Franklin Wireless Corp. — Form 10-Q Summary
Business Context and Reporting Period
Franklin Wireless provides wireless access products, including mobile hotspots, routers, modems, and hardware and software supporting machine-to-machine and Internet of Things applications. The company operates one reportable segment and holds a 51.8% controlling interest in Franklin Technology Inc. of South Korea.
This filing covers the three months ended September 30, 2017, compared with the three months ended September 30, 2016. The interim financial statements are unaudited and prepared under U.S. GAAP.
Financial Results and Position
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $7.645 million | $12.704 million |
| Gross profit | $1.450 million | $2.261 million |
| Gross margin | 19.0% | 17.8% |
| Operating income (loss) | ($0.623 million) | $0.367 million |
| Net income (loss) | ($0.428 million) | $0.193 million |
| Net income (loss) attributable to parent | ($0.437 million) | $0.263 million |
| Parent diluted EPS | ($0.04) | $0.02 |
| Net cash used in operating activities | ($2.288 million) | ($2.200 million) |
- Operating expenses rose 9.5% to $2.074 million, including research and development expense of $0.947 million and selling, general and administrative expense of $1.127 million.
- Cash and cash equivalents were $11.755 million at September 30, 2017, compared with $14.285 million at June 30, 2017.
- Total assets were $24.811 million and total liabilities were $6.121 million at September 30, 2017.
- The filing presents no borrowings or other debt balances; total liabilities consisted of current liabilities.
- Accounts receivable were $7.250 million and inventories were $1.935 million at September 30, 2017.
- Investing cash outflows were $0.252 million, primarily for capitalized product development and intangible assets. There were no financing cash flows.
- Management stated that available capital was sufficient to fund existing operations and obligations for at least one year from the filing date, subject to execution of the business plan.
Material Changes Versus the Prior Comparable Period
- Net sales declined $5.060 million, or 39.8%, primarily because of lower product demand from two U.S. carrier customers. U.S. sales decreased 42.0% and represented 95.0% of total sales.
- Gross profit decreased 35.9% in dollars, but gross margin improved by 1.2 percentage points because of customer and product mix, pricing, and product-cost variations.
- The company moved from operating income of $0.367 million to an operating loss of $0.623 million as lower gross profit was combined with higher operating expenses.
- Research and development expense increased approximately 18.0%, primarily from headcount and payroll growth. Selling, general and administrative expense increased approximately 3.2%.
- Other income increased to $58,878 from a $39,258 loss, primarily because Franklin Technology received product-development funding from a government entity.
- Operating cash use increased to $2.288 million. The principal working-capital uses were a $7.077 million decrease in accounts payable, partially offset by collections of accounts receivable and reductions in inventory.
- Accounts payable declined to $5.786 million from $12.863 million at June 30, 2017, while total equity declined to $18.690 million from $19.109 million, primarily reflecting the quarterly loss.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- No quantitative revenue or earnings guidance was provided. Management identified existing-customer retention, wireless-data demand, new-product acceptance, new customer relationships, and the ability to meet customer demand as key operating drivers.
- Management warned that failure to achieve the current business plan or obtain additional funding, if needed, could require curtailing operations or taking actions outside the ordinary course of business.
- Customer concentration is significant: two customers represented 65% and 19% of quarterly sales and 67% and 20% of accounts receivable at September 30, 2017.
- A single Asian manufacturer supplied 84% of product purchases during the quarter and represented $4.542 million of accounts payable. Delays, capacity constraints, or quality problems could disrupt shipments and revenue.
- Inventory demand is described as highly unpredictable. The company maintained an inventory reserve of $143,173 for obsolete or slow-moving inventory.
- Change-of-control agreements provide potential lump-sum payments of $5 million to the president and $2 million to the chief operating officer; the agreements were extended through September 21, 2020.
- Operating leases include San Diego office space through October 2019 and Seoul facilities extended through September 2019. The Seoul corporate housing lease was extended through September 2018.
- Management reported no material change in previously disclosed risk factors, no material litigation outcome, no off-balance-sheet arrangements, and effective disclosure controls as of September 30, 2017.
- The company adopted the revised inventory measurement standard prospectively and did not expect a material impact. It was evaluating the future effects of the lease and revenue-recognition standards.
Important Facts for Investors to Verify
- Whether sales recover from the two major U.S. carrier customers and whether customer concentration remains elevated.
- Whether gross-margin improvement is sustainable or primarily reflects temporary product and customer mix.
- Whether operating cash flow turns positive after the substantial reduction in accounts payable.
- The company’s ability to fund continued product development while reporting losses and negative operating cash flow.
- Reliance on one primary Asian manufacturer and the related supply-chain and payable exposure.
- The realization of the $1.798 million non-current deferred tax asset and the company’s continuing tax benefits.
- Potential obligations under the $7 million aggregate change-of-control agreements and ongoing lease commitments.