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SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 for the quarterly period ended December 31, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number 0-3295
 
 KOSS CORPORATION
  A DELAWARE CORPORATION
    
    39-1168275(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 4129 North Port Washington Avenue, Milwaukee, Wisconsin
    
    53212(Address of principal executive offices)
    
    (Zip Code)
 (414) 964-5000
  þ o
  o o þ
  o þ




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PagePART I FINANCIAL INFORMATIONItem 1 Financial StatementsCondensed Consolidated Balance SheetsDecember 31, 2005 (Unaudited) and June 30, 2005
    
    
    3Condensed Consolidated Statements
of Income (Unaudited)Three months and six months ended
December 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash
Flows (Unaudited)Six months ended December 31, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial
Statements (Unaudited) December 31, 2005
    
    
    6-9Item 2 Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    9-11Item 3 Quantitative and Qualitative Disclosures
About Market Risk
    
    
    11Item 4 Controls and Procedures
    
    
    11-12PART II OTHER INFORMATIONItem 6 Exhibits
    
    
    13Rule 13a-14(a)/15d-14(a) Certification of CEO/CFOSection 1350 Certification of CEO/CFO
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##### Table of Contents



PART I
FINANCIAL INFORMATION
 
 Item 1. Financial Statements.
  
  (Unaudited)December 31, 2005
    
    June 30, 2005ASSETSCurrent Assets:Cash
    
    $
    4,839,303
    
    
    $
    5,218,698Accounts Receivable
    
    
    11,597,999
    
    
    
    8,763,968Inventories
    
    
    9,362,126
    
    
    
    7,595,803Other current assets
    
    
    1,368,833
    
    
    
    1,987,779Total current assets
    
    
    27,168,261
    
    
    
    23,566,248Property and equipment, net
    
    
    3,226,977
    
    
    
    2,993,700Deferred income taxes
    
    
    315,531
    
    
    
    315,531Other assets
    
    
    2,327,320
    
    
    
    2,365,982$
    33,038,089
    
    
    $
    29,241,461LIABILITIES AND STOCKHOLDERS INVESTMENTCurrent liabilities:Accounts payable
    
    $
    4,391,957
    
    
    $
    3,012,736Accrued liabilities
    
    
    2,660,477
    
    
    
    1,841,862Income taxes
    
    
    1,023,999
    
    
    
    692,538Dividends payable
    
    
    479,385
    
    
    
    486,918Total current liabilities
    
    
    8,555,818
    
    
    
    6,034,054Deferred compensation
    
    
    961,165
    
    
    
    961,165Derivative liability
    
    
    125,000
    
    
    
    125,000Stockholders investment
    
    
    23,396,106
    
    
    
    22,121,242$
    33,038,089
    
    
    $
    29,241,461
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Three Months
    
    Six MonthsPeriod Ended December 31
    
    2005
    
    2004
    
    2005
    
    2004Net Sales
    
    $
    15,435,597
    
    
    $
    10,225,079
    
    
    $
    27,385,438
    
    
    $
    19,197,659Cost of goods sold
    
    
    9,397,027
    
    
    
    6,266,461
    
    
    
    16,671,989
    
    
    
    11,816,068Gross Profit
    
    
    6,038,570
    
    
    
    3,958,618
    
    
    
    10,713,449
    
    
    
    7,381,591Selling general and
administrative expense
    
    
    2,849,784
    
    
    
    2,456,825
    
    
    
    5,297,401
    
    
    
    4,576,346Income from operations
    
    
    3,188,786
    
    
    
    1,501,793
    
    
    
    5,416,048
    
    
    
    2,805,245Other income (expense)Royalty income
    
    
    100,307
    
    
    
    484,614
    
    
    
    201,918
    
    
    
    636,070Interest income
    
    
    40,825
    
    
    
    12,678
    
    
    
    75,470
    
    
    
    16,876Interest expense
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Income before income tax provision
    
    
    3,329,918
    
    
    
    1,999,085
    
    
    
    5,693,436
    
    
    
    3,458,191Provision for income taxes
    
    
    1,298,672
    
    
    
    779,643
    
    
    
    2,220,972
    
    
    
    1,348,838Net Income
    
    $
    2,031,246
    
    
    $
    1,219,442
    
    
    $
    3,472,464
    
    
    $
    2,109,353Earnings per common share:Basic
    
    $
    0.55
    
    
    $
    0.33
    
    
    $
    0.93
    
    
    $
    0.57Diluted
    
    $
    0.53
    
    
    $
    0.31
    
    
    $
    0.92
    
    
    $
    0.55Dividends per common share
    
    $
    0.13
    
    
    $
    0.13
    
    
    $
    0.26
    
    
    $
    0.26
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Six Months Ended December 31,
    
    2005
    
    2004CASH FLOWS FROM OPERATING
ACTIVITIES:Net income
    
    $
    3,472,464
    
    
    $
    2,109,353Adjustments to reconcile net
income to net cash provided
by operating activities:Depreciation and amortization
    
    
    503,061
    
    
    
    401,975Increase in
allowance for doubtful accounts
    
    
    193,000
    
    
    
    Net changes in operating assets and
liabilities
    
    
    (1,652,645
    )
    
    
    2,760,271Net cash provided by operating activities
    
    
    2,515,880
    
    
    
    5,271,599CASH FLOWS FROM INVESTING ACTIVITIES:Acquisition of equipment
    
    
    (697,675
    )
    
    
    (818,116
    )Net cash used in investing activities
    
    
    (697,675
    )
    
    
    (818,116
    )CASH FLOWS FROM FINANCING ACTIVITIES:Dividends paid
    
    
    (966,173
    )
    
    
    (960,121
    )Purchase of common stock
    
    
    (1,231,427
    )
    
    
    (2,130,625
    )Exercise of stock options
    
    
    
    
    
    
    123,400Net cash used in financing
activities
    
    
    (2,197,600
    )
    
    
    (2,967,346
    )Net increase (decrease) in cash
    
    
    (379,395
    )
    
    
    1,486,137Cash at beginning of period
    
    
    5,218,698
    
    
    
    2,110,917Cash at end of period
    
    $
    4,839,303
    
    
    $
    3,597,054
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1.
    
    CONDENSED CONSOLIDATED FINANCIAL STATEMENTSThe financial statements presented herein are based on interim amounts. In the opinion of
management, all adjustments (consisting of normal recurring accruals) necessary to present
fairly the financial position, results of operations and cash flows at December 31, 2005 and
for all periods presented have been made. All significant intercompany transactions have
been eliminated. The income from operations for the quarter and six months ended December
31, 2005 is not necessarily indicative of the operating results for the full year.Certain information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted. It is suggested that these condensed consolidated
financial statements be read in conjunction with the financial statements and notes thereto
included in the Registrants June 30, 2005 Annual Report on Form 10-K.2.
    
    EARNINGS PER COMMON SHAREBasic earnings per common share are computed based on the
weighted average number of common shares outstanding. The weighted average number of common shares outstanding for the
quarters ending December 31, 2005 and 2004 were 3,696,796 and 3,692,970, respectively. For
the six months ended December 31, 2005 and 2004, weighted average number of common shares
outstanding were 3,716,337 and 3,856,895, respectively. When dilutive, stock options are
included as share equivalents using the treasury stock method. Common stock equivalents of
124,450 and 132,392 related to stock option grants were included in the computation of the
average number of shares outstanding for diluted earnings per common share for the quarters
ended December 31, 2005 and 2004, respectively. Common stock
equivalents of 72,180 and
147,380 related to stock option grants were included in the computation of the average
number of shares outstanding for diluted earnings per common share for the six months ended
December 31, 2005 and 2004, respectively.3.
    
    INVENTORIESThe classification of inventories is as follows:
 December 31, 2005
    
    June 30, 2005Raw materials and work in process
    
    $
    4,962,789
    
    
    $
    3,649,069Finished goods
    
    
    5,272,730
    
    
    
    4,820,12710,235,519
    
    
    
    8,469,196LIFO reserve
    
    
    (873,393
    )
    
    
    (873,393
    )$
    9,362,126
    
    
    $
    7,595,803
 4.
    
    STOCK PURCHASE AGREEMENTThe Company has an agreement with its Chairman, John C. Koss, to, at the request of the
executor of the estate, repurchase Company common stock from his estate in the event of his
death. The Company does not have the right to require the estate to sell stock to the
Company.
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As such, this arrangement is accounted for as a written put option with the fair value of
the put option recorded as a derivative liability. The fair value of the option at December
31, 2005 was $125,000. The repurchase price is 95% of the fair market value of the common
stock on the date that notice, if the estate elects, to repurchase is provided to the
Company. Under the agreement, the total number of shares to be repurchased will be
sufficient to provide proceeds which are the lesser of $2,500,000 or the amount of estate
taxes and administrative expenses incurred by the Chairmans estate. The Company may elect
to pay the purchase price in cash or may elect to pay cash equal to 25% of the total amount
due and to execute a promissory note for the balance, payable over four years, at the prime
rate of interest. The Company maintains a $1,150,000 life insurance policy to fund a
substantial portion of this obligation. At December 31, 2005 and June 30, 2005, $125,000
has been classified as a derivative liability on the Companys financial statements.5.
    
    DIVIDENDS DECLAREDOn December 20, 2005, the Company declared a quarterly cash dividend of $0.13 per share for
stockholders of record on December 31, 2005 to be paid January 13, 2006. Such dividend
payable has been recorded at December 31, 2005.6.
    
    STOCK-BASED COMPENSATIONIn 1990, pursuant to the recommendation of the Board of Directors, the stockholders ratified
the creation of the Companys 1990 Flexible Incentive Plan (the 1990 Plan). The 1990 Plan
is administered by a committee of the Board of Directors and provides for the granting of
various stock-based awards including stock options to eligible participants, primarily
officers and certain key employees. A total of 225,000 shares of common stock were
available in the first year of the Plans existence. Each year thereafter additional shares
equal to .25% of the shares outstanding as of the first day of the applicable fiscal year
were reserved for issuance pursuant to the 1990 Plan. On July 22, 1992, the Board of
Directors authorized 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 an additional 300,000 shares for the 1990 Plan, which was approved by the
stockholders. In 1997, the Board of Directors authorized the reservation of an additional
300,000 shares for the 1990 Plan, which was approved by the stockholders. In 2001, the
Board of Directors authorized the reservation of an additional 300,000 shares for the 1990
Plan, which was also approved by the stockholders. Options generally vest at 25% each
anniversary date after grant, with a maximum term of five to ten years.During December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 123R, Shared-Based Payments (SFAS 123R),
which changed the accounting for equity compensation programs. Under SFAS 123R, companies
that award share-based payments to employees, including stock options, must begin to
recognize the expense of these awards in the financial statements at the time the employees
receive the awards. As allowed by SFAS 123 and SFAS 148, the Company elected to follow APB
Opinion No. 25 (APB 25) in accounting for its stock option plan until the effective date
of SFAS 123R. The accounting as provided by SFAS 123R was effective for the Company
beginning July 1, 2005, which was the beginning of the Companys current fiscal year. The
adoption of SFAS 123Rs fair value method has an impact on the Companys results of
operations, although it does not have an impact on the overall financial position.The effect of applying the expense recognition provisions of SFAS 123R on income before
provision for income taxes, net income and basic and diluted earnings per share for the
three months ended December 31, 2005 is presented below:
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Changefrom SFASThree months ended December 31, 2005
    
    As Reported
    
    
    123R
    
    
    Pro FormaIncome before income tax provision
    
    $
    3,329,918
    
    
    $
    98,992
    
    
    $
    3,428,910Provision for income taxes
    
    
    1,298,672
    
    
    
    38,607
    
    
    
    1,337,279Net income
    
    
    2,031,246
    
    
    
    60,385
    
    
    
    2,091,631Earnings per share:Basic earnings per share
    
    $
    0.55
    
    
    $
    0.02
    
    
    $
    0.57Diluted earnings per share
    
    $
    0.53
    
    
    $
    0.02
    
    
    $
    0.55
 The fair value of each option grant was estimated as of the date of grant using the
Black-Scholes pricing model. The resulting compensation cost for fixed awards with graded
vesting schedules was amortized on a straight line basis over the vesting period for the
entire award.As of December 31, 2005, there was approximately $1,088,000 of total unrecognized
compensation cost related to nonvested options granted under the plan. This cost is
expected to be recognized over a weighted average period of 4.83 years.SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation
cost to be reported as financing cash flow, rather than as operating cash flow as required
under the current standards. This requirement reduces the net cash provided by operation
activities and increase the net cash from financing activities in periods after adoption.
The Company cannot estimate what these amounts will be in the future because it will depend
on, among other things, when employees exercise stock options. The effect of applying the
provisions of SFAS 123R on cash flow from operations and cash flow from financing activities
was not material for the three months or the six months ended December 31, 2005.Prior to fiscal 2006, the Company accounted for its stock-based employee compensation plan
under the recognition and measurement principles of APB 25. All options granted under the
plan had an exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS 123R to
stock-based employee compensation, for the three months ended December 31, 2004:
 Three Months Ended December 31,
    
    2004Net income, as reported
    
    $
    1,219,442Add: Total stock-based employee compensation recorded
    
    
    26,187Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards
outstanding
    
    
    85,298Pro forma net income
    
    $
    1,160,331Earnings per share:Basic-as reported
    
    $
    0.33Basic-pro forma
    
    $
    0.31Diluted-as reported
    
    $
    0.31Diluted-pro forma
    
    $
    0.30
 7.
    
    SUBSEQUENT EVENTOn January 12, 2006, a customer of the Company,
Musicland Holding Corp., declared bankruptcy. As
a result, the Company has recorded a reserve for
the amounts due from
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Musicland of $193,000 at December 31, 2005. This amount is reflected in the
condensed consolidated statements of income for the periods ending December 31,
2005.
 
 Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations.
 Financial Condition, Liquidity and Capital Resources
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Results of Operations
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Recently Issued Financial Accounting Pronouncements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk.
  
 Item 4. Controls and Procedures.
 (a)
    
    Evaluation of Disclosure Controls and Procedures. The Company maintains a system of
disclosure controls and procedures that are designed to provide reasonable assurance that
information, which is required to be timely disclosed, is accumulated and communicated to
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management in a timely fashion. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the objectives of the
control system are met. The Company, under the supervision and with the participation of
the Companys management, including the Companys Chief Executive Officer/Chief Financial
Officer, after evaluating the effectiveness of the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities Exchange Act of
1934, as amended (the Exchange Act)) as of the end of the period covered by this report,
has concluded that the Companys disclosure controls and procedures are effective to provide
reasonable assurance that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated to the
Companys management, including its principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required disclosure and are
effective to provide reasonable assurance that such information is recorded, processed,
summarized and reported within the time periods specified in the SECs rules and forms.(b)
    
    Changes in Internal Controls. The Companys internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) is designed to provide reasonable
assurances regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles.
There were no changes in the Companys internal control over financial reporting that occurred
during the Companys most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, the Companys internal control over financial
reporting. However, because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.
 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
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PART II
OTHER INFORMATION
 
 Item 6 Exhibits
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Signatures
  KOSS CORPORATIONDate: February 14, 2006
    
    
    
    /s/ Michael J. KossMichael J. KossVice Chairman, President,Chief Executive Officer,Chief Financial OfficerDate: February 14, 2006
    
    
    
    /s/ Sue SachdevaSue SachdevaVice PresidentFinance,
Secretary
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EXHIBIT INDEX
 Exhibit No.
    
    Exhibit Description3.1
    
    Certificate of Incorporation of Koss Corporation. Filed as Exhibit 3.1 to the
Companys Annual Report on Form 10-K for the year ended June 30, 1996 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.




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Exhibit No.
    
    Exhibit Description10.12
    
    Loan Agreement, effective as of February 17, 1995. Filed as Exhibit 10 to the
Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 1995
and incorporated herein by reference.10.13
    
    Amendment to Loan Agreement dated June 15, 1995, effective as of February 17,
1995. Filed as Exhibit 10.13 to the Companys Annual Report on Form 10-K for
the year ended June 30, 1995 and incorporated herein by reference.10.14
    
    Amendment to Loan Agreement dated April 29, 1999. Filed as Exhibit 10.14 to
the Companys Annual Report on Form 10-K for the year ended June 30, 1999 and
incorporated herein by reference.10.15
    
    Amendment to Loan Agreement dated December 15, 1999. Filed as Exhibit 10.15 to
the Companys Annual Report on Form 10-K for the year ended June 30, 2000 and
incorporated herein by reference.10.16
    
    Amendment to Loan Agreement dated October 10, 2001. Filed as Exhibit 10.16 to
the Companys Quarterly Report on Form 10-Q for the quarter ended December 31,
2001 and incorporated herein by reference.10.17
    
    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.10.18
    
    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.10.19
    
    License Agreement dated June 30, 2003 between Koss Corporation and Sonigem
Products, Inc. Filed as Exhibit 10.19 to the Companys Annual Report on Form
10-K for the year ended June 30, 2005 and incorporated herein by reference.10.20
    
    Amendment to License Agreement dated August 1, 2005, between Koss Corporation
and Sonigem Products, Inc. Filed as Exhibit 10.20 to the Companys Annual
Report on Form 10-K for the year ended June 30, 2005 and incorporated herein by
reference.31
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer/Chief
Financial Officer *32
    
    Section 1350 Certification of Chief Executive Officer/Chief Financial Officer ***        Filed herewith**      Furnished herewith