Franklin Wireless Corp. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2021, compared primarily with fiscal 2020. The supplied filing is not a 2020 Q4 report; it is the fiscal 2021 annual report filed September 28, 2021.
Business Context
Franklin Wireless provides 5G/4G mobile hotspots, customer-premises equipment, routers, tracking devices, connected-car products, and related IoT, M2M, and mobile-device-management solutions. Products are sold primarily to wireless operators, strategic partners, and distributors. The company has one reportable segment and owns 66.3% of Franklin Technology Inc. in South Korea, which provides product-development services.
North America represented 99.8% of fiscal 2021 sales. Manufacturing is primarily outsourced to two Asian suppliers, which accounted for 99% of product purchases during the year.
Financial Performance and Liquidity
| Metric | FY2021 | FY2020 | Change |
|---|---|---|---|
| Net sales | $184.1 million | $75.1 million | +145.3% |
| Gross profit | $32.5 million | $14.5 million | +123.5% |
| Gross margin | 17.6% | 19.3% | Down 1.7 percentage points |
| Income from operations | $22.8 million | $7.1 million | +222.4% |
| Net income | $18.4 million | $5.9 million | +210.5% |
| Net income attributable to parent | $17.7 million | $5.6 million | +218.9% |
| Basic diluted EPS | $1.56 / $1.53 | $0.52 / $0.52 | Substantial increase |
| Operating cash flow | $12.1 million | $22.0 million | Down $9.9 million |
Revenue growth was driven by increased demand for wireless connectivity during the COVID-19 remote-work and remote-learning period, including high-volume school-district orders, and the timing of carrier orders. The two largest customers represented 63% and 30% of consolidated sales, respectively.
Cost of goods sold was $151.7 million, or 82.4% of sales, compared with 80.7% in fiscal 2020. Management attributed the lower gross margin to competitive pricing and higher production costs. Operating expenses increased 29.5% to $9.6 million, including $5.1 million of selling, general and administrative expense and $4.6 million of research and development expense.
Other income included a $487,300 gain from forgiveness of the Paycheck Protection Program loan and $147,166 of governmental subsidy income. Income tax expense increased to $5.0 million from $1.4 million.
Cash and cash equivalents were $45.8 million at June 30, 2021, and certificates of deposit were $5.4 million, for total stated liquidity of $51.2 million. Accounts receivable declined to $2.5 million from $16.0 million, and inventories declined to $1.0 million from $11.8 million. Total liabilities were $11.6 million, including $0.8 million of lease liabilities; the PPP loan was fully forgiven and no longer outstanding. Total equity was $46.2 million.
Investing cash outflows were $0.7 million, primarily for $0.7 million of capitalized product development. Financing cash inflows were $6.1 million, primarily from the issuance of 923,078 treasury shares for $6.0 million and stock-option exercises.
Material Changes Versus the Prior Comparable Period
- Sales increased by $109.0 million, principally from North American wireless-access demand associated with remote learning and remote work.
- Gross profit increased, but gross margin declined from 19.3% to 17.6% because of pricing pressure and higher manufacturing costs.
- Operating income increased to $22.8 million from $7.1 million, while operating expenses rose more slowly than revenue.
- Operating cash flow decreased despite higher earnings, primarily because fiscal 2020 benefited from a $36.4 million increase in accounts payable, whereas fiscal 2021 included a $32.4 million decrease.
- Accounts receivable, inventory, and accounts payable all declined materially as the company converted working capital and reduced supplier balances.
- Common shares outstanding increased to 11.6 million from 10.6 million, primarily due to the sale of treasury stock and option exercises.
- Capitalized product-development costs in progress increased to $602,388 from $140,192. The company disposed of $140,192 of technology in progress after concluding that its economic prospects were limited.
Guidance, Outlook, Risks, and Unusual Items
Management stated that available capital was expected to fund existing operations and obligations through at least June 30, 2022. The company expected to require more than $5 million over the following twelve months for capital expenditures, software licenses, and testing and certification of new products. No specific revenue or earnings guidance was provided.
Management identified customer retention, demand for wireless-data products, acceptance of new products, new customer relationships, and the ability to meet customer demand as key factors affecting future results. The company stated that additional debt or equity financing could be required if operating cash flow is insufficient to support expansion and working-capital needs.
- Customer concentration: Two customers generated 93% of fiscal 2021 sales. Customer agreements do not require minimum purchase volumes.
- Verizon Jetpack recall: Verizon announced a voluntary recall of approximately 2.5 million Ellipsis Jetpack devices because of alleged lithium-ion battery overheating. Franklin had not reproduced the reported failures and had not been able to estimate potential recall, litigation, indemnification, or future-business costs.
- Litigation: The company disclosed shareholder litigation relating to alleged nondisclosure of recall information and a July 2021 action alleging short-swing profits involving the company’s president. Management intended to vigorously defend both matters.
- Anydata contingency: Anydata may not fulfill a minimum purchase commitment, and Franklin stated that a potential loss related to inventory and supplier commitments was reasonably possible but not estimable. Franklin commenced legal action against Anydata and its principal officers in January 2021.
- Supply-chain concentration: Two Asian manufacturers supplied 99% of product purchases. Delays, capacity constraints, quality issues, or shipping disruptions could materially affect sales.
- COVID-19 exposure: Pandemic-related demand may decline as remote learning and remote work normalize, while supply-chain and manufacturing disruptions may continue.
- Technology and market risk: The business operates in a rapidly changing and competitive telecommunications market and depends on timely product development, regulatory certification, and market acceptance.
- Change-of-control obligations: Agreements provide potential payments of $5 million to the president and $2 million to the chief operating officer upon a qualifying change of control.
Important Facts for Investors to Verify
- Whether the unusually strong fiscal 2021 demand was temporary and how post-pandemic demand affected subsequent revenue and margins.
- The status, ultimate cost, insurance coverage, and customer consequences of the Verizon Jetpack recall.
- The identity and ongoing purchase commitments of the two customers representing 93% of fiscal 2021 sales.
- The outcome and potential financial exposure from the shareholder, short-swing-profit, and Anydata proceedings.
- Whether gross-margin pressure from competitive pricing, production costs, and supplier concentration persists.
- Whether operating cash flow remains sufficient to fund more than $5 million of planned near-term product-development and certification spending.
- The filing’s stated effective internal controls and unqualified financial-statement and internal-control audit opinions, while separately evaluating the revenue-recognition judgments identified as a critical audit matter.