<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 9, 1997
REGISTRATION NO. 333-
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
FRANKLIN TELECOMMUNICATIONS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 3670 95-3733534
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
733 LAKEFIELD ROAD, WESTLAKE VILLAGE, CALIFORNIA 91361 (805) 373-8688
(ADDRESS AND TELEPHONE NUMBER, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
FRANK W. PETERS
733 LAKEFIELD ROAD, WESTLAKE VILLAGE, CALIFORNIA 91361
(805) 373-8688
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
COPY TO:
ROBERT J. ZEPFEL, ESQ.
HADDAN & ZEPFEL LLP
4675 MACARTHUR COURT, SUITE 710
NEWPORT BEACH, CALIFORNIA 92660
(714) 752-6100
---------------
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable
after this Registration Statement is declared effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
The combined prospectus contained in this Registration Statement also
relates to the Registrant's Registration Statement on Form S-1 (File No. 333-
24791).
CALCULATION OF REGISTRATION FEE*
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED PROPOSED
TITLE OF EACH CLASS OF DOLLAR AMOUNT MAXIMUM MAXIMUM AMOUNT OF
SECURITIES TO BE TO BE OFFERING PRICE AGGREGATE REGISTRATION
REGISTERED REGISTERED PER UNIT OFFERING PRICE FEE
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock........... $8,880,000** $4.44 $8,880,000** $2,619.60
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
* All of the securities registered pursuant to Registrant's Registration
Statement on Form S-1 (File No. 333-24791), consisting of 3,103,750 shares
of Common Stock, are being carried forward in the combined prospectus
included herein. A filing fee of $3,291.86 was paid in connecting with such
Registration Statement.
** Estimated solely for the purpose of calculating the filing fee.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PROSPECTUS
[LOGO of FTC]
5,103,750 SHARES
FRANKLIN TELECOMMUNICATIONS CORP.
COMMON STOCK
----------------
All of the 5,103,750 shares of Common Stock offered hereby are being sold by
certain shareholders (the "Selling Shareholders") of Franklin
Telecommunications Corp. (the "Company"). Of such shares, 2,055,000 shares are
issuable upon the exercise of warrants held by certain Selling Shareholders
(the "Warrants"), and 2,000,000 shares are issuable upon conversion of shares
of the Company's Series C Preferred Stock held by certain Selling Shareholders
(the "Convertible Preferred Stock"). The Company will not receive any of the
proceeds from the sale of shares by the Selling Shareholders; however, it may
receive proceeds from the exercise of the Warrants, and an additional amount
equal to 30% of the net proceeds received by those Selling Shareholders from
the sale of the shares issuable upon exercise of the Warrants, to the extent
such net proceeds exceed $4.00 per share. See "Selling Shareholders" and "Plan
of Distribution." The Company's Common Stock is traded on the OTC Bulletin
Board under the symbol FTEL. The closing price of the Company's Common Stock
on December 3, 1997 was $4.44 per share.
The Company designs, manufactures and markets high speed communications
products and subsystems. The products are marketed through Original Equipment
Manufacturers ("OEMs") and distributors, as well as directly to end users. In
addition, through its majority-owned subsidiary, FNet, the Company is a
provider of Internet access and services to businesses and individuals.
----------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK
AND LIMITED LIQUIDITY. SEE "RISK FACTORS" ON PAGE 5.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
----------------
The date of this Prospectus is , 1997.
<PAGE>
THE COMPANY INTENDS TO FURNISH TO ITS STOCKHOLDERS ANNUAL REPORTS CONTAINING
FINANCIAL STATEMENTS AUDITED BY AN INDEPENDENT PUBLIC ACCOUNTING FIRM AFTER
THE END OF EACH FISCAL YEAR. IN ADDITION, THE COMPANY WILL FURNISH TO ITS
STOCKHOLDERS QUARTERLY REPORTS FOR THE FIRST THREE QUARTERS OF EACH FISCAL
YEAR CONTAINING UNAUDITED FINANCIAL AND OTHER INFORMATION AFTER THE END OF
EACH FISCAL QUARTER, UPON WRITTEN REQUEST TO THE SECRETARY OF THE COMPANY.
2
<PAGE>
PROSPECTUS SUMMARY
This Prospectus contains forward-looking statements that involve risks and
uncertainties. Actual events and results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth under "Risk Factors" and elsewhere in this
Prospectus. The following summary should be read in conjunction with, and is
qualified in its entirety by, the more detailed information and financial
statements and notes thereto appearing elsewhere in this Prospectus.
THE COMPANY
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems. The products are
marketed through Original Equipment Manufacturers ("OEMs") and distributors, as
well as directly to end users. In addition, through its majority-owned
subsidiary, FNet Corp. ("FNet"), the Company is a provider of Internet access
and services to businesses and individuals. The Company is a California
corporation formed in 1981. Its address is 733 Lakefield Road, Westlake
Village, California 91361 and its telephone number is (805) 373-8688.
THE OFFERING
<TABLE>
<C> <S>
By Selling Shareholders............ 5,103,750 shares of the Company's Common
Stock.
Common Stock Currently Outstanding. 15,394,515 shares, not including the
shares to be issued pursuant to the
exercise of outstanding Warrants or the
conversion of the outstanding Convertible
Preferred Stock.
Risk Factors....................... The securities involve a high degree of
risk and limited liquidity. See "Risk
Factors."
</TABLE>
3
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data has been derived from the Company's
audited and unaudited consolidated financial statements included elsewhere
herein.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED JUNE 30, ENDED SEPTEMBER 30,
--------------------------------- ----------------------
1995 1996 1997 1996 1997
--------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA (IN THOUSANDS,
EXCEPT PER SHARE DATA
AND OUTSTANDING
SHARES):
Net sales............... $ 1,481 $ 430 1,735 209 244
Gross profit (loss)..... 963 (160) 745 44 10
Loss from operations.... (173) (1,497) (2,775) (377) (960)
Net loss................ (160) (1,467) (2,824) (384) (960)
Net loss per common
share.................. $ (0.02) $ (0.14) (.23) (.03) (.07)
Weighted average common
shares outstanding..... 6,475,984 10,279,281 12,267,991 11,503,114 13,125,318
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
1997 1997
-------- -------------
<S> <C> <C>
BALANCE SHEET DATA (IN THOUSANDS):
Total assets............................................ $ 3,514 $ 2,987
Total liabilities....................................... $ 1,939 $ 2,032
Accumulated deficit..................................... $(8,975) $(9,935)
</TABLE>
4
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, the following
factors should carefully be considered in evaluating an investment in the
shares of Common Stock offered hereby.
OPERATING LOSSES
The Company has incurred operating losses in each of its last three fiscal
years and and for the three months ended September 30, 1997, and has an
accumulated deficit, as of September 30, 1997, of $9,935,000. The Company's
operating losses have resulted from a number of factors, including reduced
demand for the Company's legacy hardware products, increasing expenses
relating to the development of new hardware products, expenses related to
installing the infrastructure for the Internet services business of its
majority-owned subsidiary, FNet, and increasing sales and marketing expenses
to promote new products and services. During the year ended June 30, 1997, the
Company's subsidiary, FNet, raised approximately $1,950,000 in equity
financing. Additionally, in September, October and November 1997 the Company
received net proceeds of $7,807,500 from private equity financings. See
"Business--Recent Financings." The Company has been dependent on these equity
financings to sustain its ongoing operations. Consequently, an investment in
the Company is highly speculative and no assurance can be given that
purchasers of the shares of Common Stock offered hereby will realize any
return on their investment or that purchasers will not lose their entire
investment.
ORGANIZATION OF SUBSIDIARY AND POTENTIAL CONFLICTS OF INTEREST; NEW BUSINESS
VENTURE
During 1996 the Company restructured its subsidiary, Franklin Datacom, Inc.
from a manufacturer of communications hardware into an Internet service
provider and changed its name to FNet. The Company has devoted significant
resources and management time to the organization and development of FNet. As
of September 30, 1997, the Company owned approximately 67% of the common stock
of FNet, with the balance owned by members of management, including the
Company's President, and certain investors. To the extent that FNet issues
additional securities, either for cash, in connection with acquisitions or
upon the exercise of options, the Company's percentage ownership will be
reduced. As of September 30, 1997 there were options to purchase 2,744,000
shares of FNet outstanding, constituting approximately 11.7% of the
outstanding shares. While management believes that the growth of FNet will
eventually inure to the benefit of the Company through increased demand for
its communications hardware as well as the value of its interest in FNet, it
may have an adverse effect on the Company's principal business in the short
term due to competing demands on the Company's resources and management. Also,
the fact that members of the Company's management, including its President,
hold a direct interest in FNet may pose conflicts of interest over the long
term. FNet is in the nature of a new business venture, with relatively
insignificant assets and revenues from operations; accordingly, it can be
expected that its future operating results will be subject to many of the
problems, expenses, delays and risks inherent in the establishment of a new
business enterprise, over many of which the Company has no control. There can
be no assurance, therefore, that FNet will be able to achieve or sustain
profitability in future periods or that the Company's investment of time and
resources into it will be repaid.
RESULTS FOR YEAR ENDED JUNE 30, 1997; DEPENDENCE ON A SINGLE CUSTOMER
While the Company's revenues for the year ended June 30, 1997 showed a
significant increase over the revenues for the prior period, 38% of the
increase was due to sales of the Company's Wide Area Network products to a
single customer, Revco Drug Stores. Such products are technologically dated,
and the demand for them during the period was due principally to expansion of
the business of the customer that already had a significant investment in a
wide area network utilizing the products. Accordingly, there can be no
assurance that revenues for subsequent periods will remain at these levels,
and it is unlikely that the Company will receive significant additional orders
for its Wide Area Network products from this customer or others.
5
<PAGE>
DEPENDENCE ON MAJOR CUSTOMERS
Sales of the Company's communications products are concentrated in a
relatively small number of customers, who account for a significant portion of
revenues. During the fiscal year ended June 30, 1996, the customers accounting
for over 10% of the Company's product sales were Hughes Aircraft Company
(18%), Citibank (17%), Vanstar (13%) and Revco Drug Stores (12%). For the year
ended June 30, 1997 the customers accounting for over 10% of revenues were
Revco Drug Stores (29%) and Citibank (10%). The loss of any of these major
customers could have a material adverse effect on the Company. The Company has
no ongoing supply contracts with any of these customers.
GENERAL RISKS OF BUSINESS
Any future success that the Company might enjoy will depend upon many
factors, including factors which may be beyond the control of the Company or
which cannot be predicted at this time. These factors may include
technological advances or product obsolescence, increased levels of
competition, including the entry of additional competitors and increased
success by existing competitors, changes in general economic conditions,
increases in operating costs, including costs of supplies, personnel, and
equipment, reduced margins caused by competitive pressures and other factors,
and changes in governmental regulation imposed under federal, state or local
laws.
RISKS ASSOCIATED WITH MANAGEMENT OF POTENTIAL GROWTH
The Company's growth has placed, and is expected to continue to place, a
significant strain on its managerial, operational, financial and information
systems resources. To accommodate its current size and manage growth, the
Company must continue to implement and improve its operational, financial and
information systems, and expand, train and manage its employee base.
Additionally, expansion of the Company's information and network systems is
required to accommodate its growth. There can be no assurance that the Company
will be able to effectively manage the expansion of its operations, or that
the Company's facilities, systems, procedures or controls will be adequate to
support the Company's operations. The inability of the Company to manage its
future growth would have a material adverse effect on the Company. This
problem may be exacerbated to the extent the Company continues to acquire
additional businesses, as each such business must then be integrated into the
Company's operations and systems.
Demand on the Company's network infrastructure, technical staff and
resources has grown rapidly with the Company's expanding customer base, and
the Company has occasionally experienced difficulties satisfying the demand
for its Internet services. If such difficulties were to become widespread, it
could adversely impact operations by causing subscribers or potential
subscribers to utilize competitive Internet service providers. There can be no
assurance that the Company's infrastructure, technical staff and resources
will be adequate to facilitate the Company's growth. The Company believes that
its ability to provide timely access for customers and adequate customer and
technical support largely will depend on its ability to attract, identify,
train, integrate and retain qualified personnel. Failure to provide adequate
customer and technical support services would adversely affect the Company's
ability to maintain and increase its customer base, and could therefore have a
material adverse effect on the Company. See "Dependence on Network
Infrastructure and Capacity; System Failure and Security Risks," "Dependence
on Key Personnel," "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview" and "Business."
NEED FOR ADDITIONAL CAPITAL
The proceeds of this offering will be received by the Selling Shareholders.
While the Company may receive cash from the exercise of warrants held by
certain Selling Shareholders, there can be no assurance that the Company will
derive any specific amount of proceeds from this offering. Developments in the
Company's business and possible expansion into other markets could indicate
that the Company should expand its business at a faster rate than that
currently planned for. Moreover, there can be no assurance that the Company
will not encounter unforeseen difficulties that may deplete its capital
resources more rapidly than anticipated, which would require that the Company
seek additional funds through equity, debt or other external financing. In any
6
<PAGE>
event, it is likely that the Company will attempt to raise additional capital
to meet its obligations and to accelerate its growth. There can be no
assurance that any additional capital resources which the Company may need
will be available to the Company if and when required, or on terms that will
be acceptable to the Company. If additional financing is required, or desired,
the Company may be required to forgo a substantial interest in its future
revenues or dilute the equity interests of existing shareholders, and a change
in control of the Company may result.
QUARTERLY OPERATING RESULTS
The Company's operating results may vary significantly due to a variety of
factors, including the availability and cost of materials and components, the
introduction of new products by the Company or its competitors, the timing of
the Company's marketing efforts, pricing pressures, general economic and
industry conditions that affect customer demand, and other factors.
DEPENDENCE ON KEY PERSONNEL
The Company's success will depend to a significant extent upon the continued
service of its founder, Frank W. Peters, the Company's President and Chief
Executive Officer. The Company also will depend on its ability to attract,
retain and motivate such additional qualified personnel as may be needed. The
competition for such personnel is intense. There can be no assurance that the
Company will be successful in retaining its existing key employees or in
attracting and retaining any additional personnel it requires. The Company
does not maintain "key man" insurance on any of its employees.
COMPETITION; NEW PRODUCTS AND TECHNOLOGICAL CHANGES
The data communications industry is extremely competitive. The Company's
principal competitors in the manufacture of communications hardware are
Telematics, Micom, Memotech Data, Dynatech Corporation, Ascend Communications,
Cisco Systems and U.S. Robotics. Most of these companies have substantially
greater marketing, financial, technical and field support resources than the
Company. In addition, the Company could face strong competition from a number
of established computer and telecommunications firms which may enter the
market in the future. The field of data communications is also marked by rapid
changes in technology, which can cause products to become obsolete over very
short time frames.
The performance of the Company will depend on the success of its existing
hardware products and services as well as its ability to develop and market
new hardware products and services or enhance its existing hardware products
and services to meet changing technology, pricing considerations and other
market factors. The Company's business would be adversely affected if the
Company were to experience delays in developing new hardware products and
services or enhancements to existing hardware products and services or if such
hardware products and services or enhancements did not gain market acceptance.
There can be no assurance that the Company's existing or future hardware
products and services will be successful or profitable. In addition, there can
be no assurance that new hardware products and services developed by others
will not render the Company's hardware products and services noncompetitive or
obsolete.
The Internet services market in which the Company's FNet subsidiary operates
is extremely competitive, and the Company expects competition in this market
to intensify in the future. FNet's current and prospective competitors include
many large companies that have substantially greater market presence and
financial, technical, marketing and other resources than FNet. FNet competes
(or in the future is expected to compete) directly or indirectly with the
following categories of companies: (i) national and regional Internet Service
Providers such as IDT Corporation, MindSpring Enterprises, Inc., Netcom On-
line Communication Services, Inc., PSINet, Earthlink and UUNET; (ii)
established online services such as America Online, CompuServe, Prodigy and
the Microsoft Network; (iii) computer software and technology companies such
as Microsoft;
7
<PAGE>
(iv) national telecommunications companies such as AT&T Corp., MCI
Communications Corporation and Sprint Corporation; (v) regional Bell operating
companies ("RBOCs"); (vi) cable operators such as Comcast Corporation, Tele-
Communications, Inc. and Time Warner, Inc.; and (vii) nonprofit or educational
Internet Service Providers.
The entry of new participants from these categories and the potential entry
of competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company and FNet.
The ability of these competitors or others to bundle services and products
with Internet connectivity services could place FNet at a significant
competitive disadvantage. In addition, competitors in the telecommunications
industry may be able to provide customers with reduced communications costs in
connection with their Internet access services, reducing the overall cost of
Internet access and significantly increasing pricing pressures on FNet. For
example, AT&T has recently expanded its Internet services offerings. The
Company believes that AT&T's expansion has substantially increased pricing
pressure in the industry. In addition, certain of FNet's online competitors,
including America Online, the Microsoft Network and Prodigy, have introduced
unlimited access to the Internet and their proprietary content at flat rates
that are generally equivalent to FNet's monthly flat rate, and do not require
a set-up fee. Certain of the RBOCs have also introduced competitive flat-rate
pricing for unlimited access (without a set-up fee for at least some period of
time). As a result, competition for active users of Internet services has
intensified. There can be no assurance that FNet will be able to offset the
adverse effect on revenues of any necessary price reductions resulting from
competitive pricing pressures by increasing the number of its customers, by
generating higher revenue from enhanced services, by reducing costs or
otherwise.
Competition is also expected to focus increasingly on overseas markets, in
which Internet services are just beginning to be introduced. Although the
Company has established sales of its data communications hardware products
overseas, FNet is not presently seeking to penetrate overseas markets for
Internet services. To the extent that the ability to provide Internet services
overseas becomes a competitive advantage in the Internet services industry,
the failure of FNet to penetrate overseas markets may result in FNet being at
a competitive disadvantage relative to other Internet access providers.
The Company has recently entered the Internet telephony business, and plans
to sell hardware products and (through FNet) provide telephone service in this
new business area. There is no assurance that this new business venture will
be successful. The current and prospective competitors in this business
include many large companies that have substantially greater market presence
and financial, technical, marketing and other resources than the Company and
FNet. The Company and FNet compete (or in the future are expected to compete)
directly or indirectly with the following categories of companies in the
Internet telephony business: (i) PC software providers such as VocalTec,
Inter-Tel and ITXC Corp.; (ii) PC to PC telephony product suppliers such as
VDONet, Inc. and Netspeak; (iii) Internet telephony hardware product suppliers
such as Micom, Cisco Systems, Bay Networks and 3COM; (iv) telecommunications
equipment vendors such as Lucent Technologies, Siemens and Nortel; and (v)
Internet telephony service providers such as Delta Three, Inc., Networks
Telephony Corp., IDT and Concentric Networks.
DEPENDENCE ON NETWORK INFRASTRUCTURE AND CAPACITY; SYSTEM FAILURE AND SECURITY
RISKS
The future success of FNet's business will depend on the capacity,
reliability and security of its network infrastructure. FNet will be required
to expand and improve this infrastructure as the number of customers and the
amount and type of information its customers communicate over the Internet
increases, and the means by which customers connect to the Internet evolve.
Such expansion and improvement may require substantial financial, operational
and managerial resources. There can be no assurance that the Company will be
able to expand or improve its network infrastructure to meet any additional
demand or changing customer requirements on a timely basis or at a
commercially reasonable cost, if at all.
Capacity constraints have occurred at many Internet Service Providers, both
at the level of particular "points of presence" ("POPs") (affecting only
customers attempting to use that particular POP) and in connection with system
wide services (such as e-mail and news services, which can affect all
customers). From
8
<PAGE>
time to time, FNet has experienced delayed delivery from suppliers of new
telephone lines, modems, servers and other equipment used by FNet in providing
its services. Any severe shortage of new telephone lines, modems, servers or
other equipment could result in incoming access lines becoming full during
peak times, causing busy signals for customers who are trying to connect to
the Internet. Similar problems may occur if FNet is unable to expand the
capacity of its various network, e-mail, World Wide Web and other servers
quickly enough to keep pace with demand from the Company's expanding customer
base. If the capacity of such servers is exceeded, customers will experience
delays when trying to use a particular service. Further, if FNet does not
maintain sufficient capacity in its network connections, customers will
experience a general slowdown of all services on the Internet. Any of these
events could cause customers to terminate use of FNet's services. Accordingly,
any failure of FNet to expand or enhance its network infrastructure on a
timely basis, or to adapt it to an expanding customer base, changing customer
requirements or evolving industry standards, could have a material adverse
effect on the Company.
FNet's operations are dependent on its ability to protect its
telecommunications and computer equipment against damage from fire,
earthquake, power loss, telecommunication failure and similar events. The
occurrence of a natural disaster or another unanticipated problem at the
Company's headquarters and network hub or at POPs through which customers
connect to the Internet could cause interruptions in the services provided by
FNet. In addition, failure of FNet's telecommunications providers to provide
the data communications capacity required by FNet as a result of a natural
disaster, operational disruption or for any other reason could cause
interruptions in the services provided by FNet, which could have a material
adverse effect on the Company.
FNet's network infrastructure may be vulnerable to computer viruses and
other similar disruptive problems caused by its customers, other Internet
users or other third parties. Computer viruses and other problems could lead
to interruptions, delays in or cessation of service to FNet's customers, as
well as corruption of FNet's or its customers' computer systems. Inappropriate
use of the Internet by third parties could also potentially jeopardize the
security of confidential information stored in the computer systems of FNet or
those of its customers, which may cause losses to FNet or its customers, or
deter certain persons from using FNet's services. The Company expects that
FNet's customers may increasingly use the Internet for commercial transactions
in the future. Any network malfunction or security breach could cause these
transactions to be delayed, not completed or completed with compromised
security. Alleviating problems caused by computer viruses or other
inappropriate uses or security breaches may cause interruptions, delays or
cessation in service to FNet's customers, which could have a material adverse
effect on the Company. In addition, there can be no assurance that customers
or others will not assert claims of liability against FNet or the Company as a
result of these events.
FNet does not presently maintain redundant or backup Internet services or
backbone facilities or other redundant computing and telecommunications
facilities. Any accident, incident or system failure that causes interruptions
in FNet's operations could have a material adverse effect on its ability to
provide Internet services to its customers, and, in turn, on the Company.
PROPRIETARY TECHNOLOGY
The Company's success will depend in part on protecting its proprietary
technology. While the Company has patents covering certain of its products,
its relies principally on trade secret law, confidentiality agreements and its
technical abilities and responsiveness to the demands of customers to protect
its proprietary rights. See "Business--Patents and Trademarks." There can be
no assurance that the Company's technology will not be subject to
misappropriation or independent third-party development of similar technology.
REGULATORY MATTERS
Regulations of the Federal Communications Commission (the "FCC") affect
various products of the Company. Certain regulations require that products
which reside on a customer's premises and interconnect the public switched
network meet certain standards to prevent harm to the network. Other
regulations limit the levels
9
<PAGE>
of electromagnetic radiation which may emanate from an electronic device
located on a customer's premises. The Company currently complies with these
regulations and foresees no problem in complying with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunications industry could affect the business of the Company.
FNet provides Internet services, in part, through data transmissions over
public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for wire line communications. FNet is
not currently subject to direct regulation by the FCC or any other
governmental agency, other than regulations applicable to businesses
generally. However, in the future FNet could become subject to regulation by
the FCC or another regulatory agency as a provider of basic telecommunications
services. Several long distance telephone carriers have filed a petition with
the FCC seeking a declaration that Internet telephone service is a
"telecommunications service" subject to common carrier regulation. Such a
declaration, if enacted, would create substantial barriers to FNet's entry
into the Internet telephone market. Also, a number of local telephone
companies have asked the FCC to levy access charges on "enhanced service
providers," which may be deemed to include Internet Service Providers.
Although the Chairman of the FCC has indicated his opposition to levying
service charges against Internet Service Providers, local interconnection
charges could be levied in the future. Moreover, the public service
commissions of certain states are exploring the adoption of regulations that
might subject Internet Service Providers to state regulation.
The Telecommunications Act of 1996 (the "Telecommunications Act") contains
certain provisions that lift, or establish procedures for lifting, certain
restrictions relating to the RBOCs' ability to engage directly in the Internet
access business. The Telecommunications Act also makes it easier for national
long distance carriers such as AT&T to offer local telephone service and
allows RBOCs to provide electronic publishing of information and databases.
Competition from these companies could have a material adverse effect on the
Company. See "Business--Government Regulation."
POTENTIAL LIABILITIES ASSOCIATED WITH OPERATING AN INTERNET SERVICE PROVIDER
The law relating to the liability of Internet Service Providers and online
service companies for information carried on or disseminated through their
networks has not yet been definitively established. Several private lawsuits
seeking to impose such liability upon Internet Service Providers and online
services companies are currently pending. Although no such claims have been
asserted against FNet to date, there can be no assurance that such claims will
not be asserted in the future, or if asserted, will not be successful. The
Telecommunications Act imposes fines on any entity that knowingly (i) uses any
interactive computer service or telecommunications device to send obscene or
indecent material to minors; (ii) makes obscene or indecent material available
to minors via an interactive computer service; or (iii) permits any
telecommunications facility under such entity's control to be used for the
purposes detailed above. As the law in this area develops, the potential
imposition of liability upon FNet for information carried on and disseminated
through its network could require it to implement measures to reduce its
exposure to such liability. The implementation of such measures could require
the expenditure of substantial resources or the discontinuation of certain
service offerings. Any costs that are incurred as a result of such
expenditure, contesting any such asserted claims or the imposition of
liability could have a material adverse effect on FNet.
Due to the increasing use of the Internet, it is possible that additional
laws and regulations may be adopted with respect to the Internet covering
issues such as content, user privacy, pricing, libel, intellectual property
protection and infringement and technology export and other controls. Changes
in the regulatory environment relating to the Internet services industry,
including regulatory changes that directly or indirectly affect
telecommunication costs or increase the likelihood or scope of competition,
could have a material adverse effect on the Company.
DEPENDENCE ON TELECOMMUNICATIONS CARRIERS
FNet relies on local telephone companies and other companies to provide data
communications capacity via local telecommunications lines and leased long
distance lines for its Internet service. As such, FNet is subject to
10
<PAGE>
potential disruptions in these telecommunications services and may have no
means of replacing these services, on a timely basis or at all, in the event
of such disruption. Any such disruptions could have a material adverse effect
on FNet.
DEPENDENCE ON CONTINUED GROWTH IN USE OF THE INTERNET; NEW AND UNCERTAIN
MARKET; CUSTOMER RETENTION
FNet's future success is substantially dependent on continued growth in the
use of the Internet. Rapid growth in the use of, and interest in, the
Internet, and in particular the World Wide Web, is a recent phenomenon and
there can be no assurance that Internet usage will become more widespread,
that extensive Internet content will continue to be developed or that
extensive Internet content will continue to be accessible at no or nominal
cost. The Internet may not prove to be viable for a number of reasons,
including potentially inadequate development of the necessary infrastructure
or of performance improvements. If use of the Internet does not continue to
grow, FNet would be materially and adversely affected. Conversely, to the
extent that the Internet continues to experience significant growth in the
number of users and level of use, there can be no assurance that the Internet
infrastructure will be able to support the demands placed on it by such
potential growth. See "Risks Associated with Management of Potential Growth."
The sales, marketing and other costs to FNet of acquiring new customers are
substantial relative to the monthly fee derived from such customers.
Accordingly, FNet's long-term success largely depends on its ability to retain
its existing customers, while continuing to attract new customers. FNet
continues to invest significant resources in its infrastructure and customer
and technical support capabilities. However, there can be no assurance that
such investment will improve customer retention. Because the Internet services
market is new and the variety of available services is not well understood by
new and potential customers, it is difficult, if not impossible, for FNet to
predict future customer retention rates. Moreover, intense competition from
competitors, some of whom offer many free hours of services for new customers,
have most likely caused, and may continue to cause, some of FNet's customers
to switch to a competitor's service. In addition, a certain number of new
Internet users experience the Internet only as a novelty and do not become
consistent users of Internet services. These factors could adversely affect
FNet's customer retention rates. Any decline in customer retention rates would
have a material adverse effect on FNet.
LIMITED MARKET FOR THE COMMON STOCK
The Company's Common Stock is traded on the OTC Bulletin Board, but is not
listed on any stock exchange or on NASDAQ. Trading volume in the Common Stock
has fluctuated considerably in the recent past.
POSSIBLE VOLATILITY OF STOCK PRICES; PENNY STOCK RULES
The over-the-counter markets for securities such as the Company's Common
Stock historically have experienced extreme price and volume fluctuations
during certain periods. These broad market fluctuations and other factors,
such as new product developments and general trends in the investment markets,
as well as general economic conditions and quarterly variations in the
Company's results of operations, may adversely affect the market price of the
Company's Common Stock. Moreover, unless and until it is approved for
quotation on NASDAQ, the Company's Common Stock could become subject to rules
adopted by the Commission regulating broker-dealer practices in connection
with transactions in "penny stocks." Penny stocks generally are equity
securities with a price of less than $5.00 (other than securities registered
on certain national securities exchanges or quoted on NASDAQ, provided that
current price and volume information with respect to transactions in such
securities is provided by the exchange or the NASDAQ system). Unless an
exemption from the definition of a "penny stock" were available, any broker
engaging in a transaction in the Company's Common Stock would be required to
provide any customer with a risk disclosure document, disclosure of market
conditions, if any, disclosure of the compensation of the broker-dealer and
its salesperson in the transaction, and monthly accounts showing the market
values of the Company's Common Stock held in the customer's account. The bid
and offer quotation and compensation information must be provided prior to
effecting the transaction and must be
11
<PAGE>
contained on the customer's confirmation. It may be anticipated that a number
of brokers may be unwilling to engage in transactions in the Company's Common
Stock because of the need to comply with the "penny stock" rules, thereby
making it more difficult for purchasers of Common Stock offered hereby to
dispose of their shares. The Company's Common Stock is covered by a Securities
and Exchange Commission rule that imposes additional sales practice
requirements on broker-dealers who sell such securities to persons other than
established customers and accredited investors (generally institutions with
assets in excess of $5,000,000 or individuals with net worth in excess of
$1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their
spouse). For transactions covered by the rule, the broker-dealer must make a
special suitability determination for the purchaser and receive the
purchaser's written agreement to the transaction prior to the sale.
Consequently, the rule may affect the ability of broker-dealers to sell the
Company's securities and also may affect the ability of purchasers in this
offering to sell their shares in the secondary market.
12
<PAGE>
DIVIDEND POLICY
The Company has never paid any cash dividends on its Common Stock and does
not anticipate that it will pay dividends in the foreseeable future. Instead,
the Company intends to apply any earnings to the development and expansion of
its business.
USE OF PROCEEDS
The Company will not receive the proceeds of sales of shares by the Selling
Shareholders. However, if the Selling Shareholders who hold Warrants determine
to exercise their Warrants in order to sell shares hereunder, the Company
would receive the proceeds of the exercise of the Warrants. If all of the
Warrants were exercised, the Company would receive net proceeds of a minimum
of $2,628,750, plus an additional amount equal to 30% of the net proceeds of
the sale of the shares issued upon exercise of the Warrants, to the extent
such proceeds exceed $4.00 per share. See "The Warrants." The Company plans to
use any such net proceeds for expanded advertising and marketing, payment of
trade accounts payable, and as working capital. The amounts actually expended
for each such use, if any, are at the discretion of the Company and may vary
significantly depending upon a number of factors, including the amount of such
proceeds, future revenue growth and the amount of cash generated by the
Company's operations. To the extent such proceeds are not utilized
immediately, they will be invested in United States government or governmental
agency securities or short-term insured certificates of deposit.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems. The products are
marketed through original equipment manufacturers ("OEMs") and distributors,
as well as directly to end users. In addition, through its majority-owned
subsidiary, FNet, the Company is a provider of Internet access and services,
including Intenet telephony, to businesses and individuals. The Company is a
California corporation formed in 1981.
Forward-looking statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, including statements regarding
the Company's entrance into the Internet business, newly introduced products,
development of "telephone-to-telephone" service capabilities over the
Internet, net sales, gross profit, operating expenses, other income and
expenses, liquidity and cash needs and the Company's plans and strategies are
all based on current expectations, and the Company assumes no obligation to
update this information. Numerous factors could cause actual results to differ
from those described in the forward-looking statements. See "Risk Factors."
The Company has recently re-focused its business from manufacturing
primarily LAN and WAN products to providing telecommunications and Internet
products and services. Beginning in the year ended June 30, 1997 and
continuing in the three months ended September 30, 1997, the Company has begun
to generate revenues from these new business lines. Sales had been declining
for the Company's existing hardware products during the previous fiscal year,
while the newly developed hardware products and Internet services were not yet
ready for market. Initial demand for the Company's newly introduced D-Mark
Channel Bank, Cyclone and Data Voice Gateway hardware product lines have yet
to be established, since many potential customers are in the process of
evaluating the products.
FNet is in the nature of a new business venture; accordingly, it can be
expected that its future operating results will be subject to many of the
risks inherent in establishing a new business enterprise. There can be no
assurance, therefore, that FNet will be able to achieve or sustain
profitability in future periods or that the Company's investment of resources
into it will be repaid.
The Company's D-Mark Channel Bank terminates a digital T1 telephone line
from the local telephone company and channelizes it into 24 analog data/voice
lines for either modems, faxes, or telephones. With the declining cost of T1
digital lines, the Company believes that the D-Mark Channel Bank provides an
effective, cost saving solution for companies using 10 or more phones or
modems. The Cyclone is an evolution of the D-Mark and includes modems
integrated into the PC cards, thus eliminating the need to add external modems
for those applications requiring them. The Data Voice Gateway, or DVG, is a
further evolution of the D-Mark, which adds the capability of transmitting
voice traffic over the Internet and Frame relay circuits.
Other products under development include the Tornado, which is a further
evolution of the Cyclone by providing terminal server function. The Tornado is
targeted to become the Company's point of presence "POP in a box" solution for
ISPs or a corporation's data center. This would permit a new or existing
Internet Service Provider or corporation to install all of the hardware
required to provide an Internet service connection.
Other features of the D-Mark series include FXO and, in the future, Ground
Start capabilities for the voice card integrated in the D-Mark systems. FXO
allows the D-Mark to extend the functions of a PBX telephone system. Ground
Start will allow access to devices (PBX trunk lines, telephones, fax machines,
etc.) that operate in this environment, thus expanding the types of devices
that the D-Mark systems can utilize. The T-1 card in the D-Mark system is also
being improved to add a MVIP interface. The MVIP interface is an open
architecture standard interface, which would permit users to customize
applications and directly connect third party hardware to the D-Mark systems.
14
<PAGE>
In designing the D-Mark Channel Bank, the Company's primary target market
was Internet Service Providers. With the growth of the Internet, the Company
believes that the D-Mark Channel Bank can satisfy the requirements of Internet
Service Providers for providing analog lines for modem banks to provide
service for their dial-up accounts.
Companies such as U.S. Robotics, Texas Instruments and Cirrus Logic have
purchased the D-Mark Channel Bank for testing and engineering of the latest
56K (X2) modem technology.
These applications were not originally considered by the Company, but were
discovered by and in conjunction with purchasers of the product. Due to the
rapidly changing pace of the telecommunications industry, management believes
that the D-Mark Channel Bank will continue to be a leading edge product
because of its upgradability and flexibility. The Company also manufactures D4
T-1 Channel Banks, which are capable of terminating a telephone company T1
line which contains 24 voice and or data circuits. This termination takes the
T-1 serial port and turns it into 24 central office type telephone outlets
which will accept 24 desk phones or a PBX. As part of the channel bank the
Company also offers an 8 port station analog card (ICV-8) for the CTI market.
As with any new line of business, there can be no assurance that the D-Mark
Channel Bank, The Cyclone, DVG and other newly developed communications
products will gain widespread market acceptance or be profitable. In addition,
there can be no assurance that new hardware products and services developed by
others will not render the Company's hardware products and services
noncompetitive or obsolete.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1997 Compared To Three Months Ended
September 30, 1996
Net Sales. Net sales increased by $35,000, or 17%, from $209,000 in the
three months ended September 30, 1996 to $244,000 in the three months ended
September 30, 1997. The overall increase is due to increased Internet services
revenue, with a reduced demand for wide area network products. Initial demand
for newly introduced hardware products has yet to be established, in that most
sales to date have been to customers for testing and evaluation purposes. The
revenue mix for the three months ended September 30, 1997 consisted of 69%
Internet services revenue and 31% hardware product sales.
Gross Profit. Gross profit decreased as a percentage of net sales to 4% for
the three months ended September 30, 1997, from a gross profit of 21% of net
sales for the corresponding period of 1996. The gross profit percentage
decrease can be attributed to increased manufacturing overhead infrastructure
expenditures, including increased numbers of personnel to support an
anticipated ramp up of sales activity.
Operating Expenses. Operating expenses increased by $549,000, or 130%, from
$421,000 in the three months ended September 30, 1996 to $970,000 in the three
months ended September 30, 1997. The increase is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet services infrastructure, increased sales and
marketing efforts, and costs in enhancing the general and administrative
infrastructure to support higher sales volumes.
Other Income (Expense). Interest expense increased by $10,000, or 143%, from
$7,000 in the three months ended September 30, 1996 to $17,000 in the three
months ended September 30, 1997, due primarily to an increase in loans from an
officer of the Company and assumed lease debt from Internet Passport. Other
income increased by $17,000, or 100%, from $-0- in the three months ended
September 30, 1996 to $17,000 in the three months ended September 30, 1997,
due to various non-operating items.
Fiscal Year Ended June 30, 1997 Compared To Fiscal Year Ended June 30, 1996
Net Sales. Net sales increased by $1,305,000, or 303%, from $430,000 in the
year ended June 30, 1996 to $1,735,000 in the year ended June 30, 1997. The
overall increase is due to resurgence in demand for wide area
15
<PAGE>
network products, initial demand for newly introduced hardware products, and
introduction of Internet services. Seven customers constituted 60% of total
sales for the year ended June 30, 1997. The increase in sales of wide area
network products related to shipments of the ACP 186, an existing
communication board used by a significant customer that significantly expanded
its operations during the period. Sales of the ACP 186 for the year ended June
30, 1997 were $436,000. The revenue mix for the year ended June 30, 1997
consisted of 68% wide area network products, including repair services, 9%
newly introduced D-Mark hardware products, and 23% Internet services.
Gross Profit (Loss). Gross profit increased as a percentage of net sales to
43% for the year ended June 30, 1997, from a gross loss of 37% of net sales
for the corresponding period of 1996. The gross profit percentage increase can
be attributed to increased sales of higher margin products and a spreading of
fixed manufacturing overhead costs over a larger sales base.
Operating Expenses. Operating expenses increased by $2,183,000, or 163%,
from $1,337,000 in the year ended June 30, 1996 to $3,520,000 in the year
ended June 30, 1997. Approximately 70% of the increase is attributable to a
one-time write-off of goodwill. The balance is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet services infrastructure, increased sales and
marketing efforts, and costs in enhancing the general and administrative
infrastructure to support higher sales volumes.
Other Income (Expense). Interest expense increased by $15,000, or 58%, from
$26,000 in the year ended June 30, 1996 to $41,000 in the year ended June 30,
1997, due primarily to an increase in loans from an officer of the Company and
assumed lease debt from Internet Passport. Other expense increased by $1,000,
or 20%, from $5,000 in the year ended June 30, 1996 to $6,000 in the year
ended June 30, 1997, due to various non-operating items.
Fiscal Year Ended June 30, 1996 Compared to Fiscal Year Ended June 30, 1995
Net Sales. Net Sales decreased by $1,051,000, or 71%, from $1,481,000 in the
year ended June 30, 1995 to $430,000 in the year ended June 30, 1996. The
decrease was due to reduced demand for the Company's legacy wide area network
products. The new products introduced in the six months ended December 31,
1996 were under continuing development during the year ended June 30, 1996,
and therefore were not available for sale. In addition, the Internet services
offered by the Company's subsidiary, FNet, were still in development, and
therefore were not yet available.
Gross Profit (Loss). The Company experienced a decrease in gross margin that
resulted in a gross loss as a percentage of net sales of 37% for the year
ended June 30, 1996, from 65% gross profit on net sales for the corresponding
period of 1995. The gross margin percentage decrease can be attributed to a
$226,000 write down of inventory valuation to reserve for obsolete and slow
moving inventory and a spreading of fixed manufacturing overhead costs over a
smaller sales base.
Operating Expenses. Operating expenses increased by $201,000, or 18%, from
$1,136,000 in the year ended June 30, 1995 to $1,337,000 in the year ended
June 30, 1996. The increase is attributable to increased product development
costs for the recently introduced hardware products, costs in developing the
Internet services infrastructure, increased sales and marketing efforts, and
costs in expanding administrative capabilities to support higher sales
volumes.
Other Income (Expense). Interest expense increased by $16,000, or 160%, from
$10,000 in the year ended June 30, 1995 to $26,000 in the year ended June 30,
1996, due primarily to an increase in loans from an officer of the Company.
Other income decreased by $30,000, or 120%, from $25,000 in the year ended
June 30, 1995 to an expense of $5,000 in the year ended December 31, 1996, due
to various non-operating items.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $908,000 and
$190,000, respectively, as of September 30, 1997 and 1996. The primary source
of cash was net proceeds generated from equity financing. The Company has
relied on sales of new shares and the exercise of warrants and options to fund
operations for an extended period of time. The Company received $114,000,
$1,007,000, $1,109,000 and $289,000 in equity financing, for the years ended
June 30, 1995, 1996, and 1997, and the three months ended September 30, 1997,
respectively. Its subsidiary, FNet, raised $1,950,000 for the year ended June
30, 1997 and $51,000 for the three months ended September 30, 1997. FNet has
continued to experience losses, due to the growth nature of the Internet
services business. In addition to the equity financing described above, the
Company's President has deferred portions of his compensation, and has on
occasion, converted debt to equity, in order to preserve the Company's cash.
The Company anticipates that its primary uses of working capital in future
periods will be for acquisitions, increases in product development, expansion
of its marketing plan, development of new branch offices and funding of
increases in accounts receivable. Development of new branch offices may be
achievable through acquisitions. Although the Company seeks to use its Common
Stock to make acquisitions to the extent possible, many acquisition candidates
may require that all or a significant portion of the purchase price be paid in
cash.
The Company believes that existing cash and cash equivalents, cash flow from
operations, and cash being raised through private placements of securities
will be sufficient to meet the Company's presently anticipated working capital
needs for at least the next 13 months. The Company regularly evaluates various
potential acquisitions, which could require a substantial portion of the net
proceeds from the exercise of the Warrants. To the extent the Company uses its
cash resources for acquisitions, the Company may be required to obtain
additional funds, if available, through borrowings or equity financings. There
can be no assurance that such capital will be available on acceptable terms.
If the Company is unable to obtain sufficient financing, it may be unable to
fully implement its growth strategy.
17
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data set forth below for the fiscal years ended June
30, 1995, 1996 and 1997 have been derived from the Company's consolidated
financial statements, audited by Singer, Lewak, Greenbaum & Goldstein LLP
(1997) and Corbin & Wertz (1996 and 1995), respectively, included elsewhere in
this Prospectus, and should be read in conjunction with those consolidated
financial statements (including the notes thereto). The selected financial
data set forth below for the fiscal years ended June 30, 1993 and 1994 have
been derived from the Company's consolidated financial statements, audited by
Corbin & Wertz, but which are not included in this Prospectus. The selected
financial data for the three month periods ended September 30, 1996 and 1997
have been derived from the unaudited financial statements of the Company
included elsewhere herein and include, in the opinion of management of the
Company, all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results for such periods.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED JUNE 30, SEPTEMBER 30,
------------------------------------------------------- ----------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales................... $ 2,512 $ 1,241 $ 1,481 $ 430 $ 1,735 $ 209 $ 244
Cost of sales........... 778 516 518 590 990 165 234
--------- --------- --------- ---------- ---------- ---------- ----------
Gross profit (loss).... 1,734 725 963 (160) 745 44 10
--------- --------- --------- ---------- ---------- ---------- ----------
Operating expenses:
Research and
development expenses.. 519 327 308 320 480 97 121
Selling, general and
administrative
expenses.............. 1,088 871 828 947 1,456 324 849
Write-off of goodwill.. -- -- -- 70 1,584 -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Total operating
expenses.............. 1,607 1,198 1,136 1,337 3,520 421 970
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) from
operations............. 127 (473) (173) (1,497) (2,775) (377) (960)
--------- --------- --------- ---------- ---------- ---------- ----------
Other income (expense):
Interest expense....... (21) (14) (10) (26) (41) (7) (17)
Gain on settlement of
accounts payable...... 108
Loss on settlement of
litigation............ (82)
Other.................. 1 4 25 (5) (6) -- 17
--------- --------- --------- ---------- ---------- ---------- ----------
Total other income
(expense)............. 6 (10) 15 (31) (47) (7) --
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) before
minority interest and
income taxes........... 133 (483) (158) (1,528) (2,822) (384) (960)
Minority interest in
loss of subsidiary..... -- -- -- 63 -- -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes........... 133 (483) (158) (1,465) (2,822) (384) (960)
Provision for income
taxes.................. (13) 2 2 2 2 -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Net income (loss)....... $ 120 $ (485) $ (160) $ (1,467) $ (2,824) $ (384) $ (960)
========= ========= ========= ========== ========== ========== ==========
Net income (loss) per
common share........... $ 0.02 $ (0.08) $ (0.02) $ (0.14) $ (.23) $ (.03) $ (.07)
========= ========= ========= ========== ========== ========== ==========
Weighted average number
of shares outstanding . 5,736,512 5,753,589 6,475,984 10,279,281 12,267,991 11,503,114 13,125,318
BALANCE SHEET DATA (IN THOUSANDS):
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED JUNE 30, SEPTEMBER 30,
------------------------------------------------------- ----------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash.................... $ 492 $ 98 $ 135 $ 166 $ 1,464 $ 799 $ 908
Working capital
(deficit).............. 452 (15) 98 (206) 809 96 190
Total assets............ 1,220 769 998 712 3,514 1,533 2,987
Long-term debt.......... 120 50 161 238 360 432 360
Other liabilities....... 537 543 508 503 183 501 183
Stockholder's equity
(deficiency)........... (75) (549) (386) (749) 1,575 (126) 955
</TABLE>
- --------
During the year ended June 30, 1994, the Company declared a 1-for-10 reverse
stock split. Accordingly, all share and per share information has been
retroactively restated to reflect the reverse split. The Company has not
declared dividends since its inception.
18
<PAGE>
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the OTC Bulletin Board under the
symbol FTEL. The following table sets forth the range of high and low bid
quotation per share for the Common Stock as reported by the OTC Bulletin Board
during the calendar years indicated. The bid price reflects inter-dealer
prices and does not include retail mark-up, markdown, or commission.
<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
1995
First Quarter............................................... $ .39 $ .32
Second Quarter.............................................. 2.25 .98
Third Quarter............................................... 1.69 .74
Fourth Quarter.............................................. .75 .38
1996
First Quarter............................................... .81 .66
Second Quarter.............................................. 1.53 .72
Third Quarter............................................... 2.88 .97
Fourth Quarter.............................................. 2.25 1.25
1997
First Quarter............................................... 5.50 1.81
Second Quarter.............................................. 3.75 2.25
Third Quarter............................................... 3.25 1.56
Fourth Quarter (through 12/5/97)............................ 9.93 3.44
</TABLE>
The Company has never declared or paid a cash dividend on its Common Stock
and does not expect to pay any cash dividends in the foreseeable future.
19
<PAGE>
BUSINESS
GENERAL
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems, including wide area
networks ("WAN"), Local Area Networks ("LAN") and telecommunications
equipment. The products are marketed through Original Equipment Manufacturers
(OEMs) and distributors, as well as directly to end users. In addition,
through its majority-owned subsidiary, FNet, the Company is a provider of
Internet access and services to businesses and individuals. FNet also
distributes the equipment manufactured by the Company to corporations,
including Internet Service Providers.
INDUSTRY BACKGROUND--COMMUNICATIONS PRODUCTS
The demand for products that connect and control electronic data processing
devices, such as point of sale equipment, personal computers and bank
automated teller machines, has increased rapidly due to reductions in the cost
of high speed digital communications. The Company's products are designed to
address the need of geographically dispersed communications networks such as
Computer Telephone Integration (CTI), Internet Telephony (IT), Wide Area
Networks (WAN) and Local Area Networks (LAN), for which the Company provides
proprietary hardware and software.
The IT, WAN and LAN connectivity segments of the communications industry
continue to experience rapid growth. Corporations and governmental
organizations are increasing the flow of information among their
geographically separate facilities. Intelligent workstations (e.g., personal
computer and departmental systems) are replacing character oriented
(asynchronous) "dumb terminals" as the principal users of the device. These
newer devices communicate on a record oriented basis (synchronous mode) which
can utilize much faster transmission rates and thus take advantage of modern,
high speed telecommunications facilities. The greater popularity of
intelligent workstations has increased the demand for flexible and manageable
networks that support devices from multiple vendors.
COMMUNICATIONS PRODUCTS
Wide Area Network Connectivity Products. The Company manufactures three
principal connectivity products for wide area networks. The Franklin Branch
Node is a fully integrated small T-1 packet/circuit switch/multiplexes with
LAN bridge/routing; it is designed for relatively small offices and supports
interconnection of data, voice, image LAN and video applications.
The Multi-Protocol Switching PAD is used to connect host computers and user
systems through one international standard X.25 packet switching protocol, and
provides sophisticated, real time management using simple, menu-oriented
operator functions contained in a Network Control Center ("NCC"). The Company
offers a product line of programmable high performance data communication
processor circuit boards that support both synchronous and asynchronous modes
for a variety of computer architectures. These cards are used in a variety of
applications, including network system products, terminal emulators,
programmable machine tools, voice response systems, protocol test devices, and
load generation tools.
Local Area Network Connectivity Products. The Franklin UltraFast
Hurricane/155 Fast Ethernet Network Card offers high-speed and low-cost
connectivity for LAN applications. Also, the Company manufactures the only
155Mbps Fast Ethernet daisy-chainable network card. As the majority of
networks today send data packets at 10Mbps or 100Mbps, they require a hub
(costing approximately $800) to connect the computers together via their
network cards. The UltraFast Hurricane/155 network cards use a patented
technology which allows packet sizes of 155Mps to be passed through. The
Company believes that competing products, such as Intels 100Mbps cards, are
substantially more expensive or provide inferior performance.
The Hurricane/155 also does not require an expensive hub to network
computers together because it is daisy-chainable. This feature can prove to be
a significant cost savings for small networks and peer-to-peer
20
<PAGE>
environments. For applications such as computer aided design or graphic
environments, the Hurricane/155 can function on its own segment of an existing
network without interfering with the performance of the LAN. For those
environments with large network needs (more than 15 users), the Company also
manufactures 8 and 22 port hubs. The cards come in industry standard
architectures (ISA, EISA, VESA, and PCI) and easily install into any PC.
Telephone Interface Equipment & Computer Telephone Integration ("CTI"). The
Company's D-Mark Channel Bank terminates a digital T1 telephone line from the
local telephone company and channelizes it into 24 analog data/voice lines for
either modems, faxes, or telephones. With reductions in the cost of T1 digital
lines from the telephone companies, the D-Mark Channel Bank can be an
effective method of utilizing analog lines for companies using 16 or more
phones or modems. The product offers easy installation, automatic disaster
recovery, remote manageability, and high reliability.
In designing the D-Mark Channel Bank, the Company's primary target market
was Internet Service Providers. With the growth of the Internet, the Company
believes that the D-Mark Channel Bank can satisfy the requirements of Internet
Service Providers for providing analog lines for modem banks to provide
service for their dial-up accounts.
Customers such as U.S. Robotics, Texas Instruments and Cirrus Logic have
purchased the D-Mark Channel Bank for testing and engineering of the latest
56K (X2) modem technology.
These applications were not originally considered by the Company, but were
discovered by and in conjunction with purchasers of the product. Due to the
rapidly changing pace of the telecommunications industry, management believes
that the D-Mark Channel Bank will continue to be a leading edge product
because of its upgradability and flexibility. The Company also manufactures D4
T-1 Channel Banks, which are capable of terminating a telephone company T1
line which contains 24 voice and or data circuits. This termination takes the
T-1 serial port and turns it into 24 central office type telephone outlets
which will accept 24 desk phones or a PBX. The Company also has under
development an ISA bus computer card which combines a V.34 Modem and the
functions of the channel bank into one 8 port card, thus lowering the cost of
data, not voice, for Internet Service Providers to accept a large number of
analog modem subscribers. As part of the channel bank the Company also offers
an 8 port station analog card (ICV-8) for the CTI market.
Data Voice Gateway ("DVG"). The recently introduced Data Voice Gateway
allows the Company to provide "telephone to telephone' long distance telephone
service over the Internet and frame relay circuits. From the end user's
standpoint, there is no hardware or software required, other than a standard
telephone. The functional use is similar to using a long distance calling card
today. The Company plans to market this platform to corporations and local
telephone companies, who wish to integrate the hardware and software in their
own systems. For a large multinational corporation, this device will allow
them to piggyback their international and national long distance telephone
calls over their existing data networks, and virtually eliminate the need for
long distance telephone carriers between their offices.
The Company's majority owned subsidiary, FNet Corp., plans to set up a
service organization, including a "long distance telephone network', utilizing
the DVG hardware and software technology of the Company. FNet plans to set up
this network by co-locating the DVG hardware platforms into existing data
networks, and offering long distance telephone service worldwide, via the
Internet and private frame relay. The use of the Internet and other data
networks should be transparent to the end user.
INDUSTRY BACKGROUND--INTERNET SERVICES
The Internet is a collection of computer networks linking millions of public
and private computers around the world. Historically, the Internet was used by
government agencies and academic institutions to exchange
21
<PAGE>
information, publish research and transfer email. A number of factors,
including the proliferation of communication-enabled personal computers, the
availability of intuitive graphical user interface software and the wide
accessibility of an increasingly robust network infrastructure, have combined
to allow users to easily access the Internet and, in turn, have produced rapid
growth in the number of Internet users.
The emergence of the World Wide Web, the graphical, multimedia environment
of the Internet, has resulted in the development of the Internet as a new mass
communications medium. The ease and speed of publishing, distributing and
communicating text, graphics, audio and video over the Internet has led to a
proliferation of Internet-based services, including chat, online magazines,
news feeds, interactive games and a wealth of educational and entertainment
information, as well as to the development of online communities. In addition,
the reduced cost of executing transactions over the Internet provides
individuals and organizations with a new means to conduct business.
FNET STRATEGY
Through its subsidiary, FNet, the Company plans to offer international
voice, fax, data and video exchange services over the Internet. The Company
has installed and is operating Internet access and related services through an
advanced TCP/IP based and ISDN and SMDS compatible T-1 and frame relay
network. The services offered cover one spectrum of low-cost dial-up services
to high performance continuous high speed access. In addition to acting as an
Internet Service Provider, the Company operates a World Wide Web design and
hosting service.
Through FNet, the Company also plans to offer Internet services to
individuals without computers, allowing them to deliver voice and fax messages
over the Internet by use of a telephone only. Also, FNet plans to provide
voice communication over the Internet from telephone and telephone, without
any PC required, with voice quality comparable to current telephone company
communications.
FNet believes that the introduction of additional service offerings can
serve not only to expand and maintain its customer base, but also, in certain
instances, to enhance revenues. Accordingly, the Company has introduced a
variety of services for business consumers, including business Web sites,
high-speed ISDN communications capability and frame relay connections, each of
which involve a monthly service charge plus set-up fees.
Each FNet customer is provided a mailbox, or address, from which to send and
receive email. Email functionality allows customers to exchange an unlimited
number of multimedia text, graphics, audio and video messages with other FNet
customers as well as with non-FNet Internet users.
FNet provides space on its Web server for commercial customers to publish
their own Web pages. Monthly fees for business Web sites range from $50 to
$100, plus one-time setup fees of $50 to $100, depending on whether the site
is unsecured or secure.
FNet offers high-speed ISDN Internet access communication lines on a
nationwide basis. ISDN provides a faster, more efficient method for
communicating digital data over telephone lines. ISDN speeds are significantly
faster than conventional modem speeds (up to 128 Kbps versus up to the current
maximum of 33.6 Kbps). The monthly ISDN service charge ranges from $110 to
$350, depending on speed and service options. A one-time setup fee ranging
from $110 to $350 is also charged.
FNet also offers frame relay capability. Frame relay enables direct, high-
speed continuous connection of an organization's internal local area network
to the Internet using dedicated circuits at speeds ranging from 56 Kbps to
1,536 Kbps. This service enables businesses to connect an entire local area
network or high-end workstation to the Internet and provides the fastest data
transfer rate generally available. Frame relay service fees range from $250 to
$1,350 per month depending on access speeds, data throughput and other data
transfer metrics. A one-time setup fee ranging from $250 to $1,350 is also
charged.
22
<PAGE>
In addition, FNet offers RF Wireless services. RF Wireless allows businesses
to utilize connections at 1,536 Kbps without contracting for T-1 service from
local telephone companies. The RF Wireless service connects to FNet via
antennas from the customer's site, thus utilizing FNet's high speed network.
RF Wireless service fees are $595 per month, with a one-time setup fee of $595
and equipment cost of $3,500.
MARKETING AND DISTRIBUTION OF COMMUNICATIONS PRODUCTS
The Company maintains a small direct sales force for the marketing of its
communications products. It maintains a home page on the World Wide Web and a
headquarters-based sales and service offices. It also markets its products
through direct mail, participation in trade shows, telemarketing, and
advertising in trade and technical publications. The Company has expanded the
sales and marketing operation through acquisitions and the opening of field
offices as well as employing manufactures representatives.
The growth of the Internet has spawned a new industry, consisting of the
building of infrastructure for Internet Service Providers and offering
connections to corporate America as well as private individuals. The Company
designs and manufactures products which are basic to the operation of an
Internet Service Provider. In addition, these same products are required in
the expansion of corporate based private Intranets. Sales to large corporate
clients are handled one at a time through telemarketing with in person follow-
up sales calls, whereas sales to Internet Service Providers and the
communication of the product lines are through advertising in trade journals.
MARKETING OF INTERNET SERVICES
The market for Internet products and services is varied, including both
hardware and software products and related services. Most companies in the
industry provide either hardware, software or services. FNet offers both
hardware and software specifically designed to provide enhanced Internet
accessibility and usage.
Internet users generally fall into one of two specific market segments, the
individual user and the business user. Management of the Company believes that
the individual user segment will continue to show rapid growth, with the
principal uses being information services, on-line shopping and personal
communications. The advent and increasing popularity of home shopping via
television programming may also extend to the Internet. The Internet can
provide consumers with vastly wider choices from a much greater base of
vendors. Many catalogue and mail order companies now utilize electronic
catalogues accessible through the Internet.
The other significant market is the business user. At present, electronic
mail is the most common application, utilizing computer-based LAN or WAN
communication. The trend for companies with multiple, remote site locations is
to link existing WANs utilizing the Internet, in order to minimize direct
telephone company charges; this market segment is usually referred to as the
Intranet. Internet access provides a fast, inexpensive method of achieving
this connectivity. Although currently available technology provides some
limited ability for voice communication over the Internet, the quality is poor
and communication is generally possible only if users at both ends have PCs
with modems and identical software. It is possible that Intranet applications
could eventually eliminate the need for resident operating software and
massive on-site at a storage facilities for many businesses. Under this
scenario, a PC with resident software will no longer be necessary, with access
to any desired program available through an inexpensive workstation connected
to the Internet. Also, data storage could be centralized in a secure database
accessible through the Internet.
The Company currently markets its Internet services through press releases,
its home page on the World Wide Web, and other targeted marketing strategies.
The Company plans to commence advertising its Internet services in business
trade journals, national business publications, direct mail and local business
publications.
COMPETITION
The data communications industry is extremely competitive. The Company's
principal competitors in this market are: Telematics, Micom, Memotech Data,
Dynatech Corporation, Cisco Systems, Ascend
23
<PAGE>
Communications and U.S. Robotics. Most of these companies have substantially
greater marketing, financial, technical and field support resources than the
Company. In addition, the Company could face strong competition from a number
of established computer and telecommunications firms which may enter the
market in the future.
The Internet services market in which FNet operates is extremely
competitive, and the Company expects competition in this market to intensify
in the future. The Company's current and prospective competitors include many
large companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company
competes (or in the future is expected to compete) directly or indirectly with
the following categories of companies: (i) national and regional Internet
Service Providers, such as Earthlink, IDT, MindSpring, NETCOM, PSINet and
UUNET; (ii) established online services such as America Online, CompuServe,
Prodigy and the Microsoft Network; (iii) computer software and technology
companies such as Microsoft; (iv) national telecommunications companies, such
as AT&T, MCI and Sprint; (v) RBOCs; (vi) cable operators, such as Comcast, TCI
and Time Warner; and (vii) nonprofit or educational ISPs.
The entry of new participants from these categories and the potential entry
of competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company. The ability
of these competitors or others to bundle services and products with Internet
connectivity services could place the Company at a significant competitive
disadvantage. In addition, competitors in the telecommunications industry may
be able to provide customers with reduced communications costs in connection
with their Internet access services, reducing the overall cost of Internet
access and significantly increasing pricing pressures on the Company.
Moreover, certain of the Company's online competitors, including America
Online, the Microsoft Network and Prodigy, offer unlimited access to the
Internet and their proprietary content at flat rates that are generally
equivalent to the Company's flat rate, and do not require a set-up fee.
Certain of the RBOCs have also introduced competitive flat-rate pricing for
unlimited access (without a set-up fee) for at least some period of time. As a
result, competition for active users of Internet services has intensified.
There can be no assurance that the Company will be able to offset the adverse
effect on revenues of any necessary price reductions resulting from
competitive pricing pressures by increasing the number of its customers, by
generating higher revenue from enhanced services, by reducing costs or
otherwise. See "Risk Factors--Competition; New Products and Technological
Changes."
The Company believes that its ability to compete successfully in the
Internet services market depends on a number of factors, including market
presence; the adequacy of the Company's customer and technical support
services; the capacity, reliability and security of its network
infrastructure; the ease of access to and navigation of the Internet provided
by the Company's services; the pricing policies of the Company, its
competitors and its suppliers; the timing of introductions of new services by
the Company and its competitors; the Company's ability to support existing and
emerging industry standards; and industry and general economic trends. There
can be no assurance that the Company will have the financial resources,
technical expertise or marketing and support capabilities to compete
successfully. Also, the Company believes that it has a competitive advantage
over most Internet Service Providers because it manufactures much of the
equipment necessary to operate an Internet Service Provider, and is able to
react quickly to technological changes in the industry.
The Internet telephony field is a relatively new market, but already
includes a number of strong competitors, many of which have significantly
greater financial and technological resources than the Company. Competitors
include PC software providers, PC telephone product suppliers,
telecommunications equipment vendors, and Internet telephony service
providers. See "Risk Factors--Competition; New Products and Technological
Changes."
RECENT ACQUISITIONS AND TRANSACTIONS
During the fiscal year ended June 30, 1996, the Company acquired Alphalink,
an Internet Service Provider, for 50,000 shares of Common Stock of the Company
valued at $19,760, and Malibu Internet Services, an Internet Service Provider
and designer of "home pages" for the World Wide Web, for 60,000 shares of
Common Stock of the Company and 50,000 shares of the Common Stock of FNet,
valued, in the aggregate, at $55,020.
24
<PAGE>
In December 1996 the Company acquired Number One Internet Service, a company
offering high speed wireless, frame relay and ATM Internet services. The
services offered by Number One Internet Service have been integrated with the
services of FNet, and are offered to FNet customers seeking high speed
Internet service and sophisticated applications. In connection with the
acquisition, the owners of Number One Internet Service received 40,000 shares
of the Company's Common Stock and options to purchase an additional 10,000
shares at an exercise price of $1.25 per share, exercisable in January 1998.
In addition, they received 20,000 newly-issued shares of FNet and options to
purchase an additional 80,000 shares of FNet, exercisable over a four year
period. The securities issued were valued at $89,780.
In February 1997 the Company acquired Internet Passport, a company offering
high end Internet services for business customers, including a system for
alternate delivery Internet service using satellite technology for transfer of
large files. Internet Passport was organized in 1996, and has had limited
operations to date. In connection with the acquisition, the Company issued
600,000 shares of its Common Stock, and assumed certain obligations, with a
net value of $1,700,789.
In February 1997 the Company acquired the shares of CPR Computer Repair,
Inc., a service company specializing in the repair of computers and printers,
for 25,000 shares of the Company's Common Stock and assumption of certain
obligations, valued at $69,425. The Company sold the shares of CPR Computer
Repair Inc. in June of 1997, in exchange for a royalty, based on the gross
profits of CPR Computer Repair, Inc., up to a maximum of $100,000.
In March 1997 the Company's subsidiary, Internet Passport, entered into a
Memorandum of Understanding with DigitalXPress LLC ("DigitalXPress"), a
purveyor of video and data network satellite services. Under the terms of the
agreement, Internet Passport and DigitalXpress will jointly develop a product
line, to be called "XPressNet," to furnish Internet connectivity to the
products currently marketed by DigitalXPress, and to combine marketing efforts
for certain customers, applications and products.
In May 1997 the Company's subsidiary, FNet, entered into a licensing and
joint development agreement with Peak Technologies, Inc. ("Peak"), by which
Peak granted FNet a license to use Peak's Java-based PeakJet Internet browser
accelerator in FNet's Internet service. In addition, FNet is to provide a
customized version of the PeakJet technology as a component in the Franklin
XPress satellite product line offered in conjunction with DigitalXPress. Under
the agreement, FNet is to issue 50,000 shares of its Common Stock to Peak.
ASSEMBLY AND MANUFACTURING OPERATIONS
The Company's manufacturing facility is located in Westlake Village,
California. Assembly of the Company's products is ordinarily contracted out to
local circuit board assembly contractors, with final systems tests completed
at the Company's facility. The Company's manufacturing operations consist
primarily of procurement, inspection and testing of components, final assembly
of subsystems, and extensive testing of finished products. The Company
procures substantially all of its parts from outside suppliers. The Company is
currently able to obtain parts without difficulty and at competitive prices.
However, in common with others in the electronics industry, the Company has in
the past paid premium prices to obtain components that are in short supply.
There can be no assurance that shortages will not occur in the future which
could significantly increase the cost or delay the shipment of the Company's
products. This could adversely affect its sales or profitability.
FACILITIES
The Company occupies two leased facilities in Westlake Village, California.
One of the facilities houses sales, engineering, administrative and Internet
services. The facility is 8,000 square feet, with a lease rate of $8,634 per
month, expiring in September 1998. The lease for this facility is renewable on
a year-to-year basis at the option of the Company. The other facility houses
the manufacturing and inventory warehouse. This facility is 4,000 square feet,
with a lease rate of $3,767 per month, expiring in March, 1998, and has a two
year option on renewal.
25
<PAGE>
The Company also leases a 1,688 square foot office in Atlanta, Georgia for
its Internet Passport operation. The current lease rate is $1,477 per month,
with annual rate increases, providing for a lease rate of $1,617 per month by
the end of the lease term. The lease expires in March 2000.
PATENTS AND TRADEMARKS
The Company has been granted two U.S. patents for hardware designs in the
LAN field, one of which expires in 2009 and the other expires in 2006. The
Company also has copyrighted over 300 software programs and 20 hardware
designs. While the Company vigorously defends its patents and other
intellectual property, it protects its proprietary technology through the
filing of patent applications and copyright notifications, and by seeking
employee and business nondisclosure agreements. The Company believes that the
success of its business depends primarily on its technical innovations,
marketing abilities and responsiveness to customer requirements, rather than
on patents, trade secrets, copyrights and other intellectual property rights.
The Company enters into confidentiality agreements with its key employees. In
addition, all suppliers, distributors, licensees, and other business contacts
who have access to the Company's proprietary technology are required to sign
confidentiality agreements. However, there can be no assurance that the
Company's efforts to protect its proprietary rights will be successful in
preventing misappropriation or that those rights will provide the Company with
a competitive advantage. There can be no assurance that others will not
develop products or technology that are equivalent or superior to those of the
Company, or that the confidentiality agreements and internal safeguards upon
which the Company relies will be adequate to protect its interests.
Nevertheless, the Company has a policy of seeking to protect its intellectual
property through patents, confidential disclosure agreements and trade
secrets.
The laws of some foreign countries in which the Company sells or may sell
its products do not protect the Company's proprietary rights in its products
to the same extent as do the laws of the United States.
BACKLOG
At September 30, 1997 and 1996, the Company did not have any backlog of
orders. Since the Company ordinarily fills orders for its communications
products in less than 30 days, backlog is not a significant factor in the
Company's business.
RESEARCH AND DEVELOPMENT
The Company is engaged in ongoing efforts to develop and improve its
products, adapt its products for new applications and design and engineer new
products. During the three months ended September 30, 1997 and for the fiscal
years ended June 30, 1997 and 1996, the Company's research and product
development expenses were approximately $121,000, $480,000 and $320,000,
respectively. The Company expects that its ability to compete effectively in
the communications products marketplace will depend substantially upon
achieving greater speed and flexibility in the Company's products and upon
reducing the cost of the Company's systems. There can be no assurance that the
Company will be able to do so or that the Company's competitors will not
develop products that are less expensive or otherwise superior to those of the
Company.
The Company's internal research and product development efforts are focused
primarily on improving the performance and cost-effectiveness of the Company's
systems through better configurations of system components and developing new
product applications. The Company also has depended upon certain key suppliers
to provide product components in accordance with the Company's specifications.
The Company continues to be engaged with certain of its component suppliers,
independent consultants and other third parties in seeking improvements in the
Company's products.
GOVERNMENT REGULATION
Regulations of the Federal Communications Commission affect various products
of the Company. Certain regulations require that products which reside on a
customer's premises and interconnect the public switched network meet certain
standards to prevent harm to the network. Other regulations limit the levels
of
26
<PAGE>
electromagnetic radiation which may emanate from an electronic device located
on a customer's premise. The Company currently complies with these regulations
and foresees no difficulties in complying with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunication industry could affect the business of the Company.
FNet provides Internet services, in part, through data transmissions over
public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for wire line communications. FNet is
not currently subject to direct regulation by the FCC or any other
governmental agency, other than regulations applicable to businesses
generally. However, in the future FNet could become subject to regulation by
the FCC or another regulatory agency as a provider of basic telecommunications
services. Several long distance telephone carriers have filed a petition with
the FCC seeking a declaration that Internet telephone service is a
"telecommunications service" subject to common carrier regulation. Such a
declaration, if enacted, would create substantial barriers to FNet's entry
into the Internet telephone market. Also, a number of local telephone
companies have asked the FCC to levy access charges on "enhanced service
providers," which may be deemed to include Internet Service Providers.
Although the Chairman of the FCC has indicated his opposition to levying
service charges against Internet Service Providers, local interconnection
charges could be levied in the future. Moreover, the public service
commissions of certain states are exploring the adoption of regulations that
might subject Internet Service Providers to state regulation.
The Telecommunications Act of 1996 (the "Telecommunications Act") contains
certain provisions that lift, or establish procedures for lifting, certain
restrictions relating to the RBOCs' ability to engage directly in the Internet
access business. The Telecommunications Act also makes it easier for national
long distance carriers such as AT&T to offer local telephone service and
allows RBOCs to provide electronic publishing of information and databases.
Competition from these companies could have a material adverse effect on the
Company.
LEGAL PROCEEDINGS
On July 28, 1997 the Company was named as a defendant in an action brought
by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number
service, its officers and affiliates, and several Internet Service Providers,
including the Company. The action was brought in the U.S. District Court for
the Central District of California. In general, the complaint alleges that
Connect America and its officers fraudulently acquired 800 numbers from AT&T,
failed to pay for them, and resold them to the Company and the other Internet
Service Providers on a "flat rate" basis, notwithstanding the fact that AT&T's
charges for 800 service are typically based on time utilized. The claims
against the Company and the other Internet Service Providers are based on
unjust enrichment, on the theory that the Company and the other Internet
Service Providers knew or should have known that flat rate 800 service was
unavailable. In addition to injunctive relief against Connect America and its
officers, the complaint seeks damages of $7.4 million, punitive damages and
attorneys' fees. The Company has filed an answer to the complaint denying the
material allegations thereof, and plans to vigorously contest the action.
There can be no assurance that the Company will be successful in its defense
of the action. Because of the large amount sought in the complaint, an adverse
outcome would have a material adverse effect on the Company's financial
condition.
EMPLOYEES
As of September 30, 1997, the Company had 33 full time employees, including
employees of all subsidiaries. The Company's employees have never been covered
by a collective bargaining agreement. The Company has never experienced any
work stoppages, slowdowns, or other serious labor problems and considers its
relations with its employees to be excellent.
RECENT FINANCINGS
During September, October and November of 1997 the Company completed private
financings with net proceeds of $7,807,000. The financings included the
issuance by the Company of 333,333 shares of Common
27
<PAGE>
Stock and warrants to purchase an additional 333,333 shares of Common Stock,
at an exercise price of $5.00 per share. In addition, the Company issued 740
shares of Series C Preferred Stock at a purchase price of $10,000 per share,
which shares are convertible into shares of Common Stock at a conversion price
of $5.00 per share, subject to certain adjustments relating to the market
price of the underlying Common Stock. In connection with the issuance of the
Series C Preferred Stock, the Company also issued warrants which are
exercisable to purchase shares of Common Stock of the Company's subsidiary,
FNet, and which may, under certain circumstances, be exercisable to acquire
shares of Common Stock of the Company at the conversion price of the Series C
Preferred Stock.
28
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Frank W. Peters......... 59 President, Chief Executive Officer and Chairman of the Board
Peter S. Buswell........ 48 Director
Robert S. Harp.......... 59 Director
Thomas Russell.......... 46 Chief Financial Officer and a Director
Sparrow Marcioni........ 39 Vice President of Marketing
</TABLE>
Mr. Peters has been President of the Company since its organization in 1981.
Between 1975 and 1984 he was also President of Franklin Data Systems and
Franklin Systems Corporation, predecessors to the Company. From 1973 to 1975,
he was Vice President of Jacquard Systems Corporation, a computer hardware and
word processing software development marketer. Between 1965 and 1973 he held
various marketing and sales positions with IBM.
Mr. Buswell has been the Vice President of Marketing and Business
Development for Xantel, since 1996. Previously, he was Chief Marketing Officer
for TAA, a software developer engaged in the development of enterprise wide
mixed media messaging systems. During the 1980s he was manager of Strategic
Planning for the Communications Systems Group of Exxon Enterprises, the
venture capital unit of Exxon. He has also served as Director of Product Line
Management at ITT and as Manager of Program Development at Datapoint. Mr.
Buswell has been a director of the Company since 1996. He also served as a
Vice President of the Company during the 1980's.
Dr. Harp has been Chairman of Quesant Instruments, a manufacturer of
scanning probe microscopes, since 1992. Between 1987 and 1992, he was Chairman
of Vertek, a manufacturer of PC peripheral devices. He is also a founder of
Vector Graphic, Inc. Dr. Harp has been a director of the Company since 1996.
Mr. Russell has been the Chief Financial Officer and a director of the
Company since 1996. He also served as its Chief Financial Officer between 1988
and 1990. Between 1990 and 1996 Mr. Russell owned and operated Russell
Industries, a manufacturer's representative and distribution firm. Prior to
that time Mr. Russell was a partner at Sorenson, Russell & Company, a public
accounting firm, and was employed by Peat Marwick. Mr. Russell is a certified
public accountant.
Ms. Marcioni has been Vice President of Marketing of the Company since
February, 1997. She is the founder and since 1995 was President of Internet
Passport, a company which offered direct link satellite technology to the
Internet industry, and which was acquired by the Company in February 1997.
From 1988 to 1995, she served as president of The Omni Group, a marketing and
promotion company based in Atlanta.
29
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1996 and June 30, 1997 to its
President and its Chief Financial Officer (the "Named Executive Officers").
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
--------------------------- ---- -------- -------- ------------
<S> <C> <C> <C> <C>
Frank W. Peters, President.............. 1996 $275,056(1) $100,000 -0-
1997 $291,556(1) $100,000 -0-
Thomas Russell, Chief Financial
Officer(2)............................. 1996 -0- -0- -0-
1997 $ 60,208 $ 10,000 -0-
</TABLE>
- --------
(1) Portions of these amounts were deferred. See "Transactions with
Management," below.
(2) Mr. Russell was employed by the Company beginning in October 1996.
Except as disclosed above, no compensation characterized as long-term
compensation, including restricted stock awards issued at a price below fair
market value or long-term incentive plan payouts, were paid by the Company
during the years ended June 30, 1996 and 1997 to any of the Named Executive
Officers.
STOCK OPTIONS
The Company's 1986 Stock Option Plan, as amended (the "1986 Plan"),
authorizes the granting of options to employees that are intended to qualify
as "incentive stock options" under the Internal Revenue Code of 1986
("Incentive Stock Options"), as well as stock options that are not intended to
so qualify ("Nonstatutory Options"), which may be granted to officers,
directors, employees, consultants, and others expected to provide significant
services to the Company or its subsidiaries. The 1986 Plan, which is
administered by the Board of Directors, currently covers an aggregate of
700,000 shares. The maximum term of a stock option granted under the 1986 Plan
is ten years, but if the optionee at the time of grant has voting power over
more than 10% of the Company's stock, the maximum term is five years. If an
option granted expires or terminates, the shares subject to the unexercised
portion of that option will become available for the grant of future options
under the 1986 Plan. If an optionee terminates his or her service to the
Company, the optionee may exercise only those option shares vested as of the
date of termination and must effect such exercise within three months,
although the Board of Directors may set a longer period for exercise of stock
options. The 1986 Plan may be amended at any time by the Board of Directors,
although certain amendments would require shareholder approval.
The exercise price of Incentive Stock Options granted under the 1986 Plan
must be at least equal to the fair market value of the stock subject to the
option on the date of grant, except that the exercise price of an Incentive
Stock Option granted to an optionee who owns stock possessing more than 10% of
the voting power of the Company's outstanding capital stock must equal at
least 110% of the fair market value of the stock subject to the option on the
date of grant. The exercise price of Nonstatutory Stock Options granted under
the 1986 Plan must be at least equal to 85% of the fair market value of the
stock subject to the option on the date of the grant. Payment of the exercise
price may be made in cash, promissory notes or other consideration as
determined by the Board of Directors.
The Company has also adopted a 1988 Stock Option Plan on substantially
similar terms as the 1986 Plan. The 1988 Plan covers 300,000 shares. In 1994
the Company adopted an Incentive Stock Option Plan, providing for the grant of
incentive stock options to purchase up to 600,000 shares on substantially the
same terms as the incentive stock options under the 1986 Plan. In 1995 the
Company adopted its 1994 Nonstatutory Stock Option Plan, which provides for
the grant of nonstatutory options to purchase up to 1,400,000 shares on
substantially the same terms as the Nonstatutory Options under the 1986 Plan.
30
<PAGE>
The following table sets forth information with respect to ownership of
options and option values as of June 30, 1997 with respect to the Named
Executive Officers. No options were exercised by the Named Executive Officers
in the fiscal year ended June 30, 1997. The Company has no outstanding stock
appreciation rights, either freestanding or in tandem with options.
<TABLE>
<CAPTION>
OPTION VALUES AS OF JUNE 30, 1997
---------------------------------------------------
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
JUNE 30, 1997 JUNE 30, 1997(1)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
<S> <C> <C>
Frank W. Peters....... 3,008,695(2)/175,000 $6,620,477(2)/$273,000
Thomas Russell........ 100,000/150,000 $ 103,000/$247,000
</TABLE>
- --------
(1) Assumes that a share of Common Stock was valued at $2.34 per share on
June 30, 1997. Amounts reflected are based on this assumed price minus
the exercise price and do not indicate that shares were sold.
(2) Does not include shares issuable upon conversion of convertible notes.
See "Transactions with Management," below.
Option Grants During the Years Ended June 30, 1996 and 1997. The following
table sets forth certain information regarding stock options granted to the
Named Executive Officers during the twelve months ended June 30, 1995 and
1996:
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES
OPTIONS IN FISCAL EXERCISE
NAME YEAR GRANTED YEAR PRICE EXERCISE DATE
---- ---- ---------- ---------- -------- -----------------
<S> <C> <C> <C> <C> <C>
Frank W. Peters....... 1996 350,000 39% $ .78 3/15/97-3/15/98
Frank W. Peters....... 1997 500,000 40% $1.31 12/13/96
Thomas Russell........ 1996 200,000 22% $ .69 5/11/97-5/11/2000
Thomas Russell........ 1997 100,000 8% $1.31 12/13/96
</TABLE>
Employment Arrangements. The Company's President is employed pursuant to an
Employment Agreement expiring on December 31, 1997. The Employment Agreement
provides for monthly compensation at the rate of $20,000, with annual
increases of 6%. The Company's Board of Directors has approved a new six year
Employment Agreement for the Company's President, effective January 1, 1998.
The new Employment Agreement provides for compensation at the rate of $27,000
per month, with annual increases of 6%. The Company's Chief Financial Officer
and Engineering Manager are employed pursuant to Employment Agreements for a
three year period, commencing on September 2, 1997, providing monthly
compensation at the rate of $10,000 per month. The Company's Software
Engineering Manager is employed pursuant to Employment Agreement for a two
year period, commencing on December 2, 1997, providing monthly compensation at
the rate of $10,000 per month.
TRANSACTIONS WITH MANAGEMENT
During the year ended June 30, 1995, the Company issued notes for an
aggregate of $217,000 payable to its President, Frank W. Peters, in lieu of
compensation, included in the table above. These notes bear interest at the
rate of 9% per annum and are due and payable as follows: $12,000 due on August
20, 1995, $65,000 due on August 20, 1997, and $140,000 due on January 5, 1999.
Mr. Peters has waived any defaults or penalties with respect to the unpaid
portions of these notes. The $140,000 note is convertible into shares of the
Company's Common Stock at a conversion price of $.10 per share.
During the year ended June 30, 1995, the Company issued 2,000,000 shares to
its President, Frank W. Peters, upon exercise of options previously granted.
The exercise price was paid by the cancellation of notes in the amount of
$92,000 and accrued interest in the amount of $42,000.
31
<PAGE>
During the year ended June 30, 1996, the Company transferred 4,200,000 of
its shares of FNet to its President, Frank W. Peters, and to Colin Patterson,
who was a director of the Company at the time, in cancellation of notes
payable and for consulting services. Management of the Company valued the FNet
shares at $.015 per share, based upon the book value of FNet at the time of
the transaction. The issuance of these shares caused the Company's ownership
percentage of FNet to decrease from 100% to 79% as of June 30, 1996.
During the year ended June 30, 1996, the Company deferred payment of
$117,000 in compensation, included in the table above, to its President, Frank
W. Peters, with his permission, for an undetermined time period.
On September 20, 1995, the Company issued a promissory note for $100,000,
bearing interest at the rate of 8%, to its President, in lieu of bonus
compensation, included in the table above, for attaining certain corporate
objectives. The note is payable in twenty four equal monthly installments of
$4,523. No payments have been made to date on this Note, and the President has
waived the default provisions.
On September 20, 1996, the Company issued a $100,000 promissory note to its
President in exchange for services rendered in fiscal 1997. No compensation
expense was recorded in fiscal 1996 relating to this note. Bonus compensation
expense of $100,000 will be recorded in connection therewith in fiscal 1997.
The note bears interest at 8% per annum, and is payable in thirty-six equal
monthly installments of $3,134.
On December 13, 1996, the Company granted an option to purchase 1,000,000
shares of its Common Stock at an exercise price of $1.31 per share, the market
price as of December 13, 1996. The options were granted to key management
employees for achievement of certain goals. The options are all currently
exercisable. Of the options, 500,000 were granted to the Company's President,
Frank W. Peters, and 100,000 were granted to its Chief Financial Officer,
Thomas Russell.
During the year ended June 30, 1997, the Company deferred payment of
$112,000 in compensation, included in the table above, to its President, with
his permission, for an undetermined time period.
As of June 30, 1997, the deferred compensation of $117,000 and $112,000 was
converted into two promissory notes. One half of the principal balance of the
notes is convertible into shares of the Company's Common Stock at a conversion
rate of 50% of the fair market value of the Common Stock at the date of
conversion.
On October 7, 1997, the Company's President exercised an option to purchase
1,333,695 shares of the Company's Commons stock at the exercise price of $.10
per share.
On November 3, 1997, the Company's Chief Financial Officer exercised options
to purchase 150,000 shares of the Company's Common stock at exercise prices
ranging from $.69 to $1.31.
32
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of November 13, 1997 by each
director and executive officer of the Company, each person known to the
Company to be the beneficial owner of more than 5% of the outstanding Common
Stock, and all directors and executive officers of the Company as a group.
Except as otherwise indicated below, each person has sole voting and
investment power with respect to the shares owned, subject to applicable
community property laws.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
(INCLUDES EXERCISABLE OPTIONS)
------------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- ------------------ ---------------
<S> <C> <C>
Frank W. Peters..................... 4,596,694(1) 30%
733 Lakefield Road
Westlake Village, CA 91361
Peter S. Buswell.................... 105,000 1%
733 Lakefield Road
Westlake Village, CA 91361
Robert S. Harp...................... -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Thomas Russell...................... 179,040 1%
733 Lakefield Road
Westlake Village, CA 91361
Sparrow Marcioni.................... 600,000 4%
733 Lakefield Road
Westlake Village, CA 91361
All directors and executive officers
of the Company as a group
(5 persons)........................ 5,480,734 36%
</TABLE>
- --------
(1) Does not include shares issuable upon conversion of 50% of the balance of
notes totalling $229,000 into shares at 50% of market value.
33
<PAGE>
SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of November 25, 1997 by each
Selling Shareholder, the number of shares to be sold by each, and the
percentage ownership of each Selling Shareholder after the sale of the Shares
included in this Registration Statement (including exercise of all Warrants
underlying shares in this table and conversion of all Convertible Preferred
Stock underlying shares included in this table).
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
SHARES BENEFICIALLY OWNED SHARES OFFERING
------------------------- TO BE ----------------------
NAME NUMBER PERCENT SOLD NUMBER PERCENT
---- -------------- ------------- ------- ----------- ----------
<S> <C> <C> <C> <C> <C>
M.H. Meyerson & Co.,
Inc.................... 595,000 3.1% 595,000 -0- -0-
Wilson Davis............ 30,000 0.2% 30,000 -0- -0-
Sam Wilson.............. 50,000 0.3% 50,000 -0- -0-
Paul Davis.............. 60,000 0.3% 50,000 10,000 0.1%
Lyle Davis.............. 120,000 0.6% 60,000 60,000 0.3%
Byron Barkley........... 40,000 0.2% 40,000 -0- -0-
Bollard Investment Co... 80,000 0.4% 40,000 40,000 0.2%
Bruce Whaley............ 40,000 0.2% 40,000 -0- -0-
E. Bryan Bagley......... 40,000 0.2% 40,000 -0- -0-
Joe Fisher.............. 132,000 0.7% 110,000 22,000 0.1%
Gary Nelson............. 128,000 0.7% 64,000 64,000 0.3%
Gary Nelson Transcorp
C/F.................... 11,000 0.1% 11,000 -0- -0-
Raleigh Baughman........ 87,300 0.4% 50,000 37,300 0.2%
Blair Holder............ 135,000 0.7% 50,000 85,000 0.4%
Vince Clements.......... 100,000 0.5% 50,000 50,000 0.3%
Terry Widner............ 135,175 0.7% 50,000 85,175 0.4%
Mike Peters............. 498,568 2.6% 190,000 308,568 1.6%
Delaware Charter
Guaranty & Trust Co.,
FBO
Ronald Heller.......... 303,000 1.6% 303,000 -0- -0-
Delaware Charter
Guaranty & Trust Co.,
FBO
David Nagelberg........ 303,000 1.6% 303,000 -0- -0-
Martin & Co............. 146,000 0.8% 146,000 -0- -0-
Michael and Linda
Silvestri.............. 28,000 0.2% 28,000 -0- -0-
Jeffrey Barber.......... 14,000 0.1% 14,000 -0- -0-
Joel Marcus............. 12,000 0.1% 12,000 -0- -0-
Rocco Vezza............. 12,000 0.1% 12,000 -0- -0-
Joanne Gioia............ 12,000 0.1% 12,000 -0- -0-
Joseph Schmidt.......... 10,000 0.1% 10,000 -0- -0-
Eileen Rouse............ 60,000 0.3% 10,000 50,000 0.3%
Kevin Charos............ 10,000 0.1% 10,000 -0- -0-
Marcia Joedicker........ 20,000 0.1% 20,000 -0- -0-
Frederick I. Camerer.... 161,647 0.8% 17,500 144,147 0.7%
Paul Sper............... 60,000 0.3% 60,000 -0- -0-
Sparrow Marcioni........ 600,000 3.1% 300,000 300,000 1.6%
Mark Milhollan.......... 12,000 0.1% 12,000 -0- -0-
Neil Wyenn.............. 25,000 0.1% 25,000 -0- -0-
Dianne Oliver........... 10,000 0.1% 8,000 2,000 -0-
Peter Buswell........... 30,000 0.2% 30,000 -0- -0-
John Calderwood......... 6,250 0.0% 6,250 -0- -0-
Kristin Peters.......... 138,127 0.7% 10,000 128,127 0.7%
Terry Lee............... 20,000 0.1% 20,000 -0- -0-
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
SHARES BENEFICIALLY OWNED SHARES OFFERING
------------------------- TO BE -----------------------
NAME NUMBER PERCENT SOLD NUMBER PERCENT
---- --------------- ------------- --------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Steve Sullivan.......... 20,000 0.1% 20,000 -0- -0-
Garry Fredericksen...... 190,000 1.0% 190,000 -0- -0-
Larry Kupferberg........ 2,500 0.0% 2,500 -0- -0-
Jacqueline Knapp........ 2,500 0.0% 2,500 -0- -0-
The Matthew Fund N.V.... 94,594 0.5% 94,594 -0- -0-
Ellis AG................ 27,027 0.1% 27,027 -0- -0-
Triton Capital
Investments, Ltd....... 94,594 0.5% 94,594 -0- -0-
JMG Capital Partners,
L.P.................... 94,594 0.5% 94,594 -0- -0-
Banque Edouard Constant
S.A.................... 135,135 0.7% 135,135 -0- -0-
Lakeshore International,
Ltd.................... 405,406 2.1% 405,406 -0- -0-
Elara Ltd............... 405,406 2.1% 405,406 -0- -0-
Banque Franck S.A....... 202,704 1.0% 202,704 -0- -0-
JNC Opportunity Fund
Ltd.................... 540,540 2.8% 540,540 -0- -0-
--------------- ---------- --------- ------------ ------
Total................. 6,490,067 42.2% 5,103,750 1,386,317 9.1%
=============== ========== ========= ============ ======
</TABLE>
35
<PAGE>
PLAN OF DISTRIBUTION
THE WARRANTS
Of the shares covered by this Prospectus, 2,055,000 are issuable upon the
exercise of certain warrants to purchase Common Stock of the Company (the
"Warrants"). The Warrants were issued in connection with a private placement
of shares and warrants by the Company that occurred between May 1995 and
February 1996. The initial exercise prices of the Warrants were between $1.25
and $1.35 per share.
In consideration for the filing of the Registration Statement of which this
Prospectus is a part, the holders of the Warrants have agreed to pay the
Company an additional exercise price equal to 30% of the net proceeds of the
sale of the shares issued upon exercise of the Warrants, to the extent such
net proceeds exceed $4.00 per share. Also, the largest Warrant holder, M.H.
Meyerson & Co., Inc., has agreed to reimburse the Company for up to $70,000 in
legal and accounting fees incurred in connection with the Registration
Statement of which this Prospectus is a part.
SALES BY SELLING SHAREHOLDERS
The Selling Shareholders have informed the Company that they intend to sell
the shares of Common Stock offered by them hereby, from time to time in
transactions (which may include block transactions), in the over-the-counter
market, in negotiated transactions, or a combination of such methods of sale,
at fixed prices which may be changed, at market prices prevailing at the time
of sale, or at negotiated prices. The Selling Shareholders may effect such
transactions by selling their shares directly to purchasers or to or through
broker-dealers, which may act as agents or principals. Each Selling
Shareholder will bear all expenses with respect to the offering of shares by
him, except that the Company will pay the costs associated with registering
the shares under the Act and preparing this Prospectus, subject to
reimbursement of up to $70,000 of such costs by M.H. Meyerson & Co., Inc. All
sales by Selling Shareholders will be effected through delivery of a copy of
this Prospectus as it may be amended or supplemented from time to time in
accordance with the provisions of the Securities Act of 1933 (the "Act") and
the rules and regulations promulgated by the Commission thereunder. If
necessary, the Prospectus will be amended by the filing of a supplement or
post-effective amendment to describe any material changes in the stated plan
of distribution. The Selling Shareholders, and any intermediaries, including
broker-dealers through whom their shares are sold, may be deemed
"underwriters" within the meaning of the Act of the shares to be sold by them
in connection with this offering. The Selling Shareholders may agree to
indemnify any agent, dealer, or broker-dealer that participates in
transactions involving sales of the shares against certain liabilities,
including liabilities arising under the Act.
36
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The Company is authorized to issue up to 90,000,000 shares of Common Stock,
without par value, of which 15,394,515 shares of Common Stock have been issued
and are outstanding. Holders of the Common Stock are entitled to one vote per
share on all matters to be voted upon by the shareholders, and to cumulate
votes in the election of directors. Holders of Common Stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available therefor. See "Dividend Policy." Upon
the liquidation, dissolution, or winding up of the Company, the holders of
Common Stock are entitled to share ratably in all assets of the Company which
are legally available for distribution, after payment of all debts and other
liabilities and the liquidation preference of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive, subscription, redemption or
conversion rights.
The Company is authorized to issue 10,000,000 shares of Preferred Stock,
issuable in one or more series, each with such designations, preferences,
rights, and restrictions as the Board of Directors may determine. In
accordance with such authorization, the Board of Directors has designated 740
shares as Series C Preferred Stock, of which all 740 shares are issued and
outstanding. The Series C Preferred Stock is not redeemable, and has no
dividend preference. Each share of Series C Preferred Stock has a liquidation
preference of $10,000 per share, and accrues a premium at the rate of 8% per
annum. The Series C Preferred Stock has no voting rights, except as required
by law, and is convertible into Common Stock commencing in March 1998 at a
conversion price equal to the lesser of (a) $5.00 per share (which amount is
subject to adjustment to reflect decreases in the market price of the Common
Stock during a 30-day measuring period following the issuance of the Series C
Preferred, but not below $4.00 per share) or (b) between 80% and 85% of the
fair market value of the Common Stock, based on closing prices during a
measuring period prior to conversion, with a minimum of $1.00 per share. The
Series C Preferred Stock is automatically converted into Common Stock in May
of 1999.
LEGAL MATTERS
Certain legal matters with respect to the legality under California law of
the shares of Common Stock offered hereby will be passed upon for the Company
by Haddan & Zepfel LLP, Newport Beach, California.
EXPERTS
The consolidated financial statements of the Company as of June 30, 1996,
and for the two years then ended, included in this Prospectus, have been
audited by Corbin & Wertz, independent certified public accountants, to the
extent and for the periods indicated in their report appearing elsewhere
herein. The consolidated financial statements of the Company as of June 30,
1997, and for the year then ended, included in this Prospectus, have been
audited by Singer Lewak Greenbaum & Goldstein LLP, independent certified
public accountants, to the extent and for the period indicated in their report
appearing elsewhere herein. The financial statements of Internet Passport, LLC
as of June 30, 1996 and for the period from February 16, 1996 to June 30, 1996
have been audited by Corbin & Wertz, independent certified public accountants,
to the extent and for the period indicated in their report appearing elsewhere
herein. The consolidated financial statements included herein are included in
reliance upon the reports of Corbin & Wertz and Singer Lewak Greenbaum &
Goldstein LLP, given upon the authority of such firms as experts in auditing
and accounting.
CHANGE IN ACCOUNTANTS
On August 15, 1997 the Company engaged Singer Lewak Greenbaum & Goldstein
LLP ("SLGG") as the Company's independent accountants to report on the
Company's balance sheet as of June 30, 1997, and the related consolidated
statements of operations, shareholders' equity and cash flows for the year
then ended. The decision to appoint SLGG was approved by the Company's Board
of Directors.
Corbin & Wertz ("C&W") was dismissed by the Company on August 15, 1997. C&W
had acted as the Company's independent accountants since 1992. The independent
auditors' reports issued by C&W on the
37
<PAGE>
Company's consolidated financial statements for the years ended June 30, 1996
and 1995 did not contain an adverse opinion or disclaimer of opinion, and such
reports were not modified for any departure from generally accepted accounting
principles or for any limitation of audit scope. C&W's independent auditors'
report, dated September 20, 1996, on the consolidated financial statements of
the Company for the years ended June 30, 1996 and 1995 was modified as to the
uncertainty of the Company to continue as a going concern. There were no
disagreements with C&W, resolved or unresolved, on any matter of accounting
principles or practices, financial disclosure, or auditing scope or procedure,
which, if not resolved to C&W's satisfaction, would have caused it to make
reference to the subject matter of the disagreement in connection with its
reports. C&W was not retained to report on the Company's 1997 financial
statements.
The Company has requested C&W to review the disclosure contained herein and
has provided C&W the opportunity to furnish the Company with a letter
addressed to the Commission containing any new information, clarification of
the Company's expression of C&W's views or the respects in which C&W does not
agree with the statements contained herein. C&W has reviewed the disclosure
contained herein and has advised the Company that it does not intend to
deliver such a letter to the Company.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 under the Securities Act of
1933, as amended, with respect to the securities offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement. For further information with respect to the Company and the
securities offered hereby, reference is made to the Registration Statement,
including the exhibits and financial statements filed therewith. Statements
contained in this Prospectus as to the contents of any contract or other
documents are not necessarily complete, and in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each statement being qualified in its entirety by such
reference. All of these documents may be obtained upon payment of the
prescribed fees or examined without charge at the office of the Commission,
450 Fifth Street, N. W., Washington, D. C. 20549, or by way of the
Commission's Internet address, http://www.sec.gov.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith is required to file reports, proxy statements and other information
with the Commission. Such reports and other information may be inspected and
copied at the Commission's Public Reference Section, Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, where copies can be obtained at
prescribed rates, as well as at the Commission's regional offices at Northwest
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661
and 7 World Trade Center, Suite 1300, New York, New York 10048. The Commission
also maintains a website that contains reports, proxy and other information
filed electronically with the Commission, the address of which is
http://www.sec.gov.
38
<PAGE>
INDEX TO FINANCIAL STATEMENTS
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Certified Public Accountants........................ F-2
Independent Auditors' Report.............................................. F-3
Financial Statements
Consolidated Balance Sheets............................................. F-4
Consolidated Statements of Operations................................... F-5
Consolidated Statements of Shareholders' Equity (Deficit)............... F-6
Consolidated Statements of Cash Flows................................... F-7
Notes to Financial Statements........................................... F-9
INTERNET PASSPORT, LLC
Independent Auditors' Report.............................................. F-28
Balance Sheet as of June 30, 1996......................................... F-29
Statements of Operations for the Eight-Month Period Ended February 28,
1997 and the Period Ended June 30, 1996.................................. F-30
Statements of Member's Deficit............................................ F-31
Statements of Cash Flows for the Eight-Month Period Ended February 28,
1997 and the Period Ended June 30, 1996.................................. F-32
Notes to Financial Statements............................................. F-33
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Franklin Telecommunications Corp.
We have audited the accompanying consolidated balance sheet of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1997, and the related
consolidated statements of operations, shareholders' equity (deficit), and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1997, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
September 17, 1997, (except for
Note 14, as to which the date
is October 31, 1997)
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Franklin Telecommunications Corp.
We have audited the consolidated balance sheet of Franklin
Telecommunications Corp. and subsidiaries (the "Company") as of June 30, 1996
and the related consolidated statements of operations, shareholders' equity
(deficit) and cash flows for each of the years in the two-year period ended
June 30, 1996. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Franklin Telecommunications Corp., and subsidiaries as of June 30, 1996,
and the results of their operations and their cash flows for each of the years
in the two-year period ended June 30, 1996 in conformity with generally
accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As disclosed in
Note 1 to the consolidated financial statements, the Company's recurring
losses from operations through June 30, 1996, and its working capital deficit
at June 30, 1996, raise substantial doubt about the entity's ability to
continue as a going concern. Management's plans in regard to these matters are
further described in Note 1. The consolidated financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
CORBIN & WERTZ
Irvine, California
September 20, 1996
F-3
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1997 AND 1996 AND SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, ------------------------
1997 1997 1996
------------- ----------- -----------
(UNAUDITED)
ASSETS (NOTE 4)
---------------
<S> <C> <C> <C>
Current assets
Cash.................................. $ 908,000 $ 1,464,000 $ 166,000
Accounts receivable, less allowance
for doubtful accounts of $19,000
(unaudited), $34,000, and $8,000,
respectively......................... 111,000 80,000 86,000
Other receivables..................... 189,000 199,000 --
Inventories (Note 2).................. 403,000 394,000 257,000
Prepaid expenses...................... 68,000 68,000 5,000
----------- ----------- -----------
Total current assets.................. 1,679,000 2,205,000 514,000
----------- ----------- -----------
Property and equipment (Note 8)
Machinery and equipment............... 165,000 163,000 215,000
Furniture and fixtures................ 98,000 97,000 46,000
Computers and software................ 728,000 713,000 280,000
----------- ----------- -----------
991,000 973,000 541,000
Less accumulated depreciation......... 442,000 406,000 456,000
----------- ----------- -----------
Total property and equipment.......... 549,000 567,000 85,000
----------- ----------- -----------
Excess of cost over fair value of net
assets of companies acquired, net of
accumulated amortization of $70,000
(unaudited), $40,000, and $32,000,
respectively.......................... 561,000 591,000 62,000
Other assets........................... 198,000 151,000 51,000
----------- ----------- -----------
Total assets.......................... $ 2,987,000 $ 3,514,000 $ 712,000
=========== =========== ===========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
------------------------------------
<S> <C> <C> <C>
Current portion of obligations under
capital lease obligations (Note 8)... $ 352,000 $ 361,000 $ --
Current portion of long-term debt
(majority due to a related party)
(Note 4)............................. 301,000 301,000 94,000
Accounts payable...................... 339,000 175,000 143,000
Accrued liabilities (Note 3).......... 497,000 559,000 483,000
----------- ----------- -----------
Total current liabilities............. 1,489,000 1,396,000 720,000
Long-term debt, (majority due to a
related party) less current portion
(Note 4).............................. 360,000 360,000 238,000
Other liabilities (Note 9)............. 183,000 183,000 503,000
----------- ----------- -----------
Total liabilities..................... 2,032,000 1,939,000 1,461,000
----------- ----------- -----------
Minority Interest...................... -- -- --
Commitments and contingencies (Notes 8
and 12)
Shareholders' equity (deficit) (Notes
5, 12 and 14)
Preferred stock, no par value
10,000,000 shares authorized no
shares issued and outstanding........ -- -- --
Common stock, no par value 90,000,000
shares authorized 13,475,289
(unaudited), 13,191,223, and
10,868,786 shares issued and
outstanding.......................... 10,569,000 9,971,000 5,372,000
Common stock committed, no par value
109,033 (unaudited), 296,066, and
48,350 shares committed but not yet
issued............................... 321,000 579,000 30,000
Accumulated deficit................... (9,935,000) (8,975,000) (6,151,000)
----------- ----------- -----------
Total shareholders' equity (deficit).. 955,000 1,575,000 (749,000)
----------- ----------- -----------
Total liabilities and shareholders'
equity (deficit)..................... $ 2,987,000 $ 3,514,000 $ 712,000
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------------ ------------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- ----------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales
Product............... $ 76,000 $ 158,000 $ 1,337,000 $ 397,000 $1,481,000
Internet services..... 168,000 51,000 398,000 33,000 --
----------- ----------- ----------- ----------- ----------
Total sales......... 244,000 209,000 1,735,000 430,000 1,481,000
----------- ----------- ----------- ----------- ----------
Cost of sales
Product............... 97,000 130,000 681,000 549,000 518,000
Internet services..... 137,000 35,000 309,000 41,000 --
----------- ----------- ----------- ----------- ----------
Total cost of sales. 234,000 165,000 990,000 590,000 518,000
----------- ----------- ----------- ----------- ----------
Gross profit (loss)..... 10,000 44,000 745,000 (160,000) 963,000
----------- ----------- ----------- ----------- ----------
Operating expenses
Research and
development expenses. 121,000 97,000 480,000 320,000 308,000
Selling, general, and
administrative ex-
penses............... 849,000 324,000 1,456,000 947,000 828,000
Write-down of good-
will................. -- -- 1,584,000 70,000 --
----------- ----------- ----------- ----------- ----------
Total operating ex-
penses............. 970,000 421,000 3,520,000 1,337,000 1,136,000
----------- ----------- ----------- ----------- ----------
Loss from operations.... (960,000) (377,000) (2,775,000) (1,497,000) (173,000)
----------- ----------- ----------- ----------- ----------
Other income (expense)
Interest expense...... (17,000) (7,000) (41,000) (26,000) (10,000)
Other income (ex-
pense)............... 17,000 -- (6,000) (5,000) 25,000
----------- ----------- ----------- ----------- ----------
Total other income
(expense).......... -- (7,000) (47,000) (31,000) 15,000
----------- ----------- ----------- ----------- ----------
Loss before minority
interest and provision
for income taxes....... (960,000) (384,000) (2,822,000) (1,528,000) (158,000)
Minority interest in
loss of subsidiary..... -- -- -- 63,000 --
----------- ----------- ----------- ----------- ----------
Loss before provision
for income taxes....... (960,000) (384,000) (2,822,000) (1,465,000) (158,000)
Provision for income
taxes.................. -- -- 2,000 2,000 2,000
----------- ----------- ----------- ----------- ----------
Net loss................ $ (960,000) $ (384,000) $(2,824,000) $(1,467,000) $ (160,000)
=========== =========== =========== =========== ==========
Net loss per common
share.................. $ (.07) $ (.03) $ (.23) $ (.14) $ (.02)
=========== =========== =========== =========== ==========
Weighted average common
shares outstanding..... 13,125,318 11,503,114 12,267,991 10,279,281 6,475,984
=========== =========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 ANDTHE THREE MONTHS ENDED
SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK
COMMON STOCK COMMITTED
---------------------- -------------------
SHARES AMOUNT SHARES AMOUNT ACCUMULATED DEFICIT TOTAL
---------- ----------- -------- --------- ------------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1994.. 5,847,512 $ 3,975,000 -- $ -- $(4,524,000) $ (549,000)
Common stock issued for
Cash................... 220,000 110,000 110,000
Business acquisition.... 326,497 47,000 47,000
Stock options/warrants.. 304,280 30,000 30,000
Compensation............ 22,000 2,000 2,000
Notes payable and
accrued interest....... 2,000,000 134,000 134,000
Net loss................ (160,000) (160,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1995.. 8,720,289 4,298,000 -- -- (4,684,000) (386,000)
Correction of error..... 23,031 --
Common stock issued for
Cash................... 1,808,572 910,000 23,350 20,000 930,000
Business acquisition.... 85,000 65,000 25,000 10,000 75,000
Stock options/ warrants. 189,500 77,000 77,000
Compensation............ 34,839 11,000 11,000
Accounts payable........ 7,555 11,000 11,000
Net loss................ (1,467,000) (1,467,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1996.. 10,868,786 5,372,000 48,350 30,000 (6,151,000) (749,000)
Common stock issued for
Cash................... 880,200 888,000 20,000 25,000 913,000
Issuance for notes
receivable............. 243,250 --
Issuance of committed
shares................. 48,350 30,000 (48,350) (30,000) --
Business acquisition.... 708,887 1,458,000 232,066 525,000 1,983,000
Services rendered....... 77,000 44,000 29,000 106,000
Stock options/warrants.. 441,750 196,000 196,000
Proceeds received from
the sale of
subsidiaries' common
stock.................. 1,950,000 1,950,000
Net loss................ (2,824,000) (2,824,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1997.. 13,191,223 $ 9,971,000 296,066 $ 579,000 $(8,975,000) $ 1,575,000
Common stock issued for
cash (unaudited)....... 97,033 289,000 289,000
Issuance of committed
shares (unaudited)..... 284,066 547,000 (284,066) (547,000) --
Proceeds received from
the sale of
subsidiaries' common
stock (unaudited)...... 51,000 51,000
Net loss (unaudited).... (960,000) (960,000)
---------- ----------- -------- --------- ----------- -----------
Balance, September 30,
1997 (unaudited)....... 13,475,289 $10,569,000 109,033 $ 321,000 $(9,935,000) $ 955,000
========== =========== ======== ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND
THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------------ -----------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- ----------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERAT-
ING ACTIVITIES
Net loss................ $ (960,000) $ (384,000) $(2,824,000) $(1,467,000) $(160,000)
Adjustments to reconcile
net loss to net cash
provided by (used in)
operating activities
Depreciation and
amortization......... 66,000 12,000 110,000 45,000 29,000
Provision for loss on
obsolete inventory... -- -- -- 226,000 4,000
Provision for loss on
doubtful accounts.... 15,000 -- -- (2,000) (24,000)
Write-down of
goodwill............. -- -- 1,584,000 70,000 --
Notes payable for
services rendered.... -- -- 329,000 -- 217,000
Stock issued for
services rendered.... -- -- 106,000 11,000 28,000
Loss on disposal of
property............. -- -- 37,000 1,000 --
(Increase) decrease in
Accounts receivable... (46,000) 26,000 14,000 (34,000) 130,000
Inventories........... (9,000) 8,000 (132,000) 131,000 (117,000)
Prepaid expenses...... -- (20,000) (63,000) 9,000 (8,000)
Increase (decrease) in
Accounts payable...... 164,000 80,000 (96,000) (97,000) 40,000
Accrued liabilities... (62,000) 19,000 71,000 175,000 (38,000)
Accrued other
liabilities.......... -- -- -- (24,000) (92,000)
Other liabilities..... -- (1,000) (310,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash provided by
(used in) operating
activities............. (832,000) (260,000) (1,174,000) (956,000) 9,000
---------- ---------- ----------- ----------- ---------
CASH FLOWS FROM
INVESTING ACTIVITIES
Purchases of property
and equipment.......... (18,000) (24,000) (324,000) (58,000) (8,000)
Cash received (paid) in
connection with
business acquisitions.. -- -- 4,000 3,000 (8,000)
Issuance of notes
receivable............. -- (190,000) (100,000) -- --
Proceeds from notes
receivable............. 10,000 -- 32,000 -- --
Other assets............ (47,000) -- 100,000 1,000 1,000
Other liabilities....... -- -- (38,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash used in
investing activities... (55,000) (214,000) (526,000) (54,000) (15,000)
---------- ---------- ----------- ----------- ---------
CASH FLOWS FROM
FINANCING ACTIVITIES
Payments on other
liabilities............ -- -- (10,000) (5,000) (35,000)
Proceeds from sale of
Company stock.......... 340,000 1,007,000 1,109,000 1,007,000 114,000
Proceeds from sale of
minority stock in
consolidated
subsidiary............. -- -- 1,950,000 -- --
Issuance of long-term
debt................... -- 100,000 -- 102,000 --
Payments on long-term
debt................... -- -- -- (63,000) (36,000)
Payments on capital
lease obligation....... (9,000) -- (51,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash provided by
financing activities... 331,000 1,107,000 2,998,000 1,041,000 43,000
---------- ---------- ----------- ----------- ---------
Net increase (decrease)
in cash................ (556,000) 633,000 1,298,000 31,000 37,000
Cash, beginning of year. 1,464,000 166,000 166,000 135,000 98,000
---------- ---------- ----------- ----------- ---------
Cash, end of year....... $ 908,000 $ 799,000 $ 1,464,000 $ 166,000 $ 135,000
========== ========== =========== =========== =========
SUPPLEMENTAL DISCLOSURES
OF CASH FLOW
INFORMATION
Interest paid........... $ -- $ -- $ -- $ 12,000 $ 4,000
========== ========== =========== =========== =========
Income taxes paid....... $ 2,000 $ -- $ 2,000 $ 2,000 $ 2,000
========== ========== =========== =========== =========
</TABLE>
F-7
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the years ended June 30, 1997 and 1996, the Company completed certain
acquisitions as described in Note 1. In conjunction with these acquisitions,
aggregate liabilities assumed were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- --------
<S> <C> <C>
Fair value of the assets acquired, net of cash and
including intangibles............................... $ 2,371,000 $ 72,000
Value of Company and subsidiary common stock issued
and committed for consideration..................... (1,983,000) (75,000)
Cash received in connection with the acquisition..... 4,000 3,000
----------- --------
Aggregate liabilities assumed........................ $ 392,000 $ --
=========== ========
</TABLE>
See Notes 1 and 5 for additional non-cash investing and financing
activities.
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND
1996 IS UNAUDITED)
NOTE 1--GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Franklin Telecommunications Corp. ("Franklin") and its subsidiaries
(collectively the "Company") manufacture and distribute data communications
and access and connectivity products for T-1 and X.25 wide-area networks and
provide Internet services through its majority-owned subsidiary, FNet Corp.
("FNet"). FNet has had limited operations to date. The Company's customers are
located predominantly in the United States, Canada, Australia, and parts of
Europe in a wide range of industries including financial services, government,
and manufacturing.
Interim Financial Information
The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, which in the
opinion of management, are necessary to fairly state the Company's
consolidated financial position, the consolidated results of its operations,
and consolidated cash flows for the periods presented. The results of
consolidated operations for the three months ended September 30, 1997 are not
necessarily indicative of results for the entire fiscal year ending June 30,
1998.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles which contemplate the
Company as a going concern.
As reflected in the accompanying consolidated statements of operations, the
Company has had net losses for each of the years ended June 30, 1997, 1996,
and 1995. As shown in the accompanying consolidated statements of cash flows
for the years ended June 30, 1997, 1996, and 1995, the Company has raised
funds from sales of its common stock and the common stock of its majority-
owned subsidiary, FNet, to fund its operating losses. In previous years, the
Company has had fluctuating sales. With the introduction of the Company's new
products and services, sales may or may not continue to fluctuate.
In view of the matters described in the preceding paragraph, recoverability
of a major portion of the recorded asset amounts shown in the accompanying
consolidated balance sheets is dependent upon continued operations of the
Company, which in turn is dependent upon the Company's ability to continue to
raise capital and generate positive cash flows from operations. The
consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classifications of liabilities that might be necessary should the Company be
unable to continue its existence.
Management plans to take the following steps that it believes will be
sufficient to provide the Company with the ability to continue in existence:
. The Company plans to utilize the cash on hand at June 30, 1997 to fund
operations.
. The Company plans to issue stock under Regulation D. Management believes
that this private placement will raise approximately $1,000,000 (see Note
14).
. The Company has entered into a letter of agreement with an investment
banker which management believes will raise $2,000,000 to $5,000,000
through the private placement of convertible preferred stock (see Note
14).
F-9
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Management of the Company believes that the cash on hand as of June 30,
1997, plus anticipated future equity sales, will sustain the Company's
operations for at least one year.
Acquisitions
Effective December 9, 1994, the Company acquired all of the outstanding
common stock of Lan Performance Labs, Inc. ("LPL") in exchange for 300,002
shares of its common stock. In conjunction with the acquisition, 26,495 shares
of Franklin's common stock were issued to certain creditors of LPL in exchange
for payables totaling $26,495. This reduction in payables was considered in
the allocation of fair market value of the assets acquired and liabilities
assumed for purposes of allocating the purchase price. On December 2, 1996 and
July 31, 1997, the Company issued an additional 60,987 and 207,066 shares,
respectively, of its common stock to resolve a dispute in the final purchase
price of LPL. The value of the shares issued of $85,000 and $453,000 was
recorded to goodwill. The 207,066 shares issued on July 31, 1997 have been
recorded as common stock committed in the accompanying balance sheet as of
June 30, 1997.
The acquisition of LPL was accounted for by the Company using the purchase
method of accounting. The excess of approximately $637,000 (as adjusted for
the $85,000 and $453,000 as mentioned above) of the total acquisition cost
over the net assets acquired and liabilities assumed was allocated to
goodwill. The results of operations from December 9, 1994 to June 30, 1995 are
included in the accompanying consolidated statement of operations for the year
ended June 30, 1995. Fiscal 1995 pro forma presentation as if LPL had been
acquired July 1, 1994 is not presented because the effect on operations would
be immaterial.
During the year ended June 30, 1996, the Company completed two acquisitions
whereby the Company acquired all of the outstanding common stock of AlphaLink
("Alpha") and Malibu Internet Services ("MIS") in exchange for an aggregate of
110,000 shares of Franklin's common stock and 50,000 shares of FNet common
stock.
The acquisitions of Alpha and MIS were accounted for by using the purchase
method of accounting with the excess of approximately $65,000 of the total
acquisition cost over the net assets acquired and liabilities assumed being
allocated to goodwill. The results of operations from January 1, 1996 to June
30, 1996 for Alpha and June 1, 1996 to June 30, 1996 for MIS, respectively,
are included in the accompanying consolidated statement of operations for the
year ended June 30, 1996. Fiscal 1996 pro forma presentation as if these two
acquisitions had been acquired as of the beginning of the 1996 fiscal year and
fiscal 1995 pro forma presentation is not presented because the effect on
operations would be immaterial.
On December 13, 1996, the Company acquired the assets of No. 1 Internet
Services ("No. 1") in exchange for 40,000 shares of Franklin's common stock
and options to purchase 10,000 shares of Franklin's common stock at $1.25,
which was the fair market value on December 2, 1996, exercisable January 1,
1998. In addition, FNet issued 20,000 shares of its common stock valued at
$20,000 and granted options to purchase 80,000 shares of FNet common stock,
exercisable at the rate of 20,000 shares per year at $1.00 per share in each
of the four years beginning January 1, 1998. The acquisition was accounted for
as a purchase with the excess of approximately $74,000 of the total
acquisition cost over the net assets acquired and liabilities assumed being
allocated to goodwill. Pro forma results for the year ended June 30, 1997, as
if the acquisition had taken place as of the beginning of the 1997 fiscal
year, is not presented because the effect on operations would be immaterial.
On February 26, 1997, the Company agreed to acquire all of the outstanding
common stock of CPR Computer Repair ("CPR") in exchange for 25,000 shares of
Franklin's common stock. As part of the agreement, CPR's shareholder committed
to pay all of the outstanding obligations of CPR as of February 26, 1997 (the
"Commitment"). The Commitment is secured by a promissory note of $117,000. The
acquisition was accounted for using the purchase method of accounting with
excess of approximately $61,000 of the total acquisition costs
F-10
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
over the net assets acquired and liabilities assumed being allocated to
goodwill. Pro forma results for the year ended June 30, 1997, as if the
acquisition had taken place as of the beginning of the 1997 fiscal year, is
not presented because the effect on operations would be immaterial.
On June 30, 1997, the Company sold CPR for future royalties to be paid by
the buyer to the Company as defined in the purchase agreement. The Company
wrote-off the remaining goodwill of approximately $61,000 related to the
acquisition of CPR due to the uncertainty of the royalty stream.
On February 28, 1997, the Company agreed to acquire Internet Passport, LLC
("Passport"), a limited liability company, in exchange for 600,000 shares of
Franklin's common stock. The agreement also provided for the assumption of
certain debts totaling $411,000, including the issuance of an additional 7,900
shares of Franklin's common stock valued at $1.73 to satisfy certain
obligations of Passport. Passport is a start-up company incorporated in August
1996 that provides Internet services pursuant to contractual arrangements with
satellite transmission providers. The acquisition was accounted for using the
purchase method of accounting with the excess of approximately $1,478,000 of
the total acquisition costs over the net assets acquired and liabilities
assumed being allocated to goodwill. Pro forma net loss and net loss per share
of the year ended June 30, 1997 and 1996, as if the transaction had occurred
at the beginning of those years, would have been $(2,160,000) ($(.17) per
share) and $1,533,000 ($(0.15) per share), respectively, as presented in Note
11.
Joint Venture
In May 1996, the Company and a modem manufacturer formed Franklin Modem
Corp. (the "Venture"), a joint venture to design and manufacture a V.34 modem
to function with the Company's newly introduced D-Mark Channel Bank hardware.
The Company has a 70% ownership interest in the venture with the remaining
interest being owned by the modem manufacturer. As of May 16, 1997, this joint
venture agreement was replaced with a mutual supply agreement between the two
parties that provides for the Company to purchase 70% of certain boards
manufactured by the modem manufacturer.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Franklin Telecommunications Corp. and its wholly-owned or majority owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated.
Concentrations of Credit Risk
At times, the Company holds cash with financial institutions in excess of
amounts insured by federal agencies.
The Company sells its products throughout the United States, Canada,
Australia, and parts of Europe and extends credit to its customers and
performs ongoing credit evaluations of such customers. The Company does not
obtain collateral to secure its accounts receivable. The Company evaluates its
accounts receivable on a regular basis for collectability and provides for an
allowance for potential credit losses as deemed necessary.
Two customers accounted for 29% and 10%, respectively, of the Company's
product sales for the year ended June 30, 1997. Four customers accounted for
18%, 17%, 13% and 12%, respectively, of the Company's product sales for the
year ended June 30, 1996. Two customers accounted for 28% and 15%,
respectively, of the Company's product sales for the year ended June 30, 1995.
One customer accounted for 10% (unaudited) of the Company's product sales for
the three months ended September 30, 1997. One customer accounted for 48%
(unaudited) of the Company's product sales for the three months ended
September 30, 1996. At June 30, 1997,
F-11
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
amounts due from two customers amounted to 20% and 10%, respectively, of
accounts receivable. At June 30, 1996, amounts due from three customers
amounted to 60%, 20% and 16%, respectively, of accounts receivable. At
September 30, 1997, amounts due from two customers amounted to 21% (unaudited)
and 10% (unaudited), respectively, of accounts receivable. One customer, a
related party, accounted for 5%, 1%, 9%, 0% (unaudited) and 4% (unaudited) of
product sales for the years ended June 30, 1997, 1996, and 1995, and the three
months ended September 30, 1997 and 1996, respectively, and comprised 0%, 3%
and 0% (unaudited) of accounts receivable at June 30, 1997 and 1996 and
September 30, 1997, respectively.
Export sales, primarily to Canada, Australia, Poland, and England,
represented 6%, 15%, 19%, 0% (unaudited), and 6% (unaudited) of net sales for
the years ended June 30, 1997, 1996, and 1995 and the three months ended
September 30, 1997 and 1996, respectively.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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. Such estimates affect the reported amounts of revenues and
expenses during the reported period. Actual results could materially differ
from these estimates.
Fair Value of Financial Instruments
The Company measures its financial assets and liabilities in accordance with
generally accepted accounting principles. For certain of the Company's
financial instruments including cash, accounts receivable, and accounts
payable and accrued expenses, the carrying amounts approximate fair value due
to their short maturities. The amounts shown for notes payable and capital
lease obligations also approximate fair value because current interest rates
and terms offered to the Company for similar notes and lease agreements are
substantially the same.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly-liquid investments purchased with original maturities of three months
or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market (estimated net
realizable value). Cost is determined using the average cost method, which
approximates the first-in, first-out ("FIFO") method. Net realizable value is
based on forecasts for sales of the Company's products in the ensuing years.
The industry in which the Company operates is characterized by rapid
technological advancement and change. Should demand for the Company's products
prove to be significantly less than anticipated, the ultimate realizable value
of the Company's inventories could be substantially less than the amount shown
on the accompanying consolidated balance sheets.
Property and Equipment
Property and equipment are stated at cost. The Company provides for
depreciation using the straight-line method over the estimated useful lives of
5 to 7 years as follows:
<TABLE>
<S> <C>
Machinery and equipment........................................... 7 years
Furniture and fixtures............................................ 7 years
Computers and software............................................ 5 years
</TABLE>
F-12
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Expenditures for maintenance and repairs are charged to operations as
incurred while renewals and betterments are capitalized. Gains or losses on
the sale of property and equipment are reflected in the statements of
operations.
Stock Options and Warrants
During 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," which defines a fair value based method of accounting for
stock-based compensation. However, SFAS 123 allows an entity to continue to
measure compensation cost related to stock and stock options issued to
employees using the intrinsic method of accounting prescribed by Accounting
Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees." Entities electing to remain with the accounting method of APB 25
must make pro forma disclosures of net income and earnings per share, as if
the fair value method of accounting defined in SFAS 123 had been applied. The
Company has elected to account for its stock-based compensation to employees
under APB 25.
Excess of Cost Over Fair Value of Net Assets of Companies Acquired (Goodwill)
Goodwill arising in connection with the aforementioned business acquisitions
is amortized using the straight-line method over five years. The Company
assesses the recoverability of these intangibles on a quarterly basis by
determining whether the amortization of the balance over its remaining life
can be recovered through projected undiscounted future cash flows. The amount
of goodwill impairment, if any, is based on fair value as measured by future
cash flows and charged to operations in the period in which goodwill
impairment is determined by management. During the years ended June 30, 1997
and 1996, management of the Company determined that $1,584,000 and $70,000,
respectively, of goodwill had been impaired and, accordingly, the Company
charged these amounts to operations. Amortization of goodwill for the years
ended June 30, 1997, 1996 and 1995 and the three months ended September 30,
1997 and 1996 amounted to $40,000, $22,000, $10,000, $30,000 (unaudited), and
$3,000 (unaudited), respectively.
Patents
Included in other assets in the accompanying consolidated balance sheets is
$30,000 of capitalized patent costs, net of accumulated amortization of
$16,000, $12,000 and $17,000 (unaudited) at June 30, 1997 and 1996 and
September 30, 1997, respectively. Patent costs are amortized on a straight-
line method over their respective lives not to exceed 17 years. Amortization
of patent expense for the years ended June 30, 1997, 1996 and 1995 and the
three months ended September 30, 1997 and 1996 was $4,000, $4,000, $2,000,
$1,000 (unaudited), and $1,000 (unaudited), respectively.
Minority Interest
Minority interest represents the minority shareholders' proportionate share
of the equity of FNet. During the year ended June 30, 1996, Franklin
transferred 4,200,000 shares of its ownership in FNet to two officers of the
Company as payments on notes payable and for consulting services and issued an
additional 50,000 shares to MIS as aforementioned. Management of the Company
valued the FNet shares at $.015 per share, based upon the book value of FNet
at the time of the transaction. The issuance of these shares caused Franklin's
ownership percentage of FNet to decrease from 100% to 79% as of June 30, 1996.
During the year ended June 30, 1997, FNet sold approximately 1,949,500
shares of its stock to outside investors at $1.00 per share and issued 20,000
shares to acquire No. 1 and 76,000 shares for services rendered. The shares
sold to investors were issued under a private offering circular pursuant to
the exemption from registration under the 1933 Act provided in Rule 505 of
Regulation D. After the issuance of these shares, Franklin's ownership
percentage decreased to 71% as of June 30, 1997.
F-13
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FNet, on a stand-alone basis, had a shareholders' deficit. As a result,
Franklin's investment in FNet had a negative carrying value. The increase in
capitalization of FNet resulting from the sale of 1,949,500 and 51,000
(unaudited) shares of common stock for the year ended June 30, 1997 and the
three months ended September 30, 1997, respectively, to outside investors
benefited Franklin in that it reduced the negative carrying value of
Franklin's investment in FNet. Accordingly, Franklin has accounted for the
change in its proportionate share of FNet's equity resulting from the issuance
of stock to outside investors as an increase in shareholders' equity and a
reduction in minority interest liability in the consolidated financial
statements.
The accompanying consolidated financial statements do not reflect a minority
interest liability as of June 30, 1997 and 1996 and September 30, 1997
(unaudited) as FNet, on a stand-alone basis, had a shareholders' deficit as of
such dates. The accompanying consolidated statements of operations for the
year ended June 30, 1997 and the three months ended September 30, 1997 do not
reflect the minority interest's share of FNet's losses for said periods as the
related accrual would result in the Company's recordation of a minority
interest receivable.
Revenue Recognition
Revenues are recognized upon shipment of the products to customers. The
Company does not allow the right of return on sales.
Warranties
The Company provides limited warranties of one year from the date of
purchase of its products. No accrual has been made for warranty liabilities
because they are not expected to be significant.
Research and Development Costs
Research and development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred and have not been historically
material.
Net Loss Per Common Share
The computation of loss per common share is based on the weighted average
number of common and common equivalent shares outstanding during the years
ended June 30, 1997, 1996, and 1995 and the three months ended September 30,
1997 and 1996 (unaudited). Common stock equivalents have been excluded from
the aforementioned computations as their effect would be anti-dilutive.
Income Taxes
The Company accounts for income taxes under the Financial Accounting
Standards Board SFAS No. 109, "Accounting for Income Taxes," SFAS 109 requires
the asset and liability method of accounting for income taxes. Under the asset
and liability method of SFAS 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS 109, the effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is required when it is less likely than
not that the Company will be able to realize all or a portion of its deferred
tax assets.
F-14
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Reclassifications
Certain amounts in the 1996 and 1995 consolidated financial statements have
been reclassified to conform to the 1997 presentation.
Recently Issued Accounting Pronouncements
The Financial Accounting Standards Board issued SFAS 128, "Earnings Per
Share," which is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods. SFAS 128 requires public
companies to present basic earnings per share and, if applicable, diluted
earnings per share instead of primary and fully-diluted earnings per share.
The Company does not believe that reporting earnings per share in accordance
with SFAS 128 will be materially different from the earnings per share
previously reported.
SFAS 130, "Reporting Comprehensive Income" issued by the Financial
Accounting Standards Board is effective for financial statements with fiscal
years beginning after December 15, 1997. Earlier application is permitted.
SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial
statements. The Company does not expect adoption of SFAS 130 to have a
material impact, if any, on its financial position or results of operations.
The Financial Accounting Standards Board issued SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information," effective for fiscal years
beginning after December 15, 1997. SFAS 131 requires a company to report
certain information about its operating segments including factors used to
identify the reportable segments and types of products and services from which
each reportable segment derives its revenues. The Company does not anticipate
any material change in the manner that it reports its segment information
under this new pronouncement.
NOTE 2--INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Raw materials................................ $217,000 $155,000 $ 49,000
Work in process.............................. 148,000 152,000 44,000
Finished goods............................... 38,000 87,000 164,000
-------- -------- --------
Total...................................... $403,000 $394,000 $257,000
======== ======== ========
</TABLE>
NOTE 3--ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Salaries and related expenses............... $310,000 $277,000 $309,000
Sales tax payable........................... -- -- 76,000
Accrued interest payable, primarily to
related party.............................. 103,000 88,000 45,000
Accrued audit............................... -- 30,000 20,000
Other accrued liabilities................... 84,000 164,000 33,000
-------- -------- --------
Total..................................... $497,000 $559,000 $483,000
======== ======== ========
</TABLE>
F-15
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Convertible notes payable to former
vendors, bearing interest at 12% per
annum, unsecured and due in December
1999..................................... $ 24,000 $ 24,000 $ 24,000
Notes payable to the president and
majority shareholder, bearing interest
from 8% to 9% per annum, secured by
substantially all of the Company's
assets, with due dates ranging through
June 2000................................ 637,000 637,000 308,000
-------- -------- --------
661,000 661,000 332,000
Less current portion...................... 301,000 301,000 94,000
-------- -------- --------
Long-term portion....................... $360,000 $360,000 $238,000
======== ======== ========
</TABLE>
The Company is past due in certain of its payments under its notes payable
to its president and majority shareholder. The president and majority
shareholder has waived the default provisions of the past due notes payable
and does not intend to demand payment until after September 30, 1998.
Future principal payments required under such notes are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDING
JUNE 30,
-----------
<S> <C>
1998.......................................................... $301,000
1999.......................................................... 267,000
2000.......................................................... 93,000
--------
Total....................................................... $661,000
========
</TABLE>
Included in the $637,000 due to the Company's president is a note of
$140,000 which can be converted into shares of the Company's common stock at a
rate of $.10 per share and two notes in the amount of $117,000 and $112,000
which can be converted into $114,500 of the Company's common stock at a rate
of 50% of the fair value of the common stock at the date of conversion.
During fiscal 1995, the Company canceled notes payable in the amount of
$92,000 to the president and majority shareholder in exchange for the issuance
of common stock.
NOTE 5--SHAREHOLDERS' EQUITY (DEFICIT)
Stock Option Plans
The Company adopted an Incentive Stock Option Plan ("Plan A") and
Nonqualified Stock Option Plan ("Plan B") (collectively the "1986 Plans").
Plan A provides for the granting of options to purchase shares of common stock
that are intended to qualify as incentive stock options within the meaning of
Section 422A of the Internal Revenue Code, and Plan B provides for the
granting of options to purchase shares of common stock that are not intended
to qualify. The 1986 Plans provide for the issuance of up to 700,000 shares in
the aggregate at fair market value.
During the year ended June 30, 1989, the Company adopted the 1988 Stock
Option Plan (the "1988 Plan"). Under the terms of the plan, options to
purchase 300,000 shares of the Company's common stock are available
F-16
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
for issuance to employees, officers and directors. Options granted may be
either incentive stock options or non-statutory options. The exercise price of
the incentive stock options and non-statutory options may not be greater or
less than 110% and 85%, respectively, of the fair market value of the
Company's common stock at the date of grant.
During the year ended June 30, 1994, the Company adopted the 1993 Stock
Option Plan (the "1993 Plan"). The 1993 Plan provides for the granting of
options to purchase up to 600,000 shares of common stock that are intended to
qualify as incentive stock options within the meaning of Section 422A of the
Internal Revenue Code.
During the year ended June 30, 1995, the Company adopted the 1994 Stock
Option Plan (the "1994 Plan"). The 1994 Plan provides for the granting of
options to purchase up to 1,400,000 shares of common stock. Such options will
be non-statutory.
Options granted under all four of the aforementioned plans vest in
accordance with the terms established by the Company's stock option committee.
All such options granted to date have vesting periods of between two to four
years and generally terminate at the earlier of the end of the option period
or termination of employment.
On December 13, 1996, the Company granted options to purchase 1,000,000
shares of the Company's common stock to key management employees which were
fully vested on the date of grant. The option price was set at $1.31 per
share, the fair value of the underlying shares. The options are not included
in the stock option plans below.
In addition, the Company has also issued options in connection with the
acquisition of No. 1 as discussed in Note 1.
Activity for the 1986 Plans, 1988 Plan, 1993 Plan, and 1994 Plan is as
follows:
<TABLE>
<CAPTION>
GRANTED
PRICE
SHARES PER SHARE
--------- ----------
<S> <C> <C>
Outstanding, June 30, 1994............................... 1,220,000 $ 0.10
Granted................................................ 1,075,000 $ 0.10
Exercised.............................................. (304,280) $ 0.10
Canceled............................................... (25,720) $ 0.10
---------
Outstanding, June 30, 1995............................... 1,965,000 $ 0.10
Granted................................................ 1,052,000 $0.15-1.18
Exercised.............................................. (44,500) $ 0.10
Canceled............................................... (225,000) $ 0.10
---------
Outstanding, June 30, 1996............................... 2,747,500 $0.10-1.18
Granted................................................ 248,000 $1.18-2.12
Exercised.............................................. (335,000) $0.10-0.90
Canceled............................................... (150,000) $ 0.10
---------
Outstanding, June 30, 1997............................... 2,510,500 $0.10-2.12
Granted (unaudited).................................... 90,000 $ 1.56
Exercised (unaudited).................................. -- $ --
Canceled (unaudited)................................... (18,750) $ 0.70
---------
Outstanding, September 30, 1997 (unaudited).............. 2,581,750 $0.10-2.12
========= ==========
</TABLE>
F-17
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At June 30, 1997 and September 30, 1997, 1,563,500 and 1,574,125 (unaudited)
options, respectively, were exercisable.
The Company has adopted only the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." It applies Accounting Principles
Bulletin ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related Interpretations in accounting for its plans and does not recognize
compensation expense for its stock-based compensation plans other than for
restricted stock and options issued to outside third parties. If the Company
had elected to recognize compensation expense based upon the fair value at the
grant date for awards under these plans consistent with the methodology
prescribed by SFAS 123, the Company's net loss and loss per share would be
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Net loss
As reported...................................... $(2,824,000) $(1,467,000)
Pro forma........................................ $(3,925,000) $(1,513,000)
Loss per common share
As reported...................................... $ (0.23) $ (0.14)
Pro forma........................................ $ (0.32) $ (0.15)
</TABLE>
Included in the year ended June 30, 1997, is the effect of the
aforementioned 1,000,000 options issued to key employees on December 13, 1996
to purchase the Company's common stock which were fully vested on the date of
grant. Compensation expense under SFAS 123 for the year ended June 30, 1997 of
$945,000 was charged to pro forma net loss for the entire estimated fair
market value of the 1,000,000 options awarded.
These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expense related to
grants made before June 30, 1996. The pro forma amounts take into account the
pro forma compensation expense of the FTEL and FNet options. The fair value of
the FTEL options described above was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for the years ended June 30, 1997 and 1996: dividend yields of 0%
and 0%, respectively; expected volatility of 100% and 100%, respectively;
risk-free interest rates of 6.2% and 6.3%, respectively; and expected lives of
4 and 2 to 4 years, respectively. The weighted-average fair value of options
granted during the year ended June 30, 1997 was $0.99, and the weighted-
average exercise price was $1.37.
The fair value of the FNet options described below was estimated at the date
of grant using the minimum value method with the following weighted-average
assumptions for the year ended June 30, 1997: dividend yields of 0%; risk-free
interest rate of 6.2%; and expected life of 4 years. The weighted-average fair
value of options granted during the year ended June 30, 1997 was $0.22 and the
weighted-average exercise price was $1.00.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
F-18
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company's majority-owned subsidiary, FNet, established a 1996 stock
option plan (the "FNet Plan"). The FNet Plan provides for the granting of
options to purchase up to 3,000,000 shares of FNet common stock that are
intended to qualify as incentive stock options within the meaning of Section
422A of the Internal Revenue Code. Such options will become exercisable in
accordance with the terms established by FNet's stock option committee. All
options granted to date vest between zero and four years and generally
terminate at the earlier of the end of the option period or termination of
employment. During the years ended June 30, 1997 and 1996 and for the three
months ended September 30, 1997, FNet granted 2,106,000, 448,000 and 110,000
(unaudited), respectively, options to employees to acquire FNet common stock
at an exercise price of $1.00, $1.00, and $1.00 (unaudited), respectively.
Total FNet options outstanding and exercisable at June 30, 1997 and 1996 and
for the three months ended September 30, 1997 were 2,634,000 and 1,174,000,
respectively, 448,000 and 0, respectively, and 2,744,000 (unaudited) and
1,174,000 (unaudited), respectively.
During 1995 and 1996, the Company granted to its president an option to
acquire 1,000,000 and 350,000 shares, respectively, of its common stock at an
exercise price of $.10 and $.78 per share. The options were both issued in the
year of grant and are exercisable over a two-year period.
On February 12, 1993, the Company entered into an option agreement with its
president whereby the Company granted options to purchase 2,000,000 shares of
the Company's common stock in exchange for the potential cancellation of debt
owed to the related party. Such options were exercisable over a two year
period at an exercise price of $.067 per share, the approximate fair value of
the common stock of the Company at the date of grant. These options were
exercised during the year ended June 30, 1995.
Warrants
In May 1995, in connection with the 1995 Private Placement, the Company
entered into an investment banking agreement with an unrelated entity whereby
the Company granted to the investment banker warrants to purchase 600,000
shares, as amended, of the Company's common stock at an exercise price of
$1.35 per share. The warrants vested over a twelve-month period and include
demand and piggy back registration rights after a period of 24 months from the
date of the agreement. The warrants and/or underlying shares may be exercised
anytime after two years and for a period of four years from the date of the
agreement. As of June 30, 1997 and 1996, none of these warrants had been
exercised.
In connection with the 1995 Private Placement, during the years ended June
30, 1996 and 1995, the Company issued 1,780,000 and 220,000 warrants,
respectively, to purchase shares of the Company's common stock. The exercise
price of the warrants was $0.50, as amended, if exercised on or before March
24, 1996 and $1.25 if exercised after March 24, 1996 but on or before
September 30, 1998 (the expiration date). There was no additional expense
recorded in connection with the issuance of the warrants as the exercise price
approximated the fair value at the date of issuance, as determined by
management of the Company, of the underlying stock at the date of issuance.
For the years ended June 30, 1997 and 1996, 400,000 and 145,000 warrants were
exercised leaving a remaining balance of 1,455,000 unexercised as of June 30,
1997.
Stock Issuances
During the year ended June 30, 1995, The Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 2,000,000 shares of its common stock for the exercise of options
and canceled notes payable in the amount of $92,000 and accrued interest
in the amount of $42,000.
. Issued 259,280 shares of its common stock in connection with stock
options exercised at $.10 per share by employees for compensation of
$26,000.
F-19
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
. Issued 22,000 shares of its common stock to an employee for a bonus. The
stock was issued at $.10 per share in accordance with the bonus
agreement.
. Issued 220,000 shares of its common stock for $110,000 in connection with
the 1995 Private Placement. The Company paid no commissions or fees in
connection with this private placement.
. Issued 45,000 shares of its common stock in connection with stock
options, exercised at $.10 per share for cash of $4,500.
. Issued 326,497 shares of its common stock in connection with a business
acquisition.
During the year ended June 30, 1996, the Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 1,780,000 of its common stock for $890,000 in connection with the
1995 Private Placement. The Company paid no commissions or fees in
connection with this private placement.
. Issued or committed to issue 110,000 shares of its common stock valued at
$75,000 during fiscal 1996 in connection with two business acquisitions
(see Note 1).
. Issued 34,839 shares of its common stock to certain employees for
compensation. The stock was issued at prices ranging from $.25 to $.70
per share in accordance with the respective agreements.
. Issued 7,555 shares of its common stock to certain vendors as payment on
accounts payable of approximately $11,000.
. Issued 44,500 shares of its common stock in connection with stock
options, exercised at $.10 per share for cash of $4,000.
. In March and April 1996, the Company received cash of $73,000 and issued
145,000 shares of its common stock upon the conversion of warrants issued
in connection with the 1995 Private Placement.
. In June 1996, the Company issued 28,572 shares of its common stock for
cash of $20,000, the approximate fair value at the date of the issuance.
. Reflected in the accompanying 1996 consolidated statements of capital
deficiency the addition of 23,031 shares as outstanding to correct the
omission of such shares in previously issued consolidated financial
statements.
During the year ended June 30, 1997, the Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 880,200 shares of its common stock in connection with the 1996
Private Placement for cash of $888,000. The Company paid no commissions
or fees in connection with this private placement.
. In December 1996 and July 1997, the Company issued an additional 60,987
and 207,066 shares, respectively, of its common stock to former
shareholders of LPL (see Note 1) at a value of $85,000 and $453,000,
respectively.
. In connection with the acquisition of No. 1, issued 40,000 shares, valued
at $50,000, of its common stock and options to purchase 10,000 shares,
valued at $6,000, of the Company's common stock at $1.25, which was the
fair market value on December 2, 1996, exercisable on January 1, 1998. In
connection therewith, FNet issued 20,000 shares of its common stock
valued at $20,000 and granted options to purchase 80,000 shares of FNet
common stock valued at $13,000, exercisable at the rate of 20,000 shares
per year at $1.00 per share in each of the four years beginning January
1, 1998 (see Note 1).
F-20
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
. In connection with the acquisition of CPR, committed to issued 25,000
shares of common stock for a value of $65,000 (see Notes 1 and 12) and
assumed certain debt of $4,425.
. In connection with the acquisition of Passport, issued 600,000 shares of
common stock for a value of $1,275,000 and assumed certain liabilities of
$411,000. Also, on March 24, 1997, the Company issued an additional 7,900
shares of common stock, valued at $14,000, to satisfy certain obligations
of Passport (see Note 1).
. Issued 380,000 shares in connection with the exercise of warrants for
$190,000.
. Issued 335,000 shares in connection with the exercise of stock options.
243,250 shares were issued upon the exercise of options whereby the
option holders issued notes receivable in favor of the Company in the
amount of 129,000. 30,000 shares were issued upon the exercise of options
whereby the option holder performed services valued at $3,000. The
remaining 61,750 were issued for cash of $6,000.
See Note 14 for stock issuances for the three months ended September 30,
1997.
Pursuant to state laws, the Company is currently restricted, and may be
restricted for the foreseeable future, from making dividends to its
shareholders as a result of its accumulated deficit as of June 30, 1997.
NOTE 6--INCOME TAXES
The tax effects of temporary differences that give rise to deferred taxes at
June 30, 1996 are as follows:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, ---------------------
1997 1997 1996
------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets
Accounts receivable, principally due
to allowance for doubtful accounts.. $ 8,000 $ 13,000 $ 3,000
Compensated absences and deferred
salaries, principally due to accrual
for financial reporting purposes.... 125,000 87,000 112,000
Inventories, principally due to
additional costs inventoried for tax
purposes pursuant to the Tax Reform
Act of 1986 and allowance for
inventory obsolescence.............. 128,000 128,000 191,000
General business tax credit
carryforwards....................... 345,000 335,000 345,000
Net operating loss carryforwards..... 3,363,000 3,027,000 2,498,000
---------- ---------- ----------
Total gross deferred tax assets...... 3,836,000 3,590,000 3,149,000
Less valuation allowance............. 3,832,000 3,586,000 3,145,000
---------- ---------- ----------
Net deferred tax assets.............. 4,000 4,000 4,000
Deferred tax liabilities
Plant and equipment, principally due
to differences in depreciation...... $ 4,000 $ 4,000 $ 4,000
---------- ---------- ----------
Net deferred tax liability......... $ -- $ -- $ --
========== ========== ==========
</TABLE>
The valuation allowance increased by approximately $441,000, $626,000, and
$246,000 (unaudited) during the years ended June 30, 1997 and 1996 and the
three months ended September 30, 1997, respectively. No provision for income
taxes for the years ended June 30, 1997, 1996, and 1995 and the three months
ended September 30, 1997 and 1996 is required, except for minimum state taxes,
since the Company incurred losses during such periods.
F-21
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Income tax expense was $2,000 and differs from the amounts computed by
applying the U.S. federal income tax rate of 34 percent to loss before
minority interest and income taxes as a result of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
----------------------- --------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- --------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Computed "expected" tax
benefit................ $(326,000) $(131,000) $(1,450,000) $(520,000) $(54,000)
Increase in income taxes
resulting from
Change in the
beginning-of-the-year
balance of the
valuation allowance
for deferred tax
assets allocated to
income tax expense... 326,000 131,000 1,450,000 520,000 54,000
State income taxes.... 2,000 2,000 2,000
--------- --------- ----------- --------- --------
Total............... $ -- $ -- $ 2,000 $ 2,000 $ 2,000
========= ========= =========== ========= ========
</TABLE>
As of June 30, 1997 the Company had consolidated net operating loss
carryforwards of approximately $8,467,000 and $2,401,000 for Federal and state
income tax reporting purposes, respectively, which expire in varying amounts
through 2012. The Company also has general business tax credit carryforwards
of approximately $310,000 and $24,000 available to offset against future
Federal and state income taxes, respectively, which expire at various times
through 2012. Should a substantial change in the Company's ownership occur,
there could be an annual limitation on the amount of the net operating less
carryforwards available for use in the future.
NOTE 7--RELATED PARTY TRANSACTIONS
The Company recorded sales of approximately $82,000, $3,000, $131,000, $0
(unaudited), and $10,000 (unaudited) to an entity affiliated with a
shareholder of the Company during the years ended June 30, 1997, 1996, and
1995 and for the three months ended September 30, 1997 and 1996, respectively.
On January 1, 1993, the Company entered into a five year employment
agreement with the president and majority shareholder which provides for
annual salary increases of six percent per annum. Compensation related to this
agreement, a portion of which is paid semi-monthly and a portion of which is
deferred and is therefore included in accrued salaries and related expenses in
the accompanying consolidated balance sheets, was $173,000, $275,000,
$259,000, and $76,000 (unaudited) for the years ended June 30, 1997, 1996, and
1995 and the three months ended September 30, 1997, respectively (see Note
12).
During the year ended June 30, 1997 and 1995, the Company issued notes
payable to the president and majority shareholder for $329,000 and $217,000,
respectively, of accrued compensation.
NOTE 8--COMMITMENTS AND CONTINGENCIES
Operating Leases and Capital Lease Obligations
The Company leases its production, warehouse and administrative facilities
under non-cancelable operating leases that expire starting September 1998
through March 2000. In addition to the minimum annual rental commitments, the
lease provides for periodic cost of living increases in the base rent and
payment by the Company of common area costs. Rent expense related to the
operating lease was $88,000, $51,000, $59,000, $25,000 (unaudited) and $13,400
(unaudited) for the years ended June 30, 1997, 1996, and 1995, and the three
months ended September 30, 1997 and 1996, respectively.
F-22
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In connection with the acquisition of Passport (see Note 1), the Company
assumed six capital leases that were assumed by Passport from two entities
owned by the previous sole member of Passport. All six capital leases are
technically in default because of provisions in the leases that prohibit the
assignment of the leases. In addition, the assets underlying four of the six
leases were sold by Passport for cash, which was not used to repay the
principal, prior to its acquisition by the Company. Such sales are also
prohibited under the terms of the leases and the lessors have not been
informed of such sales. The lessors technically have the right to accelerate
payment under all of the leases due to such defaults. Passport is continuing
to make the lease payments on all six leases pursuant to the lease terms.
Since the leases are in technical default, the Company has classified the full
lease liability as current.
Future minimum lease payments under non-cancelable operating and capital
leases with initial or remaining terms of one year or more at June 30, 1997
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING CAPITAL
JUNE 30, LEASES LEASES
----------- --------- --------
<S> <C> <C>
1998................................................ $122,000 $361,000
1999................................................ 35,000 --
2000................................................ 15,000 --
-------- --------
$172,000 $361,000
======== ========
</TABLE>
At June 30, leased capital assets included in property and equipment
consisted of the following:
<TABLE>
<S> <C>
Furniture and equipment......................................... $222,000
Less accumulated depreciation................................... 35,000
--------
Total......................................................... $187,000
========
</TABLE>
The Company assumed capital lease arrangements totaling $316,000 in 1997.
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 a material adverse effect on the Company's
consolidated financial position or results of operations.
Dealer Agreement
In March 1996, FNet entered into a dealer agreement with an individual (the
"Dealer") whereby the Dealer would be granted the exclusive right by FNet to
market, sell or otherwise offer certain services and goods to customers within
the Dealer's territory, as defined. In connection with this agreement, the
Dealer paid $45,000 to FNet as consideration for the rights described above.
The Dealer was to receive commissions at rates ranging from 10% to 30% based
on certain terms and conditions. Commissions paid to the Dealer during fiscal
1996 were not material.
In September 1996, FNet and the Dealer entered into a mutual general release
whereby both parties were released from all claims pursuant to the agreement.
In connection therewith, the Company converted $20,000 of the monies paid by
the Dealer to FNet, as noted above, to 23,350 shares of the Company's common
stock as consideration for the mutual general release. Such shares are
considered to be committed as of June 30, 1996 and are therefore included as
such in the accompanying consolidated balance sheet.
F-23
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
LICENSE AGREEMENTS
Satellite Services
In March 1997, the Company's subsidiary, Internet Passport, entered into a
Memorandum of Understanding with DigitalXPress LLC ("DigitalXPress"), a
purveyor of video and data network satellite services. Under the terms of the
agreement, Internet Passport and DigitalXPress will jointly develop a product
line, to be called "XPressNet," to furnish Internet connectivity to the
products currently marketed by DigitalXPress, and to combine marketing efforts
for certain customers, applications and products.
In May 1997, the Company's subsidiary, FNet, entered into a licensing and
joint development agreement with Peak Technologies, Inc. ("Peak"), by which
Peak granted FNet a license to use Peak's Java-based PeakJet Internet browser
accelerator in FNet's Internet service. In addition, FNet is to provide a
customized version of the PeakJet technology as a component in the Franklin
XPress satellite product line offered in conjunction with DigitalXPress. Under
the agreement, FNet is to issue 50,000 shares of its Common Stock to Peak.
800 Service Agreement
In December 1996, the Company entered into two agreements with an 800 number
supplier (the "Supplier") to service the FNet customer base, both internally
and for resale. The agreements provide the Company exclusive rights to 800
service in exchange for an incremental fee of $5,000 per month for each group
of 4,000 customers. The monthly fee has a minimum payment of $25,000 or up to
20,000 customers. The agreements call for the Company to issue the Supplier
50,000 shares of the Company's stock, options to purchase 100,000 shares of
FNet stock at $1.00 per share, and options to purchase 100,000 shares of
Franklin 800 Corp., a new wholly owned subsidiary of FNet, at $1.00 per share.
In management's opinion, the Supplier has failed to date to perform pursuant
to the agreement. Accordingly, the Company has withheld issuance of the
aforementioned shares and options.
Private Placement Exemptions
The Company's and FNet's private placements of securities have been issued
in transactions intended to be exempt from registration under the Securities
Act of 1933 pursuant to the provisions of Regulation D promulgated thereunder.
These rules include factors pursuant to which one or more private placement
transactions may be integrated as part of other offerings and include rules
that limit the dollar amount that can be raised and the number of non-
accredited investors that can participate. In the event any of the Company's
private placement transactions, including private placement transactions
undertaken by the Company since the transactions referred to above, were
deemed to be integrated, it is possible that the exemption from the
registration requirements of the Securities Act of 1933 would not be available
for one or more of those offerings. In the event that one or more of such
transactions are determined not to have been exempt from such registration
requirements, the purchasers may have the right to seek recission of the sales
and/or seek money damages against the Company. Management believes that each
of the Company's private offerings were exempt from the registration
requirements of the Securities Act of 1933.
NOTE 9--OTHER LIABILITIES
On February 5, 1993, the Company modified the terms of a note payable to a
former supplier with a balance of $572,000 that required the payment of
$30,000 in cash and an agreement to pay the former supplier $10 per Franklin
manufactured board up to a total of $700,000. There is no expiration date on
the revised agreement. On November 29, 1994, the agreement was further
modified. The modified terms are $10 per Franklin board sold for $300 and $2
per board sold for $300 or less. The modified agreement was effective through
June 1995 and
F-24
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
no new modification has been entered into. At June 30, 1997, the Company
estimated its future obligation to this supplier to be $183,000 under the
modified agreement based on the number of boards expected to be sold.
Accordingly, this obligation has been reduced to $183,000, the amount expected
to be paid in the future. Amounts paid under these agreements totaled
approximately $10,000, $5,000, $16,000, $0 (unaudited), and $1,000 (unaudited)
during the years ended June 30, 1997, 1996, and 1995 and the three months
ended September 30, 1997 and 1996, respectively.
NOTE 10--401(K) PLAN
The Company sponsors a 401(k) plan which includes a deferred feature under
section 401(k) of the Internal Revenue Code (the "Plan"). The Plan covers all
full-time employees of the Company. Contributions to the plan are at the
discretion of the Company's Board of Directors, but limited to the amounts
allowable for federal income tax purposes. Under the section 401(k) portion of
the Plan, employees may elect to contribute up to 20% of their compensation.
The Company did not make any contributions to the Plan during the years ended
June 30, 1997, 1996, or 1995 or the three months ended September 30, 1997 and
1996.
NOTE 11--LINES OF BUSINESS
The Company operates in two major lines of business: the manufacture and
distribution of data communications and connectivity products ("Franklin") and
Internet services ("FNet"). Information concerning operations in these lines
of business is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales
Franklin.............. $ 76,000 $ 158,000 $ 1,337,000 $ 397,000
FNet.................. $ 168,000 $ 51,000 $ 398,000 33,000
---------- ---------- ----------- -----------
Total............... $ 244,000 $ 209,000 $ 1,735,000 $ 430,000
========== ========== =========== ===========
Operating losses
Franklin.............. $ (692,000) $ (303,000) $(1,867,000) $(1,318,000)
FNet.................. (268,000) $ (74,000) (957,000) (149,000)
---------- ---------- ----------- -----------
Total............... $ (960,000) $ (377,000) $(2,824,000) $(1,467,000)
========== ========== =========== ===========
Identifiable assets
Franklin.............. $2,035,000 $1,195,000 $ 3,163,000 $ 575,000
FNet.................. 952,000 338,000 351,000 137,000
---------- ---------- ----------- -----------
Total............... 2,987,000 $1,533,000 $ 3,514,000 $ 712,000
========== ========== =========== ===========
Capital expenditures
Franklin.............. $ 7,000 $ 1,000 $ 204,000 $ 25,000
FNet.................. 13,000 21,000 120,000 33,000
---------- ---------- ----------- -----------
Total............... $ 20,000 $ 22,000 $ 324,000 $ 58,000
========== ========== =========== ===========
Depreciation and
amortization
Franklin.............. $ 42,000 $ 10,000 $ 52,000 $ 42,000
FNet.................. 24,000 2,000 58,000 3,000
---------- ---------- ----------- -----------
Total............... $ 66,000 $ 12,000 $ 110,000 $ 45,000
========== ========== =========== ===========
</TABLE>
Segment information is not shown for any other periods because the Internet
business was not material to the operations of the Company.
F-25
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Pro Forma Information (Unaudited)
The Company acquired Internet Passport, LLC ("Passport") on February 28,
1997. All other business acquisitions have been de minimis; therefore, the
Passport pro forma information has been reflected herein on a disaggregated
basis. The assets acquired and liabilities assumed are included in the
consolidated balance sheet of the Company as of June 30, 1997 included
elsewhere herein; therefore, no pro forma consolidated balance sheet has been
reflected below. The historical consolidated statements of operations for the
year ended June 30, 1996 are included elsewhere in this Prospectus. In the
opinion of management, there are no pro forma adjustments necessary to the
aforementioned historical statements of operations, assuming that the
acquisition occurred at the beginning of each of those years, expect for
showing the effects of the addition of the goodwill and subsequent write-off.
Because of the one-time unusual nature of the goodwill write-off, management
believes that the pro forma statement of operations information is better
reflected exclusive of such write-off as follows:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Historical net loss............................... $(2,824,000) $(1,467,000)
Add goodwill write-down related to Passport....... 835,000 --
----------- -----------
Adjusted historical net loss...................... (1,989,000) (1,467,000)
Add Passport losses prior to acquisition.......... (171,000) (66,000)
----------- -----------
Pro forma net loss exclusive of goodwill........ $(2,160,000) $(1,533,000)
=========== ===========
Adjusted historical net loss per share exclusive
of goodwill write-down........................... $ (.16) $ (.14)
Impact of Passport loss........................... (.01) (.01)
----------- -----------
Pro forma net loss per share exclusive of
goodwill....................................... $ (.17) $ (.15)
=========== ===========
</TABLE>
NOTE 12--SUBSEQUENT EVENTS (UNAUDITED)
The Company's President is employed pursuant to an Employment Agreement
expiring on December 31, 1997. The Employment Agreement provides for monthly
compensation at the rate of $20,000, with annual increases of 6%. The
Company's Board of Directors has approved a new six year Employment Agreement
for the Company's President, effective January 1, 1998. The new Employment
Agreement provides for compensation at the rate of $27,000 per month, with
annual increases of 6%.
During the three months ended September 30, 1997, FNet sold 51,000
(unaudited) shares of its stock to outside investors at $1.00 per share. The
shares sold to investors were issued under a private offering circular
pursuant to the exemption from registration under the 1933 Act provided in
Rule 505 of Regulation D. After the issuance of these shares, Franklin's
ownership percentage decreased to 67% (unaudited) as of September 30, 1997.
In October 1997, the Company's President exercised stock options for
1,333,695 shares of common stock at $0.10 per share.
In November 1997, an employee of the Company exercised stock options for
50,000 and 100,000 shares of common stock at $0.69 and $1.31 per share,
respectively.
F-26
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 13--FOURTH QUARTER ADJUSTMENTS
In the fourth quarter of fiscal 1996, the Company recorded certain fourth
quarter adjustments that, in the aggregate, increased the Company's net loss
by approximately $777,000. The adjustments principally consisted of reductions
of inventory and increases in accrued expenses.
NOTE 14--RECENT SALE OF EQUITY SECURITIES
During September and October 1997, the Company completed two Regulation D
private placement offerings as follows:
. An offering of 333,333 units for $1,000,000. Each unit consists of one
share of the Company's common stock and one common stock warrant to
purchase one share of the Company's common stock for $5.00 per share. The
net proceeds to the Company were $1,000,000, and
. An offering of 540 units for $5,400,000. Each unit in this offering
consists of one share of the Company's Series C Convertible Preferred
Stock and one warrant to purchase one share of FNet's common stock. The
net proceeds to the Company were $4,957,500.
(Unaudited) In November 1997, the Company issued an additional 200 units for
$2,000,000. Each unit in this offering consists of one share of the Company's
Series C Convertible Preferred Stock and one Warrant to purchase one share of
FNet's common stock. The net proceeds to the Company were $1,850,000.
F-27
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Internet Passport, LLC
We have audited the accompanying balance sheet of Internet Passport, LLC
(the "Company") as of June 30, 1996, and the related statements of operations,
member's deficit and cash flows for the period from February 16, 1996 (date
operations commenced) to June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Internet Passport, LLC as
of June 30, 1996, and the results of its operations and its cash flows for the
period from February 16, 1996 (date operations commenced) to June 30, 1996 in
conformity with generally accepted accounting principles.
As more fully discussed in Note 1 to the accompanying financial statements,
as of February 28, 1997, the Company was sold and has ceased operations as a
stand-alone entity as of such date.
CORBIN & WERTZ
Irvine, California
June 6, 1997
F-28
<PAGE>
INTERNET PASSPORT, LLC
BALANCE SHEET
JUNE 30, 1996
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash................................................................ $ 12,400
Loan receivable--employee........................................... 5,300
Loan receivable from related party.................................. 1,600
--------
Total current assets.............................................. 19,300
Property:
Machinery and equipment............................................. 19,100
Furniture and fixtures.............................................. 400
--------
19,500
Less accumulated depreciation....................................... (300)
--------
Property, net..................................................... 19,200
Other assets.......................................................... 5,100
--------
Total assets...................................................... $ 43,600
========
LIABILITIES AND MEMBER'S DEFICIT
Current liabilities:
Accounts payable.................................................... $ 1,300
Capital lease payable............................................... 73,500
--------
Total current liabilities......................................... 74,800
--------
Member's deficit:
Member's equity..................................................... 35,100
Accumulated deficit................................................. (66,300)
--------
Total member's deficit............................................ (31,200)
--------
Total liabilities and member's deficit............................ $ 43,600
========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-29
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
EIGHT-MONTH
PERIOD ENDED PERIOD ENDED
FEBRUARY 28, JUNE 30,
1997 1996
------------ ------------
(UNAUDITED)
<S> <C> <C>
Consulting revenues................................... $ 16,800 $ 9,000
Selling, general and administrative expenses.......... (117,500) (49,700)
--------- --------
Loss from operations.............................. (100,700) (40,700)
--------- --------
Other income (expense):
Provision for lease liability....................... (55,000) (26,000)
Interest expense.................................... (15,100) (2,200)
Loss on sale of assets.............................. -- (1,200)
Rental income....................................... -- 3,800
--------- --------
Total other income (expense)...................... (70,100) (25,600)
--------- --------
Net loss.............................................. $(170,800) $(66,300)
========= ========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-30
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF MEMBER'S DEFICIT
<TABLE>
<CAPTION>
TOTAL
MEMBER'S ACCUMULATED MEMBER'S
EQUITY DEFICIT DEFICIT
-------- ----------- ---------
<S> <C> <C> <C>
Member contribution at inception............... $10,100 $ -- $ 10,100
Contributed services........................... 25,000 -- 25,000
Net loss for period ended June 30, 1996........ -- (66,300) (66,300)
------- --------- ---------
Balance at June 30, 1996....................... 35,100 (66,300) (31,200)
Contributed services (unaudited)............... 40,000 -- 40,000
Net loss for eight months ended February 28,
1997 (unaudited).............................. -- (170,800) (170,800)
------- --------- ---------
Balance at February 28, 1997 (unaudited)....... $75,100 $(237,100) $(162,000)
======= ========= =========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-31
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
EIGHT-MONTH
PERIOD ENDED PERIOD ENDED
FEBRUARY 28, JUNE 30,
1997 1996
------------ ------------
(UNAUDITED)
<S> <C> <C>
Cash flow from operating activities:
Net loss........................................... $(170,800) $(66,300)
Adjustment to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization.................... 1,600 300
Loss on sale of machinery and equipment.......... -- 1,200
Contributed services............................. 40,000 25,000
Provision for lease liability.................... 55,000 26,000
Change in operating assets and liabilities:
Accounts receivable............................ (300) --
Other assets................................... 100 (5,100)
Deferred revenue............................... 5,300 --
Accounts payable............................... 8,400 1,300
--------- --------
Net cash used in operating activities.............. (60,700) (17,600)
--------- --------
Cash flow from investing activities:
Loan receivable--employee.......................... (8,500) (5,300)
Loan receivable--related party..................... (5,200) (1,600)
Purchase of equipment.............................. (9,800) (400)
Proceeds from sale of leased equipment............. 59,800 31,000
Proceeds from sale of equipment.................... -- 2,000
--------- --------
Net cash provided by investing activities.......... 36,300 25,700
--------- --------
Cash flow from financing activities:
Principal payments on lease obligations............ (14,700) (2,600)
Debt proceeds...................................... 38,000 --
Cash provided from equity investment............... -- 6,900
--------- --------
Net cash provided by financing activities.......... 23,300 4,300
--------- --------
Net change in cash................................... (1,100) 12,400
Cash at beginning of period.......................... 12,400 --
--------- --------
Cash at end of period................................ $ 11,300 $ 12,400
========= ========
Supplemental disclosure of cash flow information--
Cash paid during the period for:
Interest......................................... $ 15,100 $ 2,200
========= ========
Income taxes..................................... $ -- $ --
========= ========
</TABLE>
Supplemental disclosure of non-cash investing activities--
During the period ended June 30, 1996, property in the amount of $3,200 was
acquired as part of the initial contributed capital. Such property was sold
during the period ended June 30, 1996 for a loss of $1,200. For the periods
ended February 28, 1997 and June 30, 1996, equipment in the amount of
$262,300 (unaudited) and $50,100, respectively, was acquired through
capital lease transactions.
See independent auditors' report and accompanying notes to financial statements
F-32
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM FEBRUARY 16, 1996 (DATE OPERATIONS
COMMENCED) TO JUNE 30, 1996
NOTE 1--GENERAL AND BASIS OF PRESENTATION
General
Internet Passport, LLC (the "Company") was formed on February 16, 1996 as a
Georgia limited liability company. The Company operated as a start-up internet
access provider of custom internet services and related products.
Basis of Presentation
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles on a going concern basis. The Company
was acquired by Franklin Telecommunications Corp. ("Franklin") on February 28,
1997 and has ceased operations as a stand-alone entity as of such date.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Risks and Uncertainties
The Company is a start-up company in its first year of operations. The
Company is subject to the substantial business risks and uncertainties
inherent in a start-up operation, including the potential risk of business
failure.
The Company does not maintain general business liability insurance. As a
result, the Company is exposed to potential loss resulting from uninsured
future loss of or damage to the Company's property, damage to the property of
others, injury to others and/or interruption of the Company's business.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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. Such estimates also affect the reported amounts of revenues and
expenses during the reported period. Actual results could materially differ
from those estimates.
Fair Value of Financial Instruments
The accompanying consolidated balance sheets include financial instruments
whereby the fair market value of the financial instruments could be different
than that recorded on a historical basis. The Company's financial instruments
consist of its cash, receivables from an employee and a related party and
accounts payable. The carrying amounts of the Company's financial instruments
generally approximate their fair values at June 30, 1996. The fair value of
the receivables from an employee and a related party are not readily
determinable as market comparables were not available for such instruments.
Property
Property is recorded at cost and depreciated on a straight-line basis over
the estimated useful lives of the related assets, principally five years.
Repairs and maintenance are charged to expense. Betterments are capitalized.
Depreciation expense for the periods ended February 28, 1997 and June 30, 1996
was $1,600 (unaudited) and $300, respectively.
Revenue Recognition
Revenues are recognized in the month of service.
F-33
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Advertising Costs
Advertising costs are expensed as incurred.
Income Taxes
The Company is taxed as a limited liability company under the provisions of
the Federal and state tax codes. Under Federal and state law, taxes based on
income of a limited liability company are payable by the member individually.
Accordingly, no provision for income taxes has been provided in the
accompanying financial statements.
NOTE 2--LOANS TO RELATED PARTIES
The loan receivable--employee of $5,300 at June 30, 1996 is non-interest
bearing and $2,800 (unaudited) of the balance was paid during the eight-month
period ended February 28, 1997.
As of June 30, 1996, the Company had a related party receivable totaling
$1,600 from the president and sole member. The loan is non-interest bearing
and has no due date.
During the eight-month period ended February 28, 1997, the Company advanced
approximately $7,000 to an affiliated company owned 100% by the sole member of
the Company. The advance is non-interest bearing and has no due date. During
the same period, the Company loaned an additional $10,000 to its president and
sole member. The loan is non-interest bearing and has no due date.
NOTE 4--CAPITAL LEASE OBLIGATIONS
The Company has assumed six capital leases since its inception from two
entities owned by the sole member of the Company. All six capital leases are
technically in default because of provisions in the leases that prohibit the
assignment of the leases. In addition, the assets underlying four of the six
leases were sold by the Company for cash. Such sales are also prohibited under
the terms of the leases and the lessors have not been informed of such sales.
The lessors technically have the right to accelerate payment under all of the
leases due to such defaults. The Company is continuing to make the lease
payments on all six leases pursuant to the lease terms. The Company recorded
additional provisions for lease liability for the eight-month period ended
February 28, 1997 and the period ended June 30, 1996 of $55,000 (unaudited)
and $26,000 to reflect the full, undiscounted, lease obligations as a result
of the defaults. In addition, the capital lease obligation at June 30, 1996
has been reflected as a current liability. A summary of the capital lease
activity follows:
<TABLE>
<CAPTION>
LEASE LEASED
OBLIGATION PROPERTY
---------- --------
<S> <C> <C>
Balance at inception.................................... $ -- $ --
Equipment acquired under capital leases................. 50,100 50,100
Lease principal payments................................ (2,600) --
Sale of property........................................ -- (31,000)
Provision for lease liability........................... 26,000 --
-------- --------
Balances at June 30, 1996............................. 73,500 19,100
Equipment acquired under capital leases (unaudited)..... 262,300 262,300
Lease principal payments (unaudited).................... (14,700) --
Sale of property (unaudited)............................ -- (59,800)
Provision for lease liability (unaudited)............... 55,000 --
-------- --------
Balances at February 28, 1997 (unaudited)............... $376,100 $221,600
======== ========
</TABLE>
F-34
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5--AMOUNTS BORROWED FROM FRANKLIN
During the eight-month period ended February 28, 1997, the Company was
advanced $38,000 (unaudited) from Franklin. Such advances were non-interest
bearing and due on demand.
NOTE 6--CONTRIBUTED SERVICES
The sole member has provided services to the Company during the periods
presented without cash compensation. The Company has recorded $40,000
(unaudited) and $25,000 during the periods ended February 28, 1997 and June
30, 1996 as a member's equity contribution for the estimated fair value of the
services provided.
F-35
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY ANY SECURITY OTHER THAN THE
SHARES OF THE COMMON STOCK OFFERED BY THIS PROSPECTUS, NOR DOES IT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE SHARES OF COMMON
STOCK BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT INFORMA-
TION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 5
Dividend Policy........................................................... 13
Use of Proceeds........................................................... 13
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 14
Selected Financial Data................................................... 18
Price Range of Common Stock............................................... 19
Business.................................................................. 20
Management................................................................ 29
Principal Shareholders.................................................... 33
Selling Shareholders...................................................... 34
Plan of Distribution...................................................... 36
Description of Capital Stock.............................................. 37
Legal Matters............................................................. 37
Experts................................................................... 37
Available Information..................................................... 38
Index to Financial Statements............................................. F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
5,103,750 SHARES
[LOGO APPEARS HERE]
FRANKLIN
TELECOMMUNICATIONS
CORP.
COMMON STOCK
----------------
PROSPECTUS
----------------
, 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses incurred or to be incurred by the Company in connection with
the preparation and filing of this Registration Statement are estimated to be
as follows:
<TABLE>
<S> <C>
Printing and duplication expenses................................. $20,000
Registration fee.................................................. 2,620
Legal fees and expenses........................................... 20,000
Accounting fees and expenses...................................... 25,000
Transfer Agent fees............................................... 2,000
Miscellaneous..................................................... 2,380
-------
Total........................................................... $72,000
=======
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's Bylaws provide that the Company may indemnify its officers and
directors, and may indemnify its employees and other agents, to the fullest
extent permitted by California law. Insofar as indemnification for liabilities
arising under the Securities Act of 1933 may be permitted to officers,
directors or persons controlling the Company pursuant to the foregoing
provisions, the Company has been informed that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following table sets forth a list of all unregistered securities issued
by the Company during the past three years. All securities were issued
pursuant to the exemptions provided for under Section 4(2) of the Securities
Act of 1933 and Regulation D and Rule 701 promulgated thereunder. The
securities were issued for cash, upon exercise of employee stock options and
in connection with certain acquisitions by the Company.
<TABLE>
<CAPTION>
SHARE
NAME DATE SHARES CONSIDERATION
---- -------- --------- -------------
<S> <C> <C> <C>
Triton Capital Investments, Ltd.*........... 10/31/97 35* $ 350,000
Banque Edouard Constant SA*................. 10/31/97 50* 500,000
Banque Franck S.A.*......................... 10/31/97 75* 750,000
Elara Ltd. *................................ 10/31/97 150* 1,500,000
Ellis AG*................................... 10/31/97 10* 100,000
JMG Capital Partners, L.P.*................. 10/31/97 35* 350,000
Lakeshore International, Ltd.*.............. 10/31/97 150* 1,500,000
JNC Opportunity Fund*....................... 11/25/97 200* 2,000,000
The Matthew Fund, N.V.*..................... 10/31/97 35* 350,000
Frank W. Peters............................. 10/7/97 1,333,695 133,370
E. Bryan Bagley............................. 10/15/97 40,000 50,000
Bruce Whaley................................ 10/15/97 13,000 16,250
Wilson-Davis Company........................ 10/15/97 30,000 37,500
Tom Russell................................. 11/3/97 150,000 165,500
Vic Klimpl.................................. 9/22/97 22,000 66,000
Blair Holder................................ 9/22/97 30,000 90,000
Raleigh Baughman............................ 9/22/97 30,000 90,000
Mark Jenkins................................ 9/22/97 11,000 33,000
Dale Berman................................. 9/22/97 10,000 30,000
Cindy Cannon................................ 9/22/97 15,000 45,000
</TABLE>
- --------
* Series C Preferred
II-1
<PAGE>
<TABLE>
<CAPTION>
SHARE
NAME DATE SHARES CONSIDERATION
---- --------- ------- -------------
<S> <C> <C> <C>
Clay & Bobbie Lasiter........................ 9/22/97 10,000 $ 30,000
Scott Holder................................. 9/22/97 10,000 30,000
Terry Widner................................. 9/22/97 33,333 99,999
Roberto Alvarez.............................. 9/22/97 20,000 60,000
Mike & Marcia Marino......................... 9/22/97 7,000 21,000
George Willse................................ 9/22/97 10,000 30,000
Frank Culker................................. 9/22/97 7,000 21,000
Gary Nelson.................................. 9/22/97 16,000 48,000
Gary Nelson IRA acct. ....................... 9/22/97 45,000 135,000
Doug Best.................................... 9/22/97 7,000 21,000
Martin Smith................................. 9/22/97 7,000 21,000
Bob Zimdar................................... 9/22/97 10,000 30,000
Anthony Chan................................. 9/23/97 9,000 27,000
Tim LaFrance................................. 9/23/97 7,000 21,000
Marvin Mansky................................ 9/24/97 10,000 30,000
Richard & Lorna Valentine.................... 9/24/97 7,000 21,000
John Costello................................ 7/31/97 207,066 453,475
Thomas Russell............................... 6/13/97 50,000 34,500
Eileen Rouse................................. 6/13/97 50,000 45,000
Alan London.................................. 6/13/97 25,000 17,500
Dianne Oliver................................ 6/13/97 2,000 200
Helen West................................... 6/17/97 12,000 10,800
Alice Amanet................................. 6/24/97 6,250 4,375
1996 Private Placement (28 Individuals) ..... 8/1/96 890,595 737,500
Len Bartz.................................... 6/30/96 23,350 20,000
Michael C. Peters............................ 3/1/96 380,000 190,000
Eileen Rouse................................. 3/1/96 10,000 5,000
Michael Parkhurst............................ 8/26/96 5,000 500
Patrick Klos................................. 10/1/96 15,000 1,500
Dianne Oliver................................ 10/8/96 8,000 800
Michael Klos................................. 10/10/96 5,000 500
Terry Lee.................................... 12/2/96 20,000 25,000
Steve Sullivan............................... 12/2/96 20,000 25,000
Millhollan/Ellis............................. 3/96-2/97 12,000 26,246
Charles & Barb Arledge....................... 12/4/96 5,808 8,131
Brew & Shirley Arms.......................... 12/4/96 5,808 8,131
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ------- ------- ------------- -----------
<S> <C> <C> <C> <C>
Andrew & Joan Chitiea.............. 12/4/96 5,808 $ 8,131
Daniel & Pat Derbes................ 12/4/96 11,617 16,264
Kenneth King....................... 12/4/96 2,905 4,067
Herman & D. Krantz................. 12/4/96 7,260 10,164
Dale & Monica Sheets............... 12/4/96 14,521 20,329
Robert & Erma Sheets............... 12/4/96 7,260 10,164
John Calderwood.................... 1/7/97 5,000 625
Frederick I. Camerer............... 3/96 5,000 2,500
Edward D. Bagley................... 2/5/97 59,608 190,000
Marcia Marino...................... 2/7/97 20,000 25,000
Peter Buswell...................... 2/25/97 30,000 3,000
Kristin Peters..................... 2/26/97 10,000 1,000
Sparrow Marcioni................... 1/28/97 600,000 3,150,000
Neil Wyenn......................... 2/26/97 25,000 131,250
M.H. Meyerson & Co., Inc. ......... 5/11/95 600,000
Wilson Davis....................... 10/1/95 30,000
Sam Wilson......................... 10/1/95 50,000
Paul Davis......................... 10/1/95 50,000
Lyle Davis......................... 10/1/95 60,000
Byron Barkley...................... 3/96 20,000 10,000
Byron Barkley...................... 10/1/95 20,000
Bryan B. Bagley PFT Sharing........ 3/1/96 20,000 10,000
Bryan B. Bagley.................... 3/1/96 20,000 10,000
Bollard Investment Co. ............ 10/1/95 40,000
Bruce Whaley....................... 10/1/95 40,000
Joe Fisher......................... 3/96 70,000 35,000
Joe Fisher......................... 10/1/95 40,000
Gary Nelson........................ 10/1/95 64,000
Gary Nelson Transcorp C/F.......... 10/1/95 11,000
Gary Conrad........................ 10/1/95 200,000
Ronald Heller...................... 10/1/95 303,000
David Nagelberg.................... 10/1/95 303,000
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ------- --------- ------------- -----------
<S> <C> <C> <C> <C>
Martin & Co...................... 10/1/95 146,000
Michael and Linda Silvestri...... 10/1/95 28,000
Jeffrey Barber................... 10/1/95 14,000
Joel Marcus...................... 10/1/95 12,000
Rocco Vezza...................... 10/1/95 12,000
Joanne Gioia..................... 10/1/95 12,000
Joseph Schmidt................... 10/1/95 10,000
Kevin Charos..................... 10/1/95 10,000
Frederick I. Camerer............. 5/11/94 30,000 $ 3,000
Michael C. Peters................ 5/12/94 30,000 3,000
Frederick I. Camerer............. 5/31/94 50,000 5,000
Mark Peters...................... 6/17/94 1,000 100
Kristen Peters................... Jan-95 10,000 1,000
John Costello.................... Jan-95 199,806 61,141
Herman & D. Krantz............... Jan-95 7,260 2,222
Dale & Monica Sheets............. Jan-95 14,521 4,443
Robert & Erma Sheets............. Jan-95 7,260 2,222
Colin Patterson.................. Jan-95 29,042 8,887
John Costello.................... Jan-95 7,260 2,222
Added Value...................... Jan-95 3,493 1,034
Robert & Erma Sheets............. Jan-95 1,529 453
Herman & D. Krantz............... Jan-95 1,529 453
Colin Patterson.................. Jan-95 6,087 1,802
Photo Vision..................... Jan-95 405 120
Added Value...................... Feb-95 389 121
Micropolus....................... Feb-95 489 153
Future Elect..................... Feb-95 2,043 637
Charles Arledge.................. Feb-95 1,159 362
Brew Arms........................ Feb-95 1,159 362
Andew Chitiea.................... Feb-95 1,160 362
Dan Derbes....................... Feb-95 2,319 724
Kenneth King..................... Feb-95 580 181
Frederick I. Camerer............. Apr-95 25,000 2,500
Kristen Peters................... Apr-95 10,000 1,000
UPS.............................. Apr-95 1,084 1,642
Frank Peters..................... Apr-95 2,000,000 134,000
Dale & Monica Sheets............. May-95 3,070 2,398
Michelle Nisbet.................. May-95 4,280 783
Frank Dragun..................... May-95 22,000 2,200
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ---------- --------- ------------- -----------
<S> <C> <C> <C> <C>
Charles & Barb Arledge....... May-95 5,808 $ 1,626
Brew & Shirley Arms.......... May-95 5,808 1,626
Andrew & Joan Chitiea........ May-95 5,808 1,626
Daniel & Pat Derbes.......... May-95 11,617 3,253
Kenneth King................. May-95 2,905 813
Michael C. Peters............ 6/30/95 255,000 25,500
Kristen Peters............... Jul-95 10,000 1,000
Frank Jones.................. Aug-95 5,000 500
Michael Parkhurst............ Aug-95 15,000 1,500
Wyle......................... Aug-95 7,555 10,388
Bill Woods................... Aug-95 4,000 2,800
Kristen Peters............... Aug-95 8,127 2,032
Frederick I. Camerer......... Sep-95 9,147 2,287
Michael Peters............... Sep-95 13,565 3,391
1995 Reg. D. Private
Placement................... 6/95-10/95 2,000,000 1,000,000
Richard Parkhurst............ Dec-95 25,000 9,835
Frederick I. Camerer......... Feb-96 12,500 1,250
Michael & Marcia Marino...... 6/30/96 28,572 20,000
</TABLE>
II-5
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES.
The following exhibits are filed with this Registration Statement:
<TABLE>
<C> <S>
3.1*** Restated Articles of Incorporation of Franklin Telecommunications
Corp.
3.2* Bylaws of Franklin Telecommunications Corp.
3.3 Certificate of Determination of Preferences of Series C Preferred
Stock.
5.1 Opinion of Haddan & Zepfel LLP.
10.1* Employment Agreement, dated March 1, 1993 between Franklin
Telecommunications Corp. and Frank W. Peters.
10.2* Confidential Agreement dated June 3, 1996 between Malibu Internet
Services and Franklin Telecommunications Corp.
10.3* Joint Venture Agreement dated May 23, 1996 between StarComm Products
Inc. and Franklin Telecommunications Corp.
10.4* Letter Agreement dated February 28, 1997 between Internet Passport
LLC and Franklin Telecommunications Corp.
10.5* Subscriber Agreement dated January 2, 1997 between LaserVend, Inc
and Franklin Telecommunications Corp.
10.6* Subscriber Agreement dated January 28, 1997 between A-Online
Information Services, Inc. and Franklin Telecommunications Corp.
10.7* Subscriber Agreement dated January 17, 1997 between WebTV Networks,
Inc. and Franklin Telecommunications Corp.
10.8* Letter Agreement dated February 26, 1997 between CPR Computer
Repair, Inc. and Franklin Telecommunications Corp.
10.9* Letter Agreement dated December 2, 1996 between Number 1 Internet
Services and Franklin Telecommunications Corp.
10.10* Warrant Agreement dated May 18, 1995 between M. H. Myerson & Co. and
Franklin Telecommunications Corp.
10.11* Form of Letter Agreement dated March 17, 1997 between M. H. Myerson
& Co. and Franklin Telecommunications Corp.
10.12** Form of Indemnity Agreement for all Directors of Franklin
Telecommunications Corp.
10.13** Memorandum of Understanding, dated March 13, 1997, between Internet
Passport and DigitalXPress LLC.
10.14** Agreement, dated May 16, 1997, between StarComm and Franklin
Telecommunications Corp.
10.15** Agreement, dated May 15, 1997, between Peak Technologies, Inc. and
Franklin Telecommunications Corp.
10.16 Form of Regulation D Subscription Agreement between Franklin
Telecommunications Corp. and certain purchasers of Series C
Preferred Stock.
10.17 Form of Series C Registration Rights Agreement between Franklin
Telecommunications Corp. and certain purchasers of Series C
Preferred Stock.
10.18 Form of Warrant issued to purchasers of Series C Preferred Stock.
16.1** Letter from Corbin & Wertz, Certified Public Accountants.
23.1 Consent of Corbin & Wertz, Certified Public Accountants.
23.2 Consent of Haddan & Zepfel LLP (included as part of Exhibit 5.1).
23.3 Consent of Singer, Lewak, Greenbaum & Goldstein LLP.
27.1 Financial Data Schedule
</TABLE>
II-6
<PAGE>
- --------
* Incorporated by reference from Registration Statement on Form S-1 (File No.
333-24791), filed on April 7, 1997
** Incorporated by reference from Amendment No. 1 to Registration Statement on
Form S-1 (File No. 333-24791), filed on October 1, 1997
*** Incorporated by reference from Amendment No. 2 to Registration Statement
on Form S-1 (File No. 333-24791), filed on November 7, 1997
ITEM 17. UNDERTAKINGS.
The undersigned Registrant undertakes as follows:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(4) Insofar as indemnification for liabilities arising under the
Securities Act of 1993 (the "Act") may be permitted to directors, officers
and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expense incurred
or paid by a director, officer or controlling person of the registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
II-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Westlake Village, State
of California, on December 9, 1997.
Franklin Telecommunications Corp.
By /s/ Frank W. Peters
___________________________________
Frank W. Peters
President
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Frank W. Peters his attorney-in-fact and agent,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any or all amendments to
this Registration Statement, and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming
all that said attorney-in-fact and agent, or his substitute or substitutes,
may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement was signed by the following persons in the capacities
and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
(1) Principal Executive Officer
/s/ Frank W. Peters President and a Director December 9, 1997
____________________________________
Frank W. Peters
(2) Principal Financial and Accounting Officer
/s/ Thomas Russell Chief Financial Officer and December 9, 1997
____________________________________ a Director
Thomas Russell
(3) Directors
/s/ Peter S. Buswell Director December 9, 1997
____________________________________
Peter S. Buswell
/s/ Robert S. Harp Director December 9, 1997
____________________________________
Robert S. Harp
</TABLE>
II-8
<PAGE>
EXHIBIT 3.3
CERTIFICATE OF DETERMINATION OF
SERIES C PREFERRED STOCK
OF
FRANKLIN TELECOMMUNICATIONS CORP.
Thomas Russell and Helen West hereby certify that:
1. They are the Vice President and Secretary, respectively, of Franklin
Telecommunications Corp., a California corporation (hereinafter called the
"Company").
2. The Restated Articles of Incorporation of the Company authorizes the
issuance of Ten million (10,000,000) shares of preferred stock, and expressly
vests in the Board of Directors of the Company the authority provided therein to
issue any or all of said shares in one (1) or more series and by resolution or
resolutions to establish the designation and number and to fix the relative
rights and preferences of each series to be issued.
3. The Board of Directors of the Company, pursuant to the authority
expressly vested in it as aforesaid, has adopted the following resolutions
creating a Series C issue of Preferred Stock:
RESOLVED, that Seven Hundred Forty (740) of the Ten (10) million
(10,000,000) authorized shares of Preferred Stock of the Company shall be
designated Series C Preferred Stock, and shall possess the rights and
preferences set forth below:
Section 1. Designation and Amount. The shares of such series shall be
----------------------
designated as Series C Preferred Stock (the "Series C Preferred Stock") and the
number of shares constituting the Series C Preferred Stock shall be Seven
Hundred Forty (740). The Series C Preferred Stock shall be offered at a purchase
price of Ten Thousand Dollars ($10,000) per share (the "Original Series C Issue
Price"), with an eight percent (8%) per annum accretion rate as set forth
herein.
Section 2. Rank. Subject to Section 8 below, the Series C Preferred Stock
----
shall rank: (i) prior to all of the Company's Common Stock ("Common Stock") and
all other classes of the Company's equity securities other than the Parity
Securities, as defined below; (ii) prior to any class or series of capital stock
of the Company hereafter created not specifically ranking by its terms on parity
with any Series C Preferred Stock of whatever subdivision (collectively, with
the Common Stock, "Junior Securities"); and (iii) on parity with the Series A
Preferred Stock and any class or series of capital stock of the Company
hereafter created specifically ranking by its terms on parity with the Series C
Preferred Stock ("Parity Securities") in each case as to distributions of assets
upon liquidation, dissolution or winding up of the Company, whether voluntary or
involuntary (all such distributions being referred to collectively as
"Distributions").
Section 3. Dividends. The Series C Preferred Stock will bear no
---------
dividends, and the holders of the Series C Preferred Stock ("Holders") shall not
be entitled to receive dividends on the Series C Preferred Stock.
Section 4. Liquidation Preference.
----------------------
<PAGE>
(a) In the event of any liquidation, dissolution or winding up of
the Company ("Liquidation Event"), either voluntary or involuntary, the then
Holders of shares of Series C Preferred Stock shall be entitled to receive ,
prior in preference to any distribution to Junior Securities but in parity with
any distribution to Parity Securities, an amount per share (the "Liquidation
Amount") equal to the sum of (i) the Original Series C Issue Price for each
outstanding share of Series C Preferred Stock and (ii) an amount equal to eight
percent (8%) of the Original Series C Issue Price, per annum, accruing daily,
for the period that has passed since the Closing Date (as defined in Section
5(a) below) for the purchase by Holder of such shares of Series C Preferred
Stock from the Company (such amount being referred to herein as the "Premium").
If upon the occurrence of such event, the assets and funds available to be
distributed among the Holders of the Series C Preferred Stock and Parity
Securities shall be insufficient to permit the payment to such Holders of the
full preferential amounts due to the Holders of the Series C Preferred Stock and
the Parity Securities, respectively, then the entire assets and funds of the
Company legally available for distribution shall be distributed among the
Holders of the Series C Preferred Stock and the Parity Securities, pro rata,
based on the respective liquidation amounts to which each such series of stock
is entitled by the Company's Articles of Incorporation and any certificate(s) of
determination relating thereto.
(b) Upon the completion of the distribution required by subsection
4(a), if assets remain in this Company, they shall be distributed to holders of
Junior Securities in accordance with the Company's Articles of Incorporation
including any duly adopted certificate(s) of determination.
(c) At each Holder's option, a sale, conveyance or disposition of
all or substantially all of the assets of the Company or the effectuation by the
Company of a transaction or series of related transactions in which more than
fifty percent (50%) of the voting power of the Company is disposed of shall be
deemed to be a Liquidation Event as defined in Section 4(a); provided further
that (i) a consolidation, merger, acquisition, or other business combination of
the Company with or into any other publicly traded company or companies shall
not be treated as a Liquidation Event as defined in Section 4(a) but instead
shall be treated pursuant to Section 5(d) hereof, and (ii) a consolidation,
merger, acquisition, or other business combination of the Company with or into
any other non-publicly traded company or companies where the surviving entity is
either a non-publicly traded company or an entity other than the Company, shall
be treated as a Liquidation Event as defined in Section 4(a) except that, with
respect to an event described in this subsection (ii), the Liquidation Amount
shall equal 120% of the sum of (x) the Original Series C Issue Price of the
Preferred Stock to be prepaid, plus (y) the accrued Premium. The Company shall
not consummate any transaction described in subsection 4(c)(ii) unless it first
gives thirty (30) days prior notice of such transaction (during which time the
Holder shall be entitled to immediately convert any or all of its shares of
Series C Preferred Stock into Common Stock at the Conversion Price, as defined
below, then in effect, which conversion shall not be subject to the conversion
restrictions set forth in Section 5(a); provided however, that, if such
conversion takes place prior to the end of the four (4) month holding period set
forth in Section 5(a), for purposes of calculating the Variable Conversion Price
(as defined in Section 5(a)), "X" shall equal eighty percent (80%)).
(d) In the event that, immediately prior to or concurrent with the
closing of a transaction described in Section 4(c) which would constitute a
Liquidation Event, the cash distributions required by Section 4(a) have not been
made, the Company shall either: (i) cause such closing to be postponed until
such cash distributions have been made, or (ii) cancel such transaction, in
which event the rights of the Holders of Series C Preferred Stock shall be the
same as existing immediately prior to such proposed transaction.
2
<PAGE>
Section 5. Conversion. Subject to Section 4(c) herein, the record Holders
----------
of this Series C Preferred Stock shall have conversion rights as follows (the
"Conversion Rights"):
(a) Right to Convert. The record Holder of the Series C Preferred
Stock shall be entitled to convert, subject to the conversion restrictions
herein below, any or all the shares of the Series C Preferred Stock on or after
the date that is four (4) months after the Record Date, as defined below, at the
office of the Company or its designated transfer agent (the "Transfer Agent"),
into that number of fully-paid and non-assessable shares of Common Stock
calculated in accordance with the following formula (the "Conversion Rate"):
Number of shares of Common Stock issued upon conversion of one (1) share of
Series C Preferred Stock =
(.08) (N/365) (10,000) + 10,000
-------------------------------
Conversion Price
3
<PAGE>
where,
. N = the number of days between (i) the Closing Date of the purchase by
Holder of the shares of Series C Preferred Stock from the Company, for
which conversion is being elected, and (ii) the applicable Date of
Conversion (as defined in Section 5(b)(iv) below) for the shares of Series
C Preferred Stock for which conversion is being elected, and
. Conversion Price = the lesser of (x) a "Fixed Conversion Price" equal to
the lesser of $5.00 or the average Closing Bid Price, as that term is
defined below, of the Company's Common Stock for the thirty (30) trading
days immediately following the Record Date, as defined below, provided that
in no event shall the Fixed Conversion Price be less than $4.00, or (y) a
"Variable Conversion Price" equal to X% of the average Closing Bid Price,
as that term is defined below, of the Company's Common Stock for the twenty
(20) trading days immediately preceding the Date of Conversion, as defined
below, where X is determined as follows:
<TABLE>
<CAPTION>
No. Months Between Record
Date and Date of Conversion "X"
--------------------------- ---
<S> <C>
4 months-6 months 85%
after 6 months 80%
</TABLE>
provided, that in no event shall the Variable Conversion Price be less than
$1.00, and provided, however, that, unless otherwise indicated herein, beginning
on the date that is four (4) months following the Record Date, as defined below,
the right of the Holder to convert into Common Stock using the Variable
Conversion Price initially shall be limited to a maximum of twenty percent (20%)
of the aggregate principal amount of the Series C Preferred Stock issued to such
Holder, and for each one (1) month period which expires thereafter, the Holder
shall accrue the right to convert into Common Stock an additional twenty percent
(20%) of the aggregate principal amount of the Series C Preferred Stock issued
to such Holder, (the number of shares that may be converted at any given time
using the Variable Conversion Price, in the aggregate, is referred to
hereinafter as the "Conversion Quota"); and provided, further, in the event that
the Holder elects not to convert its full Conversion Quota during any one (1)
month period, the unconverted amount shall be carried forward and added to the
Conversion Quota, and thereafter the Holder may, from time to time, convert any
portion of the Conversion Quota at the Variable Conversion Price; and provided,
further, that subsequent to the date that is nine (9) months following the
Record Date, there shall be no restrictions on the number of shares of Series C
Preferred Stock that may be converted into Common Stock using the Variable
Conversion Price; and provided, further, that a Holder can convert one hundred
percent (100%) of the Series C Preferred Stock, or any portion thereof, into
Common Stock using the Fixed Conversion Price on or after the date that is four
(4) months after the Record Date whether or not the Fixed Conversion Price is
less than the Variable Conversion Price.
As used herein, a "Closing Date" shall mean the date of the closing of a
purchase and sale of Series C Preferred Stock that occurs pursuant to the
offering of the Series C Preferred Stock by the Company or, if such Series C
Preferred Stock was obtained in exchange for Series A Preferred Stock, the
"Closing Date", as used herein, shall mean the original Closing Date, as defined
in the Certificate of Determination of the Series A Preferred Stock, of the
purchase by Holder of such shares of Series A Preferred Stock from the Company,
and the "Record Date" shall be deemed to be November 5, 1997, regardless of the
actual
4
<PAGE>
date of the last such closing.
For purposes hereof, any Holder which acquires shares of Series C Preferred
Stock from another Holder (the "Transferor") and not upon original issuance from
the Company shall be entitled to exercise its conversion right as to the
percentages of such shares specified under Section 5(a) in such amounts and at
such times such that the number of shares eligible for conversion by such Holder
at any time shall be in the same proportion that the number of shares of Series
C Preferred Stock acquired by such Holder from its Transferor bears to the total
number of shares of Series C Preferred Stock originally issued by the Company to
such Transferor (or its predecessor Transferor).
For purposes hereof, the term "Closing Bid Price" shall mean the closing
bid price of the Company's Common Stock on the OTC Bulletin Board, or if no
longer traded on the OTC Bulletin Board, the closing bid price on the principal
national securities exchange or the over-the-counter on which the Common Stock
is so traded and if not available, the mean of the high and low prices on the
principal securities exchange on which the Common Stock is so traded.
(b) Mechanics of Conversion. In order to convert Series C
Preferred Stock into full shares of Common Stock, the Holder shall (i) send via
facsimile, on or prior to 11:59 p.m., New York City time (the "Conversion Notice
Deadline") on the Date of Conversion, a copy of the fully executed notice of
conversion ("Notice of Conversion") to the Company at the office of the Company
with a copy to its designated transfer agent (the "Transfer Agent") for the
Series C Preferred Stock stating that the Holder elects to convert, which notice
shall specify the Date of Conversion, the number of shares of Series C Preferred
Stock to be converted, the applicable Conversion Price and a calculation of the
number of shares of Common Stock issuable upon such conversion (together with a
copy of the front page of each certificate to be converted) and (ii) surrender
to a common courier for delivery to the office of the Company or the Transfer
Agent, the original certificates representing the Series C Preferred Stock being
converted (the "Preferred Stock Certificates"), duly endorsed for transfer;
provided, however, that the Company shall not be obligated to issue certificates
evidencing the shares of Common Stock issuable upon such conversion unless
either the Preferred Stock Certificates are delivered to the Company or its
Transfer Agent as provided above, or the Holder notifies the Company or its
Transfer Agent that such certificates have been lost, stolen or destroyed
(subject to the requirements of subparagraph (i) below). Upon receipt by the
Company of a facsimile copy of a Notice of Conversion, the Company shall
immediately send, via facsimile, a confirmation of receipt of the Notice of
Conversion to Holder which shall specify that the Notice of Conversion has been
received and the name and telephone number of a contact person at the Company
whom the Holder should contact regarding information related to the Conversion.
In the case of a dispute as to the calculation of the Conversion Rate, the
Company shall promptly issue to the Holder the number of Shares that are not
disputed and shall submit the disputed calculations to its outside accountant
via facsimile within three (3) days of receipt of Holder's Notice of Conversion.
The Company shall cause the accountant to perform the calculations and notify
the Company and Holder of the results no later than two business days from the
time it receives the disputed calculations. Accountant's calculation shall be
deemed conclusive absent manifest error.
(i) Lost or Stolen Certificates. Upon receipt by the Company
of evidence of the loss, theft, destruction or mutilation of any Preferred Stock
Certificates representing shares of Series C Preferred Stock, and (in the case
of loss, theft or destruction) of indemnity or security reasonably satisfactory
to the Company, and upon surrender and cancellation of the Preferred Stock
Certificate(s),
5
<PAGE>
if mutilated, the Company shall execute and deliver new Preferred Stock
Certificate(s) of like tenor and date. However, the Company shall not be
obligated to re-issue such lost or stolen Preferred Stock Certificates if Holder
contemporaneously requests the Company to convert such Series C Preferred Stock
into Common Stock.
(ii) Delivery of Common Stock Upon Conversion. The Company
shall or shall cause the Transfer Agent to, no later than the close of business
on the third (3rd) business day (the "Deadline") after receipt by the Company or
the Transfer Agent of a facsimile copy of a Notice of Conversion and receipt by
Company or the Transfer Agent of all necessary documentation duly executed and
in proper form required for conversion, including the original Preferred Stock
Certificates to be converted (or after provision for security or indemnification
in the case of lost or destroyed certificates, if required), issue and surrender
to a common courier for either overnight or (if delivery is outside the United
States) two (2) day delivery to the Holder at the address of the Holder as shown
on the stock records of the Company a certificate for the number of shares of
Common Stock to which the Holder shall be entitled as aforesaid.
(iii) No Fractional Shares. If any conversion of the Series C
Preferred Stock would create a fractional share of Common Stock or a right to
acquire a fractional share of Common Stock, such fractional share shall be
disregarded and the number of shares of Common Stock issuable upon conversion,
in the aggregate, shall be the next higher number of shares.
(iv) Date of Conversion. The date on which conversion occurs
(the "Date of Conversion") shall be deemed to be the date set forth in such
Notice of Conversion, provided (i) that the advance copy of the Notice of
Conversion is sent via facsimile to the Company before 11:59 p.m., New York City
time, on the Date of Conversion, and (ii) that the original Preferred Stock
Certificates representing the shares of Series C Preferred Stock to be converted
are surrendered by depositing such certificates with a common courier, for
delivery to the Company or the Transfer Agent as provided above, as soon as
practicable after the Date of Conversion. The person or persons entitled to
receive the shares of Common Stock issuable upon such conversion shall be
treated for all purposes as the record Holder or Holders of such shares of
Common Stock on the Date of Conversion.
(c) Automatic Conversion. Each share of Series C Preferred Stock
outstanding on the date which is eighteen (18) months after the Record Date or,
if not a business day, the first business day thereafter ("Termination Date")
automatically shall be converted ("Automatic Conversion") into Common Stock on
such date at the Conversion Rate then in effect (calculated in accordance with
the formula in Section 5(a) above), and the Termination Date shall be deemed the
Date of Conversion with respect to such conversion for purposes of this
Certificate of Determination; provided, however, that no automatic conversion
can occur (an "Automatic Conversion Delay") at a time when (i) the Common Stock
is not actively trading on the OTC Bulletin Board or another national securities
exchange or market, or (ii) there is not an effective registration statement
covering the resale of the Common Stock issuable upon conversion of the
Preferred Stock and such Common Stock is not eligible for resale under Rule
144(k) (each a "Delaying Event"). In the event of an Automatic Conversion
Delay, the Termination Date shall be deemed to be the first business day after
the Delaying Event(s) are no longer occurring. If an Automatic Conversion
occurs, the Company and the Holders shall follow the applicable conversion
procedures set forth in this Certificate of Determination; provided, however,
that the Holders are not required to send the Notice of Conversion contemplated
by Section 5(b).
6
<PAGE>
(d) Adjustment to Conversion Rate.
(i) Adjustment to Fixed Conversion Price Due to Stock Split,
Stock Dividend, Etc. If, prior to the conversion of all of the Series C
Preferred Stock, the number of outstanding shares of Common Stock is increased
by a stock split, stock dividend, or other similar event, the Fixed Conversion
Price shall be proportionately reduced, or if the number of outstanding shares
of Common Stock is decreased by a combination or reclassification of shares, or
other similar event, the Fixed Conversion Price shall be proportionately
increased.
(ii) Adjustment to Variable Conversion Price. If, at any time
when any shares of the Series C Preferred Stock are issued and outstanding, the
number of outstanding shares of Common Stock is increased or decreased by a
stock split, stock dividend, or other similar event, which event shall have
taken place during the reference period for determination of the Conversion
Price for any conversion of the Series C Preferred Stock, then the Variable
Conversion Price shall be calculated giving appropriate effect to the stock
split, stock dividend, combination, reclassification or other similar event for
all five (5) trading days immediately preceding the Date of Conversion.
(iii) Adjustments.
(A) Adjustment Due to Merger, Consolidation, Etc. If,
prior to the conversion of all Series C Preferred Stock, there shall be any
merger, consolidation, exchange of shares, recapitalization, reorganization, or
other similar event, as a result of which shares of Common Stock of the Company
shall be changed into (or the shares of Common Stock become entitled to receive)
the same or a different number of shares of the same or another class or classes
of stock or securities of the Company or another entity or there is a sale of
all or substantially all the Company's assets or there is a change of control
transaction not deemed to be a liquidation pursuant to Section 4(c), then the
Holders of Series C Preferred Stock shall be issued derivative securities of the
new company on substantially the same terms as those set forth in the
Certificate of Determination of the Series C Preferred Stock and shall
thereafter have the right to receive upon conversion of Series C Preferred
Stock, upon the basis and upon the terms and conditions specified herein and in
lieu of the shares of Common Stock immediately theretofore issuable upon
conversion, such stock, securities and/or other assets which the Holder would
have been entitled to receive in such transaction had the Series C Preferred
Stock been converted immediately prior to such transaction, and in any such case
appropriate provisions shall be made with respect to the rights and interests of
the Holders of the Series C Preferred Stock to the end that the provisions
hereof (including, without limitation, provisions for the adjustment of the
Conversion Price and of the number of shares issuable upon conversion of the
Series C Preferred Stock) shall thereafter be applicable, as nearly as may be
practicable in relation to any securities thereafter deliverable upon the
exercise hereof. The Company shall not effect any transaction described in this
subsection 5(d)(iii) unless (a) it first gives at least thirty (30) days prior
notice of such merger, consolidation, exchange of shares, recapitalization,
reorganization, or other similar event (during which time the Holder shall be
entitled to convert its shares of Series C Preferred Stock into Common Stock,
which conversions shall not be subject to the conversion restrictions set forth
in Section 5(a);) and (b) the resulting successor or acquiring entity (if not
the Company) assumes by written instrument the obligations of the Company under
this Certificate of Determination including this subsection 5(d)(iii).
(B) Adjustment Due to Distribution. If at any time
after the Record Date,
7
<PAGE>
the Company shall declare or make any distribution of its assets (or rights to
acquire its assets) to Holders of Common Stock as a partial liquidating
dividend, by way of return of capital or otherwise (including any dividend or
distribution to the Company's shareholders in cash or shares (or rights to
acquire shares) of capital stock of any other public or private company,
including but not limited to a subsidiary or spin-off of the Company (a
"Distribution"), then the Holders of Series C Preferred Stock shall be entitled,
upon any conversion of shares of Series C Preferred Stock after the date of
record for determining shareholders entitled to such Distribution, to receive
the amount of such assets which would have been payable to the Holder with
respect to the shares of Common Stock issuable upon such conversion had such
Holder been the holder of such shares of Common Stock on the record date for
determination of shareholders entitled to such Distribution.
(iv) Issuance of Other Securities With Variable Conversion
Price. If, at any time after the Record Date the Company shall issue any
securities which are convertible into or exchangeable for Common Stock
("Convertible Securities") either (i) at a conversion or exchange rate based on
a discount from the market price of the Common Stock at the time of conversion
or exercise or (ii) with a fixed conversion or exercise price less than the
Fixed Conversion Price, excluding employee stock options and options issued in
conjunction with an acquisition then, at the Holder's option: (x) in the case of
clause (i), the Variable Conversion Price in respect of any conversion of Series
C Preferred Stock after such issuance shall be calculated utilizing the greatest
discount applicable to any such Convertible Securities, and (y) in the case of
clause (ii), the Fixed Conversion Price shall be reduced to such lesser
conversion or exercise price.
(v) No Fractional Shares. If any adjustment under this
Section 5(d) would create a fractional share of Common Stock or a right to
acquire a fractional share of Common Stock, such fractional share shall be
disregarded and the number of shares of Common Stock issuable upon conversion
shall be the next higher number of shares.
Section 6. [Intentionally Omitted]
Section 7. Voting Rights. The Holders of the Series C Preferred Stock
-------------
shall have no voting power whatsoever, except as otherwise provided by the
General Corporation Law of the State of California ("California Law"), and no
Holder of Series C Preferred Stock shall vote or otherwise participate in any
proceeding in which actions shall be taken by the Company or the shareholders
thereof or be entitled to notification as to any meeting of the shareholders.
Notwithstanding the above, the Company shall provide Holder with
notification of any meeting of the shareholders regarding any major corporate
events affecting the Company. In the event of any taking by the Company of a
record of its shareholders for the purpose of determining shareholders who are
entitled to receive payment of any dividend or other distribution, any right to
subscribe for, purchase or otherwise acquire any share of any class or any other
securities or property (including by way of merger, consolidation or
reorganization), or to receive any other right, or for the purpose of
determining shareholders who are entitled to vote in connection with any
proposed sale, lease or conveyance of all or substantially all of the assets of
the Company, or any proposed liquidation, dissolution or winding up of the
Company, the Company shall mail a notice to Holder, at least ten (10) days prior
to the record date specified therein, of the date on which any such record is to
be taken for the purpose of such dividend, distribution, right or other event,
and a brief statement regarding the amount and character of such
8
<PAGE>
dividend, distribution, right or other event to the extent known at such time.
To the extent that under California Law the vote of the Holders of the
Series C Preferred Stock, voting separately as a class, is required to authorize
a given action of the Company, the affirmative vote or consent of the Holders of
at least a majority of the shares of the Series C Preferred Stock represented at
a duly held meeting at which a quorum is present or by written consent of a
majority of the shares of Series C Preferred Stock (except as otherwise may be
required under California Law) shall constitute the approval of such action by
the class. To the extent that under California Law the Holders of the Series C
Preferred Stock are entitled to vote on a matter with holders of Common Stock,
voting together as one (1) class, each share of Series C Preferred Stock shall
be entitled to a number of votes equal to the number of shares of Common Stock
into which it is then convertible using the record date for the taking of such
vote of stockholders as the date as of which the Conversion Price is calculated.
Holders of the Series C Preferred Stock also shall be entitled to notice of all
shareholder meetings or written consents with respect to which they would be
entitled to vote, which notice would be provided pursuant to the Company's by-
laws and applicable statutes.
Section 8. Protective Provision. So long as shares of Series C Preferred
--------------------
Stock are outstanding, the Company shall not without first obtaining the
approval (by vote or written consent, as provided by California Law) of the
Holders of at least ninety percent (90%) of the then outstanding shares of
Series C Preferred Stock:
(a) alter or change the rights, preferences or privileges of the
Series C Preferred Stock or any securities so as to affect adversely the Series
C Preferred Stock;
and the Company shall not, without first obtaining the approval (by vote or
written consent, as provided by California law) of the Holders of at least
seventy-five percent (75%) of the then outstanding shares of Series C Preferred
Stock:
(b) create any new class or series of stock having a preference
over or on parity with the Series C Preferred Stock with respect to
Distributions (as defined in Section 2 above) or increase the size of the
authorized number of Series C Preferred; or
(c) do any act or thing not authorized or contemplated by this
Certificate of Determination which would result in taxation of the holders of
shares of the Series C Preferred Stock under Section 305 of the Internal Revenue
Code of 1986, as amended (or any comparable provision of the Internal Revenue
Code as hereafter from time to time amended).
In the event Holders of at least ninety percent (90%) of the then
outstanding shares of Series C Preferred Stock agree to allow the Company to
alter or change the rights, preferences or privileges of the shares of Series C
Preferred Stock, pursuant to subsection (a) above, so as to affect the Series C
Preferred Stock, then the Company will deliver notice of such approved change to
the Holders of the Series C Preferred Stock that did not agree to such
alteration or change (the "Dissenting Holders") and Dissenting Holders shall
have the right for a period of thirty (30) days to convert pursuant to the terms
of this Certificate of Determination as they exist prior to such alteration or
change (provided that, for purposes of calculating the Variable Conversion
Price, as defined in Section 5(a), "X" shall equal eighty percent (80%), and
provided further that the holding requirements set forth in Section 5(a) hereof
are met), or
9
<PAGE>
continue to hold their shares of Series C Preferred Stock, as amended.
Section 9. Status of Converted Stock. In the event any shares of Series C
-------------------------
Preferred Stock shall be converted pursuant to Section 5 hereof, the shares so
converted shall be canceled, shall return to the status of authorized but
unissued Preferred Stock of no designated series, and shall not be issuable by
the Company as Series C Preferred Stock.
Section 10. Preference Rights. Nothing contained herein shall be construed
-----------------
to prevent the Board of Directors of the Company from issuing one (1) or more
series of Preferred Stock with dividend and/or liquidation preferences junior to
the dividend and liquidation preferences of the Series C Preferred Stock.
Section 11. Authorization and Reservation of Shares of Common Stock.
-------------------------------------------------------
(a) Authorized and Reserved Amount. The Company has authorized and
reserved for issuance and shall keep available for issuance Five Million Five
Hundred Thousand (5,500,000) shares of Common Stock (the "Reserved Amount")
solely for the purpose of effecting the conversion of the Series C Preferred
Stock, and exercise of the warrants to acquire Common Stock (the "Common
Warrants") issued or to be issued to the Holders, which number shall not be
reduced. The Company shall at all times reserve and keep available out of its
authorized but unissued shares of Common Stock a sufficient number of shares of
Common Stock to provide for the full conversion of all outstanding Series C
Preferred Stock, and issuance of the shares of Common Stock in connection
therewith and the full exercise of the Common Warrants and issuance of the
shares of Common Stock in connection therewith.
(b) Increases to Reserved Amount. Without limiting any other
provision of this Section 11, if the Reserved Amount for any three (3)
consecutive trading days (the last of such three (3) trading days being the
"Reservation Trigger Date") shall be less than one hundred twenty-five percent
(125%) of the number of shares of Common Stock issuable upon conversion of this
Series C Preferred Stock, and exercise of the Common Warrants on such trading
days (a "Share Authorization Failure"), the Company shall immediately notify all
Holders of such occurrence and shall take action as soon as possible, but in any
event within sixty (60) days after a Reservation Trigger Date (including, if
necessary, seeking shareholder approval to authorize the issuance of additional
shares of Common Stock), or, if shareholder approval is not required to reserve
such shares, within ten (10) days after a Reservation Trigger Date, to increase
the Reserved Amount to one hundred fifty percent (150%) of the number of shares
of Common Stock then issuable upon conversion of the Series C Preferred Stock,
and exercise of the Common Warrants.
(c) Reduction of Reserved Amount Under Certain Circumstances.
Prior to complete conversion of all Series C Preferred Stock the Company shall
not reduce the number of shares required to be reserved for issuance under this
Section 11 without the written consent of all Holders except for a reduction
proportionate to a reverse stock split effected for a business purpose other
than affecting the obligations of Company under this Section 11, which reverse
stock split affects all shares of Common Stock equally. Following complete
conversion of all the Series C Preferred Stock, the Company may, with fifteen
(15) days prior written notice to Holder, reduce the Reserved Amount to one
hundred twenty-five percent (125%) of the number of shares of Common Stock
issuable upon the full exercise of the Common Warrants; provided, however, that
the Reserved Amount shall continue to be subject to increase pursuant
10
<PAGE>
to Section 11 hereof.
(d) Allocation of Reserved Amount. Each increase to the Reserved
Amount shall be allocated pro rata among the Holders based on the number of
shares of Series C Preferred Stock, and Common Warrants held by each Holder at
the time of the establishment of or increase in the Reserved Amount. In the
event a Holder shall sell or otherwise transfer any of such Holder's Series C
Preferred Stock, or Common Warrants, each transferee shall be allocated a pro
rata portion of such transferor's Reserved Amount. Any portion of the Reserved
Amount which remains allocated to any person or entity which does not hold any
Series C Preferred Stock shall be allocated to the remaining Holders, pro rata
based on the number of Series C Preferred Stock, and Common Warrants then held
by such Holders.
(e) Cap Amount. In the event that the Company becomes subject to
the Nasdaq 20% Rule (as defined below) during the term of the Series C Preferred
Stock, in no event shall the total number of shares of Common Stock issued upon
conversion of the Series C Preferred Stock exceed the maximum number of shares
of Common Stock (the "Cap Amount") that the Company can, without shareholder
approval, so issue pursuant to Nasdaq Rule 4460(i)(1)(d)(ii) (or any other
applicable Nasdaq Rules or any successor rule) (the "Nasdaq 20% Rule"). The
Cap Amount shall be allocated pro-rata to the holders of Series C Preferred
Stock as provided in subsection (f) below. In the event the Company is
prohibited from issuing shares of Common Stock as a result of the operation of
this subsection (e), the Company shall comply with subsection (g) below.
(f) Allocations of Cap Amount and Reserved Amount. The initial Cap
Amount and Reserved Amount shall be allocated pro rata among the Holders of
Series C Preferred Stock based on the number of the shares of Series C Preferred
Stock initially issued to each Holder. Each increase to the Cap Amount and
Reserved Amount shall be allocated pro rata among the Holders of Series C
Preferred Stock based on the number of the shares of Series C Preferred Stock
held by each Holder at the time of the increase in the Cap Amount or Reserved
Amount, as the case may be. In the event a holder shall sell or otherwise
transfer any of such Holder's shares of Series C Preferred Stock, each
transferee shall be allocated a pro rata portion of such transferor's Cap amount
and Reserved Amount. Any portion of the Cap Amount or Reserved Amount which
remains allocated to any person or entity which does not hold any Series C
Preferred Stock shall be allocated to the remaining holders of shares of Series
C Preferred Stock, pro rata based on the number of shares of Series C Preferred
Stock then held by such Holders.
(g) Inability to Convert due to Cap Amount.
(i) Obligation to Cure. If at any time the then unissued
portion of any Holder's Cap Amount is less than 125% of the number of shares of
Common Stock then issuable upon conversion of such Holder's shares of Series C
Preferred Stock (a "Trading Market Trigger Event"), the Company shall
immediately notify the Holders of Series C Preferred Stock of such occurrence
and shall immediately take all necessary action (including, if necessary,
approval of its shareholders to authorize the issuance of the full number of
shares of Common Stock which would be issuable upon the conversion of Series C
Preferred Stock but for the Cap Amount) to eliminate any prohibitions under
applicable law or the rules or regulations of any stock exchange, interdealer
quotation system or other self-regulatory organization with jurisdiction over
the Company or any of its securities on the Company's ability to issue shares of
Common Stock in excess of the Cap Amount. In the event the Company fails to
eliminate all such prohibitions within one hundred twenty (120) days after the
Trading Market Trigger Event (provided,
11
<PAGE>
however, that (A) the Company must file preliminary proxy materials with the SEC
within thirty (30) days of the Trading Market Trigger Event and (B) officers and
directors of the Company shall promptly upon the occasion of any such Trading
Market Trigger event enter into irrevocable agreements to vote all of their
shares in favor of eliminating such prohibitions), each Holder of Series C
Preferred Stock shall thereafter have the option, exercisable in whole or in
part at any time and from time to time by delivery of written notice ("Cap
Redemption Notice") to the Company, to require the Company, to purchase for
cash, at an amount per share to the Redemption Rate in effect on the date of the
Cap Redemption Notice, a portion of the Holder's Series C Preferred Stock such
that, after giving effect to such purchase, the holder's allocated portion of
the Cap Amount exceeds 125% of the total number of shares of Common Stock
issuable to such holder upon conversion of its Series C Preferred Stock on the
date of such Cap Redemption Notice. If the Company fails to redeem any of such
shares within five (5) business days after its receipt of a Cap Redemption
Notice, then such Holder shall be entitled to the remedies provided in Section
11(g)(ii) below.
(ii) Remedies. If the Company fails to eliminate the
applicable prohibitions within the one hundred twenty (120) day cure period
referred to in Section 11(g)(i) above and thereafter the Company is prohibited,
at any time, from issuing shares of Common Stock upon conversion of Series C
Preferred Stock to any holder because such issuance would exceed such holder's
allocated portion of the Cap Amount because of applicable law or the rules or
regulations of any stock exchange, interdealer quotation system or other self-
regulatory organization with jurisdiction over the Company or its securities,
any holder who is prohibited from converting its Series C Preferred Stock may:
(A) require, with the consent of Holders of at least
fifty percent (50%) of the outstanding shares of Series C Preferred Stock
(including any shares of Series C Preferred Stock held by the requesting
Holder), the Company to terminate the listing of its Common Stock and to cause
its Common Stock to be eligible for trading on the American Stock Exchange, or
another exchange or market which is not subject to the Nasdaq 20% Rule, at the
option of the requesting Holders; and, as a result thereof
(B) require the Company to issue shares of Common Stock,
resalable on such other exchange, in accordance with such Holder's Notice of
Conversion at a conversion price equal to the Conversion Price (without regard
to the Conversion Quota) in effect on the date of the holder's written notice to
the Company of its election to receive shares of Common Stock pursuant to this
subparagraph (B).
Section 12. Failure to Satisfy Conversions.
------------------------------
(a) Conversion Failure Payments. If, at any time, (x) a Holder
submits a Notice of Conversion (or is deemed to submit such notice pursuant to
Section 5(c) hereof), and the Company fails for any reason to deliver, on or
prior to the second business day following the Deadline ("Delivery Period") for
such conversion, such number of shares of Common Stock to which such Converting
Holder is entitled upon such conversion (which shares shall be listed,
authorized, reserved, registered, and freely tradeable to the extent required in
this Certificate of Determination, the Registration Rights Agreement between the
Company and the Holder(s) and the Subscription Agreement between the Company and
the Holder(s), collectively referred to as the "Governing Agreements"), or (y)
the Company provides notice to Holder at any time of its intention not to issue
shares of Common Stock upon exercise by Holder of its conversion
12
<PAGE>
rights in accordance with the terms of this Certificate of Determination (each
of (x) and (y) being a "Conversion Failure"), then the Company shall accrue for
the benefit of the Holder, damages in an amount equal to the lower of:
(i) "Damages Amount" X "D" X .005, and
(ii) the highest interest rate permitted by applicable
California law, where:
"D" means the number of days beginning the date of the Conversion Failure
through and including the Cure Date with respect to such Conversion Failure;
"Damages Amount" means the Original Series C Issue Price for each share of
Series C Preferred Stock subject to conversion plus all accrued and unpaid
Premium thereon as of the first day of the Conversion Failure, plus all damage
payments previously owed and unpaid.
"Cure Date" means (i) with respect to a Conversion Failure described in
clause (x) of its definition, the date the Company effects the conversion of the
shares of Series C Preferred Stock submitted for conversion and (ii) with
respect to a Conversion Failure described in clause (y) of its definition, the
date the Company undertakes in writing to timely issue Common Stock in
satisfaction of all conversions of Series C Preferred Stock in accordance with
the terms of this Certificate of Determination.
The amount to which a Holder shall be entitled pursuant to this Section are
referred to herein as "Conversion Failure Payments." The parties agree that the
damages caused by a breach hereof would be difficult or impossible to estimate
accurately. For the first thirty (30) days after the Conversion Failure, the
accrued Conversion Failure Payments shall be paid in Common Stock, as follows:
Upon conversion of each share of Preferred Stock, the Company shall issue
to the Subscriber the number of shares of Common Stock determined as set forth
in Section 5(a) of the Certificate of Determination, plus an additional number
of shares of Common Stock attributable to such share of Preferred Stock (the
Additional Shares") determined as set forth below:
Additional Shares = Conversion Failure Payment
--------------------------
Lowest Conversion Price
where the "Lowest Conversion Price" means the lowest Conversion Price in effect
during the period beginning on the date of the Conversion Failure through the
Cure Date for such Conversion Failure.
Such Additional Shares shall also be deemed "Registrable Securities" as defined
in the Registration Rights Agreement. Any Conversion Failure Payment(s)
accruing after the date that is thirty (30) days after the Conversion Failure
shall be payable Common Stock or in cash, at the Subscriber's option, as
follows: If Subscriber elects to be paid in cash, he, she or it shall so notify
the Company in writing, and such Conversion Failure Payment(s) shall be paid to
such Subscriber by a cashiers check, no later than ten (10) days after the end
of (i) the month in which the Company receives the Holder's cash payment request
and (ii) any subsequent month(s) for which such amounts accrue.
(b) Buy-In Cure. Unless a Conversion Failure described in clause
(y) of Section 12(a)
13
<PAGE>
hereof has occurred with respect to such a Holder, if (i) the Company fails for
any reason to deliver during the Delivery Period shares of Common Stock to a
Holder upon a conversion of the Series C Preferred Stock and (ii) after the
applicable Delivery Period with respect to such conversion, a Holder purchases
(in an open market transaction or otherwise) shares of Common Stock to make
delivery upon a sale by a Holder of the shares of Common Stock (the "Sold
Shares") which such Holder anticipated receiving upon such conversion (a "Buy-
In"), the Company shall pay such Holder within two (2) business days following
receipt of written notice of a claim pursuant to Section 12(b) (in addition to
any other remedies available to Holder) the amount by which (x) such Holder's
total purchase price (including brokerage commission, if any) for the shares of
Common Stock so purchased exceeds (y) the net proceeds received by such Holder
from the sale of the Sold Shares. For example, if a Holder purchases shares of
Common Stock having a total purchase price of $11,000 to cover a Buy-In with
respect to shares of Common Stock sold for $10,000, the Company will be required
to pay such Holder $1,000. A Holder shall provide the Company written
notification indicating any amounts payable to Holder pursuant to this Section
12.
(c) Adjustment to Conversion Price. If a Holder has not received
certificates for all shares of Common Stock within three (3) business days
following the expiration of the Delivery Period with respect to a conversion of
any portion of any of such Holder's Series C Preferred Stock for any reason,
then the Conversion Price applicable upon conversion of such portion of the
Series C Preferred Stock shall thereafter be the lowest Conversion Price in
effect during the period beginning on, and including, such Conversion Date
through and including the Cure Date. If there shall occur a Conversion Failure
of the type described in clause (y) of Section 12(a), then the Fixed Conversion
Price with respect to any conversion of Series C Preferred Stock thereafter
shall be the lowest Conversion Price in effect at any time during the period
beginning on, and including, the date of the occurrence of such Conversion
Failure through and including the Cure Date. The Conversion Price shall
thereafter be subject to further adjustment for any events described in Section
5(d).
Section 13. Events of Default.
-----------------
(a) Holder's Option to Demand Redemption. Upon the occurrence of
an Event of Default (as herein defined), each Holder shall have the right to
elect at any time and from time to time prior to the cure by Company of such
Event of Default to have all or any portion of such Holder's then outstanding
Series C Preferred Stock redeemed by the Company in cash for an amount equal to
the Holder Demand Redemption Amount (as herein defined).
(i) The right of a Holder to elect redemption shall be
exercisable upon the occurrence of an Event of Default by such Holder in its
sole discretion by delivery of a Demand Redemption Notice (as herein defined) in
accordance with the procedures set forth in this Section 13. Notwithstanding the
exercise of such right, the Holder shall be entitled to exercise all other
rights and remedies available under the provisions of this Certificate of
Determination and at law or in equity.
(ii) A Holder shall effect each demand for redemption under
this Section 13 by giving at least two (2) business days prior to written notice
(the "Demand Redemption Notice") of the date which such redemption is to become
effective (the "Effective Date of Demand of Redemption"), the Series C Preferred
Stock selected for redemption and the Holder Demand Redemption Amount to the
Company at the address and facsimile number provided in the stock records of the
Company, which Demand Redemption Notice shall be deemed to have been delivered
on the business day after the date of
14
<PAGE>
transmission of Holder's facsimile (with a copy sent by overnight courier to the
Company) of such notice.
(iii) The Holder Demand Redemption Amount shall be paid to a
Holder whose Series C Preferred Stock are being redeemed within one (1) business
day following the Effective Date of Demand of Redemption; provided, however,
that the Company shall not be obligated to deliver any portion of the Holder
Demand Redemption Amount until one (1) business day following either the date on
which the Series C Preferred Stock being redeemed are delivered to the office of
the Company or the Transfer Agent, or the date on which the Holder notifies the
Company or the Transfer Agent that such Series C Preferred Stock have been lost,
stolen or destroyed and delivers the documentation required in accordance with
Section 5(b)(i) hereof.
(b) Holder Demand Redemption Amount. The "Holder Demand Redemption
Amount" means an amount of cash equal to the greater of: (a) 1.3 times the Total
Value of the Series C Preferred Stock for which demand is being made, through
the date of redemption or (b) the product of (1) the highest price at which the
Common Stock is traded on the date of the Event of Default (or on the most
recent trading date for the Common Stock if the Common Stock is not traded on
such date) divided by the Conversion Price in effect as of the date of the Event
of Default, and (2) the Total Value through the date of redemption, where,
"Total Value" shall mean the Stated Value of the Series C Preferred Stock, plus
liquidated damages, Conversion Failure Payments, Late Registration Payments and
any other cash payments then due from the Company and then unpaid, where "Stated
Value" shall mean the Original Series C Issue Price (as defined in Section 1) of
each share of Series C Preferred Stock, together with the accreted but unpaid
Premium (as defined in Section 4(a)).
(c) Events of Default. An "Event of Default" means any one of the
following:
(i) a Conversion Failure described in Section 12(a) hereof,
if such failure continues uncured for thirty (30) days, at which time (in
addition to the other rights of the Holder hereunder) such conversion may be
rescinded, at the option of the Holder;
(ii) a Share Authorization Failure described in Section 11(b)
hereof, if such Share Authorization Failure continues uncured for ninety (90)
days after the Reservation Trigger Date;
(iii) the Company fails, and such failure continues uncured
for three (3) business days after the Company has been notified thereof in
writing by a Holder, to satisfy the share reservation requirements of Section 11
hereof;
(iv) the Company fails to have an effective registration
statement, as required by the Registration Rights Agreement between the Company
and the Holder(s) (the "Registration Rights Agreement"), declared effective on
or prior to the date that is six (6) months after the Record Date (which date
may be extended for up to two (2) months upon written notice from the Company to
the Holders given prior to the expiration of the six (6) month period, provided
that the reasons for the delay are set forth with specificity and are beyond the
reasonable control of the Company), or the Company fails to maintain the
effectiveness of such registration statement, except where such failure to
maintain lasts no longer than three (3) consecutive trading days and is caused
solely by failure of the Securities and Exchange Commission to timely review the
customary submission of or respond to the customary requests of the Company, or
exceeds by more than thirty (30) days the permitted duration of a Blackout under
Section 6 of the
15
<PAGE>
Registration Rights Agreement;
(v) for three (3) consecutive trading days or for an
aggregate of ten (10) trading days in any nine (9) month period, the Common
Stock (including any of the shares of Common Stock issuable upon conversion of
the Series C Preferred Stock, and exercise of the Common Warrants) is (i)
suspended from trading on any of the OTC Bulletin Board, Nasdaq SmallCap, NMS,
NYSE, or AMEX, or (ii) is not qualified for trading on at least one of the OTC
Bulletin Board, Nasdaq SmallCap, NMS, NYSE, or;
(vi) the Company fails, and such failure continues uncured
for three (3) business days after the Company has been notified thereof in
writing by a Holder, to remove any restrictive legend on any certificate for any
shares of Common Stock issued to a Holder upon conversion of any Series C
Preferred Stock, or exercise of any Common Warrant as and when required by this
Certificate of Determination, the Common Warrants, the Subscription Agreement,
between the Company and the Holder(s) (the "Subscription Agreement") or the
Registration Rights Agreement;
(vii) the Company fails to pay any cash payments due to Holder
under the terms of this Certificate of Determination or the Registration Rights
Agreement within ten (10) days after Holder has notified the Company, in
writing, that such payment is past due and that the Holder intends to declare an
"Event of Default" under this Section 13 if such payment is not made;
(viii) the Company breaches, and such breach continues uncured
for three (3) business days after the Company has been notified thereof in
writing by a Holder, any significant covenant or other material term or
condition of this Certificate of Determination, the Subscription Agreement, the
Common Warrants or the Registration Rights Agreement;
(ix) any representation or warranty of the Company made
herein or in any agreement, statement or certificate given in writing pursuant
hereto or in connection herewith (including, without limitation, the
Subscription Agreement and Registration Rights Agreement), shall be false or
misleading in any material respect when made;
(x) the Company or any subsidiary of the Company shall make
an assignment for the benefit of its creditors, or apply for or consent to the
appointment of a receiver or trustee for it or for a substantial part of its
property or business, or such receiver or trustee shall otherwise be appointed;
or
(xi) bankruptcy, insolvency, reorganization or liquidation
proceedings or other proceedings for relief under any bankruptcy law or any law
for the relief of debtors shall be instituted by or against the Company or any
subsidiary of the Company (and such proceedings shall continue unstayed for
thirty (30) days).
(d) Failure to Pay Damages Amount. If the Company fails to pay the
Holder Demand Redemption Amount within five (5) business days of its receipt of
a Demand Redemption Notice, then such Holder shall have the right, at any time
and from time to time prior to the payment of the Holder Demand Redemption
Amount, to require the Company, upon written notice, to immediately convert (in
16
<PAGE>
accordance with the terms of Section 5) all or any portion of the Holder Demand
Redemption Amount, into shares of Common Stock at the then current Conversion
Price, provided that if the Company has not delivered the full number of shares
of Common Stock issuable upon such conversion within three (3) business days
after the Company receives written notice of such conversion, the Conversion
Price with respect to such Holder Demand Redemption Amount shall thereafter be
deemed to be the lowest Conversion Price in effect during the period beginning
on the date of the Event of Default through the date on which the Company
delivers to the Holder the full number of freely tradable shares of Common Stock
issuable upon such conversion. In the event the Company is not able to pay all
amounts due and payable with respect to all Series C Preferred Stock subject to
Holder Demand Redemption Notices, the Company shall pay the Holders such amounts
pro rata, based on the total amounts payable to such Holder relative to the
total amounts payable to all Holders.
Section 14. Remedies, Other Obligations, Breaches and Injunctive Relief.
-----------------------------------------------------------
The remedies provided in this Certificate of Determination shall be cumulative
and in addition to all other remedies available under the Certificate of
Determination at law or in equity (including a decree of specific performance
and/or other injunctive relief), no remedy contained herein shall be deemed a
waiver of compliance with the provision giving rise to such remedy and nothing
herein shall limit a holder's right to pursue actual damages for any failure by
the Company to comply with the terms of this Certificate of Determination.
Amounts set forth or provided for herein with respect to payments, conversion
and the like (and the computation thereof) shall be the amounts to be received
by the holder hereof and shall not, except as expressly provided herein, be
subject to any other obligation of the Company (or the performance thereof).
The Company acknowledges that a breach by it of its obligations hereunder will
cause irreparable harm to the holders of Series C Preferred Stock and that the
remedy at law for any such breach may be inadequate. The Company therefore
agrees, in the event of any such breach or threatened breach, the holders of
Series C Preferred Stock shall be entitled, in addition to all other available
remedies, to an injunction restraining any breach, without the necessity of
showing economic loss and without any bond or other security being required.
4. The authorized number of shares of Series C Preferred Stock is Seven
Hundred Forty (740), and no such shares have been issued.
5. The creation of the Series C Preferred Stock has been approved by
holders of more than 75% of the outstanding shares of Series A Preferred Stock.
[INTENTIONALLY LEFT BLANK]
17
<PAGE>
We declare under penalty of perjury under the laws of the State of California
that the matters set forth in this Certificate are true and correct of our own
knowledge.
Dated: November 14, 1997.
-----------
/s/ THOMAS RUSSELL
------------------------------
Thomas Russell, Vice President
/s/ HELEN WEST
------------------------------
Helen West, Secretary
18
<PAGE>
EXHIBIT 5.1
Haddan & Zepfel LLP
4675 MacArthur Court, Suite 710
Newport Beach, CA 92660
(714) 752-6100
(714) 752-6161 (facsimile)
e-mail: [email protected]
December 9, 1997
Franklin Telecommunications Corp.
733 Lakefield Road
Westlake Village, CA 91361
Dear Sirs:
You have requested our opinion in connection with the Registration
Statement on Form S-1 (the "Registration Statement") being filed by you with the
Securities and Exchange Commission for the purpose of registering under the
Securities Act of 1933, as amended, 2,000,000 shares of your Common Stock,
without par value (the "Shares"), to be sold by the selling shareholders
identified therein (the "Selling Shareholders").
On the basis of such investigation as we have deemed necessary, we are of
the opinion that the Shares will be, when sold by the Selling Shareholders,
fully-paid and non-assessable shares of Common Stock of the Company.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to us under "Legal Matters."
Very truly yours,
Haddan & Zepfel LLP
<PAGE>
EXHIBIT 10.16
FRANKLIN TELECOMMUNICATIONS CORP.
REGULATION D SUBSCRIPTION AGREEMENT
FOR SERIES C PREFERRED STOCK
THE SECURITIES OFFERED HEREBY HAVE NOT BEEN REGISTERED WITH THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE OR OTHER SECURITIES AUTHORITIES. THEY
MAY NOT BE SOLD OR TRANSFERRED EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION
STATEMENT OR AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THOSE
SECURITIES LAWS.
THIS SUBSCRIPTION AGREEMENT DOES NOT CONSTITUTE AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO PURCHASE, ANY OF THE SECURITIES DESCRIBED
HEREIN BY OR TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION WOULD BE UNLAWFUL. THESE SECURITIES HAVE NOT BEEN RECOMMENDED
BY ANY FEDERAL OR STATE SECURITIES AUTHORITIES, NOR HAVE SUCH AUTHORITIES
REVIEWED OR DETERMINED THE ACCURACY OF THIS DOCUMENT. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
AN INVESTMENT IN THESE SECURITIES INVOLVES A HIGH DEGREE OF RISK.
SUBSCRIBERS MUST RELY ON THEIR OWN ANALYSIS OF THE INVESTMENT AND
ASSESSMENT OF THE RISKS INVOLVED. SEE THE RISK FACTORS SET FORTH IN THE
ATTACHED DISCLOSURE DOCUMENTS AS EXHIBIT G.
SEE ADDITIONAL LEGENDS AT SECTIONS 3.7 and 9.
THIS REGULATION D SUBSCRIPTION AGREEMENT (this "Agreement") is made as
of the _____ day of November, 1997, by and between Franklin Telecommunications
Corp., a corporation duly organized and existing under the laws of the State of
California (the "Company"), and the undersigned subscriber executing this
Agreement ("Subscriber").
THE PARTIES HEREBY AGREE AS FOLLOWS:
This Agreement is executed by Subscriber in connection with the offer by
the Company and the purchase by Subscriber of Series C Preferred Stock (the
"Preferred Stock"), of the Company. The Preferred Stock is being offered at a
purchase price of Ten Thousand Dollars ($10,000), U.S., per share, in minimum
subscription amounts of at least ten (10) shares ($100,000), and increments
<PAGE>
of five (5) shares ($50,000) in excess thereof, with a minimum aggregate
offering amount (when aggregated with the number of shares of Series A Preferred
Stock that have not been exchanged for Series C Preferred Stock) of Five Hundred
(500) shares of Preferred Stock, or Five Million Dollars ($5,000,000) (the
"Minimum Amount"), and up to a maximum aggregate amount (when aggregated with
the number of shares of Series A Preferred Stock that have not been exchanged
for Series C Preferred Stock) of Seven Hundred Forty (740) shares of Preferred
Stock, or Seven Million Four Hundred Thousand Dollars ($7,400,000) (the "Maximum
Amount") (collectively, the "Offering"). The terms of the Preferred Stock,
including the terms on which the Preferred Stock may be converted into common
stock of the Company (the "Common Stock"), are set forth in the Certificate of
Determination of Series C Preferred Stock (the "Certificate of Determination"),
in the form attached hereto as Composite Exhibit A. The Preferred Stock is
-------------------
accompanied by a warrant or warrants, in the form of Exhibit B annexed hereto
(the "Series C Common Warrants"), that entitles the holder thereof to purchase a
number of shares of the common stock of the Company's subsidiary, FNet Corp.
(hereinafter "FNet") equal to one hundred percent (100%) of the aggregate
purchase price of the Subscriber's Preferred Stock divided by the Fixed
Conversion Price, as defined in the Certificate of Determination of the Series C
Preferred Stock, at an exercise price of $1.00 ("Series C Exercise Option #1).
However, if FNet fails to complete a public offering by June 30, 1998, the
Holder has the option, upon written notice to FNet and FTEL no later than July
31, 1998, to convert to "Series C Exercise Option #2" (in lieu of Series C
Exercise Option #1), which entitles the holder to purchase a number of shares of
Common Stock of the Company, equal to one hundred percent (100%) of the
aggregate purchase price of the Subscriber's Preferred Stock divided by the
Fixed Conversion Price exercisable at the Fixed Conversion Price. The Preferred
Stock is also accompanied by an option to purchase an amount of shares of Series
B Preferred Stock up to fifty percent (50%) of the principal amount of Series C
Preferred Stock purchased by Subscriber in the Offering (the "Preferred Option")
in a second closing (the "Second Closing"), as further described in Section 4.12
below. The terms of the Series B Preferred Stock, including the terms on which
the Series B Preferred Stock may be converted into Common Stock, are set forth
in the form of the Certificate of Determination for the Series B Preferred Stock
(the "Series B Certificate of Determination") attached hereto as Composite
---------
Exhibit A. Each share of Series B Preferred Stock is accompanied by a warrant
- ---------
or warrants, in the form of Exhibit C annexed hereto, (the "Series B Common
Warrants") that entitles the holder thereof to purchase a number of shares of
the common stock of FNet equal to one hundred percent (100%) of the aggregate
purchase price of the Subscriber's Series B Preferred Stock divided by the Fixed
Conversion Price, at an exercise price of (x) 80% of the average closing bid
price of FNet's common stock for the five (5) trading days prior to issuance, or
(y) if FNet common stock is not then publicly traded, then the price of the most
recent private placement of one million dollars ($1,000,000) or more by FNet
("Series B Exercise Option #1"). However, if FNet fails to complete a public
offering by June 30, 1998, Holder has the option, upon written notice to FNet
and FTEL no later than July 31, 1998, to convert to "Series B Exercise Option
#2" (in lieu of Series B Exercise Option #1), which entitles the holder to
purchase a number of shares of Common Stock of the Company, equal to one hundred
percent (100%) of the aggregate purchase price of the Subscriber's Preferred
Stock divided by the Fixed Conversion Price exercisable at the Fixed Conversion
Price.
The Series C Common Warrants may be referred to hereinafter as the "Common
Warrants" or the "Warrants." The solicitation of this subscription and, if
accepted by the Company, the offer and sale
2
<PAGE>
of the Preferred Stock are being made in reliance upon the provisions of
Regulation D ("Regulation D") promulgated under the Securities Act of 1933, as
amended ("the Act"). The Preferred Stock and the Common Stock issuable upon
conversion thereof (the "Conversion Shares"), together with the Common Warrants
and the Common Stock issuable upon exercise thereof (the "Warrant Shares") are
sometimes referred to herein singularly as "Security" and collectively as the
"Securities." As used herein, the term "Subscribers" shall mean the purchasers
of the Company's Series A Preferred Stock and the Company's Series C Preferred
Stock.
It is agreed as follows:
1. Offering
1.1 Offer to Subscribe; Purchase Price and Closing; and Placement
-------------------------------------------------------------
Fees.
- ----
Subject to satisfaction of the conditions to closing set forth in Section 1.2
below, Subscriber hereby offers to subscribe for and purchase Preferred Stock
and accompanying Warrants, for the aggregate purchase price in the amount set
forth in Section 10 of this Agreement, in accordance with the terms and
conditions of this Agreement. Assuming that the Minimum Amount and
corresponding subscription agreements accepted by the Company are received into
the Company's designated escrow account for this Offering established pursuant
to the Escrow Agreement and Instructions (the "Escrow Agreement") by and among
the Company, First Union National Bank of Georgia (the "Escrow Agent") and the
Placement Agent (as defined below) (the "Escrow Account"), the closing of a sale
and purchase of Preferred Stock as to each Subscriber (the "Closing") shall be
deemed to occur when this Agreement has been executed by both Subscriber and the
Company and full payment shall have been made by Subscriber, by wire transfer to
the Escrow Account as set forth in Section 7.1(a) for payment in consideration
for the Company's delivery of certificates representing the Preferred Stock
subscribed for.
The parties hereto acknowledge that Swartz Investments, LLC is acting as
placement agent (the "Placement Agent") for this Offering and will be
compensated by the Company in cash and warrants to purchase Common Stock. The
Placement Agent has acted solely as placement agent in connection with the
Offering by the Company of the Preferred Stock pursuant to this Agreement. The
information and data contained in the Disclosure Documents (as defined in
Section 2.2.4) have not been subjected to independent verification by the
Placement Agent, and no representation or warranty is made by the Placement
Agent as to the accuracy or completeness of the information contained in the
Disclosure Documents.
The Company and Subscriber acknowledge that the Matthew Fund, N.V. (the "Fund"),
which is managed by affiliates of the Placement Agent, may subscribe for
securities in the Offering. The parties acknowledge that neither the Placement
Agent nor any of its affiliates shall be under any obligation to advise the
Company or Subscriber of the activities of the Fund with respect to such
securities following the consummation of the Offering. Such acknowledgment
shall not act as a waiver of any obligation required by law or written agreement
of which the Fund is a party. It is understood that the Fund will act
independently of the Placement Agent and may take action with
3
<PAGE>
respect to such investment which may be inconsistent or contrary to any action
or interest of the Placement Agent, the Company or any of the other Subscribers.
1.2 Conditions to Subscriber's Obligations. Subscriber's obligations
--------------------------------------
hereunder are conditioned upon all of the following:
(a) the following documents, with respect to the Series C Preferred
Stock, shall have been deposited with the Escrow Agent: the
Registration Rights Agreement, substantially in the form attached
hereto as Exhibit D (the "Registration Rights Agreement") (executed by
---------
the Company), an opinion of counsel, substantially in the form
attached hereto as Exhibit E (the "Opinion of Counsel") (signed by the
---------
Company's counsel), the Irrevocable Instructions to Transfer Agent,
substantially in the form attached hereto as Exhibit F (the
---------
"Irrevocable Instructions to Transfer Agent")(executed by the Company
and the Company's transfer agent, the "Transfer Agent"), the
Certificate of Determination of Series C Preferred Stock,
substantially in the form attached hereto as Composite Exhibit A
-------------------
(together with evidence showing that it has been filed with the
Secretary of State of California), a form of the Series B Certificate
of Determination, substantially in the form attached as Composite
---------
Exhibit A; certificates representing the Preferred Stock issued in the
---------
name of the Subscriber; the Common Warrants issued in the name of the
Subscriber;
(b) the Company's Common Stock shall be actively trading on the OTC
Bulletin Board;
(c) other than losses described in the Risk Factors as set forth in
Section 2.2.4 below there have been no material adverse changes in the
Company's business prospects or financial condition since the date of
the last balance sheet included in the Disclosure Documents (defined
below in Section 2.2.4), including but not limited to incurring
material liabilities;
(d) the representations and warranties of the Company are true and
correct in all material respects at the Closing as if made on such
date, and the Company shall deliver a certificate, signed by an
officer of the Company, to such effect to the Escrow Agent;
(e) with respect to each share of Series C Preferred Stock to be
issued, cash in the amount of the purchase price, or (in the case of
an Exchange, as defined below) an equivalent amount of Series A
Preferred Stock and corresponding subscription agreements accepted by
the Company shall have been received by the Escrow Agent; and
(f) the Company shall have reserved for issuance a sufficient number
of shares of Common Stock to effect conversions of the Preferred Stock
and exercise of the Common Warrants, which number of shares shall
initially be equal to Five Million
4
<PAGE>
Five Hundred Thousand (5,500,000) shares.
2. Representations and Warranties of Subscriber. Subscriber hereby
represents and warrants to the Company as follows:
2.1 Accredited Investor. Subscriber is an accredited investor, as
-------------------
defined in Rule 501 of Regulation D, and has checked the applicable box set
forth in Section 10 of this Agreement.
2.2 Investment Experience; Access to Information; Independent
---------------------------------------------------------
Investigation.
- -------------
2.2.1 Access to Information. Subscriber or Subscriber's professional
advisor has been granted the opportunity to ask questions of and receive answers
from representatives of the Company, its officers, directors, employees and
agents concerning the terms and conditions of this Offering, the Company and its
business and prospects, and to obtain any additional information which
Subscriber or Subscriber's professional advisor deems necessary to verify the
accuracy and completeness of the information received.
2.2.2 Reliance on Own Advisors. Subscriber has relied completely on
the advice of, or has consulted with, Subscriber's own personal tax, investment,
legal or other advisors and has not relied on the Company or any of its
affiliates, officers, directors, attorneys, accountants or any affiliates of any
thereof and each other person, if any, who controls any thereof, within the
meaning of Section 15 of the Act for any tax or legal advice (other than
reliance on information in the Disclosure Documents as defined in Section 2.2.4
below and on the Opinion of Counsel). The foregoing, however, does not limit or
modify Subscriber's right to rely upon representations and warranties of the
Company in Section 4 of this Agreement.
2.2.3 Capability to Evaluate. Subscriber has such knowledge and
experience in financial and business matters so as to enable such Subscriber to
utilize the information made available to it in connection with the Offering in
order to evaluate the merits and risks of the prospective investment, which are
substantial, including without limitation those set forth in the Disclosure
Documents (as defined in Section 2.2.4 below).
2.2.4 Disclosure Documents. Subscriber, in making Subscriber's
investment decision to subscribe for the Securities hereunder, represents that
(a) Subscriber has received and had an opportunity to review (i) Amendment No. 1
to the Company's Registration Statement on Form S-1, as filed with the
Securities and Exchange Commission on November 1, 1997, (ii) the Risk Factors,
attached as Exhibit G, (iii) the Capitalization Schedule, attached as Exhibit H
--------- ---------
(the "Capitalization Schedule") and (iv) the Use of Proceeds Schedule, attached
as Exhibit I (the "Use of Proceeds Schedule"); (b) Subscriber has read,
---------
reviewed, and relied solely on the documents described in (a) above, the
Company's representations and warranties and other information in this
Agreement, including the exhibits, any other written information prepared by the
Company which has been specifically provided to Subscriber in connection with
this Offering (the documents described in Section 2.2.4 (a) and (b) are
collectively referred to as the "Disclosure Documents"), and an independent
investigation made by Subscriber and Subscriber's representatives, if any; (c)
Subscriber
5
<PAGE>
has, prior to the date of this Agreement, been given an opportunity to review
material contracts and documents of the Company which have been filed as
exhibits to the Company's Registration Statement on From S-1 and has had an
opportunity to ask questions of and receive answers from the Company's officers
and directors; and (d) is not relying on any oral representation of the Company
or any other person, nor any written representation or assurance from the
Company other than those referred to in this Agreement or otherwise contained in
the Disclosure Documents or incorporated herein or therein. The foregoing,
however, does not limit or modify Subscriber's right to rely upon
representations and warranties of the Company in this Agreement. Subscriber
acknowledges and agrees that the Company has no responsibility for, does not
ratify, and is under no responsibility whatsoever to comment upon or correct any
reports, analyses or other comments made about the Company by any third parties,
including, but not limited to, analysts' research reports or comments
(collectively, "Third Party Reports"), and Subscriber has not relied upon any
Third Party Reports, including any provided by the Placement Agent, in making
the decision to invest.
2.2.5 Investment Experience; Fend for Self. Subscriber has
substantial experience in investing in securities and he, she or it has made
investments in securities other than those of the Company. Subscriber
acknowledges that Subscriber is able to fend for Subscriber's self in the
transaction contemplated by this Agreement, that Subscriber has the ability to
bear the economic risk of Subscriber's investment pursuant to this Agreement and
that Subscriber is an "Accredited Investor" by virtue of the fact that
Subscriber meets the investor qualification standards set forth in Section 2.1
above. Subscriber has not been organized for the purpose of investing in
securities of the Company, although such investment is consistent with
Subscriber's purposes.
2.3 Exempt Offering Under Regulation D.
-----------------------------------
2.3.1 Investment; No Distribution. Subscriber is acquiring the
Securities to be issued and sold hereunder for his, her or its own account (or a
trust account if such Subscriber is a trustee) for investment and not as a
nominee and not with a present view to the distribution thereof. Subscriber is
aware that there are legal and practical limits on Subscriber's ability to sell
or dispose of the Securities and, therefore, that Subscriber must bear the
economic risk of the investment for an indefinite period of time and has
adequate means of providing for Subscriber's current needs and possible personal
contingencies and has need for only limited liquidity of this investment.
Subscriber's commitment to illiquid investments is reasonable in relation to
Subscriber's net worth. By making the representations in this Section 2.3.1,
the Subscriber does not agree to hold the Securities for any minimum or other
specific term and reserves the right to dispose of the Securities at any time in
accordance with or pursuant to a registration statement or an exemption from
registration under the Act, except as otherwise required in this Agreement or in
the Registration Rights Agreement.
2.3.2 No General Solicitation. The Securities were not offered to
Subscriber through, and Subscriber is not aware of, any form of general
solicitation or general advertising, including, without limitation, (i) any
advertisement, article, notice or other communication published in any
newspaper, magazine or similar media or broadcast over television or radio, and
(ii) any seminar or meeting whose attendees have been invited by any general
solicitation or general advertising.
6
<PAGE>
2.3.3 Restricted Securities. Subscriber understands that the
Preferred Stock and the Common Warrants issued at Closing are, and the
Conversion Shares, the Warrant Shares and the Series B Preferred Stock issued
upon exercise of the Preferred Option will be, characterized as "restricted
securities" under the federal securities laws inasmuch as they are being
acquired from the Company in a transaction not involving a public offering and
that under such laws and applicable regulations such securities may not be
transferred or resold without registration under the Act or pursuant to an
exemption therefrom. In this connection, Subscriber represents that Subscriber
is familiar with Rule 144 under the Act, as presently in effect, and understands
the resale limitations imposed thereby and by the Act.
2.3.4 Disposition. Without in any way limiting the representations
set forth above, Subscriber further agrees not to make any disposition of all or
any portion of the Securities unless and until:
(a) There is then in effect a registration statement under the Act
covering such proposed disposition and such disposition is made in accordance
with such registration statement; or
(b) (i) Subscriber shall dispose of its securities under an exemption
from registration under the Act, including pursuant to Rule 144, and (ii) if
reasonably requested by the Company, Subscriber shall have furnished the Company
with an opinion of counsel, reasonably satisfactory to the Company, that such
disposition will not require registration of the Securities under the Act. It
is agreed that the Company will not require opinions of counsel for transactions
made pursuant to Rule 144.
2.4 Due Authorization.
-----------------
2.4.1 Authority. Subscriber, if executing this Agreement in a
representative or fiduciary capacity, has full power and authority to execute
and deliver this Agreement and each other document included herein for which a
signature is required in such capacity and on behalf of the subscribing
individual, partnership, trust, estate, corporation or other entity for whom or
which Subscriber is executing this Agreement. Subscriber has reached the age of
majority (if an individual) according to the laws of the state in which he
resides, has adequate means for providing for his current needs and personal
contingencies, is able to bear the economic risk of his investment in the
Securities for an indefinite period of time and could afford a complete loss of
such investment. Subscriber's commitment to illiquid investments is reasonable
in relation to Subscriber's net worth.
2.4.2 Due Authorization. If Subscriber is a corporation, Subscriber
is duly and validly organized, validly existing and in good tax and corporate
standing as a corporation under the laws of the jurisdiction of its
incorporation with full power and authority to purchase the Securities to be
purchased by Subscriber and to execute and deliver this Agreement.
2.4.3 Partnerships. If Subscriber is a partnership, the
representations, warranties, agreements and understandings set forth above are
true with respect to all partners of
7
<PAGE>
Subscriber (and if any such partner is itself a partnership, all persons holding
an interest in such partnership, directly or indirectly, including through one
or more partnerships), and the person executing this Agreement has made due
inquiry to determine the truthfulness of the representations and warranties made
hereby.
2.4.4 Representatives. If Subscriber is purchasing in a
representative or fiduciary capacity, the representations and warranties shall
be deemed to have been made on behalf of the person or persons for whom
Subscriber is so purchasing.
3. Acknowledgments Subscriber is aware that:
3.1 Risks of Investment. Subscriber recognizes that an investment in
-------------------
the Company involves substantial risks, including the potential loss of
Subscriber's entire investment herein. Subscriber recognizes that this
Agreement and the exhibits hereto do not purport to contain all the information
which would be contained in a registration statement under the Act;
3.2 No Government Approval. No federal or state agency has passed
----------------------
upon the Securities, recommended or endorsed the Offering, or made any finding
or determination as to the fairness of this transaction;
3.3 No Registration. The Securities and any component thereof have
---------------
not been registered under the Act or any applicable state securities laws by
reason of exemptions from the registration requirements of the Act and such
laws, and may not be sold, pledged, assigned or otherwise disposed of in the
absence of an effective registration of the Securities and any component thereof
under the Act or unless an exemption from such registration is available;
3.4 Restrictions on Transfer. Subscriber may not attempt to sell,
------------------------
transfer, assign, pledge or otherwise dispose of all or any portion of the
Securities or any component thereof in the absence of either an effective
registration statement or an exemption from the registration requirements of the
Act and applicable state securities laws;
3.5 No Assurances of Registration. There can be no assurance that
-----------------------------
any registration statement will become effective at the scheduled time.
Therefore, Subscriber may bear the economic risk of Subscriber's investment for
an indefinite period of time;
3.6 Exempt Transaction. Subscriber understands that the Securities
------------------
are being offered and sold in reliance on specific exemptions from the
registration requirements of federal and state law and that the representations,
warranties, agreements, acknowledgments and understandings set forth herein are
being relied upon by the Company in determining the applicability of such
exemptions and the suitability of Subscriber to acquire such Securities;
3.7 Legends. It is understood that the certificates evidencing the
-------
Preferred Stock, the Common Warrants, the Conversion Shares and the Warrant
Shares shall bear the following legend (the "Legend") (unless legend removal is
allowed under Section 5.9 below or otherwise allowed by
8
<PAGE>
applicable law):
"The securities represented hereby have not been registered under the
Securities Act of 1933, as amended, or applicable state securities
laws, nor the securities laws of any other jurisdiction. They may not
be sold or transferred in the absence of an effective registration
statement under those securities laws or pursuant to an exemption
therefrom."
4. Representations and Warranties of the Company . The Company hereby
makes the following representations and warranties to Subscriber (which shall be
true at the signing of this Agreement, as of Closing, and as of any such later
date as contemplated hereunder) and agrees with Subscriber that:
4.1 Organization, Good Standing, and Qualification. The Company is a
----------------------------------------------
corporation duly organized, validly existing and in good standing under the laws
of the State of California USA and has all requisite corporate power and
authority to carry on its business as now conducted and as proposed to be
conducted. The Company is duly qualified to transact business and is in good
standing in each jurisdiction in which the failure to so qualify would have a
material adverse effect on the business or properties or prospects of the
Company and its subsidiaries taken as a whole. The Company is not the subject
of any pending, threatened or, to its knowledge, contemplated investigation or
administrative or legal proceeding by the Internal Revenue Service, the taxing
authorities of any state or local jurisdiction, or the Securities and Exchange
Commission ("SEC"), or any state securities commission, or any other
governmental entity, which have not been disclosed in the Disclosure Documents.
4.2 Corporate Condition. The Company's condition is, in all material
-------------------
respects, as described in the Disclosure Documents, except for changes in the
ordinary course of business and normal year-end adjustments that are not, in the
aggregate, materially adverse to the Company. There have been no material
adverse changes to the Company's business, financial condition, or prospects
since the date of such Disclosure Documents. The financial statements contained
in the Disclosure Documents have been prepared in accordance with generally
accepted accounting principles, consistently applied (except as specified in the
notes thereto), and fairly present the consolidated financial condition of the
Company as of the dates of the balance sheets included therein and the
consolidated results of its operations and cash flows for the periods then
ended. Without limiting the foregoing, there are no material liabilities,
contingent or actual, that are not disclosed in the Disclosure Documents (other
than liabilities incurred by the Company in the ordinary course of its business,
consistent with its past practice, after the period covered by the Disclosure
Documents). The Company has paid all material taxes which are due, except for
taxes which it reasonably disputes for which adequate reserves have been
established. There is no material claim, litigation, or administrative
proceeding pending, or, to the best of the Company's knowledge, threatened
against the Company, except as disclosed in the Disclosure Documents. This
Agreement and the Disclosure Documents do not contain any untrue statement of a
material fact and do not omit to state any material fact required to be stated
therein or herein necessary to make the statements contained therein or herein
not misleading in the light of the circumstances under which they were made. No
9
<PAGE>
event or circumstance exists relating to the Company which under applicable law,
requires public disclosure but which has not been so publicly announced or
disclosed.
4.3 Authorization. Except for the filing of the Certificate of
-------------
Determination, all corporate action on the part of the Company by its officers,
directors and shareholders necessary for the authorization, execution and
delivery of this Agreement, the performance of all obligations of the Company
hereunder and the authorization, issuance and delivery of the Preferred Stock
being sold hereunder and the issuance (and/or the reservation for issuance) of
the Conversion Shares, the Common Warrants, and the Warrant Shares have been
taken, and this Agreement, the Certificate of Determination, the Irrevocable
Instructions to Transfer Agent, the Escrow Agreement and the Registration Rights
Agreement constitute valid and legally binding obligations of the Company,
enforceable in accordance with their terms, except insofar as the enforceability
may be limited by applicable bankruptcy, insolvency, reorganization, or other
similar laws affecting creditors' rights generally or by principles governing
the availability of equitable remedies. The Company has obtained all consents
and approvals required for it to execute, deliver and perform each agreement
referenced in the previous sentence.
4.4 Valid Issuance of Preferred Stock and Common Stock. The
--------------------------------------------------
Preferred Stock and the Common Warrants, when issued, sold and delivered in
accordance with the terms hereof, for the consideration expressed herein, will
be validly issued, fully paid and nonassessable and, based in part upon the
representations of Subscriber in this Agreement, will be issued in compliance
with all applicable U.S. federal and state securities laws free and clear of
all liens. The Conversion Shares, when issued in accordance with the terms of
the Certificate of Determination, and the Warrant Shares, when issued upon
exercise of the Common Warrants, as applicable, shall be duly and validly issued
and outstanding, fully paid and nonassessable, and based in part on the
representations and warranties of Subscriber of the Preferred Stock, will be
issued in compliance with all applicable U.S. federal and state securities laws
free and clear of all liens. The Preferred Stock, the Conversion Shares, the
Common Warrants and the Warrant Shares will be issued free of any preemptive
rights. The Company currently has at least Five Million Five Hundred Thousand
(5,500,000) Conversion Shares and Warrant Shares reserved for issuance upon
conversion of the Preferred Stock and upon exercise of the Common Warrants,
respectively.
4.5 Compliance with Other Instruments. The Company is not in
---------------------------------
violation or default of any provisions of its Articles of Incorporation or
Bylaws each as amended, and in effect on and as of the date of the Agreement or
of any material provision of any material instrument or material contract to
which it is a party or by which it is bound or, to its knowledge, of any
provision of any federal or state judgment, writ, decree, order, statute, rule
or governmental regulation applicable to the Company, which would have a
material adverse affect on the Company's business or prospects, except as
described in the Disclosure Documents. The execution, delivery and performance
of this Agreement and the other agreements entered into in conjunction with the
Offering and the consummation of the transactions contemplated hereby will not
result in any such violation or be in conflict with or constitute, with or
without the passage of time and giving of notice, either a default nor give
others the right to accelerate under any such provision, instrument or contract
or an event which results in the creation of any lien, charge or encumbrance
upon any assets of the Company.
10
<PAGE>
4.6 Reporting Company. The Company currently has a class of
-----------------
securities registered under Section 12 of the Securities Exchange Act of 1934,
as amended (the "Exchange Act").
4.7 Capitalization. The capitalization of the Company as of June 30,
--------------
1997, is, and the capitalization as of the Closing, after taking into account
the offering of the Securities contemplated by this Agreement and all other
share issuances occurring prior to this Offering, will be, as set forth in the
Capitalization Schedule as set forth in Exhibit H. Except as disclosed in the
---------
Capitalization Schedule, as of the date of this Agreement, (i) there are no
outstanding options, warrants, scrip, rights to subscribe for, calls or
commitments of any character whatsoever relating to, or securities or rights
convertible into or exercisable or exchangeable for, any shares of capital stock
of the Company or any of its subsidiaries, or arrangements by which the Company
or any of its subsidiaries is or may become bound to issue additional shares of
capital stock of the Company or any of its subsidiaries, and (ii) other than
agreements with M.H. Myerson & Co. and certain warrant holders, there are no
agreements or arrangements under which the Company or any of its subsidiaries is
obligated to register the sale of any of its or their securities under the Act
(except the Registration Rights Agreement).
4.8 Intellectual Property. The Company has all of the valid,
---------------------
unrestricted and exclusive patents, trademarks, trademark registrations, trade
names, copyrights, know-how, technology and other intellectual property that is
necessary to the conduct of its business in the manner presently conducted as
set forth on Exhibit J-1, it being acknowledged that the Company continues to
-----------
develop new product lines which often requires licenses or other agreements with
hardware manufacturers or software developers, and the Company is in the process
of negotiation, such licenses or agreements with respect to product lines that
are in development. The Company has granted such licenses or has assigned or
otherwise transferred a portion of (or all of) such valid, unrestricted and
exclusive patents, trademarks, trademark registrations, trade names, copyrights,
know-how, technology and other intellectual property necessary to the conduct of
its business as set forth on Exhibit J-2. The Company has been granted
-----------
licenses, know-how, technology and/or other intellectual property necessary to
the conduct of its business as set forth on Exhibit J-3. To the best of the
-----------
Company's knowledge, the Company is not infringing on the intellectual property
rights of any third party, nor is any third party infringing on the Company's
intellectual property rights. There are no restrictions in any agreements,
licenses, franchises, or other instruments which preclude the Company from
engaging in its business as presently conducted.
4.9 Use of Proceeds. As of the date hereof, the Company expects to
---------------
use the proceeds from this Offering (less fees and expenses) for the purposes
and in the approximate amounts set forth on the Use of Proceeds Schedule set
forth as Exhibit I hereto. These purposes and amounts are estimates and are
----------
subject to change without notice to any Subscriber.
4.10 No Rights of Participation. No person or entity, including, but
--------------------------
not limited to, current or former shareholders of the Company, underwriters,
brokers, agents or other third parties, has any right of first refusal,
preemptive right, right of participation, or any similar right to participate
11
<PAGE>
in the financing contemplated by this Agreement which has not been waived.
4.11 Company Acknowledgment. The Company hereby acknowledges that
----------------------
Subscriber may elect to hold the Securities for various periods of time, as
permitted by the terms of this Agreement, the Certificate of Determination, the
Common Warrants and other agreements contemplated hereby, and the Company
further acknowledges that Subscriber and the Placement Agent have made no
representations or warranties, either written or oral (other than those in
Section 2.3.1, to the extent applicable), as to how long the Securities will be
held by Subscriber or regarding Subscriber's trading history or investment
strategies.
4.12 Termination Date of Offering. In no event shall the last
----------------------------
Closing ("Last Closing") of a sale and purchase of the Series C Preferred Stock
and accompanying Common Warrants occur later than November 28, 1997, which date
can be extended by up to ten (10) days upon written approval by the Company and
the Placement Agent (the "Termination Date"). The closing of the offering of
Series B Preferred Stock (the "Series B Closing") shall occur on the date that
is six (6) months after the Record Date (as defined in the Certificate of
Determination for the Series C Preferred Stock) (or, if not a business day, the
next business day thereafter), which date may be extended by up to six (6)
months upon the written agreement of the Company and the Placement Agent.
4.13 Underwriter's Fees and Rights of First Refusal. The Company is
----------------------------------------------
not obligated to pay any compensation or other fees, costs or related
expenditures in cash or securities to any underwriter, broker, agent or other
representative other than the Placement Agent in connection with this Offering.
4.14 [Intentionally Omitted].
4.15 No Integrated Offering. Neither the Company, nor any of its
----------------------
affiliates, nor any person acting on its or their behalf, has directly or
indirectly made any offers or sales of any of the Company's securities or
solicited any offers to buy any security under circumstances that would prevent
the parties hereto from consummating the transactions contemplated hereby
pursuant to an exemption from registration under the Act pursuant to the
provisions of Regulation D. The Company has not engaged in any form of general
solicitation or advertising in connection with the offering of the Series C
Preferred Stock.
4.16 Acknowledgment of Dilution. The number of Conversion Shares
--------------------------
issuable upon conversion of the Preferred Stock may increase substantially in
certain circumstances, including the circumstance wherein the trading price of
the Common Stock declines. The Company's executive officers and directors have
studied and fully understand the nature of the Securities being sold hereunder
and recognize that they have a potential dilutive effect. The board of
directors of the Company has concluded in its good faith business judgment that
such issuance is in the best interests of the Company. The Company acknowledges
that its obligation to issue Conversion Shares upon conversion of the Preferred
Stock is binding upon it and enforceable regardless of the dilution that such
issuance may have on the ownership interests of the other stockholders.
12
<PAGE>
4.17 Foreign Corrupt Practices. Neither the Company, nor any of its
-------------------------
subsidiaries, nor any director, officer, agent, employee or other person acting
on behalf of the Company or any subsidiary has, in the course of its actions
for, or on behalf of, the Company, used any corporate funds for any unlawful
contribution, gift, entertainment or other unlawful expenses relating to
political activity; made any direct or indirect unlawful payment to any foreign
or domestic government official or employee from corporate funds; violated or is
in violation of any provision of the U.S. Foreign Corrupt Practices Act of
1977, as amended; or made any bribe, rebate, payoff, influence payment, kickback
or other unlawful payment to any foreign or domestic government official or
employee.
4.18 Key Employees. Each Key Employee (as defined below) is
-------------
currently serving the Company in the capacity disclosed in Exhibit K. No Key
---------
Employee, to the best knowledge of the Company and its subsidiaries, is, or is
now expected to be, in violation of any material term of any employment
contract, confidentiality, disclosure or proprietary information agreement, non-
competition agreement, or any other contract or agreement or any restrictive
covenant, and the continued employment of each Key Employee does not subject the
Company or any of its subsidiaries to any liability with respect to any of the
foregoing matters. No Key Employee has, to the best knowledge of the Company
and its subsidiaries, any intention to terminate his employment with, or
services to, the Company or any of its subsidiaries. "Key Employee" means Frank
W. Peters.
4.19 Representations Correct. The foregoing representations,
-----------------------
warranties and agreements are true, correct and complete in all material
respects, and shall survive the Closing and the issuance of the shares of
Preferred Stock.
5. Covenants of the Company
5.1 Independent Auditors. The Company shall, until at least three
--------------------
(3) years after the Record Date, maintain as its independent auditors an
accounting firm authorized to practice before the SEC.
5.2 Corporate Existence and Taxes. The Company shall, until at least
-----------------------------
the later of (i) the date that is three (3) years after the Record Date or (ii)
the conversion or redemption of all of the Preferred Stock purchased pursuant to
this Agreement, including the Series B Preferred Stock issued upon exercise of
the Preferred Option and the exercise of the Common Warrants, maintain its
corporate existence in good standing (provided, however, that the foregoing
covenant shall not prevent the Company from entering into any merger or
corporate reorganization as long as the surviving entity in such transaction, if
not the Company, assumes the Company's obligations with respect to the Preferred
Stock and has Common Stock trading on a stock exchange or on Nasdaq and is a
"Reporting Issuer") and shall pay all its taxes when due except for taxes which
the Company disputes.
5.3 Registration Rights. The Company will enter into a registration
-------------------
rights agreement covering the resale of the Conversion Shares and the Warrant
Shares substantially in the form of the Registration Rights Agreement attached
as Exhibit D.
---------
13
<PAGE>
5.4 Notification of Last Closing Date by Company. Within thirty (30)
--------------------------------------------
days after the Last Closing, the Company shall notify Subscriber in writing that
the Last Closing has occurred, the date of the Last Closing, the dates that
Subscriber is entitled to convert Subscriber's Preferred Stock, the value of the
Fixed Conversion Price, as that term is defined in the Certificate of
Determination, and the name and telephone number of an administrative contact
person at the Company whom Subscriber may contact regarding information related
to conversion of the Preferred Stock as contemplated by the Certificate of
Determination.
5.5 Asset Transfers. The Company shall not transfer, sell, convey or
----------------
otherwise dispose of any of its material assets to any Subsidiary or affiliate
except for a cash or cash equivalent consideration and for a proper business
purpose, while any of the Series C Preferred Stock are outstanding; provided,
however, that asset transfers between FTEL and FNet that occur in the ordinary
course of business shall be permissible.
5.6 Capital Raising Limitations; Rights of First Refusal.
----------------------------------------------------
5.6.1 Capital Raising Limitations. Except for offerings contemplated
herein, the Company shall not issue any debt or equity securities for cash in
private capital raising transactions ("Future Offerings") for a period beginning
on the date hereof and ending One Hundred and Eighty (180) days after the Last
Closing without obtaining the prior written approval of Subscribers holding a
majority of the purchase price of Series A and Series C Preferred Stock then
outstanding.
5.6.2 Right of First Offer. The Company agrees that, during the
period beginning on the date hereof and terminating on the first anniversary of
the date of the Last Closing, the Company will not, without the prior written
consent of each Subscriber (which shall be deemed given for the warrants to
purchase Common Stock issued or to be issued to the Placement Agent in
consideration of its services in connection with this Agreement and the
transactions contemplated hereby) issue or sell, or agree to issue or sell any
equity or debt securities of the Company or any of its subsidiaries (or any
security convertible into or exercisable or exchangeable, directly or
indirectly, for equity or debt securities of the Company or any of its
subsidiaries) ("Future Offerings") unless the Company or its Placement Agent
shall have first delivered to each Subscriber at least thirty (30) days prior to
the closing of such Future Offering, written notice describing the proposed
Future Offering, including the terms and conditions thereof, and providing each
Subscriber and its affiliates an option during the twenty (20) day period
following delivery of such notice to purchase up to the full amount of the
securities being offered in the Future Offering on the same terms as
contemplated by such Future Offering (the limitations referred to in this
sentence are collectively referred to as the "Capital Raising Limitations").
The Subscriber shall notify the Company or the Placement Agent, in writing,
prior to the end of such thirty (30) day period if it desires to participate in
the Future Offering.
5.6.3 Amount of Subscriber's Right of First Refusal. The amount of
securities which a Subscriber is entitled to purchase in such a Future Offering
shall be a number obtained by multiplying the aggregate amount of securities
being offered in the Future Offering by
14
<PAGE>
a fraction, the numerator of which is the purchase price of the Preferred Stock
purchased by the Subscriber pursuant to this Agreement and the denominator of
which is the aggregate dollar amount of Preferred Stock placed in this Offering.
5.6.4 Exceptions to the Capital Raising Limitation. The Capital
Raising Limitations shall not apply to any transaction involving issuances of
securities in connection with a merger, consolidation, acquisition or sale of
assets, or in connection with any strategic partnership or joint venture (the
primary purpose of which is not to raise equity capital), or in connection with
the disposition or acquisition of a business, product or license by the Company
or exercise of options by employees, consultants or directors. The Capital
Raising Limitations also shall not apply to (a) the issuance of securities
pursuant to an underwritten public offering, (b) the issuance of securities upon
exercise or conversion of the Company's options, warrants or other convertible
securities outstanding as of the date hereof or (c) the grant of additional
options or warrants, or the issuance of additional securities, under any Company
stock option or restricted stock plan for the benefit of the Company's
employees, directors or consultants.
5.6.5 Right of Series A Holders to Exchange into Series C Preferred
Stock. Each holder of Series A Preferred Stock shall be entitled to subscribe
for Series C Preferred Stock by exchanging all of its Series A Preferred Stock
for an equivalent face amount of Series C Preferred Stock (the "Exchange"). In
order to participate in the Exchange, each Series A Holder shall execute, with
respect to the Series C Offering, a Subscription Agreement, Registration Rights
Agreement and Irrevocable Instructions to Transfer Agent, and shall deliver its
Series A Preferred Stock certificates and Series A Warrants being exchanged to
the Escrow Agent, accompanied by a stock assignment in favor of the Company.
The Exchange shall occur on or prior to the Termination Date.
5.7 Financial 10-K Statements, Etc. and Current Reports on Form 8-K.
---------------------------------------------------------------
The Company shall make available to the Subscriber copies of its Exchange Act
documents for the period commencing with the Company's registration for its
Common Stock for as long any Preferred Stock may remain outstanding.
5.8 Opinion of Counsel. Subscribers shall, upon purchase of the
------------------
Preferred Stock and accompanying Warrants pursuant to this Agreement, receive an
opinion letter from Phillips & Haddan LLP, 4675 MacArthur Court, Suite 710,
Newport Beach, CA 92660, Telephone (714) 752-6100, Telefax (714) 752-6161
("Counsel"), counsel to the Company, in the form attached as Exhibit E.
----------
5.9 Removal of Legend Upon Conversion. As contemplated by the
---------------------------------
Certificate of Determination, upon conversion of the Preferred Stock, Subscriber
shall submit a Notice of Conversion and Resale, substantially in the form
attached hereto as Exhibit L. The Legend shall be removed and the Company shall
---------
issue a certificate without such Legend to the holder of any Security upon which
it is stamped, and a certificate for a security shall be originally issued
without the Legend, if, unless otherwise required by state securities laws, (a)
there is an effective registration statement covering the resale of such
Security under the Act or (b) if no registration statement is then effective
for the resale of the Securities, such holder provides the Company with an
opinion of counsel, in form, substance and scope customary for opinions of
counsel in comparable transactions (the
15
<PAGE>
reasonable cost of which shall be borne by the Company), to the effect that a
public sale or transfer of such Security may be made without registration under
the Act, or (c) such holder provides the Company with reasonable assurances that
such Security can be sold pursuant to Rule 144. Each Subscriber agrees to sell
all Securities, including those represented by a certificate(s) from which the
Legend has been removed, or which were originally issued without the Legend,
pursuant to an effective registration statement and to deliver a prospectus in
connection with such sale or in compliance with an exemption from the
registration requirements of the Act. In the event the Legend is removed from
any Security or any Security is issued without the Legend and thereafter the
effectiveness of a registration statement covering the resale of such Security
is suspended or the Company determines that a supplement or amendment thereto is
required by applicable securities laws, then upon reasonable advance notice to
Subscriber holding such Security, the Company may require that the Legend be
placed on any such Security that cannot then be sold pursuant to an effective
registration statement or Rule 144 or with respect to which the opinion referred
to in clause (b) next above has not been rendered, which Legend shall be removed
when such Security may be sold pursuant to an effective registration statement
or Rule 144 or such holder provides the opinion with respect thereto described
in clause (b) next above.
5.10 Listing. The Company shall (i) use its best efforts to continue
-------
the trading of its Common Stock on the OTC Bulletin Board, or on the Nasdaq
Small Cap Market ("NASDAQ"), Nasdaq National Market System ("NMS"), the New York
Stock Exchange ("NYSE"), or the American Stock Exchange ("AMEX") or any other
national exchange or over-the-counter market system; (ii) take all action
necessary to cause and maintain the trading of its Common Stock on the OTC
Bulletin Board at any time the Common Stock is not traded on NASDAQ, NMS, NYSE
or AMEX; and (iii) comply in all respects with the Company's reporting, filing
and other obligations under the by-laws or rules of the National Association of
Securities Dealers ("NASD") and such exchanges, as applicable.
5.11 The Company's Instructions to Transfer Agent. The Company will
--------------------------------------------
issue to its Transfer Agent the Irrevocable Instructions to Transfer Agent
substantially in the form of Exhibit F instructing the Transfer Agent to issue
---------
certificates, registered in the name of each Subscriber or its nominee, for the
Conversion Shares and Warrant Shares in such amounts as specified from time to
time by such Subscriber to the Company upon conversion of the Preferred Stock,
including the Series B Preferred Stock issued upon the exercise of the Preferred
Option and exercise of the Common Warrants. Such certificates shall bear a
Legend only to the extent permitted by Section 5.9 hereof. The Company warrants
that no instruction, other than such instructions referred to in Section 5.9
hereof or in this Section 5.11 and stop transfer instructions to give effect to
Section 3.7 hereof in the case of Conversion Shares and Warrant Shares prior to
registration of the Conversion Shares and Warrant Shares under the Act, will be
given by the Company to its Transfer Agent and that the Securities shall
otherwise be freely transferable on the books and records of the Company as and
to the extent provided in this Agreement and the Registration Rights Agreement.
Nothing in this Section shall affect in any way each Subscriber's obligations
and agreement set forth in Sections 2.3.3 or 2.3.4 hereof to resell the
Securities pursuant to an effective registration statement and to deliver a
prospectus in connection with such sale or in compliance with an exemption from
the registration requirements of applicable securities laws. If (a) a
Subscriber provides the Company with an opinion
16
<PAGE>
of counsel, which opinion of counsel shall be in form, substance and scope
customary for opinions of counsel in comparable transactions (the reasonable
cost of which shall be borne by the Company), to the effect that the Securities
to be sold or transferred may be sold or transferred pursuant to an exemption
from registration or (b) a Subscriber transfers Securities to an affiliate which
is an accredited investor pursuant to Rule 144, the Company shall permit the
transfer, and, in the case of Conversion Shares and Warrant Shares, promptly
instruct its transfer agent to issue one or more certificates in such name and
in such denomination as specified by such Subscriber. The Company acknowledges
that a breach by it of its obligations hereunder will cause irreparable harm to
a Subscriber by vitiating the intent and purpose of the transaction contemplated
hereby. Accordingly, the Company acknowledges that the remedy at law for a
breach of its obligations under this Section 5.11 will be inadequate and agrees,
in the event of a breach or threatened breach by the Company of the provisions
of this Section 5.11, that a Subscriber shall be entitled, in addition to all
other available remedies, to an injunction restraining any breach and requiring
immediate issuance and transfer, without the necessity of showing economic loss
and without any bond or other security being required. The Company hereby agrees
that, without the written approval of the Placement Agent, it will not
unilaterally terminate its relationship with the Transfer Agent for any reason
prior to the date which is three (3) years after the Record Date or one (1)
month after the first date that no Preferred Stock and no Warrants are
outstanding, whichever is earlier (the "Ending Date"). In the event the
Company's agency relationship with the Transfer Agent should be terminated for
any other reason prior to the date which is three (3) years after the Record
Date, the Company's Transfer Agent shall continue acting as transfer agent
pursuant to the terms of the Irrevocable Instructions to Transfer Agent until
such time that a successor transfer agent (i) is appointed by the Company; (ii)
is approved by seventy-five percent (75%) of the Subscribers of outstanding
Preferred Stock; and (iii) executes and agrees to be bound by the terms of the
Irrevocable Instructions to Transfer Agent.
5.12 Terms of Series B Preferred Option. The Preferred Option shall
-----------------------------------
inure to the benefit of the holders of the Series A Preferred Stock and Series C
Preferred Stock (or if such preferred stock has been converted, the last holder
thereof). In conjunction with the issuance of the Series B Preferred Stock and
the accompanying Series B Common Warrants, the Company agrees to execute
agreements substantially similar to this Subscription Agreement, the
Registration Rights Agreement, the Irrevocable Instructions to Transfer Agent
and other applicable agreements from the Series C offering. No person or entity
other than the holders of the Series A Preferred Stock or Series C Preferred
Stock (or if such preferred stock has been converted, the last holder thereof)
shall be entitled to purchase Series B Preferred Stock.
6. Subscriber Covenants/Miscellaneous
6.1 Representations and Warranties Survive the Closing; Severability.
-----------------------------------------------------------------
Subscriber's and the Company's representations and warranties shall survive the
Closing of the transactions contemplated by this Agreement and the conversion of
the Preferred Stock notwithstanding any due diligence investigation made by or
on behalf of the party seeking to rely thereon. In the event that any provision
of this Agreement becomes or is declared by a court of competent jurisdiction to
be illegal, unenforceable or void, this Agreement shall continue in full force
and effect without said provision; provided that no such severability shall be
effective if it materially changes the economic
17
<PAGE>
benefit of this Agreement to any party.
6.2 Successors and Assigns. The terms and conditions of this
----------------------
Agreement shall inure to the benefit of and be binding upon the respective
successors and assigns of the parties. Nothing in this Agreement, express or
implied, is intended to confer upon any party other than the parties hereto or
their respective successors and assigns any rights, remedies, obligations, or
liabilities under or by reason of this Agreement, except as expressly provided
in this Agreement. Subscriber may assign Subscriber's rights hereunder, in
connection with any private sale of the Preferred Stock of such Subscriber, so
long as, as a condition precedent to such transfer, the transferee executes an
acknowledgment agreeing to be bound by the applicable provisions of this
Agreement.
6.3 Governing Law. This Agreement shall be governed by and construed
-------------
under the laws of the State of California without respect to conflict of laws
principles.
6.4 Execution in Counterparts Permitted. This Agreement may be
-----------------------------------
executed in any number of counterparts, each of which shall be enforceable
against the parties actually executing such counterparts, and all of which
together shall constitute one (1) instrument.
6.5 Titles and Subtitles; Gender. The titles and subtitles used in
----------------------------
this Agreement are used for convenience only and are not to be considered in
construing or interpreting this Agreement. The use in this Agreement of a
masculine, feminine or neither pronoun shall be deemed to include a reference to
the others.
6.6 Written Notices, Etc. Any notice, demand or request required or
--------------------
permitted to be given by the Company or Subscriber pursuant to the terms of this
Agreement shall be in writing and shall be deemed given when delivered
personally, or by facsimile (with a hard copy to follow by two (2) day courier),
addressed to the parties at the addresses and/or facsimile telephone number of
the parties set forth at the end of this Agreement or such other address as a
party may request by notifying the other in writing.
6.7 Expenses. Each of the Company and Subscriber shall pay all costs
--------
and expenses that it respectively incurs, with respect to the negotiation,
execution, delivery and performance of this Agreement.
6.8 Entire Agreement; Written Amendments Required. This Agreement,
---------------------------------------------
including the Exhibits attached hereto, the Certificate of Determination, the
Preferred Stock certificates, the Common Warrants, the Registration Rights
Agreement, the Escrow Agreement, the Irrevocable Instructions to Transfer Agent
and the other documents delivered pursuant hereto constitute the full and entire
understanding and agreement between the parties with regard to the subjects
hereof and thereof, and no party shall be liable or bound to any other party in
any manner by any warranties, representations or covenants except as
specifically set forth herein or therein. Except as expressly provided herein,
neither this Agreement nor any term hereof may be amended, waived, discharged or
terminated other than by a written instrument signed by the party against whom
enforcement of any such amendment, waiver, discharge or termination is sought.
18
<PAGE>
6.9 Arbitration. Any controversy or claim arising out of or related
-----------
to this Agreement or the breach thereof, shall be settled by binding arbitration
in Los Angeles, California in accordance with the Expedited Procedures (Rules
53-57) of the Commercial Arbitration Rules of the American Arbitration
Association ("AAA"). A proceeding shall be commenced upon written demand by
Company or any Subscriber to the other. The arbitrator(s) shall enter a
judgment by default against any party which fails or refuses to appear in any
properly noticed arbitration proceeding. The proceeding shall be conducted by
one (1) arbitrator, unless the amount alleged to be in dispute exceeds two
hundred fifty thousand dollars ($250,000), in which case three (3) arbitrators
shall preside. The arbitrator(s) will be chosen by the parties from a list
provided by the AAA, and if they are unable to agree within ten (10) days, the
AAA shall select the arbitrator(s). The arbitrators must be experts in
securities law and financial transactions. The arbitrators shall assess costs
and expenses of the arbitration, including all attorneys' and experts' fees, as
the arbitrators believe is appropriate in light of the merits of the parties'
respective positions in the issues in dispute. Each party submits irrevocably
to the jurisdiction of any state court sitting in Los Angeles, California or to
the United States District Court sitting in California for purposes of
enforcement of any discovery order, judgment or award in connection with such
arbitration. The award of the arbitrator(s) shall be final and binding upon the
parties and may be enforced in any court having jurisdiction. The arbitration
shall be held in such place as set by the arbitrator(s) in accordance with Rule
55.
6.10 Voting Trust Agreement. Upon issuance of Conversion Shares upon
----------------------
any conversion of Preferred Stock, or issuance of Warrant Shares upon exercise
of the Common Warrants, the Subscribers shall execute and deliver a Voting Trust
Agreement in the form of Exhibit M hereto, covering the Excess Shares, as that
term is defined below. As used herein, the term "Excess Shares" shall mean all
shares of Common Stock of the Company acquired by Subscribers in excess of the
number obtained by dividing the aggregate purchase price of all Series C
Preferred Stock issued to such Subscriber by the Fixed Conversion Price of the
Series C Preferred Stock. When and to the extent that the Conversion Shares and
Warrant Shares which are subject to the Voting Trust are sold in a public market
transaction, such shares shall thereafter no longer be subject to the Voting
Trust Agreement.
7. Subscription and Wiring Instructions; Irrevocability.
7.1 Subscription
------------
(a) Wire transfer of Subscription Funds. Subscriber shall send this
signed Agreement by facsimile to the Placement Agent at (770)
640-7150, and send the subscription funds by wire transfer, to
the Escrow Agent as follows:
First Union National Bank
ABA No. 053000219
Account No. 465946
Account Name: Trust Ledger
Attn: Claire Moore/Nicole Stefanini
Telephone No.: (404) 827-7326
19
<PAGE>
Reference: Franklin Esc #3072236887
Ref: Subscriber's Name
(b) Irrevocable Subscription. Subscriber hereby acknowledges and
agrees, subject to the provisions of any applicable laws
providing for the refund of subscription amounts submitted by
Subscriber, that this Agreement is irrevocable and that
Subscriber is not entitled to cancel, terminate or revoke this
Agreement or any other agreements executed by such Subscriber and
delivered pursuant hereto, and that this Agreement and such other
agreements shall survive the death or disability of such
Subscriber and shall be binding upon and inure to the benefit of
the parties and their heirs, executors, administrators,
successors, legal representatives and assigns. If the Securities
subscribed for by Subscriber are to be owned by more than one
person, the obligations of all such owners under this Agreement
shall be joint and several, and the agreements, representations,
warranties and acknowledgments herein contained shall be deemed
to be made by and be binding upon each such person and his heirs,
executors, administrators, successors, legal representatives and
assigns. Notwithstanding the foregoing, (i) if the conditions to
Closing are not satisfied or (ii) if the Disclosure Documents are
discovered prior to Closing to contain statements which are
materially inaccurate, or omit statements of material fact,
Subscriber may revoke or cancel this Agreement.
(c) Company's Right to Reject Subscription. Subscriber understands
that this Agreement is not binding on the Company until the
Company accepts it. This Agreement shall be accepted by the
Company when the Company countersigns this Agreement. Subscriber
hereby confirms that the Company has full right in its sole
discretion to accept or reject the subscription of Subscriber, in
whole or in part, provided that, if the Company decides to reject
such subscription, the Company must do so promptly and in
writing. In the case of rejection, the Company will promptly
return any rejected payments and (if rejected in whole) copies of
all executed subscription documents (including without limitation
this Agreement) to Subscriber. In the event of rejection, no
interest will be payable by the Company to Subscriber on any
return of payment, provided however, that any such interest
accrued on such funds in the Escrow Account shall be returned to
the Subscriber by the Escrow Agent.
7.2 Acceptance of Subscription. In the case of acceptance of
--------------------------
Subscriber's subscription, ownership of the number of securities being purchased
hereby will pass to Subscriber upon the Closing.
7.3 Subscriber to Forward Original Signed Subscription Agreement to
---------------------------------------------------------------
Company. Subscriber agrees to courier to Company his, her or its original inked
- -------
signed Subscription Agreement
20
<PAGE>
within two (2) days after faxing said signed agreement to Placement Agent.
8. Indemnification.
The Company agrees to indemnify and hold harmless Subscriber and the
Placement Agent and each of their respective officers, directors, employees and
agents, and each person who controls Subscriber or the Placement Agent within
the meaning of the Act or the Exchange Act (each, a "Subscriber Indemnified
Party") against any losses, claims, damages or liabilities, joint or several, to
which it, they or any of them, may become subject and not otherwise reimbursed
arising from or due to any untrue statement of a material fact or the omission
to state any material fact required to be stated in order to make the statements
not misleading in any representation or warranty made by the Company contained
in this Agreement or in any statements contained in the Disclosure Documents.
Subscriber agrees to indemnify and hold harmless the Company and the
Placement Agent and each of their respective officers, directors, employees and
agents, and each person who controls Company or the Placement Agent within the
meaning of the Act or the Exchange Act (each, a "Company Indemnified Party") (a
Subscriber Indemnified Party or a Company Indemnified Party may be hereinafter
referred to singularly as "Indemnified Party") against any losses, claims,
damages or liabilities, joint or several, to which it, they or any of them, may
become subject and not otherwise reimbursed arising from or due to any untrue
statement of a material fact or the omission to state any material fact required
to be stated in order to make the statements not misleading in any
representation or warranty made by Subscriber contained in this Agreement.
Promptly after receipt by an Indemnified Party of notice of the
commencement of any action pursuant to which indemnification may be sought, such
Indemnified Party will, if a claim in respect thereof is to be made against the
other party (hereinafter "Indemnitor") under this Section 8, deliver to the
Indemnitor a written notice of the commencement thereof and the Indemnitor shall
have the right to participate in and to assume the defense thereof with counsel
reasonably selected by the Indemnitor, provided, however, that an Indemnified
Party shall have the right to retain its own counsel, with the reasonably
incurred fees and expenses of such counsel to be paid by the Indemnitor, if
representation of such Indemnified Party by the counsel retained by the
Indemnitor would be inappropriate due to actual or potential conflicts of
interest between such Indemnified Party and any other party represented by such
counsel in such proceeding. The failure to deliver written notice to the
Indemnitor within a reasonable time of the commencement of any such action, if
prejudicial to the Indemnitor's ability to defend such action, shall relieve the
Indemnitor of any liability to the Indemnified Party under this Section 8, but
the omission to so deliver written notice to the Indemnitor will not relieve it
of any liability that it may have to any Indemnified Party other than under this
Section 8 to the extent it is prejudicial.
9. Certain Additional Legends and Information.
FOR FLORIDA RESIDENTS:
THE SECURITIES REFERRED TO HEREIN WILL BE SOLD TO, AND ACQUIRED
21
<PAGE>
BY, THE HOLDER IN A TRANSACTION EXEMPT UNDER SECTION 517.061 OF THE FLORIDA
SECURITIES ACT. THE SECURITIES HAVE NOT BEEN REGISTERED UNDER SAID ACT IN THE
STATE OF FLORIDA. IN ADDITION, ALL FLORIDA RESIDENTS SHALL HAVE THE PRIVILEGE
OF VOIDING THE PURCHASE WITHIN THREE (3) DAYS AFTER THE FIRST TENDER OF
CONSIDERATION IS MADE BY SUCH SUBSCRIBER TO THE ISSUER, AN AGENT OF THE ISSUER,
OR AN ESCROW AGENT OR WITHIN THREE DAYS AFTER THE AVAILABILITY OF THAT PRIVILEGE
IS COMMUNICATED TO SUCH SUBSCRIBER, WHICHEVER OCCURS LATER.
FOR MAINE RESIDENTS:
THESE SECURITIES ARE BEING SOLD PURSUANT TO AN EXEMPTION FROM
REGISTRATION WITH THE BANK SUPERINTENDENT OF THE STATE OF MAINE UNDER SECTION
10502(2)(R) OF TITLE 32 OF THE MAINE REVISED STATUTES. THESE SECURITIES MAY BE
DEEMED RESTRICTED SECURITIES AND AS SUCH THE HOLDER MAY NOT BE ABLE TO RESELL
THE SECURITIES UNLESS PURSUANT TO REGISTRATION UNDER STATE OR FEDERAL SECURITIES
LAWS OR UNLESS AN EXEMPTION UNDER SUCH LAWS EXISTS.
22
<PAGE>
FOR PENNSYLVANIA RESIDENTS:
EACH PENNSYLVANIA RESIDENT WHO SUBSCRIBES FOR THE SECURITIES BEING
OFFERED HEREBY AGREES NOT TO SELL THESE SECURITIES FOR A PERIOD OF TWELVE MONTHS
AFTER THE DATE OF PURCHASE UNLESS SUCH SECURITIES HAVE BEEN REGISTERED FOR SALE.
UNDER PROVISION OF THE PENNSYLVANIA SECURITIES ACT OF 1972 (THE "1972 ACT"),
EACH PENNSYLVANIA RESIDENT SHALL HAVE THE RIGHT TO WITHDRAW HIS ACCEPTANCE
WITHOUT INCURRING ANY LIABILITY, TO THE SELLER, UNDERWRITER (IF ANY) OR ANY
PERSON, WITHIN TWO (2) BUSINESS DAYS FROM THE DATE OF RECEIPT BY THE ISSUER OF
HIS WRITTEN BINDING CONTRACT OF PURCHASE OR IN THE CASE OF A TRANSACTION IN
WHICH THERE IS NO WRITTEN BINDING CONTRACT OF PURCHASE, WITHIN TWO BUSINESS DAYS
AFTER HE MAKES THE INITIAL PAYMENT FOR THE SECURITIES BEING OFFERED. TO
ACCOMPLISH THIS WITHDRAWAL, A SUBSCRIBER NEED ONLY SEND A LETTER OR TELEGRAM TO
THE SELLING AGENT AT THE ADDRESS SET FORTH IN THE TEXT OF THE MEMORANDUM,
INDICATING HIS OR HER INTENTION TO WITHDRAW. SUCH LETTER OR TELEGRAM SHOULD BE
SENT AND POSTMARKED PRIOR TO THE END OF THE AFOREMENTIONED SECOND BUSINESS DAY.
IT IS PRUDENT TO SEND SUCH LETTER BY CERTIFIED MAIL, RETURN RECEIPT REQUESTED,
TO ENSURE THAT IT IS RECEIVED AND ALSO TO EVIDENCE THE TIME WHEN IT WAS MAILED.
IF THE REQUEST IS MADE ORALLY (IN PERSON OR BY TELEPHONE, TO THE SELLING AGENT
AT THE NUMBER LISTED IN THE TEXT OF THE MEMORANDUM) A WRITTEN CONFIRMATION THAT
THE REQUEST HAS BEEN RECEIVED SHOULD BE REQUESTED.
FOR NEW HAMPSHIRE RESIDENTS:
NEITHER THE FACT THAT A REGISTRATION STATEMENT OR AN APPLICATION FOR A
LICENSE HAS BEEN FILED WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT THAT A
SECURITY IS EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN THE STATE OF NEW
HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE THAT ANY DOCUMENT
FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER ANY SUCH
FACT NOR THE FACT THAT AN EXEMPTION OR EXCEPTION IS AVAILABLE FOR A SECURITY OR
A TRANSACTION MEANS THAT THE SECRETARY OF STATE HAS PASSED IN ANY WAY UPON THE
MERITS OR QUALIFICATIONS OF, OR RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON,
SECURITY, OR TRANSACTION. IT IS UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY
PROSPECTIVE PURCHASER, CUSTOMER OR CLIENT ANY REPRESENTATION INCONSISTENT WITH
THE PROVISIONS OF THIS PARAGRAPH.
[INTENTIONALLY LEFT BLANK]
23
<PAGE>
10. Number of Shares and Purchase Price. Subscriber subscribes for _________
shares of Preferred Stock (in the amount of $10,000 per Share) and the
accompanying Common Warrants against payment by wire transfer in the amount of
$___________________ ("Purchase Price") or $______________ in Face Value of
Series A Preferred Stock certificates.
11. Accredited Investor. Subscriber is an "accredited investor" because
(check all applicable boxes):
(a) [_] it is an organization described in Section 501(c)(3) of the Internal
Revenue Code, or a corporation, business trust, or partnership not
formed for the specific purpose of acquiring the securities offered,
with total assets in excess of $5,000,000.
(b) [_] any trust, with total assets in excess of $5,000,000, not formed for
the specific purpose of acquiring the securities offered, whose
purchase is directed by a sophisticated person who has such
knowledge and experience in financial and business matters that he
is capable of evaluating the merits and risks of the prospective
investment.
(c) [_] a natural person, who
[_] is a director, executive officer or general partner of the issuer of
the securities being offered or sold or a director, executive
officer or general partner of a general partner of that issuer.
[_] has an individual net worth, or joint net worth with that person's
spouse, at the time of his purchase exceeding $1,000,000.
[_] had an individual income in excess of $200,000 in each of the two most
recent years or joint income with that person's spouse in excess of
$300,000 in each of those years and has a reasonable expectation of
reaching the same income level in the current year.
(d) [_] an entity each equity owner of which is an entity described in a - b
above or is an individual who could check one (1) of the last three
(3) boxes under subparagraph (c) above.
(e) [ ] other [specify]
-------------------------------------------------------
The undersigned acknowledges that this Agreement and the subscription
represented hereby shall not be effective unless accepted by the Company as
indicated below.
IN WITNESS WHEREOF, the undersigned Subscriber does represent and certify under
penalty of perjury that the foregoing statements are true and correct and that
Subscriber by the following signature(s) executed this Agreement.
Dated this _____ day of November, 1997.
- ------------------------------------ ----------------------------------------
Your Signature PRINT EXACT NAME IN WHICH YOU WANT
THE SECURITIES TO BE REGISTERED
DELIVERY INSTRUCTIONS:
- ------------------------------------ ----------------------
Name: Please Print Please type or print address where your
security is to be delivered
ATTN.:
- ------------------------------------ ----------------------------------
Title/Representative Capacity
(if applicable)
- ------------------------------------ ----------------------------------------
Name of Company You Represent Street Address
(if applicable)
- ------------------------------------ ----------------------------------------
Place of Execution of this Agreement City, State or Province, Country,
Offshore Postal Code
-----------------------------------
Phone Number (For Federal Express)
and Fax Number (re: Notice)
THIS AGREEMENT IS ACCEPTED BY THE COMPANY IN THE AMOUNT OF $ _________________
ON THE ____ DAY OF November, 1997.
Franklin Telecommunications Corp.
24
<PAGE>
By:________________________________
Name:______________________________
Title:_____________________________
NOTICE OF CONVERSION [AND RESALE]
(To be Executed by the Registered Holder
in order to Convert the Preferred Stock)
The undersigned hereby elects to convert _____________ shares of Series C
Preferred Stock, represented by stock certificate No(s). ________________ (the
"Preferred Stock Certificates") into shares of common stock ("Common Stock") of
Franklin Telecommunications Corp. (the "Company") according to the conditions of
the Certificate of Determination of Series C Preferred Stock, as of the date
written below [in connection with the resale of the underlying Common Stock
unless otherwise indicated below]. If shares are to be issued in the name of a
person other than the undersigned, the undersigned will pay all transfer taxes
payable with respect thereto and is delivering herewith such certificates. No
fee will be charged to the Holder for any conversion, except for transfer taxes,
if any. A copy of each of the Preferred Stock Certificates being converted is
attached hereto. The undersigned agrees to deliver a Prospectus in connection
with any sale made pursuant to the Registration Statement, as provided in
Section 5.10 of the Subscription Agreement.
____ Check here if this conversion is not being made in connection
with the resale of the Common Stock.
Date of Conversion:____________________
Applicable Conversion Price:___________
Number of Shares of
Common Stock to be Issued:_____________
Signature:_____________________________
Name:__________________________________
Address: ______________________________
* No shares of Common Stock will be issued until the original Series C Preferred
Stock Certificate(s) to be converted and the Notice of Conversion are received
by the Company or its Transfer Agent. The Holder shall (i) send via facsimile,
on or prior to 11:59 p.m., New York City time, on the date of conversion, a copy
of this completed and fully executed Notice of Conversion to the Company at the
office of the Company with a copy to its designated Transfer Agent for the
Series C Preferred Stock that the Holder elects to convert and (ii) surrender,
to a common courier for either overnight or two (2) day delivery to the office
of the Company or the Transfer Agent, the original Series C Preferred Stock
Certificate(s) representing the Series C Preferred Stock being converted, duly
endorsed for transfer. The Company or its Transfer Agent shall issue shares of
Common Stock and surrender them to a common courier for delivery to the
shareholder within three (3) business days following receipt of a facsimile of
this Notice of Conversion and receipt by the Company or its Transfer Agent of
---
the original Series C Preferred Stock Certificate(s) to be converted, all in
accordance with the terms
25
<PAGE>
of the Certificate of Determination and the Subscription Agreement, and shall
make payments for the number of business days such issuance and delivery is
late, pursuant to the terms of the Subscription Agreement.
EXHIBIT L
26
<PAGE>
EXHIBIT 10.17
SERIES C REGISTRATION RIGHTS AGREEMENT
THIS REGISTRATION RIGHTS AGREEMENT ("Agreement") is entered into as of
November ___, 1997, by and among Franklin Telecommunications Corp., a
corporation duly incorporated and existing under the laws of the State of
California ("Company"), Swartz Investments, LLC ("Swartz"), a Georgia limited
liability company, and the subscribers (hereinafter referred to as
"Subscribers") to the Company's offering ("Offering") of up to Seven Million
Four Hundred Thousand Dollars ($7,400,000) of Series C Preferred Stock
(including shares of the Company's Series A Preferred Stock which may or may not
be exchanged for Series C Preferred Stock, the "Preferred Stock"), each pursuant
to the Regulation D Subscription Agreement between the Company and each of the
Subscribers ("Subscription Agreement").
1. Definitions. For purposes of this Agreement:
-----------
(a) The terms "register," "registered," and "registration" refer to a
registration effected by preparing and filing a registration statement or
similar document in compliance with the Securities Act of 1933 (the "Act"), and
pursuant to Rule 415 under the Act or any successor rule, and the declaration or
ordering of effectiveness of such registration statement or document;
(b) For purposes hereof, the term "Registrable Securities" means the
shares of the Company's Common Stock together with any capital stock issued in
replacement of, in exchange for or otherwise in respect of such Common Stock
(the "Common Stock"), issuable or issued upon (i) conversion of the Preferred
Stock, (ii) exercise of the warrants to purchase Common Stock to be issued to
the Subscribers in connection with the Offering (the "Subscriber Warrants") and
(iii) exercise, by Swartz or any subsequent Holder of the Warrant or portion
thereof, of the Warrant to purchase Common stock issued to Swartz in connection
with the Offering (the "Placement Agent Warrant", together with the Subscriber
Warrants, collectively referred to as the "Warrants").
Notwithstanding the above:
1. Common Stock which would otherwise be deemed to be Registrable
Securities shall not constitute Registrable Securities if those shares
of Common Stock may be resold without volume limitations without
registration pursuant to Rule 144(k) under the Act, as evidenced by a
letter from the Company, in form and substance acceptable to the
Company's transfer agent, to such effect; and
2. any Registrable Securities resold in a public transaction shall
cease to constitute Registrable Securities.
(c) The number of shares of "Registrable Securities then outstanding"
shall be determined by the number of shares of Common Stock which have been
issued or are issuable upon conversion of the Preferred Stock and exercise of
the then outstanding Warrants at the time of such determination;
1
<PAGE>
(d) The term "Holder" means any person owning or having the right to
acquire Registrable Securities or any permitted assignee thereof; and
(e) The term "Due Date" means the date which is four (4) months after
the Record Date (as defined in the Certificate of Determination of the Series C
Preferred Stock) of the Offering.
EXHIBIT D
2
<PAGE>
2. Required Registration.
---------------------
(a) The Company shall, within two (2) months after the Record Date of
the Offering of the Preferred Stock, file a registration statement on Form S-1
(or other suitable form), or, at the Company's discretion, a post-effective
amendment to an effective registration statement (collectively, a "Registration
Statement"), but subject to the reasonable approval of Subscribers), covering
the resale of all shares of Registrable Securities then outstanding or issuable
upon conversion of all then outstanding Preferred Stock or upon exercise of the
Warrants. Such Registration Statement shall initially cover the number of shares
issuable upon exercise of the Placement Agent Warrant plus at least Five Million
Five Hundred Thousand (5,500,000) shares of Common Stock and shall cover, to the
extent allowed by applicable law, such additional indeterminate number of shares
of Common Stock as are required to effect conversion of the Preferred Stock due
to fluctuations in the price of the Company's Common Stock, in accordance with
Rule 416 of the Act. The Company shall use its best efforts to have the
Registration Statement declared effective as soon as possible. In the event
that the Company determines, which determination shall be made by the Company
within five (5) business days after the last business day of each month after
the Due Date or is notified at any time by a Holder, that the Registration
Statement does not cover a sufficient number of shares of Common Stock to effect
the resales of a number of shares of Common Stock equal to one hundred twenty
five percent (125%) of the number of shares of Common Stock issuable to each
Subscriber upon conversion of all outstanding Preferred Stock then eligible for
conversion, at the Conversion Price (as defined in the Certificate of
Determination of the Preferred Stock) in effect on the last business day of such
month (the "Assumed Conversion Price"), and upon exercise of all the outstanding
Warrants (a "Registration Shortfall"), the Company shall, within five (5)
business days, amend the Registration Statement or file a new Registration
Statement (also an "Amended" or "New" Registration Statement, respectively), as
appropriate, to add such number of additional shares as would be necessary to
effect the resales of a number of shares of Common Stock equal to one hundred
fifty percent (150%) of the number of shares of Common Stock issuable to each
Subscriber upon conversion of all outstanding Preferred Stock then eligible for
conversion, at the Assumed Conversion Price then in effect and upon exercise of
all the outstanding Warrants. If the Registration Statement is not filed within
two (2) months after the Record Date of the Offering, the Company shall pay each
of the Subscribers an amount equal to two percent (2%) per month of the
aggregate amount of outstanding Preferred Stock held by such Subscriber,
accruing daily until the Registration Statement is filed, payable in cash or
Common Stock, as set forth below ("Late Filing Payment"). If the Registration
Statement is not declared effective by the Due Date, or if any Amended or New
Registration Statement required to be filed hereunder is not declared effective
within two (2) calendar months of the date it is required to be filed, the
Company shall pay each Subscriber an amount equal to two (2%) per month of the
aggregate amount of outstanding Preferred Stock held by such Subscriber,
accruing daily until the Registration Statement or a registration statement
filed pursuant to Section 3 of this Agreement is declared effective (the "Late
Registration Payment"). Any Late Filing Payment or Late Registration Payment
shall be payable in Common Stock for the first three (3) months of accrual of
such payments, and thereafter shall be payable in Common Stock or cash, at the
Subscriber's option, as follows: If Subscriber elects to be paid in cash, such
late Filing Payment or Late Registration Payment shall be paid to such
Subscriber within five
3
<PAGE>
(5) business days following the end of the month in which such Late Registration
Payment was accrued. If Subscriber elects to be paid in Common Stock, such
number of shares shall be determined as follows:
Upon conversion of each share of Preferred Stock, the Company shall issue
to the Subscriber the number of shares of Common Stock determined as set
forth in Section 5(a) of the Certificate of Designation, plus an additional
number of shares of Common Stock
4
<PAGE>
attributable to such share of Preferred Stock (the "Additional Shares")
determined as set forth below:
Additional Shares = Late Registration Payment + Late Filing Payment
-----------------------------------------------
Conversion Price
With respect to the Preferred Stock, "Conversion Price" has the definition
ascribed to it in the Certificate of Designation.
Such Additional Shares shall also be deemed "Registrable Securities" as defined
herein. The Company covenants to use its best efforts to use Form S-1 for the
registration required by this Section during all applicable times contemplated
by this Agreement.
(b) The Registration Statement shall be prepared as a "shelf"
registration statement under Rule 415, and shall be maintained effective until
all Registrable Securities cease to exist.
(c) The Company represents that it is presently eligible to effect the
registration contemplated hereby on Form S-1 and will use its best efforts to
continue to take such actions as are necessary to maintain such eligibility.
3. Piggyback Registration. If the Registration Statement described
----------------------
in Section 2 is not effective by the Due Date or lapses at anytime thereafter
that it is required to be effective, and if (but without any obligation to do
so) the Company proposes to register (including for this purpose a registration
effected by the Company for shareholders other than the Holders) any of its
Common Stock under the Act in connection with the public offering of such
securities solely for cash (other than a registration relating solely for the
sale of securities to participants in a Company stock plan or a registration on
Form S-4 promulgated under the Act or any successor or similar form registering
stock issuable upon a reclassification, upon a business combination involving an
exchange of securities or upon an exchange offer for securities of the issuer or
another entity), the Company shall, at such time, promptly give each Holder
written notice of such registration (a "Piggyback Registration Statement"). Upon
the written request of each Holder given by fax within ten (10) days after
mailing of such notice by the Company, the Company shall cause to be included in
such registration statement under the Act all of the Registrable Securities that
each such Holder has requested to be registered ("Piggyback Registration") to
the extent such inclusion does not violate the registration rights of any other
Security holder of the company granted prior to the date hereof; nothing herein
shall prevent the Company from withdrawing or abandoning the registration
statement prior to its effectiveness. The election of initiating Holders to
participate in a Piggyback Registration Statement shall not impact the amount
payable to investors pursuant to Section 2(a) herein except that the Late
Registration Payment shall cease to accrue as of the date of effectiveness of
the Piggyback Registration Statement.
4. Limitation on Obligations to Register.
-------------------------------------
(a) In the case of a Piggyback Registration on an underwritten public
offering by the Company, if the managing underwriter determines and advises in
writing that the inclusion in the
5
<PAGE>
registration statement of all Registrable Securities proposed to be included
would interfere with the successful marketing of the securities proposed to be
registered by the Company, then the number of such Registrable Securities to be
included in the registration statement, to the extent such Registrable
Securities may be included in such Piggyback Registration Statement shall be
allocated among all Holders who had requested Piggyback Registration pursuant to
the terms hereof, in the proportion that the number of Registrable Securities
which each such Holder, including Swartz, seeks to register bears to the total
number of Registrable Securities sought to be included by all Holders, including
Swartz. If required by the managing underwriter of such an underwritten public
offering, the Holders shall enter into an agreement in customary form reasonably
limiting the number of Registrable Securities to be included in such Piggyback
Registration Statement and the terms, if any, regarding the future sale of such
Registrable Securities included in such registration statement.
(b) In the event the Company believes that shares sought to be
registered under Section 2 or Section 3 by Holders do not constitute
"Registrable Securities" by virtue of Section 1(b) of this Agreement, and the
status of those shares as Registrable Securities is disputed, the Company shall
provide, at its expense, an Opinion of Counsel, reasonably acceptable to the
Holders of the Securities at issue (and satisfactory to the Company's transfer
agent to permit the sale and transfer) that those securities may be sold
immediately, without volume limitation, without registration under the Act, by
virtue of Rule 144(k).
5. Obligations of the Company. Whenever required under this
--------------------------
Agreement, or a post-effective amendment to an effective registration statement,
to effect the registration of any Registrable Securities, the Company shall, as
expeditiously as reasonably possible:
(a) Prepare and file with the Securities and Exchange Commission
("SEC") a registration statement, or such a post-effective amendment, with
respect to such Registrable Securities and use its best efforts to cause such
registration statement to become effective.
(b) Prepare and file with the SEC such amendments and supplements to
such registration statement, or such a post-effective amendment, and the
prospectus used in connection with such registration statement as may be
necessary to comply with the provisions of the Act with respect to the
disposition of all securities covered by such registration statement.
(c) Furnish to the Holders such numbers of copies of a prospectus,
including a preliminary prospectus, in conformity with the requirements of the
Securities Act, and such other documents as they may reasonably request in order
to facilitate the disposition of Registrable Securities owned by them.
(d) Use its best efforts to register and qualify the securities
covered by such registration statement under such other securities or Blue Sky
laws of such jurisdictions as shall be reasonably requested by the Holders of
the Registrable Securities covered by such registration statement, provided that
the Company shall not be required in connection therewith or as a condition
thereto to qualify to do business or to file a general consent to service of
process in any such states or jurisdictions.
6
<PAGE>
(e) In the event of any underwritten public offering, enter into and
perform its obligations under an underwriting agreement, in usual and customary
form, with the managing underwriter of such offering. Each Holder participating
in such underwriting shall also enter into and perform its obligations under
such an agreement.
(f) As promptly as practicable after becoming aware of such event,
notify each Holder of Registrable Securities of the happening of any event of
which the Company has knowledge, as a result of which the prospectus included in
the registration statement, as then in effect, includes an untrue statement of a
material fact or omits to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading, and subject to Section 6 use its best
efforts promptly to prepare a supplement or amendment to the registration
statement to correct such untrue statement or omission, and deliver a number of
copies of such supplement or amendment to each Holder as such Holder may
reasonably request.
(g) Provide Holders with written notice of the date that a
registration statement registering the resale of the Registrable Securities is
declared effective by the SEC, and the date or dates when the Registration
Statement is no longer effective.
(h) Provide Holders and their representatives the opportunity to
conduct a reasonable due diligence inquiry of Company's pertinent financial and
other records and make available its officers, directors and employees for
questions regarding such information as it relates to information contained in
the registration statement.
(i) Provide Holders and their representatives the opportunity to
review the registration statement and all amendments thereto a reasonable period
of time prior to their filing with the SEC if so requested by Holder in writing.
6. Black Out. In the event that, during the time that the
---------
Registration Statement is effective, the Company reasonably determines, based
upon advice of counsel, that due to the existence of material non-public
information, disclosure of such material non-public information would be
required to make the statements contained in the Registration Statement not
misleading, and the Company has a bona fide business purpose for preserving as
confidential such material non-public information (a "Blackout"), the Company
shall have the right to suspend the effectiveness of the Registration Statement,
and no Holder shall be permitted to sell any Registrable Securities pursuant
thereto, until such time as such suspension is no longer advisable; provided,
however, that such time shall not exceed a period of fifteen (15) days. The
Company shall be entitled to no more than two (2) such blackouts in any one (1)
year period. As soon as such suspension is no longer advisable, the Company
shall, if required, promptly, but in no event later than the date the Company
files any documents with the Securities and Exchange Commission ("SEC")
referencing such material information, file with the SEC an amendment to the
Registration Statement disclosing such information and use its best efforts to
have such amendment declared effective as soon as possible.
In the event the effectiveness of the Registration Statement is
suspended by
7
<PAGE>
the Company pursuant hereto, the Company shall promptly notify all Holders whose
securities are covered by the Registration Statement of such suspension, and
shall promptly notify each such Holder as soon as the effectiveness of the
Registration Statement has been resumed. The Company shall be entitled to effect
no more than one such suspension during the one (1) year period following the
Record Date.
If the Company exceeds the limits set forth in this Section, then the
Company shall pay to the Holders 2% per month, accruing daily, of the aggregate
Stated Value (as defined in the Certificate of Determination), in cash, of the
subscriber's outstanding Preferred Stock payable within 5 business days of end
of the month in which they accrue.
7. Furnish Information. It shall be a condition precedent to the
-------------------
obligations of the Company to take any action pursuant to this Agreement with
regard to each selling Holder that such selling Holder shall furnish to the
Company such information regarding Holder, the Registrable Securities held by
it, and the intended method of disposition of such securities as shall be
required to effect the registration of its Registrable Securities or to
determine that registration is not required pursuant to Rule 144 or other
applicable provision of the Act.
8. Expenses. All expenses other than underwriting discounts and
--------
commissions and fees and expenses of counsel to the selling Holders incurred in
connection with registrations, filings or qualifications pursuant hereto,
including (without limitation) all registration, filing and qualification fees,
printers' and accounting fees, fees and disbursements of counsel for the
Company, shall be borne by the Company.
9. Indemnification. In the event any Registrable Securities are
---------------
included in a Registration Statement or a post-effective amendment to an
effective registration statement or a Piggyback Registration Statement under
this Agreement:
(a) To the extent permitted by law, the Company will indemnify and
hold harmless each Holder, the officers, directors, representatives, agents and
employees of each Holder, any underwriter (as defined in the Act) for such
Holder and each person, if any, who controls such Holder or underwriter within
the meaning of the Act or the Securities Exchange Act of 1934, as amended (the
"1934 Act"), against any losses, claims, damages, judgments, settlements or
liabilities (joint or several) to which they may become subject under the Act,
the 1934 Act or other federal or state law, insofar as such losses, claims,
damages, judgments, settlements or liabilities (or actions in respect thereof)
arise out of or are based upon any of the following statements or omissions: (i)
any untrue statement or alleged untrue statement of a material fact contained in
such registration statement, including any preliminary prospectus or final
prospectus contained therein or any amendments or supplements thereto, or (ii)
the omission or alleged omission to state therein a material fact required to be
stated therein, or necessary to make the statements therein not misleading, and
the Company will reimburse each such Holder, officer or director, employee,
representative, agent, underwriter or controlling person for any legal or other
expenses reasonably incurred by them in connection with investigating or
defending any such loss, claim, damage, judgment, settlement, liability, or
action; provided, however, that the indemnity agreement contained in this
subsection 9(a) shall not apply to
8
<PAGE>
amounts paid in settlement of any such loss, claim, damage, liability, or action
if such settlement is effected without the consent of the Company (which consent
shall not be unreasonably withheld), nor shall the Company be liable in any such
case for any such loss, claim, damage, liability, or action to the extent that
it arises out of or is based upon a loss which occurs in reliance upon and in
conformity with written information furnished expressly for use in connection
with the selling stockholder section of such registration by any such Holder,
officer, director, employee, representative, agent, underwriter or controlling
person.
(b) To the extent permitted by law, each selling Holder, severally and
not jointly, will indemnify and hold harmless the Company, each of its
directors, each of its officers who have signed the registration statement, each
person, if any, who controls the Company within the meaning of the Act, any
underwriter and any other Holder selling securities in such registration
statement or any of its directors or officers or any person who controls such
Holder, against any losses, claims, damages, judgments, settlements or
liabilities (joint or several) to which the Company or any such director,
officer, controlling person, or underwriter or controlling person, or other such
Holder or director, officer or controlling person may become subject, under the
Act, the 1934 Act or other federal or state law, insofar as such losses, claims,
damages, judgments, settlements or liabilities (or actions in respect thereto)
arise out of or are based upon any statement or omission in each case to the
extent (and only to the extent) that such statement or omission is made in
reliance upon and in conformity with written information furnished by such
Holder expressly for use in connection with the selling stockholder section of
such registration statement; and each such Holder will reimburse any legal or
other expenses reasonably incurred by the Company and any such director,
officer, controlling person, underwriter or controlling person, other Holder,
officer, director, or controlling person in connection with investigating or
defending any such loss, claim, damage, liability, or action; provided, however,
that the indemnity agreement contained in this subsection 9(b) shall not apply
to amounts paid in settlement of any such loss, claim, damage, liability or
action if such settlement is effected without the consent of the Holder, which
consent shall not be unreasonably withheld.
(c) Promptly after receipt by an indemnified party under this Section
9 of notice of the commencement of any action (including any governmental
action), such indemnified party will, if a claim in respect thereof is to be
made against any indemnifying party under this Section 9, deliver to the
indemnifying party a written notice of the commencement thereof and the
indemnifying party shall have the right to participate in, and, to the extent
the indemnifying party so desires, jointly with any other indemnifying party
similarly noticed, to assume the defense thereof with counsel mutually
satisfactory to the parties; provided, however, that an indemnified party shall
have the right to retain its own counsel, with the reasonably incurred fees and
expenses of one such counsel to be paid by the indemnifying party, if
representation of such indemnified party by the counsel retained by the
indemnifying party would be inappropriate due to actual or potential conflicting
interests between such indemnified party and any other party represented by such
counsel in such proceeding. The failure to deliver written notice to the
indemnifying party within a reasonable time of the commencement of any such
action, if prejudicial to its ability to defend such action, shall relieve such
indemnifying party of any liability to the indemnified party under this Section
9 to the extent of such proven prejudice, but the omission so to deliver written
notice to the indemnifying party will not relieve it of any liability that it
may have to any indemnified party otherwise than under this Section 9.
9
<PAGE>
(d) In the event that the indemnity provided in paragraph (a) or (b)
of this Section 9 is unavailable to or insufficient to hold harmless an
indemnified party for any reason, the Company and each Holder agree to
contribute to the aggregate claims, losses, damages and liabilities (including
legal or other expenses reasonably incurred in connection with investigating or
defending same) (collectively "Losses") to which the Company and one or more of
the Holder may be subject in such proportion as is appropriate to reflect the
relative fault of the Company and the Holders in connection with the statements
or omissions which resulted in such Losses. Relative fault shall be determined
by reference to whether any alleged untrue statement or omission relates to
information provided by the Company or by the Holders in accordance with Section
9(b) and 9(c) above. The Company and the Holders agree that it would not be
just and equitable if contribution were determined by pro rata allocation or any
other method of allocation which does not take account of the equitable
considerations referred to above. Notwithstanding the provisions of this
paragraph (d), no person guilty of fraudulent misrepresentation (within the
meaning of Section 10(f) of the Securities Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation. For purposes of this Section 9, each person who controls a
Holder of Registrable Securities within the meaning of either the Securities Act
or the Exchange Act and each director, officer, partner, employee and agent of a
Holder shall have the same rights to contribution as such holder, and each
person who controls the Company within the meaning of either the Act or the
Exchange Act and each director of the Company, and each officer of the Company
who has signed the registration statement, shall have the same rights to
contribution as the Company, subject in each case to the applicable terms and
conditions of this paragraph (d).
(e) The obligations of the Company and Holders under this Section 9
shall survive the redemption and conversion, if any, of the Preferred Stock, the
completion of any offering of Registrable Securities in a Registration Statement
under this Agreement, and otherwise.
10. Reports Under Securities Exchange Act of 1934. With a view to
---------------------------------------------
making available to the Holders the benefits of Rule 144 promulgated under the
Act and any other rule or regulation of the SEC that may at any time permit a
Holder to sell securities of the Company to the public without registration, the
Company agrees to:
(a) make and keep public information available, as those terms are
understood and defined in Rule 144;
(b) use its best efforts to file with the SEC in a timely manner all
reports and other documents required of the Company under the Act and the 1934
Act; and
11. Amendment of Registration Rights. Any provision of this
--------------------------------
Agreement may be amended and the observance thereof may be waived (either
generally or in a particular instance and either retroactively or
prospectively), only with the written consent of the Company and the Holders of
a majority of the Registrable Securities provided that the amendment treats all
Holders equally. Any amendment or waiver effected in accordance with this
paragraph shall be binding upon
10
<PAGE>
each Holder, each future Holder, and the Company.
12. Notices. All notices required or permitted under this Agreement
-------
shall be made in writing signed by the party making the same, shall specify the
section under this Agreement pursuant to which it is given, and shall be
addressed if to (i) the Company at: Tom Russell, 733 A Lakefield Road, Westlake
Village, CA 91361, Phone (805) 373-8688, Fax (805) 373-7373, and (ii) the
Holders at their respective last address as the party as shown on the records of
the Company. Any notice, except as otherwise provided in this Agreement, shall
be made by fax and shall be deemed given at the time of transmission of the fax.
13. Termination. The Company's obligation to maintain an effective
-----------
registration statement hereunder shall terminate on the earlier of (i) the date
that is thirty (30) days following the date of issuance of the last of the
Registrable Securities to be issued (provided, that such 30-day period shall be
increased for any trading days during such period which a Registration Statement
shall not be effective or shall be subject to any blackout), (ii) the date all
Registrable Securities cease to exist or (iii) the date that all of the
Registrable Securities (issued or to be issued) can be resold by the holders
thereof under Rule 144(k) of the Act, without volume limitations; but without
prejudice to (i) the parties' rights and obligations arising from breaches of
this Agreement occurring prior to such termination (ii) other indemnification
obligations under this Agreement.
14. Assignment. No assignment, transfer or delegation, whether by
----------
operation of law or otherwise, of any rights or obligations under this Agreement
by the Company or any Holder, respectively, shall be made without the prior
written consent of the majority in interest of the Holders or the Company,
respectively; provided that the rights of a Holder may be transferred to a
subsequent holder of the Holder's Registrable Securities (provided such
transferee shall provide to the Company, together with or prior to such
transferee's request to have such Registrable Securities included in a Piggyback
Registration, a writing executed by such transferee agreeing to be bound as a
Holder by the terms of this Agreement); and provided further that the Company
may transfer its rights and obligations under this Agreement to a purchaser of
all or a substantial portion of its business if the obligations of the Company
under this Agreement are assumed in connection with such transfer, either by
merger or other operation of law (which may include without limitation a
transaction whereby the Registrable Securities are converted into securities of
the successor in interest) or by specific assumption executed by the transferee.
15. Governing Law. This Agreement shall be governed by and construed
-------------
in accordance with the laws of the State of Delaware applicable to agreements
made in and wholly to be performed in that jurisdiction, except for matters
arising under the Act or the Securities Exchange Act of 1934, which matters
shall be construed and interpreted in accordance with such laws.
16. Execution in Counterparts Permitted. This Agreement may be
-----------------------------------
executed in any number of counterparts, each of which shall be enforceable
against the parties actually executing such counterparts, and all of which
together shall constitute one (1) instrument.
11
<PAGE>
[INTENTIONALLY LEFT BLANK]
12
<PAGE>
IN WITNESS WHEREOF, the undersigned have executed this Agreement as of this
day of November, 1997.
- ----
FRANKLIN TELECOMMUNICATIONS CORP.
By: ________________________________
Frank Peters, President - CEO
Address: 733A Lakefield Road
Westlake Village, CA 91361
Telephone: (805) 373-8688
Facsimile: (805) 373-7373
SWARTZ INVESTMENTS, LLC
By: ________________________________
Eric S. Swartz, President
Address: 200 Roswell Summit, Suite 285
1080 Holcomb Bridge Road
Roswell, Georgia 30076
Telephone: (770) 640-8130
Facsimile: (770) 640-7150
INVESTOR(S)
___________________________________
Investor's Name
By:_________________________________
(Signature)
Address: ____________________________________
____________________________________
____________________________________
13
<PAGE>
14
<PAGE>
EXHIBIT 10.18
THIS WARRANT AND THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"),
OR ANY STATE SECURITIES LAW, AND MAY NOT BE SOLD, TRANSFERRED, PLEDGED,
HYPOTHECATED OR OTHERWISE DISPOSED OF OR EXERCISED UNLESS (i) A REGISTRATION
STATEMENT UNDER THE SECURITIES ACT AND APPLICABLE STATE SECURITIES LAWS SHALL
HAVE BECOME EFFECTIVE WITH REGARD THERETO, OR (ii) AN EXEMPTION FROM
REGISTRATION UNDER THE SECURITIES ACT AND APPLICABLE STATE SECURITIES LAWS IS
AVAILABLE IN CONNECTION WITH SUCH OFFER, SALE OR TRANSFER.
AN INVESTMENT IN THESE SECURITIES INVOLVES A HIGH DEGREE OF RISK. SUBSCRIBERS
MUST RELY ON THEIR OWN ANALYSIS OF THE INVESTMENT AND ASSESSMENT OF THE RISKS
INVOLVED. SEE THE RISK FACTORS SET FORTH IN THE ATTACHED DISCLOSURE DOCUMENTS
AS EXHIBIT F.
Warrant to Purchase
"N" shares
- -------
Warrant to Purchase Common Stock
(Issued in Connection with Series C Preferred Stock)
THIS CERTIFIES that ________________ or any subsequent holder hereof
("Holder"), has the right to purchase from FNet Corp. ("FNet"), a California
corporation and a subsidiary of FRANKLIN TELECOMMUNICATIONS CORP., a California
corporation ("FTEL"), up to "N" fully paid and nonassessable shares of FNet's
---
common stock ("FNet Common Stock"), subject to adjustment as provided herein, at
a price equal to the FNet Exercise Price as defined in Section 3 below, at any
time beginning on the Date of Issuance (as defined below) and ending at 5:00
p.m., New York, New York time, on November ___, 2002 (the "Exercise
Period")("Exercise Option # 1"); provided however, that if FNet fails to
complete a public offering by June 30, 1998, the Holder has the option, upon
written notice to FNet and FTEL no later than July 31, 1998 and in lieu of the
right to purchase FNet common stock, to purchase from FTEL up to "N" fully paid
---
and nonassessable shares of common stock of FTEL ("Common Stock"), subject to
adjustment as provided herein, at a price equal to the FTEL Exercise Price, as
defined in Section 3 below, until the end of the Exercise Period ("Exercise
Option # 2"). For purposes hereof, "N" shall equal the principal amount of
Series C Preferred Stock purchased by the original Holder divided by the "Fixed
Conversion Price", as defined in the Certificate of Determination of the Series
C Preferred Stock. Holder purchased $__________ of Series C Preferred Stock,
therefore "N" equals $_____________ divided by the "Fixed Conversion Price".
Holder agrees with FTEL and FNet (individually referred to, as applicable,
the "Company" and collectively as the "Companies") that this Warrant to Purchase
Common
<PAGE>
Stock of the Companies (this "Warrant") is issued and all rights hereunder shall
be held subject to all of the conditions, limitations and provisions set forth
herein.
1. Date of Issuance.
-----------------
This Warrant shall be deemed to be issued on November 5, 1997 ("Date of
Issuance").
2
<PAGE>
2. Exercise.
--------
(a) Manner of Exercise. During the Exercise Period, this Warrant may be
exercised as to all or any lesser number of full shares of Common Stock covered
hereby upon surrender of this Warrant, with the Exercise Form attached hereto as
Exhibit A, for FTEL pursuant to Exercise Option # 2 or Exhibit B, for FNet
pursuant to Exercise Option # 1 (as applicable, the "Exercise Form") duly
completed and executed, together with the full Exercise Price (as defined below)
for each share of Common Stock as to which this Warrant is exercised, at the
office of FTEL, attn: Helen West, 733 Lakefield Road, Westlake Village, CA
91361, Phone (805) 373-8688, Fax (805) 373-7373, or, as applicable, at the
office of FNet, attn: President at the same address (or at such other office or
agency as the applicable Company may designate in writing), by overnight mail,
with an advance copy of the Exercise Form sent to FTEL or FNet, as applicable,
and its Transfer Agent by facsimile (such surrender and payment of the Exercise
Price hereinafter called the "Exercise of this Warrant").
(b) Date of Exercise. The "Date of Exercise" of the Warrant shall be
defined as the date that the advance copy of the completed and executed Exercise
Form is sent by facsimile to the applicable Company, provided that the original
Warrant and Exercise Form are received by the applicable Company as soon as
practicable thereafter. Alternatively, the Date of Exercise shall be defined as
the date the original Exercise Form is received by the applicable Company, if
Holder has not sent advance notice by facsimile.
(c) Cancellation of Warrant. This Warrant shall be canceled upon the
Exercise of this Warrant, and, as soon as practical after the Date of Exercise,
Holder shall be entitled to receive Common Stock for the number of shares
purchased upon such Exercise of this Warrant, and if this Warrant is not
exercised in full, Holder shall be entitled to receive a new Warrant (containing
terms identical to this Warrant) representing any unexercised portion of this
Warrant in addition to such Common Stock.
(d) Holder of Record. Each person in whose name any Warrant for shares of
Common Stock is issued shall, for all purposes, be deemed to be the Holder of
record of such shares on the Date of Exercise of this Warrant, irrespective of
the date of delivery of the Common Stock purchased upon the Exercise of this
Warrant. Nothing in this Warrant shall be construed as conferring upon Holder
any rights as a stockholder of the applicable Company.
3. Payment of Warrant Exercise Price.
---------------------------------
The "FNet Exercise Price" shall equal $1.00 per share and the "FTEL
Exercise Price" shall equal the Fixed Conversion Price per share, each subject
to adjustment as set forth herein.
Payment of the Exercise Price may be made by either of the following, or a
combination thereof, at the election of Holder:
(a) Cash Exercise: cash, bank or cashiers check or wire transfer; or
3
<PAGE>
(b) Cashless Exercise: subject to the last sentence of this Section 3,
surrender of this Warrant at the principal office of the applicable Company
together with notice of cashless election, in which event the applicable Company
shall issue Holder a number of shares of Common Stock computed using the
following formula:
4
<PAGE>
X = Y (A-B)/A
where: X = the number of shares of Common Stock to be issued to Holder.
Y = the number of shares of Common Stock for which this Warrant
is being exercised.
A = the Market Price of one (1) share of Common Stock (for purposes of
this Section 3(b), the "Market Price" shall be defined as the
average closing bid price of the Common Stock for the five (5)
trading days prior to the Date of Exercise of this Warrant (the
"Average Closing Price"), as reported on the OTC Bulletin Board, or
if no longer traded on the OTC Bulletin Board, the closing bid price
on the principal national securities exchange or the over-the-
counter on which the Common Stock is so traded and if not available,
the mean of the high and low prices on the principal securities
exchange on which the Common Stock is so traded. If the Common Stock
is/was not traded during the five (5) trading days prior to the Date
of Exercise, then the closing price for the last publicly traded day
shall be deemed to be the closing price for any and all (if
applicable) days during such five (5) trading day period.
B = the Exercise Price.
For purposes of Rule 144 and sub-section (d)(3)(ii) thereof, it is intended,
understood and acknowledged that the Common Stock issuable upon exercise of this
Warrant in a cashless exercise transaction shall be deemed to have been acquired
at the time this Warrant was issued. Moreover, it is intended, understood and
acknowledged that the holding period for the Common Stock issuable upon exercise
of this Warrant in a cashless exercise transaction shall be deemed to have
commenced on the date this Warrant was issued.
Notwithstanding anything to the contrary contained herein, this Warrant may not
be exercised in a cashless exercise transaction if, on the Date of Exercise, the
shares of Common Stock to be issued upon exercise of this Warrant would upon
such issuance (x) be immediately transferable in the United States free of any
restrictive legend, including without limitation under Rule 144; (y) be then
registered pursuant to an effective registration statement filed pursuant to
that certain Series C Registration Rights Agreement (the "Registration Rights
Agreement") dated on or about November 17, 1997 by and among the Companies and
certain investors; or (z) otherwise be registered under the Securities Act of
1933, as amended.
4. Transfer and Registration.
-------------------------
(a) Transfer Rights. Subject to the provisions of Section 8 of this
Warrant, this Warrant may be transferred on the books of the Companies, in whole
or in part, in person or by attorney, upon surrender of this Warrant properly
completed and endorsed. This Warrant shall be canceled upon such surrender and,
as soon as practicable thereafter, the person to
5
<PAGE>
whom such transfer is made shall be entitled to receive a new Warrant or
Warrants as to the portion of this Warrant transferred, and Holder shall be
entitled to receive a new Warrant as to the portion hereof retained.
(b) Registrable FTEL Securities. The FTEL Common Stock issuable upon the
exercise of this Warrant constitutes "Registrable Securities" under that certain
Registration Rights Agreement dated on or about November 17, 1997 between FTEL
and certain investors and, accordingly, has the benefit of the registration
rights pursuant to that agreement.
(c) Registration Rights for FNet Common Stock.
(i) Piggyback Registration. If (but without any obligation to do so)
----------------------
FNet proposes, after its initial public offering, to register (including for
this purpose a registration effected by FNet for shareholders other than the
Holders) any of its Common Stock under the Act in connection with the public
offering of such securities solely for cash (other than a registration relating
solely for the sale of securities to participants in a Company stock plan or a
registration on Form S-4 promulgated under the Act or any successor or similar
form registering stock issuable upon a reclassification, upon a business
combination involving an exchange of securities or upon an exchange offer for
securities of the issuer or another entity), FNet shall, at such time, promptly
give each Holder written notice of such registration (a "Piggyback Registration
Statement"). Upon the written request of each Holder given by fax within ten
(10) days after mailing of such notice by FNet, FNet shall cause to be included
in such registration statement under the Act all of the FNet Shares issuable
upon exercise of this Warrant (the "FNet Registrable Securities") that each such
Holder has requested to be registered ("Piggyback Registration") to the extent
such inclusion does not violate the registration rights of any other Security
holder of FNet granted prior to the date hereof; nothing herein shall prevent
FNet from withdrawing or abandoning the registration statement prior to its
effectiveness. The election of initiating Holders to participate in a Piggyback
Registration Statement shall not impact the amount payable to investors pursuant
to Section 2(a) herein except that the Late Registration Payment shall cease to
accrue as of the date of effectiveness of the Piggyback Registration Statement.
These rights shall exist as to one (1) such Registration Statement, unless an
underwriter limits the number of Holder's securities to be included in such
Registration Statement to less than all of Holder's securities, as set forth
below.
(ii) Demand Registration. On or after the first anniversary of the
-------------------
date on which FNet has completed an underwritten public offering of its Common
Stock with net proceeds of $15 million or more, the Holder may, by written
notice to FNet, require FNet to file a Registration Statement under the Act
covering the Holder's FNet Registrable Securities (to the extent such FNet
Registrable Securities were not eligible for inclusion in any previous
Registration Statement). Upon receipt of such notice, FNet shall use its best
efforts within reason to promptly effect the registration under the Securities
Act, of such Shares as to which the Holder shall have requested registration in
the written request specified above; provided, however, that in no event shall
FNet be required to register the Shares if (1) the requests of the Holder (and
all other Holders of FNet Registrable Securities) cover less than 25% of the
6
<PAGE>
shares of FNet's Common Stock issued or issuable upon exercise of the Warrants
issued in connection with the issuance Series C Preferred Stock, or (2) the
Board of Directors of FNet determines in good faith that filing a registration
statement at the time requested may have a materially adverse effect on FNet and
is not in the best interest of FNet, in which event the filing and processing of
the registration statement may be deferred (but not for more than 120 days)
until the likelihood of the occurrence of such material adverse effect is
eliminated. FNet shall not be obligated to file any registration statement
pursuant to this Section within 180 days following the effective date of any
registration statements as to which FNet shall have given notice to the Holder
as provided above.
(iii) Limitation on Obligations to Register.
-------------------------------------
(a) In the case of a Piggyback Registration on an underwritten public
offering by FNet, if the managing underwriter determines and advises in writing
that the inclusion in the registration statement of all securities of the
Holders' proposed to be included would interfere with the successful marketing
of the securities proposed to be registered by FNet, then the number of such
securities to be included in the registration statement, to the extent such
securities may be included in such Piggyback Registration Statement shall be
allocated among all Holders who had requested Piggyback Registration pursuant to
the terms hereof, in the proportion that the number of FNet Registrable
Securities which each such Holder seeks to register bears to the total number of
such securities sought to be included by all Holders. If required by the
managing underwriter of such an underwritten public offering, the Holders shall
enter into an agreement in customary form reasonably limiting the number of such
securities to be included in such Piggyback Registration Statement and the
terms, if any, regarding the future sale of such securities.
(b) In the event FNet believes that shares sought to be registered
under this Warrant by Holders do not require registration for public sale and
the status of those shares is disputed, FNet shall provide, at its expense, an
Opinion of Counsel, reasonably acceptable to the Holders of the Securities at
issue (and satisfactory to FNet's transfer agent to permit the sale and
transfer) that those securities may be sold immediately, without volume
limitation, without registration under the Act, by virtue of Rule 144 or similar
provisions.
(iv) General. The provisions of Sections 6,7,8 and 9 of the Series C
-------
Registration Rights Agreement, dated on or about November 18, 1997 between FTEL
and certain investors named therein are hereby incorporated by reference, with
the term "Company" referring to FNet and the term "Holder" referring to the
Holder of this Warrant.
5. Anti-Dilution Adjustments.
-------------------------
(a) Stock Dividend. If the applicable Company shall at any time declare a
dividend payable in shares of Common Stock, then Holder, upon Exercise of this
Warrant after the record date for the determination of holders of Common Stock
entitled to receive such dividend, shall be entitled to receive upon Exercise of
this Warrant, in addition to the number of shares of Common Stock as to which
this Warrant is exercised, such additional shares of
7
<PAGE>
Common Stock as such Holder would have received had this Warrant been exercised
immediately prior to such record date and the Exercise Price will be
proportionately adjusted.
(b) Recapitalization or Reclassification. If the applicable Company shall
at any time effect a recapitalization, reclassification, stock splits, stock
dividends or other similar transaction of such character that the shares of
Common Stock shall be changed into or become exchangeable for a larger or
smaller number of shares, then upon the effective date thereof, the number of
shares of Common Stock which Holder shall be entitled to purchase upon Exercise
of this Warrant shall be increased or decreased, as the case may be, in direct
proportion to the increase or decrease in the number of shares of Common Stock
by reason of such recapitalization, reclassification or similar transaction, and
the Exercise Price shall be, in the case of an increase in the number of shares,
proportionally decreased and, in the case of decrease in the number of shares,
proportionally increased. Each Company shall give Holder the same notice it
provides to holders of Common Stock of any transaction described in this Section
5(b).
(c) Distributions. If the applicable Company shall at any time distribute
for no consideration to holders of Common Stock cash, evidences of indebtedness
or other securities or assets (other than cash dividends or distributions
payable out of earned surplus or net profits for the current or preceding year)
then, in any such case, Holder shall be entitled to receive, upon Exercise of
this Warrant, with respect to each share of Common Stock issuable upon such
exercise, the amount of cash or evidences of indebtedness or other securities or
assets which Holder would have been entitled to receive with respect to each
such share of Common Stock as a result of the happening of such event had this
Warrant been exercised immediately prior to the record date or other date fixing
shareholders to be affected by such event (the "Determination Date") or, in lieu
thereof, if the Board of Directors of the applicable Company should so determine
at the time of such distribution, a reduced Exercise Price determined by
multiplying the Exercise Price on the Determination Date by a fraction, the
numerator of which is the result of such Exercise Price reduced by the value of
such distribution applicable to one share of Common Stock (such value to be
determined by the Board of Directors of the applicable Company in its
discretion) and the denominator of which is such Exercise Price.
(d) Notice of Consolidation or Merger. In the event of a merger,
consolidation, exchange of shares, recapitalization, reorganization, or other
similar event, as a result of which shares of Common Stock shall be changed into
the same or a different number of shares of the same or another class or classes
of stock or securities or other assets of the applicable Company or another
entity or there is a sale of all or substantially all the applicable Company's
assets (a "Corporate Change"), then this Warrant shall be exerciseable into such
class and type of securities or other assets as Holder would have received had
Holder exercised this Warrant immediately prior to such Corporate Change;
provided, however, that Company may not affect any Corporate Change unless it
first shall have given thirty (30) days notice to Holder hereof of any Corporate
Change.
(e) Exercise Price Adjusted. As used in this Warrant, the term "Exercise
Price" shall mean the purchase price per share specified in Section 3 of this
Warrant, until the
8
<PAGE>
occurrence of an event stated in subsection (a), (b) or (c) of this Section 5,
and thereafter shall mean said price as adjusted from time to time in accordance
with the provisions of said subsection. No such adjustment under this Section 5
shall be made unless such adjustment would change the Exercise Price at the time
by $.01 or more; provided, however, that all adjustments not so made shall be
deferred and made when the aggregate thereof would change the Exercise Price at
the time by $.01 or more. No adjustment made pursuant to any provision of this
Section 5 shall have the net effect of increasing the Exercise Price. The number
of shares of Common Stock subject hereto shall increase proportionately with
each decrease in the Exercise Price.
(f) Adjustments: Additional Shares, Securities or Assets. In the event
that at any time, as a result of an adjustment made pursuant to this Section 5,
Holder shall, upon Exercise of this Warrant, become entitled to receive shares
and/or other securities or assets (other than Common Stock) then, wherever
appropriate, all references herein to shares of Common Stock shall be deemed to
refer to and include such shares and/or other securities or assets; and
thereafter the number of such shares and/or other securities or assets shall be
subject to adjustment from time to time in a manner and upon terms as nearly
equivalent as practicable to the provisions of this Section 5.
6. Fractional Interests.
--------------------
No fractional shares or scrip representing fractional shares shall be
issuable upon the Exercise of this Warrant, but on Exercise of this Warrant,
Holder may purchase only a whole number of shares of Common Stock. If, on
Exercise of this Warrant, Holder would be entitled to a fractional share of
Common Stock or a right to acquire a fractional share of Common Stock, such
fractional share shall be disregarded and the number of shares of Common Stock
issuable upon exercise shall be the next higher number of shares.
9
<PAGE>
7. Reservation of Shares.
---------------------
Each Company shall at all times reserve for issuance such number of
authorized and unissued shares of Common Stock (or other securities substituted
therefor as herein above provided) as shall be sufficient for the Exercise of
this Warrant and payment of the Exercise Price. Each Company covenants and
agrees that upon the Exercise of this Warrant, all shares of Common Stock
issuable upon such exercise shall be duly and validly issued, fully paid,
nonassessable and not subject to preemptive rights, rights of first refusal or
similar rights of any person or entity.
8. Restrictions on Transfer.
------------------------
(a) Registration or Exemption Required. This Warrant has been issued in a
transaction exempt from the registration requirements of the Act by virtue of
Regulation D and exempt from state registration under applicable state laws. The
Warrant and the Common Stock issuable upon the Exercise of this Warrant may not
be pledged, transferred, sold or assigned except pursuant to an effective
registration statement or an exemption to the registration requirements of the
Act and applicable state laws.
(b) Assignment. If Holder can provide the applicable Company with
reasonably satisfactory evidence that the conditions of (a) above regarding
registration or exemption have been satisfied, Holder may sell, transfer,
assign, pledge or otherwise dispose of this Warrant, in whole or in part. Holder
shall deliver a written notice to Company, substantially in the form of the
Assignment attached hereto as Exhibit C, indicating the person or persons to
whom the Warrant shall be assigned and the respective number of warrants to be
assigned to each assignee. Each Company shall effect the assignment within ten
(10) days, and shall deliver to the assignee(s) designated by Holder a Warrant
or Warrants of like tenor and terms for the appropriate number of shares.
9. Benefits of this Warrant.
------------------------
Nothing in this Warrant shall be construed to confer upon any person
other than the Companies and Holder any legal or equitable right, remedy or
claim under this Warrant and this Warrant shall be for the sole and exclusive
benefit of the Companies and Holder.
10. Applicable Law.
--------------
This Warrant is issued under and shall for all purposes be governed by
and construed in accordance with the laws of the state of California, without
giving effect to conflict of law provisions thereof.
11. Loss of Warrant.
---------------
Upon receipt by the Companies of evidence of the loss, theft,
destruction or mutilation of this Warrant, and (in the case of loss, theft or
destruction) of indemnity or security reasonably satisfactory to each of the
Companies, and upon surrender and cancellation of this Warrant, if mutilated,
the Companies shall execute and deliver a new
10
<PAGE>
Warrant of like tenor and date.
12. Notice or Demands.
-----------------
Notices or demands pursuant to this Warrant to be given or made by Holder to or
on the applicable Company shall be sufficiently given or made if sent by
certified or registered mail, return receipt requested, postage prepaid, and
addressed, until another address is designated in writing by the applicable
Company, to the applicable Company's address as set forth in Section 2(a) above.
Notices or demands pursuant to this Warrant to be given or made by either
Company to or on Holder shall be sufficiently given or made if sent by certified
or registered mail, return receipt requested, postage prepaid, and addressed, to
the address of Holder set forth in the applicable Company's records, until
another address is designated in writing by Holder.
IN WITNESS WHEREOF, the undersigned has executed this Warrant as of the
______ day of November, 1997.
FRANKLIN TELECOMMUNICATIONS CORP.
By: ________________________________
_______________, _______________
FNet CORP.
By: ________________________________
_______________, _______________
11
<PAGE>
EXHIBIT A
FRANKLIN TELECOMMUNICATIONS CORP. EXERCISE FORM
TO: FRANKLIN TELECOMMUNICATIONS CORP.
The undersigned hereby irrevocably exercises the right to purchase
____________ of the shares of Class A Common Stock (the "Common Stock") of
FRANKLIN TELECOMMUNICATIONS CORP., a California corporation (the "Company"),
evidenced by the attached warrant (the "Warrant"), and herewith makes payment of
the exercise price with respect to such shares in full, all in accordance with
the conditions and provisions of said Warrant.
1. The undersigned agrees not to offer, sell, transfer or otherwise dispose of
any of the Common Stock obtained on exercise of the Warrant, except in
accordance with the provisions of Section 8(a) of the Warrant.
2. The undersigned requests that stock certificates for such shares be issued
free of any restrictive legend, if appropriate, and a warrant representing any
unexercised portion hereof be issued, pursuant to the Warrant in the name of the
undersigned and delivered to the undersigned at the address set forth below:
Dated:
________________________________________________________________________________
Signature
________________________________________________________________________________
Print Name
________________________________________________________________________________
Address
________________________________________________________________________________
NOTICE
The signature to the foregoing Exercise Form must correspond to the name as
written upon the face of the attached Warrant in every particular, without
alteration or enlargement or any change whatsoever.
________________________________________________________________________________
12
<PAGE>
EXHIBIT B
FNet CORP. EXERCISE FORM
TO: FNet CORP.
The undersigned hereby irrevocably exercises the right to purchase
____________ of the shares of Class A Common Stock (the "Common Stock") of FNet
CORP., a California corporation (the "Company"), evidenced by the attached
warrant (the "Warrant"), and herewith makes payment of the exercise price with
respect to such shares in full, all in accordance with the conditions and
provisions of said Warrant.
1. The undersigned agrees not to offer, sell, transfer or otherwise dispose of
any of the Common Stock obtained on exercise of the Warrant, except in
accordance with the provisions of Section 8(a) of the Warrant.
2. The undersigned requests that stock certificates for such shares be issued
free of any restrictive legend, if appropriate, and a warrant representing any
unexercised portion hereof be issued, pursuant to the Warrant in the name of the
undersigned and delivered to the undersigned at the address set forth below:
Dated:
________________________________________________________________________________
Signature
________________________________________________________________________________
Print Name
________________________________________________________________________________
Address
________________________________________________________________________________
NOTICE
The signature to the foregoing Exercise Form must correspond to the name as
written upon the face of the attached Warrant in every particular, without
alteration or enlargement or any change whatsoever.
________________________________________________________________________________
13
<PAGE>
EXHIBIT C
ASSIGNMENT
(To be executed by the registered holder
desiring to transfer the Warrant)
FOR VALUE RECEIVED, the undersigned holder of the attached warrant (the
"Warrant") hereby sells, assigns and transfers unto the person or persons below
named the right to purchase either _______ shares of the Common Stock of FNet
Corp. or _________ shares of the Common Stock of FRANKLIN TELECOMMUNICATIONS
CORP., evidenced by the attached Warrant and does hereby irrevocably constitute
and appoint _______________________ attorney to transfer the said Warrant on the
books of FTEL, with full power of substitution in the premises.
Dated: ______________________________
Signature
Fill in for new registration of Warrant:
_________________________________________
Name
_________________________________________
Address
_________________________________________
Please print name and address of assignee
(including zip code number)
________________________________________________________________________________
NOTICE
The signature to the foregoing Assignment must correspond to the name as written
upon the face of the attached Warrant in every particular, without alteration or
enlargement or any change whatsoever.
________________________________________________________________________________
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated September 20, 1996,
relating to the 1996 and 1995 consolidated financial statement of Franklin
Telecommunications Corp. and subsidiaries, which appears in such Prospectus. We
also consent to the use in the Prospectus constituting part of this Registration
Statement on Form S-1 of our report dated June 6, 1997, relating to the 1996
financial statements of Internet Passport, LLC, which appears in such
Prospectus. We also consent to the references to us under the headings
"Experts," "Selected Financial Data" and "Change in Accountants" in such
Prospectus. However, it should be noted that Corbin & Wertz has not prepared or
certified such "Selected Financial Data."
Corbin & Wertz
Irvine, California
December 9, 1997
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated September 17, 1997, accompanying the
consolidated financial statements of Franklin Telecommunications Corp. contained
in the Registration Statement and Prospectus. We consent to the use of the
aforementioned report in the Registration Statement and Prospectus, and to the
use of our name as it appears under the caption "Experts."
Singer Lewak Greenbaum & Goldstein LLP
Los Angeles, California
December 9, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR 3-MOS
<FISCAL-YEAR-END> JUN-30-1997 SEP-30-1997
<PERIOD-START> APR-01-1997 JUL-01-1997
<PERIOD-END> JUN-30-1997 SEP-30-1997
<CASH> 1,464,000 908,000
<SECURITIES> 0 0
<RECEIVABLES> 313,000 319,000
<ALLOWANCES> (34,000) (19,000)
<INVENTORY> 394,000 403,000
<CURRENT-ASSETS> 2,205,000 1,679,000
<PP&E> 973,000 991,000
<DEPRECIATION> (406,000) (442,000)
<TOTAL-ASSETS> 3,514,000 2,987,000
<CURRENT-LIABILITIES> 1,396,000 1,489,000
<BONDS> 0 0
0 0
0 0
<COMMON> 10,550,000 10,890,000
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 3,514,000 2,987,000
<SALES> 1,735,000 244,000
<TOTAL-REVENUES> 1,735,000 244,000
<CGS> 990,000 234,000
<TOTAL-COSTS> 990,000 234,000
<OTHER-EXPENSES> 3,526,000 953,000
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 41,000 17,000
<INCOME-PRETAX> (2,822,000) (960,000)
<INCOME-TAX> 2,000 0
<INCOME-CONTINUING> (2,824,000) (960,000)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (2,824,000) (960,000)
<EPS-PRIMARY> (.23) (.07)
<EPS-DILUTED> 0 0
</TABLE>
