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 filing covers the three months ended September 30, 2016, the first quarter of fiscal 2017, and was filed November 14, 2016.
Key financial metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $12.70 million | $11.95 million | Up 6.3% |
| Gross profit | $2.26 million | $1.96 million | Up 15.2% |
| Gross margin | 17.8% | 16.4% | Up 1.4 percentage points |
| Operating income | $367,472 | $85,562 | Up $281,910 |
| Operating margin | 2.9% | 0.7% | Improved |
| Net income | $193,092 | $37,484 | Up $155,608 |
| Net income attributable to Parent Company | $262,541 | $17,947 | Up $244,594 |
| Diluted EPS | $0.02 | $0.00 | Improved |
| Net cash used in operating activities | $(2.20) million | $(142,595) | Higher use of cash |
Cash and cash equivalents were $10.94 million at September 30, 2016, compared with $13.16 million at June 30, 2016. Total current assets were $25.95 million and total current liabilities were $10.98 million, producing approximately $14.97 million of working capital. Accounts receivable were $12.31 million and inventories were $2.12 million. Total assets were $29.49 million and total stockholders’ equity was $18.51 million.
The filing reports no separate debt balance; liabilities consisted of current accounts payable, customer advances, accrued liabilities, and income taxes payable. Accounts payable declined to $10.58 million from $13.28 million at June 30, 2016. Capital expenditures were minimal, while investing cash use included $82,500 of capitalized product development and $44,161 of intangible asset purchases. Financing cash inflow of $47,100 resulted from stock-option exercises.
Material changes versus the prior comparable period
- U.S. sales increased 23.9% to $12.52 million, primarily due to the launch of a new product with a carrier customer. U.S. sales represented 98.6% of total sales.
- EMEA sales fell 92.6% to $128,103, primarily because of the timing of orders from an African carrier customer. Caribbean and South American sales declined to zero from $93,000.
- Gross margin improved because of changes in customer and product mix, competitive pricing, and product costs.
- Total operating expenses increased 0.9% to $1.89 million. Research and development expense rose to $802,382 from $722,569, partly offset by lower selling, general and administrative expenses.
- Operating cash flow worsened primarily because accounts payable decreased by $2.70 million. Cash declined by $2.22 million during the quarter.
- Amortization expense decreased to $126,483 from $254,346. A $12,500 stock-based compensation credit resulted from reversing previously recorded expense for canceled options.
Guidance, outlook, risks, contingencies, and unusual items
No formal revenue, earnings, or margin guidance was provided. Management stated that future revenue will depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer relationships, and the ability to meet customer requirements. Management believed available capital was sufficient to fund operations and obligations through at least September 30, 2017, but cautioned that failure to achieve the business plan or obtain additional funding could require curtailment of operations.
- Customer concentration is significant: two customers represented 63% and 35% of quarterly sales and 62% and 36% of accounts receivable at September 30, 2016.
- One Asian manufacturer supplied 99% of the Company’s wireless data products purchased during the quarter and accounted for $10.05 million of accounts payable. Delays, capacity constraints, quality issues, or cancellations could materially affect revenue.
- Demand is described as highly unpredictable, creating inventory-obsolescence and excess-inventory risk. The inventory reserve was $90,917.
- The TC Technology patent proceeding against a customer remained pending; the Company did not believe it would have a material effect. Previously disclosed Novatel/NIS and Adaptix matters had been dismissed or settled.
- 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.
- The Company reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and effective disclosure controls as of September 30, 2016.
Important facts for investors to verify
- Whether the new carrier product and customer orders can sustain the increase in U.S. revenue and improved gross margin.
- The collectability and concentration of the $12.31 million accounts receivable balance.
- The Company’s dependence on one manufacturer and the effect of supplier pricing, quality, capacity, or delivery disruptions.
- Whether negative operating cash flow reverses as accounts payable and working-capital balances normalize.
- The adequacy and recoverability of $1.13 million of net intangible assets, $1.73 million of non-current deferred tax assets, and the $90,917 inventory reserve.
- The status and potential exposure of pending or future litigation and the $7 million of disclosed change-of-control obligations.
- The expected effect of pending accounting standards, including inventory, leases, stock compensation, and revenue recognition requirements.