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 the Emerson, HH Scott and Olevia trademarks. This unaudited report covers the three and six months ended September 30, 2011, the second quarter and first six months of fiscal 2012, compared with the corresponding fiscal 2011 periods.
As of November 14, 2011, the company had 27,129,832 common shares outstanding. Grande, the controlling shareholder, beneficially owned approximately 56.2% of the outstanding common stock, although ownership of approximately 12.5% of the shares pledged to Deutsche Bank could not be independently verified.
Financial performance and liquidity
| Metric | Three months ended September 30, 2011 | Three months ended September 30, 2010 | Six months ended September 30, 2011 | Six months ended September 30, 2010 |
|---|---|---|---|---|
| Net revenues | $41.4 million | $52.0 million | $92.9 million | $119.1 million |
| Operating income | $1.7 million | $3.3 million | $5.5 million | $10.7 million |
| Net income | $1.8 million | $3.2 million | $5.1 million | $9.1 million |
| Diluted EPS | $0.06 | $0.12 | $0.19 | $0.34 |
| Net cash used in operating activities | Not separately reported for the quarter | $(10.0) million | $(10.0) million |
- Second-quarter revenue decreased 20.4%; six-month revenue decreased 22.0% year over year.
- Approximate operating margins were 4.1% versus 6.4% in the quarter and 6.0% versus 9.0% for the six-month period. Approximate net margins were 4.3% versus 6.2% and 5.5% versus 7.6%, respectively.
- Gross margin declined to approximately 10.6% from 11.7% in the quarter and to 11.1% from 13.2% for the six-month period, primarily reflecting higher landed product costs relative to selling prices.
- Cash and cash equivalents were $31.9 million at September 30, 2011, compared with $39.8 million at March 31, 2011 and $2.6 million at September 30, 2010. Restricted cash was $0.7 million.
- Working capital was approximately $55.9 million at September 30, 2011, compared with $34.2 million at September 30, 2010.
- Inventory increased to $25.3 million from $8.5 million at March 31, 2011, while accounts receivable increased to $16.3 million from $10.9 million.
- The company had no short-term borrowings at September 30, 2011, compared with $2.5 million at March 31, 2011. Long-term borrowings, including current maturities, totaled $0.2 million.
- Operating cash flow was negative $10.0 million, driven primarily by increases in inventory and accounts receivable, partially offset by net income and higher accounts payable.
- Investing cash flow was positive $4.7 million, principally from selling the company’s remaining auction-rate securities. Financing cash flow was negative $2.5 million, primarily from repaying the related short-term borrowing.
Material changes versus the prior comparable period
- Houseware sales declined 19.8% in the quarter and 21.8% for the six-month period, principally because a major retail customer discontinued a microwave-oven model beginning in December 2010. Sales of toaster ovens, coffee makers and, for the six-month period, wine coolers also declined.
- Audio sales declined 30.1% in the quarter and 29.8% for the six-month period due primarily to lower volumes. Licensing revenue declined 10.0% and 9.0%, respectively.
- Cost of sales declined in absolute dollars but increased as a percentage of revenue. Inventory valuation reserves were lower year over year, partially offsetting higher landed product costs.
- SG&A increased 16.4% in the quarter and 2.4% for the six-month period, primarily because of higher legal expenses related to the Kayne litigation.
- The company recognized an $828,000 realized gain in the six-month period from selling its final student-loan auction-rate security. The securities had a $4.7 million carrying value at March 31, 2011 and were fully sold by September 30, 2011.
- Inventory allowances declined to $397,000 from $2.1 million at March 31, 2011.
Guidance, outlook, risks and unusual items
Management did not provide quantitative revenue or earnings guidance. It stated that existing cash and cash generated from operations should be sufficient to support existing operations for the next 12 months. Products imported directly to customers represented approximately 49% of second-quarter sales and 52% of six-month sales, which management said benefits liquidity because the company does not need to finance that inventory.
- Following the May 31, 2011 appointment of provisional liquidators over Grande, major factory suppliers, including Midea, reduced available open-credit lines. Emerson made accelerated payments in June and July to comply with revised supplier credit terms and relies on cash on hand and operating cash flow.
- Outstanding letters of credit totaled $667,000 and were fully cash collateralized.
- The Kayne litigation alleges that Emerson and others interfered with plaintiffs’ collection of an approximately $47 million judgment against Grande, including through the March 2010 dividend. Emerson moved to dismiss the amended complaint and stated that it considered the claims lacking merit. Oral argument was scheduled for December 19, 2011. The ultimate liability, if any, was not estimable from the filing.
- Key operating risks include weaker consumer spending, supplier price increases, customer concentration, dependence on third-party manufacturers and Chinese suppliers, rising China production costs and renminbi appreciation, competition, licensing and distribution relationships, and risks arising from Grande’s provisional liquidation and related-party relationships.
- Deferred tax assets are dependent on future taxable income and tax-planning strategies; management believed realization was more likely than not, but noted that the assets could be reduced or eliminated.
- Management concluded that disclosure controls were effective as of September 30, 2011 and reported no material changes in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue weakness from the discontinued microwave model and lower audio volumes persists, particularly with major retail customers.
- Whether higher landed product costs, supplier credit restrictions and inventory levels pressure margins and operating cash flow.
- The company’s ability to fund operations given six-month operating cash burn of $10.0 million and reliance on cash on hand and future operating cash flow.
- The status and potential financial exposure of the Kayne litigation and any effect of Grande’s provisional liquidation on suppliers, related-party arrangements or corporate control.
- The collectability of accounts receivable, the adequacy of inventory reserves and the realization of deferred tax assets.
- The terms and future collateral requirements of the company’s letters of credit and other remaining borrowings.