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

Show all filings for EMERSON RADIO CORP

Form 10-Q for EMERSON RADIO CORP


14-Nov-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 and
six month periods ended September 30, 2013 (fiscal 2014) and September 30, 2012
(fiscal 2013) (in thousands):



                                                    Three months ended            Six months ended
                                                       September 30                 September 30
                                                   2013            2012          2013          2012
Net product sales                                $  17,258       $ 32,299      $ 40,739      $ 77,175
Licensing revenue                                    1,080          2,416         2,251         3,551

Net revenues                                        18,338         34,715        42,990        80,726
Cost of sales                                       15,635         29,102        36,619        68,275
Other operating costs and expenses                     171            385           322           793
Selling, general and administrative expenses         2,325          1,737         4,513         3,745
Impairment of trademark                                 -           1,326            -          1,326

Operating income                                       207          2,165         1,536         6,587
Interest income, net                                   121             67           343            98

Income before income taxes                             328          2,232         1,879         6,685
Provision (benefit) for income taxes                   (60 )          285           122           898

Net income                                       $     388       $  1,947      $  1,757      $  5,787

Net product sales - Net product sales for the second quarter of fiscal 2014 were $17.3 million as compared to $32.3 million for the second quarter of fiscal 2013, a decrease of $15.0 million or 46.6%. For the six month period of fiscal 2014, net product sales were $40.7 million as compared to $77.2 million for the six month period of fiscal 2013, a decrease of $36.5 million or 47.2%. The Company's sales during the six month periods of fiscal 2014 and fiscal 2013 were highly concentrated among the Company's two largest customers, as to which gross product sales comprised approximately 89.7% and 94.9%, 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 approximately $0.1 million and $0.3 million for the second quarters of fiscal 2014 and fiscal 2013, respectively, and approximately $0.2 million and $0.5 million for the six month periods 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 $14.6 million, or 46.8%, to $16.7 million in the second quarter of fiscal 2014 as compared to $31.3 million in the second quarter of fiscal 2013, principally driven by a decrease in sales of microwave ovens and compact refrigerators, partially offset by an increase in wine coolers. For the six month period of fiscal 2014, houseware products net sales were $39.0 million, a decrease of $36.1 million or 48.1%, from $75.1 million for the six month period of fiscal 2013, principally driven by a decrease in sales of microwave ovens and compact refrigerators, partially offset by an increase in 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 one of its major customers, that, commencing with the Spring of 2013, this customer would discontinue purchasing from Emerson two microwave oven products that had been sold by the Company to this customer. 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 this customer'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, this customer's decision is having 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 this customer's decision, if at all.


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As a result of the above, during the second quarter and six month periods of fiscal 2014, sales of these two products by the Company were nil as compared to approximately $11.9 million and $24.0 million during the second quarter and six month periods of fiscal 2013, respectively.

ii) Audio product net sales were $0.6 million in the second quarter of fiscal 2014 as compared to $1.0 million in the second quarter of fiscal 2013, a decrease of $0.4 million, or 39.2%, resulting from decreased sales of the Company's portable audio and clock radio product offerings. For the six month period of fiscal 2014, audio product net sales were $1.8 million, a decrease of $0.3 million, or 13.8%, from $2.1 million in the six month period of fiscal 2013, resulting from decreased net sales of the Company's portable audio and clock radio product offerings.

Licensing revenue - Licensing revenue in the second quarter of fiscal 2014 was $1.1 million compared to $2.4 million in the second quarter of fiscal 2013, a decrease of $1.3 million or 55.3%. Licensing revenue for the six month period of fiscal 2014 was $2.3 million as compared to $3.6 million for the six month period of fiscal 2013, a decrease of $1.3 million or 36.6%. The decrease in year-over-year licensing revenue for both the second quarter and six month periods of fiscal 2013 was due to approximately $1.3 million of lower year-over-year licensing revenue earned from the Company's largest licensee, Funai Corporation, Inc. ("Funai"), because Funai has not yet met or exceeded its annual minimum royalty payment obligation for fiscal 2014, whereas in fiscal 2013 Funai exceeded its annual minimum royalty payment obligation during the second quarter of the Company's fiscal year.

The Company's largest license agreement is with Funai, which accounted for approximately 87% and 83% of the Company's total licensing revenue for the second quarter and six month period of fiscal 2014, respectively, and approximately 92% and 89% of the Company's total licensing revenue for the second quarter and six month period of fiscal 2013, and which was amended during 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 Funai's sales of product in excess of the minimum annual royalties.

Net revenues - As a result of the foregoing factors, the Company's net revenues were $18.3 million in the second quarter of fiscal 2014 as compared to $34.7 million in the second quarter of fiscal 2013, a decrease of $16.4 million, or 47.2%, and $43.0 million in the six month period of fiscal 2014 as compared to $80.7 million in the six month period of fiscal 2013, a decrease of $37.7 million, or 46.8%.

Cost of Sales - In absolute terms, cost of sales decreased $13.5 million, or 46.3%, to $15.6 million in the second quarter of fiscal 2014 as compared to $29.1 million in the second quarter of fiscal 2013. Cost of sales, as a percentage of net revenues was 85.3% in the second quarter of fiscal 2014 as compared to 83.8% in the second quarter of fiscal 2013. Cost of sales, as a percentage of net product sales was 90.6% in the second quarter of fiscal 2014 as compared to 90.1% in the second quarter of fiscal 2013. The decrease in absolute terms for the second quarter of fiscal 2014 as compared to the second quarter of fiscal 2013 was primarily related to the reduced net product sales, partly offset by slightly higher year-over-year gross cost of sales as a percentage of gross sales.

In absolute terms, cost of sales decreased $31.7 million, or 46.4%, to $36.6 million in the six month period of fiscal 2014 as compared to $68.3 million in the six month period of fiscal 2013. Cost of sales, as a percentage of net revenues was 85.2% in the six month period of fiscal 2014 as compared to 84.6% in the six month period of fiscal 2013. Cost of sales, as a percentage of net product sales was 89.9% in the six month period of fiscal 2014 as compared to 88.5% in the six month period of fiscal 2013. The decrease in absolute terms for the six month period of fiscal 2014 as compared to the six month period of fiscal 2013 was primarily related to the reduced net product sales, partly offset by slightly higher year-over-year gross cost of sales as a percentage of gross sales.

The Company purchases the products it sells from a limited number of factory suppliers. For the second quarter of fiscal 2014 and fiscal 2013, 78% and 84%, respectively, of such purchases were from the Company's largest two suppliers. For the six month period of fiscal 2014 and fiscal 2013, 76% and 76%, respectively, of such purchases were from the Company's largest two suppliers.

Other Operating Costs and Expenses - As a percentage of net revenues, other operating costs and expenses were 0.9% in the second quarter of fiscal 2014 and 1.1% in the second quarter of fiscal 2013. In absolute terms, other operating costs and expenses decreased $0.2 million, or 55.6%, to $0.2 million for the second quarter of fiscal 2014 as compared to $0.4 million in the second quarter of fiscal 2013 as a result of lower warranty and returns processing costs. For the six month period of fiscal 2014, other operating costs were 0.8% of net revenues as compared to 1.0% of net revenues for the six month period of fiscal 2013. In absolute terms, other operating costs and expenses decreased $0.5 million, or 59.4%, to $0.3 million for the six month period of fiscal 2014 as compared to $0.8 million for the six month period of fiscal 2013 also resulting from lower warranty and returns processing costs.


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Selling, General and Administrative Expenses ("S,G&A") - S,G&A, as a percentage of net revenues, was 12.7% in the second quarter of fiscal 2014 as compared to 5.0% in the second quarter of fiscal 2013. S,G&A, in absolute terms, increased $0.6 million, or 33.9%, to $2.3 million for the second quarter of fiscal 2014 as compared to $1.7 million for the second quarter of fiscal 2013. The increase in S,G&A in absolute terms between the second quarter of fiscal 2014 and second quarter of fiscal 2013 was primarily due to higher legal fees, a reduced benefit in bad debt expense, higher tax consulting costs and higher fees paid to outside providers. For the six month period of fiscal 2014, S,G&A was 10.5% of net revenues as compared to 4.6% for the six month period of fiscal 2013. In absolute terms, S,G&A increased $0.8 million, or 20.5%, to $4.5 million for the six month period of fiscal 2014 as compared to $3.7 million in the six month period of fiscal 2013. The increase in S,G&A in absolute terms between the six month periods of fiscal 2014 and fiscal 2013 was primarily due to higher legal fees, higher tax consulting costs, a reduced benefit in bad debt expense, and higher fees paid to outside providers.

Impairment of trademark - During the three months ended September 30, 2012, upon completion of an analysis which showed the absence of future expected cash flows, the Company determined that the value of one of its non-strategic trademarks was fully impaired. Thus, the Company recorded in September 2012 an impairment charge of $1.3 million to write off this trademark. The Company does not anticipate any future material adverse financial impacts arising from this impairment.

Interest income (expense), net - Interest income, net, was $121,000 in the second quarter of fiscal 2014 as compared to $67,000 in the second quarter of fiscal 2013, an increase of $54,000. Interest income, net, was $343,000 in the six month period of fiscal 2014 as compared to $98,000 in the six month period of fiscal 2013, an increase of $245,000.

Provision (benefit) for Income Taxes - In the second quarter and six month period of fiscal 2014, the Company recorded a benefit of $60,00 and income tax expense of $0.1 million, respectively, as compared to income tax expense of $0.3 million and $0.9 million, respectively, in the second quarter and six month period of fiscal 2013.

Net income - As a result of the foregoing factors, the Company realized net income of $0.4 million in the second quarter of fiscal 2014 as compared to $1.9 million in the second quarter of fiscal 2013, a decrease of $1.5 million, or 80.1%. For the six month period of fiscal 2014, the Company realized net income of $1.8 million as compared to $5.8 million in the six month period of fiscal 2013, a decrease of $4.0 million, or 69.6%.

Liquidity and Capital Resources

General

As of September 30, 2013, the Company had cash and cash equivalents of approximately $52.1 million, as compared to approximately $27.5 million at September 30, 2012. Working capital increased to $74.4 million at September 30, 2013 as compared to $71.6 million at September 30, 2012. The increase in cash and cash equivalents of approximately $24.6 million was primarily due to a decrease in accounts receivable, a decrease in short term investments, a decrease in inventory, a decrease in prepaid expenses, a decrease in other receivables and the net income generated by the Company during the twelve months ended September 30, 2013, partly offset by a decrease in accounts payable inventory and a decrease in accrued sales returns.

Cash flow provided by operating activities was $0.7 million for the six months ended September 30, 2013, resulting primarily from decreases in accounts receivable, the net income generated during the period, a decrease in other receivables and an increase in accounts payable, partially offset by increases in inventory, an increase in prepaid expenses and a decrease in income taxes payable.

Net cash provided by investing activities was $30.1 million for the six months ended September 30, 2013, primarily due to redemptions of short term investments in certificates of deposit, partially offset by additions to property and equipment.

Net cash used by financing activities was $15,000 for the six months ended September 30, 2013, resulting from payments made on the Company's capital lease and rental obligations.

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.


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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.

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 September 30, 2013 or March 31, 2013 balance sheets 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 at approximately $1.1 million the amount of taxes, . . .

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