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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11616
FRANKLIN TELECOMMUNICATIONS CORP.
(Exact Name of Registrant as Specified in its Charter)
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California 95-3733534
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
733 Lakefield Road, Westlake Village, California 91361
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (805) 373-8688
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
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Common stock, American Stock Exchange
without par value
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
--
The aggregate market value of the voting stock held by non-affiliates of the
registrant at September 13, 1999 was $78,391,304 based on the closing sale price
on such date of $3.69.
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT SEPTEMBER 13, 1999
- ----------------------------------- ---------------------------------
Common Stock, no par value 26,959,149
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Index
Franklin Telecommunications Corp.
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Part I.
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Part II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Selected Consolidated Financial Data
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
Part III.
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
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Part I.
Item 1. Business
OVERVIEW
Franklin Telecommunications Corp. ("Company") designs, builds and sells Internet
Telephony equipment, also called Voice Over Internet Protocol equipment ("VOIP")
and other high speed communications products and subsystems. Our products are
marketed through Original Equipment Manufacturers ("OEMs") and distributors, as
well as directly to end users. In addition, through our majority-owned
subsidiary, FNet Corp. ("FNet"), we provide traditional switched network and
Internet Protocol telephony services, and Internet access to businesses and
individuals. FNet has had limited operations to date. The Company's customers
are located predominantly in the United States, Canada, South America, Asia and
parts of Europe in a wide range of industries including financial services,
government, telephone services and manufacturing.
The Company offers a suite of Internet Telephony solutions that enable business
communications over the Internet. From the small office home office (SOHO) to
the branch office and HQ operations of medium to large scale corporate America,
the Company offers a cost-effective call handling solution. From the enterprise
to the carrier market, the Company can deal with "convergence" managing the
connectivity and integration of voice, data, fax and video. Where ever possible,
the Company offers a turnkey solution that can be "owned" by its customers. When
equipment sales are not in the best interest of a particular customer's business
communications solution, the Company plans to provide that solution as a
"service" that can be leased. The Company is a leading edge supplier of Internet
Telephony solutions as a result of its flexibility in providing business
communication solutions as equipment or services on a global basis. The
Company's products and services enable connectivity and e-commerce.
The Company is both an equipment supplier and a service provider, offering
turn-key business communications solutions to both the carrier and enterprise
segments of the Internet Telephony market. The Company produces gateways,
gatekeepers and edge servers that provide advanced packet switching solutions
that significantly reduce the infrastructure costs associated with
communications networks. The Company's products are designed, developed and
manufactured by the Company.
In addition to manufactured solutions, the Company maintains a Network
Operations Center that provides both "on -net" and "off-net" connectivity for
the Company's equipment customers. The Network Operations Center interconnects
the Company's customers on a global basis. The Network Operations Center
includes Internet access facilities and a Harris Class 4 circuit switch. The
center interconnects with over eleven International Record Carriers and is
capable of completing a voice call to any phone in the world. The Company's
equipment customer is offered the opportunity to access the Harris facilities
and to interconnect with each other, using the Company to enable "settlement"
between the networks. This interconnection can be either "free" through the
Internet, or delivered through private leased lines.
In addition to the Company's circuit switched capabilities at its headquarters
facility in Westlake Village, California , the Company provides a combination of
satellite and VOIP solutions to enable telephone communications for NATO forces
throughout the Bosnia region. Some 23 earth station transponders are connected
to "telephone calling booths" linked via satellite to the US where they are
interconnected via VOIP circuits to the Harris circuit switch in the Company's
headquarters. NATO soldiers, using FNET calling cards, are able to make calls
all over the world through FNET facilities.
As a result of the Company's expertise in network operations, the Company is
also able to provide additional assistance to its customers by offering design,
installation and network management services. The company believes that this
strategy of combining network operations and equipment design is a significant
product differentiation strategy, uniquely positioning the Company. The Company
may consider spinning off its Network Operations capability (i.e. FNET) when
sufficient volume and value have been created. Currently, more than 80% of
Company customers elect to interconnect with the Network Operations center. Much
like the Internet, the Company is growing with each additional gateway sale.
INDUSTRY BACKGROUND--VOIP PRODUCTS
The telecommunications industry has historically followed a path of development
based on the belief that voice and data require separate technologies and
network resources. Traditional telephone systems were, and are still, built
around an architecture that requires a dedicated connection, or circuit, in
order for a call to be completed. This technology requires the circuit to remain
dedicated between calling parties for the entire duration of a call.
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Most data today is transmitted over Internet protocol-based networks. These
networks are more efficient because they do not require a dedicated circuit for
the entire path of the call. In a network using Internet protocol, the voice,
fax, video or data is divided into packets that are simultaneously sent to a
final destination where they are reassembled back to their original form. In
this type of network, multiple types of information including voice, fax and
different forms of data can travel through the network at the same time. The
improvements in the technologies used in data networks have led to an increase
in use of this type of network to transmit both voice and data. The IP telephony
market emerged from these technological advances. Recent developments in IP
telephony technology have significantly bridged the voice quality gap between
the traditional telephone system, which is commonly referred to as a
circuit-switched system, and IP telephony systems.
A phone call transmits signals that direct a series of switches to open a
dedicated circuit to a second phone. The dedicated circuit carries the
electronic signals through the line. The phones convert the signals back into
speech. Unlike the traditional circuit switched phone call, which travels on a
dedicated circuit, the electronic signals go to a data voice gateway, which
converts them into small packets of compressed digital information. The packets
may take different routes to their destination. After traveling through the IP
network, the packets are converted back into electronic signals by another data
voice gateway and put back on the phone network.
Today a voice call placed over an IP telephony network can sound virtually
indistinguishable from the same call made over the traditional telephone system.
What distinguishes IP telephony technology, however, is that it allows service
providers to simultaneously send voice, fax and data transmissions over their
networks and enables them to quickly add and use additional features and
services without the need for costly network upgrades. In contrast, changes to
the traditional telephone system are costly and difficult. For example, based on
estimates from the International Engineering Consortium, we believe the recent
integration of such basic services as caller ID and call return services into
the traditional telephone system took over a decade and hundreds of millions of
dollars to implement in the United States alone.
The added flexibility and cost-effectiveness of IP telephony networks are
particularly important in an increasingly deregulated and competitive market
environment. Deregulation acts as a catalyst for the rapid deployment of these
services by allowing new service providers to quickly enter formerly regulated
markets and by forcing existing service providers to rapidly respond to the
challenge of competition. According to a 1998 Frost & Sullivan report, the total
number of worldwide voice minutes running over Internet protocol-based data
networks is expected to grow from 6.3 million in 1997 to 8.8 billion in 2002,
representing a compound annual growth rate of 325% for the period. Accordingly,
spending on IP telephony equipment is projected to grow from $47.3 million in
1997 to $3.2 billion in 2002, representing a compound annual growth rate of
132%.
We believe a significant market opportunity now exists for the makers of IP
telephony systems. We believe that very few of our competitors to date have
developed a comprehensive solution that incorporates the functionality that
service providers require to provide end-to-end service. Some vendors have
developed products that embed the instructions on where to route the IP
telephony call in the same equipment that provides the IP telephony technology.
This approach limits service providers' flexibility to make modifications to
their networks because any modification must be made at several different points
throughout the network.
Many vendors only provide limited billing and network management data. This data
is gathered and formatted in a simplistic fashion, limiting the ability of
service providers to manage sophisticated networks or to bill using any pricing
structure they desire. Also, these simplistic billing systems make it difficult
to connect service providers' networks to the networks of other service
providers.
Some router, switch and IP telephony companies have formed partnerships with
billing and network management technology providers in order to provide even the
most basic operational support solution to service providers. A router is a
device that routes packets over the Internet or other Internet protocol
networks. A switch is a device that takes multiple incoming calls and places
these calls onto fewer lines. This partnering necessitates integration, which
can be technologically difficult, time consuming and expensive.
Many IP telephony vendors require dedicated ports for voice, fax or data. A port
is the connection between the traditional telephone system and the IP telephony
system. Each port handles a single call. Systems that use dedicated ports are
inefficient and more costly because more ports are needed to handle the
different types of transmissions anticipated. In addition, many vendors do not
have the technical capability to integrate these ports with the traditional
telephone system so
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that the ports can correctly interpret busy signals, dial tones and disconnects.
This means that service providers cannot accurately bill for the call.
Furthermore, the inability to integrate well with the traditional telephone
system makes it more difficult for end-users to gain the benefits of this
technology because they have to dial separate phone numbers or use multi-step
dialing processes.
INDUSTRY BACKGROUND--TELEPHONE SERVICES
According to the International Telecommunications Union ("ITU"), the global
telecommunications services market has grown rapidly, increasing from
approximately $377 billion in 1990 to an estimated $700 billion in 1997 for a
compound annual growth rate ("CAGR") of 9.2%. By the year 2001, global telecom
services revenues are forecasted to exceed $1 trillion with spending on
telecommunications services growing at a CAGR of 9.5%.
The international long distance industry segment of the global
telecommunications market (consisting of the transmission of voice and data
between countries) is undergoing a period of fundamental change that has
resulted, and is expected to continue to result, in significant growth in usage
of international telecommunications services. According to the ITU, in 1996 the
international long distance telecommunications industry generated approximately
$61.3 billion in revenues and 70 billion minutes of use. This is a significant
increase from 1987 when international long distance revenues reached
approximately $23.9 billion in revenues and 19.1 billion minutes of use. The ITU
estimates that by 2000 this market may approach $85.7 billion in revenues and
122.4 billion minutes of use.
The Company believes that growth in international long distance services is
being driven by a number of factors including:
- - the globalization of the world's economies and the worldwide trend toward
deregulation of the telecommunications sector;
- - declining prices arising from increased competition generated by
privatization and deregulation;
- - increased worldwide telephone density (tele-density) and accessibility
arising from technological advances and greater investment in
telecommunications infrastructure, including the deployment of wireless
networks;
- - a wider selection of products and services; and
- - the growth in the transmission of data traffic via internal company networks
and the Internet.
The Company believes that growth of traffic originated in markets outside the
U.S. will be higher than growth in traffic originated within the U.S. due to
recent deregulation in many foreign markets, relative economic growth rates and
increasing access to telecommunications facilities in emerging markets.
Regulatory and Competitive Environment
Consumer demand and competitive initiatives have acted as catalysts for
government deregulation, especially in developed countries. Deregulation
accelerated in the U.S. in 1984 with the divestiture by AT&T of the Regional
Bell Operating Companies ("RBOCs"). Today, there are more than 500 U.S. long
distance companies, most of which are small or medium-sized companies. In order
to be successful, these small and medium-sized companies typically offer their
customers a full range of services, including international long distance.
However, most of these carriers do not have the critical mass of customers to
receive volume discounts on international traffic from larger facilities-based
carriers such as AT&T, Sprint and MCI WorldCom. In addition, these companies
have only a limited ability to invest in international facilities. Emerging
multinational carriers have capitalized on this demand for less expensive
international transmission facilities. These alternative international carriers
are able to take advantage of larger traffic volumes in order to obtain volume
discounts on international routes (resale traffic) and/or invest in facilities
when the volume of particular routes justifies such investments. As these
emerging international carriers have become established, they have also begun to
carry overflow traffic from the larger long distance providers that own overseas
transmission facilities.
Deregulation in the U.K. began in 1981 when Mercury, a subsidiary of Cable
&Wireless plc, was granted a license to operate a facilities-based network and
compete with British Telecommunications plc. In 1990, deregulation spread to
other European countries with the adoption of the "Directive on Competition in
the Markets for Telecommunication Services." A series of subsequent European
Union ("EU") directives, reports and actions are expected to result in
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substantial deregulation of the telecommunications industries in most EU member
states by the end of the decade. Further deregulation of the EU
telecommunications market will occur in 2000 upon the implementation of the EU's
Amending Directive to the Interconnection Directive, which mandates the
introduction of equal access and carrier pre-selection by 2000. A similar
movement toward deregulation has already taken place in Australia and New
Zealand, and is also taking place in Japan, Mexico, Hong Kong and other markets.
Other governments have begun to allow competition for value-added and other
selected telecommunications services and features, including data and facsimile
services and certain restricted voice services.
On February 15, 1997, the United States and 67 other countries signed the WTO
Agreement and agreed to open their telecommunications markets to competition and
foreign ownership starting in February 1998.
These 68 countries represent approximately 95% of worldwide telecommunications
traffic. The Company believes that the WTO Agreement will provide the Company
with significant opportunities to compete in international markets and provide
end-to-end facilities-based services to and from these countries. The FCC
recently released an order that significantly changes U.S. regulation of
international services in order to implement the U.S. open market commitments
under the WTO Agreement. This order is expected to increase opportunities for
foreign carriers to compete in the U.S. communications market, while increasing
opportunities for U.S. carriers to enter foreign markets and to develop
alternative termination arrangements with non-dominant carriers in other
countries.
Competitive Opportunities and Advances in Telecommunications Technology
As a result of deregulation and other competitive pressures in the global
telecommunications industry, prices for telecommunications services generally
have fallen, releasing pent-up consumer demand and creating the impetus for
improved quality and service. New technologies, including fiber optic cable and
improvements in digital compression, have played an important role in this
process by, among other things, improving the quality and speed of transmission
capacity while lowering costs. The growth of the Internet as a communications
medium, as well as advances in packet switching technology and Internet
telephony, are expected to have an increasing impact on the international
telecommunications market.
Advances in technology have created a variety of ways for telecommunications
carriers to provide customer access to their networks and services. These
include customer-paid local access, international and domestic toll-free access,
direct digital access through a dedicated line, equal access through automated
routing from the PSTN, call re-origination and Internet telephony. The type of
access offered depends on the proximity of switching facilities to the customer,
the needs of the customer and the regulatory environment in which the carrier
competes. Overall, these changes have resulted in a trend towards bypassing
traditional international long distance operating agreements as companies seek
to operate more efficiently.
As countries deregulate, the demand for alternative access methods typically
decreases because carriers are permitted to offer a wider range of
facilities-based services on a transparent basis. In a deregulated country such
as the United States, carriers can establish switching facilities, own or lease
fiber optic cable, enter into operating agreements with foreign carriers and,
accordingly, provide direct access service. In countries where deregulation has
commenced, but is not yet complete, carriers are permitted to offer
facilities-based data and facsimile services, as well as limited voice services,
although for the most part they are not yet permitted to offer full voice
telephony. In less developed markets, international long distance carriers have
used advances in technology to develop innovative alternative access methods,
such as call re-origination.
The most common form of alternative international access, traditional call
re-origination, avoids the high international rates offered by the incumbent
monopoly PTT in a particular regulated country by providing dial tone from a
deregulated country, typically the U.S. The call re-origination industry has
grown rapidly since its origination in the early 1990s. According to
International Insider, revenues from international call re-origination services
were more than $1.5 billion in 1996, an 80% increase in revenues for
international callback from 1995. To place a call using traditional call
re-origination, a user dials a unique phone number to an international carrier's
switching center and then hangs up after it rings. The user then receives an
automated callback providing dial tone from the U.S., which enables the user to
complete the call. Technical innovations, ranging from inexpensive dialers to
sophisticated in-country switching platforms, have enabled telecommunications
carriers to offer a "transparent" form of call re-origination. The customer
dials into the local switch, and then dials the international number in the
usual fashion, without the "hang-up" and "callback," and the international call
is automatically and rapidly processed. The Company believes that as
deregulation occurs and
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competition increases in various markets around the world, the pricing advantage
of traditional call re-origination to most destinations relative to conventional
international direct dial service will diminish in those markets.
Developments in the Internet Industry
Use of the Internet has grown rapidly since its initial commercialization in the
early 1990's. However, determining the precise number of Internet users is
extremely difficult because (i) the Internet does not have a single point of
control from which statistics may be recorded; (ii) computers are connected and
disconnected from the Internet on a continual basis; and (iii) a large number of
users may access the Internet through a single network. According to the
estimates of the ITU, there were approximately 60 million Internet users
worldwide at the end of 1996. In addition, the ITU estimates that the number of
Internet users may increase to 300 million by 2001. Pew Research estimates that
25% of Americans now access the Internet daily from home or work, up from only
4% in 1995.
The Internet has evolved dramatically over the last several years as a result of
several trends affecting the computer and communications industries. These
trends include:
- - the migration by organizations from proprietary mainframe environments to
open systems and distributed computing;
- - the emergence of low-cost, high-capacity telecommunications bandwidth;
- - the increased use of PCs in the home;
- - the growth of commercial on-line services;
- - the growth of information, entertainment and commercial applications; and
- - an increase in the number and variety of services available on the Internet.
Reliance on the Internet for the transmission of data, applications and
electronic commerce is growing among organizations and corporations. As the
volume of information available on organizations' computer systems has
increased, and the use of data communications has grown as a preferred means of
day-to-day communications, these organizations are increasingly seeking a number
of geographically dispersed access points to their own networks and to the
networks of other organizations. The number of interconnections that businesses
desire to establish with networks, customers, suppliers and affiliates generally
has made the development of proprietary access systems on a case-by-case basis
costly and time consuming. Increasingly, many organizations are seeking
reliable, high-speed and cost-effective means of internetworking by relying on
the Internet. The Company believes that as reliance on the Internet for the
transmission of data, applications and electronic commerce continues to grow
among organizations, these organizations will require reliable, geographically
dispersed and competitively priced Internet access and services available on
international private networks.
Internet Telephony
The Internet telephony industry began in 1995, when experienced Internet users
began to transfer voice messages from one PC to another. In 1995, VocalTec
Communications, Ltd. ("VocalTec") introduced software that allowed PC users to
place international calls via the Internet to other PC users for the price of a
local call. In its early months, the growth of Internet telephony was
constrained due to the poor sound quality of the calls and because calls were
mainly limited to those placed from one PC to another. The poor sound quality of
Internet telephony was due to the fact that the Internet was not created to
provide for simultaneous voice traffic. Unlike conventional voice communication
circuits, in which the entire circuit is reserved for a call, Internet telephony
uses packet switching technology in which voice data is divided into discrete
packets that are transmitted over the Internet. These packets must travel
through several routers in order to reach their destination, which may cause
misrouting, and delays in transmission and reception. The limited capacity of
the Internet also restrained the growth rate of Internet telephony.
Recent improvements in technology have overcome many of the initial
developmental shortcomings of Internet telephony. New software algorithms have
substantially reduced delays and the use of private networks or intranets to
transmit calls as an alternative to the public Internet has alleviated capacity
problems. The introduction of gateway servers connecting packet-switched data
networks such as the Internet to circuit-switched public telephone networks has
also improved
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overall transmission quality. Developments in hardware, software and networks
are expected to continue to improve the quality and viability of Internet
telephony.
A significant attribute of Internet telephony is the ability to reduce overall
transmission costs versus traditional circuit switched networks. Packet switched
networks are substantially less expensive to operate than circuit-switched
networks because carriers can compress voice traffic and place more calls on a
single line. In addition, packet switching avoids international settlement rates
which only apply to interconnection between circuit switched networks. The total
cost of an Internet telephone call, for example, is based on the local calls to
and from the gateways of the respective ISPs, thereby bypassing the
international settlement process. IDC estimates that by the year 2002, IP
telephony could account for 11% of U.S. and international long distance voice
traffic alone. According to Probe Research, the market for IP telephony is
expected to grow from an estimated $309 million in 1998 to approximately $4.4
billion in 2002, a 93.8% compound annual growth rate. Probe Research also
estimates that the volume of voice and fax traffic over IP networks will
increase from 31 million minutes in 1997 to approximately 55.2 million minutes
of use in 2002, for a CAGR of 346.8%. The growth in IP services far outpaces
growth expected in the circuit switched market, currently estimated to be
growing at a CAGR of 8.3%.
INDUSTRY BACKGROUND--INTERNET SERVICES
The Internet is a collection of computer networks linking millions of public and
private computers around the world. Historically, the Internet was used by
government agencies and academic institutions to exchange information, publish
research and transfer e-mail. A number of factors, including the proliferation
of communication-enabled personal computers, the availability of intuitive
graphical user interface software and the wide accessibility of an increasingly
robust network infrastructure, have combined to allow users to easily access the
Internet and, in turn, have produced rapid growth in the number of Internet
users.
The emergence of the World Wide Web, the graphical, multimedia environment of
the Internet, has resulted in the development of the Internet as a new mass
communications medium. The ease and speed of publishing, distributing and
communicating text, graphics, audio and video over the Internet has led to a
proliferation of Internet-based services, including chat, online magazines, news
feeds, interactive games and a wealth of educational and entertainment
information, as well as to the development of online communities. In addition,
the reduced cost of executing transactions over the Internet provides
individuals and organizations with a new means to conduct business.
COMPANY'S PRODUCTS AND SERVICES
Unlike many of its competitors, the Company produces its own hardware solutions.
Designed from the motherboard up, including DSP technology, voice compressors
(called VOCODERS), telephone line interfaces and system software, all Company
products are the result of internal engineering. Although the products represent
the Company's proprietary engineering, the complete product family is built on
industry standards, such as H.323, MGCP and INow, to assure interoperability and
connectivity with products manufactured by other vendors.
The Company produces a family of Internet Telephony solutions that range from
small 2 port solutions to meet the access requirements of branch office and
geographically distributed work groups; to Carrier Class solutions with 1000's
of ports of voice, fax, data and video connectivity. The Company also produces
"back office" software solutions that facilitate the integration,
interoperability and management of VOIP networks. These software solutions
include the Company's H.323/MGCP Gatekeeper; an Authentication Mapping and
Billing Server (AMAS); a "Choose to Schmooze" push to talk solution to voice
enable a website; and an Internet PBX software application. The Company's
philosophy is to use the robust, real time, fault tolerant operating system
Linux for mission critical hardware operations and Microsoft NT for back office
applications.
The Company's data voice "gateway" products are named for tropical storms: the
Tempest(R), the Typhoon(R) and the Breeze(TM):
The Breeze(TM) is a branch office access solution that enables two telephone
devices such as phones or fax machines to be interconnected to the Internet or a
managed private data network. Offering a rich feature set, the Hurricane is
fully compatible with the Tempest and Typhoon product lines. It provides full
T.38 relay fax and a wide range of voice compression options. It contains a Wide
Area Network interface with internal router and is the most cost effective VOIP
solution in the market.
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The Tempest(R) has been the Company's primary data voice gateway since
introduction in 1997. The Tempest is a PC based platform that supports 24 analog
ports per node or from 1-4 digital spans (T1/E1) per node. Using T1 Primary Rate
ISDN lines, for example, the Tempest is able to support 96 ports. The product
integrates with the Company's billing and Gatekeeper products. It is also used
to support the CTS products and is often selected as an enterprise solution by
medium to large-scale vendors.
The Typhoon(R) is the Company's Carrier Class product line and it represents our
next generation of VOIP solutions. It features 24 analog ports or 96 digital
ports in a 2U high (3.5"), rack mounted solution that is less than half the size
and power consumption of the Tempest product line. The Typhoon will support true
SS7 carrier class connectivity and will enable over 1300 ports per POP
collocation rack. Typhoon interconnects with the AMAS gatekeeper and the
Franklin family of SNMP software.
AMAS - "Authentication Mapping and Billing Server" is the core of Company's
"back office" telephone company solutions. Managing the best route (i.e. least
cost route) through a network is the job of AMAS. Determining who is authorized
to use the network, is the job of AMAS. Billing customers, either by invoice or
debit card, is the job of AMAS. When a customer puts the Tempest/Typhoon
together with an AMAS, it gets a "phone company in a box" solution that enables
NetGen Teleco's a turn-key solution for VOIP global networking.
GateKeeper - The Gatekeeper plays the role of enabling data voice gateways of
different manufacturers to "talk to each other", or "interoperate", enabling
computer to phone, website to phone and computer to computer communications.
There are several contending standards for interoperability in the market. They
are called H.323; MGCP and Inow. The Company supports all three protocols,
enabling us to reach the widest cross section of interoperability options in the
market.
Software Applications: - The Company has a suite of software applications that
provide specific business communications solutions based on the Company's
hardware products:
"Choose To Schmooze" (CTS) - is a "push to talk" button for websites. Using any
of the Company's data voice gateway family members (Tempest, Typhoon, Breeze) a
customer can voice enable its website. Visitors to the website can click on a
button that opens a real time telephone connection through the browser and
website, directly into a call center that supports the visited website.
"Linux Internet Voice Exchange" (LIVE) - This application runs on a Gatekeeper
and enables any Tempest or Typhoon to act as a complete business telephone
switching system or PBX. Suitable for use by a small business that requires both
telephone system and Internet access, the LIVE can seamlessly integrate multiple
branch offices into a "virtual corporation" regardless of where on the network
they are located. As an example, put a LIVE in New York, one in California and
one in London, and a caller to any office can be seamlessly transferred to any
other office, transparently over the Internet.
Unified Messaging - This software application enables a voice, fax or email
message to be integrated in a single "mail box" that can be accessed with a
standard Internet browser (IE or Netscape) and retrieved from any where over the
Internet.
"Internet Call Waiting" - While surfing the web, a customer can be alerted to an
incoming telephone call while using his telephone to support his computer's
modem connection. A "window" will pop up on the screen, alerting the customer to
the call and the callers identity. The customer can then "click" to accept the
call through your computer, or transfer the caller to voice messaging with a
pre-recorded customer care message!
E - Commerce Solutions - All Company software solutions can also be made
available on a "service bureau" basis. If equipment purchase is not appropriate
for a particular customer, the Company can provide the solution as a service on
an annual contract basis, payable monthly, like any other phone bill.
The Company also provides a variety of Internet services through its subsidiary
FNet, including dial up, ADSL, ISDN, frame relay, Web page hosting and various
other Internet related services. This segment of the business has played a minor
role in the Company's revenue and is not expected to contribute a significant
amount to future growth.
9
<PAGE> 10
MARKETING AND DISTRIBUTION OF PRODUCTS AND SERVICES
The Company maintains a small direct sales force for the marketing of its VOIP
and data communications products. It maintains a home page on the World Wide Web
and a headquarters-based sales and service office. It also markets its products
through Original Equipment Manufacturers (OEM), distributors, participation in
trade shows, telemarketing, and advertising in trade and technical publications.
The Company has expanded the sales and marketing operation by opening of field
offices, as well as employing manufacturers representatives.
The growth of the Internet has spawned new industries consisting of the building
of infrastructure for Next Generation Telephone Companies that utilize VOIP and
Internet Service Providers, both offering connections to corporate America as
well as private individuals. The Company designs and manufactures products which
are basic to the operation of both Next Generation Telephone Companies and
Internet Service Providers. In addition, these same products are required in the
expansion of corporate based private Intranets. Sales to large corporate
clients, Next Generation Telephone Companies and Internet Service Providers are
handled through telemarketing with in person follow-up sales calls.
MARKETING OF TELEPHONE SERVICES
The Company maintains a Network Operations Center that provides "off-net"
connectivity for the Company's equipment customers. The Network Operations
Center interconnects the Company's customers on a global basis. Telephone off
net delivery is offered to all customers that would like to connect their
networks to FNet, so that calls can be completed anywhere in the world. This
allows a customer to become a world wide telephone company, even though their
own network only directly covers a certain regional area. The Network operations
center includes Internet access facilities and a Harris Class 4 circuit switch.
The center interconnects with over eleven International Record Carriers and is
capable of completing a voice call to any phone in the world. The Company's
equipment customer is offered the opportunity to access the Harris facilities
and to interconnect with each other, using the Company to enable "settlement"
between the networks.
In addition to the Company's circuit switched capabilities at the WLV facility,
the Company provides a combination of satellite and VOIP solutions to enable
telephone communications for NATO forces throughout the Bosnia region. Prepaid
calling cards are sold through base concessionaires on a consignment basis. The
prepaid calling cards are available in several languages. Some twenty three
earth station transponders are connected to "telephone calling booths" linked
via satellite to the US where they are interconnect via VOIP circuits to the
Harris circuit switch in at the Company's headquarters. NATO soldiers, using
FNET calling cards are able to make calls all over the world through FNET
facilities.
As a result of the Company's expertise in network operations, the Company is
also able to provide additional assistance to its customers by offering design,
installation and network management services. The company believes that this
strategy of combining network operations and equipment design is a significant
product differentiation strategy, uniquely positioning the Company. The Company
will consider spinning off its network operations capability (i.e. FNET) when
sufficient velocity and value have been created. Currently, more than 80% of
Company customers elect to interconnect with the Network Operations Center. Much
like the Internet, the Company is growing with each additional Gateway sale.
On a much smaller scale, the Company also offers prepaid calling cards on a
retail basis through its web site.
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.
10
<PAGE> 11
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 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,
direct mail and its home page on the World Wide Web, and other targeted
marketing strategies.
COMPETITION - VOIP PRODUCTS
We compete in a new, rapidly evolving and highly competitive and fragmented
market. We expect competition to intensify in the future. We believe that the
main competitive factors in our market are product quality, features, cost and
customer relationships. We believe a critical component to success in this
market is the ability to establish and maintain strong customer relationships
with a wide variety of international service providers and to facilitate
relationships between those service providers to increase the geographic
coverage of their services.
Our current principal competitors include large networking equipment
manufacturers, such as 3Com Corporation and Cisco Systems, Inc., large
telecommunications equipment manufacturers, such as Lucent Technologies Inc. and
Nortel Networks Corporation, and IP telephony technology companies, such as
VocalTec Communications, Ltd. and Clarent Corporation. We also expect new
competitors to emerge. Many of our competitors are substantially larger than we
are and have significantly greater financial, sales and marketing, technical,
manufacturing and other resources and more established distribution channels and
stronger relationships with service providers. These competitors may be able to
respond more rapidly to new or emerging technologies and changes in customer
requirements or devote greater resources to the development, promotion and sale
of their products than we can. Furthermore, we believe some of our competitors
may offer aggressive sales terms, including financing alternatives, which we
might not be able to match. These competitors may enter our existing or future
markets with solutions that may be less expensive, provide higher performance or
additional features or be introduced earlier than our solutions. Given the
market opportunity, we also expect that other companies may enter our market
with better products and technologies. If any technology that is competing with
ours is more reliable, faster, less expensive or has other advantages over our
technology, then the demand for our products and services could decrease. We
expect our competitors to continue to improve the performance of their current
products and introduce new products or new technologies. Successful new product
introductions or enhancements by our competitors could reduce the sales or
market acceptance of our products and services, perpetuate intense price
competition or make our products obsolete. To be competitive, we must continue
to invest significant resources in research and development, sales and marketing
and customer support. We cannot be sure that we will have sufficient resources
to make these investments or that we will be able to make the technological
advances necessary to be competitive.
Increased competition is likely to result in price reductions, reduced gross
margins and loss of market share. Our failure to compete successfully against
current or future competitors could seriously harm our business, financial
condition and results of operations.
COMPETITION - TELEPHONE SERVICES
The Company competes with (i) large carriers, such as AT&T, Sprint and MCI
WorldCom; (ii) foreign PTTs; (iii) other providers of international long
distance services such as STAR Telecommunications, Inc., Pacific Gateway
Exchange, Inc., RSL Communications Ltd. and Telegroup, Inc.; (iv) alliances that
provide wholesale carrier services, such as "Global One" (Sprint, Deutsche
Telekom AG and France Telecom S.A.) and Uniworld (AT&T, Unisource-Telecom
Netherlands, Telia AB~ Swiss Telecom PTT and Telefonica de Espana S.A.); (v)
small long distance resellers; (vi) call re-origination companies; and (vii)
providers of IP telephony services.
11
<PAGE> 12
Primary Competitors
Of these groups listed above, the Company views its primary competition coming
from providers of IP telephony services which are listed as follows: ALPHANET
TELECOM, INC., AT&T AND AT&T JENS (SUBSIDIARY), DELTA THREE, SONERA LTD.,
GLOBALNET SYSTEMS, LTD., NET2PHONE, INC, PSINET, INC., QWEST COMMUNICATIONS
INTERNATIONAL INC. AND ITXC CORP.
COMPETITION - INTERNET SERVICES
The Internet services market in which FNet operates is extremely competitive,
and the Company expects competition in this market to intensify in the future.
The Company's current and prospective competitors include many large companies
that have substantially greater market presence and financial, technical,
marketing and other resources than the Company. The Company competes (or in the
future is expected to compete) directly or indirectly with the following
categories of companies: (i) national and regional Internet Service Providers,
such as Earthlink, IDT, MindSpring, NETCOM, PSINet and UUNET; (ii) established
online services such as America Online, CompuServe, Prodigy and the Microsoft
Network; (iii) computer software and technology companies such as Microsoft;
(iv) national telecommunications companies, such as AT&T, MCI and Sprint; (v)
the Regional Bell Operating Companies ("RBOCs"); (vi) cable operators, such as
Comcast, TCI and Time Warner; and (vii) nonprofit or educational ISPs.
The entry of new participants from these categories and the potential entry of
competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company. The ability
of these competitors or others to bundle services and products with Internet
connectivity services could place the Company at a significant competitive
disadvantage. In addition, competitors in the telecommunications industry may be
able to provide customers with reduced communications costs in connection with
their Internet access services, reducing the overall cost of Internet access and
significantly increasing pricing pressures on the Company. Moreover, certain of
the Company's online competitors, including America Online, the Microsoft
Network and Prodigy, offer unlimited access to the Internet and their
proprietary content at flat rates that are generally equivalent to the Company's
flat rate, and do not require a set-up fee. Certain of the RBOCs have also
introduced competitive flat-rate pricing for unlimited access (without a set-up
fee) for at least some period of time. As a result, competition for active users
of Internet services has intensified. There can be no assurance that the Company
will be able to offset the adverse effect on revenues of any necessary price
reductions resulting from competitive pricing pressures by increasing the number
of its customers, by generating higher revenue from enhanced services, by
reducing costs or otherwise.
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.
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.
Item 2. Properties
12
<PAGE> 13
The Company occupies three leased facilities, two in Westlake Village,
California, and one in Scottsdale, Arizona. One of the Westlake Village
facilities houses sales, software engineering, administrative, telephone and
Internet services. The facility is 8,000 square feet, with a lease rate of
$8,762 per month, expiring in October 1999. The lease for this facility is
renewable on a year-to-year basis at the option of the Company. The Company
plans to renew this lease. The other Westlake Village facility houses the
manufacturing and inventory warehouse. This facility is 4,000 square feet, with
a lease rate of $4,085 per month, expiring in February, 2000. The Scottsdale
facility houses sales and hardware engineering. This facility is 576 square
feet, with a lease rate of $815 per month, expiring in September, 1999. The
Company plans to renew this lease.
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
On June 18, 1999, the Company held its Annual Meeting of Shareholders. The
meeting provided for an election of Directors and to give approval for changing
the name of the Company at the discretion of the Board of Directors.
The current Board of Directors were reelected for a term of one year as follows:
<TABLE>
<CAPTION>
For Withhold
<S> <C> <C>
Frank W. Peters 20,818,401 373,756
Peter S. Buswell 21,116,901 72,256
Robert S. Harp 20,880,951 311,206
Herb Mitchell 20,646,826 545,331
Thomas L. Russell 21,021,301 170,856
</TABLE>
Approval of a name change for the Company at the discretion of the Board of
Directors, was adopted as follows:
<TABLE>
<CAPTION>
For Against Abstain
<S> <C> <C>
20,474,177 669,470 48,510
</TABLE>
Part II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is traded on the American Stock Exchange ("AMEX")
under the symbol FCM. During the first quarter 1999, the Company moved from the
OTC Bulletin Board to AMEX. The following table sets forth the range of high and
low bid quotation per share for the Common Stock as reported by AMEX for first
and second quarters 1999 and the OTC Bulletin Board during the prior calendar
years as 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>
1997
Third Quarter ................................... 3.25 1.56
Fourth Quarter .................................. 9.94 3.88
1998
First Quarter ................................... 6.69 4.50
Second Quarter .................................. 3.94 2.50
Third Quarter ................................... 2.56 .69
Fourth Quarter .................................. 1.24 .44
1999
First Quarter ................................... 4.22 1.25
Second Quarter .................................. 3.00 1.87
</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.
As of June 30, 1999, the Company had approximately 791 shareholders of record.
However, the majority of shares are held in street name, of which there are
approximately 7,000 shareholders
13
<PAGE> 14
Item 6. Selected Consolidated Financial Data
The selected financial data set forth below for the fiscal years ended June
30, 1997, 1998 and 1999 have been derived from the Company's consolidated
financial statements, audited by Singer, Lewak, Greenbaum & Goldstein LLP 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, 1995 and 1996 have been derived from the
Company's audited financial statements not included in this 10-K.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------------------------------------
1995 1996 1997 1998 1999
----------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Sales ................................. $ 1,481 $ 430 $ 1,735 $ 1,377 $ 10,631
Cost of sales ......................... 518 590 990 834 5,641
----------- ------------ ------------ ------------ ------------
Gross profit (loss) ................ 963 (160) 745 543 4,990
----------- ------------ ------------ ------------ ------------
Operating expenses:
Research and development expenses .. 308 320 480 1,612 1,870
Selling, general and administrative
expenses ......................... 828 947 1,766 3,304 5,602
Write-off of goodwill .............. -- 70 1,584 591 --
----------- ------------ ------------ ------------ ------------
Total operating expenses ......... 1,136 1,337 3,830 5,507 7,472
----------- ------------ ------------ ------------ ------------
Loss from operations .................. (173) (1,497) (3,085) (4,964) (2,482)
----------- ------------ ------------ ------------ ------------
Other income (expense):
Interest income..................... 250 148
Interest expense ................... (10) (26) (41) (43) (27)
Gain (loss) on extinguishment
of debt........................... 310 227 (2)
Loss on settlement of litigation....
Other .............................. 25 (5) (6) 26 (43)
----------- ------------ ------------ ------------ ------------
Total other income (expense) ..... 15 (31) 263 460 76
----------- ------------ ------------ ------------ ------------
Loss before minority interest and
income taxes ....................... (158) (1,528) (2,822) (4,504) (2,406)
Minority interest in loss of
subsidiary.......................... -- 63 -- -- --
----------- ------------ ------------ ------------ ------------
Loss before income taxes .............. (158) (1,465) (2,822) (4,504) (2,406)
Provision for income taxes ............ 2 2 2 3 7
----------- ------------ ------------ ------------ ------------
Net loss .............................. $ (160) $ (1,467) $ (2,824) $ (4,507) $ (2,413)
=========== ============ ============ ============ ============
Net loss per common share ............. $ (0.02) $ (0.14) $ (.23) $ (.29) $ (.11)
=========== ============ ============ ============ ============
Weighted average number of shares
outstanding ........................ 6,475,984 10,279,281 12,267,991 15,524,556 22,596,694
BALANCE SHEET DATA (IN THOUSANDS):
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------------------------------
1995 1996 1997 1998 1999
----- ----- ------ ------ ------
<S> <C> <C> <C> <C> <C>
Cash ............................ $ 135 $ 166 $1,464 $5,750 $1,637
Working capital (deficit) ....... 98 (206) 809 5,963 3,355
Total assets .................... 998 712 3,514 8,892 9,435
Long-term debt .................. 161 238 360 404 762
Other liabilities ............... 508 503 183 -- --
Stockholder's equity
(deficiency).................. (386) (749) 1,575 7,036 5,739
</TABLE>
14
<PAGE> 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
OVERVIEW
Franklin Telecommunications Corp. ("Company") designs, builds and sells Internet
Telephony equipment and other high speed communications products and subsystems.
Our products are marketed through Original Equipment Manufacturers ("OEMs") and
distributors, as well as directly to end users. In addition, through our
majority-owned subsidiary, FNet Corp. ("FNet"), we provide traditional switched
network and Internet Protocol telephony services, and Internet access to
businesses and individuals. FNet has had limited operations to date. The
Company's customers are located predominantly in the United States, Canada,
South America, Asia and parts of Europe in a wide range of industries including
financial services, government, telephone services and manufacturing.
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 Telephone and Internet business, newly
introduced products, development of "VOIP" 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's new products that have been under development for the past two
years have begun to generate substantial revenues, as compared to previous
years. Sales had been declining for the Company's existing legacy Wide Area
Network hardware products during the previous years, while the newly developed
DVG VOIP hardware products and Telephone and Internet services were not yet
ready for market.
The Company offers a suite of Internet Telephony solutions that enable business
communications over the Internet. From the small office home office (SOHO) to
the branch office and HQ operations of medium to large scale corporate America,
the Company offers a cost-effective call handling solution. From the enterprise
to the carrier market, the Company can deal with "convergence" managing the
connectivity and integration of voice, data, fax and video. Where ever possible,
the Company offers a turnkey solution that can be "owned" by its customers. When
equipment sales are not in the best interest of a particular customer's business
communications solution, the Company plans to provide that solution as a
"service" that can be leased. The Company is a leading edge supplier of Internet
Telephony solutions as a result of its flexibility in providing business
communication solutions as equipment or services on a global basis. The
Company's products and services enable connectivity and e-commerce.
The Company is both an equipment supplier and a service provider, offering
turn-key business communications solutions to both the carrier and enterprise
segments of the Internet Telephony market. The Company produces gateways,
gatekeepers and edge servers that provide advanced packet switching solutions
that significantly reduce the infrastructure costs associated with
communications networks. The Company's products are designed, developed and
manufactured by the Company.
In addition to manufactured solutions, the Company maintains a Network
Operations Center that provides both "on -net" and "off-net" connectivity for
the Company's equipment customers. The Network Operations Center interconnects
the Company's customers on a global basis. The Network Operations Center
includes Internet access facilities and a Harris Class 4 circuit switch. The
center interconnects with over eleven International Record Carriers and is
capable of completing a voice call to any phone in the world. The Company's
equipment customer is offered the opportunity to access the Harris facilities
and to interconnect with each other, using the Company to enable "settlement"
between the networks. This interconnection can be either "free" through the
Internet, or delivered through private leased lines.
In addition to the Company's circuit switched capabilities at its headquarters
facility in Westlake Village, California , the Company provides a combination of
satellite and VOIP solutions to enable telephone communications for NATO forces
throughout the Bosnia region. Some 23 earth station transponders are connected
to "telephone calling booths" linked via satellite to the US where they are
interconnected via VOIP circuits to the Harris circuit switch in the Company's
headquarters. NATO soldiers, using FNET calling cards, are able to make calls
all over the world through FNET facilities.
15
<PAGE> 16
As a result of the Company's expertise in network operations, the Company is
also able to provide additional assistance to its customers by offering design,
installation and network management services. The company believes that this
strategy of combining network operations and equipment design is a significant
product differentiation strategy, uniquely positioning the Company. The Company
may consider spinning off its Network Operations capability (i.e. FNET) when
sufficient volume and value have been created. Currently, more than 80% of
Company customers elect to interconnect with the Network Operations center. Much
like the Internet, the Company is growing with each additional gateway sale.
As with any line of business, there can be no assurance that the DVG VOIP
products will gain widespread market acceptance or be profitable. In addition,
there can be no assurance that new hardware products and services developed by
others will not render the Company's hardware products and services
noncompetitive or obsolete.
RESULTS OF OPERATIONS
Fiscal Year Ended June 30, 1999 Compared To Fiscal Year Ended June 30, 1998
Net Sales. Net sales increased by $9,254,000, or 672%, from $1,377,000 in
the year ended June 30, 1998 to $10,631,000 in the year ended June 30, 1999. The
overall increase is due to sales of newly introduced DVG products. One customer
constituted 76% of total sales for the year ended June 30, 1999. The revenue mix
for the year ended June 30, 1999 consisted of 82% DVG and other hardware and
software products, and 18% Telephone and Internet services.
Gross Profit (Loss). Gross profit increased as a percentage of net sales to
47% for the year ended June 30, 1999, from a gross profit of 39% of net sales
for the corresponding period of 1998. 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 $1,965,000, or 36%, from
$5,507,000 in the year ended June 30, 1998 to $7,472,000 in the year ended June
30, 1999. The increase is attributable to increased product development costs
for the recently introduced hardware products, costs in developing the IP
telephony and Internet services infrastructure, increased sales and marketing
efforts, and costs in enhancing the general and administrative infrastructure.
Other Income (Expense). The gain on extinguishment of debt for the years
ended June 30, 1998 and 1999 were one time events and were attributable to
renegotiation and reclassification of certain debt. Interest income decreased by
$102,000, or 41%, from $250,000 in the year ended June 30, 1998 to $148,000 in
the year ended June 30, 1999, due to a reduction in the availability of equity
funds for investment in interest bearing accounts. Other expense increased from
$-0- in the year ended June 30, 1998 to $43,000 in the year ended June 30, 1999,
due to various non-operating items. Other income decreased to from $26,000 in
the year ended June 30, 1998 to $-0- in the year ended June 30, 1999, due to
various non-operating items.
Fiscal Year Ended June 30, 1998 Compared To Fiscal Year Ended June 30, 1997
Net Sales. Net sales decreased by $358,000, or 21%, from $1,735,000 in the
year ended June 30, 1997 to $1,377,000 in the year ended June 30, 1998. The
overall decrease is due to reduced demand for wide area network products,
partially offset by increased demand for newly introduced hardware products, and
Internet services. Three customers constituted 49% of total sales for the year
ended June 30, 1998. The revenue mix for the year ended June 30, 1998 consisted
of 13% wide area network products, including repair services, 43% DVG and D-Mark
hardware products, and 44% Internet services.
Gross Profit (Loss). Gross profit decreased as a percentage of net sales to
39% for the year ended June 30, 1998, from a gross profit of 43% of net sales
for the corresponding period of 1997. The gross profit percentage decrease can
be attributed to decreased sales of higher margin products and a spreading of
fixed manufacturing overhead costs over a smaller sales base.
Operating Expenses. Operating expenses increased by $1,677,000, or 44%, from
$3,830,000 in the year ended June 30, 1997 to $5,507,000 in the year ended June
30, 1998. The increase is attributable to increased product development costs
for the recently introduced hardware products, costs in developing the IP
telephony and Internet services infrastructure, increased sales and marketing
efforts, and costs in enhancing the general and administrative infrastructure.
16
<PAGE> 17
Other Income (Expense). The gain on extinguishment of debt for both years
ended June 30, 1997 and 1998 were one time events and were attributable to
renegotiation and reclassification of certain debt. Interest income increased by
$250,000, from $-0- in the year ended June 30, 1997 to $250,000 in the year
ended June 30, 1998, due primarily to investment of equity funds in interest
bearing accounts. Other expense decreased by $6,000, or 100%, from $6,000 in the
year ended June 30, 1997 to $-0- in the year ended June 30, 1998, due to various
non-operating items. Other income increased by $26,000, or 100%, from $-0- in
the year ended June 30, 1997 to $26,000 in the year ended June 30, 1998, due to
various non-operating items.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $1,637,000 and
$3,355,000, respectively, as of June 30, 1999. The sources of cash were provided
primarily by collections of sales revenue, and to a lesser extent, issuance of
equity securities. However, the Company has relied on sales of new shares and
the exercise of warrants and options to supplement the funding of operations for
an extended period of time. The Company received $1,109,000, $10,355,000 and
$1,011,000 in equity financing, for the years ended June 30, 1997, 1998, and
1999, respectively. Its subsidiary, FNet, received $1,950,000, $406,000 and
$110,000 in equity financing for the years ended June 30, 1997, 1998 and 1999,
respectively. FNet has continued to experience losses, due to the expansion of
infrastructure for the IP telephony and Internet services business. In addition
to the equity financing described above, the Company's CEO has deferred portions
of his compensation, and has on occasion, converted debt to equity, in order to
preserve the Company's cash.
The Company anticipates that its primary uses of working capital in future
periods will be for operations, including increases in product development,
expansion of its marketing plan, development of new branch offices and funding
of increases in accounts receivable and possibly 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 twelve months and the foreseeable future.
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, with the exception of software specifically to
operate the billing for the switch platform , and the cost was not material. The
switch billing software will be replaced sometime within the last calendar
quarter for approximately $70,000, which has already been accrued.
17
<PAGE> 18
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
end 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
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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk generally represents the risk that losses may occur in the
values of financial instruments as a result of movements in interest rates,
foreign currency exchange rates and commodity prices. The Company is exposed to
changes in financial market conditions in the normal course of its business due
to its use of certain financial instruments as well as transacting in various
foreign currencies.
INTEREST RATE RISK. At June 30, 1999 and 1998, the Company's cash
equivalents and short-term investments included approximately $1,637,000 and
$5,750,000, respectively. Since the Company typically does not purchase
fixed-income securities, its cash and cash equivalents are not subject to
significant interest rate risk. The Company places substantially all of its
interest bearing investments with major financial institutions and by policy
limits the amount of credit exposure to any one financial institution.
Additionally, the Company does not hold or issue financial instruments for
trading, profit or speculative purposes.
EQUITY PRICE RISK The Company does not invest in available-for-sale equity
securities, and is not subject to significant equity price risk.
FOREIGN EXCHANGE RATE RISK The Company operates internationally and
sometimes receives payments in local currencies. This can expose the Company to
market risk from changes in foreign exchange rates to the extent that
transactions are not denominated in the U.S. dollar. As a result the Company
faces the risk that the foreign currencies will have declined in value as
compared to the U.S. dollar, resulting in a foreign currency translation loss.
Item 8. Financial Statements and Supplementary Data
See Part IV, Item 14
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
18
<PAGE> 19
Part III.
Item 10. Directors and Executive Officers of the Registrant
The directors and executive officers of the Company are as follows:
NAME AGE POSITION
----------------------- --- -------------------------------------------------
Frank W. Peters........ 61 Chief Executive Officer and Chairman of the Board
Peter S. Buswell....... 50 President and a Director
Robert S. Harp......... 62 Director
Herb Mitchell.......... 62 Director
Thomas Russell......... 47 Chief Financial Officer and a Director
Mr. Peters has been the Chief Executive Officer of the Company since its
organization in 1981. Between 1975 and 1984 he was also President of Franklin
Data Systems and Franklin Systems Corporation, predecessors to the Company. From
1973 to 1975, he was Vice President of Jacquard Systems Corporation, a computer
hardware and word processing software development marketer. Between 1965 and
1973 he held various marketing and sales positions with IBM.
Mr. Buswell has been the President of the Company since June 1998. Between
1996 and 1998 he was President of Xantel Corp. and Chief Marketing Officer for
TAA, a software developer engaged in the development of enterprise wide mixed
media messaging systems. During the 1980s he was manager of Strategic Planning
for the Communications Systems Group of Exxon Enterprises, the venture capital
unit of Exxon. He has also served as Director of Product Line Management at ITT
and as Manager of Program Development at Datapoint. Mr. Buswell has been a
director of the Company since 1996. He also served as a Vice President of the
Company during the 1980's.
Dr. Harp has been Chairman of Quesant Instruments, a manufacturer of
scanning probe microscopes, since 1992. Between 1987 and 1992 he was Chairman of
Vertek, a manufacturer of PC peripheral devices. He is also a founder of Vector
Graphic, Inc. Dr. Harp has been a director of the Company since 1996.
Mr. Mitchell has thirteen years experience as a stock broker with Hornblower
& Weeks in Boston. He negotiated the first cultural exchange program between Los
Angeles and her sister city Leningrad (now St. Petersburg) for which he received
a commendation from the Mayor of Los Angeles. He is currently enjoying a
successful career as an actor, writer and producer for theatre, motion pictures
and television.
Mr. Russell has been the Chief Financial Officer and a director of Franklin
Telecom since 1996. He also served as its Chief Financial Officer between 1988
and 1990. Between 1990 and 1996 Mr. Russell was President of Russell Industries,
a manufacturer's representative and distribution firm for optical storage memory
products. Prior to that time Mr. Russell was a founder and CFO of Plasmon PLC, a
UK based manufacturer of optical media and jukeboxes for the computer industry
and partner at Sorenson, Russell & Company, a public accounting firm, and was
employed by Peat Marwick. Mr. Russell is a Certified Public Accountant.
19
<PAGE> 20
Item 11. Executive Compensation
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1998 and June 30, 1999 to its CEO,
President and Chief Operating Officer, and its Chief Financial Officer (the
"Named Executive Officers").
<TABLE>
<CAPTION>
ALL OTHER
ANNUAL COMPENSATION COMPENSATION
-------------------------------- ------------
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS
- ------------------------------------------------------------- ---- ---------- -----
<S> <C> <C> <C> <C>
Frank W. Peters, CEO ......................................... 1998 $309,048(1) -0- -0-
1999 $341,583(1) -0- -0-
Peter Buswell, President and COO (2) ......................... 1998 $ 16,298 -0- -0-
1999 $226,125 -0- -0-
Thomas Russell, Chief Financial Officer ...................... 1998 $109,167 $5,000 -0-
1999 $137,016 -0- -0-
</TABLE>
(1) Portions of these amounts were deferred.
(2) Mr. Buswell was employed by the Company beginning in June 1998.
Except as disclosed above, no compensation characterized as long-term
compensation, including restricted stock awards issued at a price below fair
market value or long-term incentive plan payouts, were paid by the Company
during the years ended June 30, 1998 and 1999 to any of the Named Executive
Officers.
Employment Arrangements. The Company's CEO is employed pursuant to a six
year Employment Agreement, effective January 1, 1998. The Employment Agreement
provides for compensation at the rate of $27,000 per month, with annual
increases of 6%. The Company's President is employed pursuant to a two year
Employment Agreement, commencing within June 1998. The Employment Agreement
provides for compensation at the rate of $18,750 per month, with annual
increases of 6%. The Company's Chief Financial Officer is employed pursuant to
Employment Agreement for a two year period, commencing on January 10, 1999,
providing monthly compensation at the rate of $12,500 per month, with annual
increases of 6%.
Option Grants During the Years Ended June 30, 1998 and 1999. The following
table sets forth certain information regarding stock options granted to the
Named Executive Officers during the twelve months ended June 30, 1998 and 1999:
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES
OPTIONS IN FISCAL EXERCISE
YEAR GRANTED YEAR PRICE EXERCISE DATE
<S> <C> <C> <C> <C> <C>
---- ------- ---- ------- -------------
NAME
- -------------------
Frank W. Peters ..... 1998 -0- 0%
Frank W. Peters ..... 1999 -0- 0%
Peter Buswell(1)..... 1998 350,000 32% $ .44 Various
Peter Buswell ....... 1999 700,000 25% $ .44 Various
Thomas Russell(1).... 1998 200,000 18% $ .44 Various
Thomas Russell ...... 1999 600,000 21% $ .44 Various
</TABLE>
(1) Options granted in 1998 were cancelled in 1999 and reissued at the current
market price.
REPORT ON THE REPRICING OF OPTIONS.
On October 14, 1998, the Board of Directors of the Company approved the
cancellation and reissuance of all outstanding employee stock options. The
repricing was effective October 14,1998. The repriced options are identical to
the original options except for their exercise price, which was changed to $.44
per share, the closing price of one share of Common Stock on the effective date
of the grant. The vesting and expiration dates of the options were not changed.
20
<PAGE> 21
Stock options are intended to provide incentives to the Company's officers and
employees. The Board believes that such equity incentives are a significant
factor in the Company's ability to attract, retain and motivate key employees
who are critical to the Company's long-term success. The Board believed that, at
their original exercise prices, the disparity between the exercise price of
these options and recent market prices for the Company's Common Stock did not
provide meaningful incentives to the employees holding these options. The Board
approved the repricing of these options as a means of ensuring that optionees
will continue to have meaningful equity incentives to work toward the success of
the Company. The Board deemed the adjustment to be in the best interest of the
Company and its shareholders. The following table sets forth the specified
information concerning all options repriced for all executive officers of the
Company for the past ten years:
<TABLE>
<CAPTION>
Length of
No. of Securities Market Exercise Option Term
Underlying Price of Stock at Price at Remaining
Options Time of Time of New Exercise at Date of
Name Date Repriced Repricing Repricing Price Repricing
- ------------- ------------- -------- --------- ------------ ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Frank Peters Oct. 14, 1998 850,000 $ .44 $.78 - $1.31 $ .44 All exercisable
Peter Buswell Oct. 14, 1998 400,000 $ .44 $.66 - $2.59 $ .44 1 to 4 years
Tom Russell Oct. 14, 1998 200,000 $ .44 $ 2.69 $ .44 1 to 4 years
</TABLE>
REPORT OF THE COMPENSATION COMMITTEE. The Company's executive compensation
program is designed to help attract, retain, and motivate the highly qualified
personnel needed to manage the Company's business and affairs. To meet these
goals, the Company has implemented a compensation program with the following
components:
- - base salaries that reflect the scope and responsibilities of the position,
as well as the skills, knowledge, experience, abilities, and contributions
of each individual executive.
- - short-term incentives that are based on the financial performance of the
Company.
- - long-term incentives that balance the executive officer's short- and
long-term perspectives and provide rewards consistent with shareholder
returns.
Compensation decisions are made following an assessment of the individual's
contributions to the Company's success, any significant changes in the
individual's role or responsibility, and internal equity of the Company's
compensation relationships.
The competitiveness of the Company's total compensation
program-incorporating base salaries, short-term incentives and long-term
incentives is regularly reviewed by the Compensation Committee. Based on such
reviews, the Company concluded that the compensation paid to its executives was
fair and reasonable. In general, the Company believes that the overall
compensation levels for the executive group should reflect competitive levels of
compensation for comparable positions in similarly sized companies over the long
term.
The Company believes that it is essential to link executive compensation and
Company performance. To meet this objective, the Company maintains stock option
programs which provide option grants on a regular, though not necessarily
annual, basis to provide participants with an opportunity to share in the
Company's performance. Stock option grants reflect the past contributions of the
individual, the individual's ability to affect Company profitability, the scope
of the individual's responsibilities, the need to retain the individual's
services over time and management's assessments and recommendations. All
executive officers, including the chief executive officer, are eligible
to participate in this program.
The Company's policy of awarding cash bonuses is designed to specifically
relate executive pay to Company and individual performance. As a
pay-for-performance program, cash bonuses provide financial rewards for
achievement of substantive Company and personal objectives. Actual awards paid
are based primarily on actual Company performance.
The compensation of the Company's Chief Executive Officer, President and
Chief Financial Officer for the fiscal year ending June 30, 1999 was based on an
Employment Agreements outlined above.
21
<PAGE> 22
COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(m). The Company analyzes
its executive compensation practices and plans on an ongoing basis with respect
to Section 162(m) of the Internal Revenue Code. Where it deems advisable, the
Company will take appropriate action to maintain the tax deductibility of its
executive compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of June 30, 1999 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 .............................................. 5,344,393 20%
733 Lakefield Road
Westlake Village, CA 91361
Peter S. Buswell ............................................. 127,600 1%
733 Lakefield Road
Westlake Village, CA 91361
Robert S. Harp ............................................... 12,500 -0-
733 Lakefield Road
Westlake Village, CA 91361
Herb Mitchell ................................................ -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Thomas Russell ............................................... 230,400 1%
733 Lakefield Road
Westlake Village, CA 91361
All directors and executive officers of the Company as a group
(5 persons) ............................................... 5,714,893 22%
</TABLE>
The following table sets forth information with respect to ownership of options
and option values as of June 30, 1999 with respect to the Named Executive
Officers. The Company has no outstanding stock appreciation rights, either
freestanding or in tandem with options.
<TABLE>
<CAPTION>
OPTION VALUES AS OF JUNE 30, 1999
-----------------------------------------------------
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
JUNE 30, 1999 JUNE 30, 1999(1)
------------------------- -------------------------
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
<S> <C> <C>
Frank W. Peters....... 1,550,000/-0- $3,617,000/-0-
Peter Buswell......... 87,500/987,500 $190,750/$2,152,750
Thomas Russell........ -0-/700,000 -0-/$1,526,000
</TABLE>
(1) Assumes that a share of Common Stock was valued at $2.62 per share on June
30, 1999. Amounts reflected are based on this assumed price minus the
exercise price and do not indicate that shares were sold.
22
<PAGE> 23
Item 13. Certain Relationships and Related Transactions
TRANSACTIONS WITH MANAGEMENT
In October, 1998, the Company sold and issued 570,000 restricted shares to
the Company's Chief Executive Officer, at $.35 per share.
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. The CEO also
agreed to defer any repayment until July 1, 2000.
On March 11, 1999, the Company's President exercised options to purchase
25,000 shares of the Company's Common stock at an exercise price of $.44 per
share.
On June 1, 1999, the Company's Chief Financial Officer exercised options to
purchase 100,000 shares of the Company's Common stock at an exercise price of
$.44 per share. The exercise was done on a net basis, so that the actual number
of shares issued were 82,400.
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Financial Statements
(c) Reports on From 8-K
None.
23
<PAGE> 24
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FRANKLIN TELECOMMUNICATIONS CORP.
By /s/ FRANK W. PETERS
----------------------------------------
Frank W. Peters
Chief Executive Officer
Dated: September 15, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ---------------------------------- ----------------------------- ------------------
<S> <C> <C>
(1) Principal Executive Officer
/s/ FRANK W. PETERS Chief Executive Officer and a September 15, 1999
-------------------- Director
Frank W. Peters
(2) Principal Financial and Accounting Officer
/s/ THOMAS RUSSELL Chief Financial Officer and a September 15, 1999
------------------- Director
Thomas Russell
(3) Directors
/s/ PETER S. BUSWELL President and a Director September 15, 1999
---------------------
Peter S. Buswell
/s/ ROBERT S. HARP Director September 15, 1999
--------------------
Robert S. Harp
/s/ HERB MITCHELL Director September 15, 1999
--------------------
Herb Mitchell
</TABLE>
24
<PAGE> 25
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
25
<PAGE> 26
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
JUNE 30, 1999, 1998, AND 1997
<PAGE> 27
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONTENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1
FINANCIAL STATEMENTS
<S> <C>
Consolidated Balance Sheets 2 - 3
Consolidated Statements of Operations 4
Consolidated Statements of Shareholders' Equity (Deficit) 5 - 6
Consolidated Statements of Cash Flows 7 - 9
Notes to Consolidated Financial Statements 10 - 42
</TABLE>
<PAGE> 28
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Franklin Telecommunications Corp.
We have audited the accompanying consolidated balance sheets of Franklin
Telecommunications Corp. and subsidiaries as of June 30, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity (deficit),
and cash flows for each of the three years in the period ending June 30, 1999.
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 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 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, 1999 and 1998, and the
results of their consolidated operations and their consolidated cash flows for
each of the three years in the period ended June 30, 1999 in conformity with
generally accepted accounting principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
August 20, 1999
<PAGE> 29
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
1999 1998
------------- -------------
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 1,637,000 $ 5,750,000
Accounts receivable, less allowance for doubtful accounts
of $106,000 and $8,000 2,610,000 91,000
Other receivables 137,000 107,000
Current portion of notes receivable 150,000 241,000
Inventories 1,674,000 671,000
Prepaid expenses 81,000 555,000
------------- -------------
Total current assets 6,289,000 7,415,000
PROPERTY AND EQUIPMENT, net 2,164,000 778,000
NOTES RECEIVABLE, net of current portion 160,000 276,000
OTHER ASSETS 822,000 423,000
------------- -------------
TOTAL ASSETS $ 9,435,000 $ 8,892,000
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 30
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
JUNE 30,
- --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
CURRENT LIABILITIES
Current portion of notes payable (majority due
to a related party) $ 24,000 $ 252,000
Accounts payable 1,027,000 173,000
Accrued liabilities 1,883,000 1,027,000
------------- -------------
Total current liabilities 2,934,000 1,452,000
NOTES PAYABLE (majority due to a related party),
less current portion 762,000 404,000
------------- -------------
Total liabilities 3,696,000 1,856,000
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Series C convertible preferred stock, no par value
10,000,000 shares authorized
0 and 548 shares issued and outstanding - 4,856,000
Common stock, no par value
90,000,000 shares authorized
25,796,726 and 18,344,178 shares issued
and outstanding 21,628,000 15,571,000
Common stock committed, no par value
10,000 and 77,336 shares committed but
not yet issued 6,000 91,000
Accumulated deficit (15,895,000) (13,482,000)
------------- -------------
Total shareholders' equity 5,739,000 7,036,000
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 9,435,000 $ 8,892,000
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 31
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
SALES
<S> <C> <C> <C>
Product $ 8,767,000 $ 778,000 $ 1,337,000
Telephone and internet services 1,864,000 599,000 398,000
------------ ------------ ------------
Total sales 10,631,000 1,377,000 1,735,000
------------ ------------ ------------
COST OF SALES
Product 4,475,000 749,000 681,000
Telephone and internet services 1,166,000 85,000 309,000
------------ ------------ ------------
Total cost of sales 5,641,000 834,000 990,000
------------ ------------ ------------
GROSS PROFIT 4,990,000 543,000 745,000
------------ ------------ ------------
OPERATING EXPENSES
Research and development expenses 1,870,000 1,612,000 480,000
Selling, general, and administrative expenses 5,602,000 3,304,000 1,766,000
Write-down of goodwill -- 591,000 1,584,000
------------ ------------ ------------
Total operating expenses 7,472,000 5,507,000 3,830,000
------------ ------------ ------------
LOSS FROM OPERATIONS (2,482,000) (4,964,000) (3,085,000)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Gain (loss) on extinguishment of debt (2,000) 227,000 310,000
Interest income 148,000 250,000 --
Other income -- 26,000 --
Interest expense (27,000) (43,000) (41,000)
Other expense (43,000) -- (6,000)
------------ ------------ ------------
Total other income (expense) 76,000 460,000 263,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (2,406,000) (4,504,000)
(2,822,000)
PROVISION FOR INCOME TAXES 7,000 3,000 2,000
------------ ------------ ------------
NET LOSS $ (2,413,000) $ (4,507,000) $
============ ============ ============
(2,824,000)
BASIC AND DILUTED LOSS PER COMMON SHARE $ (0.11) $ (0.29) $ (0.23)
============ ============ ============
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 22,596,694 15,524,556 12,267,991
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 32
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
For the Years Ended June 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock Common Stock Committed
------------------------ --------------------------- ---------------------------
Shares Amount Shares Amount Shares Amount
--------- --------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1996 -- $ -- 10,868,786 $5,372,000 48,350 $30,000
COMMON STOCK ISSUED FOR
Cash 880,200 888,000 20,000 25,000
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
Services rendered 77,000 44,000 29,000
Stock options/warrants 441,750 196,000
PROCEEDS RECEIVED FROM THE
SALE OF SUBSIDIARIES'
COMMON STOCK 1,950,000
NET LOSS
--------- ---------- ---------- ---------- ---------- ---------
BALANCE, JUNE 30, 1997 -- -- 13,191,223 9,971,000 296,066 579,000
SALE OF PREFERRED STOCK 740 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (23,818) (161,000)
COMMON STOCK ISSUED FOR
Cash 333,333 1,060,000
Notes receivable 345,500
Stock options/warrants 1,838,748 2,518,000 11,000 14,000
Exchange of common shares
with related parties 400,000 161,000
Conversion of notes payable
by a related party 1,333,695 133,000
<CAPTION>
Accumulated
Deficit Total
----------- ----------
<S> <C> <C>
BALANCE, JUNE 30, 1996 $(6,151,000) $(749,000)
COMMON STOCK ISSUED FOR
Cash 913,000
Issuance for notes receivable --
Issuance of committed shares --
Business acquisition 1,983,000
Services rendered 106,000
Stock options/warrants 196,000
PROCEEDS RECEIVED FROM THE
SALE OF SUBSIDIARIES'
COMMON STOCK 1,950,000
NET LOSS (2,824,000) (2,824,000)
---------- ----------
BALANCE, JUNE 30, 1997 (8,975,000) 1,575,000
SALE OF PREFERRED STOCK 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (161,000)
COMMON STOCK ISSUED FOR
Cash 1,060,000
Notes receivable --
Stock options/warrants 2,532,000
Exchange of common shares
with related parties 161,000
Conversion of notes payable
by a related party 133,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 33
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock Common Stock
--------------------------- ---------------------------- ------------
Shares Amount Shares Amount Shares
---------- ----------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Conversion of preferred stock (192) $(1,702,000) 799,431 $ 1,702,000
Issuance of committed shares 286,066 573,000 (286,066)
Services rendered 56,336
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (842,000) (142,000)
CANCELLATION OF SHARES (160,000) (650,000)
NET LOSS
---------- ----------- ---------- ----------- ------------
BALANCE, JUNE 30, 1998 548 4,856,000 18,344,178 15,571,000 77,336
COMMON STOCK ISSUED FOR
Cash 444,725 474,000
Notes receivable 807,536
Conversion of preferred stock (548) (4,856,000) 5,543,468 4,856,000
Issuance of committed shares 67,336 85,000 (67,336)
Services rendered 121,356 64,000
Stock options/warrants 468,127 468,000
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 60,000
Stock options 50,000
NET LOSS
---------- ----------- ---------- ----------- ------------
BALANCE, JUNE 30, 1999 -- $ -- 25,796,726 $21,628,000 10,000
========== =========== ========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
Committed Accumulated
----------- ------------
Amount Deficit Total
----------- ------------ -----------
<S> <C> <C> <C>
Conversion of preferred stock $ -- $ -- $ --
Issuance of committed shares (573,000) --
Services rendered 71,000 71,000
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (984,000)
CANCELLATION OF SHARES (650,000)
NET LOSS (4,507,000) (4,507,000)
----------- ------------ -----------
BALANCE, JUNE 30, 1998 91,000 (13,482,000) 7,036,000
COMMON STOCK ISSUED FOR
Cash 474,000
Notes receivable
Conversion of preferred stock --
Issuance of committed shares (85,000) --
Services rendered 64,000
Stock options/warrants 468,000
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 60,000
Stock options 50,000
NET LOSS (2,413,000) (2,413,000)
----------- ------------ -----------
BALANCE, JUNE 30, 1999 $6,000 $(15,895,000) $ 5,739,000
=========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 34
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C> <C>
Net loss $(2,413,000) $ (4,507,000) $(2,824,000)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 434,000 167,000 110,000
Compensation expense -- 71,000 --
Write-down of goodwill -- -- 1,584,000
Notes payable for services rendered -- -- 329,000
Stock issued for services rendered 50,000 -- 106,000
Loss on disposal of property -- -- 37,000
(Increase) decrease in
Accounts receivable (2,519,000) (11,000) 14,000
Other receivables 25,000 92,000 --
Inventories (1,003,000) (277,000) (132,000)
Prepaid expenses (26,000) (487,000) (63,000)
Increase (decrease) in
Accounts payable 854,000 (2,000) (96,000)
Accrued liabilities 747,000 468,000 71,000
Other liabilities -- -- (310,000)
---------- ---------- ----------
Net cash used in operating activities (3,851,000) (4,486,000) (1,174,000)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (1,275,000) (378,000) (324,000)
Cash received in connection with business
acquisitions -- -- 4,000
Issuance of notes receivable -- (517,000) (100,000)
Proceeds from notes receivable 207,000 -- 32,000
Other assets (260,000) (272,000) (100,000)
Other liabilities -- (183,000) (38,000)
---------- ---------- ----------
Net cash used in investing activities (1,328,000) (1,350,000) (526,000)
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE> 35
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
<S> <C> <C> <C>
Proceeds from notes payable $ -- $ 129,000 $ --
Payments on notes payable -- (1,000) --
Payments on other liabilities -- -- (10,000)
Proceeds from sale of preferred stock, net of
offering costs -- 6,558,000 --
Proceeds from sale of common stock 1,011,000 3,797,000 1,109,000
Proceeds from sale of minority stock in
consolidated subsidiary 55,000 -- 1,950,000
Payments on capital lease obligation -- (361,000) (51,000)
------------ ------------ ------------
Net cash provided by financing activities 1,066,000 10,122,000 2,998,000
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents (4,113,000) 4,286,000 1,298,000
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 5,750,000 1,464,000 166,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,637,000 $ 5,750,000 $ 1,464,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INCOME TAXES PAID $ -- $ 3,000 $ 2,000
============ ============ ============
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended June 30, 1999, the Company completed the following:
- - Equipment valued at $500,000 that was prepaid at June 30, 1998 was
delivered to the Company.
- - 5,543,468 shares of common stock were issued upon the conversion of 548
shares of its Series C preferred stock.
- - Equipment with a net book value of $16,000 and the trade name "Malibu
Internet Services" were sold to an individual in exchange for a note
receivable of $55,000.
- - The current portion of a note payable to a related party for $228,000 plus
accrued interest of $130,000 was converted into a long-term note payable to
the same related party.
The accompanying notes are an integral part of these financial statements.
8
<PAGE> 36
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (CONTINUED)
During the year ended June 30, 1998, the Company completed the following:
- - Reduced goodwill valued at $591,000 to $0 as part of the repurchase of
160,000 shares of the Company's common stock.
- - Issued 1,333,695 shares of common stock upon the conversion of a note
payable by an officer of the Company for $133,000.
- - Issued 799,431 shares of common stock upon the conversion of 192 shares of
its Series C preferred stock.
- - Issued 400,000 new shares of common stock valued at $161,000 to related
parties in exchange for 23,818 shares of previously issued common stock
from related parties.
During the year ended June 30, 1997, the Company completed certain acquisitions
as described in Note 1. In conjunction with these acquisitions, aggregate
liabilities assumed were as follows:
<TABLE>
<S> <C>
Fair value of the assets acquired, net of cash and including intangibles $ 2,371,000
Value of Company and subsidiary common stock issued and committed for
consideration (1,983,000)
Cash received in connection with the acquisition 4,000
-------------
AGGREGATE LIABILITIES ASSUMED $ 392,000
=============
</TABLE>
See Notes 1 and 7 for additional non-cash investing and financing activities.
The accompanying notes are an integral part of these financial statements.
9
<PAGE> 37
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Franklin Telecommunications Corp. ("Franklin") and its subsidiaries
(collectively, the "Company") design, build, and sell Internet Telephony
equipment, also called Voice Over Internet Protocol equipment ("VOIP")
and other high speed communications products and subsystems. The
Company's 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 provides traditional switched network and Internet Protocol
telephony services and Internet access to businesses and individuals.
FNet has had limited operations to date. The Company's customers are
located primarily in the United States, Canada, South America, Asia, and
parts of Europe in a wide range of industries including financial
services, government, telephone services, and manufacturing.
The Company offers a suite of Internet Telephony solutions that enable
business communications over the Internet. From the small office home
office ("SOHO") to the branch office and headquarters operations of
medium to large scale corporate America, the Company offers a
cost-effective call handling solution. From the enterprise to the
carrier market, the Company can deal with "convergence" managing the
connectivity and integration of voice, data, fax, and video. Wherever
possible, the Company offers a turnkey solution that can be "owned" by
its customers. When equipment sales are not in the best interest of a
particular customer's business communications solution, the Company
plans to provide that solution as a "service" that can be leased. The
Company is a leading edge supplier of Internet Telephony solutions as a
result of its flexibility in providing business communication solutions
as equipment or services on a global basis. The Company's products and
services enable connectivity and e-commerce.
The Company is both an equipment supplier and a service provider,
offering turnkey business communications solutions to both the carrier
and enterprise segments of the Internet Telephony market. The Company
produces gateways, gatekeepers, and edge servers that provide advanced
packet switching solutions that significantly reduce the infrastructure
costs associated with communications networks. The Company's products
are designed, developed, and manufactured by the Company.
10
<PAGE> 38
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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, respectively, was recorded to excess of cost over fair value
of net assets of companies acquired. The 207,066 shares issued on July
31, 1997 have been recorded as common stock committed.
The acquisition of LPL was accounted for by the Company using the
purchase method of accounting. The excess of approximately $637,000
(adjusted for the $85,000 and $453,000 as mentioned above) of the total
acquisition cost over the net assets acquired and liabilities assumed
was allocated to excess of cost over fair value of net assets of
companies acquired.
During the year ended June 30, 1996, the Company completed two
acquisitions whereby the Company acquired all of the outstanding common
stock of AlphaLink ("Alpha") and Malibu Internet Services ("MIS") in
exchange for an aggregate of 110,000 shares of Franklin's common stock
and 50,000 shares of FNet common stock.
The acquisitions of Alpha and MIS were accounted for by using the
purchase method of accounting with the excess of approximately $65,000
of the total acquisition cost over the net assets acquired and
liabilities assumed being allocated to excess of cost over fair value of
net assets of companies acquired.
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 per share, which was the fair market value on December 2, 1996,
exercisable January 1, 1998. In addition, FNet issued 20,000 shares of
its common stock valued at $20,000 and granted options to purchase
80,000 shares of FNet common stock, exercisable at the rate of 20,000
shares per year at $1.00 per share in each of the four years beginning
January 1, 1998. The acquisition was accounted for as a purchase with
the excess of approximately $74,000 of the total acquisition cost over
the net assets acquired and liabilities assumed being allocated to
excess of cost over fair value of net assets of companies acquired.
11
<PAGE> 39
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Acquisitions (Continued)
On February 26, 1997, the Company agreed to acquire all of the
outstanding common stock of CPR Computer Repair ("CPR") in exchange for
25,000 shares of Franklin's common stock. As part of the agreement,
CPR's shareholder committed to pay all of the outstanding obligations of
CPR as of February 26, 1997 (the "Commitment"). The Commitment is
secured by a promissory note of $117,000. The acquisition was accounted
for using the purchase method of accounting with the excess of
approximately $61,000 of the total acquisition costs over the net assets
acquired and liabilities assumed being allocated to excess of cost over
fair value of net assets of companies acquired.
On June 30, 1997, the Company sold CPR for future royalties to be paid
by the buyer to the Company as defined in the purchase agreement. The
Company wrote-off the remaining excess of cost over fair value of net
assets acquired of approximately $61,000 related to the acquisition of
CPR due to the uncertainty of the royalty stream.
During the year ended June 30, 1998, 160,000 shares of the Company's
common stock at a value of $650,000 were returned to the Company and
cancelled, as provided under the contract. The remaining excess of cost
over fair value of net assets acquired related to the acquisition of
$591,000 was reduced to $0.
During April 1998, FNet entered into a joint venture with LibertyOne
Limited, an Australian limited liability corporation that provides
project management services and marketing and sales of
telecommunications services in New Zealand. The joint venture is to
provide voice and data communications through a FNet network to
customers in New Zealand, Australia, Asia, and the South Pacific. The
joint venture is for an initial term of five years with an option to
extend at the expiration date. As of June 30, 1998, the joint venture
had not commenced operations.
During June 1998, FNet entered into a joint venture agreement with
Megaburst, Inc. to operate an 11-site satellite telephone network in
Bosnia used by NATO troops. The joint venture will operate a network
that was purchased by Megaburst, Inc. from a third party for $150,000.
FNet advanced funds to Megaburst, Inc. for the purchase of the assets.
Megaburst, Inc. will subsequently transfer the assets to FNet.
During June 1998, FNet purchased all of the assets of LDNet, Inc. for
$20,000. These assets consisted of equipment.
12
<PAGE> 40
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of Franklin Telecommunications Corp. and its wholly-owned or majority
owned subsidiaries. All intercompany balances and transactions have been
eliminated.
Concentrations of Credit Risk
The Company sells its products throughout the United States, Canada,
Australia, and parts of Europe and South America and extends credit to
its customers and performs ongoing credit evaluations of such customers.
The Company evaluates its accounts receivable on a regular basis for
collectability and provides for an allowance for potential credit losses
as deemed necessary.
One customer accounted for 76% of the Company's product sales for the
year ended June 30, 1999. Three customers accounted for 30%, 13%, and 6%
of the Company's product sales for the year ended June 30, 1998. Two
customers accounted for 29% and 10% of the Company's product sales for
the year ended June 30, 1997. At June 30, 1999, amounts due from one
customer amounted to 92% of accounts receivable. At June 30, 1998,
amounts due from two customers amounted to 35% and 25% of accounts
receivable. At June 30, 1997, amounts due from two customers amounted to
20% and 10% of accounts receivable. One customer, a related party,
accounted for 0%, 0%, and 5% of product sales for the years ended June
30, 1999, 1998, and 1997, respectively, and comprised 0% and 0% of
accounts receivable at June 30, 1999 and 1998, respectively.
Export sales, primarily to Canada, Australia, Europe, and South America,
represented 9%, 1%, and 6% of net sales for the years ended June 30,
1999, 1998, and 1997, 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,
as well as 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.
13
<PAGE> 41
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of the assets to
future net cash flows expected to be generated by the assets. If the
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount exceeds the fair
value of the assets. To date, no impairment has occurred.
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 and cash equivalents,
accounts receivable, accounts payable, and accrued liabilities, the
carrying amounts approximate fair value due to their short maturities.
The amounts shown for notes receivable, notes payable, and capital lease
obligations also approximate fair value because current interest rates
and terms offered by and to the Company for similar notes and lease
agreements are substantially the same.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly-liquid investments purchased with original maturities of three
months or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market (estimated net
realizable value). Cost is determined using the average cost method,
which approximates the first-in, first-out ("FIFO") method. Net
realizable value is based on forecasts for sales of the Company's
products in the ensuing years. The industry in which the Company
operates is characterized by rapid technological advancement and change.
Should demand for the Company's products prove to be significantly less
than anticipated, the ultimate realizable value of the Company's
inventories could be substantially less than the amount shown on the
accompanying consolidated balance sheets.
14
<PAGE> 42
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
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 as follows:
Computers and software 5 years
Machinery and equipment 7 years
Furniture and fixtures 7 years
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
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," defines a fair value based
method of accounting for stock-based compensation. However, SFAS No. 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 No. 123 had been applied. The
Company has elected to account for its stock-based compensation to
employees under APB 25.
Excess of Cost Over Fair Value of Net Assets of Companies Acquired
Excess of cost over fair value of net assets of companies acquired
arising in connection with the aforementioned business acquisitions is
amortized using the straight-line method over five years. The Company
assesses the recoverability of these intangibles on a quarterly basis by
determining whether the amortization of the balance over its remaining
life can be recovered through projected undiscounted future cash flows.
The amount of impairment, if any, is based on fair value as measured by
future cash flows and charged to operations in the period in which
goodwill impairment is determined by management. During the years ended
June 30, 1998 and 1997, management of the Company determined that
$591,000 and $1,584,000, respectively, had been impaired and,
accordingly, the Company charged these amounts to operations.
Amortization of excess of cost over fair value of net assets of
companies acquired for the years ended June 30, 1999, 1998, and 1997
amounted to $0, $0, and $40,000, respectively.
15
<PAGE> 43
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Minority Interest
Minority interest represents the minority shareholders' proportionate
share of the equity of FNet.
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
Securities Act of 1933 provided in Rule 505 of Regulation D. After the
issuance of these shares, Franklin's ownership percentage decreased to
71% as of June 30, 1997.
During the year ended June 30, 1998, FNet sold approximately 362,000
shares of its stock to outside investors at $1.00 per share. It also
issued 35,500 shares upon the exercise of 35,500 stock options and 8,000
shares for services rendered valued at $8,000. The shares sold to
investors were issued under a private offering circular pursuant to the
exemption from registration under the Securities Act of 1933 provided in
Rule 505 of Regulation D. In addition, FNet converted a payable for
$311,000 to its parent, FTEL, into 310,718 shares of its stock. After
the issuance of these shares, Franklin's ownership percentage remained
at 71% as of June 30, 1998.
During the year ended June 30, 1999, FNet sold approximately 60,000
shares of its stock to outside investors at $1.00 per share. It also
issued 50,000 shares upon the exercise of 50,000 stock options. The
shares sold to investors were issued under a private offering circular
pursuant to the exemption from registration under the Securities Act of
1933 provided in Rule 505 of Regulation D. After the issuance of these
shares, Franklin's ownership percentage remained at 71% as of June 30,
1999.
FNet, on a stand-alone basis, had a shareholders' deficit. As a result,
Franklin's investment in FNet had a negative carrying value. The
increase in capitalization of FNet resulting from the sale of 1,949,500
shares of common stock to outside investors benefited Franklin in that
it reduced the negative carrying value of Franklin's investment in FNet.
Accordingly, Franklin has accounted for the change in its proportionate
share of FNet's equity resulting from the issuance of stock to outside
investors as an increase in shareholders' equity and a reduction in
minority interest liability in the consolidated financial statements.
16
<PAGE> 44
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Minority Interest (Continued)
The accompanying consolidated financial statements do not reflect a
minority interest liability as of June 30, 1999 and 1998 as FNet, on a
stand-alone basis, had a shareholders' deficit as of such dates. The
accompanying consolidated statements of operations for the years ended
June 30, 1999 and 1998 do not reflect the minority interest's share of
FNet's losses for said years as the related accrual would result in the
Company's recordation of a minority interest receivable.
Revenue Recognition
Revenues are recognized upon shipment of the products to customers. The
Company does not allow the right of return on sales.
Warranties
The Company provides limited warranties of one year from the date of
purchase of its products. A minimal 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.
Loss per Share
For the year ended June 30, 1998, 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 loss per share except that the denominator is increased to include
the number of additional common shares that would have been outstanding
if the potential common shares had been issued and if the additional
common shares were dilutive. Because the Company has incurred net
losses, basic and diluted loss per share are the same.
Reclassifications
Certain amounts in the 1997 and 1998 consolidated financial statements
have been reclassified to conform with the 1999 presentation.
17
<PAGE> 45
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 1 - GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Income Taxes
The Company accounts for income taxes under the asset and liability
method of accounting. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred
tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A
valuation allowance is required when it is less likely than not that the
Company will be able to realize all or a portion of its deferred tax
assets.
Comprehensive Income
For the year ended June 30, 1999, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income." This statement establishes standards
for reporting comprehensive income and its components in a financial
statement. Comprehensive income as defined includes all changes in
equity (net assets) during a period from non-owner sources. Examples of
items to be included in comprehensive income, which are excluded from
net income, include foreign currency translation adjustments and
unrealized gains and losses on available-for-sale securities.
Comprehensive income is not presented in the Company's financials
statements since the Company did not have any of the items of
comprehensive income in any period presented.
Recently Issued Accounting Pronouncements
In June 1999, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 136, "Transfer of Assets to a Not-for-Profit Organization or
Charitable Trust that Raises or Holds Contributions for Others." The
Company does not expect adoption of SFAS No. 136 to have a material
impact, if any, on its financial position or results of operations.
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities." The Company does not expect
adoption of SFAS No. 137 to have a material impact, if any, on its
financial position or results of operations.
18
<PAGE> 46
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 2 - CASH AND CASH EQUIVALENTS
The Company maintains cash deposits at banks located in California.
Deposits at each bank are insured by the Federal Deposit Insurance
Corporation up to $100,000. At times, the Company holds cash with these
banks in excess of amounts insured by federal agencies. Excess cash is
invested in money market accounts, certificates of deposit, and United
States Government agency notes. As of June 30, 1999, the uninsured
portions of these balances held at the banks aggregated to $1,410,000.
Income from these investments consists entirely of interest income in
the amount of $148,000. The aggregate carrying amount of cash and
short-term investments by major types at June 30 is as follows:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Cash $ 969,000 $ 538,000
Money market accounts 633,000 1,796,000
Certificates of deposit 35,000 1,362,000
United Sates Government agency notes - 2,054,000
------------- -------------
TOTAL $ 1,637,000 $ 5,750,000
============= =============
NOTE 3 - INVENTORIES
Inventories at June 30 consisted of the following:
1999 1998
------------- -------------
Raw materials $ 980,000 $ 260,000
Work in process 510,000 164,000
Finished goods 184,000 247,000
------------- -------------
TOTAL $ 1,674,000 $ 671,000
============= =============
</TABLE>
19
<PAGE> 47
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment at June 30 consisted of the following:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Computers and software $ 1,029,000 $ 997,000
Machinery and equipment 1,681,000 184,000
Furniture and fixtures 256,000 168,000
------------- -------------
2,966,000 1,349,000
Less accumulated depreciation 802,000 571,000
------------- -------------
TOTAL PROPERTY AND EQUIPMENT $ 2,164,000 $ 778,000
============= =============
NOTE 5 - NOTES RECEIVABLE
Notes receivable at June 30 consisted of the following:
1999 1998
------------- -------------
Note receivable from customer, bearing interest at
11.5% per annum, secured by certain
equipment, and due in August 2001. $ 160,000 $ 367,000
Note receivable from joint venture partner, bearing
interest at 10% per annum, secured by a personal
guarantee from the president of the
joint venture partners, and due in June 1999. 150,000 150,000
------------- -------------
310,000 517,000
Less current portion 150,000 241,000
------------- -------------
LONG-TERM PORTION $ 160,000 $ 276,000
============= =============
</TABLE>
20
<PAGE> 48
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 6 - ACCRUED LIABILITIES
Accrued liabilities at June 30 consisted of the following:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Salaries and related expenses $ 633,000 $ 421,000
Accrued offering costs 6,000 153,000
Accrued interest payable 27,000 130,000
Accrued sales tax 605,000 29,000
Other accrued liabilities 612,000 294,000
------------- -------------
TOTAL $ 1,883,000 $ 1,027,000
============= =============
NOTE 7 - NOTES PAYABLE
Notes payable at June 30 consisted of the following:
1999 1998
------------- -------------
Convertible notes payable to former vendors,
bearing interest at 12% per annum,
unsecured, and due in December 1999. $ 24,000 $ 24,000
Notes payable to the chief executive
officer, non-interest-bearing,
with payments due through June 2001. 762,000 632,000
------------- -------------
786,000 656,000
Less current portion 24,000 252,000
------------- -------------
LONG-TERM PORTION $ 762,000 $ 404,000
============= =============
</TABLE>
The $762,000 due to the Company's CEO represents three separate notes
that were consolidated into one non-interest-bearing promissory note on
December 31, 1998. The promissory note contains a set repayment plan
with payments through June 30, 2001. If the Company violates the plan,
the note is due on demand. As of June 30, 1999, the Company has violated
the repayment plan, but the Company's CEO has signed a waiver, deferring
all payments due until the earlier of June 30, 2000 or upon an
acquisition of the Company. As of the date of this report, no
acquisition offers have been made.
21
<PAGE> 49
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 7 - NOTES PAYABLE (CONTINUED)
Future principal payments required under such notes are summarized as
follows:
<TABLE>
<CAPTION>
Year Ending
June 30,
<S> <C>
2000 $ 24,000
2001 762,000
-------------
TOTAL $ 786,000
=============
</TABLE>
NOTE 8 - OTHER LIABILITIES
On February 5, 1993, the Company modified the terms of a note payable to
a former supplier with a balance of $572,000 that required the payment
of $30,000 in cash and an agreement to pay the former supplier $10 per
board manufactured by Franklin up to a total of $700,000. There was no
expiration date on the revised agreement. On November 29, 1994, the
agreement was further modified. The modified terms are $10 per board
sold for $300 and $2 per board sold for $300 or less. The modified
agreement was effective through June 1995, and no new modification has
been made. At June 30, 1999 and 1998, the Company estimated its future
obligation to this supplier to be $0 and $183,000, respectively, under
the modified agreement based on the number of boards expected to be
sold. Accordingly, management reduced this obligation to $0 and $183,000
during the years ended June 30, 1999 and 1998, respectively, and the
Company recognized a gain of $0 and $310,000, respectively. Amounts paid
under this agreement totaled approximately $0, $2,000, and $10,000
during the years ended June 30, 1999, 1998, and 1997, respectively.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Operating Leases and Capital Lease Obligations
The Company leases its production, warehouse, and administrative
facilities under various non-cancelable operating leases that expire
through March 2000. In addition to the minimum annual rental
commitments, the lease provides for periodic cost of living increases in
the base rent and payment by the Company of common area costs. All
leases have various renewal features. Rent expense related to the
operating leases was $170,000, $170,000, and $88,000 for the years ended
June 30, 1999, 1998, and 1997, respectively.
22
<PAGE> 50
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Operating Leases and Capital Lease Obligations (Continued)
The Company leases two condominiums from a related party on a
month-to-month basis for business travel and employee relocation. Rent
expense related to these operating leases was $49,000, $0, and $0 for
the years ended June 30, 1999, 1998, and 1997, respectively.
In connection with the acquisition of Internet Passport, LLC, a limited
liability company ("Passport"), the Company assumed six capital leases
that were assumed by Passport from two entities owned by the previous
sole member of Passport. At June 30, 1997, all six capital leases were
in default because of provisions in the leases that prohibited the
assignment of the leases. In addition, the assets underlying four of the
six leases were sold by Passport for cash, which was not used to repay
the principal, prior to its acquisition by the Company. Such sales were
also prohibited under the terms of the leases and the lessors had not
been informed of such sales. As a result, the lessors had the right to
accelerate the payments under all of the leases due to such defaults.
During the year ended June 30, 1998, the Company paid off the six leases
and recognized a gain of $45,000.
Litigation
On July 28, 1997, the Company was named as a defendant in an action
brought by AT&T Corp. ("AT&T") against Connect America, a reseller of
"800" number services, its officers and affiliates, and several Internet
Service Providers, including the Company. The action was brought in the
United States District Court for the Central District of California. In
general, the complaint alleges that Connect America and its officers
fraudulently acquired 800 numbers from AT&T, failed to pay for them, and
resold them to the Company and the other Internet Service Providers on a
"flat rate" basis, notwithstanding the fact that AT&T's charges for 800
service are typically based on time utilized. The claims against the
Company and the other Internet Service Providers are based on unjust
enrichment on the theory that the Company and the other Internet Service
Providers knew or should have known the flat rate 800 service was
unavailable. In addition to injunctive relief against Connect America
and its officers, the complaint seeks damages of $7,400,000, punitive
damages, and attorneys' fees. The Company has settled the action. Per
the settlement, terms of the agreement may not be disclosed. However,
the terms of the settlement will not materially affect the operating
results or financial position of the Company in future periods.
The Company is also involved in certain legal proceedings and claims
which arise in the normal course of business. Management does not
believe that the outcome of these matters will have a material adverse
effect on the Company's consolidated financial position or results of
operations.
23
<PAGE> 51
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
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.
License Agreements
Satellite Services
In March 1997, one of the Company's subsidiaries, 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, Passport and DigitalXPress will jointly develop a
product line, to be called "XPressNet," to furnish Internet connectivity
to the products currently marketed by DigitalXPress and to combine
marketing efforts for certain customers, applications and products. In
December 1997, the Memorandum of Understanding was cancelled.
In May 1997, one of the Company's subsidiaries, 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.
24
<PAGE> 52
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
License Agreements (Continued)
Software
During November 1997, the Company entered into a contract for software
development and a worldwide license agreement with a software
development company which was amended in May 1998 to include additional
software. The license agreement provides for a three-year term and may
be extended on a year-to-year basis thereafter. In addition to the fixed
fee of $285,000, there is a royalty of $0.75 per port for each personal
computer board sold containing the licensed software. As of June 30,
1999, $5,112 had been paid under the terms of the license agreement.
During January 1998, the Company entered into a worldwide license,
manufacturing, and sales agreement with a third party for certain
Digital Signal Processing board designs. The license fee consists of an
up-front fixed payment of $30,000, plus a royalty of $100 per board
manufactured directly, or by contract, up to a maximum total royalty of
$200,000. In addition, the Company licensed certain software to the
third party at a royalty rate of $1.00 per port. As of June 30, 1999,
$97,800 had been paid and $0 had been received under the terms of the
license agreement.
During March 1998, the Company entered into a five-year, worldwide
license agreement with a company to use certain software of this company
to create software for sale to third parties. The Company must pay a
license fee of $35,000, a royalty of $10 per port, and an annual program
maintenance and support services fee of $10,000. At June 30, 1999,
$1,360 had been paid under the license agreement.
Private Placement Exemptions
The Company and FNet's private placements of securities have been issued
in transactions intended to be exempt from registration under the
Securities Act of 1933 pursuant to the provisions of Regulation D
promulgated thereunder. These rules include factors pursuant to which
one or more private placement transactions may be integrated as part of
other offerings and include rules that limit the dollar amount that can
be raised and the number of non-accredited investors that can
participate. In the event any of the Company's private placement
transactions, including private placement transactions undertaken by the
Company since the transactions referred to above, were deemed to be
integrated, it is possible that the exemption from the registration
requirements of the Securities Act of 1933 would not be available for
one or more of those offerings. In the event that one or more of such
transactions are determined not to have been exempt from such
registration requirements, the purchasers may have the right to seek
recission of the sales and/or seek money damages against the Company.
Management believes that each of the Company's private offerings were
exempt from the registration requirements of the Securities Act of 1933.
25
<PAGE> 53
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employment Agreements
The Company has entered into employment agreements with certain
officers/directors/shareholders of FTEL and FNet for terms from two to
six years. A portion of the compensation paid pursuant to these
agreements is paid semi-monthly, and a portion is deferred and therefore
included in accrued salaries and related expenses in the accompanying
consolidated balance sheets.
NOTE 10 - SHAREHOLDERS' EQUITY
Stock Option Plans
The Company adopted an Incentive Stock Option Plan ("Plan A") and
Nonqualified Stock Option Plan ("Plan B") (the "1986 Plans"). Plan A
provides for the granting of options to purchase shares of common stock
that are intended to qualify as incentive stock options within the
meaning of Section 422A of the Internal Revenue Code, and Plan B
provides for the granting of options to purchase shares of common stock
that are not intended to qualify. The 1986 Plans provide for the
issuance of up to 700,000 shares in the aggregate at fair market value.
During the year ended June 30, 1989, the Company adopted the 1988 Stock
Option Plan (the "1988 Plan"). Under the terms of the plan, options to
purchase 300,000 shares of the Company's common stock are available for
issuance to employees, officers, and directors. Options granted may be
either incentive stock options or non-statutory options. The exercise
price of the incentive stock options and non-statutory options may not
be greater or less than 110% and 85%, respectively, of the fair market
value of the Company's common stock at the date of grant.
During the year ended June 30, 1994, the Company adopted the 1993 Stock
Option Plan (the "1993 Plan"). The 1993 Plan provides for the granting
of options to purchase up to 600,000 shares of common stock.
During the year ended June 30, 1995, the Company adopted the 1994 Stock
Option Plan (the "1994 Plan"). The 1994 Plan provides for the granting
of options to purchase up to 1,400,000 shares of common stock. Such
options will be non-statutory.
During the year ended June 30, 1998, the Company adopted the 1998 Stock
Option Plan (the "1998 Plan"). The 1998 Plan provides for the granting
of options to purchase up to 2,000,000 shares of common stock that are
intended to qualify as incentive stock options within the meaning of
Section 422A of the Internal Revenue Code.
26
<PAGE> 54
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Options granted under all of the aforementioned plans vest in accordance
with the terms established by the Company's stock option committee. All
such options granted to date have vesting periods of between two to four
years and generally terminate at the earlier of one year beyond the end
of the option period or termination of employment.
During the year ended June 30, 1999, certain outstanding options granted
to employees in prior years were repriced on October 14, 1998. Per SFAS
No. 123, the Company should incur additional compensation cost for the
excess of the fair value of the modified options issued over the value
of the original options at the date of the exchange. The Company thus
added that incremental amount to the remaining unrecognized compensation
cost for the original options at the June 30, 1999 pro forma disclosure
and recognized the total amount over the remaining years of the
remaining life of the options. The remaining expected life of the
options is five years at June 30, 1999.
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. These options were
repriced to $0.44 per share on October 14, 1998.
On April 24, 1998 and May 26, 1998, the Company granted options to
purchase 300,000 and 165,000 shares, respectively, of the Company's
common stock to key management employees which vest from two to four
years from the date of grant. The option price was set at $2.59 and
$2.69 per share, respectively, the fair value of the underlying shares.
The options are not included in the stock option plans below. These
options were repriced to $0.44 per share on October 14, 1998.
On October 14, 1998, the Company granted options to purchase 1,300,000
shares of the Company's common stock to key management employees, which
vest over four years from the date of grant. The option price was set at
$0.44 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.
27
<PAGE> 55
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Activity for the 1986 Plans, the 1988 Plan, the 1993 Plan, the 1994
Plan, and the 1998 Plan is as follows:
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
---------- ---------
<S> <C> <C>
Outstanding, June 30, 1996 2,747,500 $ 0.35
Granted 248,000 $ 1.59
Exercised (335,000) $ 0.39
Canceled (150,000) $ 0.10
----------
Outstanding, June 30, 1997 2,510,500 $ 0.49
Granted 626,500 $ 2.66
Exercised (934,250) $ 0.40
Canceled (37,500) $ 1.19
----------
Outstanding, June 30, 1998 2,165,250 $ 1.14
Granted 1,452,000 $ 0.63
Exercised (281,750) $ 0.42
Canceled (268,750) $ 2.60
----------
OUTSTANDING, JUNE 30, 1999 3,066,750 $ 0.83
==========
EXERCISABLE AT JUNE 30, 1999 1,367,125 $ 0.24
==========
</TABLE>
28
<PAGE> 56
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
The exercise prices for the options outstanding at June 30, 1999 ranged
from $0.10 to $3.22. The weighted-average remaining contractual life of
the options outstanding at June 30, 1999 is 6.0 years, and information
relating to these options is as follows:
<TABLE>
<CAPTION>
Weighted- Weighted- Weighted-
Average Average Average
Remaining Exercise Exercise
Stock Stock Contractual Price Price
Exercise Options Options Life of Options of Options of Options
Price Outstanding Exercisable Outstanding Outstanding Exercisable
------------ ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
$0.10 - 0.44 2,939,750 1,367,125 5.91 years $ 0.35 $ 0.24
$0.45 - 3.22 127,000 - 7.96 years $ 2.58 $ -
------------ -------------
3,066,750 1,367,125
============ =============
</TABLE>
The Company's majority-owned subsidiary, FNet, established a 1996 stock
option plan (the "FNet Plan") which was amended in 1998. The FNet Plan,
as amended, provides for the granting of options to purchase up to
7,000,000 shares of FNet common stock that are intended to qualify as
incentive stock options within the meaning of Section 422A of the
Internal Revenue Code. Such options will become exercisable in
accordance with the terms established by FNet's stock option committee.
All options granted to date vest between zero and four years and
generally terminate at the earlier of the end of the option period or
termination of employment.
On December 2, 1996, the Company granted options to purchase 80,000
shares of FNet's common stock to key management employees, which were
fully vested on the date of grant. The option price was set at $1.00 per
share, the fair value of the underlying shares. The options are not
included in the stock option plan below.
On May 10, 1998, the Company granted options to purchase 300,000 shares
of FNet's common stock to a key management employee, which were fully
vested on the date of grant. The option price was set at $1.00 per
share, the fair value of the underlying shares. The options are not
included in the stock option plan below.
29
<PAGE> 57
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Activity for the FNet Plan is as follows:
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
------------- -------------
<S> <C> <C>
Outstanding, June 30, 1996 448,000 $ 1.00
Granted 2,106,000 $ 1.00
-------------
Outstanding, June 30, 1997 2,554,000 $ 1.00
Granted 3,633,000 $ 1.00
Exercised (35,500) $ 1.00
Expired/cancelled (532,500) $ 1.00
-------------
Outstanding, June 30, 1998 5,619,000 $ 1.00
Granted 1,114,000 $ 1.00
Exercised (12,000) $ 1.00
Expired/cancelled (3,450,000) $ 1.00
-------------
OUTSTANDING, JUNE 30, 1999 3,271,000 $ 1.00
=============
EXERCISABLE AT JUNE 30, 1999 1,754,250 $ 1.00
=============
</TABLE>
The weighted-average remaining contractual life of the options outstanding at
June 30, 1999 is 2.01 years.
30
<PAGE> 58
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
The Company has adopted only the disclosure provisions of Statement of
Financial Accounting Standards ("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 options
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 No. 123, the
Company's net loss and loss per share would be reduced to the pro forma
amounts indicated below:
Year Ended June 30,
---------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
Net loss
As reported $ (2,413,000) $ (4,507,000) $ (2,824,000)
Pro forma $ (3,343,268) $ (4,804,000) $ (3,925,000)
Loss per common share
As reported $ (0.11) $ (0.29) $ (0.23)
Pro forma $ (0.15) $ (0.31) $ (0.32)
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 No. 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 issued to employees
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, 1999, 1998, and 1997: dividend
yields of 0%, 0%, and 0%, respectively; expected volatility of 100%,
60%, and 100%, respectively; risk-free interest rates of 5.60%, 5.54%,
and 6.20%, respectively; and expected lives of four, four, and four,
respectively. The weighted-average fair value of options granted during
the years ended June 30, 1999, 1998, and 1997 were $0.34, $0.99, and
$1.09, respectively, and the weighted-average exercise price was $0.63,
$2.66 and $1.59, respectively.
31
<PAGE> 59
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
The fair value of the FNet options issued to employees described above
was estimated at the date of grant using the minimum value method with
the following weighted-average assumptions for the years ended June 30,
1999 and 1998: dividend yields of 0% and 0%, respectively; risk-free
interest rates of 5.8% and 6.2%, respectively; and expected lives of
four and four years, respectively. The weighted-average fair value of
options granted during the years ended June 30, 1999 and 1998 was $0.20
and $0.99, respectively, and the weighted-average exercise price was
$1.00 and $1.00, respectively.
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.
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, 1999, 1998, and 1997, 600,000, 600,000, and 0 of these
warrants, respectively, had been exercised.
In connection with the 1995 Private Placement, during the years ended
June 30, 1996 and 1995, the Company issued 2,380,000 and 220,000
warrants, respectively, to purchase shares of the Company's common
stock. The exercise price of the warrants was $0.50, as amended, if
exercised on or before March 24, 1996 and $1.25 if exercised after March
24, 1996 but on or before September 30, 1998 (the expiration date).
There was no additional expense recorded in connection with the issuance
of the warrants as the exercise price approximated the fair value at the
date of issuance, as determined by management of the Company, of the
underlying stock at the date of issuance. For the years ended June 30,
1999, 1998, and 1997, 113,250, 1,841,750, and 400,000 warrants,
respectively, were exercised leaving a remaining balance of 100,000
unexercised as of June 30, 1999.
32
<PAGE> 60
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances
During the year ended June 30, 1999, the Company completed the following
significant common stock transactions of previously unissued common
shares:
- - The Company sold 444,725 shares at prices ranging from $0.50 to $2.27 for
total cash of $474,000.
- - Issued 5,543,468 shares valued at $4,856,000 upon the conversion of 548
shares of its Series C preferred common stock valued at $4,856,000.
- - The Company sold 570,000 shares valued at $200,000 to the Company's CEO.
- - Issued 121,356 shares for services valued at $64,000.
- - Issued 21,524 shares in connection with the exercise of warrants, whereby
the option holders issued notes receivable in favor of the Company for
$22,000.
- - Issued 215,514 shares in connection with the exercise of stock options,
whereby the option holders issued notes receivable in favor of the Company
for $216,000.
- - Issued 60,625 shares in connection with the exercise of stock options for
cash of $29,000.
- - Issued or committed to issue 408,000 shares in connection with the exercise
of warrants for cash of $467,000.
During the year ended June 30, 1998, the Company completed the following
significant common stock transactions of previously unissued common shares:
- - Received 23,818 shares of its common stock valued at $161,000 from certain
officers of the Company as consideration to exercise stock options for
400,000 shares also valued at $161,000.
- - In connection with the 1997 Private Placement, the Company sold 333,333
units for $1,000,000. Each unit consists of one share and one warrant to
purchase one share of the Company's common stock at an exercise price of
$5.00 per share, exercisable after October 1, 1998. The warrants expire
October 2, 2001. The Company paid no commissions or fees in connection with
this private placement. During the year ended June 30, 1999, 287,333 of the
warrants were cancelled.
33
<PAGE> 61
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
- - Issued 345,500 shares in connection with the exercise of stock options,
whereby the option holders issued notes receivable in favor of the Company
for $315,950.
- - Issued 63,750 shares in connection with the exercise of stock options for
cash of $66,000.
- - Issued or committed to issue 1,761,000 shares in connection with the
exercise of warrants for $2,261,000.
- - Committed to issue 56,336 shares for services valued at $71,000.
- - Issued 1,333,695 shares upon the conversion of a note payable by an officer
for the Company for $133,000.
- - Issued 799,431 shares valued at $1,702,000 upon the conversion of 192
shares of its Series C preferred stock valued at $1,702,000.
- - 160,000 shares of the Company's common stock at a value of $650,000 were
returned to the Company and cancelled, as provided under the contract, thus
reducing the initial purchase price of Passport.
During the year ended June 30, 1997, the Company completed the following
significant common stock transactions of previously unissued common shares:
- - Issued 880,200 shares of its common stock in connection with the 1996
Private Placement for cash of $888,000. The Company paid no commissions or
fees in connection with this private placement.
- - In December 1996 and July 1997, issued an additional 60,987 and 207,066
shares, respectively, of the Company's common stock to former shareholders
of LPL at a value of $85,000 and $453,000, respectively.
34
<PAGE> 62
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
- - In connection with the acquisition of No. 1, issued 40,000 shares, valued
at $50,000, of its common stock and options to purchase 10,000 shares,
valued at $6,000, of the Company's common stock at $1.25, which was the
fair market value on December 2, 1996, exercisable on January 1, 1998. In
connection therewith, FNet issued 20,000 shares of its common stock valued
at $20,000 and granted options to purchase 80,000 shares of FNet common
stock valued at $13,000, exercisable at the rate of 20,000 shares per year
at $1.00 per share in each of the four years beginning January 1, 1998.
- - In connection with the acquisition of CPR, committed to issued 25,000
shares of common stock for a value of $65,000 and assumed certain debt of
$4,425.
- - 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. In addition, on March 24, 1997, the Company issued an additional
7,900 shares of common stock, valued at $14,000, to satisfy certain
obligations of Passport.
- - Issued 380,000 shares in connection with the exercise of warrants for
$190,000.
- - Issued 335,000 shares in connection with the exercise of stock options.
243,250 shares were issued upon the exercise of options, whereby the option
holders issued notes receivable in favor of the Company in the amount of
129,000. 30,000 shares were issued upon the exercise of options, whereby
the option holder performed services valued at $3,000. The remaining 61,750
shares were issued for cash of $6,000.
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, 1999.
35
<PAGE> 63
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 10 - SHAREHOLDERS' EQUITY (CONTINUED)
Convertible Preferred Stock
During the year ended June 30, 1998, the Company issued 740 shares of its
Series C convertible preferred stock in a private placement for $7,400,000.
20% of the shares held may be converted to common stock four months after
issuance with an additional 20% eligible for conversion each month
thereafter, in which the limitation on conversion ends nine months after
issuance. Any unconverted shares will be automatically converted to common
shares at the later of either 18 months from issuance, the Company's common
stock being traded on a national exchange, or the filing of a registration
statement covering the resale of the common shares issued upon conversion.
Series C shares do not pay dividends and do not have voting rights. The
shares are convertible into shares of common stock at a conversion price of
$4.64 per share, subject to certain adjustments relating to the market
price of the underlying common stock. Each preferred share is accompanied
by a warrant that is exercisable to purchase shares of common stock of the
Company's subsidiary, FNet, and which, under certain circumstances, may be
exercisable to acquire shares of common stock of the Company at the
exercise price of $4.64 during September 1998. As of June 30, 1999, all
shares of preferred stock have been converted to common stock. On September
30, 1998, 995,510 of the warrants were converted into warrants exercisable
to acquire the Company's common stock, leaving 668,104 warrants exercisable
to acquire FNet's common stock. The warrants expire November 24, 2002. No
warrants have been exercised at June 30, 1999.
Form S-1
During the year ended June 30, 1998, the Company filed a Form S-1 with the
Securities and Exchange Commission to register certain shares of common
stock of the Company including the following:
- - The shares of common stock issued as part of the acquisitions of No. 1,
CPR, and Passport.
- - The common shares to be issued upon the conversion of the Series C
convertible preferred stock.
- - The common shares to be issued upon the exercise of the warrants issued in
the 1995 Private Placement.
36
<PAGE> 64
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES
The tax effects of temporary differences that give rise to deferred taxes
at June 30 are as follows:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Deferred tax assets
Accounts receivable, principally due to allowance
for doubtful accounts $ 42,000 $ 3,000
Goodwill 530,000 317,000
Compensated absences and deferred salaries,
principally due to accrual for financial reporting
purposes 233,000 146,000
Bad debt - 3,000
Inventories, principally due to additional costs
inventoried for tax purposes pursuant to the
Tax Reform Act of 1986 and allowance for
inventory obsolescence 113,000 34,000
Accrued warranty 5,000 5,000
General business tax credit carryforwards 335,000 335,000
Net operating loss carryforwards 5,621,000 4,972,000
------------- -------------
Total gross deferred tax assets 6,879,000 5,815,000
Less valuation allowance 6,759,000 5,763,000
------------- -------------
Net deferred tax assets 120,000 52,000
Deferred tax liabilities
Plant and equipment, principally due to
differences in depreciation 120,000 52,000
------------- -------------
NET DEFERRED TAX LIABILITY $ - $ -
============= =============
</TABLE>
The valuation allowance increased by approximately $996,000 and
$2,177,000 during the years ended June 30, 1999 and 1998, respectively.
No provision for income taxes for the years ended June 30, 1999, 1998,
and 1997 is required, except for minimum state taxes, since the Company
incurred losses during such years.
37
<PAGE> 65
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 11 - INCOME TAXES (CONTINUED)
Income tax expense differs from the amounts computed by applying the
United States federal income tax rate of 34% to income taxes as a result
of the following:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" tax benefit $ (818,000) $(1,572,000) $(1,450,000)
Increase in income taxes resulting from
Other 4,000 4,000 --
Change in the beginning-of-the-
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense 814,000 1,568,000 1,450,000
State income taxes 7,000 3,000 2,000
----------- ----------- -----------
TOTAL $ 7,000 $ 3,000 $ 2,000
=========== =========== ===========
</TABLE>
As of June 30, 1999, the Company had consolidated net operating loss
carryforwards of approximately $15,518,000 and $5,902,000 for federal
and state income tax reporting purposes, respectively, which expire in
varying amounts through 2014. 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 2014. Should a substantial change
in the Company's ownership occur, there could be an annual limitation on
the amount of the net operating loss carryforwards available for use in
the future.
NOTE 12 - RELATED PARTY TRANSACTIONS
The Company recorded sales of approximately $0, $0, and $82,000 to an
entity affiliated with a shareholder of the Company during the years
ended June 30, 1999, 1998, and 1997, respectively.
During the years ended June 30, 1999, 1998, and 1997, the Company issued
notes payable to the chief executive officer/majority shareholder for
$0, $129,000, and $212,000, respectively, for accrued compensation.
38
<PAGE> 66
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 12 - RELATED PARTY TRANSACTIONS (CONTINUED)
At June 30, 1999, 1998, and 1997, certain
officers/directors/shareholders of the Company had been granted
1,459,500, 1,352,500, and 1,600,000 stock options, respectively, in the
FTEL stock option plans, of which 0, 1,050,000, and 1,200,000 stock
options were exercisable, respectively, at exercise prices between $0.10
and $3.66 per share. In addition, the same
officers/directors/shareholders had been granted 1,300,000, 965,000, and
650,000 stock options outside the FTEL plans at June 30, 1999, 1998, and
1997, respectively, of which 0, 500,000, and 650,000 stock options were
exercisable, respectively, at exercise prices between $0.44 and $2.69.
At June 30, 1999, 1998, and 1997, certain
officers/directors/shareholders of the Company held 1,600,000,
2,300,000, and 650,000 stock options, respectively, in the FNet stock
option plan, of which 1,317,000, 512,525, and 300,000 stock options were
exercisable, respectively, at an exercise price of $1.00. In addition,
the same officers/directors/shareholders had been granted 0, 300,000,
and 0 stock options outside the FNet plan at June 30, 1999, 1998, and
1997, respectively, of which 0, 0, and 0 stock options were exercisable,
respectively, at an exercise price of $1.00.
NOTE 13 - 401(K) PLAN
The Company sponsors a 401(k) plan which includes a deferred feature
under section 401(k) of the Internal Revenue Code (the "Plan"). The Plan
covers all full-time employees of the Company. Contributions to the plan
are at the discretion of the Company's Board of Directors, but limited
to the amounts allowable for federal income tax purposes. Under the
section 401(k) portion of the Plan, employees may elect to contribute up
to 15% of their compensation. The Company did not make any contributions
to the Plan during the years ended June 30, 1999, 1998, and 1997.
39
<PAGE> 67
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 14 - LINES OF BUSINESS
The Company operates in two major lines of business: the manufacture and
distribution of data communications and connectivity products ("Franklin")
and Telephone and Internet services ("FNet"). Information concerning
operations in these lines of business is as follows:
<TABLE>
<CAPTION>
For the Year Ended
June 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net sales
Franklin $ 8,745,000 $ 778,000
FNet 1,886,000 599,000
------------ ------------
TOTAL $ 10,631,000 $ 1,377,000
============ ============
Operating losses
Franklin $ (104,000) $ (3,257,000)
FNet (2,378,000) (1,707,000)
------------ ------------
TOTAL $ (2,482,000) $ (4,964,000)
============ ============
Identifiable assets
Franklin $ 7,039,000 $ 7,175,000
FNet 2,396,000 1,717,000
------------ ------------
TOTAL $ 9,435,000 $ 8,892,000
============ ============
Capital expenditures
Franklin $ 130,000 $ 315,000
FNet 1,540,000 54,000
------------ ------------
TOTAL $ 1,670,000 $ 369,000
============ ============
Depreciation and amortization
Franklin $ 224,000 $ 81,000
FNet 210,000 86,000
------------ ------------
TOTAL $ 434,000 $ 167,000
============ ============
</TABLE>
Segment information is not shown for the year ended June 30, 1997
because the Internet business was not material to the operations of the
Company.
40
<PAGE> 68
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 14 - LINES OF BUSINESS (CONTINUED)
Pro Forma Information (unaudited)
The Company acquired 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. In the
opinion of management, there are no pro forma adjustments necessary to
the historical statements of operations for the year ended June 30,
1997, assuming that the acquisition occurred at the beginning of the
year, except for showing the effects of the addition of the goodwill and
its subsequent write-off. Because of the one-time unusual nature of the
goodwill write-off, management believes that the pro forma statement of
operations information is better reflected exclusive of such write-off
as follows for the year ended June 30, 1997:
<TABLE>
<CAPTION>
<S> <C>
Historical net loss $(2,824,000)
Add goodwill write-down related to Passport 835,000
-----------
Adjusted historical net loss (1,989,000)
Add Passport losses prior to acquisition (171,000)
PRO FORMA NET LOSS EXCLUSIVE OF GOODWILL $(2,160,000)
===========
Adjusted historical net loss per share exclusive of goodwill
write-down $ (0.16)
Impact of Passport loss (0.01)
PRO FORMA NET LOSS PER SHARE EXCLUSIVE OF GOODWILL $ (0.17)
===========
</TABLE>
NOTE 15 - YEAR 2000 ISSUE
The Company is conducting a comprehensive review of its computer systems
to identify the systems that could be affected by the Year 2000 Issue
and is developing an implementation plan to resolve the Issue.
The Issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that
do not properly recognize such information could generate erroneous data
or cause a system to fail. The Company is dependent on computer
processing in the conduct of its business activities.
Based on the review of the computer systems, management has accrued
$70,000 for the estimated costs to ensure Year 2000 compliance, which is
included in Accrued Liabilities.
41
<PAGE> 69
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED JUNE 30,
- --------------------------------------------------------------------------------
NOTE 16 - SUBSEQUENT EVENTS
Subsequent to June 30, 1999, the Company entered into an equity line of
credit for the sale of up $6,500,000 of common stock.
42
<PAGE> 70
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FRANKLIN TELECOMMUNICATIONS CORP.
By /s/ FRANK W. PETERS
------------------------------
Frank W. Peters
Chief Executive Officer
Dated: September 15, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------ ----------------------- -------------------
(1) Principal Executive
Officer
<S> <C> <C>
/s/ FRANK W. PETERS Chief Executive Officer September 15, 1999
- ------------------------ and a Director
Frank W. Peters
(2) Principal Financial
and Accounting Officer
/s/ THOMAS RUSSELL Chief Financial Officer September 15, 1999
- ------------------------ and a Director
Thomas Russell
(3) Directors
/s/ PETER S. BUSWELL President and a Director September 15, 1999
- ------------------------
Peter S. Buswell
/s/ ROBERT S. HARP Director September 15, 1999
- ------------------------
Robert S. Harp
/s/ HERB MITCHELL Director September 15, 1999
- ------------------------
Herb Mitchell
</TABLE>
<PAGE> 71
EXHIBIT INDEX
Exhibit No. Description
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 1,637,000
<SECURITIES> 0
<RECEIVABLES> 3,003,000
<ALLOWANCES> 106,000
<INVENTORY> 1,674,000
<CURRENT-ASSETS> 6,289,000
<PP&E> 2,966,000
<DEPRECIATION> 802,000
<TOTAL-ASSETS> 9,435,000
<CURRENT-LIABILITIES> 2,934,000
<BONDS> 0
0
0
<COMMON> 21,634,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 9,435,000
<SALES> 10,631,000
<TOTAL-REVENUES> 10,631,000
<CGS> 5,641,000
<TOTAL-COSTS> 5,641,000
<OTHER-EXPENSES> 7,127,000
<LOSS-PROVISION> 242,000
<INTEREST-EXPENSE> 27,000
<INCOME-PRETAX> (2,406,000)
<INCOME-TAX> 7,000
<INCOME-CONTINUING> (2,413,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,413,000)
<EPS-BASIC> (0.11)
<EPS-DILUTED> (0.11)
</TABLE>
