FRANKLIN WIRELESS CORP quarterly report, Q2 FY2019

Franklin Wireless Corp. Form 10-Q Summary

Reporting period: Three and six months ended December 31, 2018, representing the company’s fiscal second quarter and first six months of fiscal 2019. The filing identifies Franklin Wireless as a smaller reporting company. The company provides mobile hotspots, routers, modems, and M2M/IoT connectivity products, with majority-owned Franklin Technology Inc. providing research and development services.

Financial Performance and Position

Metric	Three Months Ended Dec. 31, 2018	Three Months Ended Dec. 31, 2017	Six Months Ended Dec. 31, 2018	Six Months Ended Dec. 31, 2017
Net sales	$9.2 million	$8.4 million	$22.5 million	$16.0 million
Gross profit	$1.3 million	$1.4 million	$3.5 million	$2.8 million
Gross margin	13.9%	16.6%	15.3%	17.7%
Operating loss	$(0.7) million	$(0.5) million	$(0.6) million	$(1.1) million
Net loss attributable to parent	$(0.5) million	$(0.7) million	$(0.3) million	$(1.2) million
Loss per diluted share	$(0.05)	$(0.07)	$(0.03)	$(0.11)

Six-month revenue increased 40.7%, primarily from higher demand from two major U.S. carrier customers. U.S. sales represented 99.2% of six-month revenue.
Operating expenses were $2.0 million in the quarter and $4.1 million for the six months. Selling, general and administrative expense increased, while research and development expense declined.
Interest income and favorable foreign-currency movements contributed to other income of $39,114 in the quarter and $92,270 for the six months.
The six-month net loss improved from $1.2 million to $429,692, partly reflecting a $77,040 income tax benefit. The comparable 2017 period included approximately $400,000 of tax expense from remeasurement of deferred tax assets following the Tax Cuts and Jobs Act.
Cash and cash equivalents were $12.6 million at December 31, 2018, compared with $12.0 million at June 30, 2018. Six-month operating cash flow was $936,813, versus cash used of $577,781 in the prior-year period.
Investing cash outflows were $358,679, including $234,330 to acquire additional shares of the subsidiary and $64,405 of capitalized product development costs. There were no financing cash flows.
Total assets were $24.9 million and total liabilities were $8.6 million at December 31, 2018. The filing does not report outstanding debt or borrowings.
Current assets were $21.6 million compared with current liabilities of $8.6 million, implying substantial reported working-capital coverage. Accounts receivable were $7.1 million and inventory was $1.9 million.

Material Changes Versus Prior Comparable Period

Quarterly revenue rose 10.0%, but gross profit declined 7.7% and gross margin fell 2.7 percentage points because of competitive pricing, higher product costs, and customer and product mix.
Six-month gross profit increased 21.7%, although gross margin declined 2.4 percentage points to 15.3%.
Quarterly operating loss widened to $710,986 from $512,871, despite higher sales, as gross profit declined and operating expenses increased.
Six-month operating loss narrowed to $599,002 from $1.1 million because of higher gross profit and relatively modest operating-expense growth.
Shipping and handling expense increased to $715,680 for the six months from $382,835, primarily due to higher shipment volume.
The company increased its ownership of Franklin Technology Inc. from 51.8% to 64.2% by purchasing 246,663 shares for $234,330. Non-controlling ownership declined from 48.2% to 35.8%.
On July 1, 2018, the company adopted ASC Topic 606 using the modified retrospective method; no cumulative-effect adjustment to retained earnings was recorded.

Outlook, Risks, Contingencies, and Unusual Items

Management expects revenue to depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer relationships, and the ability to meet customer demand. No specific numerical revenue or earnings guidance was provided.
Management stated that cash resources were sufficient to fund operations and obligations for at least one year from the filing date, but warned that failure to achieve its business plan or secure additional funding could require curtailment of operations or other actions outside the ordinary course.
The company transferred $9.0 million into a brokered certificate of deposit and government money-market accounts in October 2018.
A significant customer cancelled a purchase commitment, and a vendor requested approximately $2.9 million for components purchased for that order. The company expects to seek payment from the customer and has personal guarantees from the customer’s owners, but the matter remained unresolved and no receivable or payable was recorded.
Customer concentration is significant: three customers accounted for 47%, 15%, and 10% of six-month sales and 66%, 19%, and 3% of accounts receivable at December 31, 2018.
Two Asian manufacturers supplied 98% of six-month product purchases, totaling $18.8 million, and represented $7.7 million of accounts payable. Manufacturing delays, capacity constraints, or quality issues could affect shipments and revenue.
Operating leases include the San Diego office lease, expiring October 2019, and FTI office leases in Korea, expiring September 2019. Change-of-control agreements provide potential payments of $5 million to the president and $2 million to the chief operating officer.
Management reported no material changes to previously disclosed risk factors, no material litigation matters, no off-balance-sheet arrangements, and effective disclosure controls, although the filing’s controls discussion references an evaluation date of September 30, 2018.

Important Facts for Investors to Verify

Whether the unresolved $2.9 million cancelled-order component obligation will result in a future cash payment or accounting liability.
The sustainability of revenue growth given reliance on two major carrier customers and the concentration of sales in the United States.
Whether competitive pricing and higher product costs continue to pressure gross margins.
The financial and operational impact of dependence on two Asian manufacturers representing 98% of product purchases.
Whether operating cash flow remains positive after working-capital movements, particularly accounts payable, receivables, and inventory.
The terms and renewal requirements for leases expiring in 2019 and the potential $7 million aggregate change-of-control obligations.
The effect of increased ownership of Franklin Technology Inc. on future non-controlling interests, cash usage, and consolidated results.