<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER PERIOD ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11616
FRANKLIN TELECOMMUNICATIONS CORP.
(Exact Name of Registrant as Specified in its Charter)
---------------
<TABLE>
<S> <C>
California 95-3733534
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
733 Lakefield Road, Westlake Village, California 91361
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (805) 373-8688
---------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes[ X] No [ ]
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
<TABLE>
<S> <C>
TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT JANUARY 29, 1999
- ----------------------------------- --------------------------------
Common Stock, no par value 24,699,277
</TABLE>
<PAGE> 2
Index
Franklin Telecommunications Corp.
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 1998 (Unaudited) and June 30, 1998
Consolidated Statements of Operations (Unaudited) Three months and six
months ended December 31, 1998 and 1997
Consolidated Statements of Cash Flows (Unaudited) Six months ended
December 31, 1998 and 1997
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE> 3
Item 1. Financial Statements
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 (UNAUDITED) AND JUNE 30, 1998
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------- -----------
1998 1998
------------- -----------
(UNAUDITED)
ASSETS
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<S> <C> <C>
Current assets
Cash and cash equivalents .................................. $ 2,724,000 $ 5,750,000
Accounts receivable, less allowance for doubtful accounts of
$53,000 (unaudited) and $8,000, respectively ............. 294,000 91,000
Other receivables .......................................... 138,000 107,000
Current portion of note receivable ......................... 241,000 241,000
Inventories (Note 2) ....................................... 652,000 671,000
Prepaid expenses ........................................... 163,000 555,000
------------ ------------
Total current assets ..................................... 4,212,000 7,415,000
------------ ------------
Property and equipment
Machinery and equipment .................................... 1,442,000 184,000
Furniture and fixtures ..................................... 168,000 168,000
Computers and software ..................................... 1,039,000 997,000
------------ ------------
2,649,000 1,349,000
Less accumulated depreciation .............................. 714,000 571,000
------------ ------------
Total property and equipment ............................. 1,935,000 778,000
------------ ------------
Note receivable, net of current portion ...................... 277,000 276,000
Other assets ................................................. 499,000 423,000
------------ ------------
Total assets ............................................. $ 6,923,000 $ 8,892,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities
Current portion of long-term debt (majority due to a related
party) ................................................... $ 541,000 $ 252,000
Accounts payable ........................................... 442,000 173,000
Accrued liabilities ........................................ 1,192,000 1,027,000
------------ ------------
Total current liabilities ................................ 2,175,000 1,452,000
Long-term debt, (majority due to a related party) net of
current portion ............................................ 115,000 404,000
------------ -----------
Total liabilities ........................................ 2,290,000 1,856,000
------------ ------------
Contingencies (Note 3)
Shareholders' equity
Preferred stock, no par value 10,000,000 shares authorized,
Convertible Series C 223 (unaudited) and 548 shares issued
and outstanding .......................................... 1,976,000 4,856,000
Common stock, no par value 90,000,000 shares authorized
21,601,213 (unaudited) and 18,344,178 shares issued and
outstanding .............................................. 18,503,000 15,571,000
Common stock committed, no par value 77,336 (unaudited) and
77,336 shares committed but not yet issued ............... 91,000 91,000
Accumulated deficit ........................................ (15,937,000) (13,482,000)
------------ ------------
Total shareholders' equity ............................... 4,633,000 7,036,000
------------ ------------
Total liabilities and shareholders' equity ............... $ 6,923,000 $ 8,892,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 4
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND SIX MONTHS ENDED DECEMBER 31, 1998 AND 1997 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
DECEMBER 31, DECEMBER 31,
------------ ------------
1998 1997 1998 1997
---- ---- ---- ----
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Sales
Product .......................... $ 953,000 $ 161,000 $ 1,625,000 $ 237,000
Internet services ................ 287,000 123,000 548,000 291,000
----------- ----------- ----------- -----------
Total sales .................. 1,240,000 284,000 2,173,000 528,000
----------- ----------- ----------- -----------
Cost of sales
Product .......................... 509,000 44,000 787,000 141,000
Internet services ................ 306,000 119,000 491,000 256,000
----------- ----------- ----------- -----------
Total cost of sales .......... 815,000 163,000 1,278,000 397,000
----------- ----------- ----------- -----------
Gross profit ......................... 425,000 121,000 895,000 131,000
----------- ----------- ----------- -----------
Operating expenses
Research and development expenses 448,000 385,000 866,000 506,000
Selling, general, and
administrative Expenses ........ 1,361,000 639,000 2,553,000 1,488,000
----------- ----------- ----------- -----------
Total operating expenses ..... 1,809,000 1,024,000 3,419,000 1,994,000
----------- ----------- ----------- -----------
Loss from operations ................. (1,384,000) (903,000) (2,524,000) (1,863,000)
----------- ----------- ----------- -----------
Other income (expense)
Interest income .................. 31,000 66,000 91,000 66,000
Interest expense ................. (13,000) (14,000) (25,000) (31,000)
Other income ..................... 1,000 (17,000) 4,000 --
----------- ----------- ----------- -----------
Total other income ........... 19,000 35,000 70,000 35,000
----------- ----------- ----------- -----------
Loss before provision for income taxes
and minority interest .............. (1,365,000) (868,000) (2,454,000) (1,828,000)
Provision for income taxes ........... -- -- 1,000 --
----------- ----------- ----------- -----------
Loss before minority interest ........ $(1,365,000) $ (868,000) $(2,455,000) $(1,828,000)
Minority interest in subsidiary ...... 75,000 -- -- --
----------- ----------- ----------- -----------
Net loss ..................... $(1,290,000) $ (868,000) $(2,455,000) $(1,828,000)
=========== =========== =========== ===========
Basic net loss per common share ...... $ (.06) $ (.06) $ (.13) $ (.13)
=========== =========== =========== ===========
Diluted net loss per common share .... $ (.06) $ (.06) $ (.13) $ (.13)
=========== =========== =========== ===========
Weighted average common shares
Outstanding used to compute basic .. 20,872,059 15,383,037 19,875,641 14,449,384
loss per common share =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 5
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 AND 1997 (UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
-----------------------------
1998 1997
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................ $(2,455,000) $(1,828,000)
Adjustments to reconcile net loss to net
cash Used in operating activities
Depreciation and amortization ....... 181,000 136,000
Provision for loss on obsolete
inventory ......................... 100,000 --
Provision for loss on doubtful
accounts .......................... 46,000 10,000
Stock issued for services rendered .. 33,000 --
(Increase) decrease in
Accounts receivable ................. (249,000) (79,000)
Other receivables ................... 24,000 --
Inventories ......................... (81,000) (207,000)
Prepaid expenses .................... (108,000) (11,000)
Increase in
Accounts payable .................... 269,000 62,000
Accrued liabilities ................. 126,000 5,000
----------- -----------
Net cash used in operating Activities ... (2,114,000) (1,912,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment ..... (822,000) (201,000)
Issuance of notes receivable ............ (1,000) (4,000)
Other assets ............................ (108,000) (171,000)
----------- -----------
Net cash used in investing activities ... (931,000) (376,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on other liabilities ........... -- (1,000)
Proceeds from sale of Company stock ..... 1,000 7,960,000
Proceeds from sale of minority stock in
Consolidated subsidiary ............... 18,000 284,000
Payments on capital lease obligation .... -- (89,000)
----------- -----------
Net cash provided by financing activities 19,000 8,154,000
----------- -----------
Net increase (decrease) in cash ......... (3,026,000) 5,866,000
Cash and cash equivalents, beginning of
the period ............................ 5,750,000 1,464,000
----------- -----------
Cash and cash equivalents, end of the
period ................................ $ 2,724,000 $ 7,330,000
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
1998 1997
----------- -----------
(unaudited) (unaudited)
Interest paid $ -- $ --
========== ==========
Income taxes paid $ -- $ 2,000
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 6
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX
MONTHS ENDED DECEMBER 31, 1998 AND 1997 (UNAUDITED) (CONTINUED)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES.
During the six months ended December 31, 1998, the Company completed the
following:
o Equipment valued at $500,000 that was prepaid at June 30, 1998 was delivered
to the Company.
o The Company issued 3,151,740 shares of common stock upon the conversion of 325
shares of its Series C preferred stock.
o The Company sold equipment with a net book value of $16,000 and the trade name
"Malibu Internet Services" to an individual in exchange for a note receivable
of $55,000.
The accompanying notes are an integral part of these financial statements.
<PAGE> 7
FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE 1--GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Franklin Telecommunications Corp. ("Franklin") and its subsidiaries
(collectively the "Company") manufacture and distribute data and telephony
communications, access and connectivity products for IP Telephony networks, T-1
and X.25 wide-area networks and provide IP Telephony and 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, South America and parts of Europe in a wide
range of industries including financial services, government, telephone services
and manufacturing.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all normal, recurring adjustments considered
necessary for a fair presentation have been included. The financial statements
should be read in conjunction with the audited financial statements included in
the Company's annual report on Form 10-K for the fiscal year ended June 30,
1998. The results of operations for the three months and six months ended
December 31, 1998 are not necessarily indicative of the results that may be
expected for the fiscal year ending June 30, 1999.
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.
Loss Per Common Share
For the three month and six month periods ended December 31, 1998 and 1997,
the Company adopted SFAS No. 128 "Earnings per Share." Basic loss per share is
computed by dividing loss available to common shareholders by the
weighted-average number of common shares outstanding. Diluted loss per share is
computed similar to basic losses per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Common stock equivalents have been excluded from
the aforementioned computations as their effect would be anti-dilutive.
<PAGE> 8
Income Taxes
The Company accounts 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. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is required when
it is less likely than not that the Company will be able to realize all or a
portion of its deferred tax assets.
Recently Issued Accounting Pronouncements
SFAS 130, "Reporting Comprehensive Income" issued by the Financial
Accounting Standards Board is effective for financial statements with fiscal
years beginning after December 15, 1997. Earlier application is permitted. SFAS
130 establishes standards for reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements. The
Company does not expect adoption of SFAS 130 to have a material impact, if any,
on its financial position or results of operations.
The Financial Accounting Standards Board issued SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information," effective for fiscal years
beginning after December 15, 1997. SFAS 131 requires a company to report certain
information about its operating segments including factors used to identify the
reportable segments and types of products and services from which each
reportable segment derives its revenues. The Company does not anticipate any
material change in the manner that it reports its segment information under this
new pronouncement.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Post Retirement Benefits." This statement is not
applicable to the Company.
In June 1998, The FASB issued SFAS No.133, "Accounting for Derivative
Instruments and Hedging Activities." This statement established accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities and is
effective for fiscal years beginning after June 15, 1999. Management believes
that SFAS No. 133 will not have an effect on the Company's financial statements.
SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held by a Mortgage Banking Enterprise," was
issued in October 1998. This statement is not applicable to the Company.
NOTE 2--INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------ --------
1998 1998
---- ----
(UNAUDITED)
<S> <C> <C>
Raw materials... $171,000 $260,000
Work in process. 179,000 164,000
Finished goods.. 302,000 247,000
-------- --------
Total....... $652,000 $671,000
======== ========
</TABLE>
NOTE 3--CONTINGENCIES
Legal Proceedings
On July 28, 1997 the Company was named as a defendant in an action brought
by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number
service, its officers and affiliates, and several Internet Service Providers,
<PAGE> 9
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. The Company
settled the matter in December 1998.
NOTE 4--RECENT SALE OF EQUITY SECURITIES
During the three months ended December 31, 1998, the Company issued 1,804,218
shares of common stock upon the conversion of 167 shares of Series C Convertible
Preferred Stock. The Company did not receive any proceeds from this conversion.
During the three months ended December 31, 1998, the Company sold and issued
570,000 restricted shares to the Company's Chief Executive Officer, at $.35 per
share. The issued shares are subject to a one year holding period.
During the three months ended December 31, 1998, the Company issued 92,795
restricted shares, in lieu of salaries for employees, at $.35 per share. The
issued shares are subject to a one year holding period.
NOTE 5 - NOTES PAYABLE TO OFFICER
Effective December 31, 1998, the Company's Chief Executive Officer agreed
to consolidate all notes payable and accrued interest owed to the CEO by the
Company into one single note. Changes to the note include no interest charges
from January 1, 1999, onward, removal of all security interest in the Company's
assets and elimination of previous stock conversion features.
<PAGE> 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
Franklin Telecommunications Corp. (the "Company") designs, manufactures and
markets high speed communications products and subsystems. The products are
marketed through original equipment manufacturers ("OEMs") and distributors, as
well as directly to end users. In addition, through its majority-owned
subsidiary, FNet, the Company is a provider of Internet access and services,
including Internet telephony, to businesses and individuals. The Company is a
California corporation formed in 1981.
Forward-looking statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, including statements regarding
the Company's entrance into the Internet business, newly introduced products,
development of "telephone-to-telephone" service capabilities over the Internet,
net sales, gross profit, operating expenses, other income and expenses,
liquidity and cash needs and the Company's plans and strategies are all based on
current expectations, and the Company assumes no obligation to update this
information. Numerous factors could cause actual results to differ from those
described in the forward-looking statements.
The Company has re-focused its business over the past two years from
manufacturing primarily LAN and WAN products to providing telecommunications and
Internet products and services. Beginning in the year ended June 30, 1998 and
continuing in the three months and six months ended December 31, 1998, the
Company has begun to generate revenues from these new business lines. Sales had
been declining for the Company's existing hardware products during the previous
years, while the newly developed hardware products and Internet services were
not yet ready for market. Demand for the Company's new products, including the
Data Voice Gateway and D-Mark Channel Bank hardware product lines are now coming
into fruition.
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.
FNet is now beginning to produce revenues from its international next generation
IP Telephony network.
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 Data Voice Gateway, or DVG, is a further evolution of the D-Mark, which adds
the capability of transmitting voice and fax traffic over the Internet and Frame
relay circuits. The Company has several other products under various stages of
development, which have at their roots DVG technology. Many of these products
will be introduced over the coming year.
As with any new line of business, there can be no assurance that the Data
Voice Gateway and D-Mark Channel Bank and other newly developed communications
products will sustain widespread market acceptance or be profitable. In
addition, there can be no assurance that new hardware products and services
developed by others will not render the Company's hardware products and services
noncompetitive or obsolete.
RESULTS OF OPERATIONS
Three Months Ended December 31, 1998 Compared To Three Months Ended
December 31, 1997
Net Sales. Net sales increased by $956,000, or 337%, from $284,000 in the
three months ended December 31, 1997 to $1,240,000 in the three months ended
December 31, 1998. The increase is due both to increased DVG hardware systems
sales and increasing telephone revenue from the Company's subsidiary FNet. The
revenue mix for the three months ended December 31, 1998 consisted of 23%
Telephone and Internet services revenue and 77% hardware product sales.
<PAGE> 11
Gross Profit. Gross profit decreased as a percentage of net sales to 34% for
the three months ended December 31, 1998, from a gross profit of 43% of net
sales for the corresponding period of 1997. The gross profit percentage decrease
can be attributed to increased infrastructure costs for the Company's subsidiary
FNet. FNet has been building out facilities and capacity in anticipation of
future services revenue. Hardware margins remain high, reaching 47% for the
three months ended December 31, 1998.
Operating Expenses. Operating expenses increased by $785,000, or 77%, from
$1,024,000 in the three months ended December 31, 1997 to $1,809,000 in the
three months ended December 31, 1998. The increase is attributable to increased
product development costs for hardware products under development, costs in
developing the Internet and telephony services infrastructure, increased sales
and marketing efforts, and costs in enhancing the general and administrative
infrastructure.
Other Income (Expense). Interest income decreased by $35,000 , or 53%, from
$66,000 in the three months ended December 31, 1997 to $31,000 in the three
months ended December 31, 1998, due to reduced cash balances available to earn
interest. Interest expense decreased by $1,000, or 7%, from $14,000 in the three
months ended December 31, 1997 to $13,000 in the three months ended December 31,
1998, due primarily to a reduction in loans from an officer of the Company.
Other income (expense) changed by $18,000, from an expense of $17,000 in the
three months ended December 31, 1997 to income of $1,000 in the three months
ended December 31, 1998, due to various non operating items.
Six Months Ended December 31, 1998 Compared To Six Months Ended December 31,
1997
Net Sales. Net sales increased by $1,645,000, or 312%, from $528,000 in the
six months ended December 31, 1997 to $2,173,000 in the six months ended
December 31, 1998. The increase is due both to increased DVG hardware systems
sales and increasing telephone revenue from the Company's subsidiary FNet. The
revenue mix for the six months ended December 31, 1998 consisted of 25%
Telephone and Internet services revenue and 75% hardware product sales.
Gross Profit. Gross profit increased as a percentage of net sales to 41% for
the six months ended December 31, 1998, from a gross profit of 25% of net sales
for the corresponding period of 1997. The gross profit percentage increase can
be attributed to increased sales of higher margin hardware products. Telephone
and Internet services produced a relatively low margin during the same period
due to increased infrastructure costs for the Company's subsidiary FNet. FNet
has been building out facilities and capacity in anticipation of future services
revenue.
Operating Expenses. Operating expenses increased by $1,425,000, or 71%, from
$1,994,000 in the six months ended December 31, 1997 to $3,419,000 in the six
months ended December 31, 1998. The increase is attributable to increased
product development costs for hardware products under development, costs in
developing the Internet and telephony services infrastructure, increased sales
and marketing efforts, and costs in enhancing the general and administrative
infrastructure.
Other Income (Expense). Interest income increased by $25,000, or 38%, from
$66,000 in the six months ended December 31, 1997 to $91,000 in the six months
ended December 31, 1998, due to increased cash balances available to earn
interest over a longer period. Interest expense decreased by $1,000, or 7%, from
$14,000 in the three months ended December 31, 1997 to $13,000 in the three
months ended December 31, 1998, due primarily to a reduction in loans from an
officer of the Company. Other income increased by 100%, from $-0- in the six
months ended December 31, 1997 to $4,000 in the six months ended December 31,
1998, due to various non operating items.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $2,724,000 and
$2,037,000, respectively, as of December 31, 1998. The primary source of cash
was net proceeds generated from equity financings. The Company has relied on
sales of new shares and the exercise of warrants and options to fund operations
for an extended period of time. The Company received $10,150,000 and $201,000 in
equity financing, for the year ended June 30, 1998, and the six months ended
December 31, 1998, respectively. Its subsidiary, FNet, raised $398,000 for the
year ended June 30, 1998 and $18,000 for the six months ended December 31, 1998.
FNet has continued to experience losses, due to the growth nature of the
Internet services business and development of the IP Telephony business. In
addition to the equity financing
<PAGE> 12
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 increases in product development, expansion of its marketing
plan, development of new branch offices and funding of increases in accounts
receivable.
The Company believes that existing cash and cash equivalents, cash flow from
operations and cash raised through private placements will be sufficient to meet
the Company's presently anticipated working capital needs for at least the next
13 months. To the extent the Company uses its cash resources for acquisitions,
the Company may be required to obtain additional funds, if available, through
borrowings or equity financings. There can be no assurance that such capital
will be available on acceptable terms. If the Company is unable to obtain
sufficient financing, it may be unable to fully implement its growth strategy.
YEAR 2000 COMPLIANCE
The "Year 2000" issue concerns the potential exposures related to the
possible automatic generation of business and financial misinformation resulting
from the application of computer programs which have been written using two
digits, rather than four, to define the applicable year of business
transactions. When the year 2000 begins, programs with such date-related logic
will not be able to distinguish between the years 1900 and 2000, potentially
causing software and hardware to fail, generating erroneous calculations or
presenting information in an unusable format.
The Company is dependent on multiple computer servers and the third-party
computer programs running on them to provide data in support of its accounting
and engineering functions. Also, FNet's ability to route its traffic in a cost
effective manner, to deliver a material portion of its services, to properly
obtain payment for such services, and/or to maintain accurate records of its
business and operations, could be substantially impaired until such issue is
resolved. The Company's plan for year 2000 compliance includes the following
phases: (i) conducting a comprehensive inventory of the Company's internal
systems, including information technology systems and non-information technology
systems (which include switching, billing and other platforms and electrical
systems) and the systems acquired or to be acquired by the Company from third
parties, (ii) assessing and prioritizing any required changes, upgrades, or
enhancements, (iii) resolving any problems by repairing or, if appropriate,
replacing the non-compliant systems, (iv) testing all remediated systems for
Year 2000 compliance, and (v) developing contingency plans that may be employed
in the event that any system used by the Company or FNet is unexpectedly
affected by a previously unanticipated problem relating to the Year 2000.
In recognition of the potential year 2000 problem, the Company began a
program to replace any of its existing communications, engineering and
accounting software that is not year 2000 compliant with new software that is
warranted by its vendors as being year 2000 compliant. The software replacement
program has been completed, and the cost was not material.
The Company has relationships with various third parties on whom it relies
to provide goods and services necessary for the manufacture and distribution of
its products. These include suppliers and vendors. As part of its determination
of year 2000 readiness, the Company has identified material relationships with
third party vendors and is in the process of assessing the status of their
compliance through the use of informal inquiries and review of hardware and
software documentation. The Company expects this process will be complete by the
first quarter of 1999 and the cost will not be material.
The components purchased by the Company in connection with the manufacture
of its products are available through numerous independent sources. Due to the
broad diversification of these sources, the risk associated with potential
business interruptions as a result of year 2000 non-compliance by one or more
sources is not considered significant. It is anticipated that the steps the
Company has taken and is continuing to take to deal with the year 2000 problem
will reduce the risk of significant business interruptions, but there is no
assurance that this outcome will be achieved. Failure to detect and correct all
internal instances of non-compliance or the inability of third parties to
achieve timely compliance could result in the interruption of normal business
operations which could, depending on its duration, have a material adverse
<PAGE> 13
effect on the Company. In particular, FNet may experience problems to the extent
that other telecommunications carriers to which the Company sends traffic for
termination are not Year 2000 compliant. FNet's ability to determine the
capacity of these third parties to address issues relating to the Year 2000
problem is necessarily limited. To the extent that a limited number of carriers
experience disruptions in service due to the Year 2000 issue, the Company
believes that it will be able to obtain service from alternate carriers.
However, the Company's ability to provide certain services to customers in
selected geographic locations may be limited. There can be no assurance that
such problems will not have a material adverse effect on the Company.
<PAGE> 14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 28, 1997 the Company was named as a defendant in an action brought
by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number
service, its officers and affiliates, and several Internet Service Providers,
including the Company. The action was brought in the U.S. District Court for the
Central District of California. In general, the complaint alleges that Connect
America and its officers fraudulently acquired 800 numbers from AT&T, failed to
pay for them, and resold them to the Company and the other Internet Service
Providers on a "flat rate" basis, notwithstanding the fact that AT&T's charges
for 800 service are typically based on time utilized. The claims against the
Company and the other Internet Service Providers are based on unjust enrichment,
on the theory that the Company and the other Internet Service Providers knew or
should have known that flat rate 800 service was unavailable. The Company
settled the matter in December 1998.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on From 8-K
None
<PAGE> 15
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FRANKLIN TELECOMMUNICATIONS CORP.
By: /s/ FRANK W. PETERS
-------------------------------------
Frank W. Peters
Chief Executive Officer
By: /s/ THOMAS L. RUSSELL
-------------------------------------
Thomas L. Russell
Chief Financial Officer
Dated: February 5, 1999
<PAGE> 16
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,724,000
<SECURITIES> 0
<RECEIVABLES> 347,000
<ALLOWANCES> 53,000
<INVENTORY> 652,000
<CURRENT-ASSETS> 4,212,000
<PP&E> 2,649,000
<DEPRECIATION> 714,000
<TOTAL-ASSETS> 6,923,000
<CURRENT-LIABILITIES> 2,175,000
<BONDS> 0
1,976,000
0
<COMMON> 18,594,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 6,923,000
<SALES> 1,240,000
<TOTAL-REVENUES> 1,240,000
<CGS> 815,000
<TOTAL-COSTS> 815,000
<OTHER-EXPENSES> 1,777,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,000
<INCOME-PRETAX> (1,365,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,365,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,365,000)
<EPS-PRIMARY> (.07)
<EPS-DILUTED> (.07)
</TABLE>
