Franklin Wireless Corp. — Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2013, compared with fiscal 2012. The provided filing is an annual 10-K, not a quarterly filing for 2012 Q4.
Business Context
Franklin Wireless designs, manufactures and sells 3G and 4G wireless data products, including USB modems, mobile hotspots, routers, embedded modules and M2M devices using CDMA, HSPA, WiMAX and LTE technologies. Products are sold directly to wireless operators and indirectly through partners and distributors. The company has one reportable segment and consolidates its 51.8%-owned Korean subsidiary, Franklin Technology, Inc.; the remaining 48.2% is held by non-controlling interests.
Manufacturing is primarily outsourced to Samsung Electro-Mechanics and other Asian manufacturers. The company had 67 employees as of June 30, 2013.
Financial Performance and Position
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net sales | $32.750 million | $24.267 million | Up 35.0% |
| Gross profit | $7.233 million | $5.228 million | Up 38.4% |
| Gross margin | 22.1% | 21.5% | Up 0.6 percentage points |
| Operating expenses | $7.402 million | $7.486 million | Down 1.1% |
| Loss from operations | $(0.169) million | $(2.257) million | Improved |
| Net loss | $(0.241) million | $(0.920) million | Improved |
| Net income attributable to parent | $0.175 million | $(0.129) million | Turned profitable |
| Basic EPS attributable to parent | $0.02 | $(0.01) | Improved |
| Net cash from operating activities | $4.898 million | $(0.240) million | Improved |
United States sales increased 116.4% to $29.978 million and represented 91.6% of consolidated sales. Caribbean and South American sales declined 74.4% to $1.648 million, while Asian sales declined 71.7% to $1.123 million. Research and development expense increased to $2.770 million from $1.590 million.
Cash and cash equivalents were $10.431 million at June 30, 2013, compared with $9.419 million at June 30, 2012. Current assets were $17.596 million and current liabilities were $6.647 million. Accounts receivable declined to $5.322 million from $13.073 million, and inventories declined to $0.263 million from $1.747 million.
Total debt consisted of $0.139 million of short-term bank borrowings, with the loan extended to March 2014 at an interest rate of 10.55%. Total liabilities were $6.647 million, compared with $12.978 million in the prior year. The company reported no dividends and does not expect to pay cash dividends in the foreseeable future.
Cash Flow, Capital Spending and Liquidity
- Operating cash flow was $4.898 million, primarily reflecting reductions in receivables and inventory, partly offset by a $5.862 million decrease in accounts payable.
- Investing cash flow was $(1.460) million, including $0.689 million for intangible assets, $0.431 million for property and equipment and $0.252 million for capitalized development costs.
- Financing cash flow was $(2.384) million, primarily due to the $2.406 million repurchase of common stock from the Sherman Group.
- Management stated that cash on hand, operating cash flows, bank lines and potential equity issuance were expected to fund operations for the next twelve months.
- Management also disclosed that the company may incur more than $5.0 million over the next twelve months for capital expenditures, software licenses, testing and product certifications. Additional financing may be required if operating cash flow is insufficient.
Material Changes and Unusual Items
- Sales growth was driven primarily by new product releases and new U.S. customers, while international sales declined because of order timing and the nonrecurrence of significant Asian module sales.
- Operating results improved substantially, but the company remained loss-making on a consolidated basis because of the 48.2% non-controlling interest in the subsidiary’s loss and a $168,808 income-tax provision.
- Fiscal 2012 operating expenses included a $440,000 premium related to the Sherman Group stock repurchase; this item did not recur in fiscal 2013.
- The company repurchased 1,538,602 shares from the Sherman Group for $2.831 million, including a $440,000 premium, reducing outstanding shares to 10,374,369 at June 30, 2013.
- Capitalized product-development costs in progress declined to $32,500 from $1.258 million as development costs were transferred to completed technology, property and equipment, and certifications and licenses.
- Intangible-asset amortization increased to $1.384 million from $0.892 million and is expected to total approximately $1.226 million in fiscal 2014.
Guidance, Outlook and Management Commentary
The filing does not provide formal revenue or earnings guidance. Management expects future revenue 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 expects operating results and revenue to fluctuate and plans continued investment in product development, certifications and expansion.
Key Risks, Contingencies and Concentrations
- Customer concentration is significant: three customers represented 47%, 20% and 19% of fiscal 2013 sales. The customer agreements do not require minimum purchases.
- Supplier concentration is also significant: one Asian manufacturer supplied $19.702 million, or 86.1% of total purchases, and represented $3.372 million of accounts payable at year-end.
- The company faces competition from larger, better-capitalized competitors, rapidly changing wireless standards, regulatory certification requirements, product-development risk and potential product obsolescence.
- Franklin is a defendant in patent litigation brought by Novatel Wireless concerning mobile hotspots and data modems. The company stated that any potential loss could not reasonably be estimated.
- A lawsuit against C-Motech seeks damages and other relief regarding an uncompleted repurchase of 1,566,672 shares for a remaining contractual amount of $1.627 million. Ownership of the shares is also disputed in U.S. and Korean proceedings.
- The company has leases and other contractual commitments totaling $0.803 million, including $0.664 million of lease obligations and $0.139 million of bank borrowings due within the disclosed schedule.
- Change-of-control agreements could require payments of $5.0 million to the president, $2.0 million to the chief operating officer and $1.0 million to the vice president of engineering if triggering conditions occur.
- Federal and state net operating loss carryforwards were approximately $4.0 million and $1.7 million, respectively, but their use may be limited under applicable tax rules.
Investor Verification Checklist
- Verify whether U.S. sales growth and new-product demand continued after June 30, 2013.
- Assess the sustainability of the 22.1% gross margin and the company’s ability to convert reported operating cash flow into recurring cash generation.
- Review customer concentration, order commitments and accounts-receivable collectability.
- Evaluate dependence on the primary Asian manufacturer and potential effects of supply disruption or quality issues.
- Monitor the Novatel patent litigation and C-Motech share-repurchase and ownership disputes.
- Confirm funding sources for the disclosed potential excess of $5.0 million in near-term capital and product-certification expenditures.
- Review the impact of non-controlling interests, stock repurchases, outstanding options and potential dilution.