Franklin Wireless Corp. 10-K Summary
Reporting period: Fiscal year ended June 30, 2018, compared with fiscal 2017. The requested “2017 Q4” period does not match this annual filing; the filing includes fourth-quarter internal-control information but reports full-year results.
Business Context
Franklin Wireless provides wireless access products, including mobile hotspots, routers, modems, embedded modules, gateways, and hardware and software supporting machine-to-machine and Internet of Things applications. The company has a 51.8% majority interest in Franklin Technology Inc. in South Korea, which provides product research and development services. The company reports one operating segment and generates most revenue in the United States.
Manufacturing of the majority of products is outsourced to one Asian supplier. The company had 67 employees as of June 30, 2018.
Key Financial Metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net sales | $30.1 million | $48.6 million | Down 38.1% |
| Gross profit | $5.2 million | $9.2 million | Down 43.7% |
| Gross margin | 17.8% as stated in MD&A | 19.0% | Down 1.2 percentage points |
| Operating expenses | $7.9 million | $8.3 million | Down 5.5% |
| Operating income (loss) | $(2.7) million | $0.9 million | Declined to a loss |
| Other income, net | $0.3 million | $0.3 million | Up 22.5% |
| Net income (loss) | $(2.2) million | $0.8 million | Declined to a loss |
| Net loss attributable to parent | $(2.1) million | $0.9 million | Declined to a loss |
| Basic and diluted EPS | $(0.20) | $0.08 | Declined |
| Net cash from operating activities | $(2.0) million | $1.5 million | Cash use increased |
| Cash and cash equivalents | $12.0 million | $14.3 million | Down $2.3 million |
The MD&A percentage table reports FY2018 gross margin as 17.3%, while the detailed results section reports 17.8%; the filing text does not reconcile this discrepancy. No debt balance is reported on the consolidated balance sheet. Current liabilities were $8.1 million, primarily accounts payable of $7.6 million.
Liquidity, Cash Flow and Capital Requirements
- Current assets were $21.7 million versus current liabilities of $8.1 million, implying substantial reported working-capital coverage.
- Operating cash flow was negative $2.0 million, principally reflecting the net loss and a $5.3 million decrease in accounts payable, partly offset by reductions in accounts receivable and inventory.
- Investing cash use was $0.4 million, including $0.3 million of capitalized product development costs.
- Financing cash inflow was $67,000 from stock-option exercises.
- Management stated that available capital was sufficient to fund existing operations and obligations through at least June 30, 2019, but indicated that more than $5.0 million could be required over the following twelve months for capital expenditures, software licenses, testing, and product certification.
- Operating lease commitments totaled $393,827, including $301,368 due by June 30, 2019.
Material Changes Versus FY2017
- Revenue fell $18.5 million, primarily because of lower demand from two U.S. carrier customers. The U.S. represented 97.2% of FY2018 sales.
- Gross profit declined faster than sales, and gross margin contracted because of customer and product mix, competitive pricing, and product-cost fluctuations.
- Operating expenses decreased only modestly despite lower sales, resulting in an operating loss of $2.7 million.
- Accounts receivable declined by $3.1 million and inventory declined by $1.8 million, while accounts payable declined by $5.3 million.
- Capitalized product development costs in progress declined to $100,000 from $360,248, although $291,386 of new product-development costs was capitalized during FY2018.
- Customer concentration increased in risk significance: the three largest customers represented 54%, 21%, and 11% of sales, respectively. The filing identifies Verizon, Sprint, and Anydata Corp. as customers exceeding 10% of sales.
- The company’s former CFO resigned on April 6, 2018, and the president resumed the acting CFO role.
Outlook, Risks and Unusual Items
- Management expects revenue performance to depend on retaining existing customers, demand for wireless data products, acceptance of new products, new customer contracts, and the ability to meet customer requirements. No specific revenue or earnings guidance was provided.
- Other income included $330,856 of government subsidy income received by FTI.
- The company recorded a $186,973 income tax benefit. The Tax Cuts and Jobs Act required a $661,629 tax-rate-reduction adjustment in the tax reconciliation; the ultimate impact of provisional tax accounting could differ.
- The company has approximately $4.3 million of federal net operating loss carryforwards expiring through 2038, subject to potential Internal Revenue Code Section 382 limitations.
- Key risks include limited financial resources and potential need for additional debt or equity financing, customer concentration, dependence on one principal Asian manufacturer, rapidly changing wireless technology, regulatory certifications, competition, intellectual-property claims, international operations, and unpredictable product demand.
- Products were exempt from Chinese tariffs at filing. If that exemption changes, a tariff of 10% to 25% of purchase price could apply.
- Management reported no material expected adverse outcome from ordinary-course litigation and no off-balance-sheet arrangements.
- Change-of-control agreements could require lump-sum payments of $5.0 million to the president and $2.0 million to the chief operating officer.
- Management concluded that disclosure controls and internal control over financial reporting were effective as of June 30, 2018. The independent auditor did not provide an internal-control attestation because the company is a smaller reporting company.
Investor Verification Checklist
- Verify the gross-margin inconsistency between the MD&A narrative and percentage table.
- Assess whether customer demand and revenue concentration have stabilized after the FY2018 decline.
- Review the company’s ability to generate positive operating cash flow and fund the stated capital and product-certification requirements.
- Evaluate dependence on the principal Asian manufacturer, including its $5.8 million related accounts payable balance and 87% share of FY2018 purchases.
- Monitor the potential effect of Chinese tariffs, customer concentration, product obsolescence, and intellectual-property claims.
- Review the realizability of the $1.85 million deferred tax asset and the limitations applicable to the $4.3 million federal net operating loss carryforward.
- Confirm the terms and potential cash impact of the $7.0 million aggregate change-of-control obligations.