<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 27, 1998
REGISTRATION NO. 333-41781
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
FRANKLIN TELECOMMUNICATIONS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 3670 95-3733534
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
733 LAKEFIELD ROAD, WESTLAKE VILLAGE, CALIFORNIA 91361 (805) 373-8688
(ADDRESS AND TELEPHONE NUMBER, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
FRANK W. PETERS
733 LAKEFIELD ROAD, WESTLAKE VILLAGE, CALIFORNIA 91361
(805) 373-8688
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
COPY TO:
ROBERT J. ZEPFEL, ESQ.
HADDAN & ZEPFEL LLP
4675 MACARTHUR COURT, SUITE 710
NEWPORT BEACH, CALIFORNIA 92660
(714) 752-6100
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APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable
after this Registration Statement is declared effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
The combined prospectus contained in this Registration Statement also
relates to the Registrant's Registration Statement on Form S-1 (File No. 333-
24791).
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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<PAGE>
PROSPECTUS
[LOGO OF FTC]
6,740,172 SHARES
FRANKLIN TELECOMMUNICATIONS CORP.
COMMON STOCK
----------------
All of the 6,740,172 shares of Common Stock offered hereby are being sold by
certain shareholders (the "Selling Shareholders") of Franklin
Telecommunications Corp. (the "Company"). Of such shares, up to 3,905,215
shares are issuable upon the exercise of warrants held by certain Selling
Shareholders, and up to 1,786,207 shares are issuable upon conversion of
shares of the Company's Series C Preferred Stock held by certain Selling
Shareholders (the "Convertible Preferred Stock"). The Company will not receive
any of the proceeds from the sale of shares by the Selling Shareholders;
however, it will receive proceeds from any exercise of the warrants, and an
additional amount equal to 30% of the net proceeds received by those Selling
Shareholders from the sale of the shares issuable upon exercise of certain of
the warrants, to the extent such net proceeds exceed $4.00 per share. See
"Selling Shareholders" and "Plan of Distribution." The Company's Common Stock
is traded on the OTC Bulletin Board under the symbol FTEL.
The Company designs, manufactures and markets high speed communications
products and subsystems. The products are marketed through Original Equipment
Manufacturers ("OEMs") and distributors, as well as directly to end users. In
addition, through its majority-owned subsidiary, FNet, the Company is a
provider of Internet access and services to businesses and individuals.
----------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK
AND LIMITED LIQUIDITY. SEE "RISK FACTORS" ON PAGE 5.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
----------------
The date of this Prospectus is , 1998.
<PAGE>
THE COMPANY INTENDS TO FURNISH TO ITS STOCKHOLDERS ANNUAL REPORTS CONTAINING
FINANCIAL STATEMENTS AUDITED BY AN INDEPENDENT PUBLIC ACCOUNTING FIRM AFTER
THE END OF EACH FISCAL YEAR. IN ADDITION, THE COMPANY WILL FURNISH TO ITS
STOCKHOLDERS QUARTERLY REPORTS FOR THE FIRST THREE QUARTERS OF EACH FISCAL
YEAR CONTAINING UNAUDITED FINANCIAL AND OTHER INFORMATION AFTER THE END OF
EACH FISCAL QUARTER, UPON WRITTEN REQUEST TO THE SECRETARY OF THE COMPANY.
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<PAGE>
PROSPECTUS SUMMARY
This Prospectus contains forward-looking statements that involve risks and
uncertainties. Actual events and results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth under "Risk Factors" and elsewhere in this
Prospectus. The following summary should be read in conjunction with, and is
qualified in its entirety by, the more detailed information and financial
statements and notes thereto appearing elsewhere in this Prospectus.
THE COMPANY
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems. The products are
marketed through Original Equipment Manufacturers ("OEMs") and distributors, as
well as directly to end users. In addition, through its majority-owned
subsidiary, FNet Corp. ("FNet"), the Company is a provider of Internet access
and services to businesses and individuals. The Company is a California
corporation formed in 1981. Its address is 733 Lakefield Road, Westlake
Village, California 91361 and its telephone number is (805) 373-8688.
THE OFFERING
<TABLE>
<C> <S>
By Selling Shareholders............ 6,740,172 shares of the Company's Common
Stock.
Common Stock Currently Outstanding. 16,018,184 shares, not including the
shares to be issued pursuant to the
exercise of outstanding warrants or the
conversion of the outstanding Convertible
Preferred Stock.
Risk Factors....................... The securities involve a high degree of
risk and limited liquidity. See "Risk
Factors."
</TABLE>
3
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data has been derived from the Company's
audited and unaudited consolidated financial statements included elsewhere
herein.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED JUNE 30, ENDED SEPTEMBER 30,
--------------------------------- ----------------------
1995 1996 1997 1996 1997
--------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA (IN THOUSANDS,
EXCEPT PER SHARE DATA
AND OUTSTANDING
SHARES):
Net sales............... $ 1,481 $ 430 1,735 209 244
Gross profit (loss)..... 963 (160) 745 44 10
Loss from operations.... (173) (1,497) (2,775) (377) (960)
Net loss................ (160) (1,467) (2,824) (384) (960)
Net loss per common
share.................. $ (0.02) $ (0.14) (.23) (.03) (.07)
Weighted average common
shares outstanding..... 6,475,984 10,279,281 12,267,991 11,503,114 13,125,318
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
1997 1997
-------- -------------
<S> <C> <C>
BALANCE SHEET DATA (IN THOUSANDS):
Total assets............................................ $ 3,514 $ 2,987
Total liabilities....................................... $ 1,939 $ 2,032
Accumulated deficit..................................... $(8,975) $(9,935)
</TABLE>
4
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, the following
factors should carefully be considered in evaluating an investment in the
shares of Common Stock offered hereby.
OPERATING LOSSES
The Company has incurred operating losses in each of its last three fiscal
years and and for the three months ended September 30, 1997, and has an
accumulated deficit, as of September 30, 1997, of $9,935,000. The Company's
operating losses have resulted from a number of factors, including reduced
demand for the Company's legacy hardware products, increasing expenses
relating to the development of new hardware products, expenses related to
installing the infrastructure for the Internet services business of its
majority-owned subsidiary, FNet, and increasing sales and marketing expenses
to promote new products and services. During the year ended June 30, 1997, the
Company's subsidiary, FNet, raised approximately $1,950,000 in equity
financing. Additionally, in September, October and November 1997 the Company
received net proceeds of $7,807,500 from private equity financings. See
"Business--Recent Financings." The Company has been dependent on these equity
financings to sustain its ongoing operations. Consequently, an investment in
the Company is highly speculative and no assurance can be given that
purchasers of the shares of Common Stock offered hereby will realize any
return on their investment or that purchasers will not lose their entire
investment.
ORGANIZATION OF SUBSIDIARY AND POTENTIAL CONFLICTS OF INTEREST; NEW BUSINESS
VENTURE
During 1996 the Company restructured its subsidiary, Franklin Datacom, Inc.
from a manufacturer of communications hardware into an Internet service
provider and changed its name to FNet. The Company has devoted significant
resources and management time to the organization and development of FNet. As
of September 30, 1997, the Company owned approximately 67% of the common stock
of FNet, with the balance owned by members of management, including the
Company's President, and certain investors. To the extent that FNet issues
additional securities, either for cash, in connection with acquisitions or
upon the exercise of options, the Company's percentage ownership will be
reduced. As of September 30, 1997 there were options to purchase 2,744,000
shares of FNet outstanding, constituting approximately 11.7% of the
outstanding shares. While management believes that the growth of FNet will
eventually inure to the benefit of the Company through increased demand for
its communications hardware as well as the value of its interest in FNet, it
may have an adverse effect on the Company's principal business in the short
term due to competing demands on the Company's resources and management. Also,
the fact that members of the Company's management, including its President,
hold a direct interest in FNet may pose conflicts of interest over the long
term. FNet is in the nature of a new business venture, with relatively
insignificant assets and revenues from operations; accordingly, it can be
expected that its future operating results will be subject to many of the
problems, expenses, delays and risks inherent in the establishment of a new
business enterprise, over many of which the Company has no control. There can
be no assurance, therefore, that FNet will be able to achieve or sustain
profitability in future periods or that the Company's investment of time and
resources into it will be repaid.
RESULTS FOR YEAR ENDED JUNE 30, 1997; DEPENDENCE ON A SINGLE CUSTOMER
While the Company's revenues for the year ended June 30, 1997 showed a
significant increase over the revenues for the prior period, 38% of the
increase was due to sales of the Company's Wide Area Network products to a
single customer, Revco Drug Stores. Such products are technologically dated,
and the demand for them during the period was due principally to expansion of
the business of the customer that already had a significant investment in a
wide area network utilizing the products. Accordingly, there can be no
assurance that revenues for subsequent periods will remain at these levels,
and it is unlikely that the Company will receive significant additional orders
for its Wide Area Network products from this customer or others.
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<PAGE>
DEPENDENCE ON MAJOR CUSTOMERS
Sales of the Company's communications products are concentrated in a
relatively small number of customers, who account for a significant portion of
revenues. During the fiscal year ended June 30, 1996, the customers accounting
for over 10% of the Company's product sales were Hughes Aircraft Company
(18%), Citibank (17%), Vanstar (13%) and Revco Drug Stores (12%). For the year
ended June 30, 1997 the customers accounting for over 10% of revenues were
Revco Drug Stores (29%) and Citibank (10%). The loss of any of these major
customers could have a material adverse effect on the Company. The Company has
no ongoing supply contracts with any of these customers.
GENERAL RISKS OF BUSINESS
Any future success that the Company might enjoy will depend upon many
factors, including factors which may be beyond the control of the Company or
which cannot be predicted at this time. These factors may include
technological advances or product obsolescence, increased levels of
competition, including the entry of additional competitors and increased
success by existing competitors, changes in general economic conditions,
increases in operating costs, including costs of supplies, personnel, and
equipment, reduced margins caused by competitive pressures and other factors,
and changes in governmental regulation imposed under federal, state or local
laws.
RISKS ASSOCIATED WITH MANAGEMENT OF POTENTIAL GROWTH
The Company's growth has placed, and is expected to continue to place, a
significant strain on its managerial, operational, financial and information
systems resources. To accommodate its current size and manage growth, the
Company must continue to implement and improve its operational, financial and
information systems, and expand, train and manage its employee base.
Additionally, expansion of the Company's information and network systems is
required to accommodate its growth. There can be no assurance that the Company
will be able to effectively manage the expansion of its operations, or that
the Company's facilities, systems, procedures or controls will be adequate to
support the Company's operations. The inability of the Company to manage its
future growth would have a material adverse effect on the Company. This
problem may be exacerbated to the extent the Company continues to acquire
additional businesses, as each such business must then be integrated into the
Company's operations and systems.
Demand on the Company's network infrastructure, technical staff and
resources has grown rapidly with the Company's expanding customer base, and
the Company has occasionally experienced difficulties satisfying the demand
for its Internet services. If such difficulties were to become widespread, it
could adversely impact operations by causing subscribers or potential
subscribers to utilize competitive Internet service providers. There can be no
assurance that the Company's infrastructure, technical staff and resources
will be adequate to facilitate the Company's growth. The Company believes that
its ability to provide timely access for customers and adequate customer and
technical support largely will depend on its ability to attract, identify,
train, integrate and retain qualified personnel. Failure to provide adequate
customer and technical support services would adversely affect the Company's
ability to maintain and increase its customer base, and could therefore have a
material adverse effect on the Company. See "Dependence on Network
Infrastructure and Capacity; System Failure and Security Risks," "Dependence
on Key Personnel," "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview" and "Business."
NEED FOR ADDITIONAL CAPITAL
The proceeds of this offering will be received by the Selling Shareholders.
While the Company may receive cash from the exercise of warrants held by
certain Selling Shareholders, there can be no assurance that the Company will
derive any specific amount of proceeds from this offering. Developments in the
Company's business and possible expansion into other markets could indicate
that the Company should expand its business at a faster rate than that
currently planned for. Moreover, there can be no assurance that the Company
will not encounter unforeseen difficulties that may deplete its capital
resources more rapidly than anticipated, which would require that the Company
seek additional funds through equity, debt or other external financing. In any
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<PAGE>
event, it is likely that the Company will attempt to raise additional capital
to meet its obligations and to accelerate its growth. There can be no
assurance that any additional capital resources which the Company may need
will be available to the Company if and when required, or on terms that will
be acceptable to the Company. If additional financing is required, or desired,
the Company may be required to forgo a substantial interest in its future
revenues or dilute the equity interests of existing shareholders, and a change
in control of the Company may result.
QUARTERLY OPERATING RESULTS
The Company's operating results may vary significantly due to a variety of
factors, including the availability and cost of materials and components, the
introduction of new products by the Company or its competitors, the timing of
the Company's marketing efforts, pricing pressures, general economic and
industry conditions that affect customer demand, and other factors.
DEPENDENCE ON KEY PERSONNEL
The Company's success will depend to a significant extent upon the continued
service of its founder, Frank W. Peters, the Company's President and Chief
Executive Officer. The Company also will depend on its ability to attract,
retain and motivate such additional qualified personnel as may be needed. The
competition for such personnel is intense. There can be no assurance that the
Company will be successful in retaining its existing key employees or in
attracting and retaining any additional personnel it requires. The Company
does not maintain "key man" insurance on any of its employees.
COMPETITION; NEW PRODUCTS AND TECHNOLOGICAL CHANGES
The data communications industry is extremely competitive. The Company's
principal competitors in the manufacture of communications hardware are
Telematics, Micom, Memotech Data, Dynatech Corporation, Ascend Communications,
Cisco Systems and U.S. Robotics. Most of these companies have substantially
greater marketing, financial, technical and field support resources than the
Company. In addition, the Company could face strong competition from a number
of established computer and telecommunications firms which may enter the
market in the future. The field of data communications is also marked by rapid
changes in technology, which can cause products to become obsolete over very
short time frames.
The performance of the Company will depend on the success of its existing
hardware products and services as well as its ability to develop and market
new hardware products and services or enhance its existing hardware products
and services to meet changing technology, pricing considerations and other
market factors. The Company's business would be adversely affected if the
Company were to experience delays in developing new hardware products and
services or enhancements to existing hardware products and services or if such
hardware products and services or enhancements did not gain market acceptance.
There can be no assurance that the Company's existing or future hardware
products and services will be successful or profitable. In addition, there can
be no assurance that new hardware products and services developed by others
will not render the Company's hardware products and services noncompetitive or
obsolete.
The Internet services market in which the Company's FNet subsidiary operates
is extremely competitive, and the Company expects competition in this market
to intensify in the future. FNet's current and prospective competitors include
many large companies that have substantially greater market presence and
financial, technical, marketing and other resources than FNet. FNet competes
(or in the future is expected to compete) directly or indirectly with the
following categories of companies: (i) national and regional Internet Service
Providers such as IDT Corporation, MindSpring Enterprises, Inc., Netcom On-
line Communication Services, Inc., PSINet, Earthlink and UUNET; (ii)
established online services such as America Online, CompuServe, Prodigy and
the Microsoft Network; (iii) computer software and technology companies such
as Microsoft;
7
<PAGE>
(iv) national telecommunications companies such as AT&T Corp., MCI
Communications Corporation and Sprint Corporation; (v) regional Bell operating
companies ("RBOCs"); (vi) cable operators such as Comcast Corporation, Tele-
Communications, Inc. and Time Warner, Inc.; and (vii) nonprofit or educational
Internet Service Providers.
The entry of new participants from these categories and the potential entry
of competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company and FNet.
The ability of these competitors or others to bundle services and products
with Internet connectivity services could place FNet at a significant
competitive disadvantage. In addition, competitors in the telecommunications
industry may be able to provide customers with reduced communications costs in
connection with their Internet access services, reducing the overall cost of
Internet access and significantly increasing pricing pressures on FNet. For
example, AT&T has recently expanded its Internet services offerings. The
Company believes that AT&T's expansion has substantially increased pricing
pressure in the industry. In addition, certain of FNet's online competitors,
including America Online, the Microsoft Network and Prodigy, have introduced
unlimited access to the Internet and their proprietary content at flat rates
that are generally equivalent to FNet's monthly flat rate, and do not require
a set-up fee. Certain of the RBOCs have also introduced competitive flat-rate
pricing for unlimited access (without a set-up fee for at least some period of
time). As a result, competition for active users of Internet services has
intensified. There can be no assurance that FNet will be able to offset the
adverse effect on revenues of any necessary price reductions resulting from
competitive pricing pressures by increasing the number of its customers, by
generating higher revenue from enhanced services, by reducing costs or
otherwise.
Competition is also expected to focus increasingly on overseas markets, in
which Internet services are just beginning to be introduced. Although the
Company has established sales of its data communications hardware products
overseas, FNet is not presently seeking to penetrate overseas markets for
Internet services. To the extent that the ability to provide Internet services
overseas becomes a competitive advantage in the Internet services industry,
the failure of FNet to penetrate overseas markets may result in FNet being at
a competitive disadvantage relative to other Internet access providers.
The Company has recently entered the Internet telephony business, and plans
to sell hardware products and (through FNet) provide telephone service in this
new business area. There is no assurance that this new business venture will
be successful. The current and prospective competitors in this business
include many large companies that have substantially greater market presence
and financial, technical, marketing and other resources than the Company and
FNet. The Company and FNet compete (or in the future are expected to compete)
directly or indirectly with the following categories of companies in the
Internet telephony business: (i) PC software providers such as VocalTec,
Inter-Tel and ITXC Corp.; (ii) PC to PC telephony product suppliers such as
VDONet, Inc. and Netspeak; (iii) Internet telephony hardware product suppliers
such as Micom, Cisco Systems, Bay Networks and 3COM; (iv) telecommunications
equipment vendors such as Lucent Technologies, Siemens and Nortel; and (v)
Internet telephony service providers such as Delta Three, Inc., Networks
Telephony Corp., IDT and Concentric Networks.
DEPENDENCE ON NETWORK INFRASTRUCTURE AND CAPACITY; SYSTEM FAILURE AND SECURITY
RISKS
The future success of FNet's business will depend on the capacity,
reliability and security of its network infrastructure. FNet will be required
to expand and improve this infrastructure as the number of customers and the
amount and type of information its customers communicate over the Internet
increases, and the means by which customers connect to the Internet evolve.
Such expansion and improvement may require substantial financial, operational
and managerial resources. There can be no assurance that the Company will be
able to expand or improve its network infrastructure to meet any additional
demand or changing customer requirements on a timely basis or at a
commercially reasonable cost, if at all.
Capacity constraints have occurred at many Internet Service Providers, both
at the level of particular "points of presence" ("POPs") (affecting only
customers attempting to use that particular POP) and in connection with system
wide services (such as e-mail and news services, which can affect all
customers). From
8
<PAGE>
time to time, FNet has experienced delayed delivery from suppliers of new
telephone lines, modems, servers and other equipment used by FNet in providing
its services. Any severe shortage of new telephone lines, modems, servers or
other equipment could result in incoming access lines becoming full during
peak times, causing busy signals for customers who are trying to connect to
the Internet. Similar problems may occur if FNet is unable to expand the
capacity of its various network, e-mail, World Wide Web and other servers
quickly enough to keep pace with demand from the Company's expanding customer
base. If the capacity of such servers is exceeded, customers will experience
delays when trying to use a particular service. Further, if FNet does not
maintain sufficient capacity in its network connections, customers will
experience a general slowdown of all services on the Internet. Any of these
events could cause customers to terminate use of FNet's services. Accordingly,
any failure of FNet to expand or enhance its network infrastructure on a
timely basis, or to adapt it to an expanding customer base, changing customer
requirements or evolving industry standards, could have a material adverse
effect on the Company.
FNet's operations are dependent on its ability to protect its
telecommunications and computer equipment against damage from fire,
earthquake, power loss, telecommunication failure and similar events. The
occurrence of a natural disaster or another unanticipated problem at the
Company's headquarters and network hub or at POPs through which customers
connect to the Internet could cause interruptions in the services provided by
FNet. In addition, failure of FNet's telecommunications providers to provide
the data communications capacity required by FNet as a result of a natural
disaster, operational disruption or for any other reason could cause
interruptions in the services provided by FNet, which could have a material
adverse effect on the Company.
FNet's network infrastructure may be vulnerable to computer viruses and
other similar disruptive problems caused by its customers, other Internet
users or other third parties. Computer viruses and other problems could lead
to interruptions, delays in or cessation of service to FNet's customers, as
well as corruption of FNet's or its customers' computer systems. Inappropriate
use of the Internet by third parties could also potentially jeopardize the
security of confidential information stored in the computer systems of FNet or
those of its customers, which may cause losses to FNet or its customers, or
deter certain persons from using FNet's services. The Company expects that
FNet's customers may increasingly use the Internet for commercial transactions
in the future. Any network malfunction or security breach could cause these
transactions to be delayed, not completed or completed with compromised
security. Alleviating problems caused by computer viruses or other
inappropriate uses or security breaches may cause interruptions, delays or
cessation in service to FNet's customers, which could have a material adverse
effect on the Company. In addition, there can be no assurance that customers
or others will not assert claims of liability against FNet or the Company as a
result of these events.
FNet does not presently maintain redundant or backup Internet services or
backbone facilities or other redundant computing and telecommunications
facilities. Any accident, incident or system failure that causes interruptions
in FNet's operations could have a material adverse effect on its ability to
provide Internet services to its customers, and, in turn, on the Company.
PROPRIETARY TECHNOLOGY
The Company's success will depend in part on protecting its proprietary
technology. While the Company has patents covering certain of its products,
its relies principally on trade secret law, confidentiality agreements and its
technical abilities and responsiveness to the demands of customers to protect
its proprietary rights. See "Business--Patents and Trademarks." There can be
no assurance that the Company's technology will not be subject to
misappropriation or independent third-party development of similar technology.
REGULATORY MATTERS
Regulations of the Federal Communications Commission (the "FCC") affect
various products of the Company. Certain regulations require that products
which reside on a customer's premises and interconnect the public switched
network meet certain standards to prevent harm to the network. Other
regulations limit the levels
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<PAGE>
of electromagnetic radiation which may emanate from an electronic device
located on a customer's premises. The Company currently complies with these
regulations and foresees no problem in complying with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunications industry could affect the business of the Company.
FNet provides Internet services, in part, through data transmissions over
public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for wire line communications. FNet is
not currently subject to direct regulation by the FCC or any other
governmental agency, other than regulations applicable to businesses
generally. However, in the future FNet could become subject to regulation by
the FCC or another regulatory agency as a provider of basic telecommunications
services. Several long distance telephone carriers have filed a petition with
the FCC seeking a declaration that Internet telephone service is a
"telecommunications service" subject to common carrier regulation. Such a
declaration, if enacted, would create substantial barriers to FNet's entry
into the Internet telephone market. Also, a number of local telephone
companies have asked the FCC to levy access charges on "enhanced service
providers," which may be deemed to include Internet Service Providers.
Although the Chairman of the FCC has indicated his opposition to levying
service charges against Internet Service Providers, local interconnection
charges could be levied in the future. Moreover, the public service
commissions of certain states are exploring the adoption of regulations that
might subject Internet Service Providers to state regulation.
The Telecommunications Act of 1996 (the "Telecommunications Act") contains
certain provisions that lift, or establish procedures for lifting, certain
restrictions relating to the RBOCs' ability to engage directly in the Internet
access business. The Telecommunications Act also makes it easier for national
long distance carriers such as AT&T to offer local telephone service and
allows RBOCs to provide electronic publishing of information and databases.
Competition from these companies could have a material adverse effect on the
Company. See "Business--Government Regulation."
POTENTIAL LIABILITIES ASSOCIATED WITH OPERATING AN INTERNET SERVICE PROVIDER
The law relating to the liability of Internet Service Providers and online
service companies for information carried on or disseminated through their
networks has not yet been definitively established. Several private lawsuits
seeking to impose such liability upon Internet Service Providers and online
services companies are currently pending. Although no such claims have been
asserted against FNet to date, there can be no assurance that such claims will
not be asserted in the future, or if asserted, will not be successful. The
Telecommunications Act imposes fines on any entity that knowingly (i) uses any
interactive computer service or telecommunications device to send obscene or
indecent material to minors; (ii) makes obscene or indecent material available
to minors via an interactive computer service; or (iii) permits any
telecommunications facility under such entity's control to be used for the
purposes detailed above. As the law in this area develops, the potential
imposition of liability upon FNet for information carried on and disseminated
through its network could require it to implement measures to reduce its
exposure to such liability. The implementation of such measures could require
the expenditure of substantial resources or the discontinuation of certain
service offerings. Any costs that are incurred as a result of such
expenditure, contesting any such asserted claims or the imposition of
liability could have a material adverse effect on FNet.
Due to the increasing use of the Internet, it is possible that additional
laws and regulations may be adopted with respect to the Internet covering
issues such as content, user privacy, pricing, libel, intellectual property
protection and infringement and technology export and other controls. Changes
in the regulatory environment relating to the Internet services industry,
including regulatory changes that directly or indirectly affect
telecommunication costs or increase the likelihood or scope of competition,
could have a material adverse effect on the Company.
DEPENDENCE ON TELECOMMUNICATIONS CARRIERS
FNet relies on local telephone companies and other companies to provide data
communications capacity via local telecommunications lines and leased long
distance lines for its Internet service. As such, FNet is subject to
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<PAGE>
potential disruptions in these telecommunications services and may have no
means of replacing these services, on a timely basis or at all, in the event
of such disruption. Any such disruptions could have a material adverse effect
on FNet.
DEPENDENCE ON CONTINUED GROWTH IN USE OF THE INTERNET; NEW AND UNCERTAIN
MARKET; CUSTOMER RETENTION
FNet's future success is substantially dependent on continued growth in the
use of the Internet. Rapid growth in the use of, and interest in, the
Internet, and in particular the World Wide Web, is a recent phenomenon and
there can be no assurance that Internet usage will become more widespread,
that extensive Internet content will continue to be developed or that
extensive Internet content will continue to be accessible at no or nominal
cost. The Internet may not prove to be viable for a number of reasons,
including potentially inadequate development of the necessary infrastructure
or of performance improvements. If use of the Internet does not continue to
grow, FNet would be materially and adversely affected. Conversely, to the
extent that the Internet continues to experience significant growth in the
number of users and level of use, there can be no assurance that the Internet
infrastructure will be able to support the demands placed on it by such
potential growth. See "Risks Associated with Management of Potential Growth."
The sales, marketing and other costs to FNet of acquiring new customers are
substantial relative to the monthly fee derived from such customers.
Accordingly, FNet's long-term success largely depends on its ability to retain
its existing customers, while continuing to attract new customers. FNet
continues to invest significant resources in its infrastructure and customer
and technical support capabilities. However, there can be no assurance that
such investment will improve customer retention. Because the Internet services
market is new and the variety of available services is not well understood by
new and potential customers, it is difficult, if not impossible, for FNet to
predict future customer retention rates. Moreover, intense competition from
competitors, some of whom offer many free hours of services for new customers,
have most likely caused, and may continue to cause, some of FNet's customers
to switch to a competitor's service. In addition, a certain number of new
Internet users experience the Internet only as a novelty and do not become
consistent users of Internet services. These factors could adversely affect
FNet's customer retention rates. Any decline in customer retention rates would
have a material adverse effect on FNet.
LIMITED MARKET FOR THE COMMON STOCK
The Company's Common Stock is traded on the OTC Bulletin Board, but, as of
the date of this Prospectus, is not listed on any stock exchange or on NASDAQ.
Trading volume in the Common Stock has fluctuated considerably in the recent
past.
POSSIBLE VOLATILITY OF STOCK PRICES; PENNY STOCK RULES
The over-the-counter markets for securities such as the Company's Common
Stock historically have experienced extreme price and volume fluctuations
during certain periods. These broad market fluctuations and other factors,
such as new product developments and general trends in the investment markets,
as well as general economic conditions and quarterly variations in the
Company's results of operations, may adversely affect the market price of the
Company's Common Stock. Moreover, unless and until it is approved for
quotation on NASDAQ, the Company's Common Stock could become subject to rules
adopted by the Commission regulating broker-dealer practices in connection
with transactions in "penny stocks." Penny stocks generally are equity
securities with a price of less than $5.00 (other than securities registered
on certain national securities exchanges or quoted on NASDAQ, provided that
current price and volume information with respect to transactions in such
securities is provided by the exchange or the NASDAQ system). Unless an
exemption from the definition of a "penny stock" were available, any broker
engaging in a transaction in the Company's Common Stock would be required to
provide any customer with a risk disclosure document, disclosure of market
conditions, if any, disclosure of the compensation of the broker-dealer and
its salesperson in the transaction, and monthly accounts showing the market
values of the Company's Common Stock held in the customer's account. The bid
and offer quotation and compensation information must be provided prior to
effecting the transaction and must be
11
<PAGE>
contained on the customer's confirmation. It may be anticipated that a number
of brokers may be unwilling to engage in transactions in the Company's Common
Stock because of the need to comply with the "penny stock" rules, thereby
making it more difficult for purchasers of Common Stock offered hereby to
dispose of their shares. The Company's Common Stock is covered by a Securities
and Exchange Commission rule that imposes additional sales practice
requirements on broker-dealers who sell such securities to persons other than
established customers and accredited investors (generally institutions with
assets in excess of $5,000,000 or individuals with net worth in excess of
$1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their
spouse). For transactions covered by the rule, the broker-dealer must make a
special suitability determination for the purchaser and receive the
purchaser's written agreement to the transaction prior to the sale.
Consequently, the rule may affect the ability of broker-dealers to sell the
Company's securities and also may affect the ability of purchasers in this
offering to sell their shares in the secondary market.
12
<PAGE>
DIVIDEND POLICY
The Company has never paid any cash dividends on its Common Stock and does
not anticipate that it will pay dividends in the foreseeable future. Instead,
the Company intends to apply any earnings to the development and expansion of
its business.
USE OF PROCEEDS
The Company will not receive the proceeds of sales of shares by the Selling
Shareholders. However, if the Selling Shareholders who hold warrants determine
to exercise their warrants in order to sell shares hereunder, the Company
would receive the proceeds of the exercise of the Warrants. If all of the
Warrants were exercised to purchase shares of the Company's Common Stock, the
Company would receive net proceeds of $11,213,747, plus an additional amount
equal to 30% of the net proceeds of the sale of the shares issued upon
exercise of certain of the warrants, to the extent such proceeds exceed $4.00
per share. See "Plan of Distribution--The Warrants." The Company plans to use
any such net proceeds for expanded advertising and marketing, payment of trade
accounts payable, and as working capital. The amounts actually expended for
each such use, if any, are at the discretion of the Company and may vary
significantly depending upon a number of factors, including the amount of such
proceeds, future revenue growth and the amount of cash generated by the
Company's operations. To the extent such proceeds are not utilized
immediately, they will be invested in United States government or governmental
agency securities or short-term insured certificates of deposit.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems. The products are
marketed through original equipment manufacturers ("OEMs") and distributors,
as well as directly to end users. In addition, through its majority-owned
subsidiary, FNet, the Company is a provider of Internet access and services,
including Intenet telephony, to businesses and individuals. The Company is a
California corporation formed in 1981.
Forward-looking statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, including statements regarding
the Company's entrance into the Internet business, newly introduced products,
development of "telephone-to-telephone" service capabilities over the
Internet, net sales, gross profit, operating expenses, other income and
expenses, liquidity and cash needs and the Company's plans and strategies are
all based on current expectations, and the Company assumes no obligation to
update this information. Numerous factors could cause actual results to differ
from those described in the forward-looking statements. See "Risk Factors."
The Company has recently re-focused its business from manufacturing
primarily LAN and WAN products to providing telecommunications and Internet
products and services. Beginning in the year ended June 30, 1997 and
continuing in the three months ended September 30, 1997, the Company has begun
to generate revenues from these new business lines. Sales had been declining
for the Company's existing hardware products during the previous fiscal year,
while the newly developed hardware products and Internet services were not yet
ready for market. Initial demand for the Company's newly introduced D-Mark
Channel Bank, Cyclone and Data Voice Gateway hardware product lines have yet
to be established, since many potential customers are in the process of
evaluating the products.
FNet is in the nature of a new business venture; accordingly, it can be
expected that its future operating results will be subject to many of the
risks inherent in establishing a new business enterprise. There can be no
assurance, therefore, that FNet will be able to achieve or sustain
profitability in future periods or that the Company's investment of resources
into it will be repaid.
The Company's D-Mark Channel Bank terminates a digital T1 telephone line
from the local telephone company and channelizes it into 24 analog data/voice
lines for either modems, faxes, or telephones. With the declining cost of T1
digital lines, the Company believes that the D-Mark Channel Bank provides an
effective, cost saving solution for companies using 10 or more phones or
modems. The Cyclone is an evolution of the D-Mark and includes modems
integrated into the PC cards, thus eliminating the need to add external modems
for those applications requiring them. The Data Voice Gateway, or DVG, is a
further evolution of the D-Mark, which adds the capability of transmitting
voice traffic over the Internet and Frame relay circuits.
Other products under development include the Tornado, which is a further
evolution of the Cyclone by providing terminal server function. The Tornado is
targeted to become the Company's point of presence "POP in a box" solution for
ISPs or a corporation's data center. This would permit a new or existing
Internet Service Provider or corporation to install all of the hardware
required to provide an Internet service connection.
Other features of the D-Mark series include FXO and, in the future, Ground
Start capabilities for the voice card integrated in the D-Mark systems. FXO
allows the D-Mark to extend the functions of a PBX telephone system. Ground
Start will allow access to devices (PBX trunk lines, telephones, fax machines,
etc.) that operate in this environment, thus expanding the types of devices
that the D-Mark systems can utilize. The T-1 card in the D-Mark system is also
being improved to add a MVIP interface. The MVIP interface is an open
architecture standard interface, which would permit users to customize
applications and directly connect third party hardware to the D-Mark systems.
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<PAGE>
In designing the D-Mark Channel Bank, the Company's primary target market
was Internet Service Providers. With the growth of the Internet, the Company
believes that the D-Mark Channel Bank can satisfy the requirements of Internet
Service Providers for providing analog lines for modem banks to provide
service for their dial-up accounts.
Companies such as U.S. Robotics, Texas Instruments and Cirrus Logic have
purchased the D-Mark Channel Bank for testing and engineering of the latest
56K (X2) modem technology.
These applications were not originally considered by the Company, but were
discovered by and in conjunction with purchasers of the product. Due to the
rapidly changing pace of the telecommunications industry, management believes
that the D-Mark Channel Bank will continue to be a leading edge product
because of its upgradability and flexibility. The Company also manufactures D4
T-1 Channel Banks, which are capable of terminating a telephone company T1
line which contains 24 voice and or data circuits. This termination takes the
T-1 serial port and turns it into 24 central office type telephone outlets
which will accept 24 desk phones or a PBX. As part of the channel bank the
Company also offers an 8 port station analog card (ICV-8) for the CTI market.
As with any new line of business, there can be no assurance that the D-Mark
Channel Bank, The Cyclone, DVG and other newly developed communications
products will gain widespread market acceptance or be profitable. In addition,
there can be no assurance that new hardware products and services developed by
others will not render the Company's hardware products and services
noncompetitive or obsolete.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1997 Compared To Three Months Ended
September 30, 1996
Net Sales. Net sales increased by $35,000, or 17%, from $209,000 in the
three months ended September 30, 1996 to $244,000 in the three months ended
September 30, 1997. The overall increase is due to increased Internet services
revenue, with a reduced demand for wide area network products. Initial demand
for newly introduced hardware products has yet to be established, in that most
sales to date have been to customers for testing and evaluation purposes. The
revenue mix for the three months ended September 30, 1997 consisted of 69%
Internet services revenue and 31% hardware product sales.
Gross Profit. Gross profit decreased as a percentage of net sales to 4% for
the three months ended September 30, 1997, from a gross profit of 21% of net
sales for the corresponding period of 1996. The gross profit percentage
decrease can be attributed to increased manufacturing overhead infrastructure
expenditures, including increased numbers of personnel to support an
anticipated ramp up of sales activity.
Operating Expenses. Operating expenses increased by $549,000, or 130%, from
$421,000 in the three months ended September 30, 1996 to $970,000 in the three
months ended September 30, 1997. The increase is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet services infrastructure, increased sales and
marketing efforts, and costs in enhancing the general and administrative
infrastructure to support higher sales volumes.
Other Income (Expense). Interest expense increased by $10,000, or 143%, from
$7,000 in the three months ended September 30, 1996 to $17,000 in the three
months ended September 30, 1997, due primarily to an increase in loans from an
officer of the Company and assumed lease debt from Internet Passport. Other
income increased by $17,000, or 100%, from $-0- in the three months ended
September 30, 1996 to $17,000 in the three months ended September 30, 1997,
due to various non-operating items.
Fiscal Year Ended June 30, 1997 Compared To Fiscal Year Ended June 30, 1996
Net Sales. Net sales increased by $1,305,000, or 303%, from $430,000 in the
year ended June 30, 1996 to $1,735,000 in the year ended June 30, 1997. The
overall increase is due to resurgence in demand for wide area
15
<PAGE>
network products, initial demand for newly introduced hardware products, and
introduction of Internet services. Seven customers constituted 60% of total
sales for the year ended June 30, 1997. The increase in sales of wide area
network products related to shipments of the ACP 186, an existing
communication board used by a significant customer that significantly expanded
its operations during the period. Sales of the ACP 186 for the year ended June
30, 1997 were $436,000. The revenue mix for the year ended June 30, 1997
consisted of 68% wide area network products, including repair services, 9%
newly introduced D-Mark hardware products, and 23% Internet services.
Gross Profit (Loss). Gross profit increased as a percentage of net sales to
43% for the year ended June 30, 1997, from a gross loss of 37% of net sales
for the corresponding period of 1996. The gross profit percentage increase can
be attributed to increased sales of higher margin products and a spreading of
fixed manufacturing overhead costs over a larger sales base.
Operating Expenses. Operating expenses increased by $2,183,000, or 163%,
from $1,337,000 in the year ended June 30, 1996 to $3,520,000 in the year
ended June 30, 1997. Approximately 70% of the increase is attributable to a
one-time write-off of goodwill. The balance is attributable to increased
product development costs for the recently introduced hardware products, costs
in developing the Internet services infrastructure, increased sales and
marketing efforts, and costs in enhancing the general and administrative
infrastructure to support higher sales volumes.
Other Income (Expense). Interest expense increased by $15,000, or 58%, from
$26,000 in the year ended June 30, 1996 to $41,000 in the year ended June 30,
1997, due primarily to an increase in loans from an officer of the Company and
assumed lease debt from Internet Passport. Other expense increased by $1,000,
or 20%, from $5,000 in the year ended June 30, 1996 to $6,000 in the year
ended June 30, 1997, due to various non-operating items.
Fiscal Year Ended June 30, 1996 Compared to Fiscal Year Ended June 30, 1995
Net Sales. Net Sales decreased by $1,051,000, or 71%, from $1,481,000 in the
year ended June 30, 1995 to $430,000 in the year ended June 30, 1996. The
decrease was due to reduced demand for the Company's legacy wide area network
products. The new products introduced in the six months ended December 31,
1996 were under continuing development during the year ended June 30, 1996,
and therefore were not available for sale. In addition, the Internet services
offered by the Company's subsidiary, FNet, were still in development, and
therefore were not yet available.
Gross Profit (Loss). The Company experienced a decrease in gross margin that
resulted in a gross loss as a percentage of net sales of 37% for the year
ended June 30, 1996, from 65% gross profit on net sales for the corresponding
period of 1995. The gross margin percentage decrease can be attributed to a
$226,000 write down of inventory valuation to reserve for obsolete and slow
moving inventory and a spreading of fixed manufacturing overhead costs over a
smaller sales base.
Operating Expenses. Operating expenses increased by $201,000, or 18%, from
$1,136,000 in the year ended June 30, 1995 to $1,337,000 in the year ended
June 30, 1996. The increase is attributable to increased product development
costs for the recently introduced hardware products, costs in developing the
Internet services infrastructure, increased sales and marketing efforts, and
costs in expanding administrative capabilities to support higher sales
volumes.
Other Income (Expense). Interest expense increased by $16,000, or 160%, from
$10,000 in the year ended June 30, 1995 to $26,000 in the year ended June 30,
1996, due primarily to an increase in loans from an officer of the Company.
Other income decreased by $30,000, or 120%, from $25,000 in the year ended
June 30, 1995 to an expense of $5,000 in the year ended December 31, 1996, due
to various non-operating items.
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<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $908,000 and
$190,000, respectively, as of September 30, 1997 and 1996. The primary source
of cash was net proceeds generated from equity financing. The Company has
relied on sales of new shares and the exercise of warrants and options to fund
operations for an extended period of time. The Company received $114,000,
$1,007,000, $1,109,000 and $289,000 in equity financing, for the years ended
June 30, 1995, 1996, and 1997, and the three months ended September 30, 1997,
respectively. Its subsidiary, FNet, raised $1,950,000 for the year ended June
30, 1997 and $51,000 for the three months ended September 30, 1997. FNet has
continued to experience losses, due to the growth nature of the Internet
services business. In addition to the equity financing described above, the
Company's President has deferred portions of his compensation, and has on
occasion, converted debt to equity, in order to preserve the Company's cash.
The Company anticipates that its primary uses of working capital in future
periods will be for acquisitions, increases in product development, expansion
of its marketing plan, development of new branch offices and funding of
increases in accounts receivable. Development of new branch offices may be
achievable through acquisitions. Although the Company seeks to use its Common
Stock to make acquisitions to the extent possible, many acquisition candidates
may require that all or a significant portion of the purchase price be paid in
cash.
The Company believes that existing cash and cash equivalents, cash flow from
operations, and cash raised through private placements of securities will be
sufficient to meet the Company's presently anticipated working capital needs
for at least the next 13 months. The Company regularly evaluates various
potential acquisitions, which could require a substantial portion of the net
proceeds from any exercise of the warrants. To the extent the Company uses its
cash resources for acquisitions, the Company may be required to obtain
additional funds, if available, through borrowings or equity financings. There
can be no assurance that such capital will be available on acceptable terms.
If the Company is unable to obtain sufficient financing, it may be unable to
fully implement its growth strategy.
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<PAGE>
SELECTED FINANCIAL DATA
The selected financial data set forth below for the fiscal years ended June
30, 1995, 1996 and 1997 have been derived from the Company's consolidated
financial statements, audited by Singer, Lewak, Greenbaum & Goldstein LLP
(1997) and Corbin & Wertz (1996 and 1995), respectively, included elsewhere in
this Prospectus, and should be read in conjunction with those consolidated
financial statements (including the notes thereto). The selected financial
data set forth below for the fiscal years ended June 30, 1993 and 1994 have
been derived from the Company's consolidated financial statements, audited by
Corbin & Wertz, but which are not included in this Prospectus. The selected
financial data for the three month periods ended September 30, 1996 and 1997
have been derived from the unaudited financial statements of the Company
included elsewhere herein and include, in the opinion of management of the
Company, all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results for such periods.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED JUNE 30, SEPTEMBER 30,
------------------------------------------------------- ----------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales................... $ 2,512 $ 1,241 $ 1,481 $ 430 $ 1,735 $ 209 $ 244
Cost of sales........... 778 516 518 590 990 165 234
--------- --------- --------- ---------- ---------- ---------- ----------
Gross profit (loss).... 1,734 725 963 (160) 745 44 10
--------- --------- --------- ---------- ---------- ---------- ----------
Operating expenses:
Research and
development expenses.. 519 327 308 320 480 97 121
Selling, general and
administrative
expenses.............. 1,088 871 828 947 1,456 324 849
Write-off of goodwill.. -- -- -- 70 1,584 -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Total operating
expenses.............. 1,607 1,198 1,136 1,337 3,520 421 970
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) from
operations............. 127 (473) (173) (1,497) (2,775) (377) (960)
--------- --------- --------- ---------- ---------- ---------- ----------
Other income (expense):
Interest expense....... (21) (14) (10) (26) (41) (7) (17)
Gain on settlement of
accounts payable...... 108
Loss on settlement of
litigation............ (82)
Other.................. 1 4 25 (5) (6) -- 17
--------- --------- --------- ---------- ---------- ---------- ----------
Total other income
(expense)............. 6 (10) 15 (31) (47) (7) --
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) before
minority interest and
income taxes........... 133 (483) (158) (1,528) (2,822) (384) (960)
Minority interest in
loss of subsidiary..... -- -- -- 63 -- -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes........... 133 (483) (158) (1,465) (2,822) (384) (960)
Provision for income
taxes.................. (13) 2 2 2 2 -- --
--------- --------- --------- ---------- ---------- ---------- ----------
Net income (loss)....... $ 120 $ (485) $ (160) $ (1,467) $ (2,824) $ (384) $ (960)
========= ========= ========= ========== ========== ========== ==========
Net income (loss) per
common share........... $ 0.02 $ (0.08) $ (0.02) $ (0.14) $ (.23) $ (.03) $ (.07)
========= ========= ========= ========== ========== ========== ==========
Weighted average number
of shares outstanding . 5,736,512 5,753,589 6,475,984 10,279,281 12,267,991 11,503,114 13,125,318
BALANCE SHEET DATA (IN THOUSANDS):
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED JUNE 30, SEPTEMBER 30,
------------------------------------------------------- ----------------------
1993 1994 1995 1996 1997 1996 1997
--------- --------- --------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash.................... $ 492 $ 98 $ 135 $ 166 $ 1,464 $ 799 $ 908
Working capital
(deficit).............. 452 (15) 98 (206) 809 96 190
Total assets............ 1,220 769 998 712 3,514 1,533 2,987
Long-term debt.......... 120 50 161 238 360 432 360
Other liabilities....... 537 543 508 503 183 501 183
Stockholder's equity
(deficiency)........... (75) (549) (386) (749) 1,575 (126) 955
</TABLE>
- --------
During the year ended June 30, 1994, the Company declared a 1-for-10 reverse
stock split. Accordingly, all share and per share information has been
retroactively restated to reflect the reverse split. The Company has not
declared dividends since its inception.
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<PAGE>
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the OTC Bulletin Board under the
symbol FTEL. The following table sets forth the range of high and low bid
quotation per share for the Common Stock as reported by the OTC Bulletin Board
during the calendar years indicated. The bid price reflects inter-dealer
prices and does not include retail mark-up, markdown, or commission.
<TABLE>
<CAPTION>
HIGH LOW
----- -----
<S> <C> <C>
1995
First Quarter............................................... $ .39 $ .32
Second Quarter.............................................. 2.25 .98
Third Quarter............................................... 1.69 .74
Fourth Quarter.............................................. .75 .38
1996
First Quarter............................................... .81 .66
Second Quarter.............................................. 1.53 .72
Third Quarter............................................... 2.88 .97
Fourth Quarter.............................................. 2.25 1.25
1997
First Quarter............................................... 5.50 1.81
Second Quarter.............................................. 3.75 2.25
Third Quarter............................................... 3.25 1.56
Fourth Quarter.............................................. 9.93 3.44
1998
First Quarter (through 1/20/98)............................. 6.69 4.50
</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.
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<PAGE>
BUSINESS
GENERAL
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems, including wide area
networks ("WAN"), Local Area Networks ("LAN") and telecommunications
equipment. The products are marketed through Original Equipment Manufacturers
(OEMs) and distributors, as well as directly to end users. In addition,
through its majority-owned subsidiary, FNet, the Company is a provider of
Internet access and services to businesses and individuals. FNet also
distributes the equipment manufactured by the Company to corporations,
including Internet Service Providers.
INDUSTRY BACKGROUND--COMMUNICATIONS PRODUCTS
The demand for products that connect and control electronic data processing
devices, such as point of sale equipment, personal computers and bank
automated teller machines, has increased rapidly due to reductions in the cost
of high speed digital communications. The Company's products are designed to
address the need of geographically dispersed communications networks such as
Computer Telephone Integration (CTI), Internet Telephony (IT), Wide Area
Networks (WAN) and Local Area Networks (LAN), for which the Company provides
proprietary hardware and software.
The IT, WAN and LAN connectivity segments of the communications industry
continue to experience rapid growth. Corporations and governmental
organizations are increasing the flow of information among their
geographically separate facilities. Intelligent workstations (e.g., personal
computer and departmental systems) are replacing character oriented
(asynchronous) "dumb terminals" as the principal users of the device. These
newer devices communicate on a record oriented basis (synchronous mode) which
can utilize much faster transmission rates and thus take advantage of modern,
high speed telecommunications facilities. The greater popularity of
intelligent workstations has increased the demand for flexible and manageable
networks that support devices from multiple vendors.
COMMUNICATIONS PRODUCTS
Wide Area Network Connectivity Products. The Company manufactures three
principal connectivity products for wide area networks. The Franklin Branch
Node is a fully integrated small T-1 packet/circuit switch/multiplexes with
LAN bridge/routing; it is designed for relatively small offices and supports
interconnection of data, voice, image LAN and video applications.
The Multi-Protocol Switching PAD is used to connect host computers and user
systems through one international standard X.25 packet switching protocol, and
provides sophisticated, real time management using simple, menu-oriented
operator functions contained in a Network Control Center ("NCC"). The Company
offers a product line of programmable high performance data communication
processor circuit boards that support both synchronous and asynchronous modes
for a variety of computer architectures. These cards are used in a variety of
applications, including network system products, terminal emulators,
programmable machine tools, voice response systems, protocol test devices, and
load generation tools.
Local Area Network Connectivity Products. The Franklin UltraFast
Hurricane/155 Fast Ethernet Network Card offers high-speed and low-cost
connectivity for LAN applications. Also, the Company manufactures the only
155Mbps Fast Ethernet daisy-chainable network card. As the majority of
networks today send data packets at 10Mbps or 100Mbps, they require a hub
(costing approximately $800) to connect the computers together via their
network cards. The UltraFast Hurricane/155 network cards use a patented
technology which allows packet sizes of 155Mps to be passed through. The
Company believes that competing products, such as Intels 100Mbps cards, are
substantially more expensive or provide inferior performance.
The Hurricane/155 also does not require an expensive hub to network
computers together because it is daisy-chainable. This feature can prove to be
a significant cost savings for small networks and peer-to-peer
20
<PAGE>
environments. For applications such as computer aided design or graphic
environments, the Hurricane/155 can function on its own segment of an existing
network without interfering with the performance of the LAN. For those
environments with large network needs (more than 15 users), the Company also
manufactures 8 and 22 port hubs. The cards come in industry standard
architectures (ISA, EISA, VESA, and PCI) and easily install into any PC.
Telephone Interface Equipment & Computer Telephone Integration ("CTI"). The
Company's D-Mark Channel Bank terminates a digital T1 telephone line from the
local telephone company and channelizes it into 24 analog data/voice lines for
either modems, faxes, or telephones. With reductions in the cost of T1 digital
lines from the telephone companies, the D-Mark Channel Bank can be an
effective method of utilizing analog lines for companies using 16 or more
phones or modems. The product offers easy installation, automatic disaster
recovery, remote manageability, and high reliability.
In designing the D-Mark Channel Bank, the Company's primary target market
was Internet Service Providers. With the growth of the Internet, the Company
believes that the D-Mark Channel Bank can satisfy the requirements of Internet
Service Providers for providing analog lines for modem banks to provide
service for their dial-up accounts.
Customers such as U.S. Robotics, Texas Instruments and Cirrus Logic have
purchased the D-Mark Channel Bank for testing and engineering of the latest
56K (X2) modem technology.
These applications were not originally considered by the Company, but were
discovered by and in conjunction with purchasers of the product. Due to the
rapidly changing pace of the telecommunications industry, management believes
that the D-Mark Channel Bank will continue to be a leading edge product
because of its upgradability and flexibility. The Company also manufactures D4
T-1 Channel Banks, which are capable of terminating a telephone company T1
line which contains 24 voice and or data circuits. This termination takes the
T-1 serial port and turns it into 24 central office type telephone outlets
which will accept 24 desk phones or a PBX. The Company also has under
development an ISA bus computer card which combines a V.34 Modem and the
functions of the channel bank into one 8 port card, thus lowering the cost of
data, not voice, for Internet Service Providers to accept a large number of
analog modem subscribers. As part of the channel bank the Company also offers
an 8 port station analog card (ICV-8) for the CTI market.
Data Voice Gateway ("DVG"). The recently introduced Data Voice Gateway
allows the Company to provide "telephone to telephone' long distance telephone
service over the Internet and frame relay circuits. From the end user's
standpoint, there is no hardware or software required, other than a standard
telephone. The functional use is similar to using a long distance calling card
today. The Company plans to market this platform to corporations and local
telephone companies, who wish to integrate the hardware and software in their
own systems. For a large multinational corporation, this device will allow
them to piggyback their international and national long distance telephone
calls over their existing data networks, and virtually eliminate the need for
long distance telephone carriers between their offices.
The Company's majority owned subsidiary, FNet Corp., plans to set up a
service organization, including a "long distance telephone network', utilizing
the DVG hardware and software technology of the Company. FNet plans to set up
this network by co-locating the DVG hardware platforms into existing data
networks, and offering long distance telephone service worldwide, via the
Internet and private frame relay. The use of the Internet and other data
networks should be transparent to the end user.
INDUSTRY BACKGROUND--INTERNET SERVICES
The Internet is a collection of computer networks linking millions of public
and private computers around the world. Historically, the Internet was used by
government agencies and academic institutions to exchange
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<PAGE>
information, publish research and transfer email. A number of factors,
including the proliferation of communication-enabled personal computers, the
availability of intuitive graphical user interface software and the wide
accessibility of an increasingly robust network infrastructure, have combined
to allow users to easily access the Internet and, in turn, have produced rapid
growth in the number of Internet users.
The emergence of the World Wide Web, the graphical, multimedia environment
of the Internet, has resulted in the development of the Internet as a new mass
communications medium. The ease and speed of publishing, distributing and
communicating text, graphics, audio and video over the Internet has led to a
proliferation of Internet-based services, including chat, online magazines,
news feeds, interactive games and a wealth of educational and entertainment
information, as well as to the development of online communities. In addition,
the reduced cost of executing transactions over the Internet provides
individuals and organizations with a new means to conduct business.
FNET STRATEGY
Through its subsidiary, FNet, the Company plans to offer international
voice, fax, data and video exchange services over the Internet. The Company
has installed and is operating Internet access and related services through an
advanced TCP/IP based and ISDN and SMDS compatible T-1 and frame relay
network. The services offered cover one spectrum of low-cost dial-up services
to high performance continuous high speed access. In addition to acting as an
Internet Service Provider, the Company operates a World Wide Web design and
hosting service.
Through FNet, the Company also plans to offer Internet services to
individuals without computers, allowing them to deliver voice and fax messages
over the Internet by use of a telephone only. Also, FNet plans to provide
voice communication over the Internet from telephone and telephone, without
any PC required, with voice quality comparable to current telephone company
communications.
FNet believes that the introduction of additional service offerings can
serve not only to expand and maintain its customer base, but also, in certain
instances, to enhance revenues. Accordingly, the Company has introduced a
variety of services for business consumers, including business Web sites,
high-speed ISDN communications capability and frame relay connections, each of
which involve a monthly service charge plus set-up fees.
Each FNet customer is provided a mailbox, or address, from which to send and
receive email. Email functionality allows customers to exchange an unlimited
number of multimedia text, graphics, audio and video messages with other FNet
customers as well as with non-FNet Internet users.
FNet provides space on its Web server for commercial customers to publish
their own Web pages. Monthly fees for business Web sites range from $50 to
$100, plus one-time setup fees of $50 to $100, depending on whether the site
is unsecured or secure.
FNet offers high-speed ISDN Internet access communication lines on a
nationwide basis. ISDN provides a faster, more efficient method for
communicating digital data over telephone lines. ISDN speeds are significantly
faster than conventional modem speeds (up to 128 Kbps versus up to the current
maximum of 33.6 Kbps). The monthly ISDN service charge ranges from $110 to
$350, depending on speed and service options. A one-time setup fee ranging
from $110 to $350 is also charged.
FNet also offers frame relay capability. Frame relay enables direct, high-
speed continuous connection of an organization's internal local area network
to the Internet using dedicated circuits at speeds ranging from 56 Kbps to
1,536 Kbps. This service enables businesses to connect an entire local area
network or high-end workstation to the Internet and provides the fastest data
transfer rate generally available. Frame relay service fees range from $250 to
$1,350 per month depending on access speeds, data throughput and other data
transfer metrics. A one-time setup fee ranging from $250 to $1,350 is also
charged.
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<PAGE>
In addition, FNet offers RF Wireless services. RF Wireless allows businesses
to utilize connections at 1,536 Kbps without contracting for T-1 service from
local telephone companies. The RF Wireless service connects to FNet via
antennas from the customer's site, thus utilizing FNet's high speed network.
RF Wireless service fees are $595 per month, with a one-time setup fee of $595
and equipment cost of $3,500.
MARKETING AND DISTRIBUTION OF COMMUNICATIONS PRODUCTS
The Company maintains a small direct sales force for the marketing of its
communications products. It maintains a home page on the World Wide Web and a
headquarters-based sales and service offices. It also markets its products
through direct mail, participation in trade shows, telemarketing, and
advertising in trade and technical publications. The Company has expanded the
sales and marketing operation through acquisitions and the opening of field
offices as well as employing manufactures representatives.
The growth of the Internet has spawned a new industry, consisting of the
building of infrastructure for Internet Service Providers and offering
connections to corporate America as well as private individuals. The Company
designs and manufactures products which are basic to the operation of an
Internet Service Provider. In addition, these same products are required in
the expansion of corporate based private Intranets. Sales to large corporate
clients are handled one at a time through telemarketing with in person follow-
up sales calls, whereas sales to Internet Service Providers and the
communication of the product lines are through advertising in trade journals.
MARKETING OF INTERNET SERVICES
The market for Internet products and services is varied, including both
hardware and software products and related services. Most companies in the
industry provide either hardware, software or services. FNet offers both
hardware and software specifically designed to provide enhanced Internet
accessibility and usage.
Internet users generally fall into one of two specific market segments, the
individual user and the business user. Management of the Company believes that
the individual user segment will continue to show rapid growth, with the
principal uses being information services, on-line shopping and personal
communications. The advent and increasing popularity of home shopping via
television programming may also extend to the Internet. The Internet can
provide consumers with vastly wider choices from a much greater base of
vendors. Many catalogue and mail order companies now utilize electronic
catalogues accessible through the Internet.
The other significant market is the business user. At present, electronic
mail is the most common application, utilizing computer-based LAN or WAN
communication. The trend for companies with multiple, remote site locations is
to link existing WANs utilizing the Internet, in order to minimize direct
telephone company charges; this market segment is usually referred to as the
Intranet. Internet access provides a fast, inexpensive method of achieving
this connectivity. Although currently available technology provides some
limited ability for voice communication over the Internet, the quality is poor
and communication is generally possible only if users at both ends have PCs
with modems and identical software. It is possible that Intranet applications
could eventually eliminate the need for resident operating software and
massive on-site at a storage facilities for many businesses. Under this
scenario, a PC with resident software will no longer be necessary, with access
to any desired program available through an inexpensive workstation connected
to the Internet. Also, data storage could be centralized in a secure database
accessible through the Internet.
The Company currently markets its Internet services through press releases,
its home page on the World Wide Web, and other targeted marketing strategies.
The Company plans to commence advertising its Internet services in business
trade journals, national business publications, direct mail and local business
publications.
COMPETITION
The data communications industry is extremely competitive. The Company's
principal competitors in this market are: Telematics, Micom, Memotech Data,
Dynatech Corporation, Cisco Systems, Ascend
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<PAGE>
Communications and U.S. Robotics. Most of these companies have substantially
greater marketing, financial, technical and field support resources than the
Company. In addition, the Company could face strong competition from a number
of established computer and telecommunications firms which may enter the
market in the future.
The Internet services market in which FNet operates is extremely
competitive, and the Company expects competition in this market to intensify
in the future. The Company's current and prospective competitors include many
large companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company
competes (or in the future is expected to compete) directly or indirectly with
the following categories of companies: (i) national and regional Internet
Service Providers, such as Earthlink, IDT, MindSpring, NETCOM, PSINet and
UUNET; (ii) established online services such as America Online, CompuServe,
Prodigy and the Microsoft Network; (iii) computer software and technology
companies such as Microsoft; (iv) national telecommunications companies, such
as AT&T, MCI and Sprint; (v) RBOCs; (vi) cable operators, such as Comcast, TCI
and Time Warner; and (vii) nonprofit or educational ISPs.
The entry of new participants from these categories and the potential entry
of competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company. The ability
of these competitors or others to bundle services and products with Internet
connectivity services could place the Company at a significant competitive
disadvantage. In addition, competitors in the telecommunications industry may
be able to provide customers with reduced communications costs in connection
with their Internet access services, reducing the overall cost of Internet
access and significantly increasing pricing pressures on the Company.
Moreover, certain of the Company's online competitors, including America
Online, the Microsoft Network and Prodigy, offer unlimited access to the
Internet and their proprietary content at flat rates that are generally
equivalent to the Company's flat rate, and do not require a set-up fee.
Certain of the RBOCs have also introduced competitive flat-rate pricing for
unlimited access (without a set-up fee) for at least some period of time. As a
result, competition for active users of Internet services has intensified.
There can be no assurance that the Company will be able to offset the adverse
effect on revenues of any necessary price reductions resulting from
competitive pricing pressures by increasing the number of its customers, by
generating higher revenue from enhanced services, by reducing costs or
otherwise. See "Risk Factors--Competition; New Products and Technological
Changes."
The Company believes that its ability to compete successfully in the
Internet services market depends on a number of factors, including market
presence; the adequacy of the Company's customer and technical support
services; the capacity, reliability and security of its network
infrastructure; the ease of access to and navigation of the Internet provided
by the Company's services; the pricing policies of the Company, its
competitors and its suppliers; the timing of introductions of new services by
the Company and its competitors; the Company's ability to support existing and
emerging industry standards; and industry and general economic trends. There
can be no assurance that the Company will have the financial resources,
technical expertise or marketing and support capabilities to compete
successfully. Also, the Company believes that it has a competitive advantage
over most Internet Service Providers because it manufactures much of the
equipment necessary to operate an Internet Service Provider, and is able to
react quickly to technological changes in the industry.
The Internet telephony field is a relatively new market, but already
includes a number of strong competitors, many of which have significantly
greater financial and technological resources than the Company. Competitors
include PC software providers, PC telephone product suppliers,
telecommunications equipment vendors, and Internet telephony service
providers. See "Risk Factors--Competition; New Products and Technological
Changes."
RECENT ACQUISITIONS AND TRANSACTIONS
During the fiscal year ended June 30, 1996, the Company acquired Alphalink,
an Internet Service Provider, for 50,000 shares of Common Stock of the Company
valued at $19,760, and Malibu Internet Services, an Internet Service Provider
and designer of "home pages" for the World Wide Web, for 60,000 shares of
Common Stock of the Company and 50,000 shares of the Common Stock of FNet,
valued, in the aggregate, at $55,020.
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<PAGE>
In December 1996 the Company acquired Number One Internet Service, a company
offering high speed wireless, frame relay and ATM Internet services. The
services offered by Number One Internet Service have been integrated with the
services of FNet, and are offered to FNet customers seeking high speed
Internet service and sophisticated applications. In connection with the
acquisition, the owners of Number One Internet Service received 40,000 shares
of the Company's Common Stock and options to purchase an additional 10,000
shares at an exercise price of $1.25 per share, exercisable in January 1998.
In addition, they received 20,000 newly-issued shares of FNet and options to
purchase an additional 80,000 shares of FNet, exercisable over a four year
period. The securities issued were valued at $89,780.
In February 1997 the Company acquired Internet Passport, a company offering
high end Internet services for business customers, including a system for
alternate delivery Internet service using satellite technology for transfer of
large files. Internet Passport was organized in 1996, and has had limited
operations to date. In connection with the acquisition, the Company issued
600,000 shares of its Common Stock, and assumed certain obligations, with a
net value of $1,700,789.
In February 1997 the Company acquired the shares of CPR Computer Repair,
Inc., a service company specializing in the repair of computers and printers,
for 25,000 shares of the Company's Common Stock and assumption of certain
obligations, valued at $69,425. The Company sold the shares of CPR Computer
Repair Inc. in June of 1997, in exchange for a royalty, based on the gross
profits of CPR Computer Repair, Inc., up to a maximum of $100,000.
In March 1997 the Company's subsidiary, Internet Passport, entered into a
Memorandum of Understanding with DigitalXPress LLC ("DigitalXPress"), a
purveyor of video and data network satellite services. Under the terms of the
agreement, Internet Passport and DigitalXpress will jointly develop a product
line, to be called "XPressNet," to furnish Internet connectivity to the
products currently marketed by DigitalXPress, and to combine marketing efforts
for certain customers, applications and products.
In May 1997 the Company's subsidiary, FNet, entered into a licensing and
joint development agreement with Peak Technologies, Inc. ("Peak"), by which
Peak granted FNet a license to use Peak's Java-based PeakJet Internet browser
accelerator in FNet's Internet service. In addition, FNet is to provide a
customized version of the PeakJet technology as a component in the Franklin
XPress satellite product line offered in conjunction with DigitalXPress. Under
the agreement, FNet is to issue 50,000 shares of its Common Stock to Peak.
ASSEMBLY AND MANUFACTURING OPERATIONS
The Company's manufacturing facility is located in Westlake Village,
California. Assembly of the Company's products is ordinarily contracted out to
local circuit board assembly contractors, with final systems tests completed
at the Company's facility. The Company's manufacturing operations consist
primarily of procurement, inspection and testing of components, final assembly
of subsystems, and extensive testing of finished products. The Company
procures substantially all of its parts from outside suppliers. The Company is
currently able to obtain parts without difficulty and at competitive prices.
However, in common with others in the electronics industry, the Company has in
the past paid premium prices to obtain components that are in short supply.
There can be no assurance that shortages will not occur in the future which
could significantly increase the cost or delay the shipment of the Company's
products. This could adversely affect its sales or profitability.
FACILITIES
The Company occupies two leased facilities in Westlake Village, California.
One of the facilities houses sales, engineering, administrative and Internet
services. The facility is 8,000 square feet, with a lease rate of $8,634 per
month, expiring in September 1998. The lease for this facility is renewable on
a year-to-year basis at the option of the Company. The other facility houses
the manufacturing and inventory warehouse. This facility is 4,000 square feet,
with a lease rate of $3,767 per month, expiring in March, 1998, and has a two
year option on renewal.
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<PAGE>
The Company also leases a 1,688 square foot office in Atlanta, Georgia for
its Internet Passport operation. The current lease rate is $1,477 per month,
with annual rate increases, providing for a lease rate of $1,617 per month by
the end of the lease term. The lease expires in March 2000.
PATENTS AND TRADEMARKS
The Company has been granted two U.S. patents for hardware designs in the
LAN field, one of which expires in 2009 and the other expires in 2006. The
Company also has copyrighted over 300 software programs and 20 hardware
designs. While the Company vigorously defends its patents and other
intellectual property, it protects its proprietary technology through the
filing of patent applications and copyright notifications, and by seeking
employee and business nondisclosure agreements. The Company believes that the
success of its business depends primarily on its technical innovations,
marketing abilities and responsiveness to customer requirements, rather than
on patents, trade secrets, copyrights and other intellectual property rights.
The Company enters into confidentiality agreements with its key employees. In
addition, all suppliers, distributors, licensees, and other business contacts
who have access to the Company's proprietary technology are required to sign
confidentiality agreements. However, there can be no assurance that the
Company's efforts to protect its proprietary rights will be successful in
preventing misappropriation or that those rights will provide the Company with
a competitive advantage. There can be no assurance that others will not
develop products or technology that are equivalent or superior to those of the
Company, or that the confidentiality agreements and internal safeguards upon
which the Company relies will be adequate to protect its interests.
Nevertheless, the Company has a policy of seeking to protect its intellectual
property through patents, confidential disclosure agreements and trade
secrets.
The laws of some foreign countries in which the Company sells or may sell
its products do not protect the Company's proprietary rights in its products
to the same extent as do the laws of the United States.
BACKLOG
At September 30, 1997 and 1996, the Company did not have any backlog of
orders. Since the Company ordinarily fills orders for its communications
products in less than 30 days, backlog is not a significant factor in the
Company's business.
RESEARCH AND DEVELOPMENT
The Company is engaged in ongoing efforts to develop and improve its
products, adapt its products for new applications and design and engineer new
products. During the three months ended September 30, 1997 and for the fiscal
years ended June 30, 1997 and 1996, the Company's research and product
development expenses were approximately $121,000, $480,000 and $320,000,
respectively. The Company expects that its ability to compete effectively in
the communications products marketplace will depend substantially upon
achieving greater speed and flexibility in the Company's products and upon
reducing the cost of the Company's systems. There can be no assurance that the
Company will be able to do so or that the Company's competitors will not
develop products that are less expensive or otherwise superior to those of the
Company.
The Company's internal research and product development efforts are focused
primarily on improving the performance and cost-effectiveness of the Company's
systems through better configurations of system components and developing new
product applications. The Company also has depended upon certain key suppliers
to provide product components in accordance with the Company's specifications.
The Company continues to be engaged with certain of its component suppliers,
independent consultants and other third parties in seeking improvements in the
Company's products.
GOVERNMENT REGULATION
Regulations of the Federal Communications Commission affect various products
of the Company. Certain regulations require that products which reside on a
customer's premises and interconnect the public switched network meet certain
standards to prevent harm to the network. Other regulations limit the levels
of
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<PAGE>
electromagnetic radiation which may emanate from an electronic device located
on a customer's premise. The Company currently complies with these regulations
and foresees no difficulties in complying with these regulations in the
future. Changes in existing laws and regulations which govern the
telecommunication industry could affect the business of the Company.
FNet provides Internet services, in part, through data transmissions over
public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for wire line communications. FNet is
not currently subject to direct regulation by the FCC or any other
governmental agency, other than regulations applicable to businesses
generally. However, in the future FNet could become subject to regulation by
the FCC or another regulatory agency as a provider of basic telecommunications
services. Several long distance telephone carriers have filed a petition with
the FCC seeking a declaration that Internet telephone service is a
"telecommunications service" subject to common carrier regulation. Such a
declaration, if enacted, would create substantial barriers to FNet's entry
into the Internet telephone market. Also, a number of local telephone
companies have asked the FCC to levy access charges on "enhanced service
providers," which may be deemed to include Internet Service Providers.
Although the Chairman of the FCC has indicated his opposition to levying
service charges against Internet Service Providers, local interconnection
charges could be levied in the future. Moreover, the public service
commissions of certain states are exploring the adoption of regulations that
might subject Internet Service Providers to state regulation.
The Telecommunications Act of 1996 (the "Telecommunications Act") contains
certain provisions that lift, or establish procedures for lifting, certain
restrictions relating to the RBOCs' ability to engage directly in the Internet
access business. The Telecommunications Act also makes it easier for national
long distance carriers such as AT&T to offer local telephone service and
allows RBOCs to provide electronic publishing of information and databases.
Competition from these companies could have a material adverse effect on the
Company.
LEGAL PROCEEDINGS
On July 28, 1997 the Company was named as a defendant in an action brought
by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number
service, its officers and affiliates, and several Internet Service Providers,
including the Company. The action was brought in the U.S. District Court for
the Central District of California. In general, the complaint alleges that
Connect America and its officers fraudulently acquired 800 numbers from AT&T,
failed to pay for them, and resold them to the Company and the other Internet
Service Providers on a "flat rate" basis, notwithstanding the fact that AT&T's
charges for 800 service are typically based on time utilized. The claims
against the Company and the other Internet Service Providers are based on
unjust enrichment, on the theory that the Company and the other Internet
Service Providers knew or should have known that flat rate 800 service was
unavailable. In addition to injunctive relief against Connect America and its
officers, the complaint seeks damages of $7.4 million, punitive damages and
attorneys' fees. The Company has filed an answer to the complaint denying the
material allegations thereof, and plans to vigorously contest the action.
There can be no assurance that the Company will be successful in its defense
of the action. Because of the large amount sought in the complaint, an adverse
outcome would have a material adverse effect on the Company's financial
condition.
EMPLOYEES
As of September 30, 1997, the Company had 33 full time employees, including
employees of all subsidiaries. The Company's employees have never been covered
by a collective bargaining agreement. The Company has never experienced any
work stoppages, slowdowns, or other serious labor problems and considers its
relations with its employees to be excellent.
RECENT FINANCINGS
During September, October and November of 1997 the Company completed private
financings with net proceeds of $7,807,000. The financings included the
issuance by the Company of 333,333 shares of Common
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<PAGE>
Stock and warrants to purchase an additional 333,333 shares of Common Stock,
at an exercise price of $5.00 per share. In addition, the Company issued 740
shares of Series C Preferred Stock at a purchase price of $10,000 per share,
which shares are convertible into shares of Common Stock at a conversion price
of $4.64 per share, subject to certain adjustments relating to the market
price of the underlying Common Stock. In connection with the issuance of the
Series C Preferred Stock, the Company also issued warrants which are
exercisable to purchase shares of Common Stock of the Company's subsidiary,
FNet, and which may, under certain circumstances, be exercisable to acquire
shares of Common Stock of the Company at the conversion price of the Series C
Preferred Stock.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Frank W. Peters......... 59 President, Chief Executive Officer and Chairman of the Board
Peter S. Buswell........ 48 Director
Robert S. Harp.......... 59 Director
Thomas Russell.......... 46 Chief Financial Officer and a Director
</TABLE>
Mr. Peters has been President of the Company since its organization in 1981.
Between 1975 and 1984 he was also President of Franklin Data Systems and
Franklin Systems Corporation, predecessors to the Company. From 1973 to 1975,
he was Vice President of Jacquard Systems Corporation, a computer hardware and
word processing software development marketer. Between 1965 and 1973 he held
various marketing and sales positions with IBM.
Mr. Buswell has been the Vice President of Marketing and Business
Development for Xantel, since 1996. Previously, he was Chief Marketing Officer
for TAA, a software developer engaged in the development of enterprise wide
mixed media messaging systems. During the 1980s he was manager of Strategic
Planning for the Communications Systems Group of Exxon Enterprises, the
venture capital unit of Exxon. He has also served as Director of Product Line
Management at ITT and as Manager of Program Development at Datapoint. Mr.
Buswell has been a director of the Company since 1996. He also served as a
Vice President of the Company during the 1980's.
Dr. Harp has been Chairman of Quesant Instruments, a manufacturer of
scanning probe microscopes, since 1992. Between 1987 and 1992, he was Chairman
of Vertek, a manufacturer of PC peripheral devices. He is also a founder of
Vector Graphic, Inc. Dr. Harp has been a director of the Company since 1996.
Mr. Russell has been the Chief Financial Officer and a director of the
Company since 1996. He also served as its Chief Financial Officer between 1988
and 1990. Between 1990 and 1996 Mr. Russell owned and operated Russell
Industries, a manufacturer's representative and distribution firm. Prior to
that time Mr. Russell was a partner at Sorenson, Russell & Company, a public
accounting firm, and was employed by Peat Marwick. Mr. Russell is a certified
public accountant.
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EXECUTIVE COMPENSATION
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1996 and June 30, 1997 to its
President and its Chief Financial Officer (the "Named Executive Officers").
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
--------------------------- ---- -------- -------- ------------
<S> <C> <C> <C> <C>
Frank W. Peters, President.............. 1996 $275,056(1) $100,000 -0-
1997 $291,556(1) $100,000 -0-
Thomas Russell, Chief Financial
Officer(2)............................. 1996 -0- -0- -0-
1997 $ 60,208 $ 10,000 -0-
</TABLE>
- --------
(1) Portions of these amounts were deferred. See "Transactions with
Management," below.
(2) Mr. Russell was employed by the Company beginning in October 1996.
Except as disclosed above, no compensation characterized as long-term
compensation, including restricted stock awards issued at a price below fair
market value or long-term incentive plan payouts, were paid by the Company
during the years ended June 30, 1996 and 1997 to any of the Named Executive
Officers.
STOCK OPTIONS
The Company's 1986 Stock Option Plan, as amended (the "1986 Plan"),
authorizes the granting of options to employees that are intended to qualify
as "incentive stock options" under the Internal Revenue Code of 1986
("Incentive Stock Options"), as well as stock options that are not intended to
so qualify ("Nonstatutory Options"), which may be granted to officers,
directors, employees, consultants, and others expected to provide significant
services to the Company or its subsidiaries. The 1986 Plan, which is
administered by the Board of Directors, currently covers an aggregate of
700,000 shares. The maximum term of a stock option granted under the 1986 Plan
is ten years, but if the optionee at the time of grant has voting power over
more than 10% of the Company's stock, the maximum term is five years. If an
option granted expires or terminates, the shares subject to the unexercised
portion of that option will become available for the grant of future options
under the 1986 Plan. If an optionee terminates his or her service to the
Company, the optionee may exercise only those option shares vested as of the
date of termination and must effect such exercise within three months,
although the Board of Directors may set a longer period for exercise of stock
options. The 1986 Plan may be amended at any time by the Board of Directors,
although certain amendments would require shareholder approval.
The exercise price of Incentive Stock Options granted under the 1986 Plan
must be at least equal to the fair market value of the stock subject to the
option on the date of grant, except that the exercise price of an Incentive
Stock Option granted to an optionee who owns stock possessing more than 10% of
the voting power of the Company's outstanding capital stock must equal at
least 110% of the fair market value of the stock subject to the option on the
date of grant. The exercise price of Nonstatutory Stock Options granted under
the 1986 Plan must be at least equal to 85% of the fair market value of the
stock subject to the option on the date of the grant. Payment of the exercise
price may be made in cash, promissory notes or other consideration as
determined by the Board of Directors.
The Company has also adopted a 1988 Stock Option Plan on substantially
similar terms as the 1986 Plan. The 1988 Plan covers 300,000 shares. In 1994
the Company adopted an Incentive Stock Option Plan, providing for the grant of
incentive stock options to purchase up to 600,000 shares on substantially the
same terms as the incentive stock options under the 1986 Plan. In 1995 the
Company adopted its 1994 Nonstatutory Stock Option Plan, which provides for
the grant of nonstatutory options to purchase up to 1,400,000 shares on
substantially the same terms as the Nonstatutory Options under the 1986 Plan.
30
<PAGE>
The following table sets forth information with respect to ownership of
options and option values as of June 30, 1997 with respect to the Named
Executive Officers. No options were exercised by the Named Executive Officers
in the fiscal year ended June 30, 1997. The Company has no outstanding stock
appreciation rights, either freestanding or in tandem with options.
<TABLE>
<CAPTION>
OPTION VALUES AS OF JUNE 30, 1997
---------------------------------------------------
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
JUNE 30, 1997 JUNE 30, 1997(1)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
<S> <C> <C>
Frank W. Peters....... 3,008,695(2)/175,000 $6,620,477(2)/$273,000
Thomas Russell........ 100,000/150,000 $ 103,000/$247,000
</TABLE>
- --------
(1) Assumes that a share of Common Stock was valued at $2.34 per share on
June 30, 1997. Amounts reflected are based on this assumed price minus
the exercise price and do not indicate that shares were sold.
(2) Does not include shares issuable upon conversion of convertible notes.
See "Transactions with Management," below.
Option Grants During the Years Ended June 30, 1996 and 1997. The following
table sets forth certain information regarding stock options granted to the
Named Executive Officers during the twelve months ended June 30, 1995 and
1996:
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES
OPTIONS IN FISCAL EXERCISE
NAME YEAR GRANTED YEAR PRICE EXERCISE DATE
---- ---- ---------- ---------- -------- -----------------
<S> <C> <C> <C> <C> <C>
Frank W. Peters....... 1996 350,000 39% $ .78 3/15/97-3/15/98
Frank W. Peters....... 1997 500,000 40% $1.31 12/13/96
Thomas Russell........ 1996 200,000 22% $ .69 5/11/97-5/11/2000
Thomas Russell........ 1997 100,000 8% $1.31 12/13/96
</TABLE>
Employment Arrangements. The Company's President is employed pursuant to an
Employment Agreement expiring on December 31, 1997. The Employment Agreement
provides for monthly compensation at the rate of $20,000, with annual
increases of 6%. The Company's Board of Directors has approved a new six year
Employment Agreement for the Company's President, effective January 1, 1998.
The new Employment Agreement provides for compensation at the rate of $27,000
per month, with annual increases of 6%. The Company's Chief Financial Officer
and Engineering Manager are employed pursuant to Employment Agreements for a
three year period, commencing on September 2, 1997, providing monthly
compensation at the rate of $10,000 per month. The Company's Software
Engineering Manager is employed pursuant to Employment Agreement for a two
year period, commencing on December 2, 1997, providing monthly compensation at
the rate of $10,000 per month.
TRANSACTIONS WITH MANAGEMENT
During the year ended June 30, 1995, the Company issued notes for an
aggregate of $217,000 payable to its President, Frank W. Peters, in lieu of
compensation, included in the table above. These notes bear interest at the
rate of 9% per annum and are due and payable as follows: $12,000 due on August
20, 1995, $65,000 due on August 20, 1997, and $140,000 due on January 5, 1999.
Mr. Peters has waived any defaults or penalties with respect to the unpaid
portions of these notes. The $140,000 note is convertible into shares of the
Company's Common Stock at a conversion price of $.10 per share.
During the year ended June 30, 1995, the Company issued 2,000,000 shares to
its President, Frank W. Peters, upon exercise of options previously granted.
The exercise price was paid by the cancellation of notes in the amount of
$92,000 and accrued interest in the amount of $42,000.
31
<PAGE>
During the year ended June 30, 1996, the Company transferred 4,200,000 of
its shares of FNet to its President, Frank W. Peters, and to Colin Patterson,
who was a director of the Company at the time, in cancellation of notes
payable and for consulting services. Management of the Company valued the FNet
shares at $.015 per share, based upon the book value of FNet at the time of
the transaction. The issuance of these shares caused the Company's ownership
percentage of FNet to decrease from 100% to 79% as of June 30, 1996.
During the year ended June 30, 1996, the Company deferred payment of
$117,000 in compensation, included in the table above, to its President, Frank
W. Peters, with his permission, for an undetermined time period.
On September 20, 1995, the Company issued a promissory note for $100,000,
bearing interest at the rate of 8%, to its President, in lieu of bonus
compensation, included in the table above, for attaining certain corporate
objectives. The note is payable in twenty four equal monthly installments of
$4,523. No payments have been made to date on this Note, and the President has
waived the default provisions.
On September 20, 1996, the Company issued a $100,000 promissory note to its
President in exchange for services rendered in fiscal 1997. No compensation
expense was recorded in fiscal 1996 relating to this note. Bonus compensation
expense of $100,000 will be recorded in connection therewith in fiscal 1997.
The note bears interest at 8% per annum, and is payable in thirty-six equal
monthly installments of $3,134.
On December 13, 1996, the Company granted an option to purchase 1,000,000
shares of its Common Stock at an exercise price of $1.31 per share, the market
price as of December 13, 1996. The options were granted to key management
employees for achievement of certain goals. The options are all currently
exercisable. Of the options, 500,000 were granted to the Company's President,
Frank W. Peters, and 100,000 were granted to its Chief Financial Officer,
Thomas Russell.
During the year ended June 30, 1997, the Company deferred payment of
$112,000 in compensation, included in the table above, to its President, with
his permission, for an undetermined time period.
As of June 30, 1997, the deferred compensation of $117,000 and $112,000 was
converted into two promissory notes. One half of the principal balance of the
notes is convertible into shares of the Company's Common Stock at a conversion
rate of 50% of the fair market value of the Common Stock at the date of
conversion.
On October 7, 1997, the Company's President exercised an option to purchase
1,333,695 shares of the Company's Commons stock at the exercise price of $.10
per share.
On November 3, 1997, the Company's Chief Financial Officer exercised options
to purchase 150,000 shares of the Company's Common stock at exercise prices
ranging from $.69 to $1.31.
32
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of December 31, 1997 by each
director and executive officer of the Company, each person known to the
Company to be the beneficial owner of more than 5% of the outstanding Common
Stock, and all directors and executive officers of the Company as a group.
Except as otherwise indicated below, each person has sole voting and
investment power with respect to the shares owned, subject to applicable
community property laws.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
(INCLUDES EXERCISABLE OPTIONS)
------------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- ------------------ ---------------
<S> <C> <C>
Frank W. Peters..................... 4,596,694(1) 30%
733 Lakefield Road
Westlake Village, CA 91361
Peter S. Buswell.................... 105,000 1%
733 Lakefield Road
Westlake Village, CA 91361
Robert S. Harp...................... -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Thomas Russell...................... 179,040 1%
733 Lakefield Road
Westlake Village, CA 91361
All directors and executive officers
of the Company as a group
(5 persons)........................ 4,880,734 32%
</TABLE>
- --------
(1) Does not include shares issuable upon conversion of 50% of the balance of
notes totalling $229,000 into shares at 50% of market value.
33
<PAGE>
SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of November 25, 1997 by each
Selling Shareholder, the number of shares to be sold by each and the
percentage ownership of each Selling Shareholder after the sale of the Shares
included in this Registration Statement (including exercise of all warrants
underlying shares in this table and conversion of all Convertible Preferred
Stock underlying shares included in this table). Under certain circumstances
the number of shares issuable upon conversion of the Convertible Preferred
Stock and the number of shares issuable upon exercise of warrants may be
increased due to adjustments in the conversion price or the exercise price, as
the case may be, and pursuant to penalty provisions, designed to protect the
holders against dilution and against decreases in the market price of the
underlying Common Stock. In such event, the number of shares to be sold by the
Selling Shareholders and covered by the Registration Statement of which this
Prospectus is a part is increased appropriately pursuant to Rule 416 under the
Securities Act of 1933, as amended.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
SHARES BENEFICIALLY OWNED SHARES OFFERING
------------------------- TO BE ----------------------
NAME NUMBER PERCENT SOLD NUMBER PERCENT
---- -------------- -------------------- ----------- ----------
<S> <C> <C> <C> <C> <C>
M.H. Meyerson & Co.,
Inc.................... 595,000 2.7% 595,000 -0- -0-
Wilson Davis............ 30,000 0.1% 30,000 -0- -0-
Sam Wilson.............. 50,000 0.2% 50,000 -0- -0-
Paul Davis.............. 60,000 0.3% 50,000 10,000 *
Lyle Davis.............. 120,000 0.5% 60,000 60,000 0.3%
Byron Barkley........... 40,000 0.2% 40,000 -0- -0-
Bollard Investment Co... 80,000 0.3% 40,000 40,000 0.2%
Bruce Whaley............ 40,000 0.2% 40,000 -0- -0-
E. Bryan Bagley......... 40,000 0.2% 40,000 -0- -0-
Joe Fisher.............. 132,000 0.6% 110,000 22,000 0.1%
Gary Nelson............. 128,000 0.6% 64,000 64,000 0.3%
Gary Nelson Transcorp
C/F.................... 11,000 * 11,000 -0- -0-
Raleigh Baughman........ 87,300 0.4% 50,000 37,300 0.2%
Blair Holder............ 135,000 0.6% 50,000 85,000 0.4%
Vince Clements.......... 100,000 0.5% 50,000 50,000 0.2%
Terry Widner............ 135,175 0.6% 50,000 85,175 0.4%
Mike Peters............. 498,568 2.2% 190,000 308,568 1.4%
Delaware Charter
Guaranty & Trust Co.,
FBO
Ronald Heller.......... 303,000 1.4% 303,000 -0- -0-
Delaware Charter
Guaranty & Trust Co.,
FBO
David Nagelberg........ 303,000 1.4% 303,000 -0- -0-
Martan & Co............. 146,000 0.7% 146,000 -0- -0-
Michael and Linda
Silvestri.............. 28,000 0.1% 28,000 -0- -0-
Jeffrey Barber.......... 14,000 0.1% 14,000 -0- -0-
Joel Marcus............. 12,000 0.1% 12,000 -0- -0-
Rocco Vezza............. 12,000 0.1% 12,000 -0- -0-
Joanne Gioia............ 12,000 0.1% 12,000 -0- -0-
Joseph Schmidt.......... 10,000 * 10,000 -0- -0-
Eileen Rouse............ 60,000 0.3% 10,000 50,000 0.2%
Kevin Charos............ 10,000 * 10,000 -0- -0-
Marcia Joedicker........ 20,000 0.1% 20,000 -0- -0-
Frederick I. Camerer.... 161,647 0.7% 17,500 144,147 0.7%
Paul Sper............... 60,000 0.3% 60,000 -0- -0-
Sparrow Marcioni........ 440,000 2.0% 300,000 140,000 0.6%
Mark Milhollan.......... 12,000 0.1% 12,000 -0- -0-
Neil Wyenn.............. 25,000 0.1% 25,000 -0- -0-
Dianne Oliver........... 10,000 * 8,000 2,000 *
Peter Buswell........... 30,000 0.1% 30,000 -0- -0-
John Calderwood......... 6,250 * 6,250 -0- -0-
Kristin Peters.......... 138,127 0.6% 10,000 128,127 0.6%
Terry Lee............... 20,000 0.1% 20,000 -0- -0-
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
SHARES BENEFICIALLY OWNED SHARES OFFERING
------------------------- TO BE -----------------------
NAME NUMBER PERCENT SOLD NUMBER PERCENT
---- --------------- --------------------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Steve Sullivan.......... 20,000 0.1% 20,000 -0- -0-
Garry Fredericksen...... 190,000 0.9% 190,000 -0- -0-
Larry Kupferberg........ 2,500 * 2,500 -0- -0-
Jacqueline Knapp........ 2,500 * 2,500 -0- -0-
The Matthew Fund, N.V... 83,483(1) 0.4% 84,483(1) -0- -0-
75,431(2) 0.3% 75,431(2) -0- -0-
Ellis AG................ 24,138(1) 0.1% 24,138(1) -0- -0-
21,552(2) 0.1% 21,552(2) -0- -0-
Triton Capital
Investments, Ltd....... 84,483(1) 0.4% 84,483(1) -0- -0-
75,431(2) 0.3% 75,431(2) -0- -0-
JMG Capital Partners,
L.P.................... 84,483(1) 0.4% 84,483(1) -0- -0-
75,431(2) 0.3% 75,431(2) -0- -0-
Banque Edouard Constant
S.A.................... 120,690(1) 0.5% 120,690(1) -0- -0-
107,759(2) 0.5% 107,759(2) -0- -0-
Lakeshore International,
Ltd.................... 362,069(1) 1.6% 362,069(1) -0- -0-
323,276(2) 1.5% 323,276(2) -0- -0-
Elara Ltd............... 362,069(1) 1.6% 362,069(1) -0- -0-
323,276(2) 1.5% 323,276(2) -0- -0-
Banque Franck S.A....... 181,034(1) 0.8% 181,034(1) -0- -0-
161,639(2) 0.7% 161,639(2) -0- -0-
JNC Opportunity Fund
Ltd.(4)................ 482,758(1) 2.2% 482,758(1) -0- -0-
431,034(2) 2.0% 431,034(2) -0- -0-
Swartz Family
Partnership, L.P....... 58,000(3) 0.3% 58,000(3) -0- -0-
Kendrick Family
Partnership, L.P....... 58,000(3) 0.3% 58,000(3) -0- -0-
Frank Mauro............. 58,000(3) 0.3% 58,000(3) -0- -0-
John M. Harris.......... 17,600(3) 0.1% 17,600(3) -0- -0-
Carlton M. Johnson, Jr.. 6,000(3) * 6,000(3) -0- -0-
Davis C. Holden......... 5,000(3) * 5,000(3) -0- -0-
P. Bradford Hathorn..... 10,000(3) * 10,000(3) -0- -0-
Charles M. Whiteman..... 10,000(3) * 10,000(3) -0- -0-
Michael E. Stough....... 4,000(3) * 4,000(3) -0- -0-
H. Nelson Logan......... 4,000(3) * 4,000(3) -0- -0-
David Kern Peteler...... 16,786(3) 0.1% 16,786(3) -0- -0-
Stephanie E. Flamm...... 4,000(3) * 4,000(3) -0- -0-
Dwight D. Bronnum....... 2,000(3) * 2,000(3) -0- -0-
Robert L. Hopkins....... 2,000(3) * 2,000(3) -0- -0-
--------------- --------- --------- ------------ ------
Total................. 7,966,489 37% 6,740,172 1,226,317 5.5%
=============== ========= ========= ============ ======
</TABLE>
- -------
* Less than .1%
(1) Common Stock issuable upon conversion of Series C Preferred Stock.
(2) Common Stock conditionally issuable upon exercise of warrants. These
warrants are primarily exercisable to purchase shares of Common Stock of
FNet Corp., a subsidiary of the Company. However, if FNet has not
completed a public offering by June 30, 1998, the holder may elect to
convert the warrants into warrants to purchase shares of the Company's
Common Stock.
(3) Common Stock issuable upon exercise of warrants. 50% of the warrants are
primarily exercisable to purchase shares of Common Stock of FNet Corp., a
subsidiary of the Company. However if, FNet has not completed a public
offering by June 30, 1998, the holder may elect to convert the warrants
into warrants to purchase shares of the Company's Common Stock. The
remaining 50% are exercisable only to purchase shares of the Company's
Common Stock.
(4) JNC Opportunity Fund Ltd. has agreed to restrict its ability to convert
its Convertible Preferred Stock and exercise Warrants to the extent that
the number of shares of Common Stock held by it and its affiliates after
such conversion and/or exercise exceeds 4.999% of the then issued and
outstanding shares of Common Stock following such conversion and/or
exercise.
35
<PAGE>
PLAN OF DISTRIBUTION
SALES BY SERIES C SELLING SHAREHOLDERS
Of the Shares covered by this Prospectus, up to 3,636,422 are issuable to
the purchasers of shares of the Company's Series C Preferred Stock and
associated warrants (which persons, along with their pledgees, donees,
transferees and other successors-in-interest, are referred to herein as the
"Series C Selling Shareholders") upon conversion or exercise thereof, as the
case may be. Of such warrants, 1,755,522 are primarily exercisable to purchase
shares of Common Stock of FNet Corp., a subsidiary of the Company; however, if
FNet Corp. fails to complete a public offering by June 30, 1998, then the
holders of these warrants have the option to convert them into warrants to
purchase Common Stock of the Company. If so converted, the exercise price is
$4.64 per share, subject to certain adjustments.
The Series C Selling Shareholders have informed the Company that they (and
their pledgees, donees, transferees and other successors-in-interest) intend
to sell the shares of Common Stock offered by them hereby, from time to time
in transactions (which may include block transactions), in the over-the-
counter market, in negotiated transactions, or a combination of such methods
of sale, at fixed prices which may be changed, at market prices prevailing at
the time of sale, or at negotiated prices. The shares of Common Stock offered
hereby may be sold by the Series C Selling Shareholders, their pledgees,
donees, transferees and other successors in interest by any one or more of the
following methods, without limitation: (a) block trades in which the broker or
dealer so engaged will attempt to sell the shares as agent but may position
and resell a portion of the block as principal to facilitate the transaction,
(b) purchase by a broker or dealer as principal and resale by such broker or
dealer for its account pursuant to this Prospectus, (c) an exchange
distribution, (d) ordinary brokerage transactions and transactions in which
the broker solicits purchasers, (e) short sales, including short sales against
the box, and (f) a combination of the foregoing. Broker-dealers who acquire
shares offered hereby as principal may thereafter resell such shares from time
to time under this Prospectus in transactions including those described above.
From time to time the Series C Selling Shareholders may engage in short
sales, including short sales against the box, puts and calls and other
transactions in securities of the Company or derivatives thereof, and may sell
and deliver the shares offered in this Prospectus in connection therewith or
in settlement of securities loans. If the Series C Selling Shareholders engage
in such transactions, the market price of the Common Stock (and, accordingly,
the conversion price of the Convertible Preferred Stock) could be affected.
From time to time the Series C Selling Shareholders may pledge the shares
offered by them hereby pursuant to the margin provisions of its customer
agreements with brokers. Upon a default by the Series C Selling Shareholders,
the broker may offer and sell the pledged shares from time to time under this
Prospectus.
SALES BY OTHER SELLING SHAREHOLDERS
The other Selling Shareholders have informed the Company that they intend to
sell the shares of Common Stock offered by them hereby, from time to time in
transactions (which may include block transactions), in the over-the-counter
market, in negotiated transactions, or a combination of such methods of sale,
at fixed prices which may be changed, at market prices prevailing at the time
of sale, or at negotiated prices. The other Selling Shareholders may effect
such transactions by selling their shares directly to purchasers or to or
through broker-dealers, which may act as agents or principals.
Of the shares covered by this Prospectus, 2,055,000 are issuable upon the
exercise of certain warrants to purchase Common Stock of the Company issued in
connection with a private placement of shares and warrants by the Company that
occurred between May 1995 and February 1996. The initial exercise prices of
these warrants were between $1.25 and $1.35 per share.
The Selling Shareholders (other than the Series C Selling Shareholders) have
informed the Company that they intend to sell the shares of Common Stock
offered by them hereby, from time to time in transactions (which may include
block transactions), in the over-the-counter market, in negotiated
transactions, or a combination of such methods of sale, at fixed prices which
may be changed, at market prices prevailing at the time of sale, or at
negotiated prices. Such other Selling Shareholders may effect such
transactions by selling their shares directly to purchasers or to or through
broker-dealers, which may act as agents or principals.
In consideration for registering the Common Stock issuable upon exercise of
these warrants, the holders of these warrants have agreed to pay the Company
an additional exercise price equal to 30% of the net proceeds of
36
<PAGE>
the sale of the shares issued upon exercise of these warrants, to the extent
such net proceeds exceed $4.00 per share. Also, the largest holder of these
warrants, M.H. Meyerson & Co., Inc., has agreed to reimburse the Company for
up to $70,000 in legal and accounting fees incurred in connection with such
registration.
GENERAL
Each Selling Shareholder will bear all expenses with respect to the offering
of shares by him, except that the Company will pay the costs associated with
registering the shares under the Act and preparing the Prospectus, subject to
the reimbursement described above. All sales by Selling Shareholders will be
effected through delivery of a copy of this Prospectus as it may be amended or
supplemented from time to time in accordance with the provisions of the
Securities Act of 1933 (the "Act") and the rules and regulations promulgated
by the Commission thereunder. If necessary, the Prospectus will be amended by
the filing of a supplement or post-effective amendment to describe any
material changes in the stated plan of distribution. The Selling Shareholders,
and any intermediaries, including broker-dealers through whom their shares are
sold, may be deemed "underwriters" within the meaning of the Act of the shares
to be sold by them in connection with this offering. The Selling Shareholders
may agree to indemnify any agent, dealer, or broker-dealer that participates
in transactions involving sales of the shares against certain liabilities,
including liabilities arising under the Act. The Company and some of the
Selling Shareholders have agreed to indemnify the other against certain
liabilities arising out of the Registration Statement of which this Prospectus
is a part, including liabilities under the Securities Act of 1933.
DESCRIPTION OF CAPITAL STOCK
The Company is authorized to issue up to 90,000,000 shares of Common Stock,
without par value, of which 15,394,515 shares of Common Stock have been issued
and are outstanding. Holders of the Common Stock are entitled to one vote per
share on all matters to be voted upon by the shareholders, and to cumulate
votes in the election of directors. Holders of Common Stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available therefor. See "Dividend Policy." Upon
the liquidation, dissolution, or winding up of the Company, the holders of
Common Stock are entitled to share ratably in all assets of the Company which
are legally available for distribution, after payment of all debts and other
liabilities and the liquidation preference of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive, subscription, redemption or
conversion rights.
The Company is authorized to issue 10,000,000 shares of Preferred Stock,
issuable in one or more series, each with such designations, preferences,
rights, and restrictions as the Board of Directors may determine. In
accordance with such authorization, the Board of Directors has designated 740
shares as Series C Preferred Stock, of which all 740 shares are issued and
outstanding. The Series C Preferred Stock is not redeemable, and has no
dividend preference. Each share of Series C Preferred Stock has a liquidation
preference of $10,000 per share, and accrues a premium at the rate of 8% per
annum. The Series C Preferred Stock has no voting rights, except as required
by law, and is convertible into Common Stock commencing in March 1998 at a
conversion price equal to the lesser of (a) $4.64 per share or (b) between 80%
and 85% of the fair market value of the Common Stock, based on closing prices
during a measuring period prior to conversion, with a minimum of $1.00 per
share. The Series C Preferred Stock is automatically converted into Common
Stock in May of 1999.
LEGAL MATTERS
Certain legal matters with respect to the legality under California law of
the shares of Common Stock offered hereby will be passed upon for the Company
by Haddan & Zepfel LLP, Newport Beach, California.
37
<PAGE>
EXPERTS
The consolidated financial statements of the Company as of June 30, 1996,
and for the two years then ended, included in this Prospectus, have been
audited by Corbin & Wertz, independent certified public accountants, to the
extent and for the periods indicated in their report appearing elsewhere
herein. The consolidated financial statements of the Company as of June 30,
1997, and for the year then ended, included in this Prospectus, have been
audited by Singer Lewak Greenbaum & Goldstein LLP, independent certified
public accountants, to the extent and for the period indicated in their report
appearing elsewhere herein. The financial statements of Internet Passport, LLC
as of June 30, 1996 and for the period from February 16, 1996 to June 30, 1996
have been audited by Corbin & Wertz, independent certified public accountants,
to the extent and for the period indicated in their report appearing elsewhere
herein. The consolidated financial statements included herein are included in
reliance upon the reports of Corbin & Wertz and Singer Lewak Greenbaum &
Goldstein LLP, given upon the authority of such firms as experts in auditing
and accounting.
CHANGE IN ACCOUNTANTS
On August 15, 1997 the Company engaged Singer Lewak Greenbaum & Goldstein
LLP ("SLGG") as the Company's independent accountants to report on the
Company's balance sheet as of June 30, 1997, and the related consolidated
statements of operations, shareholders' equity and cash flows for the year
then ended. The decision to appoint SLGG was approved by the Company's Board
of Directors.
Corbin & Wertz ("C&W") was dismissed by the Company on August 15, 1997. C&W
had acted as the Company's independent accountants since 1992. The independent
auditors' reports issued by C&W on the Company's consolidated financial
statements for the years ended June 30, 1996 and 1995 did not contain an
adverse opinion or disclaimer of opinion, and such reports were not modified
for any departure from generally accepted accounting principles or for any
limitation of audit scope. C&W's independent auditors' report, dated September
20, 1996, on the consolidated financial statements of the Company for the
years ended June 30, 1996 and 1995 was modified as to the uncertainty of the
Company to continue as a going concern. There were no disagreements with C&W,
resolved or unresolved, on any matter of accounting principles or practices,
financial disclosure, or auditing scope or procedure, which, if not resolved
to C&W's satisfaction, would have caused it to make reference to the subject
matter of the disagreement in connection with its reports. C&W was not
retained to report on the Company's 1997 financial statements.
The Company has requested C&W to review the disclosure contained herein and
has provided C&W the opportunity to furnish the Company with a letter
addressed to the Commission containing any new information, clarification of
the Company's expression of C&W's views or the respects in which C&W does not
agree with the statements contained herein. C&W has reviewed the disclosure
contained herein and has advised the Company that it does not intend to
deliver such a letter to the Company.
38
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 under the Securities Act of
1933, as amended, with respect to the securities offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement. For further information with respect to the Company and the
securities offered hereby, reference is made to the Registration Statement,
including the exhibits and financial statements filed therewith. Statements
contained in this Prospectus as to the contents of any contract or other
documents are not necessarily complete, and in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each statement being qualified in its entirety by such
reference. All of these documents may be obtained upon payment of the
prescribed fees or examined without charge at the office of the Commission,
450 Fifth Street, N. W., Washington, D. C. 20549, or by way of the
Commission's Internet address, http://www.sec.gov.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith is required to file reports, proxy statements and other information
with the Commission. Such reports and other information may be inspected and
copied at the Commission's Public Reference Section, Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, where copies can be obtained at
prescribed rates, as well as at the Commission's regional offices at Northwest
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661
and 7 World Trade Center, Suite 1300, New York, New York 10048. The Commission
also maintains a website that contains reports, proxy and other information
filed electronically with the Commission, the address of which is
http://www.sec.gov.
39
<PAGE>
INDEX TO FINANCIAL STATEMENTS
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Certified Public Accountants........................ F-2
Independent Auditors' Report.............................................. F-3
Financial Statements
Consolidated Balance Sheets............................................. F-4
Consolidated Statements of Operations................................... F-5
Consolidated Statements of Shareholders' Equity (Deficit)............... F-6
Consolidated Statements of Cash Flows................................... F-7
Notes to Financial Statements........................................... F-9
INTERNET PASSPORT, LLC
Independent Auditors' Report.............................................. F-28
Balance Sheet as of June 30, 1996......................................... F-29
Statements of Operations for the Eight-Month Period Ended February 28,
1997 and the Period Ended June 30, 1996.................................. F-30
Statements of Member's Deficit............................................ F-31
Statements of Cash Flows for the Eight-Month Period Ended February 28,
1997 and the Period Ended June 30, 1996.................................. F-32
Notes to Financial Statements............................................. F-33
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Franklin Telecommunications Corp.
We have audited the accompanying consolidated balance sheet of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1997, and the related
consolidated statements of operations, shareholders' equity (deficit), and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1997, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
September 17, 1997, (except for
Note 14, as to which the date
is October 31, 1997)
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Franklin Telecommunications Corp.
We have audited the consolidated balance sheet of Franklin
Telecommunications Corp. and subsidiaries (the "Company") as of June 30, 1996
and the related consolidated statements of operations, shareholders' equity
(deficit) and cash flows for each of the years in the two-year period ended
June 30, 1996. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Franklin Telecommunications Corp., and subsidiaries as of June 30, 1996,
and the results of their operations and their cash flows for each of the years
in the two-year period ended June 30, 1996 in conformity with generally
accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As disclosed in
Note 1 to the consolidated financial statements, the Company's recurring
losses from operations through June 30, 1996, and its working capital deficit
at June 30, 1996, raise substantial doubt about the entity's ability to
continue as a going concern. Management's plans in regard to these matters are
further described in Note 1. The consolidated financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
CORBIN & WERTZ
Irvine, California
September 20, 1996
F-3
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1997 AND 1996 AND SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, ------------------------
1997 1997 1996
------------- ----------- -----------
(UNAUDITED)
ASSETS (NOTE 4)
---------------
<S> <C> <C> <C>
Current assets
Cash.................................. $ 908,000 $ 1,464,000 $ 166,000
Accounts receivable, less allowance
for doubtful accounts of $19,000
(unaudited), $34,000, and $8,000,
respectively......................... 111,000 80,000 86,000
Other receivables..................... 189,000 199,000 --
Inventories (Note 2).................. 403,000 394,000 257,000
Prepaid expenses...................... 68,000 68,000 5,000
----------- ----------- -----------
Total current assets.................. 1,679,000 2,205,000 514,000
----------- ----------- -----------
Property and equipment (Note 8)
Machinery and equipment............... 165,000 163,000 215,000
Furniture and fixtures................ 98,000 97,000 46,000
Computers and software................ 728,000 713,000 280,000
----------- ----------- -----------
991,000 973,000 541,000
Less accumulated depreciation......... 442,000 406,000 456,000
----------- ----------- -----------
Total property and equipment.......... 549,000 567,000 85,000
----------- ----------- -----------
Excess of cost over fair value of net
assets of companies acquired, net of
accumulated amortization of $70,000
(unaudited), $40,000, and $32,000,
respectively.......................... 561,000 591,000 62,000
Other assets........................... 198,000 151,000 51,000
----------- ----------- -----------
Total assets.......................... $ 2,987,000 $ 3,514,000 $ 712,000
=========== =========== ===========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
------------------------------------
<S> <C> <C> <C>
Current portion of obligations under
capital lease obligations (Note 8)... $ 352,000 $ 361,000 $ --
Current portion of long-term debt
(majority due to a related party)
(Note 4)............................. 301,000 301,000 94,000
Accounts payable...................... 339,000 175,000 143,000
Accrued liabilities (Note 3).......... 497,000 559,000 483,000
----------- ----------- -----------
Total current liabilities............. 1,489,000 1,396,000 720,000
Long-term debt, (majority due to a
related party) less current portion
(Note 4).............................. 360,000 360,000 238,000
Other liabilities (Note 9)............. 183,000 183,000 503,000
----------- ----------- -----------
Total liabilities..................... 2,032,000 1,939,000 1,461,000
----------- ----------- -----------
Minority Interest...................... -- -- --
Commitments and contingencies (Notes 8
and 12)
Shareholders' equity (deficit) (Notes
5, 12 and 14)
Preferred stock, no par value
10,000,000 shares authorized no
shares issued and outstanding........ -- -- --
Common stock, no par value 90,000,000
shares authorized 13,475,289
(unaudited), 13,191,223, and
10,868,786 shares issued and
outstanding.......................... 10,569,000 9,971,000 5,372,000
Common stock committed, no par value
109,033 (unaudited), 296,066, and
48,350 shares committed but not yet
issued............................... 321,000 579,000 30,000
Accumulated deficit................... (9,935,000) (8,975,000) (6,151,000)
----------- ----------- -----------
Total shareholders' equity (deficit).. 955,000 1,575,000 (749,000)
----------- ----------- -----------
Total liabilities and shareholders'
equity (deficit)..................... $ 2,987,000 $ 3,514,000 $ 712,000
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------------ ------------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- ----------- ----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales
Product............... $ 76,000 $ 158,000 $ 1,337,000 $ 397,000 $1,481,000
Internet services..... 168,000 51,000 398,000 33,000 --
----------- ----------- ----------- ----------- ----------
Total sales......... 244,000 209,000 1,735,000 430,000 1,481,000
----------- ----------- ----------- ----------- ----------
Cost of sales
Product............... 97,000 130,000 681,000 549,000 518,000
Internet services..... 137,000 35,000 309,000 41,000 --
----------- ----------- ----------- ----------- ----------
Total cost of sales. 234,000 165,000 990,000 590,000 518,000
----------- ----------- ----------- ----------- ----------
Gross profit (loss)..... 10,000 44,000 745,000 (160,000) 963,000
----------- ----------- ----------- ----------- ----------
Operating expenses
Research and
development expenses. 121,000 97,000 480,000 320,000 308,000
Selling, general, and
administrative ex-
penses............... 849,000 324,000 1,456,000 947,000 828,000
Write-down of good-
will................. -- -- 1,584,000 70,000 --
----------- ----------- ----------- ----------- ----------
Total operating ex-
penses............. 970,000 421,000 3,520,000 1,337,000 1,136,000
----------- ----------- ----------- ----------- ----------
Loss from operations.... (960,000) (377,000) (2,775,000) (1,497,000) (173,000)
----------- ----------- ----------- ----------- ----------
Other income (expense)
Interest expense...... (17,000) (7,000) (41,000) (26,000) (10,000)
Other income (ex-
pense)............... 17,000 -- (6,000) (5,000) 25,000
----------- ----------- ----------- ----------- ----------
Total other income
(expense).......... -- (7,000) (47,000) (31,000) 15,000
----------- ----------- ----------- ----------- ----------
Loss before minority
interest and provision
for income taxes....... (960,000) (384,000) (2,822,000) (1,528,000) (158,000)
Minority interest in
loss of subsidiary..... -- -- -- 63,000 --
----------- ----------- ----------- ----------- ----------
Loss before provision
for income taxes....... (960,000) (384,000) (2,822,000) (1,465,000) (158,000)
Provision for income
taxes.................. -- -- 2,000 2,000 2,000
----------- ----------- ----------- ----------- ----------
Net loss................ $ (960,000) $ (384,000) $(2,824,000) $(1,467,000) $ (160,000)
=========== =========== =========== =========== ==========
Net loss per common
share.................. $ (.07) $ (.03) $ (.23) $ (.14) $ (.02)
=========== =========== =========== =========== ==========
Weighted average common
shares outstanding..... 13,125,318 11,503,114 12,267,991 10,279,281 6,475,984
=========== =========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK
COMMON STOCK COMMITTED
---------------------- -------------------
SHARES AMOUNT SHARES AMOUNT ACCUMULATED DEFICIT TOTAL
---------- ----------- -------- --------- ------------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1994.. 5,847,512 $ 3,975,000 -- $ -- $(4,524,000) $ (549,000)
Common stock issued for
Cash................... 220,000 110,000 110,000
Business acquisition.... 326,497 47,000 47,000
Stock options/warrants.. 304,280 30,000 30,000
Compensation............ 22,000 2,000 2,000
Notes payable and
accrued interest....... 2,000,000 134,000 134,000
Net loss................ (160,000) (160,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1995.. 8,720,289 4,298,000 -- -- (4,684,000) (386,000)
Correction of error..... 23,031 --
Common stock issued for
Cash................... 1,808,572 910,000 23,350 20,000 930,000
Business acquisition.... 85,000 65,000 25,000 10,000 75,000
Stock options/ warrants. 189,500 77,000 77,000
Compensation............ 34,839 11,000 11,000
Accounts payable........ 7,555 11,000 11,000
Net loss................ (1,467,000) (1,467,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1996.. 10,868,786 5,372,000 48,350 30,000 (6,151,000) (749,000)
Common stock issued for
Cash................... 880,200 888,000 20,000 25,000 913,000
Issuance for notes
receivable............. 243,250 --
Issuance of committed
shares................. 48,350 30,000 (48,350) (30,000) --
Business acquisition.... 708,887 1,458,000 232,066 525,000 1,983,000
Services rendered....... 77,000 44,000 29,000 106,000
Stock options/warrants.. 441,750 196,000 196,000
Proceeds received from
the sale of
subsidiaries' common
stock.................. 1,950,000 1,950,000
Net loss................ (2,824,000) (2,824,000)
---------- ----------- -------- --------- ----------- -----------
Balance, June 30, 1997.. 13,191,223 $ 9,971,000 296,066 $ 579,000 $(8,975,000) $ 1,575,000
Common stock issued for
cash (unaudited)....... 97,033 289,000 289,000
Issuance of committed
shares (unaudited)..... 284,066 547,000 (284,066) (547,000) --
Proceeds received from
the sale of
subsidiaries' common
stock (unaudited)...... 51,000 51,000
Net loss (unaudited).... (960,000) (960,000)
---------- ----------- -------- --------- ----------- -----------
Balance, September 30,
1997 (unaudited)....... 13,475,289 $10,569,000 109,033 $ 321,000 $(9,935,000) $ 955,000
========== =========== ======== ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND
THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
------------------------ -----------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- ----------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERAT-
ING ACTIVITIES
Net loss................ $ (960,000) $ (384,000) $(2,824,000) $(1,467,000) $(160,000)
Adjustments to reconcile
net loss to net cash
provided by (used in)
operating activities
Depreciation and
amortization......... 66,000 12,000 110,000 45,000 29,000
Provision for loss on
obsolete inventory... -- -- -- 226,000 4,000
Provision for loss on
doubtful accounts.... 15,000 -- -- (2,000) (24,000)
Write-down of
goodwill............. -- -- 1,584,000 70,000 --
Notes payable for
services rendered.... -- -- 329,000 -- 217,000
Stock issued for
services rendered.... -- -- 106,000 11,000 28,000
Loss on disposal of
property............. -- -- 37,000 1,000 --
(Increase) decrease in
Accounts receivable... (46,000) 26,000 14,000 (34,000) 130,000
Inventories........... (9,000) 8,000 (132,000) 131,000 (117,000)
Prepaid expenses...... -- (20,000) (63,000) 9,000 (8,000)
Increase (decrease) in
Accounts payable...... 164,000 80,000 (96,000) (97,000) 40,000
Accrued liabilities... (62,000) 19,000 71,000 175,000 (38,000)
Accrued other
liabilities.......... -- -- -- (24,000) (92,000)
Other liabilities..... -- (1,000) (310,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash provided by
(used in) operating
activities............. (832,000) (260,000) (1,174,000) (956,000) 9,000
---------- ---------- ----------- ----------- ---------
CASH FLOWS FROM
INVESTING ACTIVITIES
Purchases of property
and equipment.......... (18,000) (24,000) (324,000) (58,000) (8,000)
Cash received (paid) in
connection with
business acquisitions.. -- -- 4,000 3,000 (8,000)
Issuance of notes
receivable............. -- (190,000) (100,000) -- --
Proceeds from notes
receivable............. 10,000 -- 32,000 -- --
Other assets............ (47,000) -- 100,000 1,000 1,000
Other liabilities....... -- -- (38,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash used in
investing activities... (55,000) (214,000) (526,000) (54,000) (15,000)
---------- ---------- ----------- ----------- ---------
CASH FLOWS FROM
FINANCING ACTIVITIES
Payments on other
liabilities............ -- -- (10,000) (5,000) (35,000)
Proceeds from sale of
Company stock.......... 340,000 1,007,000 1,109,000 1,007,000 114,000
Proceeds from sale of
minority stock in
consolidated
subsidiary............. -- -- 1,950,000 -- --
Issuance of long-term
debt................... -- 100,000 -- 102,000 --
Payments on long-term
debt................... -- -- -- (63,000) (36,000)
Payments on capital
lease obligation....... (9,000) -- (51,000) -- --
---------- ---------- ----------- ----------- ---------
Net cash provided by
financing activities... 331,000 1,107,000 2,998,000 1,041,000 43,000
---------- ---------- ----------- ----------- ---------
Net increase (decrease)
in cash................ (556,000) 633,000 1,298,000 31,000 37,000
Cash, beginning of year. 1,464,000 166,000 166,000 135,000 98,000
---------- ---------- ----------- ----------- ---------
Cash, end of year....... $ 908,000 $ 799,000 $ 1,464,000 $ 166,000 $ 135,000
========== ========== =========== =========== =========
SUPPLEMENTAL DISCLOSURES
OF CASH FLOW
INFORMATION
Interest paid........... $ -- $ -- $ -- $ 12,000 $ 4,000
========== ========== =========== =========== =========
Income taxes paid....... $ 2,000 $ -- $ 2,000 $ 2,000 $ 2,000
========== ========== =========== =========== =========
</TABLE>
F-7
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the years ended June 30, 1997 and 1996, the Company completed certain
acquisitions as described in Note 1. In conjunction with these acquisitions,
aggregate liabilities assumed were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- --------
<S> <C> <C>
Fair value of the assets acquired, net of cash and
including intangibles............................... $ 2,371,000 $ 72,000
Value of Company and subsidiary common stock issued
and committed for consideration..................... (1,983,000) (75,000)
Cash received in connection with the acquisition..... 4,000 3,000
----------- --------
Aggregate liabilities assumed........................ $ 392,000 $ --
=========== ========
</TABLE>
See Notes 1 and 5 for additional non-cash investing and financing
activities.
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995 AND THE THREE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND
1996 IS UNAUDITED)
NOTE 1--GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Franklin Telecommunications Corp. ("Franklin") and its subsidiaries
(collectively the "Company") manufacture and distribute data communications
and access and connectivity products for T-1 and X.25 wide-area networks and
provide Internet services through its majority-owned subsidiary, FNet Corp.
("FNet"). FNet has had limited operations to date. The Company's customers are
located predominantly in the United States, Canada, Australia, and parts of
Europe in a wide range of industries including financial services, government,
and manufacturing.
Interim Financial Information
The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, which in the
opinion of management, are necessary to fairly state the Company's
consolidated financial position, the consolidated results of its operations,
and consolidated cash flows for the periods presented. The results of
consolidated operations for the three months ended September 30, 1997 are not
necessarily indicative of results for the entire fiscal year ending June 30,
1998.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles which contemplate the
Company as a going concern.
As reflected in the accompanying consolidated statements of operations, the
Company has had net losses for each of the years ended June 30, 1997, 1996,
and 1995. As shown in the accompanying consolidated statements of cash flows
for the years ended June 30, 1997, 1996, and 1995, the Company has raised
funds from sales of its common stock and the common stock of its majority-
owned subsidiary, FNet, to fund its operating losses. In previous years, the
Company has had fluctuating sales. With the introduction of the Company's new
products and services, sales may or may not continue to fluctuate.
In view of the matters described in the preceding paragraph, recoverability
of a major portion of the recorded asset amounts shown in the accompanying
consolidated balance sheets is dependent upon continued operations of the
Company, which in turn is dependent upon the Company's ability to continue to
raise capital and generate positive cash flows from operations. The
consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classifications of liabilities that might be necessary should the Company be
unable to continue its existence.
Management plans to take the following steps that it believes will be
sufficient to provide the Company with the ability to continue in existence:
. The Company plans to utilize the cash on hand at June 30, 1997 to fund
operations.
. The Company plans to issue stock under Regulation D. Management believes
that this private placement will raise approximately $1,000,000 (see Note
14).
. The Company has entered into a letter of agreement with an investment
banker which management believes will raise $2,000,000 to $5,000,000
through the private placement of convertible preferred stock (see Note
14).
F-9
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Management of the Company believes that the cash on hand as of June 30,
1997, plus anticipated future equity sales, will sustain the Company's
operations for at least one year.
Acquisitions
Effective December 9, 1994, the Company acquired all of the outstanding
common stock of Lan Performance Labs, Inc. ("LPL") in exchange for 300,002
shares of its common stock. In conjunction with the acquisition, 26,495 shares
of Franklin's common stock were issued to certain creditors of LPL in exchange
for payables totaling $26,495. This reduction in payables was considered in
the allocation of fair market value of the assets acquired and liabilities
assumed for purposes of allocating the purchase price. On December 2, 1996 and
July 31, 1997, the Company issued an additional 60,987 and 207,066 shares,
respectively, of its common stock to resolve a dispute in the final purchase
price of LPL. The value of the shares issued of $85,000 and $453,000 was
recorded to goodwill. The 207,066 shares issued on July 31, 1997 have been
recorded as common stock committed in the accompanying balance sheet as of
June 30, 1997.
The acquisition of LPL was accounted for by the Company using the purchase
method of accounting. The excess of approximately $637,000 (as adjusted for
the $85,000 and $453,000 as mentioned above) of the total acquisition cost
over the net assets acquired and liabilities assumed was allocated to
goodwill. The results of operations from December 9, 1994 to June 30, 1995 are
included in the accompanying consolidated statement of operations for the year
ended June 30, 1995. Fiscal 1995 pro forma presentation as if LPL had been
acquired July 1, 1994 is not presented because the effect on operations would
be immaterial.
During the year ended June 30, 1996, the Company completed two acquisitions
whereby the Company acquired all of the outstanding common stock of AlphaLink
("Alpha") and Malibu Internet Services ("MIS") in exchange for an aggregate of
110,000 shares of Franklin's common stock and 50,000 shares of FNet common
stock.
The acquisitions of Alpha and MIS were accounted for by using the purchase
method of accounting with the excess of approximately $65,000 of the total
acquisition cost over the net assets acquired and liabilities assumed being
allocated to goodwill. The results of operations from January 1, 1996 to June
30, 1996 for Alpha and June 1, 1996 to June 30, 1996 for MIS, respectively,
are included in the accompanying consolidated statement of operations for the
year ended June 30, 1996. Fiscal 1996 pro forma presentation as if these two
acquisitions had been acquired as of the beginning of the 1996 fiscal year and
fiscal 1995 pro forma presentation is not presented because the effect on
operations would be immaterial.
On December 13, 1996, the Company acquired the assets of No. 1 Internet
Services ("No. 1") in exchange for 40,000 shares of Franklin's common stock
and options to purchase 10,000 shares of Franklin's common stock at $1.25,
which was the fair market value on December 2, 1996, exercisable January 1,
1998. In addition, FNet issued 20,000 shares of its common stock valued at
$20,000 and granted options to purchase 80,000 shares of FNet common stock,
exercisable at the rate of 20,000 shares per year at $1.00 per share in each
of the four years beginning January 1, 1998. The acquisition was accounted for
as a purchase with the excess of approximately $74,000 of the total
acquisition cost over the net assets acquired and liabilities assumed being
allocated to goodwill. Pro forma results for the year ended June 30, 1997, as
if the acquisition had taken place as of the beginning of the 1997 fiscal
year, is not presented because the effect on operations would be immaterial.
On February 26, 1997, the Company agreed to acquire all of the outstanding
common stock of CPR Computer Repair ("CPR") in exchange for 25,000 shares of
Franklin's common stock. As part of the agreement, CPR's shareholder committed
to pay all of the outstanding obligations of CPR as of February 26, 1997 (the
"Commitment"). The Commitment is secured by a promissory note of $117,000. The
acquisition was accounted for using the purchase method of accounting with
excess of approximately $61,000 of the total acquisition costs
F-10
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
over the net assets acquired and liabilities assumed being allocated to
goodwill. Pro forma results for the year ended June 30, 1997, as if the
acquisition had taken place as of the beginning of the 1997 fiscal year, is
not presented because the effect on operations would be immaterial.
On June 30, 1997, the Company sold CPR for future royalties to be paid by
the buyer to the Company as defined in the purchase agreement. The Company
wrote-off the remaining goodwill of approximately $61,000 related to the
acquisition of CPR due to the uncertainty of the royalty stream.
On February 28, 1997, the Company agreed to acquire Internet Passport, LLC
("Passport"), a limited liability company, in exchange for 600,000 shares of
Franklin's common stock. The agreement also provided for the assumption of
certain debts totaling $411,000, including the issuance of an additional 7,900
shares of Franklin's common stock valued at $1.73 to satisfy certain
obligations of Passport. Passport is a start-up company incorporated in August
1996 that provides Internet services pursuant to contractual arrangements with
satellite transmission providers. The acquisition was accounted for using the
purchase method of accounting with the excess of approximately $1,478,000 of
the total acquisition costs over the net assets acquired and liabilities
assumed being allocated to goodwill. Pro forma net loss and net loss per share
of the year ended June 30, 1997 and 1996, as if the transaction had occurred
at the beginning of those years, would have been $(2,160,000) ($(.17) per
share) and $1,533,000 ($(0.15) per share), respectively, as presented in Note
11.
Joint Venture
In May 1996, the Company and a modem manufacturer formed Franklin Modem
Corp. (the "Venture"), a joint venture to design and manufacture a V.34 modem
to function with the Company's newly introduced D-Mark Channel Bank hardware.
The Company has a 70% ownership interest in the venture with the remaining
interest being owned by the modem manufacturer. As of May 16, 1997, this joint
venture agreement was replaced with a mutual supply agreement between the two
parties that provides for the Company to purchase 70% of certain boards
manufactured by the modem manufacturer.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Franklin Telecommunications Corp. and its wholly-owned or majority owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated.
Concentrations of Credit Risk
At times, the Company holds cash with financial institutions in excess of
amounts insured by federal agencies.
The Company sells its products throughout the United States, Canada,
Australia, and parts of Europe and extends credit to its customers and
performs ongoing credit evaluations of such customers. The Company does not
obtain collateral to secure its accounts receivable. The Company evaluates its
accounts receivable on a regular basis for collectability and provides for an
allowance for potential credit losses as deemed necessary.
Two customers accounted for 29% and 10%, respectively, of the Company's
product sales for the year ended June 30, 1997. Four customers accounted for
18%, 17%, 13% and 12%, respectively, of the Company's product sales for the
year ended June 30, 1996. Two customers accounted for 28% and 15%,
respectively, of the Company's product sales for the year ended June 30, 1995.
One customer accounted for 10% (unaudited) of the Company's product sales for
the three months ended September 30, 1997. One customer accounted for 48%
(unaudited) of the Company's product sales for the three months ended
September 30, 1996. At June 30, 1997,
F-11
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
amounts due from two customers amounted to 20% and 10%, respectively, of
accounts receivable. At June 30, 1996, amounts due from three customers
amounted to 60%, 20% and 16%, respectively, of accounts receivable. At
September 30, 1997, amounts due from two customers amounted to 21% (unaudited)
and 10% (unaudited), respectively, of accounts receivable. One customer, a
related party, accounted for 5%, 1%, 9%, 0% (unaudited) and 4% (unaudited) of
product sales for the years ended June 30, 1997, 1996, and 1995, and the three
months ended September 30, 1997 and 1996, respectively, and comprised 0%, 3%
and 0% (unaudited) of accounts receivable at June 30, 1997 and 1996 and
September 30, 1997, respectively.
Export sales, primarily to Canada, Australia, Poland, and England,
represented 6%, 15%, 19%, 0% (unaudited), and 6% (unaudited) of net sales for
the years ended June 30, 1997, 1996, and 1995 and the three months ended
September 30, 1997 and 1996, respectively.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements. Such estimates affect the reported amounts of revenues and
expenses during the reported period. Actual results could materially differ
from these estimates.
Fair Value of Financial Instruments
The Company measures its financial assets and liabilities in accordance with
generally accepted accounting principles. For certain of the Company's
financial instruments including cash, accounts receivable, and accounts
payable and accrued expenses, the carrying amounts approximate fair value due
to their short maturities. The amounts shown for notes payable and capital
lease obligations also approximate fair value because current interest rates
and terms offered to the Company for similar notes and lease agreements are
substantially the same.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly-liquid investments purchased with original maturities of three months
or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market (estimated net
realizable value). Cost is determined using the average cost method, which
approximates the first-in, first-out ("FIFO") method. Net realizable value is
based on forecasts for sales of the Company's products in the ensuing years.
The industry in which the Company operates is characterized by rapid
technological advancement and change. Should demand for the Company's products
prove to be significantly less than anticipated, the ultimate realizable value
of the Company's inventories could be substantially less than the amount shown
on the accompanying consolidated balance sheets.
Property and Equipment
Property and equipment are stated at cost. The Company provides for
depreciation using the straight-line method over the estimated useful lives of
5 to 7 years as follows:
<TABLE>
<S> <C>
Machinery and equipment........................................... 7 years
Furniture and fixtures............................................ 7 years
Computers and software............................................ 5 years
</TABLE>
F-12
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Expenditures for maintenance and repairs are charged to operations as
incurred while renewals and betterments are capitalized. Gains or losses on
the sale of property and equipment are reflected in the statements of
operations.
Stock Options and Warrants
During 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," which defines a fair value based method of accounting for
stock-based compensation. However, SFAS 123 allows an entity to continue to
measure compensation cost related to stock and stock options issued to
employees using the intrinsic method of accounting prescribed by Accounting
Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees." Entities electing to remain with the accounting method of APB 25
must make pro forma disclosures of net income and earnings per share, as if
the fair value method of accounting defined in SFAS 123 had been applied. The
Company has elected to account for its stock-based compensation to employees
under APB 25.
Excess of Cost Over Fair Value of Net Assets of Companies Acquired (Goodwill)
Goodwill arising in connection with the aforementioned business acquisitions
is amortized using the straight-line method over five years. The Company
assesses the recoverability of these intangibles on a quarterly basis by
determining whether the amortization of the balance over its remaining life
can be recovered through projected undiscounted future cash flows. The amount
of goodwill impairment, if any, is based on fair value as measured by future
cash flows and charged to operations in the period in which goodwill
impairment is determined by management. During the years ended June 30, 1997
and 1996, management of the Company determined that $1,584,000 and $70,000,
respectively, of goodwill had been impaired and, accordingly, the Company
charged these amounts to operations. Amortization of goodwill for the years
ended June 30, 1997, 1996 and 1995 and the three months ended September 30,
1997 and 1996 amounted to $40,000, $22,000, $10,000, $30,000 (unaudited), and
$3,000 (unaudited), respectively.
Patents
Included in other assets in the accompanying consolidated balance sheets is
$30,000 of capitalized patent costs, net of accumulated amortization of
$16,000, $12,000 and $17,000 (unaudited) at June 30, 1997 and 1996 and
September 30, 1997, respectively. Patent costs are amortized on a straight-
line method over their respective lives not to exceed 17 years. Amortization
of patent expense for the years ended June 30, 1997, 1996 and 1995 and the
three months ended September 30, 1997 and 1996 was $4,000, $4,000, $2,000,
$1,000 (unaudited), and $1,000 (unaudited), respectively.
Minority Interest
Minority interest represents the minority shareholders' proportionate share
of the equity of FNet. During the year ended June 30, 1996, Franklin
transferred 4,200,000 shares of its ownership in FNet to two officers of the
Company as payments on notes payable and for consulting services and issued an
additional 50,000 shares to MIS as aforementioned. Management of the Company
valued the FNet shares at $.015 per share, based upon the book value of FNet
at the time of the transaction. The issuance of these shares caused Franklin's
ownership percentage of FNet to decrease from 100% to 79% as of June 30, 1996.
During the year ended June 30, 1997, FNet sold approximately 1,949,500
shares of its stock to outside investors at $1.00 per share and issued 20,000
shares to acquire No. 1 and 76,000 shares for services rendered. The shares
sold to investors were issued under a private offering circular pursuant to
the exemption from registration under the 1933 Act provided in Rule 505 of
Regulation D. After the issuance of these shares, Franklin's ownership
percentage decreased to 71% as of June 30, 1997.
F-13
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FNet, on a stand-alone basis, had a shareholders' deficit. As a result,
Franklin's investment in FNet had a negative carrying value. The increase in
capitalization of FNet resulting from the sale of 1,949,500 and 51,000
(unaudited) shares of common stock for the year ended June 30, 1997 and the
three months ended September 30, 1997, respectively, to outside investors
benefited Franklin in that it reduced the negative carrying value of
Franklin's investment in FNet. Accordingly, Franklin has accounted for the
change in its proportionate share of FNet's equity resulting from the issuance
of stock to outside investors as an increase in shareholders' equity and a
reduction in minority interest liability in the consolidated financial
statements.
The accompanying consolidated financial statements do not reflect a minority
interest liability as of June 30, 1997 and 1996 and September 30, 1997
(unaudited) as FNet, on a stand-alone basis, had a shareholders' deficit as of
such dates. The accompanying consolidated statements of operations for the
year ended June 30, 1997 and the three months ended September 30, 1997 do not
reflect the minority interest's share of FNet's losses for said periods as the
related accrual would result in the Company's recordation of a minority
interest receivable.
Revenue Recognition
Revenues are recognized upon shipment of the products to customers. The
Company does not allow the right of return on sales.
Warranties
The Company provides limited warranties of one year from the date of
purchase of its products. No accrual has been made for warranty liabilities
because they are not expected to be significant.
Research and Development Costs
Research and development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred and have not been historically
material.
Net Loss Per Common Share
The computation of loss per common share is based on the weighted average
number of common and common equivalent shares outstanding during the years
ended June 30, 1997, 1996, and 1995 and the three months ended September 30,
1997 and 1996 (unaudited). Common stock equivalents have been excluded from
the aforementioned computations as their effect would be anti-dilutive.
Income Taxes
The Company accounts for income taxes under the Financial Accounting
Standards Board SFAS No. 109, "Accounting for Income Taxes," SFAS 109 requires
the asset and liability method of accounting for income taxes. Under the asset
and liability method of SFAS 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS 109, the effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is required when it is less likely than
not that the Company will be able to realize all or a portion of its deferred
tax assets.
F-14
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Reclassifications
Certain amounts in the 1996 and 1995 consolidated financial statements have
been reclassified to conform to the 1997 presentation.
Recently Issued Accounting Pronouncements
The Financial Accounting Standards Board issued SFAS 128, "Earnings Per
Share," which is effective for financial statements issued for periods ending
after December 15, 1997, including interim periods. SFAS 128 requires public
companies to present basic earnings per share and, if applicable, diluted
earnings per share instead of primary and fully-diluted earnings per share.
The Company does not believe that reporting earnings per share in accordance
with SFAS 128 will be materially different from the earnings per share
previously reported.
SFAS 130, "Reporting Comprehensive Income" issued by the Financial
Accounting Standards Board is effective for financial statements with fiscal
years beginning after December 15, 1997. Earlier application is permitted.
SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial
statements. The Company does not expect adoption of SFAS 130 to have a
material impact, if any, on its financial position or results of operations.
The Financial Accounting Standards Board issued SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information," effective for fiscal years
beginning after December 15, 1997. SFAS 131 requires a company to report
certain information about its operating segments including factors used to
identify the reportable segments and types of products and services from which
each reportable segment derives its revenues. The Company does not anticipate
any material change in the manner that it reports its segment information
under this new pronouncement.
NOTE 2--INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Raw materials................................ $217,000 $155,000 $ 49,000
Work in process.............................. 148,000 152,000 44,000
Finished goods............................... 38,000 87,000 164,000
-------- -------- --------
Total...................................... $403,000 $394,000 $257,000
======== ======== ========
</TABLE>
NOTE 3--ACCRUED LIABILITIES
Accrued liabilities consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Salaries and related expenses............... $310,000 $277,000 $309,000
Sales tax payable........................... -- -- 76,000
Accrued interest payable, primarily to
related party.............................. 103,000 88,000 45,000
Accrued audit............................... -- 30,000 20,000
Other accrued liabilities................... 84,000 164,000 33,000
-------- -------- --------
Total..................................... $497,000 $559,000 $483,000
======== ======== ========
</TABLE>
F-15
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, -----------------
1997 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Convertible notes payable to former
vendors, bearing interest at 12% per
annum, unsecured and due in December
1999..................................... $ 24,000 $ 24,000 $ 24,000
Notes payable to the president and
majority shareholder, bearing interest
from 8% to 9% per annum, secured by
substantially all of the Company's
assets, with due dates ranging through
June 2000................................ 637,000 637,000 308,000
-------- -------- --------
661,000 661,000 332,000
Less current portion...................... 301,000 301,000 94,000
-------- -------- --------
Long-term portion....................... $360,000 $360,000 $238,000
======== ======== ========
</TABLE>
The Company is past due in certain of its payments under its notes payable
to its president and majority shareholder. The president and majority
shareholder has waived the default provisions of the past due notes payable
and does not intend to demand payment until after September 30, 1998.
Future principal payments required under such notes are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDING
JUNE 30,
-----------
<S> <C>
1998.......................................................... $301,000
1999.......................................................... 267,000
2000.......................................................... 93,000
--------
Total....................................................... $661,000
========
</TABLE>
Included in the $637,000 due to the Company's president is a note of
$140,000 which can be converted into shares of the Company's common stock at a
rate of $.10 per share and two notes in the amount of $117,000 and $112,000
which can be converted into $114,500 of the Company's common stock at a rate
of 50% of the fair value of the common stock at the date of conversion.
During fiscal 1995, the Company canceled notes payable in the amount of
$92,000 to the president and majority shareholder in exchange for the issuance
of common stock.
NOTE 5--SHAREHOLDERS' EQUITY (DEFICIT)
Stock Option Plans
The Company adopted an Incentive Stock Option Plan ("Plan A") and
Nonqualified Stock Option Plan ("Plan B") (collectively the "1986 Plans").
Plan A provides for the granting of options to purchase shares of common stock
that are intended to qualify as incentive stock options within the meaning of
Section 422A of the Internal Revenue Code, and Plan B provides for the
granting of options to purchase shares of common stock that are not intended
to qualify. The 1986 Plans provide for the issuance of up to 700,000 shares in
the aggregate at fair market value.
During the year ended June 30, 1989, the Company adopted the 1988 Stock
Option Plan (the "1988 Plan"). Under the terms of the plan, options to
purchase 300,000 shares of the Company's common stock are available
F-16
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
for issuance to employees, officers and directors. Options granted may be
either incentive stock options or non-statutory options. The exercise price of
the incentive stock options and non-statutory options may not be greater or
less than 110% and 85%, respectively, of the fair market value of the
Company's common stock at the date of grant.
During the year ended June 30, 1994, the Company adopted the 1993 Stock
Option Plan (the "1993 Plan"). The 1993 Plan provides for the granting of
options to purchase up to 600,000 shares of common stock that are intended to
qualify as incentive stock options within the meaning of Section 422A of the
Internal Revenue Code.
During the year ended June 30, 1995, the Company adopted the 1994 Stock
Option Plan (the "1994 Plan"). The 1994 Plan provides for the granting of
options to purchase up to 1,400,000 shares of common stock. Such options will
be non-statutory.
Options granted under all four of the aforementioned plans vest in
accordance with the terms established by the Company's stock option committee.
All such options granted to date have vesting periods of between two to four
years and generally terminate at the earlier of the end of the option period
or termination of employment.
On December 13, 1996, the Company granted options to purchase 1,000,000
shares of the Company's common stock to key management employees which were
fully vested on the date of grant. The option price was set at $1.31 per
share, the fair value of the underlying shares. The options are not included
in the stock option plans below.
In addition, the Company has also issued options in connection with the
acquisition of No. 1 as discussed in Note 1.
Activity for the 1986 Plans, 1988 Plan, 1993 Plan, and 1994 Plan is as
follows:
<TABLE>
<CAPTION>
GRANTED
PRICE
SHARES PER SHARE
--------- ----------
<S> <C> <C>
Outstanding, June 30, 1994............................... 1,220,000 $ 0.10
Granted................................................ 1,075,000 $ 0.10
Exercised.............................................. (304,280) $ 0.10
Canceled............................................... (25,720) $ 0.10
---------
Outstanding, June 30, 1995............................... 1,965,000 $ 0.10
Granted................................................ 1,052,000 $0.15-1.18
Exercised.............................................. (44,500) $ 0.10
Canceled............................................... (225,000) $ 0.10
---------
Outstanding, June 30, 1996............................... 2,747,500 $0.10-1.18
Granted................................................ 248,000 $1.18-2.12
Exercised.............................................. (335,000) $0.10-0.90
Canceled............................................... (150,000) $ 0.10
---------
Outstanding, June 30, 1997............................... 2,510,500 $0.10-2.12
Granted (unaudited).................................... 90,000 $ 1.56
Exercised (unaudited).................................. -- $ --
Canceled (unaudited)................................... (18,750) $ 0.70
---------
Outstanding, September 30, 1997 (unaudited).............. 2,581,750 $0.10-2.12
========= ==========
</TABLE>
F-17
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At June 30, 1997 and September 30, 1997, 1,563,500 and 1,574,125 (unaudited)
options, respectively, were exercisable.
The Company has adopted only the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." It applies Accounting Principles
Bulletin ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related Interpretations in accounting for its plans and does not recognize
compensation expense for its stock-based compensation plans other than for
restricted stock and options issued to outside third parties. If the Company
had elected to recognize compensation expense based upon the fair value at the
grant date for awards under these plans consistent with the methodology
prescribed by SFAS 123, the Company's net loss and loss per share would be
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Net loss
As reported...................................... $(2,824,000) $(1,467,000)
Pro forma........................................ $(3,925,000) $(1,513,000)
Loss per common share
As reported...................................... $ (0.23) $ (0.14)
Pro forma........................................ $ (0.32) $ (0.15)
</TABLE>
Included in the year ended June 30, 1997, is the effect of the
aforementioned 1,000,000 options issued to key employees on December 13, 1996
to purchase the Company's common stock which were fully vested on the date of
grant. Compensation expense under SFAS 123 for the year ended June 30, 1997 of
$945,000 was charged to pro forma net loss for the entire estimated fair
market value of the 1,000,000 options awarded.
These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expense related to
grants made before June 30, 1996. The pro forma amounts take into account the
pro forma compensation expense of the FTEL and FNet options. The fair value of
the FTEL options described above was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for the years ended June 30, 1997 and 1996: dividend yields of 0%
and 0%, respectively; expected volatility of 100% and 100%, respectively;
risk-free interest rates of 6.2% and 6.3%, respectively; and expected lives of
4 and 2 to 4 years, respectively. The weighted-average fair value of options
granted during the year ended June 30, 1997 was $0.99, and the weighted-
average exercise price was $1.37.
The fair value of the FNet options described below was estimated at the date
of grant using the minimum value method with the following weighted-average
assumptions for the year ended June 30, 1997: dividend yields of 0%; risk-free
interest rate of 6.2%; and expected life of 4 years. The weighted-average fair
value of options granted during the year ended June 30, 1997 was $0.22 and the
weighted-average exercise price was $1.00.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
F-18
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company's majority-owned subsidiary, FNet, established a 1996 stock
option plan (the "FNet Plan"). The FNet Plan provides for the granting of
options to purchase up to 3,000,000 shares of FNet common stock that are
intended to qualify as incentive stock options within the meaning of Section
422A of the Internal Revenue Code. Such options will become exercisable in
accordance with the terms established by FNet's stock option committee. All
options granted to date vest between zero and four years and generally
terminate at the earlier of the end of the option period or termination of
employment. During the years ended June 30, 1997 and 1996 and for the three
months ended September 30, 1997, FNet granted 2,106,000, 448,000 and 110,000
(unaudited), respectively, options to employees to acquire FNet common stock
at an exercise price of $1.00, $1.00, and $1.00 (unaudited), respectively.
Total FNet options outstanding and exercisable at June 30, 1997 and 1996 and
for the three months ended September 30, 1997 were 2,634,000 and 1,174,000,
respectively, 448,000 and 0, respectively, and 2,744,000 (unaudited) and
1,174,000 (unaudited), respectively.
During 1995 and 1996, the Company granted to its president an option to
acquire 1,000,000 and 350,000 shares, respectively, of its common stock at an
exercise price of $.10 and $.78 per share. The options were both issued in the
year of grant and are exercisable over a two-year period.
On February 12, 1993, the Company entered into an option agreement with its
president whereby the Company granted options to purchase 2,000,000 shares of
the Company's common stock in exchange for the potential cancellation of debt
owed to the related party. Such options were exercisable over a two year
period at an exercise price of $.067 per share, the approximate fair value of
the common stock of the Company at the date of grant. These options were
exercised during the year ended June 30, 1995.
Warrants
In May 1995, in connection with the 1995 Private Placement, the Company
entered into an investment banking agreement with an unrelated entity whereby
the Company granted to the investment banker warrants to purchase 600,000
shares, as amended, of the Company's common stock at an exercise price of
$1.35 per share. The warrants vested over a twelve-month period and include
demand and piggy back registration rights after a period of 24 months from the
date of the agreement. The warrants and/or underlying shares may be exercised
anytime after two years and for a period of four years from the date of the
agreement. As of June 30, 1997 and 1996, none of these warrants had been
exercised.
In connection with the 1995 Private Placement, during the years ended June
30, 1996 and 1995, the Company issued 1,780,000 and 220,000 warrants,
respectively, to purchase shares of the Company's common stock. The exercise
price of the warrants was $0.50, as amended, if exercised on or before March
24, 1996 and $1.25 if exercised after March 24, 1996 but on or before
September 30, 1998 (the expiration date). There was no additional expense
recorded in connection with the issuance of the warrants as the exercise price
approximated the fair value at the date of issuance, as determined by
management of the Company, of the underlying stock at the date of issuance.
For the years ended June 30, 1997 and 1996, 400,000 and 145,000 warrants were
exercised leaving a remaining balance of 1,455,000 unexercised as of June 30,
1997.
Stock Issuances
During the year ended June 30, 1995, The Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 2,000,000 shares of its common stock for the exercise of options
and canceled notes payable in the amount of $92,000 and accrued interest
in the amount of $42,000.
. Issued 259,280 shares of its common stock in connection with stock
options exercised at $.10 per share by employees for compensation of
$26,000.
F-19
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
. Issued 22,000 shares of its common stock to an employee for a bonus. The
stock was issued at $.10 per share in accordance with the bonus
agreement.
. Issued 220,000 shares of its common stock for $110,000 in connection with
the 1995 Private Placement. The Company paid no commissions or fees in
connection with this private placement.
. Issued 45,000 shares of its common stock in connection with stock
options, exercised at $.10 per share for cash of $4,500.
. Issued 326,497 shares of its common stock in connection with a business
acquisition.
During the year ended June 30, 1996, the Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 1,780,000 of its common stock for $890,000 in connection with the
1995 Private Placement. The Company paid no commissions or fees in
connection with this private placement.
. Issued or committed to issue 110,000 shares of its common stock valued at
$75,000 during fiscal 1996 in connection with two business acquisitions
(see Note 1).
. Issued 34,839 shares of its common stock to certain employees for
compensation. The stock was issued at prices ranging from $.25 to $.70
per share in accordance with the respective agreements.
. Issued 7,555 shares of its common stock to certain vendors as payment on
accounts payable of approximately $11,000.
. Issued 44,500 shares of its common stock in connection with stock
options, exercised at $.10 per share for cash of $4,000.
. In March and April 1996, the Company received cash of $73,000 and issued
145,000 shares of its common stock upon the conversion of warrants issued
in connection with the 1995 Private Placement.
. In June 1996, the Company issued 28,572 shares of its common stock for
cash of $20,000, the approximate fair value at the date of the issuance.
. Reflected in the accompanying 1996 consolidated statements of capital
deficiency the addition of 23,031 shares as outstanding to correct the
omission of such shares in previously issued consolidated financial
statements.
During the year ended June 30, 1997, the Company completed the following
significant common stock transactions of previously unissued common shares:
. Issued 880,200 shares of its common stock in connection with the 1996
Private Placement for cash of $888,000. The Company paid no commissions
or fees in connection with this private placement.
. In December 1996 and July 1997, the Company issued an additional 60,987
and 207,066 shares, respectively, of its common stock to former
shareholders of LPL (see Note 1) at a value of $85,000 and $453,000,
respectively.
. In connection with the acquisition of No. 1, issued 40,000 shares, valued
at $50,000, of its common stock and options to purchase 10,000 shares,
valued at $6,000, of the Company's common stock at $1.25, which was the
fair market value on December 2, 1996, exercisable on January 1, 1998. In
connection therewith, FNet issued 20,000 shares of its common stock
valued at $20,000 and granted options to purchase 80,000 shares of FNet
common stock valued at $13,000, exercisable at the rate of 20,000 shares
per year at $1.00 per share in each of the four years beginning January
1, 1998 (see Note 1).
F-20
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
. In connection with the acquisition of CPR, committed to issued 25,000
shares of common stock for a value of $65,000 (see Notes 1 and 12) and
assumed certain debt of $4,425.
. In connection with the acquisition of Passport, issued 600,000 shares of
common stock for a value of $1,275,000 and assumed certain liabilities of
$411,000. Also, on March 24, 1997, the Company issued an additional 7,900
shares of common stock, valued at $14,000, to satisfy certain obligations
of Passport (see Note 1).
. Issued 380,000 shares in connection with the exercise of warrants for
$190,000.
. Issued 335,000 shares in connection with the exercise of stock options.
243,250 shares were issued upon the exercise of options whereby the
option holders issued notes receivable in favor of the Company in the
amount of 129,000. 30,000 shares were issued upon the exercise of options
whereby the option holder performed services valued at $3,000. The
remaining 61,750 were issued for cash of $6,000.
See Note 14 for stock issuances for the three months ended September 30,
1997.
Pursuant to state laws, the Company is currently restricted, and may be
restricted for the foreseeable future, from making dividends to its
shareholders as a result of its accumulated deficit as of June 30, 1997.
NOTE 6--INCOME TAXES
The tax effects of temporary differences that give rise to deferred taxes at
June 30, 1996 are as follows:
<TABLE>
<CAPTION>
JUNE 30,
SEPTEMBER 30, ---------------------
1997 1997 1996
------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets
Accounts receivable, principally due
to allowance for doubtful accounts.. $ 8,000 $ 13,000 $ 3,000
Compensated absences and deferred
salaries, principally due to accrual
for financial reporting purposes.... 125,000 87,000 112,000
Inventories, principally due to
additional costs inventoried for tax
purposes pursuant to the Tax Reform
Act of 1986 and allowance for
inventory obsolescence.............. 128,000 128,000 191,000
General business tax credit
carryforwards....................... 345,000 335,000 345,000
Net operating loss carryforwards..... 3,363,000 3,027,000 2,498,000
---------- ---------- ----------
Total gross deferred tax assets...... 3,836,000 3,590,000 3,149,000
Less valuation allowance............. 3,832,000 3,586,000 3,145,000
---------- ---------- ----------
Net deferred tax assets.............. 4,000 4,000 4,000
Deferred tax liabilities
Plant and equipment, principally due
to differences in depreciation...... $ 4,000 $ 4,000 $ 4,000
---------- ---------- ----------
Net deferred tax liability......... $ -- $ -- $ --
========== ========== ==========
</TABLE>
The valuation allowance increased by approximately $441,000, $626,000, and
$246,000 (unaudited) during the years ended June 30, 1997 and 1996 and the
three months ended September 30, 1997, respectively. No provision for income
taxes for the years ended June 30, 1997, 1996, and 1995 and the three months
ended September 30, 1997 and 1996 is required, except for minimum state taxes,
since the Company incurred losses during such periods.
F-21
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Income tax expense was $2,000 and differs from the amounts computed by
applying the U.S. federal income tax rate of 34 percent to loss before
minority interest and income taxes as a result of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED JUNE 30,
----------------------- --------------------------------
1997 1996 1997 1996 1995
----------- ----------- ----------- --------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Computed "expected" tax
benefit................ $(326,000) $(131,000) $(1,450,000) $(520,000) $(54,000)
Increase in income taxes
resulting from
Change in the
beginning-of-the-year
balance of the
valuation allowance
for deferred tax
assets allocated to
income tax expense... 326,000 131,000 1,450,000 520,000 54,000
State income taxes.... 2,000 2,000 2,000
--------- --------- ----------- --------- --------
Total............... $ -- $ -- $ 2,000 $ 2,000 $ 2,000
========= ========= =========== ========= ========
</TABLE>
As of June 30, 1997 the Company had consolidated net operating loss
carryforwards of approximately $8,467,000 and $2,401,000 for Federal and state
income tax reporting purposes, respectively, which expire in varying amounts
through 2012. The Company also has general business tax credit carryforwards
of approximately $310,000 and $24,000 available to offset against future
Federal and state income taxes, respectively, which expire at various times
through 2012. Should a substantial change in the Company's ownership occur,
there could be an annual limitation on the amount of the net operating less
carryforwards available for use in the future.
NOTE 7--RELATED PARTY TRANSACTIONS
The Company recorded sales of approximately $82,000, $3,000, $131,000, $0
(unaudited), and $10,000 (unaudited) to an entity affiliated with a
shareholder of the Company during the years ended June 30, 1997, 1996, and
1995 and for the three months ended September 30, 1997 and 1996, respectively.
On January 1, 1993, the Company entered into a five year employment
agreement with the president and majority shareholder which provides for
annual salary increases of six percent per annum. Compensation related to this
agreement, a portion of which is paid semi-monthly and a portion of which is
deferred and is therefore included in accrued salaries and related expenses in
the accompanying consolidated balance sheets, was $173,000, $275,000,
$259,000, and $76,000 (unaudited) for the years ended June 30, 1997, 1996, and
1995 and the three months ended September 30, 1997, respectively (see Note
12).
During the year ended June 30, 1997 and 1995, the Company issued notes
payable to the president and majority shareholder for $329,000 and $217,000,
respectively, of accrued compensation.
NOTE 8--COMMITMENTS AND CONTINGENCIES
Operating Leases and Capital Lease Obligations
The Company leases its production, warehouse and administrative facilities
under non-cancelable operating leases that expire starting September 1998
through March 2000. In addition to the minimum annual rental commitments, the
lease provides for periodic cost of living increases in the base rent and
payment by the Company of common area costs. Rent expense related to the
operating lease was $88,000, $51,000, $59,000, $25,000 (unaudited) and $13,400
(unaudited) for the years ended June 30, 1997, 1996, and 1995, and the three
months ended September 30, 1997 and 1996, respectively.
F-22
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In connection with the acquisition of Passport (see Note 1), the Company
assumed six capital leases that were assumed by Passport from two entities
owned by the previous sole member of Passport. All six capital leases are
technically in default because of provisions in the leases that prohibit the
assignment of the leases. In addition, the assets underlying four of the six
leases were sold by Passport for cash, which was not used to repay the
principal, prior to its acquisition by the Company. Such sales are also
prohibited under the terms of the leases and the lessors have not been
informed of such sales. The lessors technically have the right to accelerate
payment under all of the leases due to such defaults. Passport is continuing
to make the lease payments on all six leases pursuant to the lease terms.
Since the leases are in technical default, the Company has classified the full
lease liability as current.
Future minimum lease payments under non-cancelable operating and capital
leases with initial or remaining terms of one year or more at June 30, 1997
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING CAPITAL
JUNE 30, LEASES LEASES
----------- --------- --------
<S> <C> <C>
1998................................................ $122,000 $361,000
1999................................................ 35,000 --
2000................................................ 15,000 --
-------- --------
$172,000 $361,000
======== ========
</TABLE>
At June 30, leased capital assets included in property and equipment
consisted of the following:
<TABLE>
<S> <C>
Furniture and equipment......................................... $222,000
Less accumulated depreciation................................... 35,000
--------
Total......................................................... $187,000
========
</TABLE>
The Company assumed capital lease arrangements totaling $316,000 in 1997.
Litigation
The Company is involved in certain legal proceedings and claims which arise
in the normal course of business. Management does not believe that the outcome
of these matters will have a material adverse effect on the Company's
consolidated financial position or results of operations.
Dealer Agreement
In March 1996, FNet entered into a dealer agreement with an individual (the
"Dealer") whereby the Dealer would be granted the exclusive right by FNet to
market, sell or otherwise offer certain services and goods to customers within
the Dealer's territory, as defined. In connection with this agreement, the
Dealer paid $45,000 to FNet as consideration for the rights described above.
The Dealer was to receive commissions at rates ranging from 10% to 30% based
on certain terms and conditions. Commissions paid to the Dealer during fiscal
1996 were not material.
In September 1996, FNet and the Dealer entered into a mutual general release
whereby both parties were released from all claims pursuant to the agreement.
In connection therewith, the Company converted $20,000 of the monies paid by
the Dealer to FNet, as noted above, to 23,350 shares of the Company's common
stock as consideration for the mutual general release. Such shares are
considered to be committed as of June 30, 1996 and are therefore included as
such in the accompanying consolidated balance sheet.
F-23
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
LICENSE AGREEMENTS
Satellite Services
In March 1997, the Company's subsidiary, Internet Passport, entered into a
Memorandum of Understanding with DigitalXPress LLC ("DigitalXPress"), a
purveyor of video and data network satellite services. Under the terms of the
agreement, Internet Passport and DigitalXPress will jointly develop a product
line, to be called "XPressNet," to furnish Internet connectivity to the
products currently marketed by DigitalXPress, and to combine marketing efforts
for certain customers, applications and products.
In May 1997, the Company's subsidiary, FNet, entered into a licensing and
joint development agreement with Peak Technologies, Inc. ("Peak"), by which
Peak granted FNet a license to use Peak's Java-based PeakJet Internet browser
accelerator in FNet's Internet service. In addition, FNet is to provide a
customized version of the PeakJet technology as a component in the Franklin
XPress satellite product line offered in conjunction with DigitalXPress. Under
the agreement, FNet is to issue 50,000 shares of its Common Stock to Peak.
800 Service Agreement
In December 1996, the Company entered into two agreements with an 800 number
supplier (the "Supplier") to service the FNet customer base, both internally
and for resale. The agreements provide the Company exclusive rights to 800
service in exchange for an incremental fee of $5,000 per month for each group
of 4,000 customers. The monthly fee has a minimum payment of $25,000 or up to
20,000 customers. The agreements call for the Company to issue the Supplier
50,000 shares of the Company's stock, options to purchase 100,000 shares of
FNet stock at $1.00 per share, and options to purchase 100,000 shares of
Franklin 800 Corp., a new wholly owned subsidiary of FNet, at $1.00 per share.
In management's opinion, the Supplier has failed to date to perform pursuant
to the agreement. Accordingly, the Company has withheld issuance of the
aforementioned shares and options.
Private Placement Exemptions
The Company's and FNet's private placements of securities have been issued
in transactions intended to be exempt from registration under the Securities
Act of 1933 pursuant to the provisions of Regulation D promulgated thereunder.
These rules include factors pursuant to which one or more private placement
transactions may be integrated as part of other offerings and include rules
that limit the dollar amount that can be raised and the number of non-
accredited investors that can participate. In the event any of the Company's
private placement transactions, including private placement transactions
undertaken by the Company since the transactions referred to above, were
deemed to be integrated, it is possible that the exemption from the
registration requirements of the Securities Act of 1933 would not be available
for one or more of those offerings. In the event that one or more of such
transactions are determined not to have been exempt from such registration
requirements, the purchasers may have the right to seek recission of the sales
and/or seek money damages against the Company. Management believes that each
of the Company's private offerings were exempt from the registration
requirements of the Securities Act of 1933.
NOTE 9--OTHER LIABILITIES
On February 5, 1993, the Company modified the terms of a note payable to a
former supplier with a balance of $572,000 that required the payment of
$30,000 in cash and an agreement to pay the former supplier $10 per Franklin
manufactured board up to a total of $700,000. There is no expiration date on
the revised agreement. On November 29, 1994, the agreement was further
modified. The modified terms are $10 per Franklin board sold for $300 and $2
per board sold for $300 or less. The modified agreement was effective through
June 1995 and
F-24
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
no new modification has been entered into. At June 30, 1997, the Company
estimated its future obligation to this supplier to be $183,000 under the
modified agreement based on the number of boards expected to be sold.
Accordingly, this obligation has been reduced to $183,000, the amount expected
to be paid in the future. Amounts paid under these agreements totaled
approximately $10,000, $5,000, $16,000, $0 (unaudited), and $1,000 (unaudited)
during the years ended June 30, 1997, 1996, and 1995 and the three months ended
September 30, 1997 and 1996, respectively.
NOTE 10--401(k) PLAN
The Company sponsors a 401(k) plan which includes a deferred feature under
section 401(k) of the Internal Revenue Code (the "Plan"). The Plan covers all
full-time employees of the Company. Contributions to the plan are at the
discretion of the Company's Board of Directors, but limited to the amounts
allowable for federal income tax purposes. Under the section 401(k) portion of
the Plan, employees may elect to contribute up to 20% of their compensation.
The Company did not make any contributions to the Plan during the years ended
June 30, 1997, 1996, or 1995 or the three months ended September 30, 1997 and
1996.
NOTE 11--LINES OF BUSINESS
The Company operates in two major lines of business: the manufacture and
distribution of data communications and connectivity products ("Franklin") and
Internet services ("FNet"). Information concerning operations in these lines of
business is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales
Franklin.............. $ 76,000 $ 158,000 $ 1,337,000 $ 397,000
FNet.................. 168,000 51,000 398,000 33,000
---------- ---------- ----------- -----------
Total............... $ 244,000 $ 209,000 $ 1,735,000 $ 430,000
========== ========== =========== ===========
Operating losses
Franklin.............. $ (692,000) $ (303,000) $(1,867,000) $(1,318,000)
FNet.................. (268,000) (74,000) (957,000) (149,000)
---------- ---------- ----------- -----------
Total............... $ (960,000) $ (377,000) $(2,824,000) $(1,467,000)
========== ========== =========== ===========
Identifiable assets
Franklin.............. $2,035,000 $1,195,000 $ 3,163,000 $ 575,000
FNet.................. 952,000 338,000 351,000 137,000
---------- ---------- ----------- -----------
Total............... $2,987,000 $1,533,000 $ 3,514,000 $ 712,000
========== ========== =========== ===========
Capital expenditures
Franklin.............. $ 7,000 $ 1,000 $ 204,000 $ 25,000
FNet.................. 13,000 21,000 120,000 33,000
---------- ---------- ----------- -----------
Total............... $ 20,000 $ 22,000 $ 324,000 $ 58,000
========== ========== =========== ===========
Depreciation and
amortization
Franklin.............. $ 42,000 $ 10,000 $ 52,000 $ 42,000
FNet.................. 24,000 2,000 58,000 3,000
---------- ---------- ----------- -----------
Total............... $ 66,000 $ 12,000 $ 110,000 $ 45,000
========== ========== =========== ===========
</TABLE>
Segment information is not shown for any other periods because the Internet
business was not material to the operations of the Company.
F-25
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Pro Forma Information (Unaudited)
The Company acquired Internet Passport, LLC ("Passport") on February 28,
1997. All other business acquisitions have been de minimis; therefore, the
Passport pro forma information has been reflected herein on a disaggregated
basis. The assets acquired and liabilities assumed are included in the
consolidated balance sheet of the Company as of June 30, 1997 included
elsewhere herein; therefore, no pro forma consolidated balance sheet has been
reflected below. The historical consolidated statements of operations for the
year ended June 30, 1996 are included elsewhere in this Prospectus. In the
opinion of management, there are no pro forma adjustments necessary to the
aforementioned historical statements of operations, assuming that the
acquisition occurred at the beginning of each of those years, expect for
showing the effects of the addition of the goodwill and subsequent write-off.
Because of the one-time unusual nature of the goodwill write-off, management
believes that the pro forma statement of operations information is better
reflected exclusive of such write-off as follows:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Historical net loss............................... $(2,824,000) $(1,467,000)
Add goodwill write-down related to Passport....... 835,000 --
----------- -----------
Adjusted historical net loss...................... (1,989,000) (1,467,000)
Add Passport losses prior to acquisition.......... (171,000) (66,000)
----------- -----------
Pro forma net loss exclusive of goodwill........ $(2,160,000) $(1,533,000)
=========== ===========
Adjusted historical net loss per share exclusive
of goodwill write-down........................... $ (.16) $ (.14)
Impact of Passport loss........................... (.01) (.01)
----------- -----------
Pro forma net loss per share exclusive of
goodwill....................................... $ (.17) $ (.15)
=========== ===========
</TABLE>
NOTE 12--SUBSEQUENT EVENTS (UNAUDITED)
The Company's President is employed pursuant to an Employment Agreement
expiring on December 31, 1997. The Employment Agreement provides for monthly
compensation at the rate of $20,000, with annual increases of 6%. The
Company's Board of Directors has approved a new six year Employment Agreement
for the Company's President, effective January 1, 1998. The new Employment
Agreement provides for compensation at the rate of $27,000 per month, with
annual increases of 6%.
During the three months ended September 30, 1997, FNet sold 51,000
(unaudited) shares of its stock to outside investors at $1.00 per share. The
shares sold to investors were issued under a private offering circular
pursuant to the exemption from registration under the 1933 Act provided in
Rule 505 of Regulation D. After the issuance of these shares, Franklin's
ownership percentage decreased to 67% (unaudited) as of September 30, 1997.
In October 1997, the Company's President exercised stock options for
1,333,695 shares of common stock at $0.10 per share.
In November 1997, an employee of the Company exercised stock options for
50,000 and 100,000 shares of common stock at $0.69 and $1.31 per share,
respectively.
F-26
<PAGE>
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 13--FOURTH QUARTER ADJUSTMENTS
In the fourth quarter of fiscal 1996, the Company recorded certain fourth
quarter adjustments that, in the aggregate, increased the Company's net loss
by approximately $777,000. The adjustments principally consisted of reductions
of inventory and increases in accrued expenses.
NOTE 14--RECENT SALE OF EQUITY SECURITIES
During September and October 1997, the Company completed two Regulation D
private placement offerings as follows:
. An offering of 333,333 units for $1,000,000. Each unit consists of one
share of the Company's common stock and one common stock warrant to
purchase one share of the Company's common stock for $5.00 per share. The
net proceeds to the Company were $1,000,000, and
. An offering of 540 units for $5,400,000. Each unit in this offering
consists of one share of the Company's Series C Convertible Preferred
Stock and one warrant to purchase one share of FNet's common stock. The
net proceeds to the Company were $4,957,500.
(Unaudited) In November 1997, the Company issued an additional 200 units for
$2,000,000. Each unit in this offering consists of one share of the Company's
Series C Convertible Preferred Stock and one Warrant to purchase one share of
FNet's common stock. The net proceeds to the Company were $1,850,000.
F-27
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Internet Passport, LLC
We have audited the accompanying balance sheet of Internet Passport, LLC
(the "Company") as of June 30, 1996, and the related statements of operations,
member's deficit and cash flows for the period from February 16, 1996 (date
operations commenced) to June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Internet Passport, LLC as
of June 30, 1996, and the results of its operations and its cash flows for the
period from February 16, 1996 (date operations commenced) to June 30, 1996 in
conformity with generally accepted accounting principles.
As more fully discussed in Note 1 to the accompanying financial statements,
as of February 28, 1997, the Company was sold and has ceased operations as a
stand-alone entity as of such date.
CORBIN & WERTZ
Irvine, California
June 6, 1997
F-28
<PAGE>
INTERNET PASSPORT, LLC
BALANCE SHEET
JUNE 30, 1996
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash................................................................ $ 12,400
Loan receivable--employee........................................... 5,300
Loan receivable from related party.................................. 1,600
--------
Total current assets.............................................. 19,300
Property:
Machinery and equipment............................................. 19,100
Furniture and fixtures.............................................. 400
--------
19,500
Less accumulated depreciation....................................... (300)
--------
Property, net..................................................... 19,200
Other assets.......................................................... 5,100
--------
Total assets...................................................... $ 43,600
========
LIABILITIES AND MEMBER'S DEFICIT
Current liabilities:
Accounts payable.................................................... $ 1,300
Capital lease payable............................................... 73,500
--------
Total current liabilities......................................... 74,800
--------
Member's deficit:
Member's equity..................................................... 35,100
Accumulated deficit................................................. (66,300)
--------
Total member's deficit............................................ (31,200)
--------
Total liabilities and member's deficit............................ $ 43,600
========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-29
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
EIGHT-MONTH
PERIOD ENDED PERIOD ENDED
FEBRUARY 28, JUNE 30,
1997 1996
------------ ------------
(UNAUDITED)
<S> <C> <C>
Consulting revenues................................... $ 16,800 $ 9,000
Selling, general and administrative expenses.......... (117,500) (49,700)
--------- --------
Loss from operations.............................. (100,700) (40,700)
--------- --------
Other income (expense):
Provision for lease liability....................... (55,000) (26,000)
Interest expense.................................... (15,100) (2,200)
Loss on sale of assets.............................. -- (1,200)
Rental income....................................... -- 3,800
--------- --------
Total other income (expense)...................... (70,100) (25,600)
--------- --------
Net loss.............................................. $(170,800) $(66,300)
========= ========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-30
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF MEMBER'S DEFICIT
<TABLE>
<CAPTION>
TOTAL
MEMBER'S ACCUMULATED MEMBER'S
EQUITY DEFICIT DEFICIT
-------- ----------- ---------
<S> <C> <C> <C>
Member contribution at inception............... $10,100 $ -- $ 10,100
Contributed services........................... 25,000 -- 25,000
Net loss for period ended June 30, 1996........ -- (66,300) (66,300)
------- --------- ---------
Balance at June 30, 1996....................... 35,100 (66,300) (31,200)
Contributed services (unaudited)............... 40,000 -- 40,000
Net loss for eight months ended February 28,
1997 (unaudited).............................. -- (170,800) (170,800)
------- --------- ---------
Balance at February 28, 1997 (unaudited)....... $75,100 $(237,100) $(162,000)
======= ========= =========
</TABLE>
See independent auditors' report and
accompanying notes to financial statements
F-31
<PAGE>
INTERNET PASSPORT, LLC
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
EIGHT-MONTH
PERIOD ENDED PERIOD ENDED
FEBRUARY 28, JUNE 30,
1997 1996
------------ ------------
(UNAUDITED)
<S> <C> <C>
Cash flow from operating activities:
Net loss........................................... $(170,800) $(66,300)
Adjustment to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization.................... 1,600 300
Loss on sale of machinery and equipment.......... -- 1,200
Contributed services............................. 40,000 25,000
Provision for lease liability.................... 55,000 26,000
Change in operating assets and liabilities:
Accounts receivable............................ (300) --
Other assets................................... 100 (5,100)
Deferred revenue............................... 5,300 --
Accounts payable............................... 8,400 1,300
--------- --------
Net cash used in operating activities.............. (60,700) (17,600)
--------- --------
Cash flow from investing activities:
Loan receivable--employee.......................... (8,500) (5,300)
Loan receivable--related party..................... (5,200) (1,600)
Purchase of equipment.............................. (9,800) (400)
Proceeds from sale of leased equipment............. 59,800 31,000
Proceeds from sale of equipment.................... -- 2,000
--------- --------
Net cash provided by investing activities.......... 36,300 25,700
--------- --------
Cash flow from financing activities:
Principal payments on lease obligations............ (14,700) (2,600)
Debt proceeds...................................... 38,000 --
Cash provided from equity investment............... -- 6,900
--------- --------
Net cash provided by financing activities.......... 23,300 4,300
--------- --------
Net change in cash................................... (1,100) 12,400
Cash at beginning of period.......................... 12,400 --
--------- --------
Cash at end of period................................ $ 11,300 $ 12,400
========= ========
Supplemental disclosure of cash flow information--
Cash paid during the period for:
Interest......................................... $ 15,100 $ 2,200
========= ========
Income taxes..................................... $ -- $ --
========= ========
</TABLE>
Supplemental disclosure of non-cash investing activities--
During the period ended June 30, 1996, property in the amount of $3,200 was
acquired as part of the initial contributed capital. Such property was sold
during the period ended June 30, 1996 for a loss of $1,200. For the periods
ended February 28, 1997 and June 30, 1996, equipment in the amount of
$262,300 (unaudited) and $50,100, respectively, was acquired through
capital lease transactions.
See independent auditors' report and accompanying notes to financial statements
F-32
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FROM FEBRUARY 16, 1996 (DATE OPERATIONS
COMMENCED) TO JUNE 30, 1996
NOTE 1--GENERAL AND BASIS OF PRESENTATION
General
Internet Passport, LLC (the "Company") was formed on February 16, 1996 as a
Georgia limited liability company. The Company operated as a start-up internet
access provider of custom internet services and related products.
Basis of Presentation
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles on a going concern basis. The Company
was acquired by Franklin Telecommunications Corp. ("Franklin") on February 28,
1997 and has ceased operations as a stand-alone entity as of such date.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Risks and Uncertainties
The Company is a start-up company in its first year of operations. The
Company is subject to the substantial business risks and uncertainties
inherent in a start-up operation, including the potential risk of business
failure.
The Company does not maintain general business liability insurance. As a
result, the Company is exposed to potential loss resulting from uninsured
future loss of or damage to the Company's property, damage to the property of
others, injury to others and/or interruption of the Company's business.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements. Such estimates also affect the reported amounts of revenues and
expenses during the reported period. Actual results could materially differ
from those estimates.
Fair Value of Financial Instruments
The accompanying consolidated balance sheets include financial instruments
whereby the fair market value of the financial instruments could be different
than that recorded on a historical basis. The Company's financial instruments
consist of its cash, receivables from an employee and a related party and
accounts payable. The carrying amounts of the Company's financial instruments
generally approximate their fair values at June 30, 1996. The fair value of
the receivables from an employee and a related party are not readily
determinable as market comparables were not available for such instruments.
Property
Property is recorded at cost and depreciated on a straight-line basis over
the estimated useful lives of the related assets, principally five years.
Repairs and maintenance are charged to expense. Betterments are capitalized.
Depreciation expense for the periods ended February 28, 1997 and June 30, 1996
was $1,600 (unaudited) and $300, respectively.
Revenue Recognition
Revenues are recognized in the month of service.
F-33
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Advertising Costs
Advertising costs are expensed as incurred.
Income Taxes
The Company is taxed as a limited liability company under the provisions of
the Federal and state tax codes. Under Federal and state law, taxes based on
income of a limited liability company are payable by the member individually.
Accordingly, no provision for income taxes has been provided in the
accompanying financial statements.
NOTE 2--LOANS TO RELATED PARTIES
The loan receivable--employee of $5,300 at June 30, 1996 is non-interest
bearing and $2,800 (unaudited) of the balance was paid during the eight-month
period ended February 28, 1997.
As of June 30, 1996, the Company had a related party receivable totaling
$1,600 from the president and sole member. The loan is non-interest bearing
and has no due date.
During the eight-month period ended February 28, 1997, the Company advanced
approximately $7,000 to an affiliated company owned 100% by the sole member of
the Company. The advance is non-interest bearing and has no due date. During
the same period, the Company loaned an additional $10,000 to its president and
sole member. The loan is non-interest bearing and has no due date.
NOTE 4--CAPITAL LEASE OBLIGATIONS
The Company has assumed six capital leases since its inception from two
entities owned by the sole member of the Company. All six capital leases are
technically in default because of provisions in the leases that prohibit the
assignment of the leases. In addition, the assets underlying four of the six
leases were sold by the Company for cash. Such sales are also prohibited under
the terms of the leases and the lessors have not been informed of such sales.
The lessors technically have the right to accelerate payment under all of the
leases due to such defaults. The Company is continuing to make the lease
payments on all six leases pursuant to the lease terms. The Company recorded
additional provisions for lease liability for the eight-month period ended
February 28, 1997 and the period ended June 30, 1996 of $55,000 (unaudited)
and $26,000 to reflect the full, undiscounted, lease obligations as a result
of the defaults. In addition, the capital lease obligation at June 30, 1996
has been reflected as a current liability. A summary of the capital lease
activity follows:
<TABLE>
<CAPTION>
LEASE LEASED
OBLIGATION PROPERTY
---------- --------
<S> <C> <C>
Balance at inception.................................... $ -- $ --
Equipment acquired under capital leases................. 50,100 50,100
Lease principal payments................................ (2,600) --
Sale of property........................................ -- (31,000)
Provision for lease liability........................... 26,000 --
-------- --------
Balances at June 30, 1996............................. 73,500 19,100
Equipment acquired under capital leases (unaudited)..... 262,300 262,300
Lease principal payments (unaudited).................... (14,700) --
Sale of property (unaudited)............................ -- (59,800)
Provision for lease liability (unaudited)............... 55,000 --
-------- --------
Balances at February 28, 1997 (unaudited)............... $376,100 $221,600
======== ========
</TABLE>
F-34
<PAGE>
INTERNET PASSPORT, LLC
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5--AMOUNTS BORROWED FROM FRANKLIN
During the eight-month period ended February 28, 1997, the Company was
advanced $38,000 (unaudited) from Franklin. Such advances were non-interest
bearing and due on demand.
NOTE 6--CONTRIBUTED SERVICES
The sole member has provided services to the Company during the periods
presented without cash compensation. The Company has recorded $40,000
(unaudited) and $25,000 during the periods ended February 28, 1997 and June
30, 1996 as a member's equity contribution for the estimated fair value of the
services provided.
F-35
<PAGE>
===============================================================================
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY ANY SECURITY OTHER THAN THE
SHARES OF THE COMMON STOCK OFFERED BY THIS PROSPECTUS, NOR DOES IT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY THE SHARES OF COMMON
STOCK BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT
AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT
QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT INFORMA-
TION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 5
Dividend Policy........................................................... 13
Use of Proceeds........................................................... 13
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 14
Selected Financial Data................................................... 18
Price Range of Common Stock............................................... 19
Business.................................................................. 20
Management................................................................ 29
Principal Shareholders.................................................... 33
Selling Shareholders...................................................... 34
Plan of Distribution...................................................... 36
Description of Capital Stock.............................................. 37
Legal Matters............................................................. 37
Experts................................................................... 38
Available Information..................................................... 39
Index to Financial Statements............................................. F-1
</TABLE>
===============================================================================
===============================================================================
6,740,172 SHARES
[LOGO OF FRANKLIN TELECOMMUNICATIONS CORP.]
FRANKLIN
TELECOMMUNICATIONS
CORP.
COMMON STOCK
----------------
PROSPECTUS
----------------
, 1998
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses incurred or to be incurred by the Company in connection with
the preparation and filing of this Registration Statement are estimated to be
as follows:
<TABLE>
<S> <C>
Printing and duplication expenses................................. $20,000
Registration fee.................................................. 2,620
Legal fees and expenses........................................... 20,000
Accounting fees and expenses...................................... 25,000
Transfer Agent fees............................................... 2,000
Miscellaneous..................................................... 2,380
-------
Total........................................................... $72,000
=======
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's Bylaws provide that the Company may indemnify its officers and
directors, and may indemnify its employees and other agents, to the fullest
extent permitted by California law. Insofar as indemnification for liabilities
arising under the Securities Act of 1933 may be permitted to officers,
directors or persons controlling the Company pursuant to the foregoing
provisions, the Company has been informed that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following table sets forth a list of all unregistered securities issued
by the Company during the past three years. All securities were issued
pursuant to the exemptions provided for under Section 4(2) of the Securities
Act of 1933 and Regulation D and Rule 701 promulgated thereunder. The
securities were issued for cash, upon exercise of employee stock options and
in connection with certain acquisitions by the Company.
<TABLE>
<CAPTION>
SHARE
NAME DATE SHARES CONSIDERATION
---- -------- ---------- -------------
<S> <C> <C> <C>
Swartz Investments, LLC.................... 11/25/97 255,386 N/A
(warrants)
Triton Capital Investments, Ltd.*.......... 10/31/97 35* $ 350,000
Banque Edouard Constant SA*................ 10/31/97 50* 500,000
Banque Franck S.A.*........................ 10/31/97 75* 750,000
Elara Ltd. *............................... 10/31/97 150* 1,500,000
Ellis AG*.................................. 10/31/97 10* 100,000
JMG Capital Partners, L.P.*................ 10/31/97 35* 350,000
Lakeshore International, Ltd.*............. 10/31/97 150* 1,500,000
JNC Opportunity Fund*...................... 11/25/97 200* 2,000,000
The Matthew Fund, N.V.*.................... 10/31/97 35* 350,000
Frank W. Peters............................ 10/7/97 1,333,695 133,370
E. Bryan Bagley............................ 10/15/97 40,000 50,000
Bruce Whaley............................... 10/15/97 13,000 16,250
Wilson-Davis Company....................... 10/15/97 30,000 37,500
Tom Russell................................ 11/3/97 150,000 165,500
Vic Klimpl................................. 9/22/97 22,000 66,000
Blair Holder............................... 9/22/97 30,000 90,000
Raleigh Baughman........................... 9/22/97 30,000 90,000
Mark Jenkins............................... 9/22/97 11,000 33,000
Dale Berman................................ 9/22/97 10,000 30,000
Cindy Cannon............................... 9/22/97 15,000 45,000
</TABLE>
- --------
* Series C Preferred
II-1
<PAGE>
<TABLE>
<CAPTION>
SHARE
NAME DATE SHARES CONSIDERATION
---- --------- ------- -------------
<S> <C> <C> <C>
Clay & Bobbie Lasiter........................ 9/22/97 10,000 $ 30,000
Scott Holder................................. 9/22/97 10,000 30,000
Terry Widner................................. 9/22/97 33,333 99,999
Roberto Alvarez.............................. 9/22/97 20,000 60,000
Mike & Marcia Marino......................... 9/22/97 7,000 21,000
George Willse................................ 9/22/97 10,000 30,000
Frank Culker................................. 9/22/97 7,000 21,000
Gary Nelson.................................. 9/22/97 16,000 48,000
Gary Nelson IRA acct. ....................... 9/22/97 45,000 135,000
Doug Best.................................... 9/22/97 7,000 21,000
Martin Smith................................. 9/22/97 7,000 21,000
Bob Zimdar................................... 9/22/97 10,000 30,000
Anthony Chan................................. 9/23/97 9,000 27,000
Tim LaFrance................................. 9/23/97 7,000 21,000
Marvin Mansky................................ 9/24/97 10,000 30,000
Richard & Lorna Valentine.................... 9/24/97 7,000 21,000
John Costello................................ 7/31/97 207,066 453,475
Thomas Russell............................... 6/13/97 50,000 34,500
Eileen Rouse................................. 6/13/97 50,000 45,000
Alan London.................................. 6/13/97 25,000 17,500
Dianne Oliver................................ 6/13/97 2,000 200
Helen West................................... 6/17/97 12,000 10,800
Alice Amanet................................. 6/24/97 6,250 4,375
1996 Private Placement (28 Individuals) ..... 8/1/96 890,595 737,500
Len Bartz.................................... 6/30/96 23,350 20,000
Michael C. Peters............................ 3/1/96 380,000 190,000
Eileen Rouse................................. 3/1/96 10,000 5,000
Michael Parkhurst............................ 8/26/96 5,000 500
Patrick Klos................................. 10/1/96 15,000 1,500
Dianne Oliver................................ 10/8/96 8,000 800
Michael Klos................................. 10/10/96 5,000 500
Terry Lee.................................... 12/2/96 20,000 25,000
Steve Sullivan............................... 12/2/96 20,000 25,000
Millhollan/Ellis............................. 3/96-2/97 12,000 26,246
Charles & Barb Arledge....................... 12/4/96 5,808 8,131
Brew & Shirley Arms.......................... 12/4/96 5,808 8,131
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ------- ------- ------------- -----------
<S> <C> <C> <C> <C>
Andrew & Joan Chitiea.............. 12/4/96 5,808 $ 8,131
Daniel & Pat Derbes................ 12/4/96 11,617 16,264
Kenneth King....................... 12/4/96 2,905 4,067
Herman & D. Krantz................. 12/4/96 7,260 10,164
Dale & Monica Sheets............... 12/4/96 14,521 20,329
Robert & Erma Sheets............... 12/4/96 7,260 10,164
John Calderwood.................... 1/7/97 5,000 625
Frederick I. Camerer............... 3/96 5,000 2,500
Edward D. Bagley................... 2/5/97 59,608 190,000
Marcia Marino...................... 2/7/97 20,000 25,000
Peter Buswell...................... 2/25/97 30,000 3,000
Kristin Peters..................... 2/26/97 10,000 1,000
Sparrow Marcioni................... 1/28/97 600,000 3,150,000
Neil Wyenn......................... 2/26/97 25,000 131,250
M.H. Meyerson & Co., Inc. ......... 5/11/95 600,000
Wilson Davis....................... 10/1/95 30,000
Sam Wilson......................... 10/1/95 50,000
Paul Davis......................... 10/1/95 50,000
Lyle Davis......................... 10/1/95 60,000
Byron Barkley...................... 3/96 20,000 10,000
Byron Barkley...................... 10/1/95 20,000
Bryan B. Bagley PFT Sharing........ 3/1/96 20,000 10,000
Bryan B. Bagley.................... 3/1/96 20,000 10,000
Bollard Investment Co. ............ 10/1/95 40,000
Bruce Whaley....................... 10/1/95 40,000
Joe Fisher......................... 3/96 70,000 35,000
Joe Fisher......................... 10/1/95 40,000
Gary Nelson........................ 10/1/95 64,000
Gary Nelson Transcorp C/F.......... 10/1/95 11,000
Gary Conrad........................ 10/1/95 200,000
Ronald Heller...................... 10/1/95 303,000
David Nagelberg.................... 10/1/95 303,000
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ------- --------- ------------- -----------
<S> <C> <C> <C> <C>
Martin & Co...................... 10/1/95 146,000
Michael and Linda Silvestri...... 10/1/95 28,000
Jeffrey Barber................... 10/1/95 14,000
Joel Marcus...................... 10/1/95 12,000
Rocco Vezza...................... 10/1/95 12,000
Joanne Gioia..................... 10/1/95 12,000
Joseph Schmidt................... 10/1/95 10,000
Kevin Charos..................... 10/1/95 10,000
Frederick I. Camerer............. 5/11/94 30,000 $ 3,000
Michael C. Peters................ 5/12/94 30,000 3,000
Frederick I. Camerer............. 5/31/94 50,000 5,000
Mark Peters...................... 6/17/94 1,000 100
Kristen Peters................... Jan-95 10,000 1,000
John Costello.................... Jan-95 199,806 61,141
Herman & D. Krantz............... Jan-95 7,260 2,222
Dale & Monica Sheets............. Jan-95 14,521 4,443
Robert & Erma Sheets............. Jan-95 7,260 2,222
Colin Patterson.................. Jan-95 29,042 8,887
John Costello.................... Jan-95 7,260 2,222
Added Value...................... Jan-95 3,493 1,034
Robert & Erma Sheets............. Jan-95 1,529 453
Herman & D. Krantz............... Jan-95 1,529 453
Colin Patterson.................. Jan-95 6,087 1,802
Photo Vision..................... Jan-95 405 120
Added Value...................... Feb-95 389 121
Micropolus....................... Feb-95 489 153
Future Elect..................... Feb-95 2,043 637
Charles Arledge.................. Feb-95 1,159 362
Brew Arms........................ Feb-95 1,159 362
Andew Chitiea.................... Feb-95 1,160 362
Dan Derbes....................... Feb-95 2,319 724
Kenneth King..................... Feb-95 580 181
Frederick I. Camerer............. Apr-95 25,000 2,500
Kristen Peters................... Apr-95 10,000 1,000
UPS.............................. Apr-95 1,084 1,642
Frank Peters..................... Apr-95 2,000,000 134,000
Dale & Monica Sheets............. May-95 3,070 2,398
Michelle Nisbet.................. May-95 4,280 783
Frank Dragun..................... May-95 22,000 2,200
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
SHARE EXERCISABLE
NAME DATE SHARES CONSIDERATION WARRANTS
---- ---------- --------- ------------- -----------
<S> <C> <C> <C> <C>
Charles & Barb Arledge....... May-95 5,808 $ 1,626
Brew & Shirley Arms.......... May-95 5,808 1,626
Andrew & Joan Chitiea........ May-95 5,808 1,626
Daniel & Pat Derbes.......... May-95 11,617 3,253
Kenneth King................. May-95 2,905 813
Michael C. Peters............ 6/30/95 255,000 25,500
Kristen Peters............... Jul-95 10,000 1,000
Frank Jones.................. Aug-95 5,000 500
Michael Parkhurst............ Aug-95 15,000 1,500
Wyle......................... Aug-95 7,555 10,388
Bill Woods................... Aug-95 4,000 2,800
Kristen Peters............... Aug-95 8,127 2,032
Frederick I. Camerer......... Sep-95 9,147 2,287
Michael Peters............... Sep-95 13,565 3,391
1995 Reg. D. Private
Placement................... 6/95-10/95 2,000,000 1,000,000
Richard Parkhurst............ Dec-95 25,000 9,835
Frederick I. Camerer......... Feb-96 12,500 1,250
Michael & Marcia Marino...... 6/30/96 28,572 20,000
</TABLE>
II-5
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES.
The following exhibits are filed with this Registration Statement:
<TABLE>
<C> <S>
3.1* Restated Articles of Incorporation of Franklin Telecommunications
Corp.
3.2* Bylaws of Franklin Telecommunications Corp.
3.3* Certificate of Determination of Preferences of Series C Preferred
Stock.
5.1* Opinion of Haddan & Zepfel LLP.
10.1* Employment Agreement, dated March 1, 1993 between Franklin
Telecommunications Corp. and Frank W. Peters.
10.2* Confidential Agreement dated June 3, 1996 between Malibu Internet
Services and Franklin Telecommunications Corp.
10.3* Joint Venture Agreement dated May 23, 1996 between StarComm Products
Inc. and Franklin Telecommunications Corp.
10.4* Letter Agreement dated February 28, 1997 between Internet Passport
LLC and Franklin Telecommunications Corp.
10.5* Subscriber Agreement dated January 2, 1997 between LaserVend, Inc and
Franklin Telecommunications Corp.
10.6* Subscriber Agreement dated January 28, 1997 between A-Online
Information Services, Inc. and Franklin Telecommunications Corp.
10.7* Subscriber Agreement dated January 17, 1997 between WebTV Networks,
Inc. and Franklin Telecommunications Corp.
10.8* Letter Agreement dated February 26, 1997 between CPR Computer Repair,
Inc. and Franklin Telecommunications Corp.
10.9* Letter Agreement dated December 2, 1996 between Number 1 Internet
Services and Franklin Telecommunications Corp.
10.10* Warrant Agreement dated May 18, 1995 between M. H. Myerson & Co. and
Franklin Telecommunications Corp.
10.11* Form of Letter Agreement dated March 17, 1997 between M. H. Myerson &
Co. and Franklin Telecommunications Corp.
10.12* Form of Indemnity Agreement for all Directors of Franklin
Telecommunications Corp.
10.13* Memorandum of Understanding, dated March 13, 1997, between Internet
Passport and DigitalXPress LLC.
10.14* Agreement, dated May 16, 1997, between StarComm and Franklin
Telecommunications Corp.
10.15* Agreement, dated May 15, 1997, between Peak Technologies, Inc. and
Franklin Telecommunications Corp.
10.16* Form of Regulation D Subscription Agreement between Franklin
Telecommunications Corp. and certain purchasers of Series C
Preferred Stock.
10.17* Form of Series C Registration Rights Agreement between Franklin
Telecommunications Corp. and certain purchasers of Series C
Preferred Stock.
10.18* Form of Warrant issued to purchasers of Series C Preferred Stock.
10.19 Form of Letter Agreement, dated January 23, 1998, among Franklin
Telecommunications Corp. and certain warrantholders.
16.1* Letter from Corbin & Wertz, Certified Public Accountants.
23.1 Consent of Corbin & Wertz, Certified Public Accountants.
23.2* Consent of Haddan & Zepfel LLP (included as part of Exhibit 5.1).
23.3 Consent of Singer, Lewak, Greenbaum & Goldstein LLP.
27.1* Financial Data Schedule
</TABLE>
- --------
* Previously filed
II-6
<PAGE>
ITEM 17. UNDERTAKINGS.
The undersigned Registrant undertakes as follows:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(4) Insofar as indemnification for liabilities arising under the
Securities Act of 1993 (the "Act") may be permitted to directors, officers
and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expense incurred
or paid by a director, officer or controlling person of the registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
II-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Amendment to Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Westlake
Village, State of California, on January 27, 1998.
Franklin Telecommunications Corp.
By /s/ Frank W. Peters
___________________________________
Frank W. Peters
President
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement was signed by the following persons in the capacities
and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
(1) Principal Executive Officer
/s/ Frank W. Peters President and a Director January 27, 1998
____________________________________
Frank W. Peters
(2) Principal Financial and
Accounting Officer
/s/ Thomas Russell Chief Financial Officer and January 27, 1998
____________________________________ a Director
Thomas Russell
(3) Directors
/s/ Peter S. Buswell* Director January 27, 1998
____________________________________
Peter S. Buswell
/s/ Robert S. Harp* Director January 27, 1998
____________________________________
Robert S. Harp
</TABLE>
*By:
Frank W. Peters,
Attorney-In-Fact
II-8
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DOCUMENT DESCRIPTION PAGE
------- -------------------- ------------
<C> <S> <C>
3.1* Restated Articles of Incorporation of Franklin
Telecommunications Corp.
3.2* Bylaws of Franklin Telecommunications Corp.
3.3* Certificate of Determination of Preferences of Series C
Preferred Stock.
5.1* Opinion of Haddan & Zepfel LLP.
10.1* Employment Agreement, dated March 1, 1993 between
Franklin Telecommunications Corp. and Frank W. Peters.
10.2* Confidential Agreement dated June 3, 1996 between
Malibu Internet Services and Franklin
Telecommunications Corp.
10.3* Joint Venture Agreement dated May 23, 1996 between
StarComm Products Inc. and Franklin Telecommunications
Corp.
10.4* Letter Agreement dated February 28, 1997 between
Internet Passport LLC and Franklin Telecommunications
Corp.
10.5* Subscriber Agreement dated January 2, 1997 between
LaserVend, Inc and Franklin Telecommunications Corp.
10.6* Subscriber Agreement dated January 28, 1997 between A-
Online Information Services, Inc. and Franklin
Telecommunications Corp.
10.7* Subscriber Agreement dated January 17, 1997 between
WebTV Networks, Inc. and Franklin Telecommunications
Corp.
10.8* Letter Agreement dated February 26, 1997 between CPR
Computer Repair, Inc. and Franklin Telecommunications
Corp.
10.9* Letter Agreement dated December 2, 1996 between Number
1 Internet Services and Franklin Telecommunications
Corp.
10.10* Warrant Agreement dated May 18, 1995 between M. H.
Myerson & Co. and Franklin Telecommunications Corp.
10.11* Form of Letter Agreement dated March 17, 1997 between
M. H. Myerson & Co. and Franklin Telecommunications
Corp.
10.12* Form of Indemnity Agreement for all Directors of
Franklin Telecommunications Corp.
10.13* Memorandum of Understanding, dated March 13, 1997,
between Internet Passport and DigitalXPress LLC.
10.14* Agreement, dated May 16, 1997, between StarComm and
Franklin Telecommunications Corp.
10.15* Agreement, dated May 15, 1997, between Peak
Technologies, Inc. and Franklin Telecommunications
Corp.
10.16* Form of Regulation D Subscription Agreement between
Franklin Telecommunications Corp. and certain
purchasers of Series C Preferred Stock.
10.17* Form of Series C Registration Rights Agreement between
Franklin Telecommunications Corp. and certain
purchasers of Series C Preferred Stock.
10.18* Form of Warrant issued to purchasers of Series C
Preferred Stock.
10.19 Form of Letter Agreement, dated January 23, 1998, among
Franklin Telecommunications Corp. and certain
warrantholders.
16.1* Letter from Corbin & Wertz, Certified Public
Accountants.
23.1 Consent of Corbin & Wertz, Certified Public
Accountants.
23.2* Consent of Haddan & Zepfel LLP (included as part of
Exhibit 5.1).
23.3 Consent of Singer, Lewak, Greenbaum & Goldstein LLP.
27.1* Financial Data Schedule
</TABLE>
- --------
* Previously filed
<PAGE>
EXHIBIT 10.19
As of January 23, 1998
Franklin Telecommunications Corp.
733 Lakefield Road
Westlake Village, CA 91361
In consideration of Franklin Telecommunications Corp. ("Company")
registering 1,450,000 shares of its common stock issuable upon exercise of
warrants issued to the undersigned ("Warrantholders") by the Company pursuant to
the Registration Statement on Form S-1 (File No. 333-24791) declared effective
by the Securities and Exchange Commission on November 13, 1997 and of the mutual
covenants of the parties set forth herein, the Company and the undersigned,
holders of these warrants to purchase shares of common stock of the Company,
agree as follows:
1. The present exercise price of certain of these warrants (to purchase in
the aggregate 600,000 shares of common stock) is presently $1.35 per share, and
the exercise price of certain other warrants (to purchase in the aggregate
850,000 shares of common stock) is presently $1.25 per share. These two exercise
prices, for each group of warrants respectively, are referred to as the "Base
Exercise Price" for purposes of this agreement. As long as the shares of common
stock underlying the warrants continue to be registered for resale by the
holders thereof under the Securities Act of 1933, as amended ("Securities Act")
and a prospectus related thereto remains current, the exercise price of these
warrants shall be the sum of (1) the applicable Base Exercise Price and the (2)
"Additional Consideration". The Base Exercise Price shall be paid to the Company
upon exercise of a warrant. The term "Additional Consideration" shall mean 30%
of the net proceeds (gross selling price less commissions) derived from the sale
of the underlying shares of common stock by the holders over $4.00 per share.
Accordingly, if a warrantholder exercises a warrant and sells the underlying
shares of common stock for a net sales price in excess of $4.00, 30% of the
difference between the net selling price and $4.00 per share shall be due and
owing to Company as Additional Consideration and shall be paid to the Company,
accompanied by a copy of the confirmation of sale, promptly upon the
warrantholder's receipt of the net selling price, but not later than 5 business
days thereafter. After the first exercise of warrants by a Warrantholder, such
Warrantholder shall furnish to the Company a weekly report of sales of the
shares of common stock issued upon such exercise by telecopier transmission not
later than the second trading day of the following calendar week, which reports
shall continue until all of such shares have been resold.
2. (a) The Company shall indemnify the Warrantholders and any underwriter
or person deemed to be an underwriter under the Securities Act and each person,
if any, who controls the Warrantholders or underwriters or persons deemed to be
underwriters within the meaning of Section 15 of the Act or Section 20(a) of
the Securities Exchange Act of 1934, as amended ("Exchange Act"), against all
loss, claim, damage, expense or liability (including all reasonable attorneys'
fees and other expenses reasonably incurred in investigating, preparing or
defending against any claim whatsoever) to which any of them may become subject
under the Securities Act, the Exchange Act or otherwise, arising from or in
connection with such registration statement, except where such loss, claim,
damage, expense or liability arises out of information
<PAGE>
furnished by or on behalf of a Warrantholder, in writing, for specific inclusion
in such registration statement or where it arises from a violation by a
Warrantholder of the rules and regulations of the National Association of
Securities Dealers, Inc. The Warrantholder(s), and their successors and assigns,
shall severally, and not jointly, indemnify the Company, against all loss,
claim, damage, expense or liability (including all reasonable attorneys' fees
and other expenses reasonably incurred in investigating, preparing or defending
against any claim whatsoever) to which they may become subject under the
Securities Act, the Exchange Act or otherwise, arising from information
furnished by or on behalf of such Warrantholders, in writing, for specific
inclusion in such registration statement.
(b) If any action is brought against a party hereto, ("Indemnified
Party") in respect of which indemnity may be sought against the other party
("Indemnifying Party"), such Indemnified Party shall promptly notify
Indemnifying Party in writing of the institution of such action and Indemnifying
Party shall assume the defense of such action, including the employment and fees
of counsel reasonably satisfactory to the Indemnified Party. Such Indemnified
Party shall have the right to employ its or their own counsel in any such case,
but the fees and expenses of such counsel shall be at the expense of such
Indemnified Party unless (i) the employment of such counsel shall have been
authorized in writing by Indemnifying Party in connection with the defense of
such action, or (ii) Indemnifying Party shall not have employed counsel to
defend such action, or (iii) such Indemnified Party shall have been advised by
counsel that there may be one or more legal defenses available to it which may
result in a conflict between the Indemnified Party and Indemnifying Party (in
which case Indemnifying Party shall not have the right to direct the defense of
such action on behalf of the Indemnified Party), in any of which events, the
reasonable fees and expenses of not more than one additional firm of attorneys
designated in writing by the Indemnified Party shall be borne by Indemnifying
Party. Notwithstanding anything to the contrary contained herein, if Indemnified
Party shall assume the defense of such action as provided above, Indemnifying
Party shall not be liable for any settlement of any such action effected without
its written consent.
(c) If the indemnification or reimbursement provided for hereunder is
finally judicially determined by a court of competent jurisdiction to be
unavailable to an Indemnified Party (other than as a consequence of a final
judicial determination of willful misconduct, bad faith or gross negligence of
such Indemnified Party), then Indemnifying Party agrees, in lieu of indemnifying
such Indemnified Party, to contribute to the amount paid or payable by such
Indemnified Party (i) in such proportion as is appropriate to reflect the
relative benefits received, or sought to be received, by Indemnifying Party on
the one hand and by such Indemnified Party on the other or (ii) if (but only if)
the allocation provided in clause (i) of this sentence is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in such clause (i) but also the relative fault of
Indemnifying Party and of such Indemnified Party; provided, however, that in no
-----------------
event shall the aggregate amount contributed by a Warrantholder exceed the
profit, if any, earned by such Holder as a result of the exercise by him of the
warrants and the sale by him of the underlying shares of Common Stock.
(d) The rights accorded to Indemnified Parties hereunder shall be in
addition to any rights that any Indemnified Party may have at common law, by
separate agreement or otherwise.
3. MHM, being the holder of 595,000 warrants, shall reimburse the Company
in the amount of $70,000 towards the cost of legal and accounting fees
associated with the aforementioned registration statement, which amount shall be
paid upon execution of this agreement.
2
<PAGE>
IN WITNESS WHEREOF, the undersigned have executed this agreement as of the
date above written. This agreement may be signed in multiple counterparts which,
taken together, shall constitute one and the same agreement, and facsimile
signatures shall be as binding, upon the parties as an original signature.
<TABLE>
<CAPTION>
Warrantholders Warrants Held Signature
- -------------- ------------- ---------
<S> <C> <C>
By:______________________
M.H. Meyerson & Co. 595,000 Title:___________________
Delaware Charter Guaranty &
Trust Co., FBO Ronald By:______________________
Heller IRA 303,000 Title:___________________
Delaware Charter Guaranty &
Trust Co., FBO David By:______________________
Nagelberg IRA 303,000 Title:___________________
By:______________________
Martin & Co. 146,000 Title:___________________
Michael & Linda Silvestri 28,000 _________________________
Jeffery Barber 14,000 _________________________
Joel Marcus 12,000 _________________________
Rocco Vezza 12,000 _________________________
Joann Giola 12,000 _________________________
Joseph Schmidt 10,000 _________________________
Kevin Charos 10,000 _________________________
Larry Kupferberg 2,500 _________________________
Jacqueline Knapp 2,500 _________________________
TOTAL 1,450,000
</TABLE>
Agreed:
FRANKLIN TELECOMMUNICATIONS CORP.
By:_____________________________________
Frank W. Peters, Chairman and Chief
Executive Officer
3
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated September 20, 1996,
relating to the 1996 and 1995 consolidated financial statement of Franklin
Telecommunications Corp. and subsidiaries, which appears in such Prospectus. We
also consent to the use in the Prospectus constituting part of this Registration
Statement on Form S-1 of our report dated June 6, 1997, relating to the 1996
financial statements of Internet Passport, LLC, which appears in such
Prospectus. We also consent to the references to us under the headings
"Experts," "Selected Financial Data" and "Change in Accountants" in such
Prospectus. However, it should be noted that Corbin & Wertz has not prepared or
certified such "Selected Financial Data."
Corbin & Wertz
Irvine, California
January 21, 1998
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated September 17, 1997, accompanying the
consolidated financial statements of Franklin Telecommunications Corp. contained
in the Registration Statement and Prospectus. We consent to the use of the
aforementioned report in the Registration Statement and Prospectus, and to the
use of our name as it appears under the caption "Experts."
Singer Lewak Greenbaum & Goldstein LLP
Los Angeles, California
January 21, 1998
