Item 1A. Risk Factors
ITEM 1A. RISK FACTORS
We are subject to various risks that may materially harm our business, prospects, financial condition and results of operations. This discussion highlights some of the risks that may affect future operating results. These are the risks and uncertainties we believe are most important for you to consider. We cannot be certain that we will successfully address these risks. If we are unable to address these risks, our business may not grow, our stock price may suffer, and we may be unable to stay in business. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business, prospects, results of operations and financial condition. The risks discussed below include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Risks Related to Our Operations and Financial Results
Reduction in present levels of cash flow could adversely affect the Company’s business.
The Company’s primary source of liquidity historically has been operating cash flows. The Company’s future cash flows from operations (on both a short-term and long-term basis) are dependent upon the following factors, among others:
the Company’s ability to attract new customers that will sell the Company’s products and pay for them;
the Company’s ability to retain its existing customers at the level of sales previously produced;
the volume of sales for these customers;
maintaining business from one or more primary customers;
Similarly, the Company’s future cash flows from operations are subject to the following risks and, among others:
changes in types of products that customers purchase in their sales mix;
poor or deteriorating economic conditions which would directly impact the ability of the Company’s customers to remain in business and pay for their products on a timely basis;
timely, efficient and cost effective movement of products from suppliers and to export customers:
management’s ability to minimize the impact of requests for increases in material or labor cost; and
the ability to collect in full and in a timely manner amounts due to the Company.
In addition, the Company’s cash flow is also dependent, to some extent, upon the ability to maintain operating margins.
We are dependent on the proper functioning of our critical facilities, our contract manufacturers in China, our supply chain and distribution networks and the financial stability of our customers, all of which have been negatively impacted by the COVID-19 pandemic in a manner that may have a materially adverse effect on our business, financial condition or results of operations.
Our ability to produce products may be materially adversely impacted by COVID-19.
The COVID-19 pandemic continues to impact worldwide economic activity, and has had a corresponding effect on our sales activity. As the virus and variants thereof continue to spread globally, the impact of this pandemic has been and will likely continue to be extensive in many aspects of society, and has resulted in and will likely continue to result in significant disruptions to the global economy, as well as businesses and capital markets around the world. With the ongoing effect of the COVID-19 pandemic in the United States and other countries, it is unclear how economic activity and workflows will continue to be impacted and for how long. Many employers require their employees to work from home or not come into their offices or facilities. Our actions continue to evolve in response to new government measures and scientific knowledge regarding COVID-19. To date, these protocols have not resulted in a decrease in the production capabilities of our facility. However, if the manufacturing capabilities of this facility are adversely impacted as a result of COVID-19, whether by a decrease in productivity caused by precautionary measures or by one or more employees becoming ill, it may not be possible for us to timely produce relevant products at required levels or at all. A reduction or interruption in any of our manufacturing processes could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We also might be unable to obtain certain supplies, product components, or equipment from our suppliers and vendors due to constraints created by COVID-19. For instance, we have observed delays in certain suppliers’ deliveries of materials necessary for our contract manufacturers to manufacture our products. Additionally, travel restrictions and stay-at-home orders or similar mandates of foreign and domestic governments have prevented US based employees from visiting suppliers’ facilities as part of our quality control processes. These impacts may delay our launch of new products, adversely affect our ability to deliver customers’ orders timely or in the requested quantities and inhibit our ability to ensure the quality of supplies used in our products.
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Our sales may be materially adversely impacted by COVID-19 .
Our sales efforts include in-person meetings with customers and potential customers to discuss our products. Additionally, much of our customers’ sales are conducted in-person by consumers purchasing our products in brick-and-mortar stores. The method and timing of these meetings and the ability of our customers to make in-person sales have been altered due to stay-at-home orders and travel restrictions relating to COVID-19. This limitation on the ability of our sales personnel and our customers to maintain their customary interaction with customers and consumers may negatively affect demand for our products and have a material adverse effect on our results of operations, financial condition and cash flows.
Failure to attract and retain customers to sell the Company’s products could adversely affect sales volume and future profitability.
The Company markets a line of products used by consumers to listen to music. The Company distributes these products through retail channels in the U.S. and independent distributors throughout the rest of the world. The Company is dependent upon its ability to attract and retain a base of customers to sell the Company’s line of products. The Company has broad distribution across many channels including specialty stores, mass merchants, electronics stores and computer retailers. The Company may not be able to maintain customers or model selections and therefore may experience a reduction in its sales revenue until a model is restored to the mix or a lost customer is replaced by a new customer. The loss of business of one or more principal customers or a change in the sales volume from a particular customer could have a material adverse effect on the Company’s sales volume and profitability.
A shift in customer specifications to lower priced items can reduce profit margins, negatively impacting profitability.
The Company sells lines of products with a suggested retail prices ranging from less than $10 up to $1,000. The gross margin for each of these models varies in terms of percentages. The Company finds the low-priced portion of the market most competitive and therefore most subject to pressure on gross margin percentages, which tends to lower profit contributions. Therefore, a shift in retail customer specifications and preferences toward lower priced items could lead to lower gross margins and lower profit contributions per unit of sale. Due to the range of products that the Company sells, the product sales mix can produce a variation in profit margins. Some distributors sell a limited range of products that yield lower profit margins than others. Most notably, the budget-priced stereo headphone segment of the market (below $10 retail), which is distributed through mass market retailers, computer stores, and office supply stores tends to yield the lowest gross margins. An increase in business with these types of accounts, if coupled with a simultaneous reduction in sales to customers with higher gross margins, would reduce profit margins and profitability.
If we are unable to continue to develop innovative and popular products, our brand image may be harmed and demand for our products may decrease.
Consumer electronics are subject to constantly and rapidly changing consumer preferences based on industry trends and performance features, including technological advancement. Our success depends largely on our ability to lead, anticipate, gauge and respond to these changing consumer preferences and trends in a timely manner, while preserving and strengthening the perception and authenticity of our brand. We must continue to develop high performance products that provide better design and performance attributes than the products of our competitors at similar price points. Market acceptance of new designs and products is subject to uncertainty and we cannot assure you that our efforts will be successful. The inability of new product designs or new product lines to gain market acceptance, or our current products losing traction in the market, could adversely affect our brand image, our business and financial condition. Achieving market acceptance for new products may also require substantial marketing efforts and expenditures to increase consumer demand, which could constrain our management, financial and operational resources. If new products we introduce do not experience broad market acceptance or demand for our existing products wanes, our net sales and market share could decline.
We may not be able to compete effectively, which could cause our net sales and market share to decline.
The consumer electronics industry is highly competitive, and characterized by frequent introduction of new competitors, as well as increased competition from established companies expanding their product portfolio, aggressive price cutting and resulting downward pressure on gross margins and rapid consolidation of the market resulting in larger competitors. We face competition from consumer electronics brands that have historically dominated the stereo headphone market, in addition to sport brand and lifestyle companies that also produce headphone products. These companies include, among others, Apple, Sony, Bose, LG and Samsung. These competitors may have significant competitive advantages, including greater financial, distribution, marketing and other resources, longer operating histories, better brand recognition among certain groups of consumers, and greater economies of scale. In addition, these competitors have long-term relationships with many of our larger retailers that are potentially more important to those retailers. As a result, these competitors may be better equipped to influence consumer preferences or otherwise increase their market share by:
quickly adapting to changes in consumer preferences;
readily taking advantage of acquisition and other opportunities;
discounting excess inventory;
devoting greater resources to the marketing and sale of their products, including significant advertising, media placement and product endorsement;
adopting aggressive pricing policies; and
engaging in length y and costly intellectual property and other legal disputes.
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Additionally, the industry in which we compete generally has low barriers to entry that allow the introduction of new products or new competitors at a fast pace. Some retailers have begun to introduce their own private label headphones, which could reduce the volume of product they buy from us, as well as decrease the shelf space they allocate to our products. If we are unable to protect our brand image and authenticity, while carefully balancing our growth, we may be unable to effectively compete with these new market entrants or new products. The inability to compete effectively against new and existing competitors could have an adverse effect on our net sales and results of operations, preventing us from achieving future growth.
If we are unable to obtain intellectual property rights and/or enforce those rights against third parties who are violating those rights, including by obtaining a favorable outcome in litigation in which we are currently engaged, our business could suffer.
We rely on various intellectual property rights, including patents, trademarks, trade secrets and trade dress to protect our brand name, reputation, product appearance and technology. If we fail to obtain, maintain, or in some cases enforce our intellectual property rights, our competitors may be able to copy our designs, or use our brand name, trademarks or technology. As a result, if we are unable to successfully protect our intellectual property rights, or resolve any conflicts effectively, our results of operations may be harmed. In order to enforce our intellectual property rights, we recently filed complaints against certain parties alleging infringement on patents relating to our wireless audio technology. All litigation is uncertain, and there can be no assurance that any of this litigation will be decided in our favor. Regardless of the merits of the claims, litigation may be expensive, time-consuming and disruptive to our operations and distracting to management. If resolved against us, such legal proceedings could result in excessive verdicts, injunctive relief or other equitable relief that may affect how we operate our business. Similarly, if we settle such legal proceedings, it may negatively affect how we operate our business.
We may be adversely affected by the financial condition of our retailers and distributors.
Some of our retailers and distributors are experiencing financial difficulties as a result of current adverse economic conditions. A retailer or distributor experiencing such difficulties generally will not purchase and sell as many of our products as it would under normal circumstances and may cancel orders. In addition, a retailer or distributor experiencing financial difficulties generally increases our exposure to uncollectible receivables. We extend credit to our retailers and distributors based on our assessment of their financial condition, generally without requiring collateral, and sometimes are not able to obtain information regarding their current financial status. Failure of these retailers or distributors to remain current on their obligations to us could result in losses that exceed the reserves we set aside in anticipation of this risk. We are also exposed to the risk of our customers declaring bankruptcy, exposing us to claims of preferential payment claims. Financial difficulties on the part of our retailers or distributors could have a material adverse effect on our results of operations and financial condition.
One of our customer’s accounts for a significant amount of our net sales, and the loss of, or reduced purchases from, this or other customers could have a material adverse effect on our operating results.
Our largest fiscal year 2021 customer, Ingram Micro, accounted for more than 18% and 10% of our net sales in fiscal years 2021 and 2020, respectively. We do not have long-term contracts with any of our customers and all of our customers generally purchase from us on a purchase order basis. As a result, this customer generally may, with no notice or penalty, cease ordering and selling our products, or materially reduce its orders. If certain customers, individually or in the aggregate, choose to no longer sell our products, to slow their rate of purchase of our products or to decrease the number of products they purchase, our results of operations would be adversely affected.
Company profits can suffer from interruption in its supply chain.
The Company uses contract manufacturing facilities in the People’s Republic of China, Taiwan and South Korea. The Company is at risk of business interruptions due to natural disaster, war, disease and government intervention through tariffs or trade restrictions, which lately have become of increased concern in these areas. Therefore, any interruptions in the supply chain for any of these reasons could directly impact the Company’s profits in a material, negative way. Recovery of a single facility through replacement of a supplier in the event of a disaster or suspension of supply could take an estimated six to twelve months. The Company is also at risk if trade restrictions are imposed on the Company’s products based upon country of origin. In addition, the Company may not be able to pass along most increases in tariffs and freight charges to the Company’s customers, which would directly affect profits.
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Company sales and profits can suffer from disruptions and price volatility in shipping its products from China to the US and from its warehouse in Milwaukee to its customers.
We have experienced and expect to continue to experience disruptions in shipping products and volatility in cost of shipping products. These disruptions include inability to obtain containers in a timely manner, difficulty in getting confirmation from forwarders, and delayed placement on cargo ships. There have also been substantial increases in transit times resulting from congested ports on the west coast of the U.S. as well as in the Chicago rail yards. The Company uses air freight as necessary to meet customer demands. The costs to ship product have increased considerably in the last few months and we expect this to continue. The Company is at risk of lower sales due to delays in receiving and shipping products. The price volatility will directly affect profits.
Our products may experience quality problems from time to time that can result in decreased sales and operating margin and harm to our reputation.
From time to time, our products may contain design and manufacturing defects. There can be no assurance we will be able to detect and fix all defects in the hardware we sell. Failure to do so could result in lost revenue, significant warranty and other expenses, and harm to our reputation.
An information systems interruption or breach in security could adversely affect us.
Privacy, security, and compliance concerns have continued to increase as technology has evolved. We rely on accounting, financial and operational management information systems to conduct our operations. Any disruption in these systems could adversely affect our ability to conduct our business. Furthermore, as part of our normal business activities, we collect and store common confidential information about customers, employees, vendors, and suppliers. This information is entitled to protection under a number of regulatory regimes. Any failure to maintain the security of the data, including the penetration of our network security and the misappropriation of confidential and personal information, could result in business disruption, damage to our reputation, financial obligations to third parties, fines, penalties, regulatory proceedings and private litigation with potentially large costs, and also result in deterioration in customers confidence in us and other competitive disadvantages, and thus could have a material adverse impact on our financial condition and results of operations.
Changes in tax laws and unanticipated tax liabilities could adversely affect our effective income tax rate and profitability.
We are subject to income taxes in the United States. Our effective income tax rate could be adversely affected in the future by a number of factors, including: changes in the valuation of deferred tax assets and liabilities and changes in tax laws. We regularly assess all of these matters to determine the adequacy of our tax provision.
Risks Related to our International Operations
Economic regulation, trade restrictions, and increasing manufacturing costs in China could adversely impact our business and results of operations.
The Company uses contract manufacturing facilities in the People’s Republic of China. For many years, the Chinese economy has experienced periods of rapid growth. An increase in the cost of labor or taxes on wages in China may lead to an increase in the cost of goods manufactured in China. Significant increases in wages or wage taxes paid by contract manufacturing facilities may increase the cost of goods manufactured in China which could have a material adverse effect on the Company’s profit margins and profitability. Additionally, government trade policies, including the imposition of tariffs, export restrictions, sanctions or other retaliatory measures could limit our ability to source materials and products from China at acceptable prices or at all. We do not currently have arrangements with contract manufacturers in other countries that may be acceptable substitutes. We cannot predict what actions may ultimately be taken with respect to tariffs, export controls, countermeasures, or other trade measures between the U.S. and China or other countries and what products may be subject to such actions. To the extent such actions inhibit our transactions with contract manufacturing facilities and suppliers in China, our business may be materially adversely affected.
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We may be subject to risks related to doing business in, and having counterparties based in, foreign countries.
We engage in operations, and enter into agreements with counterparties, located outside the U.S., which exposes us to political, governmental and economic instability and foreign currency exchange rate fluctuations. Any disruption caused by these factors could harm our business, results of operations, financial condition, liquidity and prospects. Risks associated with potential operations, commitments and investments outside of the U.S. include but are not limited to risks of:
global and local economic, social and political conditions and uncertainty;
currency exchange restrictions and currency fluctuations;
war or terrorist attack;
local outbreak of disease, such as COVID-19;
renegotiation or nullification of existing contracts or international trade arrangements;
labor market conditions and workers’ rights affecting our manufacturing operations or those of our customers;
macro-economic conditions impacting key markets and sources of supply;
changing laws and policies affecting trade, taxation, financial regulation, immigration, and investment;
compliance with laws and regulations that differ among jurisdictions, including those covering taxes, intellectual property ownership and infringement, imports and exports, anti-corruption and anti-bribery, antitrust and competition, data privacy, and environment, health, and safety; and
general hazards associated with the assertion of sovereignty over areas in which operations are conducted, transactions occur, or counterparties are located.
Fluctuations in currency exchange rates could affect the Company’s financial results and operations, including with respect to pricing of products and overall demand for the Company’s products.
The Company receives a material portion of its sales and profits from business in Europe. To the extent that the value of the U.S. dollar increases relative to currencies in those jurisdictions, it increases the cost of the Company’s products in those jurisdictions, which could create negative pressure on the foreign demand for the Company’s products. The Company is paid by its international customers in U.S. dollars. To the extent that increased prices arising from currency fluctuations decrease the overall demand for the Company’s products or motivate customers to purchase lower-priced, lower profit products, the Company’s sales, profits and cash flows could be adversely affected.
Risks Related to our Stock
Our stock price is subject to volatility.
Our stock is subject to substantial price volatility. Additionally, the Company, the technology industry, and the stock market as a whole have experienced extreme stock price and volume fluctuations that have affected stock prices in ways that may have been unrelated to companies' operating performance. Factors such as the depth and liquidity of the market for our common stock, investor perceptions of us and our business, actions by institutional shareholders, strategic actions by us, litigation, changes in accounting standards, policies, guidance, interpretations and principles, additions or departures of key personnel and our results of operations, financial performance and future prospects may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from realizing the liquidity of their shares.
Our stock price and trading volume has recently been extremely volatile and may be volatile in the future for reasons unrelated to our operating performance or prospects and, as a result, investors in our common stock could incur substantial losses.
Our stock price has recently been extremely volatile and may be volatile in the future. By way of example, on January 22, 2021, the price of our common stock closed at $3.34 per share, and on January 29, 2021, our stock price closed at $64.00 per share with no discernible material announcements or developments relating to our operations. On January 28, 2021, the intra-day sales price of our common stock fluctuated between a reported low sale price of $25.00 and a reported high sales price of $127.45. Additionally, the trading volume in shares of our common stock during the three months ended June 30, 2021 ranged from a low of 193,400 shares on May 12, 2021 to a high of 19.4 million on June 2, 2021. Our market capitalization, as implied by various trading prices, has recently reflected valuations that diverge significantly from those seen prior to recent volatility and that are significantly higher than our market capitalization prior to the recent increase, and to the extent these valuations reflect trading dynamics unrelated to our financial performance or prospects, purchasers of our common stock could incur substantial losses if there are declines in market prices driven by a return to earlier valuations. Additionally, the stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may experience losses on their investment in our common stock.
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In the past, following periods of volatility in the market, securities class-action litigation has often been instituted against companies. Such litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which could materially and adversely affect our business, financial condition, results of operations and growth prospects. There can be no guarantee that our stock price will remain at current prices or that future sales of our common stock will not be at prices lower than those sold to investors.
A “short squeeze” due to a sudden increase in demand for shares of our common stock that largely exceeds supply has led to, and may continue to lead to, extreme price volatility in shares of our common stock.
Recently, securities of certain companies have experienced significant and extreme volatility in stock price due to a sudden increase in demand for stock resulting in aggregate short positions in the stock exceeding the number of shares available for purchase, forcing investors with short exposure to pay a premium to repurchase shares for delivery to share lenders. This is known as a “short squeeze.” These short squeezes have led to the price per share of those companies to trade at a significantly inflated rate that is disconnected from the underlying value of the company. A large proportion of our common stock has been and may continue to be traded by short sellers which may increase the likelihood that our common stock will be the target of a short squeeze. A short squeeze has led and could continue to lead to volatile price movements in shares of our common stock that are unrelated or disproportionate to our operating performance or prospects and, once investors purchase the shares of our common stock necessary to cover their short positions, the price of our common stock may rapidly decline. Stockholders that purchase shares of our common stock during a short squeeze may lose a significant portion of their investment.
The Koss family, including certain members of our management, own a significant percentage of our stock, and as a result, the trading price for our shares may be depressed and they can take actions that may be adverse to the interests of our stockholders.
Michael Koss, our President and Chief Executive Officer, beneficially owned 4,175,801 shares of our common stock as of August 1, 2021, representing 46.6% of shares outstanding on such date, including shares held by a family corporation and trusts over which Mr. Koss shares voting and dispositive power with John C. Koss Jr., our Vice President of Sales. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors may perceive disadvantages in owning stock in companies with a controlling stockholder group. The group can significantly influence all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, due to his significant ownership stake and his service as our Principal Executive Officer and Chairman of the Board and Directors, Michael Koss controls the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to our other stockholders.
Future sales of a substantial amount of our common stock in the public markets by our insiders, or the perception that these sales may occur, may cause the market price of our common stock to decline.
Our employees, directors and officers, and their affiliates, hold substantial amounts of shares of our common stock and have vested options for purchase of our common stock. Sales of a substantial number of such shares by these stockholders, or the perception that such sales will occur, may cause the market price of our common stock to decline. Other than restrictions on trading that arise under securities laws (or pursuant to our securities trading policy that is intended to facilitate compliance with securities laws), including the prohibition on trading in securities by or on behalf of a person who is aware of nonpublic material information, we have no restrictions on the right of our employees, directors and officers, and their affiliates, to sell their unrestricted shares of common stock.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.