Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q/A**

 

**Amendment No. 1**

 

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

 

**for the quarterly period ended September 30, 2009**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**Commission File Number 0-3295**

 

**KOSS CORPORATION**

(Exact Name of Registrant as Specified in its Charter)

 

| **A DELAWARE CORPORATION**                                       | ** ** | **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’s telephone number, including areacode: **(414) 964-5000**

 

Indicateby check mark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.).  Yes o  No x

 

At June 30, 2010, there were 7,382,706 shares outstanding of theregistrant’s common stock.

 

 

 

----

Tableof Contents

 

KOSS CORPORATION AND SUBSIDIARY

FORM 10-Q/A

September 30, 2009

 

INDEX

 
| ** **   | ** **            | **Page**                                                                                                          |
|--------------|-----------------------|-------------------------------------------------------------------------------------------------------------------|
|         |                  |                                                                                                              |
| PART I  | FINANCIAL INFORMATION |                                                                                                              |
|         |                  |                                                                                                              |
|         | Item 1.               | Financial Statements                                                                                              |   |
|         |                  |                                                                                                              |   |
|         |                  | Condensed  Consolidated Statements of Operations (Unaudited) Three months ended  September 30, 2009 and 2008 | 4 |
|         |                  |                                                                                                              |   |
|         |                  | Condensed Consolidated  Balance Sheets September 30, 2009 (Unaudited) and June 30, 2009                 | 5 |
|         |                  |                                                                                                              |   |
|         |                  | Condensed  Consolidated Statements of Cash Flows (Unaudited) Three months ended  September 30, 2009 and 2008 | 6 |
|         |                  |                                                                                                              |   |
|         |                  | Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                 | 7 |
|         |                  |                                                                                                              |   |
|         | Item 2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       | 27 |
|         |                  |                                                                                                              |   |
|         |                  |                                                                                                              |   |
|         | Item 4.               | Controls and  Procedures                                                                                          | 33 |
|         |                  |                                                                                                              |   |
| PART II | OTHER INFORMATION     |                                                                                                              |
|         |                  |                                                                                                              |   |
|         | Item 1.               | Legal Proceedings                                                                                                 | 36 |
|         |                  |                                                                                                              |   |
|         | Item 5.               | Exhibits                                                                                                          | 36 |

 

2

----

Table of Contents

 

**EXPLANATORYNOTE**

 

ThisQuarterly Report on Form 10-Q/A for the three months ended September 30,2009 includes the unaudited restated condensed consolidated statements ofoperations for the three months ended September 30, 2009 and 2008,unaudited restated condensed consolidated balance sheet as of September 30,2009 and unaudited restated condensed consolidated statements of cash flows forthe three months ended September 30, 2009 and 2008.  The comparative consolidated balance sheet asof June 30, 2009 has been restated.

 

OnDecember 18, 2009, the Company learned of certain unauthorized transactionsmade by Sujata Sachdeva, its former Vice President of Finance and PrincipalAccounting Officer.  The Companysubsequently learned that Ms. Sachdeva colluded with two other employeesof the accounting department in the misappropriation and circumvention of theCompany’s existing internal 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.  Ms. Sachdeva and theseother former employees were terminated shortly after the Company learned of theunauthorized transactions. On January 20, 2010, Ms. Sachdeva wasindicted in connection with these misappropriations from the Company.

 

KossCorporation and its wholly-owned subsidiary (the “Company” or “Koss Corporation”)is restating its previously issued condensed consolidated financial statementsand related notes to the condensed consolidated financial statements primarilyto reflect adjustments relating to the unauthorized transactions previouslydisclosed in Form 8-K Current Reports filed on December 21 and 24,2009 and January 4, 7, 11 and 20, 2010.  These adjustments are more fully described inNote 2 to the restated condensed consolidated financial statements in this Form 10-Q/Aand in our recently filed Annual Report on Form 10-K/A for the year ended June 30,2009.

 

TheCompany has also amended its Quarterly Reports on Form 10-Q/A for thethree months ended December 31, 2009 and March 31, 2010 to includefinancial information.  This QuarterlyReport on Form 10-Q/A should be read in conjunction with those filings on Form 10-Q/A.

 

Thefollowing items of the Form 10-Q have been modified or revised in thisAmendment No. 1 to Form 10-Q/A to reflect these restatements andrelated events:

 
| Part I, Item  1.  | Financial  Statements                                                                       |
|-----------------------------|---------------------------------------------------------------------------------------------|
|                        |                                                                                        |
| Part I, Item  2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                        |                                                                                        |
| Part I, Item  4.  | Controls  and Procedures                                                                    |
|                        |                                                                                        |
| Part II, Item  1. | Legal  Proceedings                                                                          |
|                        |                                                                                        |
| Part II, Item  5. | Exhibits                                                                                    |

 

3

----

Table of Contents

 

**PART I**

**FINANCIAL INFORMATION**

 

**Item 1.    FinancialStatements.**

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS (Unaudited)

 
| **Three  Months Ended September 30,**           | ** ** | **2009**                   | ** ** | **2008**                   | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                           | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
|                                                 |       |                       |       |                       |       |
| Net sales                                            |       | $                          | 11,614,645 |                       | $          | 12,498,036 |   |
| Cost of goods sold                                   |       | 5,964,673                  |       | 6,916,661                  |       |
| Gross profit                                         |       | 5,649,972                  |       | 5,581,375                  |       |
|                                                 |       |                       |       |                       |       |
| Operating Expenses:                                  |       |                       |       |                       |       |
| Selling, general and administrative expenses         |       | 2,739,298                  |       | 2,652,794                  |       |
| Unauthorized transactions                            |       | 5,324,164                  |       | 1,689,052                  |       |
| Total Operating Expenses                             |       | 8,063,462                  |       | 4,341,846                  |       |
|                                                 |       |                       |       |                       |       |
| (Loss) income from operations                        |       | (2,413,490                 | )          | 1,239,529                  |       |
|                                                 |       |                       |       |                       |       |
| Other Income (Expense):                              |       |                       |       |                       |       |
| Royalty income                                       |       | —                     |       | 87,500                     |       |
| Interest income                                      |       | 3                          |       | 14,053                     |       |
| Interest expense                                     |       | (58,978                    | )          | (41,349                    | )          |
| Total Other (Expense) Income, net                    |       | (58,975                    | )          | 60,204                     |       |
|                                                 |       |                       |       |                       |       |
| (Loss) income before income tax (benefit)  provision |       | (2,472,465                 | )          | 1,299,733                  |       |
|                                                 |       |                       |       |                       |       |
| Income tax (benefit) provision                       |       | (878,715                   | )          | 457,888                    |       |
|                                                 |       |                       |       |                       |       |
| Net (loss) income                                    |       | $                          | (1,593,750 | )                          | $          | 841,845 |   |
|                                                 |       |                       |       |                       |       |
| (Loss) earnings per common share:                    |       |                       |       |                       |       |
| Basic                                                |       | $                          | (0.22      | )                          | $          | 0.11 |   |
| Diluted                                              |       | $                          | (0.22      | )                          | $          | 0.11 |   |
|                                                 |       |                       |       |                       |       |
| Dividends declared per common share                  |       | $                          | 0.065      |                       | $          | 0.065 |   |

 

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

 

4

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                                             | ** ** | **(Unaudited)**                           | ** ** | ** **                                | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                             | ** ** | **September 30, 2009**               | ** ** | **June 30, 2009**                    | ** ** |
| ** **                                                                                             | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
| ASSETS                                                                                                 |       |                                      |       |                                      |       |
| Current Assets:                                                                                        |       |                                      |       |                                      |       |
| Cash and cash equivalents                                                                              |       | $                                         | 3,103      |                                      | $          | 1,498,876 |   |
| Accounts receivable, less allowance for doubtful  accounts of $1,830,035 and $1,588,923, respectively  |       | 7,152,565                                 |       | 4,660,727                                 |       |
| Inventories                                                                                            |       | 9,034,710                                 |       | 8,708,835                                 |       |
| Prepaid expenses                                                                                       |       | 439,283                                   |       | 151,337                                   |       |
| Deferred income taxes                                                                                  |       | 1,385,570                                 |       | 1,385,497                                 |       |
| Total Current Assets                                                                                   |       | 18,015,231                                |       | 16,405,272                                |       |
|                                                                                                   |       |                                      |       |                                      |       |
| Equipment and leasehold improvements, net                                                              |       | 2,423,341                                 |       | 2,240,572                                 |       |
|                                                                                                   |       |                                      |       |                                      |       |
| Other Assets:                                                                                          |       |                                      |       |                                      |       |
| Product software development costs                                                                     |       | 1,867,976                                 |       | 1,727,040                                 |       |
| Deferred income taxes                                                                                  |       | 8,219,664                                 |       | 6,311,282                                 |       |
| Cash surrender value of life insurance                                                                 |       | 3,194,546                                 |       | 2,917,223                                 |       |
| Other assets                                                                                           |       | —                                    |       | 25,000                                    |       |
| Total Other Assets                                                                                     |       | 13,282,186                                |       | 10,980,545                                |       |
| Total Assets                                                                                           |       | $                                         | 33,720,758 |                                      | $          | 29,626,389 |   |
|                                                                                                   |       |                                      |       |                                      |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                              |       |                                      |       |                                      |       |
| Current Liabilities:                                                                                   |       |                                      |       |                                      |       |
| Accounts payable                                                                                       |       | $                                         | 4,927,411  |                                      | $          | 3,122,721 |   |
| Outstanding checks in excess of funds on deposit                                                       |       | 621,393                                   |       | —                                    |       |
| Accrued liabilities                                                                                    |       | 2,137,230                                 |       | 2,090,054                                 |       |
| Dividends payable                                                                                      |       | 479,876                                   |       | 479,876                                   |       |
| Income taxes payable                                                                                   |       | 5,184,123                                 |       | 4,404,382                                 |       |
| Line of credit                                                                                         |       | 2,750,000                                 |       | —                                    |       |
| Total Current Liabilities                                                                              |       | 16,100,033                                |       | 10,097,033                                |       |
|                                                                                                   |       |                                      |       |                                      |       |
| Long-Term Liabilities:                                                                                 |       |                                      |       |                                      |       |
| Deferred compensation                                                                                  |       | 1,594,045                                 |       | 1,541,240                                 |       |
| Derivative liability                                                                                   |       | 125,000                                   |       | 125,000                                   |       |
| Other liabilities                                                                                      |       | 725,000                                   |       | 725,000                                   |       |
| Total Long-Term Liabilities                                                                            |       | 2,444,045                                 |       | 2,391,240                                 |       |
|                                                                                                   |       |                                      |       |                                      |       |
| Total Liabilities                                                                                      |       | 18,544,078                                |       | 12,488,273                                |       |
|                                                                                                   |       |                                      |       |                                      |       |
| Stockholders’ Equity:                                                                             |       |                                      |       |                                      |       |
| Common stock, $0.005 par value, authorized  20,000,000 shares; issued and outstanding 7,382,706 shares |       | 36,914                                    |       | 36,914                                    |       |
| Paid in capital                                                                                        |       | 1,169,165                                 |       | 1,056,975                                 |       |
| Retained earnings                                                                                      |       | 13,970,601                                |       | 16,044,227                                |       |
| Total Stockholders’ Equity                                                                        |       | 15,176,680                                |       | 17,138,116                                |       |
| Total Liabilities and Stockholders’ Equity                                                        |       | $                                         | 33,720,758 |                                      | $          | 29,626,389 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

5

----

Tableof Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)

 
| **Three  Months Ended September 30,**                                                          | ** ** | **2009**                   | ** ** | **2008**                   | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                                          | ** ** | **(Restated, See Note 2)** | ** ** | **(Restated, See Note 2)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |                       |       |                       |       |
| Net (loss) income                                                                                   |       | $                          | (1,593,750 | )                          | $          | 841,845 |   |
| Adjustments to reconcile net (loss) income to net  cash (used in) provided by operating activities: |       |                       |       |                       |       |
| Provision for doubtful accounts                                                                     |       | 241,112                    |       | 102,097                    |       |
| Provision (provision reversal) for obsolete  inventories                                            |       | 65,437                     |       | (28,733                    | )          |
| Loss on disposals of equipment and leasehold  improvements                                          |       | 961                        |       | 5,074                      |       |
| Depreciation of equipment and leasehold  improvements                                               |       | 172,088                    |       | 229,813                    |       |
| Stock-based compensation expense                                                                    |       | 112,190                    |       | 110,665                    |       |
| Provision for deferred income taxes                                                                 |       | (1,908,455                 | )          | (271,202                   | )          |
| Change in cash surrender value of life insurance                                                    |       | 71,180                     |       | 5,823                      |       |
| Deferred compensation                                                                               |       | 52,805                     |       | 53,635                     |       |
| Net changes in operating assets and liabilities                                                     |       | (780,601                   | )          | 720,770                    |       |
| Net cash (used in) provided by operating  activities                                                |       | (3,567,033                 | )          | 1,769,787                  |       |
|                                                                                                |       |                       |       |                       |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |                       |       |                       |       |
| Maturity of investments                                                                             |       | 25,000                     |       | —                     |       |
| Life insurance premiums paid                                                                        |       | (348,503                   | )          | (348,503                   | )          |
| Purchase of equipment and leasehold improvements                                                    |       | (355,818                   | )          | (685,343                   | )          |
| Product software development expenditures                                                           |       | (140,936                   | )          | (157,137                   | )          |
| Net cash used in investing activities                                                               |       | (820,257                   | )          | (1,190,983                 | )          |
|                                                                                                |       |                       |       |                       |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |                       |       |                       |       |
| Net proceeds from line of credit                                                                    |       | 2,750,000                  |       | —                     |       |
| Net increase in outstanding checks in excess of  funds on deposit                                   |       | 621,393                    |       | —                     |       |
| Dividends paid to stockholders                                                                      |       | (479,876                   | )          | (480,395                   | )          |
| Net cash provided by (used in) financing  activities                                                |       | 2,891,517                  |       | (480,395                   | )          |
|                                                                                                |       |                       |       |                       |       |
| Net (decrease) increase in cash and cash  equivalents                                               |       | (1,495,773                 | )          | 98,409                     |       |
| Cash and cash equivalents at beginning of period                                                    |       | 1,498,876                  |       | 3,162,233                  |       |
| Cash and cash equivalents at end of period                                                          |       | $                          | 3,103      |                       | $          | 3,260,642 |   |

 

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

 

6

----

Table ofContents

 

KOSS CORPORATION AND SUBSIDIARY

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

September 30, 2009

(Unaudited)

 

1.             CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

 

OnJune 30, 2009, the Company adopted Financial Accounting Standards Board (“FASB”)Accounting Standards Codification (“ASC”). This pronouncement establishes the FASB ASC as the source ofauthoritative accounting principles recognized by the FASB to be applied inpreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America (“GAAP”).  The adoption of this standard had no impacton the Company’s condensed consolidated financial statements.

 

The unaudited condensed consolidated financial statements presentedherein are based on interim amounts.  Inthe opinion of management, all adjustments (consisting of normal recurringaccruals) necessary to present fairly the financial position, results ofoperations and cash flows as of and for the three months ended September 30,2009 and for all periods presented have been made.  All significant intercompany accounts andtransactions have been eliminated.  Theresults of operations for the quarter ended September 30, 2009 are notnecessarily indicative of the operating results for the full year.

 

Certain information and footnote disclosures normally included infinancial statements prepared in accordance with GAAP have been condensed oromitted.  These condensed consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and notes thereto included in the Registrant’s June 30,2009 Annual Report on Form 10-K/A.

 

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 on Form 10-Ksince fiscal year 2005 and the unaudited condensed consolidated financialstatements included in our Quarterly Report on Form 10-Q for the threemonths 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, Koss Corporation learnedof certain unauthorized transactions from at least its fiscal year 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.

 

All share and per-share data have been adjusted togive effect to the stock split on December 1, 2009.

 

7

----

Table ofContents

 

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 condensed consolidated financial statementsfor the three months ended September 30, 2009 and 2008.

 
| ** **                                                                    | ** ** | **Three Months ended September 30, 2009** | ** ** | **Three Months ended September 30, 2008** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                    | ** ** | **Restatement**                                | ** ** | **Per Share**                                  | ** ** | **Restatement** | ** ** | **Per Share** | ** ** |
|                                                                          |       |                                           |       |                                           |       |   |   |   |   |
| Unauthorized transaction losses                                               |       | $                                              | (5,324,164 | )                                              | $          | (0.72 | ) | $ | (1,689,052 | ) | $ | (0.22 | ) |
| Unauthorized transaction losses previously  recorded in the income statement: |       |                                           |       |                                           |       |   |   |   |   |
| Net sales                                                                     |       | 692,556                                        |       | 0.09                                           |       | 758,237 |   | 0.10 |   |
| Cost of goods sold                                                            |       | 412,327                                        |       | 0.05                                           |       | 472,912 |   | 0.06 |   |
| Selling, general and administrative expenses                                  |       | (146,771                                       | )          | (0.02                                          | )          | 166,918 |   | 0.03 |   |
| Additional restatement adjustments:                                           |       |                                           |       |                                           |       |   |   |   |   |
| Net sales                                                                     |       | 125,236                                        |       | 0.02                                           |       | 253,765 |   | 0.03 |   |
| Cost of goods sold                                                            |       | 302,562                                        |       | 0.04                                           |       | (303,999 | ) | (0.04 | ) |
| Selling, general and administrative expenses                                  |       | 596,273                                        |       | 0.08                                           |       | 178,815 |   | 0.02 |   |
| Royalty income                                                                |       | —                                         |       | —                                         |       | 29,167 |   | 0.00 |   |
| Interest income                                                               |       | 3                                              |       | 0.00                                           |       | — |   | — |   |
| Interest expense                                                              |       | (58,978                                        | )          | (0.01                                          | )          | (41,349 | ) | (0.01 | ) |
|                                                                          |       |                                           |       |                                           |       |   |   |   |   |
| Loss before income tax benefit                                                |       | (3,400,956                                     | )          | (0.47                                          | )          | (174,586 | ) | (0.03 | ) |
| Income tax effect of restatement                                              |       | (1,240,827                                     | )          | (0.17                                          | )          | (102,667 | ) | (0.01 | ) |
| Total reduction in net income                                                 |       | $                                              | (2,160,129 | )                                              | $          | (0.30 | ) | $ | (71,919 | ) | $ | (0.02 | ) |

 

Thecondensed consolidated statements of operations, condensed consolidated balancesheets and condensed consolidated statements of cash flows detailed belowreconcile the previously reported amounts to the restated amounts beingreported on in this Quarterly Report on Form 10-Q/A.  The restatement adjustments reflected in thefinancial statement line items are further described below the reconcilingconsolidated financial statements in the applicable section to which theypertain.

 

8

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENT OF OPERATIONS INFORMATION

 
| **Three  Months Ended September 30,**   | ** ** | **2009  (as previously  reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|-------------------------|------------|
|                                         |       |                                |       |            |       |                    |       |
| Net sales                                    |       | $                                   | 10,796,853 |            | $          | 817,792                 |       | $ | 11,614,645 |   |
| Cost of goods sold                           |       | 6,679,562                           |       | (714,889        | )          | 5,964,673               |       |
| Gross profit                                 |       | 4,117,291                           |       | 1,532,681       |       | 5,649,972               |       |
|                                         |       |                                |       |            |       |                    |       |
| Operating Expenses:                          |       |                                |       |            |       |                    |       |
| Selling, general and administrative expenses |       | 3,188,800                           |       | (449,502        | )          | 2,739,298               |       |
| Unauthorized transactions                    |       | —                              |       | 5,324,164       |       | 5,324,164               |       |
| Total Operating Expenses                     |       | 3,188,800                           |       | 4,874,662       |       | 8,063,462               |       |
|                                         |       |                                |       |            |       |                    |       |
| Income (loss) from operations                |       | 928,491                             |       | (3,341,981      | )          | (2,413,490              | )          |
|                                         |       |                                |       |            |       |                    |       |
| Other Income (Expense):                      |       |                                |       |            |       |                    |       |
| Royalty income                               |       | —                              |       | —          |       | —                  |       |
| Interest income                              |       | —                              |       | 3               |       | 3                       |       |
| Interest expense                             |       | —                              |       | (58,978         | )          | (58,978                 | )          |
| Total Other (Expense), net                   |       | —                              |       | (58,975         | )          | (58,975                 | )          |
|                                         |       |                                |       |            |       |                    |       |
| Income (loss) before income tax              |       | 928,491                             |       | (3,400,956      | )          | (2,472,465              | )          |
|                                         |       |                                |       |            |       |                    |       |
| Income tax provision (benefit)               |       | 362,112                             |       | (1,240,827      | )          | (878,715                | )          |
|                                         |       |                                |       |            |       |                    |       |
| Net income (loss)                            |       | $                                   | 566,379    |            | $          | (2,160,129              | )          | $ | (1,593,750 | ) |
|                                         |       |                                |       |            |       |                    |       |
| Earnings (loss) per common share:            |       |                                |       |            |       |                    |       |
| Basic                                        |       | $                                   | 0.08       |            | $          | (0.30                   | )          | $ | (0.22 | ) |
| Diluted                                      |       | $                                   | 0.08       |            | $          | (0.30                   | )          | $ | (0.22 | ) |
|                                         |       |                                |       |            |       |                    |       |
| Dividends declared per common share          |       | $                                   | 0.065      |            | $          | —                  |       | $ | 0.065 |   |

 

9

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENT OF INCOME INFORMATION

 
| **Three  Months Ended September 30,**   | ** ** | **2008  (as previously  reported)** | ** ** | **Adjustments** | ** ** | **2008  (as restated)** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|-------------------------|------------|
|                                         |       |                                |       |            |       |                    |       |
| Net sales                                    |       | $                                   | 11,486,034 |            | $          | 1,012,002               |       | $ | 12,498,036 |   |
| Cost of goods sold                           |       | 7,085,574                           |       | (168,913        | )          | 6,916,661               |       |
| Gross profit                                 |       | 4,400,460                           |       | 1,180,915       |       | 5,581,375               |       |
|                                         |       |                                |       |            |       |                    |       |
| Operating Expenses:                          |       |                                |       |            |       |                    |       |
| Selling, general and administrative expenses |       | 2,998,527                           |       | (345,733        | )          | 2,652,794               |       |
| Unauthorized transactions                    |       | —                              |       | 1,689,052       |       | 1,689,052               |       |
| Total Operating Expenses                     |       | 2,998,527                           |       | 1,343,319       |       | 4,341,846               |       |
|                                         |       |                                |       |            |       |                    |       |
| Income from operations                       |       | 1,401,933                           |       | (162,404        | )          | 1,239,529               |       |
|                                         |       |                                |       |            |       |                    |       |
| Other Income (Expense):                      |       |                                |       |            |       |                    |       |
| Royalty income                               |       | 58,333                              |       | 29,167          |       | 87,500                  |       |
| Interest income                              |       | 14,053                              |       | —          |       | 14,053                  |       |
| Interest expense                             |       | —                              |       | (41,349         | )          | (41,349                 | )          |
| Total Other Income, net                      |       | 72,386                              |       | (12,182         | )          | 60,204                  |       |
|                                         |       |                                |       |            |       |                    |       |
| Income before income tax provision           |       | 1,474,319                           |       | (174,586        | )          | 1,299,733               |       |
|                                         |       |                                |       |            |       |                    |       |
| Income tax provision                         |       | 560,555                             |       | (102,667        | )          | 457,888                 |       |
|                                         |       |                                |       |            |       |                    |       |
| Net income                                   |       | $                                   | 913,764    |            | $          | (71,919                 | )          | $ | 841,845 |   |
|                                         |       |                                |       |            |       |                    |       |
| Earnings per common share:                   |       |                                |       |            |       |                    |       |
| Basic                                        |       | $                                   | 0.13       |            | $          | (0.02                   | )          | $ | 0.11 |   |
| Diluted                                      |       | $                                   | 0.13       |            | $          | (0.02                   | )          | $ | 0.11 |   |
|                                         |       |                                |       |            |       |                    |       |
| Dividends declared per common share          |       | $                                   | 0.065      |            | $          | —                  |       | $ | 0.065 |   |

 

10

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDBALANCE SHEET INFORMATION

 
| **As of  September 30,**                                                                          | ** ** | **2009  (as previously  reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|-------------------------|------------|
| ASSETS                                                                                                 |       |                                |       |            |       |                    |       |
| Current Assets:                                                                                        |       |                                |       |            |       |                    |       |
| Cash and cash equivalents                                                                              |       | $                                   | 2,847,643  |            | $          | (2,844,540              | )          | $ | 3,103 |   |
| Accounts receivable, less allowance for doubtful accounts  of $1,830,035                               |       | 10,280,462                          |       | (3,127,897      | )          | 7,152,565               |       |
| Inventories                                                                                            |       | 10,371,604                          |       | (1,336,894      | )          | 9,034,710               |       |
| Prepaid expenses                                                                                       |       | —                              |       | 439,283         |       | 439,283                 |       |
| Deferred income taxes                                                                                  |       | 720,121                             |       | 665,449         |       | 1,385,570               |       |
| Other current assets                                                                                   |       | 920,153                             |       | (920,153        | )          | —                  |       |
| Total Current Assets                                                                                   |       | 25,139,983                          |       | (7,124,752      | )          | 18,015,231              |       |
|                                                                                                   |       |                                |       |            |       |                    |       |
| Equipment and leasehold improvements, net                                                              |       | 4,364,028                           |       | (1,940,687      | )          | 2,423,341               |       |
|                                                                                                   |       |                                |       |            |       |                    |       |
| Other Assets:                                                                                          |       |                                |       |            |       |                    |       |
| Product software development costs                                                                     |       | —                              |       | 1,867,976       |       | 1,867,976               |       |
| Deferred income taxes                                                                                  |       | 1,237,727                           |       | 6,981,937       |       | 8,219,664               |       |
| Cash surrender value of life insurance                                                                 |       | —                              |       | 3,194,546       |       | 3,194,546               |       |
| Other Assets                                                                                           |       | 2,160,586                           |       | (2,160,586      | )          | —                  |       |
| Total Other Assets                                                                                     |       | 3,398,313                           |       | 9,883,873       |       | 13,282,186              |       |
| Total Assets                                                                                           |       | $                                   | 32,902,324 |            | $          | 818,434                 |       | $ | 33,720,758 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                              |       |                                |       |            |       |                    |       |
| Current Liabilities:                                                                                   |       |                                |       |            |       |                    |       |
| Accounts payable                                                                                       |       | $                                   | 2,428,020  |            | $          | 2,499,391               |       | $ | 4,927,411 |   |
| Outstanding checks in excess of funds on deposit                                                       |       | —                              |       | 621,393         |       | 621,393                 |       |
| Accrued liabilities                                                                                    |       | 1,935,695                           |       | 201,535         |       | 2,137,230               |       |
| Dividends payable                                                                                      |       | 479,876                             |       | —          |       | 479,876                 |       |
| Income taxes payable                                                                                   |       | 287,681                             |       | 4,896,442       |       | 5,184,123               |       |
| Line of credit                                                                                         |       | 2,750,000                           |       | —          |       | 2,750,000               |       |
| Total Current Liabilities                                                                              |       | 7,881,272                           |       | 8,218,761       |       | 16,100,033              |       |
|                                                                                                   |       |                                |       |            |       |                    |       |
| Long-Term Liabilities:                                                                                 |       |                                |       |            |       |                    |       |
| Deferred compensation                                                                                  |       | 1,095,961                           |       | 498,084         |       | 1,594,045               |       |
| Derivative liability                                                                                   |       | 125,000                             |       | —          |       | 125,000                 |       |
| Other liabilities                                                                                      |       | —                              |       | 725,000         |       | 725,000                 |       |
| Total Long-Term Liabilities                                                                            |       | 1,220,961                           |       | 1,223,084       |       | 2,444,045               |       |
|                                                                                                   |       |                                |       |            |       |                    |       |
| Total Liabilities                                                                                      |       | 9,102,233                           |       | 9,441,845       |       | 18,544,078              |       |
| Stockholders’ Equity:                                                                             |       |                                |       |            |       |                    |       |
| Common stock, $0.005 par value, authorized  20,000,000 shares; issued and outstanding 7,382,706 shares |       | —                              |       | 36,914          |       | 36,914                  |       |
| Paid in capital                                                                                        |       | —                              |       | 1,169,165       |       | 1,169,165               |       |
| Retained earnings                                                                                      |       | —                              |       | 13,970,601      |       | 13,970,601              |       |
| Stockholders’ investment                                                                          |       | 23,800,091                          |       | (23,800,091     | )          | —                  |       |
| Total Stockholders’ Equity                                                                        |       | 23,800,091                          |       | (8,623,411      | )          | 15,176,680              |       |
| Total Liabilities and Stockholders’ Equity                                                        |       | $                                   | 32,902,324 |            | $          | 818,434                 |       | $ | 33,720,758 |   |

 

11

----

Tableof Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDBALANCE SHEET INFORMATION

 
| **As of June 30,**                                                                      | ** ** | **2009  (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 |   |

 

12

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENT OF CASH FLOW INFORMATION

 
| **Three  Months Ended September 30,**                                            | ** ** | **2009  (as previously  reported)** | ** ** | **Adjustments** | ** ** | **2009  (as restated)** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|-------------------------|------------|
|                                                                                  |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                 |       |                                |       |            |       |                    |       |
| Net income (loss)                                                                     |       | $                                   | 566,379    |            | $          | (2,160,129              | )          | $ | (1,593,750 | ) |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                |       |            |       |                    |       |
| Provision for doubtful accounts                                                       |       | —                              |       | 241,112         |       | 241,112                 |       |
| Provision for obsolete inventories                                                    |       | —                              |       | 65,437          |       | 65,437                  |       |
| Loss on disposals of equipment and leasehold  improvements                            |       | —                              |       | 961             |       | 961                     |       |
| Depreciation of equipment and leasehold  improvements                                 |       | 252,107                             |       | (80,019         | )          | 172,088                 |       |
| Stock-based compensation expense                                                      |       | —                              |       | 112,190         |       | 112,190                 |       |
| Provision for deferred income taxes                                                   |       | —                              |       | (1,908,455      | )          | (1,908,455              | )          |
| Change in cash surrender value of life insurance                                      |       | —                              |       | 71,180          |       | 71,180                  |       |
| Deferred compensation                                                                 |       | —                              |       | 52,805          |       | 52,805                  |       |
| Net changes in operating assets and liabilities                                       |       | (1,363,103                          | )          | 582,502         |       | (780,601                | )          |
| Net cash used in operating activities                                                 |       | (544,617                            | )          | (3,022,416      | )          | (3,567,033              | )          |
|                                                                                  |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                 |       |                                |       |            |       |                    |       |
| Maturity of investments                                                               |       | —                              |       | 25,000          |       | 25,000                  |       |
| Life insurance premiums paid                                                          |       | —                              |       | (348,503        | )          | (348,503                | )          |
| Purchase of equipment and leasehold improvements                                      |       | (542,271                            | )          | 186,453         |       | (355,818                | )          |
| Product software development expenditures                                             |       | —                              |       | (140,936        | )          | (140,936                | )          |
| Net cash used in investing activities                                                 |       | (542,271                            | )          | (277,986        | )          | (820,257                | )          |
|                                                                                  |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                 |       |                                |       |            |       |                    |       |
| Net proceeds from line of credit                                                      |       | 2,750,000                           |       | —          |       | 2,750,000               |       |
| Net increase in outstanding checks in excess of  funds on deposit                     |       | —                              |       | 621,393         |       | 621,393                 |       |
| Dividends paid to stockholders                                                        |       | (479,876                            | )          | —          |       | (479,876                | )          |
| Net cash provided by financing activities                                             |       | 2,270,124                           |       | 621,393         |       | 2,891,517               |       |
|                                                                                  |       |                                |       |            |       |                    |       |
| Net increase (decrease) in cash and cash  equivalents                                 |       | 1,183,236                           |       | (2,679,009      | )          | (1,495,773              | )          |
| Cash and cash equivalents at beginning of period                                      |       | 1,664,407                           |       | (165,531        | )          | 1,498,876               |       |
| Cash and cash equivalents at end of period                                            |       | $                                   | 2,847,643  |            | $          | (2,844,540              | )          | $ | 3,103 |   |

 

13

----

Table of Contents

 

KOSS CORPORATION ANDSUBSIDIARY

CONDENSED CONSOLIDATEDSTATEMENT OF CASH FLOW INFORMATION

 
| **Three  Months Ended September 30,**                                         | ** ** | **2008  (as previously  reported)** | ** ** | **Adjustments** | ** ** | **2008  (as restated)** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|-------------------------|------------|
|                                                                               |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                |       |            |       |                    |       |
| Net income                                                                         |       | $                                   | 913,764    |            | $          | (71,919                 | )          | $ | 841,845 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                |       |            |       |                    |       |
| Provision for doubtful accounts                                                    |       | —                              |       | 102,097         |       | 102,097                 |       |
| Reversal of provision for obsolete inventories                                     |       | —                              |       | (28,733         | )          | (28,733                 | )          |
| Loss on disposals of equipment and leasehold improvements                          |       | —                              |       | 5,074           |       | 5,074                   |       |
| Depreciation of equipment and leasehold improvements                               |       | 289,899                             |       | (60,086         | )          | 229,813                 |       |
| Stock-based compensation expense                                                   |       | —                              |       | 110,665         |       | 110,665                 |       |
| Provision for deferred income taxes                                                |       | —                              |       | (271,202        | )          | (271,202                | )          |
| Change in cash surrender value of life insurance                                   |       | —                              |       | 5,823           |       | 5,823                   |       |
| Deferred compensation                                                              |       | —                              |       | 53,635          |       | 53,635                  |       |
| Net changes in operating assets and liabilities                                    |       | 980,370                             |       | (259,600        | )          | 720,770                 |       |
| Net cash provided by operating activities                                          |       | 2,184,033                           |       | (414,246        | )          | 1,769,787               |       |
|                                                                               |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                                |       |            |       |                    |       |
| Life insurance premiums paid                                                       |       | —                              |       | (348,503        | )          | (348,503                | )          |
| Purchase of equipment and leasehold improvements                                   |       | (941,493                            | )          | 256,150         |       | (685,343                | )          |
| Product software development expenditures                                          |       | —                              |       | (157,137        | )          | (157,137                | )          |
| Net cash used in investing activities                                              |       | (941,493                            | )          | (249,490        | )          | (1,190,983              | )          |
|                                                                               |       |                                |       |            |       |                    |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                                |       |            |       |                    |       |
| Dividends paid to stockholders                                                     |       | (480,395                            | )          | —          |       | (480,395                | )          |
| Net cash used in financing activities                                              |       | (480,395                            | )          | —          |       | (480,395                | )          |
|                                                                               |       |                                |       |            |       |                    |       |
| Net increase in cash and cash equivalents                                          |       | 762,145                             |       | (663,736        | )          | 98,409                  |       |
| Cash and cash equivalents at beginning of period                                   |       | 3,322,873                           |       | (160,640        | )          | 3,162,233               |       |
| Cash and cash equivalents at end of period                                         |       | $                                   | 4,085,018  |            | $          | (824,376                | )          | $ | 3,260,642 |   |

 

14

----

Table ofContents

 

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 condensed consolidatedfinancial statements contained errors for understatement of revenue because ofthe unauthorized transactions.  Certainunauthorized transactions improperly reduced various sales accounts through theuse of manual journal entries or system transactions.  In the three months ended September 30,2009 and September 30, 2008, net sales were understated by the amounts setforth in Table A, below.

 

Table A

Restatement Adjustments Related to Net Sales

 
| ** **                                      | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Restatement adjustments to increase gross sales |       | $                            | 700,140    |                         | $          | 696,560 |   |
| Restatement adjustments to sales allowances     |       | 117,652                      |       | 315,442                      |       |
| Total                                           |       | $                            | 817,792    |                         | $          | 1,012,002 |   |

 

*Cost ofGoods 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 for the three monthsended September 30 as set forth in Table B, below.

 

Table B

Restatement Adjustments Related to Cost of Goods Sold

 
| ** **              | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| Material  and all other |       | $                       | (496,576   | )                       | $          | (126,145 | ) |
| Labor                   |       | (183,153                | )          | (49,967                 | )          |
| Freight                 |       | 53,701                  |       | 134,459                 |       |
| Fringe  benefits        |       | —                  |       | (49,582                 | )          |
| Engineering             |       | (30,000                 | )          | (119,161                | )          |
| Depreciation            |       | (58,861                 | )          | 41,483                  |       |
| Total                   |       | $                       | (714,889   | )                       | $          | (168,913 | ) |

 

*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 the items listed belowwere misstated.

 

·                  Provision for doubtful accounts wasunderstated as was the allowance for doubtful accounts.

 

·                  Accounting for the cash surrender value oflife insurance was improperly stated because of not including all of therelated life insurance policies.

 

15

----

Tableof Contents

 

·                  Deferred compensation expense was understatedfor the three months ended September 30, 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 for professional fees and productdevelopment expense were overstated as a result of erroneous manual journalentries.  The erroneous charges wererecorded to these line items in both periods.

 

Theamounts related to the above misstatements for the three months ended September 30are summarized in Table C, below.

 

Table C

Restatement Adjustments Related to Selling,

General and Administrative Expenses

 
| ** **                                                 | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Provision for doubtful accounts                            |       | $                            | 121,112    |                         | $          | (24,412 | ) |
| Stock-based compensation expense                           |       | 112,190                      |       | 110,665                      |       |
| Change in miscellaneous income                             |       | (277,323                     | )          | (342,681                     | )          |
| Deferred compensation expense                              |       | 52,805                       |       | 53,635                       |       |
| Professional fees                                          |       | 16,961                       |       | (21,601                      | )          |
| Fringe benefits                                            |       | —                       |       | (39,893                      | )          |
| Officers’ life insurance                              |       | 260,947                      |       | 264,463                      |       |
| Bonuses                                                    |       | —                       |       | 37,000                       |       |
| Koss Employee Stock Ownership Trust/401(k)                 |       | —                       |       | (26,092                      | )          |
| Donations                                                  |       | (7,500                       | )          | (1,628                       | )          |
| Financial public relations                                 |       | (30,000                      | )          | (59,999                      | )          |
| Gain/loss on fixed asset disposals                         |       | 961                          |       | 5,074                        |       |
| New product development, sales, marketing and  commissions |       | (498,722                     | )          | (37,159                      | )          |
| Depreciation                                               |       | (21,158                      | )          | (101,569                     | )          |
| Miscellaneous expense                                      |       | (84,341                      | )          | (13,093                      | )          |
| Other selling, general and administrative                  |       | (95,434                      | )          | (148,443                     | )          |
| Total                                                      |       | $                            | (449,502   | )                            | $          | (345,733 | ) |

 

*IncomeTax Provision*

 

Theimpact of the various account adjustments for the three months ended September 30on the income tax provision is detailed in Table D, below.

 

Table D

Restatement Adjustments Related to Income Tax Provision

 
| ** **                   | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Federal income tax provision |       | $                            | (1,143,448 | )                            | $          | (144,299 | ) |
| State income tax provision   |       | (98,177                      | )          | 18,907                       |       |
| Foreign income tax provision |       | 798                          |       | 22,725                       |       |
| Income tax provision         |       | $                            | (1,240,827 | )                            | $          | (102,667 | ) |

 

16

----

Table ofContents

 

*Cashand Cash Equivalents*

 

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

 

Table E

Restatement Adjustments Related to Cash

 
| ** **                 | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------|------------|
| Correction of cash balance |       | $                       | (2,844,540 | )                 | $          | (165,531 | ) |
|                            |            |                         |            |                   |            |  |  |

 

*AccountsReceivable and Allowance for Doubtful Accounts*

 

Accountsreceivable was overstated because of not properly applying cash receivedagainst the outstanding invoices.

 

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

 
| ** **                                           | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|
| Accounts  receivable because of delayed cash posting |       | $                       | (2,395,573 | )                 | $          | (3,407,667 | ) |
| Allowance  for doubtful accounts                     |       | (732,324                | )          | (611,212          | )          |
| Total                                                |       | $                       | (3,127,897 | )                 | $          | (4,018,879 | ) |

* *

*Inventories*

* *

Inventorieswere overstated as a result of not properly accounting for the inventory in transit,insufficient provision for obsolete or slow-moving inventory and treatingadvance payments as inventory.  Theimpact of these items is provided in Table G, below.

 

Table G

Restatement Adjustments Related to Inventory

 
| ** **                         | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------|------------|
| Inventory in transit               |       | $                       | 1,310      |              | $          | 289,622 |   |
| Obsolete and slow-moving inventory |       | (846,666                | )          | (901,229          | )          |
| Prepaid inventory                  |       | (549,039                | )          | (402,642          | )          |
| LIFO reserve                       |       | 9,071                   |       | 9,071             |       |
| Freight on inventory               |       | 54,497                  |       | 25,614            |       |
| Other                              |       | (6,067                  | )          | (74,759           | )          |
| Total                              |       | $                       | (1,336,894 | )                 | $          | (1,054,323 | ) |

 

17

----

Table ofContents

 

*Equipmentand 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  were no longer being used in thebusiness.  Almost all of the assets whichwere written off had been fully depreciated prior to these adjustments.  Loss on disposal was $961 for the threemonths ended September 30, 2009 and $5,074 for the three months ended September30, 2008.  Product software developmentcosts were reclassified and reported separately in the restated consolidatedbalance sheets.   The impact of theequipment and leasehold improvements is provided in Table H below.

 

Table H

Restatement Adjustments Related to Equipment and Leasehold Improvements

 
| ** **                                    | ** ** | **September 30,  2009** | ** **       | **June 30, 2009** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------------|-------------------|------------|
| Leasehold improvements                        |       | $                       | (77,468          | )                 | $          | (77,468 | ) |
| Machinery, equipment,  furniture and fixtures |       | (508,083                | )                | (511,937          | )          |
| Tools, dies, molds and  patterns              |       | (6,727,610              | )                | (6,534,676        | )          |
|                                          |       | (7,313,161              | )                | (7,124,081        | )          |
| Accumulated depreciation                      |       | 5,372,474               |             | 5,288,455         |       |
| Total                                         |       | $                       |  (1,940,687 | )                 | $          |  (1,835,626 | ) |

 

*ProductSoftware 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

 
| ** **                                                  | ** ** | **September 30,  2009** | ** **      | **June 30, 2009** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|-----------------|-------------------|------------|
| Reclassification from equipment and leasehold  improvements |       | $                       |  1,867,976 |              | $          |  1,727,040 |   |
|                                                             |            |                         |                 |                   |            |  |  |

 

*CashSurrender Value of Life Insurance*

 

Cashsurrender value of life insurance has been restated because of an error in thepreviously calculated amounts.  In addition,it was previously reported in “Other assets” but has now been classifiedseparately 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

 
| ** **          | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|---------------------|------------|-------------------------|------------|-------------------|------------|
| Correction of error |       | $                       | 1,033,960  |              | $          |  792,637 |   |
|                     |            |                         |            |                   |            |  |  |

 

18

----

Table ofContents

 

*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 payablewas understated on the June 30, 2009 consolidated balance sheet because of anerroneous transaction for approximately $1,290,000.  Other changes to accounts payable are forreclassification of deposits to an asset account and to include accounts receivablecredit balances in accounts payable.

 

·                        Accruedliabilities have been revised to:

 

·                  Include propercutoff of professional fees at each period end;

 

·                  Adjust accruedreturns based on detailed analysis of returns, price adjustments and shippingadjustments;

 

·                  Increaseaccrued product warranty obligations to reflect the estimated costs of futurereturns of product based on an analysis of annual returns and the cost ofreplacing the returned items.  TheCompany believes this properly values the potential liability based on annualreturns and cost of replacing the returned items.

 

Theliability for deferred compensation was understated as a result of not properlyapplying the assumptions for mortality and years of service as well as using adiscount rate that was too high.

 

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

 
| ** **                                       | ** ** | **September 30,  2009** | ** **      | **June 30, 2009** | ** ** |
|--------------------------------------------------|------------|-------------------------|-----------------|-------------------|------------|
| Erroneous transactions                           |       | $                       |  —    |              | $          |  1,290,011 |   |
| Reclassification of advance payments to deposits |       | 47,729                  |            | 110,263           |       |
| Accounts receivable credit balances              |       | 15,504                  |            | 25,573            |       |
| Erroneous adjustments to accounts payable        |       | 2,782,890               |            | 167,083           |       |
| Other accounts payable                           |       | (346,732                | )               | (280,675          | )          |
| Accounts payable                                 |       | $                       |  2,499,391 |              | $          |  1,312,255 |   |

 

19

----

Table ofContents

 
| ** **                                       | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|-------------------|------------|
| Legal and professional fees                      |       | $                       | 90,683     |              | $          | 166,939 |   |
| Accrued returns                                  |       | 219,773                 |       | 219,773           |       |
| Product warranty obligations                     |       | 312,420                 |       | 312,420           |       |
| Cooperative advertising and promotion allowances |       | (267,653                | )          | (250,000          | )          |
| Accrued interest                                 |       | 413,363                 |       | 354,644           |       |
| Accrued product development                      |       | (396,354                | )          | 5,877             |       |
| Fringe benefits                                  |       | (131,518                | )          | 4,467             |       |
| Other accrued liabilities                        |       | (39,179                 | )          | 122,845           |       |
| Accrued liabilities                              |       | $                       | 201,535    |              | $          | 936,965 |   |

 
| ** **                             | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-------------------|------------|
| Long-term product warranty obligations |       | $                       | 725,000    |              | $          | 725,000 |   |
| Deferred compensation liability        |       | 498,084                 |       | 445,279           |       |
| Long-term liabilities                  |       | $                       | 1,223,084  |              | $          | 1,170,279 |   |

 

*IncomeTaxes 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

 
| ** **                 | ** ** | **September 30,  2009** | ** ** | **June 30, 2009** | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------|------------|
| Accrued federal income tax |       | $                       | 3,988,565  |              | $          | 3,428,169 |   |
| Accrued state income tax   |       | 1,109,317               |       | 1,002,085         |       |
| Other                      |       | (201,440                | )          | (201,440          | )          |
| Income taxes payable       |       | $                       | 4,896,442  |              | $          | 4,228,814 |   |

 

3.                                       EARNINGS (LOSS)PER COMMON AND COMMON STOCK EQUIVALENT SHARE

 

Basicearnings (loss) per common share are computed based on the weighted averagenumber of common shares outstanding.  Theweighted average number of common shares outstanding for the quarters endingSeptember 30, 2009 and 2008 were 7,382,706 and 7,390,702, respectively.  When dilutive, stock options are included inearnings per share as share equivalents using the treasury stock method.  For the quarter ended September 30, 2009there were no common stock equivalents related to stock option grants that wereincluded in the computation of the weighted-average number of sharesoutstanding for diluted (loss) per share. Shares under option of 1,203,308 were excluded from diluted weightedaverage common shares outstanding for the quarter ended September 30, 2009 asthey would be anti-dilutive due to the Company’s net loss for the quarter.  Common stock equivalents of 23,308, relatedto stock option grants, were included in the computation of theweighted-average number of shares outstanding for diluted earnings per sharefor the quarter ended September 30, 2008. The dilutive effect of stock options of 1,100,000 for which the exerciseprice was higher than the average market price for the quarter ended September30, 2008 were excluded from the calculation of diluted earnings per share.

 

20

----

Tableof Contents

 

4.                                       INCOME TAXES

 

The Company files income taxreturns in the United States (Federal), Wisconsin (state) and various otherstate jurisdictions.  The Company is notcurrently subject to income tax examinations in any of our significant taxjurisdictions.  Tax years open toexamination by tax authorities under the statute of limitations include fiscal2007 through 2009 for Federal and fiscal 2005 through 2009 for most statejurisdictions.

 

The total liability forunrecognized tax benefits was $300,000 as of September 30, 2009 and June 30,2009.  The liability does not include anamount for accrued penalties.  TheCompany recognizes penalties related to unrecognized tax benefits in theprovision for income taxes.  The Company recognizesinterest related to unrecognized tax benefits as interest expense.  As part of the unauthorized transactions, theCompany has accrued interest of $413,363 and $354,644 at September 30, 2009 andJune 30, 2009, respectively.  The Companydoes not expect a significant increase or decrease to the total amounts ofunrecognized tax benefits within the next 12 months.  There was no change in the amount ofunrecognized tax benefits during the three months ended September 30, 2009.

 

5.                                       INVENTORIES

 

Theclassification of inventories is as follows:

 
| ** **                                       | ** ** | **September 30 2009** | ** ** | **June 30, 2009** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                       | ** ** | **(Restated)**        | ** ** | **(Restated)**    | ** ** |
| Raw materials and work in process                |       | $                     | 2,996,591  |              | $          | 2,609,313 |   |
| Finished goods                                   |       | 7,036,921             |       | 7,032,887         |       |
|                                             |       | 10,033,512            |       | 9,642,200         |       |
| Allowance for obsolete and slow-moving inventory |       | 998,802               |       | 933,365           |       |
|                                             |       | $                     | 9,034,710  |              | $          | 8,708,835 |   |

 

6.                                       STOCK PURCHASEAGREEMENT

 

TheCompany has an agreement with its Chairman, John C. Koss, in the event of hisdeath, at the request of the executor of the estate, to repurchase his Companycommon stock from his estate.  TheCompany does not have the right to require the estate to sell stock to theCompany.  As such, this arrangement isaccounted for as a written put option with the fair value of the put optionrecorded as a derivative liability.

 

Thefair value of the option at September 30, 2009 and June 30, 2009 was$125,000.  The repurchase price is 95% ofthe fair market value of the common stock on the date that notice to repurchaseis provided 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 elect to pay the purchase price in cash or may elect topay cash equal to 25% of the total amount due and to execute a promissory notefor the balance, payable over four years, at the prime rate of interest.  The Company maintains a $1,150,000 lifeinsurance policy to fund a substantial portion of this obligation.

 

7.                                        DIVIDENDSDECLARED

 

OnSeptember 16, 2009, the Company declared a quarterly cash dividend of $0.065per share for the stockholders of record on September 30, 2009 to be paidOctober 15, 2009.  Such dividend payablehas been recorded at September 30, 2009.

 

21

----

Tableof Contents

 

8.                                       STOCK OPTIONS

 

In1990, pursuant to the recommendation of the Board of Directors, thestockholders ratified the creation of the Company’s 1990 Flexible Incentive Plan(the “1990 Plan”).  The 1990 Plan isadministered by a committee of the Board of Directors and provides for thegranting of various stock-based awards including stock options to eligibleparticipants, primarily officers and certain key employees.  A total of 225,000 shares of common stockwere available in the first year of the 1990 Plan’s existence.  Each year thereafter additional shares equalto 0.25% of the shares outstanding as of the first day of the applicable fiscalyear were reserved for issuance pursuant to the 1990 Plan.  On July 22, 1992, the Board of Directorsauthorized the reservation of an additional 250,000 shares for the 1990 Plan,which was approved by the stockholders. In 1993, the Board of Directors authorized the reservation of anadditional 300,000 shares for the 1990 Plan, which was approved by thestockholders.  In 1997, the Board ofDirectors authorized the reservation of an additional 300,000 shares for the1990 Plan, which was approved by the stockholders.  In 2001, the Board of Directors authorizedthe reservation of an additional 300,000 shares for the 1990 Plan, which wasalso approved by the stockholders. Options vest over a four or five year period, with a maximum term offive 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, givingconsideration to the expected term and vesting schedules.  The expected volatility is determined basedon the Company’s historical stock prices over the most recent periodcommensurate with the expected term of the award.  The risk-free interest rate is based on U.S.Treasury zero-coupon issues with a remaining term commensurate with theexpected term of the award.  Expectedpre-vesting option forfeitures are based on historical data.

 

Asummary of stock option activity under the plan for the three****months ended September 30, 2009 is asfollows and is adjusted for the two-for-one stock split on December 1, 2009:

 
| ** **                                | ** ** | **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, 2009      |       | 863,308               |       | $7.76 - $14.40                   |       | $                                      | 10.35      |                                                        | 3.99       |                                                       | $          | — |   |
| Granted                                   |       | 340,000               |       | $6.275 - $6.905                  |       | $                                      | 6.76       |                                                        |       |                                                       |       |   |
| Exercised                                 |       | —                |       | —                           |       | —                                 |       |                                                        |       |                                                       |       |
| Expired                                   |       | —                |       | —                           |       | —                                 |       |                                                        |       |                                                       |       |
| Forfeited                                 |       | —                |       | —                           |       | —                                 |       |                                                        |       |                                                       |       |
| Shares under option at September 30, 2009 |       | 1,203,308             |       | $6.275 - $14.40                  |       | $                                      | 9.34       |                                                        | 4.38       |                                                       | $          | — |   |
|                                      |       |                  |       |                             |       |                                   |       |                                                        |       |                                                       |       |
| Exercisable as of June 30, 2009           |       | 532,808               |       | $7.76 - $14.40                   |       | $                                      | 10.72      |                                                        |       |                                                       |       |   |
| Exercisable as of September 30, 2009      |       | 559,108               |       | $6.275 - $14.40                  |       | $                                      | 10.66      |                                                        |       |                                                       |       |   |

 

22

----

Tableof Contents

 

Asummary of intrinsic value and cash received from stock option exercises andfair value of vested stock options for the three months ended September 30,2009 and 2008 is as follows:

 
| ** **                                       | ** ** | **Three Months  Ended  September 30, 2009** | ** ** | **Three Months  Ended  September 30, 2008** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Total intrinsic value of stock options exercised |       | $                                           | —     |                                        | $          | — |   |
| Cash received from stock option exercises        |       | $                                           | —     |                                        | $          | — |   |
| Total fair value of stock options vested         |       | $                                           | 45,772     |                                        | $          | 45,772 |   |

 

23

----

Table of Contents

 

9.                                       ADDITIONAL CASHFLOW INFORMATION

 

The net changes in cash as aresult of changes in operating assets and liabilities consist of the followingfor the three months ended:

 
| ** **                         | ** ** | **September 30,  2009** | ** ** | **September 30,  2008** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **(Restated)**          | ** ** | **(Restated)**          | ** ** |
| Accounts receivable                |       | $                       | (2,732,950 | )                       | $          | 1,968,456 |   |
| Inventories                        |       | (391,312                | )          | 227,069                 |       |
| Prepaid expenses and other assets  |       | (287,946                | )          | (458,771                | )          |
| Income taxes payable               |       | 779,741                 |       | (35,911                 | )          |
| Accounts payable                   |       | 1,804,690               |       | (648,737                | )          |
| Accrued liabilities                |       | 47,176                  |       | (331,336                | )          |
| Net change                         |       | $                       | (780,601   | )                       | $          | 720,770 |   |
|                               |       |                    |       |                    |       |
| Net cash paid during the year for: |       |                    |       |                    |       |
| Income taxes                       |       | $                       | 250,000    |                    | $          | 750,000 |   |
| Interest                           |       | $                       | —     |                    | $          | — |   |

 

10.                                 CREDITFACILITIES

 

OnFebruary 16, 2009, the Company entered into a credit facility with Harris N.A.for an unsecured line of credit for up to a maximum of $10,000,000 throughJanuary 29, 2010.  On October 9, 2009 thecredit facility was extended to December 31, 2010.  The Company could use the credit facility forworking capital, to refinance existing indebtedness, for stock repurchase andfor general corporate purposes. Borrowings under this 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% determined in accordance with the loanagreement. The credit facility included financial covenants that require theCompany to maintain a minimum tangible net worth, liabilities to tangible networth ratios and interest coverage ratios. The outstanding balance on this credit facility at September 30, 2009amounted to $2,750,000.  There was nobalance outstanding on this credit facility at June 30, 2009.  The weighted-average interest rate for thethree months ended September 30, 2009 was 3.25%.

 

OnMay 12, 2010, the Company entered into a new secured credit facility withJPMorgan Chase Bank, N.A. (“Lender”). The Credit Agreement dated May 12, 2010 between the Company and theLender (“Credit Agreement”) provides for an $8,000,000 revolving secured creditfacility with interest rates either ranging from 0.0% to 0.75% over the Lender’smost recently publicly announced prime rate or 2.0% to 3.0% over LIBOR,depending on the Company’s leverage ratio. The Credit Agreement expires on July 31, 2013. In addition to therevolving loans, the Credit Agreement also provides that the Company may, fromtime to time, request the Lender to issue letters of credit for the benefit ofthe Company of up to a sublimit of $2,000,000, and subject to certain otherlimitations.  The loans may be used only for general corporate purposes ofthe Company.

 

TheCredit Agreement contains certain affirmative, negative and financial covenantscustomary for financings of this type. The negative covenants include restrictions on other indebtedness,liens, fundamental changes, certain investments, asset sales, sale andleaseback transactions, and transactions with affiliates, among otherrestrictions.  The financial covenantsinclude a minimum current ratio, minimum tangible net worth and maximumleverage ratio requirements.  The Companyand the Lender also entered into the Pledge and Security Agreement dated May12, 2010 under which the Company granted the Lender a security interest insubstantially all of the Company’s assets in connection with the 

 

24

----

Table ofContents

 

Company’sobligations under the Credit Agreement.  On May 12, 2010, the Company also terminatedits loan agreement with Harris N.A. and repaid the entire $5,863,349 balanceoutstanding as of that date.

 

11.                                 STOCKHOLDERS’EQUITY

 

The following tablesummarizes the changes in stockholders’ equity for the three month periodsended September 30, 2009 and 2008.

 
| ** **                                     | ** ** | **2009**          | ** ** | **2008**          | ** ** |
|------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                     | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** |
| Net (loss) income (as restated)                |       | $                 | (1,593,750 | )                 | $          | 841,845 |   |
| Dividends declared                             |       | (479,876          | )          | (480,395          | )          |
| Stock-based compensation expense (as restated) |       | 112,190           |       | 110,665           |       |
|                                           |       | $                 | (1,961,436 | )                 | $          | 472,115 |   |

 

12.                                 RECENT ACCOUNTINGPRONOUNCEMENTS

 

InAugust 2009, the FASB issued an update regarding measurement ofliabilities at fair value (Accounting Standards Codification 820) whichprovides additional guidance on how companies should measure liabilities.  The update provides clarification on thetechniques for measurement of fair value required of a reporting entity when aquoted price in an active market for an identical liability is notavailable.  This update had no impact onthe Company’s consolidated financial statements.

 

13.                                 LEGAL MATTERS

 

Sincelearning of the unauthorized transactions in December 2009, the Company hasbeen 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 suitalleges violations of Section 10(b), Rule 10b-5 andSection 20(a) of the Exchange Act relating to the unauthorizedtransactions and requests an award of compensatory damages in an amount to beproven at trial.  See *David A. Puskala v. Koss Corporation, et al*., United StatesDistrict Court, Eastern District of 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.

 

25

----

Tableof Contents

 

·                      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 *Mentkowski v. Koss, et al*., CircuitCourt, Milwaukee County, Wisconsin, No. 10CV002290 (February 18, 2010).  These two shareholder derivative suits havebeen 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.

 

Theultimate resolution of these matters is not determinable.

 

14.                                 OTHER

 

As more fully described inthe Explanatory Note and Note 2 to the consolidated financial statements in theCompany’s Form 10-K/A filed on June 30, 2010, and in Note 2 to these condensedconsolidated financial statements, the Company learned of certain unauthorizedtransactions made by Sujata Sachdeva, its former Vice President of Finance andPrincipal Accounting Officer.  As aresult of the unauthorized transactions, the Company is restating itsconsolidated financial information in its Annual Report on 10-K/A for thefiscal year ended June 30, 2009 and its Quarterly Reports in Form 10-Q/A forthe three months ended September 30, 2009. The Company is also amending its Quarterly Reports on 10-Q/A for thethree months ended December 31, 2009 and March 31, 2010 to include consolidatedfinancial statements, which were not available at the applicable filingdeadlines for those reports.

 

As more fully described inthe Explanatory Note in the Company’s Form 10-K/A filed on June 30, 2010 and inNote 2 to these consolidated financial statements, the Company completed atwo-for-one forward stock split on December 1, 2009.  All share and per-share data in theseconsolidated financial statements have been adjusted to give effect to thestock split.

 

On May 12, 2010, the Companyterminated its credit facility with Harris N.A. and entered into a new creditfacility with JPMorgan Chase Bank, N.A. The events associated with these credit facilities are described in Note10.

 

26

----

Table of Contents

 

**Item 2.****          ****Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

*The following discussion should be read in conjunction withthe Condensed Consolidated Financial Statements and relatednotes.  References made to years are for fiscal yearperiods.  All share and per-share data have been adjusted to reflectthe stock split in December 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 KossCorporation for the three months ended September 30, 2009 and2008.  For a more complete understanding of this discussion, pleaseread the Notes to Condensed Consolidated Financial Statements included in thisreport.*

 

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

 

**Overview**

 

KossCorporation 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 —***In December 2009, Kosslearned of 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 in 2009to $10,286,988 from July 1, 2009 until the unauthorized transactions werediscovered in December 2009.  TheCompany subsequently learned that Ms. Sachdeva colluded with two otheremployees of the accounting department in the misappropriation andcircumvention of the Company’s existing internal controls and establishedoperating procedures.  In carrying outthe unauthorized transactions, these three former employees failed to adhere tothe Company’s existing procedures for processing payments and concealed themisappropriations from management, including the directors and remainingofficers of the Company.  Variousaccounting methods and accounting entries were used to conceal the unauthorizedtransactions.  Ms. Sachdeva andthese other former employees were terminated shortly after the Company learnedof the unauthorized transactions.  As aresult of these unauthorized transactions, we are restating our condensedconsolidated financial statements in this quarterly report on Form 10-Q/A.  See the Explanatory Note to this Form 10-Q/Aand Note 2 to the restated unaudited condensed consolidated financialstatements for additional discussion of the unauthorized transactions andrestatement.

 

***Restatement***— The restated unaudited condensedconsolidated financial statements, included in this Form 10-Q/A, correcterrors in a majority of the financial statement line items in the previouslyissued condensed consolidated financial statements for all periodspresented.  The errors resulted fromfalsifications by the terminated employees, including Ms. Sachdeva, toconceal the misappropriations from management. The most significant revisions are:

 

·                              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 understateddue to journal entries made to conceal certain misappropriations.

 

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

 

27

----

Tableof Contents

 

·                              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 September 30and June 30, 2009.

 

·                              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 due to an erroneous transaction that wasposted to accounts payable in 2009 and improper cutoff of transactions.

 

·                              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.

 

**Results of Operations**

 

**QuarterEnded September 30, 2009 to Quarter Ended September 30, 2008**

 

***Sales and Gross Profit***

 

Netsales for the three months ended September 30, 2009 totaled $11,614,645,compared with $12,498,036 in the three months ended September 30,2008.  This $883,391 decrease in net sales was driven by soft retailsales in the United States.  The salesdecline in the United States was largely due to a decline in sales ofapproximately $650,000 at a large U.S. retailer.

 

Grossprofit in the three months ended September 30, 2009 was $5,649,972 or 48.6%of net sales compared to $5,581,375 or 44.7% of net sales in the three monthsended September 30, 2008.  Thisimprovement in gross margin percentage was due to a more favorable product mixas we have experienced stability in our pricing as well as pricing from ourvendors.

 

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

 

Selling,general and administrative expenses for the three months ended September 30,2009 was $2,739,298, as compared to $2,652,794 for the three months ended September 30,2008.   The increase in selling, general and administrative expenseswas the result of increased provision for doubtful accounts related to a U.S.distributor and increased professional fees. These were partially offset by reduced spending for trade shows andperformance related compensation.  Thedecreased trade show spending was due to the Company’s decision not toparticipate in a major show in 2010. Performance related bonuses and profit sharing were lower due to lowerearnings. 

 

28

----

Tableof Contents

*** ***

***Unauthorized Transactions***

 

Inthe three months ended September 30, 2009, the unauthorized transactionstotaled $5,324,164 compared to $1,689,052 in the three months ended September 30,2008.

 

***Operating Income***

 

Inthe three months ended September 30, 2009, the Company had an operatingloss, including the unauthorized transactions as expense, of $2,413,490compared to operating income, including the unauthorized transactions asexpense, of $1,239,529 in the three months ended September 30,2008.  The decrease in operating income was primarily the result oflower volume and increased unauthorized transactions.  Operating income, excluding the unauthorizedtransactions, was $2,910,674 in the three months ended September 30, 2009or 25.1% of net sales compared to $2,928,581 or 23.4% of net sales in the threemonths ended September 30, 2008.

 

***Provision for Income Taxes***

 

Incometax benefit for the three months ended September 30, 2009 was $878,715 ascompared to $457,888 of income tax provision in the three months ended September 30,2008.  The effective income tax rate was 35.5% and 35.2% for thethree months ended September 30, 2009 and 2008, respectively.

 

**Liquidity and 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 believe we havesufficient liquidity for at least the next 12 months.  We require working capital investment tomaintain our position as a leading developer and manufacturer of high qualitystereophones.  The primary drivers ofthese requirements are production costs, distribution costs and finished goodsinventories to support our customers’ requirements for short leadtimes.  As part of our continuous improvement of purchasing andmanufacturing processes, we continue to strive for alignment of inventory levelswith customer demand and current production schedules.

 

Duringthe three months ended September 30, 2009, cash used in operations was$3,567,033 and during the three months ended September 30, 2008, cashprovided by operations was $1,769,787. Working capital was $1,915,198 at September 30, 2009 and $6,308,239at June 30, 2009.  The net decreasein working capital of $4,393,041 from June 30, 2009 represents primarilythe decrease in cash, increased accounts payable and line of credit borrowingsto fund the net loss.  These werepartially offset by an increase in accounts receivable because of the increasein sales in the three months ended September 30, 2009 compared to thethree months ended June 30, 2009. As of September 30, 2009 the Company had open commitments ofapproximately $824,000 for software and new product development.

 

***Investing Activities***

 

Cashused in investing activities for the three months ended September 30, 2009was $820,257 as compared to $1,190,983 used in investing activities for thethree months ended September 30, 2008.  Cash used in investingactivities for both periods was largely due to capital expenditures whichmainly consisted of product software development costs and tooling to supportproduction.

 

29

----

Table ofContents

 

***Financing Activities***

 

Netcash provided by financing activities was $2,891,517 in the three months ended September 30,2009 compared to a use of $480,395 in the three months ended September 30,2008.  In the three months ended September 30,2009, the Company received $2,750,000 from borrowing on its line of creditoffset by a $479,876 dividend payment. In the three months ended September 30, 2008, there was a dividendpayment of $480,395. The Company intends to continue its regular quarterlydividends for the foreseeable future.

 

***Credit Facilities***

 

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 through 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 facility forworking capital, to refinance existing indebtedness, for stock repurchase andfor 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 as determined in accordance with the loan agreement.The credit facility included financial covenants that required the Company tomaintain a minimum tangible net worth, liabilities to tangible net worth ratiosand interest coverage ratios. Outstanding draws on the credit facility at September 30, 2009amounted to $2,750,000.  There was noutilization of the credit facility at June 30, 2009.

 

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 Agreement contains certain affirmative, negative andfinancial covenants customary for financings of this type.  The negative covenants include restrictionson other indebtedness, liens, fundamental changes, certain investments, assetsales, sale and leaseback transactions and transactions with affiliates, amongother restrictions.  The financialcovenants include a minimum current ratio, minimum tangible net worth andmaximum leverage ratio requirements.  TheCompany and the Lender also entered into the Pledge and Security Agreementdated May 12, 2010 under which the Company granted the Lender a securityinterest in substantially all of the Company’s assets in connection with the Company’s obligations under the CreditAgreement.  As described in the Company’spartial 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.

 

Recent Accounting Pronouncements

 

InAugust 2009, the FASB issued an update regarding measurement ofliabilities at fair value (Accounting Standards Codification 820) whichprovides additional guidance on how companies should measure liabilities.  The update provides clarification on thetechniques for measurement of fair value required of a 

 

30

----

Table ofContents

 

reportingentity when a quoted price in an active market for an identical liability isnot available.  This update had no impacton the Company’s consolidated financial statements.

 

31

----

Table of Contents

 

Stock Split

 

On September 10, 2009,NASDAQ notified the Company that it no longer met the 750,000 minimum publiclyheld shares requirement under Listing Rule 5450(b)(1)(B) forcontinued listing on The NASDAQ Global Market. On September 24, 2009, the Company submitted its compliance plan toNASDAQ proposing to implement a two-for-one forward stock split of the Company’sCommon Stock.  The proposed stock splitwould cause the Company’s total number of publicly held shares to exceed the750,000 minimum threshold while maintaining the Company’s compliance withNASDAQ’s other continued listing requirements. On September 29, 2009,NASDAQ granted the Company an extension of time in order to allow the Companyto regain compliance with NASDAQ’s listing requirements. The Company wasgranted until December 24, 2009 to regain compliance.

 

At a meeting held on October 7,2009, the Board of Directors conditionally approved a two-for-one forward stocksplit to be effected in the form of a stock dividend of one share of CommonStock for each share of Common Stock outstanding on or about November 20,2009, the record date for the stock split. The stock split was conditioned uponapproval by the stockholders of an increase in the number of authorized sharesof the Common Stock of the Company from 8,500,000 shares to 20,000,000shares.  At a special meeting ofstockholders on November 19, 2009, the Company’s stockholders approved theproposed increase.  The stock split wasdistributed to the Company’s stockholders on December 1, 2009.

 

Off-Balance Sheet Arrangements

 

The Company has no other off-balance sheet arrangements other than thelease for the facility in Milwaukee, Wisconsin, which it leases from itsChairman, John C. Koss.  OnAugust 15, 2007, the lease was renewed for a period of five years, and isbeing accounted for as an operating lease. The lease extension maintained the rent at a fixed rate of $380,000 peryear.  Management believes the lease ison terms no less favorable to the Company than those that could be obtainedfrom an independent party.  The Companyis responsible for all property maintenance, insurance, taxes, and other normalexpenses related to ownership.  Allfacilities are in good repair and, in the opinion of management, are suitableand adequate for the Company’s business purposes.

 

32

----

Table ofContents

 

**Item 4.    Controlsand 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 inreports filed or submitted under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms; and (2) that such information is accumulated and communicated tomanagement, including the principal executive officer and principal financialofficer, to allow 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 Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of the Company’s disclosure controls and procedures as of September 30,2009, and has concluded that the Company’s disclosure controls and procedureswere not sufficiently effective in that they failed to timely detect thecircumvention of the internal controls and procedures related to the processingand recording of the unauthorized transactions. The failure to timely detect the circumvention of the Company’sdisclosure controls and procedures has resulted in the restatement of theCompany’s financial statements for the periods covered by this filing.

 

Notwithstanding thisconclusion, the Company’s management believes that the restatement of thecondensed consolidated financial statements in this Quarterly Report on Form 10-Q/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,including the Company’s Chief Executive Officer and Chief Financial Officer,continues to evaluate the effectiveness of the Company’s disclosure controlsand procedures to identify any enhancements that may provide greater comfortthat the Company’s disclosure controls and procedures are effective to providereasonable assurance that information required to be disclosed by the Companyin the reports that it files or submits under the Exchange Act is accumulatedand communicated to the Company’s management, including its Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow timely decisionsregarding required disclosure and are effective to provide reasonable assurancethat such information is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms.

 

**Changes inInternal Controls over Financial Reporting**.

 

Although there were nosignificant changes in our internal control over financial reporting thatoccurred during the period ended September 30, 2009, the Company hasconcluded that the Company’s internal controls and operating procedures werecircumvented and the circumvention was concealed from management.  As a result, management believes that theCompany’s internal controls contained material 

 

33

----

Table of Contents

 

weaknesses by not timelydetecting the circumvention of internal controls related to the processing andrecording of the unauthorized transactions.

 

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

 

·            *Auditorreview*.  The circumvention of theCompany’s internal controls and procedures was not detected as part of theCompany’s annual audits and quarterly reviews by its former independent auditorGrant Thornton, LLP.  On June 24,2010, the Company filed an action against Grant Thornton, LLP and Ms. Sachdeva.

 

·            *Wiretransfers and cashier’s checks.*  Approximately $30,900,000 or 98.1% of thetotal $31,500,000 of unauthorized transactions from fiscal year 2005 through December 2009was misappropriated by circumventing the Company’s internal controls and otheroperating procedures for the payment of Company expenditures by using wiretransfers or cashier’s checks from the Company’s bank accounts to pay forpersonal expenditures.  Of the$30,900,000, approximately $8,500,000 and $5,100,000 was misappropriated by useof these means during fiscal years 2009 and 2008, respectively.  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 certain inventorypurchases and transfers of funds between the Company’s bank accounts.  Wire transfers for inventory purchases andthe recurring expense items required the approval by several employeesincluding authorized Vice Presidents, while the wire transfers between theCompany’s bank accounts were processed and approved by Ms. Sachdeva andone 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/orby directing others in the accounting department, processed wire transfers fromthe Company’s bank accounts to pay for personal expenditures directly, therebycircumventing the internal controls and procedures as described above so thatthese payments would not be submitted through the Company’s normal accountspayable system.  This has been remediatedby: (1) disallowing the use of any cashier’s checks; (2) enforcingthat all wire transfers are initiated within the financial function andelectronically approved by the CEO; and (3) performing an enhanced review,reconciliation and reporting of cash activities.

 

·            *Pettycash, manual checks and traveler’s checks*.  The remaining misappropriations ofapproximately $600,000 or 1.9% from the total amount of $31,500,000 from fiscalyear 2005 through December 2009 were carried out by circumventing theCompany’s internal controls and other standard operating procedures involvingthe Company’s petty cash system, manual check system and policy for usingtraveler’s checks.  In doing so, theCompany’s policy requiring that all expense reports be submitted and approvedby the CEO was circumvented.  Out of theestimated $600,000 of these types of transactions, approximately $83,000 and$110,000 occurred during fiscal years 2009 and 2008, respectively.  Approximately $107,000 of misappropriationsinvolving the use of the Company’s petty cash system, manual check system andtraveler’s checks policy occurred during fiscal year 2010.  Remediation of these issues has beenaccomplished by: (1) eliminating the petty cash fund so all reimbursementsrun through normal controlled accounts payable channels; (2) eliminatingthe use of manual checks so all check 

 

34

----

Table of Contents

 

disbursements are generatedfrom the Company’s accounts payable system check run; and (3) eliminatingthe use of traveler’s checks.

 

·            *Recordingof unauthorized transactions.*  Ms. Sachdeva and one of the otherterminated employees further concealed the unauthorized transactions byrecording numerous erroneous accounting entries in various accounts to hide thetrue nature of the transactions.  TheCompany has subsequently improved the controls and procedures related tojournal entries and account reconciliations to include improved segregation ofduties, review and approval of reconciliations, and approval of all manualjournal entries.

 

·            *Performanceand review of account reconciliations. *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.

 

·            *Corporatestandards and whistleblower policy.*  The three terminated employees including Ms. Sachdevafailed to comply with the Company’s established standards of integrity, ethicalvalues and its Code of Conduct, Code of Ethics and Whistleblower policy.  The Company has taken steps to reinforcethese policies with all of its employees, officers and directors.

 

·            *Applicationof GAAP.*  Theterminated employees, including Ms. Sachdeva as the principal accountingofficer in charge of financial reporting, failed to properly apply the Company’sestablished accounting policies and adherence with GAAP.  As a result, certain established accountingpolicies were not applied correctly and resulted in inaccuracies, both from thefraudulent activity directed by Ms. Sachdeva and the misapplication ofGAAP.  The affected accounts includeequipment and leasehold improvements, cash surrender value of life insurance,accrued deferred compensation and accrued warranty.  As part of the restatement of theconsolidated financial statements, the accounts were reviewed in detail andreconciled.  Integral to the reconciliationprocess was a review of all critical accounting estimates.

 

·            *InformationTechnology.*  The Company’sinternal controls and procedures relating to the Company’s computer system forprocessing financial transactions were manipulated to conceal the unauthorizedtransactions.  As the Company continuesto evaluate its internal controls, the Company plans to implement a newcomputer system that will be used to improve its processing of financialtransactions and overall segregation of duties.

 

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

 

Webelieve the subsequent changes to our system of internal controls resultingfrom these efforts will enhance the Company’s control over financialreporting.  We continue to diligently andvigorously review our financial and reporting controls and procedures.  As we continue to evaluate and work to improveour 

 

35

----

Table ofContents

 

internalcontrol over financial reporting, we may take additional measures to addressany additional control deficiencies we may identify.

 

**PART II**

**OTHER INFORMATION**

 

**Item 1.    Legal Proceedings.**

 

There were no material legal proceedings during the period covered bythis Quarterly Report on Form 10-Q/A. As of June 30, 2010, the Company has been named in severallitigation matters and has initiated certain actions against third partiesrelated to the unauthorized transactions. A description of these legal matters is included in Note 13 to therestated condensed consolidated financial statements in this Form 10-Q/Aand the Explanatory Note to the Form 10-K/A for the period ended June 30,2009, which description is incorporated herein by reference.

 

**Item 5.    Exhibits.**

 

See Exhibit Index attached hereto.

 

36

----

Tableof Contents

** **

**CAUTIONARY STATEMENT REGARDINGFORWARD-LOOKING STATEMENTS**

 

This Form 10-Q/A contains forward-lookingstatements within the meaning of that term in the Private Securities LitigationReform Act of 1995 (the “Act”) (Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934).  Additional written or oral forward-lookingstatements may be made by the Company from time to time in filings with theSecurities Exchange Commission, press releases, or otherwise.  Statements contained in this Form 10-Q/Athat are not historical facts are forward-looking statements made pursuant tothe safe harbor provisions of the Act. Forward-looking statements may include, but are not limited to,projections of revenue, income or loss and capital expenditures, statementsregarding future operations, anticipated financing needs, compliance withfinancial covenants in loan agreements, plans for acquisitions or sales ofassets or businesses, plans relating to products or services of the Company,assessments of materiality, predictions of future events, the effects ofpending and possible litigation, and assumptions relating to the foregoing.  In addition, when used in this Form 10-Q/A,the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,”and variations thereof and similar expressions are intended to identifyforward-looking statements.

 

Forward-looking statements are inherently subject torisks and uncertainties, some of which cannot be predicted or quantified basedon current expectations.  Consequently,future events and actual results could differ materially from those set forthin, contemplated by, or underlying the forward-looking statements contained inthis Form 10-Q/A, or in other Company filings, press releases, orotherwise.  In addition to the factorsdiscussed in this Form 10-Q/A, other factors that could contribute to orcause such differences include, but are not limited to, developments in any oneor more of the 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 to place undue relianceon any forward-looking statements contained herein, which speak only as of thedate hereof.  The Company undertakes noobligation to publicly release the result of any revisions to theseforward-looking statements that may be made to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unexpected events.

 

37

----

Tableof Contents

 

Signatures

 

Pursuantto the requirements of the Securities and Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

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

 

38

----

Tableof Contents

 

**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.     |

 

39

----

Table of Contents

 
| 10.12  |   | License  Agreement dated June 30, 1998 between Koss Corporation and Logitech  Electronics Inc. (including Addendum to License Agreement dated June 30,  1998). Filed as Exhibit 10.18 to the Company’s Annual Report on  Form 10-K for the year ended June 30, 1998 and incorporated herein  by reference. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.13  |   | Amendment  and Extension Agreement between Koss Corporation and Logitech Electronics  Inc. dated May 1, 2001. Filed as Exhibit 10.3 to the Company’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2001  and incorporated herein by reference.                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.14  |   | 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.                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.15  |   | 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.                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.16  |   | 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.                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.17  |   | 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.                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 10.18  |   | 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.                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 31.1   |   | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer *                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                     |
| 31.2   |   | Rule 13a-14(a)/15d-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 **                                                                                                                                                                                                                                                                           |

 

----

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

 

40

----