Franklin Wireless Corp: Form 10-Q for the period ended Dec 31, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this report. This report contains certain forward-looking statements relating to future events or our future financial performance. These statements are subject to risks and uncertainties which could cause actual results to differ materially from those discussed in this report. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. We are not obligated to publicly update this information, whether as a result of new information, future events or otherwise, except to the extent we are required to do so in connection with our obligation to file reports with the SEC. For a discussion of the important risks to our business and future operating performance, see the discussion under the caption “Item 1A. Risk Factors” and under the caption “Factors That May Influence Future Results of Operations” in the Company’s Form 10-K for the year ended June 30, 2023, filed on September 28, 2023. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur.

BUSINESS OVERVIEW

We are a leading provider of integrated wireless solutions utilizing the latest in 5G (fifth generation) and 4G LTE (fourth generation long-term evolution) technologies including mobile hotspots, routers, fixed wireless routers, and various trackers. Our integrated software subscription services provide users remote capabilities including mobile device management (MDM) and software defined wide area networking (SD-WAN).

We have majority ownership of Franklin Technology Inc. (FTI), a research and development company based in Seoul, South Korea. FTI primarily provides design and development services for our wireless products.

Our products are generally marketed and sold directly to wireless operators and indirectly through strategic partners and distributors. Our global customer base primarily extends from North America to Asia.

The Company is constantly evaluating opportunities to increase shareholder value, both based on internal initiatives and in response to suggestions from shareholders and others.

FACTORS THAT MAY INFLUENCE FUTURE RESULTS OF OPERATIONS

We believe that our revenue growth will be influenced largely by (1) the successful maintenance of our existing customers, (2) the rate of increase in demand for wireless data products, (3) customer acceptance of our new products, (4) new customer relationships and contracts, and (5) our ability to meet customers’ demands.

We have entered into and expect to continue to enter into new customer relationships and contracts for the supply of our products, and this may require significant demands on our resources, resulting in increased operating, selling, and marketing expenses associated with such new customers.

There is always a risk of disputes and disagreements with our business partners and suppliers, and the costs associated with enforcing our rights in those matters could negatively impact operating capital and reserves.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared on the basis of the most current reasonably available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions.

We have several critical accounting policies, which were described in our Annual Report on Form 10-K for the year ended June 30, 2023, that are both important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective, and complex judgments. Typically, the circumstances that make these judgments difficult, subjective, and complex have to do with making estimates about the effect of matters that are inherently uncertain. There were no material changes to our critical accounting policies for the three and six months ended December 31, 2023.

RESULTS OF OPERATIONS

The following table sets forth, for the three and six months ended December 31, 2023 and 2022, our statements of comprehensive (loss) income (unaudited) including data expressed as a percentage of sales:

27

THREE MONTHS ENDED DECEMBER 31, 2023 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2022

NET SALES - Net sales decreased by $135,864, or 1.5%, to $8,847,779 for the three months ended December 31, 2023 from $8,983,643 for the corresponding period of 2022. For the three months ended December 31, 2023, net sales by geographic regions, consisting of North America and Asia, were $8,753,451 (98.9% of net sales) and $94,328 (1.1% of net sales), respectively. For the three months ended December 31, 2022, net sales by geographic regions, consisting of North America and Asia, were $8,950,134 (99.6% of net sales) and $33,509 (0.4% of net sales), respectively.

Net sales in North America decreased by $196,683, or 2.2%, to $8,753,451 for the three months ended December 31, 2023 from $8,950,134 for the corresponding period of 2022. For the three months ended December 31 ,2023, the decrease in net sales in North America was primarily due to the lack of sales to one major carrier (which was the second largest customer for the six months ended December 31, 2023, but its purchase was concentrated in the period of the three months ended September 30, 2023), which was offset by the increased sales from several customers. Net sales in Asia increased by $60,819, or 181.5%, to $94,328 for the three months ended December 31, 2023 from $33,509 for the corresponding period of 2022. The increase in net sales was primarily due to the increased revenue generated from Wi-Fi routers sales by FTI, which typically vary from period to period.

GROSS PROFIT - Gross profit decreased by $108,967, or 11.5%, to $837,075 for the three months ended December 31, 2023 from $946,042 for the corresponding period of 2022. The gross profit in terms of net sales percentage was 9.5% for the three months ended December 31, 2023 compared to 10.5% for the corresponding period of 2022. The decrease in gross profit was primarily due to the change in net sales as described above. The decrease in gross profit in terms of net sales percentage for the three months ended December 31, 2023, was primarily due to the mixed results of competitive selling prices and the increase in production costs as well as the increased amortization expenses associated with the completed capitalized product development costs that are included in the cost of goods sold compared to the corresponding period of 2022.

OPERATING EXPENSES - Operating expenses increased by $80,634, or 3.5%, to $2,393,016 for the three months ended December 31, 2023 from $2,312,382 for the corresponding period of 2022.

Selling, general, and administrative expenses increased by $204,195 to $1,540,162 for the three months ended December 31, 2023, from $1,335,967 for the corresponding period of 2022. The increase in selling, general, and administrative expenses was primarily due to increased legal fees and operating lease expense of approximately $200,000 and $143,000, which was offset by the decreased compensation expenses related to stock options granted for employees and commission expense for sales of approximately $93,000 and $50,000, respectively.

Research and development expense decreased by $123,561 to $852,854 for the three months ended December 31, 2023, from $976,415 for the corresponding period of 2022. The decrease in research and development expense was primarily due to the decreased research and development costs and the related payroll expense of approximately $92,000 and $32,000, respectively, which is the mixed result of the timing of research and development activities and the number of active projects and typically vary from period to period.

OTHER INCOME, NET - Other income, net decreased by $710,290, or 50.7%, to $691,125 for the three months ended December 31, 2023 from $1,401,415 for the corresponding period of 2022. The decrease was primarily due to the decreased gain from the favorable changes in foreign currency exchange rates in FTI and the decreased forgiven liabilities of approximately $726,000 and $165,000, respectively, which were partially offset by the increased unrealized gain and interest income from the money market accounts and certificates of deposits of approximately $103,000 and $89,000.

SIX MONTHS ENDED DECEMBER 31, 2023 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2022

NET SALES - Net sales increased by $1,410,742, or 8.3%, to $18,503,325 for the six months ended December 31, 2023 from $17,092,583 for the corresponding period of 2022. For the six months ended December 31, 2023, net sales by geographic regions, consisting of North America and Asia, were $18,408,997 (99.5% of net sales) and $94,328 (0.5% of net sales), respectively. For the six months ended December 31, 2022, net sales by geographic regions, consisting of North America and Asia, were $17,057,585 (99.8% of net sales) and $34,998 (0.2% of net sales), respectively.

Net sales in North America increased by $1,351,412, or 7.9%, to $18,408,997 for the six months ended December 31, 2023 from $17,057,585 for the corresponding period of 2022. The increase in net sales in North America was primarily due to the increased demand for a wireless product from one major carrier customer for this fiscal period, which represents 317% (or approximately $5.3M) increase compared to the corresponding period of 2022, which were offset by the decreased demand of another major carrier customer. Net sales in Asia increased by $59,330, or 169.5%, to $94,328 for the six months ended December 31, 2023 from $34,998 for the corresponding period of 2022. The increase in net sales was primarily due to the increased revenue generated from the Wi-Fi routers sales by FTI, which typically vary from period to period.

GROSS PROFIT – Gross profit decreased by $189,669, or 7.5%, to $2,350,235 for the six months ended December 31, 2023 from $2,539,904 for the corresponding period of 2022. The gross profit in terms of net sales percentage was 12.7% for the six months ended December 31, 2023 compared to 14.9% for the corresponding period of 2022. The decrease in gross profit was primarily due to the lower gross profit in terms of net sales percentage. The decrease in gross profit in terms of net sales percentage for the six months ended December 31, 2023, was primarily due to the mixed results of competitive selling prices and the increase in production costs as well as the increased amortization expenses associated with the completed capitalized product development costs that are included in the cost of goods sold compared to the corresponding period of 2022.

OPERATING EXPENSES – Operating expenses decreased by $31,444, or 0.7%, to $4,490,693 for the six months ended December 31, 2023 from $4,522,137 for the corresponding period of 2022.

Selling, general, and administrative expenses increased by $195,282 to $2,770,884 for the six months ended December 31, 2023, from $2,575,602 for the corresponding period of 2022. The increase in selling, general, and administrative expenses was primarily due to the increased legal fees, operating lease expenses, and payroll expenses of approximately $180,000, $130,000, and $90,000, respectively, which was offset by the decreased compensation expenses related to stock options granted for employees for sales of approximately $220,000.

Research and development expense decreased by $226,726 to $1,719,809 for the six months ended December 31, 2023, from $1,946,535 for the corresponding period of 2022. The decrease in research and development expense was primarily due to the decreased research and development costs and the related payroll expense of approximately $154,000 and $72,000, respectively, which is the mixed result of the timing of research and development activities and the number of active projects and typically vary from period to period.

OTHER INCOME, NET – Other income, net increased by $401,026, or 82.3%, to $888,381 for the six months ended December 31, 2023 from $487,355 for the corresponding period of 2022. The increase was primarily due to the increased unrealized gain from the money market accounts of approximately $276,000 and the increased interest income from certificates of deposits of approximately $283,000, which was partially offset by the decreased forgiven liabilities of $165,000.

LIQUIDITY AND CAPITAL RESOURCES

Our historical operating results, capital resources and financial position, in combination with current projections and estimates, were considered in management’s plan and intentions to fund our operations over a reasonable period of time, which we define as the twelve-month period ending from the date of the filing of this Form 10-Q. For purposes of liquidity disclosures, we assess the likelihood that we have sufficient available working capital and other principal sources of liquidity to fund our operating activities and obligations as they become due.

Our principal source of liquidity as of December 31, 2023 consisted of cash and cash equivalents as well as short-term investments of $32,749,752. We believe we have sufficient available capital to cover our existing operations and obligations through at least one year from the date of the filing of this Form 10-Q. Our long-term future cash requirements will depend on numerous factors, including our revenue base, profit margins, product development activities, market acceptance of our products, future expansion plans and ability to control costs. If we are unable to achieve our current business plan or secure additional funding that may be required, we would need to curtail our operations or take other similar actions outside the ordinary course of business in order to continue to operate as a going concern.

OPERATING ACTIVITIES – Net cash used in operating activities for the six months ended December 31, 2023 and 2022 was $6,193,534 and $7,098,190, respectively.

The $6,193,534 in net cash used in operating activities for the six months ended December 31, 2023 was primarily due to the increase in accounts receivable of $4,495,638 and the decrease in accounts payable of $3,869,191 as well as our operating results (net loss adjusted for depreciation, amortization, and other non-cash charges), which was partially offset by the decrease in inventories of $2,581,682.

The $7,098,190 in net cash used in operating activities for the six months ended December 31, 2022 was primarily due to the increase in accounts receivable and inventories of $6,748,926 and $3,191,635, respectively, as well as our operating results (net loss adjusted for depreciation, amortization, and other non-cash charges), which was partially offset by an increase in accounts payable of $3,771,831.

INVESTING ACTIVITIES – Net cash used in investing activities for the six months ended December 31, 2023 and 2022 was $869,481 and $1,393,764, respectively.

The $869,481 in net cash used in investing activities for the six months ended December 31, 2023 was primarily due to the purchase of short-term investments of $779,571 and the payments for capitalized product development of $68,733. The $1,393,764 in net cash used in investing activities for the six months ended December 31, 2022 was primarily due to the payments for capitalized product development of $1,046,980 and purchase of short-term investments of $293,545.

FINANCING ACTIVITIES – Net cash used in financing activities for six months ended December 31, 2023 was $2,046, and net cash provided by financing activities for the six months ended December 31, 2022 was $45,000.

The $2,046 in net cash used in financial activities for the six months ended December 31, 2023 was from the increased loan interest to an employee. The $45,000 in net cash provided by financing activities for the six months ended December 31, 2022 were from cash received from exercise of stock options of $134,000, which was partially offset by the loan to an employee of $89,000.

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

Leases

We leased approximately 12,775 square feet of office space in San Diego, California, at a monthly rent of $25,754, pursuant to a lease that expired in December 2023. On October 19, 2023, we signed a lease for office space consisting of approximately 11,400 square feet, located in San Diego, California, at a monthly rent of $23,370, which commenced on January 1, 2024. In addition to monthly rent, the lease includes payment for certain common area costs. The term of the lease for the office space is 65 months from the lease commencement date. Our facility is covered by an appropriate level of insurance, and we believe it to be suitable for our use and adequate for our present needs.

On or about December 7, 2023, we received an invoice from our prior landlord, Hunsaker & Associates, requesting payment of additional rent on our completed and expired lease of office space located at 9707 Waples Street, San Diego, CA as of December 31, 2023. This invoice purports to represent charges for variable cost increases during the prior 7 years of the lease. We are currently reviewing these charges and will be requesting further validation of these charges, in accordance with our rights granted under the lease. For the three months ended December 31, 2023, we recorded an additional rent expense reflecting this pending invoice of $142,978 and a credit of $24,656 for our deposit on the leasehold property.

Our Korea-based subsidiary, FTI, leases approximately 10,000 square feet of office space, at a monthly rent of approximately $8,000, and additional office space consisting of approximately 2,682 square feet at a monthly rent of approximately $2,700, both located in Seoul, Korea. These leases will expire on August 31, 2024. In addition to monthly rent, the leases provide for periodic cost of living increases in the base rent and payment for certain common area costs. These facilities are covered by an appropriate level of insurance, and we believe them to be suitable for our use and adequate for our present needs. We lease one corporate housing facility, located in Seoul, Korea, primarily for our employees who travel, under a non-cancelable operating lease that will expire on September 4, 2024.

Rent expense for the three months ended December 31, 2023 and 2022 were $254,402 and $111,384, respectively. Rent expense for the six months ended December 31, 2022 and 2021 were $365,819 and $222,677, respectively.

Recently Issued Accounting Pronouncements

Refer to NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES in the Consolidated Financial Statements.

OFF-BALANCE SHEET ARRANGEMENTS

None.

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President and Acting Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our President and our Acting Chief Financial Officer have concluded that, as of December 31, 2023, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and (ii) accumulated and communicated to our management, including our principal executive and principal accounting officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934 and as a result of adopting Topic 842) during the six months ended December 31, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our Annual Report on Form 10-K for the fiscal year ended June 30, 2023, filed with the SEC on September 28, 2023 (the “Annual Report”), includes a detailed discussion of our risk factors under the heading “PART I, ITEM 1A – RISK FACTORS.” You should carefully consider the risk factors discussed in our Annual Report, as well as other information in this quarterly report. Any of these risks could cause our business, financial condition, results of operations and future growth prospects to suffer. We are not aware of any material changes from the risk factors previously disclosed.