LIQUIDITY AND CAPITAL RESOURCES

During fiscal year 2009, cash provided by operations was $2,378,626, and during fiscal year 2008, cash provided by operations was $5,337,129. Working capital was $17,387,842 at June 30, 2009 and $18,547,574 at June 30, 2008. The net decrease in working capital of $1,159,732 from June 30, 2008 represents primarily the net change in cash, accounts receivable, accounts payable and accrued liabilities.

Capital expenditures for new property and equipment (including production tooling) were $2,147,866 and $1,179,344, in fiscal years 2009 and 2008, respectively. Depreciation charges totaled $817,957 and $961,605, for the same fiscal years. Budgeted capital expenditures for fiscal year 2010 are approximately $2,000,000. The Company expects to generate sufficient funds through operations to fund these expenditures.

Stockholders' investment increased to $23,630,392 at June 30, 2009 from $23,217,435 at June 30, 2008. The increase reflects the net effect of net income, dividends declared, purchase of common stock, exercise of stock options and compensation expense recorded for vested stock options granted under SFAS No. 123(R). On June 16, 2009, the Company declared a quarterly cash dividend of $0.13 per share, for an aggregate of $479,876 payable on July 15, 2009 to stockholders of record on June 30, 2009, which is recorded as dividends payable.

On February 16, 2009, the Company entered into a new credit facility for an unsecured line of credit for up to a maximum of $10,000,000 up to and including January 29, 2010. This credit facility replaces the Company's previous credit facility, which has been terminated and contained substantially the same terms as the Company's new credit facility. The Company's credit facility matures on January 29, 2010. This unsecured credit facility provides for borrowings up to a maximum of $10,000,000. The Company can use this credit facility for working capital, to refinance existing indebtedness, for stock repurchase and for general corporate purposes. Borrowings under this credit facility bear interest at either the bank's most recently publicly announced prime rate or at a LIBOR-based rate determined in accordance with the loan agreement. This credit facility includes certain financial covenants that require the Company to maintain a minimum tangible net worth, liabilities to tangible net worth ratios and interest coverage ratios. The tangible net worth of the Company must not fall below $10.0 million at any time. The maximum leverage of the Company, which consists of the ratio of its consolidated liabilities to its consolidated tangible net worth, must not exceed 1.50 to 1.0. The interest coverage of the Company, which consists of the ratio of its earnings before interest, income taxes, depreciation, amortization, and other non-cash charges to its consolidated interest charges, must not be less than 2.00 to 1.0. The Company has been and is well within these requirements. The Company uses its credit facility from time to time, although there was no utilization of this credit facility at June 30, 2009 or June 30, 2008.

In April of 1995, the Board of Directors approved a stock repurchase program authorizing the Company to purchase from time to time up to $2,000,000 of its common stock for its own account. Subsequently, the Board of Directors periodically has approved increases of between $1,000,000 to $2,000,000 in the stock repurchase program. As of June 30, 2009, the most recently approved increase was for additional purchases of $2,000,000, which occurred in October of 2006, for an aggregate maximum of $45,500,000, of which $43,374,113 had been expended through June 30, 2009. The Company intends to effect all stock purchases either on the open market or through privately negotiated transactions, and intends to finance all stock purchases through its own cash flow or by borrowing for such purchases. The Company will continue to repurchase its shares from the market when the board determines the shares to be undervalued. The Company may elect to use the purchase of these shares to minimize the dilutive effects to its stockholders when the Company's stock is used in acquisitions as consideration. The Company has no immediate plans to make an acquisition at this time.

For fiscal year 2009, the Company purchased 3,998 shares of its common stock at an average net price of $10.91 per share, for a total purchase price of $43,620. As of June 30, 2009 the Company's Board of Directors has authorized the repurchase by the Company of up to $2,000,000 in Company common stock at the discretion of the Chief Executive Officer of the Company.

From the commencement of the Company's stock repurchase program through June 30, 2009, the Company has purchased a total of 5,474,102 shares for a total gross purchase price of $52,768,873 (representing an average gross purchase price of $9.64 per share) and a total net purchase price of $41,945,130 (representing an average net purchase price of $7.66 per share). The difference between the total gross purchase price and the total net purchase price is the result of the Company purchasing from certain employees shares of the Company's stock acquired by such employees pursuant to the Company's stock option program. In determining the dollar amount available for additional purchases under the stock repurchase program, the Company uses the total net purchase price paid by the Company for all stock purchases, as authorized by the Board of Directors.

2009 RESULTS OF OPERATIONS COMPARED WITH 2008

Net sales for 2009 were $38,184,150 compared with $46,943,293 in 2008, a decrease of $8,759,143 or 19%. The sales decrease for the fiscal year is primarily due to soft retail sales in the United States and Europe. Gross profit, as a percentage of net sales, was $13,267,137 or 35% in 2009 compared with $17,791,502 or 38% in 2008, this decrease is primarily due to softer retail sales worldwide and a less profitable product mix.

Selling, general, and administrative expenses for 2009 were $10,653,243 compared with $10,792,064 in 2008. The Company has continued spending money on research and development of new products. The company spent approximately $1,948,000 on research and development during fiscal year 2009, as compared with $981,000 during fiscal year 2008.

Income from operations was $2,613,894 in 2009 compared with $6,999,438 in 2008, a decrease of $4,385,544 or 63%. This decrease was primarily due to spending on new product development, soft retail sales worldwide and a less profitable product mix. Interest income was $15,503 in 2009 compared with $119,464 in 2008, which was a decrease of 87%.

Royalty income was $258,333 in 2009 compared with $291,667 in 2008, a decrease of 11%. The decrease in royalty income for the twelve month period was primarily a result of lower sales by the Company's primary licensee.

The provision for income taxes was $911,062 and $2,916,280 in 2009 and 2008, respectively. The decrease is the provision for income taxes is attributable primarily to the decrease in income before income tax provision in 2009 compared to 2008. The Company's effective tax rate was 32% in 2009 and 39% in 2008.

OFF-BALANCE SHEET ARRANGEMENTS



The Company has no "off balance sheet arrangements except for operating leases
disclosed in Part I, Item 2. Properties.



                                           Payments Due By Period
                                     Less                                   More
                                     Than                                   Than
                          Total     1 Year     1-3 Years     3-5 Years     5 Years
Contractual Obligation
Operating Leases         $ 1,520   $    380   $       760   $       380   $       0
Total                    $ 1,520   $    380   $       760   $       380   $       0

DISCLOSURE ABOUT CERTAIN TRADING ACTIVITIES THAT INCLUDE NON-EXCHANGE TRADED CONTRACTS ACCOUNTED FOR AT FAIR VALUE

The Company does not have any trading activities that include non-exchange traded contracts accounted for at fair value.

DISCLOSURE ABOUT EFFECTS OF TRANSACTIONS WITH RELATED AND CERTAIN OTHER PARTIES

The Company has an agreement with its Chairman, John C. Koss, in the event of his death, at the request of the executor of his estate, to repurchase his Company common stock from his estate. The repurchase price is 95% of the fair market value of the common stock on the date that notice to repurchase is provided to the Company. 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.

In 1991, the Board of Directors agreed to continue the Chairman's current base salary in the event he becomes disabled prior to age 70. After age 70, he shall receive his current base salary for the remainder of his life, whether he becomes disabled or not. The Chairman has turned 70. These payments begin upon the Chairman's retirement, and since the Chairman has not retired, he is not currently receiving any of these payments under this arrangement. The Company had a deferred compensation liability of $400,000 recorded as of June 30, 2009 and June 30, 2008 for this arrangement.

The Company leases its main plant and offices in Milwaukee, Wisconsin from its Chairman. On August 15, 2007, the lease was renewed for a period of five years, and is being accounted for as an operating lease. The lease extension maintained the rent at a fixed rate of $380,000 per year. At anytime during this period the Company has the option to renew the lease for an additional five years for the period commencing July 1, 2013 and ending June 30, 2018 under the same terms and conditions. In the opinion of the independent directors of the Board, the lease is on terms no less favorable to the Company than those that could be obtained from an independent party. The Company is responsible for all property maintenance, insurance, taxes, and other normal expenses related to ownership of the property.

DISCLOSURE ABOUT CRITICAL ACCOUNTING POLICIES

The Company's more critical accounting policies include revenue recognition, royalty income, and the use of estimates (which inherently involve judgment and uncertainties) in valuing inventory and accounts receivable.

Revenue Recognition

The Company recognizes revenue when all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred (either FOB shipping point or delivery taken at the Company's dock); the seller's price to the buyer is fixed and determinable (pricing is finalized through the purchase order); and collectibility is reasonably assured. These criteria are generally satisfied and the Company recognizes revenue upon shipment. The Company also offers certain of its customers the right to return products that do not meet the standards agreed with the customer. The Company continuously monitors such product returns and while such returns have historically been minimal, the Company cannot guarantee that they will continue to experience the same return rates that they have experienced in the past. Any significant increase in product quality failure rates and the resulting credit returns could have a material adverse impact on the Company's operating results for the period or periods in which such returns materialize.

The Company provides for certain sales incentives, which include sales rebates. The Company records a provision for estimated incentives based upon the incentives offered to customers on product related sales in the same period as the related revenues are recorded. The Company also records a provision for estimated sales returns and allowances on product related sales in the same period as the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data the Company uses to calculate these estimates does not properly reflect future returns, adjustments may be required in future periods. Products sold are covered by a lifetime warranty. The Company accrues a warranty reserve for estimated costs to provide warranty services. The Company's estimate of costs to service its warranty obligations is based on historical experience and expectation of future conditions. To the extent the Company experiences increased warranty claim activity or increased costs associated with servicing those claims, its warranty accrual will increase accordingly and result in decreased gross profit.

Royalty Income

The Company's net income is affected by the levels of royalty income generated in any given period. Royalty income is recognized when earned under the terms of the Company's license agreements. In general, these agreements have required minimum quarterly royalty payments. Royalty income owed to the Company is calculated by the licensee and then verified by the Company. Royalty payments are calculated based upon predetermined percentages of net sales of the licensed products or based upon minimum quarterly royalty payments. Royalty income is booked monthly, on an accrual basis, and the amount that the Company accrues is the monthly equivalent of the minimum royalty payment. When the royalty payments are received each quarter, the Company then reduces the accounts receivable accordingly. The Company had one royalty agreement that terminated in the fourth quarter of fiscal year 2009. As of June 30, 2009, the Company has no license agreements in effect.

Accounts Receivable

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

Inventories

The Company values its inventories at the lower of cost or market. Cost is determined using the last-in, first-out ("LIFO") method. As of June 30, 2009, approximately 99% of the Company's inventory was valued using LIFO. Valuing inventories at the lower of cost or market requires the use of estimates and judgment. Our customers may cancel their orders or change purchase volumes. Any of these, or certain additional actions, could create excess inventory levels, which would impact the valuation of our inventories. The Company continues to use the same techniques to value inventory as have been used in the past. Any actions taken by our customers that could impact the value of our inventory are considered when determining the lower of cost or market valuations. The Company regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. If the Company is not able to achieve its expectations of the net realizable value of the inventory at its current value, the Company would have to adjust its reserves accordingly.

RECENTLY ISSUED FINANCIAL ACCOUNTING PRONOUNCEMENTS

Effective July 1, 2008, the Company implemented SFAS No. 157, "Fair Value Measurements" ("SFAS 157") related to its financial assets and liabilities, which defines fair value, establishes a framework for its measurement, and expands disclosures about fair value measurements. The adoption of SFAS 157 did not have an impact on the measurement of the Company's financial assets and liabilities, nor did it result in additional disclosures.

In February 2008, the FASB issued FASB Staff Position No. 157-2 ("FSP 157-2"), which delayed the effective date by which companies must adopt certain provisions of Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). FSP 157-2 defers the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of this standard is not anticipated to have a material impact on our financial position, results of operations, or cash flows.

In May 2009, the FASB issued Statement 165, Subsequent Events, to incorporate the accounting and disclosure requirements for subsequent events into U.S. generally accepted accounting principles. Statement 165 introduces new terminology, defines a date through which management must evaluate subsequent events, and lists the circumstances under which an entity must recognize and disclose events or transactions occurring after the balance sheet date. We adopted Statement 165 as of June 30, 2009. We evaluated our June 30, 2009 financial statements for subsequent events through August 4, 2009, the date the financial statements were available to be issued. We are not aware of any subsequent events which would require recognition or disclosure in the financial statements.

In June 2009, FASB issued, "Accounting Standards Update No. 2009-1, Topic 105 -Generally Accepted Accounting Principles amendments based on the Statement of Financial Standards No. 168 - the FASB Accounting Standard Codifications and the Hierarchy of Generally Accepted Accounting Principles and Statement of Financial Accounting Standard No. 168, the FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 62." The Accounting Standards Update and SFAS No. 168 make the FASB Codification the authoritative source of GAAP. The FASB Codification is effective for interim and annual reporting periods ending after September 15, 2009. We will update GAAP referencing for our September 30, 2009 Form 10-Q. The FASB Codification is not expected to have a material impact on our financial reporting.