Emerson Radio Corp. — Form 10-Q Summary
Business context and reporting period
Emerson designs, sources, imports and markets housewares and consumer electronics and licenses its trademarks. This report covers the three and nine months ended December 31, 2017, corresponding to fiscal 2018, compared with the same periods of fiscal 2017. The interim financial statements are unaudited. Emerson was a smaller reporting company and a controlled company, with approximately 63.8% of common stock voting power held by entities related to Grande Holdings Limited.
Financial performance and position
| Metric | Three months ended Dec. 31, 2017 | Three months ended Dec. 31, 2016 | Nine months ended Dec. 31, 2017 | Nine months ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net revenues | $4.236 million | $4.934 million | $10.959 million | $17.597 million |
| Net product sales | $4.075 million | $3.764 million | $10.413 million | $14.079 million |
| Licensing revenue | $161,000 | $1.170 million | $546,000 | $3.518 million |
| Gross profit | $190,000 | $1.573 million | $667,000 | $4.676 million |
| Gross margin | 4.5% | 31.9% | 6.1% | 26.6% |
| Operating income (loss) | $(924,000) | $352,000 | $(3.155) million | $595,000 |
| Net income (loss) | $(1.171) million | $448,000 | $(3.103) million | $559,000 |
| Diluted EPS | $(0.05) | $0.02 | $(0.12) | $0.02 |
Operating margins were approximately negative 21.8% in the quarter and negative 28.8% for the nine-month period, compared with positive 7.1% and 3.4%, respectively, in the prior-year periods. SG&A was $1.1 million in the quarter and $3.784 million year to date. Interest income increased to $131,000 in the quarter and $365,000 year to date, primarily due to higher rates on short-term investments.
At December 31, 2017, cash and cash equivalents were $20.819 million and short-term investments were $22.233 million, for combined cash and investments of approximately $43.1 million. Working capital was approximately $48.4 million. Current liabilities were $1.382 million, and the filing reports no non-current liabilities or debt. Total assets were $50.562 million and shareholders’ equity was $49.180 million. Inventory increased to $3.071 million from $838,000 at March 31, 2017.
Net cash used in operating activities was $4.849 million for the nine months ended December 31, 2017, compared with $1.115 million provided in the prior-year period. Investing activities provided $2.841 million, primarily from proceeds from short-term investments. Financing activities used $4.644 million for common-stock repurchases. Cash declined by $6.652 million from March 31, 2017 to $20.819 million.
Material changes versus the prior comparable period
- Quarterly net revenues declined 14.2%, while nine-month revenues declined 37.7%.
- Quarterly product sales increased 8.3%, but nine-month product sales decreased 26.0%. Houseware sales declined materially, while audio sales increased, primarily from clock radios.
- Licensing revenue fell 86.2% in the quarter and 84.5% year to date because the Funai license agreement ended December 31, 2016. Management stated that the timing of a replacement license is uncertain given worldwide television-market conditions.
- Cost of sales increased 20.4% in the quarter despite lower revenue, resulting in a sharp gross-margin contraction. Year-to-date cost of sales declined 20.4%, but revenue declined more substantially.
- The company moved from prior-year profitability to losses: quarterly net loss was $1.171 million versus net income of $448,000, and year-to-date net loss was $3.103 million versus net income of $559,000.
- Sales were highly concentrated: the two largest customers represented approximately 79.5% of gross product sales in the quarter and 76.2% year to date. The two largest suppliers represented 97% and 93% of purchases, respectively.
- The company repurchased 669,357 shares for approximately $992,000 during the quarter. Total repurchases under the program were 3,226,388 shares for $4.711 million, with $5.289 million remaining authorized through June 30, 2018.
Guidance, outlook, risks and unusual items
Management provided no numerical revenue or earnings guidance. It plans to expand distribution channels, develop new products, regain retail shelf space and increase internet and e-commerce sales, but these initiatives require additional investment. Management believes existing cash and cash sources will support operations for the next 12 months.
- The loss of the Funai license is expected to continue to materially affect the business, financial condition, results and cash position.
- Quarterly and year-to-date SG&A included approximately $76,000 and $469,000, respectively, of legal fees related to a trademark infringement action initiated by Emerson.
- The Tax Cuts and Jobs Act produced a net adverse deferred-tax impact of approximately $246,000 in the quarter and $223,000 year to date. The company had not yet completed its analysis of tax on previously unremitted foreign earnings and expected to record an initial estimate in the fourth quarter.
- The company increased its valuation allowance by $712,000 to $1.001 million. It had approximately $3.1 million of U.S. federal and $5.6 million of state net operating-loss carryforwards, whose utilization may be limited by a change in ownership under Section 382.
- The company was assessed $128,000 by California relating to foreign-based income for fiscal years 2012 and 2013.
- Key risks include customer and supplier concentration, dependence on third-party manufacturers, competition, consumer spending, pricing pressure, foreign-exchange and China-related risks, the ability to generate operating cash flow, and the ability to secure new licensees.
- Management reported effective disclosure controls as of December 31, 2017 and no material changes to internal control over financial reporting. No off-balance-sheet arrangements were reported.
Investor verification points
- Verify whether product-sales growth can offset the continuing loss of licensing revenue and whether a replacement for the Funai agreement is secured.
- Assess the sustainability of very low gross margins and the causes of quarterly cost-of-sales growth despite lower total revenue.
- Reconcile operating cash burn, inventory and prepaid-purchase increases with expected demand and near-term liquidity.
- Review customer and supplier concentration and the potential impact of losing a major relationship.
- Confirm the final tax effects of the Tax Cuts and Jobs Act, foreign unremitted earnings, California assessment and Section 382 limitations on NOL utilization.
- Evaluate the pace and funding impact of share repurchases while the company is generating operating losses and negative operating cash flow.
- Review the trademark litigation and any subsequent developments, including potential financial exposure.