Franklin Wireless Corp. 10-Q Summary
Business Context and Reporting Period
This is a Quarterly Report on Form 10-Q for Franklin Wireless Corp. for the period ended March 31, 2011. The company designs, manufactures, and sells broadband high-speed wireless data communication products, primarily USB modems (3G and 4G). It operates as a smaller reporting company with one reportable segment. As of May 13, 2011, there were 11,727,808 shares of common stock outstanding.
Key Financial Metrics
| Metric | Three Months Ended Mar 31, 2011 | Nine Months Ended Mar 31, 2011 |
|---|---|---|
| Net Sales | $9,440,087 | $41,585,722 |
| Gross Profit | $2,803,075 (29.7% margin) | $13,792,661 (33.2% margin) |
| Net Income | $1,522,554 | $4,680,650 |
| Diluted EPS | $0.13 | $0.40 |
| Cash and Equivalents | $13,438,305 (as of Mar 31, 2011) | |
| Total Debt | $0 (All borrowings paid off) | |
| Operating Cash Flow (9mo) | ($795,999) used |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 70.2% ($22.2M) for the quarter and 32.9% ($20.3M) for the nine months compared to the prior year. This was driven by increased competition in the U.S. dual-mode USB modem market and the completion of a major 4G network rollout by a largest customer in the prior year.
- Margin Expansion: Despite lower revenue, gross profit margins improved significantly (from 13.5% to 29.7% for the quarter). This was due to a higher proportion of products supplied by the company's subsidiary, Franklin Technology Inc. (FTI), rather than third-party suppliers.
- Non-Operating Income: Other income increased substantially due to a $1.87M payment received from C-Motech (a related party), of which $1.58M was booked as other income. This payment settled marketing funds and price disputes.
- Debt Elimination: The company paid off all short-term and long-term borrowings during the period, resulting in zero debt on the balance sheet as of March 31, 2011.
- Geographic Shift: While U.S. sales dropped significantly, sales in the Caribbean and South America increased 277.2% for the quarter and 566.7% for the nine months.
Outlook, Risks, and Contingencies
- Legal Proceedings: The company is defending against a patent infringement lawsuit filed by Novatel Wireless, Inc. regarding mobile data hot spots and modems. A hearing is scheduled for June 6, 2011. A previous lawsuit by MSTG, Inc. was dismissed in February 2011.
- Related Party Dispute: C-Motech failed to complete the repurchase of 1,566,672 shares of common stock by the March 31, 2011 deadline. Franklin Wireless has notified C-Motech of the breach and intends to pursue legal remedies.
- Customer Concentration: The two largest customers accounted for 75% of consolidated revenue for the nine months ended March 31, 2011. The largest single customer accounted for 61% of revenue.
- Liquidity: The company reported a net cash outflow from operating activities of $796,000 for the nine-month period, primarily due to a $3.75M increase in accounts receivable. However, the company maintains $13.4M in cash and believes it can fund operations for the next 12 months.
- Change of Control: Executives have agreements totaling $8 million in potential lump-sum payments upon a change of control.
Investor Verification Checklist
- Verify the status of the pending patent infringement lawsuit with Novatel Wireless and potential financial exposure.
- Confirm the resolution of the breach of contract with C-Motech regarding the share repurchase and the likelihood of recovering the remaining shares or value.
- Assess the sustainability of the improved gross margins given the heavy reliance on the FTI subsidiary and the volatility of the U.S. modem market.
- Monitor the collection of accounts receivable, which increased by $3.75M and represents a significant portion of current assets.
- Review the concentration risk associated with the top two customers representing 75% of revenue.