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 owns 51.8% of Franklin Technology Inc. (“FTI”), a South Korean research and development subsidiary; the remaining 48.2% is held by non-controlling interests.
The filing covers the three and six months ended December 31, 2015, compared with the corresponding periods ended December 31, 2014. The filing date was February 16, 2016. The Company is a smaller reporting company and identified itself as a shell company.
Key financial metrics
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 |
|---|---|---|
| Net sales | $20.2 million | $32.1 million |
| Gross profit | $3.2 million; 15.7% margin | $5.1 million; 16.0% margin |
| Income from operations | $1.1 million; 5.5% margin | $1.2 million; 3.8% margin |
| Net income | $1.0 million | $1.0 million |
| Net income attributable to parent | $617,219; $0.06 diluted EPS | $635,166; $0.06 diluted EPS |
| Net cash provided by operating activities | Not separately provided | $3.9 million |
At December 31, 2015, cash and cash equivalents were $14.7 million, accounts receivable were $14.9 million, inventories were $4.6 million, and total current assets were $34.7 million. Current liabilities were $21.4 million, producing reported working capital of approximately $13.2 million.
Total debt consisted primarily of a $148,295 short-term borrowing related to FTI, with principal due in March 2016. Total liabilities were $21.4 million and stockholders’ equity was $17.0 million. The Company repurchased 130,000 common shares for $234,000 during the six months.
Material changes versus the prior comparable periods
- Three-month net sales increased 61.4% to $20.2 million from $12.5 million. Six-month sales increased 23.0% to $32.1 million from $26.1 million.
- Sales growth was concentrated in the United States and EMEA, primarily due to higher demand from carrier customers. Six-month U.S. sales rose 29.1%, while EMEA sales increased 375.7%.
- Sales in the Caribbean and South America and Asia declined substantially, reflecting order timing and lower product and component sales generated by FTI.
- Gross profit increased, but gross margin declined to 15.7% from 19.9% for the quarter and to 16.0% from 18.4% for the six-month period. Management attributed the margin pressure to customer and product mix, competitive pricing, and product costs.
- Six-month operating expenses decreased 5.3% to $3.9 million, while quarterly operating expenses increased 4.3% to $2.1 million. Quarterly expenses reflected higher shipping, handling, rent, and other costs associated with increased shipment volume.
- Six-month net income attributable to the parent declined to $635,166 from $707,628 despite higher sales. The comparison was affected by $383,663 of other income in the prior-year period versus a $14,520 other loss in the current period, primarily because prior-period marketing-related accruals expired or were reversed.
- Operating cash flow remained broadly stable at $3.9 million in both six-month periods. Current-period cash generation was supported by a $13.3 million increase in accounts payable and a $1.1 million recovery of prepaid income taxes, partly offset by increases of $9.5 million in receivables and $2.3 million in inventory.
- Investing cash use increased to $822,683 from $110,908, primarily due to $603,577 of capitalized product development costs and $177,382 of intangible asset purchases.
- Capitalized product development costs increased from zero at June 30, 2015 to $603,577 at December 31, 2015. Total intangible assets increased to $1.3 million from $1.0 million.
Guidance, outlook, risks, contingencies, and unusual items
Management did not provide quantitative revenue or earnings guidance. Management stated that future revenue will depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer relationships and contracts, and the ability to meet customer demand. Management believed available capital was sufficient to fund operations and obligations through at least December 31, 2016, but stated that failure to achieve the business plan or obtain additional funding could require curtailment of operations.
- Customer concentration is significant: two customers represented 78.2% and 19.4% of six-month sales, and 94.6% and 0.6% of accounts receivable at December 31, 2015.
- One Asian manufacturer supplied 98.9% of purchases during the six months and accounted for $19.5 million of accounts payable. Delays, capacity constraints, or quality issues could affect shipments and revenue.
- Inventory demand is described as highly unpredictable. The Company maintained a $120,867 reserve for obsolete or slow-moving inventory.
- The Company entered a new four-year San Diego office lease beginning October 28, 2015, at monthly rent of $23,115 plus certain common-area costs. FTI also maintains Seoul leases through September 2017.
- The C-Motech dispute remains subject to litigation and a South Korean bankruptcy proceeding. Ownership of the remaining 1,566,672 shares under the historical repurchase arrangement was transferred to two claimants in September 2015; the Company repurchased 130,000 shares from one claimant on December 30, 2015.
- Novatel and related patent litigation was dismissed with prejudice following settlement agreements in October 2015. An Adaptix patent action against a customer involving one Company device remained pending, although management did not believe it would materially affect the Company.
- Change-of-control agreements with the President and Chief Operating Officer provide potential payments of $5 million and $2 million, respectively, and were extended through September 21, 2017.
- Management reported effective disclosure controls, no material changes in internal control over financial reporting, and no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether sales growth from the concentrated U.S. and EMEA carrier customers is recurring or primarily reflects order timing.
- Whether gross margins can recover from the 2015 decline and how pricing, product mix, and supplier costs are trending.
- Collection of the $14.9 million accounts receivable balance and the sustainability of cash flow, which was materially supported by increased accounts payable.
- Inventory turnover and the adequacy of the $120,867 obsolescence reserve.
- Dependence on one manufacturer representing 98.9% of purchases and the associated $19.5 million payable concentration.
- Completion and commercial benefits of the $603,577 capitalized product development program.
- Resolution and potential financial impact of the C-Motech proceedings, remaining share claims, Adaptix matter, and change-of-control obligations.
- Repayment or refinancing of the $148,295 FTI borrowing due in March 2016.