Franklin Wireless Corp. 10-K Summary
Reporting period: Fiscal year ended June 30, 2019, compared with fiscal 2018. The request identifies “2018 Q4,” but the provided filing is a fiscal 2019 Form 10-K and does not provide a separate fourth-quarter income statement.
Business Context
Franklin Wireless provides mobile hotspots, routers, modems, embedded modules, gateways and software supporting wireless broadband, machine-to-machine and Internet of Things applications. Products are sold primarily to wireless operators, strategic partners and distributors. The company has one reportable segment and owns 64.2% of Franklin Technology Inc. (FTI), a South Korean research and development subsidiary, up from 51.8% in fiscal 2018 after purchasing additional subsidiary shares for $234,330.
Fiscal 2019 sales were overwhelmingly concentrated in the United States, which represented $36.2 million, or 99.3%, of consolidated sales. The company had 71 employees and outsourced most manufacturing to two Asian suppliers.
Financial Performance and Position
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net sales | $36.469 million | $30.066 million | 21.3% increase |
| Gross profit | $5.739 million | $5.192 million | 10.6% increase |
| Gross margin | 15.7% | 17.3% | Down 1.6 percentage points |
| Operating expenses | $7.847 million | $7.884 million | 0.5% decrease |
| Loss from operations | $(2.107) million | $(2.692) million | Loss narrowed |
| Net loss | $(1.474) million | $(2.173) million | Loss narrowed |
| Net loss attributable to parent | $(1.276) million | $(2.092) million | Loss narrowed |
| Loss per diluted share | $(0.12) | $(0.20) | Improved |
| Net cash from operating activities | $0.775 million | $(2.009) million | Improved by $2.784 million |
Operating expenses included $4.891 million of selling, general and administrative expense and $2.956 million of research and development expense. SG&A increased 8.4%, primarily from higher delivery charges, while research and development expense declined 12.3% due to cost reductions and increased capitalization of product development costs.
As of June 30, 2019, cash and cash equivalents were $6.448 million and certificates of deposit were $5.380 million, for total reported principal liquidity of $11.828 million. Accounts receivable declined to $4.138 million from $7.907 million, and inventory declined to $1.053 million from $1.615 million. Total liabilities were $5.921 million, consisting entirely of current liabilities; the balance sheet reports no debt.
Total assets were $21.195 million and total stockholders’ equity was $15.274 million at June 30, 2019. The company reported a current ratio of approximately 2.9x based on reported current assets and current liabilities.
Material Changes Versus the Prior Period
- Sales increased 21.3%, primarily due to approximately 46% higher product demand from four major U.S. carrier customers and order timing.
- U.S. sales increased 23.9% to $36.217 million, while Caribbean and South American sales fell to zero, EMEA sales declined 33.2%, and Asian sales declined 89.4%.
- Gross margin contracted to 15.7% from 17.3% because of customer and product mix, competitive pricing and product-cost fluctuations.
- Operating losses narrowed despite the lower gross margin because operating expenses were essentially flat and revenue increased.
- Operating cash flow turned positive, largely because accounts receivable decreased by $3.853 million and inventory decreased by $0.305 million, partially offset by a $1.937 million reduction in accounts payable.
- Investing cash use increased to $6.251 million, including $5.380 million invested in certificates of deposit, $0.234 million for additional FTI shares and $0.465 million of capitalized product development costs.
- The company adopted ASC Topic 606 on July 1, 2018 using the modified retrospective method; no cumulative-effect adjustment to retained earnings was recorded.
- Capitalized product development costs in progress increased to $0.465 million from $0.100 million.
Outlook, Risks and Unusual Items
Management stated that it expected available capital to fund existing operations and obligations through at least June 30, 2020. The company estimated that it may require more than $5.0 million over the next twelve months for capital expenditures, software licenses, testing and product certification. Management stated that additional debt or equity financing may be required if operating cash flow is insufficient.
- Customer concentration is substantial. The two largest customers accounted for approximately 80% of fiscal 2019 sales; the filing presents slightly different percentages in different sections, so the precise split should be verified.
- Two Asian suppliers represented approximately 97% of fiscal 2019 product purchases, creating manufacturing, capacity, quality and delivery risks.
- An Anydata purchase commitment had approximately $3.1 million remaining as of June 30, 2019. The company had approximately $1.9 million of preliminary related purchase commitments with Quanta and disclosed a reasonably possible but not estimable loss contingency.
- The company paid $100,000 for the right to call on inventory and recorded $22,000 of prepaid pricing adjustments related to Quanta.
- The company faces competition, rapidly changing wireless technology, regulatory certification requirements, intellectual property claims, international operating risks and potential Chinese tariffs of 10% to 25% if its current exemption changes.
- Operating lease obligations totaled $1.731 million, with $451,556 due by June 30, 2020.
- Change-of-control agreements provide potential payments of $5.0 million to the president and $2.0 million to the chief operating officer.
- Federal net operating loss carryforwards were approximately $5.6 million, subject to potential limitations under Internal Revenue Code Section 382 and similar provisions.
- Management reported effective disclosure controls and effective internal control over financial reporting. The independent auditor audited the financial statements but was not required to attest to internal control effectiveness.
Investor Verification Items
- Verify the exact fiscal 2019 customer concentration percentages, which differ between the risk-factor and financial-statement disclosures.
- Assess sustainability of the 21.3% sales increase, given reliance on U.S. carriers and order timing.
- Monitor gross-margin recovery and the effects of product mix, pricing pressure and supplier costs.
- Evaluate the Anydata and Quanta commitments, including potential inventory losses and the absence of an estimated recorded liability.
- Reconcile cash liquidity with expected spending of more than $5.0 million and determine whether external financing could be required.
- Review supplier concentration, customer concentration and the company’s ability to maintain required product certifications.
- Confirm the impact of ASC Topic 606 adoption and the planned fiscal 2020 adoption of the new lease standard.