UNITED STATES 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 June 30, 1997
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______to______.
Commission file number 0-23862
fonix corporation
(Exact name of registrant as specified in its charter)
Delaware 22-2994719
(State of Incorporation) (I.R.S. Employer Identification No.)
60 East South Temple Street, Suite 1225
Salt Lake City, UT 84111
(Address of principal executive offices and zip code)
(801) 328-0161
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or Section 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] or
No [ ].
As of August 8, 1997, 42,219,061 shares of the issuer's Common Stock, par
value $.0001 per share, were issued and outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
The interim financial statements required by Rule 10-01 of Regulation
S-X follow immediately.
2
<PAGE>
fonix corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
ASSETS
(Unaudited) (Audited)
June 30, December 31,
1997 1996
-------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 19,693,742 $ 22,805,786
Notes Receivable 950,000 1,000,000
Interest receivable 85,780 157,643
Prepaid Assets 291,314 4,172
-------------- --------------
Total Current Assets 21,020,836 23,967,601
Equipment, net of accumulated depreciation
of $225,652 and $80,232 1,671,304 1,279,746
Intangible assets, net of accumulated amortization
of $4,993 and $3,107 67,450 53,011
Financing costs 315,000 -
Other assets 44,647 30,912
-------------- --------------
$ 23,119,237 $ 25,331,270
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 347,409 $ 307,931
Accounts payable - related party 8,309 411,743
Accrued expenses 461,509 1,464,049
Convertible debenture 3,500,000 500,000
Notes payable 17,969,988 16,377,358
-------------- --------------
Total Current Liabilities 22,287,215 19,061,081
-------------- --------------
Stockholders' equity:
Preferred stock - -
Common stock 4,213 4,163
Additional paid-in capital 27,447,781 26,107,833
Accumulated deficit (26,619,972) (19,841,807)
-------------- --------------
Total stockholders' equity 832,022 6,270,189
-------------- --------------
$ 23,119,237 $ 25,331,270
============== ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
fonix corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
[Unaudited]
<TABLE>
<CAPTION>
October 1,
Three months ended Six months ended 1993
June 30, June 30, (inception) to
------------------------------- ------------------------------- June 30,
1997 1996 1997 1996 1997
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Revenues $ - $ - $ - $ - $ -
-------------- -------------- -------------- -------------- --------------
Expenses:
General and administrative 2,457,278 487,451 3,750,669 850,653 13,050,227
Research and development 1,455,221 1,090,877 3,065,279 1,907,538 13,936,278
-------------- -------------- -------------- -------------- --------------
Total expenses 3,912,499 1,578,328 6,815,948 2,758,191 26,986,505
-------------- -------------- -------------- -------------- --------------
Loss from operations (3,912,499) (1,578,328) (6,815,948) (2,758,191) (26,986,505)
-------------- -------------- -------------- -------------- --------------
Other income (Expenses):
Interest income 296,876 361,695 602,425 488,309 1,994,882
Interest (expense) (299,079) (140,552) (564,642) (244,490) (1,658,897)
-------------- -------------- -------------- -------------- --------------
Total Other Income (Expenses) (2,203) 221,143 37,783 243,819 335,985
-------------- -------------- -------------- -------------- --------------
Loss before extraordinary item (3,914,702) (1,357,185) (6,778,165) (2,514,372) (26,650,520)
Extraordinary item-
Forgiveness of debt - - - - 30,548
-------------- -------------- -------------- -------------- --------------
Net Loss $ (3,914,702) $ (1,357,185) $ (6,778,165) $ (2,514,372) $ (26,619,972)
============== ============== ============== ============== ==============
Loss per common share:
Loss before extraordinary items $ (0.09) $ (0.04) $ (0.16) $ (0.07) $ (1.04)
Extraordinary item Nil Nil Nil Nil Nil
-------------- -------------- -------------- -------------- --------------
Loss per common share $ (0.09) $ (0.04) $ (0.16) $ (0.07) $ (1.04)
============== ============== ============== ============== ==============
Weighted average shares 42,105,189 36,311,941 41,982,952 33,710,102 25,582,531
============== ============== ============== ============== ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE>
fonix corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
[Unaudited]
<TABLE>
<CAPTION>
October 1,
Six months ended 1993
June 30, (inception) to
------------------------------- June 30,
1997 1996 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from development activities:
Net loss $ (6,778,165) $ (2,514,372) $ (26,619,972)
Adjustments to reconcile net loss to net cash
used in development activities:
Common stock issued for services 915,000 - 2,239,270
Additional compensation expense recorded in
accordance with APB Opinion No. 25 - - 2,282,900
Write-off of assets received in acquisition - - 1,281
Depreciation and amortization 146,243 14,656 230,643
Non cash gain on forgiveness of debt - - (30,548)
Changes in assets and liabilities:
(Increase) decrease in interest receivable 71,863 (107,758) (85,780)
(Increase) in financing costs (315,000) - (315,000)
(Increase) in prepaid assets (287,142) - (291,314)
(Increase) in other assets (8,735) - (39,647)
Increase (decrease) in accounts payable 39,478 (51,819) 1,982,678
Increase (decrease) in accounts payable - related party (403,434) - 8,309
Increase in unearned interest revenue 9,000
Increase (decrease) in accrued expenses (1,002,540) 43,770 553,427
-------------- -------------- --------------
Net cash used in operating activities (7,622,432) (2,606,523) (20,083,753)
-------------- -------------- --------------
Cash flows from investing activities:
Purchase of equipment (536,978) (185,932) (1,896,956)
Investment in intangible assets (15,264) (9,598) (72,443)
Investment in notes receivable (888,600) (3,160,000) (1,888,600)
Payment of notes receivable 933,600 800,000 933,600
-------------- -------------- --------------
Net cash used in investing activities (507,242) (2,555,530) (2,924,399)
-------------- -------------- --------------
Cash flows from financing activities:
Net increase in revolving note payable 1,592,630 9,057,936 17,969,988
Proceeds from notes payable - - 2,351,667
Payment of notes payable - - (1,779,806)
Proceeds from issuance of convertible debenture 3,000,000 - 3,500,000
Proceeds from issuance of common stock 425,000 10,759,962 20,660,045
-------------- -------------- --------------
Net cash provided by financing activities 5,017,630 19,817,898 42,701,894
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents (3,112,044) 14,655,845 19,693,742
Cash and cash equivalents at beginning of period 22,805,786 7,849,610 -
-------------- -------------- --------------
Cash and cash equivalents at end of period $ 19,693,742 $ 22,505,455 $ 19,693,742
============== ============== ==============
</TABLE>
[Continued]
5
<PAGE>
fonix corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
[Unaudited]
<TABLE>
<CAPTION>
October 1,
Six months ended 1993
June 30, (inception) to
------------------------------- June 30,
1997 1996 1997
-------------- -------------- --------------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest paid $ 534,248 $ 200,720 $ 1,422,714
Income taxes paid $ - $ - $ -
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the six months ended June 30, 1997:
The Company issued 100,000 shares of common stock to an unrelated party
for consulting fees valued at $583,594.
The Company issued 155,000 shares of common stock to unrelated parties for
consulting fees valued at $331,406.
For the six months ended June 30, 1996:
The Company issued 220,000 shares of common stock to unrelated parties for
finders fees valued at $597,520.
The Company issued 200,000 shares of common stock to unrelated parties for
finders fees valued at $304,000.
See accompanying notes to consolidated financial statements.
6
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying financial statements have been
prepared by the Company without audit in accordance with generally accepted
accounting principles for interim information and pursuant to Rule 10-01 of
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
adjustments (which included only normal recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows
for all periods presented, have been made.
These condensed consolidated financial statements should be read in
conjunction with the audited financial statements and notes thereto
included in the Company's Form 10-KSB for the year ended December 31, 1996.
The results of operations for the six months ended June 30, 1997 and 1996
are not necessarily indicative of the operating results for the full year.
Research and Development - All payments for research and development are
charged to research and development expense as incurred. None of these
costs are capitalized because the Company does not have a product that
meets applicable capitalization requirements.
Recently Enacted Accounting Standards - In February 1997, SFAS Nos. 128,
"Earnings Per Share" and 129, "Disclosures of Information about Capital
Structure," were issued. SFAS No. 128 changes the computation,
presentation, and disclosure requirements of earnings per share (EPS) for
entities with publicly held common stock. SFAS No. 129 addresses standards
for disclosing information about an entity's capital structure. Although
such statements are not effective until December 31, 1997, the effect of
the adoption of the above statements is not significant.
2. NOTES RECEIVABLE
At June 30, 1997 the Company had an unsecured note receivable from an
unrelated third party in the amount of $250,000 which bears interest at 12%
per annum and is due and payable thirty days after written notice from the
Company.
At June 30, 1997 the Company had a secured note receivable from an
unrelated third party in the amount of $700,000 which bears interest at 12%
per annum and is due and payable on July 31, 1997.
7
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. EQUIPMENT
Equipment consists of the following at June 30, 1997:
Furniture and fixtures $ 630,931
Computer equipment 1,196,655
Leasehold improvements 69,371
-------------
Total 1,896,957
Less accumulated depreciation and amortization (225,653)
-------------
Net equipment $ 1,671,304
=============
4. CONVERTIBLE DEBENTURES
In June 1997, the Company entered into a Convertible Debenture Purchase
Agreement (the "Agreement") whereby an unrelated investment entity agreed
to purchase up to an aggregate principal amount of $10,000,000 of the
Company's Series B 5% Convertible Debentures. The debentures are due June
18, 2007, bear interest at 5% and are convertible into shares of the
Company's common stock at anytime after issuance at the holder's option.
Under terms of the Agreement, the debentures are to be purchased in three
payments. The first payment of $3,000,000 was made to the Company on June
18, 1997. The second and third payments of $3,000,000 and $4,000,000,
respectively, are to be paid to the Company upon written notice, provided
that the Company's market capitalization is in excess of $200,000,000 and
other conditions are meet. The debentures may be converted into shares of
the Company's common stock at the lesser of $6.81 or the average of the per
share market value for the five trading days immediately preceding the
conversion date multiplied by 90% for any conversion on or prior to the
120th day after the original issue date and 87.5% for any conversion
thereafter. As part of the same transaction, the Company also issued to
the investor a warrant to purchase up to 250,000 shares of common stock at
any time prior to June 18, 2002 at the exercise price of $8.28 per share.
Additionally, the Company entered into a registration rights agreement with
the investor under which the Company is contractually obligated to take
steps to register the common stock issuable upon conversion of the
debentures and exercise of the warrant. The registration statement was
filed with the Securities and Exchange Commission on July 16, 1997. The
Company covenanted in the debentures and the warrant to reserve out of its
authorized and unissued shares of common stock no less than that number of
shares that would be issuable upon the conversion of the debentures and any
interest then payable on the debentures and the exercise of the warrant.
As of June 30, 1997 none of the debentures had been converted.
Subsequently, $500,000 face value of the Series B 5% Convertible Debentures
were converted into 87,498 shares of the Company's common stock.
In October 1995, the Company issued a Series A Subordinated Convertible
Debenture in the amount of $500,000 to a private investment entity. That
debenture is due October 23, 1997 and has an annual interest rate of 5%.
The holder of that debenture has given notice of conversion and has
requested that the Company issue 166,667 shares of Series A Preferred
Stock. The Company is in the process of taking
8
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the necessary action to authorize the issuance of the Series A Preferred
Stock, into which that debenture is convertible.
5. NOTE PAYABLE
At June 30, 1997, the Company has a revolving note payable to a bank in the
amount of $17,969,988 which bears interest at the rate of 5.8%. This note
was due July 31, 1997, and is secured by a certificate of deposit in the
amount of $20,000,000. Subsequently, similar terms were negotiated to
extend the maturity date of the note for three months.
6. STOCKHOLDERS' EQUITY
Issuance of Stock - During the six months ended June 30, 1997, the Company
issued 505,000 shares of common stock. 150,000 of such shares were issued
to an unrelated private investor, 250,000 of such shares were issued upon
the exercise of previously granted warrants, and 105,000 of such shares
were issued to unaffiliated individuals for services rendered.
Preferred Stock - In 1995, the Company's board of directors adopted a
resolution to amend the articles of incorporation to provide for the
issuance of a class of preferred stock and give the board of directors
authority to fix the rights, preferences, privileges and restrictions of
any series of preferred stock. At the same time the board of directors
adopted a resolution establishing a class of Series A Preferred Stock. The
amendment has not yet been presented to the Company's shareholders nor were
any shares of Series A Preferred Stock issued. In June of 1997, the same
resolution was re-adopted by the board of directors to be presented for
approval by the shareholders.
Funding Agreement - In October 1995, the Company entered into a funding
arrangement with a private investment entity. Under the terms of the
agreement, the investor agreed to invest $6,050,000 ("Funding Commitment")
in exchange for 11,562,500 shares of the Company's common stock, and a
$500,000 debenture convertible into 166,667 Series A Preferred Stock or
166,667 shares of common stock. The Company received $3,945,000 (which
included the $500,000 convertible debenture) and $2,105,000 of the Funding
Commitment in 1996 and 1995, respectively. All of the common stock and the
debentures have been issued.
Stock Options and Warrants - On March 10, 1997, the Company's board of
directors approved a stock option plan for directors, employees and other
persons acting on behalf of the Company, under which the aggregate number
of shares available for issuance is 7,500,000. The term of options granted
under the plan is ten years from the date of grant.
In April 1996, the directors approved a directors' stock option plan, under
which the aggregate number of shares available for issuance is 5,400,000.
The shareholders of the Company approved the plan at their annual meeting
in July 1996. The plan is administered by a committee consisting of two or
more
9
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
directors of the Company. The plan provides that each director shall
receive options to purchase 200,000 shares of common stock for services
rendered as a director during each entire calendar year or portion of a
calendar year in excess of six months. The exercise price of such options
is the closing market price of the stock on the date the options are
granted. The option term is ten years from the date of grant.
In April 1996, the directors approved an employee stock option plan under
which the aggregate number of shares available for issuance is 900,000
shares. The exercise price of such options is the closing market price of
the stock on the date the options are granted. The term of the plan is 10
years and options are subject to a three year vesting schedule, pursuant to
which one-third of the total number of options granted may be exercised
each year.
A summary of options granted under the Company's various stock option plans
for the six months ended June 30, 1997 is presented below:
<TABLE>
<CAPTION>
Wt. Ave.
Stock Exercise
Options Price
-------------- --------------
<S> <C> <C>
Total options outstanding at beginning of period 4,626,000 $ 4.06
Granted 3,310,000 6.56
Exercised - -
Forfeited - -
Canceled ( 35,000) 6.23
-------------- --------------
Total options outstanding at end of period 7,901,000 $ 5.11
============== ==============
Total options exercisable at end of period 3,301,003 $ 4.06
============== ==============
</TABLE>
A summary of options outstanding under the Company's various stock option
plans at June 30, 1997 is presented below:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
-------------- ------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
$2.97 - 3.66 155,000 8.8 years $ 3.55 75,669 $ 3.43
4.06 4,400,000 8.8 years 4.06 3,200,000 4.06
5.00 - 6.50 3,026,000 9.9 years 6.49 25,334 5.00
7.13 - 9.31 320,000 9.7 years 7.17
- -------------- ------------- ------------ ------------ ------------ ------------
$2.97 - 9.31 7,901,000 9.3 years $ 5.11 3,301,003 $ 4.06
============== ============= ============ ============ ============ ============
</TABLE>
10
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A summary of warrants granted by the Company during the six months ended
June 30, 1997 is presented below:
<TABLE>
<CAPTION>
June 30, 1997
-----------------------------------
Weighted
Average
Exercise
Shares Price
--------------- ---------------
<S> <C> <C>
Total outstanding at beginning of period 600,000 $ 1.63
Granted - -
Exercised (250,000) 1.40
Forfeited - -
Canceled - -
--------------- ---------------
Total outstanding at end of period 350,000 $ 1.80
=============== ===============
</TABLE>
A summary of warrants outstanding at June 30, 1997 is presented below:
<TABLE>
<CAPTION>
Warrants Outstanding Exercisable
-------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -------------- ------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
$ .50 130,000 1.1 years $ 0.50 130,000 $ 0.50
2.00 120,000 0.8 years 2.00 120,000 2.00
3.24 100,000 0.8 years 3.24 100,000 3.24
- -------------- ------------- ------------ ------------ ------------ ------------
$.50 - 3.24 350,000 0.9 years $ 1.80 350,000 $ 1.80
============== ============= ============ ============ ============ ============
</TABLE>
7. RELATED PARTY TRANSACTIONS
Related party transactions with a company owned by the majority
shareholders not otherwise disclosed for the six months ended June 30, 1997
were as follows:
1997
--------------
Expenses:
Base rent expense $38,600
Payables:
Accounts payable $ 8,309
The Company rents office space under a month-to-month lease from a company
owned by three individuals who are each executive officers, directors and
10% beneficial owners of the Company. The lease to the company owned by
these individuals is guaranteed by them.
11
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
During 1996, the disinterested members of the Company's Board of Directors
authorized the Company to reimburse certain officers for all taxes payable
by the officers in conjunction with the exercise of 3,700,000 warrants by a
company owned by the officers. The warrants were exercised in 1995. The
total amount to be reimbursed to these officers is approximately
$2,500,000. As of June 30, 1997, the officers had drawn $1,913,536 of the
authorized reimbursements.
8. RESEARCH AND DEVELOPMENT
In October 1993, the Company entered into an agreement with Synergetics,
Inc., a research and development entity, whereby Synergetics was to develop
certain technologies related to the Company's automated speech recognition
technology ("ASRT"). The president of the Company is one of seven members
of the board of directors of Synergetics, and three executive officers,
directors and 10% beneficial owners of the Company own less than five
percent of the common stock of Synergetics. Under the terms of the
Synergetics Agreement, as subsequently modified, the Company acquired
intellectual property rights, technologies and technology rights that were
developed by Synergetics. The Company agreed to provide all funding
necessary for Synergetics to develop commercially viable technologies.
There is no minimum requirement or maximum limit with respect to the amount
of the funding to be provided by the Company. However, under the terms of
the Synergetics Agreement the Company is obligated to use its best efforts
in raising the necessary funding for the engineering, development and
marketing of the ASRT. As part of the Synergetics Agreement, the Company
agreed to pay Synergetics a royalty of 10% of gross revenues from sales of
its ASRT. The Company has not yet licensed or sold its technologies, and
consequently, has not made any royalty payments. Under the terms of the
Synergetics Agreement, the Company paid to Synergetics $312,000 and
$1,673,884 for the three and six months ended June 30, 1997, for research
and development efforts.
Until March 1997, Synergetics had compensated its engineers, employees,
members of its development team, and other financial backers, in part, with
the issuance of "Project Shares" granting the holders of such shares the
right, within limits, to share pro rata in future royalty payments. In
addition to issuance of Project Shares, Synergetics had made loans and
advances to some members of its project team on a non-recourse basis.
Repayment of the Advances was secured by future disbursements under the
Project Shares.
On March 13, 1997, the Company and Synergetics reached an agreement in
principle to modify the Synergetics Agreement with regard to the
development and assignment of the Company's ASRT.
The Synergetics Agreement is to be modified as follows:
* The rights and obligations of Synergetics under the Agreement,
including the royalty, will be assigned to a newly created wholly-
owned subsidiary of the Company, fonix Acquisition ("Acquisition");
12
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
* Acquisition will also assume the obligations of Synergetics to all
holders of Project Shares;
* The Company and Acquisition will release Synergetics from any further
obligation or duty under the Synergetics Agreements;
* In consideration for the assignment of the rights to the royalty by
Synergetics to Acquisition, the Company will issue warrants to
Synergetics and the holders of Project Shares to acquire, in the
aggregate, up to 4,800,000 shares of the Company's common stock at an
exercise price of $10.00 per share (the Warrants). A holder of
Project Shares will be entitled to receive Warrants to purchase 800
shares of the Company's common stock for each Project Share held;
provided, however, that the number of Warrants to be issued will be
reduced by the amount of one Warrant for each $37.50 in Advances;
* The Warrants will become exercisable subject to progress made in
further development of the ASRT Technology and the first to occur of
(i) a minimum daily closing bid price for shares of the Company's
common stock of $37.50 for a period of at least 15 consecutive
trading days, or (ii) thirty months from the date the Warrants are
issued. The exercise date shall be accelerated upon certain business
combinations or reorganizations, such as a merger, involving the
Company. The terms relating to development of the ASRT Technology
will be subject to a confidentiality and non-disclosure agreement and
covenants;
* In consideration of the assumption by Acquisition of the obligations
of Synergetics, the release of Synergetics from its further duties
under the Synergetics Agreements, and the issuance of the Warrants to
Synergetics and holders of Project Shares, the royalty and Project
Shares tendered in exchange for Warrants will be canceled;
* Effective March 1997, the Company employed certain former members of
the Synergetics project team as employees of the Company on terms and
conditions approximately equivalent to the terms and conditions of
their prior employment with Synergetics, and including the right to
participate in the Company's employee stock option plans; and
* The Company engaged the founder and principal stockholder of
Synergetics as a full-time consultant to assist with the further
development of the ASRT.
The Company and Synergetics have acknowledged the consummation of the
transactions described above will require, among other things, execution of
definitive agreements and compliance with applicable federal and state
laws, including securities laws. Those agreements will include standard
terms and provisions that are typical of such transactions, including
mutual releases and indemnification covenants. Synergetics has other
business interests and activities and will continue to conduct its business
in the usual course following the closing.
13
<PAGE>
fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The U.S. Patent and Trademark Office issued the initial patent to the
Company describing 36 claims on June 17, 1997.
The Company has incurred total research and development costs of $1,455,221
and $3,065,279 for the three and six months ended June 30, 1997.
9. INCOME TAXES
At June 30, 1997, net deferred tax assets, before considering the valuation
allowance, totaled approximately $10,300,000. The amount of and ultimate
realization of the benefits from the deferred tax assets for income tax
purposes is dependent, in part, upon the tax laws then in effect, the
Company's future earnings, and other future events, the effects of which
cannot presently be determined. Because of the uncertainty surrounding the
realization of the loss carryforwards the Company has established a
valuation allowance for all net deferred tax assets. Accordingly, because
of recurring losses and the valuation allowance, there is no provision for
income taxes in the accompanying statements of operations. The net change
in the valuation allowance was approximately $1,530,000 and $2,500,000 for
the three and six months ended June 30, 1997.
The Company has available at June 30, 1997, unused federal operating loss
carryforwards of approximately $23,600,000 and unused state operating loss
carryforwards of approximately $24,500,000, which may be applied against
future taxable income and which expire in various years beginning in 2008
through 2011.
10. COMMITMENTS AND CONTINGENCIES
Employment Agreements - On November 1, 1996, the Company entered into three
employment contracts with three executive officers which expire on December
31, 2001. The minimum salary payments required on these contracts are as
follows:
Year ending December 31:
1997 $ 787,500
1998 1,025,000
1999 1,337,500
2000 1,750,000
2001 1,875,000
----------------
Total $ 6,775,000
================
Litigation - On February 10, 1997 an action (the "Palomba Action") was
filed against the Company and six of its directors. The Palomba Action is
a derivative action seeking relief on behalf of all shareholders for the
benefit of the Company. The Palomba Action alleges that certain employee
directors caused the Company to engage in a series of loan transactions
with K.L.S. Enviro Resources, Inc. and thereafter appropriated for
themselves certain corporate opportunities resulting from such loan
transactions. A
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fonix(TM) corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
settlement agreement in principle was reached prior to service of the
complaint and is currently being documented. The settlement agreement will
be subject to the approval of the court and will not result in any expense
to the Company except incidental attorneys fees. The terms of the
settlement are confidential until approved by the court. Because of
certain contingencies, it is not presently possible to predict the amount
of benefit, if any, the Company may realize under the settlement.
Lease Agreement - The Company has a long-term operating lease agreement for
its Draper, Utah research and office facility with an unrelated party.
Future aggregate minimum obligations under this operating lease are as
follows:
Years ending December 31:
1997 $ 340,672
1998 340,672
1999 340,672
2000 340,672
2001 340,672
Thereafter 958,549
--------------
Total $ 2,661,909
==============
11. SUBSEQUENT EVENTS
On July 31, 1997 the holder of certain of the Company's Series B 5%
Convertible Debentures exercised its right to convert $500,000 of such
debentures into 87,498 shares of the Company's common stock.
15
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS, IN ADDITION TO HISTORICAL
INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THE RESULTS ANTICIPATED BY THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE
DISCUSSED BELOW IN THE SECTION ENTITLED "FACTORS AFFECTING FUTURE OPERATING
RESULTS."
Overview
fonix is a development-stage company engaged in scientific research
and development of proprietary automatic speech recognition and related
technologies ("ASRT") comprised of components which may be licensed in
whole or in part to third parties. The Company has completed the core
technologies related to the ASRT such that they are available for
third-party licensing and co-development. The Company is presently engaged
in discussions with potential licensees and co-developers. However, the
Company has to date received no revenues from operations, including
licenses, and there can be no assurance that revenues from operations will
be received in the future.
The Company's primary development objective is to further develop,
refine and enhance the main components of its ASRT and certain supplemental
technologies. The Company's initial marketing direction is to focus on
licensing its ASRT to third parties and co-developers. These licenses will
be made broadly available to many segments of the computer industry,
including application software, operating systems, computers and
microprocessor chips, and research and development entities worldwide,
including academia, government, industry and commercial speech product
developers who may want to take advantage of the Company's ASRT or related
technologies in their existing products. The Company anticipates that it
will sell or license its ASRT or related technologies on terms advantageous
to the Company, and that run-time product license royalty rates will vary
according to applications, sales volumes, and end-user pricing of products
using the ASRT. The Company may reserve exclusive rights in some fields of
use for the internal development of high value end-user products and
applications.
Results of Operations
Research and Development
The Company's scientific research and development activities
historically have been conducted by an unaffiliated third party,
Synergetics, Inc. pursuant to product development and assignment contracts
between the Company and Synergetics. Under that arrangement, Synergetics
provided personnel and facilities, and the Company financed such scientific
research and development activities on an as-required basis. There was no
minimum requirement or maximum limit with respect to the amount of funding
the Company was obligated to provide to Synergetics under the Agreement,
and the Company was obligated to use its best efforts in raising all of the
necessary funding for the development of the ASRT. The amounts of payments
to Synergetics pursuant to the Agreement were determined as Synergetics
submitted weekly pre-authorized work orders and budgets, which were then
reviewed and approved by the Company. All funds paid to Synergetics have
been accounted for by the Company as research and development expense.
Moreover, under the Agreement, the Company, if and when the Company began
receiving revenue from sales of the ASRT or products
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incorporating the ASRT, was obligated to pay a royalty of 10% of such
revenues to Synergetics. On March 13, 1997, the Company and Synergetics
reached an agreement in principle to modify the Synergetics Agreement with
regard to the development and assignment of the Company's ASRT. Under the
Memorandum, and further assuming that the definitive agreements relating
thereto are executed and the other preconditions to the effectiveness of
the modification understanding are satisfied, of which there can be no
assurance, the Company will no longer have any obligation to pay to
Synergetics the Royalty or any percentage of the revenues received from
entering into licensing and/or co-development agreements or otherwise from
the manufacture of products incorporating the ASRT. The Company does not
expect there to be a material change to the overall amount of research and
development spending as a result of the modification.
As a development stage company which has not yet licensed its ASRT,
the Company has not received any revenues from operations. During the
three months ended June 30, 1997 the Company incurred research and
development expenses of $1,455,221, an increase of $364,344 or
approximately 33 percent over the three months ended June 30, 1996. This
increase is due in part to increases in research and development personnel.
The Company anticipates similar or increased research and development costs
as it expands and continues to develop and market its technologies.
Operating Losses
General and administrative expenses were $2,457,278 and $487,451,
respectively, for the three months ended June 30, 1997 and June 30, 1996.
This increase over the comparable period was due primarily to increases in
salaries, rents, legal and accounting fees, outside services and a fee of
$1,913,536 paid to certain officers for taxes payable by the officers in
conjunction with the exercise of 3,700,000 warrants in 1995 by a company
owned by the officers (see note 7). Due to the lack of revenues and these
general and administrative and research and development expenses, the
Company has incurred losses from operations of $3,912,499 and $1,578,328
for the three months ended June 30, 1997 and 1996, respectively. Net
expense from other income and expenses was $2,203 for the three months
ended June 30, 1997, an increase in net expense of $223,346 over the three
months ended June 30, 1996. This increase was due primarily to the Company
drawing on its line of credit for internal operations, investing smaller
amounts of cash reserves, decreasing interest income and increasing
interest expense. At June 30, 1997, the Company had an accumulated deficit
of $26,619,972 and stockholders' equity of $832,022. The Company
anticipates that its investment in ongoing scientific research and
development of the ASRT and related artificial intelligence and
compression/decompression technologies will continue at present or
increased levels for at least the remainder of fiscal 1997.
Liquidity and Capital Resources
The Company's current liabilities exceeded its current assets by
$1,266,379 at June 30, 1997 and current assets exceeded current liabilities
by $4,906,520 at December 31, 1996. The current ratio of assets to
liabilities was .94 at June 30, 1997 as compared with 1.26 at December 31,
1996. Current assets decreased by $2,946,765 to $21,020,836 from December
31, 1996 to June 30, 1997. Current liabilities increased by $3,226,134 to
$22,287,215 during the same period. The decrease in working capital over
this period is primarily attributable to the Company's use of its cash
reserves to support increased operational expenses during the six months
ended June 30, 1997. Total assets were $23,119,237 at June 30, 1997 as
compared to $25,331,270 at December 31, 1996.
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<PAGE>
From its inception, the Company's principal source of operating
capital has been private and other exempt sales of the Company's equity
securities. Private and other exempt sales of the Company's equity
securities resulted in net cash proceeds of $425,000 for the six months
ended June 30, 1997. There were no private or other exempt sales of the
Company's equity securities for the three months ended June 30, 1997.
In June 1997, the Company entered into a Convertible Debenture
Purchase Agreement (the "Agreement") whereby an unrelated investment entity
agreed to purchase up to an aggregate principal amount of $10,000,000 of
the Company's Series B 5% Convertible Debentures. The debentures are due
June 18, 2007, bear interest at 5% and are convertible into shares of the
Company's common stock at anytime after issuance at the holder's option.
Under terms of the Agreement, the debentures are to be purchased in three
payments. The first payment of $3,000,000 was made to the Company on June
18, 1997. The second and third payments of $3,000,000 and $4,000,000,
respectively, are to be paid to the Company upon written notice, provided
that the Company's market capitalization is in excess of $200,000,000 and
other conditions are meet. The debentures may be converted into shares of
the Company's common stock at the lesser of $6.81 or the average of the per
share market value for the five trading days immediately preceding the
conversion date multiplied by 90% for any conversion on or prior to the
120th day after the original issue date and 87.5% for any conversion
thereafter. As part of the same transaction, the Company also issued to
the investor a warrant to purchase up to 250,000 shares of common stock at
any time prior to June 18, 2002 at the exercise price of $8.28 per share.
Additionally, the Company entered into a registration rights agreement with
the investor under which the Company is contractually obligated to take
steps to register the common stock issuable upon conversion of the
debentures and exercise of the warrant. The registration statement was
filed with the Securities and Exchange Commission on July 16, 1997. The
Company covenanted in the debentures and the warrant to reserve out of its
authorized and unissued shares of common stock no less than that number of
shares that would be issuable upon the conversion of the debentures and any
interest then payable on the debentures and the exercise of the warrant.
Although the Company presently anticipates that it will enter into
third party license or co-development agreements for its ASRT by the end of
fiscal 1997, there can be no assurance that the Company will be able to
license the ASRT within that time frame. Even assuming that the Company is
able to begin licensing the ASRT during 1997, the Company may not receive
revenues from operations until 1998. Accordingly, the Company expects to
incur significant losses at least through the end of fiscal 1997 and until
such time as it is able to enter into substantial licensing and co-
development agreements and actually receive substantial revenues from such
arrangements.
The Company has an established relationship with a major regional
federally insured financial institution pursuant to which the Company has
entered into an agreement allowing it to borrow against its own funds on
deposit with the institution. As of December 31, 1996, the Company had
funds on deposit of $20,000,000, and the Company owed $16,377,358 to the
institution. As of June 30, 1997, the Company had funds on deposit of
$20,000,000, and the Company owed the institution $17,969,988, which
obligation matured on July 31, 1997. The relationship with the institution
is re-negotiated quarterly to enhance the earning potential to the Company
of that deposit. Subsequently, the Company and the institution agreed to
extend the term of the borrowing relationship for an additional three-month
term on comparable competitive terms. The rate of interest paid by the
institution for the Company's funds on deposit at the institution and the
interest rate paid to the Company by the institution is a net difference of
1%. Interest income and expense is payable monthly and the principal
amount is payable in full at maturity.
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<PAGE>
Presently, the Company anticipates that it will need to raise
additional funds to be able to satisfy its cash requirements during the
next twelve months. The scientific research and development, corporate
operations and marketing expenses will continue to require additional
capital. Because the Company presently has no revenue from operations, the
Company intends to continue to rely primarily on financing through the sale
of its equity and debt securities to satisfy future capital requirements
until such time as the Company is able to enter into acceptable third party
licensing or co-development arrangements such that it will be able to
finance ongoing operations out of license, royalty and sales revenue.
There can be no assurance that the Company will be able to enter into
acceptable third party licensing or co-development agreements.
Furthermore, the issuance of equity securities or other securities which
are or may become convertible to the equity securities of the Company in
connection with such financing would result in dilution to the shareholders
of the Company.
In connection with the Memorandum, 55 employees of Synergetics became
full-time or part-time employees of the Company. Taking account of these
employees, the Company presently employs 78 persons and has a need for
approximately 15 additional scientific professionals and 10 additional
technology asset managers.
The Company has no plans to purchase any new plants or expand beyond
any existing facility.
Factors Affecting Future Operating Results
Notwithstanding the Company's efforts and planning, any one or more
of several factors could delay, obstruct or otherwise hinder the Company's
ability to achieve its objectives or cause actual results of operations to
materially differ from expected or anticipated results including, without
limitation, those which are expressed in forward-looking statements
contained in this Report. Included among such factors could be those Risk
Factors described in the Company's reports on Form 10-KSB for the period
ending December 31, 1996 and Form 10-Q for the period ending March 31,
1997, as well as the following:
Substantial and Continuing Losses; Accumulated Deficit.
Since commencing its business of developing its automatic speech
recognition technologies ("ASRT") and certain other proprietary
technologies, including data compression and neural network design
technologies (collectively the ASRT and such other related technologies are
referred to in this Prospectus as the "Core Technologies"), the Company has
had no revenues from operations. During each of the preceding three fiscal
years, the Company has sustained ongoing losses associated with its
research and development costs. The Company incurred a net loss of
$7,829,508 for the year ended December 31, 1996 and a net loss of
$6,778,165 for the six-month period ended June 30, 1997. Accordingly, the
auditor's report in the fiscal 1996 financial statements includes an
explanatory paragraph relating to the Company's ability to continue as a
going concern. Losses of this magnitude are expected to continue for the
near term and until such time as the Company is able to complete licensing
or co-development arrangements with third parties which produce revenues
sufficient to offset losses associated with the Company's ongoing operating
expenses, and there can be no assurance that the Company will achieve
profitable operations or that profitable operations will be sustained if
achieved. At December 31, 1996, the Company's accumulated deficit was
$19,841,807 and at June 30, 1997, the Company's accumulated deficit was
$26,619,972. The Company anticipates incurring substantial research and
development expenses for the foreseeable future, which will require
substantial amounts of additional cash on an ongoing basis. The Company
must continue to secure additional financing to complete its research and
development activities, and to seek and engage in negotiations with
potential strategic alliance partners and otherwise market its technology
to industry segments that can incorporate the Company's technologies into
their
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<PAGE>
products. The Company believes that the cash generated to date from its
financing activities and the Company's ability to raise cash in future
financing activities will be sufficient to satisfy its working capital
requirements through the next twelve-month period. However, there can be
no assurance that this assumption will prove to be accurate or that events
in the future will not require the Company to obtain additional financing
sooner than presently anticipated. To the extent that the Company's future
financing activities involve the issuance of equity securities or
securities convertible into equity securities, additional dilution to the
interests of the Company's stockholders will result. Although the Company
continues to investigate several financing alternatives, including
strategic partnerships, private, debt and equity financing and other
sources in relation to its ongoing and research and development activities,
there can be no assurance that the current levels of funding or additional
funding will be available when needed, or if available will be on terms
satisfactory to the Company. Failure to obtain additional financing could
have a material adverse effect on the Company, including possibly requiring
it to significantly curtail its operations.
Development Stage of Core Technologies.
While the Company generally is pleased with the progress made to date
with respect to the research and development of its Core Technologies,
currently there are no products incorporating the Core Technologies. As a
development stage company, fonix intends to enter into licensing and
co-development arrangements or strategic alliances with third parties,
although no such relationships presently exist. The Company presently
anticipates that any products incorporating the Company's Core Technologies
would be manufactured and marketed by such third party licensees and
co-development and strategic alliance partners. There can be no assurance
that the Company will ever be able to license its Core Technologies or
enter into co-development or strategic alliance agreements such that the
Core Technologies or products based thereon will be commercially viable.
Implementation of Business Strategy.
The Company's business strategy is to achieve revenues through
appropriate strategic alliances, co-development arrangements and license
agreements. To date, the Company has not yet entered into any
revenue-generating license, co-development or strategic relationships. The
Company's ability to implement its strategy fully over the long term, and
the ultimate success of this strategy, are subject to a broad range of
uncertainties and contingencies, many of which are beyond the Company's
control. The Company may not be able to achieve the revenue it is seeking
as a result of incompatibilities between its Core Technologies and the
needs of third-party developers and manufacturers or an unwillingness of
companies with existing voice recognition products to integrate the
Company's technologies. In addition, there can be no assurance that the
Company will be able to enter into revenue-generating licensing or
co-development arrangements or to implement strategic relationships, or, if
entered into, that such strategic relationships will in fact further the
implementation of the Company's business strategy.
Unproven Market; Risks of New Technology.
The market for speech recognition technologies is relatively new.
The Company's Core Technologies are new and represent a significant
departure from technologies which have already found a degree of acceptance
in the nascent voice recognition marketplace. The financial performance of
the Company will depend, in part, on the future development, growth and
ultimate size of the market for voice recognition products generally, and
products incorporating the Company's Core Technologies specifically.
Products, if any, incorporating the Company's Core Technologies will
compete with more conventional means of
20
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information processing (e.g., data entry or access by keyboard or
touch-tone phone). The Company believes that there is a substantial
potential market for products incorporating speaker- independent, natural
language, continuous speech recognition technology with vocabulary
contextually sufficient to be useful for general purpose consumer,
commercial and industrial use, and capable of operating in real time with
acceptable levels of accuracy. Nevertheless, there can be no assurance
that any market for the Company's Core Technologies or for products
incorporating the Company's Core Technologies will develop, or that the
Company's technology will find general acceptance in the marketplace, or
that sales of products incorporating the Core Technologies will be
profitable. Accordingly, the Company is subject to all of the risks
inherent in developing and marketing new products based on new technology,
together with the risks associated with market acceptance of such
technology, technological obsolescence, inappropriate and/or illegal
intellectual property appropriation and inadequate funding to commence
and/or sustain operations. Even if the Core Technologies are licensed and
products incorporating such technologies are manufactured and marketed, the
occurrence of warranty or product liability, or retraction of market
acceptance due to product failure, excess product returns or failure of the
products to meet market expectations could prevent the Company from
achieving or sustaining profitable operations.
Reliance on Strategic Partners.
The Company's strategy for commercialization of its Core Technologies
depends, in part, upon the formation of strategic alliances and licensing
arrangements, although the Company has not entered into any such
arrangements to date. There can be no assurance that the Company will be
able to establish such strategic alliance or licensing arrangements, that
any such arrangements or licenses will be on terms favorable to the
Company, or that any such strategic alliances or licensing arrangements
ultimately will be successful. Even if the Company were to enter into
third party licensing agreements, the extent of revenues to the Company
resulting from such agreements would depend on factors beyond the Company's
control such as the timing and extent of such licensee's manufacture of
products incorporating the Company's Core Technologies, the scope of the
marketing effort related to such products, the price of any product
incorporating the Company's Core Technologies, and competition from new or
existing products. Moreover, disputes may arise with respect to the
ownership of rights to any technology developed with strategic partners.
These and other possible disagreements between strategic partners and the
Company could lead to delays in the collaborative research, development or
commercialization of certain product candidates, or could require or result
in litigation or arbitration, which could be time consuming and expensive,
and which could have a material adverse effect on the Company's business,
financial condition and results of operations.
Competition and Technological Change.
The computer hardware and software industries into which the Core
Technologies would be incorporated are highly and intensely competitive.
In particular, the speech recognition field and the computer voice and
communications industries in which products employing the Company's Core
Technologies would be incorporated are characterized by rapid technological
change. Competition in the field of speech recognition is based largely on
technological superiority. The development of new technology or material
improvements to existing technologies by the Company's competitors may
render the Company's technology obsolete. Accordingly, the success of the
Company will depend upon its ability to continually enhance its Core
Technologies to keep pace with or ahead of technological developments and
to address the changing needs of the marketplace. Although the Company
expects to continue to devote significant resources to research and
development activities, there can be no assurance that these activities
will allow the Company's Core
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Technologies to successfully be incorporated into marketable products or to
keep pace with changing demands and needs of the marketplace. In addition,
there can be no assurance that the introduction of products or
technological developments by others will not have a material adverse
effect on the Company's operations. Although the Company believes that its
Core Technologies could beneficially be incorporated into most existing
computer speech recognition applications based on traditional Hidden Markov
Models ("HMMs") technology, several companies already manufacture and
market computer speech recognition products against which products
incorporating the Core Technologies would compete. Some, if not all, of
those companies have greater experience in manufacturing and marketing
speech recognition products, and many have far greater financial and other
resources than the Company and/or its potential licensees and
co-developers, as well as broader name-recognition, more-established
technology reputations, and mature distribution channels for their
products. One computer speech company, Dragon Systems, Inc., has recently
introduced a continuous speech dictation product that could have the effect
of desensitizing the market to new dictation products and increasing the
installed base of products incorporating traditional voice recognition
technologies. Additionally, as the market for automatic speech recognition
expands and matures, the Company expects many more entrants into this
already competitive arena. There can be no assurance that the
distinguishing characteristics of the Core Technologies as presently
completed and/or as may be enhanced in the future and any products
employing such technology will be sufficient to allow the Company to
successfully compete in the marketplace.
Need for Additional Financing.
The development of the Company's Core Technologies has required that
fonix establish a substantial research and scientific infrastructure
consisting of teams of experts in, among others, the fields of computer
programming and design, electrical engineering and linguistics, as well as
the assembly of certain specialized equipment and developmental and
diagnostic software and hardware, some of which has been designed and built
exclusively by the Company. The Company has consumed substantial amounts
of cash to date in developing this infrastructure and in developing and
refining its Core Technologies. During the year ended December 31, 1996,
the Company incurred total research and development expenses in the amount
of $4,758,012. During the six months ended June 30, 1997, the Company
incurred total research and development expenses of $3,065,279. The
Company anticipates that its research and development expenditures will
continue at present rates or increased rates for the foreseeable future.
Absent revenues from co-development or licensing agreements, the Company
believes that existing cash and cash from anticipated financings will be
required to support the Company's operations for at least the next 12
months. The Company's future capital requirements will depend on many
factors, including further development of its Core Technologies, the
Company's ability to enter into strategic alliance, co-development and
licensing arrangements, the progress of the development, manufacturing and
marketing efforts of the Company's strategic partners, if any, the level of
the Company's activities relating to commercialization rights it may retain
in its strategic alliance arrangements, competing technological and market
developments, and the costs involved in enforcing patent claims and other
intellectual property rights. When and as substantial amounts of
additional financing are required, the Company does not believe it will be
able to obtain such financing from traditional commercial lenders. Rather,
the Company likely will have to conduct additional sales of its equity
and/or debt securities. There can be no assurance that such additional
financing will be available if and when, and in the amounts required, by
the Company. Moreover, even if such financing is available if and when
required, there can be no assurance that such financing will be obtained on
terms that are favorable to the Company, and substantial and immediate
dilution to existing stockholders likely would result from any sales of
equity securities or other securities convertible into equity securities.
To the extent that the Company raises additional funds through strategic
alliance and licensing arrangements, the Company may be required to
relinquish rights to certain of its technologies, or to grant licenses on
terms that are not favorable to the Company, either of which could have
22
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a material adverse effect on the Company's business, financial condition
and results of operations. In the event that adequate funds are not
available when and as needed, the Company's business would be adversely
affected.
Intellectual Property Protection.
On June 17, 1997, the United States Patent and Trademark Office
issued U.S. Patent No. 5,640,490 entitled "A User Independent, Real-time
Speech Recognition System and Method." . The patent has a 20-year life
running from the November 4, 1994 filing date, and has been assigned to the
Company. However, there can be no assurance that such patent will be
incontestable to a user with prior rights. The Company is unaware of any
facts or circumstances suggesting that the Core Technologies or the
Company's anticipated use thereof infringes or will infringe any third
party intellectual property rights. Regardless of the foregoing, there can
be no assurance that the Core Technologies will not infringe upon third
party intellectual property rights, nor can there be any assurance that a
third party will not assert that the Company has infringed its intellectual
property rights, in which case the Company could be involved in protracted
and costly litigation which could seriously impede the Company's
development or otherwise adversely affect its operations. Additionally,
attempts may be made to copy or reverse engineer aspects of the Core
Technologies, or to obtain, use or exploit information or methods which the
Company deems proprietary. Policing the use of the Core Technologies and
perhaps infringing technology is difficult and expensive. Litigation or
other action may be necessary in the future to protect the Company's
proprietary rights and to determine the validity and scope of the
proprietary rights of others. Such litigation or proceedings could result
in substantial costs and diversions of resources and management's
attention, and could have a material adverse impact upon the Company's
business, operating results and financial condition. In addition to
patents, the Company relies on proprietary technology that it closely
guards as trade secrets. The Company has required non-disclosure and
confidentiality agreements to be executed by its employees, potential
licensees, and potential strategic alliance and co-development partners,
and the Company expects to continue this requirement. However, there can be
no assurance that such non-disclosure and confidentiality agreements will
be legally enforceable or sufficient to maintain the secrecy of the
Company's proprietary technology. Moreover, although the Company presently
is seeking patent protection for certain additional technologies, there can
be no assurance that such patents will issue or that the Company will be
able to sufficiently protect any technologies developed by it in the
future.
Controlling Interest of Related Parties.
Thomas A. Murdock, a director, executive officer and founding
shareholder of the Company is the trustee of a voting trust into which is
deposited a majority of the Company's issued and outstanding common stock,
which effectively gives Mr. Murdock control of the Company. The Company
believes that it will be controlled by Mr. Murdock, as the trustee of the
voting trust and one of its founding shareholders, for the foreseeable
future.
Lack of Diversification of the Company's Business.
The Company is not engaged in and does not intend to engage in any
business other than the further development and marketing of its Core
Technologies and related technologies.
Dependence on Key Personnel.
The Company is dependent on the knowledge, skill and expertise of
several key scientific employees and consultants, including but not limited
to C. Hal Hansen, Dale Lynn Shepherd, R. Brian Moncur, and Tony R.
23
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Martinez, and its executive officers, Messrs. Studdert, Murdock and Dudley.
The loss of any of such personnel could materially and adversely affect the
Company's future business efforts. Moreover, although the Company has
taken reasonable steps to protect its intellectual property rights, if one
or more of the Company's key scientific employees or consultants resigns
from the Company to join a competitor, the loss of such personnel and the
employment of such personnel by a competitor could have a material adverse
effect on the Company. In the event of loss of any of the Company's key
employees or consultants, there can be no assurance that the Company would
be able to prevent the unauthorized disclosure or use of its proprietary
technology by such former employees or consultants, although the Company's
employees and consultants have entered into confidentiality agreements with
the Company. The Company does not presently have any key man life insurance
on any of its employees.
Assets Consisting Primarily of Intangible Intellectual Property Rights.
The Company's assets consist primarily of intangible assets,
principally intellectual rights such as patents, trademarks and trade
secrets, the value of which will depend significantly upon the success of
the Company's development of the Core Technologies and its ability to enter
into licensing and co-development arrangements with third parties. In the
event of default on indebtedness or liquidation of the Company, there can
be no assurance that the value of these assets will be sufficient to
satisfy its obligations.
Significant Outstanding Indebtedness.
The Company has incurred substantial indebtedness in relation to its
assets and will be subject to all of the risks associated with substantial
leverage, including the risk that available cash may not be adequate to
make required payments to the holders of the Company's debentures. The
Company's ability to satisfy its obligations under the debentures from cash
flow will be dependent upon the Company's future performance and will be
subject to financial, business and other factors affecting the operation of
the Company, many of which may be beyond the Company's control. In the
event the Company does not have sufficient cash resources to satisfy
repayment obligations or other obligations of the Company to the holders of
the debentures, the Company will be in default under the debentures, which
would have a material adverse effect on the Company and could result in a
reduction of the price of the Company's Common Stock. The debentures are
unsecured and subordinate in right of payment to all senior indebtedness of
the Company. The debentures do not restrict the Company's ability to incur
additional senior indebtedness and most other indebtedness. The terms of
senior indebtedness now existing or incurred in the future could affect the
Company's ability to make payments of principal and/or interest to the
holders of debentures.
Risks Associated With Pending Litigation.
The Company has been named as a defendant in a shareholder derivative
action brought by a shareholder of the Company against certain directors of
the Company and a third party affiliated with certain of the
director-defendants. Although the parties have reached, in principal, a
settlement agreement, as is discussed in more detail below, the complaint
in that action alleges that certain of the individual employee director
defendants wrongfully caused the Company to engage in a series of loan
transactions with K.L.S. Enviro Resources, Inc., a Nevada corporation
("KLSE"), and thereafter appropriated to themselves certain corporate
opportunities resulting from such loan transactions. The Complaint further
alleges that the non-employee director defendants wrongfully acquiesced in
or ratified the conduct of the employee-directors, and that all of the
individual defendants breached their fiduciary duties to the Company. The
Complaint seeks to compel an accounting for any alleged profits earned by
the employee director defendants, equitable relief in the form of
24
<PAGE>
an order requiring certain of the employee director defendants to forfeit
certain securities of KLSE they allegedly acquired in breach of their
fiduciary duties to the Company, monetary damages in an unspecified amount,
and costs and legal fees. After that action was filed but before process
was served, the Company commenced settlement negotiations with the
plaintiff. Although a settlement agreement in principal was reached by the
parties, no settlement agreement has been executed; process has been served
and the discovery process with respect to the settlement is ongoing. The
terms of the definitive settlement agreement between the parties will be
subject to approval by the court. Regardless of the outcome of the
discovery relating to the settlement or the commencement of litigation
proceedings if the settlement is not consummated, the Company believes that
the claims asserted against the Company in this action are entirely without
merit, and that the material facts and circumstances surrounding the
relationship between the Company and KLSE have been fully disclosed in
accordance with applicable laws and regulations. After consideration of
the nature of the claims and the facts relating to this action, the Company
believes that the resolution of this action will not have a material effect
on the Company's business, financial condition and results of operations;
however, the results of this action, including any potential settlement,
are uncertain and there can be no assurance to that effect. At a minimum
this action will result in some diversion of management time and effort
from the operations of the business.
PART II
Item 2. Changes in Securities
c. Unregistered sales of equity securities during quarter (other
than in reliance on Regulation S).
Recent Sales of Unregistered Securities. During the quarter ended
June 30, 1997, the Company issued equity securities that were not
registered under the Securities Act of 1933, as amended (the "Act"), other
than unregistered sales in reliance on Regulation S under the Act, as
follows:
On April 24, 1997 the Company issued 100,000 shares of common stock
to a company as compensation for consulting services rendered. The Company
issued such shares without registration under the Act in reliance on
Section 4(2) of the Act and/or Regulation D. Such shares of common stock
were issued as restricted securities and the certificates representing such
shares were stamped with a restrictive legend to prevent any resale without
registration under the Act or in compliance with an exemption.
On May 21, 1997 the Company granted options to purchase 10,000
shares of common stock to an employee. All of such options were issued
under the Company's 1997 Stock Incentive Plan without registration under
the Act in reliance on Sections 3(b) and 4(2) of the Act and the rules and
regulations promulgated thereunder. The exercise price of such options is
$7.16, which was the closing market price on the date of grant.
On May 29, 1997 the Company granted options to purchase an aggregate
of 3,000,000 shares of common stock to various employees. All of such
options were issued under the Company's 1997 Stock Incentive Plan without
registration under the Act in reliance on Sections 3(b) and 4(2) of the Act
and the rules and regulations promulgated thereunder. The exercise price
of such options is $6.50, which was the closing market price on the date of
grant.
25
<PAGE>
Item 4. Submission of Vote of Security Holders
At its Annual Meeting of Shareholders on June 16, 1997, the following
actions were submitted and approved by vote of the majority of the issued
and outstanding shares of the Company:
(1) Election of directors;
(2) Approval of the Board of Directors' selection of Deloitte &
Touche LLP, as the Company's independent certified public
accountants.
A total of 33,643,095 shares (approximately 80%) of the issued and
outstanding shares of the Company were represented by proxy or in person at
the meeting. These shares were voted on the matters described above as
follows:
1. For the directors as follows:
<TABLE>
<CAPTION>
# Shares Abstaining/
Name # Shares For # Shares Against Withheld
- -------------------------- -------------- ----------------- --------------------
<S> <C> <C> <C>
Stephen M. Studdert 33,573,429 6,203 63,463
Alan C. Ashton, Ph.D. 33,573,429 6,203 63,463
John A. Oberteuffer, Ph.D. 33,573,429 6,203 63,463
Joseph Verner Reed 33,573,429 6,203 63,463
James B. Hayes 33,573,429 6,203 63,463
Thomas A. Murdock 33,573,429 6,203 63,463
Roger D. Dudley 33,572,429 7,203 63,463
Rick D. Nydegger 33,573,429 6,203 63,463
</TABLE>
2. For the ratification of the Board of Directors' selection of
Deloitte & Touche LLP as the independent certified accountants of the
Company as follows:
# Shares For # Shares Against # Shares Abstaining
------------- ---------------- -------------------
33,570,577 9,055 63,463
Broker non-votes were counted as abstentions on matter 2 above.
Item 6. Exhibits and Reports on Form 8-K
a. Regulation S-K Exhibits.
Exhibit No. Description
(3)(i) Articles of Incorporation of the Company which are
incorporated by reference from the Company's Registration
Statement on Form S-18 dated as of September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of Incorporation
dated as of March 21, 1994, which is incorporated by
reference from the Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
26
<PAGE>
(3)(iiii) Certificate of Amendment of Certificate of Incorporation
dated as of May 13, 1994, which is incorporated by
reference from the Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
(3)(iv) The Company's Bylaws, as amended, which are incorporated
by reference from the Company's Annual Report for the
Fiscal Year Ended December 31, 1994 on Form 10-KSB
(4) Description of the Company's common stock and other
securities and specimen certificates representing such
securities which are incorporated by reference from the
Company's Registration Statement on Form S-18 dated as of
September 12, 1989, as amended
(10)(i) Product Development and Assignment Agreement dated as of
October 16, 1993 between Phonic Technologies, Inc. and
Synergetics, Inc., which is incorporated by reference
from the Company's Current Report on Form 8-K dated as
of June 17, 1994
(10)(ii) Re-Stated Product Development and Assignment Agreement
dated as of March 30, 1995, between fonix Corporation and
Synergetics, Inc., which is incorporated by reference
from the Company's Annual Report for the Fiscal Year
Ended December 31, 1994 on Form 10-KSB
(10)(iii) Memorandum of Understanding dated as of March 13, 1997,
by and among the Company, Synergetics, Inc. and C. Hal
Hansen, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1996
(10)(iv) Employment Agreement by and between the Company and
Stephen M. Studdert, which is incorporated by reference
from the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(v) Employment Agreement by and between the Company and
Thomas A. Murdock, which is incorporated by reference
from the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(vi) Employment Agreement by and between the Company and Roger
D. Dudley, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1996
(27) Financial Data Schedule, filed herewith.
27
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
fonix corporation
Date: August 13, 1997 /s/ Douglas L. Rex
-------------------------------
Douglas L. Rex, Chief Financial Officer
28
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<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 19,694
<SECURITIES> 0
<RECEIVABLES> 1,036
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 21,021
<PP&E> 1,897
<DEPRECIATION> 226
<TOTAL-ASSETS> 23,119
<CURRENT-LIABILITIES> 22,287
<BONDS> 0
0
0
<COMMON> 4
<OTHER-SE> 828
<TOTAL-LIABILITY-AND-EQUITY> 23,119
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,816
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 565
<INCOME-PRETAX> (6,778)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,778)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,778)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> 0
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