Emerson Radio Corp. — Form 10-Q Summary
Business Context and Reporting Period
Emerson designs, sources, imports and markets houseware and consumer electronic products and licenses its trademarks. This unaudited Form 10-Q covers the three and nine months ended December 31, 2013, representing fiscal 2014, compared with the corresponding fiscal 2013 periods. The company was a smaller reporting company and had 27.1 million common shares outstanding as of February 14, 2014.
Financial Performance and Position
| Metric | Three months ended Dec. 31, 2013 | Three months ended Dec. 31, 2012 | Nine months ended Dec. 31, 2013 | Nine months ended Dec. 31, 2012 |
|---|---|---|---|---|
| Net revenues | $20.9 million | $24.7 million | $63.8 million | $105.4 million |
| Net product sales | $18.4 million | $22.6 million | $59.2 million | $99.8 million |
| Licensing revenue | $2.4 million | $2.0 million | $4.7 million | $5.6 million |
| Operating income | $1.1 million | $2.0 million | $2.6 million | $8.6 million |
| Net income (loss) | $(1.4) million | $1.7 million | $0.4 million | $7.5 million |
| Basic and diluted EPS | $(0.05) | $0.06 | $0.01 | $0.28 |
- Net revenue declined 15.4% in the quarter and 39.4% year to date. Net product sales declined 18.4% and 40.7%, respectively.
- Operating margin was approximately 5.2% in the quarter and 4.1% year to date, compared with approximately 8.1% and 8.1% in the prior comparable periods.
- Gross margin, calculated from net revenues less cost of sales, improved to approximately 23.3% from 16.9% in the quarter and to 17.6% from 15.8% year to date.
- SG&A increased 67.0% to $3.2 million in the quarter and 36.3% to $7.7 million year to date, primarily because of higher legal fees and consulting costs.
- The company recorded a $4.0 million non-operating loss related to the Kayne Litigation settlement and a $0.2 million trademark impairment charge in the quarter and year-to-date period.
- The company recorded an income tax benefit of $1.4 million in the quarter and $1.3 million year to date, compared with tax expense of $0.4 million and $1.3 million, respectively, in the prior-year periods.
- Cash and cash equivalents were $18.7 million at December 31, 2013, compared with $21.4 million at March 31, 2013. Short-term investments were $37.2 million, principally certificates of deposit maturing in March and May 2014.
- Working capital was approximately $71.8 million at December 31, 2013. Total liabilities were $6.2 million, including $58,000 of capitalized lease obligations, of which $43,000 was current. No letters of credit were outstanding.
- Operating activities used $10.8 million of cash during the first nine months, while investing activities provided $8.1 million, primarily from short-term investment redemptions. Financing activities used $15,000.
Material Changes Versus the Prior Comparable Period
- Wal-Mart discontinued purchases of two microwave oven products beginning in spring 2013. Sales of those products were nil in the current-year quarter and nine-month period, compared with approximately $8.0 million and $32.0 million, respectively, in the prior-year periods.
- Houseware sales declined 18.4% in the quarter and 41.5% year to date, driven by lower microwave oven and wine cooler sales and broader weakness across the product category.
- Licensing revenue increased 18.0% in the quarter but declined 16.7% year to date, primarily because of lower sales by the largest licensee, Funai. The Funai license agreement was amended in November 2013 to extend through March 31, 2018 and includes minimum annual royalties of $3.75 million.
- The two largest customers represented approximately 89.1% of gross product sales during the first nine months of fiscal 2014, compared with 94.1% in the prior-year period. The two largest suppliers represented 74% of purchases, creating significant concentration risk.
- The company settled the Kayne Litigation for $4.0 million, compared with no comparable settlement expense in the prior-year period. Related legal fees were approximately $1.6 million year to date, compared with $0.8 million in the prior year.
- Accumulated deficit improved from $(4.4) million at March 31, 2013 to $(4.0) million at December 31, 2013, reflecting year-to-date net income of $0.4 million.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expects existing cash and operating sources to be sufficient to support current operations over the next 12 months, although operating cash flow was significantly negative year to date.
- Management expects continued pricing pressure and faces a challenging retail environment, intense competition, uncertain consumer spending, supplier cost increases and dependence on key customers, suppliers and third-party manufacturers.
- The Kayne settlement remains subject to court approval as a good-faith settlement. If approval is denied, the payment would be returned and the litigation could resume. The company had paid $4.0 million into the plaintiffs’ attorney trust account as of the filing.
- The IRS is challenging the company’s treatment of certain Macao controlled-foreign-corporation income. The company estimates potential taxes, penalties and interest of up to approximately $13.3 million for NOPA 1, for which no liability has been recorded because management believes its appeal is more likely than not to succeed. The company recorded approximately $1.1 million for NOPA 2.
- The IRS also challenges the tax treatment of the company’s 2010 extraordinary dividend. Potential company exposure, including penalties and interest, was estimated at approximately $4.5 million as of December 31, 2013, although the company expects indemnification from S&T if liability arises. Recovery may be impaired because S&T’s parent, The Grande Holdings Limited, is in liquidation.
- Grande-related restructuring could affect control of the company. Grande-affiliated entities reportedly controlled approximately 56.2% of Emerson’s common stock, and a proposed restructuring could allow Grande to retain or regain voting control.
- The company reported no material changes to the risk factors in its prior Form 10-K and stated that disclosure controls were effective as of December 31, 2013, with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the Kayne Litigation settlement receives court approval and whether any recovery claims against co-defendants are pursued.
- The outcome of the IRS NOPA 1 and NOPA 2 disputes and the extraordinary-dividend tax matter, including potential penalties, interest and collectability of indemnification.
- The company’s ability to replace lost Wal-Mart microwave sales and reduce customer concentration.
- Whether operating cash flow improves after the substantial year-to-date use of cash and whether certificates of deposit mature as scheduled.
- The status and terms of any Grande restructuring and its effect on Emerson’s control, governance and share price.
- The sustainability of licensing revenue, including Funai’s performance and compliance with the amended minimum royalty arrangement.