<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
_____________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER PERIOD ENDED DECEMBER 31, 1997
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11616
FRANKLIN TELECOMMUNICATIONS CORP.
(Exact Name of Registrant as Specified in its Charter)
_______________
California 95-3733534
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
733 Lakefield Road, Westlake Village, California 91361
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (805) 373-8688
_______________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT JANUARY 19, 1997
- ----------------------------------- -------------------------------
<S> <C>
Common Stock, no par value 16,135,183
</TABLE>
<PAGE>
Index
Franklin Telecommunications Corp.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 1997 (unaudited) and June 30, 1997
Consolidated Statements of Operations (Unaudited)-
Three months and six months ended December 31, 1997 and 1996
Consolidated Statements of Cash Flows (Unaudited)-
Six months ended December 31, 1997 and 1996
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
Item 1. Financial Statements
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 1997 (unaudited) and June 30, 1997
<TABLE>
<CAPTION>
December 31, June 30, 1997
------------ -------------
1997
------------
(unaudited)
<S> <C> <C>
ASSETS
-------------------------------------------
Current assets
Cash and cash equivalents........................ $ 7,330,000 $ 1,464,000
Accounts receivable, less allowance for doubtful
accounts of $44,000 (unaudited) and $34,000,
respectively.................................... 149,000 80,000
Other receivables................................ 282,000 199,000
Inventories (Note 2)............................. 601,000 394,000
Prepaid expenses................................. 79,000 68,000
------------ -----------
Total current assets............................ 8,441,000 2,205,000
------------ -----------
Property and equipment
Machinery and equipment.......................... 166,000 163,000
Furniture and fixtures........................... 113,000 97,000
Computers and software........................... 893,000 713,000
------------ -----------
1,172,000 973,000
Less accumulated depreciation.................... 481,000 406,000
------------ -----------
Total property and equipment.................... 691,000 567,000
------------ -----------
Excess of cost over fair value of net assets of
companies acquired, net of accumulated
amortization of $-0-(unaudited), and $40,000,
respectively..................................... -- 591,000
Other assets...................................... 322,000 151,000
------------ -----------
Total assets.................................... $ 9,454,000 $ 3,514,000
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
--------------------------------------------
Current liabilities
Current portion of obligations under capital
lease obligations............................... $ 272,000 $ 361,000
Current portion of long-term debt (majority due
to a related party)............................. 207,000 301,000
Accounts payable................................. 355,000 175,000
Accrued liabilities.............................. 764,000 559,000
------------ -----------
Total current liabilities....................... 1,598,000 1,396,000
Long-term debt, (majority due to a related party)
less current portion............................. 320,000 360,000
Other liabilities................................. 183,000 183,000
------------ -----------
Total liabilities............................... 2,101,000 1,939,000
------------ -----------
Minority Interest................................. -- --
Contingencies (Note 3)
Shareholders' equity
Preferred stock, no par value 10,000,000 shares
authorized, Series C 740 shares (unaudited)
issued and outstanding.......................... 6,558,000 --
Common stock, no par value 90,000,000 shares
authorized 14,190,328 (unaudited) and 10,868,786
shares issued and outstanding................... 11,465,000 9,971,000
Common stock committed, no par value 1,333,695
(unaudited) and 296,066 shares committed but not
yet issued...................................... 133,000 579,000
Accumulated deficit.............................. (10,803,000) (8,975,000)
------------ -----------
Total shareholders' equity...................... 7,353,000 1,575,000
------------ -----------
Total liabilities and shareholders' equity...... $ 9,454,000 $ 3,514,000
============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Six Months Ended December 31, 1997 and 1996 (unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
December 31, December 31,
------------ ------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Sales
Product.................................. $ 161,000 $ 611,000 $ 237,000 $ 769,000
Internet services........................ 123,000 61,000 291,000 112,000
---------- ---------- ----------- ----------
Total sales........................... 284,000 672,000 528,000 881,000
---------- ---------- ----------- ----------
Cost of sales
Product.................................. 44,000 254,000 141,000 384,000
Internet services........................ 119,000 22,000 256,000 57,000
---------- ---------- ----------- ----------
Total cost of sales................... 163,000 276,000 397,000 441,000
---------- ---------- ----------- ----------
Gross profit............................... 121,000 396,000 131,000 440,000
---------- ---------- ----------- ----------
Operating Expenses
Research and development expenses........ 385,000 118,000 506,000 215,000
Selling, general, and administrative
expenses............................... 639,000 335,000 1,488,000 659,000
---------- ---------- ----------- ----------
Total operating expenses.............. 1,024,000 453,000 1,994,000 874,000
---------- ---------- ----------- ----------
Loss from operations....................... (903,000) (57,000) (1,863,000) (434,000)
---------- ---------- ----------- ----------
Other income (expense)
Interest expense......................... (14,000) (10,000) (31,000) (17,000)
Other income............................. 49,000 11,000 66,000 11,000
---------- ---------- ----------- ----------
Total other income (expense).......... 35,000 1,000 35,000 (6,000)
---------- ---------- ----------- ----------
Loss before provision for income taxes..... (868,000) (56,000) (1,828,000) (440,000)
Provision for income taxes................. -- -- -- --
---------- ---------- ----------- ----------
Net loss................................... $ (868,000) $ (56,000) $(1,828,000) $ (440,000)
========== ========== =========== ==========
Basic loss per common share................ $ (.06) $ (.01) $ (.13) $ (.04)
========== ========== =========== ==========
Diluted loss per common share.............. $ (.06) $ (.01) $ (.13) $ (.04)
========== ========== =========== ==========
Weighted average common shares outstanding
used to compile basic net loss per
common share............................ 15,383,037 12,148,906 14,449,384 11,864,085
========== ========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended December 31, 1997 and 1996 (unaudited)
<TABLE>
<CAPTION>
Six Months Ended
----------------
December 31,
------------
1997 1996
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities
Net loss............................................. $(1,828,000) $(440,000)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation and amortization...................... 136,000 23,000
Provision for loss on obsolete inventory........... -- 2,000
Provision for loss on doubtful accounts............ 10,000 9,000
Notes payable for services rendered................ -- 100,000
Stock issued for services rendered................. -- 24,000
(Increase) decrease in
Accounts receivable................................ (79,000) (395,000)
Inventories........................................ (207,000) (80,000)
Prepaid expenses................................... (11,000) (21,000)
Increase (decrease) in
Accounts payable................................... 62,000 180,000
Accrued salaries and related expenses.............. 5,000 51,000
Accrued other liabilities.......................... -- (1,000)
----------- ---------
Net cash used in operating activities................ (1,912,000) (548,000)
----------- ---------
Cash flows from investing activities
Purchases of property and equipment.................. (201,000) (83,000)
Issuance of notes receivable......................... (4,000) --
Other assets......................................... (171,000) (5,000)
----------- ---------
Other liabilities -- --
----------- ---------
Net cash used in investing activities................ (376,000) (88,000)
----------- ---------
Cash flows from financing activities
Payments on other liabilities........................ (1,000) --
Proceeds from sale of Company stock.................. 7,960,000 701,000
Proceeds from sale of minority stock in consolidated
subsidiary.......................................... 284,000 148,000
Payments on capital lease obligation................. (89,000) --
----------- ---------
Net cash provided by financing activities............ 8,154,000 849,000
----------- ---------
Net increase (decrease) in cash...................... 5,866,000 213,000
Cash, beginning of the period........................ 1,464,000 166,000
----------- ---------
Cash, end of the period.............................. $ 7,330,000 $ 379,000
=========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
For the Three Months Ended September 30, 1997 and 1996 (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.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accouning priciples for complete financial statements. In
the opinion of management, all normal, recurring adjustments considered
necessary for a fair presentation have been included. The financial statements
should be read in conjunction with the audited financail statements included in
the Form S-1 Amendment 2 of Franklin Telecommuncations Corp., filed with the
Securities and Exchange Commission on January 27, 1998. The results of
operations for the three months and six months ended December 31, 1997 are not
necessarily indicative of the results that may be expected for the fiscal year
ending June 30, 1998.
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.
Minority Interest
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 363,000 shares
of common stock for the year ended June 30, 1997 and the six months ended
December 31, 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 December 31, 1997 as FNet,
on a stand-alone basis, had a shareholders' deficit as of such dates. The
accompanying consolidated statements of operations for the three months and six
months ended December 31, 1997 and 1996 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.
Loss Per Common Share
The computation of basic and diluted loss per common share is based on the
weighted average number of common and common equivalent shares outstanding
during the three month and the six month periods ended December 31, 1997, and
1996, in accordance with SFAS No. 128. The prior periods have been restated to
comply with the new method of computed earnings per share in accordance with
SFAS No. 128. Common stock equivalents have been excluded from the
aforementioned computations as their effect would be anti-dilutive.
<PAGE>
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.
Recently Issued Accounting Pronouncements
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>
December 31, June 30,
------------ --------
1997 1997
---- ----
(unaudited)
<S> <C> <C>
Raw materials.......... $ 88,000 $155,000
Work in process........ 248,000 152,000
Finished goods......... 265,000 87,000
-------- --------
Total............... $601,000 $394,000
======== ========
</TABLE>
NOTE 3--CONTINGENCIES
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
<PAGE>
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.
NOTE 4--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.
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.
During the six months ended December 31, 1997, FNet sold 363,000 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 70% as of
December 31, 1997.
<PAGE>
Item 2. 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.
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 and six months ended December 31, 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.
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.
<PAGE>
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 December 31, 1997 Compared To Three Months Ended December
31, 1996
Net Sales. Net sales decreased by $388,000, or 58%, from $672,000 in the
three months ended December 31, 1996 to $284,000 in the three months ended
December 31, 1997. The overall decrease is due to 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 December 31,
1997 consisted of 43% Internet services revenue and 57% hardware product sales.
Gross Profit. Gross profit decreased as a percentage of net sales to 42%
for the three months ended December 31, 1997, from a gross profit of 59% of net
sales for the corresponding period of 1996. The gross profit percentage decrease
can be attributed to reduced sales of higher margin wide area network products.
Although the Internet services revenue increased, the margins were lower.
Operating Expenses. Operating expenses increased by $571,000, or 126%,
from $453,000 in the three months ended December 31, 1996 to $1,024,000 in the
three months ended December 31, 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 $4,000, or 40%, from
$10,000 in the three months ended December 31, 1996 to $14,000 in the three
months ended December 31, 1997, due primarily to assumed lease debt from
Internet Passport. Other income increased by $38,000, or 345%, from $11,000 in
the three months ended December 31, 1996 to $49,000 in the three months ended
December 31, 1997, due to interest earned on cash investments.
Six Months Ended December 31, 1997 Compared To Six Months Ended December 31,
1996
Net Sales. Net sales decreased by $353,000, or 40%, from $881,000 in the
six months ended December 31, 1996 to $528,000 in the six months ended December
31, 1997. The overall decrease is due to 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 six months ended December 31, 1997
consisted of 55% Internet services revenue and 45% hardware product sales.
Gross Profit. Gross profit decreased as a percentage of net sales to 25%
for the six months ended December 31, 1997, from a gross profit of 50% of net
sales for the corresponding period of 1996. The gross profit percentage decrease
can be attributed to reduced sales of higher margin wide area network products.
Although the Internet services revenue increased, the margins were lower.
Operating Expenses. Operating expenses increased by $1,120,000, or 128%,
from $874,000 in the six months ended December 31, 1996 to $1,994,000 in the six
months ended December 31, 1997. The increase is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet services
<PAGE>
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 $14,000, or 82%,
from $17,000 in the six months ended December 31, 1996 to $31,000 in the six
months ended December 31, 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 $55,000, or 500%, from $11,000 in the six months ended
December 31, 1996 to $66,000 in the six months ended December 31, 1997, due
primarily to interest earned on cash investments.
Liquidity and Capital Resources
Cash and cash equivalents and net working capital totaled $7,330,000 and
$6,843,000, respectively, as of December 31, 1997. The primary source of cash
was net proceeds generated from equity financings. 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 $1,109,000 and $7,960,000
in equity financing, for the year ended June 30, 1997, and the six months ended
December 31, 1997, respectively. Its subsidiary, FNet, raised $1,950,000 for
the year ended June 30, 1997 and $363,000 for the six months ended December 31,
1997. FNet has continued to experience losses, due to the growth nature of the
Internet services business and development of the Internet Telephony 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 and cash flow
from operations will be sufficient to meet the Company's presently anticipated
working capital needs for at least the next 13 months. 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.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
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<RECEIVABLES> 475,000 475,000
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