Franklin Wireless Corp. — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three and six months ended December 31, 2022, corresponding to the company’s fiscal second quarter and first six months of fiscal 2023, despite the request metadata identifying “2022 Q2.” Franklin Wireless provides 4G LTE and 5G wireless products, including mobile hotspots, routers, customer-premise equipment and trackers, together with related device-management and networking software. Franklin Technology Inc., a 66.3%-owned South Korean subsidiary, conducts product design and development.
Financial performance and position
| Metric | Three months ended Dec. 31, 2022 | Three months ended Dec. 31, 2021 | Six months ended Dec. 31, 2022 | Six months ended Dec. 31, 2021 |
|---|---|---|---|---|
| Net sales | $8.98 million | $1.82 million | $17.09 million | $5.17 million |
| Gross profit | $946 thousand | $364 thousand | $2.54 million | $857 thousand |
| Gross margin | 10.5% | 20.0% | 14.9% | 16.6% |
| Operating loss | $(1.37) million | $(1.77) million | $(1.98) million | $(3.37) million |
| Net loss | $(84) thousand | $(1.16) million | $(1.51) million | $(2.22) million |
| Loss attributable to parent | $(378) thousand | $(1.19) million | $(1.51) million | $(2.29) million |
| Loss per share | $(0.03) | $(0.10) | $(0.13) | $(0.20) |
For the six months ended December 31, 2022, operating expenses were $4.52 million, including $2.58 million of selling, general and administrative expense and $1.95 million of research and development expense. Other income was $1.40 million in the second quarter and $487 thousand for the six-month period. The second-quarter result included a $1.07 million foreign-currency gain and a $165 thousand gain from forgiveness of liabilities.
Operating cash flow was negative $7.19 million for the six months ended December 31, 2022, compared with negative $8.44 million in the prior-year period. Investing cash flow was negative $1.39 million, principally reflecting $1.05 million of capitalized product-development costs and $294 thousand of short-term investment purchases. Financing cash flow was positive $134 thousand from stock-option exercises. Cash and cash equivalents declined to $17.90 million from $26.28 million at June 30, 2022.
Short-term investments were $16.63 million, resulting in cash and short-term investments of $34.53 million. Accounts receivable increased to $8.07 million from $1.32 million, and inventories increased to $7.39 million from $4.20 million. Total assets were $54.65 million and total stockholders’ equity was $41.66 million at December 31, 2022.
The filing reports no borrowings or conventional debt. Current lease liabilities were $315 thousand, with no non-current lease liability reported at December 31, 2022. Management stated that available capital should fund existing operations and obligations for at least one year from the filing date, while noting that failure to achieve the business plan or obtain additional funding could require curtailment of operations.
Material changes versus the prior comparable period
- Second-quarter sales increased 393.2% year over year, and six-month sales increased 230.9%, primarily from demand for two newly launched products purchased by two major North American carrier customers.
- North America represented 99.6% of second-quarter sales and 99.8% of six-month sales, compared with 70.5% and 86.3%, respectively, in the comparable 2021 periods.
- Gross margin declined to 10.5% in the quarter and 14.9% for six months, driven by product mix, competitive pricing and higher production costs. Management stated that one new product represented approximately 58% of quarterly sales and had cost of goods sold of approximately 93% of revenue.
- The quarterly loss attributable to the parent improved to $378 thousand from $1.19 million, aided materially by foreign-currency gains and forgiven liabilities. The six-month loss attributable to the parent improved to $1.51 million from $2.29 million.
- Accounts receivable and inventories increased substantially, producing significant operating cash use despite improved reported sales.
- Stock-option exercises increased common shares outstanding to 11,784,280 at December 31, 2022 from 11,684,280 at June 30, 2022. There were 650,001 options outstanding at quarter-end.
Guidance, outlook, risks and unusual items
The company did not provide numerical revenue or earnings guidance. 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. Management also expects new customer relationships to require additional selling, marketing and operating resources.
- Customer concentration is significant: one customer accounted for 83% of six-month sales and 63% of accounts receivable at December 31, 2022.
- Three Asian manufacturers supplied 99% of product purchases during the six months ended December 31, 2022; related accounts payable to those manufacturers was $11.15 million.
- The company maintains an inventory reserve of $557 thousand for obsolete or slow-moving inventory and warns that customer demand is unpredictable.
- Pending matters include litigation related to the Verizon Jetpack recall, shareholder and derivative actions, a short-swing-profit action, the Anydata purchase-commitment dispute, and a patent-infringement suit filed by Aperture Net in November 2022. No liabilities were recorded because management believes the matters are not probable and reasonably estimable, although the Anydata matter presents a reasonable possibility of loss with an amount that is not estimable.
- Change-of-control agreements provide for payments of $5 million to the president and $2 million to the chief operating officer. An amended employment agreement with the president provides for specified severance payments of $3 million or $1.5 million depending on the circumstances, accelerated vesting of unvested options, and a $125 thousand quarterly incentive bonus during the remaining term.
- Potential future tariffs of 10% to 25% on imported products could materially affect sales and operating results. The company also identifies manufacturing disruptions, customer concentration, foreign-exchange movements, product acceptance, intellectual-property claims and infectious-disease outbreaks as risks.
- The filing states that disclosure controls were effective as of December 31, 2022 and that there were no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the unusually strong sales growth from two new products and two major carrier customers is recurring and whether volumes can improve the reported gross margin.
- The collectability and timing of the $8.07 million accounts receivable balance and the conversion of $7.39 million of inventory into cash.
- The sustainability of liquidity after the $7.19 million six-month operating cash outflow.
- Customer and supplier concentration, including the 83% sales concentration and 99% reliance on three Asian manufacturers.
- Potential financial exposure from the Verizon recall, related shareholder litigation, the Anydata dispute and the Aperture Net patent case.
- The effect of the president’s severance, incentive and change-of-control arrangements on future cash requirements.
- Whether foreign-currency gains and liability forgiveness materially affected the quarter and should be excluded when assessing underlying operating performance.