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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, 2000
[ ] 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.)
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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:
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Title of each class Name of each exchange
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Common stock, American Stock Exchange
without par value
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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 20, 2000 was $38,021,291 based on the closing sale price
on such date of $1.00.
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
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TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT SEPTEMBER 20, 2000
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Common Stock, no par value 38,021,291
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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, manufactures 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. The Company's customers are located throughout the
world 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 data networks. From the small office home office (SOHO) to
the branch office and headquarters operations of medium to large scale
corporations, the Company offers a cost-effective call handling solution. From
the enterprise to the carrier market, the Company offers converged network
solutions; 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 aims to be
a leading edge supplier of Internet Telephony solutions as a result of its
flexibility in providing on net and off net business communication solutions as
customer owned equipment or Franklin provided 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 Class 4 circuit switch. The center
interconnects with three International Record Carriers and is capable of
completing a voice call to any phone in the world. The Company's equipment and
services customers are offered the opportunity to access the circuit switched
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 21 earth station transponders are connected
to "telephone calling booths" linked via satellite to the US where they are
interconnected via VOIP circuits to the 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. Many of the
Company's 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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Much 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 that the ports can correctly interpret busy signals, dial
tones and disconnects. This means that service providers cannot
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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
telecommunication services revenues are forecasted to exceed $1 trillion with
spending on telecommunications services growing at a cumulative annual growth
rate 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 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
substantial deregulation of the telecommunications industries in most EU member
states by the end of the decade. Further
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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 cumulative annual growth rate 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.
THE 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 Company plans to comply with 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 type solutions with thousands
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 Gatekeeper; an Authentication Mapping and Billing Server
(Softswitch 2000) and "Click to Speak" a push to talk solution to voice enable a
website or e-mail. 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. 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 its
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) will be 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 configuration 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 Softswitch
2000 gatekeeper and the Franklin family of SNMP software. The Company plans to
release the Typhoon in late 2000.
Softswitch 2000 -- is an "Authentication Mapping and Billing Server" and is the
core of the Company's "back office" telephone company solutions. It is designed
to manage the best route (i.e. least cost route) through a network, determine
who is authorized to use the network, and bill customers, either by invoice or
debit card. When a customer puts the Tempest/Typhoon together with a Softswitch
2000, it gets a "phone company in a box" solution that enables next generation
telephone companies 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 plans to support all three
protocols, enabling us to reach the widest cross section of interoperability
options in the market.
"Click to Speak" (CTS) -- is a "push to talk" button for websites. Using the
Company's Tempest and Typhoon data voice gateways, 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.
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.
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.
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 Class 4 circuit switch. The
center interconnects with three 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 circuit switched facilities
and to interconnect with each other, using the Company to enable "settlement"
between the networks.
<PAGE> 10
In addition to the Company's circuit switched capabilities at its headquarters
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. Prepaid calling cards are sold through base concessionaires
on a consignment basis. The prepaid calling cards are available in several
languages. Twenty one earth station transponders are connected to "telephone
calling booths" linked via satellite to the US where they are interconnect via
VOIP circuits to the 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. Many of the
Company's 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.
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
<PAGE> 11
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.
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)
<PAGE> 12
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.
EMPLOYEES
As of September 15, 2000, The Company had 44 employees. The Company's employees
are not represented by any collective bargaining organization and the Company
has never experienced a work stoppage. The Company believes that its relations
with its employees are good.
Item 2. Properties
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 9,900 square feet, with a lease rate of
$8,981 per month, expiring in October 2000. 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 7,100 square feet, with
a lease rate of $8,080 per month, expiring in March, 2003. The Scottsdale
facility houses sales and hardware engineering. This facility is 2,049 square
feet, with a lease rate of $2,089 per month, expiring in December, 2002.
Item 3. Legal Proceedings
During June 2000, two shareholders who acquired their shares in a
private placement in March 2000, filed a lawsuit against Franklin and
officer-directors Frank W. Peters and Thomas L. Russell. The lawsuit sought to
postpone the June 28, 2000 annual stockholders meeting, based upon alleged
deficiencies in the proxy materials pertaining to the meeting. At a Court
hearing held on June 28, 2000, the Court declined to enjoin the meeting as
requested by plaintiffs. Thereafter, plaintiffs amended the lawsuit several
times and ultimately added new claims pertaining to the private placement and
alleging securities law violations. A motion to dismiss those claims was filed
by Franklin and is scheduled for hearing on October 16, 2000. Because Franklin
believes the lawsuit is without merit, it is being vigorously defended. Franklin
also has engaged in on-going settlement discussions in order to end the expense
and distraction of litigation.
<PAGE> 13
Item 4. Submission of Matters to a Vote of Security Holders
On June 28, 2000, the Company held its Annual Meeting of Shareholders. The
meeting provided for an election of Directors.
The current members of the Board of Directors were reelected for a term of one
year, as follows:
<TABLE>
<CAPTION>
Votes For Withhold
<S> <C> <C>
Frank W. Peters 23,945,111 4,606,490
Robert S. Harp 23,968,269 4,563,332
Herb Mitchell 23,950,067 4,581,534
Thomas L. Russell 23,959,067 4,572,534
Sidney B. Smith 24,367,667 4,163,934
</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. The following table sets forth the range of high
and low bid quotation per share for the Common Stock as reported by AMEX for the
first and second calendar quarters of 2000 and for calendar year 1999, and the
OTC Bulletin Board during the third and fourth calendar quarters of 1998. The
bid price reflects inter-dealer prices and does not include retail mark-up,
markdown, or commission.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1998
Third Quarter............... 2.56 .69
Fourth Quarter.............. 1.24 .44
1999
First Quarter............... 4.22 1.25
Second Quarter.............. 3.00 1.87
Third Quarter............... 3.69 1.38
Fourth Quarter.............. 4.00 1.94
2000
First Quarter............... 2.94 1.87
Second Quarter.............. 2.00 .69
</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, 2000, the Company had approximately 814 shareholders of record.
<PAGE> 14
Item 6. Selected Consolidated Financial Data
The selected financial data set forth below for the fiscal years ended
June 30, 1998, 1999 and 2000 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, 1996 and 1997 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,
--------------------------------------------------------------------------------
1996 1997 1998 1999 2000
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Sales ......................................... $ 430 $ 1,735 $ 1,377 $ 10,631 $ 3,207
Cost of sales ................................. 590 990 834 5,641 4,775
------------ ------------ ------------ ------------ ------------
Gross profit (loss) ........................ (160) 745 543 4,990 (1,568)
------------ ------------ ------------ ------------ ------------
Operating expenses:
Research and development expenses .......... 320 480 1,612 1,870 1,834
Selling, general and administrative
expenses ................................. 947 1,766 3,304 5,602 7,518
Impairment of long-lived assets ............ 70 1,584 591 -- 224
------------ ------------ ------------ ------------ ------------
Total operating expenses ................. 1,337 3,830 5,507 7,472 9,576
------------ ------------ ------------ ------------ ------------
Loss from operations .......................... (1,497) (3,085) (4,964) (2,482) (11,144)
------------ ------------ ------------ ------------ ------------
Other income (expense):
Interest income ............................ -- -- 250 148 68
Interest expense ........................... (26) (41) (43) (27) (109)
Abandonment of property and equipment ...... -- -- -- -- (367)
Other ...................................... (5) (6) 26 (43) (56)
------------ ------------ ------------ ------------ ------------
Total other income (expense) ............. (31) (47) 233 78 (464)
------------ ------------ ------------ ------------ ------------
Loss before minority interest,
income taxes and extraordinary item ........ (1,528) (3,132) (4,731) (2,404) (11,608)
Minority interest in loss of subsidiary ....... 63 -- -- -- --
------------ ------------ ------------ ------------ ------------
Loss before income taxes and extraordinary item (1,465) (3,132) (4,731) (2,404) (11,608)
Provision for income taxes .................... 2 2 3 7 3
------------ ------------ ------------ ------------ ------------
Loss before extraordinary item ................ (1,467) (3,134) (4,734) (2,411) (11,611)
Extraordinary item
Gain (loss) on extinguishment of debt, net . -- 310 227 (2) 60
Net loss ...................................... $ (1,467) $ (2,824) $ (4,507) $ (2,413) $ (11,551)
============ ============ ============ ============ ============
Net loss per common share ..................... $ (0.14) $ (.23) $ (.29) $ (.11) $ (.39)
============ ============ ============ ============ ============
Weighted average number of shares
outstanding ................................ 10,279,281 12,267,991 15,524,556 22,596,694 29,797,493
</TABLE>
BALANCE SHEET DATA (IN THOUSANDS):
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------------------------------
1996 1997 1998 1999 2000
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Cash ............................ $ 166 $1,464 $5,750 $1,637 $1,275
Working capital (deficit) ....... (206) 809 5,963 3,355 2,792
Total assets .................... 712 3,514 8,892 9,435 7,157
Long-term debt .................. 238 360 404 762 782
Other liabilities ............... 503 183 -- -- --
Stockholder's equity (deficiency) (749) 1,575 7,036 5,739 4,906
</TABLE>
<PAGE> 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
RESULTS OF OPERATIONS
Fiscal Year Ended June 30, 2000 Compared To Fiscal Year Ended June 30,
1999
Net Sales. Net sales decreased by $7,424,000, or 70%, from $10,631,000
in the year ended June 30, 1999 to $3,207,000 in the year ended June 30, 2000.
The overall decrease is attributable to the loss of a single customer that
constituted 76% of total sales for the year ended June 30, 1999. The revenue mix
for the year ended June 30, 2000 consisted of 35% DVG and other hardware and
software products, and 65% Telephone and Internet services.
Gross Profit (Loss). Gross profit decreased as a percentage of net
sales to a loss of (49)% for the year ended June 30, 2000, from a gross profit
of 47% of net sales for the corresponding period of 1999. The gross profit
percentage decrease can be attributed to a combination of carrier termination
costs exceeding flat rate revenues for telephone services and fixed
manufacturing overhead costs exceeding the margins produced by a smaller
hardware sales base.
Operating Expenses. Operating expenses increased by $2,104,000, or 28%,
from $7,472,000 in the year ended June 30, 1999 to $9,576,000 in the year ended
June 30, 2000. The increase is attributable to increased sales and marketing
efforts, accounting charges associated with cashless exercise of employee stock
options, and costs in enhancing the general and administrative infrastructure.
Other Income (Expense). Interest income decreased by $80,000, or 54%,
from $148,000 in the year ended June 30, 1999 to $68,000 in the year ended June
30, 2000, due to a reduction in the availability of equity funds for investment
in interest bearing accounts. Interest expense increased by $82,000, or 304%
from $27,000 in the year ended June 30, 1999 to $109,000 in the year ended June
30, 2000, due to the $2,500,000 in convertible notes issued by the Company
during the year ended June 30, 2000. The convertible notes, including accrued
interest, were subsequently repaid in May, 2000. Other expense increased from
$43,000 in the year ended June 30, 1999 to $56,000 in the year ended June 30,
2000, due to various non-operating items. During the year ended June 30, 2000,
the Company took a charge of $367,000 for equipment located at previous joint
venture partner locations, which was deemed to be not recoverable.
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). 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 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.
<PAGE> 16
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and net working capital totaled $1,275,000
and $2,792,000, respectively, as of June 30, 2000. The sources of cash were
provided primarily by issuance of equity securities, and to a lesser extent,
collections of sales revenues. 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 $10,355,000, $1,011,000 and
$10,589,000 in equity financing, for the years ended June 30, 1998, 1999, and
2000, respectively. Its subsidiary, FNet, received $406,000, $110,000 and
$53,000 in equity financing for the years ended June 30, 1998, 1999 and 2000,
respectively. FNet has continued to experience losses, due primarily to the
carrier termination costs associated with the flat rat service business. This
flat rate service business has been discontinued.
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, 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 future anticipated 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.
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, 2000 and 1999, the Company's cash
equivalents and short-term investments totalled approximately $1,275,000 and
$1,637,000, 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 may decline 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
<PAGE> 17
Part III.
Item 10. Directors and Executive Officers of the Registrant
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Frank W. Peters .............. 62 Chairman of the Board of Directors
Robert Stewart ............... 53 Chief Executive Officer
Philip Ericson ............... 45 President and Chief Operations Officer
Robert S. Harp ............... 63 Director
Herb Mitchell ................ 63 Director
Sidney Smith ................. 62 Director
Thomas Russell ............... 48 Chief Financial Officer and a Director
</TABLE>
Mr. Peters has been the Chairman of the Board of Directors since its
organization in 1981 and served as its Chief Executive Officer until September
2000. 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. Stewart has served as Chief Executive Officer since September 2000.
In addition to a diplomatic career with the Canadian Secretary of State between
1973 and 1976, Mr. Stewart has thirty years of senior global business experience
in finance, construction, mining, petroleum and energy. He has developed several
world class IPP gas-to-electricity projects as chairman of Tangas A.G. and
Camgas A.G. including the start-up of the giant $500 million Songo Songo Field
in Tanzania between 1990 and 1993. Between 1979-97, as chairman/CEO of Interop
A.G., International Cobalt Corporation and Canada-Africa Mining Corporation, he
joint ventured with Bechtel International Corporation on several global
infrastructure projects including the $5 billion Congo Master Plan. Concurrently
he also has 20 years experience completing large infrastructure projects with
two chairmen of Krupp Thyssen International A.G., Europe's largest steel and
construction manufacturer.
Mr. Ericson has been President and Chief Operations Officer of the
Company since January 2000. Mr.Ericson has been a major force in the development
of digital telephony and the emergence of voice over the Internet applications.
Widely published in trade journals and a frequent speaker at industry
conferences, Mr. Ericson has worked at the cutting edge of communications and
control systems for over twenty years. Before joining Franklin Telecom, Mr.
Ericson founded four research and development and production manufacturing
companies. One of his ventures had a successful IPO and the balance of the firms
were acquisitions for major telecommunications and technology buyers. Mr.
Ericson designed and analyzed communications systems for Harris Corporation and
Litton Industries for six years before beginning his entrepreneurial career. He
holds an MS degree in Engineering from the University of Illinois.
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. Mitchell has been a director of the Company
since 1999.
Mr. Smith, currently Manager of ITS Services for TRW, Inc., where he
has been employed for more than thirteen years. He brings extensive experience
in the telecommunications industry, including overall responsibility for TRW's
entire communications networks. Mr. Smith also serves as a systems engineer in
TRW's worldwide satellite communications subsidiary and is a member of TRW's
Architectural Review Board. Prior to joining TRW, Mr. Smith was the principal in
Sidney B. Smith & Associates, an engineering consulting firm, with a client list
including Bechtel Corp., TRW, First Interstate Bank, and GTEL-GTE. He holds a
Bachelors degree in Engineering and majored in Industrial Engineering with a
minor in Mathematics. Mr. Smith has been a Director for the Company since May,
2000.
<PAGE> 18
Mr. Russell has been the Chief Financial Officer and a director of the
Company since 1996. He also served as its Chief Financial Officer between 1988
and 1990. Between 1990 and 1996 Mr. Russell 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.
Item 11. Executive Compensation
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1998, 1999 and 2000 to its Chief
Executive Officer, President and Chief Operating Officer, and its Chief
Financial Officer (the "Named Executive Officers").
<TABLE>
<CAPTION>
ALL OTHER NUMBER OF
ANNUAL COMPENSATION COMPENSATION SECURITIES
---------------------------------- ------------ UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS GRANTED
--------------------------- ---- ----------- ------ ---------------
<S> <C> <C> <C> <C> <C>
Frank W. Peters, CEO(3) ............... 1998 $309,048(1) -0- -0- -0-
1999 $341,583(1) -0- -0- -0-
2000 $341,681 -0- -0- -0-
Philip Ericson, President and COO(2) .. 1998 -0- -0- -0- -0-
1999 -0- -0- -0- -0-
2000 $100,962 -0- -0- 400,000
Thomas Russell, Chief Financial Officer 1998 $109,167 $5,000 -0- 200,000
1999 $137,016 -0- -0- 600,000
2000 $154,327 -0- -0- -0-
</TABLE>
(1) Portions of these amounts were deferred.
(2) Mr. Ericson was employed by the Company beginning in January 2000.
(3) Mr. Peters was succeeded by Mr. Robert Stewart as CEO on September 15, 2000.
Except as disclosed above, no compensation characterized as long-term
compensation, including or long-term incentive plan payouts, were paid by the
Company during the years ended June 30, 1998, 1999 and 2000 to any of the Named
Executive Officers.
Employment Arrangements. The Company's Chairman 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%. Beginning in June 2000, the Company's Chairman
temporarily reduced his salary to $12,500 per month until certain goals are
achieved by the Company. 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 Year Ended June 30, 2000. The following table
sets forth certain information regarding stock options granted to the Named
Executive Officers during the twelve months ended June 30, 2000:
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF OPTIONS POTENTIAL REALIZABLE
SECURITIES GRANTED TO VALUE AT ASSUMED ANNUAL
UNDERLYING EMPLOYEES RATE OF STOCK PRICE
OPTIONS IN FISCAL EXERCISE APPRECIATION FOR
NAME YEAR GRANTED YEAR PRICE EXPIRATION DATE OPTION TERM
---- ---- ------- ---- ----- --------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
5% 10%
Frank W. Peters ......2000 -0- 0% -0- -0-
Philip Ericson .......2000 400,000 28% $.69 June 23,2003 $28,290 $57,960
Thomas Russell .......2000 -0- 0% -0- -0-
</TABLE>
<PAGE> 19
The following table sets forth certain information as of June 30, 2000 with
respect to options held by the Named Executive Officers. The Company has no
outstanding stock appreciation rights, either freestanding or in tandem with
options.
<TABLE>
<CAPTION>
OPTION VALUES AS OF JUNE 30, 2000
------------------------------------------------------
NUMBER OF VALUE OF UNEXERCISED
SHARES UNEXERCISED IN-THE-MONEY
ACQUIRED ON VALUE OPTIONS AT OPTIONS AT
EXERCISE REALIZED JUNE 30, 2000 JUNE 30, 2000(1)
NAME (#) ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ---------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Frank W. Peters... N/A -0- 1,550,000/-0- $1,013,000/-0-
Philip Ericson... N/A -0- -0-/400,000 -0-/$100,000
Thomas Russell.... 300,000 $539,608 400,000/-0- $200,000/-0-
</TABLE>
(1) Assumes that a share of Common Stock was valued at $0.94 per share on
June 30, 2000. Amounts reflected are based on this assumed price minus
the exercise price and do not indicate that shares were sold.
<PAGE> 20
PERFORMANCE GRAPH
The following graph summarizes cumulative total shareholders return data
(assuming reinvestment of dividends) for the five-year period beginning June 30,
1995. The graph assumes that $100 was invested on June 30, 1995: (i) in the
Common Stock of Franklin Telecommunications, Corp., (ii) in the S&P 500 Index
and (iii) a peer group of comparable companies. The stock price performance on
the following graph is not necessarily indicative of future stock price
performance.
[PERFORMANCE GRAPH]
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
TOTAL RETURN ANALYSIS
06/30/1995 06/28/1996 06/30/1997 06/30/1998 06/30/1999 06/30/2000
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FRANKLIN TELECOMMUNICATIONS $100.00 $139.71 $275.74 $301.47 $308.82 $110.29
PEER GROUP $100.00 $ 99.46 $ 90.54 $126.59 $152.26 $256.60
S&P 500 $100.00 $125.98 $169.67 $220.83 $271.10 $290.75
-----------------------------------------------------------------------------------------------------------
</TABLE>
Source: Carl Thompson Associates www.ctaonline.com (800) 959-9677. Data from
Bloomberg Financial Markets.
Note: Vodavi Technology, Inc. and Vocaltec Communications Ltd., members of the
peer group, started trading 10/6/95 and 2/6/96, respectively. Netrix, a peer
group member for the 1999 proxy stock chart, is not included in the current peer
group for the 2000 proxy stock chart.
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.
<PAGE> 21
- 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, 2000 was based on an
Employment Agreements outlined above.
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.
<PAGE> 22
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, 2000 by each
director and executive officer of the Company, each person known to the Company
to be the beneficial owner of more than 5% of the outstanding Common Stock, and
all directors and executive officers of the Company as a group. Except as
otherwise indicated below, each person has sole voting and investment power with
respect to the shares owned, subject to applicable community property laws.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
(INCLUDES EXERCISABLE OPTIONS)
------------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- ------ -------
<S> <C> <C>
Frank W. Peters ...................................... 4,744,669 14%
733 Lakefield Road
Westlake Village, CA 91361
Philip Ericson ....................................... -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Robert S. Harp ....................................... 25,000 -0-
733 Lakefield Road
Westlake Village, CA 91361
Herb Mitchell ........................................ 193,875 1%
733 Lakefield Road
Westlake Village, CA 91361
Sidney Smith ......................................... -0- -0-
733 Lakefield Road
Westlake Village, CA 91361
Thomas Russell ....................................... 517,992 2%
733 Lakefield Road
Westlake Village, CA 91361
All directors and executive officers of the Company as
a group (5 persons) .................................. 5,481,536 16%
</TABLE>
<PAGE> 23
Item 13. Certain Relationships and Related Transactions
In August, 1999, Herb Mitchell, a non executive director of the Company,
received warrants to purchase 140,000 shares at an exercise price of $1.38 per
share as consideration for production of advertising materials.
In October, 1999, the Company's former President exercised options to
purchase 262,500 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 215,973.
In October, 1999, the Company's Chief Financial Officer exercised
options to purchase 150,000 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 103,043.
In February, 2000, the Company's Chief Financial Officer exercised
options to purchase 150,000 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 117,992.
In May, 2000, the Company's President was granted options to purchase
400,000 shares of the Company's Common stock at an exercise price of $.69 per
share. The options vest over a two year period.
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Restated Articles of Incorporation of Franklin Telecommunications
Corp.(1)
3.2 Bylaws of Franklin Telecommunications Corp.(2)
10.1 Employment Agreement, dated March 1, 1993 between Franklin
Telecommunications Corp. and Frank W. Peters(1)
10.2 Form of Securities Purchase Agreement, dated as of March 16,
2000, between Registrant and the investors named therein(3)
10.3 Form of Protective Warrant(3)
10.4 Form of Term Warrant(3)
10.5 Registration Rights Agreement, dated as of March 16, 2000(3)
23.1 Consent of Singer, Lewak, Greenbaum & Goldstein LLP
27.1 Financial Data Schedule
(1) Incorporated by reference from Registrant's Registration Statement on Form
S-1 (No. 333-24791), filed with the Commission on April 9, 1997.
(2) Incorporated by reference from Amendment No. 2 to Registrant's Registration
Statement on Form S-3 (No. 333-35834), filed with the Commission on July 31,
2000.
(3) Incorporated by reference from Registrant's Registration Statement on Form
S-3 (No. 333-35834), filed with the Commission on April 28, 2000.
(b) Financial Statements
(c) Reports on From 8-K
None.
<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/ Robert Stewart
---------------------------------
Robert Stewart
Chief Executive Officer
Dated: September 26, 2000
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/ ROBERT STEWART Chief Executive Officer September 26, 2000
---------------------------------
Robert Stewart
(2) Principal Financial and Accounting Officer
/s/ THOMAS RUSSELL Chief Financial Officer and a September 26, 2000
--------------------------------- Director
Thomas Russell
(3) Directors
/s/ FRANK W. PETERS Chairman of the Board of September 26, 2000
--------------------------------- Directors
Frank W. Peters
/s/ SIDNEY SMITH Director September 26, 2000
---------------------------------
Sidney Smith
/s/ ROBERT S. HARP Director September 26, 2000
---------------------------------
Robert S. Harp
/s/ HERB MITCHELL Director September 26, 2000
---------------------------------
Herb Mitchell
</TABLE>
<PAGE> 25
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONTENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1
FINANCIAL STATEMENTS
Consolidated Balance Sheets ............................ 2 - 3
Consolidated Statements of Operations .................. 4 - 5
Consolidated Statements of Shareholders' Equity ........ 6 - 8
Consolidated Statements of Cash Flows .................. 9 - 11
Notes to Consolidated Financial Statements ............. 12 - 42
</TABLE>
<PAGE> 26
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, 2000 and 1999, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ending June 30, 2000. 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, 2000 and 1999, and the
results of their consolidated operations and their consolidated cash flows for
each of the three years in the period ended June 30, 2000 in conformity with
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, during the year ended June 30, 2000, the
Company incurred a net loss of $11,551,000, it had negative cash flows from
operations of $9,300,000 and it had an accumulated deficit of $27,446,000. These
factors, among others, as discussed in Note 2 to the consolidated financial
statements, raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 2. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
August 30, 2000
1
<PAGE> 27
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
--------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $1,275,000 $1,637,000
Accounts receivable, less allowance for doubtful accounts
of $50,000 and $106,000 136,000 2,610,000
Other receivables 8,000 137,000
Current portion of notes receivable (a portion due from a
related party) 64,000 150,000
Inventories 2,698,000 1,674,000
Prepaid expenses 80,000 81,000
---------- ----------
Total current assets 4,261,000 6,289,000
PROPERTY AND EQUIPMENT, net 2,158,000 2,164,000
NOTES RECEIVABLE, net of current portion -- 160,000
OTHER ASSETS 738,000 822,000
---------- ----------
TOTAL ASSETS $7,157,000 $9,435,000
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 28
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
--------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
2000 1999
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES
Current portion of notes payable (majority due
to a related party) $ -- $ 24,000
Current portion of capital lease obligations 34,000 --
Accounts payable 407,000 1,027,000
Accrued liabilities 1,028,000 1,883,000
------------ ------------
Total current liabilities 1,469,000 2,934,000
NOTES PAYABLE (majority due to a related party),
less current portion 762,000 762,000
CAPITAL LEASE OBLIGATIONS, net of current portion 20,000 --
------------ ------------
Total liabilities 2,251,000 3,696,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Series C convertible preferred stock, no par value
10,000,000 shares authorized
0 and 0 shares issued and outstanding -- --
Common stock, no par value
90,000,000 shares authorized
34,247,013 and 25,796,726 shares issued
and outstanding 32,270,000 21,628,000
Common stock committed, no par value
74,716 and 10,000 shares committed but
not yet issued 82,000 6,000
Accumulated deficit (27,446,000) (15,895,000)
------------ ------------
Total shareholders' equity 4,906,000 5,739,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,157,000 $ 9,435,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 29
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
SALES
Product $ 1,109,000 $ 8,767,000 $ 778,000
Telephone and Internet services 2,098,000 1,864,000 599,000
------------ ------------ ------------
Total sales 3,207,000 10,631,000 1,377,000
------------ ------------ ------------
COST OF SALES
Product 1,115,000 4,475,000 749,000
Telephone and Internet services 3,660,000 1,166,000 85,000
------------ ------------ ------------
Total cost of sales 4,775,000 5,641,000 834,000
------------ ------------ ------------
GROSS PROFIT (LOSS) (1,568,000) 4,990,000 543,000
------------ ------------ ------------
OPERATING EXPENSES
Research and development expenses 1,834,000 1,870,000 1,612,000
Selling, general, and administrative expenses 7,518,000 5,602,000 3,304,000
Impairment of long-lived assets 224,000 -- 591,000
------------ ------------ ------------
Total operating expenses 9,576,000 7,472,000 5,507,000
------------ ------------ ------------
LOSS FROM OPERATIONS (11,144,000) (2,482,000) (4,964,000)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest income 68,000 148,000 250,000
Other income -- -- 26,000
Interest expense (109,000) (27,000) (43,000)
Other expense (56,000) (43,000) --
Abandonment of property and equipment (367,000) -- --
------------ ------------ ------------
Total other income (expense) (464,000) 78,000 233,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM (11,608,000) (2,404,000) (4,731,000)
PROVISION FOR INCOME TAXES 3,000 7,000 3,000
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 30
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ --------------
<S> <C> <C> <C>
LOSS BEFORE EXTRAORDINARY ITEM $(11,611,000) $ (2,411,000) $ (4,734,000)
EXTRAORDINARY ITEM
Gain (loss) on extinguishment of debt, net of
taxes of $0, $0, and $0 60,000 (2,000) 227,000
------------ ------------ ------------
NET LOSS $(11,551,000) $ (2,413,000) $ (4,507,000)
============ ============ ============
BASIC AND DILUTED LOSS PER SHARE ATTRIBUTABLE TO
COMMON SHAREHOLDERS
Loss before extraordinary gain (loss) $ (0.39) $ (0.11) $ (0.30)
Extraordinary gain (loss) -- -- 0.01
------------ ------------ ------------
NET LOSS PER COMMON SHARE $ (0.39) $ (0.11) $ (0.29)
============ ============ ============
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 29,797,493 22,596,694 15,524,556
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 31
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock
------------------- ---------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1997 -- $ -- 13,191,223 $ 9,971,000
SALE OF PREFERRED STOCK 740 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (23,818) (161,000)
COMMON STOCK ISSUED FOR
Cash 333,333 1,060,000
Notes receivable 345,500
Stock options/warrants 1,838,748 2,518,000
Exchange of common shares
with related parties 400,000 161,000
Conversion of notes payable
by a related party 1,333,695 133,000
Conversion of preferred stock (192) (1,702,000) 799,431 1,702,000
Issuance of committed shares 286,066 573,000
Services rendered
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (842,000) (142,000)
CANCELLATION OF SHARES (160,000) (650,000)
NET LOSS
---- ---------- ---------- -----------
</TABLE>
<TABLE>
<CAPTION>
Common Stock Committed Accumulated
----------------------
Shares Amount Deficit Total
------ ------ ------- -----
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1997 296,066 $ 579,000 $(8,975,000) $ 1,575,000
SALE OF PREFERRED STOCK 7,400,000
REPURCHASE OF COMMON
STOCK FROM RELATED PARTIES (161,000)
COMMON STOCK ISSUED FOR
Cash 1,060,000
Notes receivable --
Stock options/warrants 11,000 14,000 2,532,000
Exchange of common shares
with related parties 161,000
Conversion of notes payable
by a related party 133,000
Conversion of preferred stock --
Issuance of committed shares (286,066) (573,000) --
Services rendered 56,336 71,000 71,000
COMMON STOCK OF SUBSIDIARY
ISSUED FOR
Cash 362,000
Stock options 36,000
Services rendered 8,000
OFFERING COSTS (984,000)
CANCELLATION OF SHARES (650,000)
NET LOSS (4,507,000) (4,507,000)
-------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 32
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock
-------------------- ----------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1998 548 $ 4,856,000 18,344,178 $ 15,571,000
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
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
SHARES OF COMMON STOCK
COMMITTED FOR ACCRUED
COMPENSATION
EXPIRATION OF COMMITTED
SHARES
COMMON STOCK ISSUED FOR
Cash 6,955,957 8,056,000
Services rendered 21,694 48,000
Stock options/warrants 261,603 179,000
</TABLE>
<TABLE>
<CAPTION>
Common Stock Committed
---------------------- Accumulated
Shares Amount Deficit Total
------ ------ ------- -----
<S> <C> <C> <C> <C>
BALANCE, JUNE 30, 1998 77,336 $ 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 (67,336) (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 10,000 6,000 (15,895,000) 5,739,000
SHARES OF COMMON STOCK
COMMITTED FOR ACCRUED
COMPENSATION 74,716 82,000 82,000
EXPIRATION OF COMMITTED
SHARES (10,000) (6,000) (6,000)
COMMON STOCK ISSUED FOR
Cash 8,056,000
Services rendered 48,000
Stock options/warrants 179,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE> 33
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Preferred Stock Common Stock
------------------- ---------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Cashless exercise of
options $ 1,211,033 $ 717,000
Warrants issued in exchange
for services rendered 60,000
Warrants issued in exchange
for private placement 2,039,000
Warrants issued for financing
costs 110,000
Offering costs (620,000)
COMMON STOCK OF SUBSIDIARY
ISSUED FOR CASH 53,000
NET LOSS
----- ------------ ---------- ------------
BALANCE, JUNE 30, 2000 -- $ -- 34,247,013 $ 32,270,000
===== ============ ========== ============
</TABLE>
<TABLE>
<CAPTION>
Common Stock Committed
----------------------- Accumulated
Shares Amount Deficit Total
------ ------ ------- -----
<S> <C> <C> <C> <C>
Cashless exercise of
options $ $ $ 717,000
Warrants issued in exchange
for services rendered 60,000
Warrants issued in exchange
for private placement 2,039,000
Warrants issued for financing
costs 110,000
Offering costs (620,000)
COMMON STOCK OF SUBSIDIARY
ISSUED FOR CASH 53,000
NET LOSS (11,551,000) (11,551,000)
------------ ------------ ------------ ------------
BALANCE, JUNE 30, 2000 74,716 $ 82,000 $(27,446,000) $ 4,906,000
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE> 34
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(11,551,000) $ (2,413,000) $ (4,507,000)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 642,000 434,000 167,000
Compensation expense -- -- 71,000
Stock issued for services rendered 48,000 50,000 --
Warrants issued for services rendered 60,000 -- --
Cashless exercise of stock options and warrants 717,000 -- --
Warrants issued for financing costs 110,000 -- --
Loss on abandonment of property and equipment 367,000 -- --
Impairment of long-lived assets 224,000 -- --
Gain on write-off of debt (60,000) -- --
Provision for doubtful accounts 1,355,000 98,000 (26,000)
(Increase) decrease in
Accounts receivable 251,000 (2,617,000) 15,000
Other receivables 65,000 25,000 92,000
Inventories (156,000) (1,003,000) (277,000)
Prepaid expenses 1,000 (26,000) (487,000)
Other assets (10,000) -- --
Increase (decrease) in
Accounts payable (620,000) 854,000 (2,000)
Accrued liabilities (743,000) 747,000 468,000
------------ ------------ ------------
Net cash used in operating activities (9,300,000) (3,851,000) (4,486,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (720,000) (1,275,000) (378,000)
Issuance of notes receivable -- -- (517,000)
Proceeds from notes receivable -- 207,000 --
Other assets (49,000) (260,000) (272,000)
Other liabilities -- -- (183,000)
------------ ------------ ------------
Net cash used in investing activities (769,000) (1,328,000) (1,350,000)
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
9
<PAGE> 35
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable $ 2,500,000 $ -- $ 129,000
Payments on notes payable (2,500,000) -- (1,000)
Proceeds from sale of preferred stock, net of
offering costs -- -- 6,558,000
Proceeds from sale of common stock and warrants 9,475,000 1,011,000 3,797,000
Proceeds from sale of minority stock in
consolidated subsidiary 53,000 55,000 --
Proceeds from exercise of options 179,000 -- --
Payments on capital lease obligation -- -- (361,000)
------------ ------------ ------------
Net cash provided by financing activities 9,707,000 1,066,000 10,122,000
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents (362,000) (4,113,000) 4,286,000
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,637,000 5,750,000 1,464,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,275,000 $ 1,637,000 $ 5,750,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INCOME TAXES PAID $ -- $ -- $ 3,000
============ ============ ============
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended June 30, 2000, the Company completed the following:
- Repossessed equipment from a customer who was in arrears on payment for
said equipment at a cost of $868,000.
- Equipment with a net book value of $150,000 was transferred to the
Company in exchange for payment of a long-term note receivable.
- Committed to issue 74,716 shares of common stock valued at $82,000 as
payment for accrued compensation to an employee.
- Issued 275,625 warrants to purchase common stock for services valued at
$60,000.
- Purchased equipment under a capital lease in the amount of $54,000.
The accompanying notes are an integral part of these financial statements.
10
<PAGE> 36
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
--------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (CONTINUED)
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.
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.
The accompanying notes are an integral part of these financial statements.
11
<PAGE> 37
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 1 - 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.
12
<PAGE> 38
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 2 - GOING CONCERN MATTERS
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles which
contemplate continuation of the Company as a going concern. However, the
Company incurred a net loss of $11,551,000 during the year ended June
30, 2000 and it had negative cash flows from operations of $9,300,000.
These factors raise substantial doubt about the Company's ability to
continue as a going concern.
Recovery of the Company's assets is dependent upon future events, the
outcome of which is indeterminable. The Company's attainment of
profitable operations is dependent upon its obtaining adequate debt and
equity financing and achieving a level of sales adequate to support the
Company's cost structure. In addition, realization of a major portion of
the assets in the accompanying balance sheet is dependent upon the
Company's ability to meet its financing requirements and the success of
its plans to sell its products. The financial statements do not include
any adjustments relating to the recoverability and classification of
recorded asset amounts or amounts and classification of liabilities that
might be necessary should the Company be unable to continue in
existence.
Management plans to raise additional equity capital, continue to develop
its products, and look for merger or acquisition candidates.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Acquisitions
On February 28, 1997, the Company acquired Internet Passport, LLC, a
limited liability company, ("Passport") in exchange for 600,000 shares
of Franklin's common stock. The agreement also provided for the
assumption of certain debts totaling $411,000, including the issuance of
an additional 7,900 shares of Franklin's common stock valued at $1.73 to
satisfy certain obligations of Passport. Passport is a start-up company
incorporated in August 1996 that provides Internet services pursuant to
contractual arrangements with satellite transmission providers. The
acquisition was accounted for using the purchase method of accounting
with the excess of approximately $1,478,000 of the total acquisition
costs over the net assets acquired and liabilities assumed being
allocated to excess of cost over fair value of net assets of companies
acquired.
During the year ended June 30, 1998, 160,000 shares of the Company's
common stock at a value of $650,000 were returned by Passport 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.
13
<PAGE> 39
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Acquisitions (Continued)
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, 2000, the Company had not
contributed any funds to the joint venture, and the joint venture had
not begun and does not intent to commence 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. transferred the assets to FNet during the year ended
June 30, 2000.
During June 1998, FNet purchased all of the assets of LDNet, Inc. for
$20,000. These assets consisted of equipment.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of Franklin 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.
For the year ended June 30, 2000, no customers accounted for more than
5% of the Company's product sales. One customer accounted for 76% of the
Company's product sales for the year ended June 30, 1999. At June 30,
1999, the amount due from this customer amounted to 92% of accounts
receivable. Two customers accounted for 30% and 13% of the Company's
product sales for the year ended June 30, 1998. At June 30, 1998,
amounts due from these two customers amounted to 35% and 25% of accounts
receivable.
14
<PAGE> 40
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Concentrations of Credit Risk (Continued)
Export sales, primarily to Canada, Australia, Europe, and South America,
represented 2%, 9%, and 1% of net sales for the years ended June 30,
2000, 1999, and 1998, 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.
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. During the year ended June 30, 2000, the Company
recognized $64,000 as an impairment loss related to licenses which the
Company is no longer using and $160,000 as an impairment loss related to
an uncollectible note receivable.
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.
15
<PAGE> 41
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Inventories
Inventories are stated at the lower of cost or market (estimated net
realizable value). Cost is determined using the average cost method,
which approximates the first-in, first-out ("FIFO") method. Net
realizable value is based on forecasts for sales of the Company's
products in the ensuing years. The industry in which the Company
operates is characterized by rapid technological advancement and change.
Should demand for the Company's products prove to be significantly less
than anticipated, the ultimate realizable value of the Company's
inventories could be substantially less than the amount shown on the
accompanying consolidated balance sheets.
Property and Equipment
Property and equipment are stated at cost. The Company provides for
depreciation using the straight-line method over the estimated useful
lives as follows:
<TABLE>
<S> <C>
Computers and software 5 years
Machinery and equipment 7 years
Furniture and fixtures 7 years
</TABLE>
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.
16
<PAGE> 42
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Excess of Cost Over Fair Value of Net Assets of Companies Acquired
Excess of cost over fair value of net assets of companies acquired
arising in connection with the aforementioned business acquisitions is
amortized using the straight-line method over five years. The Company
assesses the recoverability of these intangibles on a quarterly basis by
determining whether the amortization of the balance over its remaining
life can be recovered through projected undiscounted future cash flows.
The amount of impairment, if any, is based on fair value as measured by
future cash flows and charged to operations in the period in which
goodwill impairment is determined by management. During the year ended
June 30, 1998, management of the Company determined that $591,000 had
been impaired and, accordingly, the Company charged this amount to
operations. No amortization of excess of cost over fair value of net
assets of companies acquired was recorded for the years ended June 30,
2000, 1999, and 1998.
Minority Interest
Minority interest represents the minority shareholders' proportionate
share of the equity of FNet.
During the year ended June 30, 1999, FNet sold approximately 60,000
shares of its stock to outside investors at $1 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.
During the year ended June 30, 2000, FNet sold approximately 26,250
shares of its stock to outside investors at $2 per share. 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,
2000.
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.
17
<PAGE> 43
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Minority Interest (Continued)
The accompanying consolidated financial statements do not reflect a
minority interest liability as of June 30, 2000 and 1999 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, 2000 and 1999 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. Advertising expense was
$393,000, $204,000, and $109,000 for the years ended June 30, 2000,
1999, and 1998 respectively.
Loss per Share
The Company utilizes 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.
18
<PAGE> 44
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF 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
The Company utilizes 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 financial statements since the Company did not have any of
the items of comprehensive income in any period presented.
Recently Issued Accounting Pronouncements
In June 2000, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 138, "Accounting for Certain Instruments and Certain Hedging
Activities." This statement is not applicable to the Company.
In June 2000, the FASB issued SFAS No. 139, "Rescission of FASB
Statement No. 53 and Amendments to Statements No. 63, 89, and 121." This
statement is not applicable to the Company.
NOTE 4 - 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, 2000 and 1999, the
uninsured portions of these balances held at the banks aggregated to
$1,116,000 and $1,410,000, respectively.
19
<PAGE> 45
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 4 - CASH AND CASH EQUIVALENTS (CONTINUED)
Income from these investments consists entirely of interest income in
the amount of $68,000, $148,000, and $250,000 for the years ended June
30, 2000, 1999, and 1998, respectively. The aggregate carrying amount of
cash and short-term investments by major types at June 30 was as
follows:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Cash $ 519,000 $ 969,000
Money market accounts 756,000 633,000
Certificates of deposit -- 35,000
---------- ----------
TOTAL $1,275,000 $1,637,000
========== ==========
</TABLE>
NOTE 5 - INVENTORIES
Inventories at June 30 consisted of the following:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Raw materials $1,314,000 $ 980,000
Work in process 222,000 510,000
Finished goods 1,162,000 184,000
---------- ----------
TOTAL $2,698,000 $1,674,000
========== ==========
</TABLE>
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment at June 30 consisted of the following:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Computers and software $1,607,000 $1,029,000
Machinery and equipment 1,562,000 1,681,000
Furniture and fixtures 280,000 256,000
---------- ----------
3,449,000 2,966,000
Less accumulated depreciation 1,291,000 802,000
---------- ----------
TOTAL $2,158,000 $2,164,000
========== ==========
</TABLE>
20
<PAGE> 46
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 6 - PROPERTY AND EQUIPMENT (CONTINUED)
During the year ended June 30, 2000, the Company was unable to take
possession of certain property and equipment and therefore recognized an
expense of $367,000 for the abandonment of these assets.
NOTE 7 - NOTES RECEIVABLE
Notes receivable at June 30 consisted of the following:
<TABLE>
<CAPTION>
2000 1999
-------- --------
<S> <C> <C>
Note receivable from director, bearing
interest at 6% per annum, secured
by certain shares of Franklin's
common stock, and was due in July
2000 but was mutually extended for one year $ 64,000 $ --
Note receivable from customer, bearing interest at
11.5% per annum, secured by certain
equipment, and due in August 2001 -- 160,000
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
-------- --------
64,000 310,000
Less current portion 64,000 150,000
-------- --------
LONG-TERM PORTION $ -- $160,000
======== ========
</TABLE>
During the year ended June 30, 2000, the Company determined that the
note receivable from its customer was uncollectible and wrote off the
entire balance. The Company recorded a loss on impairment on the note
receivable of $160,000.
In April 2000, the Company obtained the title to certain telephone and
satellite equipment from its joint venture partner in exchange for
payment of its note receivable. The fair market value of the equipment
was $150,000, and as such, no gain or loss was recorded.
21
<PAGE> 47
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 8 - ACCRUED LIABILITIES
Accrued liabilities at June 30 consisted of the following:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Salaries and related expenses $ 690,000 $ 633,000
Accrued offering costs -- 6,000
Accrued interest payable -- 27,000
Accrued sales tax 3,000 605,000
Other accrued liabilities 335,000 612,000
---------- ----------
TOTAL $1,028,000 $1,883,000
========== ==========
</TABLE>
NOTE 9 - NOTES PAYABLE
Notes payable at June 30 consisted of the following:
<TABLE>
<CAPTION>
2000 1999
-------- --------
<S> <C> <C>
Convertible notes payable to former vendors,
bearing interest at 12% per annum,
unsecured, and due in December 1999 $ -- $ 24,000
Notes payable to the chief executive officer, non-
interest-bearing, with payments due through
June 2001 762,000 762,000
-------- --------
762,000 786,000
Less current portion -- 24,000
-------- --------
LONG-TERM PORTION $762,000 $762,000
======== ========
</TABLE>
During the year ended June 30, 2000, the conversion feature of the notes
payable to former vendors expired. The Company wrote off the notes
payable and recognized an extraordinary gain on the extinguishment of
debt in the amount of $60,000, which represents $24,000 in principal and
$36,000 in accrued interest.
22
<PAGE> 48
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 9 - NOTES PAYABLE (CONTINUED)
The $762,000 due to the Company's chief executive officer 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, 2000, the Company had violated the plan, but the
Company's chief executive officer has signed a waiver, deferring all
payments due until the earlier of July 1, 2001 or upon an acquisition of
the Company. As of June 30, 2000, no acquisition offers have been made.
In December 1999, the Company issued five convertible notes payable for
$500,000 each and 1,000,000 warrants to purchase shares of the Company's
common stock at an exercise price of $1.65 per share to an investment
company. The notes bear interest at 10% per annum, are unsecured,
require quarterly interest payments on the unconverted balance, and
mature on December 3, 2002. The notes are convertible into shares of the
Company's common stock if the Company elects not to pay the aggregate
principal amount outstanding and accrued interest by May 3, 2000. If the
Company elects not to pay the notes in full, the holders may convert all
or a portion of the notes into shares of common stock at any time after
May 3, 2000 until maturity. Any notes outstanding at the maturity date
will be converted into shares of common stock. The conversion price is
the lesser of $2.50 or 92% of the three lowest per share prices of the
Company's common stock during the 22 trading days prior to conversion.
The notes were repaid in May 2000. The warrants vest upon issuance and
expire three years from the date of the private placement.
NOTE 10 - 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 2003. In
addition to the minimum annual rental commitments, the leases provide
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 $218,000,
$170,000, and $170,000 for the years ended June 30, 2000, 1999, and
1998, respectively.
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 $53,100, $49,000, and $0
for the years ended June 30, 2000, 1999, and 1998, respectively.
23
<PAGE> 49
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Operating Leases and Capital Lease Obligations (Continued)
The Company also leases certain telephone equipment under a capital
lease. The lease has an initial term of two years and requires fixed
monthly payments.
Future minimum lease payments under capital and operating leases at June
30, 2000 were as follows:
<TABLE>
<CAPTION>
Year Ending Operating Capital
June 30 Lease Lease
------- -------- --------
<S> <C> <C>
2001 $157,000 $ 34,000
2002 122,000 25,000
2003 85,000 --
-------- --------
$364,000 59,000
========
Less amount representing interest 5,000
--------
54,000
Less current portion 34,000
--------
LONG TERM PORTION $ 20,000
========
</TABLE>
In connection with the acquisition of 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
During June 2000, two shareholders who acquired their shares in
a private placement in March 2000, filed a lawsuit against Franklin and
officer-directors Frank W. Peters and Thomas L. Russell. The lawsuit
sought to postpone the June 28, 2000 annual stockholders meeting, based
upon alleged deficiencies in the proxy materials pertaining to the
meeting. At a court hearing held on June 28, 2000, the Court declined to
enjoin the meeting as requested by plaintiffs. Thereafter, plaintiffs
amended the lawsuit several times and ultimately added new claims
pertaining to the private placement and alleging securities law
violations. A motion to dismiss those claims was filed by Franklin and
is scheduled for hearing on October 16, 2000. Because Franklin believes
the lawsuit is without merit, it is being vigorously defended. Franklin
also has engaged in on-going settlement discussions in order to end the
expense and distraction of litigation.
The Company is involved in certain legal proceedings and claims which
arise in the normal course of business. Management does not believe that
the outcome of these matters will have a material adverse effect on the
Company's consolidated financial position or results of operations.
24
<PAGE> 50
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Software License Agreements
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 $426,000, there is a royalty of $0.75 per port for each personal
computer board sold containing the licensed software. Amounts paid under
the license agreement totaled $4,500, $103,000, and $328,000 during the
years ended June 30, 2000, 1999, and 1998 respectively.
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 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 a one-time,
active maintenance and support services fee of $10,000. Amounts paid
under this license agreement totaled $0, $0, and $1,360 during the years
ended June 30, 2000, 1999, and 1998, respectively. During the year ended
June 30, 2000, the Company recognized an impairment of the license of
$28,000, which represented the unamortized purchase price of the license
that the Company deemed to be impaired.
During May 1999, the Company entered into a license agreement with a
Company to manufacture and sell certain hardware and software which were
developed by the licensor. In addition to the fixed fee of $250,000,
there is a royalty of $35 per unit for each product sold containing the
licensed software and hardware. During the year ended June 30, 1999, the
Company paid $150,000 of the fixed fee and $0 in royalty expenses.
During the year ended June 30, 2000, the Company accrued the remaining
$100,000 for the fixed fee and paid $0 in royalty expenses.
25
<PAGE> 51
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
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
rescission 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.
Employment Agreements
The Company has entered into employment agreements with certain
officers/directors/shareholders of Franklin 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 liabilities in the accompanying consolidated balance
sheets. At June 30, 2000, there were no employment agreements in effect
that deferred any of the payment of compensation.
NOTE 11 - 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.
26
<PAGE> 52
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
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.
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.
In October 1998, certain outstanding options granted to employees in
prior years were repriced. 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.
In October 1999, the Company re-priced an aggregate of 547,000 options
issued to 14 employees under the 1998 Plan and outside of the Plan. In
relation to this re-pricing, the Company did not record any compensation
expense for the year ended June 30, 2000 since none of the options had
vested.
27
<PAGE> 53
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
In March 2000, the FASB issued an interpretation of SFAS No. 40,
"Accounting for Certain Transactions involving Stock Compensation." In
accordance with the interpretation, employee stock option awards that
are re-priced will be accounted for as variable awards from the date of
the re-pricing to the date the options are exercised, forfeited, or
expire. The interpretation of this FASB is effective for all re-pricings
subsequent to December 15, 1998.
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, 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
Granted 322,000 $ 0.67
Exercised (691,000) $ 0.41
Canceled (347,500) $ 0.58
---------
OUTSTANDING, JUNE 30, 2000 2,350,250 $ 0.37
========
EXERCISABLE AT JUNE 30, 2000 1,300,500 $ 0.26
========
</TABLE>
The exercise prices for the options outstanding at June 30, 2000 ranged
from $0.10 to $0.69. The weighted-average remaining contractual life of
the options outstanding at June 30, 2000 is 7.1 years.
28
<PAGE> 54
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
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. 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.
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.
During the year ended June 30, 2000, the Company granted options to
purchase 1,095,000 shares of common stock to key management employees,
which vest over a period of two to four years. The option price was set
at $0.69 per share, the fair value of the underlying shares.
29
<PAGE> 55
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Activity for Company options outside of the Plan is as follows:
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
------ -----
<S> <C> <C>
Outstanding, June 30, 1997 1,010,000 $1.31
Granted 465,000 $2.63
Exercised (150,000) $1.31
----------
Outstanding, June 30, 1998 1,325,000 $1.77
Granted 2,615,000 $0.44
Exercised (82,500) $0.44
Expired/cancelled (1,315,000) $1.78
----------
Outstanding, June 30, 1999 2,542,500 $0.44
Granted 1,095,000 $0.69
Exercised (605,000) $0.45
Expired/cancelled (755,000) $0.45
----------
OUTSTANDING, JUNE 30, 2000 2,277,500 $0.56
----------
EXERCISABLE, JUNE 30, 2000 1,112,500 $0.44
----------
</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.
30
<PAGE> 56
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - 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, 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
Granted 50,000 $2.00
Expired/cancelled (737,000) $1.00
----------
OUTSTANDING, JUNE 30, 2000 2,584,000 $1.02
----------
EXERCISABLE AT JUNE 30, 2000 1,840,750 $1.00
----------
</TABLE>
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 per share,
the fair value of the underlying shares.
During the year ended June 30, 2000, the Company granted options to
purchase 2,845,000 shares of FNet's common stock to key management
employees, which vest over a period of two to four years. The option
price was set at $2 per share, the fair value of the underlying shares.
31
<PAGE> 57
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
Activity for FNet options outside of the FNet Plan is as follows:
<TABLE>
<CAPTION>
Weighted-
Average
Exercise
Shares Price
------ -----
<S> <C> <C>
Outstanding, June 30, 1997 80,000 $1.00
Granted 300,000 $1.00
----------
Outstanding, June 30, 1998 380,000 $1.00
Granted 355,000 $1.00
Expired/cancelled (255,000) $1.00
----------
Outstanding, June 30, 1999 480,000 $1.00
Granted 2,845,000 $2.00
Expired/cancelled (1,800,000) $1.83
----------
OUTSTANDING, JUNE 30, 2000 1,525,000 $1.86
----------
EXERCISABLE, JUNE 30, 2000 85,000 $1.00
----------
</TABLE>
The weighted-average remaining contractual life of the options
outstanding at June 30, 2000 is 6.63 years.
32
<PAGE> 58
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
The Company has adopted only the disclosure provisions of SFAS No. 123.
It applies APB 25 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:
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Net loss
As reported $ (11,551,000) $ (2,413,000) $ (4,507,000)
Pro forma $ (12,154,000) $ (3,343,268) $ (4,804,000)
Loss per common share
As reported $ (0.39) $ (0.11) $ (0.29)
Pro forma $ (0.41) $ (0.15) $ (0.31)
</TABLE>
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 Franklin and FNet
options. The fair value of the Franklin 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, 2000, 1999, and 1998: dividend
yields of 0%, 0%, and 0%, respectively; expected volatility of 100%,
100%, and 60%, respectively; risk-free interest rates of 6.4%, 5.6%, and
5.5%, respectively; and expected lives of four, four, and four,
respectively. The weighted-average fair value of options granted during
the years ended June 30, 2000, 1999, and 1998 were $1.27, $0.34, and
$0.99, respectively, and the weighted-average exercise price was $0.69,
$0.63, and $2.66, respectively.
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,
2000, 1999, and 1998: dividend yields of 0%, 0%, and 0%, respectively;
risk-free interest rates of 6.4%, 5.8%, and 6.2%, respectively; and
expected lives of four, four, and four years, respectively. The
weighted-average fair value of options granted during the years ended
June 30, 2000, 1999, and 1998 was $0.44, $0.20, and $0.99, respectively,
and the weighted-average exercise price was $2, $1, and $1,
respectively.
33
<PAGE> 59
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (Continued)
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 12-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,
2000, 1999, and 1998, 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,
2000, 1999, and 1998, 50,000, 113,250, and 1,841,750 warrants,
respectively, were exercised, leaving a remaining balance of 50,000
unexercised as of June 30, 2000.
In connection with a private placement in August 1999, the Company
issued 400,000 incentive warrants to purchase shares of the Company's
common stock at an exercise price of $1.55 per share. The warrants may
be exercised any time after issuance and for a period of five years from
the date of the private placement. There was no additional expense
recorded in connection with the issuance of the warrants as the exercise
price approximated the fair value of the Company's common stock at the
date of issuance. As of June 30, 2000, no warrants were exercised.
34
<PAGE> 60
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Warrants (Continued)
In connection with the convertible notes payable for $2,500,000 issued
in December 1999, the Company issued to an investment banker 100,000
warrants to purchase shares of the Company's common stock at an exercise
price of $1.65 per share. The warrants may be exercised any time after
issuance and for a period of three years from the date of the private
placement. The Company recognized a financing expense of $25,000 in
connection with the issuance. As of June 30, 2000, no warrants were
exercised.
In connection with a private placement in March 2000, the Company issued
1,205,667 incentive warrants to purchase shares of the Company's common
stock at an exercise price of $2.50 per share. The warrants may be
exercised any time after issuance and for a period of five years from
the date of the private placement. There was no additional expense
recorded in connection with the issuance of the warrants as the exercise
price approximated the fair value of the Company's common stock at the
date of issuance. As of June 30, 2000, no warrants were exercised.
In connection with advertising services received, the Company issued
420,000 warrants to purchase shares of the Company's common stock at an
exercise price of $1.38 per share. The warrants may be exercised any
time after issuance and for a period of one and a half years from the
date of the private placement. The Company recognized an expense of
$60,000 in connection with the issuance, which represented the value of
services received by the advertising company. As of June 30, 2000,
420,000 warrants were exercised, leaving no unexercised warrants
available.
In connection with a private placement in March 2000, the Company issued
to various investors 73,600 FNet warrants to purchase shares of FNet's
common stock at exercise price ranging from $0.32 to $0.35 per share.
The warrants may be exercised any time after issuance and for a period
of five years from the date of the private placement. There was no
additional expense recorded in connection with the issuance of the
warrants as the exercise price approximated the fair value of the
Company's common stock at the date of issuance. As of June 30, 2000,
43,600 warrants were exercised, leaving a remaining balance of 30,000
unexercised warrants.
35
<PAGE> 61
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances
During the year ended June 30, 2000, the Company completed the following
significant common stock transactions of previously unissued common
shares:
- Issued 1,211,033 shares in connection with a cashless exercise
of options and warrants that were processed by the Company. The
Company recognized an expense of $717,000 related to this
cashless exercise, primarily due to employees that are not
officers of the Company.
- Issued 261,603 shares in connection with the exercise of stock
options for cash of $179,000.
- In connection with a private placement in August 1999, the
Company sold 1,932,368 shares for gross proceeds of $2,000,000,
less $371,000 for the value of the 400,000 warrants issued as
part of the private placement. The Company paid commissions and
fees of $205,000 in connection with this private placement.
- In connection with a private placement in February 2000, the
Company sold 841,515 shares for $1,500,000. The Company paid
commissions and fees of $36,000 in connection with this private
placement.
- In connection with a private placement in March 2000, the
Company sold 4,022,667 shares for gross proceeds of $6,040,000,
less $1,668,000 for the value of the 1,205,667 warrants issued
as part of the private placement. The Company paid commissions
and fees of $344,000 in connections with this private placement.
- In connection with a private placement in March 2000, the
Company sold 43,600 shares for $376,000. The Company paid
commissions and fees of $35,000 in connection with this private
placement.
- Issued 115,807 shares at prices ranging from $0.44 to $10 for
total cash of $179,000.
- Committed to issue 74,716 shares for accrued compensation to an
employee.
- Issued 21,694 shares as compensation to certain employees.
36
<PAGE> 62
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Issuances (Continued)
During the year ended June 30, 1999, the Company completed the following
significant common stock transactions of previously unissued common
shares:
- Issued 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.
- Issued 570,000 shares valued at $200,000 to the Company's chief
executive officer in exchange for a note receivable.
- 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 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, 2000, 287,333
of the warrants were cancelled.
37
<PAGE> 63
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - 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.
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, 2000.
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. As of June 30, 2000, all shares of preferred stock have
been converted to common stock.
38
<PAGE> 64
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED)
Convertible Preferred Stock (Continued)
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, could be exercisable to acquire
shares of common stock of the Company at the exercise price of $4.64
during September 1998. On September 30, 1998, 995,510 of the warrants
were converted into warrants exercisable to acquire the Company's common
stock, and on September 22, 1999, 17,786 of these warrants were
exercised for shares of 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, 2000.
NOTE 12 - INCOME TAXES
The tax effects of temporary differences that give rise to deferred
taxes at June 30 are as follows:
<TABLE>
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
Deferred tax assets
Accounts receivable, principally due to allowance
for doubtful accounts $ 20,000 $ 42,000
Goodwill 200,000 530,000
Compensated absences and deferred salaries,
principally due to accrual for financial reporting
purposes 211,000 233,000
Inventories, principally due to additional costs
inventoried for tax purposes pursuant to the
Tax Reform Act of 1986 and allowance for
inventory obsolescence 78,000 113,000
Warrants for services 24,000 --
Accrued warranty 5,000 5,000
General business tax credit carryforwards 335,000 335,000
Net operating loss carryforwards 10,501,000 5,621,000
---------- ----------
Total gross deferred tax assets 11,374,000 6,879,000
Less valuation allowance 10,891,000 6,759,000
---------- ----------
Net deferred tax assets 483,000 120,000
Deferred tax liabilities
State taxes 363,000 --
Plant and equipment, principally due to
differences in depreciation 120,000 120,000
---------- ----------
NET DEFERRED TAX LIABILITY $ -- $ --
========== ==========
</TABLE>
39
<PAGE> 65
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 12 - INCOME TAXES (CONTINUED)
The valuation allowance increased by $4,132,000 and $814,000 during the
years ended June 30, 2000 and 1999, respectively. No provision for
income taxes for the years ended June 30, 2000, 1999, and 1998 is
required, except for minimum state taxes, since the Company incurred
losses during such years.
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>
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
Computed "expected" tax benefit $(3,910,000) $ (818,000) $(1,572,000)
Increase in income taxes resulting from
Other 8,000 4,000 4,000
Exercise of stock options (230,000) -- --
Change in the beginning-of-the-
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense 4,132,000 814,000 1,568,000
State income taxes 3,000 7,000 3,000
----------- ----------- -----------
TOTAL $ 3,000 $ 7,000 $ 3,000
=========== =========== ===========
</TABLE>
As of June 30, 2000, the Company had consolidated net operating loss
carryforwards of $28,000,000 and $10,800,000 for federal and state
income tax reporting purposes, respectively, which expire in varying
amounts through 2020. The Company also has general business tax credit
carryforwards of $310,000 and $24,000 available to offset against future
federal and state income taxes, respectively, which expire at various
times through 2020. 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 13 - RELATED PARTY TRANSACTIONS
In August, 1999, Herb Mitchell, a non executive director of the
Company, received warrants to purchase 140,000 shares at an exercise
price of $1.38 per share as consideration for production of advertising
materials.
In October, 1999, the Company's former President exercised options to
purchase 252,000 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 215,973.
In October, 1999, the Company's Chief Financial Officer exercised
options to purchase 150,000 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 103,043.
In February, 2000, the Company's Chief Financial Officer exercised
options to purchase 150,000 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 117,992.
In May, 2000, the Company's President was granted options to purchase
400,000 shares of the Company's common stock at an exercise price of
$.69 per share. The options vest over a two year period.
NOTE 14 - 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, 2000, 1999, and 1998.
40
<PAGE> 66
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 15 - LINES OF BUSINESS
The Company operates in two major lines of business: the manufacture and
distribution of data communications and connectivity products
("Franklin") and Internet services ("FNet"). Information concerning
operations in these lines of business for the years ended June 30, 2000,
1999, and 1998 was as follows:
<TABLE>
<CAPTION>
2000 1999 1998
------------ ------------ ------------
<S> <C> <C> <C>
Net sales
Franklin $ 1,109,000 $ 8,745,000 $ 778,000
FNet 2,098,000 1,886,000 599,000
------------ ------------ ------------
TOTAL $ 3,207,000 $ 10,631,000 $ 1,377,000
============ ============ ============
Operating losses
Franklin $ (6,990,000) $ (104,000) $ (3,257,000)
FNet (4,154,000) (2,378,000) (1,707,000)
------------ ------------ ------------
TOTAL $(11,144,000) $ (2,482,000) $ (4,964,000)
============ ============ ============
Identifiable assets
Franklin $ 5,198,000 $ 7,039,000 $ 7,175,000
FNet 1,959,000 2,396,000 1,717,000
------------ ------------ ------------
TOTAL $ 7,157,000 $ 9,435,000 $ 8,892,000
============ ============ ============
Capital expenditures
Franklin $ 152,000 $ 130,000 $ 315,000
FNet 640,000 1,540,000 54,000
------------ ------------ ------------
TOTAL $ 792,000 $ 1,670,000 $ 369,000
============ ============ ============
Depreciation and amortization
Franklin $ 275,000 $ 224,000 $ 81,000
FNet 367,000 210,000 86,000
------------ ------------ ------------
TOTAL $ 642,000 $ 434,000 $ 167,000
============ ============ ============
</TABLE>
41
<PAGE> 67
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2000
--------------------------------------------------------------------------------
NOTE 16 - YEAR 2000 ISSUE
The Company has completed a comprehensive review of its computer systems
to identify the systems that could be affected by ongoing Year 2000
problems. Upgrades to systems judged critical to business operations
have been successfully installed. To date, no significant costs have
been incurred in the Company's systems related to the Year 2000.
Based on the review of the computer systems, management believes all
action necessary to prevent significant additional problems has been
taken. While the Company has taken steps to communicate with outside
suppliers, it cannot guarantee that the suppliers have all taken the
necessary steps to prevent any service interruption that may affect the
Company.
NOTE 17 - SUBSEQUENT EVENTS
Subsequent to June 30, 2000, the Company entered into subscription
agreements for the sale of 4,944,600 units for proceeds of $2,472,300.
Each unit consists of one share of the Company's common stock and one
warrant convertible into one share of the Company's common stock at $3
per share.
42
<PAGE> 68
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
3.1 Restated Articles of Incorporation of Franklin Telecommunications Corp.(1)
3.2 Bylaws of Franklin Telecommunications Corp.(2)
10.1 Employment Agreement, dated March 1, 1993 between Franklin Telecommunications
Corp. and Frank W. Peters(1)
10.2 Form of Securities Purchase Agreement, dated as of March 16, 2000, between
Registrant and the investors named therein(3)
10.3 Form of Protective Warrant(3)
10.4 Form of Term Warrant(3)
10.5 Registration Rights Agreement, dated as of March 16, 2000(3)
23.1 Consent of Singer, Lewak, Greenbaum & Goldstein LLP
27.1 Financial Data Schedule
</TABLE>
(1) Incorporated by reference from Registrant's Registration Statement on Form
S-1 (No. 333-24791), filed with the Commission on April 9, 1997.
(2) Incorporated by reference from Amendment No. 2 to Registrant's Registration
Statement on Form S-3 (No. 333-35834), filed with the Commission on July 31,
2000.
(3) Incorporated by reference from Registrant's Registration Statement on Form
S-3 (No. 333-35834), filed with the Commission on April 28, 2000.
