Business Context and Reporting Period
Emerson Radio Corp. designs, sources, imports and markets houseware and consumer electronic products and licenses the Emerson trademark. This unaudited Form 10-Q covers the three and nine months ended December 31, 2014, the third quarter and first nine months of fiscal 2015, compared with the corresponding fiscal 2014 periods.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2014 | Three Months Ended Dec. 31, 2013 | Nine Months Ended Dec. 31, 2014 | Nine Months Ended Dec. 31, 2013 |
|---|---|---|---|---|
| Net revenues | $22.9 million | $20.9 million | $63.1 million | $63.8 million |
| Operating income | $3.7 million | $1.1 million | $4.5 million | $2.6 million |
| Net income (loss) | $2.9 million | $(1.4) million | $3.6 million | $0.4 million |
| Basic and diluted EPS | $0.11 | $(0.05) | $0.13 | $0.01 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $0.2 million | $(10.8) million |
Third-quarter operating margin was approximately 16.1%, compared with 5.2% in the prior-year quarter; net margin was approximately 12.5%, compared with negative 6.6%. Nine-month operating margin was approximately 7.2%, compared with 4.1%; net margin was approximately 5.6%, compared with 0.6%.
- Third-quarter product sales increased 6.3% to $19.6 million, while licensing revenue increased 36.8% to $3.3 million.
- Nine-month product sales declined 3.2% to $57.3 million, partially offset by a 24.1% increase in licensing revenue to $5.8 million.
- Cost of sales was $17.2 million in the quarter and $51.4 million year to date. Cost of sales as a percentage of product sales increased to 88.0% from 86.7% for the quarter and to 89.8% from 88.9% year to date.
- SG&A declined 42.7% in the quarter to $1.8 million and 15.0% year to date to $6.6 million.
- At December 31, 2014, cash and cash equivalents were $24.2 million, restricted cash was $0.5 million, and short-term investments were $15.0 million. Working capital was approximately $58.9 million.
- The Company had no borrowings and no outstanding letters of credit. Total liabilities were $3.8 million and shareholders’ equity was $59.9 million.
- Nine-month investing cash flow was $16.7 million, primarily from redemptions of certificates of deposit. Financing cash flow was negative $19.0 million, primarily reflecting the September 2014 extraordinary dividend.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased $2.0 million, or 9.8%, while nine-month revenue decreased $0.7 million, or 1.2%.
- Houseware sales increased 7.5% in the quarter, principally from microwave ovens, but decreased 2.8% year to date due mainly to lower compact refrigerator and wine cooler sales.
- Audio sales declined 18.6% in the quarter and 11.7% year to date, primarily because of lower portable audio and clock radio sales.
- Licensing growth was driven by higher sales by licensees. Funai represented approximately 92% of quarterly and 85% of year-to-date licensing revenue; its agreement runs through March 31, 2018 and includes minimum annual royalties of $3.75 million.
- Net income improved substantially, partly because the prior-year periods included a $4.0 million loss on settlement of litigation and higher legal expenses. The prior-year quarter also included a $0.2 million trademark impairment charge.
- The Company paid an extraordinary cash dividend of $0.70 per common share, with approximately $18.5 million paid to stockholders on September 30, 2014.
- Customer and supplier concentration increased risk: the two largest customers represented approximately 89.1% of gross product sales for both nine-month periods, while the two largest suppliers represented 89% of purchases in fiscal 2015 versus 74% in fiscal 2014.
Outlook, Risks, Contingencies and Unusual Items
Management stated that existing cash and operating sources should be sufficient to support operations for the next 12 months. The filing does not provide quantitative revenue or earnings guidance.
- The IRS is challenging the Company’s treatment of overseas income. The Company estimates potential taxes, penalties and interest related to NOPA 1 could reach approximately $14.9 million for fiscal 2010 through fiscal 2014, but has recorded no liability because it believes its appeal is more likely than not to succeed.
- For NOPA 2, the Company recorded approximately $0.4 million of income tax expense and liability for estimated exposure related to fiscal 2014 and the nine months ended December 31, 2014. It is also considering recovery of approximately $1.6 million previously paid for fiscal 2010–2013.
- The IRS is also disputing the tax treatment of the March 2010 extraordinary dividend. Potential Company exposure, including penalties and interest, was estimated at approximately $4.8 million at December 31, 2014. Of this amount, $0.5 million was collateralized by restricted cash; recovery from S&T could be impaired because its parent, Grande, is in liquidation.
- Grande-related restructuring and liquidation proceedings could affect control of approximately 56.2% of Emerson’s common stock and may affect the Company, its shareholders and trading price.
- Principal operating risks include consumer spending, dependence on key customers, licensees, suppliers and third-party manufacturers, Chinese production and currency exposure, transportation disruptions, competition, pricing pressure and the Company’s reliance on operating cash flow.
- The Company purchases virtually all products from manufacturers in China, although exposure to currency fluctuations is reduced through U.S.-dollar-denominated purchase orders.
- Management reported effective disclosure controls as of December 31, 2014 and no material changes in internal control over financial reporting during the quarter.
Investor Verification Points
- Verify the sustainability of licensing revenue and the Company’s concentration in Funai and its other major customers.
- Assess whether gross margins can improve despite higher cost of sales as a percentage of product sales.
- Review operating cash conversion, particularly the impact of accounts receivable growth and low year-to-date operating cash flow.
- Monitor the IRS disputes, including the unrecorded NOPA 1 exposure, the recorded NOPA 2 liability and the extraordinary-dividend tax contingency.
- Evaluate liquidity after the $18.5 million extraordinary dividend and the status of the $15.1 million certificate-of-deposit investments maturing April 30, 2015.
- Track Grande’s restructuring and any resulting change in control or ownership of Emerson’s common stock.