provision |       | (332,592                   | )          | 5,987,154                  |       |
|                                                 |       |                       |       |                       |       |
| Income tax (benefit) provision                       |       | (75,434                    | )          | 2,533,505                  |       |
|                                                 |       |                       |       |                       |       |
| Net (loss) income                                    |       | $                          | (257,158   | )                          | $          | 3,453,649 |   |
|                                                 |       |                       |       |                       |       |
| (Loss) earnings per common share:                    |       |                       |       |                       |       |
| Basic                                                |       | $                          | (0.03      | )                          | $          | 0.47 |   |
| Diluted                                              |       | $                          | (0.03      | )                          | $          | 0.47 |   |
|                                                 |       |                       |       |                       |       |
| Dividends declared per common share                  |       | $                          | 0.26       |                       | $          | 0.76 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 
| **As of June 30,**                                                                                                   | ** ** | **2009**                   | ** ** | **2008**                   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                                                                          | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
| ASSETS                                                                                                                              |       |                       |       |                       |       |
| Current Assets:                                                                                                                     |       |                       |       |                       |       |
| Cash and cash equivalents                                                                                                           |       | $                          | 1,498,876  |                       | $          | 3,162,233 |   |
| Accounts receivable, less allowance for doubtful  accounts of $1,588,923 and $1,343,386, respectively                               |       | 4,660,727                  |       | 8,170,995                  |       |
| Inventories                                                                                                                         |       | 8,708,835                  |       | 8,432,335                  |       |
| Prepaid expenses                                                                                                                    |       | 151,337                    |       | 199,155                    |       |
| Deferred income taxes                                                                                                               |       | 1,385,497                  |       | 1,499,941                  |       |
| Total Current Assets                                                                                                                |       | 16,405,272                 |       | 21,464,659                 |       |
|                                                                                                                                |       |                       |       |                       |       |
| Equipment and leasehold improvements, net                                                                                           |       | 2,240,572                  |       | 2,174,855                  |       |
|                                                                                                                                |       |                       |       |                       |       |
| Other Assets:                                                                                                                       |       |                       |       |                       |       |
| Product software development costs                                                                                                  |       | 1,727,040                  |       | 673,302                    |       |
| Deferred income taxes                                                                                                               |       | 6,311,282                  |       | 3,441,524                  |       |
| Cash surrender value of life insurance                                                                                              |       | 2,917,223                  |       | 2,510,156                  |       |
| Other assets                                                                                                                        |       | 25,000                     |       | 100,000                    |       |
| Total Other Assets                                                                                                                  |       | 10,980,545                 |       | 6,724,982                  |       |
|                                                                                                                                |       |                       |       |                       |       |
| Total Assets                                                                                                                        |       | $                          | 29,626,389 |                       | $          | 30,364,496 |   |
|                                                                                                                                |       |                       |       |                       |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                           |       |                       |       |                       |       |
| Current Liabilities:                                                                                                                |       |                       |       |                       |       |
| Accounts payable                                                                                                                    |       | $                          | 3,122,721  |                       | $          | 3,196,108 |   |
| Accrued liabilities                                                                                                                 |       | 2,090,054                  |       | 2,653,689                  |       |
| Dividends payable                                                                                                                   |       | 479,876                    |       | 480,395                    |       |
| Income taxes payable                                                                                                                |       | 4,404,382                  |       | 2,924,306                  |       |
| Total Current Liabilities                                                                                                           |       | 10,097,033                 |       | 9,254,498                  |       |
|                                                                                                                                |       |                       |       |                       |       |
| Long-Term Liabilities:                                                                                                              |       |                       |       |                       |       |
| Deferred compensation                                                                                                               |       | 1,541,240                  |       | 1,326,698                  |       |
| Derivative liability                                                                                                                |       | 125,000                    |       | 125,000                    |       |
| Other liabilities                                                                                                                   |       | 725,000                    |       | 742,000                    |       |
| Total Long-Term Liabilities                                                                                                         |       | 2,391,240                  |       | 2,193,698                  |       |
|                                                                                                                                |       |                       |       |                       |       |
| Total Liabilities                                                                                                                   |       | 12,488,273                 |       | 11,448,196                 |       |
|                                                                                                                                |       |                       |       |                       |       |
| Stockholders’ Equity:                                                                                                          |       |                       |       |                       |       |
| Common stock, $0.005 par value, authorized  20,000,000 shares; issued and outstanding 7,382,706 and 7,390,702 shares,  respectively |       | 36,914                     |       | 36,954                     |       |
| Paid in capital                                                                                                                     |       | 1,056,975                  |       | 657,895                    |       |
| Retained earnings                                                                                                                   |       | 16,044,227                 |       | 18,221,451                 |       |
| Total Stockholders’ Equity                                                                                                     |       | 17,138,116                 |       | 18,916,300                 |       |
|                                                                                                                                |       |                       |       |                       |       |
| Total Liabilities and Stockholders’ Equity                                                                                     |       | $                          | 29,626,389 |                       | $          | 30,364,496 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENTS OFCASH FLOWS

 
| **Years Ended June 30,**                                                   | ** ** | **2009**                   | ** ** | **2008**                   | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                                | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                       |       |                       |       |
| Net (loss) income                                                                         |       | $                          | (257,158   | )                          | $          | 3,453,649 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities: |       |                       |       |                       |       |
| Provision for doubtful accounts                                                           |       | 245,537                    |       | 275,760                    |       |
| Provision (provision reversal) for obsolete  inventories                                  |       | 12,358                     |       | (19,746                    | )          |
| Loss on disposals of equipment and leasehold  improvements                                |       | 224,286                    |       | 2,331                      |       |
| Gain on sale of certain Bi-Audio assets                                                   |       | —                     |       | (151,133                   | )          |
| Amortization of intangible assets                                                         |       | —                     |       | 100,774                    |       |
| Depreciation of equipment and leasehold  improvements                                     |       | 728,054                    |       | 852,215                    |       |
| Stock-based compensation expense                                                          |       | 442,660                    |       | 527,738                    |       |
| Provision for deferred income taxes                                                       |       | (2,755,314                 | )          | (1,580,089                 | )          |
| Increase in cash surrender value of life insurance                                        |       | (58,564                    | )          | (49,765                    | )          |
| Deferred compensation                                                                     |       | 214,542                    |       | 181,096                    |       |
| Net changes in operating assets and liabilities  (see note 10)                            |       | 3,849,745                  |       | 1,835,276                  |       |
| Net cash provided by operating activities                                                 |       | 2,646,146                  |       | 5,428,106                  |       |
|                                                                                      |       |                       |       |                       |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                       |       |                       |       |
| Maturity of investments                                                                   |       | 75,000                     |       | 25,000                     |       |
| Life insurance premiums paid                                                              |       | (348,503                   | )          | (348,503                   | )          |
| Proceeds from sale of certain Bi-Audio assets                                             |       | —                     |       | 700,000                    |       |
| Purchases of equipment and leasehold improvements                                         |       | (1,018,057                 | )          | (625,535                   | )          |
| Product software development expenditures                                                 |       | (1,053,738                 | )          | (673,302                   | )          |
| Net cash used in investing activities                                                     |       | (2,345,298                 | )          | (922,340                   | )          |
|                                                                                      |       |                       |       |                       |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                       |       |                       |       |
| Dividends paid to stockholders                                                            |       | (1,920,585                 | )          | (5,592,511                 | )          |
| Purchase of treasury shares                                                               |       | (43,620                    | )          | (244,409                   | )          |
| Exercise of stock options                                                                 |       | —                     |       | 374,869                    |       |
| Net cash used in financing activities                                                     |       | (1,964,205                 | )          | (5,462,051                 | )          |
|                                                                                      |       |                       |       |                       |       |
| Net decrease in cash and cash equivalents                                                 |       | (1,663,357                 | )          | (956,285                   | )          |
| Cash and cash equivalents at beginning of year                                            |       | 3,162,233                  |       | 4,118,518                  |       |
| Cash and cash equivalents at end of year                                                  |       | $                          | 1,498,876  |                       | $          | 3,162,233 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY

 
| ** **                                            | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Retained** | ** ** | ** **   | ** ** |
|-------------------------------------------------------|------------|------------------|------------|-------------|------------|--------------|------------|--------------|------------|
| ** **                                            | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**  | ** ** | **Earnings** | ** ** | **Total** | ** ** |
| Balance, July 1, 2007 (as restated, see Note  2) |       | 7,330,138        |       | $           | 36,651     |         | $          | —       |       | $ | 20,364,249 |   | $ | 20,400,900 |   |
| Net income (as restated)                              |       | —           |       | —      |       | —       |       | 3,453,649    |       | 3,453,649 |   |
| Dividends declared                                    |       | —           |       | —      |       | —       |       | (5,596,447   | )          | (5,596,447 | ) |
| Stock-based compensation expense                      |       | —           |       | —      |       | 527,738      |       | —       |       | 527,738 |   |
| Exercise of stock options                             |       | 188,016          |       | 940         |       | 1,412,929    |       | —       |       | 1,413,869 |   |
| Purchase and cancellation of treasury shares          |       | (127,452         | )          | (637        | )          | (1,282,772   | )          | —       |       | (1,283,409 | ) |
| Balance, June 30, 2008 (as restated)             |       | 7,390,702        |       | 36,954      |       | 657,895      |       | 18,221,451   |       | 18,916,300 |   |
| Net loss (as restated)                                |       | —           |       | —      |       | —       |       | (257,158     | )          | (257,158 | ) |
| Dividends declared                                    |       | —           |       | —      |       | —       |       | (1,920,066   | )          | (1,920,066 | ) |
| Stock-based compensation expense                      |       | —           |       | —      |       | 442,660      |       | —       |       | 442,660 |   |
| Purchase and cancellation of treasury shares          |       | (7,996           | )          | (40         | )          | (43,580      | )          | —       |       | (43,620 | ) |
| Balance, June 30, 2009 (as restated)             |       | 7,382,706        |       | $           | 36,914     |         | $          | 1,056,975    |       | $ | 16,044,227 |   | $ | 17,138,116 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

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KOSS CORPORATION ANDSUBSIDIARY

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

 

1.                                       ACCOUNTINGPOLICIES

 

NATURE OF BUSINESS — KossCorporation and its wholly-owned subsidiary (the “Company”), a DelawareCorporation, reports its finances as a single reporting segment, as theCompany’s principal business line is the design, manufacture and sale of stereoheadphones and related accessories.  TheCompany leases its plant and offices in Milwaukee, Wisconsin.  In addition, the Company has more than 250domestic dealers and its products are carried by approximately 17,000 domesticretailers and numerous retailers worldwide. International markets are served by domestic sales representatives and asales office in Switzerland which utilizes independent distributors in severalforeign countries.  The Company has onesubsidiary, Koss Classics Ltd. (“Koss Classics”).

 

BASIS OF CONSOLIDATION — Theconsolidated financial statements include the accounts of the Company and itssubsidiary, Koss Classics, which is a wholly-owned subsidiary.  All significant intercompany accounts andtransactions have been eliminated.

 

STOCKSPLIT —  On September 10, 2009,NASDAQ notified the Company that it no longer met the minimum 750,000 publiclyheld shares requirement under Listing Rule 5450(b)(1)(B). The Companyremedied its noncompliance with Listing Rule 5450(b)(1)(B) byimplementing a two-for-one forward stock split on December 1, 2009.  Allshare and per-share data have been adjusted to give effect to the stock split.

 

CONCENTRATION OF CREDIT RISK— The Company operates in the audio/video industry segment of the homeentertainment industry through its design, manufacture and sale of stereoheadphones and related accessory products. The Company’s products are sold through national retailers,international distributors, audio specialty stores, the Internet, direct mailcatalogs, regional department store chains and military exchanges under the“Koss” name and dual label.  The Companygrants unsecured credit to its domestic and international customers based onthe extension of credit from 30 to 120 days, depending on the customer.  Collection is dependent on the retailingindustry economy.  The vast majority ofinternational customers, outside of Canada, are sold on a cash againstdocuments or cash in advance basis. Approximately 14% and 22% of the Company’s accounts receivable atJune 30, 2009 and 2008, respectively, were foreign receivables denominatedin U.S. dollars.

 

REVENUE RECOGNITION —Revenue is recognized by the Company when all of the following criteria aremet:  persuasive evidence of anarrangement exists; delivery has occurred; the seller’s price to the buyer isfixed and determinable; and collectibility is reasonably assured.  These criteria are generally satisfied uponshipment of the Company’s products.  TheCompany may periodically offer slotting fees, cooperative advertising programs,rebates and sales discounts and the estimated costs for these items are accruedfor at the time revenue is recognized. These amounts are recorded as a reduction to sales.

 

ROYALTY INCOME — The Companyrecognizes royalty income when earned under the terms of its licenseagreements.  Royalty payments were calculatedbased upon predetermined percentages of net sales of the licensed products orbased upon minimum quarterly royalty payments, as set forth in the Company’slicense agreements.  Royalty income isbooked monthly, on an accrual basis, and the amount that the Company accrues isthe monthly equivalent of the minimum royalty payment.  When the royalty payments are received eachquarter, the Company then applies the payment to accounts receivableaccordingly.  In 2009, the Company hadone license agreement that terminated in the fourth quarter.  As of June 30, 2009, the Company had nolicense agreements in effect that would provide for royalty income.

 

SHIPPING AND HANDLING FEESAND COSTS — Shipping and handling fees are included in cost of goods sold withinthe accompanying consolidated statements of operations.

 

RESEARCH AND DEVELOPMENT —Research and development expenditures charged to operations amounted toapproximately $1,559,000, in 2009 and $726,000 in 2008.

 

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ADVERTISING COSTS —Advertising costs included within selling, general and administrative expensesin the accompanying consolidated statements of operations were approximately$130,000 in 2009 and $119,000 in 2008. Such costs are expensed as incurred.

 

INCOMETAXES — The Company operates as a C Corporation under the Internal Revenue Codeof 1986, as amended (the “Code”). Amounts provided for income tax expense are based on income reported forfinancial statement purposes and do not necessarily represent amounts currentlypayable under tax laws. Deferred income tax assets and liabilities are computedannually for differences between the financial statement and tax bases ofassets and liabilities that will result in taxable or deductible amounts in thefuture based on enacted tax laws and rates applicable to the periods in whichthe differences are expected to affect taxable income. As changes in tax lawsor rates are enacted, deferred income tax assets and liabilities are adjustedthrough the provision for income taxes. The differences relate principally todifferent methods used for depreciation for income tax purposes, net operatinglosses, capitalization requirements of the Code, allowances for doubtfulaccounts and obsolete inventory, unauthorized transactions, warranty reserves,and other carryforwards. Valuation allowances are established when necessary toreduce deferred income tax assets to the amount expected to be realized.

 

EARNINGS (LOSS) PER COMMON SHARE — Earnings (loss) per common share iscalculated under the provisions of Topic 260 in the Accounting StandardsCodification which provides for calculation of “basic” and “diluted” earningsper share.  Basic earnings (loss) percommon share includes no dilution and is computed by dividing net income(loss)  by the weighted average commonshares outstanding for the period. Diluted earnings (loss) per common share reflect the potential dilution ofsecurities that could share in the earnings of an entity.

 

CASH AND CASH EQUIVALENTS —The Company considers depository accounts and investments with a maturity atthe date of acquisition and expected usage of three months or less to be cashand cash equivalents.  The Companymaintains its cash on deposit at commercial banks located in the United Statesof America.  The Company periodically hascash balances in excess of insured amounts. The Company has not experienced and does not expect to incur any losseson these deposits.

 

ACCOUNTS RECEIVABLE —Accounts receivable consists of unsecured trade receivables due fromcustomers.  The Company performs creditevaluations of its customers and does not require collateral to establish anaccount receivable.  The Companyevaluates collectibility of accounts receivable based on a number offactors.  Accounts receivable areconsidered to be past due if unpaid one day after their due date.  An allowance for doubtful accounts isrecorded for significant past due receivable balances based on a review of thepast due item, general economic conditions and the industry as a whole.  The Company writes off accounts receivablewhen they become uncollectible.  Therewere no recoveries of previously written-off accounts receivable during2009.  Changes in the allowance fordoubtful accounts are as follows:

 
| **Year  Ended  June 30,** | ** ** | **Balance,  Beginning  of Year** | ** ** | **Provision  Charged to  Expense** | ** ** | **Amounts  (Recovered)** | ** ** | **Balance at  End Year** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|------------------------------------|------------|
| 2009 (Restated)                     |       | $                                     | 1,343,386  |                                    | 245,537    |                     | —     |                               | $          | 1,588,923 |   |
| 2008 (Restated)                     |       | $                                     | 1,132,062  |                                    | 275,760    |                     | (64,436    | )                                  | $          | 1,343,386 |   |

 

INVENTORIES — As ofJune 30, 2009, 100% of the Company’s inventory was valued at the lower oflast-in, first-out (“LIFO”) cost or market. If the first-in, first-out (“FIFO”) method of inventory accounting hadbeen used by the Company for inventories valued at LIFO, inventories would havebeen $776,307 and $1,213,364 higher than reported at June 30, 2009 and2008, respectively.  Allowance is providedfor obsolete or slow-moving inventory. The Company did not maintain any work-in-process inventories atJune 30, 2009 and June 30, 2008.

 

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The components ofinventories at June 30 are as follows:

 
| ** **                                         | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|----------------------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                                         | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Raw materials                                      |       | $              | 2,609,313  |           | $          | 1,898,658 |   |
| Finished goods                                     |       | 7,032,887      |       | 7,454,684      |       |
|                                               |       | 9,642,200      |       | 9,353,342      |       |
| Allowance for obsolete and slow-moving inventories |       | 933,365        |       | 921,007        |       |
|                                               |       | $              | 8,708,835  |           | $          | 8,432,335 |   |

 

EQUIPMENTAND LEASEHOLD IMPROVEMENTS — Equipment and leasehold improvements are stated atcost.  Depreciation and amortization isprovided using the straight-line method over the estimated useful lives of therespective assets.  Leaseholdimprovements are amortized using the straight-line method over the shorter ofthe lease term or the estimated useful life of the asset.  Major expenditures for property and equipmentand significant renewals are capitalized. Maintenance, repairs and minor renewals are expensed as incurred.  When assets are retired or otherwise disposedof, their costs and related accumulated depreciation and amortization areremoved from the accounts and any resulting gains or losses are included inoperations.

 

PRODUCT SOFTWARE DEVELOPMENT COSTS — The Companyfollows the guidance of ASC 985-20 “Costs of Software to be Sold, Leased, orMarketed” when capitalizing development costs associated with software to beincorporated into its products.  The costof purchased software technology is capitalized and stated at the lower ofunamortized cost or expected net realizable value.  Software is subject to rapid technologicalobsolescence and future revenue estimates supporting the capitalized softwarecost can be negatively affected based upon competitive products, services andpricing.  Such adverse developments couldreduce the estimated net realizable value of our product software developmentcosts and could result in impairment or a shorter estimated life.  Such events would require us to take a chargein the period in which the event occurs or to increase the amortization expensein future periods and would have a negative effect on our results ofoperations. At a minimum, we review for impairments each balance sheetdate.  The Company expects to launch therelated products and begin amortization in 2011.

 

LIFEINSURANCE POLICIES — The Company carries its cash surrender value of lifeinsurance related to its deferred compensation arrangements at values stated bythe insurance carriers, reduced by the value of outstanding policy loans madeto the insured, or at the amount the Company would receive in the case ofsplit-dollar arrangements.  Increases incash surrender value are included in other income in the Consolidated Statements of Operations.  The carrying value of Cash Surrender Value ofLife Insurance has been reduced by $61,157 of policy loans at June 30,2009 and 2008.

 

INVESTMENTS — Included in“Other Assets” at June 30, 2009 and 2008 is $25,000 and $100,000,respectively, of Israel government bonds with maturity dates throughJuly 2009.  Securities areclassified as held-to-maturity when the Company has the positive intent andability to hold the securities to maturity. Held-to-maturity securities are stated at cost, adjusted foramortization of premiums and discounts to maturity.

 

PRODUCT WARRANTY OBLIGATIONS — Estimated future warranty costs related toproducts are charged to cost of goods sold during the period the relatedrevenue is recognized. The product warranty liability reflects the Company’sbest estimate of probable obligations under those warranties. As of June 30,2009 and 2008, the Company has recorded a warranty reserve of $1,087,000 and$1,112,000, respectively.  (See Note 11)

 

DEFERRED COMPENSATION — The Company’s deferredcompensation liabilities are for a current and former officer and arecalculated based on compensation, years of service and mortality tables.  The related expense is included in selling,general and administrative expenses in the Consolidated Statements ofOperations.

 

FAIR VALUE OF FINANCIALINSTRUMENTS — Cash and cash equivalents, accounts receivable and accountspayable approximate fair value based on the short maturity of theseinstruments.

 

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IMPAIRMENTOF LONG-LIVED ASSETS — The Company evaluates the recoverability of the carryingamount of long-lived assets whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be fullyrecoverable.  The Company evaluates therecoverability of equipment and leasehold improvements and product softwaredevelopment costs annually or more frequently if events or circumstancesindicate that an asset might be impaired. If an asset is considered to be impaired, the impairment to berecognized is measured as the amount by which the carrying amount of the assetexceeds its fair value.  Assets to bedisposed of are reported at the lower of the carrying amount or fair value lesscost to sell.  Management determines fairvalue using discounted future cash flow analysis or other accepted valuationtechniques.  Management believes thatthere has not been any impairment of the Company’s long-lived assets as of June 30,2009 and 2008

 

LEGALCOSTS — All legal costs related to litigation are charged to operations asincurred except settlements, which are expensed when a claim is probable andcan be estimated.

 

STOCK-BASED COMPENSATION —The Company has a stock-based employee compensation plan, which is describedmore fully in Note 6.  The Companyaccounts for stock-based compensation in accordance with ASC 718.  Under the fair value recognition provisionsof this statement, share-based compensation cost is measured at the grant datebased on the fair value of the award and is recognized as expense over thevesting period.  Determining the fairvalue of share-based awards at the grant date requires judgment, includingestimating future volatility of the Company’s stock, the amount of share-basedawards that are expected to be forfeited and the expected term of awardsgranted.  The Company estimates the fairvalue of stock options granted using the Black-Scholes option valuationmodel.  The fair value of all awards isamortized on a straight-line basis over the vesting periods.  The expected term of awards granted representthe period of time they are expected to be outstanding.  The Company determines the expected term basedon historical experience with similar awards, giving consideration to thecontractual terms and vesting schedules. The Company estimates the expected volatility of its common stock at thedate of grant based on the historical volatility of its common stock.  The volatility factor used in theBlack-Scholes option valuation model is based on the Company’s historical stockprices over the most recent period commensurate with the estimated expectedterm of the awards.  The risk-freeinterest rate used in the Black-Scholes option valuation model is based on theimplied yield currently available on U.S. Treasury zero-coupon issues with aremaining term commensurate with the expected term of the awards.  Pre-vesting option forfeitures are estimatedusing historical actual forfeitures. Stock-based compensation is recorded only for those options expected tovest.  If actual results differsignificantly from these estimates, stock-based compensation expense and theCompany’s results of operations could be materially impacted.

 

NEW ACCOUNTINGPRONOUNCEMENTS — In September 2006, the FASB issued new accountingguidance (ASC 820) that defines fair value and expands disclosures about fairvalue measurements.  It also establishesa fair value hierarchy that prioritizes information used in developingassumptions when pricing an asset or liability. We adopted this guidance for financial assets and liabilities effectiveJuly 1, 2008. The adoption of the new accounting guidance did not have amaterial effect on our financial statements.

 

InJune 2009, FASB issued, “Accounting Standards Update No. 2009-1,Topic 105 (ASC 105)— Generally Accepted Accounting Principles amendments basedon the Statement of Financial Standards No. 168 — the FASB AccountingStandard Codifications and the Hierarchy of Generally Accepted AccountingPrinciples and Statement of Financial Accounting Standard No. 168, theFASB Accounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles, a replacement of FASB Statement No. 62.” TheAccounting Standards Update and SFAS No. 168 make the FASB Codificationthe authoritative source of GAAP. The FASB Codification is effective forinterim and annual reporting periods ending after September 15, 2009.  The FASB Codification is not expected to havea material impact on our financial reporting.

 

USE OF ESTIMATES — Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date of 

 

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the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

SUBSEQUENT EVENTS —Management has evaluated the impact of all subsequent events and determinedthat all subsequent events have been appropriately recognized and disclosed inthe accompanying consolidated financial statements.

 

2.             RESTATEMENT OF CONSOLIDATEDFINANCIAL STATEMENTS

 

OnDecember 24, 2009 and January 4, 2010, the Company announced that theaudited consolidated financial statements included in our Annual Reports onForm 10-K since fiscal year 2005 and the unaudited condensed consolidatedfinancial statements included in our Quarterly Report on Form 10-Q for thethree months ended September 30, 2009 should no longer be relied upon.

 

Aspreviously disclosed in Form 8-K Current Reports filed on December 21and 24, 2009 and January 4, 7, 11 and 20, 2010, the Company learned ofcertain unauthorized transactions from at least its fiscal years ended June 30,2005 and through December 2009.  TheCompany has determined that its previously issued consolidated financialstatements contained errors resulting from these unauthorized transactions.

 

Aspart of the financial statement review to isolate the unauthorizedtransactions, it was determined that certain accounting policies had not beenapplied properly in the current and prior periods.  As a result, the restatements also includecertain accounting adjustments related to the correction of errors resultingfrom the noncompliance with the Company’s accounting policies.

 

Thefollowing table summarizes the changes to previously reported earnings.  The amounts listed as previously recorded inthe income statement were recorded as reductions to net sales, increases tocost of goods sold or as increases to selling, general and administrativeexpenses in the previously issued consolidated financial statements for theyears ended June 30, 2009 and 2008.

 
| ** **                                                                    | ** ** | **Year ended June 30, 2009** | ** ** | **Year ended June 30, 2008** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                                                    | ** ** | **Restatement**                   | ** ** | **Per Share**                     | ** ** | **Restatement** | ** ** | **Per Share** | ** ** |
| Unauthorized transaction losses                                               |       | $                                 | (8,498,434 | )                                 | $          | (1.15 | ) | $ | (5,099,900 | ) | $ | (0.70 | ) |
| Unauthorized transaction losses previously  recorded in the income statement: |       |                              |       |                              |       |   |   |   |   |
| Net sales                                                                     |       | 3,286,733                         |       | 0.46                              |       | 2,569,100 |   | 0.35 |   |
| Cost of goods sold                                                            |       | 829,829                           |       | 0.11                              |       | 659,363 |   | 0.09 |   |
| Selling, general and administrative expenses                                  |       | 623,749                           |       | 0.08                              |       | 426,889 |   | 0.06 |   |
| Additional restatement adjustments:                                           |       |                              |       |                              |       |   |   |   |   |
| Net sales                                                                     |       | 246,231                           |       | 0.03                              |       | (428,072 | ) | (0.06 | ) |
| Cost of goods sold                                                            |       | 918,762                           |       | 0.12                              |       | 348,399 |   | 0.05 |   |
| Selling, general and administrative expenses                                  |       | (360,858                          | )          | (0.05                             | )          | 188,108 |   | 0.03 |   |
| Royalty income                                                                |       | (49,583                           | )          | (0.01                             | )          | 57,707 |   | 0.01 |   |
| Interest expense                                                              |       | (216,751                          | )          | (0.03                             | )          | (145,009 | ) | (0.02 | ) |
| Loss before income tax benefit                                                |       | (3,220,322                        | )          | (0.44                             | )          | (1,423,415 | ) | (0.19 | ) |
| Income tax effect of restatement                                              |       | (986,496                          | )          | (0.14                             | )          | (382,775 | ) | (0.05 | ) |
| Total reduction in net income                                                 |       | $                                 | (2,233,826 | )                                 | $          | (0.30 | ) | $ | (1,040,640 | ) | $ | (0.14 | ) |

 

Theconsolidated statements of operations, consolidated balance sheets andconsolidated statements of cash flows detailed below reconcile the previouslyreported amounts to the restated amounts being reported on in this AnnualReport on Form 10-K/A.  Therestatement adjustments reflected in the financial statement line items arefurther described below the reconciling consolidated financial statements inthe applicable section to which they pertain.

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENT OFOPERATIONS INFORMATION

 
| ** **                                           | ** ** | **2009**                      | ** ** | ** **      | ** ** | ** **              | ** ** |
|------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|-------------------------|------------|
| **Year  Ended June 30,**                        | ** ** | **(as previously  reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
| Net sales                                            |       | $                             | 38,184,150 |            | $          | 3,532,964               |       | $ | 41,717,114 |   |
| Cost of goods sold                                   |       | 24,917,013                    |       | (1,748,591      | )          | 23,168,422              |       |
| Gross profit                                         |       | 13,267,137                    |       | 5,281,555       |       | 18,548,692              |       |
|                                                 |       |                          |       |            |       |                    |       |
| Operating Expenses:                                  |       |                          |       |            |       |                    |       |
| Selling, general and administrative expenses         |       | 10,653,243                    |       | (262,891        | )          | 10,390,352              |       |
| Unauthorized transactions                            |       | —                        |       | 8,498,434       |       | 8,498,434               |       |
| Total Operating Expenses                             |       | 10,653,243                    |       | 8,235,543       |       | 18,888,786              |       |
|                                                 |       |                          |       |            |       |                    |       |
| Income (loss) from operations                        |       | 2,613,894                     |       | (2,953,988      | )          | (340,094                | )          |
|                                                 |       |                          |       |            |       |                    |       |
| Other Income (Expense):                              |       |                          |       |            |       |                    |       |
| Royalty income                                       |       | 258,333                       |       | (49,583         | )          | 208,750                 |       |
| Interest income                                      |       | 15,503                        |       | —          |       | 15,503                  |       |
| Interest expense                                     |       | —                        |       | (216,751        | )          | (216,751                | )          |
| Total Other Income, net                              |       | 273,836                       |       | (266,334        | )          | 7,502                   |       |
|                                                 |       |                          |       |            |       |                    |       |
| Income (loss) before income tax provision  (benefit) |       | 2,887,730                     |       | (3,220,322      | )          | (332,592                | )          |
|                                                 |       |                          |       |            |       |                    |       |
| Income tax provision (benefit)                       |       | 911,062                       |       | (986,496        | )          | (75,434                 | )          |
|                                                 |       |                          |       |            |       |                    |       |
| Net income (loss)                                    |       | $                             | 1,976,668  |            | $          | (2,233,826              | )          | $ | (257,158 | ) |
|                                                 |       |                          |       |            |       |                    |       |
| Earnings (loss) per common share:                    |       |                          |       |            |       |                    |       |
| Basic                                                |       | $                             | 0.27       |            | $          | (0.30                   | )          | $ | (0.03 | ) |
| Diluted                                              |       | $                             | 0.27       |            | $          | (0.30                   | )          | $ | (0.03 | ) |
|                                                 |       |                          |       |            |       |                    |       |
| Dividends declared per common share                  |       | $                             | 0.26       |            | $          | —                  |       | $ | 0.26 |   |

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENT OFINCOME INFORMATION

 
| ** **                                   | ** ** | **2008**                      | ** ** | ** **      | ** ** | ** **              | ** ** |
|----------------------------------------------|------------|-------------------------------|------------|-----------------|------------|-------------------------|------------|
| **Year  Ended June 30,**                | ** ** | **(as previously  reported)** | ** ** | **Adjustments** | ** ** | **2008  (as restated)** | ** ** |
| Net sales                                    |       | $                             | 46,943,293 |            | $          | 2,141,028               |       | $ | 49,084,321 |   |
| Cost of goods sold                           |       | 29,151,791                    |       | (1,007,762      | )          | 28,144,029              |       |
| Gross profit                                 |       | 17,791,502                    |       | 3,148,790       |       | 20,940,292              |       |
|                                         |       |                          |       |            |       |                    |       |
| Operating Expenses:                          |       |                          |       |            |       |                    |       |
| Selling, general and administrative expenses |       | 10,792,064                    |       | (614,997        | )          | 10,177,067              |       |
| Unauthorized transactions                    |       | —                        |       | 5,099,900       |       | 5,099,900               |       |
| Total Operating Expenses                     |       | 10,792,064                    |       | 4,484,903       |       | 15,276,967              |       |
|                                         |       |                          |       |            |       |                    |       |
| Income from operations                       |       | 6,999,438                     |       | (1,336,113      | )          | 5,663,325               |       |
|                                         |       |                          |       |            |       |                    |       |
| Other Income (Expense):                      |       |                          |       |            |       |                    |       |
| Royalty income                               |       | 291,667                       |       | 57,707          |       | 349,374                 |       |
| Interest income                              |       | 119,464                       |       | —          |       | 119,464                 |       |
| Interest expense                             |       | —                        |       | (145,009        | )          | (145,009                | )          |
| Total Other Income, net                      |       | 411,131                       |       | (87,302         | )          | 323,829                 |       |
|                                         |       |                          |       |            |       |                    |       |
| Income before income tax provision           |       | 7,410,569                     |       | (1,423,415      | )          | 5,987,154               |       |
|                                         |       |                          |       |            |       |                    |       |
| Income tax provision                         |       | 2,916,280                     |       | (382,775        | )          | 2,533,505               |       |
|                                         |       |                          |       |            |       |                    |       |
| Net income                                   |       | $                             | 4,494,289  |            | $          | (1,040,640              | )          | $ | 3,453,649 |   |
|                                         |       |                          |       |            |       |                    |       |
| Earnings per common share:                   |       |                          |       |            |       |                    |       |
| Basic                                        |       | $                             | 0.61       |            | $          | (0.14                   | )          | $ | 0.47 |   |
| Diluted                                      |       | $                             | 0.61       |            | $          | (0.14                   | )          | $ | 0.47 |   |
|                                         |       |                          |       |            |       |                    |       |
| Dividends declared per common share          |       | $                             | 0.76       |            | $          | —                  |       | $ | 0.76 |   |

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED BALANCE SHEETINFORMATION

 
| ** **                                                                                             | ** ** | **2009**                      | ** ** | ** **      | ** ** | ** **              | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|-------------------------|------------|
| **As of  June 30,**                                                                               | ** ** | **(as previously  reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
| ASSETS                                                                                                 |       |                          |       |            |       |                    |       |
| Current Assets:                                                                                        |       |                          |       |            |       |                    |       |
| Cash and cash equivalents                                                                              |       | $                             | 1,664,407  |            | $          | (165,531                | )          | $ | 1,498,876 |   |
| Accounts receivable, less allowance for doubtful accounts  of $1,588,923                               |       | 8,679,606                     |       | (4,018,879      | )          | 4,660,727               |       |
| Inventories                                                                                            |       | 9,763,158                     |       | (1,054,323      | )          | 8,708,835               |       |
| Prepaid expenses                                                                                       |       | 179,549                       |       | (28,212         | )          | 151,337                 |       |
| Deferred income taxes                                                                                  |       | 720,121                       |       | 665,376         |       | 1,385,497               |       |
| Total Current Assets                                                                                   |       | 21,006,841                    |       | (4,601,569      | )          | 16,405,272              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Equipment and leasehold improvements, net                                                              |       | 4,076,198                     |       | (1,835,626      | )          | 2,240,572               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Other Assets:                                                                                          |       |                          |       |            |       |                    |       |
| Product software development costs                                                                     |       | —                        |       | 1,727,040       |       | 1,727,040               |       |
| Deferred income taxes                                                                                  |       | 1,237,727                     |       | 5,073,555       |       | 6,311,282               |       |
| Cash surrender value of life insurance                                                                 |       | —                        |       | 2,917,223       |       | 2,917,223               |       |
| Other assets                                                                                           |       | 2,149,586                     |       | (2,124,586      | )          | 25,000                  |       |
| Total Other Assets                                                                                     |       | 3,387,313                     |       | 7,593,232       |       | 10,980,545              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Assets                                                                                           |       | $                             | 28,470,352 |            | $          | 1,156,037               |       | $ | 29,626,389 |   |
|                                                                                                   |       |                          |       |            |       |                    |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                              |       |                          |       |            |       |                    |       |
| Current Liabilities:                                                                                   |       |                          |       |            |       |                    |       |
| Accounts payable                                                                                       |       | $                             | 1,810,466  |            | $          | 1,312,255               |       | $ | 3,122,721 |   |
| Accrued liabilities                                                                                    |       | 1,153,089                     |       | 936,965         |       | 2,090,054               |       |
| Dividends payable                                                                                      |       | 479,876                       |       | —          |       | 479,876                 |       |
| Income taxes payable                                                                                   |       | 175,568                       |       | 4,228,814       |       | 4,404,382               |       |
| Total Current Liabilities                                                                              |       | 3,618,999                     |       | 6,478,034       |       | 10,097,033              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Long-Term Liabilities:                                                                                 |       |                          |       |            |       |                    |       |
| Deferred compensation                                                                                  |       | 1,095,961                     |       | 445,279         |       | 1,541,240               |       |
| Derivative liability                                                                                   |       | 125,000                       |       | —          |       | 125,000                 |       |
| Other liabilities                                                                                      |       | —                        |       | 725,000         |       | 725,000                 |       |
| Total Long-Term Liabilities                                                                            |       | 1,220,961                     |       | 1,170,279       |       | 2,391,240               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Liabilities                                                                                      |       | 4,839,960                     |       | 7,648,313       |       | 12,488,273              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Stockholders’ Equity:                                                                             |       |                          |       |            |       |                    |       |
| Common stock, $0.005 par value, authorized  20,000,000 shares; issued and outstanding 7,382,706 shares |       | 2,049,384                     |       | (2,012,470      | )          | 36,914                  |       |
| Paid in capital                                                                                        |       | —                        |       | 1,056,975       |       | 1,056,975               |       |
| Retained earnings                                                                                      |       | 21,581,008                    |       | (5,536,781      | )          | 16,044,227              |       |
| Total Stockholders’ Equity                                                                        |       | 23,630,392                    |       | (6,492,276      | )          | 17,138,116              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Liabilities and Stockholders’ Equity                                                        |       | $                             | 28,470,352 |            | $          | 1,156,037               |       | $ | 29,626,389 |   |

 

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CONSOLIDATED BALANCE SHEETINFORMATION

 
| ** **                                                                                             | ** ** | **2008**                      | ** ** | ** **      | ** ** | ** **              | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|-------------------------|------------|
| **As of  June 30,**                                                                               | ** ** | **(as previously  reported)** | ** ** | **Adjustments** | ** ** | **2008  (as restated)** | ** ** |
| ASSETS                                                                                                 |       |                          |       |            |       |                    |       |
| Current Assets:                                                                                        |       |                          |       |            |       |                    |       |
| Cash and cash equivalents                                                                              |       | $                             | 3,322,873  |            | $          | (160,640                | )          | $ | 3,162,233 |   |
| Accounts receivable, less allowance for doubtful accounts  of $1,343,386                               |       | 10,148,646                    |       | (1,977,651      | )          | 8,170,995               |       |
| Inventories                                                                                            |       | 9,374,344                     |       | (942,009        | )          | 8,432,335               |       |
| Prepaid expenses                                                                                       |       | 504,806                       |       | (305,651        | )          | 199,155                 |       |
| Deferred income taxes                                                                                  |       | 783,995                       |       | 715,946         |       | 1,499,941               |       |
| Total Current Assets                                                                                   |       | 24,134,664                    |       | (2,670,005      | )          | 21,464,659              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Equipment and leasehold improvements, net                                                              |       | 2,746,367                     |       | (571,512        | )          | 2,174,855               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Other Assets:                                                                                          |       |                          |       |            |       |                    |       |
| Product software development costs                                                                     |       | —                        |       | 673,302         |       | 673,302                 |       |
| Deferred income taxes                                                                                  |       | 1,066,853                     |       | 2,374,671       |       | 3,441,524               |       |
| Cash surrender value of life insurance                                                                 |       | —                        |       | 2,510,156       |       | 2,510,156               |       |
| Other assets                                                                                           |       | 2,029,123                     |       | (1,929,123      | )          | 100,000                 |       |
| Total Other Assets                                                                                     |       | 3,095,976                     |       | 3,629,006       |       | 6,724,982               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Assets                                                                                           |       | $                             | 29,977,007 |            | $          | 387,489                 |       | $ | 30,364,496 |   |
|                                                                                                   |       |                          |       |            |       |                    |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                              |       |                          |       |            |       |                    |       |
| Current Liabilities:                                                                                   |       |                          |       |            |       |                    |       |
| Accounts payable                                                                                       |       | $                             | 2,950,721  |            | $          | 245,387                 |       | $ | 3,196,108 |   |
| Accrued liabilities                                                                                    |       | 1,808,467                     |       | 845,222         |       | 2,653,689               |       |
| Dividends payable                                                                                      |       | 480,395                       |       | —          |       | 480,395                 |       |
| Income taxes payable                                                                                   |       | 347,507                       |       | 2,576,799       |       | 2,924,306               |       |
| Total Current Liabilities                                                                              |       | 5,587,090                     |       | 3,667,408       |       | 9,254,498               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Long-Term Liabilities:                                                                                 |       |                          |       |            |       |                    |       |
| Deferred compensation                                                                                  |       | 1,047,482                     |       | 279,216         |       | 1,326,698               |       |
| Derivative liability                                                                                   |       | 125,000                       |       | —          |       | 125,000                 |       |
| Other liabilities                                                                                      |       | —                        |       | 742,000         |       | 742,000                 |       |
| Total Long-Term Liabilities                                                                            |       | 1,172,482                     |       | 1,021,216       |       | 2,193,698               |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Liabilities                                                                                      |       | 6,759,572                     |       | 4,688,624       |       | 11,448,196              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Stockholders’ Equity:                                                                             |       |                          |       |            |       |                    |       |
| Common stock, $0.005 par value, authorized  20,000,000 shares; issued and outstanding 7,390,702 shares |       | 1,649,408                     |       | (1,612,454      | )          | 36,954                  |       |
| Paid in capital                                                                                        |       | —                        |       | 657,895         |       | 657,895                 |       |
| Retained earnings                                                                                      |       | 21,568,027                    |       | (3,346,576      | )          | 18,221,451              |       |
| Total Stockholders’ Equity                                                                        |       | 23,217,435                    |       | (4,301,135      | )          | 18,916,300              |       |
|                                                                                                   |       |                          |       |            |       |                    |       |
| Total Liabilities and Stockholders’ Equity                                                        |       | $                             | 29,977,007 |            | $          | 387,489                 |       | $ | 30,364,496 |   |

 

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KOSS CORPORATION ANDSUBSIDIARY

CONSOLIDATED STATEMENT OFCASH FLOW INFORMATION

 
| ** **                                                                                | ** ** | **2009**                     | ** ** | ** **      | ** ** | ** **              | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------|------------|-------------------------|------------|
| **Year  Ended June 30,**                                                             | ** ** | **(as previously reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                         |       |            |       |                    |       |
| Net income (loss)                                                                         |       | $                            | 1,976,668  |            | $          | (2,233,826              | )          | $ | (257,158 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                         |       |            |       |                    |       |
| Provision for doubtful accounts                                                           |       | 77,007                       |       | 168,530         |       | 245,537                 |       |
| Provision for obsolete inventories                                                        |       | —                       |       | 12,358          |       | 12,358                  |       |
| Loss on disposals of equipment and leasehold Improvements                                 |       | —                       |       | 224,286         |       | 224,286                 |       |
| Depreciation of equipment and leasehold improvements                                      |       | 817,957                      |       | (89,903         | )          | 728,054                 |       |
| Stock-based compensation expense                                                          |       | 399,996                      |       | 42,664          |       | 442,660                 |       |
| Provision for deferred income taxes                                                       |       | (107,000                     | )          | (2,648,314      | )          | (2,755,314              | )          |
| Increase in cash surrender value of life insurance                                        |       | (195,463                     | )          | 136,899         |       | (58,564                 | )          |
| Deferred compensation                                                                     |       | 48,479                       |       | 166,063         |       | 214,542                 |       |
| Net changes in operating assets and liabilities  (see note 10)                            |       | (639,018                     | )          | 4,488,763       |       | 3,849,745               |       |
| Net cash provided by operating activities                                                 |       | 2,378,626                    |       | 267,520         |       | 2,646,146               |       |
|                                                                                      |       |                         |       |            |       |                    |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                         |       |            |       |                    |       |
| Maturity of investments                                                                   |       | 75,000                       |       | —          |       | 75,000                  |       |
| Life insurance premiums paid                                                              |       | —                       |       | (348,503        | )          | (348,503                | )          |
| Purchases of equipment and leasehold improvements                                         |       | (2,147,866                   | )          | 1,129,809       |       | (1,018,057              | )          |
| Product software development expenditures                                                 |       | —                       |       | (1,053,738      | )          | (1,053,738              | )          |
| Net cash used in investing activities                                                     |       | (2,072,866                   | )          | (272,432        | )          | (2,345,298              | )          |
|                                                                                      |       |                         |       |            |       |                    |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                         |       |            |       |                    |       |
| Dividends paid to stockholders                                                            |       | (1,920,586                   | )          | 1               |       | (1,920,585              | )          |
| Purchase of treasury shares                                                               |       | (43,640                      | )          | 20              |       | (43,620                 | )          |
| Net cash used in financing activities                                                     |       | (1,964,226                   | )          | 21              |       | (1,964,205              | )          |
|                                                                                      |       |                         |       |            |       |                    |       |
| Net decrease in cash and cash equivalents                                                 |       | (1,658,466                   | )          | (4,891          | )          | (1,663,357              | )          |
| Cash and cash equivalents at beginning of year                                            |       | 3,322,873                    |       | (160,640        | )          | 3,162,233               |       |
| Cash and cash equivalents at end of year                                                  |       | $                            | 1,664,407  |            | $          | (165,531                | )          | $ | 1,498,876 |   |

 

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CONSOLIDATED STATEMENT OFCASH FLOW INFORMATION

 
| ** **                                                                         | ** ** | **2008**                      | ** ** | ** **      | ** ** | ** **              | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------|------------|-------------------------|------------|
| **Year  Ended June 30,**                                                      | ** ** | **(as previously  reported)** | ** ** | **Adjustments** | ** ** | **2008  (as restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                          |       |            |       |                    |       |
| Net income                                                                         |       | $                             | 4,494,289  |            | $          | (1,040,640              | )          | $ | 3,453,649 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                          |       |            |       |                    |       |
| Provision for doubtful accounts                                                    |       | (58,164                       | )          | 333,924         |       | 275,760                 |       |
| Provision reversal for obsolete inventories                                        |       | —                        |       | (19,746         | )          | (19,746                 | )          |
| Loss on disposals of equipment and leasehold improvements                          |       | —                        |       | 2,331           |       | 2,331                   |       |
| Gain on sale of certain Bi-Audio assets                                            |       | (149,775                      | )          | (1,358          | )          | (151,133                | )          |
| Amortization of intangible assets                                                  |       | —                        |       | 100,774         |       | 100,774                 |       |
| Depreciation of equipment and leasehold improvements                               |       | 961,605                       |       | (109,390        | )          | 852,215                 |       |
| Stock-based compensation expense                                                   |       | 545,052                       |       | (17,314         | )          | 527,738                 |       |
| Provision for deferred income taxes                                                |       | (302,121                      | )          | (1,277,968      | )          | (1,580,089              | )          |
| Increase in cash surrender value of life insurance                                 |       | (193,533                      | )          | 143,768         |       | (49,765                 | )          |
| Deferred compensation                                                              |       | 58,329                        |       | 122,767         |       | 181,096                 |       |
| Net changes in operating assets and liabilities  (see note 10)                     |       | (18,553                       | )          | 1,853,829       |       | 1,835,276               |       |
| Net cash provided by operating activities                                          |       | 5,337,129                     |       | 90,977          |       | 5,428,106               |       |
|                                                                               |       |                          |       |            |       |                    |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                          |       |            |       |                    |       |
| Maturity of investments                                                            |       | 25,000                        |       | —          |       | 25,000                  |       |
| Life insurance premiums paid                                                       |       | —                        |       | (348,503        | )          | (348,503                | )          |
| Proceeds from sale of certain Bi-Audio assets                                      |       | 700,000                       |       | —          |       | 700,000                 |       |
| Purchases of equipment and leasehold improvements                                  |       | (1,179,344                    | )          | 553,809         |       | (625,535                | )          |
| Product software development expenditures                                          |       | —                        |       | (673,302        | )          | (673,302                | )          |
| Net cash used in investing activities                                              |       | (454,344                      | )          | (467,996        | )          | (922,340                | )          |
|                                                                               |       |                          |       |            |       |                    |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                          |       |            |       |                    |       |
| Tax benefit of non-qualified stock options                                         |       | (286,200                      | )          | 286,200         |       | —                  |       |
| Dividends paid to stockholders                                                     |       | (5,591,850                    | )          | (661            | )          | (5,592,511              | )          |
| Purchase of treasury shares                                                        |       | (1,283,413                    | )          | 1,039,004       |       | (244,409                | )          |
| Exercise of stock options                                                          |       | 1,413,869                     |       | (1,039,000      | )          | 374,869                 |       |
| Net cash used in financing activities                                              |       | (5,747,594                    | )          | 285,543         |       | (5,462,051              | )          |
|                                                                               |       |                          |       |            |       |                    |       |
| Net decrease in cash and cash equivalents                                          |       | (864,809                      | )          | (91,476         | )          | (956,285                | )          |
| Cash and cash equivalents at beginning of year                                     |       | 4,187,682                     |       | (69,164         | )          | 4,118,518               |       |
| Cash and cash equivalents at end of year                                           |       | $                             | 3,322,873  |            | $          | (160,640                | )          | $ | 3,162,233 |   |

 

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Thefinancial accounts and transactions that were affected and a description ofmatters that were discovered in the restatement process are summarized asfollows:

 

*NetSales*

 

TheCompany has determined that its previously filed consolidated financialstatements contained errors for understatement of revenue because of theunauthorized transactions.  Certainunauthorized transactions improperly reduced various sales accounts through theuse of manual journal entries or system transactions.  In the years ended June 30, 2009 and June 30,2008, net sales were understated by the amounts set forth in Table A, below.

 

Table A

Restatement Adjustments Related to Net Sales

 
| ** **                                       | ** ** | **2009** | ** ** | **2008**  | ** ** |
|--------------------------------------------------|------------|----------|------------|-----------|------------|
| Restatement adjustments  to increase gross sales |       | $        | 2,801,281  |      | $          | 1,069,457 |   |
| Restatement adjustments  to sales allowances     |       | 731,683  |       | 1,071,571 |       |
| Total                                            |       | $        | 3,532,964  |      | $          | 2,141,028 |   |

 

*Cost of Goods Sold*

 

Costof goods sold was overstated in the reporting periods as a result of variousentries made in connection with the unauthorized transactions.  Portions of the unauthorized transactionswere improperly charged to cost of goods sold. The majority of the erroneous charges were made to materials, fringebenefit overhead accounts, engineering and depreciation as set forth in TableB, below.

 

Table B

Restatement Adjustments Related to Cost of Goods Sold

 
| ** **             | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
| Material and all other |       | $        | (1,125,122 | )        | $          | (231,438 | ) |
| Labor                  |       | (63,638  | )          | (676     | )          |
| Freight                |       | (49,835  | )          | (431,903 | )          |
| Fringe benefits        |       | (165,873 | )          | (97,815  | )          |
| Engineering            |       | (181,661 | )          | (227,658 | )          |
| Depreciation           |       | (162,462 | )          | (18,272  | )          |
| Total                  |       | $        | (1,748,591 | )        | $          | (1,007,762 | ) |

 

*Selling, General and Administrative Expenses*

 

Thefinancial statement review included an evaluation of various balance sheetaccounts along with their corresponding income statement items that areincluded in selling, general and administrative expenses.  It was determined that certain items listedbelow were misstated.

 

·                  Provision fordoubtful accounts was understated as was the allowance for doubtful accounts.

 

·                  Accounting forthe cash surrender value of life insurance was improperly stated because of notincluding all of the related life insurance policies.

 

·                  Deferredcompensation expense was understated in both 2009 and 2008 as a result of notproperly applying the assumptions for mortality and years of service as well asusing a discount rate that was too high.

 

·                  Costs forprofessional fees and product development expense were overstated as a resultof erroneous manual journal entries.  Theerroneous charges were recorded to these line items in both years.

 

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Theamounts related to the above misstatements are summarized in Table C, below.

 

Table C

Restatement Adjustments Related to Selling,

General and Administrative Expenses

 
| ** **                                                | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| Provision for doubtful accounts                           |       | $        | 128,901    |     | $          | 61,408 |   |
| Stock-based compensation expense                          |       | 42,664   |       | (17,314  | )          |
| Change in miscellaneous income                            |       | (211,605 | )          | (205,393 | )          |
| Deferred compensation expense                             |       | 166,063  |       | 122,767  |       |
| Professional fees                                         |       | (43,859  | )          | 16,240   |       |
| Fringe benefits                                           |       | (139,263 | )          | (148,764 | )          |
| Officers’ life insurance                             |       | (7,787   | )          | (40,021  | )          |
| Dealer shows                                              |       | (65,000  | )          | (45,000  | )          |
| Financial public relations                                |       | (55,000  | )          | (25,832  | )          |
| Data processing – outside services                   |       | —   |       | (53,694  | )          |
| Gain/loss on fixed asset disposals                        |       | 224,286  |       | 2,331    |       |
| New product development, sales, marketing and commissions |       | (251,171 | )          | (118,127 | )          |
| Depreciation                                              |       | 72,559   |       | (91,118  | )          |
| Miscellaneous expense                                     |       | (88,916  | )          | (121,346 | )          |
| Other selling, general and administrative                 |       | (34,763  | )          | 48,866   |       |
| Total                                                     |       | $        | (262,891   | )        | $          | (614,997 | ) |

 

*Income Tax Provision*

 

Theimpact of the various account adjustments on the income tax provision isdetailed below in Table D, below.

 

Table D

Restatement Adjustments Related to Income Tax Provision

 
| ** **                   | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Federal income tax provision |       | $        | (1,018,510 | )        | $          | (623,791 | ) |
| State income tax provision   |       | (9,565   | )          | 168,029  |       |
| Foreign income tax provision |       | 41,579   |       | 72,987   |       |
| Income tax provision         |       | $        | (986,496   | )        | $          | (382,775 | ) |

 

*Cash and Cash Equivalents*

 

Cashwas improperly overstated because of he unauthorized transactions.  The impact on cash is shown in Table E,below.

 

Table E

Restatement Adjustments Related to Cash

 
| ** **                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Correction of cash balance |       | $        | (165,531   | )        | $          | (160,640 | ) |
|                            |            |          |            |          |            |  |  |

 

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*Accounts Receivable and Allowance for Doubtful Accounts*

 

Accountsreceivable was overstated because of not properly applying cash receivedagainst the outstanding invoices. Application of cash was delayed to conceal the unauthorized transactionswhich created an overstatement of accounts receivable.

 

Theallowance for doubtful accounts was understated.  It has been restated to provide for amountsthat are expected to not be collected because of bankruptcies and accountsshowing slow payment.  The impact ofaccounts receivable and allowance for doubtful accounts is provided in Table F,below.

 

Table F

Restatement Adjustments Related to Accounts Receivable

and Allowance for Doubtful Accounts

 
| ** **                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Accounts receivable because of delayed cash  posting |       | $        | (3,407,667 | )        | $          | (1,534,970 | ) |
| Allowance for doubtful accounts                      |       | (611,212 | )          | (442,681 | )          |
| Total                                                |       | $        | (4,018,879 | )        | $          | (1,977,651 | ) |

 

*Inventories*

 

Inventorieswere overstated as a result of not properly accounting for the inventory intransit, insufficient provision for obsolete or slow-moving inventory andtreating advance payments as inventory. The impact of these items is provided in Table G, below.

 

Table G

Restatement Adjustments Related to Inventory

 
| ** **                         | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Inventory in transit               |       | $        | 289,622    |     | $          | 355,281 |   |
| Obsolete and slow-moving inventory |       | (901,229 | )          | (880,345 | )          |
| Prepaid inventory                  |       | (402,642 | )          | (380,629 | )          |
| LIFO reserve                       |       | 9,071    |       | 5,502    |       |
| Freight on inventory               |       | 25,614   |       | 50,934   |       |
| Other                              |       | (74,759  | )          | (92,752  | )          |
| Total                              |       | $        | (1,054,323 | )        | $          | (942,009 | ) |

 

*Equipment and Leasehold Improvements*

 

Assetsno longer used in the business were not removed from equipment and leaseholdimprovements.  As part of therestatement, the Company reviewed the assets and wrote off assets that did notphysically exist or were no longer being used in the business.  Almost all of the assets which were writtenoff had been fully depreciated prior to these adjustments.  Loss on disposal was $224,286 in 2009 and$2,331 in 2008.  Product softwaredevelopment costs were reclassified and reported separately in the restatedconsolidated balance sheets.  The impactof the equipment and leasehold improvements is provided in Table H below.

 

Table H

Restatement Adjustments Related to Equipment and Leasehold Improvements

 
| ** **                                   | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| Leasehold improvements                       |       | $          | (77,468    | )          | $          | (49,549 | ) |
| Machinery, equipment, furniture and fixtures |       | (511,937   | )          | (104,216   | )          |
| Tools, dies, molds and patterns              |       | (6,534,676 | )          | (4,783,662 | )          |
|                                         |       | (7,124,081 | )          | (4,937,427 | )          |
| Accumulated depreciation                     |       | 5,288,455  |       | 4,365,915  |       |
| Total                                        |       | $          | (1,835,626 | )          | $          | (571,512 | ) |

 

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*Product Software Development Costs*

 

Thecost of purchased software technology is capitalized and stated at the lower ofunamortized cost or expected net realizable value.  These amounts were included in equipment andleasehold improvements in the previous filings and have been reclassified to aseparate line item in the consolidated balance sheets in the restatement.  The balance sheet impact of the restatementto product software development costs is as shown in Table I, below.

 

Table I

Restatement Adjustments Related to Product Software Development Costs

 
| ** **                                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|
| Reclassification from equipment and leasehold  improvements |       | $        | 1,727,040  |     | $          | 673,302 |   |
|                                                             |            |          |            |          |            |  |  |

 

*Cash Surrender Value of Life Insurance*

 

Cashsurrender value of life insurance has been restated because of an error in thepreviously calculated amounts.  Inaddition, it was previously reported in “Other assets” but has now beenclassified separately in the restated consolidated balance sheets.  The balance sheet impact of the restatementto cash surrender value is as shown in Table J, below.

 

Table J

Restatement Adjustments Related to Cash Surrender Value

 
| ** **          | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| Correction of error |       | $        | 792,637    |     | $          | 581,033 |   |
|                     |            |          |            |          |            |  |  |

 

*Liabilities*

 

Variouscurrent liabilities were not properly stated due to the unauthorizedtransactions or as a result of different estimates at the time the statementswere prepared.  The following accountswere affected:

 

·                              Accounts payable wasunderstated on the June 30, 2009 consolidated balance sheet because of anerroneous transaction for approximately $1,290,000.  Other changes to accounts payable for theyears ended June 30, 2009 and 2008 are for reclassification of deposits toan asset account and to include accounts receivable credit balances in accountspayable.

 

·                              Accrued liabilities havebeen revised to:

 

·                  Include proper cutoff of professional fees ateach year end;

 

·                  Adjust accrued returns based on detailedanalysis of returns, price adjustments and shipping adjustments.

 

·                  Increase accrued product warranty obligationsto reflect the estimated costs of future returns of product based on ananalysis of annual returns and the cost of replacing the returned items duringthe three year period ended June 30, 2009. The Company believes this properly values the potential liability basedon annual returns and cost of replacing the returned items.

 

·                              The liability for deferredcompensation was understated as a result of not properly applying theassumptions for mortality and years of service as well as using a discount ratethat was too high.

 

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Thebalance sheet impact of the restatement of liabilities is as shown in Table K,below.

 

Table K

Restatement Adjustments Related to Accounts Payable,

Accrued Liabilities and Long-Term Liabilities

 
| ** **                                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Erroneous transactions                           |       | $        | 1,290,011  |     | $          | — |   |
| Reclassification of advance payments to deposits |       | 110,263  |       | —   |       |
| Accounts receivable credit balances              |       | 25,573   |       | 63,000   |       |
| Other accounts payable                           |       | (113,592 | )          | 182,387  |       |
| Accounts payable                                 |       | $        | 1,312,255  |     | $          | 245,387 |   |

 
| ** **                                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Legal and professional fees                      |       | $        | 166,939    |     | $          | 97,047 |   |
| Accrued returns                                  |       | 219,773  |       | 511,611  |       |
| Product warranty obligations                     |       | 312,420  |       | 320,420  |       |
| Cooperative advertising and promotion allowances |       | (250,000 | )          | (250,000 | )          |
| Accrued interest                                 |       | 354,644  |       | 141,451  |       |
| Other accrued liabilities                        |       | 133,189  |       | 24,693   |       |
| Accrued liabilities                              |       | $        | 936,965    |     | $          | 845,222 |   |

 
| ** **                             | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Long-term product warranty obligations |       | $        | 725,000    |     | $          | 742,000 |   |
| Deferred compensation liability        |       | 445,279  |       | 279,216  |       |
| Long-term liabilities                  |       | $        | 1,170,279  |     | $          | 1,021,216 |   |

 

*Income Taxes Payable*

 

Theimpact of the various account adjustments on income taxes payable is detailedbelow in Table L, below.

 

Table L

Restatement Adjustments Related to Income Taxes Payable

 
| ** **                 | ** ** | **2009**  | ** ** | **2008** | ** ** |
|----------------------------|------------|-----------|------------|----------|------------|
| Accrued federal income tax |       | $         | 3,428,169  |     | $          | 2,027,595 |   |
| Accrued state income tax   |       | 1,002,085 |       | 549,204  |       |
| Other                      |       | (201,440  | )          | —   |       |
| Income taxes payable       |       | $         | 4,228,814  |     | $          | 2,576,799 |   |

 

*Balance Sheet as of July 1,2007*

 

The financial statementreview included a comprehensive review and restatement of the consolidatedbalance sheet as of July 1, 2007. The net adjustment to stockholders’ equity, resulting from this reviewand related adjustments, was to decrease stockholders’ equity by $3,528,724from $23,929,624 as reported to a restated value of $20,400,900.  This adjustment mainly consisted of lossesfrom unauthorized transactions, increases to certain valuation reserves andincreases to certain liability and accrual accounts net of tax in the yearsending on or before June 30, 2007 which had not been recorded in theconsolidated statements of income as reductions to net sales or as increases toexpense.

 

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Theprimary components of the net adjustment to stockholders’ equity at July 1,2007 are as follows:

 
| Tax effected  adjustments:                                                                |   |       |      |
|-------------------------------------------------------------------------------------------|--------|------------|-----------|
| Total unauthorized transaction losses in prior  periods                                   |   | $          | 8,397,945 |   |
| Total unauthorized transaction losses previously  recorded in the statement of operations |   | (7,650,389 | )         |
| Increase in allowance for doubtful accounts                                               |   | 173,194    |      |
| Increase in valuation reserves and cost  adjustments                                      |   | 1,140,658  |      |
| Increase in product warranty obligations                                                  |   | 1,030,720  |      |
| Other unrecorded liabilities                                                              |   | 198,108    |      |
| Increase in deferred compensation accrual                                                 |   | 156,449    |      |
| Decrease in cash balance                                                                  |   | 69,164     |      |
| Write off of certain fixed assets                                                         |   | 25,378     |      |
| Decrease in prepaid expenses                                                              |   | 194,817    |      |
| Total tax effected adjustments before tax effect                                          |   | 3,736,044  |      |
| Income tax effect                                                                         |   | (1,382,336 | )         |
| Net after tax effect                                                                      |   | 2,353,708  |      |
| Non tax effected adjustments:                                                             |   |       |      |
| Increases in valuation allowance, income tax  liability and other tax adjustments         |   | 1,175,016  |      |
| Net adjustment to stockholders’ equity                                               |   | $          | 3,528,724 |   |

 

3.             EQUIPMENT ANDLEASEHOLD IMPROVEMENTS

 

Themajor categories of equipment and leasehold improvements at June 30, 2009and 2008 are summarized as follows:

 
| ** **                                      | ** **   | **Estimated**    | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------|--------------|------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** **   | **Useful Lives** | ** ** | **2009**   | ** ** | **2008**   | ** ** |
| Machinery and equipment                         |         | 5-10 years       |       | $          | 701,925    |       | $          | 698,526 |   |
| Furniture and office equipment                  |         | 5-10 years       |       | 370,611    |       | 495,789    |       |
| Tooling                                         |         | 5-10 years       |       | 4,498,535  |       | 4,779,063  |       |
| Display booths                                  |         | 5-7 years        |       | 288,183    |       | 384,138    |       |
| Computer equipment                              |         | 5 years          |       | 777,790    |       | 806,276    |       |
| Leasehold improvements                          |         | 5-15 years       |       | 1,706,478  |       | 1,717,293  |       |
| Assets in progress                              |         | N/A              |       | 337,903    |       | 42,707     |       |
|                                            | *** *** | *** ***     |       | 8,681,425  |       | 8,923,792  |       |
| Less: accumulated depreciation and amortization |         |             |       | 6,440,853  |       | 6,748,937  |       |
| Equipment and leasehold improvements, net       |         |             |       | $          | 2,240,572  |       | $          | 2,174,855 |   |

 

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4.             EARNINGS (LOSS) PER COMMONAND COMMON EQUIVALENT SHARE

 

Basic earnings (loss) pershare are computed based on the weighted-average number of common shares outstanding.  The weighted-average number of common sharesoutstanding for the years ended June 30, 2009 and 2008 were 7,386,250 and7,365,319, respectively.  When dilutive,stock options are included in earnings per share as share equivalents using thetreasury stock method. For the year ended June 30, 2009 there were nocommon stock equivalents related to stock option grants that were included inthe computation of the weighted-average number of shares outstanding fordiluted loss per share.  Shares under optionof 863,308 were excluded from diluted weighted average common sharesoutstanding for the year ended June 30, 2009 as they would be anti-dilutive dueto the Company’s net loss for the year.  Commonstock equivalents of 23,308, related to stock option grants, were included inthe computation of the weighted-average number of shares outstanding fordiluted earnings per share for the year ended June 30, 2008.  The dilutive effect of stock options of1,100,000 for which the exercise price was higher than the average market pricefor the year ended June 30, 2008 were excluded from the calculation of dilutedearnings per share (See Note 6 for stock options excluded from dilutive lossper common share). 

 

5.                                       CREDITFACILITIES

 

On February 16, 2009,the Company entered into a credit facility with Harris N.A. for an unsecuredline of credit for up to a maximum of $10,000,000 up to and including January 29,2010.  On October 9, 2009 the creditfacility was extended to December 31, 2010.  The credit facility replaced the Company’sprevious credit facility, which was terminated and contained substantially thesame terms as the Company’s new credit facility.    The Company could use the credit facilityfor working capital, to refinance existing indebtedness, for stock repurchaseand for general corporate purposes. Borrowings under the credit facility bore interest at either the bank’smost recently publicly announced prime rate or at a London Interbank OfferedRate (“LIBOR”) based rate plus 1.25% as determined in accordance with the loanagreement. The credit facility included certain financial covenants thatrequired the Company to maintain a minimum tangible net worth, liabilities totangible net worth ratios and interest coverage ratios.  The Company used its credit facility fromtime to time, although there was no utilization of this credit facility at June 30,2009 or June 30, 2008.

 

On May 12, 2010, theCompany entered into a new secured credit facility with JPMorgan Chase Bank,N.A. (“Lender”).  The Credit Agreementdated May 12, 2010 between the Company and the Lender (“Credit Agreement”)provides for an $8,000,000 revolving secured credit facility with interestrates either ranging from 0.0% to 0.75% over the Lender’s most recentlypublicly announced prime rate or 2.0% to 3.0% over LIBOR, depending on theCompany’s leverage ratio.  The CreditAgreement expires on July 31, 2013. In addition to the revolving loans,the Credit Agreement also provides that the Company may, from time to time,request the Lender to issue letters of credit for the benefit of the Company ofup to a sublimit of $2,000,000 and subject to certain other limitations. The loans may be used only for general corporate purposes of the Company.

 

The Credit Agreementcontains certain affirmative, negative and financial covenants customary forfinancings of this type.  The negativecovenants include restrictions on other indebtedness, liens, fundamentalchanges, certain investments, asset sales, sale and leaseback transactions andtransactions with affiliates, among other restrictions.  The financial covenants include a minimumcurrent ratio, minimum tangible net worth and maximum leverage ratiorequirements.  The Company and the Lenderalso entered into the Pledge and Security Agreement dated May 12, 2010under which the Company granted the Lender a security interest in substantiallyall of the Company’s assets in connection with the Company’s obligations underthe Credit Agreement.  As described inthe Company’s partial Form 10-Q for the period ended March 31, 2010that was filed on May 17, 2010, the Company’s credit facility with HarrisN.A. was terminated on May 12, 2010 and the outstanding balance of$5,863,349 as of that date was fully repaid.

 

6.                                       STOCK OPTIONS

 

In 1990, pursuant to therecommendation of the Board of Directors, the stockholders ratified thecreation of the Company’s 1990 Flexible Incentive Plan (the “1990 Plan”).  The 1990 Plan is administered by a committeeof the Board of Directors and provides for granting of various stock-based awardsincluding stock options to eligible participants, primarily officers andcertain key employees.  A total of225,000 shares of common stock were available in the first year of the 1990Plan’s existence.  Each year thereafteradditional shares equal to 0.25% of the shares outstanding as of the first dayof the applicable fiscal year were reserved for issuance pursuant to the 1990Plan.  On July 22, 1992, the Boardof Directors authorized the reservation of an additional 250,000 shares 

 

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for the 1990 Plan, which wasapproved by the stockholders.  In 1993,the Board of Directors authorized the reservation of an additional 300,000shares for the 1990 Plan, which was approved by the stockholders.  In 1997, the Board of Directors authorizedthe reservation of an additional 300,000 shares for the 1990 Plan, which wasapproved by the stockholders.  In 2001,the Board of Directors authorized the reservation of an additional 300,000shares for the 1990 Plan, which was also approved by the stockholders.  As of June 30, 2009, there are 763,050options available for future grants. Options vest over a four or five year period from the date of grant,with a maximum term of five to ten years.

 

The fair value of each stockoption grant was estimated as of the date of grant using the Black-Scholespricing model.  The resultingcompensation cost for fixed awards with graded vesting schedules is amortizedon a straight-line basis over the vesting period for the entire award.  The expected term of awards granted isdetermined based on historical experience with similar awards, giving considerationto the expected term and vesting schedules. The expected volatility is determined based on the Company’s historicalstock prices over the most recent period commensurate with the expected term ofthe award.  The risk-free interest rateis based on U.S. Treasury zero-coupon issues with a remaining term commensuratewith the expected term of the award. Expected pre-vesting option forfeitures are based on historical data.

 

As of June 30, 2009,there was approximately $633,278 of total unrecognized compensation costrelated to stock options granted under the 1990 Plan.  This cost is expected to be recognized over aweighted average period of 1.68 years. Total unrecognized compensation cost will be adjusted for any futurechanges in estimated and actual forfeitures.  The Company recognized stock-based compensation expense of $442,660 and$527,738 in 2009 and 2008, respectively. These expenses were included in selling, general and administrativeexpenses.

 

There was no cash receivedfrom stock option exercises during 2009. Proceeds received from stock option exercises were $1,413,869 during2008.

 

The fair value of eachoption granted is estimated on the date of grant using the Black-Scholesoption-pricing model.  There were nooptions granted in 2009.  For the optionsgranted in 2008, the Company used the following weighted-average assumptions:

 
| ** **                                     | ** ** | **2008**  | ** ** |
|------------------------------------------------|------------|-----------|------------|
| Expected stock price volatility                |       | 35.00     | %          |
| Risk free interest rate                        |       | 2.90      | %          |
| Expected dividend yield                        |       | 2.27      | %          |
| Expected forfeitures                           |       | 1.50      | %          |
| Expected life of options                       |       | 4.7 years |       |
| Weighted average fair value of options granted |       | $         |       | 8.39 |   |
|                                                |            |           |            |  |  |

 

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The following tableidentifies options granted, exercised, cancelled, or available for exercisepursuant to the 1990 Plan:

 
| ** **                                | ** ** | **Number of  Shares** | ** ** | **Stock  Options  Price Range** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life - Years** | ** ** | **Aggregate  Intrinsic  Value of  In-The-  Money  Options** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|---------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Shares under option at June 30, 2007 |       | 1,171,324             |       | $2.69 - $14.40                  |       | $                                      | 10.53      |                                                        | 3.83       |                                                        | $          | 465,438 |   |
| Granted                                   |       | 220,000               |       | $7.76 - $8.53                   |       | $                                      | 8.39       |                                                        |       |                                                        |       |   |
| Exercised                                 |       | (188,016              | )          | $2.69 - $8.66                   |       | $                                      | 7.52       |                                                        |       |                                                        |       |   |
| Expired                                   |       | (80,000               | )          | $8.66                           |       | $                                      | 8.66       |                                                        |       |                                                        |       |   |
| Forfeited                                 |       | —                |       | —                          |       | —                                 |       |                                                        |       |                                                        |       |
| Shares under option at June 30, 2008 |       | 1,123,308             |       | $7.76 - $14.40                  |       | $                                      | 10.75      |                                                        | 3.90       |                                                        | $          | 816 |   |
| Granted                                   |       | —                |       | —                          |       | —                                 |       |                                                        |       |                                                        |       |
| Exercised                                 |       | —                |       | —                          |       | —                                 |       |                                                        |       |                                                        |       |
| Expired                                   |       | (260,000              | )          | $12.055                         |       | $                                      | 12.055     |                                                        |       |                                                        |       |   |
| Forfeited                                 |       | —                |       | —                          |       | —                                 |       |                                                        |       |                                                        |       |
| Shares under option at June 30, 2009 |       | 863,308               |       | $7.76 - $14.40                  |       | $                                      | 10.35      |                                                        | 3.99       |                                                        | $          | — |   |
|                                      |       |                  |       |                            |       |                                   |       |                                                        |       |                                                        |       |
| Exercisable as of June 30, 2008      |       | 631,808               |       | $7.875 - $14.40                 |       | $                                      | 11.26      |                                                        |       |                                                        |       |   |
| Exercisable as of June 30, 2009      |       | 532,808               |       | $7.76 - $14.40                  |       | $                                      | 10.72      |                                                        |       |                                                        |       |   |

 

Asummary of intrinsic value and cash received from stock option exercises and fairvalue of vested stock options for the fiscal years ended June 30, 2009 and2008 is as follows:

 
| ** **                                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Total intrinsic value of stock options exercised |       | $        | —     |     | $          | 467,679 |   |
| Cash received from stock option exercises        |       | $        | —     |     | $          | 374,699 |   |
| Total fair value of stock options vested         |       | $        | 440,137    |     | $          | 483,284 |   |

 

No options were grantedduring the year ended June 30, 2009. Total options of 220,000 were grantedduring 2008 at a price greater than the market value of the common stock on thedate of grant. These options had a weighted-average exercise price of $8.39.

 

7.             STOCK PURCHASE AGREEMENTS

 

The Company has an agreementwith its Chairman, John C. Koss, in the event of his death, at the request ofthe executor of his estate, to repurchase his Company common stock from hisestate.  The Company does not have theright to require the estate to sell stock to the Company.  As such, this arrangement is accounted for asa written put option with the fair value of the put option recorded as aderivative liability.

 

The fair value of thewritten put option at June 30, 2009 and 2008 was $125,000.  The repurchase price is 95% of the fairmarket value of the common stock on the date that notice to repurchase isprovided to the Company.  The totalnumber of shares to be repurchased will be sufficient to provide proceeds whichare the lesser of $2,500,000 or the amount of estate taxes and administrativeexpenses incurred by the Chairman’s estate. The Company may 

 

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elect to pay the purchaseprice in cash or may elect to pay cash equal to 25% of the total amount due andto execute a promissory note for the balance, payable over four years, at theprime rate of interest.  The Companymaintains a $1,150,000 life insurance policy to fund a substantial portion ofthis obligation.

 

In April 1995, theBoard of Directors approved a stock repurchase program authorizing the Companyto purchase from time to time up to $2,000,000 of its common stock for its ownaccount.  Subsequently, the Board ofDirectors periodically has approved increases in the stock repurchaseprogram.  As of June 30, 2009, themost 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, 2009.  The Company repurchased 7,996 shares for$43,620 in 2009 and 127,452 shares for $1,283,409 in 2008.

 

8.             INCOME TAXES

 

The Company utilizes theliability method of accounting for income taxes.  The liability method measures the expectedincome tax impact of future taxable income and deductions implicit in theconsolidated balance sheets.  The(benefit) provision for income taxes in 2009 and 2008 consists of thefollowing:

 
| ** **                             | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|----------------------------------------|------------|----------------|------------|----------------|------------|
| **Year Ended June 30,** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Current:                               |       |           |       |           |       |
| Federal                                |       | $              | 2,251,167  |           | $          | 3,805,363 |   |
| State                                  |       | 428,713        |       | 308,231        |       |
| Deferred                               |       | (2,755,314     | )          | (1,580,089     | )          |
|                                   |       | $              | (75,434    | )              | $          | 2,533,505 |   |

 

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The 2009 and 2008 tax(benefit) provision results in an effective rate different than the federalstatutory rate because of the following:

 
| ** **                                                | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|-----------------------------------------------------------|------------|----------------|------------|----------------|------------|
| **Year Ended June 30,**                    | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Federal income (benefit) tax at statutory rate            |       | $              | (113,081   | )              | $          | 2,035,633 |   |
| State income taxes, net of federal tax (benefit)  expense |       | (14,716        | )          | 214,066        |       |
| Other                                                     |       | 52,363         |       | 283,806        |       |
| Total (benefit) provision for income taxes                |       | $              | (75,434    | )              | $          | 2,533,505 |   |

 

Temporarydifferences which give rise to deferred income tax assets and liabilities at June 30include:

 
| ** **                                         | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|----------------------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                                         | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Deferred Income Tax Assets:                        |       |           |       |           |       |
| Deferred compensation                              |       | $              | 570,259    |           | $          | 477,611 |   |
| Stock-based compensation                           |       | 588,785        |       | 465,947        |       |
| Accrued expenses and reserves                      |       | 1,630,520      |       | 1,723,117      |       |
| Package design and trademarks                      |       | 100,609        |       | 117,799        |       |
| Unauthorized transactions                          |       | 6,392,045      |       | 3,158,319      |       |
| Federal and state net operating loss carryforwards |       | 28,736         |       | 28,415         |       |
| Valuation allowance                                |       | (917,521       | )          | (794,362       | )          |
|                                               |       | 8,393,433      |       | 5,176,846      |       |
| Deferred Income Tax Liabilities:                   |       |           |       |           |       |
| Equipment and leasehold improvements               |       | (264,968       | )          | (230,863       | )          |
| Capitalized research and development costs         |       | (416,603       | )          | —         |       |
| Other                                              |       | (15,083        | )          | (4,518         | )          |
| Net deferred income tax asset                      |       | $              | 7,696,779  |           | $          | 4,941,465 |   |

 

Deferred income tax assetsas presented on the consolidated balance sheets:

 
| ** **                            | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|---------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                            | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Current deferred income tax assets    |       | $              | 1,385,497  |           | $          | 1,499,941 |   |
| Noncurrent deferred income tax assets |       | 6,311,282      |       | 3,441,524      |       |
| Net deferred income tax assets        |       | $              | 7,696,779  |           | $          | 4,941,465 |   |

 

Deferred income tax balancesreflect the effects of temporary differences between the tax bases of assetsand liabilities and their carrying amounts. These differences are stated at enacted tax rates expected to be ineffect when taxes are actually paid or recovered.  The recognition of these deferred taxbalances will be realized through normal recurring operations and, as such, theCompany has recorded the full value of such expected benefits.

 

EffectiveJuly 1, 2007, the Company adopted ASC 740. This interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken, or expected to be taken, in a tax return.  There were no significant matters determinedto be unrecognized tax benefits taken or expected to be taken in a tax returnthat have been recorded on the Company’s consolidated financial statements forthe year ended June 30, 2009.  Aspart of the unauthorized transactions, the Company has accrued interest of$354,644 and $141,451 at June 30, 2009 and 2008, respectively.

 

Additionally,ASC 740 provides guidance on the recognition of interest and penalties relatedto income taxes.  There were no penaltiesrelated to income taxes that have been accrued or recognized as of and for theyears ended June 30, 2009 and 2008. The Company records interest related to unrecognized tax benefits ininterest expense.

 

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Areconciliation of the beginning and ending amount of unrecognized tax benefitsis as follows (restated):

 
| ** **                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Unrecognized tax benefits at beginning of  year      |       | $        | 300,000    |     | $          | 300,000 |   |
| Gross decreases — tax positions in prior  years |       | —   |       | —   |       |
| Unrecognized tax benefits at end of year             |       | $        | 300,000    |     | $          | 300,000 |   |

 

TheCompany files income tax returns in the United States federal jurisdiction andin a state jurisdiction.  The Company’sfederal tax returns through tax year June 30, 2005 are settled and theincome tax returns for tax years beginning July 1, 2005 are open.  Most state jurisdictions have tax returnsopen for tax years beginning July 1, 2004. 

 

Thefollowing are the changes in the valuation allowance:

 
| **Year Ended June 30,** | ** ** | **Balance,  Beginning  of Year** | ** ** | **Increase in  Valuation  Allowance** | ** ** | **Release of  Valuation  Allowance** | ** ** | **Balance at  End Year** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|------------------------------------|------------|
| 2009 (Restated)                        |       | $                                | (794,362   | )                                          | (123,159   | )                                         | —     |                               | $          | (917,521 | ) |
| 2008 (Restated)                        |       | $                                | (788,415   | )                                          | (5,947     | )                                         | —     |                               | $          | (794,362 | ) |

 

9.                                       ACCRUEDLIABILITIES

 

Accrued liabilities atJune 30 consist of the following:

 
| ** **                                       | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|--------------------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Cooperative advertising and promotion allowances |       | $              | 401,483    |           | $          | 440,484 |   |
| Accrued returns                                  |       | 364,773        |       | 656,611        |       |
| Product warranty obligations                     |       | 362,000        |       | 370,000        |       |
| Accrued interest                                 |       | 354,644        |       | 141,451        |       |
| Payroll taxes and other employee benefits        |       | 208,180        |       | 190,987        |       |
| Legal and professional fees                      |       | 135,739        |       | 147,047        |       |
| Charitable donations                             |       | —         |       | 239,603        |       |
| Other                                            |       | 263,235        |       | 467,506        |       |
|                                             |       | $              | 2,090,054  |           | $          | 2,653,689 |   |

 

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10.                                 ADDITIONAL CASHFLOW INFORMATION

 

The net changes in cash as aresult of changes in operating assets and liabilities consist of the following:

 
| ** **                                                           | ** ** | **2009**       | ** ** | **2008**       | ** ** |
|----------------------------------------------------------------------|------------|----------------|------------|----------------|------------|
| ** **                                                           | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Accounts receivable                                                  |       | $              | 3,264,731  |           | $          | (1,428,595 | ) |
| Inventories                                                          |       | (288,858       | )          | 308,551        |       |
| Prepaid expenses and other assets                                    |       | 47,818         |       | 10,013         |       |
| Income taxes payable                                                 |       | 1,480,076      |       | 1,235,645      |       |
| Accounts payable                                                     |       | (73,387        | )          | 1,927,072      |       |
| Accrued liabilities                                                  |       | (580,635       | )          | (217,410       | )          |
| Net change                                                           |       | $              | 3,849,745  |           | $          | 1,835,276 |   |
|                                                                 |       |           |       |           |       |
| Net cash paid during the year for:                                   |       |           |       |           |       |
| Income taxes                                                         |       | $              | 1,190,000  |           | $          | 2,863,000 |   |
| Interest                                                             |       | $              | —     |           | $          | — |   |
|                                                                 |       |           |       |           |       |
| Noncash financing activities:                                        |       |           |       |           |       |
| Exercise of stock options exchanged for purchase  of treasury shares |       | $              | —     |           | $          | 1,039,000 |   |

 

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11.                                 PRODUCTWARRANTY OBLIGATIONS

 

The Company records aliability for product warranty obligations at the time of sale based uponhistorical warranty experience.  TheCompany’s products carry a lifetime warranty. The Company also records a liability for specific warranty matters whenthey become known and are reasonably estimated. The Company’s current and non-current product warranty obligations areincluded in accrued liabilities and other liabilities, respectively, in theconsolidated balance sheets.  Changes tothe product warranty obligations for the years ended June 30, 2009 and2008 are as follows:

 
| **Year  Ended June 30,** | ** ** | **Balance,  Beginning  of Year** | ** ** | **Provision  Charged to  Expense** | ** ** | **Warranty  Expenses  Incurred** | ** ** | **Balance at  End Year** | ** ** |
|------------------------------------|------------|----------------------------------|------------|-----------------------------------------|------------|----------------------------------|------------|------------------------------------|------------|
| 2009                               |       | $                                | 1,112,000  |                                    | 324,695    |                             | (349,695   | )                                  | $          | 1,087,000 |   |
| 2008                               |       | $                                | 1,074,000  |                                    | 367,605    |                             | (329,605   | )                                  | $          | 1,112,000 |   |

 

The warranty obligation isrecorded as a current and long-term liability.

 

12.                                 EMPLOYEEBENEFIT PLANS

 

Substantially all domesticemployees are participants in the Koss Employee Stock Ownership Trust underwhich an annual contribution in either cash or common stock may be made at thediscretion of the Board of Directors. The expense recorded for such cash contributions approximated $30,000 in2009 and $100,000 in 2008.

 

The Company maintains aretirement savings plan under Section 401(k) of the Internal RevenueCode.  This plan covers all employees ofthe Company who have completed one full fiscal quarter of service.  Matching contributions can be made at thediscretion of the Board of Directors. For fiscal years 2009 and 2008, the matching contribution was 100% ofemployee contributions to the plan. Vesting of Company contributions occurs immediately.  Company contributions were approximately$312,822 and $374,000 during 2009 and 2008, respectively.

 

13.                                 DEFERREDCOMPENSATION

 

The Company has deferred compensation agreements with a former andcurrent officer.

 

The Board of Directorsentered into an agreement to continue the Chairman’s 1991 base salary for theremainder of his life.  These paymentsbegin upon the Chairman’s retirement, and since the Chairman has not retired,he is not currently receiving any payments under this arrangement.  The Company has a deferred compensationliability of $421,469 and $354,661 recorded as of June 30, 2009 and 2008,respectively.  Deferred compensationexpense of $66,808 and $60,280 was recognized under this arrangement in 2009and 2008, respectively.

 

The Board of Directors hasapproved a supplemental retirement plan with an officer that calls for annualcash compensation following retirement from the Company in an amount equal to2% of base salary, as defined in the agreement, multiplied by the number ofyears of service to the Company.  Theretirement payments are to be paid monthly to the officer until his death andthen to his surviving spouse monthly until her death.  The Company has a deferred compensationliability of $1,119,771 and $972,037 recorded as of June 30, 2009 and 2008,respectively.  Deferred compensationexpense of $147,734 and $120,816 was recognized under this arrangement in 2009and 2008, respectively.

 

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14.                                 FOREIGN SALESAND SIGNIFICANT CUSTOMERS

 

The Company’s net foreignsales amounted to $17,495,075 during 2009 and $19,121,512 during 2008.

 

The Company’s sales byregion are as follows:

 
| ** **          | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|---------------------|------------|------------|------------|------------|------------|
| U.S.                |       | $          | 24,222,039 |       | $          | 29,962,809 |   |
| Europe              |       | 15,744,430 |       | 16,870,177 |       |
| All other countries |       | 1,750,645  |       | 2,251,335  |       |
| Net sales           |       | $          | 41,717,114 |       | $          | 49,084,321 |   |

 

Sales during 2009 and 2008to the Company’s five largest customers, which are generally large nationalretailers or foreign distributors, represented approximately 54% and 50% of theCompany’s net sales, respectively. Included in these percentages, sales to a single U.S. customerrepresented approximately 22% and 19%, of the Company’s net sales during 2009and 2008, respectively.  Net sales to asingle Scandinavian distributor represented approximately 17% and 14%, of theCompany’s total sales during 2009 and 2008, respectively.

 

Included in accountsreceivable as of June 30, 2009 and 2008 was 49% and 64%, respectively, duefrom the Company’s five largest customers.

 

15.                                 COMMITMENTS ANDCONTINGENCIES

 

The Company leases itsfacility in Milwaukee, Wisconsin from its Chairman.  On August 15, 2007, the lease wasrenewed for a period of five years, ending June 30, 2013, and is beingaccounted for as an operating lease.  Thelease extension maintained the rent at a fixed rate of $380,000 per year.  The Company is responsible for all propertymaintenance, insurance, taxes and other normal expenses related toownership.  Total rent expense was$380,000 in both 2009 and 2008.

 

In August 2009 theCompany entered into agreements totaling approximately $1,078,000 for softwareand new product development.  The term ofthese commitments is less than one year.

 

16.                                 RESTATEDQUARTERLY FINANCIAL DATA (unaudited)

 

The following tables setforth unaudited restated consolidated statements of operations for the quartersindicated.  The restated quarterlyfinancial information has been derived from unaudited consolidated financialstatements, which, in the opinion of management, include all adjustments(consisting of normal recurring adjustments and restatement adjustments whichare set forth in the tables below and are described in Note 2 to the Company’sconsolidated financial statements) necessary for a fair presentation of suchinformation.  The results of any quarterare not necessarily indicative of the results to be expected for any futureperiod.

 

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| ** **                                          | ** ** | **Year  Ended June 30, 2009 — Quarters Ended (unaudited)** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **September 30, 2008**                                          | ** ** | **December 31, 2008** | ** ** | **March 31, 2009** | ** ** | **June 30, 2009** | ** ** |
| ** **                                          | ** ** | **(Restated)**                                                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net sales                                           |       | $                                                                    | 12,498,036 |   | $ | 10,946,469 |   | $ | 8,840,780 |   | $ | 9,431,829 |   |
| Cost of goods sold                                  |       | 6,916,661                                                            |       | 5,762,389 |   | 4,961,188 |   | 5,528,184 |   |
| Gross profit                                        |       | 5,581,375                                                            |       | 5,184,080 |   | 3,879,592 |   | 3,903,645 |   |
| Selling, general and administrative expenses        |       | 2,652,794                                                            |       | 2,844,952 |   | 2,213,326 |   | 2,679,280 |   |
| Unauthorized transactions                           |       | 1,689,052                                                            |       | 2,102,820 |   | 1,990,228 |   | 2,716,334 |   |
| Total operating expenses                            |       | 4,341,846                                                            |       | 4,947,772 |   | 4,203,554 |   | 5,395,614 |   |
| Income (loss) from operations                       |       | 1,239,529                                                            |       | 236,308 |   | (323,962 | ) | (1,491,969 | ) |
| Other Income (Expense):                             |       |                                                                 |       |   |   |   |   |   |   |
| Royalty income                                      |       | 87,500                                                               |       | 78,750 |   | 42,500 |   | — |   |
| Interest income                                     |       | 14,053                                                               |       | 1,446 |   | 3 |   | 1 |   |
| Interest expense                                    |       | (41,349                                                              | )          | (64,800 | ) | (60,152 | ) | (50,450 | ) |
| Total Other Income (Expense), net                   |       | 60,204                                                               |       | 15,396 |   | (17,649 | ) | (50,449 | ) |
| Income (loss) before income tax provision (benefit) |       | 1,299,733                                                            |       | 251,704 |   | (341,611 | ) | (1,542,418 | ) |
| Income tax provision (benefit)                      |       | 457,888                                                              |       | 73,997 |   | (159,468 | ) | (447,851 | ) |
| Net income (loss)                                   |       | $                                                                    | 841,845    |   | $ | 177,707 |   | $ | (182,143 | ) | $ | (1,094,567 | ) |
| Earnings (loss) per common share:                   |       |                                                                 |       |   |   |   |   |   |   |
| Basic                                               |       | $                                                                    | 0.11       |   | $ | 0.02 |   | $ | (0.02 | ) | $ | (0.14 | ) |
| Diluted                                             |       | $                                                                    | 0.11       |   | $ | 0.02 |   | $ | (0.02 | ) | $ | (0.14 | ) |
| Dividends per common share                          |       | $                                                                    | 0.065      |   | $ | 0.065 |   | $ | 0.065 |   | $ | 0.065 |   |

 
| ** **                                   | ** ** | **Year Ended June 30, 2008 — Quarters Ended (unaudited)** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **September 30, 2007**                                         | ** ** | **December 31, 2007** | ** ** | **March 31, 2008** | ** ** | **June 30, 2008** | ** ** |
| ** **                                   | ** ** | **(Restated)**                                                      | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Net sales                                    |       | $                                                                   | 13,039,983 |   | $ | 12,557,830 |   | $ | 10,493,369 |   | $ | 12,993,139 |   |
| Cost of goods sold                           |       | 7,324,820                                                           |       | 7,547,779 |   | 6,219,144 |   | 7,052,286 |   |
| Gross profit                                 |       | 5,715,163                                                           |       | 5,010,051 |   | 4,274,225 |   | 5,940,853 |   |
| Selling, general and administrative expenses |       | 2,419,312                                                           |       | 2,444,014 |   | 2,243,431 |   | 3,070,310 |   |
| Unauthorized transactions                    |       | 1,016,596                                                           |       | 1,844,687 |   | 1,208,497 |   | 1,030,120 |   |
| Total operating expenses                     |       | 3,435,908                                                           |       | 4,288,701 |   | 3,451,928 |   | 4,100,430 |   |
| Income from operations                       |       | 2,279,255                                                           |       | 721,350 |   | 822,297 |   | 1,840,423 |   |
| Other Income (Expense):                      |       |                                                                |       |   |   |   |   |   |   |
| Royalty income                               |       | 86,874                                                              |       | 87,500 |   | 87,500 |   | 87,500 |   |
| Interest income                              |       | 50,440                                                              |       | 46,751 |   | 11,929 |   | 10,344 |   |
| Interest expense                             |       | (13,047                                                             | )          | (47,375 | ) | (45,994 | ) | (38,593 | ) |
| Total Other Income, net                      |       | 124,267                                                             |       | 86,876 |   | 53,435 |   | 59,251 |   |
| Income before income tax provision           |       | 2,403,522                                                           |       | 808,226 |   | 875,732 |   | 1,899,674 |   |
| Income tax provision                         |       | 916,830                                                             |       | 336,662 |   | 402,164 |   | 877,849 |   |
| Net income                                   |       | $                                                                   | 1,486,692  |   | $ | 471,564 |   | $ | 473,568 |   | $ | 1,021,825 |   |
| Earnings per common share:                   |       |                                                                |       |   |   |   |   |   |   |
| Basic                                        |       | $                                                                   | 0.20       |   | $ | 0.06 |   | $ | 0.06 |   | $ | 0.15 |   |
| Diluted                                      |       | $                                                                   | 0.20       |   | $ | 0.06 |   | $ | 0.06 |   | $ | 0.15 |   |
| Dividends per common share                   |       | $                                                                   | 0.065      |   | $ | 0.565 |   | $ | 0.065 |   | $ | 0.065 |   |

 

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The following tables reflectthe effects of the restatement of the unaudited consolidated statements ofoperations for the quarters ended in 2009.

 
| ** **                                   | ** ** | **Quarter Ended September 30, 2008 (unaudited)** | ** ** | **Quarter Ended December 31, 2008 (unaudited)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **As previously**                                     | ** ** | **Restatement**                                      | ** ** | ** ** | ** ** | **As previously** | ** ** | **Restatement** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Reported**                                          | ** ** | **Adjustments**                                      | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Net sales                                    |       | $                                                     | 11,486,034 |                                                 | $          | 1,012,002 |   | $ | 12,498,036 |   | $ | 10,287,595 |   | $ | 658,874 |   | $ | 10,946,469 |   |
| Cost of goods sold                           |       | 7,085,574                                             |       | (168,913                                             | )          | 6,916,661 |   | 6,804,711 |   | (1,042,322 | ) | 5,762,389 |   |
| Gross profit                                 |       | 4,400,460                                             |       | 1,180,915                                            |       | 5,581,375 |   | 3,482,884 |   | 1,701,196 |   | 5,184,080 |   |
| Selling, general and administrative expenses |       | 2,998,527                                             |       | (345,733                                             | )          | 2,652,794 |   | 2,956,099 |   | (111,147 | ) | 2,844,952 |   |
| Unauthorized transactions                    |       | —                                                |       | 1,689,052                                            |       | 1,689,052 |   | — |   | 2,102,820 |   | 2,102,820 |   |
| Total operating expenses                     |       | 2,998,527                                             |       | 1,343,319                                            |       | 4,341,846 |   | 2,956,099 |   | 1,991,673 |   | 4,947,772 |   |
| Income from operations                       |       | 1,401,933                                             |       | (162,404                                             | )          | 1,239,529 |   | 526,785 |   | (290,477 | ) | 236,308 |   |
| Other Income (Expense):                      |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Royalty income                               |       | 58,333                                                |       | 29,167                                               |       | 87,500 |   | — |   | 78,750 |   | 78,750 |   |
| Interest income                              |       | 14,053                                                |       | —                                               |       | 14,053 |   | 1,446 |   | — |   | 1,446 |   |
| Interest expense                             |       | —                                                |       | (41,349                                              | )          | (41,349 | ) | — |   | (64,800 | ) | (64,800 | ) |
| Total Other Income, net                      |       | 72,386                                                |       | (12,182                                              | )          | 60,204 |   | 1,446 |   | 13,950 |   | 15,396 |   |
| Income before income tax provision           |       | 1,474,319                                             |       | (174,586                                             | )          | 1,299,733 |   | 528,231 |   | (276,527 | ) | 251,704 |   |
| Income tax provision                         |       | 560,555                                               |       | (102,667                                             | )          | 457,888 |   | 205,777 |   | (131,780 | ) | 73,997 |   |
| Net income                                   |       | $                                                     | 913,764    |                                                 | $          | (71,919 | ) | $ | 841,845 |   | $ | 322,454 |   | $ | (144,747 | ) | $ | 177,707 |   |
| Earnings per common share:                   |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Basic                                        |       | $                                                     | 0.13       |                                                 | $          | (0.02 | ) | $ | 0.11 |   | $ | 0.05 |   | $ | (0.03 | ) | $ | 0.02 |   |
| Diluted                                      |       | $                                                     | 0.13       |                                                 | $          | (0.02 | ) | $ | 0.11 |   | $ | 0.05 |   | $ | (0.03 | ) | $ | 0.02 |   |
| Dividends per common share                   |       | $                                                     | 0.065      |                                                 | $          | — |   | $ | 0.065 |   | $ | 0.065 |   | $ | — |   | $ | 0.065 |   |

 
| ** **                                   | ** ** | **Quarter  Ended March 31, 2009 (unaudited)** | ** ** | **Quarter  Ended June 30, 2009 (unaudited)** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                   | ** ** | **As previously**                                  | ** ** | **Restatement**                                   | ** ** | ** ** | ** ** | **As previously** | ** ** | **Restatement** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Reported**                                       | ** ** | **Adjustments**                                   | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Net sales                                    |       | $                                                  | 8,145,930  |                                              | $          | 694,850 |   | $ | 8,840,780 |   | $ | 8,264,591 |   | $ | 1,167,238 |   | $ | 9,431,829 |   |
| Cost of goods sold                           |       | 5,531,938                                          |       | (570,750                                          | )          | 4,961,188 |   | 5,494,790 |   | 33,394 |   | 5,528,184 |   |
| Gross profit                                 |       | 2,613,992                                          |       | 1,265,600                                         |       | 3,879,592 |   | 2,769,801 |   | 1,133,844 |   | 3,903,645 |   |
| Selling, general and administrative expenses |       | 2,388,169                                          |       | (174,843                                          | )          | 2,213,326 |   | 2,310,448 |   | 368,832 |   | 2,679,280 |   |
| Unauthorized transactions                    |       | —                                             |       | 1,990,228                                         |       | 1,990,228 |   | — |   | 2,716,334 |   | 2,716,334 |   |
| Total operating expenses                     |       | 2,388,169                                          |       | 1,815,385                                         |       | 4,203,554 |   | 2,310,448 |   | 3,085,166 |   | 5,395,614 |   |
| Income (loss) from operations                |       | 225,823                                            |       | (549,785                                          | )          | (323,962 | ) | 459,353 |   | (1,951,322 | ) | (1,491,969 | ) |
| Other Income (Expense):                      |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Royalty income                               |       | —                                             |       | 42,500                                            |       | 42,500 |   | 200,000 |   | (200,000 | ) | — |   |
| Interest income                              |       | 2                                                  |       | 1                                                 |       | 3 |   | 2 |   | (1 | ) | 1 |   |
| Interest expense                             |       | —                                             |       | (60,152                                           | )          | (60,152 | ) | — |   | (50,450 | ) | (50,450 | ) |
| Total Other Income (Expense), net            |       | 2                                                  |       | (17,651                                           | )          | (17,649 | ) | 200,002 |   | (250,451 | ) | (50,449 | ) |
| Income (loss) before income tax provision    |       | 225,825                                            |       | (567,436                                          | )          | (341,611 | ) | 659,355 |   | (2,201,773 | ) | (1,542,418 | ) |
| Income tax provision (benefit)               |       | 88,058                                             |       | (247,526                                          | )          | (159,468 | ) | 56,672 |   | (504,523 | ) | (447,851 | ) |
| Net income (loss)                            |       | $                                                  | 137,767    |                                              | $          | (319,910 | ) | $ | (182,143 | ) | $ | 602,683 |   | $ | (1,697,250 | ) | $ | (1,094,567 | ) |
| Earnings(loss) per common share:             |       |                                               |       |                                              |       |   |   |   |   |   |   |   |   |
| Basic                                        |       | $                                                  | 0.02       |                                              | $          | (0.04 | ) | $ | (0.02 | ) | $ | 0.08 |   | $ | (0.22 | ) | $ | (0.14 | ) |
| Diluted                                      |       | $                                                  | 0.02       |                                              | $          | (0.04 | ) | $ | (0.02 | ) | $ | 0.08 |   | $ | (0.22 | ) | $ | (0.14 | ) |
| Dividends per common share                   |       | $                                                  | 0.065      |                                              | $          | — |   | $ | 0.065 |   | $ | 0.065 |   | $ | — |   | $ | 0.065 |   |

 

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The following tables reflectthe effects of the restatement of the unaudited consolidated statements of operationsfor the quarters ended in 2008.

 
| ** **                                   | ** ** | **Quarter Ended September 30, 2007 (unaudited)** | ** ** | **Quarter Ended December 31, 2007 (unaudited)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **As previously**                                     | ** ** | **Restatement**                                      | ** ** | ** ** | ** ** | **As previously** | ** ** | **Restatement** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Reported**                                          | ** ** | **Adjustments**                                      | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Net sales                                    |       | $                                                     | 12,637,606 |                                                 | $          | 402,377 |   | $ | 13,039,983 |   | $ | 12,099,397 |   | $ | 458,433 |   | $ | 12,557,830 |   |
| Cost of goods sold                           |       | 7,845,626                                             |       | (520,806                                             | )          | 7,324,820 |   | 7,775,022 |   | (227,243 | ) | 7,547,779 |   |
| Gross profit                                 |       | 4,791,980                                             |       | 923,183                                              |       | 5,715,163 |   | 4,324,375 |   | 685,676 |   | 5,010,051 |   |
| Selling, general and administrative expenses |       | 2,784,026                                             |       | (364,714                                             | )          | 2,419,312 |   | 2,371,276 |   | 72,738 |   | 2,444,014 |   |
| Unauthorized transactions                    |       | —                                                |       | 1,016,596                                            |       | 1,016,596 |   | — |   | 1,844,687 |   | 1,844,687 |   |
| Total operating expenses                     |       | 2,784,026                                             |       | 651,882                                              |       | 3,435,908 |   | 2,371,276 |   | 1,917,425 |   | 4,288,701 |   |
| Income from operations                       |       | 2,007,954                                             |       | 271,301                                              |       | 2,279,255 |   | 1,953,099 |   | (1,231,749 | ) | 721,350 |   |
| Other Income (Expense):                      |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Royalty income                               |       | 131,250                                               |       | (44,376                                              | )          | 86,874 |   | 43,750 |   | 43,750 |   | 87,500 |   |
| Interest income                              |       | 50,440                                                |       | —                                               |       | 50,440 |   | 46,751 |   | — |   | 46,751 |   |
| Interest expense                             |       | —                                                |       | (13,047                                              | )          | (13,047 | ) | — |   | (47,375 | ) | (47,375 | ) |
| Total Other Income, net                      |       | 181,690                                               |       | (57,423                                              | )          | 124,267 |   | 90,501 |   | (3,625 | ) | 86,876 |   |
| Income before income tax provision           |       | 2,189,644                                             |       | 213,878                                              |       | 2,403,522 |   | 2,043,600 |   | (1,235,374 | ) | 808,226 |   |
| Income tax provision                         |       | 853,970                                               |       | 62,860                                               |       | 916,830 |   | 797,048 |   | (460,386 | ) | 336,662 |   |
| Net income                                   |       | $                                                     | 1,335,674  |                                                 | $          | 151,018 |   | $ | 1,486,692 |   | $ | 1,246,552 |   | $ | (774,988 | ) | $ | 471,564 |   |
| Earnings per common share:                   |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Basic                                        |       | $                                                     | 0.18       |                                                 | $          | 0.02 |   | $ | 0.20 |   | $ | 0.17 |   | $ | (0.11 | ) | $ | 0.06 |   |
| Diluted                                      |       | $                                                     | 0.18       |                                                 | $          | 0.02 |   | $ | 0.20 |   | $ | 0.17 |   | $ | (0.11 | ) | $ | 0.06 |   |
| Dividends per common share                   |       | $                                                     | 0.065      |                                                 | $          | — |   | $ | 0.065 |   | $ | 0.565 |   | $ | — |   | $ | 0.565 |   |

 
| ** **                                   | ** ** | **Quarter Ended March 31, 2008 (unaudited)** | ** ** | **Quarter Ended June 30, 2008 (unaudited)** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **As previously**                                 | ** ** | **Restatement**                                  | ** ** | ** ** | ** ** | **As previously** | ** ** | **Restatement** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Reported**                                      | ** ** | **Adjustments**                                  | ** ** | **Restated** | ** ** | **Reported** | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| Net sales                                    |       | $                                                 | 10,003,648 |                                             | $          | 489,721 |   | $ | 10,493,369 |   | $ | 12,202,642 |   | $ | 790,497 |   | $ | 12,993,139 |   |
| Cost of goods sold                           |       | 6,438,524                                         |       | (219,380                                         | )          | 6,219,144 |   | 7,092,619 |   | (40,333 | ) | 7,052,286 |   |
| Gross profit                                 |       | 3,565,124                                         |       | 709,101                                          |       | 4,274,225 |   | 5,110,023 |   | 830,830 |   | 5,940,853 |   |
| Selling, general and administrative expenses |       | 2,602,122                                         |       | (358,691                                         | )          | 2,243,431 |   | 3,034,640 |   | 35,671 |   | 3,070,310 |   |
| Unauthorized transactions                    |       | —                                            |       | 1,208,497                                        |       | 1,208,497 |   | — |   | 1,030,119 |   | 1,030,120 |   |
| Total operating expenses                     |       | 2,602,122                                         |       | 849,806                                          |       | 3,451,928 |   | 3,034,640 |   | 1,065,790 |   | 4,100,430 |   |
| Income from operations                       |       | 963,002                                           |       | (140,705                                         | )          | 822,297 |   | 2,075,383 |   | (234,960 | ) | 1,840,423 |   |
| Other Income (Expense):                      |       |                                              |       |                                             |       |   |   |   |   |   |   |   |   |
| Royalty income                               |       | 87,501                                            |       | (1                                               | )          | 87,500 |   | 29,166 |   | 58,334 |   | 87,500 |   |
| Interest income                              |       | 11,929                                            |       | —                                           |       | 11,929 |   | 10,344 |   | — |   | 10,344 |   |
| Interest expense                             |       | —                                            |       | (45,994                                          | )          | (45,994 | ) | — |   | (38,593 | ) | (38,593 | ) |
| Total Other Income, net                      |       | 99,430                                            |       | (45,995                                          | )          | 53,435 |   | 39,510 |   | 19,741 |   | 59,251 |   |
| Income before income tax provision           |       | 1,062,432                                         |       | (186,700                                         | )          | 875,732 |   | 2,114,893 |   | (215,219 | ) | 1,899,674 |   |
| Income tax provision                         |       | 414,435                                           |       | (12,271                                          | )          | 402,164 |   | 850,827 |   | 27,022 |   | 877,849 |   |
| Net income                                   |       | $                                                 | 647,997    |                                             | $          | (174,429 | ) | $ | 473,568 |   | $ | 1,264,066 |   | $ | (242,241 | ) | $ | 1,021,825 |   |
| Earnings per common share:                   |       |                                              |       |                                             |       |   |   |   |   |   |   |   |   |
| Basic                                        |       | $                                                 | 0.09       |                                             | $          | (0.03 | ) | $ | 0.06 |   | $ | 0.17 |   | $ | (0.02 | ) | $ | 0.15 |   |
| Diluted                                      |       | $                                                 | 0.09       |                                             | $          | (0.03 | ) | $ | 0.06 |   | $ | 0.17 |   | $ | (0.02 | ) | $ | 0.15 |   |
| Dividends per common share                   |       | $                                                 | 0.065      |                                             | $          | — |   | $ | 0.065 |   | $ | 0.065 |   | $ | — |   | $ | 0.065 |   |

 

Restatement adjustments aredescribed in NOTE 2. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS.

 

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17.                               LEGAL MATTERS

 

Sincelearning of the unauthorized transactions in December 2009, the Companyhas been named in the matters described below. The Company has also initiated certain actions against third parties,which are also described below, and may bring additional claims against otherthird parties.

 

·                  On January 11, 2010, the Companyreceived a letter from a law firm stating that it represented a shareholder anddemanding that the Company’s Board of Directors investigate and take legalaction against all responsible parties to ensure compensation for the Company’slosses stemming from the unauthorized transactions.  The Company’s legal counsel has respondedpreliminarily to the letter indicating that the Board of Directors willdetermine the appropriate course of action after the Independent Investigationis completed.

 

·                  OnJanuary 15, 2010, a class action complaint was filed in federal court inWisconsin against the Company, Michael Koss and Sujata Sachdeva.  The suit alleges violations ofSection 10(b), Rule 10b-5 and Section 20(a) of the ExchangeAct relating to the unauthorized transactions and requests an award ofcompensatory damages in an amount to be proven at trial.  See *David A. Puskala v. KossCorporation, et al.*, United States District Court, Eastern Districtof Wisconsin, Case No. 2:2010cv00041.

 

·                  On January 26, 2010, the SEC’s Divisionof Enforcement advised the Company that it obtained a formal order ofinvestigation in connection with the unauthorized transactions. The Companyvoluntarily brought the unauthorized transactions to the SEC staff’s attentionwhen they were discovered in December 2009, and is cooperating with theongoing SEC investigation.

 

·                      On February 16and 18, 2010, separate shareholder derivative suits were filed in MilwaukeeCounty Circuit Court in connection with the previously disclosed unauthorizedtransactions. The first suit names as defendants Michael Koss, John Koss Sr.,the other Koss directors, Sujata Sachdeva, Grant Thornton, LLP, and KossCorporation (as a nominal defendant); the second suit names the same partiesexcept Grant Thornton, LLP. Among other things, both suits allege variousbreaches of fiduciary and other duties, and seek recovery of unspecifieddamages and other relief. See *Ruiz**v. Koss, et al.*, Circuit Court, Milwaukee County, Wisconsin,No. 10CV002422 (February 16, 2010) and *Mentkowskiv. Koss, et al*., Circuit Court, Milwaukee County, Wisconsin, No. 10CV002290(February 18, 2010).  These twoshareholder derivative suits have been consolidated under Master File No. 10CV002422.

 

·                      On February 18,2010, the Company filed an action against American Express Company, AmericanExpress Travel Related Services Company, Inc., AMEX Card Services Company,Decision Science, and Pamela S. Hopkins in Superior Court of Maricopa County,Arizona, case no. CV2010-006631, alleging various claims of aiding and abettingbreach of fiduciary duty, aiding and abetting fraud, conversion, and negligencerelating to the unauthorized transactions.

 

·                      On June 24,2010, the Company filed an action against its former independent auditor, GrantThornton, LLP, and Ms. Sachdeva, in Circuit Court of Cook County, Illinois,alleging various claims of accounting malpractice, negligent misrepresentation,and fraud relating to the unauthorized transactions.

 

The ultimate resolution of these matters is notdeterminable.

 

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18.                               SUBSEQUENTEVENTS

 

As more fully described inthe Explanatory Note and in Note 2, on December 18, 2009, the Companylearned of certain unauthorized transactions made by Sujata Sachdeva, itsformer Vice President of Finance and Principal Accounting Officer.  As a result of the unauthorized transactions,the Company is restating its consolidated financial information in its AnnualReport on Form 10-K/A for the fiscal year ended June 30, 2009 and itsQuarterly Reports in Form 10-Q/A for the three months ended September 30,2009.  The Company is also amending itsQuarterly Reports on Form 10-Q/A for the three months ended December 31,2009 and March 31, 2010 to include consolidated financial statements,which were not available at the applicable filing deadlines for those reports.

 

As more fully described inthe Explanatory Note, the Company completed a two-for-one forward split of itscommon stock on December 1, 2009. All share and per-share data in these consolidated financial statementshave been adjusted to give effect to the stock split.

 

On May 12, 2010, theCompany terminated its credit facility with Harris N.A. and entered into a newcredit facility with JPMorgan Chase Bank, N.A. The events associated with these credit facilities are described in Note5.

 

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SIGNATURES

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| KOSS  CORPORATION |                          |   |
|-------------------|-------------------------------|--------|
|              |                          |   |   |
| By:               | /s/ Michael J. Koss           |   | Dated: June 30, 2010 |
|              | Michael J. Koss               |   |   |
|              | Vice Chairman                 |   |   |
|              | President                     |   |   |
|              | Chief Executive Officer       |   |   |
|              | Chief Operating Officer       |   |   |
|              |                          |   |   |
|              |                          |   |   |
| By:               | /s/ David D. Smith            |   | Dated: June 30, 2010 |
|              | David D. Smith                |   |   |
|              | Executive Vice President      |   |   |
|              | Chief Financial Officer       |   |   |
|              | Principal Accounting  Officer |   |   |
|              | Secretary                     |   |   |

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons on behalf of the Registrant and in the capacitiesindicated on June 30, 2010.

 

 
| /s/ John C. Koss               |   | /s/ Michael J. Koss            |
|--------------------------------|--------|--------------------------------|
| John C. Koss, Director         |   | Michael J. Koss, Director      |
|                           |   |                           |
|                           |   |                           |
| /s/ Lawrence S. Mattson        |   | /s/ John J. Stollenwerk        |
| Lawrence S. Mattson,  Director |   | John J. Stollenwerk,  Director |
|                           |   |                           |
|                           |   |                           |
| /s/ Thomas L. Doerr            |   | /s/ Theodore H. Nixon          |
| Thomas L. Doerr, Director      |   | Theodore H. Nixon,  Director   |

 

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EXHIBIT INDEX

 
| **Exhibit No.** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                            |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                    |
| 3.1                  |       | Amended and Restated  Certificate of Incorporation of Koss Corporation, as in effect on  November 19, 2009. Filed as Exhibit 3.1 to the Company’s Quarterly  Report on Form 10-Q for the period ended December 31, 2009 and  incorporated herein by reference. |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 3.2                  |       | By-Laws of Koss  Corporation, as in effect on September 25, 1996. Filed as  Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the  year ended June 30, 1996 and incorporated herein by reference.                                                    |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.1                 |       | Death Benefit Agreement  with John C. Koss. Filed as Exhibit 10.4 to the Company’s Annual Report  on Form 10-K for the year ended June 30, 1996 and incorporated  herein by reference.                                                                              |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.2                 |       | Stock Purchase Agreement  with John C. Koss. Filed as Exhibit 10.5 to the Company’s Annual Report  on Form 10-K for the year ended June 30, 1996 and incorporated  herein by reference.                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.3                 |       | Salary Continuation  Resolution for John C. Koss. Filed as Exhibit 10.6 to the Company’s  Annual Report on Form 10-K for the year ended June 30, 1996 and  incorporated herein by reference.                                                                        |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.4                 |       | 1983 Incentive Stock  Option Plan. Filed as Exhibit 10.7 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 1996 and incorporated herein  by reference.                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.5                 |       | Assignment of Lease to  John C. Koss. Filed as Exhibit 10.7 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 1988 and incorporated herein  by reference.                                                                                    |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.6                 |       | Addendum to Lease. Filed  as Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the  year ended June 30, 1988 and incorporated herein by reference.                                                                                                       |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.7                 |       | Amendment to Lease. Filed  as Exhibit 10.22 to the Company’s Annual Report on Form 10-K for  the year ended June 30, 2000 and incorporated herein by reference.                                                                                                     |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.8                 |       | Partial Assignment,  Termination and Modification of Lease. Filed as Exhibit 10.25 to the  Company’s Annual Report on Form 10-K for the year ended June 30,  2001 and incorporated herein by reference.                                                             |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.9                 |       | Restated Lease. Filed as  Exhibit 10.26 to the Company’s Annual Report on Form 10-K for the  year ended June 30, 2001 and incorporated herein by reference.                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.10                |       | 1990 Flexible Incentive  Plan. Filed as Exhibit 25 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 1990 and incorporated herein  by reference.                                                                                             |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.11                |       | Consent of Directors  (Supplemental Executive Retirement Plan for Michael J. Koss dated  March 7, 1997). Filed as Exhibit 10.2 to the Company’s Quarterly  Report on Form 10-Q for the quarter ended March 31, 1997 and  incorporated herein by reference.     |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.12                |       | Loan Agreement, effective  as of February 17, 1995. Filed as Exhibit 10 to the Company’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 1995  and incorporated herein by reference.                                                            |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.13                |       | Amendment to Loan  Agreement dated June 15, 1995, effective as of February 17, 1995.  Filed as Exhibit 10.13 to the Company’s Annual Report on Form 10-K  for the year ended June 30, 1995 and incorporated herein by reference.                          |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.14                |       | Amendment to Loan  Agreement dated April 29, 1999. Filed as Exhibit 10.14 to the  Company’s Annual Report on Form 10-K for the year ended June 30,  1999 and incorporated herein by reference.                                                                 |
|                 |       |                                                                                                                                                                                                                                                                                    |
| 10.15                |       | Amendment to Loan  Agreement dated December 15, 1999. Filed as Exhibit 10.15 to the  Company’s Annual Report on Form 10-K for the year ended June 30,  2000 and incorporated herein by reference.                                                              |

 

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Table of Contents

 
| 10.16  |   | Amendment to Loan  Agreement dated October 10, 2001. Filed as Exhibit 10.16 to the  Company’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2001 and incorporated herein by reference.                                                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.19  |   | License Agreement dated  June 30, 2003 between Koss Corporation and Sonigem Products, Inc.  Filed as Exhibit 10.19 to the Company’s Annual Report on Form 10-K  for the year ended June 30, 2005 and incorporated herein by reference.                            |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.20  |   | Amendment to License  Agreement dated August 1, 2005, between Koss Corporation and Sonigem  Products, Inc. Filed as Exhibit 10.20 to the Company’s Annual  Report on Form 10-K for the year ended June 30, 2005 and  incorporated herein by reference.            |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.21  |   | Loan Agreement dated  February 16, 2009, between Koss Corporation and Harris N.A., a national  banking association. Filed as Exhibit 10.21 to the Company’s Quarterly  Report on Form 10-Q for the quarter ended March 31, 2009 and  incorporated by reference herein. |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.22  |   | Credit Agreement dated  May 12, 2010, between Koss Corporation and JPMorgan Chase Bank, N.A.  Filed as Exhibit 10.12 to the Company’s Quarterly Report on  Form 10-Q for the quarter ended March 31, 2010 and incorporated by  reference herein.                       |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.23  |   | Pledge and Security  Agreement dated May 12, 2010, between Koss Corporation and JPMorgan  Chase Bank, N.A. Filed as Exhibit 10.13 to the Company’s Quarterly  Report on Form 10-Q for the quarter ended March 31, 2010 and  incorporated by reference herein.          |
|   |   |                                                                                                                                                                                                                                                                                            |
| 14     |   | Koss Corporation Code of  Ethics. Filed as Exhibit 14 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 2004 and incorporated herein  by reference.                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                            |
| 21     |   | List of Subsidiaries of  Koss Corporation. Filed as Exhibit 21 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 2009 and incorporated by  reference herein.                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                            |
| 23.1   |   | Consent of Baker Tilly  Virchow Krause, LLP*                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                            |
| 31.1   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Chief Executive Officer *                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                            |
| 31.2   |   | Rule 13(a)-14(a)/15(d)-14(a) Certification  of Chief Financial Officer*                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                            |
| 32.1   |   | Section 1350  Certification of Chief Executive Officer **                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                            |
| 32.2   |   | Section 1350  Certification of Chief Financial Officer**                                                                                                                                                                                                                                   |

 

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| *  |   | Filed herewith     |
|----|--------|--------------------|
| ** |   | Furnished herewith |

 

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