FKWL

Business Context and Reporting Period

Company: Franklin Wireless Corp.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2019
Business Overview: The Company provides intelligent wireless solutions, including mobile hotspots, routers, and modems, as well as hardware and software for machine-to-machine (M2M) and Internet of Things (IoT) applications. It holds a majority ownership (64.2%) in Franklin Technology Inc. (FTI), a Seoul-based R&D subsidiary.

Key Financial Metrics

Debt: The Company reported no long-term debt. Total liabilities consist entirely of current liabilities, primarily accounts payable ($6.64M).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 36.6% for the three months and 39.5% for the nine months ended March 31, 2019, compared to the prior year periods. This growth was driven primarily by a 31% (quarterly) and 54% (nine-month) increase in product demand from two major carrier customers in the United States and Canada.
• Margin Compression: While gross profit dollars increased, gross margin percentage declined from 22.0% to 17.8% (quarterly) and from 19.0% to 16.0% (nine-month) due to variations in customer/product mix and competitive pricing.
• Operating Expenses: Operating expenses increased 6.1% (quarterly) and 3.3% (nine-month), primarily due to higher shipping and handling costs associated with increased shipment volumes.
• Geographic Shift: Sales in the United States and Canada now represent 99.2% of total net sales. Sales in EMEA and Asia declined significantly compared to the prior year.
• Subsidiary Ownership: The Company increased its ownership in its Korean subsidiary (FTI) from 51.8% to 64.2% by purchasing additional shares from non-controlling shareholders for $234,330.

Outlook, Risks, and Contingencies

• Liquidity: Management believes cash and cash equivalents of $10.76 million are sufficient to fund operations for at least the next 12 months. Net cash used in operating activities was $717,026 for the nine months ended March 31, 2019.
• Customer Concentration Risk: The Company is highly dependent on a few customers. For the nine months ended March 31, 2019, two customers accounted for 57% and 23% of net sales, respectively. These same two customers represented 70% and 22% of accounts receivable.
• Supplier Concentration Risk: 98% of wireless data product purchases were made from two manufacturing companies in Asia. Disruptions at these facilities could severely impact revenue.
• Material Contingency: A significant customer cancelled a purchase commitment, resulting in a vendor claim against the Company for $2.9 million for components purchased. The Company has requested reimbursement from the customer and has received personal guarantees from the customer's owners. As of the filing date, the amounts have not been recorded in accounts payable or receivable pending resolution.
• Change of Control: Agreements exist to pay $5 million to the President and $2 million to the COO in the event of a change of control.

Investor Verification Checklist

• Contingency Resolution: Verify the status of the $2.9 million vendor claim related to the cancelled customer order and the likelihood of collection from the customer.
• Customer Retention: Assess the stability of the two major carrier customers who collectively drive 80% of revenue.
• Supply Chain Resilience: Evaluate the risk exposure associated with relying on two Asian manufacturers for 98% of product purchases.
• Cash Burn Rate: Monitor the trend of net cash used in operating activities to ensure the $10.76 million cash balance remains sufficient for the projected 12-month runway.
• Margin Trends: Investigate the causes of the declining gross margin percentage despite revenue growth to determine if pricing power is eroding.