<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 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)
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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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
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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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at September 15, 1998 was $16,309,587 based on the closing sale price
on such date of $1.03.
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 SEPTEMBER 15, 1998
- ----------------------------------- ---------------------------------
<S> <C>
Common Stock, no par value 19,263,444
</TABLE>
<PAGE> 2
Index
Franklin Telecommunications Corp.
<TABLE>
<S> <C>
Part I.
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Selected Consolidated Financial Data
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Part III.
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
</TABLE>
<PAGE> 3
Part I.
Item 1. Business
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 Corp., the Company is a provider of Internet
Protocol ("IP") telephony and 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), IP Telephony (IPT), Wide Area Networks
(WAN) and Local Area Networks (LAN), for which the Company provides proprietary
hardware and software.
The IPT, 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/multiplexers 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 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
<PAGE> 4
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
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.
IP Telephony Products ("IPT"). The recently introduced Data Voice Gateway
("DVG") 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., is in the process of
setting up a service organization, including a 'long distance telephone
network', utilizing IP telephony hardware and software technology, including the
DVG systems manufactured by 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 information,
publish research and transfer e-mail. 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 private data networks and 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.
<PAGE> 5
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 to 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, FNet 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.
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 office. 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 manufacturers 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.
<PAGE> 6
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 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) the Regional Bell Operating Companies ("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
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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.
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. During the year ended June 30, 1998, 160,000 shares of the
Company's common stock at a value of $650,000, were returned to the Company, as
provided under contract, thus reducing the initial purchase value.
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 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. Under the agreement, FNet issued 50,000
shares of its Common Stock to Peak.
In May 1998, the Company's subsidiary, FNet, entered into a joint venture
agreement with LibertyOne for the operation of telephone services in New Zealand
and Australia. Operations of this joint venture have not yet commenced.
In June 1998, the Company's subsidiary, FNet, entered into a joint venture
agreement with Megaburst for the operation of telephone services for NATO troops
within Bosnia. Operations commenced in August 1998. (See Note 1, Page 12 to the
Financial Statements).
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
<PAGE> 8
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.
Item 2. Properties
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 November 1998. The lease for this facility is
renewable on a year-to-year basis at the option of the Company. The Company
plans to renew this lease. The other facility houses the manufacturing and
inventory warehouse. This facility is 4,000 square feet, with a lease rate of
$3,982 per month, expiring in March, 1999, and has a one year option on renewal.
The Company's subsidiary, FNet, has a sublease arrangement for a 960 square foot
facility at the rate of $1,392 per month, expiring in January 1999.
Item 3. 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 4. Submission of Matters to a Vote of Security Holders
None
Part II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
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.
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HIGH LOW
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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
</TABLE>
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<TABLE>
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Fourth Quarter......................... 9.94 3.88
1998
First Quarter.......................... 6.69 4.50
Second Quarter......................... 3.94 2.50
</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.
Item 6. Selected Consolidated Financial Data
The selected financial data set forth below for the fiscal years ended
June 30, 1996, 1997 and 1998 have been derived from the Company's consolidated
financial statements, audited by Singer, Lewak, Greenbaum & Goldstein LLP (1997
and 1998) and Corbin & Wertz (1996), respectively, 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, 1994 and 1995 have been derived from the Company's consolidated
financial statements, audited by Corbin & Wertz, but which are not included in
this 10-K.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
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YEARS ENDED JUNE 30,
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1994 1995 1996 1997 1998
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Sales .................................... $ 1,241 $ 1,481 $ 430 $ 1,735 $ 1,377
Cost of sales ............................ 516 518 590 990 834
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Gross profit (loss) ................... 725 963 (160) 745 543
------------ ------------ ------------ ------------ ------------
Operating expenses:
Research and development expenses ..... 327 308 320 480 1,612
Selling, general and administrative
expenses ............................ 871 828 947 1,766 3,895
Write-off of goodwill ................. -- -- 70 1,584 --
------------ ------------ ------------ ------------ ------------
Total operating expenses ............ 1,198 1,136 1,337 3,830 5,507
------------ ------------ ------------ ------------ ------------
Income (loss) from operations ............ (473) (173) (1,497) (3,085) (4,964)
------------ ------------ ------------ ------------ ------------
Other income (expense):
Interest income ...................... 250
Interest expense ...................... (14) (10) (26) (41) (43)
Gain on extinguishment of debt ........ 310 227
Loss on settlement of litigation ......
Other ................................. 4 25 (5) (6) 26
------------ ------------ ------------ ------------ ------------
Total other income (expense) ........ (10) 15 (31) 263 460
------------ ------------ ------------ ------------ ------------
Income (loss) before minority interest and
Income taxes .......................... (483) (158) (1,528) (2,822) (4,504)
Minority interest in loss of subsidiary .. -- -- 63 -- --
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes ........ (483) (158) (1,465) (2,822) (4,504)
Provision for income taxes ............... 2 2 2 2 3
------------ ------------ ------------ ------------ ------------
Net income (loss) ........................ $ (485) $ (160) $ (1,467) $ (2,824) $ (4,507)
============ ============ ============ ============ ============
Net income (loss) per common share ....... $ (0.08) $ (0.02) $ (0.14) $ (.23) $ (.29)
============ ============ ============ ============ ============
Weighted average number of shares
outstanding ........................... 5,753,589 6,475,984 10,279,281 12,267,991 15,524,556
</TABLE>
BALANCE SHEET DATA (IN THOUSANDS):
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-----------------------------------------------------
1994 1995 1996 1997 1998
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Cash ............................ $ 98 $ 135 $ 166 $1,464 $5,750
Working capital (deficit) ....... (15) 98 (206) 809 5,963
Total assets .................... 769 998 712 3,514 8,892
Long-term debt .................. 50 161 238 360 404
Other liabilities ............... 543 508 503 183 --
Stockholder's equity (deficiency) (549) (386) (749) 1,575 7,036
</TABLE>
<PAGE> 10
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.
Item 7. 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 IP Telephony and Internet access
and services 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 year ended June 30, 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 years, while the newly developed hardware
products and Internet services were not yet ready for market. Initial demand for
the Company's D-Mark Channel Bank, Cyclone and Data Voice Gateway hardware
product lines have yet to be established.
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 and fax
traffic over the Internet and Frame relay circuits.
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
modem technology.
<PAGE> 11
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
Fiscal Year Ended June 30, 1998 Compared To Fiscal Year Ended June 30,
1997
Net Sales. Net sales decreased by $358,000, or 21%, from $1,735,000 in the
year ended June 30, 1997 to $1,377,000 in the year ended June 30, 1998. The
overall decrease is due to reduced demand for wide area network products,
partially offset by increased demand for newly introduced hardware products, and
Internet services. Three customers constituted 49% of total sales for the year
ended June 30, 1998. The revenue mix for the year ended June 30, 1998 consisted
of 13% wide area network products, including repair services, 43% DVG and D-Mark
hardware products, and 44% Internet services.
Gross Profit (Loss). Gross profit decreased as a percentage of net sales
to 39% for the year ended June 30, 1998, from a gross profit of 43% of net sales
for the corresponding period of 1997. The gross profit percentage decrease can
be attributed to decreased sales of higher margin products and a spreading of
fixed manufacturing overhead costs over a smaller sales base.
Operating Expenses. Operating expenses increased by $1,677,000, or 44%,
from $3,830,000 in the year ended June 30, 1997 to $5,507,000 in the year ended
June 30, 1998. The increase is attributable to increased product development
costs for the recently introduced hardware products, costs in developing the IP
telephony and Internet services infrastructure, increased sales and marketing
efforts, and costs in enhancing the general and administrative infrastructure.
Other Income (Expense). The gain on extinguishment of debt for both years
ended June 30, 1997 and 1998 were one time events and were attributable to
renegotiation and reclassification of certain debt. Interest income increased by
$250,000, from $-0- in the year ended June 30, 1997 to $250,000 in the year
ended June 30, 1998, due primarily to investment of equity funds in interest
bearing accounts. Other expense decreased by $6,000, or 100%, from $6,000 in the
year ended June 30, 1997 to $-0- in the year ended June 30, 1998, due to various
non-operating items. Other income increased by $26,000, or 100%, from $-0- in
the year ended June 30, 1997 to $26,000 in the year ended June 30, 1998, 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 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 $2,493,000, or 186%,
from $1,337,000 in the year ended June 30, 1996 to $3,830,000 in the year ended
June 30, 1997. Approximately 64% 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
<PAGE> 12
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). The gain on extinguishment of debt for the year
ended June 30, 1997 was a one time event and attributable to the
reclassification of certain debt. 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.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $5,750,000 and
$5,963,000, respectively, as of June 30, 1998. 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 $1,007,000, $1,109,000 and
$10,150,000 in equity financing, for the years ended June 30, 1996, 1997, and
1998, respectively. Its subsidiary, FNet, raised $1,950,000 for the year ended
June 30, 1997 and $398,000 for the year ended June 30, 1998. FNet recently
engaged an investment banking firm to seek additional private equity funding for
deployment of its planned worldwide IP Telephony network. FNet has continued to
experience losses, due to the expansion of infrastructure for the IP telephony
and Internet services business. In addition to the equity financing described
above, the Company's CEO 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 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
<PAGE> 13
Item 8. Financial Statements and Supplementary Data
See Part IV, Item 14
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None
Part III.
Item 10. Directors and Executive Officers of the Registrant
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Frank W. Peters........ 60 Chief Executive Officer and Chairman of the Board
Peter S. Buswell....... 50 President and a Director
Robert S. Harp......... 62 Director
Thomas Russell......... 46 Chief Financial Officer and a Director
</TABLE>
Mr. Peters has been the Chief Executive Officer 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 President of the Company since June 1998. Between
1996 and 1998 he was President of Xantel Corp. and 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.
Item 11. Executive Compensation
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1997 and June 30, 1998 to its CEO 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, CEO ..................... 1997 $291,556(1) $100,000 -0-
1998 $309,048(1) -0- -0-
Peter Buswell, President (3) ............. 1997 -0- -0- -0-
1998 $ 16,298 -0- -0-
Thomas Russell, Chief Financial Officer(2) 1997 $ 60,208 $ 10,000 -0-
1998 $109,167 $ 5,000 -0-
</TABLE>
<PAGE> 14
(1) Portions of these amounts were deferred. See "Transactions with
Management," below.
(2) Mr. Russell was employed by the Company beginning in October 1996.
(3) Mr. Buswell was employed by the Company beginning in June 1998.
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, 1997 and 1998 to any of the Named Executive
Officers.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of June 30, 1998 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 .............................................. 4,755,893(1) 26%
733 Lakefield Road
Westlake Village, CA 91361
Peter S. Buswell ............................................. 75,000 .4%
733 Lakefield Road
Westlake Village, CA 91361
Robert S. Harp ............................................... -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Thomas Russell ............................................... 148,000 .8%
733 Lakefield Road
Westlake Village, CA 91361
All directors and executive officers of the Company as a group
(5 persons) ............................................... 4,978,893 27%
</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.
The following table sets forth information with respect to ownership of options
and option values as of June 30, 1998 with respect to the Named Executive
Officers. The Company has no outstanding stock appreciation rights, either
freestanding or in tandem with options.
OPTION VALUES AS OF JUNE 30, 1998
---------------------------------
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
JUNE 30, 1998 JUNE 30, 1998(1)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
Frank W. Peters .... 1,550,000(2)/-0- $2,970,000(2)/-0-
Peter Buswell ...... -0-/400,000 -0-/$95,000
Thomas Russell ..... -0-/200,000 -0-/-0-
(1) Assumes that a share of Common Stock was valued at $2.56 per share on June
30, 1998. 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.
<PAGE> 15
Option Grants During the Years Ended June 30, 1997 and 1998. The following
table sets forth certain information regarding stock options granted to the
Named Executive Officers during the twelve months ended June 30, 1997 and 1998:
<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 .......... 1997 500,000 40% $1.31 12/13/96
Frank W. Peters .......... 1998 -0- 0%
Peter Buswell ............ 1997 50,000 4% $1.31 12/13/96
Peter Buswell ............ 1998 350,000 32% $2.59 Various
Thomas Russell ........... 1997 100,000 8% $1.31 12/13/96
Thomas Russell ........... 1998 200,000 18% $2.69 Various
</TABLE>
Item 13. Certain Relationships and Related Transactions
Employment Arrangements. The Company's CEO is employed pursuant to a six
year Employment Agreement, effective January 1, 1998. The Employment Agreement
provides for compensation at the rate of $27,000 per month, with annual
increases of 6%. The Company's President is employed pursuant to a two year
Employment Agreement, commencing within June 1998. The Employment Agreement
provides for compensation at the rate of $18,750 per month, with annual
increases of 6%. The Company's Chief Financial Officer is employed pursuant to
Employment Agreement for a three year period, commencing on September 2, 1997,
providing monthly compensation at the rate of $10,000 per month.
TRANSACTIONS WITH MANAGEMENT
On October 7, 1997, the Company's CEO exercised an option to convert a
note for $133,000 into 1,333,695 shares of the Company's Common stock at the
exercise price of $.10 per share.
On October 14, 1997, the Company's CEO exercised an option to purchase
300,000 shares of the Company's Common 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.
On May 11, 1998, the Company's Chief Financial Officer exercised options
to purchase 100,000 shares of the Company's Common stock at an exercise price of
$.69 per share.
As of June 30, 1998, the deferred compensation of $129,000 for the CEO
was converted into a promissory note. One half of the principal balance of the
note 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.
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Financial Statements
(c) Reports on From 8-K
None.
<PAGE> 16
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
JUNE 30, 1998, 1997, AND 1996
<PAGE> 17
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONTENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1
INDEPENDENT AUDITORS' REPORT 1A
FINANCIAL STATEMENTS
Consolidated Balance Sheets 2 - 3
Consolidated Statements of Operations 4
Consolidated Statements of Shareholders' Equity 5 - 6
Consolidated Statements of Cash Flows 7 - 9
Notes to Consolidated Financial Statements 10 - 40
</TABLE>
<PAGE> 18
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Franklin Telecommunications Corp.
We have audited the accompanying consolidated balance sheets of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1998 and 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the years 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, 1998 and 1997, and the
results of consolidated their operations and their consolidated cash flows for
the years then ended, in conformity with generally accepted accounting
principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
September 14, 1998
<PAGE> 19
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Franklin Telecommunications Corp.
We have audited the consolidated statement of operations, shareholders'
equity (deficit) and cash flow for the year ended June 30, 1996 of Franklin
Telecommunications Corp. and subsidiaries (the "Company"). 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 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 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 results of the Company's
operations and their cash flows for year 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. 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. 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, except
as to Note 12 which is as
of October 31, 1996
<PAGE> 20
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $5,750,000 $1,464,000
Accounts receivable, less allowance for doubtful accounts
of $8,000 and $34,000 91,000 80,000
Other receivables 107,000 199,000
Current portion of note receivable 241,000 --
Inventories 671,000 394,000
Prepaid expenses 555,000 68,000
---------- ----------
Total current assets 7,415,000 2,205,000
---------- ----------
PROPERTY AND EQUIPMENT, net 778,000 567,000
EXCESS OF COST OVER FAIR VALUE OF NET ASSETS OF COMPANIES
ACQUIRED, net of accumulated amortization of $0 and $40,000 -- 591,000
NOTE RECEIVABLE, net of current portion 276,000 --
OTHER ASSETS 423,000 151,000
---------- ----------
TOTAL ASSETS $8,892,000 $3,514,000
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 21
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
JUNE 30,
- --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<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) 252,000 301,000
Accounts payable 173,000 175,000
Accrued liabilities 1,027,000 559,000
------------ ------------
Total current liabilities 1,452,000 1,396,000
LONG-TERM DEBT, (majority due to a related party)
less current portion 404,000 360,000
OTHER LIABILITIES -- 183,000
------------ ------------
Total liabilities 1,856,000 1,939,000
------------ ------------
MINORITY INTEREST -- --
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Series C Convertible Preferred stock, no par value
10,000,000 shares authorized
548 and 0 shares issued and outstanding 4,856,000 --
Common stock, no par value
90,000,000 shares authorized
18,344,178 and 13,191,223 shares issued
and outstanding 15,571,000 9,971,000
Common stock committed, no par value
77,336 and 296,066 shares committed but
not yet issued 91,000 579,000
Accumulated deficit (13,482,000) (8,975,000)
------------ ------------
Total shareholders' equity 7,036,000 1,575,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,892,000 $ 3,514,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 22
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
SALES
Product $ 778,000 $ 1,337,000 $ 397,000
Internet services 599,000 398,000 33,000
------------ ------------ ------------
Total sales 1,377,000 1,735,000 430,000
------------ ------------ ------------
COST OF SALES
Product 749,000 681,000 549,000
Internet services 85,000 309,000 41,000
------------ ------------ ------------
Total cost of sales 834,000 990,000 590,000
------------ ------------ ------------
GROSS PROFIT (LOSS) 543,000 745,000 (160,000)
------------ ------------ ------------
OPERATING EXPENSES
Research and development expenses 1,612,000 480,000 320,000
Selling, general, and administrative expenses 3,895,000 1,766,000 947,000
Write-down of goodwill -- 1,584,000 70,000
------------ ------------ ------------
Total operating expenses 5,507,000 3,830,000 1,337,000
------------ ------------ ------------
LOSS FROM OPERATIONS (4,964,000) (3,085,000) (1,497,000)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Gain on extinguishment of debt 227,000 310,000 --
Interest income 250,000 -- --
Other income 26,000 -- --
Interest expense (43,000) (41,000) (26,000)
Other expense -- (6,000) (5,000)
------------ ------------ ------------
Total other income (expense) 460,000 263,000 (31,000)
------------ ------------ ------------
LOSS BEFORE MINORITY INTEREST AND
PROVISION FOR INCOME TAXES (4,504,000) (2,822,000) (1,528,000)
MINORITY INTEREST IN LOSS OF SUBSIDIARY -- -- 63,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (4,504,000) (2,822,000) (1,465,000)
PROVISION FOR INCOME TAXES 3,000 2,000 2,000
------------ ------------ ------------
NET LOSS $ (4,507,000) $ (2,824,000) $ (1,467,000)
============ ============ ============
NET LOSS PER COMMON SHARE $ (0.29) $ (0.23) $ (0.14)
============ ============ ============
WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING 15,524,556 12,267,991 10,279,281
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 23
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------------------------------- ---------------------------------
Shares Amount Shares Amount
------------------ ------------------ ------------------ ------------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1995 $ - 8,720,289 $4,298,000
CORRECTION OF ERROR 23,031
COMMON STOCK ISSUED FOR
Cash 1,808,572 910,000
Business acquisition 85,000 65,000
Stock options/warrants 189,500 77,000
Compensation 34,839 11,000
Accounts payable 7,555 11,000
NET LOSS
------------------ ------------------ ------------------ ------------
BALANCE, JUNE 30, 1996 - - 10,868,786 5,372,000
COMMON STOCK ISSUED FOR
Cash 880,200 888,000
Issuance for notes
receivable 243,250
Issuance of committed
shares 48,350 30,000
Business acquisition 708,887 1,458,000
Services rendered 77,000
Stock options/warrants 441,750 196,000
PROCEEDS RECEIVED FROM THE
SALE OF SUBSIDIARIES'
COMMON STOCK 1,950,000
NET LOSS
------------------ ------------------ ------------------ ------------
</TABLE>
<TABLE>
<CAPTION>
Common Stock Committed
-------------------------------- Accumulated
Shares Amount Deficit Total
------------------ ----------- ------------------ -----------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1995 - $ - $(4,684,000) $ (386,000)
CORRECTION OF ERROR -
COMMON STOCK ISSUED FOR
Cash 23,350 20,000 930,000
Business acquisition 25,000 10,000 75,000
Stock options/warrants 77,000
Compensation 11,000
Accounts payable 11,000
NET LOSS (1,467,000) (1,467,000)
------------------ ---------- ------------- -----------
BALANCE, JUNE 30, 1996 48,350 30,000 (6,151,000) (749,000)
COMMON STOCK ISSUED FOR
Cash 20,000 25,000 913,000
Issuance for notes
receivable -
Issuance of committed
shares (48,350) (30,000) -
Business acquisition 232,066 525,000 1,983,000
Services rendered 44,000 29,000 106,000
Stock options/warrants 196,000
PROCEEDS RECEIVED FROM THE
SALE OF SUBSIDIARIES'
COMMON STOCK 1,950,000
NET LOSS (2,824,000) (2,824,000)
------------------ ---------- ------------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 24
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------------------------- --------------------------------
Shares Amount Shares Amount
------------------ ------------ ------------------ -----------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1997 - $ - 13,191,223 $ 9,971,000
SALE OF PREFERRED STOCK 740 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (23,818) (161,000)
COMMON STOCK ISSUED FOR
Cash 333,333 1,060,000
Notes receivable 345,500
Stock options/warrants 1,838,748 2,518,000
Exchange of common shares
with related parties 400,000 161,000
Conversion of notes payable
by a related party 1,333,695 133,000
Conversion of preferred stock (192) (1,702,000) 799,431 1,702,000
Issuance of committed shares 286,066 573,000
Services rendered
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (842,000) (142,000)
CANCELLATION OF SHARES (160,000) (650,000)
NET LOSS
------------------ ----------- ------------------ -----------
BALANCE, JUNE 30, 1998 548 $ 4,856,000 18,344,178 $15,571,000
================== =========== ================== ===========
</TABLE>
<TABLE>
<CAPTION>
Common Stock Committed
-------------------------------- Accumulated
Shares Amount Deficit Total
------------------ ----------- ------------- -----------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1997 296,066 $ 579,000 $ (8,975,000) $ 1,575,000
SALE OF PREFERRED STOCK 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (161,000)
COMMON STOCK ISSUED FOR
Cash 1,060,000
Notes receivable -
Stock options/warrants 11,000 14,000 2,532,000
Exchange of common shares
with related parties 161,000
Conversion of notes payable
by a related party 133,000
Conversion of preferred stock -
Issuance of committed shares (286,066) (573,000) -
Services rendered 56,336 71,000 71,000
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (984,000)
CANCELLATION OF SHARES (650,000)
NET LOSS (4,507,000) (4,507,000)
------------------ ----------- ------------ -----------
BALANCE, JUNE 30, 1998 77,336 $ 91,000 $(13,482,000) $ 7,036,000
================== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 25
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(4,507,000) $(2,824,000) $(1,467,000)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 167,000 110,000 45,000
Compensation expense 71,000 -- --
Provision for loss on obsolete inventory -- -- 226,000
Provision for loss on doubtful accounts -- -- (2,000)
Write-down of goodwill -- 1,584,000 70,000
Notes payable for services rendered -- 329,000 --
Stock issued for services rendered -- 106,000 11,000
Loss on disposal of property -- 37,000 1,000
(Increase) decrease in
Accounts receivable (11,000) 14,000 (34,000)
Other receivables 92,000 -- --
Inventories (277,000) (132,000) 131,000
Prepaid expenses (487,000) (63,000) 9,000
Increase (decrease) in
Accounts payable (2,000) (96,000) (97,000)
Accrued liabilities 468,000 71,000 175,000
Accrued other liabilities -- -- (24,000)
Other liabilities -- (310,000) --
----------- ----------- -----------
Net cash used in operating activities (4,486,000) (1,174,000) (956,000)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (378,000) (324,000) (58,000)
Cash received in connection with business
acquisitions -- 4,000 3,000
Issuance of notes receivable (517,000) (100,000) --
Proceeds from notes receivable -- 32,000 --
Other assets (272,000) (100,000) 1,000
Other liabilities (183,000) (38,000) --
----------- ----------- -----------
Net cash used in investing activities (1,350,000) (526,000) (54,000)
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE> 26
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable $ 129,000 $ -- $ --
Payments on notes payable (1,000) -- --
Payments on other liabilities -- (10,000) (5,000)
Proceeds from sale of preferred stock, net of
offering costs 6,558,000 -- --
Proceeds from sale of common stock 3,797,000 1,109,000 1,007,000
Proceeds from sale of minority stock in
consolidated subsidiary -- 1,950,000 --
Issuance of long-term debt -- -- 102,000
Payments on long-term debt -- -- (63,000)
Payments on capital lease obligation (361,000) (51,000) --
------------ ------------ ------------
Net cash provided by financing activities 10,122,000 2,998,000 1,041,000
------------ ------------ ------------
Net increase in cash and cash equivalents 4,286,000 1,298,000 31,000
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,464,000 166,000 135,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 5,750,000 $ 1,464,000 $ 166,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID $ -- $ -- $ 12,000
============ ============ ============
INCOME TAXES PAID $ 3,000 $ 2,000 $ 2,000
============ ============ ============
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended June 30, 1998, the Company completed the following:
- - Reduced goodwill valued at $591,000 to $0 as part of the repurchase of
160,000 shares of the Company's common stock.
- - Issued 1,333,695 shares of common stock upon the conversion of a note
payable by an officer of the Company for $133,000.
- - Issued 799,431 shares of common stock upon the conversion of 192 shares of
its Series C preferred stock.
The accompanying notes are an integral part of these financial statements.
8
<PAGE> 27
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (CONTINUED)
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>
JUNE 30, 1997 JUNE 30, 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 $ 0
=========== ========
</TABLE>
See Notes 1 and 7 for additional non-cash investing and financing activities.
The accompanying notes are an integral part of these financial statements.
9
<PAGE> 28
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Franklin Telecommunications Corp. ("Franklin") and its subsidiaries
(collectively the "Company") design, manufacture, and market 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 Corp.
("FNet"), the Company is a provider of Internet Protocol ("IP")
telephony and Internet access and services to businesses and
individuals. FNet also distributes the equipment manufactured by the
Company to corporations, including Internet Service Providers.
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 excess of cost over
fair value of net assets of companies acquired. 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
(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 excess of cost over fair value of net assets
of companies acquired.
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.
10
<PAGE> 29
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Acquisitions (Continued)
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 excess of cost over fair
value of net assets of companies acquired. 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. Pro forma results for the year ended June 30, 1997, as if the
acquisitions had taken place as of the beginning of the 1997 fiscal
year, are 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 excess of cost over fair
value of net assets of companies acquired. 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, are 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 the excess of approximately $61,000 of the total acquisition
costs over the net assets acquired and liabilities assumed being
allocated to excess of cost over fair value of net assets of
companies acquired. 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, are 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 excess of cost over
fair value of net assets acquired of approximately $61,000 related to
the acquisition of CPR due to the uncertainty of the royalty stream.
11
<PAGE> 30
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Acquisitions (Continued)
On February 28, 1997, the Company agreed to acquire Internet
Passport, LLC, a limited liability company, ("Passport") 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 excess of
cost over fair value of net assets of companies acquired. Pro forma
net loss and net loss per share of the years 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
14.
During the year ended June 30, 1998, 160,000 shares of common stock
valued at $650,000 were returned to the Company and cancelled as
provided under contract. The remaining excess of cost over fair value
of net assets acquired related to the acquisition of $591,000 was
reduced to $0.
During April 1998, FNet entered into a joint venture with LibertyOne
Limited, an Australian limited liability corporation that provides
project management services and marketing and sales of
telecommunications services in New Zealand. The joint venture is to
provide voice and data communications through a FNet network to
customers in New Zealand, Australia, Asia, and the South Pacific. The
joint venture is for an initial term of five years with an option to
extend at the expiration date. As of June 30, 1998, the joint venture
had not commenced operations.
During June 1998, FNet entered into a joint venture agreement with
Megaburst, Inc. to operate an 11-site satellite telephone network in
Bosnia used by NATO troops. The joint venture will operate a network
that was purchased by Megaburst, Inc. from a third party for
$150,000. FNet advanced funds to Megaburst, Inc. for the purchase of
the assets. Megaburst, Inc. will subsequently transfer the assets to
FNet.
During June 1998, FNet purchased all of the assets of LDNet, Inc. for
$20,000. These assets consisted of equipment.
12
<PAGE> 31
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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 intercompany balances and
transactions have been eliminated.
Concentrations of Credit Risk
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.
Three customers accounted for 30%, 13%, and 6%, respectively, of the
Company's product sales for the year ended June 30, 1998. 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. At June 30, 1998,
amounts due from two customers amounted to 35% and 25%, respectively,
of accounts receivable. At June 30, 1997, amounts due from two
customers amounted to 20% and 10%, respectively, of accounts
receivable. One customer, a related party, accounted for 0%, 5%, and
1% of product sales for the years ended June 30, 1998, 1997, and
1996, respectively, and comprised 0% and 0% of accounts receivable at
June 30, 1998 and 1997, respectively.
Export sales, primarily to Canada, Australia, Poland, and England,
represented 1%, 6%, and 15% of net sales for the years ended June 30,
1998, 1997, and 1996, respectively.
13
<PAGE> 32
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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 receivable, notes payable, and capital lease
obligations also approximate fair value because current interest
rates and terms offered by and 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>
Computers and software 5 years
Machinery and equipment 7 years
Furniture and fixtures 7 years
</TABLE>
14
<PAGE> 33
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Property and Equipment (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 ("FASB") 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
Excess of cost over fair value of net assets of companies acquired
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 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 year ended June 30, 1997, management of the
Company determined that $1,584,000 had been impaired and,
accordingly, the Company charged this amount to operations.
Amortization of excess of cost over fair value of net assets of
companies acquired for the years ended June 30, 1998, 1997, and 1996
amounted to $0, $40,000, and $22,000, 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.
15
<PAGE> 34
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Minority Interest (Continued)
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.
During the year ended June 30, 1998, FNet sold approximately 362,000
shares of its stock to outside investors at $1.00 per share. It also
issued 35,500 shares upon the exercise of 35,500 stock options and
8,000 shares for services rendered valued at $8,000. 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. In addition, FNet converted a payable for
$311,000 to its parent, FTEL, into 310,718 shares of its stock. After
the issuance of these shares, Franklin's ownership percentage
remained at 71% as of June 30, 1998.
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 shares of common stock 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, 1998 and 1997 as FNet, on
a stand-alone basis, had a shareholders' deficit as of such dates.
The accompanying consolidated statements of operations for the years
ended June 30, 1998 and 1997 do not reflect the minority interest's
share of FNet's losses for said years 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.
16
<PAGE> 35
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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.
Earnings per Share
For the year ended June 30, 1998, the Company adopted SFAS No. 128,
"Earnings per Share." Basic earnings per share is computed by
dividing income available to common shareholders by the
weighted-average number of common shares outstanding. Diluted
earnings per share is computed similar to basic earnings 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. Because the Company has incurred net losses,
basic and diluted loss per share are the same.
Income Taxes
The Company accounts for income taxes under the asset and liability
method of accounting. Under this method, 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.
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.
Reclassifications
Certain amounts in the 1996 consolidated financial statements have
been reclassified to conform to the 1998 and 1997 presentations.
Recently Issued Accounting Pronouncements
The FASB issued SFAS 130, "Reporting Comprehensive Income," which 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.
17
<PAGE> 36
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Recently Issued Accounting Pronouncements (Continued)
The FASB 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 - CASH AND CASH EQUIVALENTS
The Company maintains cash deposits at banks located in California.
Deposits at each bank are insured by the Federal Deposit Insurance
Corporation up to $100,000. At times, the Company holds cash with
these banks in excess of amounts insured by federal agencies. Excess
cash is invested in money market accounts, certificates of deposit,
and United States Government agency notes. As of June 30, 1998, the
uninsured portions of these balances held at financial institutions
aggregated to $5,534,000.
Income from these investments consists entirely of interest income in
the amount of $250,000. The aggregate carrying amount of cash and
short-term investments by major types is as follows:
<TABLE>
<S> <C>
Cash $ 338,000
Money market accounts 1,796,000
Certificates of deposit 1,362,000
United States Government agency notes 2,054,000
----------
TOTAL $5,750,000
==========
</TABLE>
18
<PAGE> 37
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 3 - INVENTORIES
Inventories at June 30 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Raw materials $260,000 $155,000
Work in process 164,000 152,000
Finished goods 247,000 87,000
-------- --------
TOTAL $671,000 $394,000
======== ========
</TABLE>
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment at June 30 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Computers and software $ 997,000 $ 713,000
Machinery and equipment 184,000 163,000
Furniture and fixtures 168,000 97,000
---------- ----------
1,349,000 973,000
Less accumulated depreciation 571,000 406,000
---------- ----------
TOTAL PROPERTY AND EQUIPMENT $ 778,000 $ 567,000
========== ==========
</TABLE>
NOTE 5 - NOTES RECEIVABLE
Notes receivable at June 30, 1998 consisted of the following:
<TABLE>
<S> <C>
Note receivable from customer, bearing interest at 11.5%
per annum, secured by certain equipment, and due in
August 2001. $367,000
Note receivable from joint venture partner, bearing
interest at 10% per annum, secured by a personal
guarantee from the president of the joint venture
partners, and due in June 1999 150,000
--------
517,000
Less current portion 241,000
--------
LONG-TERM PORTION $276,000
========
</TABLE>
19
<PAGE> 38
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 6 - ACCRUED LIABILITIES
Accrued liabilities at June 30 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Salaries and related expenses $ 421,000 $ 277,000
Accrued offering costs 153,000 --
Accrued interest payable, primarily to related party 130,000 88,000
Other accrued liabilities 323,000 194,000
---------- ----------
TOTAL $1,027,000 $ 559,000
========== ==========
</TABLE>
NOTE 7 - LONG-TERM DEBT
Long-term debt at June 30 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Convertible notes payable to former vendors,
bearing interest at 12% per annum,
unsecured and due in December 1999 $ 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 2001 632,000 637,000
-------- --------
656,000 661,000
Less current portion 252,000 301,000
-------- --------
LONG-TERM PORTION $404,000 $360,000
======== ========
</TABLE>
The Company is past due on certain payments under its notes payable
to its chief executive officer/majority shareholder. The chief
executive officer/majority shareholder has waived the default
provisions of the past due notes payable and does not intend to
demand payment until after June 30, 1999.
20
<PAGE> 39
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 7 - LONG-TERM DEBT (CONTINUED)
Future principal payments required under such notes are summarized as
follows:
<TABLE>
<CAPTION>
Year Ending
June 30,
- -----------
<S> <C>
1999 $225,000
2000 136,000
2001 43,000
--------
TOTAL $404,000
========
</TABLE>
Included in the $632,000 due to the Company's president are three
notes in the amount of $129,000, $117,000, and $112,000 which can be
converted into $179,000 of the Company's common stock at a rate of
50% of the fair value of the common stock at the date of conversion
and/or FNet stock at $1.00.
NOTE 8 - 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 was 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 no new modification has been entered into. At June 30, 1998
and 1997, the Company estimated its future obligation to this
supplier to be $183,000 and $2,000, respectively, under the modified
agreement based on the number of boards expected to be sold.
Accordingly, management reduced this obligation to $183,000 and $0,
respectively, and the Company recognized a gain of $310,000 and
$182,000, respectively. Amounts paid under these agreements totaled
approximately $2,000, $10,000, and $5,000 during the years ended June
30, 1998, 1997, and 1996, respectively.
21
<PAGE> 40
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Operating Leases and Capital Lease Obligations
The Company leases its production, warehouse and administrative
facilities under various 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. All leases have various renewal features. Rent
expense related to the operating lease was $170,000, $88,000, and
$51,000 for the years ended June 30, 1998, 1997, and 1996,
respectively.
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. At June
30, 1997, all six capital leases were in default because of
provisions in the leases that prohibited 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 were
also prohibited under the terms of the leases and the lessors had not
been informed of such sales. As a result, the lessors had the right
to accelerate the payments under all of the leases due to such
defaults. During the year ended June 30, 1998, the Company paid off
the six leases and recognized a gain of $45,000.
Future minimum lease payments under non-cancelable operating and
capital leases with initial or remaining terms of one year or more at
June 30, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ending
June 30,
--------
<S> <C>
1999 $ 90,000
2000 15,000
--------
$105,000
========
</TABLE>
22
<PAGE> 41
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Litigation
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 services, its officers and affiliates, and several
Internet Service Providers, including the Company. The action was
brought in the United States 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 the flat rate 800 service was unavailable. In addition to
injunctive relief against Connect America and its officers, the
complaint seeks damages of $7,400,000, 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.
The Company is also 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.
23
<PAGE> 42
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (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 December 1997,
the Memorandum of Understanding was cancelled.
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 calls 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 a
$1.00. The supplier has yet to perform in accordance with the
agreement. Accordingly, the Company has withheld issuance of the
aforementioned shares and options.
Software
During November 1997, the Company entered into a contract for
software development and a worldwide license agreement with a
software development company which was amended in May 1998 to include
additional software. The license agreement provides for a three year
term and may be extended on a year-to-year basis thereafter. In
addition to the fixed fee of $285,000, there is a royalty of $0.75
per port for each PC board sold containing the licensed software. As
of June 30, 1998, $500 had been paid under the terms of the license
agreement.
24
<PAGE> 43
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
License Agreements (Continued)
Software (Continued)
During January 1998, the Company entered into a worldwide license and
manufacturing and sales agreement with a third party for certain DSP
board designs. The license fee consists of an up-front fixed payment
of $30,000 plus a royalty of $100 per board manufactured directly, or
by contract, up to a maximum total royalty of $200,000. In addition,
the Company licensed certain software to the third party at a royalty
rate is $1.00 per port. As of June 30, 1998, $20,000 had been paid
and $0 had been received under the terms of the license agreement.
During March 1998, the Company entered into a five-year, worldwide
license agreement with a company to use certain software of this
company to create software for sale to third parties. The Company
must pay a license fee of $35,000, a royalty of $10 per port, and an
annual program maintenance and support services fee of $10,000. At
June 30, 1998, $0 had been paid under the license agreement.
Private Placement Exemptions
The Company 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.
25
<PAGE> 44
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employment Agreements
The Company has entered into employment agreements with certain
officers/directors/shareholders of FTEL and FNet for terms from two
to six years. A portion of the compensation paid pursuant to these
agreements is paid semi-monthly, and a portion is deferred and is
therefore included in accrued salaries and related expenses in the
accompanying consolidated balance sheets. Certain officers/directors/
shareholders have been given the option to convert up to 50% of their
compensation into stock options at fair market value less 50% for
FTEL common stock and at $1.00 per share for FNet common stock. The
stock issued is restricted from trading for one year from issuance.
NOTE 10 - SHAREHOLDERS' EQUITY
Stock Option Plans
The Company adopted an Incentive Stock Option Plan (Plan A) and
Nonqualified Stock Option Plan (Plan B) (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 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.
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.
26
<PAGE> 45
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
During the year ended June 30, 1998, the Company adopted the 1998
Stock Option Plan (the "1998 Plan"). The 1998 Plan provides for the
granting of options to purchase up to 2,000,000 shares of common
stock that are intended to qualify as incentive stock options within
the meaning of Section 422A of the Internal Revenue Code.
Options granted under all five 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
one year beyond 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.
On April 24, 1998 and May 26, 1998, the Company granted options to
purchase 300,000 and 165,000 shares, respectively, of the Company's
common stock to key management employees which vest from two to four
years from the date of grant. The option price was set at $2.59 and
$2.69 per share, respectively, 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.
27
<PAGE> 46
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Activity for the 1986 Plans, 1988 Plan, 1993 Plan, 1994 Plan, and
1998 Plan is as follows:
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
------ -----
<S> <C> <C>
Outstanding, June 30, 1995 1,965,000 $0.10
Granted 1,052,000 $0.76
Exercised (44,500) $0.10
Canceled (225,000) $0.10
---------
Outstanding, June 30, 1996 2,747,500 $0.35
Granted 248,000 $1.59
Exercised (335,000) $0.39
Canceled (150,000) $0.10
---------
Outstanding, June 30, 1997 2,510,500 $0.49
Granted 626,500 $2.66
Exercised (934,250) $0.40
Canceled (37,520) $1.19
---------
OUTSTANDING, JUNE 30, 1998 2,165,250 $1.14
=========
EXERCISABLE AT JUNE 30, 1998 1,192,375
=========
</TABLE>
The exercise prices for the options outstanding at June 30, 1998
ranged from $0.10 to $3.66.
The Company's majority-owned subsidiary, FNet, established a 1996
stock option plan (the "FNet Plan") which was amended in 1998. The
FNet Plan, as amended, provides for the granting of options to
purchase up to 7,000,000 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. Activity for the FNet
Plan is as follows:
28
<PAGE> 47
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
------ -----
<S> <C> <C>
Outstanding, June 30, 1995 -- $ --
Granted 448,000 $1.00
---------
Outstanding, June 30, 1996 448,500 $1.00
Granted 2,106,000 $1.00
---------
Outstanding, June 30, 1997 2,554,000 $1.00
Expired/cancelled (532,500) $1.00
Granted 3,633,000 $1.00
Exercised (35,500) $1.00
---------
OUTSTANDING, JUNE 30, 1998 5,619,000 $1.00
=========
EXERCISABLE AT JUNE 30, 1998 1,435,250
=========
</TABLE>
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>
Year Ended June 30,
-------------------------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Net loss
As reported $ (4,507,000) $ (2,824,000) $ (1,467,000)
Pro forma $ (4,804,000) $ (3,925,000) $ (1,513,000)
Loss per common share
As reported $ (0.29) $ (0.23) $ (0.14)
Pro forma $ (0.31) $ (0.32) $ (0.15)
</TABLE>
29
<PAGE> 48
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
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, 1998, 1997,
and 1996: dividend yields of 0%, 0%, and 0%, respectively; expected
volatility of 60%, 100%, and 100%, respectively; risk-free interest
rates of 5.54%, 6.2%, and 3%, respectively; and expected lives of 4,
4, and 2 to 4 years, respectively. For options granted during the
year ended June 30, 1998, the weighted-average fair value and
weighted-average exercise price for options granted whose exercise
price exceeded the market price of the stock on the grant date were
$1.34 and $2.95, respectively, and the weighted-average fair value
and weighted-average exercise price for options granted whose
exercise price equaled the market price of the stock on the grant
date were $1.30 and $2.54, respectively.
The fair value of the FNet options described above was estimated at
the date of grant using the minimum value method with the following
weighted-average assumptions for the year ended June 30, 1998:
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, 1998 was $0.99 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.
30
<PAGE> 49
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
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, 1998, 1997, and 1996, 600,000, 0,
and 0 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 2,380,000 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, 1998, 1997, and 1996, 1,841,750, 400,000, and
145,000 warrants were exercised leaving a remaining balance of
213,250 unexercised as of June 30, 1998.
Stock Issuances
During the year ended June 30, 1998, the Company completed the
following significant common stock transactions of previously
unissued common shares:
- Received 23,818 shares of its common stock valued at
$161,000 from certain officers of the Company as
consideration to exercise stock options for 400,000 shares
also valued at $161.000.
- In connection with the 1997 Private Placement, the Company
sold 333,333 units for $1,000,000. The units consist of
one share and one warrant to purchase one share of the
Company's common stock at an exercise price of $5.00 per
share, exercisable after October 1, 1998. The warrants
expire October 2, 2001. The Company paid no commissions or
fees in connection with this private placement.
- Issued 345,500 shares in connection with the exercise of
stock options whereby the option holders issued notes
receivable in favor of the Company for $315,950.
- Issued 63,750 shares in connection with the exercise of
stock options for cash of $66,000.
31
<PAGE> 50
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
- Issued or committed to issue 1,761,000 shares in
connection with the exercise of warrants for $2,261,000.
- Committed to issue 56,336 shares for services valued at
$71,000.
- Issued 1,333,695 shares upon the conversion of a note
payable by an officer for the Company for $133,000.
- Issued 799,431 shares valued at $1,702,000 upon the
conversion of 192 shares of its Series C preferred stock
valued at $1,702,000.
- 160,000 shares of the Company's common stock at a value of
$650,000 were returned to the Company and cancelled, as
provided under the contract, thus reducing the initial
purchase price of Passport.
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 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.
- In connection with the acquisition of CPR, committed to
issued 25,000 shares of common stock for a value of
$65,000 and assumed certain debt of $4,425.
32
<PAGE> 51
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
- 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.
- 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.
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.
- 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.
33
<PAGE> 52
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
- 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.
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, 1998.
Convertible Preferred Stock
During the year ended June 30, 1998, the Company issued 740 shares of
its Series C convertible preferred stock in a private placement for
$7,400,000. 20% of the shares held may be converted to common stock
four months after issuance with an additional 20% eligible for
conversion each month thereafter, in which the limitation on
conversion ends nine months after issuance. Any unconverted shares
will be automatically converted to common shares at the later of
either 18 months from issuance, the Company's common stock being
traded on a national exchange, or the filing of a registration
statement covering the resale of the common shares issued upon
conversion. Series C shares do not pay dividends and do not have
voting rights. The shares are convertible into shares of common stock
at a conversion price of $4.64 per share, subject to certain
adjustments relating to the market price of the underlying common
stock. Each preferred share is accompanied by a warrant that is
exercisable to purchase shares of common stock of the Company's
subsidiary, FNet, and which, under certain circumstances, may be
exercisable to acquire shares of common stock of the Company at the
exercise price of $4.64.
Form S-1
During the year ended June 30, 1998, the Company filed a Form S-1
with the Securities and Exchange Commission to register certain
shares of common stock of the Company including the following:
- The shares of common stock issued as part of the
acquisitions of No. 1, CPR, and Passport.
- The common shares to be issued upon the conversion of the
Series C convertible preferred stock.
- The common shares to be issued upon the exercise of the
warrants issued in the 1995 Private Placement.
34
<PAGE> 53
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES
The tax effects of temporary differences that give rise to deferred
taxes at June 30 are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets
Accounts receivable, principally due to
allowance for doubtful accounts $ 3,000 $ 13,000
Goodwill 317,000 --
Compensated absences and deferred salaries,
principally due to accrual for financial
reporting purposes 146,000 87,000
Bad debt 3,000 --
Inventories, principally due to additional costs
inventoried for tax purposes pursuant to the
Tax Reform Act of 1986 and allowance for
inventory obsolescence 34,000 128,000
Accrued warranty 5,000
General business tax credit carryforwards 335,000 335,000
Net operating loss carryforwards 4,972,000 3,027,000
---------- ----------
Total gross deferred tax assets 5,815,000 3,590,000
Less valuation allowance 5,763,000 3,586,000
---------- ----------
Net deferred tax assets 52,000 4,000
Deferred tax liabilities
Plant and equipment, principally due to
differences in depreciation 52,000 4,000
---------- ----------
NET DEFERRED TAX LIABILITY $ -- $ --
========== ==========
</TABLE>
The valuation allowance increased by approximately $2,177,000 and
$441,000 during the years ended June 30, 1998 and 1997, respectively.
No provision for income taxes for the years ended June 30, 1998,
1997, and 1996 is required, except for minimum state taxes, since the
Company incurred losses during such years.
35
<PAGE> 54
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES (CONTINUED)
Income tax expense was $4,000 and differs from the amounts computed
by applying the U.S. federal income tax rate of 34% to loss before
minority interest and income taxes as a result of the following:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" tax benefit $(1,572,000) $(1,450,000) $ (520,000)
Increase in income taxes resulting
from
Other 4,000 -- --
Change in the beginning-of-the-
year balance of the valuation
allowance for deferred tax
assets allocated to income
tax expense 1,568,000 1,450,000 520,000
State income taxes 4,000 2,000 2,000
----------- ----------- -----------
TOTAL $ 4,000 $ 2,000 $ 2,000
=========== =========== ===========
</TABLE>
As of June 30, 1998 the Company had consolidated net operating loss
carryforwards of approximately $13,368,000 and $4,827,000 for Federal
and state income tax reporting purposes, respectively, which expire
in varying amounts through 2013. 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 2013.
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 12 - RELATED PARTY TRANSACTIONS
The Company recorded sales of approximately $0, $82,000, and $3,000
to an entity affiliated with a shareholder of the Company during the
years ended June 30, 1998, 1997, and 1996, respectively.
During the years ended June 30, 1998, 1997, and 1996, the Company
issued notes payable to the chief executive officer/majority
shareholder for $129,000, $212,000, and $217,000, respectively, for
accrued compensation.
36
<PAGE> 55
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 12 - RELATED PARTY TRANSACTIONS (CONTINUED)
At June 30, 1998, 1997, and 1996, certain officers/directors/
shareholders of the Company had been granted 1,352,500, 1,600,000,
and 1,650,000 stock options, respectively, in the FTEL stock option
plans, of which 1,050,000, 1,200,000, and 500,000 stock options were
exercisable, respectively, at exercise prices between $0.10 and $3.66
per share. In addition, the same officers/directors/shareholders had
been granted 965,000, 650,000, and 0 stock options outside the FTEL
plans at June 30, 1998, 1997, and 1996, respectively, of which
500,000, 650,000, and 0 stock options were exercisable, respectively,
at exercise prices between $1.31 and $2.69.
At June 30, 1998, 1997, and 1996, certain officers/directors/
shareholders of the Company held 2,300,000, 650,000, and 300,000
stock options, respectively, in the FNet stock option plan, of which
512,525, 300,000, and 0 stock options were exercisable, respectively,
at an exercise price of $1.00. In addition, the same officers/
directors/shareholders had been granted 300,000, 0, and 0 stock
options outside the FNet plan at June 30, 1998, 1997, and 1996,
respectively, of which 0, 0, and 0 stock options were exercisable,
respectively, at an exercise price of $1.00.
NOTE 13 - 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, 1998,
1997, or 1996.
NOTE 14 - 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:
37
<PAGE> 56
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 14 - LINES OF BUSINESS (CONTINUED)
<TABLE>
<CAPTION>
For the Year Ended
---------------------------------
June 30, June 30,
1998 1997
----------- -----------
<S> <C> <C>
Net sales
Franklin $ 771,000 $ 1,337,000
FNet 606,000 398,000
----------- -----------
TOTAL $ 1,377,000 $ 1,735,000
=========== ===========
Operating losses
Franklin $(3,257,000) $(1,867,000)
FNet (1,707,000) (957,000)
----------- -----------
TOTAL $(4,964,000) $(2,824,000)
=========== ===========
Identifiable assets
Franklin $ 7,175,000 $ 3,163,000
FNet 1,717,000 351,000
----------- -----------
TOTAL $ 8,892,000 $ 3,514,000
=========== ===========
Capital expenditures
Franklin $ 315,000 $ 204,000
FNet 54,000 120,000
----------- -----------
TOTAL $ 369,000 $ 324,000
=========== ===========
Depreciation and amortization
Franklin $ 81,000 $ 52,000
FNet 86,000 58,000
----------- -----------
TOTAL $ 167,000 $ 110,000
=========== ===========
</TABLE>
Segment information is not shown for any other periods because the
Internet business was not material to the operations of the Company.
38
<PAGE> 57
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 14 - LINES OF BUSINESS (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; therefore, no pro forma consolidated balance
sheet has been reflected below. In the opinion of management, there
are no pro forma adjustments necessary to the historical statements
of operations for the years ended June 30, 1997 and 1996, assuming
that the acquisition occurred at the beginning of each of those
years, except for showing the effects of the addition of the goodwill
and its 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 for the year ended June 30, 1997:
<TABLE>
<S> <C>
Historical net loss $(2,824,000)
Add goodwill write-down related to Passport 835,000
-----------
Adjusted historical net loss (1,989,000)
Add Passport losses prior to acquisition (171,000)
-----------
PRO FORMA NET LOSS EXCLUSIVE OF GOODWILL $(1,260,000)
===========
Adjusted historical net loss per share exclusive of goodwill
write-down $ (.16)
Impact of Passport loss (.01)
-----------
PRO FORMA NET LOSS PER SHARE EXCLUSIVE OF GOODWILL $ (.17)
===========
</TABLE>
NOTE 15 - SUBSEQUENT EVENTS
Subsequent to June 30, 1998, 115 shares of Series C preferred stock
valued at $1,046,000 were converted into 919,266 shares of common
stock.
Subsequent to June 30, 1998, two officers/directors/shareholders of
the Company purchased 50,000 and 1,000 shares, respectively, of the
Company's common stock on the open market.
Subsequent to June 30, 1998, the Company granted 20,000 options under
the FNet plan.
39
<PAGE> 58
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
NOTE 15 - SUBSEQUENT EVENTS (CONTINUED)
Subsequent to June 30, 1998, FNet entered into a joint venture
agreement with a third party to provide telecommunications service to
Guatemala, El Salvador, and Honduras. The joint venture is for an
initial term of five years with an option to renew at the expiration
date. In addition, FNet purchased certain assets in Guatemala from
the third party for $215,000.
40
<PAGE> 59
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Franklin Telecommunications Corp.
By /s/ Frank W. Peters
------------------------------
Frank W. Peters
Chief Executive Officer
Dated: September 28, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
(1) Principal Executive Officer
/s/ Frank W. Peters Chief Executive Officer and a September 28, 1998
-------------------- Director
Frank W. Peters
(2) Principal Financial and Accounting Officer
/s/ Thomas Russell Chief Financial Officer and a September 28, 1998
-------------------- Director
Thomas Russell
(3) Directors
/s/ Peter S. Buswell President and a Director September 28, 1998
--------------------
Peter S. Buswell
/s/ Robert S. Harp Director September 28, 1998
--------------------
Robert S. Harp
</TABLE>
<PAGE> 60
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 5,750,000
<SECURITIES> 0
<RECEIVABLES> 447,000
<ALLOWANCES> 8,000
<INVENTORY> 671,000
<CURRENT-ASSETS> 7,415,000
<PP&E> 1,349,000
<DEPRECIATION> 571,000
<TOTAL-ASSETS> 8,892,000
<CURRENT-LIABILITIES> 1,452,000
<BONDS> 0
4,856,000
0
<COMMON> 15,662,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 8,892,000
<SALES> 1,377,000
<TOTAL-REVENUES> 1,377,000
<CGS> 834,000
<TOTAL-COSTS> 834,000
<OTHER-EXPENSES> 5,004,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 43,000
<INCOME-PRETAX> (4,504,000)
<INCOME-TAX> 3,000
<INCOME-CONTINUING> (4,507,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,507,000)
<EPS-PRIMARY> (.29)
<EPS-DILUTED> (.29)
</TABLE>
