Emerson Radio Corp. — Form 10-Q Summary
Business context and reporting period
Emerson Radio Corp. designs, sources, imports and markets houseware and consumer electronic products and licenses the Emerson, HH Scott and Olevia brands. This unaudited report covers the three months ended June 30, 2011, the first quarter of fiscal 2012, compared with the three months ended June 30, 2010.
Financial performance and position
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Net revenues | $51.5 million | $67.2 million | Down 23.3% |
| Operating income | $3.9 million | $7.4 million | Down 47.9% |
| Net income | $3.3 million | $5.9 million | Down 43.3% |
| Basic and diluted EPS | $0.12 | $0.22 | Down $0.10 |
| Net cash used in operations | $19.0 million | $5.1 million | Greater use of cash |
- Gross profit was approximately $5.9 million versus $9.6 million. Gross margin declined to approximately 11.5% from 14.3%, primarily because landed product costs increased relative to selling prices.
- Operating margin declined to approximately 7.5% from 11.0%. SG&A decreased to $1.7 million from $1.9 million, but increased as a percentage of revenue to 3.3% from 2.9%. Other operating costs rose to $0.4 million, mainly because of higher warranty and returns-processing costs.
- Net income included an $828,000 realized gain from the sale of the Company’s final student loan auction-rate security. Excluding this unusual gain, reported earnings were lower than the prior-year comparable period.
- Cash and cash equivalents were $21.5 million at June 30, 2011, compared with $39.8 million at March 31, 2011 and $7.3 million at June 30, 2010. Restricted cash was $2.0 million, supporting collateralized letters of credit.
- Working capital was approximately $54.2 million at June 30, 2011. Accounts receivable increased to $30.8 million from $10.9 million at March 31, 2011, and inventory increased to $20.5 million from $8.5 million.
- Operating cash use was driven principally by increases of $20.5 million in accounts receivable and $10.4 million in inventory, partially offset by an $8.3 million increase in accounts payable and other current liabilities.
- Investing activities provided $3.3 million, principally from proceeds on the sale of the final auction-rate security. Financing activities used $2.5 million to repay short-term borrowings.
- Short-term borrowings were zero at June 30, 2011, compared with $2.5 million at March 31, 2011. Long-term borrowings totaled $0.2 million, including $46,000 of current maturities.
- Outstanding letters of credit totaled $2.049 million and were 100% cash collateralized.
Material changes versus the prior comparable period
- Houseware product sales decreased $14.4 million, or 23.4%, to $47.3 million, primarily due to lower microwave oven, toaster oven and wine cooler sales; compact refrigerator sales increased.
- Emerson-branded product sales were $2.8 million, compared with $3.9 million in the period cited by management, due to lower audio sales volumes. Licensing revenue declined 8.1% to $1.4 million.
- Revenue deductions and marketing-support accrual adjustments increased revenue and operating income by approximately $253,000 in Q1 FY2012, compared with $131,000 in the prior-year quarter.
- Inventory allowances declined to $484,000 from $2.078 million at March 31, 2011, contributing to the year-over-year cost-of-sales comparison.
- The Company sold its final auction-rate security in May 2011 for $4.725 million, recognized an $828,000 gain, and used the proceeds to repay its $2.5 million short-term loan.
- Grande Holdings, the majority shareholder, became subject to provisional liquidation proceedings in Hong Kong on May 31, 2011. Certain major suppliers subsequently reduced open-credit limits, requiring accelerated payments and increasing reliance on cash on hand and operating cash flow.
Guidance, outlook, risks and unusual items
- Management stated that existing cash and cash sources are expected to support operations for the next 12 months, but operating cash flow is the principal funding source.
- Approximately 55% of first-quarter net sales involved products imported directly to customers, which management stated benefits liquidity because the related inventory does not need to be financed by Emerson.
- Key risks include weaker consumer spending, supplier price increases, loss of key customers, dependence on limited suppliers and third-party manufacturers, competition, foreign operating conditions, rising Chinese production costs and renminbi appreciation.
- The Company identified potential conflicts and operating effects related to Grande’s provisional liquidators and its relationship with Grande. Grande’s indirect subsidiary reportedly beneficially owned approximately 56.2% of Emerson’s outstanding common stock; ownership of approximately 12.5% of the shares pledged to Deutsche Bank could not be independently verified.
- A shareholder derivative litigation settlement fee of $0.9 million was paid in April 2011; the expense had been recorded in the fourth fiscal quarter of fiscal 2011.
- An amended Kayne litigation complaint was served in July 2011. Plaintiffs allege that Emerson and others interfered with collection of an approximately $47 million judgment against Grande and assert civil RICO and alter-ego claims. Management considers the claims meritless and intends to defend the action; ultimate liability cannot be estimated from the filing.
- On August 5, 2011, Adrian Ma resigned as chief executive officer, other Company positions and director, effective August 8, 2011. He will continue as a consultant.
- Management reported effective disclosure controls as of June 30, 2011 and no material changes in internal control over financial reporting during the quarter. No material changes to previously disclosed risk factors were reported.
Investor verification checklist
- Verify whether the sharp increase in receivables and inventory converts to cash and whether operating cash flow normalizes.
- Monitor gross margin, landed product costs, supplier credit terms and the impact of Grande’s provisional liquidation.
- Assess the liquidity effect of $2.049 million of restricted cash and outstanding letters of credit.
- Review the potential financial and governance implications of the Kayne litigation and the uncertainty over pledged-share ownership.
- Evaluate the sustainability of earnings excluding the $828,000 auction-rate-security gain and other nonrecurring items.
- Confirm the effects of the August 2011 CEO resignation and subsequent management transition.