FRANKLIN WIRELESS CORP quarterly report, Q2 FY2021

Franklin Wireless Corp. Form 10-Q Summary

Reporting period: Quarterly and six-month periods ended December 31, 2020. Although the request metadata identifies “2020 Q2,” the filing is the company’s fiscal second-quarter Form 10-Q. Financial statements are unaudited and presented under U.S. GAAP.

Business Context

Franklin Wireless provides wireless connectivity products, including mobile hotspots, routers, trackers, embedded modules, modems and gateways supporting 4G and 5G applications. Products are sold primarily to wireless operators, strategic partners and distributors. The company owns 66.3% of Franklin Technology Inc. in South Korea, with a 33.7% non-controlling interest.

North America represented virtually all revenue: 99.97% of sales for the six months ended December 31, 2020. Revenue is highly concentrated among a small number of customers.

Key Financial Metrics

Metric	Three Months Ended Dec. 31, 2020	Three Months Ended Dec. 31, 2019	Six Months Ended Dec. 31, 2020	Six Months Ended Dec. 31, 2019
Net sales	$66.2 million	$13.3 million	$128.8 million	$22.1 million
Gross profit	$11.3 million	$2.6 million	$23.0 million	$4.6 million
Gross margin	17.0%	19.5%	17.8%	20.8%
Income from operations	$8.7 million	$0.8 million	$17.9 million	$1.1 million
Net income attributable to parent	$6.9 million	$0.6 million	$13.8 million	$0.8 million
Diluted EPS	$0.58	$0.05	$1.22	$0.08
Operating cash flow	Not separately provided	Not separately provided	$37.1 million	$3.4 million

Six-month operating expenses were $5.1 million, or 3.9% of sales, compared with $3.5 million, or 16.0% of sales, in the prior-year period. The six-month effective income tax provision was $4.1 million. Other income included $487,300 from forgiveness of the Paycheck Protection Program loan.

Financial Position and Liquidity

Cash and cash equivalents were $71.0 million at December 31, 2020, compared with $28.2 million at June 30, 2020.
Certificates of deposit were $5.4 million, resulting in cash and short-term investments of $76.4 million.
Total current assets were $106.1 million versus current liabilities of $67.3 million, implying substantial positive working capital.
Accounts payable increased to $63.9 million from $42.1 million, primarily supporting the significant increase in product purchases.
The $487,300 PPP loan was forgiven and is no longer outstanding. The filing reports no material conventional debt; lease liabilities totaled approximately $994,000.
Total stockholders’ equity increased to $41.8 million from $21.1 million at June 30, 2020.
Management believes available capital is sufficient to fund operations and obligations for at least one year from the filing date.

Cash Flow and Capital Allocation

Operating cash flow was $37.1 million, compared with $3.4 million in the prior-year period. The increase was driven principally by net income and a $21.9 million increase in accounts payable, so operating cash flow benefited materially from working-capital timing.
Investing cash flow was an outflow of $0.5 million, including $533,146 of capitalized product-development costs.
Financing cash flow was $6.1 million, principally from the sale of 923,078 shares of treasury stock for $6.0 million and $56,000 from option exercises.
Capitalized technology-in-progress costs increased to $590,000 from $140,000 at June 30, 2020.

Material Changes Versus the Prior Comparable Period

Six-month sales increased 482.0% to $128.8 million, primarily from a newly launched product and order timing from a new carrier customer. Approximately 59% of six-month sales came from that customer; the comparable quarterly concentration was approximately 70%.
Gross margin declined to 17.8% from 20.8% for the six-month period and to 17.0% from 19.5% for the quarter, reflecting competitive pricing and higher production costs.
Six-month parent-company net income increased to $13.8 million from $0.8 million.
Accounts receivable included a $61,890 allowance for doubtful accounts, whereas no allowance was recorded at June 30, 2020.
Inventory increased to $13.2 million from $11.8 million, while the inventory reserve declined to zero from $399,437.
The company sold 923,078 shares of treasury stock for $6.0 million and issued additional shares upon option exercises, increasing shares outstanding to 11,576,281 at December 31, 2020 from 10,605,912 at June 30, 2020.
Research and development expense increased to $2.1 million from $1.9 million for the six-month period. Stock-option compensation expense was $184,229 versus none in the prior-year period.

Guidance, Outlook, Risks and Unusual Items

Management expects the current pace of 4G/LTE sales to begin slowing in the third and fourth quarters of fiscal 2021 and is pursuing 5G opportunities across major domestic and international carrier networks.
Management believes remote work and education will support long-term demand for wireless hotspots.
Two customers represented 59% and 33% of six-month sales, and one customer represented 92% of accounts receivable at December 31, 2020.
Two Asian manufacturers supplied 99% of product purchases during the six months, with related accounts payable of approximately $63.0 million. Manufacturing delays, capacity constraints or quality issues could disrupt shipments and revenue.
COVID-19 may cause supply-chain and manufacturing disruptions, and its effect on future sales remains difficult to predict.
The company commenced legal action against Anydata and its principal officers on January 25, 2021. A potential loss related to unfulfilled purchase commitments and vendor arrangements is considered reasonably possible but is not estimable.
Operating leases require future payments of approximately $1.1 million before imputed interest. Change-of-control agreements provide lump-sum payments of $5 million to the President and $2 million to the Chief Operating Officer upon specified change-of-control events.
Potential future tariffs of 10% to 25% on imported products, if exemptions cease, could materially affect results. The company also provides certain customer indemnifications for intellectual-property claims.
Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes to previously disclosed risk factors were reported.

Investor Verification Checklist

Verify whether the unusually large sales increase and customer concentration are sustainable after the newly launched product and initial carrier orders.
Monitor gross-margin trends, competitive pricing and production costs, particularly as 4G/LTE demand slows.
Assess collectability of receivables, including the customer representing 92% of accounts receivable and the newly recorded bad-debt allowance.
Review supplier concentration, product availability, inventory levels and the $63.0 million of related supplier payables.
Follow the Anydata litigation and determine whether any loss or recovery becomes estimable.
Confirm the treatment and final tax effects of the forgiven PPP loan and the company’s elevated income-tax payable.
Evaluate the conversion of operating cash flow into sustainable cash generation after working-capital movements, especially the large increase in accounts payable.
Track execution of the 5G product strategy and the effect of the additional stock options and share issuance on future dilution.