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MSN > SEC Filings for MSN > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for EMERSON RADIO CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for EMERSON RADIO CORP


14-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition

The following discussion of the Company's operations and financial condition should be read in conjunction with the Financial Statements and notes thereto included elsewhere in this Quarterly Report.

In the following discussions, most percentages and dollar amounts have been rounded to aid presentation. Accordingly, all amounts are approximations.

Forward-Looking Information

This report contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements include statements with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond the Company's control, and which may cause the Company's actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. The reader can identify these forward-looking statements through the Company's use of words such as "may," "will," "can," "anticipate," "assume," "should," "indicate," "would," "believe," "contemplate," "expect," "seek," "estimate," "continue," "plan," "project," "predict," "could," "intend," "target," "potential," and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

• the impact, if any, on the Company's business, financial condition and results of operation arising from the appointment of the Provisional Liquidators over Grande;

• the decline in, and any further deterioration of, consumer spending for retail products, such as the Company's products;

• the Company's inability to resist price increases from its suppliers or pass through such increases to its customers;

• the loss of any of the Company's key customers or reduction in the purchase of the Company's products by any such customers;

• conflicts of interest that exist based on the Company's relationship with Grande;

• the Company's inability to improve and maintain effective internal controls or the failure by its personnel to comply with such internal controls;

• the Company's inability to maintain its relationships with its licensees and distributors, renew existing licenses, or the failure to obtain new licensees or distribution relationships on favorable terms;

• cash generated by operating activities represents the Company's principal source of funding and therefore the Company depends on its ability to successfully manage its operating cash flows to fund its operations;

• the Company's inability to anticipate market trends, enhance existing products or achieve market acceptance of new products;

• the Company's dependence on a limited number of suppliers for its components and raw materials;

• the Company's dependence on third party manufacturers to manufacture and deliver its products;

• changes in consumer spending and economic conditions;

• the failure of third party sales representatives to adequately promote, market and sell the Company's products;

• the Company's inability to protect its intellectual property;

• the effects of competition;

• changes in foreign laws and regulations and changes in the political and economic conditions in the foreign countries in which the Company operates;

• changes in accounting policies, rules and practices;

• limited access to financing or increased cost of financing;

• the effects of the continuing appreciation of the renminbi and increases in costs of production in China and;

• the other factors listed under "Risk Factors" in the Company's Form 10-K, as amended, for the fiscal year ended March 31, 2013 and other filings with the Securities and Exchange Commission (the "SEC").


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All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The reader is cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this report or the date of the document incorporated by reference into this report. The Company has no obligation, and expressly disclaims any obligation, to update, revise or correct any of the forward-looking statements, whether as a result of new information, future events or otherwise. Management has expressed its expectations, beliefs and projections in good faith and it believes it has a reasonable basis for them. However, management cannot assure the reader that its expectations, beliefs or projections will be achieved or accomplished.

Results of Operations

The following table summarizes certain financial information for the three month
periods ended June 30, 2013 (first quarter of fiscal 2014) and June 30, 2012
(first quarter of fiscal 2013) (in thousands):



                                                         Three months ended
                                                               June 30
                                                          2013          2012
        Net product sales                              $   23,481     $ 44,876
        Licensing revenue                                   1,171        1,135

        Net revenues                                       24,652       46,011
        Cost of sales                                      20,984       39,173
        Other operating costs and expenses                    151          408
        Selling, general and administrative expenses        2,188        2,008

        Operating income                                    1,329        4,422
        Interest income, net                                  222           31

        Income before income taxes                          1,551        4,453
        Provision for income taxes                            182          613

        Net income                                     $    1,369     $  3,840

Net product sales - Net product sales for the first quarter of fiscal 2014 were $23.5 million as compared to $44.9 million for fiscal 2013, a decrease of $21.4 million, or 47.7%. The Company's sales during the first quarters of fiscal 2014 and 2013 were highly concentrated among the Company's two largest customers, where gross product sales comprised approximately 88.4% and 94.7%, respectively, of the Company's total gross product sales. Net product sales may be periodically impacted by adjustments made to the Company's sales allowance and marketing support accrual to record unanticipated customer deductions from accounts receivable or to reduce the accrual by any amounts which were accrued in the past but not taken by customers through deductions from accounts receivable within a certain time period. In the aggregate, these adjustments had the effect of increasing net product sales and operating income by $0.1 million and $0.3 million for the first quarters of fiscal 2014 and fiscal 2013, respectively. The Company confronts increasing pricing pressure which is a trend that management expects to continue.

Net product sales are comprised primarily of the sales of houseware and audio products which bear the Emersonฎ brand name. The major elements which contributed to the overall decrease in net product sales were as follows:

i) Houseware product net sales decreased $21.5 million, or 49.1%, to $22.3 million in the first quarter of fiscal 2014 as compared to $43.8 million in the first quarter of fiscal 2013, on decreased net sales of microwave ovens, compact refrigerators and wine coolers.

As reported by the Company in a Form 8-K filed with the SEC on October 19, 2012, the Company was informed by its customer Wal-Mart, that, commencing with the Spring of 2013, Wal-Mart would discontinue purchasing from Emerson two microwave oven products that had been currently sold by the Company to Wal-Mart. Emerson continued shipping these two products throughout the remainder of Fiscal 2013 (the year ending March 31, 2013), with sales of such products declining through the fourth quarter of Fiscal 2013. During Fiscal 2013, these two microwave oven products comprised, in the aggregate, approximately $36.1 million, or 29.7%, of the Company's net product sales. Emerson anticipates that the full impact of Wal-Mart's decision will be realized by the Company in Fiscal 2014, which began on April 1, 2013. As previously disclosed by the Company, the complete loss of, or significant reduction in, business with either of the Company's key customers will have a material adverse effect on the Company's business and results of operations. Accordingly, Wal-Mart's decision will have a material adverse effect on the Company's business and results of operations. There can be no assurance that the Company will be able to increase sales of such products at levels sufficient to offset the adverse impact of Wal-Mart's decision, if at all.

As a result of the above, during the first quarter of fiscal 2014, sales of these two products by the Company were nil as compared to approximately $12.1 million during the first quarter of fiscal 2013.


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ii) Audio product net sales were $1.2 million in the first quarter of fiscal 2014 as compared to $1.1 million in the first quarter of fiscal 2013, an increase of $0.1 million, or 8.2%, resulting from increased net sales of the Company's clock radio and portable audio product offerings.

Licensing revenue - Licensing revenue in the first quarter of fiscal 2014 was $1.2 million as compared to $1.1 million in the first quarter of fiscal 2013, an increase of $0.1 million, or 9.1%, due to higher year-over-year sales by the Company's licensees of branded products under license from the Company during the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013.

The Company's largest license agreement is with Funai Corporation, Inc. ("Funai"), which accounted for approximately 80% of the Company's total licensing revenue for the first quarter of fiscal 2014 and which was amended in December 2012 to extend the term of the agreement until March 31, 2015. The agreement provides that Funai will manufacture, market, sell and distribute specified products bearing the Emersonฎ trademark to customers in the U.S. and Canadian markets. Under the terms of the agreement, the Company receives non-refundable minimum annual royalty payments of $3.75 million each calendar year and a license fee on sales of product subject to the agreement in excess of the minimum annual royalties. During the first quarter of fiscal 2014 and 2013, revenues of $0.9 million and $0.9 million, respectively, were earned under this agreement

Net revenues - As a result of the foregoing factors, the Company's net revenues were $24.7 million in the first quarter of fiscal 2014 as compared to $46.0 million in the first quarter of fiscal 2013, a decrease of $21.3 million, or 46.4%.

Cost of sales - In absolute terms, cost of sales decreased $18.2 million, or 46.4%, to $21.0 million in the first quarter of fiscal 2014 as compared to $39.2 million in the first quarter of fiscal 2013. Cost of sales, as a percentage of net revenues was 85.1% in the first quarter of each of fiscal 2014 and fiscal 2013. Cost of sales, as a percentage of net product sales was 89.4% in the first quarter of fiscal 2014 as compared to 87.3% in the first quarter of fiscal 2013. The decrease in absolute terms for the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013 was primarily related to the reduced net product sales, partially offset by a smaller increase to the sales return reserve compared to the prior year.

The Company purchases the products it sells from a limited number of factory suppliers. For the first quarter of fiscal 2014 and fiscal 2013, 75% and 72%, respectively, of such purchases were from the Company's largest two suppliers.

Other operating costs and expenses - Other operating costs and expenses as a percentage of net revenues were 0.6% in the first quarter of fiscal 2014 and 0.9% in the first quarter of fiscal 2013. In absolute terms, other operating costs and expenses decreased $257,000, or 63.0%, to $151,000 in the first quarter of fiscal 2014 as compared to $408,000 in the first quarter of fiscal 2013 resulting from lower warranty and returns processing costs.

Selling, general and administrative expenses ("S,G&A") - S,G&A, as a percentage of net revenues, was 8.9% in the first quarter of fiscal 2014 as compared to 4.4% in the first quarter of fiscal 2013. S,G&A, in absolute terms, increased $0.2 million, or 9.0%, to $2.2 million in the first quarter of fiscal 2014 as compared to $2.0 million in the first quarter of fiscal 2013. The increase in S,G&A in absolute terms between the first quarter of fiscal 2014 and the first quarter of fiscal 2013 was primarily due to an increase in legal fees of $0.2 million, an increase in tax consulting fees of $0.1 million and a reduced benefit in bad debt recoveries of $0.1 million, partially offset by a decrease in compensation costs of $0.2 million.

Interest income, net - Interest income, net, was $222,000 in the first quarter of fiscal 2014 as compared to $31,000 in the first quarter of fiscal 2013 resulting from the interest earned during the first quarter of fiscal 2014 on investments in Certificates of Deposit which were made subsequent to the first quarter of fiscal 2013.

Provision for income taxes - In the first quarter of fiscal 2014 and the first quarter of fiscal 2013, the Company recorded income tax expense of $0.2 million and $0.6 million, respectively. In the first quarter of fiscal 2014, the amount of income tax expense recorded by the Company was lower than in the first quarter of fiscal 2013 because the Company recorded a larger percentage of its taxable earnings in the first quarter of fiscal 2014 in tax jurisdictions with lower comparative tax rates than in the first quarter of fiscal 2013.

Net income - As a result of the foregoing factors, the Company's net income was $1.4 million in the first quarter of fiscal 2014 as compared to net income of $3.8 million in the first quarter of fiscal 2013.

Liquidity and Capital Resources

General

As of June 30, 2013, the Company had cash and cash equivalents of approximately $16.0 million, as compared to approximately $39.7 million of June 30, 2012. Working capital increased to $74.0 million at June 30, 2013 as compared to $68.5 million at June 30, 2012. The decrease in cash and cash equivalents of approximately $23.7 million was primarily due to an increase in short term investments of $45.3 million, partially offset by a decrease in accounts receivable of $11.5 million, a decrease in prepaid expenses and other current assets of $5.7 million, a reduction in accounts payable and other current liabilities of $5.7 million, a decrease in inventory of $3.8 million and the net income generated by the Company of $3.5 million during the twelve months ended June 30, 2013,


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Cash flow used by operating activities was $5.4 million for the three months ended June 30, 2013, resulting primarily from increases in accounts receivable, prepaid expenses and other current assets and inventory, partially offset by increased accounts payable and other current liabilities and the net income generated during the period. The increase in accounts receivable at June 30, 2013 as compared to March 31, 2013 was due to increased sales in June 2013 as compared to March 2013. The increase in prepaid expenses and other current assets at June 30, 2013 as compared to March 31, 2013 was due to a higher level of prepaid factory purchases at June 30, 2013 as compared to March 31, 2013.

Net cash used by investing activities was $0.1 million for the three months ended June 30, 2013, which was primarily due to an increase in short term investments.

Net cash used by financing activities was $11,000 for the three months ended June 30, 2013, resulting from a decrease in the Company's long term borrowings.

Other Events and Circumstances Pertaining to Liquidity

Potential Income Tax Issues Concerning the Extraordinary Dividend Paid by the Company in March 2010

On March 2, 2010, the Board declared an extraordinary dividend of $1.10 per common share which was paid on March 24, 2010. In connection with the Company's determination as to the taxability of the dividend, the Board relied upon information and research provided to it by the Company's tax advisors and, in reliance on the "stock-for-debt" exception in the Internal Revenue Code Sections 108(e)(8) and (e)(10), concluded that 4.9% of such dividend paid was taxable to the recipients.

In August 2012, the Company received a Form 886-A from the IRS which challenges the Company's conclusions and determines that the Company does not qualify for the above-referenced exception. Accordingly, the IRS has concluded that 100% of the dividend paid was taxable to the recipients. The Company is defending its position and calculations and is contesting the position asserted by the IRS. The Company prepared and, on October 25, 2012, delivered its rebuttal to the IRS contesting the IRS determination. There can be no assurance that the Company will be successful in defending its position.

In the event that the Company is not successful in establishing with the IRS that the Company calculations were correct, then the shareholders who received the dividend likely will be subject to and liable for an assessment of additional taxes due. Moreover, the Company may be contingently liable for taxes due by certain of its shareholders resulting from the dividend paid by the Company.

Initially, the Company withheld from the dividend paid to foreign shareholders an amount equal to the tax liability associated with such dividend. On April 7, 2010, upon a request made to the Company by its foreign controlling shareholder, S&T, the Company entered into an agreement with S&T (the "Agreement"), whereby the Company returned to S&T on April 7, 2010 that portion of the funds withheld for taxes from the dividend paid on March 24, 2010 to S&T, which the Company believes is not subject to U.S. tax based on the Company's good-faith estimate of its accumulated earnings and profits. The Agreement includes provisions pursuant to which S&T agreed to indemnify the Company for any liability imposed on it as a result of the Company's agreement not to withhold such funds for S&T's possible tax liability and a pledge of stock as collateral. The Company continues to assert that such dividend is largely not subject to U.S. tax based on the Company's good-faith estimate of its accumulated earnings and profits. In addition, the Company also continues to assert that this transaction results in an off-balance sheet arrangement and a possible contingent tax liability of the Company, which, if recognized, would be offset in part by the calling by the Company on S&T of the indemnification provisions of the Agreement.


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In February 2011, upon the request of S&T to the Company, the Company and S&T agreed that the collateral pledged as a part of the Agreement would no longer be required and such collateral was returned by the Company to S&T in March 2011 and the Agreement was amended and restated to remove the collateral requirement but retain the indemnification provisions. The Agreement, as amended (the "Amended Agreement"), remains in effect as of today. In the event that (i) the Company is not successful in establishing with the IRS that the Company's calculations were correct and (ii) S&T is unable or unwilling to pay the additional taxes due or indemnify the Company under the terms of the Amended Agreement, the Company may be liable to pay such additional taxes which would have a material adverse effect on the Company's financial condition and results of operations.

Income Tax Issues Concerning Overseas Income

On April 15, 2013 and June 5, 2013, Emerson received correspondence from the IRS including a (i) Form 5701 and Form 886-A regarding Adjusted Sales Income (collectively referred to as "NOPA 1") and (ii) Form 5701 and Form 886-A regarding Adjusted Subpart F-Foreign Base Company Sales Income (collectively referred to as "NOPA 2").

With respect to NOPA 1, the IRS is (i) challenging the position of the Company with respect to the way the Company's controlled foreign corporation in Macao (the "Macao CFC") recorded its product sales during Fiscal 2010 and Fiscal 2011 and (ii) asserting that an upward adjustment to the Company's Fiscal 2010 and Fiscal 2011 taxable income of $4,981,520 and $5,680,182, respectively, is required.

With respect to NOPA 2, the IRS is challenging the position of the Company with respect to the fact that the Company considered the service fee paid by the Company to the Macao CFC to be non-taxable in the U.S. The IRS has taken the position that the service fee paid to the Macao CFC by the Company constitutes foreign base company sales income ("FBCSI"). The IRS asserts that the service fee earned by the Macao CFC in connection with its sales of products to the Company should be taxable to the Company as FBCSI. As a result, the IRS determined that an upward adjustment to the Company's Fiscal 2010 and Fiscal 2011 taxable income of $1,553,984 and $1,143,162, respectively, is required.

The Company has evaluated the determinations made by the IRS as set forth in each of NOPA 1 and NOPA 2 in order to decide (a) how it will proceed and (b) the potential impact on the Company's financial condition and operations. Furthermore, although NOPA 1 and NOPA 2 represent potential adjustments to Fiscal 2010 and Fiscal 2011 only, the Company believes it is likely that the IRS will take the position that the same type of adjustments should be made for each of the Company's subsequent fiscal years. The assessment and payment of such additional taxes, penalties and interest would have a material adverse effect on the Company's financial condition and results of operations.

With respect to NOPA 1, the Company is appealing the proposed adjustment with the IRS. In the event that the Company is not successful in its appeal, the Company estimates that it could be liable for a maximum in taxes, penalties and interest of approximately $13.3 million pertaining to NOPA 1, in the aggregate, for its Fiscal 2010, Fiscal 2011, Fiscal 2012 and Fiscal 2013 periods. However, because the Company's current assessment is that its appeal of NOPA 1 is more likely than not to be successful, the Company has not recorded any liability to its March 31, 2013 balance sheet related to NOPA 1.

With respect to NOPA 2, the Company agrees in principle with the IRS' position that the service fee paid to the Macao CFC by the Company would be treated as FBCSI and taxable to the Company but the Company does not agree with the adjustment to the Company's taxable income as calculated by the IRS. However, the Company has estimated as approximately $1.1 million the amount of taxes, penalties and interest for which it would be liable for its Fiscal 2010, Fiscal 2011, Fiscal 2012 and Fiscal 2013 periods using the adjustments to taxable income as proposed by the IRS, and recorded such amount as a liability to its March 31, 2013 balance sheet.

Credit Arrangements

Letters of Credit - The Company uses Hang Seng Bank to issue letters of credit on behalf of the Company, as needed, on a 100% cash collateralized basis. At June 30, 2013, the Company had no outstanding letters of credit.

Short-term Liquidity

In the first quarter of fiscal 2014, products representing approximately 71% of net sales were imported directly to the Company's customers. The direct importation of product by the Company to its customers significantly benefits the Company's liquidity because this inventory does not need to be financed by the Company.

The Company's principal existing sources of cash are generated from operations. The Company believes that its existing cash balance and sources of cash will be sufficient to support existing operations over the next 12 months.


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Recently Issued Accounting Pronouncements

The following Accounting Standards Updates ("ASUs") were issued by the Financial Accounting Standards Board during the three months ended June 30, 2013 or during the interim period between June 30, 2013 and August 14, 2013 which relate to or could relate to the Company as concerns the Company's normal ongoing operations or the industry in which the Company operates:

Accounting Standards Update 2013-10, Derivatives and Hedging (Topic 815):
Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes (Issued July 2013)

The amendments in this Update permit the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to UST and LIBOR. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013.

Accounting Standards Update 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Issued July 2013)

An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this Update do not require new recurring disclosures. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Early adoption is . . .

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