FRANKLIN WIRELESS CORP — Annual Report 2000

Sep 28, 2000

1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ---------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-11616 FRANKLIN TELECOMMUNICATIONS CORP. (Exact Name of Registrant as Specified in its Charter) ----------

733 Lakefield Road, Westlake Village, California 91361 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (805) 373-8688 Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None ---------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant at September 20, 2000 was $38,021,291 based on the closing sale price on such date of $1.00. Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date:

2 Index Franklin Telecommunications Corp.

3 Part I. Item 1. Business OVERVIEW Franklin Telecommunications Corp. ("Company") designs, manufactures and sells Internet Telephony equipment, also called Voice Over Internet Protocol equipment ("VOIP") and other high speed communications products and subsystems. Our products are marketed through Original Equipment Manufacturers ("OEMs") and distributors, as well as directly to end users. In addition, through our majority-owned subsidiary, FNet Corp. ("FNet"), we provide traditional switched network and Internet Protocol telephony services, and Internet access to businesses and individuals. The Company's customers are located throughout the world in a wide range of industries including financial services, government, telephone services and manufacturing. The Company offers a suite of Internet Telephony solutions that enable business communications over data networks. From the small office home office (SOHO) to the branch office and headquarters operations of medium to large scale corporations, the Company offers a cost-effective call handling solution. From the enterprise to the carrier market, the Company offers converged network solutions; managing the connectivity and integration of voice, data, fax and video. Where ever possible, the Company offers a turnkey solution that can be "owned" by its customers. When equipment sales are not in the best interest of a particular customer's business communications solution, the Company plans to provide that solution as a "service" that can be leased. The Company aims to be a leading edge supplier of Internet Telephony solutions as a result of its flexibility in providing on net and off net business communication solutions as customer owned equipment or Franklin provided services on a global basis. The Company's products and services enable connectivity and e-commerce. The Company is both an equipment supplier and a service provider, offering turn-key business communications solutions to both the carrier and enterprise segments of the Internet Telephony market. The Company produces gateways, gatekeepers and edge servers that provide advanced packet switching solutions that significantly reduce the infrastructure costs associated with communications networks. The Company's products are designed, developed and manufactured by the Company. In addition to manufactured solutions, the Company maintains a Network Operations Center that provides both "on -net" and "off-net" connectivity for the Company's equipment customers. The Network Operations Center interconnects the Company's customers on a global basis. The Network Operations Center includes Internet access facilities and a Class 4 circuit switch. The center interconnects with three International Record Carriers and is capable of completing a voice call to any phone in the world. The Company's equipment and services customers are offered the opportunity to access the circuit switched facilities and to interconnect with each other, using the Company to enable "settlement" between the networks. This interconnection can be either "free" through the Internet, or delivered through private leased lines. In addition to the Company's circuit switched capabilities at its headquarters facility in Westlake Village, California , the Company provides a combination of satellite and VOIP solutions to enable telephone communications for NATO forces throughout the Bosnia region. Some 21 earth station transponders are connected to "telephone calling booths" linked via satellite to the US where they are interconnected via VOIP circuits to the circuit switch in the Company's headquarters. NATO soldiers, using FNET calling cards, are able to make calls all over the world through FNET facilities. As a result of the Company's expertise in network operations, the Company is also able to provide additional assistance to its customers by offering design, installation and network management services. The company believes that this strategy of combining network operations and equipment design is a significant product differentiation strategy, uniquely positioning the Company. Many of the Company's customers elect to interconnect with the Network Operations center. Much like the Internet, the Company is growing with each additional gateway sale. INDUSTRY BACKGROUND--VOIP PRODUCTS The telecommunications industry has historically followed a path of development based on the belief that voice and data require separate technologies and network resources. Traditional telephone systems were, and are still, built around an architecture that requires a dedicated connection, or circuit, in order for a call to be completed. This technology requires the circuit to remain dedicated between calling parties for the entire duration of a call. 4 Much data today is transmitted over Internet protocol-based networks. These networks are more efficient because they do not require a dedicated circuit for the entire path of the call. In a network using Internet protocol, the voice, fax, video or data is divided into packets that are simultaneously sent to a final destination where they are reassembled back to their original form. In this type of network, multiple types of information including voice, fax and different forms of data can travel through the network at the same time. The improvements in the technologies used in data networks have led to an increase in use of this type of network to transmit both voice and data. The IP telephony market emerged from these technological advances. Recent developments in IP telephony technology have significantly bridged the voice quality gap between the traditional telephone system, which is commonly referred to as a circuit-switched system, and IP telephony systems. A phone call transmits signals that direct a series of switches to open a dedicated circuit to a second phone. The dedicated circuit carries the electronic signals through the line. The phones convert the signals back into speech. Unlike the traditional circuit switched phone call, which travels on a dedicated circuit, the electronic signals go to a data voice gateway, which converts them into small packets of compressed digital information. The packets may take different routes to their destination. After traveling through the IP network, the packets are converted back into electronic signals by another data voice gateway and put back on the phone network. Today a voice call placed over an IP telephony network can sound virtually indistinguishable from the same call made over the traditional telephone system. What distinguishes IP telephony technology, however, is that it allows service providers to simultaneously send voice, fax and data transmissions over their networks and enables them to quickly add and use additional features and services without the need for costly network upgrades. In contrast, changes to the traditional telephone system are costly and difficult. For example, based on estimates from the International Engineering Consortium, we believe the recent integration of such basic services as caller ID and call return services into the traditional telephone system took over a decade and hundreds of millions of dollars to implement in the United States alone. The added flexibility and cost-effectiveness of IP telephony networks are particularly important in an increasingly deregulated and competitive market environment. Deregulation acts as a catalyst for the rapid deployment of these services by allowing new service providers to quickly enter formerly regulated markets and by forcing existing service providers to rapidly respond to the challenge of competition. According to a 1998 Frost & Sullivan report, the total number of worldwide voice minutes running over Internet protocol-based data networks is expected to grow from 6.3 million in 1997 to 8.8 billion in 2002, representing a compound annual growth rate of 325% for the period. Accordingly, spending on IP telephony equipment is projected to grow from $47.3 million in 1997 to $3.2 billion in 2002, representing a compound annual growth rate of 132%. We believe a significant market opportunity now exists for the makers of IP telephony systems. We believe that very few of our competitors to date have developed a comprehensive solution that incorporates the functionality that service providers require to provide end-to-end service. Some vendors have developed products that embed the instructions on where to route the IP telephony call in the same equipment that provides the IP telephony technology. This approach limits service providers' flexibility to make modifications to their networks because any modification must be made at several different points throughout the network. Many vendors only provide limited billing and network management data. This data is gathered and formatted in a simplistic fashion, limiting the ability of service providers to manage sophisticated networks or to bill using any pricing structure they desire. Also, these simplistic billing systems make it difficult to connect service providers' networks to the networks of other service providers. Some router, switch and IP telephony companies have formed partnerships with billing and network management technology providers in order to provide even the most basic operational support solution to service providers. A router is a device that routes packets over the Internet or other Internet protocol networks. A switch is a device that takes multiple incoming calls and places these calls onto fewer lines. This partnering necessitates integration, which can be technologically difficult, time consuming and expensive. Many IP telephony vendors require dedicated ports for voice, fax or data. A port is the connection between the traditional telephone system and the IP telephony system. Each port handles a single call. Systems that use dedicated ports are inefficient and more costly because more ports are needed to handle the different types of transmissions anticipated. In addition, many vendors do not have the technical capability to integrate these ports with the traditional telephone system so that the ports can correctly interpret busy signals, dial tones and disconnects. This means that service providers cannot 5 accurately bill for the call. Furthermore, the inability to integrate well with the traditional telephone system makes it more difficult for end-users to gain the benefits of this technology because they have to dial separate phone numbers or use multi-step dialing processes. INDUSTRY BACKGROUND--TELEPHONE SERVICES According to the International Telecommunications Union ("ITU"), the global telecommunications services market has grown rapidly, increasing from approximately $377 billion in 1990 to an estimated $700 billion in 1997 for a compound annual growth rate ("CAGR") of 9.2%. By the year 2001, global telecommunication services revenues are forecasted to exceed $1 trillion with spending on telecommunications services growing at a cumulative annual growth rate of 9.5%. The international long distance industry segment of the global telecommunications market (consisting of the transmission of voice and data between countries) is undergoing a period of fundamental change that has resulted, and is expected to continue to result, in significant growth in usage of international telecommunications services. According to the ITU, in 1996 the international long distance telecommunications industry generated approximately $61.3 billion in revenues and 70 billion minutes of use. This is a significant increase from 1987 when international long distance revenues reached approximately $23.9 billion in revenues and 19.1 billion minutes of use. The ITU estimates that by 2000 this market may approach $85.7 billion in revenues and 122.4 billion minutes of use. The Company believes that growth in international long distance services is being driven by a number of factors including: - - the globalization of the world's economies and the worldwide trend toward deregulation of the telecommunications sector; - - declining prices arising from increased competition generated by privatization and deregulation; - - increased worldwide telephone density (tele-density) and accessibility arising from technological advances and greater investment in telecommunications infrastructure, including the deployment of wireless networks; - - a wider selection of products and services; and - - the growth in the transmission of data traffic via internal company networks and the Internet. The Company believes that growth of traffic originated in markets outside the U.S. will be higher than growth in traffic originated within the U.S. due to recent deregulation in many foreign markets, relative economic growth rates and increasing access to telecommunications facilities in emerging markets. Regulatory and Competitive Environment Consumer demand and competitive initiatives have acted as catalysts for government deregulation, especially in developed countries. Deregulation accelerated in the U.S. in 1984 with the divestiture by AT&T of the Regional Bell Operating Companies ("RBOCs"). Today, there are more than 500 U.S. long distance companies, most of which are small or medium-sized companies. In order to be successful, these small and medium-sized companies typically offer their customers a full range of services, including international long distance. However, most of these carriers do not have the critical mass of customers to receive volume discounts on international traffic from larger facilities-based carriers such as AT&T and MCI WorldCom. In addition, these companies have only a limited ability to invest in international facilities. Emerging multinational carriers have capitalized on this demand for less expensive international transmission facilities. These alternative international carriers are able to take advantage of larger traffic volumes in order to obtain volume discounts on international routes (resale traffic) and/or invest in facilities when the volume of particular routes justifies such investments. As these emerging international carriers have become established, they have also begun to carry overflow traffic from the larger long distance providers that own overseas transmission facilities. Deregulation in the U.K. began in 1981 when Mercury, a subsidiary of Cable & Wireless plc, was granted a license to operate a facilities-based network and compete with British Telecommunications plc. In 1990, deregulation spread to other European countries with the adoption of the "Directive on Competition in the Markets for Telecommunication Services." A series of subsequent European Union ("EU") directives, reports and actions are expected to result in substantial deregulation of the telecommunications industries in most EU member states by the end of the decade. Further 6 deregulation of the EU telecommunications market will occur in 2000 upon the implementation of the EU's Amending Directive to the Interconnection Directive, which mandates the introduction of equal access and carrier pre-selection by 2000. A similar movement toward deregulation has already taken place in Australia and New Zealand, and is also taking place in Japan, Mexico, Hong Kong and other markets. Other governments have begun to allow competition for value-added and other selected telecommunications services and features, including data and facsimile services and certain restricted voice services. On February 15, 1997, the United States and 67 other countries signed the WTO Agreement and agreed to open their telecommunications markets to competition and foreign ownership starting in February 1998. These 68 countries represent approximately 95% of worldwide telecommunications traffic. The Company believes that the WTO Agreement will provide the Company with significant opportunities to compete in international markets and provide end-to-end facilities-based services to and from these countries. The FCC recently released an order that significantly changes U.S. regulation of international services in order to implement the U.S. open market commitments under the WTO Agreement. This order is expected to increase opportunities for foreign carriers to compete in the U.S. communications market, while increasing opportunities for U.S. carriers to enter foreign markets and to develop alternative termination arrangements with non-dominant carriers in other countries. Competitive Opportunities and Advances in Telecommunications Technology As a result of deregulation and other competitive pressures in the global telecommunications industry, prices for telecommunications services generally have fallen, releasing pent-up consumer demand and creating the impetus for improved quality and service. New technologies, including fiber optic cable and improvements in digital compression, have played an important role in this process by, among other things, improving the quality and speed of transmission capacity while lowering costs. The growth of the Internet as a communications medium, as well as advances in packet switching technology and Internet telephony, are expected to have an increasing impact on the international telecommunications market. Advances in technology have created a variety of ways for telecommunications carriers to provide customer access to their networks and services. These include customer-paid local access, international and domestic toll-free access, direct digital access through a dedicated line, equal access through automated routing from the PSTN, call re-origination and Internet telephony. The type of access offered depends on the proximity of switching facilities to the customer, the needs of the customer and the regulatory environment in which the carrier competes. Overall, these changes have resulted in a trend towards bypassing traditional international long distance operating agreements as companies seek to operate more efficiently. As countries deregulate, the demand for alternative access methods typically decreases because carriers are permitted to offer a wider range of facilities-based services on a transparent basis. In a deregulated country such as the United States, carriers can establish switching facilities, own or lease fiber optic cable, enter into operating agreements with foreign carriers and, accordingly, provide direct access service. In countries where deregulation has commenced, but is not yet complete, carriers are permitted to offer facilities-based data and facsimile services, as well as limited voice services, although for the most part they are not yet permitted to offer full voice telephony. In less developed markets, international long distance carriers have used advances in technology to develop innovative alternative access methods, such as call re-origination. The most common form of alternative international access, traditional call re-origination, avoids the high international rates offered by the incumbent monopoly PTT in a particular regulated country by providing dial tone from a deregulated country, typically the U.S. The call re-origination industry has grown rapidly since its origination in the early 1990s. According to International Insider, revenues from international call re-origination services were more than $1.5 billion in 1996, an 80% increase in revenues for international callback from 1995. To place a call using traditional call re-origination, a user dials a unique phone number to an international carrier's switching center and then hangs up after it rings. The user then receives an automated callback providing dial tone from the U.S., which enables the user to complete the call. Technical innovations, ranging from inexpensive dialers to sophisticated in-country switching platforms, have enabled telecommunications carriers to offer a "transparent" form of call re-origination. The customer dials into the local switch, and then dials the international number in the usual fashion, without the "hang-up" and "callback," and the international call is automatically and rapidly processed. The Company believes that as deregulation occurs and 7 competition increases in various markets around the world, the pricing advantage of traditional call re-origination to most destinations relative to conventional international direct dial service will diminish in those markets. Developments in the Internet Industry Use of the Internet has grown rapidly since its initial commercialization in the early 1990's. However, determining the precise number of Internet users is extremely difficult because (i) the Internet does not have a single point of control from which statistics may be recorded; (ii) computers are connected and disconnected from the Internet on a continual basis; and (iii) a large number of users may access the Internet through a single network. According to the estimates of the ITU, there were approximately 60 million Internet users worldwide at the end of 1996. In addition, the ITU estimates that the number of Internet users may increase to 300 million by 2001. Pew Research estimates that 25% of Americans now access the Internet daily from home or work, up from only 4% in 1995. The Internet has evolved dramatically over the last several years as a result of several trends affecting the computer and communications industries. These trends include: - - the migration by organizations from proprietary mainframe environments to open systems and distributed computing; - - the emergence of low-cost, high-capacity telecommunications bandwidth; - - the increased use of PCs in the home; - - the growth of commercial on-line services; - - the growth of information, entertainment and commercial applications; and - - an increase in the number and variety of services available on the Internet. Reliance on the Internet for the transmission of data, applications and electronic commerce is growing among organizations and corporations. As the volume of information available on organizations' computer systems has increased, and the use of data communications has grown as a preferred means of day-to-day communications, these organizations are increasingly seeking a number of geographically dispersed access points to their own networks and to the networks of other organizations. The number of interconnections that businesses desire to establish with networks, customers, suppliers and affiliates generally has made the development of proprietary access systems on a case-by-case basis costly and time consuming. Increasingly, many organizations are seeking reliable, high-speed and cost-effective means of internetworking by relying on the Internet. The Company believes that as reliance on the Internet for the transmission of data, applications and electronic commerce continues to grow among organizations, these organizations will require reliable, geographically dispersed and competitively priced Internet access and services available on international private networks. Internet Telephony The Internet telephony industry began in 1995, when experienced Internet users began to transfer voice messages from one PC to another. In 1995, VocalTec Communications, Ltd. ("VocalTec") introduced software that allowed PC users to place international calls via the Internet to other PC users for the price of a local call. In its early months, the growth of Internet telephony was constrained due to the poor sound quality of the calls and because calls were mainly limited to those placed from one PC to another. The poor sound quality of Internet telephony was due to the fact that the Internet was not created to provide for simultaneous voice traffic. Unlike conventional voice communication circuits, in which the entire circuit is reserved for a call, Internet telephony uses packet switching technology in which voice data is divided into discrete packets that are transmitted over the Internet. These packets must travel through several routers in order to reach their destination, which may cause misrouting, and delays in transmission and reception. The limited capacity of the Internet also restrained the growth rate of Internet telephony. Recent improvements in technology have overcome many of the initial developmental shortcomings of Internet telephony. New software algorithms have substantially reduced delays and the use of private networks or intranets to transmit calls as an alternative to the public Internet has alleviated capacity problems. The introduction of gateway servers connecting packet-switched data networks such as the Internet to circuit-switched public telephone networks has also improved 8 overall transmission quality. Developments in hardware, software and networks are expected to continue to improve the quality and viability of Internet telephony. A significant attribute of Internet telephony is the ability to reduce overall transmission costs versus traditional circuit switched networks. Packet switched networks are substantially less expensive to operate than circuit-switched networks because carriers can compress voice traffic and place more calls on a single line. In addition, packet switching avoids international settlement rates which only apply to interconnection between circuit switched networks. The total cost of an Internet telephone call, for example, is based on the local calls to and from the gateways of the respective ISPs, thereby bypassing the international settlement process. IDC estimates that by the year 2002, IP telephony could account for 11% of U.S. and international long distance voice traffic alone. According to Probe Research, the market for IP telephony is expected to grow from an estimated $309 million in 1998 to approximately $4.4 billion in 2002, a 93.8% compound annual growth rate. Probe Research also estimates that the volume of voice and fax traffic over IP networks will increase from 31 million minutes in 1997 to approximately 55.2 million minutes of use in 2002, for a CAGR of 346.8%. The growth in IP services far outpaces growth expected in the circuit switched market, currently estimated to be growing at a cumulative annual growth rate of 8.3%. INDUSTRY BACKGROUND--INTERNET SERVICES The Internet is a collection of computer networks linking millions of public and private computers around the world. Historically, the Internet was used by government agencies and academic institutions to exchange information, publish research and transfer e-mail. A number of factors, including the proliferation of communication-enabled personal computers, the availability of intuitive graphical user interface software and the wide accessibility of an increasingly robust network infrastructure, have combined to allow users to easily access the Internet and, in turn, have produced rapid growth in the number of Internet users. The emergence of the World Wide Web, the graphical, multimedia environment of the Internet, has resulted in the development of the Internet as a new mass communications medium. The ease and speed of publishing, distributing and communicating text, graphics, audio and video over the Internet has led to a proliferation of Internet-based services, including chat, online magazines, news feeds, interactive games and a wealth of educational and entertainment information, as well as to the development of online communities. In addition, the reduced cost of executing transactions over the Internet provides individuals and organizations with a new means to conduct business. THE COMPANY'S PRODUCTS AND SERVICES Unlike many of its competitors, the Company produces its own hardware solutions. Designed from the motherboard up, including DSP technology, voice compressors (called VOCODERS), telephone line interfaces and system software, all Company products are the result of internal engineering. Although the products represent the Company's proprietary engineering, the Company plans to comply with industry standards, such as H.323, MGCP and INow, to assure interoperability and connectivity with products manufactured by other vendors. The Company produces a family of Internet Telephony solutions that range from small 2 port solutions to meet the access requirements of branch office and geographically distributed work groups; to Carrier type solutions with thousands of ports of voice, fax, data and video connectivity. The Company also produces "back office" software solutions that facilitate the integration, interoperability and management of VOIP networks. These software solutions include the Company's Gatekeeper; an Authentication Mapping and Billing Server (Softswitch 2000) and "Click to Speak" a push to talk solution to voice enable a website or e-mail. The Company's philosophy is to use the robust, real time, fault tolerant operating system Linux for mission critical hardware operations and Microsoft NT for back office applications. The Company's data voice "gateway" products are named for tropical storms: the Tempest(R), the Typhoon(R) and the Breeze(TM): The Breeze(TM) is a branch office access solution that enables two telephone devices such as phones or fax machines to be interconnected to the Internet or a managed private data network. It provides full T.38 relay fax and a wide range of voice compression options. It contains a Wide Area Network interface with internal router and is the most cost effective VOIP solution in the market. 9 The Tempest(R) has been the Company's primary data voice gateway since its introduction in 1997. The Tempest is a PC based platform that supports 24 analog ports per node or from 1-4 digital spans (T1/E1) per node. Using T1 Primary Rate ISDN lines, for example, the Tempest is able to support 96 ports. The product integrates with the Company's billing and Gatekeeper products. It is also used to support the CTS products and is often selected as an enterprise solution by medium to large-scale vendors. The Typhoon(R) will be the Company's Carrier Class product line and it represents our next generation of VOIP solutions. It features 24 analog ports or 96 digital ports in a 2U high (3.5"), rack mounted configuration that is less than half the size and power consumption of the Tempest product line. The Typhoon will support true SS7 carrier class connectivity and will enable over 1300 ports per POP collocation rack. Typhoon interconnects with the Softswitch 2000 gatekeeper and the Franklin family of SNMP software. The Company plans to release the Typhoon in late 2000. Softswitch 2000 -- is an "Authentication Mapping and Billing Server" and is the core of the Company's "back office" telephone company solutions. It is designed to manage the best route (i.e. least cost route) through a network, determine who is authorized to use the network, and bill customers, either by invoice or debit card. When a customer puts the Tempest/Typhoon together with a Softswitch 2000, it gets a "phone company in a box" solution that enables next generation telephone companies a turn-key solution for VOIP global networking. GateKeeper -- The Gatekeeper plays the role of enabling data voice gateways of different manufacturers to "talk to each other", or "interoperate", enabling computer to phone, website to phone and computer to computer communications. There are several contending standards for interoperability in the market. They are called H.323; MGCP and Inow. The Company plans to support all three protocols, enabling us to reach the widest cross section of interoperability options in the market. "Click to Speak" (CTS) -- is a "push to talk" button for websites. Using the Company's Tempest and Typhoon data voice gateways, a customer can voice enable its website. Visitors to the website can click on a button that opens a real time telephone connection through the browser and website, directly into a call center that supports the visited website. The Company also provides a variety of Internet services through its subsidiary FNet, including dial up, ADSL, ISDN, frame relay, Web page hosting and various other Internet related services. This segment of the business has played a minor role in the Company's revenue and is not expected to contribute a significant amount to future growth. MARKETING AND DISTRIBUTION OF PRODUCTS AND SERVICES The Company maintains a small direct sales force for the marketing of its VOIP and data communications products. It maintains a home page on the World Wide Web and a headquarters-based sales and service office. It also markets its products through Original Equipment Manufacturers (OEM), distributors, participation in trade shows, telemarketing, and advertising in trade and technical publications. The Company has expanded the sales and marketing operation by opening of field offices. The growth of the Internet has spawned new industries consisting of the building of infrastructure for next generation telephone companies that utilize VOIP and Internet Service Providers, both offering connections to corporate America as well as private individuals. The Company designs and manufactures products which are basic to the operation of both Next Generation Telephone Companies and Internet Service Providers. In addition, these same products are required in the expansion of corporate based private Intranets. Sales to large corporate clients, next generation telephone companies and Internet Service Providers are handled through telemarketing with in person follow-up sales calls. MARKETING OF TELEPHONE SERVICES The Company maintains a Network Operations Center that provides "off-net" connectivity for the Company's equipment customers. The Network Operations Center interconnects the Company's customers on a global basis. Telephone off net delivery is offered to all customers that would like to connect their networks to FNet, so that calls can be completed anywhere in the world. This allows a customer to become a world wide telephone company, even though their own network only directly covers a certain regional area. The Network operations center includes Internet access facilities and a Class 4 circuit switch. The center interconnects with three International Record Carriers and is capable of completing a voice call to any phone in the world. The Company's equipment customer is offered the opportunity to access the circuit switched facilities and to interconnect with each other, using the Company to enable "settlement" between the networks. 10 In addition to the Company's circuit switched capabilities at its headquarters in Westlake Village, California, the Company provides a combination of satellite and VOIP solutions to enable telephone communications for NATO forces throughout the Bosnia region. Prepaid calling cards are sold through base concessionaires on a consignment basis. The prepaid calling cards are available in several languages. Twenty one earth station transponders are connected to "telephone calling booths" linked via satellite to the US where they are interconnect via VOIP circuits to the circuit switch in at the Company's headquarters. NATO soldiers, using FNET calling cards are able to make calls all over the world through FNET facilities. As a result of the Company's expertise in network operations, the Company is also able to provide additional assistance to its customers by offering design, installation and network management services. The company believes that this strategy of combining network operations and equipment design is a significant product differentiation strategy, uniquely positioning the Company. Many of the Company's customers elect to interconnect with the Network Operations Center. Much like the Internet, the Company is growing with each additional Gateway sale. On a much smaller scale, the Company also offers prepaid calling cards on a retail basis through its web site. MARKETING OF INTERNET SERVICES The market for Internet products and services is varied, including both hardware and software products and related services. Most companies in the industry provide either hardware, software or services. FNet offers both hardware and software specifically designed to provide enhanced Internet accessibility and usage. Internet users generally fall into one of two specific market segments, the individual user and the business user. Management of the Company believes that the individual user segment will continue to show rapid growth, with the principal uses being information services, on-line shopping and personal communications. The advent and increasing popularity of home shopping via television programming may also extend to the Internet. The Internet can provide consumers with vastly wider choices from a much greater base of vendors. Many catalogue and mail order companies now utilize electronic catalogues accessible through the Internet. The other significant market is the business user. At present, electronic mail is the most common application, utilizing computer-based LAN or WAN communication. The trend for companies with multiple, remote site locations is to link existing WANs utilizing the Internet, in order to minimize direct telephone company charges; this market segment is usually referred to as the Intranet. Internet access provides a fast, inexpensive method of achieving this connectivity. Although currently available technology provides some limited ability for voice communication over the Internet, the quality is poor and communication is generally possible only if users at both ends have PCs with modems and identical software. It is possible that Intranet applications could eventually eliminate the need for resident operating software and massive on-site storage facilities for many businesses. Under this scenario, a PC with resident software will no longer be necessary, with access to any desired program available through an inexpensive workstation connected to the Internet. Also, data storage could be centralized in a secure database accessible through the Internet. The Company currently markets its Internet services through press releases, direct mail and its home page on the World Wide Web, and other targeted marketing strategies. COMPETITION -- VOIP PRODUCTS We compete in a new, rapidly evolving and highly competitive and fragmented market. We expect competition to intensify in the future. We believe that the main competitive factors in our market are product quality, features, cost and customer relationships. We believe a critical component to success in this market is the ability to establish and maintain strong customer relationships with a wide variety of international service providers and to facilitate relationships between those service providers to increase the geographic coverage of their services. Our current principal competitors include large networking equipment manufacturers, such as 3Com Corporation and Cisco Systems, Inc., large telecommunications equipment manufacturers, such as Lucent Technologies Inc. and Nortel Networks Corporation, and IP telephony technology companies, such as VocalTec Communications, Ltd. and Clarent Corporation. We also expect new competitors to emerge. Many of our competitors are substantially larger than we are and have significantly greater financial, sales and marketing, technical, manufacturing and other resources and more 11 established distribution channels and stronger relationships with service providers. These competitors may be able to respond more rapidly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. Furthermore, we believe some of our competitors may offer aggressive sales terms, including financing alternatives, which we might not be able to match. These competitors may enter our existing or future markets with solutions that may be less expensive, provide higher performance or additional features or be introduced earlier than our solutions. Given the market opportunity, we also expect that other companies may enter our market with better products and technologies. If any technology that is competing with ours is more reliable, faster, less expensive or has other advantages over our technology, then the demand for our products and services could decrease. We expect our competitors to continue to improve the performance of their current products and introduce new products or new technologies. Successful new product introductions or enhancements by our competitors could reduce the sales or market acceptance of our products and services, perpetuate intense price competition or make our products obsolete. To be competitive, we must continue to invest significant resources in research and development, sales and marketing and customer support. We cannot be sure that we will have sufficient resources to make these investments or that we will be able to make the technological advances necessary to be competitive. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share. Our failure to compete successfully against current or future competitors could seriously harm our business, financial condition and results of operations. COMPETITION -- TELEPHONE SERVICES The Company competes with (i) large carriers, such as AT&T, Sprint and MCI WorldCom; (ii) foreign PTTs; (iii) other providers of international long distance services such as STAR Telecommunications, Inc., Pacific Gateway Exchange, Inc., RSL Communications Ltd. and Telegroup, Inc.; (iv) alliances that provide wholesale carrier services, such as "Global One" (Sprint, Deutsche Telekom AG and France Telecom S.A.) and Uniworld (AT&T, Unisource-Telecom Netherlands, Telia AB- Swiss Telecom PTT and Telefonica de Espana S.A.); (v) small long distance resellers; (vi) call re-origination companies; and (vii) providers of IP telephony services. Primary Competitors Of these groups listed above, the Company views its primary competition coming from providers of IP telephony services which are listed as follows: ALPHANET TELECOM, INC., AT&T AND AT&T JENS (SUBSIDIARY), DELTA THREE, SONERA LTD., GLOBALNET SYSTEMS, LTD., NET2PHONE, INC, PSINET, INC., QWEST COMMUNICATIONS INTERNATIONAL INC. AND ITXC CORP. COMPETITION -- INTERNET SERVICES The Internet services market in which FNet operates is extremely competitive, and the Company expects competition in this market to intensify in the future. The Company's current and prospective competitors include many large companies that have substantially greater market presence and financial, technical, marketing and other resources than the Company. The Company competes (or in the future is expected to compete) directly or indirectly with the following categories of companies: (i) national and regional Internet Service Providers, such as Earthlink, IDT, MindSpring, NETCOM, PSINet and UUNET; (ii) established online services such as America Online, CompuServe, Prodigy and the Microsoft Network; (iii) computer software and technology companies such as Microsoft; (iv) national telecommunications companies, such as AT&T, MCI and Sprint; (v) the Regional Bell Operating Companies ("RBOCs"); (vi) cable operators, such as Comcast, TCI and Time Warner; and (vii) nonprofit or educational ISPs. The entry of new participants from these categories and the potential entry of competitors from other categories (such as computer hardware manufacturers) would result in substantially greater competition for the Company. The ability of these competitors or others to bundle services and products with Internet connectivity services could place the Company at a significant competitive disadvantage. In addition, competitors in the telecommunications industry may be able to provide customers with reduced communications costs in connection with their Internet access services, reducing the overall cost of Internet access and significantly increasing pricing pressures on the Company. Moreover, certain of the Company's online competitors, including America Online, the Microsoft Network and Prodigy, offer unlimited access to the Internet and their proprietary content at flat rates that are generally equivalent to the Company's flat rate, and do not require a set-up fee. Certain of the RBOCs have also introduced competitive flat-rate pricing for unlimited access (without a set-up fee) 12 for at least some period of time. As a result, competition for active users of Internet services has intensified. There can be no assurance that the Company will be able to offset the adverse effect on revenues of any necessary price reductions resulting from competitive pricing pressures by increasing the number of its customers, by generating higher revenue from enhanced services, by reducing costs or otherwise. The Company believes that its ability to compete successfully in the Internet services market depends on a number of factors, including market presence; the adequacy of the Company's customer and technical support services; the capacity, reliability and security of its network infrastructure; the ease of access to and navigation of the Internet provided by the Company's services; the pricing policies of the Company, its competitors and its suppliers; the timing of introductions of new services by the Company and its competitors; the Company's ability to support existing and emerging industry standards; and industry and general economic trends. There can be no assurance that the Company will have the financial resources, technical expertise or marketing and support capabilities to compete successfully. Also, the Company believes that it has a competitive advantage over most Internet Service Providers because it manufactures much of the equipment necessary to operate an Internet Service Provider, and is able to react quickly to technological changes in the industry. ASSEMBLY AND MANUFACTURING OPERATIONS The Company's manufacturing facility is located in Westlake Village, California. Assembly of the Company's products is ordinarily contracted out to local circuit board assembly contractors, with final systems tests completed at the Company's facility. The Company's manufacturing operations consist primarily of procurement, inspection and testing of components, final assembly of subsystems, and extensive testing of finished products. The Company procures substantially all of its parts from outside suppliers. The Company is currently able to obtain parts without difficulty and at competitive prices. However, in common with others in the electronics industry, the Company has in the past paid premium prices to obtain components that are in short supply. There can be no assurance that shortages will not occur in the future which could significantly increase the cost or delay the shipment of the Company's products. This could adversely affect its sales or profitability. EMPLOYEES As of September 15, 2000, The Company had 44 employees. The Company's employees are not represented by any collective bargaining organization and the Company has never experienced a work stoppage. The Company believes that its relations with its employees are good. Item 2. Properties The Company occupies three leased facilities, two in Westlake Village, California, and one in Scottsdale, Arizona. One of the Westlake Village facilities houses sales, software engineering, administrative, telephone and Internet services. The facility is 9,900 square feet, with a lease rate of $8,981 per month, expiring in October 2000. The lease for this facility is renewable on a year-to-year basis at the option of the Company. The Company plans to renew this lease. The other Westlake Village facility houses the manufacturing and inventory warehouse. This facility is 7,100 square feet, with a lease rate of $8,080 per month, expiring in March, 2003. The Scottsdale facility houses sales and hardware engineering. This facility is 2,049 square feet, with a lease rate of $2,089 per month, expiring in December, 2002. Item 3. Legal Proceedings During June 2000, two shareholders who acquired their shares in a private placement in March 2000, filed a lawsuit against Franklin and officer-directors Frank W. Peters and Thomas L. Russell. The lawsuit sought to postpone the June 28, 2000 annual stockholders meeting, based upon alleged deficiencies in the proxy materials pertaining to the meeting. At a Court hearing held on June 28, 2000, the Court declined to enjoin the meeting as requested by plaintiffs. Thereafter, plaintiffs amended the lawsuit several times and ultimately added new claims pertaining to the private placement and alleging securities law violations. A motion to dismiss those claims was filed by Franklin and is scheduled for hearing on October 16, 2000. Because Franklin believes the lawsuit is without merit, it is being vigorously defended. Franklin also has engaged in on-going settlement discussions in order to end the expense and distraction of litigation. 13 Item 4. Submission of Matters to a Vote of Security Holders On June 28, 2000, the Company held its Annual Meeting of Shareholders. The meeting provided for an election of Directors. The current members of the Board of Directors were reelected for a term of one year, as follows:

Part II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock is traded on the American Stock Exchange ("AMEX") under the symbol FCM. The following table sets forth the range of high and low bid quotation per share for the Common Stock as reported by AMEX for the first and second calendar quarters of 2000 and for calendar year 1999, and the OTC Bulletin Board during the third and fourth calendar quarters of 1998. The bid price reflects inter-dealer prices and does not include retail mark-up, markdown, or commission.

The Company has never declared or paid a cash dividend on its Common Stock and does not expect to pay any cash dividends in the foreseeable future. As of June 30, 2000, the Company had approximately 814 shareholders of record. 14 Item 6. Selected Consolidated Financial Data The selected financial data set forth below for the fiscal years ended June 30, 1998, 1999 and 2000 have been derived from the Company's consolidated financial statements, audited by Singer, Lewak, Greenbaum & Goldstein LLP and should be read in conjunction with those consolidated financial statements (including the notes thereto). The selected financial data set forth below for the fiscal years ended June 30, 1996 and 1997 have been derived from the Company's audited financial statements not included in this 10-K. STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA):

BALANCE SHEET DATA (IN THOUSANDS):

15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS Fiscal Year Ended June 30, 2000 Compared To Fiscal Year Ended June 30, 1999 Net Sales. Net sales decreased by $7,424,000, or 70%, from $10,631,000 in the year ended June 30, 1999 to $3,207,000 in the year ended June 30, 2000. The overall decrease is attributable to the loss of a single customer that constituted 76% of total sales for the year ended June 30, 1999. The revenue mix for the year ended June 30, 2000 consisted of 35% DVG and other hardware and software products, and 65% Telephone and Internet services. Gross Profit (Loss). Gross profit decreased as a percentage of net sales to a loss of (49)% for the year ended June 30, 2000, from a gross profit of 47% of net sales for the corresponding period of 1999. The gross profit percentage decrease can be attributed to a combination of carrier termination costs exceeding flat rate revenues for telephone services and fixed manufacturing overhead costs exceeding the margins produced by a smaller hardware sales base. Operating Expenses. Operating expenses increased by $2,104,000, or 28%, from $7,472,000 in the year ended June 30, 1999 to $9,576,000 in the year ended June 30, 2000. The increase is attributable to increased sales and marketing efforts, accounting charges associated with cashless exercise of employee stock options, and costs in enhancing the general and administrative infrastructure. Other Income (Expense). Interest income decreased by $80,000, or 54%, from $148,000 in the year ended June 30, 1999 to $68,000 in the year ended June 30, 2000, due to a reduction in the availability of equity funds for investment in interest bearing accounts. Interest expense increased by $82,000, or 304% from $27,000 in the year ended June 30, 1999 to $109,000 in the year ended June 30, 2000, due to the $2,500,000 in convertible notes issued by the Company during the year ended June 30, 2000. The convertible notes, including accrued interest, were subsequently repaid in May, 2000. Other expense increased from $43,000 in the year ended June 30, 1999 to $56,000 in the year ended June 30, 2000, due to various non-operating items. During the year ended June 30, 2000, the Company took a charge of $367,000 for equipment located at previous joint venture partner locations, which was deemed to be not recoverable. Fiscal Year Ended June 30, 1999 Compared To Fiscal Year Ended June 30, 1998 Net Sales. Net sales increased by $9,254,000, or 672%, from $1,377,000 in the year ended June 30, 1998 to $10,631,000 in the year ended June 30, 1999. The overall increase is due to sales of newly introduced DVG products. One customer constituted 76% of total sales for the year ended June 30, 1999. The revenue mix for the year ended June 30, 1999 consisted of 82% DVG and other hardware and software products, and 18% Telephone and Internet services. Gross Profit (Loss). Gross profit increased as a percentage of net sales to 47% for the year ended June 30, 1999, from a gross profit of 39% of net sales for the corresponding period of 1998. The gross profit percentage increase can be attributed to increased sales of higher margin products and a spreading of fixed manufacturing overhead costs over a larger sales base. Operating Expenses. Operating expenses increased by $1,965,000, or 36%, from $5,507,000 in the year ended June 30, 1998 to $7,472,000 in the year ended June 30, 1999. The increase is attributable to increased product development costs for the recently introduced hardware products, costs in developing the IP telephony and Internet services infrastructure, increased sales and marketing efforts, and costs in enhancing the general and administrative infrastructure. Other Income (Expense). Interest income decreased by $102,000, or 41%, from $250,000 in the year ended June 30, 1998 to $148,000 in the year ended June 30, 1999, due to a reduction in the availability of equity funds for investment in interest bearing accounts. Other expense increased from $-0- in the year ended June 30, 1998 to $43,000 in the year ended June 30, 1999, due to various non-operating items. Other income decreased from $26,000 in the year ended June 30, 1998 to $-0- in the year ended June 30, 1999, due to various non-operating items. 16 LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents and net working capital totaled $1,275,000 and $2,792,000, respectively, as of June 30, 2000. The sources of cash were provided primarily by issuance of equity securities, and to a lesser extent, collections of sales revenues. The Company has relied on sales of new shares and the exercise of warrants and options to supplement the funding of operations for an extended period of time. The Company received $10,355,000, $1,011,000 and $10,589,000 in equity financing, for the years ended June 30, 1998, 1999, and 2000, respectively. Its subsidiary, FNet, received $406,000, $110,000 and $53,000 in equity financing for the years ended June 30, 1998, 1999 and 2000, respectively. FNet has continued to experience losses, due primarily to the carrier termination costs associated with the flat rat service business. This flat rate service business has been discontinued. The Company anticipates that its primary uses of working capital in future periods will be for operations, including increases in product development, expansion of its marketing plan, and funding of increases in accounts receivable and possibly acquisitions. Although the Company seeks to use its Common Stock to make acquisitions to the extent possible, many acquisition candidates may require that all or a significant portion of the purchase price be paid in cash. The Company believes that existing cash and cash equivalents, cash flow from operations, and cash raised through future anticipated private placements of securities will be sufficient to meet the Company's presently anticipated working capital needs for at least the next twelve months and the foreseeable future. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices. The Company is exposed to changes in financial market conditions in the normal course of its business due to its use of certain financial instruments as well as transacting in various foreign currencies. INTEREST RATE RISK. At June 30, 2000 and 1999, the Company's cash equivalents and short-term investments totalled approximately $1,275,000 and $1,637,000, respectively. Since the Company typically does not purchase fixed-income securities, its cash and cash equivalents are not subject to significant interest rate risk. The Company places substantially all of its interest bearing investments with major financial institutions and by policy limits the amount of credit exposure to any one financial institution. Additionally, the Company does not hold or issue financial instruments for trading, profit or speculative purposes. EQUITY PRICE RISK The Company does not invest in available-for-sale equity securities, and is not subject to significant equity price risk. FOREIGN EXCHANGE RATE RISK The Company operates internationally and sometimes receives payments in local currencies. This can expose the Company to market risk from changes in foreign exchange rates to the extent that transactions are not denominated in the U.S. dollar. As a result the Company faces the risk that the foreign currencies may decline in value as compared to the U.S. dollar, resulting in a foreign currency translation loss. Item 8. Financial Statements and Supplementary Data See Part IV, Item 14 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None 17 Part III. Item 10. Directors and Executive Officers of the Registrant The directors and executive officers of the Company are as follows:

Mr. Peters has been the Chairman of the Board of Directors since its organization in 1981 and served as its Chief Executive Officer until September 2000. Between 1975 and 1984 he was also President of Franklin Data Systems and Franklin Systems Corporation, predecessors to the Company. From 1973 to 1975, he was Vice President of Jacquard Systems Corporation, a computer hardware and word processing software development marketer. Between 1965 and 1973 he held various marketing and sales positions with IBM. Mr. Stewart has served as Chief Executive Officer since September 2000. In addition to a diplomatic career with the Canadian Secretary of State between 1973 and 1976, Mr. Stewart has thirty years of senior global business experience in finance, construction, mining, petroleum and energy. He has developed several world class IPP gas-to-electricity projects as chairman of Tangas A.G. and Camgas A.G. including the start-up of the giant $500 million Songo Songo Field in Tanzania between 1990 and 1993. Between 1979-97, as chairman/CEO of Interop A.G., International Cobalt Corporation and Canada-Africa Mining Corporation, he joint ventured with Bechtel International Corporation on several global infrastructure projects including the $5 billion Congo Master Plan. Concurrently he also has 20 years experience completing large infrastructure projects with two chairmen of Krupp Thyssen International A.G., Europe's largest steel and construction manufacturer. Mr. Ericson has been President and Chief Operations Officer of the Company since January 2000. Mr.Ericson has been a major force in the development of digital telephony and the emergence of voice over the Internet applications. Widely published in trade journals and a frequent speaker at industry conferences, Mr. Ericson has worked at the cutting edge of communications and control systems for over twenty years. Before joining Franklin Telecom, Mr. Ericson founded four research and development and production manufacturing companies. One of his ventures had a successful IPO and the balance of the firms were acquisitions for major telecommunications and technology buyers. Mr. Ericson designed and analyzed communications systems for Harris Corporation and Litton Industries for six years before beginning his entrepreneurial career. He holds an MS degree in Engineering from the University of Illinois. Dr. Harp has been Chairman of Quesant Instruments, a manufacturer of scanning probe microscopes, since 1992. Between 1987 and 1992 he was Chairman of Vertek, a manufacturer of PC peripheral devices. He is also a founder of Vector Graphic, Inc. Dr. Harp has been a director of the Company since 1996. Mr. Mitchell has thirteen years experience as a stock broker with Hornblower & Weeks in Boston. He negotiated the first cultural exchange program between Los Angeles and her sister city Leningrad (now St. Petersburg) for which he received a commendation from the Mayor of Los Angeles. He is currently enjoying a successful career as an actor, writer and producer for theatre, motion pictures and television. Mr. Mitchell has been a director of the Company since 1999. Mr. Smith, currently Manager of ITS Services for TRW, Inc., where he has been employed for more than thirteen years. He brings extensive experience in the telecommunications industry, including overall responsibility for TRW's entire communications networks. Mr. Smith also serves as a systems engineer in TRW's worldwide satellite communications subsidiary and is a member of TRW's Architectural Review Board. Prior to joining TRW, Mr. Smith was the principal in Sidney B. Smith & Associates, an engineering consulting firm, with a client list including Bechtel Corp., TRW, First Interstate Bank, and GTEL-GTE. He holds a Bachelors degree in Engineering and majored in Industrial Engineering with a minor in Mathematics. Mr. Smith has been a Director for the Company since May, 2000. 18 Mr. Russell has been the Chief Financial Officer and a director of the Company since 1996. He also served as its Chief Financial Officer between 1988 and 1990. Between 1990 and 1996 Mr. Russell was President of Russell Industries, a manufacturer's representative and distribution firm for optical storage memory products. Prior to that time Mr. Russell was a founder and CFO of Plasmon PLC, a UK based manufacturer of optical media and jukeboxes for the computer industry and partner at Sorenson, Russell & Company, a public accounting firm, and was employed by Peat Marwick. Mr. Russell is a Certified Public Accountant. Item 11. Executive Compensation The following table sets forth certain compensation paid or accrued by the Company during the years ended June 30, 1998, 1999 and 2000 to its Chief Executive Officer, President and Chief Operating Officer, and its Chief Financial Officer (the "Named Executive Officers").

(1) Portions of these amounts were deferred. (2) Mr. Ericson was employed by the Company beginning in January 2000. (3) Mr. Peters was succeeded by Mr. Robert Stewart as CEO on September 15, 2000. Except as disclosed above, no compensation characterized as long-term compensation, including or long-term incentive plan payouts, were paid by the Company during the years ended June 30, 1998, 1999 and 2000 to any of the Named Executive Officers. Employment Arrangements. The Company's Chairman is employed pursuant to a six year Employment Agreement, effective January 1, 1998. The Employment Agreement provides for compensation at the rate of $27,000 per month, with annual increases of 6%. Beginning in June 2000, the Company's Chairman temporarily reduced his salary to $12,500 per month until certain goals are achieved by the Company. The Company's Chief Financial Officer is employed pursuant to Employment Agreement for a two year period, commencing on January 10, 1999, providing monthly compensation at the rate of $12,500 per month, with annual increases of 6%. Option Grants During the Year Ended June 30, 2000. The following table sets forth certain information regarding stock options granted to the Named Executive Officers during the twelve months ended June 30, 2000:

19 The following table sets forth certain information as of June 30, 2000 with respect to options held by the Named Executive Officers. The Company has no outstanding stock appreciation rights, either freestanding or in tandem with options.

(1) Assumes that a share of Common Stock was valued at $0.94 per share on June 30, 2000. Amounts reflected are based on this assumed price minus the exercise price and do not indicate that shares were sold. 20 PERFORMANCE GRAPH The following graph summarizes cumulative total shareholders return data (assuming reinvestment of dividends) for the five-year period beginning June 30, 1995. The graph assumes that $100 was invested on June 30, 1995: (i) in the Common Stock of Franklin Telecommunications, Corp., (ii) in the S&P 500 Index and (iii) a peer group of comparable companies. The stock price performance on the following graph is not necessarily indicative of future stock price performance. [PERFORMANCE GRAPH]

Source: Carl Thompson Associates www.ctaonline.com (800) 959-9677. Data from Bloomberg Financial Markets. Note: Vodavi Technology, Inc. and Vocaltec Communications Ltd., members of the peer group, started trading 10/6/95 and 2/6/96, respectively. Netrix, a peer group member for the 1999 proxy stock chart, is not included in the current peer group for the 2000 proxy stock chart. REPORT OF THE COMPENSATION COMMITTEE. The Company's executive compensation program is designed to help attract, retain, and motivate the highly qualified personnel needed to manage the Company's business and affairs. To meet these goals, the Company has implemented a compensation program with the following components: - - base salaries that reflect the scope and responsibilities of the position, as well as the skills, knowledge, experience, abilities, and contributions of each individual executive. - - short-term incentives that are based on the financial performance of the Company. 21 - - long-term incentives that balance the executive officer's short- and long-term perspectives and provide rewards consistent with shareholder returns. Compensation decisions are made following an assessment of the individual's contributions to the Company's success, any significant changes in the individual's role or responsibility, and internal equity of the Company's compensation relationships. The competitiveness of the Company's total compensation program-incorporating base salaries, short-term incentives and long-term incentives is regularly reviewed by the Compensation Committee. Based on such reviews, the Company concluded that the compensation paid to its executives was fair and reasonable. In general, the Company believes that the overall compensation levels for the executive group should reflect competitive levels of compensation for comparable positions in similarly sized companies over the long term. The Company believes that it is essential to link executive compensation and Company performance. To meet this objective, the Company maintains stock option programs which provide option grants on a regular, though not necessarily annual, basis to provide participants with an opportunity to share in the Company's performance. Stock option grants reflect the past contributions of the individual, the individual's ability to affect Company profitability, the scope of the individual's responsibilities, the need to retain the individual's services over time and management's assessments and recommendations. All executive officers, including the chief executive officer, are eligible to participate in this program. The Company's policy of awarding cash bonuses is designed to specifically relate executive pay to Company and individual performance. As a pay-for-performance program, cash bonuses provide financial rewards for achievement of substantive Company and personal objectives. Actual awards paid are based primarily on actual Company performance. The compensation of the Company's Chief Executive Officer, President and Chief Financial Officer for the fiscal year ending June 30, 2000 was based on an Employment Agreements outlined above. COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(m). The Company analyzes its executive compensation practices and plans on an ongoing basis with respect to Section 162(m) of the Internal Revenue Code. Where it deems advisable, the Company will take appropriate action to maintain the tax deductibility of its executive compensation. 22 Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of June 30, 2000 by each director and executive officer of the Company, each person known to the Company to be the beneficial owner of more than 5% of the outstanding Common Stock, and all directors and executive officers of the Company as a group. Except as otherwise indicated below, each person has sole voting and investment power with respect to the shares owned, subject to applicable community property laws.

23 Item 13. Certain Relationships and Related Transactions In August, 1999, Herb Mitchell, a non executive director of the Company, received warrants to purchase 140,000 shares at an exercise price of $1.38 per share as consideration for production of advertising materials. In October, 1999, the Company's former President exercised options to purchase 262,500 shares of the Company's Common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 215,973. In October, 1999, the Company's Chief Financial Officer exercised options to purchase 150,000 shares of the Company's Common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 103,043. In February, 2000, the Company's Chief Financial Officer exercised options to purchase 150,000 shares of the Company's Common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 117,992. In May, 2000, the Company's President was granted options to purchase 400,000 shares of the Company's Common stock at an exercise price of $.69 per share. The options vest over a two year period. Part IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Exhibits 3.1 Restated Articles of Incorporation of Franklin Telecommunications Corp.(1) 3.2 Bylaws of Franklin Telecommunications Corp.(2) 10.1 Employment Agreement, dated March 1, 1993 between Franklin Telecommunications Corp. and Frank W. Peters(1) 10.2 Form of Securities Purchase Agreement, dated as of March 16, 2000, between Registrant and the investors named therein(3) 10.3 Form of Protective Warrant(3) 10.4 Form of Term Warrant(3) 10.5 Registration Rights Agreement, dated as of March 16, 2000(3) 23.1 Consent of Singer, Lewak, Greenbaum & Goldstein LLP 27.1 Financial Data Schedule (1) Incorporated by reference from Registrant's Registration Statement on Form S-1 (No. 333-24791), filed with the Commission on April 9, 1997. (2) Incorporated by reference from Amendment No. 2 to Registrant's Registration Statement on Form S-3 (No. 333-35834), filed with the Commission on July 31, 2000. (3) Incorporated by reference from Registrant's Registration Statement on Form S-3 (No. 333-35834), filed with the Commission on April 28, 2000. (b) Financial Statements (c) Reports on From 8-K None. 24 SIGNATURES Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. FRANKLIN TELECOMMUNICATIONS CORP. By /s/ Robert Stewart --------------------------------- Robert Stewart Chief Executive Officer Dated: September 26, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

25 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONTENTS JUNE 30, 2000 - --------------------------------------------------------------------------------

26 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Franklin Telecommunications Corp. We have audited the accompanying consolidated balance sheets of Franklin Telecommunications Corp. and subsidiaries as of June 30, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ending June 30, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Franklin Telecommunications Corp. and subsidiaries as of June 30, 2000 and 1999, and the results of their consolidated operations and their consolidated cash flows for each of the three years in the period ended June 30, 2000 in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, during the year ended June 30, 2000, the Company incurred a net loss of $11,551,000, it had negative cash flows from operations of $9,300,000 and it had an accumulated deficit of $27,446,000. These factors, among others, as discussed in Note 2 to the consolidated financial statements, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. SINGER LEWAK GREENBAUM & GOLDSTEIN LLP Los Angeles, California August 30, 2000 1 27 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, - -------------------------------------------------------------------------------- ASSETS

The accompanying notes are an integral part of these financial statements. 2 28 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, - -------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY

The accompanying notes are an integral part of these financial statements. 3 29 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 3 30 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 5 31 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 6 32 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 7 33 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 8 34 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, - --------------------------------------------------------------------------------

The accompanying notes are an integral part of these financial statements. 9 35 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 During the year ended June 30, 2000, the Company completed the following: - - Repossessed equipment from a customer who was in arrears on payment for said equipment at a cost of $868,000. - - Equipment with a net book value of $150,000 was transferred to the Company in exchange for payment of a long-term note receivable. - - Committed to issue 74,716 shares of common stock valued at $82,000 as payment for accrued compensation to an employee. - - Issued 275,625 warrants to purchase common stock for services valued at $60,000. - - Purchased equipment under a capital lease in the amount of $54,000. The accompanying notes are an integral part of these financial statements. 10 36 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, - -------------------------------------------------------------------------------- SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES (CONTINUED) During the year ended June 30, 1999, the Company completed the following: - - Equipment valued at $500,000 that was prepaid at June 30, 1998 was delivered to the Company. - - 5,543,468 shares of common stock were issued upon the conversion of 548 shares of its Series C preferred stock. - - Equipment with a net book value of $16,000 and the trade name "Malibu Internet Services" were sold to an individual in exchange for a note receivable of $55,000. - - The current portion of a note payable to a related party for $228,000 plus accrued interest of $130,000 was converted into a long-term note payable to the same related party. During the year ended June 30, 1998, the Company completed the following: - - Reduced goodwill valued at $591,000 to $0 as part of the repurchase of 160,000 shares of the Company's common stock. - - Issued 1,333,695 shares of common stock upon the conversion of a note payable by an officer of the Company for $133,000. - - Issued 799,431 shares of common stock upon the conversion of 192 shares of its Series C preferred stock. - - Issued 400,000 new shares of common stock valued at $161,000 to related parties in exchange for 23,818 shares of previously issued common stock from related parties. The accompanying notes are an integral part of these financial statements. 11 37 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 1 - BUSINESS AND ORGANIZATION Franklin Telecommunications Corp. ("Franklin") and its subsidiaries (collectively, the "Company") design, build, and sell Internet Telephony equipment, also called Voice Over Internet Protocol equipment ("VOIP"), and other high speed communications products and subsystems. The Company's products are marketed through Original Equipment Manufacturers ("OEMs") and distributors, as well as directly to end users. In addition, through its majority-owned subsidiary, FNet Corp. ("FNet"), the Company provides traditional switched network and Internet Protocol telephony services and Internet access to businesses and individuals. FNet has had limited operations to date. The Company's customers are located primarily in the United States, Canada, South America, Asia, and parts of Europe in a wide range of industries including financial services, government, telephone services, and manufacturing. The Company offers a suite of Internet Telephony solutions that enable business communications over the Internet. From the small office home office ("SOHO") to the branch office and headquarters operations of medium to large scale corporate America, the Company offers a cost-effective call handling solution. From the enterprise to the carrier market, the Company can deal with "convergence," managing the connectivity and integration of voice, data, fax, and video. Wherever possible, the Company offers a turnkey solution that can be "owned" by its customers. When equipment sales are not in the best interest of a particular customer's business communications solution, the Company plans to provide that solution as a "service" that can be leased. The Company is a leading edge supplier of Internet Telephony solutions as a result of its flexibility in providing business communication solutions as equipment or services on a global basis. The Company's products and services enable connectivity and e-commerce. The Company is both an equipment supplier and a service provider, offering turnkey business communications solutions to both the carrier and enterprise segments of the Internet Telephony market. The Company produces gateways, gatekeepers, and edge servers that provide advanced packet switching solutions that significantly reduce the infrastructure costs associated with communications networks. The Company's products are designed, developed, and manufactured by the Company. 12 38 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 2 - GOING CONCERN MATTERS The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles which contemplate continuation of the Company as a going concern. However, the Company incurred a net loss of $11,551,000 during the year ended June 30, 2000 and it had negative cash flows from operations of $9,300,000. These factors raise substantial doubt about the Company's ability to continue as a going concern. Recovery of the Company's assets is dependent upon future events, the outcome of which is indeterminable. The Company's attainment of profitable operations is dependent upon its obtaining adequate debt and equity financing and achieving a level of sales adequate to support the Company's cost structure. In addition, realization of a major portion of the assets in the accompanying balance sheet is dependent upon the Company's ability to meet its financing requirements and the success of its plans to sell its products. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence. Management plans to raise additional equity capital, continue to develop its products, and look for merger or acquisition candidates. NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Acquisitions On February 28, 1997, the Company acquired Internet Passport, LLC, a limited liability company, ("Passport") in exchange for 600,000 shares of Franklin's common stock. The agreement also provided for the assumption of certain debts totaling $411,000, including the issuance of an additional 7,900 shares of Franklin's common stock valued at $1.73 to satisfy certain obligations of Passport. Passport is a start-up company incorporated in August 1996 that provides Internet services pursuant to contractual arrangements with satellite transmission providers. The acquisition was accounted for using the purchase method of accounting with the excess of approximately $1,478,000 of the total acquisition costs over the net assets acquired and liabilities assumed being allocated to excess of cost over fair value of net assets of companies acquired. During the year ended June 30, 1998, 160,000 shares of the Company's common stock at a value of $650,000 were returned by Passport to the Company and cancelled, as provided under the contract. The remaining excess of cost over fair value of net assets acquired related to the acquisition of $591,000 was reduced to $0. 13 39 NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Acquisitions (Continued) During April 1998, FNet entered into a joint venture with LibertyOne Limited, an Australian limited liability corporation that provides project management services and marketing and sales of telecommunications services in New Zealand. The joint venture is to provide voice and data communications through a FNet network to customers in New Zealand, Australia, Asia, and the South Pacific. The joint venture is for an initial term of five years with an option to extend at the expiration date. As of June 30, 2000, the Company had not contributed any funds to the joint venture, and the joint venture had not begun and does not intent to commence operations. During June 1998, FNet entered into a joint venture agreement with Megaburst, Inc. to operate an 11-site satellite telephone network in Bosnia used by NATO troops. The joint venture will operate a network that was purchased by Megaburst, Inc. from a third party for $150,000. FNet advanced funds to Megaburst, Inc. for the purchase of the assets. Megaburst, Inc. transferred the assets to FNet during the year ended June 30, 2000. During June 1998, FNet purchased all of the assets of LDNet, Inc. for $20,000. These assets consisted of equipment. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Franklin and its wholly owned or majority owned subsidiaries. All intercompany balances and transactions have been eliminated. Concentrations of Credit Risk The Company sells its products throughout the United States, Canada, Australia, and parts of Europe and South America and extends credit to its customers and performs ongoing credit evaluations of such customers. The Company evaluates its accounts receivable on a regular basis for collectability and provides for an allowance for potential credit losses as deemed necessary. For the year ended June 30, 2000, no customers accounted for more than 5% of the Company's product sales. One customer accounted for 76% of the Company's product sales for the year ended June 30, 1999. At June 30, 1999, the amount due from this customer amounted to 92% of accounts receivable. Two customers accounted for 30% and 13% of the Company's product sales for the year ended June 30, 1998. At June 30, 1998, amounts due from these two customers amounted to 35% and 25% of accounts receivable. 14 40 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Concentrations of Credit Risk (Continued) Export sales, primarily to Canada, Australia, Europe, and South America, represented 2%, 9%, and 1% of net sales for the years ended June 30, 2000, 1999, and 1998, respectively. Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities at the date of the financial statements. Such estimates affect the reported amounts of revenues and expenses during the reported period. Actual results could materially differ from these estimates. Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows expected to be generated by the assets. If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets. During the year ended June 30, 2000, the Company recognized $64,000 as an impairment loss related to licenses which the Company is no longer using and $160,000 as an impairment loss related to an uncollectible note receivable. Fair Value of Financial Instruments The Company measures its financial assets and liabilities in accordance with generally accepted accounting principles. For certain of the Company's financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, the carrying amounts approximate fair value due to their short maturities. The amounts shown for notes receivable, notes payable, and capital lease obligations also approximate fair value because current interest rates and terms offered by and to the Company for similar notes and lease agreements are substantially the same. Cash and Cash Equivalents For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. 15 41 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Inventories Inventories are stated at the lower of cost or market (estimated net realizable value). Cost is determined using the average cost method, which approximates the first-in, first-out ("FIFO") method. Net realizable value is based on forecasts for sales of the Company's products in the ensuing years. The industry in which the Company operates is characterized by rapid technological advancement and change. Should demand for the Company's products prove to be significantly less than anticipated, the ultimate realizable value of the Company's inventories could be substantially less than the amount shown on the accompanying consolidated balance sheets. Property and Equipment Property and equipment are stated at cost. The Company provides for depreciation using the straight-line method over the estimated useful lives as follows:

Expenditures for maintenance and repairs are charged to operations as incurred while renewals and betterments are capitalized. Gains or losses on the sale of property and equipment are reflected in the statements of operations. Stock Options and Warrants Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," defines a fair value based method of accounting for stock-based compensation. However, SFAS No. 123 allows an entity to continue to measure compensation cost related to stock and stock options issued to employees using the intrinsic method of accounting prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." Entities electing to remain with the accounting method of APB 25 must make pro forma disclosures of net income and earnings per share as if the fair value method of accounting defined in SFAS No. 123 had been applied. The Company has elected to account for its stock-based compensation to employees under APB 25. 16 42 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Excess of Cost Over Fair Value of Net Assets of Companies Acquired Excess of cost over fair value of net assets of companies acquired arising in connection with the aforementioned business acquisitions is amortized using the straight-line method over five years. The Company assesses the recoverability of these intangibles on a quarterly basis by determining whether the amortization of the balance over its remaining life can be recovered through projected undiscounted future cash flows. The amount of impairment, if any, is based on fair value as measured by future cash flows and charged to operations in the period in which goodwill impairment is determined by management. During the year ended June 30, 1998, management of the Company determined that $591,000 had been impaired and, accordingly, the Company charged this amount to operations. No amortization of excess of cost over fair value of net assets of companies acquired was recorded for the years ended June 30, 2000, 1999, and 1998. Minority Interest Minority interest represents the minority shareholders' proportionate share of the equity of FNet. During the year ended June 30, 1999, FNet sold approximately 60,000 shares of its stock to outside investors at $1 per share. It also issued 50,000 shares upon the exercise of 50,000 stock options. The shares sold to investors were issued under a private offering circular pursuant to the exemption from registration under the Securities Act of 1933 provided in Rule 505 of Regulation D. After the issuance of these shares, Franklin's ownership percentage remained at 71% as of June 30, 1999. During the year ended June 30, 2000, FNet sold approximately 26,250 shares of its stock to outside investors at $2 per share. The shares sold to investors were issued under a private offering circular pursuant to the exemption from registration under the Securities Act of 1933 provided in Rule 505 of Regulation D. After the issuance of these shares, Franklin's ownership percentage remained at 71% as of June 30, 2000. FNet, on a stand-alone basis, had a shareholders' deficit. As a result, Franklin's investment in FNet had a negative carrying value. The increase in capitalization of FNet resulting from the sale of 1,949,500 shares of common stock to outside investors benefited Franklin in that it reduced the negative carrying value of Franklin's investment in FNet. Accordingly, Franklin has accounted for the change in its proportionate share of FNet's equity resulting from the issuance of stock to outside investors as an increase in shareholders' equity and a reduction in minority interest liability in the consolidated financial statements. 17 43 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Minority Interest (Continued) The accompanying consolidated financial statements do not reflect a minority interest liability as of June 30, 2000 and 1999 as FNet, on a stand-alone basis, had a shareholders' deficit as of such dates. The accompanying consolidated statements of operations for the years ended June 30, 2000 and 1999 do not reflect the minority interest's share of FNet's losses for said years as the related accrual would result in the Company's recordation of a minority interest receivable. Revenue Recognition Revenues are recognized upon shipment of the products to customers. The Company does not allow the right of return on sales. Warranties The Company provides limited warranties of one year from the date of purchase of its products. A minimal accrual has been made for warranty liabilities because they are not expected to be significant. Research and Development Costs Research and development costs are expensed as incurred. Advertising Costs Advertising costs are expensed as incurred. Advertising expense was $393,000, $204,000, and $109,000 for the years ended June 30, 2000, 1999, and 1998 respectively. Loss per Share The Company utilizes SFAS No. 128, "Earnings per Share." Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Because the Company has incurred net losses, basic and diluted loss per share are the same. 18 44 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes The Company accounts for income taxes under the asset and liability method of accounting. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is required when it is less likely than not that the Company will be able to realize all or a portion of its deferred tax assets. Comprehensive Income The Company utilizes SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting comprehensive income and its components in a financial statement. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. Comprehensive income is not presented in the Company's financial statements since the Company did not have any of the items of comprehensive income in any period presented. Recently Issued Accounting Pronouncements In June 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 138, "Accounting for Certain Instruments and Certain Hedging Activities." This statement is not applicable to the Company. In June 2000, the FASB issued SFAS No. 139, "Rescission of FASB Statement No. 53 and Amendments to Statements No. 63, 89, and 121." This statement is not applicable to the Company. NOTE 4 - CASH AND CASH EQUIVALENTS The Company maintains cash deposits at banks located in California. Deposits at each bank are insured by the Federal Deposit Insurance Corporation up to $100,000. At times, the Company holds cash with these banks in excess of amounts insured by federal agencies. Excess cash is invested in money market accounts, certificates of deposit, and United States Government agency notes. As of June 30, 2000 and 1999, the uninsured portions of these balances held at the banks aggregated to $1,116,000 and $1,410,000, respectively. 19 45 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 4 - CASH AND CASH EQUIVALENTS (CONTINUED) Income from these investments consists entirely of interest income in the amount of $68,000, $148,000, and $250,000 for the years ended June 30, 2000, 1999, and 1998, respectively. The aggregate carrying amount of cash and short-term investments by major types at June 30 was as follows:

NOTE 5 - INVENTORIES Inventories at June 30 consisted of the following:

NOTE 6 - PROPERTY AND EQUIPMENT Property and equipment at June 30 consisted of the following:

20 46 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 6 - PROPERTY AND EQUIPMENT (CONTINUED) During the year ended June 30, 2000, the Company was unable to take possession of certain property and equipment and therefore recognized an expense of $367,000 for the abandonment of these assets. NOTE 7 - NOTES RECEIVABLE Notes receivable at June 30 consisted of the following:

During the year ended June 30, 2000, the Company determined that the note receivable from its customer was uncollectible and wrote off the entire balance. The Company recorded a loss on impairment on the note receivable of $160,000. In April 2000, the Company obtained the title to certain telephone and satellite equipment from its joint venture partner in exchange for payment of its note receivable. The fair market value of the equipment was $150,000, and as such, no gain or loss was recorded. 21 47 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 8 - ACCRUED LIABILITIES Accrued liabilities at June 30 consisted of the following:

NOTE 9 - NOTES PAYABLE Notes payable at June 30 consisted of the following:

During the year ended June 30, 2000, the conversion feature of the notes payable to former vendors expired. The Company wrote off the notes payable and recognized an extraordinary gain on the extinguishment of debt in the amount of $60,000, which represents $24,000 in principal and $36,000 in accrued interest. 22 48 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 9 - NOTES PAYABLE (CONTINUED) The $762,000 due to the Company's chief executive officer represents three separate notes that were consolidated into one non-interest-bearing promissory note on December 31, 1998. The promissory note contains a set repayment plan with payments through June 30, 2001. If the Company violates the plan, the note is due on demand. As of June 30, 2000, the Company had violated the plan, but the Company's chief executive officer has signed a waiver, deferring all payments due until the earlier of July 1, 2001 or upon an acquisition of the Company. As of June 30, 2000, no acquisition offers have been made. In December 1999, the Company issued five convertible notes payable for $500,000 each and 1,000,000 warrants to purchase shares of the Company's common stock at an exercise price of $1.65 per share to an investment company. The notes bear interest at 10% per annum, are unsecured, require quarterly interest payments on the unconverted balance, and mature on December 3, 2002. The notes are convertible into shares of the Company's common stock if the Company elects not to pay the aggregate principal amount outstanding and accrued interest by May 3, 2000. If the Company elects not to pay the notes in full, the holders may convert all or a portion of the notes into shares of common stock at any time after May 3, 2000 until maturity. Any notes outstanding at the maturity date will be converted into shares of common stock. The conversion price is the lesser of $2.50 or 92% of the three lowest per share prices of the Company's common stock during the 22 trading days prior to conversion. The notes were repaid in May 2000. The warrants vest upon issuance and expire three years from the date of the private placement. NOTE 10 - COMMITMENTS AND CONTINGENCIES Operating Leases and Capital Lease Obligations The Company leases its production, warehouse, and administrative facilities under various non-cancelable operating leases that expire through March 2003. In addition to the minimum annual rental commitments, the leases provide for periodic cost of living increases in the base rent and payment by the Company of common area costs. All leases have various renewal features. Rent expense related to the operating leases was $218,000, $170,000, and $170,000 for the years ended June 30, 2000, 1999, and 1998, respectively. The Company leases two condominiums from a related party on a month-to-month basis for business travel and employee relocation. Rent expense related to these operating leases was $53,100, $49,000, and $0 for the years ended June 30, 2000, 1999, and 1998, respectively. 23 49 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED) Operating Leases and Capital Lease Obligations (Continued) The Company also leases certain telephone equipment under a capital lease. The lease has an initial term of two years and requires fixed monthly payments. Future minimum lease payments under capital and operating leases at June 30, 2000 were as follows:

In connection with the acquisition of Passport, the Company assumed six capital leases that were assumed by Passport from two entities owned by the previous sole member of Passport. At June 30, 1997, all six capital leases were in default because of provisions in the leases that prohibited the assignment of the leases. In addition, the assets underlying four of the six leases were sold by Passport for cash, which was not used to repay the principal, prior to its acquisition by the Company. Such sales were also prohibited under the terms of the leases, and the lessors had not been informed of such sales. As a result, the lessors had the right to accelerate the payments under all of the leases due to such defaults. During the year ended June 30, 1998, the Company paid off the six leases and recognized a gain of $45,000. Litigation During June 2000, two shareholders who acquired their shares in a private placement in March 2000, filed a lawsuit against Franklin and officer-directors Frank W. Peters and Thomas L. Russell. The lawsuit sought to postpone the June 28, 2000 annual stockholders meeting, based upon alleged deficiencies in the proxy materials pertaining to the meeting. At a court hearing held on June 28, 2000, the Court declined to enjoin the meeting as requested by plaintiffs. Thereafter, plaintiffs amended the lawsuit several times and ultimately added new claims pertaining to the private placement and alleging securities law violations. A motion to dismiss those claims was filed by Franklin and is scheduled for hearing on October 16, 2000. Because Franklin believes the lawsuit is without merit, it is being vigorously defended. Franklin also has engaged in on-going settlement discussions in order to end the expense and distraction of litigation. The Company is involved in certain legal proceedings and claims which arise in the normal course of business. Management does not believe that the outcome of these matters will have a material adverse effect on the Company's consolidated financial position or results of operations. 24 50 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED) Software License Agreements During November 1997, the Company entered into a contract for software development and a worldwide license agreement with a software development company which was amended in May 1998 to include additional software. The license agreement provides for a three-year term and may be extended on a year-to-year basis thereafter. In addition to the fixed fee of $426,000, there is a royalty of $0.75 per port for each personal computer board sold containing the licensed software. Amounts paid under the license agreement totaled $4,500, $103,000, and $328,000 during the years ended June 30, 2000, 1999, and 1998 respectively. During January 1998, the Company entered into a worldwide license, manufacturing, and sales agreement with a third party for certain Digital Signal Processing board designs. The license fee consists of an up-front fixed payment of $30,000, plus a royalty of $100 per board manufactured directly, or by contract, up to a maximum total royalty of $200,000. In addition, the Company licensed certain software to the third party at a royalty rate of $1 per port. As of June 30, 1999, $97,800 had been paid and $0 had been received under the terms of the license agreement. During March 1998, the Company entered into a five-year, worldwide license agreement with a company to use certain software of this company to create software for sale to third parties. The Company must pay a license fee of $35,000, a royalty of $10 per port, and a one-time, active maintenance and support services fee of $10,000. Amounts paid under this license agreement totaled $0, $0, and $1,360 during the years ended June 30, 2000, 1999, and 1998, respectively. During the year ended June 30, 2000, the Company recognized an impairment of the license of $28,000, which represented the unamortized purchase price of the license that the Company deemed to be impaired. During May 1999, the Company entered into a license agreement with a Company to manufacture and sell certain hardware and software which were developed by the licensor. In addition to the fixed fee of $250,000, there is a royalty of $35 per unit for each product sold containing the licensed software and hardware. During the year ended June 30, 1999, the Company paid $150,000 of the fixed fee and $0 in royalty expenses. During the year ended June 30, 2000, the Company accrued the remaining $100,000 for the fixed fee and paid $0 in royalty expenses. 25 51 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED) Private Placement Exemptions The Company and FNet's private placements of securities have been issued in transactions intended to be exempt from registration under the Securities Act of 1933 pursuant to the provisions of Regulation D promulgated thereunder. These rules include factors pursuant to which one or more private placement transactions may be integrated as part of other offerings and include rules that limit the dollar amount that can be raised and the number of non-accredited investors that can participate. In the event any of the Company's private placement transactions, including private placement transactions undertaken by the Company since the transactions referred to above, were deemed to be integrated, it is possible that the exemption from the registration requirements of the Securities Act of 1933 would not be available for one or more of those offerings. In the event that one or more of such transactions are determined not to have been exempt from such registration requirements, the purchasers may have the right to seek rescission of the sales and/or seek money damages against the Company. Management believes that each of the Company's private offerings were exempt from the registration requirements of the Securities Act of 1933. Employment Agreements The Company has entered into employment agreements with certain officers/directors/shareholders of Franklin and FNet for terms from two to six years. A portion of the compensation paid pursuant to these agreements is paid semi-monthly, and a portion is deferred and therefore included in accrued liabilities in the accompanying consolidated balance sheets. At June 30, 2000, there were no employment agreements in effect that deferred any of the payment of compensation. NOTE 11 - SHAREHOLDERS' EQUITY Stock Option Plans The Company adopted an Incentive Stock Option Plan ("Plan A") and Nonqualified Stock Option Plan ("Plan B") (the "1986 Plans"). Plan A provides for the granting of options to purchase shares of common stock that are intended to qualify as incentive stock options within the meaning of Section 422A of the Internal Revenue Code, and Plan B provides for the granting of options to purchase shares of common stock that are not intended to qualify. The 1986 Plans provide for the issuance of up to 700,000 shares in the aggregate at fair market value. 26 52 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) During the year ended June 30, 1989, the Company adopted the 1988 Stock Option Plan (the "1988 Plan"). Under the terms of the plan, options to purchase 300,000 shares of the Company's common stock are available for issuance to employees, officers, and directors. Options granted may be either incentive stock options or non-statutory options. The exercise price of the incentive stock options and non-statutory options may not be greater or less than 110% and 85%, respectively, of the fair market value of the Company's common stock at the date of grant. During the year ended June 30, 1994, the Company adopted the 1993 Stock Option Plan (the "1993 Plan"). The 1993 Plan provides for the granting of options to purchase up to 600,000 shares of common stock. During the year ended June 30, 1995, the Company adopted the 1994 Stock Option Plan (the "1994 Plan"). The 1994 Plan provides for the granting of options to purchase up to 1,400,000 shares of common stock. Such options will be non-statutory. During the year ended June 30, 1998, the Company adopted the 1998 Stock Option Plan (the "1998 Plan"). The 1998 Plan provides for the granting of options to purchase up to 2,000,000 shares of common stock that are intended to qualify as incentive stock options within the meaning of Section 422A of the Internal Revenue Code. Options granted under all of the aforementioned plans vest in accordance with the terms established by the Company's stock option committee. All such options granted to date have vesting periods of between two to four years and generally terminate at the earlier of one year beyond the end of the option period or termination of employment. In October 1998, certain outstanding options granted to employees in prior years were repriced. Per SFAS No. 123, the Company should incur additional compensation cost for the excess of the fair value of the modified options issued over the value of the original options at the date of the exchange. The Company thus added that incremental amount to the remaining unrecognized compensation cost for the original options at the June 30, 1999 pro forma disclosure and recognized the total amount over the remaining years of the remaining life of the options. The remaining expected life of the options is five years at June 30, 1999. In October 1999, the Company re-priced an aggregate of 547,000 options issued to 14 employees under the 1998 Plan and outside of the Plan. In relation to this re-pricing, the Company did not record any compensation expense for the year ended June 30, 2000 since none of the options had vested. 27 53 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) In March 2000, the FASB issued an interpretation of SFAS No. 40, "Accounting for Certain Transactions involving Stock Compensation." In accordance with the interpretation, employee stock option awards that are re-priced will be accounted for as variable awards from the date of the re-pricing to the date the options are exercised, forfeited, or expire. The interpretation of this FASB is effective for all re-pricings subsequent to December 15, 1998. Activity for the 1986 Plans, the 1988 Plan, the 1993 Plan, the 1994 Plan, and the 1998 Plan is as follows:

The exercise prices for the options outstanding at June 30, 2000 ranged from $0.10 to $0.69. The weighted-average remaining contractual life of the options outstanding at June 30, 2000 is 7.1 years. 28 54 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) On December 13, 1996, the Company granted options to purchase 1,000,000 shares of the Company's common stock to key management employees, which were fully vested on the date of grant. The option price was set at $1.31 per share, the fair value of the underlying shares. These options were repriced to $0.44 per share on October 14, 1998. On April 24, 1998 and May 26, 1998, the Company granted options to purchase 300,000 and 165,000 shares, respectively, of the Company's common stock to key management employees which vest from two to four years from the date of grant. The option price was set at $2.59 and $2.69 per share, respectively, the fair value of the underlying shares. These options were repriced to $0.44 per share on October 14, 1998. On October 14, 1998, the Company granted options to purchase 1,300,000 shares of the Company's common stock to key management employees, which vest over four years from the date of grant. The option price was set at $0.44 per share, the fair value of the underlying shares. During the year ended June 30, 2000, the Company granted options to purchase 1,095,000 shares of common stock to key management employees, which vest over a period of two to four years. The option price was set at $0.69 per share, the fair value of the underlying shares. 29 55 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) Activity for Company options outside of the Plan is as follows:

The Company's majority-owned subsidiary, FNet, established a 1996 stock option plan (the "FNet Plan") which was amended in 1998. The FNet Plan, as amended, provides for the granting of options to purchase up to 7,000,000 shares of FNet common stock that are intended to qualify as incentive stock options within the meaning of Section 422A of the Internal Revenue Code. Such options will become exercisable in accordance with the terms established by FNet's stock option committee. All options granted to date vest between zero and four years and generally terminate at the earlier of the end of the option period or termination of employment. 30 56 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) Activity for the FNet Plan is as follows:

On May 10, 1998, the Company granted options to purchase 300,000 shares of FNet's common stock to a key management employee, which were fully vested on the date of grant. The option price was set at $1 per share, the fair value of the underlying shares. During the year ended June 30, 2000, the Company granted options to purchase 2,845,000 shares of FNet's common stock to key management employees, which vest over a period of two to four years. The option price was set at $2 per share, the fair value of the underlying shares. 31 57 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) Activity for FNet options outside of the FNet Plan is as follows:

The weighted-average remaining contractual life of the options outstanding at June 30, 2000 is 6.63 years. 32 58 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) The Company has adopted only the disclosure provisions of SFAS No. 123. It applies APB 25 and related interpretations in accounting for its plans and does not recognize compensation expense for its stock-based compensation options other than for restricted stock and options issued to outside third parties. If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed by SFAS No. 123, the Company's net loss and loss per share would be reduced to the pro forma amounts indicated below:

These pro forma amounts may not be representative of future disclosures because they do not take into effect pro forma compensation expense related to grants made before June 30, 1996. The pro forma amounts take into account the pro forma compensation expense of the Franklin and FNet options. The fair value of the Franklin options issued to employees described above was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for the years ended June 30, 2000, 1999, and 1998: dividend yields of 0%, 0%, and 0%, respectively; expected volatility of 100%, 100%, and 60%, respectively; risk-free interest rates of 6.4%, 5.6%, and 5.5%, respectively; and expected lives of four, four, and four, respectively. The weighted-average fair value of options granted during the years ended June 30, 2000, 1999, and 1998 were $1.27, $0.34, and $0.99, respectively, and the weighted-average exercise price was $0.69, $0.63, and $2.66, respectively. The fair value of the FNet options issued to employees described above was estimated at the date of grant using the minimum value method with the following weighted-average assumptions for the years ended June 30, 2000, 1999, and 1998: dividend yields of 0%, 0%, and 0%, respectively; risk-free interest rates of 6.4%, 5.8%, and 6.2%, respectively; and expected lives of four, four, and four years, respectively. The weighted-average fair value of options granted during the years ended June 30, 2000, 1999, and 1998 was $0.44, $0.20, and $0.99, respectively, and the weighted-average exercise price was $2, $1, and $1, respectively. 33 59 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Option Plans (Continued) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Warrants In May 1995, in connection with the 1995 Private Placement, the Company entered into an investment banking agreement with an unrelated entity, whereby the Company granted to the investment banker warrants to purchase 600,000 shares, as amended, of the Company's common stock at an exercise price of $1.35 per share. The warrants vested over a 12-month period and include demand and piggy back registration rights after a period of 24 months from the date of the agreement. The warrants and/or underlying shares may be exercised anytime after two years and for a period of four years from the date of the agreement. As of June 30, 2000, 1999, and 1998, 600,000, 600,000, and 0 of these warrants, respectively, had been exercised. In connection with the 1995 Private Placement, during the years ended June 30, 1996 and 1995, the Company issued 2,380,000 and 220,000 warrants, respectively, to purchase shares of the Company's common stock. The exercise price of the warrants was $0.50, as amended, if exercised on or before March 24, 1996 and $1.25 if exercised after March 24, 1996 but on or before September 30, 1998 (the expiration date). There was no additional expense recorded in connection with the issuance of the warrants as the exercise price approximated the fair value at the date of issuance, as determined by management of the Company, of the underlying stock at the date of issuance. For the years ended June 30, 2000, 1999, and 1998, 50,000, 113,250, and 1,841,750 warrants, respectively, were exercised, leaving a remaining balance of 50,000 unexercised as of June 30, 2000. In connection with a private placement in August 1999, the Company issued 400,000 incentive warrants to purchase shares of the Company's common stock at an exercise price of $1.55 per share. The warrants may be exercised any time after issuance and for a period of five years from the date of the private placement. There was no additional expense recorded in connection with the issuance of the warrants as the exercise price approximated the fair value of the Company's common stock at the date of issuance. As of June 30, 2000, no warrants were exercised. 34 60 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Warrants (Continued) In connection with the convertible notes payable for $2,500,000 issued in December 1999, the Company issued to an investment banker 100,000 warrants to purchase shares of the Company's common stock at an exercise price of $1.65 per share. The warrants may be exercised any time after issuance and for a period of three years from the date of the private placement. The Company recognized a financing expense of $25,000 in connection with the issuance. As of June 30, 2000, no warrants were exercised. In connection with a private placement in March 2000, the Company issued 1,205,667 incentive warrants to purchase shares of the Company's common stock at an exercise price of $2.50 per share. The warrants may be exercised any time after issuance and for a period of five years from the date of the private placement. There was no additional expense recorded in connection with the issuance of the warrants as the exercise price approximated the fair value of the Company's common stock at the date of issuance. As of June 30, 2000, no warrants were exercised. In connection with advertising services received, the Company issued 420,000 warrants to purchase shares of the Company's common stock at an exercise price of $1.38 per share. The warrants may be exercised any time after issuance and for a period of one and a half years from the date of the private placement. The Company recognized an expense of $60,000 in connection with the issuance, which represented the value of services received by the advertising company. As of June 30, 2000, 420,000 warrants were exercised, leaving no unexercised warrants available. In connection with a private placement in March 2000, the Company issued to various investors 73,600 FNet warrants to purchase shares of FNet's common stock at exercise price ranging from $0.32 to $0.35 per share. The warrants may be exercised any time after issuance and for a period of five years from the date of the private placement. There was no additional expense recorded in connection with the issuance of the warrants as the exercise price approximated the fair value of the Company's common stock at the date of issuance. As of June 30, 2000, 43,600 warrants were exercised, leaving a remaining balance of 30,000 unexercised warrants. 35 61 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Issuances During the year ended June 30, 2000, the Company completed the following significant common stock transactions of previously unissued common shares: - Issued 1,211,033 shares in connection with a cashless exercise of options and warrants that were processed by the Company. The Company recognized an expense of $717,000 related to this cashless exercise, primarily due to employees that are not officers of the Company. - Issued 261,603 shares in connection with the exercise of stock options for cash of $179,000. - In connection with a private placement in August 1999, the Company sold 1,932,368 shares for gross proceeds of $2,000,000, less $371,000 for the value of the 400,000 warrants issued as part of the private placement. The Company paid commissions and fees of $205,000 in connection with this private placement. - In connection with a private placement in February 2000, the Company sold 841,515 shares for $1,500,000. The Company paid commissions and fees of $36,000 in connection with this private placement. - In connection with a private placement in March 2000, the Company sold 4,022,667 shares for gross proceeds of $6,040,000, less $1,668,000 for the value of the 1,205,667 warrants issued as part of the private placement. The Company paid commissions and fees of $344,000 in connections with this private placement. - In connection with a private placement in March 2000, the Company sold 43,600 shares for $376,000. The Company paid commissions and fees of $35,000 in connection with this private placement. - Issued 115,807 shares at prices ranging from $0.44 to $10 for total cash of $179,000. - Committed to issue 74,716 shares for accrued compensation to an employee. - Issued 21,694 shares as compensation to certain employees. 36 62 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Issuances (Continued) During the year ended June 30, 1999, the Company completed the following significant common stock transactions of previously unissued common shares: - Issued 444,725 shares at prices ranging from $0.50 to $2.27 for total cash of $474,000. - Issued 5,543,468 shares valued at $4,856,000 upon the conversion of 548 shares of its Series C preferred common stock valued at $4,856,000. - Issued 570,000 shares valued at $200,000 to the Company's chief executive officer in exchange for a note receivable. - Issued 121,356 shares for services valued at $64,000. - Issued 21,524 shares in connection with the exercise of warrants, whereby the option holders issued notes receivable in favor of the Company for $22,000. - Issued 215,514 shares in connection with the exercise of stock options, whereby the option holders issued notes receivable in favor of the Company for $216,000. - Issued 60,625 shares in connection with the exercise of stock options for cash of $29,000. - Issued or committed to issue 408,000 shares in connection with the exercise of warrants for cash of $467,000. During the year ended June 30, 1998, the Company completed the following significant common stock transactions of previously unissued common shares: - Received 23,818 shares of its common stock valued at $161,000 from certain officers of the Company as consideration to exercise stock options for 400,000 shares also valued at $161,000. - In connection with the 1997 Private Placement, the Company sold 333,333 units for $1,000,000. Each unit consists of one share and one warrant to purchase one share of the Company's common stock at an exercise price of $5 per share, exercisable after October 1, 1998. The warrants expire October 2, 2001. The Company paid no commissions or fees in connection with this private placement. During the year ended June 30, 2000, 287,333 of the warrants were cancelled. 37 63 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Stock Issuances (Continued) - Issued 345,500 shares in connection with the exercise of stock options, whereby the option holders issued notes receivable in favor of the Company for $315,950. - Issued 63,750 shares in connection with the exercise of stock options for cash of $66,000. - Issued or committed to issue 1,761,000 shares in connection with the exercise of warrants for $2,261,000. - Committed to issue 56,336 shares for services valued at $71,000. - Issued 1,333,695 shares upon the conversion of a note payable by an officer for the Company for $133,000. - Issued 799,431 shares valued at $1,702,000 upon the conversion of 192 shares of its Series C preferred stock valued at $1,702,000. - 160,000 shares of the Company's common stock at a value of $650,000 were returned to the Company and cancelled, as provided under the contract, thus reducing the initial purchase price of Passport. Pursuant to state laws, the Company is currently restricted, and may be restricted for the foreseeable future, from making dividends to its shareholders as a result of its accumulated deficit as of June 30, 2000. Convertible Preferred Stock During the year ended June 30, 1998, the Company issued 740 shares of its Series C convertible preferred stock in a private placement for $7,400,000. 20% of the shares held may be converted to common stock four months after issuance with an additional 20% eligible for conversion each month thereafter, in which the limitation on conversion ends nine months after issuance. Any unconverted shares will be automatically converted to common shares at the later of either 18 months from issuance, the Company's common stock being traded on a national exchange, or the filing of a registration statement covering the resale of the common shares issued upon conversion. Series C shares do not pay dividends and do not have voting rights. The shares are convertible into shares of common stock at a conversion price of $4.64 per share, subject to certain adjustments relating to the market price of the underlying common stock. As of June 30, 2000, all shares of preferred stock have been converted to common stock. 38 64 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 11 - SHAREHOLDERS' EQUITY (CONTINUED) Convertible Preferred Stock (Continued) Each preferred share is accompanied by a warrant that is exercisable to purchase shares of common stock of the Company's subsidiary, FNet, and which, under certain circumstances, could be exercisable to acquire shares of common stock of the Company at the exercise price of $4.64 during September 1998. On September 30, 1998, 995,510 of the warrants were converted into warrants exercisable to acquire the Company's common stock, and on September 22, 1999, 17,786 of these warrants were exercised for shares of the Company's common stock, leaving 668,104 warrants exercisable to acquire FNet's common stock. The warrants expire November 24, 2002. No warrants have been exercised at June 30, 2000. NOTE 12 - INCOME TAXES The tax effects of temporary differences that give rise to deferred taxes at June 30 are as follows:

39 65 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 12 - INCOME TAXES (CONTINUED) The valuation allowance increased by $4,132,000 and $814,000 during the years ended June 30, 2000 and 1999, respectively. No provision for income taxes for the years ended June 30, 2000, 1999, and 1998 is required, except for minimum state taxes, since the Company incurred losses during such years. Income tax expense differs from the amounts computed by applying the United States federal income tax rate of 34% to income taxes as a result of the following:

As of June 30, 2000, the Company had consolidated net operating loss carryforwards of $28,000,000 and $10,800,000 for federal and state income tax reporting purposes, respectively, which expire in varying amounts through 2020. The Company also has general business tax credit carryforwards of $310,000 and $24,000 available to offset against future federal and state income taxes, respectively, which expire at various times through 2020. Should a substantial change in the Company's ownership occur, there could be an annual limitation on the amount of the net operating loss carryforwards available for use in the future. NOTE 13 - RELATED PARTY TRANSACTIONS In August, 1999, Herb Mitchell, a non executive director of the Company, received warrants to purchase 140,000 shares at an exercise price of $1.38 per share as consideration for production of advertising materials. In October, 1999, the Company's former President exercised options to purchase 252,000 shares of the Company's common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 215,973. In October, 1999, the Company's Chief Financial Officer exercised options to purchase 150,000 shares of the Company's common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 103,043. In February, 2000, the Company's Chief Financial Officer exercised options to purchase 150,000 shares of the Company's common stock at an exercise price of $.44 per share. The exercise was done on a net basis, so that the actual number of shares issued were 117,992. In May, 2000, the Company's President was granted options to purchase 400,000 shares of the Company's common stock at an exercise price of $.69 per share. The options vest over a two year period. NOTE 14 - 401(k) PLAN The Company sponsors a 401(k) plan which includes a deferred feature under section 401(k) of the Internal Revenue Code (the "Plan"). The Plan covers all full-time employees of the Company. Contributions to the plan are at the discretion of the Company's Board of Directors, but limited to the amounts allowable for federal income tax purposes. Under the section 401(k) portion of the Plan, employees may elect to contribute up to 15% of their compensation. The Company did not make any contributions to the Plan during the years ended June 30, 2000, 1999, and 1998. 40 66 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 15 - LINES OF BUSINESS The Company operates in two major lines of business: the manufacture and distribution of data communications and connectivity products ("Franklin") and Internet services ("FNet"). Information concerning operations in these lines of business for the years ended June 30, 2000, 1999, and 1998 was as follows:

41 67 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS JUNE 30, 2000 - -------------------------------------------------------------------------------- NOTE 16 - YEAR 2000 ISSUE The Company has completed a comprehensive review of its computer systems to identify the systems that could be affected by ongoing Year 2000 problems. Upgrades to systems judged critical to business operations have been successfully installed. To date, no significant costs have been incurred in the Company's systems related to the Year 2000. Based on the review of the computer systems, management believes all action necessary to prevent significant additional problems has been taken. While the Company has taken steps to communicate with outside suppliers, it cannot guarantee that the suppliers have all taken the necessary steps to prevent any service interruption that may affect the Company. NOTE 17 - SUBSEQUENT EVENTS Subsequent to June 30, 2000, the Company entered into subscription agreements for the sale of 4,944,600 units for proceeds of $2,472,300. Each unit consists of one share of the Company's common stock and one warrant convertible into one share of the Company's common stock at $3 per share. 42 68 EXHIBIT INDEX

(1) Incorporated by reference from Registrant's Registration Statement on Form S-1 (No. 333-24791), filed with the Commission on April 9, 1997. (2) Incorporated by reference from Amendment No. 2 to Registrant's Registration Statement on Form S-3 (No. 333-35834), filed with the Commission on July 31, 2000. (3) Incorporated by reference from Registrant's Registration Statement on Form S-3 (No. 333-35834), filed with the Commission on April 28, 2000.