Franklin Wireless Corp. — Form 10-Q Summary
Business Context and Reporting Period
Franklin Wireless provides mobile hotspots, routers, modems, and hardware and software solutions for machine-to-machine and Internet of Things applications. The company also owns 51.8% of Franklin Technology Inc. (FTI), a South Korean research and development subsidiary. This Form 10-Q covers the three months ended September 30, 2018, the first quarter of fiscal 2019, with comparisons to the three months ended September 30, 2017.
Financial Performance and Position
| Metric | Three months ended September 30, 2018 | Three months ended September 30, 2017 |
|---|---|---|
| Net sales | $13.329 million | $7.645 million |
| Gross profit | $2.173 million | $1.450 million |
| Gross margin | 16.3% | 19.0% |
| Operating income (loss) | $0.112 million | $(0.623) million |
| Net income (loss) | $0.123 million | $(0.428) million |
| Net income (loss) attributable to parent | $0.179 million | $(0.437) million |
| Basic and diluted EPS | $0.02 | $(0.04) |
| Net cash provided by (used in) operating activities | $4.861 million | $(2.288) million |
- Net sales increased 74.4%, primarily from substantially higher demand from four U.S. customers. U.S. sales represented 99.9% of total sales.
- Cost of goods sold was $11.156 million, or 83.7% of sales, versus 81.0% in the prior-year period. Management attributed the margin decline to customer and product mix, competitive pricing, and product-cost variation.
- Operating expenses declined slightly to $2.061 million from $2.074 million. Selling, general and administrative expense increased to $1.304 million, while research and development expense declined to $0.757 million.
- Other income included $64,188 of governmental subsidy income. Total other income was $53,156, compared with $58,878 in the prior-year period.
- Cash and cash equivalents were $16.787 million at September 30, 2018, compared with $11.976 million at June 30, 2018. Total current assets were $27.586 million and current liabilities were $13.673 million.
- The company reported no financing activities and no debt balance was disclosed. Accounts payable increased to $13.167 million from $7.610 million and was the principal driver of operating cash flow.
- Accounts receivable increased to $8.738 million from $7.907 million, while inventory increased to $1.941 million from $1.615 million. The inventory reserve was approximately $296,000.
- Investing cash outflows were $35,983, including $33,905 of capitalized product development costs.
Material Changes Versus the Prior Comparable Period
- The company returned to profitability, with operating income of $112,000 and parent-attributable net income of $179,000, compared with operating and net losses in the prior-year quarter.
- Revenue growth was concentrated in the United States and among a small number of customers. Caribbean and South American, EMEA, and Asian sales declined sharply.
- Gross margin contracted by 2.7 percentage points despite higher gross profit.
- Operating cash flow improved by $7.149 million year over year, largely because accounts payable increased by $5.558 million; this cash-flow improvement may not be recurring.
- On July 1, 2018, the company adopted ASC Topic 606 using the modified retrospective method. The filing states that the adoption had no net impact on opening retained earnings.
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that it believes available capital is sufficient to fund existing operations and obligations for at least one year from the filing date. No quantitative revenue or earnings guidance was provided.
- Future results are expected to depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer contracts, and the ability to meet customer demand.
- Four customers accounted for 40%, 16%, 14%, and 13% of quarterly net sales. Customer concentration creates significant exposure to order timing, cancellations, and customer financial condition.
- One Asian manufacturer supplied approximately 78% of purchases during the quarter. Related accounts payable to that manufacturer was approximately $10.050 million, creating supplier, capacity, quality, and delivery risk.
- Product demand is described as unpredictable. Inventory may require additional write-downs for obsolescence or excess stock.
- FTI received $64,188 of governmental subsidy income during the quarter; subsidy income declined from the prior-year period.
- The company leases facilities in San Diego and Seoul, with material leases generally expiring in 2019. Change-of-control agreements provide potential payments of $5 million to the president and $2 million to the chief operating officer.
- Management reported no material litigation exposure, no off-balance-sheet arrangements, no material changes to previously disclosed risk factors, and effective disclosure controls as of September 30, 2018.
Important Facts for Investors to Verify
- Whether the sharp U.S. revenue increase and demand from four customers is sustainable or primarily reflects timing-related orders.
- Whether gross margin can recover from 16.3% and how product mix, pricing, and component costs may affect future profitability.
- The collectability and concentration of the $8.738 million accounts receivable balance.
- Whether the $4.861 million operating cash inflow, driven substantially by higher accounts payable, converts into recurring cash generation.
- The company’s dependence on one manufacturer for approximately 78% of purchases and the effect of any supply disruption.
- Potential inventory obsolescence, given unpredictable demand and approximately $296,000 of recorded inventory reserves.
- The effect of ASC Topic 606 adoption and future accounting changes, including the planned lease standard adoption beginning in fiscal 2020.