<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 MARCH 31, 1998
[_] 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:
TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT MARCH 31, 1998
- ------------------------------------ ------------------------------
Common Stock, no par value 17,379,747
<PAGE>
Index
Franklin Telecommunications Corp.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
March 31, 1998 (Unaudited) and June 30, 1997
Consolidated Statements of Operations (Unaudited)
Three months and nine months ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended March 31, 1998 and 1997
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 March 31, 1998 (unaudited) and June 30, 1997
<TABLE>
<CAPTION>
March 31, June 30,
------------ ----------
1998 1977
------------ ----------
(unaudited)
ASSETS
------
<S> <C> <C>
Current assets
Cash and cash equivalents $ 7,869,000 $ 1,464,000
Accounts receivable, less allowance for doubtful accounts of $46,000 (unaudited) and
$34,000, respectively....................................................................... 122,000 80,000
Other receivables............................................................................. 222,000 199,000
Inventories (Note 2).......................................................................... 648,000 394,000
Prepaid expenses.............................................................................. 65,000 68,000
------------ -----------
Total current assets......................................................................... 8,926,000 2,205,000
------------ -----------
Property and equipment
Machinery and equipment....................................................................... 242,000 163,000
Furniture and fixtures........................................................................ 148,000 97,000
Computers and software........................................................................ 872,000 713,000
------------ -----------
1,262,000 973,000
Less accumulated depreciation................................................................. 531,000 406,000
------------ -----------
Total property and equipment................................................................. 731,000 567,000
------------ -----------
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................................................................................... 307,000 151,000
------------ -----------
Total assets................................................................................. $ 9,964,000 $ 3,514,000
============ ===========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Current liabilities
Current portion of obligations under capital lease obligations................................ $ -- $ 361,000
Current portion of long-term debt (majority due to a related party)........................... 207,000 301,000
Accounts payable.............................................................................. 430,000 175,000
Accrued liabilities........................................................................... 790,000 559,000
------------ -----------
Total current liabilities.................................................................... 1,427,000 1,396,000
Long-term debt, (majority due to a related party) less current portion......................... 320,000 360,000
Other liabilities.............................................................................. 182,000 183,000
------------ -----------
Total liabilities............................................................................ 1,929,000 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 17,379,747 (unaudited) and
13,191,223 shares issued and outstanding............................................... 13,692,000 9,971,000
Common stock committed, no par value -0- (unaudited) and 296,066 shares
committed but not yet issued................................................................. -- 579,000
Accumulated deficit........................................................................... (12,215,000) (8,975,000)
------------ -----------
Total shareholders' equity................................................................... 8,035,000 1,575,000
------------ -----------
Total liabilities and shareholders' equity................................................... $ 9,964,000 $ 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 Nine Months Ended March 31, 1998 and 1997 (unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
March 31, March 31,
--------------------------- ---------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Sales
Product................................... $ 166,000 $ 317,000 $ 403,000 $ 1,086,000
Internet services......................... 159,000 161,000 450,000 273,000
----------- ----------- ----------- -----------
Total sales............................ 325,000 478,000 853,000 1,359,000
----------- ----------- ----------- -----------
Cost of sales
Product................................... 113,000 223,000 254,000 607,000
Internet services......................... 65,000 141,000 321,000 198,000
----------- ----------- ----------- -----------
Total cost of sales.................... 178,000 364,000 575,000 805,000
----------- ----------- ----------- -----------
Gross profit................................ 147,000 114,000 278,000 554,000
----------- ----------- ----------- -----------
Operating expenses
Research and development expenses......... 511,000 124,000 1,017,000 339,000
Selling, general, and administrative
Expenses................................ 1,210,000 587,000 2,698,000 1,246,000
----------- ----------- ----------- -----------
Total operating expenses............... 1,721,000 711,000 3,715,000 1,585,000
----------- ----------- ----------- -----------
Loss from operations........................ (1,574,000) (597,000) (3,437,000) (1,031,000)
----------- ----------- ----------- -----------
Other income (expense)
Interest expense.......................... (10,000) (12,000) (41,000) (29,000)
Other income.............................. 172,000 13,000 238,000 24,000
----------- ----------- ----------- -----------
Total other income (expense)........... 162,000 1,000 197,000 (5,000)
----------- ----------- ----------- -----------
Loss before provision for income taxes...... (1,412,000) (596,000) (3,240,000) (1,036,000)
Provision for income taxes.................. -- -- -- --
----------- ----------- ----------- -----------
Net loss.................................... $(1,412,000) $ (596,000) $(3,240,000) $(1,036,000)
=========== =========== =========== ===========
Basic net loss per common share............. $ (.09) $ (.05) $ (.22) $ (.09)
=========== =========== =========== ===========
Diluted net loss per common share........... $ (.09) $ (.05) $ (.22) $ (.09)
=========== =========== =========== ===========
Weighted average common shares
outstanding used to compute basic
loss per common share..................... 16,334,147 12,496,783 15,097,788 12,046,337
=========== =========== =========== ===========
</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 Nine Months Ended March 31, 1998 and 1997 (unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------
March 31,
------------------------------
1998 1997
-------------- -------------
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities
Net loss........................................ $(3,240,000) $(1,036,000)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization................. 186,000 108,000
Provision for loss on doubtful accounts....... 12,000 5,000
Gain from retirement of capital lease
liability.............................. (71,000) --
Stock issued for services rendered............ -- 48,000
(Increase) decrease in
Accounts receivable........................... (54,000) (69,000)
Inventories................................... (254,000) 15,000
Prepaid expenses.............................. 3,000 (11,000)
Increase in
Accounts payable.............................. 178,000 339,000
Accrued liabilities........................... 67,000 254,000
----------- -----------
Net cash used in operating
Activities..................................... (3,173,000) (347,000)
----------- -----------
Cash flows from investing activities
Purchases of property and equipment............. (291,000) (281,000)
Cash received in connection with business
acquisitions................................... --- 9,000
Repayment (issuance) of notes receivable........ 5,000 (124,000)
Other assets.................................... (273,000) (8,000)
----------- -----------
Net cash used in investing activities........... (559,000) (404,000)
----------- -----------
Cash flows from financing activities
Payments on other liabilities................... (1,000) (47,000)
Proceeds from sale of Company stock............. 10,055,000 1,041,000
Proceeds from sale of minority stock in
consolidated subsidiary........................ 373,000 1,506,000
Payments on long term debt...................... -- (1,000)
Payments on capital lease obligation............ (290,000) (2,000)
----------- -----------
Net cash provided by financing activities 10,137,000 2,497,000
----------- -----------
Net increase (decrease) in cash................. 6,405,000 1,746,000
Cash and cash equivalents, beginning of
the period..................................... 1,464,000 166,000
----------- -----------
Cash and cash equivalents, end of
the period..................................... $ 7,869,000 $ 1,912,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
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 and telephony
communications, 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 accounting principles 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 financial statements included in
the Form S-1 Amendment 2 of Franklin Telecommunications Corp., filed with the
Securities and Exchange Commission on January 27, 1998. The results of
operations for the three months and nine months ended March 31, 1998 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 372,500 shares
of FNet common stock for the year ended June 30, 1997 and the nine months ended
March 31, 1998, respectively, to outside investors and exercise of employee
options 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 and exercise of employee options 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 March 31, 1998 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 nine months ended
March 31, 1998 and 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.
<PAGE>
Loss Per Common Share
For the three month and nine month periods ended March 31, 1998 and 1997, the
Company adopted SFAS No. 128 "Earnings per Share." Basic losses per share is
computed by dividing losses available to common shareholders by the
weighted-average number of common shares outstanding. Diluted losses per share
is computed similar to basic losses per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. 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.
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>
March 31, June 30,
--------- --------
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Raw materials.......... $198,000 $155,000
Work in process........ 223,000 152,000
Finished goods......... 227,000 87,000
-------- --------
Total............... $648,000 $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
<PAGE>
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.
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 nine months ended March 31, 1998, FNet sold shares to outside
investors and employees exercised options for a total of 372,500 shares of its
stock 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 March 31, 1998.
During the three months ended March 31, 1998, the Company raised $2,172,000
from the exercise of options and warrants for the Company's Common Stock.
<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 Internet 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 nine months ended March 31, 1998, 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.
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.
<PAGE>
Results of Operations
Three Months Ended March 31, 1998 Compared To Three Months Ended March 31, 1997
Net Sales. Net sales decreased by $153,000, or 32%, from $478,000 in the
three months ended March 31, 1997 to $325,000 in the three months ended March
31, 1998. 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 shipments to date have been to customers for testing
and evaluation purposes. Revenue will be recorded when the customer completes
testing and evaluating and agrees to purchase the product. The revenue mix for
the three months ended March 31, 1998 consisted of 49% Internet services revenue
and 51% hardware product sales.
Gross Profit. Gross profit increased as a percentage of net sales to 45% for
the three months ended March 31, 1998, from a gross profit of 24% of net sales
for the corresponding period of 1997. The gross profit percentage increase can
be attributed to web page design sales increases. Hardware margin percentages
were comparable within both periods.
Operating Expenses. Operating expenses increased by $1,010,000, or 142%,
from $711,000 in the three months ended March 31, 1997 to $1,721,000 in the
three months ended March 31, 1998. The increase is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet and telephony services infrastructure, increased
sales and marketing efforts, and costs in enhancing the general and
administrative infrastructure.
Other Income (Expense). Interest expense decreased by $2,000, or 17%, from
$12,000 in the three months ended March 31, 1997 to $10,000 in the three months
ended March 31, 1998, due primarily to a reduction in loans from an officer of
the Company. Other income increased by $159,000, or 1,223%, from $13,000 in the
three months ended March 31, 1997 to $172,000 in the three months ended March
31, 1998, due to interest earned on cash investments and a $70,000 gain
resulting from retirement of a capital lease obligation.
Nine Months Ended March 31, 1998 Compared To Nine Months Ended March 31, 1997
Net Sales. Net sales decreased by $506,000, or 37%, from $1,359,000 in the
nine months ended March 31, 1997 to $853,000 in the nine months ended March 31,
1998. 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 nine months ended March 31, 1998
consisted of 53% Internet services revenue and 47% hardware product sales.
Gross Profit. Gross profit decreased as a percentage of net sales to 33% for
the nine months ended March 31, 1998, from a gross profit of 41% of net sales
for the corresponding period of 1997. The gross profit percentage decrease can
be attributed to reduced sales of higher margin wide area network products.
Operating Expenses. Operating expenses increased by $2,130,000, or 134%,
from $1,585,000 in the nine months ended March 31, 1997 to $3,715,000 in the
nine months ended March 31, 1998. The increase is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet and telephony services infrastructure, increased
sales and marketing efforts, and costs in enhancing the general and
administrative infrastructure.
Other Income (Expense). Interest expense increased by $12,000, or 41%, from
$29,000 in the nine months ended March 31, 1997 to $41,000 in the nine months
ended March 31, 1998, due primarily to assumed lease debt from Internet
Passport. Other income increased by $214,000, or 892%, from $24,000 in the nine
months ended March 31, 1997 to $238,000 in the nine months ended March 31, 1998,
due primarily to interest earned on cash investments and a $70,000 gain
resulting from retirement of a capital lease obligation.
Liquidity and Capital Resources
Cash and cash equivalents and net working capital totaled $7,869,000 and
$7,499,000, respectively, as of March 31, 1998. 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 $10,055,000 in
equity financing, for the year ended June 30, 1997, and the nine months ended
March 31, 1998, respectively. Its subsidiary, FNet, raised $1,950,000 for the
year ended June 30, 1997 and $373,000 for the nine months ended March 31, 1998.
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
<PAGE>
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
On February 27, 1998, the Company held an Annual Meeting of Shareholders.
The meeting provided for an election of Directors and approval of the 1998
Incentive Stock Option Plan.
The current Board of Directors were reelected for a term of one year as
follows:
<TABLE>
<CAPTION>
For Withhold
<S> <C> <C>
Frank W. Peters 9,446,487 6,518
Peter S. Buswell 9,446,646 6,359
Robert S. Harp 9,446,447 6,558
Thomas L. Russell 9,446,687 6,318
</TABLE>
The 1998 Incentive Stock Option Plan, which provides 2,000,000 common
shares available for employees, was adopted as follows:
<TABLE>
<CAPTION>
For Against Abstain Non-Vote
<S> <C> <C> <C>
5,425,365 76,468 16,277 3,934,895
</TABLE>
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
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> JUN-30-1997 JUN-30-1997
<PERIOD-START> JAN-01-1998 JUL-01-1997
<PERIOD-END> MAR-31-1998 MAR-31-1998
<CASH> 7,869,000 7,869,000
<SECURITIES> 0 0
<RECEIVABLES> 390,000 390,000
<ALLOWANCES> (46,000) (46,000)
<INVENTORY> 648,000 648,000
<CURRENT-ASSETS> 8,926,000 8,926,000
<PP&E> 1,262,000 1,262,000
<DEPRECIATION> 531,000 531,000
<TOTAL-ASSETS> 9,964,000 9,964,000
<CURRENT-LIABILITIES> 1,427,000 1,427,000
<BONDS> 0 0
0 0
6,558,000 6,558,000
<COMMON> 13,692,000 13,692,000
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 9,964,000 9,964,000
<SALES> 325,000 853,000
<TOTAL-REVENUES> 325,000 853,000
<CGS> 178,000 575,000
<TOTAL-COSTS> 178,000 575,000
<OTHER-EXPENSES> 1,549,000 3,477,000
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 10,000 41,000
<INCOME-PRETAX> (1,412,000) (3,240,000)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (1,412,000) (3,240,000)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,412,000) (3,240,000)
<EPS-PRIMARY> (.09) (.22)
<EPS-DILUTED> (.09) (.22)
</TABLE>
