UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
AMENDMENT NO. 1
TO
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM __________ TO __________.
COMMISSION FILE NUMBER: 0-11616
FRANKLIN WIRELESS CORP.
(Exact name of Registrant as specified in its charter)
NEVADA 95-3733534
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
5440 MOREHOUSE DRIVE, SUITE 1000, 92121
SAN DIEGO, CALIFORNIA (Zip code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (858) 623-0000
--------------------------------------------------------------------------------
Indicated by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (ss.232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes |_| No |_|
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The Registrant has 13,781,491 shares of common stock outstanding as of February
24, 2010
FRANKLIN WIRELESS CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009
PAGE
PART I- FINANCIAL INFORMATION
Item 1: Financial Statements 3
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3: Controls and Procedures 25
PART II- OTHER INFORMATION
Item 1: Legal Proceedings 25
Item 1A: Risk Factors 25
Item 2: Unregistered Sales of Equity Securities and
Use of Proceeds 25
Item 3: Defaults Upon Senior Securities 25
Item 4: Other Information 25
Item 5: Exhibits 25
Signatures 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN WIRELESS CORP. AND ALL SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
----------- -----------
DECEMBER 31, JUNE 30,
2009 2009
----------- -----------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents $ 5,216,579 $ 6,253,529
Accounts receivable 8,890,215 2,812,607
Inventories 674,181 2,618,344
Prepaid expense and other current assets 142,170 22,610
Advance payment to vendor 12,320 --
Deferred tax assets, current 331,582 169,731
----------- -----------
Total current assets 15,267,047 11,876,821
Goodwill 410,695 --
Property and equipment, net 1,199,628 89,807
Intangible assets, net 2,408,134 --
Deferred tax assets, noncurrent 1,254,835 1,880,081
Other assets 78,015 11,016
----------- -----------
TOTAL ASSETS $20,618,354 $13,857,725
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Trade accounts payable $ 305,075 $ 45,112
Trade accounts payable - related party 6,601,059 4,466,741
Advance payment from customer 75,087 --
Accrued liabilities 1,336,264 109,797
----------- -----------
Total current liabilities 8,317,485 4,621,650
Long-term debt, net of current portion 256,667 --
----------- -----------
Total Liabilities 8,574,152 4,621,650
----------- -----------
Callable common stock 478,500 --
Stockholders' Equity:
Preferred stock, par value $0.001 per share,
authorized 10,000,000 shares; No preferred stock issued
and outstanding as of December 31, 2009 and
June 30, 2009 -- --
Common stock, par value $0.001 per share, authorized
50,000,000 shares; 13,781,491 shares and 13,231,491
shares issued and outstanding as of December 31, 2009
and June 30, 2009, respectively 13,232 13,232
Additional paid-in capital 5,037,105 5,018,721
Retained earnings 5,083,725 4,204,122
Non-controlling interests 1,431,640 --
----------- -----------
Total stockholders' equity 11,565,702 9,236,075
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $20,618,354 $13,857,725
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
3
FRANKLIN WIRELESS CORP. AND ALL SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
--------------------------- ---------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
2009 2008 2009 2008
----------- ----------- ----------- -----------
(CONSOLIDATED) (CONSOLIDATED)
Net sales $25,177,226 $ 4,617,140 $30,302,163 $10,868,308
Cost of goods sold 22,279,796 3,512,995 26,632,873 7,907,119
----------- ----------- ----------- -----------
Gross profit 2,897,430 1,104,145 3,669,290 2,961,189
----------- ----------- ----------- -----------
Operating expenses:
Selling, general, and administrative 1,458,504 530,622 2,034,998 1,617,334
----------- ----------- ----------- -----------
Total operating expenses 1,458,504 530,622 2,034,998 1,617,334
----------- ----------- ----------- -----------
Income from operations 1,438,926 573,523 1,634,292 1,343,855
Other income:
Interest income 10,593 27,169 23,868 56,369
Forgiveness of debt -- 33,400 -- 33,400
Other income 22,094 510 22,881 223
----------- ----------- ----------- -----------
Total other income (expense), net 32,687 61,079 46,749 89,992
----------- ----------- ----------- -----------
Net income before income taxes 1,471,613 634,602 1,681,041 1,433,847
Provision for income taxes 575,514 111,610 650,521 254,388
----------- ----------- ----------- -----------
Net income 896,099 522,992 1,030,520 1,179,459
----------- ----------- ----------- -----------
Net income - non-controlling interests 74,553 -- 74,553 --
Net income - controlling interests $ 821,546 $ 522,992 $ 955,967 $ 1,179,459
=========== =========== =========== ===========
Basic earnings per share $ 0.06 $ 0.04 $ 0.07 $ 0.09
Diluted earnings per share $ 0.06 $ 0.04 $ 0.07 $ 0.09
Weighted average common shares
outstanding - basic 13,548,339 13,231,491 13,389,915 13,231,491
Weighted average common shares
outstanding - diluted 13,644,682 13,231,491 13,486,258 13,231,491
See accompanying notes to unaudited consolidated financial statements.
4
FRANKLIN WIRELESS CORP. AND ALL SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
----------------------------
SIX MONTHS ENDED
DECEMBER 31,
----------------------------
2009 2008
----------- -----------
(CONSOLIDATED)
CASH FLOWS FROM OPERATIONS ACTIVITIES:
Net income $ 955,967 $ 1,179,459
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 78,909 7,966
Amortization 75,031 --
Bad debt expense 6,000 315
Share-based compensation expenses 18,384 --
Loss on disposal of fixed assets 848 --
Forgiveness of debt -- (33,400)
Deferred income taxes (26,446) --
Non-controlling interest 74,553 --
Changes in operating assets and liabilities:
Accounts receivable (6,074,327) 3,023,952
Inventories 1,944,163 38,768
Prepaid expense and other current assets (75,020) 11,106
Prepaid income tax 18,503 352,481
Other assets (19,935) (125)
Accounts payable 2,004,323 (2,024,125)
Advance payment from customers (187,076) (390,000)
Accrued liabilities 737,036 (814,121)
Deferred rent payable -- 17,432
----------- -----------
Net cash provided by (used in) operating activities (469,087) 1,369,708
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (114,104) (12,857)
Purchase of intangible assets (442,166) --
----------- -----------
Net cash used in investing activities (556,270) (12,857)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of note payable -- (300,600)
Payment of mortgage (11,593) --
----------- -----------
Net cash provided by (used in) financing activities (11,593) (300,600)
----------- -----------
Net increase (decrease) in cash and cash equivalents (1,036,950) 1,056,251
Cash and cash equivalents, beginning of period 6,253,529 6,172,569
----------- -----------
Cash and cash equivalents, end of period $ 5,216,579 $ 7,228,820
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ -- $ --
Income taxes 190,754 939,388
Non-cash transaction in investing activities (478,500) --
Issuance of common shares
See accompanying notes to unaudited consolidated financial statements.
5
FRANKLIN WIRELESS CORP. AND ALL SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited financial statements of the Company have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP") for interim financial information and are presented in
accordance with the requirements of Form 10-Q. The balance sheet is consolidated
and unaudited as of December 31, 2009 and audited as of June 30, 2009. The
statement of operations is consolidated and unaudited for the three months and
six months ended December 31, 2009 and unaudited for the corresponding periods
of 2008. The statement of cash flows is consolidated and unaudited for the six
months ended December 31, 2009 and unaudited for the corresponding period of
2008. In the opinion of management, the financial statements included herein
contain all adjustments, including normal recurring adjustments, considered
necessary to present fairly the financial position, the results of operations
and cash flows of the Company for the periods presented. These financial
statements and notes hereto should be read in conjunction with the financial
statements and notes thereto for the fiscal year ended June 30, 2009 included in
the Company's Form 10-K, filed on October 13, 2009. The operating results or
cash flows of the interim periods presented herein are not necessarily
indicative of the results to be expected for any other interim period or the
full year.
The Company evaluated subsequent events through February 24, 2010, the date on
which this Quarterly Report on Form 10-Q was filed with the Securities and
Exchange Commission.
NOTE 2 - BUSINESS OVERVIEW
The Company designs and sells broadband high speed wireless data communication
products such as third generation ("3G") and fourth generation ("4G") wireless
modules and modems. The Company focuses primarily on wireless broadband
Universal Serial Bus ("USB") modems, which provide a flexible way for wireless
subscribers to connect to the wireless broadband network with any laptop, tablet
PC or desktop USB port without a PC card slot. The broadband wireless data
communication products are positioned at the convergence of wireless
communications, mobile computing and the Internet, each of which the Company
believes represents a growing market.
The Company's wireless products are based on Evolution Data Optimized technology
("EV-DO technology") of Code Division Multiple Access ("CDMA"), High-Speed
Packet Access technology ("HSPA technology") of Wideband Code Division Multiple
Access ("WCDMA), and Worldwide Interoperability for Microwave Access ("WIMAX")
based on the IEEE 802.16 standard, which enable end users to send and receive
email with large file attachments, play interactive games, and receive, send and
download high resolution picture, video, and music contents.
The Company markets its products directly to wireless operators, and indirectly
through strategic partners and distributors. The Company's global customer base
extends primarily from the United States to Caribbean and South American
countries. The Company's USB modems are certified by Sprint, Comcast Cable, Cox,
Clearwire, Time Warner Cable, Cellular South, Mobi PCS, NTELOS, Cincinnati Bell,
and ACS in the United States, by IUSACELL in Mexico, by Telefonica and Movilnet
in Venezuela, by Centennial in Puerto Rico, by Alegro in Ecuador, by CellularOne
in Bermuda and by TSTT in Trinidad and Tobago. The Company has built upon its
strong customer relationships to help drive strategic marketing initiatives with
its customers that provide additional opportunities to expand market reach by
combining its expertise in wireless technologies with its customers' sales and
marketing base, creating access to additional indirect distribution channels.
In October, 2009, the Company opened a branch office in Seoul, South Korea,
which operates as a wholly-owned subsidiary. As of December 31, 2009, the office
employed three people, who manage certain logistical and administrative efforts
for the Company.
6
On October 1, 2009, the Company completed the acquisition of approximately 50.6%
of the outstanding capital stock of Diffon Corporation, a South Korean
corporation ("Diffon"). The purpose of the acquisition was to acquire a
significant interest in a facility in South Korea that will provide design,
development and manufacturing services to the Company for high speed wireless
data communication products, including 3G and 4G wireless modules and modems.
Diffon has approximately 48 employees and the majority of them perform research
and development functions. Diffon outsources its manufacturing process to third
parties. The acquisition involved two separate but related transactions.
In the first transaction the Company entered into a Share Exchange Agreement,
dated October 1, 2009 with two major shareholders of Diffon (the "Diffon
Shareholders"). The Company issued the Diffon Shareholders an aggregate of
550,000 shares of the Company's Common Stock in exchange for 440,000 shares of
capital stock of Diffon, representing approximately 20.1% of the outstanding
capital stock of Diffon. Under the Agreement, the Diffon Shareholders, acting
together, have an unconditional right of rescission for one year, so that they
may elect to return the Company Common Stock received by them and receive the
Diffon shares in return.
In the second transaction, pursuant to a Common Stock Purchase Agreement dated
October 1, 2009, the Company purchased 666,667 newly-issued shares of Diffon,
representing approximately 30.5% of the outstanding capital stock of Diffon
after giving effect to the issuance, for cash in the amount of $833,333. The
Agreement provides that at the Closing the Board of Directors of Diffon will be
fixed at five directors, including two directors to be designated by the
Company. The Company, Diffon and the Diffon Shareholders entered into a
Shareholders' Agreement concerning ownership of the Diffon shares and certain
other matters.
The Company accounted for the acquisition under the purchase method of
accounting in accordance with the provisions of ASC 805, "Business
Combinations." Under this accounting method, the Company recorded at fair value
the assets of Diffon less the liabilities assumed, with the excess of the
purchase price over the estimated fair value of such net assets reflected as
goodwill. The Company's consolidated statement of operations includes the
operations of Diffon from the date of the acquisition.
7
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, a
wholly-owned subsidiary, and a subsidiary with a majority voting interest of
50.6% (49.4% is owned by non-controlling interests). In the preparation of
consolidated financial statements of the Company, all intercompany balances and
transactions have been eliminated.
As consolidated financial statements are based on the assumption that they
represent the financial position and operating results of a single economic
entity, the retained earnings or deficit of a subsidiary at the date of
acquisition, October 1, 2009, by the parent are excluded in consolidated
retained earnings. When a subsidiary is initially consolidated during the six
months ended December 31, 2009, the consolidated financial statements include
the subsidiary's revenues, expenses, gains, and losses only from the date the
subsidiary is initially consolidated, and the noncontrolling interest is
reported in the consolidated statement of financial position within equity,
separately from the parent's equity. That amount is clearly identified and
labeled. There are no shares of the Company held by the subsidiaries as of
December 31, 2009.
SEGMENT REPORTING
ASC 280, Segment Reporting, requires public companies to report financial and
descriptive information about their reportable operating segments. The Company
identifies its operating segments based on how management internally evaluates
separate financial information, business activities and management
responsibility. The Company has one reportable segment, consisting of sale of
wireless access products.
The Company generates revenues from three geographic areas, the United States,
the Caribbean and South America, and Asia. The following enterprise wide
disclosure was prepared on a basis consistent with the preparation of the
consolidated financial statements. The following table contains certain
financial information by geographic area:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
NET SALES: 2009 2008 2009 2008
----------- ----------- ----------- -----------
Unites States $24,554,545 $ 2,052,315 $28,474,432 $ 4,704,533
Caribbean and -- 2,564,825 1,205,050 6,163,775
South America
Asia 622,681 -- 622,681 --
----------- ----------- ----------- -----------
TOTALS $25,177,226 $ 4,617,140 $30,302,163 $10,868,308
=========== =========== =========== ===========
LONG-LIVED ASSETS: DECEMBER 31, 2009 JUNE 30, 2009
-------------- --------------
United States $ 102,335 $ 89,807
Asia 3,580,459 --
-------------- --------------
Totals $ 3,682,794 $ 89,807
============== ==============
ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to the
current period presentation.
8
REVENUE RECOGNITION
The Company recognizes revenue in accordance with ASC 605, Revenue Recognition,
when persuasive evidence of an arrangement exists, the price is fixed or
determinable, collection is reasonably assured and delivery of products has
occurred or services have been rendered. Accordingly, the Company recognizes
revenues from product sales upon shipment of the product to the customers or
when the products are received by the customers in accordance with shipping or
delivery terms. The Company provides a factory warranty for one year from the
shipment, which is covered by its vendor under the purchase agreement between
the Company and the vendor.
RESEARCH AND DEVELOPMENT COSTS
Research and development expenses include payroll, employee benefits, and other
headcount-related expenses associated with product development. Such costs
related to product development costs are included in research and development
expense until the point that technological feasibility is reached, which for the
Company's products, is generally shortly before the products are released to
manufacturing. Once technological feasibility is reached, such costs are
capitalized and amortized to cost of revenue over the estimated lives of the
products. As of December 31, 2009, research and development expenses are
capitalized in the amount of $442,166 and included in intangible assets in the
Company's consolidated balance sheet.
ADVERTISING AND PROMOTION COSTS
Costs associated with advertising and promotions are expensed as incurred.
Advertising and promotion costs amounted to $13,777 and $19,067 for the three
months ended December 31, 2009 and 2008, respectively, and $44,456 and $19,640
for the six months ended December 31, 2009 and 2008, respectively.
SHIPPING AND HANDLING COSTS
Most of the Company's shipping and handling costs are paid by customers or
suppliers directly to the shipping locations. The Company generally does not
collect and incur shipping and handling costs. As a result, the Company did not
incur any significant shipping and handling costs for the six months ended
December 31, 2009.
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flow, the Company considers all highly
liquid investments purchased with original maturities of three months or less to
be cash equivalents.
INVENTORIES
The Company's inventories are made up of finished goods and are stated at the
lower of cost or market, cost being determined on a first-in, first-out basis.
The Company assesses the inventory carrying value and reduces it, if necessary,
to its net realizable value based on customer orders on hand, and internal
demand forecasts using management's best estimates given information currently
available. The Company's customer demand is highly unpredictable, and can
fluctuate significantly caused by factors beyond the control of the Company. The
Company does not maintain an allowance for inventories for potential excess and
obsolete inventories and inventories that are carried at costs that are higher
than their estimated net realizable values.
9
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Significant additions or
improvements extending useful lives of assets are capitalized. Maintenance and
repairs are charged to expense as incurred. Depreciation is computed using the
straight-line method over the estimated useful lives as follows:
Building 40 years
Machinery 6 years
Office equipments 5 years
Molds 3 years
Vehicle 5 years
Computers and software 5 years
Furniture and fixtures 7 years
Facilities 5 years
Construction-in-progress Capitalized
Expenditures for maintenance and repairs are charged to operations as incurred
while renewals and betterments are capitalized.
GOODWILL AND INTANGIBLE ASSETS
On October 1, 2009, the Company acquired approximately 50.6% of the outstanding
capital stock of Diffon, which provides design, development and manufacturing
services to the company for high speed wireless data communication products,
including 3G and 4G wireless modules and modems. In accordance with ASC 805,
Business Combinations, the Company has identified and determined the fair
values of the following intangible assets of Diffon on October 1, 2009,
the date of acquisition.
Complete technology $ 490,000 3 years
Customer contracts / Relationships 430,000 8 years
In progress research and development 1,121,000 Capitalized
----------
Total $ 2,041,000
Goodwill and intangible assets are recorded in connection with Diffon
acquisition and are accounted for in accordance with ASC 805, Business
Combinations. Goodwill represents excess of the purchase price over the fair
value of the tangible and intangible net assets acquired. Intangible assets are
recorded at their fair value at the date of acquisition.
Goodwill and other intangible assets are accounted for in accordance with ASC
350, Goodwill and Other Intangible Assets. Goodwill is tested for impairment at
least annually and any related impairment losses are recognized in earnings when
identified.
LONG-LIVED ASSETS
In accordance with ASC 360, Property, Plant, and Equipment, the Company reviews
for impairment of long-lived assets and certain identifiable intangibles
whenever events or circumstances indicate that the carrying amount of assets may
not be recoverable. The Company considers the carrying value of assets may not
be recoverable based upon its review of the following events or changes in
circumstances: the asset's ability to continue to generate income from
operations and positive cash flow in future periods; loss of legal ownership or
title to the assets; significant changes in the Company's strategic business
objectives and utilization of the asset; or significant negative industry or
economic trends. An impairment loss would be recognized when estimated future
cash flows expected to result from the use of the asset is less than its
carrying amount.
As of December 31, 2009, the Company is not aware of any events or changes in
circumstances that would indicate that the long-lived assets are impaired.
10
WARRANTIES
The Company does not allow the right of return on product sales but provides a
factory warranty for one year from the date of purchase by consumers, which is
covered by its vendors. These products are shipped directly from its vendors to
customers. As a result, the Company does not accrue any warranty expenses.
INCOME TAXES
The Company follows ASC 740, Income Taxes, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each period end based on enacted tax laws
and statutory tax rates, applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.
The Company adopted ASC 740-10-25 on January 1, 2007, which provides criteria
for the recognition, measurement, presentation and disclosure of uncertain tax
position. The Company must recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position. The tax benefits recognized in the financial statements
from such a position are measured based on the largest benefit that has a
greater than 50% likelihood of being realized upon ultimate resolution. The
Company did not recognize any additional liabilities for uncertain tax positions
as a result of the implementation of ASC 740-10-25.
EARNINGS PER SHARE
The Company reports earnings per share in accordance with ASC 260, Earnings Per
Share Basic earnings per share are computed using the weighted average number of
shares outstanding during the fiscal year. Diluted earnings per share represent
basic earnings per share adjusted to include the potentially dilutive effect of
outstanding stock options.
The weighted average number of shares outstanding used to compute earnings per
share is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -------------------------
2009 2008 2009 2008
---------- ---------- ---------- ----------
Basic weighted average shares
outstanding 13,548,339 13,231,491 13,389,915 13,231,491
Dilutive potential common
shares 96,343 -- 96,343 --
---------- ---------- ---------- ----------
Diluted weighted average
shares outstanding 13,644,682 13,231,491 13,486,258 13,231,491
========== ========== ========== ==========
11
CONCENTRATIONS OF CREDIT RISK
The Company extends credit to its customers and performs ongoing credit
evaluations of such customers. The Company evaluates its accounts receivable on
a regular basis for collectability and provides for an allowance for potential
credit losses as deemed necessary. No reserve was required and recorded for any
of the periods presented.
Substantially all of the Company's revenues are derived from sales of wireless
data products. Any significant decline in market acceptance of its products or
in the financial condition of its existing customers could impair the Company's
ability to operate effectively.
A significant portion of the Company's revenue is derived from a small number of
customers. For the six months ended December 31, 2009, one customer accounted
for 76.8% of total net sales and had related accounts receivable balances in the
amount of $7,440,200 as of December 31, 2009.
The Company purchases its wireless products from a design and manufacturing
company located in South Korea. If the design and manufacturing companies were
to experience delays, capacity constraints or quality control problems, product
shipments to the Company's customers could be delayed, or its customers could
consequently elect to cancel the underlying product purchase order, which would
negatively impact the Company's revenue. The Company purchased wireless data
products from the supplier in the amounts of $24,171,964 and $7,698,041 for the
six months ended December 31, 2009 and 2008, respectively, and had related
accounts payable of $6,601,059 and $1,285,970 at December 31, 2009 and 2008,
respectively. On November 2, 2009, the Company received a written notice from
its supplier to terminate its agreement with the company effective January 5,
2010. In the future, the Company is expecting to purchase its wireless
products from Diffon, a majority of which was acquired on October 1, 2009.
The Company maintains its cash accounts with established commercial banks. Such
cash deposits periodically exceed the Federal Deposit Insurance Corporation
insured limit of $250,000 for each account. However, the Company does not
anticipate any losses on excess deposits.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2009, the FASB Accounting Standards Codification (Codification) was
issued. The Codification is the source of authoritative U.S. GAAP recognized by
the FASB to be applied by nongovernmental entities. The Codification is
effective for financial statements issued for interim and annual periods ending
after September 15, 2009. The implementation of this standard is not expected to
have a material impact on the Company's consolidated financial statements.
In May 2009, the FASB issued ASC 855, Subsequent Events. ASC 855 establishes
general standards of accounting for and disclosure of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. The standard, which includes a new required disclosure
of the date through which an entity has evaluated subsequent events, is
effective for interim or annual periods ending after June 15, 2009. The
Company's management evaluated all events or transactions that occurred after
December 31, 2009 up through February 23, 2010, the date the Company issued the
financial statements. During these periods, the Company did not have any
material recognizable subsequent events required to be disclosed to the
financial statements as of December 31, 2009 and for the six and three months
ended December 31, 2009.
12
In September 2009, the FASB issued new accounting guidance related to the
revenue recognition of multiple element arrangements. The new guidance states
that if vendor specific objective evidence or third party evidence for
deliverables in an arrangement cannot be determined, companies will be required
to develop a best estimate of the selling price to separate deliverables and
allocate arrangement consideration using the relative selling price method. The
accounting guidance will be applied prospectively and will become effective
during the first quarter of 2011. Early adoption is allowed. The Company will
adopt this guidance beginning January 1, 2010 and the Company does not expect
this accounting guidance to materially impact the Company's consolidated
financial statements.
In January 2010, the FASB issued new accounting guidance related to the
disclosure requirements for fair value measurements and provides clarification
for existing disclosures requirements. More specifically, this update will
require (a) an entity to disclose separately the amounts of significant
transfers in and out of Levels 1 and 2 fair value measurements and to describe
the reasons for the transfers; and (b) information about purchases, sales,
issuances and settlements to be presented separately (i.e. present the activity
on a gross basis rather than net) in the reconciliation for fair value
measurements using significant unobservable inputs (Level 3 inputs). This
guidance clarifies existing disclosure requirements for the level of
disaggregation used for classes of assets and liabilities measured at fair value
and requires disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements
using Level 2 and Level 3 inputs. The new disclosures and clarifications of
existing disclosure are effective for fiscal years beginning after December 15,
2009, except for the disclosure requirements for related to the purchases,
sales, issuances and settlements in the rollforward activity of Level 3 fair
value measurements. Those disclosure requirements are effective for fiscal years
ending after December 31, 2010. The Company does not believe the adoption of
this guidance will have a material impact on the Company's consolidated
financial statements.
NOTE 4 - ACQUISITION
On October 1, 2009, the Company completed the acquisition of approximately 50.6%
of the outstanding capital stock of Diffon. The purpose of the acquisition was
to support the Company's research and development of its current products,
including future products. The condensed consolidated financial statements
include the results of Diffon from the date of acquisition. The purchase price
has been allocated based on estimated fair values as of the acquisition date.
The purchase price was allocated as follows:
October 1, 2009
---------------
Current assets $ 918,210
Property, plant & equipment, net 1,075,240
Goodwill 410,695
Intangible assets:
Complete technology 490,000
In process research and development 430,000
Customer contracts/relationships 1,121,000
---------------
Total intangible assets 2,041,000
Other long-term assets 47,063
Current liabilities (1,141,553)
Deferred tax liability (489,840)
Long-term liabilities (268,260)
Non-controlling interest (1,280,722)
---------------
Total purchase price $ 1,311,833
===============
The purchase price allocation has been prepared on a preliminary basis based on
the information that was available to the Company at the time the condensed
consolidated financial statements were prepared, and revisions to the
preliminary purchase price allocation may result as additional information
becomes available.
In determining the purchase price allocation, management considered, among other
factors, the Company's intention to use the acquired assets. The intangible
assets are being amortized based upon the pattern in which the economic benefits
of the intangible assets are being utilized, with no expected residual value.
13
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2009 and June 30, 2009 consisted of the
following:
(UNAUDITED)
----------- -----------
DECEMBER 31, JUNE 30,
2009 2009
----------- -----------
Land $ 94,553 $ --
Building 319,501 --
Machinery and facility 376,085 --
Office equipment 62,037 --
Molds 88,472 --
Vehicle 9,313 --
Computers and software 107,001 86,579
Furniture and fixtures 47,430 45,267
Construction-in-progress 215,561 --
----------- -----------
1,319,953 131,846
Less accumulated depreciation (120,325) (42,039)
----------- -----------
TOTAL $ 1,199,628 $ 89,807
=========== ===========
Depreciation expense associated with property and equipment was $78,909 and
$7,966 for the six months ended December 31, 2009 and 2008, respectively.
NOTE 6 - ACCRUED LIABILITIES
Accrued liabilities at December 31, 2009, and June 30, 2009, consisted of the
following:
(UNAUDITED)
---------- ----------
DECEMBER 31, JUNE 30,
2009 2009
---------- ----------
Salaries vacation accrual $ 175,212 $ 46,995
Deferred rent payable 14,421 16,655
Marketing development fund 121,429 --
Disputed accounts 291,608 --
Income taxes 485,489 --
Other accrued liabilities 248,105 46,147
---------- ----------
TOTAL $1,336,264 $ 109,797
========== ==========
Deferred rent payable is the sum of the difference between a monthly rent
payment and the monthly rent expense of an operating lease of the Company that
contains escalated payments in future periods. The rent expense is the sum of
all rent payments over the term of the lease divided by the number of periods
contained in the lease otherwise known as straight-line amortization. This rent
expense amount differs from the monthly rent payments, which is deferred rent
payable.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases its administrative facilities under a non-cancelable
operating lease that expires on August 31, 2011. In addition to the minimum
annual rental commitments, the lease provides for periodic cost of living
increases in the base rent and payment of common area costs. Rent expense
related to the operating lease was $53,852 and $53,852 for the six months ended
December 31, 2009 and 2008, respectively.
The Company leases its corporate housing facility under a non-cancelable
operating lease that expires on May 9, 2010 for its vendors. Rent expense
related to the operating lease was $7,772 and $9,322 for the six months ended
December 31, 2009 and 2008, respectively.
RIGHT OF RESCISSION
Two shareholders, who acquired an aggregate of 550,000 shares of the Company's
Common Stock in exchange for 440,000 shares of Common Stock of Diffon
Corporation, have an unconditional right of rescission for one year, so that at
any time prior to October 1, 2010 they may elect to return the Company Common
Stock received by them and receive the Diffon shares in return. These shares are
classified as callable common stock in the Company's consolidated balance sheet.
14
LITIGATION
The Company is involved in certain legal proceedings and claims which arise in
the normal course of business. Management does not believe that the outcome of
these matters will have any material adverse effect on its financial condition.
CO-DEVELOPMENT, CO-OWNERSHIP AND SUPPLY AGREEMENT
In January 2005, the Company entered into a manufacturing and supply agreement
(the "Agreement") with C-Motech for the manufacture of its products. Under the
agreement, C-Motech is required to provide the Company with services including
all licenses, component procurement, final assembly, testing, quality control,
fulfillment and after-sale service. The Agreement provides exclusive rights to
market and sell CDMA wireless data products in countries in North America, the
Caribbean, and South America. Furthermore, the Agreement provides that the
Company is responsible for marketing, sales, field testing, and certifications
of these products to wireless service operators and other commercial buyers
within a designated territory, and C-Motech is responsible for design,
development, testing, CDG certification, and completion of these products. Under
the Agreement, products include all access devices designed with Qualcomm's MSM
5100, 5500, 6500, and 6800 chipset solutions provided or designed by C-Motech or
both companies. Both companies own the rights to the products: USB modems, Card
Bus, PCI Bus and Module designed with MSM 5500 dual band products. On January
30, 2007, C-Motech also certified that the Company has the exclusive right to
sell CDU-680 EVDO USB modems directly and indirectly in these territories. This
agreement may be amended or supplemented by mutual agreement of the parties, as
is necessary to document the addition of any new products.
The initial term of the Agreement was for two years, commencing on January 5,
2005. The agreement automatically renews for successive one year periods unless
either party provides a written notice to terminate at least sixty days prior to
the end of the term. On November 2, 2009, C-Motech provided a written notice to
terminate the agreement effective January 5, 2010. Following this date, C-Motech
continues to supply the Company with certain products (primarily the U300 and
U301 USB modems). In addition, C-Motech owns 3,370,356 shares, or approximately
25%, of the Company's outstanding Common Stock.
CHANGE OF CONTROL AGREEMENTS
On September 21, 2009, the Company entered into Change of Control Agreements
("Agreements") with OC Kim, President, David Yun Lee, Chief Operating Officer,
and Yong Bae Won, Vice President-Engineering. The Agreements provide for a lump
sum payment to the officer in case of a change of control of the Company. The
term includes the acquisition of common stock of the Company resulting in one
person or company owning more than 50% of the outstanding shares, a significant
change in the composition of the Board of Directors of the Company during any
twelve-month period, a reorganization, merger, consolidation or similar
transaction resulting in the transfer of ownership of more than fifty percent of
the Company's outstanding Common Stock, or a liquidation or dissolution of the
Company or sale of substantially all of the Company's assets.
The agreement with Mr. Kim is for three years and calls for a payment of $5
million upon a change of control; the agreement with Mr. Lee is for two years
and calls for a payment of $2 million upon a change of control; and the
agreement with Mr. Won is for two years and calls for a payment of $1 million
upon a change of control.
NOTE 8 - STOCK-BASED COMPENSATION
In June 2009, the Company adopted the 2009 Stock Incentive Plan ("2009 Plan").
The 2009 Plan provided for the grant of incentive stock options and
non-qualified stock options to the Company's employees and directors. Options
granted under the 2009 Plan generally vest and become exercisable at the rate of
between 50% and 100% per year with a life between four and five years. Upon
exercise of granted options, shares are expected to be issued from new shares
previously registered for the 2009 Plan.
The Company adopted ASC 718, Compensation - Stock Compensation, using a modified
prospective application, and the Black-Scholes model. Under this application,
the Company is required to record compensation expense for all awards granted
after the date of adoption and for the unvested portion of previously granted
awards that remain outstanding at the date of adoption. Compensation cost will
be recognized over the period that an employee provides service in exchange for
the award.
The estimated forfeiture rate considers historical turnover rates stratified
into employee pools in comparison with an overall employee turnover rate, as
well as expectations about the future. The Company periodically revises the
estimated forfeiture rate in subsequent periods if actual forfeitures differ
from those estimates. Compensation expense recorded under this method for the
six months ended December 31, 2009 was $18,384 and reduced operating income and
income before income taxes by the same amount by increasing compensation expense
recognized in selling and administrative expense. The recognized tax benefit
related to the compensation expense for the six months ended December 31, 2009
was nil.
The Company did not grant any stock options during the six months ended December
31, 2009 and 2008.
15
The risk-free interest rate is based on the U.S. Treasury yield curve in effect
at the time of grant for periods corresponding with the expected term of the
option; the expected term represents the weighted-average period of time that
options granted are expected to be outstanding giving consideration to vesting
schedules and using the simplified method; the expected volatility is based upon
historical volatilities of the Company's common stock; and the expected dividend
yield is based upon the Company's current dividend rate and future expectations.
A summary of the status of the Company's stock options is presented below:
WEIGHTED-
AVERAGE
WEIGHTED- REMAINING
AVERAGE CONTRACTUAL AGGREGATE
EXERCISE LIFE INTRINSIC
OPTIONS SHARES PRICE (IN YEARS) VALUE
--------- --------- --------- ---------
Outstanding at June 30, 2009 447,500 $ 0.45 -- --
Granted -- -- -- --
Exercised -- -- -- --
Forfeited or Expired -- -- -- --
--------- =========
Outstanding at December 31, 2009 447,500 $ 0.45 1.0 $ 294,888
========= ========= ========= =========
Exercisable at December 31, 2009 -- $ -- -- $ --
========= ========= ========= =========
Vested and Expected to Vest
at December 31, 2009 -- $ -- -- $ --
========= ========= ========= =========
The weighted-average grant-date fair value of stock options granted for six
months ended December 31, 2009 was $0.09 per share.
The aggregate intrinsic value in the preceding table represents the total pretax
intrinsic value, based upon the Company's closing stock price of $1.14 as of
December 31, 2009, which would have been received by the option holders had all
option holders exercised their options as of that date.
As of December 31, 2009, there was $25,025 of total unrecognized compensation
cost related to non-vested stock options granted. That cost is expected to be
recognized over a weighted-average period of 1.0 years
NOTE 9 - RELATED PARTY TRANSACTIONS
The Company purchased wireless data products in the amount of $24,171,964, or
99.3% of total purchases, from C-Motech Co. Ltd., for the six months ended
December 31, 2009 and had related accounts payable of $6,601,059 as of December
31, 2009. C-Motech owns 3,370,356 shares, or 24.5%, of the Company's outstanding
Common Stock and Jaeman Lee, Chief Executive Officer of C-Motech Co. Ltd., has
served as a director of the Company since September 2006.
NOTE 10 - SUBSEQUENT EVENTS
In May 2009, the FASB issued ASC 855, Subsequent Events. ASC 855 establishes
general standards of accounting for and disclosure of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. The standard, which includes a new required disclosure
of the date through which an entity has evaluated subsequent events, is
effective for interim or annual periods ending after June 15, 2009. The
Company's management evaluated all events or transactions that occurred after
December 31, 2009 up through February 22, 2010, the date the Company issued the
financial statements. During these periods, the Company did not have any
material recognizable subsequent events required to be disclosed to the
financial statements as of December 31, 2009 and for the six and three months
ended December 31, 2009.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto included in Item 1 of Part I of this
report and the financial statements and notes thereto and Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Form 10-K filed on October 13, 2009, for the year
ended June 30, 2009.
BUSINESS OVERVIEW
The Company designs and sells broadband high speed wireless data communication
products such as third generation ("3G") and fourth generation ("4G") wireless
modules and modems. The Company focuses primarily on wireless broadband USB
modems, which provide a flexible way for wireless subscribers to connect to the
wireless broadband network with any laptop, table PC or desktop USB port without
a PC card slot. The broadband wireless data communication products are
positioned at the convergence of wireless communications, mobile computing and
the Internet, each of which the Company believes represents a growing market.
The Company's wireless products are based on Evolution Data Optimized technology
("EV-DO technology") of Code Division Multiple Access ("CDMA"), High-Speed
Packet Access technology ("HSPA technology") of Wideband Code Division Multiple
Access ("WCDMA), and Worldwide Interoperability for Microwave Access ("WIMAX")
based on the IEEE 802.16 standard, which enable end users to send and receive
email with large file attachments, play interactive games, and receive, send and
download high resolution picture, video, and music contents.
The Company markets its products directly to wireless operators and indirectly
through strategic partners and distributors. Its global customer base extends
primarily from the United States to Caribbean and South American countries. The
Company's Universal Serial Bus ("USB") modems are certified by Sprint, Comcast
Cable, Cox, Time Warner Cable, Cellular South, Mobi PCS, NTELOS, Cincinnati
Bell, and ACS in the United States, by IUSACELL in Mexico, by Telefonica and
Movilnet in Venezuela, by Centennial in Puerto Rico, by Alegro in Ecuador, by
CellularOne in Bermuda and by TSTT in Trinidad and Tobago. The Company has built
upon its strong customer relationships to help drive strategic marketing
initiatives with its customers that provide additional opportunities to expand
market reach by combining the Company's expertise in wireless technologies with
its customers' sales and marketing base, creating access to additional indirect
distribution channels.
In October, 2009, the Company opened a branch office in Seoul, South Korea,
which operates as a wholly-owned subsidiary. As of December 31, 2009, the office
employed three people who manage certain logistical and administrative efforts
for the Company.
On October 1, 2009, the Company completed the acquisition of approximately 50.6%
of the outstanding capital stock of Diffon Corporation, a South Korean
corporation ("Diffon"). The purpose of the acquisition was to acquire a
significant interest in a facility in South Korea that will provide design,
development and manufacturing services to the Company for high speed wireless
data communication products including 3G and 4G wireless modules and modems.
Diffon has approximately 48 employees and the majority of them perform research
and development functions. Diffon outsources its manufacturing process to third
parties. The acquisition involved two separate but related transactions.
In the first transaction the Company entered into a Share Exchange Agreement,
dated October 1, 2009 with two major shareholders of Diffon (the "Diffon
Shareholders"). The Company issued the Diffon Shareholders an aggregate of
550,000 shares of the Company's Common Stock in exchange for 440,000 shares of
capital stock of Diffon, representing approximately 20.1% of the outstanding
capital stock of Diffon. Under the Agreement, the Diffon Shareholders, acting
together, have an unconditional right of rescission for one year, so that they
may elect to return the Company Common Stock received by them and receive the
Diffon shares in return.
In the second transaction, pursuant to a Common Stock Purchase Agreement dated
October 1, 2009, the Company purchased 666,667 newly-issued shares of Diffon,
representing approximately 30.5% of the outstanding capital stock of Diffon
after giving effect to the issuance, for cash in the amount of $833,333. The
Agreement provides that at the Closing the Board of Directors of Diffon will be
fixed at five directors, including two directors to be designated by the
Company. The Company, Diffon and the Diffon Shareholders entered into a
Shareholders' Agreement concerning ownership of the Diffon shares and certain
other matters.
The Company accounted for the acquisition under the purchase method of
accounting in accordance with the provisions of ASC 805, "Business
Combinations." Under this accounting method, the Company recorded at fair value
the assets of Diffon less the liabilities assumed, with the excess of the
purchase price over the estimated fair value of such net assets reflected as
goodwill. The Company's consolidated statement of operations includes the
operations of Diffon from the date of the acquisition.
17
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company believes the following critical accounting policies affect the
Company's more significant judgments and estimates used in the preparation of
the financial statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, a
wholly-owned subsidiary, and a subsidiary with a majority voting interest of
50.6% (49.4% is owned by non-controlling interests). In the preparation of
consolidated financial statements of the Company, all intercompany balances and
transactions have been eliminated.
As consolidated financial statements are based on the assumption that they
represent the financial position and operating results of a single economic
entity, the retained earnings or deficit of a subsidiary at the date of
acquisition, October 1, 2009, by the parent are excluded in consolidated
retained earnings. When a subsidiary is initially consolidated during the six
months ended December 31, 2009, the consolidated financial statements include
the subsidiary's revenues, expenses, gains, and losses only from the date the
subsidiary is initially consolidated, and the noncontrolling interest is
reported in the consolidated statement of financial position within equity,
separately from the parent's equity. That amount is clearly identified and
labeled. There are no shares of the Company held by the subsidiaries as of
December 31, 2009.
SEGMENT REPORTING
ASC 280, Segment Reporting, requires public companies to report financial and
descriptive information about their reportable operating segments. The Company
identifies its operating segments based on how management internally evaluates
separate financial information, business activities and management
responsibility. The Company has one reportable segment, consisting of sale of
wireless access Products.
The Company generates revenues from three geographic areas, the United States,
the Caribbean and South America, and Asia. The following enterprise wide
disclosure was prepared on a basis consistent with the preparation of the
consolidated financial statements. The following table contains certain
financial information by geographic area:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
NET SALES: 2009 2008 2009 2008
----------- ----------- ----------- -----------
Unites States $24,554,545 $ 2,052,315 $28,474,432 $ 4,704,533
Caribbean and -- 2,564,825 1,205,050 6,163,775
South America
Asia 622,681 -- 622,681 --
----------- ----------- ----------- -----------
TOTALS $25,177,226 $ 4,617,140 $30,302,163 $10,868,308
=========== =========== =========== ===========
LONG-LIVED ASSETS: DECEMBER 31, 2009 JUNE 30, 2009
-------------- --------------
United States $ 102,335 $ 89,807
Asia 3,580,459 --
-------------- --------------
Totals $ 3,682,794 $ 89,807
============== ==============
ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.
18
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to the
current period presentation.
REVENUE RECOGNITION
The Company recognizes revenue in accordance with ASC 605, Revenue Recognition,
when persuasive evidence of an arrangement exists, the price is fixed or
determinable, collection is reasonably assured and delivery of products has
occurred or services have been rendered. Accordingly, the Company recognizes
revenues from product sales upon shipment of the product to the customers or
when the products are received by the customers in accordance with shipping or
delivery terms. The Company provides a factory warranty for one year form the
shipment which is covered by its vendor under the purchase agreement between the
Company and the vendor.
INVENTORIES
The Company's inventories are made up of finished goods and are stated at the
lower of cost or market, cost being determined on a first-in, first-out basis.
The Company assesses the inventory carrying value and reduces it, if necessary,
to its net realizable value based on customer orders on hand, and internal
demand forecasts using management's best estimates given information currently
available. The Company's customer demand is highly unpredictable, and can
fluctuate significantly caused by factors beyond the control of the Company. The
Company does not maintain an allowance for inventories for potential excess and
obsolete inventories and inventories that are carried at costs that are higher
than their estimated net realizable values.
LONG-LIVED ASSETS
In accordance with ASC 360, Property, Plant, and Equipment, the Company reviews
for impairment of long-lived assets and certain identifiable intangibles
whenever events or circumstances indicate that the carrying amount of assets may
not be recoverable. The Company considers the carrying value of assets may not
be recoverable based upon its review of the following events or changes in
circumstances: the asset's ability to continue to generate income from
operations and positive cash flow in future periods; loss of legal ownership or
title to the assets; significant changes in the Company's strategic business
objectives and utilization of the asset; or significant negative industry or
economic trends. An impairment loss would be recognized when estimated future
cash flows expected to result from the use of the asset is less than its
carrying amount.
As of December 31, 2008, the Company is not aware of any events or changes in
circumstances that would indicate that the long-lived assets are impaired.
19
RESULTS OF OPERATIONS
The following table sets forth, for the three and six months ended December 31,
2009 and 2008, selected statements of operations data expressed as a percentage
of sales:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2009 2008 2009 2008
-------- -------- -------- --------
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 88.5% 76.1% 87.9% 72.8%
-------- -------- -------- --------
Gross profit 11.5% 23.9% 12.1% 27.2%
-------- -------- -------- --------
Operating expenses:
Selling, general and administrative expenses 5.8% 11.5% 6.7% 14.8%
-------- -------- -------- --------
Total operating expenses 5.8% 11.5% 6.7% 14.8%
-------- -------- -------- --------
Income from operations 5.7% 12.4% 5.4% 12.4%
Other income (expense), net 0.1% 1.3% 0.2% 0.8%
-------- -------- -------- --------
Net income before income taxes 5.8% 13.7% 5.6% 13.2%
Provision for income taxes (2.3%) (2.4%) (2.1%) (2.3%)
-------- -------- -------- --------
Net income 3.5% 11.3% 3.5% 10.9%
Net income - non-controlling interest (0.3%) -- (0.2%) --
-------- -------- -------- --------
Net income - controlling interest 3.2% 11.3% 3.3% 10.9%
======== ======== ======== ========
The results of the interim periods are not necessarily indicative of results for
the entire fiscal year.
20
THREE MONTHS ENDED DECEMBER 31, 2009
COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2008
NET SALES
Net sales increased by $20,560,086, or 445.3%, to $25,177,226, for the three
months ended December 31, 2009 from $4,617,140 for the corresponding period of
2008. The overall increase in net sales was primarily due to increased demand
for the Company's Dual Mode (3G and 4G) wireless USB modems.
For the three months ended December 31, 2009, the net sales by geographic
region, consisting primarily of Caribbean and South American countries, the
United States and Asia, were $0, (0% of net sales), $24,554,545 (97.5% of net
sales) and $622,681 (2.5% of net sales) respectively. For the corresponding
period of 2008, net sales by geographic region, consisting primarily of
Caribbean and South American countries, the United States and Asia, were
$2,564,825, (55.6% of net sales), $2,052,315 (44.4% of net sales) and $0 (0% of
net sales) respectively.
Net sales in the South America and Caribbean regions decreased by $2,564,825, or
100%, to $0 for the three months ended December 31, 2009 from $2,564,825 for the
corresponding period of 2008. This reflects increased market competition as well
as the general nature of sales in these regions, which often fluctuate
significantly from quarter to quarter due to the timing of orders placed by a
relatively small number of customers. Net sales in the United States increased
by $22,502,230, or 1,096.4%, to $24,554,545, for the three months ended December
31, 2009 from $2,052,315 for the corresponding period of 2008. The increase in
net sales was primarily due to increased demand for the Company's Dual Mode (3G
and 4G) wireless USB modems. Net sales in the Asia region increased by $622,681
to $622,681 for the three months ended December 31, 2009 from $0 for the
corresponding period of 2008. The increase is due to including $622,681 in net
sales from Diffon. Beginning in this period, Diffon's financial results were
consolidated with those of the Company following the Company's acquisition of
approximately 50.6% of Diffon's outstanding capital stock on October 1, 2009.
The corresponding period of 2008 did not include any net sales from Diffon.
GROSS PROFIT
Gross profit increased by $1,793,285, or 162.4%, to $2,897,430 for the three
months ended December 31, 2009 from $1,104,145 for the corresponding period of
2008. The increase was primarily due to the change in net sales as discussed
above. The gross profit in terms of net sales percentage was 11.5% for the three
months ended December 31, 2009 compared to 23.9% for the corresponding period of
2008. The gross profit decrease in terms of net sales percentage was primarily
due to the significant increase in sales to carrier customers in the United
States, whose gross profit in terms of net sales percentage was 9.3% and
accounted for 97.5% of total net sales for the three months ended December 31,
2009. The decrease in sales in the South America and Caribbean regions also
negatively affected the gross profit in terms of net sales percentage. The
carrier customers in the United States generally purchase greater quantities of
products than those in South America and the Caribbean, which is why the gross
profit in terms of net sales percentage is lower. The sales from the Asia region
were primarily made up of engineering service revenues, whose gross profit in
terms of net sales percentage was 100%, which positively affected the gross
profit in terms of net sales percentage for the three months ended December 31,
2009.
SELLING, GENERAL, AND ADMINISTRATIVE
Selling, general, and administrative expenses increased by $927,882, or 174.9%,
to $1,458,504 for the three months ended December 31, 2009 from $530,622 for the
corresponding period of 2008. The increase was primarily due to the
consolidation of the Diffon expenses, which accounted for $548,456 of the
increase. The remainder of the increase was due to several factors including
headcount growth, accounting and legal fees, travel, marketing expense and the
opening of the branch office in Seoul, South Korea.
OTHER INCOME (EXPENSE), NET
Other income (expense) decreased by $28,391, or 46.5%, to $32,687 for the three
months ended December 31, 2009 from $61,079 for the corresponding period of
2008. The increase is primarily due to lower interest income.
21
SIX MONTHS ENDED DECEMBER 31, 2009
COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2008
NET SALES
Net sales increased by $19,433,855, or 178.8%, to $30,302,163, for the six
months ended December 31, 2009 from $10,868,308 for the corresponding period of
2008. The overall increase in net sales was primarily due to increased demand
for the Company's Dual Mode (3G and 4G) wireless USB modems.
For the six months ended December 31, 2009, the net sales by geographic region,
consisting primarily of Caribbean and South American countries, the United
States and Asia, were $1,205,050 (4.0% of net sales), $28,474,432 (94.0% of net
sales) and $622,681 (2.0% of net sales) respectively. For the corresponding
period of 2008, net sales by geographic region, consisting primarily of
Caribbean and South American countries, the United States and Asia, were
$6,163,775, (56.7% of net sales), $4,704,533 (43.3% of net sales) and $0 (0% of
net sales) respectively.
Net sales in the South America and Caribbean regions decreased by $4,958,725, or
80.4%, to $1,205,050 for the six months ended December 31, 2009 from $6,163,775
for the corresponding period of 2008. This reflects the decline in purchasing
power of consumers, increased market competition as well as the general nature
of sales in these regions which often fluctuate significantly from quarter to
quarter due to the timing of orders placed by a relatively small number of
customers. Net sales in the United States increased by $23,769,899, or 505.3%,
to $28,474,432, for the six months ended December 31, 2009 from $4,704,533 for
the corresponding period of 2008. The increase in net sales was primarily due to
increased demand for the Company's Dual Mode (3G and 4G) wireless USB modems.
Net sales in the Asia region increased by $622,681 to $622,681 for the six
months ended December 31, 2009 from $0 for the corresponding period of 2008. The
increase is due to including $622,681 in net sales from Diffon. Beginning in
this period, Diffon's financial results were consolidated with those of the
Company following the Company's acquisition of approximately 50.6% of Diffon's
outstanding capital stock on October 1, 2009. The corresponding period of 2008
did not include any net sales from Diffon.
GROSS PROFIT
Gross profit increased by $708,101, or 23.9%, to $3,669,290 for the six months
ended December 31, 2009 from $2,961,181 for the corresponding period of 2008.
The increase was primarily due to the change in net sales as discussed above.
The gross profit in terms of net sales percentage was 12.1% for the six months
ended December 31, 2009 compared to 27.2% for the corresponding period of 2008.
The gross profit decrease in terms of net sales percentage was primarily due to
the significant increase in sales to carrier customers in the United States,
whose gross profit in terms of net sales percentage was 10.3% and accounted for
94.0% of total net sales for the six months ended December 31, 2009. The
decrease in sales in the South America and Caribbean regions also negatively
affected the gross profit in terms of net sales percentage. The carrier
customers in the United States generally purchase greater quantities of products
than those in South America and the Caribbean, which is why the gross profit in
terms of net sales percentage is lower. The sales from the Asia region were
primarily made up of engineering service revenues whose gross profit in terms of
net sales percentage was 100% which positively affected the gross profit in
terms of net sales percentage for the six months ended December 31, 2009.
SELLING, GENERAL, AND ADMINISTRATIVE
Selling, general, and administrative expenses increased by $417,664, or 25.8%,
to $2,034,998 for the six months ended December 31, 2009 from $1,617,334 for the
corresponding period of 2008. The increase was primarily due to the
consolidation of the Diffon expenses, which accounted for $548,456 of the
increase. A decrease in commission expense was partially offset by higher
payroll expense (due to headcount growth), accounting and legal fees, travel,
marketing expense and the opening of the branch office in Seoul, South Korea.
OTHER INCOME (EXPENSE), NET
Other income (expense) decreased by $43,243, or 48.1%, to $46,749 for the six
months ended December 31, 2009 from $89,992 for the corresponding period of
2008. The increase is primarily due to lower interest income.
22
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $1,036,950 to $5,216,579 as of December
31, 2009 compared to $6,253,529 as of June 30, 2009. The decrease is explained
below.
OPERATING ACTIVITIES
Net cash used by operating activities was $469,087 and net cash provided by
operating activities was $1,369,708 for the six months ended December 31, 2009,
and 2008, respectively.
INVESTING ACTIVITIES
Net cash used in investing activities was $556,270 and $12,857 for the six
months ended December 31, 2009, and 2008. The increase in cash used is primarily
due to the capitalization of certain R&D expenses for Diffon.
FINANCING ACTIVITIES
Net cash used in financing activities was $11,593 and $300,600 for the six
months ended December 31, 2009, and 2008. The increase in cash used is primarily
due to the payment of long-term liabilities of $11,593.
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The Company's material off-balance sheet contractual commitments are operating
lease obligations. The Company excluded these items from the balance sheet in
accordance with GAAP. The Company does not maintain any other off-balance sheet
arrangements, transactions, obligations or other relationships with
unconsolidated entities that would be expected to have a material current or
future effect upon its financial condition or results of operations.
OPERATING LEASES
The Company leases its administrative facilities under a non-cancelable
operating lease that expires on August 31, 2011. In addition to the minimum
annual rental commitments, the lease provides for periodic cost of living
increases in the base rent and payment of common area costs. Rent expense
related to the operating lease was $53,852 and $53,852 for the six months ended
December 31, 2009 and 2008, respectively.
The Company leases its corporate housing facility under a non-cancelable
operating lease that expires on May 9, 2010 for its vendors. Rent expense
related to the operating lease was $7,772 and $9,322 for the six months ended
December 31, 2009 and 2008, respectively.
RIGHT OF RESCISSION
Two shareholders, who acquired an aggregate of 550,000 shares of the Company's
Common Stock in exchange for 440,000 shares of Common Stock of Diffon
Corporation, have an unconditional right of rescission for one year, so that at
any time prior to October 1, 2010 they may elect to return the Company Common
Stock received by them and receive the Diffon shares in return. These shares are
classified as callable common stock in the Company's consolidated balance sheet.
LITIGATION
The Company is involved in certain legal proceedings and claims which arise in
the normal course of business. Management does not believe that the outcome of
these matters will have any material adverse effect on its financial condition.
CO-DEVELOPMENT, CO-OWNERSHIP AND SUPPLY AGREEMENT
In January 2005, the Company entered into a manufacturing and supply agreement
(the "Agreement") with C-Motech for the manufacture of its products. Under the
agreement, C-Motech is required to provide the Company with services including
all licenses, component procurement, final assembly, testing, quality control,
fulfillment and after-sale service. The Agreement provides exclusive rights to
market and sell CDMA wireless data products in countries in North America, the
Caribbean, and South America. Furthermore, the Agreement provides that the
Company is responsible for marketing, sales, field testing, and certifications
of these products to wireless service operators and other commercial buyers
within a designated territory, and C-Motech is responsible for design,
development, testing, CDG certification, and completion of these products. Under
the Agreement, products include all access devices designed with Qualcomm's MSM
5100, 5500, 6500, and 6800 chipset solutions provided or designed by C-Motech or
both companies. Both companies own the rights to the products: USB modems, Card
Bus, PCI Bus and Module designed with MSM 5500 dual band products. On January
30, 2007, C-Motech also certified that the Company has the exclusive right to
sell CDU-680 EVDO USB modems directly and indirectly in these territories. This
agreement may be amended or supplemented by mutual agreement of the parties, as
is necessary to document the addition of any new products.
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The initial term of the Agreement was for two years, commencing on January 5,
2005. The agreement automatically renews for successive one year periods unless
either party provides a written notice to terminate at least sixty days prior to
the end of the term. On November 2, 2009, C-Motech provided a written notice to
terminate the agreement effective January 5, 2010. Following this date, C-Motech
continues to supply the Company with certain products (primarily the U300 and
U301 USB modems). In addition, C-Motech owns 3,370,356 shares, or approximately
25%, of the Company's outstanding Common Stock.
CHANGE OF CONTROL AGREEMENTS
On September 21, 2009, the Company entered into Change of Control Agreements
("Agreements") with OC Kim, President, David Yun Lee, Chief Operating Officer,
and Yong Bae Won, Vice President-Engineering. The Agreements provide for a lump
sum payment to the officer in case of a change of control of the Company. The
term includes the acquisition of common stock of the Company resulting in one
person or company owning more than 50% of the outstanding shares, a significant
change in the composition of the Board of Directors of the Company during any
twelve-month period, a reorganization, merger, consolidation or similar
transaction resulting in the transfer of ownership of more than fifty percent of
the Company's outstanding Common Stock, or a liquidation or dissolution of the
Company or sale of substantially all of the Company's assets.
The agreement with Mr. Kim is for three years and calls for a payment of $5
million upon a change of control; the agreement with Mr. Lee is for two years
and calls for a payment of $2 million upon a change of control; and the
agreement with Mr. Won is for two years and calls for a payment of $1 million
upon a change of control.
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ITEM 3. CONTROLS AND PROCEDURES.
DISCLOSURE CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have
concluded, based on an evaluation of the Company's disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15d-15(e)), that such disclosure controls and procedures were effective as
of the end of the period covered by this report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There has been no change in the Company's internal control over financial
reporting during the three months ended December 31, 2009 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is not currently involved in any material legal proceedings. The
Company is, from time to time, involved in routine legal proceedings and claims
arising in the ordinary course of business.
ITEM 1A. RISK FACTORS
Our Annual Report on Form 10-K for the fiscal year ended June 30, 2009 filed
with the SEC on October 13, 2009 (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 the 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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On October 1, 2009, the Company issued an aggregate of 550,000 shares of the
Company's Common Stock to two shareholders of Diffon Corporation in exchange for
440,000 shares of capital stock of Diffon, representing approximately 20.1% of
the outstanding capital stock of Diffon.
The Company believes that the issuance of the shares of Common Stock was exempt
from the registration requirements of the Securities Act of 1933, as amended, by
reason of Section 4(2) thereof and Regulation S thereunder.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. OTHER INFORMATION.
None.
ITEM 5. EXHIBITS.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Acting Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Acting Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
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SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this amendment to report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Franklin Wireless Corp.
By: /s/ OC Kim
-------------------------------------------
OC Kim
President and Acting Chief Financial Officer
Dated: February 24, 2010
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