Business context and reporting period
Franchise Holdings International, Inc. (FNHI), whose wholly owned subsidiary is Worksport, Ltd., filed this unaudited Form 10-Q for the quarter ended June 30, 2018. Worksport sells truck bed covers, principally in the United States and Canada. The filing identifies FNHI as a smaller reporting company and indicates it had not filed all required reports during the preceding 12 months.
Financial results and liquidity
- Revenue: The financial statements report second-quarter net sales of $143,281 versus $68,484 in 2017; first-half net sales were $294,159 versus $169,747.
- Profitability: Statement-reported gross profit was $32,215 for the quarter and $43,156 for the first half. Net losses were $288,242 and $979,688, respectively, compared with $1,103,382 and $3,056,800 in the prior-year periods. First-half operating expenses were $499,361, including $395,605 in professional fees.
- Cash flow: First-half operating cash flow was positive $22,730, versus negative $31,206 in 2017. There was no investing or financing cash flow in the 2018 first half. Cash increased from $66,961 at year-end to $77,130 at June 30.
- Liquidity and debt: Current assets were $783,091 and current liabilities $639,426, including $275,844 of current notes payable and a $22,211 related-party loan. Working capital was $143,665. Accounts payable and accrued liabilities were $336,473.
- Equity and shares: Shareholders’ equity declined to $197,313 from $371,531, with an accumulated deficit of $9,570,917. The balance sheet reports 128,271,689 common shares outstanding at June 30; the filing reports 140,771,669 outstanding as of August 20, 2018.
Changes versus prior period
- Statement-reported sales increased about 109% in the second quarter and 73% in the first half year over year. Management attributes growth primarily to U.S. private-label orders and Canadian distributor sales, but says inventory shortages constrained dealer sales.
- First-half operating expenses were substantially lower than in 2017, when general and administrative expense included $1.36 million of expense for shares issued to the CEO. Professional fees rose considerably in 2018, which management links primarily to consulting services paid for with shares.
- Management says shipping costs and promotions pressured margins. Freight costs were $83,919 in the first half of 2018 versus $13,980 in 2017.
Outlook, risks, and unusual items
- Going concern: Management states that the first-half loss and accumulated deficit raise substantial doubt about the company’s ability to continue as a going concern. It may need additional financing, with no assurance that funding will be available on acceptable terms.
- Equity-settled agreements: FNHI recorded a $495,943 loss on a debt settlement tied to an agreement to issue 50 million shares in exchange for assumption of $154,057 of accounts payable. It also recorded consulting and public-relations expenses payable in shares. The filing says 12.5 million shares under share-payable agreements were issued in July 2018.
- Customer and operating risks: The filing identifies three customers with reported sales concentration percentages of 41%, 30%, and 14%, and warns that losing key customers could adversely affect the business. Inventory shortages, shipping costs, foreign-currency translation, and reliance on additional financing are also risks.
- Controls and compliance: Management states that disclosure controls were ineffective as of June 30 because of limited staffing, lack of segregation of duties, and no formal audit committee with a financial expert. A later statement in the filing says the controls were effective at a reasonable assurance level, creating an internal inconsistency. The filing also marks “No” for having filed all required reports on time during the preceding 12 months.
- The filing provides no quantified revenue or earnings guidance. It states that there were no material legal proceedings, defaults on senior securities, or off-balance-sheet arrangements.
Important facts to verify
- Reconcile revenue: the financial statements report $143,281 for the quarter and $294,159 for the first half, while MD&A reports $160,983 and $295,988.
- Reconcile net loss: the financial statements report $288,242 for the quarter and $979,688 for the first half; MD&A reports $270,242 and $961,688.
- Check related MD&A inconsistencies in second-quarter operating expenses and gross-margin descriptions against the financial statements and underlying records.
- Verify the status, terms, and dilution impact of the share-settlement, consulting, and public-relations agreements, including the July share issuance and the August share count.
- Assess near-term funding needs, debt repayment obligations, inventory availability, customer concentration, and remediation of ineffective controls.