Koss fraud. Wow, not good.

[Dreadhead]

I dunno, what's koss's revenue? My parents had someone steal a very sizable amount of money from them and hide it for 3 -5 years and their revenue is much much smaller I would guess.

May both women rot in jail.

[Wmcmanus]

Never trust a woman!

About Carl's thought that she might be the "fall guy" in a bigger cover up. I'd highly doubt that. She may have had other people involved with her (on her accounting team), but for there to be something larger occurring here, it would have to be insurance fraud involving Michael Koss (and perhaps other family members).

They'll be able to check that possibility out with reasonable accuracy as it would involve first a) creating false revenues and then creating false losses to offset those false revenues (in the hopes of getting an unrealistic insurance indemnity). Problem with that is there would need to be legitimate evidence that the supposed revenue took place to begin with, which would mean that there would have to be evidence of cash receipts and deposits to bank accounts. The trick to look out for there is the creation of an appearance of deposits by making a number of transfers from one bank account to another (some of which could be held outside of the company such that when those funds are redeposited it looks like fresh revenues).

Per the article attached by Dreadhead, it seems to still be at the "internal investigation" stage. So if the Koss family is somehow involved in a grand insurance fraud scheme of some sort (again, highly unlikely), of course their internal investigation wouldn't turn up anything of the sort. It would then be incumbent upon the insurance company to hire their own team of forensic auditors to search the Koss records for this type of evidence before paying the claim.

My guess is about the only insurance they'll have to cover any such losses would be standard business interruption insurance (won't help too much) and possibly something that might cover fraud by key employees. But that's quite rare as well. More likely, they'll have director's liability insurance, but since the Koss family owns 73% of the stock, they're the ones suffering the most. The independent directors, however, should come out of this pretty clean (other than their shareholdings suffering).

Long post, but unless we see something about a large insurance settlement in the works, there would be no reason to suspect that the Koss family was involved. Chances are they've been pretty comfortable for a long, long time and that goes as far as any explanation as to why her actions were not detected. If you don't really need the money, you don't get so concerned when profits start to slip a bit. Plus, she was at least wise enough to trickle the money out bit by bit (big bits to be sure, but never enough to create quarterly losses).

[Dusty Chalk]

Re: conspiracy theory -- isn't it (the scandal) big enough? I say the chances are negligably small.

[Hopstretch]

I'd guess that since Koss is still pretty much a classic family business despite being nominally public (the float is tiny and barely traded even before the stock was perma-frozen) it's fate entirely depends on what resources the family still commands and their determination to continue, or otherwise. Since they are old-school and somewhat out of the geographic mainstream, I'd guess again that they probably have some pretty long-standing local banking relationships that may sustain them. Unless all their local banks were gobbled up by the national giants along the way. In which case they'll be left to swing in the wind.

[aerius]

I dunno, what's koss's revenue? My parents had someone steal a very sizable amount of money from them and hide it for 3 -5 years and their revenue is much much smaller I would guess.

Well, this is Koss' income statement from their 2009 annual report. Koss says their financial info is untrustworthy since at least the end of fiscal 2006 so that's about 4 years of fraud, or about $8 million a year on average getting skimmed off. That's a good 15%-20% of their revenues every year. Someone was seriously asleep at the desk while the embezzlement was going on.

[Wmcmanus]

Actually, the progression so far has been to charge her for $4.5 million of losses (it seems this was for 2009 alone), then make an 8K non-reliance filing for all financial statements dating back to June 30, 2006 (at an estimated total loss of $20 million), and now the non-reliance goes back to 2005 (and the losses are now estimated at $31 million).

What this pattern suggests to me is that they're not done yet! The numbers will get bigger the further back they go until they figure out when she started all of this. She's been with Koss since 1992, but may not have been in charge until the late 90's or early 00's (I'm just guessing). In any case, we don't know at this point if the estimated losses will grow but I doubt that they will shrink.

If her activities go back far enough, it may well turn out to be a case of a company that simply didn't know how successful they really were. The Koss family may have simply followed the financial results from quarter to quarter and year to year and assumed all was well so long as there was a slow and steady growth. In other words, they would have been lulled into a false impression as to what their cost structure was.

I doubt that she could have hidden revenues from them and I don't see anything in the news reports suggesting that this was the case (i.e., having cash receipts diverted directly to her accounts). Had she diverted revenues such that they were never reported in the Koss books, it would have been easy to spot differences between production volume (which they would know from other records not maintained by her) and reported sales volume.

Thus, my guess is that the primary illusion that she created was that there were more costs involved in running the business than there really were, and thus profit margins appeared to be slimmer than they really were.

Again, it goes back to Michael Koss making the mistake of assuming both the CEO and CFO roles. As a "true" CFO, he should have been reviewing all company bank statements for unusual transactions. They were big numbers (payments of $600k and more) and would have been easy to spot, had he only looked... ever. Or had they hired Grant Thornton to do a review of the internal controls over financial reporting... ever.

[Wmcmanus]

Well, this is Koss' income statement from their 2009 annual report.

The falsified expenses are hidden in either Cost of Goods Sold, or Selling, General and Administrative Expense -- most likely in both.

[The Monkey]

Next step for Koss: sue Grant Thornton.

[CarlSeibert]

Re: conspiracy theory -- isn't it (the scandal) big enough? I say the chances are negligably small.

Too big, is my point. The first stories have this person washing the money by buying designer clothes. Thirty-one million dollars in designer clothes would fill a giant warehouse. You'd have to hire a staff just to move the physical goods around. The scale of this thing is just weird. Or maybe the physical stuff was peripheral and the most of the money is sitting offshore somewhere.

One the one hand it looks like absolute craziness. On the other, we have an enterprise that took some serious management and was sustained for a decade. Maybe it will all make sense in the final reel, but at the moment, I can't quite get my head around it.

[Voltron]

Next step for Koss: sue Grant Thornton.

Indeed! Can you give them my card?

[jpelg]

Indeed! Can you give them my card?

You may only get paid with a palette of KSC75's, maybe ESP-950's is you're lucky.

[Wmcmanus]

Too big, is my point. The first stories have this person washing the money by buying designer clothes. Thirty-one million dollars in designer clothes would fill a giant warehouse. You'd have to hire a staff just to move the physical goods around. The scale of this thing is just weird. Or maybe the physical stuff was peripheral and the most of the money is sitting offshore somewhere.

Great point, Carl. At first, the designer clothes thing made sense to me, but that's when they were talking about $4.5 million and had evidence of at least $2 million of payments to 3 different boutiques. I figured she had blown the rest of it traveling, fancy restaurants, and the like. My mind being focused on how she got the money out the door via wire transfers to supposed "vendors" (as opposed to her own accounts).

But you're right. This thing is much larger than that. Payments like the one she got busted for might have been part of phase two, which may not have started until she got bored with sending money to her own accounts. Given the incompetent auditors and overly relaxed senior managers, anything is possible.

[The Monkey]

Which brings me back to the point that I think it odd that one of the cc company's fraud/risk department's did not pick this up sooner.

[Wmcmanus]

Which brings me back to the point that I think it odd that one of the cc company's fraud/risk department's did not pick this up sooner.

Similar to my point above that these kinds of payments might not have occurred in the early years. Maybe they only started to happen when she became far too emboldened by her own geniusness.

[The Monkey]

You may only get paid with a palette of KSC75's, maybe ESP-950's is you're lucky.

Heh, who says he wants to represent Koss?

[Dreadhead]

Why would Koss go under over this? It is a lot of money but if they were making money while she was skimming (understatement) then it doesn't suddenly make them bankrupt now it just means their dividend should have been much larger.

Maybe what she stole was money she felt she deserved because she made the company profit margin 20% from 6% and just took the difference. That's the logic that a lot of bankers appear to follow.

[The Monkey]

I'm hoping the more financially-savvy will pipe in, but that won't stop me from spouting some bullshit. Putting aside for the moment, the potential cash implications, I can think of the following issues.

1) It is very difficult to valuate the Company now, which will put downward pressure on the stock price when it resumes trading.

2) The valuation issues could also lead to rating downgrades if they haven't already.

3) The Company's lenders, probably spooked already, will walk or start raising rates to cover risk.

4) There will almost certainly be fallout litigation against the Company (e.g., Securities and ERISA suits).

So while BK might not be imminent, you can see how it could be coming. Also, the Company now needs to consider what is in the best interest of shareholders (although that may be mitigated by the Koss family's ownership stake) or, down the road, creditors, which could result in a distressed sale.

[Dreadhead]

That's a whole lot of ifs to be deciding not to buy headphones over..... or predicting the end of a company at all for that matter. To be honest I'd be tempted to buy the stock considering this appears to mean that their margin was much higher than expected.

Edited January 8, 2010 by Dreadhead

[Wmcmanus]

That's a whole lot of ifs to be deciding not to buy headphones over..... or predicting the end of a company at all for that matter. To be honest I'd be tempted to buy the stock considering this appears to mean that their margin was much higher than expected.

What you're saying may well be true if what we have here is a case of theft only (not combined with fraudulent financial reporting), such that the financial statements themselves can still be relied upon as a true (or at least fair) reflection of the company's financial position.

In other words, yes, money is missing, but the accounts fully reflect this fact and are therefore accurate. In that assumed scenario, all of the funds that were embezzled over time would have been treated as expenses of doing business. Thus, they would have come out of the reported profits. Thus, what was reported could be relied upon as being accurate.

Problem is, that's not likely to be the case. Otherwise, they wouldn't have filed the 8K (non-reliance on prior financial statements) with the SEC. So it's fair to say that we won't know what their current financial position is (cash and other assets, as well as liabilities) until amended financials are filed and publicly disclosed.

Because of their 8k non-reliance filing, I'm led to believe that we'll soon be learning of falsified asset values (chiefly cash). Of course, I could be wrong about this, but that's the way it's looking.

[The Monkey]

^Agree, and even if it isn't the case, there's certainly the perception. And I would bet that Koss's vendors are now clamoring for any outstanding invoices to be payed ASAFP.

[terriblepaulz]

I'm not an expert in bankruptcy law, but this is something that would normally be taken into account in the company's listed debts (which they then seek relief from). Depending on the extent of the estimated warranty liability, the complexity of the work that is likely to be involved to provide such services, and the hardship it would impose upon existing product owners if those expected future claims were not met, the bankruptcy judge would need to make rulings on, a) whether to allow contingent claims such as these at all (most likely, yes, since most of the amounts involved could be reasonably estimated based on past experience with similar warranty claims), where those warranty claims will fall in the list of priorities (i.e., which "class" they will fall into).

If they're treated as unsecured creditors, which is (sadly) the most likely case, then chances are their claims would never be met because whatever funds are available for distribution to creditors would go to those in higher classes (secured creditors, like banks and such). Although Koss is a rather mature company, so perhaps they don't have a lot of long term debt on their balance sheet.

If Koss goes Chapter 7, then the above does not apply, correct? If they go Chapter 11, the Bankruptcy Court could simply void (or modify) all existing warranties. I don't know how common that is. But for that reason, and the priority issue mentioned above, holders of warranties would almost certainly get the shaft if a BK is filed.

[aerius]

Chapter 7 is liquidation bankruptcy, everything in the company including the kitchen sink is sold off to pay its creditors, after which the company is gone forever. So yeah, it wouldn't apply.

With regards to buying their shares, I wouldn't do it until the audits are complete and the revised financial info is released. Their current financial info might be good, or it might've been fucked more times than a $5 whore. I'm better off gambling my money on a roulette wheel in Vegas, at least I know what the odds are there.

[Dusty Chalk]

Thirty-one million dollars in designer clothes would fill a giant warehouse.

I agree with monkey, it's not $31M in designer clothes, it's probably a lot less, plus the giant warehouse -- did you see where that was? I bet the rent on that alone is pretty inordinate.

And yeah, I don't doubt for a minute that she probably paid for a lot of consumables / disposables / non-returnable money (limousine services etc.).

[The Monkey]

BTW, Koss successfully emerged from Chapter 11 in the '80s. (Sorry if this was already mentioned.)

[Wmcmanus]

Chapter 7 is liquidation bankruptcy, everything in the company including the kitchen sink is sold off to pay its creditors, after which the company is gone forever. So yeah, it wouldn't apply.

Even in a Chapter 7, there is a chance that the warranty claims would be paid. But that would only occur if 1) the company has enough money to first pay off all claims in higher priority classes, and 2) if the judge approved a plan to set aside a reserve fund to administer future warranty claims, which wouldn't necessarily need to be court administered, but would likely require that they set up a separate entity to deal with such claims. Thus, Koss itself wouldn't necessarily need to continue to exist (although some of their people would probably need to be involved).

The problem is #1 above. If they go Chapter 7, it's unlikely that unsecured creditors -- which all future but as yet unknown warranty claimants would most likely be considered -- will most likely not receive much, if anything because there simply won't be enough funds. At least that's typically the case in a Chapter 7 liquidation. For it to get there, the company is already bust. Thus, there is a theoretical possibility that a new entity could be set up to administer warranty claims, but it would be highly unlikely from a practical point of view.

With regards to buying their shares, I wouldn't do it until the audits are complete and the revised financial info is released. Their current financial info might be good, or it might've been fucked more times than a $5 whore. I'm better off gambling my money on a roulette wheel in Vegas, at least I know what the odds are there.

At the moment, the company's stock is still halted. Trading is unlikely to resume until, as you say, the forensic audits are complete and amended financials are publicly available. At that point, nobody has any particular trading advantage. As others have said, it is a very thinly traded security, so there's no telling what could happen. There may be a lot of panic sellers which would create a very brief buying opportunity for those who think the company will be able to survive (i.e., not to bankrupt).