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ERERSON RADIO CORP.
Filed on Feb 16 1999
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
GENERAL
The Company's operating results and liquidity are impacted by the seasonality of its business. The Company records the majority of its annual sales in the fiscal quarters ending in September and December and receives the largest amount of customer returns in the fiscal quarters ending in March and June. Therefore, the results of operations discussed below are not necessarily indicative of the Company's prospective annual results. The Company expects its United States sales for the fiscal quarter ended April 2, 1999 to be lower than the fourth quarter of Fiscal 1998. As a result, Management expects a net loss in the Company's fourth quarter of Fiscal 1999.
RESULTS OF OPERATIONS
NET REVENUES Consolidated net revenues for the three and nine month periods ended January 1, 1999 decreased $16.7 million or 34.6% and increased $13.6 million or 11.0% as compared to the same periods in the prior fiscal year. ("Fiscal 1998"), respectively. The decrease in revenues for the three months ended January 1, 1999 resulted primarily from decreases in unit sales of audio and microwave oven products. This decrease in product sales was partially offset by a significant reduction in returned product as compared to the same period in the prior year resulting from an overall more restrictive return policy by the Company's customers. It is expected that this trend will continue. The increase in revenues for the nine months ended January 1, 1999 resulted primarily from increased unit sales of audio products offset by a unit decrease in microwave oven products, combined with a significant reduction in returned product. Revenues earned from the licensing of the Emerson and G-Clef trademark were $1 million and $2.6 million in the three and nine month periods ended January 1, 1999 as compared to $1.3 million and $3.8 million in the same periods in Fiscal 1998, respectively. The decrease is attributable to the first year transition of a marketing agreement with Daewoo Electronics, Ltd. implemented to replace a previous license agreement. This decline is expected to be temporary as the new program becomes fully implemented in Fiscal 2000. The Company expects its United States sales for the fiscal quarter ended April 2, 1999 to be lower than the fourth fiscal quarter of Fiscal 1998.
COST OF SALES Cost of sales, as a percentage of consolidated revenues, was 85% and 88% for the three and nine month periods ended January 1, 1999 as compared to 87% and 88% for the same periods in Fiscal 1998, respectively. The decrease in cost of sales as a percent of sales for the three month period ended January 1, 1999 as compared to the same period in the prior fiscal year was primarily attributable to higher margins in audio and microwave oven products, and a decrease in returned product, which was partially offset by a decrease in licensing revenues and marketing fees.
The Company's gross profit margins continue to be subject to competitive pressures arising from pricing strategies associated with the category of the consumer electronics market in which the Company competes. The Company's products are generally placed in the low-to-medium priced categories of the market, which tend to be the most competitive and generate the lowest profit margins. The Company believes that its marketing agreements, its licensing agreements in the United States and various foreign countries, and its distribution agreements in Canada, Europe and parts of Asia will have a favorable impact on the Company's gross profit. The Company continues to promote its direct import programs to reduce working capital risks. In addition, the Company continues to focus on its higher margin products and continually reviews new products that can generate higher margins than its current business, either through license arrangements, acquisitions, joint ventures or on its own.
OTHER OPERATING COSTS AND EXPENSES Other operating costs and expenses increased $191,000 and $851,000 in the three and nine month periods ended January 1, 1999 as compared to the same periods in Fiscal 1998, respectively, primarily as a result of the Company's increased use of the return-to-vendor program. Under the return-to-vendor program, the Company, by paying a fee, is able to return defective product to its suppliers and, to receive in exchange, a replacement unit.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("S,G&A") S,G&A, as a
percentage of revenues, was 8.0% and 7.3% for the three and nine month periods
ended January 1, 1999, as compared to 8.6% and 9.2% for the same periods in
Fiscal 1998, respectively. In absolute terms, S,G&A decreased by $1,657,000 for
the three month period ended January 1, 1999, and for the nine month period
ended January 1, 1999 decreased by $1,314,000 as compared to the same periods in
Fiscal 1998. The decrease in S,G&A for the three month period ended January 1,
1999 was primarily attributable to reduced co-op advertising costs, reduced
charges related to bad debts and a reduction in professional fees. The decrease
of $1,314,000 in S,G&A for the nine month ended January 1, 1999 period was
primarily attributable to reduced co-op advertising costs and a decrease in the
charges incurred in the prior year for relocation costs of the Company's back
office operations from New Jersey to Texas, partially offset by an increase in
professional fees.
OPERATING INCOME The Company reported operating income of $1.1 million and $3.2 million for the three and nine months ended January 1, 1999, as compared to operating income of $1.2 million and $.9 million for the same periods in Fiscal 1998, respectively. Operating income for the nine month period ended January 1, 1999 as compared to the same period in the prior year is higher by $2.3 million primarily due to a higher revenue base of approximately $10 million and a reduction in S,G&A expenses, offset in part by higher return-to-the vendor costs.
EQUITY IN EARNINGS OF UNCONSOLIDATED AFFILIATE The Company's share in the earnings of SSG amounted to a loss of $196,000 and income of $595,000 in the three and nine month periods ended January 1, 1999 as compared to a loss of $31,000 and income of $1.0 million for the same periods in the prior fiscal year, respectively. See Note 8 - Investment in Sport Supply Group, Inc.
INTEREST EXPENSE Interest expense was substantially unchanged for the three months ended January 1, 1999 and decreased by $278,000 for the nine months ended January 1, 1999 as compared to the same periods in Fiscal 1998. The decrease for the nine month period was attributable to a significant reduction in short-term average borrowings due to a reduction in working capital requirements.
NET EARNINGS As a result of the foregoing factors, the Company generated net earnings of $310,000 and $1,657,000 for the three and nine month periods ended January 1, 1999, as compared to net earnings of $493,000 and a net loss of $210,000 for the same periods in Fiscal 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities, was $7.0 million for the nine months ended January 1, 1999. Cash was provided primarily by an increase in accounts payable, increased borrowings, a reduction in inventory partially offset by an increase in accounts receivable, combined with increased profitability of the Company.
Net cash utilized by investing activities was $2.0 million for the nine months ended January 1, 1999, which consisted of marketable securities held as available-for-sale.
In the nine months ended January 1, 1999, the Company's financing activities utilized $2.4 million of cash. The Company increased its borrowings under its U.S. line of credit facility by $1.1 million to partially fund $3.5 million for the purchase of the Company's stock for treasury and retirement.
The Company maintains an asset-based $10 million U.S. line of credit facility. In addition, the Company maintains 2 credit facilities with a Hong Kong based bank: a $3.5 million letter of credit facility which was fully utilized at January 1, 1999 and a $25 million back-to-back letter of credit facility of which $7.9 million was utilized at January 1, 1999.
At present, management believes that future cash flow from operations and its existing institutional financing noted above will be sufficient to fund all of the Company's cash requirements for the next twelve months. However, the adequacy of future cash flow from operations is dependent upon the Company achieving its operating plan.
As of January 1, 1999, the Company had no material commitments for capital expenditures.
INFLATION AND FOREIGN CURRENCY
Neither inflation nor currency fluctuations had a significant effect on the Company's results of operations during the first nine months of Fiscal 1999. The Company's exposure to currency fluctuations has been minimized by the use of U.S. dollar denominated purchase orders, and by sourcing production in more than one country. The Company purchases virtually all of its products from manufacturers located in various Asian countries. The economic crises in these countries and its related impact on their financial markets has not impacted the Company's ability to purchase product. Should these crises continue, they could have a material adverse effect on the Company by inhibiting the Company's relationship with its suppliers and its ability to acquire products for resale. Additional financial turmoil in the Mexican and South American economies may have an impact on the licensees with whom the Company has entered licenses.
YEAR 2000
The Company has in place detailed programs to address Year 2000 readiness in its internal computer systems and its key customers and suppliers. The Company's Year 2000 readiness team includes both internal personnel and external consultants. The team's activities are designed to ensure that there will be no material adverse effects on the Company's business operations and that transactions with customers, suppliers, and financial institutions will be fully supported. The specific costs of achieving Year 2000 compliance are expected to be $500,000, of which approximately $160,000 has been expended to date.
The Company has converted a significant portion of its operational software, with testing to be performed during the first half of calendar year 1999. The balance of the Company's software is to be updated from an outside vendor, which the Company expects to take place in the first quarter of Calendar 1999. The Company expects that all critical systems will be compliant by June 1999 and fully tested by September 1999. The Company is also in the process of ensuring that its significant suppliers, customers and financial institutions have appropriate plans to ensure that they are Year 2000 compliant. Risk assessment, readiness evaluation, action plans and contingency plans related to third parties have been analyzed. The Company does not have a contingency plan in place should they not be Year 2000 compliant.
While the Company believes its planning efforts are adequate to address its Year 2000 concerns, there can be no guarantee that all internal systems, as well as those of third parties on which the Company relies, will be converted on a timely basis and will not have a material adverse affect on the Company's operations.
RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
Effective as of April 4, 1998 the Company adopted "Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive Income." FAS 130 establishes standards for the reporting and displaying of comprehensive income and its components in a full set of general purpose financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information," which is effective for the Company beginning April 4, 1998. This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that these enterprises report selected information about operating segments in interim financial reports issued to shareholders. As this statement only requires certain disclosure, its adoption will not have any impact on the consolidated financial position, consolidated results of operations or cash flows of the Company.
SFAS No. 132, "Employers Disclosures about Pension and other Postretirement Benefits," revises disclosures about pension and other postretirement benefit plans. This new standard standardizes the disclosure requirements for pension and other postretirement benefits to the extent practicable and requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis. This new standard, which will be effective for Fiscal 1999, will not have a significant impact on the Company's financial statements based on the current financial structure and operations of the Company.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which will be effective for the Company for Fiscal 2000, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. The Company has not yet determined the effects, if any, of implementing SFAS No. 133 on its reporting of financial information.
FORWARD-LOOKING INFORMATION
This report contains various forward looking statements under the Private Securities Litigation Reform Act of 1995 (the "Reform Act") and information that is based on Management's beliefs as well as assumptions made by and information currently available to Management. When used in this report, the words "anticipate", "estimate", "expect", "predict", "project", and similar expressions are intended to identify forward looking statements. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, expected or projected. Among the key factors that could cause actual results to differ materially are as follows: (i) the ability of the Company to continue selling products to its largest customers whose net revenues represented 58% and 16% of Fiscal 1998 net revenues; (ii) competitive factors such as competitive pricing strategies utilized by retailers in the domestic marketplace that negatively impacts product gross margins; (iii) the ability of the Company to maintain its suppliers, primarily all of whom are located in the Far East; (iv) the Company's ability to replace the licensing income from the Supplier with commission revenues from Daewoo; (v) the outcome of litigation, as more fully described in the Company's most recent annual report on form 10-K and below; (vi) the availability of sufficient capital to finance the Company's operating plans; (vii) the ability of the Company to comply with the restrictions imposed upon it by its outstanding indebtedness; (viii) the effect of the worldwide volatility in the financial markets and its effect, among other things, on the Company's investment portfolio; and (ix) general economic conditions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
EMERSON RADIO CORP. AND SUBSIDIARIES
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