Franklin Wireless Corp. Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended March 31, 2018, filed May 15, 2018. The request metadata identifies “2017 Q3,” but the filing is for the third quarter of fiscal 2018 and compares against March 31, 2017.
Business Context
Franklin Wireless provides wireless access products, including mobile hotspots, routers, modems, embedded modules, gateways, 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 51.8% of Franklin Technology Inc. in South Korea, which provides product design and development services.
Financial Results and Position
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $6.6 million, down 32.7% | $22.6 million, down 38.7% |
| Gross profit | $1.4 million | $4.3 million |
| Gross margin | 22.0%, versus 20.0% | 19.0%, versus 19.3% |
| Operating income (loss) | $(425,058) | $(1.6 million) |
| Net income (loss) | $(188,981) | $(1.4 million) |
| Net income (loss) attributable to parent | $(140,722), or $(0.01) per share | $(1.3 million), or $(0.12) per share |
| Operating cash flow | Not separately provided | $(2.0 million) |
At March 31, 2018, cash and cash equivalents were $12.1 million, compared with $14.3 million at June 30, 2017. Total current assets were $19.9 million and current liabilities were $5.4 million, implying current assets of approximately 3.7 times current liabilities. Accounts receivable declined to $6.2 million from $11.0 million, inventories declined to $1.4 million from $3.4 million, and accounts payable declined to $5.1 million from $12.9 million.
The Company reported no debt on the consolidated balance sheet. Total liabilities were $5.4 million, and total stockholders’ equity was $17.9 million. Cash used in investing activities was $351,704, including $291,386 of capitalized product development costs. Financing activities provided $67,000 from stock-option exercises.
Material Changes Versus Prior Comparable Period
- Quarterly sales declined $3.2 million, primarily because of lower product demand from two U.S. carrier customers. A new product launch partially offset the decline.
- Nine-month U.S. sales declined 39.3%; management attributed the reduction principally to lower demand from two carrier customers, partially offset by three new product launches, including one sold to a new customer.
- Quarterly gross margin improved to 22.0% from 20.0%, primarily due to customer and product mix, pricing, and product-cost variations. Nine-month gross margin decreased slightly to 19.0% from 19.3%.
- Operating expenses decreased 8.1% in the quarter and 5.7% year to date, reflecting cost-reduction efforts and lower shipping and handling costs. Year-to-date research and development expense increased modestly to $2.6 million.
- The Company shifted from parent-attributable earnings of $73,478 in the prior-year quarter and $861,357 year to date to losses of $140,722 and $1.3 million, respectively.
- Operating cash use increased to $2.0 million year to date from $544,263, largely because accounts payable decreased by approximately $7.7 million.
Guidance, Outlook, Risks, and Unusual Items
Management provided no quantitative revenue or earnings guidance. Management stated that revenue depends on retaining existing customers, demand for wireless data products, acceptance of new products, new customer relationships, and the ability to meet customer requirements. Management believed available capital was sufficient to fund existing operations and obligations for at least one year from the filing date, but stated that failure to achieve the business plan or obtain additional funding could require curtailment of operations.
- Customer concentration is significant: three customers represented 55%, 19%, and 12% of nine-month sales. Those customers represented 58%, 34%, and 0% of accounts receivable at March 31, 2018.
- One Asian manufacturer supplied 89% of product purchases during the nine-month period, creating exposure to delays, capacity constraints, quality issues, or canceled orders.
- Inventory demand is described as highly unpredictable, and the Company maintained a $148,900 reserve for obsolete or slow-moving inventory.
- The Tax Cuts and Jobs Act caused an approximately $400,000 decrease in deferred tax assets. The Company had not completed its analysis of the Section 965 deemed-repatriation tax and had recorded no provision; a future adjustment may be required.
- Change-of-control agreements provide potential payments of $5 million to the President and $2 million to the Chief Operating Officer, subject to specified triggering events. The agreements were extended through September 21, 2020.
- The Chief Financial Officer resigned on April 6, 2018. The President was serving as Acting Chief Financial Officer while the Company searched for a replacement.
- Management reported no material changes to previously disclosed risk factors, no material litigation exposure, and no off-balance-sheet arrangements.
Facts Investors Should Verify
- Whether demand from the two key carrier customers recovers and whether new product launches offset the sales decline.
- The sustainability of quarterly gross-margin improvement and the effect of product and customer mix.
- Customer concentration, collectability of the $6.2 million receivable balance, and dependence on the primary Asian manufacturer.
- Operating cash burn, working-capital requirements, and whether the $12.1 million cash balance remains sufficient if losses continue.
- The eventual Section 965 tax liability and any related adjustment to deferred tax assets or income tax expense.
- The effect of the CFO departure and interim finance leadership on reporting and internal controls.