Franklin Wireless Corp. — Form 10-Q Summary
Business context and reporting period
Franklin Wireless provides wireless connectivity products, including mobile hotspots, routers, trackers, embedded modules, modems and gateways supporting 5G/4G, M2M and IoT applications. Products are sold primarily to wireless operators, strategic partners and distributors, with revenue concentrated in North America. The company owns 66.3% of Franklin Technology Inc. (FTI), a South Korean research and development subsidiary.
This unaudited Form 10-Q covers the three months ended September 30, 2020, compared with the three months ended September 30, 2019. The filing was signed November 16, 2020. Although the request identifies the period as 2020 Q1, the filing is for the first quarter of Franklin Wireless’s fiscal year ending June 30, 2021.
Key financial metrics
| Metric | Three months ended September 30, 2020 | Three months ended September 30, 2019 |
|---|---|---|
| Net sales | $62.57 million | $8.87 million |
| Gross profit | $11.67 million | $2.02 million |
| Gross margin | 18.7% | 22.8% |
| Income from operations | $9.17 million | $0.28 million |
| Net income | $7.18 million | $0.29 million |
| Net income attributable to parent company | $6.92 million | $0.25 million |
| Basic/diluted EPS | $0.65/$0.64 | $0.02/$0.02 |
| Net cash provided by operating activities | $9.16 million | $(1.07) million |
Net sales increased 605.4%, primarily because of heightened demand for wireless connectivity from remote work and remote learning programs, including high-volume school district deployments. North America represented virtually all sales: $62.57 million, or approximately 100% of revenue, compared with $8.86 million in the prior-year quarter.
Cost of goods sold was $50.90 million, or 81.3% of sales. Operating expenses were $2.50 million, or 4.0% of sales, including $1.52 million of selling, general and administrative expense and $0.98 million of research and development expense. Income tax expense was $2.00 million, compared with $0.06 million in the prior-year quarter.
At September 30, 2020, cash and cash equivalents were $43.32 million and certificates of deposit were $5.38 million, for total disclosed cash and short-term investments of $48.70 million. Total current assets were $79.40 million versus current liabilities of $47.48 million. Total assets were $83.14 million and stockholders’ equity was $34.48 million.
Debt consisted primarily of a $0.49 million Paycheck Protection Program loan and operating lease liabilities totaling approximately $1.09 million. The filing states that management believed available capital was sufficient to fund operations and obligations for at least one year from the filing date. No off-balance-sheet arrangements were reported.
Material changes versus the prior comparable period
- Revenue increased by $53.70 million, or 605.4%, to $62.57 million.
- Gross profit increased 477.6% to $11.67 million, while gross margin declined from 22.8% to 18.7%. Management attributed the margin decline primarily to lower-margin product sales replacing prior-year product development service revenue.
- Operating income increased from $0.28 million to $9.17 million, and parent-company net income increased from $0.25 million to $6.92 million.
- Operating expenses increased 43.3% to $2.50 million, driven by higher payroll, shipping and handling costs, bad-debt expense and stock-based compensation.
- Operating cash flow improved to $9.16 million from negative $1.07 million. The improvement reflected net income and a $9.02 million inventory reduction, partly offset by an $11.95 million increase in accounts receivable.
- Cash increased by $15.16 million during the quarter to $43.32 million, including $6.02 million of financing cash flow from issuing 923,078 shares of common stock for $6.00 million and receiving $17,420 from option exercises.
- Accounts receivable increased to $27.78 million from $15.97 million, and the company recorded a $93,151 allowance for doubtful accounts.
- Inventory declined to $2.77 million from $11.78 million. Accounts payable increased to $44.85 million from $42.08 million, and income tax payable increased to $1.92 million from $0.03 million.
- Shares outstanding increased to 11,541,990 at September 30, 2020 from 10,605,912 at June 30, 2020, primarily reflecting the treasury stock issuance.
Guidance, outlook, commentary, risks and unusual items
Management did not provide quantitative revenue or earnings guidance. Future revenue is expected to depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer relationships and the ability to meet customer demand. Management stated that COVID-19 could increase demand for the company’s products but that the ultimate impact could not be reasonably estimated.
- Customer concentration: Two customers accounted for 48% and 43% of quarterly sales. One customer represented 91% of accounts receivable at September 30, 2020.
- Supplier concentration: Two Asian manufacturers represented 98% of product purchases during the quarter, totaling $41.21 million, and related accounts payable were $44.08 million. Delays, capacity constraints or quality issues could disrupt shipments and revenue.
- COVID-19: The company operated as an essential business but reduced operations and implemented telecommuting where possible. Supply-chain and third-party manufacturing disruptions remain possible.
- Anydata/Quanta contingency: The company may incur a loss related to an unfulfilled Anydata purchase commitment and inventory ordered from Quanta. As of September 30, 2020, a loss was reasonably possible but not estimable.
- Tariffs: Products were believed to be exempt from U.S. import tariffs at the reporting date. A potential tariff of 10% to 25% could materially affect sales and operating results if imposed.
- Change-of-control agreements: Agreements entered into October 1, 2020 provide for potential lump-sum payments of $5 million to the president and $2 million to the chief operating officer upon specified change-of-control events.
- Other contingencies: The company is involved in ordinary-course legal proceedings, but management does not expect a material adverse outcome. Customer contracts may include intellectual-property indemnification obligations.
- Equity incentive activity: The company adopted a 2020 stock option plan covering 800,000 shares. Options outstanding increased to 537,291 at September 30, 2020, and stock-based compensation expense was $85,987.
Important facts for investors to verify
- Whether the exceptional revenue growth from remote learning and connectivity demand is sustainable and how sales develop after the reporting period.
- Customer concentration, collectability of the $27.78 million accounts receivable balance and the adequacy of the $93,151 bad-debt allowance.
- Dependence on two Asian manufacturers and the potential effects of supply-chain interruptions, quality problems or tariffs.
- The outcome and potential financial exposure associated with the Anydata and Quanta commitment.
- Whether gross margin remains below the prior-year level as product mix changes.
- The dilution implications of the 923,078-share issuance and 537,291 outstanding stock options.
- The effect of COVID-19 on demand, manufacturing capacity, logistics and future operating results.
- The company’s future tax payments, including the $2.00 million quarterly tax provision and increased income tax payable.