Franklin Wireless Corp. Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended December 31, 2012. The filing is an unaudited Form 10-Q filed February 14, 2013; the source metadata labels it “2012 Q2.” Franklin Wireless designs, manufactures, and sells 3G/4G wireless modules, USB modems, and related broadband products through wireless operators, partners, and distributors.
Financial performance and position
| Metric | Three months ended Dec. 31, 2012 | Three months ended Dec. 31, 2011 | Six months ended Dec. 31, 2012 | Six months ended Dec. 31, 2011 |
|---|---|---|---|---|
| Net sales | $5.36 million | $3.01 million | $18.49 million | $6.14 million |
| Gross profit | $0.87 million | $0.46 million | $4.05 million | $1.02 million |
| Gross margin | 16.2% | 15.4% | 21.9% | 16.7% |
| Operating income (loss) | $(1.27) million | $(1.01) million | $(0.01) million | $(1.95) million |
| Net income (loss) | $(0.86) million | $(0.68) million | $(0.22) million | $(1.41) million |
| Net income (loss) attributable to parent | $(0.72) million | $(0.49) million | $0.02 million | $(0.94) million |
| Basic EPS | $(0.07) | $(0.04) | $0.00 | $(0.08) |
Cash flow and liquidity: Six-month operating cash flow was $6.17 million, compared with $3.05 million in the prior-year period. Investing cash outflow was $1.27 million, including $358,630 of capitalized development costs, $615,279 of intangible-asset purchases, and $292,796 of property and equipment purchases. Financing cash outflow was $2.38 million, primarily reflecting the repurchase of 1,538,602 shares from the Sherman Group. Cash and cash equivalents increased to $11.86 million at December 31, 2012 from $9.42 million at June 30, 2012.
Balance sheet: Total assets were $22.50 million, compared with $31.87 million at June 30, 2012. Current assets were $16.22 million, including $2.20 million of accounts receivable and $0.66 million of inventory. Total liabilities declined to $6.14 million from $12.98 million. Debt consisted principally of $139,134 of short-term bank borrowings, scheduled for extension through March 2013. Stockholders’ equity was $16.37 million.
Material changes versus the prior comparable period
- Six-month sales increased 201.4% year over year, primarily from new products and new U.S. customers. U.S. sales rose 283.6% to $17.02 million and represented 92.0% of six-month sales.
- Second-quarter sales increased 77.8% to $5.36 million. U.S. sales increased 146.1%, while Asia sales decreased 69.1% because a large prior-year M600 module order did not recur.
- Six-month gross margin improved to 21.9% from 16.7%, reflecting customer and product mix, pricing, and product-cost fluctuations.
- Six-month operating results approached breakeven, with a $9,003 operating loss versus a $1.95 million loss in the prior-year period. However, the second quarter remained loss-making because operating expenses increased 45.1% to $2.13 million.
- Research and development expense increased to $1.53 million from $0.93 million for the six-month period. Selling, general, and administrative expense increased to $2.53 million from $2.04 million.
- Accounts receivable declined from $13.07 million at June 30, 2012 to $2.20 million at December 31, 2012, contributing substantially to operating cash flow. Accounts payable also declined from $10.08 million to $3.85 million.
- The company repurchased the Sherman Group’s 1,538,602 shares for $2.83 million, reducing shares outstanding. Treasury stock increased to $4.28 million from $1.87 million.
Outlook, risks, contingencies, and unusual items
- Management expects results 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 quantitative revenue or earnings guidance is provided.
- Customer concentration is significant: two customers represented 43% and 35% of six-month sales, respectively. One customer represented 81% of accounts receivable at December 31, 2012.
- Supplier concentration is also significant. One Asian manufacturer supplied 82.6% of six-month product purchases, with $2.36 million payable to that supplier at period end.
- The company capitalized development, certification, and other intangible costs; net intangible assets were $3.83 million, including $1.05 million of technology in progress. Six-month amortization expense was $658,743.
- C-Motech still owned 1,566,672 shares, or approximately 15% of the company, under an unresolved stock repurchase arrangement. The company has demanded completion of the repurchase but cannot determine whether it will occur; the remaining stated purchase price was $1.63 million.
- Pending legal matters include patent-infringement litigation involving Novatel Wireless and a separate infringement claim against a customer involving a company-supplied device. The company states that the potential loss in the Novatel matter cannot be reasonably estimated and does not believe the other matter will be material.
- Change-of-control agreements could require lump-sum payments of $5 million, $2 million, and $1 million to three executives if specified control events occur. The agreements expire in 2014 and 2015.
- The company reported no off-balance-sheet arrangements and stated that disclosure controls and procedures were effective at period end.
Investor verification points
- Verify whether the sharp sales growth is sustainable or primarily reflects new-product launches, customer additions, and timing of large orders.
- Assess customer and supplier concentration, including the collectability of the major customer receivable and dependence on the primary Asian manufacturer.
- Reconcile operating cash flow with the substantial reductions in receivables, inventory, and accounts payable.
- Monitor the March 2013 maturity or extension of the $139,134 bank borrowing and overall liquidity requirements.
- Review the accounting and potential cash impact of the unresolved C-Motech share repurchase obligation.
- Evaluate whether continued operating losses, higher R&D spending, and intangible-asset capitalization could lead to future impairment or liquidity pressure.
- Review developments in the Novatel patent litigation and other legal proceedings, for which potential exposure is not clearly quantified.