FKWL

Franklin Wireless Corp. 10-K Summary (Fiscal Year Ended June 30, 2009)

Business Context and Reporting Period

Franklin Wireless Corp. designs and sells broadband high-speed wireless data communication products, including 3G and 4G USB modems and embedded modules. The company operates in a single segment with facilities in San Diego, California, and markets products directly to wireless operators and indirectly through distributors in the United States, the Caribbean, and South America. Manufacturing is outsourced exclusively to C-Motech Co. Ltd. in South Korea. This report covers the fiscal year ended June 30, 2009.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 30.9% to $24.0 million. This was driven by a 61.9% drop in sales to Caribbean and South American markets due to currency devaluation and reduced purchasing power. This decline was partially offset by a 52.9% increase in U.S. sales, largely attributed to the launch of the CMU-300 WIMAX plus CDMA USB Modem.
• Margin Compression: Gross margin decreased slightly to 21.6% from 22.2%, primarily due to a higher mix of lower-margin EV-DO technology products sold in the U.S.
• Expense Reduction: Selling, general, and administrative (SG&A) expenses decreased 16.4% to $2.86 million, mainly due to lower sales commissions, despite increased payroll costs for sales staff.
• Tax Benefit: The company recorded a tax benefit of $1.22 million in 2009 (compared to a provision of $0.59 million in 2008) due to the reversal of a valuation allowance on deferred tax assets, resulting in a lower effective tax rate.
• Debt Repayment: The company fully repaid a $334,000 note payable assumed from a dissolved subsidiary, leaving no outstanding debt as of June 30, 2009.

Outlook, Risks, and Contingencies

• Liquidity Needs: Management anticipates requiring $2.0 million to $3.0 million for capital expenditures and certifications over the next 12 months. While current cash and operating flows are expected to fund operations, the company may need to raise additional equity or debt if cash flows are insufficient.
• Single Source Dependency: The company relies 100% on C-Motech for manufacturing. C-Motech is also a significant shareholder (25.5%) and its CEO serves on the Board. Any disruption at C-Motech poses a material risk.
• Customer Concentration: Three customers accounted for 63.5% of total revenue in fiscal 2009. Loss of any major customer could materially impact financial results.
• Legal Proceedings: A patent infringement lawsuit (DNT, LLC) was filed against a customer regarding products supplied by Franklin Wireless. The company is obligated to indemnify the customer. Management does not expect a material adverse effect at this time.
• Change of Control Agreements: Subsequent to the fiscal year end, the company entered into agreements with key executives providing for lump-sum payments totaling $8 million upon a change of control.

Investor Verification Checklist

• Customer Concentration: Verify the stability of the top three customers representing 63.5% of revenue.
• Related Party Transactions: Review the terms of the exclusive manufacturing agreement with C-Motech, which accounts for 98.6% of purchases.
• Geographic Exposure: Assess the impact of currency fluctuations and economic conditions in the Caribbean and South America on future revenue.
• Inventory Levels: Note the significant increase in inventory from $72,000 in 2008 to $2.6 million in 2009; verify the realizability of this inventory given the sales decline.
• Deferred Tax Assets: Confirm the sustainability of the reversal of the valuation allowance on deferred tax assets, which drove the tax benefit.