Description

Overview

Koss Corporation (“KOSS” or the “Company”) is a litigation firm that also sells low-end, commoditized audio equipment.  

KOSS is currently trading as a net-net with hidden asset value and potentially (more on this later) a shifting shareholder base/alignment of management that could lead to a material capital allocation decision.

In 2020, the Company began a series of lawsuits against essentially anyone who makes consumer headphones (Apple, Bose, jLab, Plantronics and Skullcandy). To date, they have settled with Apple and Plantronics, resulting in ~$11.0mm of net proceeds.

This is a no-catalyst net-net pitch, but, based on my assessment of a reasonable valuation of the current balance sheet and off-balance sheet assets I believe KOSS could have as much as 75% upside value with a downside value that is only slightly lower than today’s levels.

Business Overview

KOSS has been around since the 1950s, when its founder, John Koss, invented the stereo headphones. The business has been in secular decline for at least the past decade. The business peaked with $50.0mm of sales in 2008 and it did just $13.1mm in sales during FY 2023 (June 30), on those sales the Company earned $5.0mm of gross profit.

KOSS operates in an objectively poor business. They largely sell low-end audio equipment to consumers (they also sell to education and commercial parties, but that business has declined to <20% of sales). Traditionally their largest customers were distributors, but over the past two years DTC through Amazon has become their largest sales channel (~20% of FY23 Sales).

In addition, due to the supply chain issues over the past few years (they source a large amount of product from contract manufacturers in China), inventory has ballooned as a percentage of sales. Actual inventory levels have come down, but as a percentage of sales inventory has skyrocketed.

However, there are reasons to think that there is upside to the current revenue numbers. 

Don’t get me wrong, this is a bad business with bad future prospects, but the market is currently ascribing negative value to the operations (which may be fair! I’m just saying there may be reasons that the business isn’t dead yet).

Historically, as mentioned, the Company has sold material amounts through domestic distributors. The Company has disclosed this sales channel was very soft in FY23.  Domestic distributors have seen significant inventory build in the past year, this lack of sell-through has likely hurt recent sell-in. In past years the Company has disclosed that Ingram Micro was their largest client (pre-Amazon). Ingram Micro is privately held but the following is a list of public competitors to Ingram Micro and their DIO by year:

To the extent that the supply chain issues are normalizing, there could be increased demand in the domestic distributor market in FY24.

In addition, this is a Company that operates on the low-end of the price curve largely selling highly discretionary items to those with the lowest discretionary income. The Company just reported their FY24 First Quarter on 10/27 and they reported a (28.6%) decrease in their DTC sales (overall revenue was flat to last year as the DTC decrease was offset by a large sale to an undisclosed, new customer and increased sales internationally). Whether or not we are in a recession may be a current debate, but KOSS’ customers are clearly acting like they are in a recession.

Putting aside the potential hopes of recovery, just how bad is this business? Not great, but I’ve seen worse:

Over the time period shown revenues have come down by 50%, but the business cumulatively managed to produce cash. And, now that the Company has close to $20.0mm in ~5% treasuries producing just under $1.0mm that income could help to ensure the business, on a whole, produces at least marginal profits.

Capital Allocation

For a very long time the Koss family controlled this Company. John Koss invented the industry and ran the Company for decades, his son has been the CEO for 30 years, and his grandsons are now named executive officers.  The Koss family historically held ~70+% of the outstanding shares.

From 2007-2020 there was not a single insider sale of the stock.

Then, in 2021, KOSS became a meme stock. At one point shares of the stock reached over $100 a share (50x today’s levels). Insiders used this craze to sell over 2.2 million shares for proceeds of ~$73.5mm.

John Koss, the founder, died in 2021. 

The Company has no institutional coverage and does not do earnings calls. I finally managed to track down someone in the Company that functions as IR (her official title is Executive Assistant) and I was denied a dial-in to the Annual Meeting because I was not a holder of record (cutoff date was mid-August, call was last week, don’t think this schedule is crazy, just providing context).  The Company has zero interest in attracting investors.

I have not seen anything in any filing about capital allocation decisions (I have submitted written questions, will update to the extent the Company provides something valuable, but they have said they will only comment on items explicitly mentioned in their filings, I am not holding my breath). So there is a very good chance that management will continue to milk this business to pay themselves. 

However, management really hasn’t paid themselves too offensively. Putting aside last year, where bonuses were large due to substantial net profits based on the legal settlements, the CEO takes home ~$400,000 and the kids take home in the $200,000s. The hope clearly is that now that the patriarch has died, and that they have already sold about 40% of their personal stake in the company (they still own collectively about 45% of outstanding shares) there may be some event that would lead to monetization.

Valuation

The Company currently has a market cap of $26.3mm and no debt. As of September 30th Quarter-End, the Company had $2.0mm of cash, $17.2mm of Short Term Investments entirely invested in Treasuries, an additional $7.8mm of current assets, $6.3mm Cash Surrender Value of Life Insurance Policies related to their management team and a total of $6.1mm of liabilities. 

Based on this math the market is currently ascribing essentially zero value to the ongoing business. But even if the ongoing business is valueless, the Company still has several ways to produce upside: 

1. The Company has 3 outstanding lawsuits against deep pocketed companies in Bose, Skullcandy and JLab. 

2. The Company has 427 trademarks in 90 countries and 153 patents in 25 countries (the same IP that led litigation attorneys to suggest a $11.0mm license fee was appropriate). 

3. And the Company has over $30.0mm of federal NOLs, which have no expiration – that even if they were to be 382’ed would still have a PV ~$2-3mm (10-15% of the market cap) that currently do not appear on the Balance Sheet as they are completely offset by a valuation allowance. 

The following is the Company’s balance sheet adjusted for rough approximations of the Net Orderly Liquidation Value (“NOLV”) that I would project, as well as valuation ranges for some of the additional sources of value for the Company:

Notes

Risks/Mitigants

Risk: This is a crappy business with no competitive advantages competing against some of the most deep-pocketed and sophisticated corporations in the history of capitalism.

Mitigant: This is true. This investment is entirely predicated on the idea that the remaining family members seek to monetize their business interests rather than keep this as a going concern.

Risk: You have no insight into the capital allocation ideas of the remaining family/management and you have absolutely no recourse if the family members vote to continue the legacy of the business that bears their name and pay themselves all of the profits that are produced.

Mitigant: This is true. The hope is that by buying shares you are aligning yourself with the management team that has maybe the strongest hand they’ve had in the last 15 years. They have become quite wealthy through the sale of their stakes into the meme craze. They still have ongoing litigation that may bring in new money. They have US Treasuries that are producing close to $1.0mm per year of income. 

But now, as opposed to the past 15 years, they have shown a willingness to monetize their interests in the business.

Risk: This Company is a shrinking ice cube and its value will slowly go to nothing.

Mitigant: I think the current valuation supports some runway to figure out if there is going to be any form of monetizing event. Again, the Market Cap of this Company is currently $26.0mm, there is $20.0mm in cash and the rest of current assets offset all liabilities. The business is not so bad that it should merit negative enterprise value, it is break-even. If none of the off-balance sheet assets end up arising, then you’re left with a business trading slightly above its net-net value. The market will likely ascribe some additional negatives to the closely-held, illiquid nature of the Company but there is a lower bound based on how much of the current market cap is essentially cash. In the meantime, you get substantial option value with numerous potential avenues to realization.

Catalyst

Company Makes Capital Allocation Announcement

Settlement Proceeds in Legal Actions

Macro Economic Improvement