KOSS CORP — Annual Report 1996

Sep 27, 1996

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 [FEE REQUIRED] For the fiscal year ended June 30, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 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. [X] The aggregate market value of voting stock held by nonaffiliates of the Registrant was approximately $10,460,000 on September 18, 1996 based upon a closing price on such date of $5.875 per share as listed in the Wall Street Journal. On September 18, 1996, 3,288,098 shares of voting common stock were outstanding. Documents Incorporated by Reference ----------------------------------- Part III incorporates by reference information from Koss Corporation's Proxy Statement for its 1996 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year covered by this Report (General Instruction G(3)). 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, 1989, 1990, and 1995, and the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995. 2 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: 1996 1995 1994 ---- ---- ---- Stereophones 80% 77% 74% 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 11,000 domestic retail outlets. International markets are served by a foreign sales subsidiary in Canada 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 53% of sales occurred in the first six months of the fiscal year and 47% 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. The Company markets its products to approximately 2,000 customers worldwide. During 1996 the Company's sales to its largest single customer, Tandy Corporation, were 16% 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 35% of total sales in 1996. 2 3 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 $225,000 during fiscal 1996 as compared with $306,000 during fiscal 1995 and $310,000 during fiscal 1994. 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, 1996, the Company employed 150 people. The Company also utilizes temporary personnel to meet seasonal production demands. Foreign Sales. The Company services the Canadian market through its wholly-owned subsidiary Koss Ltd., a Canadian corporation. Other 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 8 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 new 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. The Company leases approximately 6,500 square feet of office, service and warehouse space in Canada, of which a significant portion is subleased to a third party. 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, 1996. 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 1,188 holders of the Company's common stock as of September 18, 1996. No dividends have been paid for the years ended June 30, 1996, 1995, and 1994. The quarterly high and low sale prices of the Company's common stock for the last two fiscal years are shown below.

4 5 Item 6. SELECTED FINANCIAL DATA.

5 6 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FINANCIAL CONDITION AND LIQUIDITY During 1996, cash provided by operations was $1,882,191. Working capital was $16,193,390 at June 30, 1996. The increase of $730,790 from the balance at June 30, 1995 represents primarily the net effect of an increase in accounts receivable of $1,722,351, a decrease in inventory of $576,585, and a decrease in accounts payable of $398,796. The increase in accounts receivable is a result of higher sales in the third and fourth quarter as compared to the prior year. Capital expenditures for new property and equipment including production tooling were $690,932, $806,551, and $370,839 in 1996, 1995, and 1994, respectively. Depreciation charges aggregated $629,985, $691,492, and $638,125 for the same fiscal years. Budgeted capital expenditures for fiscal year 1997 are $1,500,000. The Company expects to generate sufficient funds through operations to fulfill these expenditures. Stockholders' investment increased to $16,546,790 at June 30, 1996 from $15,341,426 at June 30, 1995. 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 credit facility with a bank which runs through March 15, 1998. 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. Utilization of this credit facility as of June 30, 1996 totaled $944,784, consisting of $470,000 in borrowings and $474,784 in commitments for foreign letters of credit. The Company also has a $2,000,000 credit facility which can be used by the Company in the event the Company desires to purchase shares of its own stock. The Company's Canadian subsidiary has a line of credit of $550,000. Borrowings under this credit facility bear interest at the bank's prime rate plus 1.5%. This credit facility is subject to the availability of qualifying receivables and inventories which serve as security for the borrowings. As of June 30, 1996, there were no borrowings outstanding against this line of credit. The due date for the line is October 31, 1996 and the Company expects the line will be renewed on substantially the same terms. In April, 1995 the Board of Directors authorized the Company's purchase from time to time of its common stock for its own account utilizing the aforementioned $2,000,000 line of credit. In January of 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. 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, 1996, the Company purchased 251,947 shares of its common stock at an average of $6.14 per share, and retired all such shares. The Company also purchased 29,408 shares of its common stock for allocation to the Company's Employee Stock Ownership Plan and Trust ("ESOP"), for the fiscal year ended June 30, 1996, at an average price of $6.80 per share. 6 7 1996 RESULTS COMPARED WITH 1995 Net sales for 1996 were $36,422,377 compared with $33,432,344 in 1995, an increase of $2,990,033 or 9%. The increase was the result of higher sales of current product as well as the introduction of new products. Gross profit was $11,180,754 or 30.7% in 1996 compared with $10,622,307 or 31.8% in 1995. Increased customer demand during this fiscal year for some product lines resulted in the company spending more on air freight than anticipated. This in turn directly affected the decrease in gross profit for the year. Selling, general and administrative expenses increased from $8,376,204 in 1995 to $8,528,098 in 1996. This increase is mainly attributed to higher professional fees including the cost related to maintaining the Company's worldwide patents and trademarks. Income from operations was $2,652,656 in 1996 compared with $2,246,103 in 1995, an increase of 18%. Interest expense for 1996 was $156,698 compared with $317,922 in 1995. The decrease is due to decreased levels of borrowings during the fiscal year. The Company has a license agreement with Trabelco N.V., a Netherlands, Antilles company and a subsidiary of Hagemeyer, N.V., covering North America and most of South America and Central America. Hagemeyer, N.V., a diverse international trading company based in the Netherlands, has business interests in food, appliances, electromechanical and automobile distribution as well as a base of consumer electronic distribution in Asia, Europe, North America, South America and Central America. Royalty income earned in connection with this License Agreement was $1,303,502 in 1996 as compared to $1,412,723 in 1995. This decrease in royalty income is a result of Trabelco N.V. experiencing higher returns volume on products under the license agreement. The license agreement expires December 31, 1997; however, said agreement contains renewal options for additional three year periods at the option of Trabelco N.V. Income taxes are discussed in Note 4 to the financial statements. 7 8 1995 RESULTS COMPARED WITH 1994 Net sales for 1995 were $33,432,344 compared with $35,561,322 in 1994, a decrease of $2,128,978 or 6%. This decrease was the result of a decline in computer speaker sales as compared to the previous year and an increase in sales returns by dealers for repairs and credit. Sources indicate that credit returns were common throughout the retail industry and not limited to the Company. Gross profit was $10,622,307 or 31.8% in 1995 compared with $11,874,351 or 33.4% in 1994. The decrease relates to higher than expected labor costs related to newer customized items and a less profitable mix of products in the last two quarters of the fiscal year. Selling, general and administrative expenses increased from $8,191,504 in 1994 to $8,376,204 in 1995. This increase is mainly attributed to higher professional fees including the cost related to maintaining the Company's worldwide patents and trademarks. Income from operations was $2,246,103 in 1995 compared with $3,682,847 in 1994, a decrease of 39%. Interest expense for 1995 was $317,922 compared with $246,911 in 1994. The increase is primarily due to increased levels of borrowings during the fiscal year. The Company has a license agreement with Trabelco N.V., a subsidiary of Hagemeyer, N.V. Hagemeyer, N.V., a diverse international trading company based in the Netherlands, has business interests in food, appliances, electromechanical and automobile distribution as well as a solid base of consumer electronic distribution business in Asia, Europe and North America. Royalty income earned in connection with the license agreement in 1995 was $1,412,723 as compared to $1,108,458 in 1994. This increase in royalty income is a result of Trabelco N.V. experiencing higher sales volumes on products under the license agreement. The license agreement expires December 31, 1997, however, can be renewed for additional three year periods at the option of Trabelco N.V. Income taxes are discussed in Note 4 to the financial statements. 8 9 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 in 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 the 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. 9 10 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Consolidated financial statements of the Company at June 30, 1996 and 1995 and for each of the three years in the period ended June 30, 1996 and the notes thereto, and the report of independent accountants thereon are set forth on pages 14 to 25. Selected unaudited quarterly financial data is as follows:

Item 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 10 11 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 1996 Annual Meeting of Stockholders (the "1996 Proxy Statement"), which 1996 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 1996 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" sections of the 1996 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 1996 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: 1. Financial Statements The following consolidated financial statements of Koss Corporation are set forth on pages 14 to 25: Report of Independent Accountants ........................ 14 Consolidated Statements of Income for the Years Ended June 30, 1996, 1995, and 1994 ...................... 15 Consolidated Balance Sheets as of June 30, 1996 and 1995 . 16 Consolidated Statements of Cash Flows for the Years Ended June 30, 1996, 1995, and 1994 ........ 17 Consolidated Statements of Stockholders' Investment for the Years Ended June 30, 1996, 1995, and 1994 ........ 18 Notes to Consolidated Financial Statements ............... 19 11 12 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, as in effect on September 25, 1996. 3.2 By-Laws of Koss Corporation, as in effect on September 25, 1996. 4.1 Certificate of Incorporation of Koss Corporation, as in effect on September 25, 1996. 4.2 By-Laws of Koss Corporation, as in effect on September 25, 1996. 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 Stock Plan. 10.12 Loan Agreement, effective as of February 17, 1995. 10.13 Amendment dated June 15, 1995 to Loan Agreement 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) 22 List of Subsidiaries of Koss Corporation 27 Financial Data Schedule b. No reports on Form 8-K were filed by the Company during the last quarter of the period covered by this report. 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 12 present fairly, in all material respects, the financial position of Koss Corporation and its subsidiaries at June 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1996, 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. PRICE WATERHOUSE LLP Milwaukee, Wisconsin July 19, 1996 13 14 CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes. 14 15 CONSOLIDATED BALANCE SHEETS

15 16 CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes. 16 17 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT

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 11,000 domestic retail outlets. International markets are served by a foreign sales subsidiary in Canada 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 22% and 25% of the Company's accounts receivable at June 30, 1996 and 1995, 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 a license agreement. The agreement expires December 31, 1997, however, contains renewal options for additional three year periods. INVENTORIES--At June 30, 1996 and 1995, approximately 95% and 88%, 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 $637,782 and $685,679 higher than reported at June 30, 1996 and 1995, respectively. The components of inventories at June 30, is as follows:

PROPERTY AND EQUIPMENT--Depreciation is provided on a straight-line basis over the estimated useful life of the asset as follows:

RESEARCH AND DEVELOPMENT--Research and development expenditures charged to operations amounted to approximately $225,000 in 1996, $306,000 in 1995, and $310,000 in 1994. 18 19 EARNINGS PER SHARE--Earnings per share are computed based on the average number of common and common share equivalents outstanding. When dilutive, stock options are included as share equivalents using the Treasury stock method. 19 20 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. NOTES PAYABLE AND LONG TERM DEBT The Company has an unsecured working capital credit facility with a bank which runs through March 15, 1998. 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. Utilization of this credit facility as of June 30, 1996 totaled $944,784, consisting of $470,000 in borrowings and $474,784 in commitments for foreign letters of credit. The Company also has a $2,000,000 credit facility which can be used by the Company in the event the Company desires to purchase shares of its own stock. The Company's Canadian subsidiary has a line of credit of $550,000. The due date for the loan is October 31, 1996 and it is renewable annually. The interest rate is the prime rate plus one and one quarter percent. The credit facility is subject to the availability of qualifying receivables and inventories which serve as security for the borrowings. There were no advances against the line at June 30, 1996 and 1995. Long term debt at June 30, 1996 and 1995 is as follows:

Maturities of long term debt in subsequent fiscal years are as follows: 1998 - $470,000. 3. STOCK OPTIONS AND STOCK PURCHASE AGREEMENTS As of June 30, 1996, there were stock options outstanding granted pursuant to the Company's 1983 Incentive Stock Option Plan (the "1983 Plan"). The 1983 Plan provides for the granting of options to certain officers and key employees to purchase up to 200,000 shares of the Company's common stock at a price not less than the market value of the stock on the date of grant. The options are exercisable at varying times and expire no later than ten years after the date of grant. All of the authorized shares available for grant pursuant to the 1983 Plan have been granted. 20 21 In 1990, pursuant to the recommendation of the Board of Directors, the stockholders ratified the creation of the Company's 1990 Flexible Incentive Stock 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. On April 18, 1996, April 3, 1995, and April 13, 1994, the Board of Directors authorized the grant of 72,500, 52,500 and 10,000 incentive stock options, respectively, under the 1990 Plan. On April 12, 1995, the Company's Chairman exercised an option for the purchase of 250,000 shares of the Company's common stock at a price of $1.00 per share. The following table identifies options granted, exercised, cancelled or available for exercise pursuant to the above mentioned Plans:

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 adoption of SFAS 123 will be reflected in the Company's 1997 consolidated financial statements. The Company anticipates continuing to account for stock-based compensation using the intrinsic value method. 21 22 4. INCOME TAXES The Company follows Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes," which requires the 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 1996, 1995, and 1994 consists of the following:

The 1996, 1995, and 1994 tax provision results in an effective rate different than the federal statutory rate due to the following:

Income (loss) before taxes for United States operations was $4,013,970 in 1996, $4,042,437 in 1995, and $4,700,339 in 1994. Such amounts for foreign operations were $(97,322), $(603,443), and $(99,484) for the respective years. 22 23 Temporary differences which give rise to deferred tax assets and liabilities at June 30 include:

The net deferred tax asset at June 30, 1996 is comprised of a current asset of $517,946 and a long term asset of $422,603. The net deferred tax asset at June 30, 1995 is comprised of a current asset of $378,946 and a long term liability of $6,862. 5. ACCRUED LIABILITIES Accrued liabilities at June 30 consist of the following:

1. ADDITIONAL CASH FLOW INFORMATION The net changes in cash as a result of changes in operating assets and liabilities, other than cash and indebtedness, consist of the following:

23 24 - ----------------------------------------------------------------------------- Net change $(802,625) $(973,699) $(2,998,260) =============================================================================

1. EMPLOYEE BENEFIT PLANS Substantially all domestic employees are participants in the Company's Employee Stock Ownership Plan and Trust (KESOT) 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 $344,000 in 1996, $205,000 in 1995, and $0 in 1994. 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 1996, 1995, and 1994, 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, 1996, 1995, and 1994 were $264,631, $144,000, and $141,700, respectively. 8. 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, 1996, 1995, and 1994.

24 25 The Company ships directly to independent distributors from its domestic plant. The Company's export sales to customers in foreign countries amounted to $6,481,135 during 1996, $2,231,509 during 1995, and $1,951,212 during 1994. Sales to one customer, Tandy Corporation, were approximately 16%, 18%, and 16% of total sales for 1996, 1995, and 1994, respectively. 9. COMMITMENTS AND CONTINGENCIES 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 new 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. The Company also leases approximately 6,500 square feet of office, service and warehouse space in Canada of which a significant portion is subleased to a third party. In addition, the Company leases certain property which requires payments of $32,000 in 1997. 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, 1996 and 1995, respectively, the related liabilities in the amounts of $536,220 and $421,140 have been included in deferred compensation in the accompanying balance sheets. 10. SUPPLEMENTARY INFORMATION Changes in the allowance for doubtful accounts for the years ended June 30, 1996, 1995, and 1994 are summarized as follows:

*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 $486,723 in 1996, $630,181 in 1995, and $756,956 in 1994. 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: 9/25/96 ---------------------- ------- Michael J. Koss, President, Chief Executive Officer Chief Operating Officer and Chief Financial Officer By: /s/ Sujata Sachdeva Dated: 9/25/96 ---------------------- ------- 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: 9/25/96 Dated: 9/25/96 ------- ------- /s/ Martin F. Stein /s/ Victor L. Hunter - -------------------- --------------------- Martin F. Stein, Director Victor L. Hunter, Director Dated: 9/25/96 Dated: 9/25/96 ------- ------- /s/ Lawrence S. Mattson - ----------------------------- ------------------------ John J. Stollenwerk, Director Lawrence S. Mattson, Director Dated: Dated: 9/25/96 ------- ------- /s/ Thomas L. Doerr - -------------------- Thomas L. Doerr, Director Dated: 9/25/96 ------- 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 Richard W. Silverthorn Oster Company Secretary General Counsel Martin F. Stein Chairman Declan Hanley Eyecare One Inc. Vice President--International Sales John J. Stollenwerk President ANNUAL MEETING Allen-Edmonds Shoe Corporation October 24, 1996 Performance Center Koss Corporation 4129 N. Port Washington Avenue Milwaukee, WI 53212 TRANSFER AGENT INDEPENDENT ACCOUNTANTS Questions regarding change of address, Price Waterhouse LLP stock transfer, lost certificate, or Milwaukee, Wisconsin information on a particular account should be directed in writing to: LEGAL COUNSEL Firstar Trust Company Box 2077 Whyte Hirschboeck Dudek S.C. Milwaukee, WI 53201 Attn: Mr. Eugene R. Lee 27 28 EXHIBIT INDEX

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