Franklin Wireless Corp. Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended March 31, 2014, compared with March 31, 2013. The request metadata identifies “2013 Q3,” but the filing itself is for the quarter ended March 31, 2014. Franklin Wireless designs, manufactures and sells 3G and 4G wireless modules and modems through wireless operators, distributors and strategic partners. The company reports one operating segment.
Financial Performance and Position
| Metric | Three months ended March 31, 2014 | Three months ended March 31, 2013 | Nine months ended March 31, 2014 | Nine months ended March 31, 2013 |
|---|---|---|---|---|
| Net sales | $10.1 million | $6.5 million | $19.0 million | $25.0 million |
| Gross profit | $1.0 million | $1.5 million | $3.2 million | $5.5 million |
| Gross margin | 9.8% | 22.3% | 16.8% | 22.0% |
| Operating loss | $(0.8) million | $(0.3) million | $(2.3) million | $(0.3) million |
| Net loss attributable to parent | $(0.1) million | $(0.1) million | $(1.1) million | $(0.03) million |
| Loss per diluted share | $(0.01) | $(0.01) | $(0.11) | $(0.00) |
Quarterly sales increased 54.1%, but gross profit declined 31.9% because of product and customer mix, competitive pricing and product costs. Nine-month sales declined 24.0%, and the gross margin fell to 16.8%. Operating expenses were $1.8 million in the quarter and $5.5 million for the nine-month period.
Other income was $557,881 in the quarter and $699,622 for the nine-month period, primarily reflecting reversals of previously accrued marketing-related expenses and gains on debt extinguishment. These items substantially offset operating losses but were unusual and should not be viewed as recurring operating earnings.
At March 31, 2014, cash and cash equivalents were $9.1 million, compared with $10.4 million at June 30, 2013. Current assets were $19.6 million and current liabilities were $9.6 million, implying working capital of approximately $10.0 million. Accounts receivable were $6.6 million and inventories were $2.2 million, compared with $0.3 million at June 30, 2013. Short-term borrowings were $140,345; the bank loan was extended to March 2015 at an interest rate of 10.55%.
Total assets were $25.1 million and total stockholders’ equity was $15.5 million at March 31, 2014. The company had 10.4 million common shares outstanding and 1.1 million stock options outstanding, of which 799,499 were exercisable.
Cash Flow and Liquidity
- Net cash used in operating activities was $680,779 for the nine months ended March 31, 2014, compared with $5.1 million provided in the prior-year period.
- Operating cash flow was pressured by increases of $1.2 million in accounts receivable and $1.9 million in inventory, partially offset by a $3.7 million increase in accounts payable.
- Investing cash outflow was $558,077, including $521,068 of capitalized product development costs and $111,681 of property and equipment purchases.
- Financing activities provided $17,361, primarily from stock-option exercises. The prior-year period included $2.4 million of common-stock repurchases.
- Cash decreased by $1.3 million during the nine months to $9.1 million. Management stated that available capital should fund existing operations and obligations through at least March 31, 2015, but cautioned that failure to achieve the business plan or obtain additional funding could require curtailment of operations.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue growth was driven by Asia and new EMEA sales, while U.S. sales declined 15.8% and South American and Caribbean sales declined 96.0%.
- Nine-month U.S. sales fell 56.1%, partly because of lower USB modem demand, order timing, discontinuation of a chipset and the absence of repeat purchases from a major customer.
- Asia revenue increased 443.6% for the nine-month period, and EMEA generated $2.1 million of sales versus none in the prior-year period. Management noted that FTI product and component sales vary substantially by period.
- Operating expenses declined 4.5% for the nine-month period, while research and development expense declined modestly to $2.1 million.
- Inventory increased materially to $2.2 million, and accounts payable increased to $7.8 million from $4.2 million at June 30, 2013.
- Intangible assets declined to $2.6 million from $3.1 million after $952,215 of nine-month amortization. The company reported no goodwill or long-lived asset impairment.
Outlook, Risks, Contingencies and Unusual Items
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 requirements. The filing provides no quantitative revenue or earnings guidance.
- Customer concentration is significant: the three largest customers represented 32%, 16% and 11% of nine-month sales. Those customers represented 56%, 15% and 1% of accounts receivable at March 31, 2014.
- Three Asian manufacturers supplied 71% of purchases during the nine-month period, creating exposure to delays, capacity constraints and quality problems.
- The company has ongoing patent litigation with Novatel Wireless and Concinnitas. The filing states that a loss related to the Novatel matter cannot currently be reasonably estimated and that the Concinnitas matter is not expected to have a material effect.
- A dispute with C-Motech concerns the uncompleted repurchase of 1,566,672 shares, representing approximately 15% of Franklin Wireless’s outstanding common stock, for an agreed balance of $1,626,935. The matter is being litigated in U.S. and Korean courts; an early neutral evaluation conference was scheduled for June 4, 2014.
- Change-of-control agreements could require aggregate payments of up to $8 million to three executives, subject to triggering events. Two agreements expire September 21, 2014, and the third expires September 21, 2015.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The company stated that there were no material changes to previously disclosed risk factors.
Investor Verification Priorities
- Verify whether the quarterly sales increase is sustainable, particularly the concentration of growth in Asia and new EMEA customers.
- Assess the causes and durability of the sharp gross-margin decline and the effect of product mix, pricing and component costs.
- Monitor working-capital requirements, inventory growth, accounts receivable collections and the shift from positive to negative operating cash flow.
- Separate recurring operating performance from the $602,481 nine-month gain on debt extinguishment and marketing-related accrual reversals.
- Review customer and supplier concentration, including the three largest customers and the three major Asian manufacturers.
- Track the C-Motech stock-repurchase dispute, patent litigation and any resulting cash, equity or liability exposure.
- Confirm management’s stated liquidity runway through March 31, 2015 against future operating losses, product-development spending and debt obligations.