Franklin Wireless Corp. — Form 10-Q Summary
Business context and reporting period
Franklin Wireless provides mobile hotspots, routers, modems, and hardware and software supporting machine-to-machine and Internet of Things applications. The company sells primarily to wireless operators, strategic partners, and distributors across the United States, the Caribbean and South America, EMEA, and Asia. Franklin owns 51.8% of Franklin Technology Inc. (FTI), a South Korean research and development subsidiary; the remaining 48.2% is held by non-controlling interests.
This unaudited quarterly report covers the three months ended September 30, 2015, compared with the three months ended September 30, 2014. The filing was signed November 16, 2015.
Financial performance and liquidity
| Metric | Three months ended September 30, 2015 | Three months ended September 30, 2014 |
|---|---|---|
| Net sales | $11.95 million | $13.62 million |
| Gross profit | $1.96 million | $2.32 million |
| Gross margin | 16.4% | 17.0% |
| Operating expenses | $1.88 million | $2.18 million |
| Income from operations | $85,562 | $132,675 |
| Operating margin | 0.7% | 1.0% |
| Net income | $37,484 | $254,091 |
| Net income attributable to parent | $17,947 | $283,148 |
| Basic and diluted EPS | $0.00 | $0.03 |
| Net cash from operating activities | $(142,595) | $606,496 |
- Sales declined 12.2%, while gross profit declined 15.2%. Operating expenses decreased 14.0%, but the reduction did not offset lower gross profit and unfavorable other income.
- Other income, net, changed from income of $179,416 to a loss of $43,013, primarily because prior-period marketing-related accruals were not reversed and foreign-exchange movements were unfavorable.
- Cash and cash equivalents were $11.50 million at September 30, 2015, compared with $11.82 million at June 30, 2015. Total current assets were $23.13 million and total current liabilities were $10.35 million.
- Operating cash flow was negative primarily because accounts receivable increased by $2.63 million. Investing cash use was $151,577, including $138,912 of capitalized product-development costs. Financing activities provided no cash.
- Short-term borrowings were $148,295, with principal due in March 2016. The company reported no long-term debt.
- Accounts receivable increased to $8.01 million from $5.46 million at June 30, 2015. Inventory declined to $1.96 million from $2.28 million and included a $120,867 reserve for obsolete or slow-moving inventory.
Material changes versus the prior comparable period
- United States sales decreased 7.3% to $10.11 million, primarily because one customer did not place significant repeat orders during the quarter.
- EMEA sales increased to $1.74 million from $6,383 because of the timing of orders from an African carrier customer.
- Asia sales decreased 99.9% to $2,928, primarily because of lower product and component sales generated by FTI.
- Caribbean and South American sales decreased 41.0% to $93,000; management attributed the volatility largely to order timing and the small number of customers in those markets.
- Gross margin declined to 16.4% from 17.0%, reflecting customer and product mix, competitive pricing, and product-cost variation.
- Operating expenses declined by $305,480, driven by lower shipping and handling, air freight, share-based compensation, depreciation, research and development, legal, and travel expenses.
- The quarter included a $12,500 credit to share-based compensation expense from the reversal of previously recorded expense for canceled employee options.
- Capitalized product-development costs increased to $138,912 from zero at June 30, 2015. Amortization of intangible assets was $254,346, compared with $332,230 in the prior-year quarter.
Guidance, outlook, risks, contingencies, and unusual items
- Management did not provide numerical revenue or earnings guidance. It 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.
- Management stated that available capital should fund existing operations and obligations through at least September 30, 2016. It cautioned that failure to achieve the business plan or obtain additional funding, if needed, could require curtailment of operations or other actions outside the ordinary course.
- Customer concentration is significant: two customers represented 84% and 13% of quarterly sales and 85% and 5% of accounts receivable at September 30, 2015.
- The company purchased 100% of its wireless data products during the quarter from one Asian manufacturer, totaling $9.62 million, and owed that manufacturer $8.04 million at quarter-end. Delays, capacity constraints, quality problems, or order cancellations could materially affect results.
- Franklin entered into a four-year lease for approximately 12,775 square feet of new San Diego office space commencing October 28, 2015, at monthly rent of $23,115 plus certain common-area costs.
- The company’s litigation with Novatel Wireless and Nova Intellectual Solutions concerning patent infringement was settled and dismissal motions were filed in October 2015. The filing states that the Adaptix patent matter was pending as of September 30, 2015 but was not expected to materially affect the company.
- The company continues to pursue claims against C-Motech relating to a stock repurchase agreement. Ownership of the remaining 1,566,672 shares was transferred to two individuals in September 2015, and the company’s U.S. litigation is stayed due to C-Motech’s Korean bankruptcy proceeding.
- Management reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and effective disclosure controls as of September 30, 2015.
Important facts for investors to verify
- Whether order timing and customer concentration will cause continued quarterly sales volatility, particularly following the decline in United States and Asia sales.
- Collection timing and credit quality of the $8.01 million accounts receivable balance, given the negative operating cash flow.
- The sustainability of the 16.4% gross margin amid competitive pricing, product-cost changes, and customer mix.
- Dependence on a single Asian manufacturer for all product purchases during the quarter and the associated $8.04 million payable.
- The March 2016 maturity of the $148,295 short-term borrowing and the company’s cash requirements under its new office lease and product-development program.
- Potential outcomes and recoveries related to the C-Motech dispute and Korean bankruptcy proceeding, as well as any residual obligations from settled patent litigation.
- The realizability of reported deferred tax assets totaling approximately $2.07 million, consisting of current and non-current deferred tax assets.