Franklin Wireless Corp. Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended December 31, 2019. The filing is a second-quarter fiscal 2020 Form 10-Q, although the request metadata labels it “2019 Q2.” Financial statements are unaudited and prepared under U.S. GAAP.
Business Context
Franklin Wireless provides mobile hotspots, routers, modems, and hardware and software supporting machine-to-machine and Internet of Things applications. Products are sold primarily to wireless operators, strategic partners, and distributors. The Company owns 64.2% of Franklin Technology Inc. in South Korea, which provides product design and development services. The Company reports one operating segment.
Financial Performance
| Metric | Three Months Ended Dec. 31, 2019 | Three Months Ended Dec. 31, 2018 | Six Months Ended Dec. 31, 2019 | Six Months Ended Dec. 31, 2018 |
|---|---|---|---|---|
| Net sales | $13.3 million | $9.2 million | $22.1 million | $22.5 million |
| Gross profit | $2.6 million | $1.3 million | $4.6 million | $3.5 million |
| Gross margin | 19.5% | 13.9% | 20.8% | 15.3% |
| Operating income (loss) | $0.8 million | $(0.7) million | $1.1 million | $(0.6) million |
| Net income (loss) attributable to parent | $0.6 million | $(0.5) million | $0.8 million | $(0.3) million |
| Diluted EPS | $0.05 | $(0.05) | $0.08 | $(0.03) |
- Second-quarter sales increased 44.4%, primarily from a newly launched product and the timing of orders from a new carrier customer.
- Year-to-date sales declined 1.7%, reflecting materially lower demand from two major carrier customers, partly offset by the new carrier relationship.
- Operating expenses declined 12.7% year to date, largely due to lower shipping and handling costs following revised vendor shipping terms.
- Research and development expense increased to $1.9 million for the six months, from $1.5 million in the prior-year period.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash and cash equivalents were $9.4 million at December 31, 2019, compared with $6.4 million at June 30, 2019. Certificates of deposit were $5.4 million, resulting in cash and short-term investments of $14.8 million.
- Net cash provided by operating activities was $3.4 million for the six months, compared with $0.9 million in the prior-year period. The increase was driven principally by a $7.2 million increase in accounts payable, partly offset by increases of $3.3 million in accounts receivable and $1.9 million in inventory.
- Net cash used in investing activities was $0.5 million, including $0.3 million of capitalized product development costs, $0.1 million of property and equipment purchases, and $0.03 million of intangible asset purchases.
- There were no financing activities during either six-month period.
- Total assets were $30.8 million and total liabilities were $14.5 million at December 31, 2019. Accounts receivable increased to $7.5 million and inventory increased to $3.0 million from $4.1 million and $1.1 million, respectively, at June 30, 2019.
- The filing does not report conventional borrowings or senior debt. Lease liabilities totaled $1.35 million, including $0.36 million current and $0.99 million non-current.
- Management believes available capital is sufficient to fund operations and obligations for at least one year from the filing date, but states that failure to achieve its business plan or obtain additional funding, if needed, could require curtailment of operations.
Material Changes, Outlook, and Risks
- Gross margin improved substantially because of the higher selling price of the newly launched product and lower-cost product development service revenue from Franklin Technology.
- Revenue concentration increased: two customers represented 43% and 30% of six-month sales, respectively. Those customers also represented 52% and 25% of accounts receivable at December 31, 2019.
- Two Asian manufacturers supplied approximately 90% of product purchases during the six months, with $11.3 million of related accounts payable. Delays, capacity constraints, or quality problems could affect shipments and revenue.
- EMEA sales fell to zero from $0.2 million in the prior-year periods because orders from an African carrier customer were discontinued. Asia sales increased primarily from variable product development service revenue.
- The Company adopted lease accounting under ASC 842 on July 1, 2019, recording operating lease right-of-use assets and liabilities. Management stated that adoption did not affect net income or cash flows.
- Anydata had an approximately $3.1 million remaining purchase commitment as of December 31, 2019 but may be unable to fulfill it. Franklin had approximately $2.0 million of related remaining product purchase commitments with Quanta. Management considered a potential loss reasonably possible but not estimable and had not recorded a receivable or liability.
- The Company paid $100,000 for the right to call on inventory and recorded an additional $49,580 prepaid expense related to pricing adjustments with Quanta. Management disclosed a reasonable possibility of additional loss, but the amount was not estimable.
- Routine legal proceedings are not expected by management to have a material adverse outcome. No material changes to previously disclosed risk factors were reported.
- Management provided no quantitative revenue or earnings guidance. Future results are expected to depend on customer retention, wireless data demand, acceptance of new products, new contracts, and the ability to meet customer demand.
- Disclosure controls and procedures were assessed as effective as of December 31, 2019, and no material change in internal control over financial reporting was reported.
Important Facts for Investors to Verify
- Whether the newly launched product and new carrier customer generate repeatable demand beyond the reported quarter.
- The collectability and aging of the $7.5 million accounts receivable balance, particularly balances concentrated among two customers.
- Whether inventory growth and the Anydata purchase-commitment issue result in inventory write-downs or other losses.
- The financial condition of the two principal Asian manufacturers and the Company’s ability to diversify its supply chain.
- The sustainability of the improved gross margin and the effect of higher research and development spending.
- The outcome and potential financial impact of the approximately $3.1 million Anydata commitment and $2.0 million Quanta commitment.
- The Company’s ability to maintain liquidity if customer orders decline or additional funding becomes necessary.
- The $7 million aggregate change-of-control payments payable to two executives if a qualifying transaction occurs.