1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 KOSS CORPORATION Commission file number 0-3295 - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) A Delaware Corporation 391168275 - ------------------------------------------------------------------------------- (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) Registrant's telephone number, including area code: (414) 964-5000 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered - ------------------- ----------------------------------------- NONE NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value (voting) -------------------------------------- (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the voting stock held by nonaffiliates of the registrant as of September 10, 1998 was approximately $12,781,844 (based on the $10.875 per share closing price of the Company's Common Stock as reported on the NASDAQ Stock Market on September 10, 1998). In determining who are affiliates of the Company for purposes of this computation, it is assumed that directors, officers, and any persons who held on September 10, 1998 more than 5% of the issued and outstanding common stock of the Company are "affiliates" of the Company. The characterization of such directors, officers, and other persons as affiliates is for purposes of this computation only and should not be construed as a determination or admission for any other purpose that any of such persons are, in fact, affiliates of the Company. On September 10, 1998, 3,177,269 shares of voting common stock were outstanding.
2 Documents Incorporated by Reference Part III incorporates by reference information from Koss Corporation's Proxy Statement for its 1998 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year covered by this Report. The exhibits hereto incorporate by reference information from the Company's Annual Report on Form 10-K for the fiscal years ended June 30, 1988, 1990, 1995, and 1996, and the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and March 31, 1997. PART I Item 1. BUSINESS. As used herein, the term "Company" means Koss Corporation and its consolidated subsidiaries, unless the context otherwise requires. The Company operates in the audio/video industry segment of the home entertainment industry through its design, manufacture and sale of stereo headphones, audio/video loudspeakers, and related accessory products. The Company's principal product is the design, manufacture, and sale of stereophones and related accessories. The percentage of total revenues related to the product line over the past three years was: 1998 1997 1996 ---- ---- ---- Stereophones 87% 83% 80% The Company's products are sold through audio specialty stores, catalog showrooms, regional department store chains, military exchanges and national retailers under the "Koss" name and dual label. The Company has more than 1,600 domestic dealers and its products are carried in more than 17,000 domestic retail outlets. International markets are served by domestic sales representatives and a sales office in Switzerland which utilizes independent distributors in several foreign countries. Management believes that it has sources of raw materials that are adequate for its needs. The Company regularly applies for registration of its trademarks and has numerous patents. Certain of its trademarks are of material value and importance to the conduct of its business. Although the Company considers protection of its proprietary developments important, the Company's business is not, in the opinion of management, materially dependent upon any single patent. Although retail sales of consumer electronics are predictably higher during the holiday season, management of the Company is of the opinion that its business and industry segment are not seasonal as evidenced by the fact that 54% of sales occurred in the first six months of the fiscal year and 46% of sales occurred in the latter six months of the fiscal year. The Company's working capital needs do not differ substantially from those of its competitors in the industry and generally reflect the need to carry significant amounts of inventory to meet delivery requirements of its customers. The Company provides extended payment terms for product sales to certain customers. Based on historical trends, management does not expect these practices to have any material effect on net sales or revenues. The Company's current backlog of orders is not material in relation to annual net sales. 2
3 The Company markets its products to approximately 2,000 customers worldwide. During 1998 the Company's sales to its largest single customer, Tandy Corporation, were 19% of total sales. Management believes that any loss of this customer's revenues would be partially offset by a corresponding decrease, on a percentage basis, in expenses thereby dampening the impact on the Company's operating income. Although perhaps initially material, management believes this impact would be offset in future years by expanded sales to both existing and new customers. The five largest customers of the Company accounted for approximately 39% of total sales in 1998. Although competition in the stereophone market has increased this past year, the Company has maintained its competitive position as a leading marketer and producer of high fidelity stereophones in the United States. In the stereophone market, the Company competes directly with approximately five major competitors, several of which are large and diversified and have greater total assets and resources than the Company. The amount spent on engineering and research activities relating to the development of new products or the improvement of existing products was $265,000 during fiscal 1998 as compared with $245,000 during fiscal 1997 and $225,000 during fiscal 1996. These activities were conducted by both Company personnel and outside consultants. The Company relies upon its unique sound, quality workmanship, brand identification, engineering skills and customer service to maintain its competitive position. As of June 30, 1998, the Company employed 184 people. The Company also utilizes temporary personnel to meet seasonal production demands. Foreign Sales. International markets are serviced through manufacturers representatives or independent distributors with product produced in the United States. In the opinion of management, the Company's competitive position and risks attendant to the conduct of its business in such markets are comparable to the domestic market. For further information, see Note 10 to consolidated financial statements accompanying this Form 10-K. Item 2. PROPERTIES. The Company leases its main plant and offices in Milwaukee, Wisconsin from its Chairman, John C. Koss. On June 25, 1993, the lease was renewed for a period of ten years, and is being accounted for as an operating lease. The lease extension increases the rent from $280,000 per year (plus Consumer Price Index increase in 1994) to a fixed rate of $350,000 per year for three years and $380,000 for the seven years thereafter. 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. All facilities are in good repair and, in the opinion of management, are suitable for the Company's purposes. Item 3. LEGAL PROCEEDINGS. Neither Koss nor its subsidiaries are subject to any material legal proceedings. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year ended June 30, 1998. 3
4 PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. MARKET INFORMATION ON COMMON STOCK The Company's common stock is traded on The Nasdaq Stock Market under the trading symbol "KOSS". There were approximately 1,087 holders of the Company's common stock as of September 10, 1998. No dividends have been paid for the years ended June 30, 1998, 1997, and 1996. The quarterly high and low sale prices of the Company's common stock for the last two fiscal years are shown below. Fiscal Year 1998 Fiscal Year 1997 ---------------- ---------------- Quarter High Low High Low - ------- ---- --- ---- --- First $14-0/0 $8-1/4 $7-3/8 $5-3/4 Second $15-1/8 $11-1/4 $7-0/0 $5-3/4 Third $12-1/2 $10-0/0 $13-0/0 $6-1/4 Fourth $11-1/4 $9-1/2 $11-1/4 $8-3/4 Item 6. SELECTED FINANCIAL DATA. <TABLE> <CAPTION> 1998 1997 1996 1995 1994 - ---------------------------------- ---------------- --------------- ---------------- --------------- ---------------- <S> <C> <C> <C> <C> <C> Net sales $40,638,747 $39,554,720 $36,422,377 $33,432,344 $35,561,322 Net income $5,477,629 $3,587,688 $2,360,963 $2,087,994 $2,800,855 Earnings per common share: Basic $1.68 $1.09 $0.69 $0.63 $0.88 Diluted $1.65 $1.07 $0.67 $0.58 $0.75 Total assets $32,028,769 $26,332,923 $22,005,257 $20,972,923 $19,220,406 Long-term debt $2,746,000 $1,221,000 $470,000 $570,000 $2,068,741 </TABLE> 4
5 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FINANCIAL CONDITION AND LIQUIDITY During 1998, cash provided by operations was $1,839,750. Working capital was $25,044,408 at June 30, 1998. The increase of $4,255,260 from the balance at June 30, 1997 represents primarily the net effect of an increase in inventory of $4,938,405. The increase in inventory is the result of anticipated higher sales volume in the upcoming year. Capital expenditures for new property and equipment including production tooling were $221,560, $782,287, and $690,932 in 1998, 1997, and 1996, respectively. Depreciation charges aggregated $636,558, $649,099, and $629,985 for the same fiscal years. Budgeted capital expenditures for fiscal year 1999 are $1,100,000. The Company expects to generate sufficient funds through operations to fulfill these expenditures. Stockholders' investment increased to $22,591,160 at June 30, 1998 from $20,274,494 at June 30, 1997. The increase reflects primarily the effect of net income, the purchase and retirement of common stock, and the exercise of stock options for the year. No cash dividends have been paid since the first quarter of fiscal 1984. The Company has an unsecured working capital line of credit facility with a bank which expires November 1, 1999. This credit facility provides for borrowings up to a maximum of $8,000,000. Borrowings under this credit facility bear interest at the bank's prime rate, or LIBOR plus 2.25%. This credit facility includes certain covenants that require the Company to maintain a minimum tangible net worth and specified current, interest coverage and leverage ratios. Borrowings under this credit facility as of June 30, 1998 totaled $2,746,000. There are no commitments for foreign letters of credit at June 30, 1998. In April, 1995 the Board of Directors approved a stock repurchase program authorizing the Company to purchase from time to time up to $2,000,000 of its common stock for its own account. In January, 1996 the Board of Directors approved an increase in the total amount of potential stock purchases for the Company's own account from $2,000,000 to $3,000,000. In July of 1997, the Board of Directors again approved an increase in the total amount of potential stock purchases for the Company's own account from $3,000,000 to $5,000,000. In August of 1998, the Board of Directors approved an increase of $3,000,000 in the Company's stock repurchase program, thereby increasing the total amount of stock repurchases for the Company's own account from $5,000,000 to $8,000,000. The Company intends to effectuate 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. For the fiscal year ended June 30, 1998, the Company purchased 547,772 shares of its common stock at an average gross price of $12.75 per share (and an average net price of $7.96 per share), and retired all such shares. From the commencement of the Company's stock repurchase program through June 30, 1998, the Company has purchased and retired a total of 891,348 shares for a total gross purchase price of $9,108,577 (representing an average gross purchase price of $10.22 per share) and a total net purchase price of $6,485,677 (representing an average net purchase price of $7.28 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. 5
6 1998 RESULTS COMPARED WITH 1997 Net sales for 1998 were $40,638,747 compared with $39,554,720 in 1997, an increase of $1,084,027 or 3%. The increase was the result of higher sales of current products as well as the introduction of new products. The Company anticipates a decline in net sales for fiscal 1999 as a result of the Company's previously announced decision to exit the computer speaker business, which accounted for $5,831,234 of gross sales for the fiscal year ending June 30, 1998. Gross profit was $15,794,779 or 38.9% in 1998 compared with $13,632,099 or 34.5% in 1997. Shifts in product mix resulted in the increase in gross profit as compared to last year. Selling, general and administrative expenses for 1998 were $7,822,338 compared with $8,594,260 in 1997, a decrease of $771,922 or 9%. This decrease is a result of the closing of Koss Limited in Canada. Income from operations was $7,972,441 in 1998 compared with $5,037,839 in 1997, an increase of 58%. Net interest expense for 1998 was $253,171 compared with $200,401 in 1997. The increase is due to increased levels of borrowings during the fiscal year. The Company had a License Agreement with Trabelco N.V., a Netherlands, Antilles company and a subsidiary of Hagemeyer, N.V., a diverse international trading company based in the Netherlands. This License Agreement covered North America, Central America, and South America. Effective March 31, 1997, the Company assigned this License Agreement to Jiangsu Electronics Industries Limited ("Jiangsu"), a subsidiary of Orient Power Holdings Limited. Orient Power is based in Hong Kong and has an extensive portfolio of audio and video products. Pursuant to this assignment, Jiangsu has agreed to make royalty payments through December 31, 2000, subject to certain minimum royalty amounts due for the years 1998, 1999, and 2000. In May of 1998, the Company and Jiangsu entered into an amendment to this License Agreement expanding the products covered by this License Agreement to include mobile electronics and increasing the minimum royalties due for the years 1998, 1999, and 2000. This License Agreement is subject to renewal for additional 3 year periods. Royalty income earned in connection with this License Agreement for the year ended June 30, 1998 was $1,206,359 as compared to $1,131,250 for the same period in 1997. The Company recognizes royalty income when earned. The increase in royalty income for the twelve-month period is the result of higher sales volume in products covered under this License Agreement. The License Agreement with Trabelco N.V. covering many European countries remains in place. No sales have been reported under this License Agreement to date; however, certain minimum royalties are due for calendar year 1998. This License Agreement expires on December 31, 1998; however, Trabelco N.V. has the option to renew this License Agreement for additional 3 year periods. Effective July 1, 1998, the Company entered into a License Agreement and an Addendum thereto with Logitech Electronics Inc. ("Logitech") of Ontario, Canada whereby the Company licensed to Logitech the right to sell multimedia/computer speakers under the Koss brand name. This License Agreement covers North America and certain countries in South America and Europe. This License Agreement extends for 5 years and includes a 5 year renewal option at the Company's discretion. This License Agreement requires royalty payments by Logitech through June 30, 2003, subject to certain minimum royalty amounts due each year. Income taxes are discussed in Note 6 to the financial statements. 6
7 1997 RESULTS COMPARED WITH 1996 Net sales for 1997 were $39,554,720 compared with $36,422,377 in 1996, an increase of $3,132,343 or 9%. The increase was the result of higher sales of current product as well as the introduction of new products. Gross profit was $13,632,099 or 34.5% in 1997 compared with $11,180,754 or 30.7% in 1996. Shifts in product mix resulted in the increase in gross profit as compared to last year. Selling, general and administrative expenses for 1997 were $8,594,260 compared with $8,528,098 in 1996, an increase of $66,162 or less than 1%. Income from operations was $5,037,839 in 1997 compared with $2,652,656 in 1996, an increase of 90%. Net interest expense for 1997 was $200,401 compared with $40,195 in 1996. The increase is due to increased levels of borrowings during the fiscal year. The Company had a License Agreement with Trabelco N.V., a Netherlands, Antilles company and a subsidiary of Hagemeyer, N.V., a diverse international trading company based in the Netherlands. This License Agreement covered North America, Central America, and South America. Effective March 31, 1997, the Company assigned this License Agreement to Jiangsu Electronics Industries Limited ("Jiangsu"), a subsidiary of Orient Power Holdings Limited. Orient Power is based in Hong Kong and has an extensive portfolio of audio and video products. Pursuant to this assignment, Jiangsu has agreed to make royalty payments through December 31, 2000, subject to certain minimum royalty amounts due for the years 1998, 1999, and 2000. In May of 1998, the Company and Jiangsu entered into an amendment to this License Agreement expanding the products covered by this License Agreement to include mobile electronics and increasing the minimum royalties due for the years 1998, 1999, and 2000. This License Agreement is subject to renewal for additional 3 year periods. Royalty income earned in connection with this License Agreement for the year ended June 30, 1997 was $1,131,250 as compared to $1,303,502 for the same period in 1996. The Company recognizes royalty income when earned. The decrease in royalty income for the twelve-month period is the result of lower sales volume in products covered under this License Agreement. The License Agreement with Trabelco N.V. covering many European countries remains in place. No sales have been reported under this License Agreement to date; however, certain minimum royalties are due for calendar years 1997 and 1998. This License Agreement expires on December 31, 1998; however, Trabelco N.V. has the option to renew this License Agreement for additional 3 year periods. Income taxes are discussed in Note 6 to the financial statements. 7
8 MANAGEMENT'S REPORT The consolidated financial statements and related financial information included in this report are the responsibility of management as to preparation, presentation and reliability. Management believes that the financial statements have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances and necessarily include amounts that are based on best estimates and judgments. The Company maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that the books and records reflect the authorized transactions of the Company. The Board of Directors, acting through the Audit Committee, is responsible for the selection and appointment of the independent auditors and reviews the scope of their audit and their findings. The independent auditors have direct access to the Audit Committee, with or without the presence of management representatives, to discuss the scope and the results of their audit work. The Audit Committee is comprised solely of non-employee directors. The independent auditors provide an objective assessment of the degree to which management meets its responsibility for fairness of financial reporting. They evaluate the system of internal accounting controls in connection with their audit and perform such tests and procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," (SFAS 131) which establishes standards for reporting information about operating segments in annual financial statements and interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 is effective for fiscal years beginning after December 15, 1997 and requires presentation of prior period financial statements for comparability purposes. The Company is currently evaluating its required disclosures under SFAS 131 and expects to adopt this standard during the year ended June 30, 1999. YEAR 2000 The Company is currently working to resolve the potential impact of the year 2000 on the processing of date sensitive information by the Company's computerized information systems. The year 2000 problem is the result of computer programs being written using 2 digits to define the applicable year (as opposed to 4 digits). Any of the Company's programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculations or systems failure. Based on a review of the Company's software by the Chief Information Officer and outside consultants, the anticipated costs of addressing potential problems are not expected to have an adverse impact on the Company's financial position, results of operations or cash flows in future periods. The Company expects its computer systems will be year 2000 compliant by January 31, 1999. A year 2000 compliance letter and survey form has been sent to all our customers doing over $10,000 annually in sales. Responses will be analyzed to see if there are any adverse conditions that the Company may have overlooked in its year 2000 plan. The same procedure is being followed with our suppliers and vendors. The Company's current inventory levels and forecasting technique will insure product is available to support customer requirements. In the event there are any adverse conditions, the Company will devote necessary resources to resolve all significant year 2000 issues in a timely manner. 8
9 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Consolidated financial statements of the Company at June 30, 1998 and 1997 and for each of the three years in the period ended June 30, 1998 and the notes thereto, and the report of independent accountants thereon are set forth on pages 13 to 25. Selected unaudited quarterly financial data is as follows: <TABLE> <CAPTION> Quarter ------- 1998 First Second Third Fourth - ---- ----- ------- ----- ------ <S> <C> <C> <C> <C> Net sales $11,755,125 $10,378,151 $8,089,590 $10,415,881 Gross profit 4,424,457 3,310,141 2,517,692 5,542,489 Net income 1,401,423 1,084,436 661,608 2,330,162 Earnings per common share: Basic .42 .33 .21 .73 Diluted .41 .32 .20 .73 Quarter ------- 1997 First Second Third Fourth - ---- ----- ------- ----- ------ Net sales $9,862,803 $13,320,166 $8,583,303 $7,788,448 Gross profit 3,287,678 4,544,115 2,922,694 2,877,612 Net income 838,990 1,482,478 531,552 734,668 Earnings per common share: Basic .25 .45 .16 .22 Diluted .25 .45 .15 .21 </TABLE> Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 9
10 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information relating to the directors of Koss Corporation is incorporated herein by reference from the "ELECTION OF DIRECTORS -- Information As To Nominees" and the "ELECTION OF DIRECTORS -- Executive Officers" contained in the Koss Corporation Proxy Statement for its 1998 Annual Meeting of Stockholders (the "1998 Proxy Statement"), which 1998 Proxy Statement is to be filed within 120 days of the end of the fiscal year covered by this Report pursuant to General Instruction G(3) of Form 10-K. Item 11. EXECUTIVE COMPENSATION. Information relating to executive compensation is incorporated herein by reference from the "ELECTION OF DIRECTORS -- Executive Compensation And Related Matters" section of the 1998 Proxy Statement. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information relating to the security ownership of certain beneficial owners and management is incorporated herein by reference from the "ELECTION OF DIRECTORS - -- Beneficial Ownership Of Company Securities" section of the 1998 Proxy Statement. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information relating to related transactions is incorporated herein by reference from the "ELECTION OF DIRECTORS -- Executive Compensation And Related Matters" and "ELECTION OF DIRECTORS -- Related Transactions" sections of the 1998 Proxy Statement. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. a. The following documents are filed as part of this report: <TABLE> <S> <C> 1. Financial Statements The following consolidated financial statements of Koss Corporation are set forth on pages 13 to 25: Report of Independent Accountants............................................................. 13 Consolidated Statements of Income for the Years Ended June 30, 1998, 1997, and 1996.......................................................... 14 Consolidated Balance Sheets as of June 30, 1998 and 1997...................................... 15 Consolidated Statements of Cash Flows for the Years Ended June 30, 1998, 1997, and 1996............................................ 16 Consolidated Statements of Stockholders' Investment for the Years Ended June 30, 1998, 1997, and 1996............................................ 17 Notes to Consolidated Financial Statements.................................................... 18 </TABLE> 10
11 2. Financial Statement Schedules All schedules have been omitted because the information is not applicable or is not material or because the information required is included in the financial statements or the notes thereto. 3. Exhibits Filed 3.1 Certificate of Incorporation of Koss Corporation. 3.2 By-Laws of Koss Corporation. 4.1 Certificate of Incorporation of Koss Corporation. 4.2 By-Laws of Koss Corporation. 10.1 Officer Loan Policy. 10.3 Supplemental Medical Care Reimbursement Plan. 10.4 Death Benefit Agreement with John C. Koss. 10.5 Stock Repurchase Agreement with John C. Koss. 10.6 Salary Continuation Resolution for John C. Koss. 10.7 1983 Incentive Stock Option Plan. 10.8 Assignment of Lease to John C. Koss. 10.9 Addendum to Lease. 10.10 1990 Flexible Incentive Plan. 10.12 Loan Agreement, effective as of February 17, 1995. 10.13 Amendment to Loan Agreement dated June 15, 1995, effective as of February 17, 1995. 10.14 License Agreement dated November 15, 1991 between Koss Corporation and Trabelco N.V. (a subsidiary of Hagemeyer N.V.) for North America, Central America and South America (including Amendment to License Agreement dated November 15, 1991; Renewal Letter dated November 18, 1994; and Second Amendment to License Agreement dated September 29, 1995). 10.15 License Agreement dated September 29, 1995 between Koss Corporation and Trabelco N.V. (a subsidiary of Hagemeyer N.V.) for Europe (including First Amendment to License Agreement dated December 26, 1995). 10.16 Third Amendment and Assignment of License Agreement to Jiangsu Electronics Industries Limited dated March 31, 1997. 11
12 10.17 Fourth Amendment to License Agreement dated as of May 29, 1998. 10.18 License Agreement dated June 30, 1998 between Koss Corporation and Logitech Electronics Inc. (including Addendum to License Agreement dated June 30, 1998). 10.19 Consent of Directors (Supplemental Executive Retirement Plan for Michael J. Koss dated March 7, 1997). 22 List of Subsidiaries of Koss Corporation. 27 Financial Data Schedule. b. One report on Form 8-K was filed by the Company during the last quarter of the period covered by this report. This Form 8-K referenced a Press Release issued by the Company announcing a decline in forecasted sales revenue of approximately $4,000,000, or 10%, for the fiscal year ending June 30, 1999, relating to an anticipated reduction in sales of the Company's computer loudspeaker and associated peripheral business. 12
13 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF KOSS CORPORATION In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 10 present fairly, in all material respects, the financial position of Koss Corporation and its subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP - -------------------------- PricewaterhouseCoopers LLP Milwaukee, Wisconsin July 15, 1998 13
14 CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> Year Ended June 30, 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Net sales $40,638,747 $39,554,720 $36,422,377 Cost of goods sold 24,843,968 25,922,621 25,241,623 - ---------------------------------------------------------------------------------------------------------- Gross profit 15,794,779 13,632,099 11,180,754 Selling, general and administrative expense 7,822,338 8,594,260 8,528,098 - --------------------------------------------------------------------------------------------------------- Income from operations 7,972,441 5,037,839 2,652,656 Other income (expense) Royalty income 1,206,359 1,131,250 1,303,502 Interest expense (net) (253,171) (200,401) (40,195) - --------------------------------------------------------------------------------------------------------- Income before income taxes 8,925,629 5,968,688 3,915,963 Provision for income taxes (note 6) 3,448,000 2,381,000 1,555,000 - --------------------------------------------------------------------------------------------------------- Net income $5,477,629 $ 3,587,688 $ 2,360,963 ========================================================================================================= Earnings per common share: Basic $1.68 $1.09 $0.69 Diluted $1.65 $1.07 $0.67 - --------------------------------------------------------------------------------------------------------- Dividends per common share None None None ========================================================================================================= </TABLE> See accompanying notes. 14
15 CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> As of June 30, 1998 1997 - ---------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current Assets: Cash $ 14,778 $ 32,551 Accounts receivable, less allowances of $556,290 and $928,605, respectively (note 12) 8,387,839 6,992,513 Inventories 19,486,058 14,547,653 Prepaid expenses 548,892 603,997 Income taxes receivable -- 65,493 Deferred income taxes (note 6) 555,946 756,946 - --------------------------------------------------------------------------------------------------------------------------- Total current assets 28,993,513 22,999,153 - --------------------------------------------------------------------------------------------------------------------------- Equipment and Leasehold Improvements, at cost: Leasehold improvements 742,289 735,930 Machinery, equipment, furniture and fixtures 4,587,729 4,548,096 Tools, dies, molds and patterns 8,351,591 8,176,023 - --------------------------------------------------------------------------------------------------------------------------- 13,681,609 13,460,049 Less--accumulated depreciation 11,619,078 10,982,520 - --------------------------------------------------------------------------------------------------------------------------- 2,062,531 2,477,529 Deferred Income Taxes (note 6) 364,135 258,135 Intangible and Other Assets 608,590 598,106 - --------------------------------------------------------------------------------------------------------------------------- $32,028,769 $26,332,923 =========================================================================================================================== LIABILITIES AND STOCKHOLDERS' INVESTMENT Current Liabilities: Accounts payable $ 1,956,877 $ 741,646 Accrued liabilities (note 7) 1,314,701 994,877 Deferred revenue -- 473,482 Income taxes payable 677,527 -- - --------------------------------------------------------------------------------------------------------------------------- Total current liabilities 3,949,105 2,210,005 - --------------------------------------------------------------------------------------------------------------------------- Long-Term Debt (note 4) 2,746,000 1,221,000 - --------------------------------------------------------------------------------------------------------------------------- Deferred Compensation and Other Liabilities (note 11) 1,252,504 1,137,424 - --------------------------------------------------------------------------------------------------------------------------- Contingently Redeemable Equity Interest (note 5) 1,490,000 1,490,000 - --------------------------------------------------------------------------------------------------------------------------- Stockholders' Investment (note 5): Common stock, $.01 par value, authorized 8,500,000 shares; issued and outstanding 3,177,269 and 3,323,791 shares, respectively 31,773 33,238 Paid in capital -- 2,328,677 Contingently redeemable common stock (1,490,000) (1,490,000) Accumulated other comprehensive income (71,322) (71,322) Undistributed retained earnings 24,120,709 19,473,901 - --------------------------------------------------------------------------------------------------------------------------- Total stockholders' investment 22,591,160 20,274,494 - --------------------------------------------------------------------------------------------------------------------------- $32,028,769 $26,332,923 =========================================================================================================================== </TABLE> See accompanying notes. 15
16 CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> Year Ended June 30, 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,477,629 $ 3,587,688 $ 2,360,963 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 676,673 712,215 777,238 Deferred income taxes 95,000 (74,532) (568,465) Deferred compensation 115,080 115,080 115,080 Net changes in operating assets and liabilities (note 8) (4,524,632) (4,407,722) (802,625) - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 1,839,750 (67,271) 1,882,191 - -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of equipment and leasehold improvements (221,560) (782,287) (690,932) - -------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments under line of credit agreement (24,385,400) (21,029,000) (13,891,000) Borrowings under line of credit agreement 25,910,400 21,780,000 13,791,000 Exercise of stock options 3,822,600 456,799 433,835 Purchase and retirement of common stock (6,983,563) (352,691) (1,547,320) - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (1,635,963) 855,108 (1,213,485) - -------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash (17,773) 5,550 (22,226) Cash at beginning of year 32,551 27,001 49,227 - -------------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 14,778 $ 32,551 $ 27,001 ========================================================================================================================== </TABLE> See accompanying notes. 16
17 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT <TABLE> <CAPTION> Accumulated Other Common Paid In Retained Comprehensive Stock Capital Earnings Income - ------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Balance, June 30, 1995 $ 34,861 $ 3,336,431 $13,525,250 $ (65,116) Net income -- -- 2,360,963 -- Foreign currency translation adjustment -- -- -- (42,114) Purchase and retirement of treasury stock (2,519) (1,544,801) -- -- Exercise of stock options 837 432,998 -- -- - ------------------------------------------------------------------------------------------------------------------------ Balance, June 30, 1996 33,179 2,224,628 15,886,213 (107,230) Net income -- -- 3,587,688 -- Foreign currency translation adjustment -- -- -- 35,908 Purchase and retirement of treasury stock (516) (352,175) -- -- Exercise of stock options 575 456,224 -- -- - ------------------------------------------------------------------------------------------------------------------------ Balance, June 30, 1997 33,238 2,328,677 19,473,901 (71,322) Net income -- -- 5,477,629 -- Purchase and retirement of treasury stock (5,478) (6,147,264) (830,821) -- Exercise of stock options 4,013 3,818,587 -- -- - ------------------------------------------------------------------------------------------------------------------------ Balance, June 30, 1998 $ 31,773 $ -- $24,120,709 $ (71,322) - ------------------------------------------------------------------------------------------------------------------------ </TABLE> See accompanying notes. 17
18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ACCOUNTING POLICIES CONCENTRATION OF CREDIT RISK--The Company operates in the audio/video industry segment of the home entertainment industry through its design, manufacture and sale of stereo headphones, audio/video loudspeakers and related accessory products. The Company's products are sold through audio specialty stores, catalog showrooms, regional department store chains, military exchanges and national retailers under the "Koss" name and dual label. The Company has more than 1,600 domestic dealers and its products are carried in more than 17,000 domestic retail outlets. International markets are served by domestic sales representatives and a sales office in Switzerland, which utilizes independent distributors in several foreign countries. The Company grants credit to its domestic and Canadian customers. Collection is dependent on the retailing industry economy. International customers outside of Canada are sold on a cash against documents or letter of credit basis. Approximately 16% and 13% of the Company's accounts receivable at June 30, 1998 and 1997, respectively, were foreign receivables. BASIS OF CONSOLIDATION--The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions have been eliminated. ROYALTY INCOME--The Company recognizes royalty income when earned under terms of license agreements, which expire in 1998 and 2000. These agreements contain three year renewal options and require minimum calendar year royalty payments. INVENTORIES--At June 30, 1998 and 1997, approximately 83% and 98%, respectively, of the Company's inventories were valued at the lower of last-in, first-out (LIFO) cost or market. All other inventories are valued at the lower of first-in, first-out (FIFO) cost, or market. If the FIFO method of inventory accounting had been used by the Company for inventories valued at LIFO, inventories would have been $461,143 and $457,484 higher than reported at June 30, 1998 and 1997, respectively. The components of inventories at June 30, is as follows: 1998 1997 ---------------------------------------------------------- Raw materials and Work in process $ 6,547,983 $ 7,242,161 Finished goods 12,938,075 7,305,492 ---------------------------------------------------------- $19,486,058 $14,547,653 ========================================================== PROPERTY AND EQUIPMENT--Depreciation is provided on a straight-line basis over the estimated useful life of the asset as follows: Leasehold Improvements 10-15 years Machinery, Equipment, Furniture and Fixtures 3-10 years Tools, Dies, Molds and Patterns 4-5 years RESEARCH AND DEVELOPMENT--Research and development expenditures charged to operations amounted to approximately $265,000 in 1998, $245,000 in 1997, and $225,000 in 1996. EARNINGS PER SHARE--Basic earnings per share are computed based on the weighted average number of common shares outstanding. When dilutive, stock options are included as share equivalents using the treasury stock method. 18
19 FAIR VALUE OF FINANCIAL INSTRUMENTS--Cash, accounts receivable, accounts payable and accrued liabilities recorded in the consolidated balance sheets approximate fair value based on the short maturity of these instruments. Amounts recorded for long-term debt, deferred compensation and other liabilities are estimated to approximate fair value based on market conditions and interest rates available to the Company for similar financial instruments. USE OF ESTIMATES--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. 2. EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 128, "Earnings per Share," (SFAS 128). This Statement establishes new standards for computing and presenting earnings per share. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997 and requires restatement of all prior-period earnings per share data. The Company's adoption of the provisions of SFAS 128 resulted in the dual presentation of basic and diluted per share amounts on the Company's income statement. Basic earnings per share are computed based on the weighted average number of common shares outstanding. The weighted average number of common shares outstanding for the fiscal years ended June 30, 1998, 1997, and 1996 were 3,263,842, 3,304,194, and 3,443,247, respectively. When dilutive, stock options are included in earnings per share as share equivalents using the treasury stock method. Common stock equivalents of 64,889, 58,648, and 60,201 related to stock option grants were included in the computation of the average number of shares outstanding for diluted earnings per share for the fiscal years ended June 30, 1998, 1997, and 1996, respectively. 3. COMPREHENSIVE INCOME In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting of Comprehensive Income," (SFAS 130). This Statement requires that certain items recognized under generally accepted accounting principles as components of comprehensive income be reported in an annual financial statement that is displayed with the same prominence of other financial statements. Total comprehensive income totaled $5,477,629 and $3,623,596 for the fiscal years ended June 30, 1998 and 1997, respectively. Total comprehensive income for the year ended June 30, 1998 and 1997, is comprised of net income of $5,477,629 and $3,587,688, respectively, and other comprehensive income of $-0- and $35,908, respectively. Other comprehensive income is comprised solely of foreign currency transaction adjustments and are included in the Consolidated Statement of Stockholder's Investment. 4. LONG TERM DEBT The Company has an unsecured working capital line of credit facility with a bank, which expires through November 1, 1999. This credit facility provides for borrowings up to a maximum of $8,000,000. Borrowings under this credit facility bear interest at the bank's prime rate, or LIBOR plus 2.25%. This credit facility includes certain covenants that require the Company to maintain a minimum tangible net worth and specified current, interest coverage, and leverage ratios. Borrowings under this credit facility as of June 30, 1998 totaled $2,746,000. There are no commitments for foreign letters of credit at June 30, 1998. Utilization of this credit facility as of June 30, 1997 was $1,274,386, consisting of $1,221,000 in borrowings and $53,386 in foreign letters of credit. 19
20 5. STOCK OPTIONS AND STOCK PURCHASE AGREEMENTS In 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 to the 1990 Plan, which was approved by the stockholders. In 1993, the Board of Directors authorized the reservation of an additional 300,000 shares to the 1990 Plan, which was approved by the stockholders. In 1997, the Board of Directors authorized the reservation of an additional 300,000 shares to the 1990 Plan, which was approved by the stockholders. The following table identifies options granted, exercised, cancelled or available for exercise pursuant to the above mentioned Plan: <TABLE> <CAPTION> Number of Price per Shares Share ------------------------------------------------------------------------------------- <S> <C> <C> Shares under option at June 30, 1995 536,250 $1.75-$10.55 Granted 72,500 $5.32-$5.85 Exercised (56,250) $1.75-$2.75 ------------------------------------------------------------------------------------- Shares under option at June 30, 1996 552,500 $1.75-$10.55 Granted 52,500 $10.20-$11.22 Exercised (57,500) $2.50-$7.50 Cancelled (11,250) $5.32-$7.35 ------------------------------------------------------------------------------------- Shares under option at June 30, 1997 536,250 $2.50-$11.22 Granted 55,000 $10.83-$11.91 Exercised (401,250) $2.50-$10.55 ------------------------------------------------------------------------------------- Shares under option at June 30, 1998 190,000 $5.32-$11.91 ===================================================================================== Options exercisable at June 30, 1998 52,500 $5.32-$10.20 ===================================================================================== </TABLE> The Company has an agreement with its Chairman to repurchase stock from his estate in the event of his death. 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 shall be sufficient to provide proceeds which are the lesser of $2,500,000 or the amount of estate taxes and administrative expenses incurred by his estate. The Company is obligated to pay in cash 25% of the total amount due and to execute a promissory note at a prime rate of interest for the balance. The Company maintains a $1,150,000 life insurance policy to fund a substantial portion of this obligation. The Company currently accounts for its stock-based compensation plans using the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). In 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Under the provisions of SFAS 123, companies can elect to account for stock-based compensation plans using a fair-value-based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed in APB 25. SFAS 123 requires that companies electing to continue using the intrinsic value method must make pro forma disclosures of net income and earnings per share as if the fair-value-based method of accounting had been applied. The Company has adopted the disclosure-only provisions of SFAS 123; accordingly, no compensation cost has been recognized for options granted under the stock-based compensation plan. Had compensation cost been determined based on the fair value at the grant date for awards in 1998, 1997, and 1996 consistent with the provisions of SFAS 123, the Company's pro forma net income and earnings per share would have been as presented below: 20
21 <TABLE> <CAPTION> 1998 1997 1996 ------------- ----------- ------------ <S> <C> <C> <C> Net income - as reported $5,477,629 $3,587,688 $2,360,963 Net income - pro forma 5,318,518 3,511,965 2,349,608 Earnings per common share - as reported Basic 1.68 1.09 .69 Diluted 1.65 1.07 .67 Earnings per common share - pro forma Basic 1.63 1.06 .68 Diluted 1.60 1.04 .67 </TABLE> The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: <TABLE> <CAPTION> 1998 1997 1996 ----------- ---------- ---------- <S> <C> <C> <C> Expected stock price volatility 69.17% 70.94% 70.53% Risk free interest rate 5.72% 6.84% 6.45% Expected life of options 5.91 years 6 years 5.6 years </TABLE> The weighted average exercise prices per share for options outstanding and exercisable at June 30, 1998 are $9.02 and $7.92, respectively. The weighted average exercise prices per share for options outstanding and exercisable at June 30, 1997 are $7.56 and $7.67, respectively. The weighted average exercise prices per share for options outstanding and exercisable at June 30, 1996 are $7.15 and $7.80, respectively. The weighted average fair value of options granted during 1998, 1997, and 1996 are $6.95, $7.02, and $3.37 per share, respectively. 21
22 6. INCOME TAXES The Company follows Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which requires use of the liability method of accounting for income taxes. The liability method measures the expected tax impact of future taxable income and deductions implicit in the consolidated balance sheet. The provision for income taxes in 1998, 1997, and 1996 consists of the following: <TABLE> <CAPTION> Year Ended June 30, 1998 1997 1996 ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Current: U.S. federal $2,839,000 $2,061,000 $1,536,000 State 514,000 394,000 296,000 Foreign -- -- (44,000) Deferred 95,000 (74,000) (233,000) ------------------------------------------------------------------------------------------------- $3,448,000 $2,381,000 $1,555,000 ================================================================================================= </TABLE> The 1998, 1997, and 1996 tax provision results in an effective rate different than the federal statutory rate due to the following: <TABLE> <CAPTION> Year Ended June 30, 1998 1997 1996 ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Federal income tax at statutory rate $3,035,000 $2,029,000 $1,331,000 State income taxes, net of federal tax benefit 339,000 260,000 195,000 Other 74,000 92,000 29,000 ------------------------------------------------------------------------------------------------- Total provision for income taxes $3,448,000 $2,381,000 $1,555,000 ================================================================================================= </TABLE> Income before taxes for United States operations was $8,925,629 in 1998, $6,803,219 in 1997, and $4,013,970 in 1996. Losses before taxes for foreign operations were $0, $834,531, and $97,322 for the respective years. 22
23 Temporary differences which give rise to deferred tax assets and liabilities at June 30 include: <TABLE> <CAPTION> 1998 1997 ------------------------------------------------------------------------------------------------- <S> <C> <C> Deferred Tax Assets Deferred compensation $307,000 $ 265,000 Accrued expenses and reserves 579,000 530,000 Royalties receivable/deferred -- 179,000 Package design and trademarks 150,000 125,000 Other 9,000 39,000 -------------------------------------------------------------------------------------------------- 1,045,000 1,138,000 Deferred Tax Liabilities Royalties receivable/deferred (32,000) -- Equipment and leasehold improvements (93,000) (123,000) -------------------------------------------------------------------------------------------------- Net deferred tax asset $920,000 $1,015,000 ================================================================================================== </TABLE> The net deferred tax asset at June 30, 1998 is comprised of a current asset of $555,946 and a long term asset of $364,135. The net deferred tax asset at June 30, 1997 is comprised of a current asset of $756,946 and a long term asset of $258,135. 7. ACCRUED LIABILITIES Accrued liabilities at June 30 consist of the following: <TABLE> <CAPTION> 1998 1997 -------------------------------------------------------------------------------------------------- <S> <C> <C> Salaries and wages $608,288 $340,498 Cooperative advertising and promotion allowances 282,761 240,612 Payroll taxes and employee benefits 161,075 162,626 Other 262,577 251,141 -------------------------------------------------------------------------------------------------- $1,314,701 $994,877 ================================================================================================== </TABLE> 8. ADDITIONAL CASH FLOW INFORMATION The net operating changes in cash as a result of changes in operating assets and liabilities consist of the following: <TABLE> <CAPTION> 1998 1997 1996 --------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Accounts receivable $(1,395,326) $ 1,972,700 $ (1,722,351) Inventories (4,938,405) (5,734,529) 576,585 Prepaid expenses 55,105 (221,860) 294,737 Net income taxes 743,020 (427,348) 738,002 Other assets (50,599) (92,422) (146,495) Accounts payable 1,215,231 (586,269) (398,796) Deferred revenue (473,482) 473,482 -- Accrued liabilities 319,824 208,524 (144,307) --------------------------------------------------------------------------------------------------- Net change $(4,524,632) $ (4,407,722) $ (802,625) =================================================================================================== </TABLE> 23
24 <TABLE> <S> <C> <C> <C> 1998 1997 1996 ---- ---- ---- Net cash paid during the year for: Interest $ 241,687 $ 297,398 $ 161,256 Income taxes $1,771,313 $2,849,333 $1,413,283 </TABLE> 9. EMPLOYEE BENEFIT PLANS Substantially all domestic employees are participants in the Company's Employee Stock Ownership Plan and Trust under which an annual contribution in either cash or common stock may be made at the discretion of the Board of Directors. The expense recorded for such contributions amounted to $216,000 in 1998, $200,000 in 1997, and $344,000 in 1996. The Company maintains a retirement savings plan under Section 401(k) of the Internal Revenue Code. This plan covers all employees of the Company who have completed six months of service. Matching contributions can be made at the discretion of the Company's Board of Directors. For calendar years 1998, 1997, and 1996, the matching contribution was 100% of employee contributions to the plan, not to exceed 10% of the employee's annual compensation. Vesting of Company contributions occurs immediately. Contributions for the years ended June 30, 1998, 1997, and 1996 were $170,600, $144,000, and $264,631, respectively. 10. INDUSTRY SEGMENT INFORMATION, FOREIGN OPERATIONS AND SIGNIFICANT CUSTOMERS The Company has one line of business--the design, manufacture and sale of stereophones and related accessories. The table below summarizes certain information regarding the Company's United States and Canadian operations for the years ended June 30, 1998, 1997, and 1996. <TABLE> <S> <C> <C> <C> <C> 000's Omitted United States Canada Eliminations Consolidated - ----------------------------------------------------------------------------------------------------- 1998: - ----------------------------------------------------------------------------------------------------- Net sales $ 40,638 $ -- $ -- $ 40,638 Intercompany transfers 300 -- (300) -- - ----------------------------------------------------------------------------------------------------- Total $ 40,938 $ -- $ (300) $ 40,638 - ----------------------------------------------------------------------------------------------------- Income from operations $ 7,964 $ -- $ 8 $ 7,972 - ----------------------------------------------------------------------------------------------------- Assets $ 32,029 $ -- $ -- $ 32,029 ===================================================================================================== 1997: - ----------------------------------------------------------------------------------------------------- Net sales $ 39,128 $ 427 $ -- $ 39,555 Intercompany transfers 1,111 -- (1,111) -- - ----------------------------------------------------------------------------------------------------- Total $ 40,239 $ 427 $ (1,111) $ 39,555 - ----------------------------------------------------------------------------------------------------- Income from operations $ 5,840 $ (742) $ (60) $ 5,038 - ----------------------------------------------------------------------------------------------------- Assets $ 26,333 $ -- $ -- $ 26,333 ===================================================================================================== 1996: - ----------------------------------------------------------------------------------------------------- Net sales $ 33,319 $ 3,103 $ -- $ 36,422 Intercompany transfers 2,829 -- (2,829) -- - ----------------------------------------------------------------------------------------------------- Total $ 36,148 $ 3,103 $ (2,829) $ 36,422 - ----------------------------------------------------------------------------------------------------- Income from operations $ 2,716 $ (70) $ 7 $ 2,653 - ----------------------------------------------------------------------------------------------------- Assets $ 20,313 $ 1,730 $ (38) $ 22,005 ===================================================================================================== 24 </TABLE>
25 The Company's export sales to customers in foreign countries amounted to $5,245,982 during 1998, $4,955,824 during 1997, and $6,481,135 during 1996. Sales to one customer, Tandy Corporation, were approximately 19% of total sales for the year ended June 30, 1998, and 17% and 16% for the years ended June 30, 1997, and 1996, respectively. 11. COMMITMENTS AND CONTINGENCIES The Company leases its main plant and offices in Milwaukee, Wisconsin from its Chairman. On June 25, 1993, the lease was renewed for a period of ten years, and is being accounted for as an operating lease. The lease extension increases the rent from $280,000 per year (plus Consumer Price Index increase in 1994) to a fixed rate of $350,000 per year for three years and $380,000 for the seven years thereafter. 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. Rent expense, which includes this lease, was $394,000 in 1998, $432,000 in 1997, and $450,000 in 1996. In 1980, the Company entered into an agreement with John C. Koss that if he dies prior to attaining 70 years of age, the Company will pay to his spouse or other designated beneficiary the sum of $50,000 every six months until the total benefits paid equal $700,000. The agreement is null and void if he reaches age 70. In 1991, the Board of Directors agreed to continue John C. Koss' current base salary in the event he becomes disabled prior to age 70. After age 70, Mr. Koss shall receive his current base salary for the remainder of his life, whether he becomes disabled or not. The Company is currently recognizing an annual expense of $115,080 in connection with this agreement, which represents the present value of the anticipated future payments. At June 30, 1998 and 1997, respectively, the related liabilities in the amounts of $766,380 and $651,300 have been included in deferred compensation and other liabilities in the accompanying balance sheets. 12. SUPPLEMENTARY INFORMATION Changes in the allowance for doubtful accounts for the years ended June 30, 1998, 1997, and 1996 are summarized as follows: <TABLE> <CAPTION> Year Balance at Beginning Charges Against Balance at End of ---- -------------------- --------------- ----------------- Ending of Period Income Deductions* Period ------ --------- ------ ----------- ------ <S> <C> <C> <C> <C> 1998 $928,605 $310,000 $682,315 $556,290 1997 $685,107 $434,000 $190,502 $928,605 1996 $289,217 $490,097 $ 94,207 $685,107 </TABLE> *Represents charges against the allowance, net of recoveries. The amounts included for advertising in selling, general and administrative expenses in the accompanying statements of income were $397,033 in 1998, $428,428 in 1997, and $486,723 in 1996. 25
26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. KOSS CORPORATION By: /s/ Michael J. Koss Dated: 9/21/98 -------------------- ------- Michael J. Koss, President, Chief Executive Officer Chief Operating Officer and Chief Financial Officer By: /s/ Sujata Sachdeva Dated: 9/21/98 --------------------- ------- Sujata Sachdeva, Vice President - Finance Principal Accounting Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: /s/ John C. Koss /s/ Michael J. Koss - ----------------- --------------------------- John C. Koss, Director Michael J. Koss, Director Dated: 9/21/98 Dated: 9/21/98 /s/ Martin F. Stein /s/ Victor L. Hunter - --------------------- --------------------------- Martin F. Stein, Director Victor L. Hunter, Director Dated: 9/21/98 Dated: 9/21/98 /s/ John J. Stollenwerk - ------------------------ --------------------------- John J. Stollenwerk, Director Lawrence S. Mattson, Director Dated: 9/21/98 Dated: -------- /s/ Thomas L. Doerr - -------------------- Thomas L. Doerr, Director Dated: 9/21/98 The signatures of the above directors constitute a majority of the Board of Directors of Koss Corporation. 26
27 OFFICERS AND DIRECTORS SENIOR MANAGEMENT John C. Koss John C. Koss Chairman of the Board Chairman of the Board Koss Corporation Michael J. Koss President Thomas L. Doerr Chief Executive Officer President Chief Operating Officer Doerr Corporation Chief Financial Officer Victor L. Hunter John C. Koss, Jr. President Vice President-Sales Hunter Business Direct Daniel Esposito Michael J. Koss Vice President-Corporate Systems President, C.E.O., C.O.O., C.F.O. Sujata Sachdeva Vice President-Finance Lawrence S. Mattson Retired President Jill McCurdy Oster Company Vice President-Product Development Martin F. Stein Lenore Lillie Chairman Vice President-Operations Eyecare One Inc. Richard W. Silverthorn John J. Stollenwerk Secretary President General Counsel Allen-Edmonds Shoe Corporation Declan Hanley Vice President-International Sales ANNUAL MEETING October 22, 1998 Performance Center Koss Corporation 4129 N. Port Washington Avenue INDEPENDENT ACCOUNTANTS Milwaukee, WI 53212 PricewaterhouseCoopers LLP TRANSFER AGENT Milwaukee, Wisconsin Questions regarding change of address, LEGAL COUNSEL stock transfer, lost certificate, or information on a particular account Whyte Hirschboeck Dudek S.C. should be directed in writing to: Firstar Trust Company Box 2077 Milwaukee, WI 53201 Attn: Nikhat Quryski 27
28 EXHIBIT INDEX The Company will furnish a copy of any exhibit described below upon request and upon reimbursement to the Company of its reasonable expenses of furnishing such exhibit, which shall be limited to a photocopying charge of $0.25 per page and, if mailed to the requesting party, the cost of first-class postage. <TABLE> <CAPTION> Designation Incorporation of Exhibit Exhibit Title by Reference - ----------- ------------- ------------- <S> <C> <C> 3.1 Certificate of Incorporation of Koss Corporation, as in effect on September 25, 1996.............................. (1) 3.2 By-Laws of Koss Corporation, as in effect on September 25, 1996....................................... (2) 4.1 Certificate of Incorporation of Koss Corporation, as in effect on September 25, 1996............................. (1) 4.2 By-Laws of Koss Corporation, as in effect on September 25, 1996....................................... (2) 10.1 Officer Loan Policy....................................... (3) 10.3 Supplemental Medical Care Reimbursement Plan.............. (4) 10.4 Death Benefit Agreement with John C. Koss................. (5) 10.5 Stock Purchase Agreement with John C. Koss................ (6) 10.6 Salary Continuation Resolution for John C . Koss.......... (7) 10.7 1983 Incentive Stock Option Plan ......................... (8) 10.8 Assignment of Lease to John C. Koss ...................... (9) 10.9 Addendum to Lease ........................................ (10) 10.10 1990 Flexible Incentive Plan ............................. (11) 10.12 Loan Agreement, effective as of February 17, 1995 ........ (12) 10.13 Amendment to Loan Agreement dated June 15, 1995, effective as of February 17, 1995......................... (13) 10.14 License Agreement dated November 15, 1991 between Koss Corporation and Trabelco N.V. (a subsidiary of Hagemeyer N.V.) for North America, Central America and South America (including Amendment to License Agreement dated November 15, 1991; Renewal Letter dated November 18, 1994; and Second Amendment to License Agreement dated September 29, 1995)... (14) </TABLE> 28
29 <TABLE> <S> <C> <C> 10.15 License Agreement dated September 29, 1995 between Koss Corporation and Trabelco N.V. (a subsidiary of Hagemeyer N.V.) for Europe (including First Amendment to License Agreement dated December 26, 1995) ........................................................................ (15) 10.16 Third Amendment and Assignment of License Agreement to Jiangsu Electronics Industries Limited dated as of March 31, 1997 .................... (16) 10.17 Fourth Amendment to License Agreement dated as of May 29, 1998 filed herewith................................................................ filed herewith 10.18 License Agreement dated June 30, 1998 between Koss Corporation and Logitech Electronics Inc. (including Addendum to License Agreement dated June 30, 1998)................................................ filed herewith 10.19 Consent of Directors (Supplemental Executive Retirement Plan for Michael J. Koss dated March 7, 1997)...................................... (17) 22 List of Subsidiaries of Koss Corporation ..................................... (18) 27 Financial Data Schedule....................................................... filed herewith (1) Incorporated by reference from Exhibit 3.1 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (2) Incorporated by reference from Exhibit 3.2 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (3) Incorporated by reference from Exhibit 10.1 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (4) Incorporated by reference from Exhibit 10.3 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (5) Incorporated by reference from Exhibit 10.4 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (6) Incorporated by reference from Exhibit 10.5 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (7) Incorporated by reference from Exhibit 10.6 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (8) Incorporated by reference from Exhibit 10.7 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (9) Incorporated by reference from Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended June 30, 1988 (Commission File No. 0-3295) </TABLE> 29
30 (10) Incorporated by reference from Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended June 30, 1988 (Commission File No. 0-3295) (11) Incorporated by reference from Exhibit 25 to the Company's Annual Report on Form 10-K for the year ended June 30, 1990 (Commission File No. 0-3295) (12) Incorporated by reference from Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 (Commission File No. 0-3295) (13) Incorporated by reference from Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended June 30, 1995 (Commission File No. 0-3295) (14) Incorporated by reference from Exhibit 10.14 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (15) Incorporated by reference from Exhibit 10.15 to the Company's Form 10-K for the year ended June 30, 1996 (Commission File No. 0-3295) (16) Incorporated by reference from Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (Commission File No. 0-3295) (17) Incorporated by reference from Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (Commission File No. 0-3295) (18) Incorporated by reference from Exhibit 22 to the Company's Annual Report on Form 10-K for the year ended June 30, 1988 (Commission File No. 0-3295) 30
31 Annual Report 1998 Dear Stockholders, We are pleased to report a third year of consecutive record sales for fiscal year 1998. Sales for the fiscal year ending June 30, 1998 were $40,638,747 compared with $39,554,720 in fiscal year 1997. Net income for the year was $5,477,629 compared with $3,587,688 for the same period in 1997, an increase of 53%. Diluted earnings per share for the year were $1.65 compared with $1.07 for the same period a year ago, an increase of 54%. Contributing to the success of this record year was an exceptionally strong fourth quarter. The capability of meeting customer demand came on the heels of the Company's decision to smooth production through a multi million dollar commitment to raising our finished goods inventory. Increasing finished goods inventory has helped reduce our seasonal labor demand and variances in cost and quality. We have also instituted an aggressive program to outsource all non-critical sub-assembly operations to lower our cost of sales and increase our gross margin contribution. In the fourth quarter, the Company also finalized an agreement with Jiangsu Electronics Industries Limited of Hong Kong to expand the license of the Koss name to include mobile electronics for the car stereo market. A second agreement was also reached with Logitech Electronics, Inc. of Ontario, Canada for Koss branded multimedia/computer speakers. These two agreements are expected to contribute increases in royalty minimums of 27% and 55% over the course of the next two fiscal years. The stock market has not reflected a multiple of earnings that is consistent with historical norms for the Company. We have therefore continued to re-purchase shares of the Company's stock from the open market or in privately negotiated transactions. We believe that fundamental changes in the nature of the stock market itself, coupled with general market concerns, have temporarily orphaned many small cap stocks. In fact, we plan to re-purchase approximately $3.5 million dollars in stock during the coming fiscal year to take advantage of the market's lower than average EPS multiple on Koss stock. 1998 marks the 40th Anniversary of the SP/3 Stereophone. The Company is focusing on the base stereophone business as it looks to new and expanded applications in the computer and telephony segments of the marketplace. This strategic focus has allowed the company to continue its earnings growth reflecting solid ROE and ROI performance. Management remains committed to the long range, profitable return on it's prudentially deployed capital in support of the stereo headphone industry we created 40 years ago. We would like to take this opportunity to thank our customers, suppliers, stockholders, as well as the entire Koss team for their efforts during this record setting year. We look to each of you for continued support and dedication in the year ahead. Sincerely, John C. Koss Michael J. Koss Chairman President and CEO
32 CONSOLIDATED STATEMENTS OF INCOME KOSS CORPORATION <TABLE> <CAPTION> Year Ended June 30, 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Net sales $40,638,747 $39,554,720 $36,422,377 Cost of goods sold 24,843,968 25,922,621 25,241,623 - ---------------------------------------------------------------------------------------------------------------------- Gross profit 15,794,779 13,632,099 11,180,754 Selling, general and administrative expense 7,822,338 8,594,260 8,528,098 - ---------------------------------------------------------------------------------------------------------------------- Income from operations 7,972,441 5,037,839 2,652,656 Other income (expense) Royalty income 1,206,359 1,131,250 1,303,502 Interest expense, net (253,171) (200,401) (40,195) - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes 8,925,629 5,968,688 3,915,963 Provision for income taxes 3,448,000 2,381,000 1,555,000 - ---------------------------------------------------------------------------------------------------------------------- Net income $5,477,629 $ 3,587,688 $2,360,963 ====================================================================================================================== Earnings per common share: Basic $1.68 $1.09 $ .69 Diluted $1.65 $1.07 $ .67 ====================================================================================================================== Dividends per common share None None None ====================================================================================================================== </TABLE>
33 CONSOLIDATED BALANCE SHEETS KOSS CORPORATION <TABLE> <CAPTION> As of June 30, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current Assets: Cash $ 14,778 $ 32,551 Accounts receivable, less allowances of $556,290 and $928,605, respectively 8,387,839 6,992,513 Inventories 19,486,058 14,547,653 Prepaid expenses 548,892 603,997 Income taxes receivable -- 65,493 Deferred income taxes 555,946 756,946 - ------------------------------------------------------------------------------------------------------------------------- Total current assets 28,993,513 22,999,153 - ------------------------------------------------------------------------------------------------------------------------- Equipment and Leasehold improvements, at cost: Leasehold improvements 742,289 735,930 Machinery, equipment, furniture and fixtures 4,587,729 4,548,096 Tools, dies, molds and patterns 8,351,591 8,176,023 - ------------------------------------------------------------------------------------------------------------------------- 13,681,609 13,460,049 Less--accumulated depreciation 11,619,078 10,982,520 - ------------------------------------------------------------------------------------------------------------------------- 2,062,531 2,477,529 Deferred Income Taxes 364,135 258,135 Intangible and Other Assets 608,590 598,106 - ------------------------------------------------------------------------------------------------------------------------- $32,028,769 $ 26,332,923 ========================================================================================================================= LIABILITIES AND STOCKHOLDERS' INVESTMENT Current Liabilities: Accounts payable $ 1,956,877 $ 741,646 Accrued liabilities 1,314,701 994,877 Deferred revenue -- 473,482 Income taxes payable 677,527 -- - ------------------------------------------------------------------------------------------------------------------------- Total current liabilities 3,949,105 2,210,005 - ------------------------------------------------------------------------------------------------------------------------- Long-Term Debt 2,746,000 1,221,000 Deferred Compensation and Other Liabilities 1,252,504 1,137,424 Contingently Redeemable Equity Interest 1,490,000 1,490,000 - ------------------------------------------------------------------------------------------------------------------------- Stockholders' Investment: Common stock, $.01 par value, authorized 8,500,000 shares; issued and outstanding 3,177,269 and 3,323,791 shares, respectively 31,773 33,238 Paid in capital -- 2,328,677 Contingently redeemable common stock (1,490,000) (1,490,000) Cumulative translation adjustment (71,322) (71,322) Retained earnings 24,120,709 19,473,901 - ------------------------------------------------------------------------------------------------------------------------- Total stockholders' investment 22,591,160 20,274,494 - ------------------------------------------------------------------------------------------------------------------------- $32,028,769 $ 26,332,923 ========================================================================================================================= </TABLE>
34 STOCKHOLDERS' INFORMATION KOSS CORPORATION Koss Corporation's 1998 Annual Report is presented in a simple, readable and functional style. This Annual Report contains condensed financial statements only. The detailed financial statements including footnotes are included in the Form 10-K which has been provided to all stockholders along with the 1998 Annual Report. The Company believes this manner of presentation provides a concise summary for those who want to be kept informed while at the same time allowing those who feel it necessary the opportunity to investigate further. Koss Corporation common stock is traded on the Over the Counter market and quotations are available through the National Market System. The trading symbol is KOSS. For additional Annual Reports, Form 10-K's or Proxy materials write to: Investment Relations Koss Corporation 4129 N. Port Washington Ave. Milwaukee, WI 53212 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Koss Corporation We have audited, in accordance with generally accepted auditing standards, the consolidated balance sheets of Koss Corporation and its subsidiaries as of June 30, 1998 and 1997, and the related consolidated statements of income, of stockholders' investment and of cash flows for each of the three years in the period ended June 30, 1998 (not presented herein); and in our report dated July 15, 1998, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheets as of June 30, 1998 and 1997, and the related condensed consolidated statements of income for each of the three years in the period ended June 30, 1998, when read in conjunction with the consolidated financial statements from which it has been derived, is fairly stated in all material respects in relation thereto. PricewaterhouseCoopers LLP Milwaukee, Wisconsin July 15, 1998
35 MANAGEMENT INFORMATION KOSS CORPORATION OFFICERS AND DIRECTORS SENIOR MANAGEMENT John C. Koss John C. Koss Chairman of the Board Chairman of the Board Michael J. Koss President Thomas L. Doerr Chief Executive Officer President Chief Operating Officer Doerr Corporation Chief Financial Officer Victor L. Hunter John C. Koss, Jr. President Vice President-Sales Hunter Business Direct Daniel Esposito Michael J. Koss Vice President-Corporate Systems President, C.E.O., C.O.O., C.F.O. Sujata Sachdeva Vice President-Finance Lawrence S. Mattson Retired President Jill McCurdy Oster Company Vice President-Product Development Martin F. Stein Lenore Lillie Chairman Vice President-Operations Eyecare One Inc. Richard W. Silverthorn John J. Stollenwerk Secretary President General Counsel Allen-Edmonds Shoe Corporation Declan Hanley Vice President-International Sales ANNUAL MEETING October 22, 1998 INDEPENDENT ACCOUNTANTS Performance Center Koss Corporation PricewaterhouseCoopers LLP 4129 N. Port Washington Avenue Milwaukee, Wisconsin Milwaukee, WI 53212 TRANSFER AGENT LEGAL COUNSEL Questions regarding change Whyte Hirschboeck Dudek S.C. of address, stock transfer, lost certificate, or information on a particular account should be directed in writing to: Firstar Trust Company Box 2077 Milwaukee, WI 53201 Attn: Mr. Eugene R. Lee