FRANKLIN WIRELESS CORP — Interim / Quarterly Report 2000

Nov 13, 2000

1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q --------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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) --------------- California 95-3733534 (State or other jurisdiction of (I.R.S Employer incorporation or organization) Identification No.) 733 Lakefield Road, Westlake Village, California 91361 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (805) 373-8688 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange ------------------- --------------------- Common stock, American Stock Exchange without par value 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 the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date: TITLE OF EACH CLASS OF COMMON STOCK OUTSTANDING AT NOVEMBER 9, 2000 - ----------------------------------- ------------------------------- Common Stock, no par value 39,467,187 2 Index Franklin Telecommunications Corp.

3 Item 1. Financial Statements FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2000 (UNAUDITED) AND JUNE 30, 2000

The accompanying notes are an integral part of these financial statements. 4 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 (UNAUDITED)

The accompanying notes are an integral part of these financial statements. 5 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 (UNAUDITED)

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES During the three months ended September 30, 2000, the Company issued 200,000 shares (unaudited) of common stock for services valued at $146,000 (unaudited) and for the prepayment of services to be rendered valued at $79,000 (unaudited). The accompanying notes are an integral part of these financial statements. 6 FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS NOTE 1--GENERAL AND SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Business and Organization Franklin Telecommunications Corp. ("Franklin") and its subsidiaries (collectively the "Company") manufacture and distribute data and telephony communications, access and connectivity products for IP Telephony networks, T-1 and X.25 wide-area networks and provide IP Telephony and Internet services through its majority-owned subsidiary, FNet Corp. ("FNet"). The Company's customers are located predominantly in the United States, Canada, Australia, South America and parts of Europe in a wide range of industries including financial services, government, telephone services and manufacturing. Basis of Presentation The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation have been included. The financial statements should be read in conjunction with the audited financial statements included in the Company's annual report on Form 10-K for the fiscal year ended June 30, 2000. The results of operations for the three months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2001. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Franklin Telecommunications Corp. and its wholly-owned or majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated. 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 three months ended September 30, 2000, the Company determined that no assets were impaired. 7 Loss Per Common Share The Company calculates loss per common share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Basic loss per share is computed by dividing the 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. The following potential common shares have been excluded from the computation of diluted net loss per share for all periods presented because the effect would have been anti-dilutive:

Income Taxes The Company accounts for income taxes under the asset and liability method. 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. NOTE 2--INVENTORIES Inventories consisted of the following:

8 NOTE 3--ACCRUED LIABILITIES Accrued liabilities consisted of the following:

NOTE 4--COMMITMENTS AND CONTINGENCIES Service Agreement During the three months ended September 30, 2000, FNet entered into a five-year service agreement with a satellite service provider to operate uplink and downlink earth stations between the United States and the Balkan region. The estimated fee for the project is $1,236,000. 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. During June 2000, two shareholders who acquired their shares in a private placement in March 2000, filed a lawsuit against the Company 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 denied plaintiffs' request to enjoin the meeting. Thereafter, plaintiffs amended the lawsuit and ultimately added new claims pertaining to the private placement and alleging securities law violations. The Company petitioned the Court to dismiss plaintiffs' new claims and, at a Court hearing held on October 16, 2000, the Court granted the Company's petition and dismissed plaintiffs' claims. Thereafter, on November 7, 2000, the plaintiffs and the Company reached an amicable settlement. NOTE 5--RECENT SALE OF EQUITY SECURITIES During the three months ended September 30, 2000, the Company granted options to purchase 2,000,000 shares of common stock to its new Chief Executive Officer. One million options vest over a period of two years, and the remaining 1,000,000 options vest when specific performance targets have been met. The exercise price was set at $0.69 per share, the fair value of the underlying shares. The options expire at the earlier of seven years from the date of grant or 90 days after termination of employment. During the three months ended September 30, 2000, the Company completed the following significant common stock transactions of previously unissued common shares: Issued 200,000 shares of common stock for services valued at $146,000, and $ 79,000 of prepayment for services to be rendered. Issued 295,858 shares of common stock to its Chief Financial Officer in connection with a cashless exercise of options that were processed by the Company. No expense was recorded in connection with the transaction because the Chief Financial Officer had owned the shares that were used to pay for the cashless exercise for more than six months prior to the transaction. Issued 2,500 shares of common stock in connection with the exercise of stock options for cash of $1,100. In connection with a private placement, the Company issued 4,144,600 shares for gross proceeds of $2,071,692, less $397,882 for the value of the 4,144,600 warrants issued as part of the private placement. The Company paid fees of $304 in connection with the private placement. For each share purchased, the investors received warrants to purchase one common share at an exercise price of $3.00. The warrants are immediately exercisable and expire on August 22, 2003. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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. Forward-looking statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, including statements regarding the Company's entrance into the Telephone and Internet business, newly introduced products, development of "VOIP" service capabilities over the Internet, net sales, gross profit, operating expenses, other income and expenses, liquidity and cash needs and the Company's plans and strategies are all based on current expectations, and the Company assumes no obligation to update this information. Numerous factors could cause actual results to differ from those described in the forward-looking statements. 10 As with any line of business, there can be no assurance that the DVG VOIP products will gain widespread market acceptance or be profitable. In addition, there can be no assurance that new hardware products and services developed by others will not render the Company's hardware products and services noncompetitive or obsolete. RESULTS OF OPERATIONS Three Months Ended September 30, 2000 Compared To Three Months Ended September 30, 1999 Net Sales. Net sales decreased by $344,000, or 44%, from $775,000 in the three months ended September 30, 1999 to $431,000 in the three months ended September 30, 2000. The decrease is due both to a reduction of DVG hardware systems sales and reduced service revenue, primarily from the Balkan operation. The revenue mix for the three months ended September 30, 2000 consisted of 72% Telephone and Internet services revenue and 28% hardware product sales. Gross Profit. Gross profit decreased as a percentage of net sales to a loss of 45% for the three months ended September 30, 2000, from a gross profit of 12% of net sales for the corresponding period of 1999. The gross profit percentage decrease can be attributed to fixed hardware and service overhead expenses spread over a smaller sales base. Operating Expenses. Operating expenses decreased by $1,402,000, or 45%, from $3,113,000 in the three months ended September 30, 1999 to $1,711,000 in the three months ended September 30, 2000. The decrease was primarily attributable to a one time bad debt expense of $1,284,000 occurring in the three month period ending September 30, 1999. Other Income (Expense). Interest income decreased by $1,000 , or 13%, from $8,000 in the three months ended September 30, 1999 to $7,000 in the three months ended September 30, 2000, due to reduced cash balances available to earn interest. Interest expense remained constant at $1,000 for both the three months ended September 30, 1999 and 2000. Other components of other income (expense) were immaterial and were due to various non operating items. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents and net working capital totaled $1,660,000 and $3,328,000, respectively, as of September 30, 2000. The primary source of cash has been net proceeds generated from equity and debt financings. The Company has relied on sales of new shares, loan proceeds and the exercise of warrants and options to fund operations for an extended period of time. The Company received $10,589,000 and $2,073,000 in equity financing for the year ended June 30, 2000, and the three months ended September 30, 2000, respectively. Its subsidiary, FNet, raised $53,000 for the year ended June 30, 2000 and $-0- for the three months ended September 30, 2000. The Company and its subsidiary FNet have continued to experience losses due to low sales results. The Company anticipates that its primary uses of working capital in future periods will be for increases in product development, expansion of its marketing plan, funding of FNet's operations and funding of increases in accounts receivable. The Company believes that existing cash and cash equivalents, cash flow from operations and cash raised through future anticipated private placements will be sufficient to meet the Company's presently anticipated working capital needs for at least the next twelve months and the foreseeable future. To the extent the Company uses its cash resources for acquisitions, the Company may be required to obtain additional funds, if available, through borrowings or equity financings. There can be no assurance that such capital will be available on acceptable terms. If the Company is unable to obtain sufficient financing, it may be unable to fully implement its growth strategy. 11 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS During June 2000, two shareholders who acquired their shares in a private placement in March 2000, filed a lawsuit against the Company 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 denied plaintiffs' request to enjoin the meeting. Thereafter, plaintiffs amended the lawsuit and ultimately added new claims pertaining to the private placement and alleging securities law violations. The Company petitioned the Court to dismiss plaintiffs' new claims and, at a Court hearing held on October 16, 2000, the Court granted the Company's petition and dismissed plaintiffs' claims. Thereafter, on November 7, 2000, the plaintiffs and the Company reached an amicable settlement. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable ITEM 5. OTHER INFORMATION Not applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27.1 Financial Data Schedule (b) Reports on Form 8-K None 12 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934. The 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 By /s/ THOMAS L. RUSSELL ----------------------------------- Thomas L. Russell Chief Financial Officer Dated: November 13, 2000 13 EXHIBIT INDEX