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, 2001
[ ] 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)
California 95-3733534
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
733 Lakefield Road, Westlake Village, California 91361
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (805) 373-8688
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
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Common stock, American Stock Exchange
without par value
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes[ ] No [X]
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 DECEMBER 31, 2001 was $1,940,461 based on the closing sale price
of $.05, on November 14, 2001, the most recent trading date.
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date:
TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT December 31, 2001
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Common Stock, no par value 43,809,231
Index
Franklin Telecommunications Corp.
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
2
Part I.
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Item 1. Business
Certain statements constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Such forward-looking statements involve known and unknown
risks, uncertainties and other factors which may cause the actual results,
performance, or achievements of the Company to be materially different from any
future results, performance or achievements, expressed or implied by such
forward-looking statements.
OVERVIEW
Franklin has substantially reduced operations due to a lack of cash, and is
functioning with minimal staff while it seeks acquisition opportunities or
financing that would allow it to resume normal operations. The following
discussion describes the state of the industry in general, and Franklin's
business and products. It should be read in light of Franklin's current
situation.
Today's telecommunications company can trace both the challenges it faces and
the potential for growth it holds to the deregulation of the industry in 1996.
One of the most visible results of this deregulation was the emergence of
Competitive Local-Exchange Carriers (CLECs). Almost immediately, CLECs became
the darlings of Wall Street, winning record amounts of financing to build out
facility based networks. This expansion, while a competitive necessity, was not
without danger. For all too many of these CLECs, the powerful upward spike in
value was matched by an equally dramatic downward plunge, as the realities of
establishing a sustainable business while paying off venture capital debt became
evident.
The dot.com's followed an almost identical profile--rapid expansion followed
closely by collapse and confusion. One example of cause and effect in this
debacle was the complete misreading of what to expect from fiber optics:
fortunes were made and lost on the myth of an imminent shortage of bandwidth to
support growing IP demands. The reality proved to be bandwidth to spare.
After the tumultuous year in 2001 for telecommunications companies, should we
despair for the industry? No! Telecommunications has taken a beating, and
Franklin has suffered with the rest of the sector. Franklin's problems were
further exacerbated by a shortage of working capital suffered before its product
line was adequately established in the marketplace. This inevitably resulted in
inadequate sales.
But after acknowledging the challenges, it is fair to examine the very real
potential that still permeates the telecommunications industry . . . including
Franklin . We are looking for a solid, continuous pattern of growth over several
years, once we have obtained sufficient financing. The consensus is that most
small businesses and enterprises alike will move toward a converged data/voice
network, but they will take a phased approach. Most organizations will deploy a
solution over a several years. This is what we hope to see--and where we believe
Franklin Telecom can find a niche.
Opportunity involves risk. In a year that has seen several of our larger
competitors quit business, Franklin survives, but barely. It has only been
through massive cuts in personnel and overhead that Franklin has been able to
escape bankruptcy, and Franklin continues to operate at a loss. We are committed
to focusing resources on finding a market for our line of VoIP products. For
example, we believe that our SoftSwitch 2000 still offers a competitive edge
over hardware solutions that lack this product's unique ability to authenticate,
route and bill for VoIP calls.
Franklin needs to rebuild its sales and marketing capabilities. We also continue
to seek alliances, partnerships and mergers with other businesses that could
bolster development of additional products and services. All of this involves
enormous risk, especially considering current economic circumstances that make
working capital hard to find, and we may be unable to attract other businesses
for such alliances or relationships.
3
Still, unlike many of our competitors, Franklin has been in business for more
than twenty years. The Company has a history of well-designed, dependable
products and services. We expect Franklin to find its place in a stable,
long-term growth cycle within the telecommunications industry.
FRANKLIN OWNS ALL THE VOIP TECHNOLOGY USED IN ITS PRODUCTS. IF THIS SEGMENT OF
THE TELECOMMUNICATIONS INDUSTRY IS TO GROW, WE HOPE THAT ONE OR MORE OF THE
REMAINING COMPANIES IN THE INDUSTRY (SUCH AS CISCO, NORTEL & LUCENT) WHO LACK
CERTAIN OF THESE TECHNOLOGY ASSETS WILL BECOME CUSTOMERS OR MERGER CANDIDATES.
However, to date we have been unable to develop significant relationships with
these companies, and we may never be able to establish any such relationships.
Our business has been the design, manufacture and sale of Internet Telephony
equipment, also called "Voice Over Internet Protocol" (VoIP) equipment and other
high speed communications products and subsystems. Our products have been
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 continue to provide traditional switched
network and Internet Protocol telephony services, and Internet access to
businesses and individuals. Our customers are located throughout the world in a
wide range of industries including financial services, government, telephone
services and manufacturing.
We offer a suite of Internet Telephony solutions that enable business
communications (voice) over data networks. From the small office home office
(SOHO) to the branch office and headquarters operations of medium to large scale
corporations, we offer a cost-effective call handling solution. From the
enterprise to the carrier market, we offer 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. Our products and services are designed to 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 has produced gateways,
gatekeepers and edge servers that provide advanced packet switching solutions
that significantly reduce the infrastructure costs associated with
communications networks. We have designed, developed and manufactured our own
products..
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 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 have elected to interconnect with the
Network Operations center.
The Company's FNet division, through a joint venture, has provided a combination
of satellite solutions to enable telephone communications for NATO forces
throughout the Bosnia and Kosovo region. As of May 2001 the Company modified the
agreement with its joint venture partner, MegaBurst, located in Washington D.C.,
to provide that Megaburst will assume responsibility for the project. Some 21
earth station transponders are connected to "telephone calling booths" linked
via satellite to the U.S., where they are interconnected to the Public Switched
Telephone Network (PSTN). NATO soldiers, using FNet calling cards, are able to
make calls throughout the world through FNet facilities. FNet was incurring a
net loss on operations of this service and hence has curtailed all costs
connected with this operation. The contract change consisted of MegaBurst taking
over all costs of providing the service and FNet transfering the fixed assets,
consisting principally of the ground stations, to MegaBurst. The Company will
receive a 50% share of any joint venture profit.
4
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 voice call to be completed. This technology requires the circuit to
remain dedicated between calling parties for the entire duration of a call.
Much data today is transmitted over Internet Protocol-based networks (IP). 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 compressed and 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, commonly referred to
as a circuit-switched system, and IP based systems. Consequently, the
circuit-switched system now finds itself in direct competition with IP telephony
systems.
A telephone call transmits signals that direct a series of switches to
open a dedicated path (circuit) to a second telephone. 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, 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.
We believe a significant market opportunity still exists for the makers of IP
telephony systems. Very few of our competitors 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.
In December 2001, Manoj Menon, Director of the Technology Practice group at
Frost & Sullivan, stated that the market is undergoing a strategic inflection
point. "We will soon witness the emergence of total solutions providers and the
rise of new companies which could overtake the giants in the field." He was
referring to the evolution of IBM from a PC company to that of becoming a system
integrator, and the genesis of Dell and HP into the computing markets in the
early 1980s as a historical example for a potential telecom shakeout.
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.
5
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 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
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. The dynamics of present day life
have caused individuals to seek more sophisticated communications solutions,
driving service providers to bundle applications to capitalize on the wide range
of consumer needs.
New analysis from Frost & Sullivan (December 7, 2001) U.S. Market for Enhanced
IP-Based Voice Services, reveals that this industry generated revenues of $520
million in 2001 and is projected to reach $31.8 billion by 2007.
Furthermore, a separate analysis from Frost & Sullivan (November 28, 2001)
reveals that WORLD VOIP EQUIPMENT MARKETS generated more than $1 billion in
revenues in 2000 and will exceed $14 billion by 2006.
By the end of 2004, 4% of American phone company revenues ($3 billion) will
shift to IP telephony -- $1 billion going to consumers in cost savings, and $2
billion going to the IP telephony industry (Forrester Research, Mar. 2000).
Franklin believes that informed studies and research like those cited here
confirm expectations for a positive market for VoIP Equipment sales and the
expansion of VoIP services, both of which this Company can supply.
The Company believes that growth in international long distance services is
being driven by a number of factors including:
o the globalization of the world's economies and the worldwide trend
toward deregulation of the telecommunications sector;
o declining prices arising from increased competition generated by
privatization and deregulation;
o increased worldwide telephone density (tele-density) and accessibility
arising from technological advances and greater investment in
telecommunications infrastructure, including the deployment of wireless
networks;
o a wider selection of products and services; and
o 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.
6
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 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 of 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 (Public Switched Telephone Network), 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.
7
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.
DEVELOPMENTS IN THE INTERNET INDUSTRY
The rate at which Internet-related companies are shutting down or declaring
bankruptcy is slowing, and the worst is over, according to Tim Miller, founder
of Webmergers.com. During 2001, he found, 537 Internet companies collapsed, more
than twice the number that met that fate in 2000. "Shutdowns followed on the
heels of the stock-market downturn as venture investors, watching their exit
opportunities dissolve, abruptly shut their doors on cash-hungry startups,"
Miller wrote. He said that the slowdown is not due to the fact there are so few
dot-coms left. Webmergers.com estimates between 7,000 and 10,000 Internet
companies received some sort of funding. "At most, then, 10 percent have shut
down," he said. "It may be safer to say that the Darwinian process has left many
fewer weak Internet companies."
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.
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 (known as PC to PC VoIP)
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. There is also PC to Phone and Phone to Phone. IDC
pioneered the PC (or Net to Phone) and the Company was the first to introduce
Phone to Phone in October 1997 and later added full Billing function.
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 overall transmission quality.
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 compounded annual growth rate of 346.8%. The growth in IP
services far outpaces growth expected in the circuit switched market, currently
estimated to be growing at a compounded annual growth rate of 8.3%.
8
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 wth industry
standards, such as SIP, to assure interoperability and connectivity with
products manufactured by other vendors.
The Company has produced 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(TM)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.
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(TM) 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 co-location 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 (AMAS) - 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.
9
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 SIP. The Company plans to support all three
protocols, enabling us to reach the widest cross section of interoperability
options in the market.
The Company also provides a variety of Internet sevices 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 intends to rebuild a direct sales force for the marketing of its
VOIP and data communications products, once it is able to secure adequate
financing or business partners. 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), and distributors.
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 Geneation 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.
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
10
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 expected new
competitors to emerge, although there has been very little movement in new
companies entering this field in 2001. Many of our competitors are substantially
larger than we are and have significantly greater financial, sales and
marketing, technical, manufacturing and other resources and more established
distribution channels and stronger relationships with service providers. These
competitors may be able to respond more rapidly to new or emerging technologies
and changes in customer requirements or devote greater resources to the
development, promotion and sale of their products than we can. 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 - 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, 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.
11
The entry of new participants from these categories and the potential entry of
competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company. The ability
of these competitors or others to bundle services and products with Internet
connectivity services could place the Company at a significant competitive
disadvantage. In addition, competitors in the telecommunications industry may be
able to provide customers with reduced communications costs in connection with
their Internet access services, reducing the overall cost of Internet access and
significantly increasing pricing pressures on the Company. Moreover, certain of
the Company's online competitors, including America Online, the Microsoft
Network and Prodigy, offer unlimited access to the Internet and their
proprietary content at flat rates that are generally equivalent to the Company's
flat rate, and do not require a set-up fee. Certain of the RBOCs have also
introduced competitive flat-rate pricing for unlimited access (without a set-up
fee) for at least some period of time. As a result, competition for active users
of Internet services has intensified. There can be no assurance that the Company
will be able to offset the adverse effect on revenues of any necessary price
reductions resulting from competitive pricing pressures by increasing the number
of its customers, by generating higher revenue from enhanced services, by
reducing costs or otherwise.
The Company believes that its ability to compete successfully in the Internet
services market depends on a number of factors, including market presence; the
adequacy of the Company's customer and technical support services; the capacity,
reliability and security of its network infrastructure; the ease of access to
and navigation of the Internet provided by the Company's services; the pricing
policies of the Company, its competitors and its suppliers; the timing of
introductions of new services by the Company and its competitors; the Company's
ability to support existing and emerging industry standards; and industry and
general economic trends. There can be no assurance that the Company will have
the financial resources, technical expertise or marketing and support
capabilities to compete successfully. Also, the Company believes that it has a
competitive advantage over most Internet Service Providers because it
manufactures much of the equipment necessary to operate an Internet Service
Provider, and is able to react quickly to technological changes in the industry.
ASSEMBLY AND MANUFACTURING OPERATIONS
The Company's facilities are located in Westlake Village, California. Assembly
of the Company's products has ordinarily been contracted out to local circuit
board assembly contractors, with final systems tests completed at the Company's
facility. At the time the Company was involved in significant manufacturing
operations, these operations consisted primarily of procurement, inspection and
testing of components, final assembly of subsystems, and extensive testing of
finished products. The Company procured substantially all of its parts from
outside suppliers.
EMPLOYEES
As of December 15, 2001, The Company had 6 full time and 2 part time 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 has reduced the total rented facilities from three leased
facilities, two in Westlake Village, California, and one in Scottsdale, Arizona,
to one in Westlake Village. The Company now occupies a leased facility in
Westlake Village, California. The Westlake Village facility houses sales,
software engineering, administrative, telephone and Internet services. The
facility is 4,900 square feet, with a lease rate of $4,981 per month, on a month
to month bassis. The total result of these moves has been a reduction in rent
from about $20,000 per month to $4,900 per month.
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 officers and
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 hearing held on June 28,
2000, the Court declined to enjoin the meeting as requested by plaintiffs, and
the meeting went forward. Thereafter, the plaintiffs amended the lawsuit several
times and ultimately added new claims pertaining to the private placement and
alleging securities law violations. The Company settled the action without any
admission of liability.
12
In August 2001, Nexbell filed a lawsuit against FNet alleging breach of a
carrier contract for circuits. This dispute has been settled for $25,000 paid at
the rate of $1,048 per month plus 240,000 shares of the Company's common stock.
In September 2001, a former employee filed an action against the Company for
wrongful termination. The dispute was settled for $12,500.
In November 2001, NEC filed a lawsuit against the Company alleging breach of
contract for $40,000 still due on a lease for a PBX. This action is still
pending.
In November 2001, two former employees filed a claim with the California labor
board, claiming certain vacation and overtime was not paid to them. In January
2002, the labor board issued a judgment in the amount of $79,115.. The Company
has appealed the ruling and intends to contest it vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable .
PART II.
--------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is listed 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
calendar years of 2001 and 2000, and the OTC Bulletin Board during the third and
fourth calendar quarters of 1999. The bid price reflects inter-dealer prices and
does not include retail mark-up, markdown, or commission..
CALENDAR HIGH LOW
-------- ---- ---
1999
Third Quarter.......................... 3.69 1.38
Fourth Quarter......................... 4.00 1.94
2000
First Quarter.......................... 2.94 1.87
Second Quarter......................... 2.00 .69
Third Quarter.......................... 1.69 .69
Fourth Quarter......................... .81 .31
2001
First Quarter.......................... .62 .09
Second Quarter......................... .12 .07
Third Quarter.......................... .06 .04
Fourth Quarter......................... .05 .04
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. On November
14, 2001 AMEX halted trading due to a delay in filing the Form 10K.
As of June 30, 2001, the Company had approximately 900 shareholders of record.
Recent sales of unregistered securities
---------------------------------------
During the year ended June 30, 2001, the Company completed the
following common stock transactions of previously unissued common
shares:
o Issued 10,000 shares in connection with the exercise of stock
options for cash of $4,000.
o In connection with a private placement in August 2000, the
Company issued 4,994,600 shares of common stock and 5,105,711
warrants for gross proceeds of $2,497,000, less fees and
commissions of $13,000. The warrants had an exercise price of
$3, vested immediately, and expire three years from the date
of issuance. The Company allocates the proceeds received from
debt, convertible debt, convertible preferred stock, or common
13
stock with detachable warrants using the relative fair value
of the individual elements at the time of issuance. The amount
allocated to the warrants of $478,000 was calculated using the
Black-Scholes option pricing model. As of June 30, 2001, no
warrants had been exercised.
o Issued 295,858 shares of common stock to its chief financial
officer in connection with a cashless exercise of options that
were processed by the Company. No expense was recorded in
connection with the transaction because the chief financial
officer had owned the shares that were used to pay for the
cashless exercise for more than six months prior to the
transaction.
o Issued 477,324 shares of common stock for services valued at
$318,000.
o In connection with a private placement in March 2000, the
Company issued warrants to the investors that were designed to
protect the investors against short-term declines in the value
of the Company's common stock during the period between the
date of the issuance of the shares and the effective date of a
Registration Statement covering the shares issued. The
warrants vest if the market price of the Company's common
stock is below $1.50 on the effective date. The registration
statement for the shares became effective in November 2000, at
which time the market price of the Company's common stock was
below $1.50. As a result, warrants for 2,011,329 shares became
exercisable at an exercise price of $0.01 per share. During
the year ended June 30, 2001, the Company issued 1,927,797 net
shares of common stock in connection with a cashless exercise
of said warrants, and 50,000 shares of common stock were
issued for cash of $500.
o In connection with a private placement in March 2000, the
Company was obligated to effect the registration of the shares
sold within a specified time period, with penalties due to the
investors if the deadline was not met. As the deadline was not
met, the Company became obligated to pay the penalties in
either cash or shares of common stock. The Company opted to
pay the penalties in shares of common stock and issued 503,538
shares to these investors in November 2000 and recognized an
expense of $430,000 in the consolidated statement of
operations for the year ended June 30, 2001.
o Issued 111,111 shares of the Company's common stock for 6,667
shares of FNet common stock in a stock-for-stock transaction.
The shares of FNet's common stock had been issued during the
year ended June 30, 1999.
Item 6. Selected Consolidated Financial Data
The selected financial data set forth below for the fiscal years ended June 30,
1999, 2000 and 2001 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, 1997 and 1998 have been derived from the Company's audited financial
statements not included in this Form 10-K.
14
CONSOLIDATED STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):
YEARS ENDED JUNE 30,
-------------------------------------------------------------------------
1997 1998 1999 2000 2001
------------- ------------- ------------- ------------- -------------
SALES $ 1,735 $ 1,377 $ 10,631 $ 3,207 $ 1,245
-------------------------------------- ------------- ------------- ------------- ------------- -------------
COST OF SALES 990 834 5,641 4,775 5,431
-------------------------------------- ------------- ------------- ------------- ------------- -------------
GROSS PROFIT (LOSS) 745 543 4,990 (1,568) (4,186)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
OPERATING EXPENSES:
-------------------------------------- ------------- ------------- ------------- ------------- -------------
RESEARCH AND DEVELOPMENT EXPENSES 480 1,612 1,870 1,834 1,152
-------------------------------------- ------------- ------------- ------------- ------------- -------------
SELLING, GENERAL AND ADMINISTRATIVE 1,766 3,304 5,602 7,518 4,351
EXPENSES
-------------------------------------- ------------- ------------- ------------- ------------- -------------
IMPAIRMENT OF LONG-LIVED ASSETS 1,584 591 -- 224 1,209
-------------------------------------- ------------- ------------- ------------- ------------- -------------
TOTAL OPERATING EXPENSES 3,830 5,507 7,472 9,576 6,712
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LOSS FROM OPERATIONS (3,085) (4,964) (2,482) (11,144) (10,898)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
-------------------------------------- ------------- ------------- ------------- ------------- -------------
INTEREST INCOME -- 250 148 68 27
-------------------------------------- ------------- ------------- ------------- ------------- -------------
INTEREST EXPENSE (41) (43) (27) (109) (303)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
ABANDONMENT OF PROPERTY
AND EQUIPMENT -- -- -- (367) --
-------------------------------------- ------------- ------------- ------------- ------------- -------------
OTHER (6) 26 (43) (56) (30)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
TOTAL OTHER INCOME (EXPENSE) (47) 233 78 (464) (306)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LOSS BEFORE MINORITY
INTEREST,INCOME TAXES AND
EXTRAORDINARY ITMES (3,132) (4,731) (2,404) (11,608) (11,204)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
MINORITY INTEREST IN LOSS OF SUBSIDIARY -- -- -- -- 0
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM (3,132) (4,731) (2,404) (11,608) (11,204)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
PROVISION FOR INCOME TAXES 2 3 7 3 3
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY ITEM (3,134) (4,734) (2,411) (11,611) (11,207)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
EXTRAORDINARY ITEM:GAIN (LOSS) ON
EXTINGUISHMENT OF DEBT, NET 310 227 (2) 60 387
-------------------------------------- ------------- ------------- ------------- ------------- -------------
NET LOSS (2,824) (4,507) (2,413) (11,551) (10,820)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
BASIC (LOSS) PER SHARE:
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY GAIN (0.26) (0.30) (0.11) (0.39) (0.28)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
EXTRAORDINARY GAIN 0.03 0.01 -- -- 0.01
-------------------------------------- ------------- ------------- ------------- ------------- -------------
NET LOSS PER COMMON SHARE (.23) (.29) (0.11) (0.39) (0.27)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
WEIGHTED AVERAGE NUMBER OF SHARES 12,267,991 15,524,556 22,596,694 29,797,493 40,113,816
OUTSTANDING
-------------------------------------- ------------- ------------- ------------- ------------- -------------
BALANCE SHEET DATA (IN THOUSANDS):
YEARS ENDED JUNE 30,
-------------------------------------------------------------------------
1997 1998 1999 2000 2001
------------- ------------- ------------- ------------- -------------
CASH $ 1,464 $ 5,750 $ 1,637 $ 1,275 $ 49
-------------------------------------- ------------- ------------- ------------- ------------- -------------
WORKING CAPITAL (DEFICIT) 809 5,963 3,355 2,792 (2,672)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
TOTAL ASSETS 3,514 8,892 9,435 7,157 1,435
-------------------------------------- ------------- ------------- ------------- ------------- -------------
LONG-TERM DEBT 360 404 762 782 686
-------------------------------------- ------------- ------------- ------------- ------------- -------------
OTHER LIABILITIES 183 -- -- -- --
-------------------------------------- ------------- ------------- ------------- ------------- -------------
STOCKHOLDER'S EQUITY (DEFICIT) 1,575 7,036 5,739 4,906 (2,334)
-------------------------------------- ------------- ------------- ------------- ------------- -------------
15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 2001 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2000
---------------------------------------------------------------------------
NET SALES. Net sales decreased by $1,962,000 or 61%, from $3,207,000 in the year
ended June 30, 2000 to $1,245,000 in the year ended June 30, 2001. The overall
decrease is attributable to a continued reduction in sales of the main product
line for the year ended June 30, 2001. The revenue mix for the year ended June
30, 2001 consisted of 34% DVG and other hardware and software products, and 66%
Telephone and Internet services.
During the fiscal year, potential enterprise customers that the Company had
pursued held back on major commitments. A commonly cited reason for a delay in
purchasing VoIP hardware was concern for the immediate stability of the
marketplace. However, a survey released in August 2001 of IT professionals from
132 small to medium organizations and 136 enterprise operations indicates that
thus far, 13% of small businesses and 19% of enterprise operations have deployed
some form of VoIP, and that 49% of small businesses and 55% or enterprises
intend to implement VoIP within the year. The general consensus within the
industry is that most small businesses and enterprises alike will move toward a
converged data/voice network, but they will take a phased approach. Most
organizations will deploy a solution over several years. We see this as
promising for long term sales and deployment of our hardware and software
solutions.
Franklin Telecom survived a very challenging time, both as a company and as part
of the telecommunications industry. The Company plans to return to a growth mode
in the near future, although this is subject to a number of unknown factors and
contingencies. As a small company, Franklin believes itself to enjoy an
advantage over some of the giants among its competitors who have experienced
comparable difficulties over the last two years in that it usually requires less
time and fewer resources to turn around a smaller, less cumbersome operation.
GROSS PROFIT (LOSS). Gross profit decreased as a percentage of net sales to a
loss of (336)% for the year ended June 30, 2001, from a gross loss of (49)% of
net sales for the corresponding period of 2000. The gross profit percentage
decrease can be attributed to a combination of carrier termination costs
exceeding revenues for telephone services and fixed manufacturing overhead costs
assigned to a hardware sales base which contracted. A large portion of the gross
loss is based on unresolved disputes with common carriers regarding invoicing
for cancelled circuits. A favorable resolution could substantially improve the
percentage of loss reported herein.
FNet is involved in a dispute with several telephone and satellite common
carriers. One of these is PanAmSat, which was contracted to carry telephone
traffic from our Bosnia NATO project. FNet claims that the service was a failure
and was canceled after two months. PanAmSat claims that FNet owes it
approximately $1 million for the remaining unpaid balance of the contract . FNet
is vigorously contesting the claim.
Most of the current loss occurred in the first half of the fiscal year. Franklin
has cut personnel and operations cost from $500,000 per month in February to an
estimated $40,000 per month currently, thereby realizing a monthly savings of
$460,000. In addition, from January 2001 forward, the Company's two top
executives have drawn no cash salary. The difficulty in this extreme reduction
in space and work force is maintaining the functionality of the Company.
Remaining personnel have had to execute three job functions and cross train in
others.
OPERATING EXPENSES. Operating expenses decreased by $2,864,000 or 30%, from
$9,576,000 in the year ended June 30, 2000 to $6,712,000 in the year ended June
30, 2001. The decrease is attributable to decreased sales and marketing efforts,
accounting charges and costs in cutting back the general and administrative
infrastructure. This also includes a $1.2M inpairment of long lived fixed
assets. The Company has also completed a consolidation of its physical plant, by
closing the Arizona office and contracting the Westlake Village office thereby
substantially reducing overhead.
OTHER INCOME (EXPENSE). Interest income decreased by $49,000 or 72% in the year
ended June 30, 2001 to $27,000 from $68,000 in the year ended June 30, 2001, due
to the reduction in cash and cash equivalents available for interest bearing
investments. Interest expense increased by $194,000 or 178% in the year ended
June 30, 2001 to $303,000 from $109,000 in the year ended June 30, 2000, due
primarily to the recording of imputed interest on a prior period note from the
Company's chairman. This is an non cash calculation required by Generally
Accepted Accounting Principles. Other expense decreased from $56,000 in the year
ended June 30, 2000 to $30,000 year ended June 30, 2001 due to various non
operating items.
16
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.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Cash and cash equivalents and net working capital deficit totaled $49,000 and
$(2,672,000), respectively, as of June 30, 2001. 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 $1,011,000, $10,589,000 and
$2,485,000 in equity financing, for the years ended June 30, 1999, 2000, and
2001, respectively. Its subsidiary, FNet, received $110,000, $53,000 and $-0- in
equity financing for the years ended June 30, 1999, 2000 and 2001, respectively.
Both Franklin Telecom and FNet have continued to experience losses. The Company
has not currently been able to raise sufficient capital from sales of additional
shares. Audit opinions on the Company's financial statements for the past two
fiscal years have advised that the Company may not be able to continue as a
going concern.
The Company is currently in a survival mode. As of December 31, 2001 it held
$33,500 of cash or cash equivalents. Current monthly cash consumption is
approximately $25,000. Sales from FTC and the FNet division are approximately
$30,000 per month. Management is currently deferring salary or taking options in
lieu of salary. Recent non-operating cash funding has been contributed by the
Company's chairman in the form of convertible debt.
The Company believes that existing cash and cash equivalents and cash flow from
operations will not be sufficient to meet the Company's presently anticipated
working capital needs during the next twelve months and the foreseeable future.
Although the Company continues the effort to raise cash through sales of
existing inventory and anticipates future private placements of its securities,
there is no assurance that this effort will be successful.
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.
17
INTEREST RATE RISK. At June 30, 2001 and 2000, the Company's cash equivalents
and short-term investments totalled approximately $49,000 and $1,275,000,
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
Part III.
---------
Item 10. Directors and Executive Officers of the Registrant
The directors and executive officers of the Company are as follows:
NAME AGE POSITION
---- --- --------
Frank W. Peters 63 Chairman of the Board of Directors
Martin S. Albert 70 Acting Chief Executive Officer & Director
Gary S. Rogers 46 Director
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. He holds an BA degree in Physics from
the State University of California at Los Angeles.
Mr. Albert has been a director since March 2001 and has been Acting Chief
Executive Officer of the Company since December 1, 2001. Before joining Franklin
Telecom, Mr. Albert was co-founder and Managing Partner of the AmerScan Group.
He has held executive marketing and general management positions at CBS,
Raytheon, Photo Circuits, Kollmorgen Corp., and Infotech before embarking on an
entrepreneurial career in 1970. He has worked in the venture capital industry
for nearly 15 years. Mr. Albert has also been a guest speaker at many
universities and conferences including UCLA and the MIT Venture Forums and has
been adjunct professor in entrepreneurship at California State University at
Northridge and California Lutheran University. He holds an BA degree in Physics
from the City College of New York.
Mr. Rogers has been a director since April 2001. He is currently serving as V.P.
Operations for AML Communications, a manufacturer of Broadband RF/microwave for
a high-speed digital world. His current responsibilities are Manufacturing,
Planning and Purchasing for the wireless and custom products divisions. His
previous assignment was as VP Operations at Neopoint Inc. a startup designer and
manufacturer of Smart phones based on CDMA technology in San Diego. He had
responsibility for establishing and maintaining, Planning and Procurement,
Logistics, Customer Service, Facilitates, IS, and Product Test departments. From
1996 to 1998 Gary served as the V.P. Operations for Tandon Associates, a leading
18
international manufacturer of components for hard disk drives. He was
responsible for the factory completion and ramp up to volume production in the
Far East manufacturing operations. Prior to this assignment (1993 to 1995) he
was Director of Quality for Reveal Computer Products, a manufacturer/distributor
of computer peripherals targeting mass merchandisers and OEM's. From 1990 to
1993 he was Director of Worldwide Quality Tandon Computer Corporation. Mr.
Rogers has a BS degree in Business Administration, operations management from
California State University Northridge.
Item 11. Executive Compensation
The following table sets forth certain compensation paid or accrued by the
Company during the years ended June 30, 1999, 2000 and 2001 to its Chief
Executive Officer, President and Chief Operating Officer, Chief Financial
Officer, Vice President of Marketing, Engineering and Chief Operating Officer of
FNet. (the "Named Executive Officers").
NUMBER OF
SECURITIES
ANNUAL COMPENSATION UNDERLYING
------------------------------ ALL OTHER OPTIONS
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION GRANTED
--------------------------- ---- ------ ----- ------------ -------
Frank W. Peters, Chairman & CEO, FTC & FNet (3) 1999 $ 350,000 -0- -0- -0-
(January 1980 to Present) 2000 $ 371,000 (1) -0- -0- -0-
2001 $ 150,000 (2) -0- -0- -0-
Philip Ericson, President and COO, FTC 1999 -0- -0- -0- -0-
(January to September 2000) 2000 $ 100,962 -0- -0- 400,000
2001 $ 150,000 -0- -0- -0-
Thomas Russell, Chief Financial Officer, FTC & FNet 1999 $ 137,016 -0- -0- 600,000
(January 1996 to May 2001) 2000 $ 154,327 -0- -0- -0-
2001 $ 60,000 -0- -0- -0-
Stephen Lee, Vice President Marketing, FTC 1999 -- -- -- --
(January to September 2000) 2000 $ 150,000 -0- -0- -0-
2001 $ 75,000 -0- -0- -0-
Sean Quine, Vice President Engineering, FTC 1999 $ 140,000 -0- -0- -0-
(October 1997 to February 2001) 2000 $ 180,000 -0- -0- -0-
2001 22,000 -0- -0- -0-
John Saltwick, Vise President Engineering, FTC 1999 $ 110,000 -0- -0- -0-
(April 1998 to May 2001) 2000 $ 121,000 -0- -0- -0-
2001 $ 15,000 -0- -0- -0-
Michael C. Peters, COO, FNet 1999 $ 127,000 -0- -0- -0-
(January 1, 1994 to Present) 2000 $ 148,432 (4) -0- -0- -0-
(COO of FNet Corp. efective May 2000) 2001 $ 189,000 (2) -0- -0- -0-
---------------------
(1) $96,667 of these amounts were deferred.
(2) All of this was deferred.
(3) Frank Peters was succeeded by Mr. Robert Stewart as CEO on September
15, 2000. Then in January 2001, Mr. Stewart resigned and Mr. Frank
Peters stepped in as acting CEO.
(4) Of these amounts, $22,432 was deferred.
19
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, 1999, 2000 and 2001 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. As of January 1, 2001 the Chairman ceased drawing any cash salary and
has deferred his new salary of $150,000 per year without interest.
OPTION GRANTS DURING THE YEAR ENDED JUNE 30, 2001.
The following table sets forth certain information as of June 30, 2001 with
respect to options held by the Named Executive Officers. The Company has no
outstanding stock appreciation rights, either freestanding or in tandem with
options.
SHARES NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED ON VALUE OPTIONS AT IN-THE-MONEY OPTIONS AT
EXERCISE REALIZED JUNE 30, 2001 JUNE 30, 2001(1)
-------- -------- -------------- ----------------
NAME (#) ($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
--- --- -------------------------- -------------------------
Frank W. Peters....... N/A -0- 1,550,000/ 0 -0- / -0-
Philip Ericson........ N/A -0- -0- /-0- -0- / -0-
Thomas Russell........ 295,858 $369,823 -0-/-0- -0- / -0-
-----------------
(1) Assumes that a share of Common Stock was valued at $0.10 per share on
June 30, 2001. Amounts reflected are based on this assumed price minus
the exercise price and do not indicate that shares were sold.
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:
o 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.
o short-term incentives that are based on the financial performance of
the Company.
o 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.
20
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.
Performance Graph
The following graph summarized cumulative total shareholder return data
(assuming reinvestment of dividends) for the five-year period beginning June 30,
1996. The graph assumes that $100 was invested on June 30, 1996: (i) in the
Common Stock of Franklin Telecommunications Corp, (ii) in the AMEX Composite
Index (where the Company's Common Stock is traded), and (iii) a peer group
comprised of Vodavi Technology, Inc. (VTEK) and VocalTec Communications Ltd.
(TOCL).
TOTAL RETURN TO STOCKHOLDERS
(assumes $100 investment on 6/30/96)
[Performance Graph Here]
============================================================================================================
TOTAL RETURN ANALYSIS 06/30/1996 06/30/1997 06/30/1998 06/30/1999 06/30/2000 06/30/2001
============================================================================================================
Franklin Telecom. (x) $ 100.00 $ 197.14 $ 215.78 $ 221.04 $ 78.94 $ 6.74
------------------------------------------------------------------------------------------------------------
Peer Group (+) $ 100.00 $ 67.14 $ 82.42 $ 88.35 $ 146.04 $ 19.72
------------------------------------------------------------------------------------------------------------
AMEX Composite (o) $ 100.00 $ 107.94 $ 125.05 $ 138.34 $ 162.26 $ 159.12
------------------------------------------------------------------------------------------------------------
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.
21
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, 2001 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.
SHARES BENEFICIALLY OWNED
(INCLUDES EXERCISABLE OPTIONS)
------------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- ------ -------
Frank W. Peters (1).......................... 11,048,835 22.0%
733 Lakefield Road
Westlake Village, CA 91361
Marty S. Albert
733 Lakefield Road
Westlake Village, CA 91361 1,000,000 2
Gary S. Rogers
733 Lakefield Road
Westlake Village, CA 91361 1,000,000 2
All directors and executive officers of
the Company as a group (3 persons)........... 13,048,835 26.0%
----------------
(1) Includes options to purchase 1,550,000 shares and rights to convert
notes to 3,304,166 shares all which could be exercised in 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In September 2000, the Company's Chief Financial Officer exercised options to
purchase 400,000 shares of 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
was 295,858.
In March 2001, the Company's Chairman loaned the Company $100,000 convertible to
stock at $0.12 per share bearing interest at 6% due in one year.
In June 2001, the Company's Chairman loaned the Company $20,000 convertible to
stock at $0.08 per share bearing interest at 6% due in one year.
In July 2001, the Company's Chairman loaned the Company $19,000 convertible to
stock at $0.05 per share bearing interest at 6% due in one year.
In September 2001, the Company granted options to purchase 1,000,000 shares of
common stock at an exercise price of $0.05 per share, the fair value of the
underlying shares, to each of two members of the board. The options were granted
outside of the Company's stock option plans, vest 10% per month over the next 10
months, and expire three years from the date of grant.
In November 2001, the Company's Chairman loaned the Company $50,000 convertible
to stock at $0.05 per share bearing interest at 6% due in one year.
In November 2001, the Company granted options to purchase 2,400,000 and
2,500,000 shares of common stock at an exercise price of $0.05 per share, the
fair value of the underlying shares, to its chief executive officer/chairman and
chief operating officer, respectively. These options were granted for payment of
deferred salaries from January to October 2001 valued at $118,000 and $128,000,
respectively. The options were granted outside of the Company's stock option
plans and may be exercised any time after issuance and for a period of three
years from the date of grant.
22
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)
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP
------------
(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.
(b) Financial Statements
--- --------------------
(c) Reports on From 8-K
--- -------------------
None.
23
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange
Act of 1934, Registrant has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Franklin Telecommunications Corp.
By: /s/ Frank W. Peters
-----------------------------
Frank W. Peters
Chairman of the Board
Dated: January 12, 2002
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.
Signature Title Date
--------- ----- ----
(1) Principal Executive Officer
/s/ Martin S. Albert Acting Chief Executive Officer January 22, 2002
--------------------------
Martin S. Albert
(2) Principal Financial and Accounting Officer
/s/ FRANK W. PETERS Acting Principle Accounting Officer
-------------------------- and a Director January 22, 2002
Frank W. Peters
(3) Directors
/s/ FRANK W. PETERS Chairman of the Board of Directors January 22, 2002
--------------------------
Frank W. Peters
/s/ Martin S. Albert Director January 22, 2002
--------------------------
Martin S. Albert
/s/ GARY S. ROGERS Director January 22, 2002
--------------------------
Gary S. Rogers
24
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
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)
23.1 CONSENT OF SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
(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.
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONTENTS
JUNE 30, 2001
================================================================================
Page
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Operations F-5 - F-6
Consolidated Statements of Shareholders' Equity (Deficit) F-7 - F-8
Consolidated Statements of Cash Flows F-9 - F-11
Notes to Consolidated Financial Statements F-12 - F-47
F-1
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, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity (deficit),
and cash flows for each of the three years in the period ending June 30, 2001.
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 auditing standards generally accepted
in the United States of America. 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, 2001 and 2000, and the
results of their consolidated operations and their consolidated cash flows for
each of the three years in the period ended June 30, 2001 in conformity with
accounting principles generally accepted in the United States of America.
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, 2001, the
Company incurred a net loss of $10,820,000 and it had negative cash flows from
operations of $3,748,000. 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
November 30, 2001
F-2
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
==========================================================================================
ASSETS
2001 2000
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 49,000 $1,275,000
Accounts receivable, less allowance for doubtful accounts
of $122,000 and $50,000 21,000 136,000
Other receivables 1,000 8,000
Note receivable - related party -- 64,000
Inventories, less allowance for obsolescence of $2,377,000
and $134,000 325,000 2,698,000
Prepaid expenses 15,000 80,000
----------- -----------
Total current assets 411,000 4,261,000
PROPERTY AND EQUIPMENT, net 589,000 2,158,000
LICENSES 391,000 695,000
OTHER ASSETS 44,000 43,000
----------- -----------
TOTAL ASSETS $1,435,000 $7,157,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30,
================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
2001 2000
------------- -------------
CURRENT LIABILITIES
Convertible promissory notes payable (majority due
to a related party) $ 122,000 $ --
Current portion of capital lease obligations 28,000 34,000
Accounts payable 1,554,000 407,000
Accrued liabilities 1,379,000 1,028,000
------------- -------------
Total current liabilities 3,083,000 1,469,000
NOTE PAYABLE - RELATED PARTY 686,000 762,000
CAPITAL LEASE OBLIGATIONS, net of current portion -- 20,000
------------- -------------
Total liabilities 3,769,000 2,251,000
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT)
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
42,617,241 and 34,247,013 shares issued
and outstanding 35,850,000 32,270,000
Common stock committed, no par value
74,716 and 74,716 shares committed but
not yet issued 82,000 82,000
Accumulated deficit (38,266,000) (27,446,000)
------------- -------------
Total shareholders' equity (deficit) (2,334,000) 4,906,000
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT) $ 1,435,000 $ 7,157,000
============= =============
The accompanying notes are an integral part of these financial statements.
F-4
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
================================================================================================
2001 2000 1999
------------- ------------- -------------
SALES
Product $ 421,000 $ 1,109,000 $ 8,767,000
Telephone and Internet services 824,000 2,098,000 1,864,000
------------- ------------- -------------
Total sales 1,245,000 3,207,000 10,631,000
------------- ------------- -------------
COST OF SALES
Product 2,772,000 1,115,000 4,475,000
Telephone and Internet services 2,659,000 3,660,000 1,166,000
------------- ------------- -------------
Total cost of sales 5,431,000 4,775,000 5,641,000
------------- ------------- -------------
GROSS PROFIT (LOSS) (4,186,000) (1,568,000) 4,990,000
------------- ------------- -------------
OPERATING EXPENSES
Research and development expenses 1,152,000 1,834,000 1,870,000
Selling, general, and administrative expenses 4,351,000 7,518,000 5,602,000
Impairment of long-lived assets 1,209,000 224,000 --
------------- ------------- -------------
Total operating expenses 6,712,000 9,576,000 7,472,000
------------- ------------- -------------
LOSS FROM OPERATIONS (10,898,000) (11,144,000) (2,482,000)
------------- ------------- -------------
OTHER INCOME (EXPENSE)
Interest income 19,000 68,000 148,000
Other income 8,000 -- --
Interest expense (303,000) (109,000) (27,000)
Other expense (30,000) (56,000) (43,000)
Abandonment of property and equipment -- (367,000) --
------------- ------------- -------------
Total other income (expense) (306,000) (464,000) 78,000
------------- ------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM (11,204,000) (11,608,000) (2,404,000)
PROVISION FOR INCOME TAXES 3,000 3,000 7,000
------------- ------------- -------------
The accompanying notes are an integral part of these financial statements.
F-5
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30,
================================================================================================
2001 2000 1999
------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY ITEM $(11,207,000) $(11,611,000) $ (2,411,000)
EXTRAORDINARY ITEM
Gain on extinguishment of debt, net of
taxes of $0, $0, and $0 387,000 60,000 (2,000)
------------- ------------- -------------
NET LOSS $(10,820,000) $(11,551,000) $ (2,413,000)
============= ============= =============
BASIC AND DILUTED LOSS PER SHARE ATTRIBUTABLE TO
COMMON SHAREHOLDERS
Loss before extraordinary gain (loss) $ (0.28) $ (0.39) $ (0.11)
Extraordinary gain (loss) 0.01 -- --
------------- ------------- -------------
NET LOSS PER COMMON SHARE $ (0.27) $ (0.39) $ (0.11)
============= ============= =============
WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING 40,113,816 29,797,493 22,596,694
============= ============= =============
The accompanying notes are an integral part of these financial statements.
F-6
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30,
==================================================================================================
Preferred Stock Common Stock
-------------------- ----------------------
Shares Amount Shares Amount
------ ------ ------ ------
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
Cashless exercise of
options 1,211,033 717,000
Common Stock Committed
---------------------- Accumulated
Shares Amount Deficit Total
------ ------ ------- -----
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
Cashless exercise of
options 717,000
The accompanying notes are an integral part of these financial statements.
F-7
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED JUNE 30,
==================================================================================================
Preferred Stock Common Stock
-------------------- ----------------------
Shares Amount Shares Amount
------ ------ ------ ------
WARRANTS ISSUED FOR
services rendered $ $ 60,000
private placement 2,039,000
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
COMMON STOCK ISSUED FOR
Cash 5,105,711 2,029,000
Services rendered 477,324 318,000
Stock options/warrants 10,000 4,000
Cashless exercise of
options 295,858 -
Cashless exercise of
protective warrants 1,977,797 -
Late registration filing 503,538 430,000
Offering costs (13,000)
WARRANTS ISSUED FOR
PRIVATE PLACEMENT 478,000
IMPUTED INTEREST ON RELATED
PARTY NOTE PAYABLE 344,000
COMMON STOCK OF
SUBSIDIARY EXCHANGED FOR
COMMON STOCK OF PARENT (10,000)
NET LOSS
---- ------------ ---------- ------------
BALANCE, JUNE 30, 2001 - $ - 42,617,241 $ 35,850,000
Common Stock Committed
---------------------- Accumulated
Shares Amount Deficit Total
------ ------ ------- -----
WARRANTS ISSUED FOR
services rendered $ $ $ 60,000
private placement 2,039,000
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
COMMON STOCK ISSUED FOR
Cash 2,029,000
Services rendered 318,000
Stock options/warrants 4,000
Cashless exercise of
options -
Cashless exercise of
protective warrants -
Late registration filing 430,000
Offering costs (13,000)
WARRANTS ISSUED FOR
PRIVATE PLACEMENT 478,000
IMPUTED INTEREST ON RELATED
PARTY NOTE PAYABLE 344,000
COMMON STOCK OF
SUBSIDIARY EXCHANGED FOR
COMMON STOCK OF PARENT 10,000
NET LOSS (10,820,000) (10,820,000)
------- ------------ ------------ ------------
BALANCE, JUNE 30, 2001 74,716 $ 82,000 $(38,266,000) $ (2,334,000)
The accompanying notes are an integral part of these financial statements.
F-8
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
======================================================================================================
2001 2000 1999
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(10,820,000) $(11,551,000) $ (2,413,000)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 699,000 642,000 434,000
Stock issued for late filing of registration
statement 430,000 - -
Stock issued for services rendered 256,000 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 -
Extraordinary gain on disposal of property
and equipment (9,000) - -
Impairment of long-lived assets 1,209,000 224,000 -
Gain on write-off of debt (387,000) (60,000) -
Provision for doubtful accounts 72,000 (56,000) 98,000
Write-off of accounts receivable - 1,411,000 -
Imputed interest on related party note
payable 267,000 - -
Reserve for inventory obsolescence 2,243,000 - -
(Increase) decrease in
Accounts receivable 43,000 251,000 (2,617,000)
Other receivables 7,000 65,000 25,000
Inventories 130,000 (156,000) (1,003,000)
Prepaid expenses 65,000 1,000 (26,000)
Other assets - (10,000) -
Increase (decrease) in
Accounts payable 1,534,000 (620,000) 854,000
Accrued liabilities 513,000 (743,000) 747,000
------------- ------------- -------------
Net cash used in operating activities (3,748,000) (9,300,000) (3,851,000)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (63,000) (720,000) (1,275,000)
Proceeds from notes receivable - - 207,000
Other assets - (49,000) (260,000)
Other liabilities - - -
------------- ------------- -------------
Net cash used in investing activities (63,000) (769,000) (1,328,000)
------------- ------------- -------------
The accompanying notes are an integral part of these financial statements.
F-9
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30,
===============================================================================================
2001 2000 1999
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from convertible notes payable $ 122,000 $ 2,500,000 $ -
Payments on convertible notes payable - (2,500,000) -
Proceeds from sale of common stock and warrants 2,485,000 9,475,000 1,011,000
Proceeds from sale of minority stock in
consolidated subsidiary - 53,000 55,000
Proceeds from exercise of options 4,000 179,000 -
Payments on capital lease obligation (26,000) - -
------------ ------------ ------------
Net cash provided by financing activities 2,585,000 9,707,000 1,066,000
------------ ------------ ------------
Net decrease in cash and cash equivalents (1,226,000) (362,000) (4,113,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,275,000 1,637,000 5,750,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 49,000 $ 1,275,000 $ 1,637,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INCOME TAXES PAID $ - $ - $ -
============ ============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES During the
year ended June 30, 2001, the Company completed the following:
o Discounted non-interest-bearing related party notes payable in the amount
of $76,000, using a discount rate of 10%.
o Issued stock for services rendered during the year ended June 30, 2000.
Said services were valued at $62,000.
During the year ended June 30, 2000, the Company completed the following:
o Repossessed equipment from a customer who was in arrears on payment for
said equipment at a cost of $868,000.
o Equipment with a net book value of $150,000 was transferred to the Company
in exchange for payment of a long-term note receivable.
The accompanying notes are an integral part of these financial statements.
F-10
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)
o Committed to issue 74,716 shares of common stock valued at $82,000 as
payment for accrued compensation to an employee.
o Issued 275,625 warrants to purchase common stock for services valued at
$60,000.
o Purchased equipment under a capital lease in the amount of $54,000.
During the year ended June 30, 1999, the Company completed the following:
o Equipment valued at $500,000 that was prepaid at June 30, 1998 was
delivered to the Company.
o 5,543,468 shares of common stock were issued upon the conversion of 548
shares of its Series C preferred stock.
o 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.
o The current portion of a note payable to a related party for $228,000 plus
accrued interest of $130,000 was converted into a long-term note payable to
the same related party.
The accompanying notes are an integral part of these financial statements.
F-11
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
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. 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, and fax. 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.
F-12
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
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 $9,948,000 during the year ended
June 30, 2001 and it had negative cash flows from operations of
$3,748,000. 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
Principles of Consolidation
---------------------------
The accompanying consolidated financial statements include the accounts
of Franklin and its wholly owned or majority owned subsidiaries, FNet
Corp., FNet/Curacao, FNet-Bosnia, IDM, Internet Passport, Lan
Performance, TCI, and FTC 800. All inter-company balances and
transactions have been eliminated.
Revenue Recognition
-------------------
Revenues from product sales are recognized upon shipment of the product
to customers. The Company does not allow the right of return on product
sales. Revenue from telephone and Internet services are recognized over
the period services are provided and consist primarily of fees charged
for the Company's billable network and Internet access services.
F-13
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income
--------------------
The Company utilizes Statement of Financial Accounting Standards
("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.
Cash and Cash Equivalents
-------------------------
For purposes of the statements of cash flows, the Company considers all
highly liquid investments purchased with original maturities of three
months or less to be cash equivalents.
Inventories
-----------
Inventories are stated at the lower of cost or market (estimated net
realizable value). Cost is determined using the average cost method,
which approximates the first-in, first-out ("FIFO") method. Net
realizable value is based on forecasts for sales of the Company's
products in the ensuing years. The industry in which the Company
operates is characterized by rapid technological advancement and
change. Should demand for the Company's products prove to be
significantly less than anticipated, the ultimate realizable value of
the Company's inventories could be substantially less than the amount
shown on the accompanying consolidated balance sheets.
Property and Equipment
----------------------
Property and equipment are stated at cost. The Company provides for
depreciation using the straight-line method over the estimated useful
lives as follows:
Computers and software 5 years
Machinery and equipment 7 years
Furniture and fixtures 7 years
Expenditures for maintenance and repairs are charged to operations as
incurred while renewals and betterments are capitalized. Gains or
losses on the sale of property and equipment are reflected in the
statements of operations.
Licenses
--------
Licenses are stated at cost and are amortized using the straight-line
method over the license periods of five years.
F-14
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Impairment of Long-Lived Assets
-------------------------------
The Company reviews its long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of the
assets to future net cash flows expected to be generated by the assets.
If the assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount
exceeds the fair value of the assets.
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.
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 note receivable - related party, convertible
promissory notes payable, note payable - related party, 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.
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,
2001 and 2000.
F-15
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Minority Interest (Continued)
-----------------
FNet, on a stand-alone basis, had a shareholders' deficit. As a result,
Franklin's investment in FNet had a negative carrying value. The
increase in capitalization of FNet resulting from the sale of shares of
common stock to outside investors benefited Franklin in that it reduced
the negative carrying value of Franklin's investment in FNet.
Accordingly, Franklin has accounted for the change in its proportionate
share of FNet's equity resulting from the issuance of stock to outside
investors as an increase in shareholders' equity and a reduction in
minority interest liability in the consolidated financial statements.
The accompanying consolidated balance sheets do not reflect a minority
interest liability as of June 30, 2001 and 2000 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, 2001, 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.
Stock Options and Warrants
--------------------------
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 ("APB") No. 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.
Advertising Costs
-----------------
Advertising costs are expensed as incurred. Advertising expense was
$83,000, $393,000, and $204,000 for the years ended June 30, 2001,
2000, and 1999 respectively.
Research and Development Costs
------------------------------
Research and development costs are expensed as incurred.
F-16
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
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.
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.
The following potential common shares have been excluded from the
computation of diluted net loss per share for all periods presented
because the effect would have been anti-dilutive:
2001 2000
--------------- ----------------
Options outstanding inside the Company's stock
option plans 1,531,000 2,350,250
Options outstanding outside the Company's stock
option plans 1,441,451 2,277,500
Convertible notes payable 1,104,033 -
Warrants issued in conjunction with convertible
notes payable 1,000,000 1,000,000
Warrants issued in conjunction with various
private placements 8,856,888 3,751,177
Warrants issued as offering costs for convertible
notes payable 100,000 100,000
Warrants issued for services rendered 420,000 420,000
FNet warrants issued in conjunction with various
private placements 30,000 30,000
FNet warrants issued in conjunction with Series C
preferred stock 668,104 668,104
F-17
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Estimates
---------
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could
differ from those estimates.
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 years ended June 30, 2001 and 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.
Export sales, primarily to Canada, Australia, Europe, and South
America, represented 0%, 2%, and 9% of net sales for the years ended
June 30, 2001, 2000, and 1999, respectively.
Recently Issued Accounting Pronouncements
-----------------------------------------
In September 2000, the FASB issued SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, a replacement of FASB Statement No. 125." This statement
is not applicable to the Company.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations."
This statement addresses financial accounting and reporting for
business combinations and supersedes APB Opinion No. 16, "Business
Combinations," and SFAS No. 38, "Accounting for Pre-Acquisition
Contingencies of Purchased Enterprises." All business combinations in
the scope of this statement are to be accounted for using one method,
the purchase method. The provisions of this statement apply to all
business combinations initiated after June 30, 2001. Use of the
pooling-of-interests method for those business combinations is
prohibited. This statement also applies to all business combinations
accounted for using the purchase method for which the date of
acquisition is July 1, 2001 or later. The Company does not expect
adoption of SFAS No. 141 to have a material impact, if any, on its
financial position or results of operations.
F-18
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recently Issued Accounting Pronouncements (Continued)
-----------------------------------------
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets." This statement addresses financial accounting and
reporting for acquired goodwill and other intangible assets and
supersedes APB Opinion No. 17, "Intangible Assets." It addresses how
intangible assets that are acquired individually or with a group of
other assets (but not those acquired in a business combination) should
be accounted for in financial statements upon their acquisition. This
statement also addresses how goodwill and other intangible assets
should be accounted for after they have been initially recognized in
the financial statements. It is effective for fiscal years beginning
after December 15, 2001. Early application is permitted for entities
with fiscal years beginning after March 15, 2001, provided that the
first interim financial statements have not been issued previously. The
Company does not expect adoption of SFAS No. 142 to have a material
impact, if any, on its financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement applies to legal obligations
associated with the retirement of long-lived assets that result from
the acquisition, construction, development, and/or the normal operation
of long-lived assets, except for certain obligations of lessees. This
statement is not applicable to the Company.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. This statement replaces SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of," the accounting and reporting provisions of APB No. 30,
"Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual, and
Infrequently Occurring Events and Transactions," for the disposal of a
segment of a business, and amends Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to eliminate the exception to
consolidation for a subsidiary for which control is likely to be
temporary. The Company does not expect adoption of SFAS No. 144 to have
a material impact, if any, on its financial position or results of
operations.
F-19
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
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, 2001 and 2000, the
uninsured portions of these balances held at the banks aggregated to $0
and $1,116,000, respectively.
Income from these investments consists entirely of interest income in
the amount of $19,000, $68,000, and $148,000 for the years ended June
30, 2001, 2000, and 1999, respectively. The aggregate carrying amount
of cash and short-term investments by major types at June 30 was as
follows:
2001 2000
-------------- --------------
Cash $ 41,000 $ 519,000
Money market accounts 8,000 756,000
-------------- --------------
TOTAL $ 49,000 $ 1,275,000
============== ==============
NOTE 5 - INVENTORIES
Inventories at June 30 consisted of the following:
2001 2000
-------------- --------------
Raw materials $ 1,360,000 $ 1,314,000
Work in process 201,000 222,000
Finished goods 1,141,000 1,296,000
Reserve for obsolescence (2,377,000) (134,000)
-------------- --------------
TOTAL $ 325,000 $ 2,698,000
============== ==============
During the year ended June 30, 2001, the Company did not realize
sufficient sales from Internet telephony equipment to support it
capital structure. Therefore, management revised its forecasts and
projections for the Company. These revised sales forecasts indicated
that future expected cash flows from sales of Internet telephony
equipment were less than the carrying value of their inventories. The
carrying value of the Company's inventories was $2,702,000, but based
on recent comparable sales of other telephony equipment, management
determined the fair value of inventories to be approximately $325,000.
As a result, the Company recorded an additional reserve for
obsolescence of $2,243,000.
F-20
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 6 - PROPERTY AND EQUIPMENT
Property and equipment at June 30 consisted of the following:
2001 2000
-------------- --------------
Computers and software $ 1,230,000 $ 1,607,000
Machinery and equipment 882,000 1,562,000
Furniture and fixtures 223,000 280,000
-------------- --------------
2,335,000 3,449,000
Less accumulated depreciation 1,746,000 1,291,000
-------------- --------------
TOTAL $ 589,000 $ 2,158,000
============== ==============
During the year ended June 30, 2001, the Company did not realize
sufficient sales from Internet telephony equipment and services to
support its capital structure. Therefore, management revised its
forecasts and projections for Franklin and FNet. These revised sales
forecasts indicated that future expected cash flows from these business
units were less than the carrying value of their long-lived assets. The
carrying value of the Company's long-lived assets was $2,125,000, but
based on recent comparable sales of other telephony equipment,
management determined the fair value of the long-lived assets to be
approximately $980,000. As a result, the Company recognized an
impairment charge of $1,145,000. The charge included $104,000 for
licenses and $1,041,000 of tenant improvements, property and equipment,
software and supporting technologies, and infrastructure, which are
included in the consolidated statement of operations for the year ended
June 30, 2001. Of this impairment charge, $365,000 is related to
Franklin, and the remaining $780,000 is related to FNet.
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.
F-21
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 7 - NOTE RECEIVABLE - RELATED PARTY
Note receivable - related party at June 30 consisted of the following:
2001 2000
-------------- --------------
Note receivable from a former 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
Less current portion - 64,000
-------------- --------------
LONG-TERM PORTION $ - $ -
============== ==============
During the year ended June 30, 2001, the Company determined that the
note receivable from its director was uncollectible and wrote off the
entire balance. The Company recorded a loss on impairment on the note
receivable of $64,000.
NOTE 8 - ACCRUED LIABILITIES
Accrued liabilities at June 30 consisted of the following:
2001 2000
-------------- --------------
Salaries and related expenses $ 249,000 $ 372,000
Salaries and related expenses due to officers 776,000 318,000
Accrued legal settlement (Note 12) 165,000 -
Other accrued liabilities 189,000 338,000
-------------- --------------
TOTAL $ 1,379,000 $ 1,028,000
============== ==============
F-22
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 9 - CONVERTIBLE NOTES PAYABLE
Convertible notes payable at June 30 consisted of the following:
2001 2000
-------------- --------------
6% convertible promissory note, due March 20,
2002 $ 100,000 $ -
6% convertible promissory note, due May 29,
2002 2,000 -
6% convertible promissory note, due June 28,
2002 20,000 -
-------------- --------------
122,000 -
Less current portion 122,000 -
-------------- --------------
LONG-TERM PORTION $ - $ -
============== ==============
On March 20, 2001 and June 28, 2001, the Company issued convertible
promissory notes to its chief executive officer/chairman in the amounts
of $100,000 and $20,000, respectively. The notes are convertible upon
issuance at the option of the holder into the Company's common stock at
a conversion price equal to the fair value of the Company's common
stock on the date of issuance, or $0.12 and $0.08, respectively. The
notes incur interest at 6% per annum, the interest is payable annually,
and the notes mature one year from the date of issuance. None of the
notes were converted into common stock during the year ended June 30,
2001. No expense was recorded in connection with the issuance of the
convertible notes since the conversion price was equal to the fair
value of the Company's common stock at the date of issuance.
On May 29, 2001, the Company issued a convertible promissory note to an
investor in the amount of $2,000. The note is convertible upon issuance
at the option of the holder into the Company's common stock at a
conversion price equal to the fair value of the Company's common stock
on the date of issuance, or $0.10. The note incurs interest at 6% per
annum, the interest is payable annually, and the note matures one year
from the date of issuance. The note was not converted into common stock
during the year ended June 30, 2001. No expense was recorded in
connection with the issuance of the convertible note since the
conversion price was equal to the fair value of the Company's common
stock at the date of issuance.
F-23
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 10 - NOTE PAYABLE - RELATED PARTY
The $762,000 due to the Company's chief executive officer/chairman
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, 2000. 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/chairman has signed a waiver,
deferring all payments due until the earlier of July 1, 2002 or upon an
acquisition of the Company. As of June 30, 2001, no acquisition offers
had been made.
In accordance with generally accepted accounting principles, all
non-interest-bearing notes must be discounted using the Company's
average borrowing rate. This discount is amortized on a straight-line
basis over the term of the note. As of June 30, 2001 the discount on
the related party note payable was $76,000, using a discount rate of
10%.
NOTE 11 - NOTE PAYABLE
During the year ended June 30, 2000, the conversion feature of certain
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.
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 bore interest at 10% per annum, were
unsecured, required quarterly interest payments on the unconverted
balance, and were scheduled to mature on December 3, 2002. The notes
were repaid in May 2000. The notes were convertible into shares of the
Company's common stock if the Company elected not to pay the aggregate
principal amount outstanding and accrued interest by May 3, 2000.
The warrants vest upon issuance and expire three years from the date of
the private placement. At June 30, 2001, none of the warrants had been
exercised.
F-24
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 12 - 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 $222,000, $218,000, and $170,000 for the years
ended June 30, 2001, 2000, and 1999, respectively.
The Company leased 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 $19,000, $53,100, and
$49,000 for the years ended June 30, 2001, 2000, and 1999,
respectively.
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, 2001 were as follows:
Year Ending Operating Capital
June 30 Lease Lease
-------------- -------------- --------------
2002 $ 122,000 $ 32,000
2003 85,000 -
-------------- --------------
$ 207,000 32,000
==============
Less amount representing interest 4,000
--------------
28,000
Less current portion 28,000
--------------
LONG TERM PORTION $ -
==============
Leased capital assets as of June 30 consisted of the following:
2001 2000
-------------- --------------
Telephone equipment $ 60,000 $ 60,000
Less accumulated depreciation 17,000 5,000
-------------- --------------
TOTAL $ 43,000 $ 55,000
============== ==============
F-25
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Operating Leases and Capital Lease Obligations (Continued)
----------------------------------------------
For the years ended June 30, 2001, 2000, and 1999, depreciation expense
related to capital leases amounted to $12,000, $5,000, and $0,
respectively.
Litigation
----------
During June 2000, two shareholders who acquired their shares in a
private placement in March 2000 filed a lawsuit against Franklin and
two of the Company's officers/directors. The lawsuit sought to postpone
the June 28, 2000 annual shareholders 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 the plaintiffs.
Thereafter, the plaintiffs amended the lawsuit several times and
ultimately added new claims pertaining to the private placement and
alleging securities law violations. During October 2000, the lawsuit
was abandoned by the plaintiffs, and both parties mutually agreed to
dismiss the suit without financial restitution.
During April 2000, Nexbell, a long distance service provider, filed
suit against FNet, alleging that FNet defaulted under the terms and
conditions of FNet's service agreement when FNet failed to pay for
services rendered valued at $165,000. FNet has engaged in ongoing
settlement discussions in order to end the expense of the litigation
and believes that a settlement in the amount of $165,000 is probable.
As such, the Company has recorded an accrual for $165,000 as of June
30, 2001 (see Note 18).
In addition, 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.
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. 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 $0, $4,500,
and $103,000 during the years ended June 30, 2001, 2000, and 1999
respectively.
F-26
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Software License Agreements (Continued)
---------------------------
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, $0 during the
years ended June 30, 2001, 2000, and 1999, 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.
During May 1999, the Company entered into a license agreement with TEK
DigiTel ("TEK") in which TEK granted the Company a license to
manufacture and sell certain hardware and software which were developed
by TEK. 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. Amounts paid under this license agreement totaled $0, $0, and
$150,000 during the years ended June 30, 2001, 2000, and 1999,
respectively. During the year ended June 30, 2001, the Company
recognized an impairment of the license of $104,000, which represents
the unamortized purchase price of the license.
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.
F-27
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 12 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employment Agreements
---------------------
On September 2, 1997, the Company entered into a six-year employment
agreement with its chief executive officer/chairman. The annual salary
for the officer is $324,000. The officer may at his option convert up
to 50% of his compensation into options to purchase the Company's
common stock. The exercise price will equal 50% of the fair market
value of the Company's common stock at the date of grant. During the
year ended June 30, 2000, the Company reduced the annual salary to
$150,000 per year.
Service Agreement
-----------------
In September 2000, FNet entered into a five-year, non-cancelable
service agreement with a satellite service provider to operate uplink
and downlink earth stations between the United States and the Balkan
region. The estimated fee for the project was $1,236,000. As of June
30, 2001, the Company had violated certain terms and conditions of the
service agreement. As such, the agreement stipulates that the Company
must immediately pay the remaining fee for the project of approximately
$1,058,000. The Company is in the process of negotiating a settlement
with the service provider and has included this balance in accounts
payable on the accompanying balance sheet.
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT)
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 the fair market
value of the Company's stock at the date of grant.
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.
F-28
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
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 were issued to employees,
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 upon 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 three years at June 30,
2001.
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 years ended June 30, 2001 and 2000 since
the fair market value of the Company's stock price was less than the
re-priced exercise price at those dates.
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.
F-29
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
Activity for the 1986 Plans, the 1988 Plan, the 1993 Plan, the 1994
Plan, and the 1998 Plan is as follows:
Weighted-
Average
Exercise
Shares Price
-------------- --------------
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
Granted 10,000 $ 0.75
Exercised (25,000) $ 0.44
Canceled (804,250) $ 0.51
--------------
OUTSTANDING, JUNE 30, 2001 1,531,000 $ 0.30
==============
EXERCISABLE AT JUNE 30, 2001 1,389,500 $ 0.27
==============
F-30
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
During the year ended June 30, 1999, the Company granted options to
purchase 2,615,000 shares of common stock to key management employees,
which vest over a period of zero to four years. The option exercise
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 exercise
price was set at $0.69 per share, the fair value of the underlying
shares.
During the year ended June 30, 2001, the Company granted options to
purchase 3,246,451 shares of common stock to employees, which vest over
a period of zero to four years. The option price of such options range
from $0.08 to $1.25 per share, which represented the fair value of the
underlying shares at the date of grant. During the year ended June 30,
2001, 2,660,000 of the options granted during that year were also
canceled.
Activity for options outside of the Plan is as follows:
Weighted-
Average
Exercise
Shares Price
-------------- --------------
Outstanding, June 30, 1998 1,325,000 $ 1.77
Granted 2,615,000 $ 0.44
Exercised (82,500) $ 0.44
Expired/canceled (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/canceled (755,000) $ 0.45
--------------
Outstanding, June 30, 2000 2,277,500 $ 0.56
Granted 3,246,451 $ 0.59
Exercised (382,500) $ 0.44
Canceled (3,700,000) $ 0.68
--------------
OUTSTANDING, JUNE 30, 2001 1,441,451 $ 0.38
==============
EXERCISABLE AT JUNE 30, 2001 1,286,451 $ 0.34
==============
F-31
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
The exercise prices for the options outstanding at June 30, 2001 inside
and outside of the Plan ranged from $0.01 to $3.66. The
weighted-average remaining contractual life of the options outstanding
at June 30, 2001 is 2.57 years, and the information relating to these
options is as follows:
Weighted- Weighted-
Weighted- Average Average
Average Exercise Exercise
Range of Stock Stock Remaining Price of Price of
Exercise Options Options Contractual Options Options
Prices Outstanding Exercisable Life Outstanding Exercisable
---------------- ----------- ----------- ----------- ----------- -----------
$ 0.01 - 0.10 441,451 441,451 3.40 years $ 0.09 $ 0.09
$ 0.11 - 1.00 2,454,000 2,182,500 1.85 years $ 0.45 $ 0.42
$ 1.01 - 3.66 77,000 52,000 5.64 years $ 2.40 $ 2.36
----------- -----------
2,972,451 2,675,951
=========== ===========
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
upon termination of employment.
F-32
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
Activity for the FNet Plan is as follows:
Weighted-
Average
Exercise
Shares Price
-------------- --------------
Outstanding, June 30, 1998 5,619,000 $ 1.00
Granted 1,114,000 $ 1.00
Exercised (12,000) $ 1.00
Expired/canceled (3,450,000) $ 1.00
--------------
Outstanding, June 30, 1999 3,271,000 $ 1.00
Granted 50,000 $ 2.00
Expired/canceled (737,000) $ 1.00
--------------
Outstanding, June 30, 2000 2,584,000 $ 1.02
Canceled (1,218,000) $ 1.04
--------------
OUTSTANDING, JUNE 30, 2001 1,366,000 $ 1.00
==============
EXERCISABLE AT JUNE 30, 2001 1,220,000 $ 1.00
==============
During the year ended June 30, 1999, the Company granted options to
purchase 355,000 shares of common stock to key management employees,
which vest over a period of four years. The option exercise 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
exercise price was set at $2 per share, the fair value of the
underlying shares.
During the year ended June 30, 2001, the Company granted options to
purchase 578,750 shares of FNet's common stock to employees, which vest
over a period of two to four years. The option exercise price was set
at $2 per share, the fair value of the underlying shares.
F-33
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Option Plans (Continued)
------------------
Activity for FNet options outside of the FNet Plan is as follows:
Weighted-
Average
Exercise
Shares Price
-------------- --------------
Outstanding, June 30, 1998 380,000 $ 1.00
Granted 355,000 $ 1.00
Expired/canceled (255,000) $ 1.00
--------------
Outstanding, June 30, 1999 480,000 $ 1.00
Granted 2,845,000 $ 2.00
Expired/canceled (1,800,000) $ 1.83
--------------
Outstanding, June 30, 2000 1,525,000 $ 1.86
Granted 578,750 $ 2.00
Canceled (1,647,500) $ 1.95
--------------
OUTSTANDING, JUNE 30, 2001 456,250 $ 1.78
==============
EXERCISABLE AT JUNE 30, 2001 165,000 $ 1.70
==============
The exercise prices for the options outstanding at June 30, 2001 inside
and outside of the FNet Plan ranged from $1 to $2. The weighted-average
remaining contractual life of the options outstanding at June 30, 2001
is 5.58 years, and the information relating to these options is as
follows:
Weighted- Weighted-
Weighted- Average Average
Average Exercise Exercise
Range of Stock Stock Remaining Price of Price of
Exercise Options Options Contractual Options Options
Prices Outstanding Exercisable Life Outstanding Exercisable
---------------- ----------- ----------- ----------- ----------- -----------
$ 1.00 1,458,500 1,270,000 5.21 years $ 1.00 $ 1.00
$ 2.00 363,750 115,000 7.10 years $ 2.00 $ 2.00
----------- -----------
1,822,250 1,385,000
=========== ===========
F-34
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (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:
Year Ended June 30,
----------------------------------------------
2001 2000 1999
-------------- -------------- --------------
Net loss
As reported $ (10,820,000) $ (11,551,000) $ (2,413,000)
Pro forma $ (11,084,000) $ (12,154,000) $ (3,343,268)
Loss per common share
As reported $ (0.27) $ (0.39) $ (0.11)
Pro forma $ (0.27) $ (0.41) $ (0.15)
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, 2001, 2000, and 1999: dividend
yields of 0%, 0%, and 0%, respectively; expected volatility of 100%,
100%, and 100%, respectively; risk-free interest rates of 5.8%, 6.4%,
and 5.6%, respectively; and expected lives of two, four, and four,
respectively. The weighted-average fair value of options granted during
the years ended June 30, 2001, 2000, and 1999 were $0.34, $1.27, and
$0.34, respectively, and the weighted-average exercise price was $0.59,
$0.69, and $0.63, 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,
2001, 2000, and 1999: dividend yields of 0%, 0%, and 0%, respectively;
risk-free interest rates of 6%, 6.4%, and 5.8%, respectively; and
expected lives of two, four, and four years, respectively. The
weighted-average fair value of options granted during the years ended
June 30, 2001, 2000, and 1999 was $0.25, $0.44, and $0.20,
respectively, and the weighted-average exercise price was $2, $2, and
$1, respectively.
F-35
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (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 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). For the years ended June 30, 2001, 2000, and 1999, 0, 50,000,
and 113,250 warrants, respectively, were exercised, leaving a remaining
balance of 50,000 unexercised as of June 30, 2001.
In connection with 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, 2001, no
warrants had been exercised.
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 an 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 not any expense recorded in connection with the issuance of
the warrants as the exercise price approximated the fair value of
FNet's common stock at the date of issuance. As of June 30, 2001,
43,600 warrants had been exercised, leaving a remaining balance of
30,000 unexercised warrants.
F-36
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Issuances
---------------
During the year ended June 30, 2001, the Company completed the
following common stock transactions of previously unissued common
shares:
o Issued 10,000 shares in connection with the exercise of stock
options for cash of $4,000.
o In connection with a private placement in August 2000, the Company
issued 4,994,600 shares of common stock and 5,105,711 warrants for
gross proceeds of $2,497,000, less fees and commissions of
$13,000. The warrants had an exercise price of $3, vested
immediately, and expire three years from the date of issuance. The
Company allocates the proceeds received from debt, convertible
debt, convertible preferred stock, or common stock with detachable
warrants using the relative fair value of the individual elements
at the time of issuance. The amount allocated to the warrants of
$478,000 was calculated using the Black-Scholes option pricing
model. As of June 30, 2001, no warrants had been exercised.
o Issued 295,858 shares of common stock to its chief financial
officer in connection with a cashless exercise of options that
were processed by the Company. No expense was recorded in
connection with the transaction because the chief financial
officer had owned the shares that were used to pay for the
cashless exercise for more than six months prior to the
transaction.
o Issued 477,324 shares of common stock for services valued at
$318,000.
o In connection with a private placement in March 2000, the Company
issued warrants to the investors that were designed to protect the
investors against short-term declines in the value of the
Company's common stock during the period between the date of the
issuance of the shares and the effective date of a Registration
Statement covering the shares issued. The warrants vest if the
market price of the Company's common stock is below $1.50 on the
effective date. The registration statement for the shares became
effective in November 2000, at which time the market price of the
Company's common stock was below $1.50. As a result, warrants for
2,011,329 shares became exercisable at an exercise price of $0.01
per share. During the year ended June 30, 2001, the Company issued
1,927,797 net shares of common stock in connection with a cashless
exercise of said warrants, and 50,000 shares of common stock were
issued for cash of $500.
F-37
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Issuances (Continued)
---------------
o In connection with a private placement in March 2000, the Company
was obligated to effect the registration of the shares sold within
a specified time period, with penalties due to the investors if
the deadline was not met. As the deadline was not met, the Company
became obligated to pay the penalties in either cash or shares of
common stock. The Company opted to pay the penalties in shares of
common stock and issued 503,538 shares to these investors in
November 2000 and recognized an expense of $430,000 in the
consolidated statement of operations for the year ended June 30,
2001.
o Issued 111,111 shares of the Company's common stock for 6,667
shares of FNet common stock in a stock-for-stock transaction. The
shares of FNet's common stock had been issued during the year
ended June 30, 1999.
During the year ended June 30, 2000, the Company completed the
following common stock transactions of previously unissued common
shares:
o Issued 1,211,033 shares of common stock 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.
o Issued 261,603 shares of common stock in connection with the
exercise of stock options for cash of $179,000.
o In connection with a private placement in August 1999, the Company
issued 1,932,368 shares of common stock and 400,000 warrants for
gross proceeds of $2,000,000, less fees and commissions of
$205,000. The warrants had an exercise price of $1.55, vested
immediately, and expire five years from the date of issuance. The
Company allocates the proceeds received from debt, convertible
debt, convertible preferred stock, or common stock with detachable
warrants using the relative fair value of the individual elements
at the time of issuance. The amount allocated to the warrants of
$371,000 was calculated using the Black-Scholes option pricing
model. As of June 30, 2001, no warrants had been exercised.
o In connection with a private placement in February 2000, the
Company sold 841,515 shares of common stock for gross proceeds of
$1,500,000. The Company paid commissions and fees of $36,000 in
connection with this private placement.
F-38
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Issuances (Continued)
---------------
o In connection with a private placement in March 2000, the Company
issued 4,022,667 shares of common stock and 1,205,667 warrants for
gross proceeds of $6,040,000, less fees and commissions of
$344,000. The warrants had an exercise price of $2.50, vested
immediately, and expire five from the date of issuance. The
Company allocates the proceeds received from debt, convertible
debt, convertible preferred stock, or common stock with detachable
warrants using the relative fair value of the individual elements
at the time of issuance. The amount allocated to the warrants of
$1,668,000 was calculated using the Black-Scholes option pricing
model. As of June 30, 2001, no warrants had been exercised.
o In connection with a private placement in March 2000, the Company
sold 43,600 shares of common stock for $376,000. The Company paid
commissions and fees of $35,000 in connection with this private
placement.
o Issued 115,807 shares of common stock at prices ranging from $0.44
to $10 for total cash of $179,000.
o Committed to issue to an employee 74,716 shares of common stock
for accrued compensation of $82,187.
o Issued 21,694 shares to certain employees of common stock as
compensation valued at $48,000.
During the year ended June 30, 1999, the Company completed the
following common stock transactions of previously unissued common
shares:
o Issued 444,725 shares of common stock at prices ranging from $0.50
to $2.27 for total cash proceeds of $474,000.
o Issued 5,543,468 shares of common stock valued at $4,856,000 upon
the conversion of 548 shares of its convertible Series C preferred
stock valued at $4,856,000.
o Issued 570,000 shares of common stock valued at $200,000 to the
Company's chief executive officer/chairman in exchange for a note
receivable.
o Issued 121,356 shares of common stock for services valued at
$64,000.
F-39
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Stock Issuances (Continued)
---------------
o Issued 21,524 shares of common stock in connection with the
exercise of warrants, whereby the warrant holders issued notes
receivable in favor of the Company for $22,000 as payment for the
exercise price.
o Issued 215,514 shares of common stock in connection with the
exercise of stock options, whereby the option holders issued notes
receivable in favor of the Company for $216,000.
o Issued 60,625 shares of common stock in connection with the
exercise of stock options for cash proceeds of $29,000.
o Issued or committed to issue 408,000 shares of common stock in
connection with the exercise of warrants for cash proceeds of
$467,000.
Pursuant to state laws, the Company is currently restricted, and may be
restricted for the foreseeable future, from making dividends to its
shareholders as a result of its accumulated deficit as of June 30,
2001.
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, 2001,
all shares of preferred stock have been converted into common stock.
F-40
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 13 - SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
Convertible Preferred Stock (Continued)
---------------------------
Each preferred share was accompanied by a warrant that is exercisable
to purchase shares of common stock of the Company's subsidiary, FNet,
at an exercise price of $1 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 had
been exercised during the year ended June 30, 2001.
NOTE 14 - INCOME TAXES
The tax effects of temporary differences that give rise to deferred
taxes at June 30 are as follows:
2001 2000
--------------- ----------------
Deferred tax assets
Accounts receivable, principally due to
allowance for doubtful accounts $ 52,000 $ 20,000
Goodwill 232,000 200,000
Compensated absences and deferred salaries,
principally due to accrual for financial reporting
purposes 442,000 211,000
Inventories, principally due to additional costs
inventoried for tax purposes pursuant to the
Tax Reform Act of 1986 and allowance for
inventory obsolescence 1,018,000 78,000
Plant and equipment, principally due to
differences in depreciation 140,000 -
Deferred revenue 81,000 -
Accrued settlement 70,000 -
Warrants for services - 24,000
Accrued warranty 5,000 5,000
General business tax credit carryforwards 335,000 335,000
Net operating loss carryforwards 13,147,000 10,501,000
--------------- ----------------
Total gross deferred tax assets 15,522,000 11,374,000
Less valuation allowance 14,972,000 10,891,000
--------------- ----------------
Net deferred tax assets 550,000 483,000
F-41
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 14 - INCOME TAXES (CONTINUED)
2001 2000
--------------- ----------------
Deferred tax liabilities
State taxes $ 550,000 $ 363,000
Plant and equipment, principally due to
differences in depreciation - 120,000
--------------- ----------------
NET DEFERRED TAX LIABILITY $ - $ -
=============== ================
The valuation allowance increased by $4,375,000 and $4,132,000 during
the years ended June 30, 2001 and 2000, respectively. No provision for
income taxes for the years ended June 30, 2001, 2000, and 1999 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:
2001 2000 1999
---------------- --------------- ----------------
Computed "expected" tax benefit $ (3,679,000) $ (3,910,000) $ (818,000)
Increase in income taxes resulting from
Other 282,000 8,000 4,000
Exercise of stock options (442,000) (230,000) -
Change in the beginning-of-the-
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense 3,839,000 4,132,000 814,000
State income taxes 3,000 3,000 7,000
---------------- --------------- ----------------
TOTAL $ 3,000 $ 3,000 $ 7,000
================ =============== ================
As of June 30, 2001, the Company had consolidated net operating loss
carryforwards of $36,000,000 and $11,600,000 for federal and state
income tax reporting purposes, respectively, which expire in varying
amounts through 2021. The Company also has general business tax credit
carryforwards of $310,000 and $25,000 available to offset against
future federal and state income taxes, respectively, which expire at
various times through 2021. 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.
F-42
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 15 - RELATED PARTY TRANSACTIONS
In August 1999, a non-employee director of the Company received
warrants to purchase 140,000 shares of common stock at an exercise
price of $1.38 per share as consideration for the production of
advertising materials valued at $60,000.
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 $0.44 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 $0.44 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 $0.44 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
$0.69 per share. The options vest over a two-year period. During the
year ended June 30, 2001, all of these options were canceled.
In September 2000, the Company chief financial officer exercised
options to purchase 400,000 shares of the Company's common stock at an
exercise price of $0.44 per share. The exercise was done on a net basis
so that the actual number of shares issued was 295,858.
NOTE 16 - 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, 2001,
2000, and 1999.
F-43
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 17 - EXTINGUISHMENT OF DEBT
During the year ended June 30, 2001, a long distance service provider
forgave certain payables in the amount of $387,000.
NOTE 18 - 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,
2001, 2000, and 1999 was as follows:
2001 2000 1999
---------------- ---------------- ----------------
Net sales
Franklin $ 421,000 $ 1,109,000 $ 8,745,000
FNet 824,000 2,098,000 1,886,000
---------------- ---------------- ----------------
TOTAL $ 1,245,000 $ 3,207,000 $ 10,631,000
================ ================ ================
Operating losses
Franklin $ (6,492,000) $ (6,990,000) $ (104,000)
FNet (4,406,000) (4,154,000) (2,378,000)
---------------- ---------------- ----------------
TOTAL $ (10,898,000) $ (11,144,000) $ (2,482,000)
================ ================ ================
Identifiable assets
Franklin $ 988,000 $ 5,198,000 $ 7,039,000
FNet 447,000 1,959,000 2,396,000
---------------- ---------------- ----------------
TOTAL $ 1,435,000 $ 7,157,000 $ 9,435,000
================ ================ ================
Capital expenditures
Franklin $ 44,000 $ 152,000 $ 130,000
FNet 19,000 640,000 1,540,000
---------------- ---------------- ----------------
TOTAL $ 63,000 $ 792,000 $ 1,670,000
================ ================ ================
Depreciation and amortization
Franklin $ 315,000 $ 275,000 $ 224,000
FNet 384,000 367,000 210,000
---------------- ---------------- ----------------
TOTAL $ 699,000 $ 642,000 $ 434,000
================ ================ ================
F-44
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 19 - SUBSEQUENT EVENTS
Common Stock and Warrants
-------------------------
In connection with a private placement in September 2001, the Company
issued 1,140,000 shares of common stock and 520,000 warrants for gross
proceeds of $57,000. The exercise price of the warrants is $0.05 per
share, unless the 10-day average price of the Company's common stock is
less than $0.25 per share between March 15, 2002 to March 25, 2002, in
which case the exercise price will be $0.001. The warrants vested
immediately and expire nine months from the date of issuance. The
Company allocates the proceeds received from debt, convertible debt,
convertible preferred stock, or common stock with detachable warrants
using the relative fair value of the individual elements at the time of
issuance. The amount allocated to the warrants will be calculated using
the Black-Scholes option pricing model.
Convertible Promissory Notes
----------------------------
In July 2001, the Company issued a convertible promissory note to its
chief executive officer/chairman in the amount of $19,000. The note is
convertible upon issuance at the option of the holder into the
Company's common stock at a conversion price equal to the fair value of
the Company's common stock on the date of issuance, or $0.05. The note
incurs interest at 6% per annum, the interest is payable annually, and
the note matures in July 2002. No expense was recorded in connection
with the issuance of the convertible note since the conversion price
was equal to the fair value of the Company's common stock at the date
of issuance.
In November 2001, the Company issued a convertible promissory note (the
"November Note") to its chief executive officer/chairman in the amount
of $50,000. The November Note is convertible upon issuance at the
option of the holder into the Company's common stock at a conversion
price equal to the fair value of the Company's common stock on the date
of issuance, or $0.05. The November Note incurs interest at 6% per
annum, the interest is payable annually, and the note matures in
November 2002. No expense was recorded in connection with the issuance
of the November Note since the conversion price was equal to the fair
value of the Company's common stock at the date of issuance. Upon
conversion of the November Note, the Company will also issue 250,000
warrants. The exercise price of the warrants will be $0.05 per share,
unless the 10-day average price of the Company's common stock is less
than $0.25 per share between March 15, 2002 to March 25, 2002, in which
case the exercise price will be $0.001. All unexercised warrants expire
in June 2002.
F-45
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 19 - SUBSEQUENT EVENTS (CONTINUED)
Convertible Promissory Notes (Continued)
----------------------------
Related to the issuance of the November Note, the Company allocates the
proceeds received from debt, convertible debt, or convertible preferred
stock with detachable warrants using the relative fair value of the
individual elements at the time of issuance. The amount allocated to
the warrants as a debt discount if the November Note is converted will
be calculated using the Black-Scholes option pricing model and will be
recognized as interest expense over the period until the note matures.
Operating Leases
----------------
Subsequent to June 30, 2001, the Company converted an operating lease
with future payments of $97,000 and $73,000 in the years ended June 30,
2002 and 2003, respectively, into a month-to-month lease.
Litigation Settlement
---------------------
In July 2001, FNet settled a lawsuit with Nexbell for $25,000, which is
payable at a rate of $1,040 per month beginning August 1, 2001, and
240,000 shares of the Company's common stock valued at $140,000.
Stock Options
-------------
In September 2001, the Company granted options to purchase 2,000,000
shares of common stock at an exercise price of $0.05 per share, the
fair value of the underlying shares, to two members of the board. The
options were granted outside of the Company's stock option plans, vest
10% per month over the next 20 months, and expire three years from the
date of grant.
In October 2001, the Company granted options to purchase 1,260,000
shares of common stock at an exercise price of $0.05 per share, the
fair value of the underlying shares, to various employees. These
options were granted for payment of deferred salaries from February to
September 2001 valued at $20,842. The options were granted outside of
the Company's stock option plans and may be exercised any time after
issuance and for a period of three years from the date of grant.
In November 2001, the Company granted options to purchase 2,400,000 and
2,500,000 shares of common stock at an exercise price of $0.05 per
share, the fair value of the underlying shares, to its chief executive
officer/chairman and chief operating officer, respectively. These
options were granted for payment of deferred salaries from January to
October 2001 valued at $118,000 and $128,000, respectively. The options
were granted outside of the Company's stock option plans and may be
exercised any time after issuance and for a period of three years from
the date of grant.
F-46
FRANKLIN TELECOMMUNICATIONS CORP.
AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
================================================================================
NOTE 19 - SUBSEQUENT EVENTS (CONTINUED)
Stock Options (Continued)
-------------
In December 2001, the Company granted options to purchase 100,000
shares of common stock at an exercise price of $.05 per share, the fair
value of the underlying shares, to an attorney as a bonus. The options
were granted outside of the Company's stock option plans and may be
exercised any time after issuance and for a period of three years from
the date of grant.
Litigation
----------
In November 2001, the lessor of certain telephone equipment, which the
Company had leased under a non-cancelable capital lease, filed suit
against the Company. The compliant alleges that the Company defaulted
under the terms and conditions of the capital lease agreement when the
Company failed to make the required monthly payments. The lessor is
seeking payment for the remaining balances due under the lease
agreement in the amount of $28,000. The Company has accrued for such
amounts as a capital lease obligation.
In November 2001, two former employees of the Company filed a claim
with the California Labor Board, claiming vacation and overtime were
not paid to them. In January 2002, the California Labor Board issued a
judgment in the amount of $79,000. The Company has appealed the case.
F-47