Franklin Wireless Corp. — Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended March 31, 2021, compared with March 31, 2020. Although the request identifies “2020 Q3,” the filing is for Franklin Wireless’s fiscal third quarter of 2021. The financial statements are unaudited. Franklin Wireless provides wireless connectivity products, including mobile hotspots, routers, trackers, and 4G/5G IoT and M2M devices. It owns 66.3% of Franklin Technology Inc. in South Korea.
Key Financial Metrics
| Metric | Three months ended March 31, 2021 | Three months ended March 31, 2020 | Nine months ended March 31, 2021 | Nine months ended March 31, 2020 |
|---|---|---|---|---|
| Net sales | $44.3 million | $15.5 million | $173.1 million | $37.7 million |
| Gross profit | $7.6 million | $3.0 million | $30.5 million | $7.6 million |
| Gross margin | 17.1% | 19.5% | 17.6% | 20.3% |
| Income from operations | $5.2 million | $1.2 million | $23.1 million | $2.3 million |
| Net income | $4.2 million | $1.1 million | $18.4 million | $2.1 million |
| Net income attributable to parent | $3.9 million | $1.0 million | $17.7 million | $1.8 million |
| Diluted earnings per share | $0.33 | $0.09 | $1.54 | $0.17 |
Quarterly sales increased 185.2% and nine-month sales increased 359.5%. Quarterly operating income increased approximately 331%, while nine-month operating income increased approximately 912%. Parent-company net income increased approximately 299% for the quarter and 872% year to date. Results benefited primarily from demand for wireless connectivity associated with remote work and schooling, a newly launched product, and the timing of carrier orders.
Margins declined despite substantial profit growth. Gross margin fell 2.4 percentage points in the quarter and 2.7 percentage points year to date, primarily because of competitive pricing and higher production costs. Operating expenses increased 28.2% in the quarter and 38.0% year to date, reflecting higher research and development, payroll, shipping, bad-debt, and stock-compensation costs.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $54.4 million at March 31, 2021, compared with $28.2 million at June 30, 2020.
- Certificates of deposit were $5.4 million, producing cash and short-term investments of $59.7 million.
- Net cash provided by operating activities was $20.5 million for the nine months ended March 31, 2021, compared with $1.9 million in the prior-year period.
- Operating cash flow benefited from net income, a $10.4 million inventory reduction, a $2.5 million accounts-receivable reduction, and a $2.3 million increase in income taxes payable, partly offset by a $14.2 million decrease in accounts payable.
- Investing activities used $0.6 million, primarily for capitalized product development. Financing activities provided $6.1 million, including $6.0 million from the sale of 923,078 treasury shares and $74,750 from option exercises.
- Total assets were $78.0 million and total stockholders’ equity was $46.1 million at March 31, 2021, compared with $65.4 million and $21.1 million, respectively, at June 30, 2020.
- Total liabilities were $31.9 million. The Payroll Protection Plan loan balance was zero after forgiveness of the $487,300 loan. Remaining lease liabilities totaled approximately $0.9 million; the filing reports no other material funded debt.
- Management believes available capital is sufficient to fund existing operations and obligations for at least one year from the filing date, although future requirements depend on sales, margins, product development, market acceptance, expansion, and cost control.
Material Changes Versus the Prior Comparable Period
- North American sales accounted for 99.4% of quarterly revenue and 99.8% of nine-month revenue. The company attributed the increase to remote-work and remote-school demand, new products, and carrier order timing.
- Revenue concentration increased: for the nine months ended March 31, 2021, two customers represented 61% and 32% of consolidated sales. One customer represented 96% of accounts receivable at March 31, 2021.
- Manufacturing concentration increased in importance. Two Asian manufacturers represented 99% of product purchases, totaling approximately $130.3 million, and related accounts payable were $27.3 million.
- Inventory declined to $1.4 million from $11.8 million, and the recorded inventory reserve declined to zero from $399,437.
- Accounts payable declined to $27.9 million from $42.1 million, while income tax payable increased to $2.3 million from $34,713.
- Common shares outstanding increased to 11.6 million from 10.6 million, primarily reflecting treasury-share sales and option exercises.
- Research and development costs increased to $3.3 million from $2.8 million for the nine-month period. The company also recorded $282,116 of stock-based compensation year to date.
Outlook, Risks, Contingencies, and Unusual Items
The filing provides no quantitative revenue, earnings, or margin 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 cautions that interim results are not necessarily indicative of full-year results.
- Verizon Jetpack recall: Verizon announced a voluntary recall involving approximately 2.5 million Ellipsis Jetpack devices because of alleged lithium-ion battery overheating risks. Franklin stated that it had not reproduced the reported failures and could not estimate the number of returns, investigation costs, defense costs, or overall financial impact. Shareholder litigation has also been filed alleging inadequate disclosure.
- Anydata dispute: The company has a remaining purchase-commitment issue involving Anydata and inventory ordered from Quanta. Franklin commenced legal action in January 2021 and stated that a loss remains reasonably possible but is not estimable.
- Customer and supplier concentration: The loss of a major carrier customer, delays or quality problems at Asian manufacturers, or cancellation of orders could materially reduce revenue and cash flow.
- COVID-19 and supply chain: The company remained an essential business but reported operating reductions and telecommuting. Future pandemic-related disruption could affect third-party manufacturing and product supply; the impact was not reasonably estimable.
- Change-of-control obligations: Agreements entered into with the president and chief operating officer provide potential lump-sum payments of $5.0 million and $2.0 million, respectively, upon specified change-of-control events.
- Tariffs and indemnification: Products are currently believed to be exempt from U.S. import tariffs, but potential tariffs of 10% to 25% could materially affect results. Customer contracts may also require intellectual-property indemnification without corresponding recourse.
- Unusual income: Year-to-date other income included a $487,300 gain from forgiveness of the PPP loan and $107,362 of government subsidy income, making the comparison with the prior year less representative of recurring performance.
- The company reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and no material expected adverse outcome from ordinary-course litigation apart from the matters described above.
Investor Verification Points
- Verify the sustainability of the sharp sales increase and the extent to which it reflects temporary pandemic demand, new-product launches, and carrier order timing.
- Assess customer concentration, particularly the customer representing approximately 61% of year-to-date sales and 96% of receivables.
- Monitor gross-margin pressure from competitive pricing and higher production costs.
- Follow the Verizon recall investigation, potential product returns, shareholder litigation, and any required accruals or insurance recoveries.
- Evaluate manufacturing concentration, supply-chain capacity, product quality, and exposure to potential tariffs.
- Separate recurring operating earnings and cash generation from the nonrecurring PPP-loan forgiveness and government subsidy income.
- Review the Anydata litigation and related Quanta purchase commitment for potential future losses.
- Confirm future working-capital needs, lease obligations, change-of-control payments, and the company’s ability to maintain liquidity without additional financing.