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 report covers the three and six months ended September 30, 2012, Emerson’s fiscal second quarter and first six months of fiscal 2013, compared with the corresponding fiscal 2012 periods. The company had 27,129,832 common shares outstanding as of November 19, 2012.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Six Months Ended September 30 |
|---|---|---|
| Net revenues | $34.7 million vs. $41.4 million | $80.7 million vs. $92.9 million |
| Net product sales | $32.3 million vs. $40.2 million | $77.2 million vs. $90.3 million |
| Licensing revenue | $2.4 million vs. $1.2 million | $3.6 million vs. $2.6 million |
| Operating income | $2.2 million vs. $1.7 million | $6.6 million vs. $5.5 million |
| Net income | $1.9 million vs. $1.8 million | $5.8 million vs. $5.1 million |
| Basic and diluted EPS | $0.07 vs. $0.06 | $0.21 vs. $0.19 |
- Net product sales declined 19.7% in the quarter and 14.6% for the six-month period. Houseware sales fell 15.9% in the quarter and 11.2% year to date; audio sales fell 67.5% and 64.1%, respectively.
- Licensing revenue increased 107.2% in the quarter and 37.2% year to date, primarily because Funai reached its annual minimum royalty obligation earlier than in the prior year.
- Cost of sales as a percentage of net revenues improved to 83.8% from 89.4% in the quarter and to 84.6% from 88.9% year to date. Management stated that these improved margins are not expected to continue for the remainder of fiscal 2013.
- Operating income included a $1.3 million trademark impairment charge in the quarter and six-month period. Excluding this unusual charge, reported operating income would have been higher, although the filing does not present an adjusted measure.
- Cash and cash equivalents were $27.5 million at September 30, 2012, compared with $45.0 million at March 31, 2012. The company also held $25.0 million of short-term certificates of deposit, of which $5.0 million matures December 31, 2012 and $20.0 million matures February 19, 2013.
- Working capital was approximately $71.6 million at September 30, 2012, compared with $55.9 million at September 30, 2011. Total current assets were $91.6 million and total current liabilities were $20.1 million.
- Operating cash flow was $7.4 million for the first six months, compared with cash used in operations of $10.0 million in the prior-year period. Investing cash flow was negative $24.9 million, primarily from the $25.0 million certificate-of-deposit investment.
- Total borrowings were approximately $116,000, consisting of capitalized lease obligations, including $65,000 of current maturities. Outstanding letters of credit totaled $118,000 and were fully cash collateralized.
Material Changes, Outlook and Risks
- Wal-Mart, which represented approximately 48% of fiscal 2012 net revenues, informed Emerson that it will discontinue purchasing two microwave oven products beginning in spring 2013. Those products represented approximately $48.4 million, or 31%, of fiscal 2012 net product sales. Emerson expects the full impact primarily in fiscal 2014 and states that the decision will have a material adverse effect on its business and results.
- The company intends to evaluate strategic alternatives and its product lines, but provides no quantified revenue or earnings guidance. Management stated that it cannot assure replacement sales sufficient to offset the Wal-Mart impact.
- Funai generated approximately 92% of quarterly and 89% of year-to-date licensing revenue. Its license agreement, providing minimum annual royalties of $3.75 million, expires December 31, 2012 unless renewed. Renewal negotiations were ongoing, with no assurance of renewal on acceptable terms.
- Sales were highly concentrated: the two largest customers represented approximately 94.9% of gross product sales in the first six months, while the two largest suppliers represented 76% of purchases. Management cited pricing pressure, supplier concentration, third-party manufacturing, competition, consumer spending, China production costs and renminbi appreciation as risks.
- Emerson relies on cash on hand and operating cash flow after suppliers, including its largest supplier, reduced available open credit following the provisional liquidation of controlling shareholder Grande Holdings Limited. Management believes existing cash and cash sources are sufficient for operations over the next 12 months.
- The IRS challenged Emerson’s treatment of the March 2010 extraordinary dividend and concluded that 100% rather than 4.9% was taxable to recipients. Emerson submitted a rebuttal and is contesting the matter. If unsuccessful and the indemnifying shareholder cannot pay, Emerson could face a material contingent tax liability; the filing does not provide a clear maximum exposure.
- The Kayne litigation alleges that Emerson and related parties interfered with collection of an approximately $47 million judgment against Grande and asserts RICO and alter-ego claims. The RICO claim was dismissed with leave to replead, the alter-ego claim remained, and a trial was scheduled for April 23, 2013. Management believes the claims lack merit but cannot estimate the ultimate financial liability.
- Competing claims exist regarding beneficial ownership of 3,380,079 Emerson shares, involving Grande-related parties and Deutsche Bank. Emerson states that it cannot determine the beneficial ownership of those shares.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2012 and reported no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Timing and magnitude of the Wal-Mart product discontinuation and whether replacement products or customers offset the expected fiscal 2014 revenue loss.
- Renewal, terms and minimum royalty economics of the Funai license after December 31, 2012.
- Whether quarterly margin improvement reverses as management expects and the effect of pricing pressure and supplier costs.
- Availability and maturity of the $25.0 million certificate-of-deposit investments, along with operating cash-flow trends and supplier credit terms.
- Resolution and potential financial exposure from the IRS dividend-tax dispute and related indemnification arrangements.
- Status, defense costs and potential liability in the Kayne litigation.
- Effects of Grande’s provisional liquidation, related-party relationships and unresolved ownership claims over 3,380,079 shares.