-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J80vM5hsXx226KAQZWTSkNpCW5GpBBgVWQk4BBmn1F5bulbk9P67cu2zq+27CrxZ QSCk6bBEMeQdo/8RfWKzeg== 0001017062-98-001002.txt : 19980506 0001017062-98-001002.hdr.sgml : 19980506 ACCESSION NUMBER: 0001017062-98-001002 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980505 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN TELECOMMUNICATIONS CORP CENTRAL INDEX KEY: 0000722572 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 953733534 STATE OF INCORPORATION: CA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-11616 FILM NUMBER: 98610350 BUSINESS ADDRESS: STREET 1: 733 LAKEFIELD RD CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 BUSINESS PHONE: 8053738688 MAIL ADDRESS: STREET 1: 733 LAKEFIELD ROAD CITY: WESTLAKE VILLAGE STATE: CA ZIP: 91361 FORMER COMPANY: FORMER CONFORMED NAME: ABM COMPUTER SYSTEMS DATE OF NAME CHANGE: 19870317 FORMER COMPANY: FORMER CONFORMED NAME: AUTOMATED BUSINESS MACHINES INC DATE OF NAME CHANGE: 19830802 10-Q 1 QUARTERLY REPORT FOR MARCH 31, 1998 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 QUARTER PERIOD ENDED MARCH 31, 1998 [_] 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 _______________ 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 MARCH 31, 1998 - ------------------------------------ ------------------------------ Common Stock, no par value 17,379,747 Index Franklin Telecommunications Corp. Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets March 31, 1998 (Unaudited) and June 30, 1997 Consolidated Statements of Operations (Unaudited) Three months and nine months ended March 31, 1998 and 1997 Consolidated Statements of Cash Flows (Unaudited) Nine months ended March 31, 1998 and 1997 Notes to Consolidated Financial Statements (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Part II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Item 1. Financial Statements FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of March 31, 1998 (unaudited) and June 30, 1997
March 31, June 30, ------------ ---------- 1998 1977 ------------ ---------- (unaudited) ASSETS ------ Current assets Cash and cash equivalents $ 7,869,000 $ 1,464,000 Accounts receivable, less allowance for doubtful accounts of $46,000 (unaudited) and $34,000, respectively....................................................................... 122,000 80,000 Other receivables............................................................................. 222,000 199,000 Inventories (Note 2).......................................................................... 648,000 394,000 Prepaid expenses.............................................................................. 65,000 68,000 ------------ ----------- Total current assets......................................................................... 8,926,000 2,205,000 ------------ ----------- Property and equipment Machinery and equipment....................................................................... 242,000 163,000 Furniture and fixtures........................................................................ 148,000 97,000 Computers and software........................................................................ 872,000 713,000 ------------ ----------- 1,262,000 973,000 Less accumulated depreciation................................................................. 531,000 406,000 ------------ ----------- Total property and equipment................................................................. 731,000 567,000 ------------ ----------- Excess of cost over fair value of net assets of companies acquired, net of accumulated amortization of $-0-(unaudited), and $40,000, respectively.................................... -- 591,000 Other assets................................................................................... 307,000 151,000 ------------ ----------- Total assets................................................................................. $ 9,964,000 $ 3,514,000 ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities Current portion of obligations under capital lease obligations................................ $ -- $ 361,000 Current portion of long-term debt (majority due to a related party)........................... 207,000 301,000 Accounts payable.............................................................................. 430,000 175,000 Accrued liabilities........................................................................... 790,000 559,000 ------------ ----------- Total current liabilities.................................................................... 1,427,000 1,396,000 Long-term debt, (majority due to a related party) less current portion......................... 320,000 360,000 Other liabilities.............................................................................. 182,000 183,000 ------------ ----------- Total liabilities............................................................................ 1,929,000 1,939,000 ------------ ----------- Minority Interest.............................................................................. -- -- Contingencies (Note 3) Shareholders' equity Preferred stock, no par value 10,000,000 shares authorized , Series C 740 shares (unaudited) issued and outstanding....................................................................... 6,558,000 -- Common stock, no par value 90,000,000 shares authorized 17,379,747 (unaudited) and 13,191,223 shares issued and outstanding............................................... 13,692,000 9,971,000 Common stock committed, no par value -0- (unaudited) and 296,066 shares committed but not yet issued................................................................. -- 579,000 Accumulated deficit........................................................................... (12,215,000) (8,975,000) ------------ ----------- Total shareholders' equity................................................................... 8,035,000 1,575,000 ------------ ----------- Total liabilities and shareholders' equity................................................... $ 9,964,000 $ 3,514,000 ============ ===========
The accompanying notes are an integral part of these financial statements. FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Three Months and Nine Months Ended March 31, 1998 and 1997 (unaudited)
Three Months Ended Nine Months Ended --------------------------- --------------------------- March 31, March 31, --------------------------- --------------------------- 1998 1997 1998 1997 ------------ ------------ ------------ ------------ (unaudited) (unaudited) (unaudited) (unaudited) Sales Product................................... $ 166,000 $ 317,000 $ 403,000 $ 1,086,000 Internet services......................... 159,000 161,000 450,000 273,000 ----------- ----------- ----------- ----------- Total sales............................ 325,000 478,000 853,000 1,359,000 ----------- ----------- ----------- ----------- Cost of sales Product................................... 113,000 223,000 254,000 607,000 Internet services......................... 65,000 141,000 321,000 198,000 ----------- ----------- ----------- ----------- Total cost of sales.................... 178,000 364,000 575,000 805,000 ----------- ----------- ----------- ----------- Gross profit................................ 147,000 114,000 278,000 554,000 ----------- ----------- ----------- ----------- Operating expenses Research and development expenses......... 511,000 124,000 1,017,000 339,000 Selling, general, and administrative Expenses................................ 1,210,000 587,000 2,698,000 1,246,000 ----------- ----------- ----------- ----------- Total operating expenses............... 1,721,000 711,000 3,715,000 1,585,000 ----------- ----------- ----------- ----------- Loss from operations........................ (1,574,000) (597,000) (3,437,000) (1,031,000) ----------- ----------- ----------- ----------- Other income (expense) Interest expense.......................... (10,000) (12,000) (41,000) (29,000) Other income.............................. 172,000 13,000 238,000 24,000 ----------- ----------- ----------- ----------- Total other income (expense)........... 162,000 1,000 197,000 (5,000) ----------- ----------- ----------- ----------- Loss before provision for income taxes...... (1,412,000) (596,000) (3,240,000) (1,036,000) Provision for income taxes.................. -- -- -- -- ----------- ----------- ----------- ----------- Net loss.................................... $(1,412,000) $ (596,000) $(3,240,000) $(1,036,000) =========== =========== =========== =========== Basic net loss per common share............. $ (.09) $ (.05) $ (.22) $ (.09) =========== =========== =========== =========== Diluted net loss per common share........... $ (.09) $ (.05) $ (.22) $ (.09) =========== =========== =========== =========== Weighted average common shares outstanding used to compute basic loss per common share..................... 16,334,147 12,496,783 15,097,788 12,046,337 =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements. FRANKLIN TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months Ended March 31, 1998 and 1997 (unaudited)
Nine Months Ended ------------------------------ March 31, ------------------------------ 1998 1997 -------------- ------------- (unaudited) (unaudited) Cash flows from operating activities Net loss........................................ $(3,240,000) $(1,036,000) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization................. 186,000 108,000 Provision for loss on doubtful accounts....... 12,000 5,000 Gain from retirement of capital lease liability.............................. (71,000) -- Stock issued for services rendered............ -- 48,000 (Increase) decrease in Accounts receivable........................... (54,000) (69,000) Inventories................................... (254,000) 15,000 Prepaid expenses.............................. 3,000 (11,000) Increase in Accounts payable.............................. 178,000 339,000 Accrued liabilities........................... 67,000 254,000 ----------- ----------- Net cash used in operating Activities..................................... (3,173,000) (347,000) ----------- ----------- Cash flows from investing activities Purchases of property and equipment............. (291,000) (281,000) Cash received in connection with business acquisitions................................... --- 9,000 Repayment (issuance) of notes receivable........ 5,000 (124,000) Other assets.................................... (273,000) (8,000) ----------- ----------- Net cash used in investing activities........... (559,000) (404,000) ----------- ----------- Cash flows from financing activities Payments on other liabilities................... (1,000) (47,000) Proceeds from sale of Company stock............. 10,055,000 1,041,000 Proceeds from sale of minority stock in consolidated subsidiary........................ 373,000 1,506,000 Payments on long term debt...................... -- (1,000) Payments on capital lease obligation............ (290,000) (2,000) ----------- ----------- Net cash provided by financing activities 10,137,000 2,497,000 ----------- ----------- Net increase (decrease) in cash................. 6,405,000 1,746,000 Cash and cash equivalents, beginning of the period..................................... 1,464,000 166,000 ----------- ----------- Cash and cash equivalents, end of the period..................................... $ 7,869,000 $ 1,912,000 =========== ===========
The accompanying notes are an integral part of these financial statements. 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 T-1 and X.25 wide-area networks and provide Internet services through its majority-owned subsidiary, FNet Corp. ("FNet"). FNet has had limited operations to date. The Company's customers are located predominantly in the United States, Canada, Australia, and parts of Europe in a wide range of industries including financial services, government, 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 Form S-1 Amendment 2 of Franklin Telecommunications Corp., filed with the Securities and Exchange Commission on January 27, 1998. The results of operations for the three months and nine months ended March 31, 1998 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 1998. 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. Minority Interest 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 and 372,500 shares of FNet common stock for the year ended June 30, 1997 and the nine months ended March 31, 1998, respectively, to outside investors and exercise of employee options 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 and exercise of employee options as an increase in shareholders' equity and a reduction in minority interest liability in the consolidated financial statements. The accompanying consolidated financial statements do not reflect a minority interest liability as of June 30, 1997 and March 31, 1998 as FNet, on a stand- alone basis, had a shareholders' deficit as of such dates. The accompanying consolidated statements of operations for the three months and nine months ended March 31, 1998 and 1997 do not reflect the minority interest's share of FNet's losses for said periods as the related accrual would result in the Company's recordation of a minority interest receivable. Loss Per Common Share For the three month and nine month periods ended March 31, 1998 and 1997, the Company adopted SFAS No. 128 "Earnings per Share." Basic losses per share is computed by dividing losses available to common shareholders by the weighted-average number of common shares outstanding. Diluted losses per share is computed similar to basic losses 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. Common stock equivalents have been excluded from the aforementioned computations as their effect would be anti-dilutive. Income Taxes The Company accounts for income taxes under the Financial Accounting Standards Board SFAS No. 109, "Accounting for Income Taxes," SFAS 109 requires the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS 109, 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. Under SFAS 109, 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. Recently Issued Accounting Pronouncements SFAS 130, "Reporting Comprehensive Income" issued by the Financial Accounting Standards Board is effective for financial statements with fiscal years beginning after December 15, 1997. Earlier application is permitted. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The Company does not expect adoption of SFAS 130 to have a material impact, if any, on its financial position or results of operations. The Financial Accounting Standards Board issued SFAS 131, "Disclosures about Segments of an Enterprise and Related Information," effective for fiscal years beginning after December 15, 1997. SFAS 131 requires a company to report certain information about its operating segments including factors used to identify the reportable segments and types of products and services from which each reportable segment derives its revenues. The Company does not anticipate any material change in the manner that it reports its segment information under this new pronouncement. NOTE 2--INVENTORIES Inventories consisted of the following:
March 31, June 30, --------- -------- 1998 1997 ---- ---- (unaudited) Raw materials.......... $198,000 $155,000 Work in process........ 223,000 152,000 Finished goods......... 227,000 87,000 -------- -------- Total............... $648,000 $394,000 ======== ========
NOTE 3--CONTINGENCIES Legal Proceedings On July 28, 1997 the Company was named as a defendant in an action brought by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number service, its officers and affiliates, and several Internet Service Providers, including the Company. The action was brought in the U.S. District Court for the Central District of California. In general, the complaint alleges that Connect America and its officers fraudulently acquired 800 numbers from AT&T, failed to pay for them, and resold them to the Company and the other Internet Service Providers on a "flat rate" basis, notwithstanding the fact that AT&T's charges for 800 service are typically based on time utilized. The claims against the Company and the other Internet Service Providers are based on unjust enrichment, on the theory that the Company and the other Internet Service Providers knew or should have known that flat rate 800 service was unavailable. In addition to injunctive relief against Connect America and its officers, the complaint seeks damages of $7.4 million, punitive damages and attorneys' fees. The Company has filed an answer to the complaint denying the material allegations thereof, and plans to vigorously contest the action. There can be no assurance that the Company will be successful in its defense of the action. Because of the large amount sought in the complaint, an adverse outcome would have a material adverse effect on the Company's financial condition. NOTE 4--RECENT SALE OF EQUITY SECURITIES During September and October 1997, the Company completed two Regulation D private placement offerings as follows: . An offering of 333,333 units for $1,000,000. Each unit consists of one share of the Company's common stock and one common stock warrant to purchase one share of the Company's common stock for $5.00 per share. The net proceeds to the Company were $1,000,000, and . An offering of 540 units for $5,400,000. Each unit in this offering consists of one share of the Company's Series C Convertible Preferred Stock and one warrant to purchase one share of FNet's common stock. The net proceeds to the Company were $4,957,500. In November 1997, the Company issued an additional 200 units for $2,000,000. Each unit in this offering consists of one share of the Company's Series C Convertible Preferred Stock and one Warrant to purchase one share of FNet's common stock. The net proceeds to the Company were $1,850,000. During the nine months ended March 31, 1998, FNet sold shares to outside investors and employees exercised options for a total of 372,500 shares of its stock at $1.00 per share. The shares sold to investors were issued under a private offering circular pursuant to the exemption from registration under the 1933 Act provided in Rule 505 of Regulation D. After the issuance of these shares, Franklin's ownership percentage decreased to 70% as of March 31, 1998. During the three months ended March 31, 1998, the Company raised $2,172,000 from the exercise of options and warrants for the Company's Common Stock. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Franklin Telecommunications Corp. (the "Company") designs, manufactures and markets high speed communications products and subsystems. The 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, the Company is a provider of Internet access and services, including Internet telephony, to businesses and individuals. The Company is a California corporation formed in 1981. 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 Internet business, newly introduced products, development of "telephone-to-telephone" service capabilities over the Internet, net sales, gross profit, operating expenses, other income and expenses, liquidity and cash needs and the Company's plans and strategies are all based on current expectations, and the Company assumes no obligation to update this information. Numerous factors could cause actual results to differ from those described in the forward-looking statements. The Company has recently re-focused its business from manufacturing primarily LAN and WAN products to providing telecommunications and Internet products and services. Beginning in the year ended June 30, 1997 and continuing in the three months and nine months ended March 31, 1998, the Company has begun to generate revenues from these new business lines. Sales had been declining for the Company's existing hardware products during the previous fiscal year, while the newly developed hardware products and Internet services were not yet ready for market. Initial demand for the Company's newly introduced D-Mark Channel Bank, Cyclone and Data Voice Gateway hardware product lines have yet to be established, since many potential customers are in the process of evaluating the products. FNet is in the nature of a new business venture; accordingly, it can be expected that its future operating results will be subject to many of the risks inherent in establishing a new business enterprise. There can be no assurance, therefore, that FNet will be able to achieve or sustain profitability in future periods or that the Company's investment of resources into it will be repaid. The Company's D-Mark Channel Bank terminates a digital T1 telephone line from the local telephone company and channelizes it into 24 analog data/voice lines for either modems, faxes, or telephones. With the declining cost of T1 digital lines, the Company believes that the D-Mark Channel Bank provides an effective, cost saving solution for companies using 10 or more phones or modems. The Cyclone is an evolution of the D-Mark and includes modems integrated into the PC cards, thus eliminating the need to add external modems for those applications requiring them. The Data Voice Gateway, or DVG, is a further evolution of the D-Mark, which adds the capability of transmitting voice traffic over the Internet and Frame relay circuits. Other products under development include the Tornado, which is a further evolution of the Cyclone by providing terminal server function. The Tornado is targeted to become the Company's point of presence "POP in a box" solution for ISPs or a corporation's data center. This would permit a new or existing Internet Service Provider or corporation to install all of the hardware required to provide an Internet service connection. Other features of the D-Mark series include FXO and, in the future, Ground Start capabilities for the voice card integrated in the D-Mark systems. FXO allows the D-Mark to extend the functions of a PBX telephone system. Ground Start will allow access to devices (PBX trunk lines, telephones, fax machines, etc.) that operate in this environment, thus expanding the types of devices that the D-Mark systems can utilize. The T-1 card in the D-Mark system is also being improved to add a MVIP interface. The MVIP interface is an open architecture standard interface, which would permit users to customize applications and directly connect third party hardware to the D-Mark systems. As with any new line of business, there can be no assurance that the D-Mark Channel Bank, The Cyclone, DVG and other newly developed communications 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 March 31, 1998 Compared To Three Months Ended March 31, 1997 Net Sales. Net sales decreased by $153,000, or 32%, from $478,000 in the three months ended March 31, 1997 to $325,000 in the three months ended March 31, 1998. The overall decrease is due to a reduced demand for wide area network products. Initial demand for newly introduced hardware products has yet to be established, in that most shipments to date have been to customers for testing and evaluation purposes. Revenue will be recorded when the customer completes testing and evaluating and agrees to purchase the product. The revenue mix for the three months ended March 31, 1998 consisted of 49% Internet services revenue and 51% hardware product sales. Gross Profit. Gross profit increased as a percentage of net sales to 45% for the three months ended March 31, 1998, from a gross profit of 24% of net sales for the corresponding period of 1997. The gross profit percentage increase can be attributed to web page design sales increases. Hardware margin percentages were comparable within both periods. Operating Expenses. Operating expenses increased by $1,010,000, or 142%, from $711,000 in the three months ended March 31, 1997 to $1,721,000 in the three months ended March 31, 1998. The increase is attributable to increased product development costs for the recently introduced hardware products, costs in developing the Internet and telephony services infrastructure, increased sales and marketing efforts, and costs in enhancing the general and administrative infrastructure. Other Income (Expense). Interest expense decreased by $2,000, or 17%, from $12,000 in the three months ended March 31, 1997 to $10,000 in the three months ended March 31, 1998, due primarily to a reduction in loans from an officer of the Company. Other income increased by $159,000, or 1,223%, from $13,000 in the three months ended March 31, 1997 to $172,000 in the three months ended March 31, 1998, due to interest earned on cash investments and a $70,000 gain resulting from retirement of a capital lease obligation. Nine Months Ended March 31, 1998 Compared To Nine Months Ended March 31, 1997 Net Sales. Net sales decreased by $506,000, or 37%, from $1,359,000 in the nine months ended March 31, 1997 to $853,000 in the nine months ended March 31, 1998. The overall decrease is due to a reduced demand for wide area network products. Initial demand for newly introduced hardware products has yet to be established, in that most sales to date have been to customers for testing and evaluation purposes. The revenue mix for the nine months ended March 31, 1998 consisted of 53% Internet services revenue and 47% hardware product sales. Gross Profit. Gross profit decreased as a percentage of net sales to 33% for the nine months ended March 31, 1998, from a gross profit of 41% of net sales for the corresponding period of 1997. The gross profit percentage decrease can be attributed to reduced sales of higher margin wide area network products. Operating Expenses. Operating expenses increased by $2,130,000, or 134%, from $1,585,000 in the nine months ended March 31, 1997 to $3,715,000 in the nine months ended March 31, 1998. The increase is attributable to increased product development costs for the recently introduced hardware products, costs in developing the Internet and telephony services infrastructure, increased sales and marketing efforts, and costs in enhancing the general and administrative infrastructure. Other Income (Expense). Interest expense increased by $12,000, or 41%, from $29,000 in the nine months ended March 31, 1997 to $41,000 in the nine months ended March 31, 1998, due primarily to assumed lease debt from Internet Passport. Other income increased by $214,000, or 892%, from $24,000 in the nine months ended March 31, 1997 to $238,000 in the nine months ended March 31, 1998, due primarily to interest earned on cash investments and a $70,000 gain resulting from retirement of a capital lease obligation. Liquidity and Capital Resources Cash and cash equivalents and net working capital totaled $7,869,000 and $7,499,000, respectively, as of March 31, 1998. The primary source of cash was net proceeds generated from equity financings. The Company has relied on sales of new shares and the exercise of warrants and options to fund operations for an extended period of time. The Company received $1,109,000 and $10,055,000 in equity financing, for the year ended June 30, 1997, and the nine months ended March 31, 1998, respectively. Its subsidiary, FNet, raised $1,950,000 for the year ended June 30, 1997 and $373,000 for the nine months ended March 31, 1998. FNet has continued to experience losses, due to the growth nature of the Internet services business and development of the Internet Telephony business. In addition to the equity financing described above, the Company's President has deferred portions of his compensation, and has on occasion, converted debt to equity, in order to preserve the Company's cash. The Company anticipates that its primary uses of working capital in future periods will be for acquisitions, increases in product development, expansion of its marketing plan, development of new branch offices and funding of increases in accounts receivable. Development of new branch offices may be achievable through 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 and cash flow from operations will be sufficient to meet the Company's presently anticipated working capital needs for at least the next 13 months. 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. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 28, 1997 the Company was named as a defendant in an action brought by AT&T Corp. ("AT&T") against Connect America, a reseller of "800" number service, its officers and affiliates, and several Internet Service Providers, including the Company. The action was brought in the U.S. District Court for the Central District of California. In general, the complaint alleges that Connect America and its officers fraudulently acquired 800 numbers from AT&T, failed to pay for them, and resold them to the Company and the other Internet Service Providers on a "flat rate" basis, notwithstanding the fact that AT&T's charges for 800 service are typically based on time utilized. The claims against the Company and the other Internet Service Providers are based on unjust enrichment, on the theory that the Company and the other Internet Service Providers knew or should have known that flat rate 800 service was unavailable. In addition to injunctive relief against Connect America and its officers, the complaint seeks damages of $7.4 million, punitive damages and attorneys' fees. The Company has filed an answer to the complaint denying the material allegations thereof, and plans to vigorously contest the action. There can be no assurance that the Company will be successful in its defense of the action. Because of the large amount sought in the complaint, an adverse outcome would have a material adverse effect on the Company's financial condition. 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 On February 27, 1998, the Company held an Annual Meeting of Shareholders. The meeting provided for an election of Directors and approval of the 1998 Incentive Stock Option Plan. The current Board of Directors were reelected for a term of one year as follows:
For Withhold Frank W. Peters 9,446,487 6,518 Peter S. Buswell 9,446,646 6,359 Robert S. Harp 9,446,447 6,558 Thomas L. Russell 9,446,687 6,318
The 1998 Incentive Stock Option Plan, which provides 2,000,000 common shares available for employees, was adopted as follows:
For Against Abstain Non-Vote 5,425,365 76,468 16,277 3,934,895
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 EX-27 2 FINANCIAL DATA SCHEDULE
5 3-MOS 9-MOS JUN-30-1997 JUN-30-1997 JAN-01-1998 JUL-01-1997 MAR-31-1998 MAR-31-1998 7,869,000 7,869,000 0 0 390,000 390,000 (46,000) (46,000) 648,000 648,000 8,926,000 8,926,000 1,262,000 1,262,000 531,000 531,000 9,964,000 9,964,000 1,427,000 1,427,000 0 0 0 0 6,558,000 6,558,000 13,692,000 13,692,000 0 0 9,964,000 9,964,000 325,000 853,000 325,000 853,000 178,000 575,000 178,000 575,000 1,549,000 3,477,000 0 0 10,000 41,000 (1,412,000) (3,240,000) 0 0 (1,412,000) (3,240,000) 0 0 0 0 0 0 (1,412,000) (3,240,000) (.09) (.22) (.09) (.22)
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