<PAGE>
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, 1999
[ ] 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 18, 1999, 70,860,944 shares of common stock, par value $.0001 per
share, were issued and outstanding.
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
June 30, December 31,
1999 1998
--------------------- --------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 490,614 $ 20,045,539
Notes receivable - 245,000
Accounts receivable, net of allowance for doubtful accounts of $72,903
and $8,115, respectively 1,024,598 219,908
Prepaid expenses 76,027 51,866
Inventory 121,968 77,386
Interest and other receivables 24,144 8,276
Employee advances - 67,231
--------------------- --------------------
Total current assets 1,737,351 20,715,206
Property and equipment, net of accumulated depreciation of $1,668,089 and
$1,195,390, respectively 1,980,322 2,328,012
Intangible assets, net of accumulated amortization of $5,191,162 and $2,599,554,
respectively 36,175,894 38,816,421
Other assets 134,748 130,288
--------------------- --------------------
Total assets $ 40,028,315 $ 61,989,927
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ - $ 138,034
Revolving notes payable 50,000 20,038,193
Notes payable - related parties 6,673,153 8,491,880
Notes payable - other 6,187,556 560,000
Accounts payable 3,639,210 3,536,074
Accrued liabilities 1,565,316 981,774
Accrued liabilities - related parties 922,407 900,004
Deferred revenues 1,225,593 695,997
Capital lease obligation - current portion 28,118 52,225
--------------------- --------------------
Total current liabilities 20,291,353 35,394,181
Capital lease obligation, net of current portion 46,385 -
Series C 5% convertible debentures 6,500,000 -
--------------------- --------------------
Total liabilities 26,837,738 35,394,181
--------------------- --------------------
Common stock and related repricing rights subject to redemption; 1,801,802
shares and repricing rights outstanding (aggregate redemption value of
$2,500,000) 1,830,000 1,830,000
--------------------- --------------------
Commitments and contingencies (Notes 3, 8, 9, 10, 13, 14, and 16)
Stockholders' equity:
Preferred stock, $.0001 par value; 100,000,000 shares authorized; Series
A, convertible; 166,667 shares outstanding
(aggregate liquidation preference of $6,055,012) 500,000 500,000
Series D, 4% cumulative convertible; 972,334 shares outstanding in 1999
(aggregate liquidation preference of $20,093,163) 22,718,024 22,200,936
Series E, 4% cumulative convertible; 43,500 shares outstanding in 1999
(aggregate liquidation preference of $896,390) 1,028,071 3,257,886
Common stock, $.0001 par value; 100,000,000 shares authorized;
69,059,142 and 64,324,480 shares outstanding, respectively 6,906 6,432
Additional paid-in capital 93,640,482 88,517,711
Outstanding warrants 3,642,750 3,323,258
Deferred consulting expense - (106,700)
Deficit accumulated during the development stage (110,175,656) (92,933,777)
--------------------- --------------------
Total stockholders' equity 11,360,577 24,765,746
--------------------- --------------------
Total liabilities and stockholders' equity $ 40,028,315 $ 61,989,927
===================== ====================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Three Months Ended Six Months Ended (Inception) to
June 30, June 30, June 30,
-------------- ------------- -------------- --------------
1999 1998 1999 1998 1999
-------------- ------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Revenues $ 655,051 $ 1,176,500 $ 1,765,383 $ 2,472,285 $ 4,655,067
Cost of revenues 129,398 - 354,837 - 431,181
-------------- ------------- -------------- -------------- ---------------
Gross margin 525,653 1,176,500 1,410,546 2,472,285 4,223,886
-------------- ------------- -------------- -------------- ---------------
Expenses:
Selling, general and administrative 2,874,910 2,084,622 6,550,472 3,464,702 38,868,003
Product development and research 2,346,907 2,960,292 5,318,186 5,661,495 36,876,227
Amortization of goodwill and purchased core
technology 1,287,581 500,776 2,575,162 599,559 5,116,316
Purchased in-process research and development - - - 9,315,000 13,136,000
-------------- ------------- -------------- -------------- ---------------
Total expenses 6,509,398 5,545,690 14,443,820 19,040,756 93,996,546
-------------- ------------- -------------- -------------- ---------------
Loss from operations (5,983,745) (4,369,190) (13,033,274) (16,568,471) (89,772,660)
-------------- ------------- -------------- -------------- ---------------
Other income (expense):
Interest income - 292,405 22,046 563,882 3,689,437
Interest expense (534,042) (282,977) (2,801,421) (594,901) (8,181,070)
Cancellation of common stock reset provision - - - - (6,111,577)
-------------- ------------- -------------- -------------- ---------------
Total other income (expense), net (534,042) 9,428 (2,779,375) (31,019) (10,603,210)
-------------- ------------- -------------- -------------- ---------------
Loss before extraordinary items (6,517,787) (4,359,762) (15,812,649) (16,599,490) (100,375,870)
Extraordinary items:
Loss on extinguishment of debt - - - - (881,864)
Gain on forgiveness of debt - - - - 30,548
-------------- ------------- -------------- -------------- ---------------
Net loss $ (6,517,787) $ (4,359,762) $ (15,812,649) $ (16,599,490) $ (101,227,186)
============== ============= ============== ============== ===============
Basic and diluted net loss per common share $ (0.10) $ (0.08) $ (0.26) $ (0.34)
============== ============= ============== ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
October 1,
1993
Six Months Ended (Inception) to
June 30, June 30,
---------------------------------
1999 1998 1999
----------------- --------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (15,812,649) $ (16,599,490) $ (101,227,186)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 100,000 - 5,587,554
Issuance of common stock for patent - 100,807 100,807
Non-cash expense related to issuance of notes payable, debentures,
warrants, preferred and common stock 2,169,556 - 12,248,470
Non-cash compensation expense related to issuance
of stock options 119,240 320,100 2,615,540
Non-cash expense related to issuance of notes payable
and accrued expense for services - - 857,000
Non-cash exchange of notes receivable for services - - 150,000
Non-cash portion of purchased in-process research and development - 8,814,768 13,136,000
Write-off of assets received in acquisition - - 1,281
Depreciation and amortization 3,113,226 889,926 6,888,680
Extraordinary loss on extinguishment of debt - - 881,864
Extraordinary gain on forgiveness of debt - - (30,548)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable (804,690) (52,425) (953,188)
Employee advances 7,245 - (59,986)
Interest and other receivables (15,868) (6,050) (21,351)
Inventory (44,582) - (64,803)
Prepaid assets (24,161) (412,201) (71,627)
Other assets (4,460) (65,227) (124,305)
Accounts payable 103,136 390,460 5,116,872
Accrued liabilities 583,542 (184,152) 1,225,331
Accrued liabilities - related party 22,403 (436,716) 170,162
Deferred revenues 529,596 - 610,862
----------------- --------------- -----------------
Net cash used in operating activities (9,958,466) (7,240,200) (52,962,571)
----------------- --------------- -----------------
Cash flows from investing activities, net of effects of acquisitions:
Acquisition of subsidiaries, net of cash acquired - (7,246,119) (15,323,173)
Purchase of property and equipment (67,677) (670,646) (3,404,147)
Investment in intangible assets - - (164,460)
Issuance of notes receivable - (781,140) (3,228,600)
Payments received on notes receivable 245,000 - 2,128,600
----------------- --------------- -----------------
Net cash provided by (used in) investing activities 177,323 (8,697,905) (19,991,780)
----------------- --------------- -----------------
Cash flows from financing activities:
Bank overdraft (138,034) - -
Net proceeds (payment) from revolving note payable (19,988,193) 1,226,511 750
Net proceeds (payments) from revolving note payable - related parties (1,758,741) (551,510) (1,677,100)
Proceeds from other notes payable 5,453,760 - 8,365,427
Payments on other notes payable - (49,250) (1,779,806)
Principal payments on capital lease obligations (35,054) (23,751) (127,760)
Proceeds from advances - - -
Proceeds from issuance of convertible debentures, net 6,254,240 - 9,439,240
Proceeds from sale of warrants 438,240 322,928 1,511,168
Proceeds from sale of common stock, net - 16,635,000 38,175,700
Proceeds from sale of preferred stock, net - - 17,707,346
Proceeds from sale of common stock and related repricing rights
subject to redemption, net - - 1,830,000
----------------- --------------- -----------------
Net cash provided by (used in) financing activities (9,773,782) 17,559,928 73,444,965
--------------------------------- -----------------
Net (decrease) increase in cash and cash equivalents (19,554,925) 1,621,823 490,614
Cash and cash equivalents at beginning of period 20,045,539 20,501,676 -
----------------- --------------- -----------------
Cash and cash equivalents at end of period $ 490,614 $ 22,123,499 $ 490,614
================= =============== =================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Six Months Ended (Inception) to
June 30, June 30,
---------------------------------------
Supplemental disclosure of cash flow information: 1999 1998 1999
------------- -------------- -----------------
<S> <C> <C> <C>
Cash paid during the period for interest $ 381,118 $ 639,472 $ 3,811,124
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Six Months Ended June 30, 1999:
The Company entered into capital lease obligations for equipment in the
amount of $57,332.
Advances to employees totaling $59,986 were applied as payments on a
related-party note payable.
A total of 143,230 shares previously pledged to a bank by certain
officers and directors of the Company as collateral for Company credit card debt
were sold by the bank and the proceeds were used to pay the debt and the related
accrued interest in full totaling $244,824.
A total of 100,000 shares previously pledged to a law firm by certain
officers and directors of the Company as collateral for legal work were sold by
the law firm and the proceeds were used to pay for legal services totaling
$72,335.
Preferred stock dividends of $997,146 were recorded related to the
beneficial conversion features of Series D and Series E convertible preferred
stock.
Preferred stock dividends of $432,084 were accrued on Series D and Series
E convertible preferred stock.
The Company issued 200,000 shares of common stock to an unrelated party
for consulting fees valued at $100,000.
A total of 36,000 shares of Series D convertible preferred stock and
related dividends of $15,741 were converted into 1,288,479 shares of common
stock.
A total of 91,572 shares of Series E convertible preferred stock and
related dividends of $33,616 were converted into 3,246,183 shares of common
stock.
For the Six Months Ended June 30, 1998:
Preferred stock dividends of $131,660 were recorded related to the
beneficial conversion features of Series B and Series C convertible preferred
stock.
A total of 27,500 shares of Series B Preferred Stock and related
dividends of $8,531 were converted into 193,582 shares of common stock.
A total of 185,000 shares of Series C Preferred Stock and related
dividends of $123,129 were converted into 1,295,919 shares of common stock.
The Company issued 2,692,216 shares of common stock (having a quoted
market value of $16,995,972) in connection with the acquisition of AcuVoice,
Inc.
See accompanying notes to condensed consolidated financial statements
5
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements of Fonix Corporation and subsidiaries (collectively, the
"Company") have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the following disclosures are adequate to make the information presented
not misleading.
These condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) that, in the opinion of
management, are necessary to present fairly the financial position and results
of operations of the Company for the periods presented.
Operating results for the three and six months ended June 30, 1999, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. The Company suggests that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K, as amended, for the year ended December 31, 1998.
Recently Enacted Accounting Standards - In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards requiring that
derivative instruments be recorded in the balance sheet as either an asset or
liability measured at its fair value and that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000. The adoption of this statement is not expected to have a material
effect on the Company's consolidated financial statements as the Company does
not currently hold any derivative or hedging instruments.
Reclassifications - Certain reclassifications have been made in the prior period
condensed consolidated financial statements to conform with the current period
presentation.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
At June 30, 1999 and 1998, there were outstanding common stock equivalents to
purchase 108,565,042 and 13,966,667 shares of common stock, respectively, that
were not included in the computation of diluted net loss per common share as
their effect would have been anti-dilutive, thereby decreasing the net loss per
common share.
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three and six months ended June 30,
1999 and 1998:
6
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------------------------------------
1999 1998
-------------------------- ----------------------------
Per Share Per Share
Loss Amount Loss Amount
<S> <C> <C> <C> <C>
Net loss $ (6,517,787) $ (4,359,762)
Preferred stock dividends (301,669) -
-------------- -------------
Net loss attributable to common
stockholders $ (6,819,456) $(0.10) $ (4,359,762) $(0.08)
============== ======= ============= =======
Weighted average common shares
outstanding 67,067,853 51,343,293
============== =============
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
----------------------------------------------------------------
1999 1998
----------------------------- --------------------------------
Per Share Per Share
Loss Amount Loss Amount
<S> <C> <C> <C> <C>
Net loss $ (15,812,649) $ (16,599,490)
Preferred stock dividends (1,429,230) (131,660)
-------------- ---------------
Net loss attributable to common
stockholders $ (17,241,879) $(0.26) $ (16,731,150) $(0.34)
============== ======= =============== =======
Weighted average common shares
outstanding 65,779,527 48,557,594
============== ===============
</TABLE>
2. ACQUISITIONS
The Company acquired AcuVoice, Inc. ("AcuVoice") in March 1998. AcuVoice
developed and marketed text-to-speech ("TTS") technologies and products directly
to end-users, systems integrators and original equipment manufacturers for use
in the telecommunications, multi-media, education and assistive technology
markets. In addition, the Company acquired Papyrus Associates, Inc. ("PAI") and
Papyrus Development Corporation ("PDC") (together with PAI, "Papyrus") in
October 1998. PAI developed, marketed and supported printing and cursive
handwriting recognition software for "personal digital assistants", pen tablets
and mobile phones under the trademark, Allegro(TM). PDC was a systems
integration provider with expertise and intellectual property in embedded
systems and enhanced Internet applications. The products and services formerly
provided by AcuVoice and Papyrus are now provided by the Company's Interactive
Technologies Solutions Group.
The Company also acquired Articulate Systems, Inc. ("Articulate") in September
1998. Articulate was a provider of sophisticated voice recognition products to
specialized segments of the health care industry under the PowerScribe(R) trade
name. These same products and services are now provided by the Company's
HealthCare Solutions Group.
All three acquisitions were accounted for as purchases.
The following unaudited pro forma financial statement data for the three and six
months ended June 30, 1998 present the results of operations of the Company as
if the acquisitions of AcuVoice, Articulate and Papyrus had occurred at January
1, 1998. The pro forma results have been prepared for comparative purposes only
and do not purport to be indicative of what would have occurred had the
acquisitions been made at January 1, 1998 or of future
7
<PAGE>
results. Purchased in-process research and development related to the
acquisitions of AcuVoice and Articulate of $9,315,000 and $3,821,000,
respectively, were recorded at the dates of the acquisitions and are not
presented in the following pro forma financial statement data since they are
non-recurring charges directly attributable to the acquisitions.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30,1998 June 30, 1998
-------------------- ------------------
<S> <C> <C>
Revenues $ 1,558,024 $ 3,183,788
Loss from operations (6,061,615) (11,336,701)
Net loss attributable to common
stockholders (6,448,954) (12,645,822)
Basic and diluted net loss
per common share (0.10) (0.22)
</TABLE>
3. POTENTIAL SALE OF HEALTHCARE SOLUTIONS GROUP
On May 19, 1999, the Company entered into an agreement to sell the operations
and a significant portion of the assets of its HealthCare Solutions Group
("HSG") to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third
party, for $28,000,000, of which $24,000,000 is to be paid at closing, and the
remaining $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years based on performance of the HSG expected during
those subsequent two years. The sale is subject to approval by Fonix's
shareholders, and is scheduled to close during the third quarter of 1999. The
proceeds from the sale will be used to reduce certain of the Company's
liabilities and to provide working capital to allow Fonix to focus on marketing
and development opportunities for its Interactive Technology Solutions Group.
However, because the requirements to consummate the sale have not yet been met,
the Company has not given effect to the potential sale in the pro forma
financial statement data reflected in Note 2.
4. CERTIFICATE OF DEPOSIT
At December 31, 1998, the Company maintained a $20,000,000 short-term
certificate of deposit at a bank which was included in cash and cash
equivalents. This certificate was pledged as collateral on a revolving note
payable (see Note 6). On January 8, 1999, this certificate of deposit matured
and was not renewed. Proceeds from the certificate were applied to reduce the
related revolving note payable balance.
5. INTANGIBLE ASSETS
Intangible assets consist of purchased core technology and goodwill in
connection with the acquisitions of AcuVoice, Articulate and Papyrus and direct
costs incurred by the Company in applying for patents covering its technologies.
Amortization is computed on a straight-line basis over the estimated useful
lives ranging from five to eight years. Total accumulated amortization was
$5,191,162 and $2,599,554 at June 30, 1999 and December 31, 1998, respectively.
The Company evaluates, at each balance sheet date, whether events and
circumstances have occurred that indicate possible impairment of long-lived
assets which may require reduction in the book value of such assets. The Company
uses an estimate of future undiscounted net cash flows of the related asset or
group of assets over the remaining life in measuring whether the assets are
recoverable. The Company assesses impairment of long-lived assets at the lowest
level for which there are identifiable cash flows that are independent of other
groups of assets. As of June 30, 1999, the Company does not believe any of its
long-lived assets are impaired. However, the amount of goodwill and other
long-lived assets considered realizable could be reduced in the near term based
on changing conditions and the Company's success in funding further marketing
and development of its products and technologies.
8
<PAGE>
6. REVOLVING AND OTHER NOTES PAYABLE
At December 31, 1998, the Company had a revolving note payable to a bank in the
amount of $19,988,193. This note was due January 8, 1999, bore an interest rate
of 6.00 percent, and was secured by a certificate of deposit in the amount of
$20,000,000 (see Note 4). The Company paid this revolving note in full,
including accrued interest, on January 8, 1999 with proceeds from the
certificate of deposit that secured the note and $22,667 in cash.
At June 30, 1999, the Company had an unsecured revolving note payable to a bank
in the amount of $50,000. Amounts loaned under the revolving note payable are
limited to $50,000. This note is payable on demand, matures April 1, 2007, bears
interest at the bank's prime rate (7.75 percent at June 30, 1999) plus 2.0
percent and requires interest to be paid monthly. The weighted average
outstanding balance during the six months ended June 30, 1999 was $50,000. The
weighted average interest rate was 9.75 percent during this period.
At June 30, 1999, the Company had a note payable to a lender in the amount of
$588,000 which bears interest at 18 percent per year, which interest is payable
monthly. The note payable was originally due January 2, 1999 and is secured by
certain accounts receivable of the Company. The Company has extended the due
date on a monthly basis, currently to August 31, 1999, by paying the lender or
capitalizing accrued interest plus a fee of 1% of the loan balance each month.
The Company anticipates that this loan will be paid in full upon the closing of
the sale of the HSG to L&H (see Note 3). The Company further anticipates that it
will request additional extensions of the due date if the sale of the HSG to L&H
has not closed by August 31, 1999. The note is personally guaranteed by two
officers and directors and a former officer and director of the Company (the
"Guarantors"). The Company anticipates that it will enter into an indemnity
agreement with the guarantors relating to this and other guarantees and pledges
(see Note 10).
At June 30, 1999, the Company had a notes payable to L&H in the amount of
$1,100,000. The note was payable in full including accrued interest on July 28,
1999 and bears interest at the prime rate as published in The Wall Street
Journal under the heading "Money Rates" (7.75 percent at June 30, 1999) plus 2.0
percent. The loan is secured by all the assets of Fonix/Articulate, Inc.
("Fonix/ASI"), a wholly owned subsidiary of the Company, including its
intellectual property rights represented by patents, copyrights and trademarks.
L&H agreed to extend the due date to the earlier of the closing of the sale of
the HSG to L&H or September 30, 1999 (see Note 3).
At June 30, 1999, the Company had a second note payable to L&H in the amount of
$4,600,000. This note was payable in full including accrued interest on July 28,
1999 and bears interest on the same terms as the loan of $1,100,000 described in
the preceding paragraph. The loan is secured by all the assets of Fonix/ASI
including its intellectual property rights represented by patents, copyrights
and trademarks. The loan is further secured by all the Company's stock of
Fonix/ASI. L&H agreed to extend the due date to the earlier of the closing of
the sale of the HSG to L&H or September 30, 1999 (see Note 3). This note was
authorized for a total of $4,900,000 and the additional $300,000 was received by
the Company in July 1999. On August 12, 1999, L&H agreed to increase this loan
by an additional $1,200,000 subject to the existing terms of the loan. The
Company received funds from this loan on August 13, 1999.
The cost of warrants issued to L&H in connection with the above two notes (see
Note 9) determined under the Black-Scholes pricing model was $246,240 and is
being amortized as a financing expense over the period of the loans. As of June
30, 1999 the unamortized financing expense was $100,444.
9
<PAGE>
7. RELATED-PARTY NOTES PAYABLE
At June 30, 1999, the Company had unsecured demand notes payable to former
Articulate stockholders in the aggregate amount of $4,063,597 related to the
acquisition of Articulate in 1998. These notes were payable on demand any time
after November 30, 1998. In December 1998, the holder of a $407,971 note
demanded payment. In connection with this demand, the Company paid the holder a
partial payment of $50,000 in 1998, extended the date on which demand could be
made to March 15, 1999 and increased the interest rate to 11 percent per year.
No additional demand has been received for payment of this note. In 1998, the
Company also negotiated extensions of $1,803,683 of the notes to May 30, 1999
and adjusted the interest rate to 10 percent per year. During the six months
ended June 30, 1999, the Company made partial payments totaling $800,000 on a
$2,535,235 note and agreed to pay the balance of all of these notes in
connection with the sale of the HSG to L&H (see Note 3).
At June 30, 1999, the Company had unsecured demand notes payable to former
Articulate employees in the aggregate amount of $452,900 and accrued liabilities
of $404,100 to the same employees. Both amounts are related to incentive
compensation granted the employees for continued employment with the Company
after the acquisition of Articulate in 1998. The demand notes bear interest at
an annual rate of 8.5 percent and were payable upon demand after November 1,
1998. None of the holders of these notes has demanded payment. The Company has
agreed to pay interest on these notes at 9 percent per year after November 1,
1998. No demand for payment has been made for the accrued liability of $404,100
of accrued liabilities by the former Articulate employees.
At June 30, 1999, the Company had unsecured demand notes payable to former
Papyrus stockholders in the aggregate amount of $1,710,000, which notes were
issued in connection with the acquisition of Papyrus in 1998. The notes were
payable in various installments from February 28, 1999 through September 30,
1999. In April 1999, the Company entered into agreements with five former
Papyrus shareholders to reduce the aggregate amounts payable to them under these
notes from $1,632,375 to $1,188,909, which amounts will be paid in connection
with the sale of the HSG to L&H (see Note 3). The aggregate remaining balance of
$77,625 of the notes payable to former shareholders of Papyrus will also be paid
in connection with the closing of the sale of the HSG to L&H (see Note 3).
At June 30, 1999, the Company had an unsecured revolving note payable in the
amount of $257,965 in principal and $7,173 in accrued interest to SMD, a company
owned by two individuals who are executive officers and directors and one
individual who is a former officer and director of the Company and who each
beneficially own more than 10 percent of the Company's common stock. The
weighted average balance outstanding during the six months ended June 30, 1999
was $134,217. This revolving note is payable on demand and bears interest at an
annual rate of 12 percent. The maximum amount outstanding under this revolving
note during the period ended June 30, 1999 was $257,965. In 1999, advances to
the three individuals in the amount of $59,986 were applied as a partial payment
of this note.
At June 30, 1999, the Company had an unsecured, non-interest bearing demand note
payable in the amount of $100,000 to Synergetics, Inc. ("Synergetics"), a
research and development entity (see Note 12). This note is payable on demand.
No demand has been received by the Company.
At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $20,000, which bears interest at an annual rate of 10
percent and was due December 31, 1998. The holder of this note agreed to extend
the due date to September 30, 1999.
At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $68,691 which bears interest at an annual rate of 10
percent and was due on or before July 31, 1999. The holder of this note agreed
to extend the due date to August 31, 1999.
The Company believes the terms of the related-party revolving notes payable are
at least as favorable to the Company as the terms that could have been obtained
from unrelated third parties in similar transactions.
10
<PAGE>
8. SERIES C 5% CONVERTIBLE DEBENTURES
On January 29, 1999, the Company entered into a Securities Purchase Agreement
with four investors pursuant to which the Company sold its Series C 5%,
Convertible Debentures (the "Debentures") in the aggregate principal amount of
$4,000,000. The outstanding principal amount of the Debentures is convertible at
any time at the option of the holders into shares of the Company's common stock
at a conversion price equal to the lesser of $1.25 or 80 percent of the average
of the closing bid price of the Company's common stock for the five trading days
immediately preceding the conversion date. The Company recorded $687,500 as
interest expense upon the issuance of the Debentures in connection with this
beneficial conversion feature. The Company also issued 400,000 warrants to
purchase an equal number of the Company's common shares at a strike price of
$1.25 per share in connection with this financing. The warrants are exercisable
for a period of three years from the date of grant. The estimated fair value of
the warrants of $192,000, as computed under the Black-Scholes pricing model, was
recorded as interest expense upon the issuance of the debentures. On March 3,
1999, the Company executed a supplemental agreement pursuant to which the
Company agreed to sell another $2,500,000 principal amount of Series C 5%
Convertible Debentures on the same terms and conditions as the January 29, 1999
agreement, except no additional warrants were issued. The Company recorded
$1,062,500 as interest expense upon the issuance of the supplemental debentures
in connection with the beneficial conversion feature. The obligations of the
Company for repayment of the debentures, as well as its obligation to register
the common stock underlying the potential conversion of the Debentures and the
exercise of the warrants issued in these transactions, are personally guaranteed
by the Guarantors (see Note 10). In connection with the March 3, 1999 funding,
the Company agreed to grant a lien on the patent covering the Company's
Automated Speech Recognition ("ASR") technologies as collateral for repayment of
the debentures. However, to date no lien on the patent has been granted. The
Guarantors guaranteed the obligations of the Company under the Debentures and
pledged 6,000,000 shares of common stock of the Company beneficially owned by
them as collateral security for their obligations under their guarantee.
Subsequent to the March 3, 1999 funding, the holders of the Debentures notified
the Company and the Guarantors that the Guarantors were in default under the
terms of the pledge and that the holders intended to exercise their rights to
sell some or all of the pledged shares of the Guarantors. At the present time,
the Company has no knowledge of sales of the Guarantors' shares by the holders.
However, if the holders proceed to sell some or all of the Guarantors' shares,
the Company may be obligated, under its indemnity agreement in favor of the
Guarantors, to issue replacement shares to the Guarantors for all shares sold by
the holders and reimburse the Guarantors for any costs incurred as a result of
the holders' sales of the Guarantors' shares (see Note 10).
On June 29, 1999, the Company received notice from the Nasdaq Stock Market
indicating that unless the minimum bid price for the Company's common stock
returned to at least $1.00 per share for at least ten consecutive trading days
prior to September 29, 1999, the Company's shares would be delisted from the
Nasdaq SmallCap Market on October 1, 1999 (see Note 13). If the Company's common
stock is delisted from the Nasdaq SmallCap Market and is not relisted within
three trading days, an event of default would result under the terms of the
Debentures. Upon the occurrence of an event of default, the full $6,500,000
principal amount of all of the Debentures, together with accrued interest and
all other amounts owing in respect thereof, would become immediately due and
payable in cash.
9. STOCKHOLDERS' EQUITY
Series D and E Preferred Stock - During the six months ended June 30, 1999,
36,000 shares of Series D Convertible Preferred Stock and 91,572 shares of
Series E Convertible Preferred Stock, together with related dividends on each,
were converted into 1,288,479 shares and 3,246,183 shares, respectively, of the
Company's common stock. After the above conversions, 972,334 shares of Series D
and 43,500 shares of Series E Convertible Preferred Stock remain outstanding.
On February 3, 1999, certain holders of Series D and Series E preferred stock
forwarded conversion notices to the Company converting (i) 27,500 shares of
Series D preferred stock and related dividends into 315,379 shares of common
stock and (ii) 77,500 shares of Series E preferred stock and related dividends
into 1,955,346 shares of common stock. Due to an error in the conversion
calculations and a subsequent delay in receiving further clarifying instructions
from the holders, the common shares issuable upon such conversions were never
issued to the Series D and Series E holders, although the Company's records
reflected that such shares had been issued. Subsequently, because the common
11
<PAGE>
stock had not been received, the Series D and Series E holders rescinded the
February 3 conversions, as they were legally entitled to do under the terms and
conditions of the Series D and E preferred stock agreements. The effects of this
recission have been retroactively reflected in the accompanying condensed
consolidated financial statements.
On June 29, 1999, the Company received notice from the Nasdaq Stock Market
indicating that unless the minimum bid price for the Company's common stock
returned to at least $1.00 per share for at least ten consecutive trading days
prior to September 29, 1999, the Company's shares would be delisted from the
Nasdaq SmallCap Market on October 1, 1999 (see Note 13). If the Company's common
stock is delisted from the Nasdaq SmallCap Market and is not relisted within
three trading days, the terms of the Series D and Series E Preferred Stock
require the Company to pay to each holder of Series D or Series E Preferred
Stock a fee of two percent of the purchase price of the Series D or Series E
Preferred Stock, to be paid in cash, for each month during which the stock is
delisted. Common Stock Issued - On June 2, 1999, the Company issued 200,000
shares of common stock (having a market value of $100,000 on that date) to an
unrelated individual in payment for consulting services rendered.
Common Stock Options - During the six months ended June 30, 1999, the Company
granted 754,500 stock options to employees and 9,500 stock options to two
consultants at exercise prices ranging from $0.59 to $1.78 per share. The term
of all options granted during this six month period is ten years from the date
of grant. Of the stock options issued, 726,334 vested immediately, 18,834 vest
six months after issuance and 18,832 vest one year after issuance. The weighted
average fair value of the options granted to employees during the six months
ended June 30, 1999 was $1.31 per share using the Black-Scholes pricing model.
Had compensation expense for the issuance of these options been recorded in
accordance with the method prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company's net loss would have been $18,226,654 or
$0.28 per share for the six months ended June 30, 1999. As of June 30, 1999, the
Company had a total of 16,139,282 options outstanding.
Common Stock Warrants - During the six months ended June 30, 1999, the Company
granted warrants to L&H in connection with loans totaling $6,000,000 which L&H
made to the Company in April and May 1999 (see Note 6). These warrants allow L&H
to purchase 850,000 shares of common stock of the Company at exercise prices
ranging from $0.60 to $0.70 per share. Of the warrants, 250,000 expire October
18, 1999 and 600,000 expire May 17, 2001. The fair value of the warrants was
$0.14 and $0.35 per share for the 250,000 and 600,000 warrants, respectively,
using the Black-Scholes pricing model. The cost of the warrants totaled $246,240
and is being amortized as a financing expense over the period of the loans.
10. RELATED-PARTY TRANSACTIONS
Related-party transactions with entities owned by two individuals who are
executive officers and directors and one individual who is a former officer and
director of the Company and who each beneficially own more than 10 percent of
the Company's issued and outstanding common stock not otherwise disclosed herein
as of and for the six months ended June 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
------ -----
<S> <C> <C>
Expenses:
Base rent $ 62,208 $ 54,235
Liabilities:
Accrued liabilities - 22,786
</TABLE>
The Company rents office space under a month-to-month lease from Studdert
Companies Corporation ("SCC"). The lease from SCC is guaranteed by the three
officers, owners and directors of SCC. The lease requires monthly payments of
$10,368. The Company believes the terms of the related-party lease are at least
as favorable to the Company as the terms that could have been obtained from an
unaffiliated third party in a similar transaction. Guarantee of Company
Obligations and Related Indemnity Agreement - The Guarantors have guaranteed
certain obligations of the Company (see Notes 6 and 8). As security for some of
the guarantees, the Guarantors have also pledged shares of Fonix common stock
12
<PAGE>
beneficially owned by them. The guaranteed obligations and the related pledged
Fonix shares as of June 30, 1999 are as follows:
<TABLE>
<CAPTION>
Amount Shares
Guaranteed Pledged
<S> <C> <C> <C>
Series C 5% Convertible Debentures $ 6,500,000 6,000,000
Note payable 560,000 -
</TABLE>
The Company has agreed to indemnify the Guarantors if they are required to pay
any sums for the benefit of the Company under their guaranty of the Debentures.
The indemnity agreement provides that the Company will issue shares of the
Company's common stock of sufficient value to reimburse the Guarantors in full,
plus interest at 10 percent per annum, for all costs associated with meeting the
guarantee commitment, including any income taxes resulting therefrom.
Additionally, in consideration for the pledge of Fonix common shares as
collateral for the Debentures, the Board of Directors authorized the issuance to
the Guarantors of one common stock purchase warrant for every three shares
pledged. However, subsequent to the Board of Directors' authorization, the
Guarantors declined to accept the warrants and they were not issued.
In December 1998, the Guarantors guaranteed certain obligations of the Company.
As security for some of the guarantees, the Guarantors also pledged shares of
Fonix common stock beneficially owned by them. In March 1999, 143,230 of the
shares previously pledged by the Guarantors to a bank were sold by the bank and
the proceeds were used to pay Company credit card balances and the related
accrued interest in full totaling $244,824. In May 1999, 100,000 of the shares
previously pledged by the Guarantors to another creditor of the Company were
sold by the creditor and the proceeds, totaling $72,335, were used to pay
amounts owed by the Company. These respective amounts are now included in the
unsecured revolving note payable to SMD described in Note 7.
The Company anticipates that in the future the Guarantors may request that the
Company provide indemnity and/or compensation for the guarantees, advances
and/or pledges by the Guarantors for the benefit of the Company. To the extent
such requests, if any, are reasonable and of a nature similar to what the
Company would grant to unrelated parties in similar transactions, the Company
presently anticipates that it will consider such requests.
11. STATEMENT OF WORK
On February 11, 1998, the Company entered into a First Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") under which the Company and Siemens are jointly pursuing the
development of Siemens' integrated circuits incorporating ASR and other related
technologies for use in certain telecommunications applications. In connection
with the license agreement Siemens purchased warrants to acquire 1,000,000
shares of restricted common stock at an average exercise price of $20 per share
with expiration dates ranging from December 31, 1998 to December 31, 1999. As of
June 30, 1999, 600,000 of the warrants originally issued had expired and 400,000
of the warrants remain outstanding at an average exercise price of $27.50 per
share.
12. PRODUCT DEVELOPMENT AND RESEARCH
Synergetics - In October 1993, the Company entered into an agreement with
Synergetics, a research and development entity, whereby Synergetics was to
develop certain technologies related to the Company's ASR technologies. Under
the terms of the Synergetics agreement, the Company expended $186,455 during the
six months ended June 30, 1999 for product development and research efforts. No
amounts were expended during the three months ended June 30, 1999.
IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2, a research and development entity, to provide assistance to the
Company in the continuing development of specific ASR technologies. The
President of IMC2 is also the President of Synergetics. The professional
services agreement is for a term of 36 months and requires the Company to make
monthly payments of $22,000. Under the terms of the agreement, the Company
13
<PAGE>
expended $66,000 and $132,000 during the three and six months ended June 30,
1999, respectively.
Adiva- Beginning in 1998, the Company utilized the research and development
services of Adiva. The president of Adiva is also the president of Synergetics
and IMC2. The Company expended $63,395 during the six months ended June 30, 1999
for research and development efforts. No amounts were expended during the three
months ended June 30, 1999.
13. COMMITMENTS AND CONTINGENCIES
Employment Agreements - In January 1998, the Company entered into employment
contracts with two employees which expire in January 2001. The minimum annual
salary payments required by these contracts total $405,000. In connection with
these agreements, these individuals were granted options to purchase 360,000
shares of the Company's common stock at $3.34 per share. These options have a
ten-year life and are subject to a three-year vesting schedule, pursuant to
which one-third of the total number of options granted are vested on the date of
grant and one-third vests each year thereafter. In the event that, during the
contract term, both a change of control occurs, and within six months after such
change in control occurs, the executive's employment is terminated by the
Company for any reason other than cause, death or retirement, the executive
shall be entitled to receive an amount in cash equal to all base salary then and
thereafter payable within thirty days of termination. In January 1999, the
Company announced a major cost reduction program for the Company's 1999
operating year wherein the two employees referred to above agreed that their
compensation would be reduced 30 percent effective February 1999.
Executive Employment Agreements - On November 1, 1996, the Company entered into
employment contracts with three executive officers (one of whom is no longer an
executive officer) which expire on December 31, 2001. The annual base salary
pursuant to the contracts with each executive officer for the year ended
December 31, 1999 is $425,000. In January 1999, the Company announced a major
cost reduction program for the Company's 1999 operating year wherein the two
remaining executive officers agreed that their annual compensation would be
reduced to $297,500 commencing February 1999. At the same time, Stephen M.
Studdert resigned as the Company's Chief Executive Officer and entered into a
separation agreement pursuant to which Mr. Studdert will be paid $250,000 per
year through January 31, 2001 and $100,000 for the year ended January 31, 2002.
Additionally, his employment contract described above was canceled.
Professional Services Agreement - Effective May 7, 1998, the Company entered
into a one-year professional services agreement with a public relations firm.
The minimum monthly retainer was $15,000 per month. In connection with this
agreement, the firm was granted options to purchase 100,000 shares of the
Company's common stock at $3.75 per share. In May 1999, the Company negotiated a
termination of this agreement for a cash payment of approximately $33,000 and
the grant of warrants was rescinded.
Operating Lease Agreement - In March 1999, the Company entered into an agreement
to lease office space in Cleveland, Ohio for sales and installation personnel of
the HSG. The lease is for three years at a monthly rate of $4,260 and became
effective May 1, 1999. L&H will assume this lease in connection with its
purchase of the HSG.
Future aggregate minimum obligations under this operating lease are as follows:
<TABLE>
<CAPTION>
Years ending December 31,
<S> <C> <C>
1999 $ 25,560
2000 51,120
2001 51,120
2002 17,040
---------
Total $144,840
</TABLE>
Sublease of Office Facilities - Effective May 14, 1999, the Company entered into
an agreement to sublease 10,224 square feet of its Draper, Utah facility to an
unrelated third party. The agreement requires the sublessee to pay $13,961 per
month, or approximately 40 percent of the Company's monthly obligation under the
primary lease agreement through December 31, 2000. The sublessee has the option
to extend the term by two additional three-month periods. Effective May 25,
1999, the Company entered into an agreement to sublease 8,048 square feet of a
total 10,048 square feet making up its Cupertino, California facility to an
unrelated third party. The remaining 2,000 square feet occupied by the Company
is to be turned over to the sublessee no sooner than six months nor later than
nine months from the commencement of the sublease. The agreement requires the
sublessee to pay $28,346 per month, or approximately 80 percent, of the
Company's obligation under the primary lease agreement through the six to nine
month period of reduced occupancy by the Company and 100 percent thereafter
through May 31, 2003.
Capital Lease Obligations - In January 1999, the Company entered into a
noncancellable capital lease arrangement for telephone equipment at its facility
in Woburn, Massachusetts. In May 1999, the Company entered into a noncancellable
capital lease arrangement for telephone equipment at its facility in Cleveland,
Ohio. Future aggregate minimum obligations under these capital leases are as
follows:
<TABLE>
<CAPTION>
Years ending December 31,
<S> <C> <C>
1999 $ 7,394
2000 14,788
2001 14,788
2002 14,788
2003 14,788
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Thereafter 2,675
-----------
Total future minimum lease payments 69,211
Less amounts representing interest (14,726)
-----------
Present value of future minimum lease payments $ 54,495
</TABLE>
Royalty Agreements - The Company has entered into various technology license
agreements. Generally, the agreements require the Company to pay royalties at
specified dollar amounts in connection with each product sold that utilizes
technologies licensed by the Company under these agreements. The royalty expense
is accrued at the time product revenues incorporating the licensed technologies
are recognized. Royalty expense of $16,648 and $63,525 was incurred during the
three and six months ended June 30, 1999, respectively, in connection with these
agreements. There were no sales of products incorporating these licensed
technologies during the six months ended June 30, 1998.
Potential Delisting of the Company's Common Stock by Nasdaq - Potential
delisting of the Company's common stock from the Nasdaq SmallCap Market could
have an adverse effect on the liquidity of the Company's common stock and would
trigger certain rights of holders of the Company's Debentures and Preferred
Stock.
The Company's common stock currently trades on the Nasdaq SmallCap Market which
requires, for continued listing, a minimum bid price of at least $1.00 per
share. At June 29, 1999, the Company's common stock had traded below $1.00 for
more than 30 consecutive trading days. On June 29, 1999, the Company received a
letter from the Nasdaq Market indicating that unless the minimum bid price for
the Company's common stock returned to at least $1.00 per share for at least 10
consecutive trading days prior to September 29, 1999, the Company's shares would
be delisted from the Nasdaq SmallCap Market on October 1, 1999. The Company has
the right to appeal the Nasdaq Stock Market's notice and/or listing
determination on or before September 29, 1999.
If the Company's common stock is delisted from the Nasdaq SmallCap Market, the
Company believes that its common stock would qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's common
stock, even if the Company's shares are thereafter traded on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically.
Additionally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted within three trading days, an event of default would
result under the terms of the Debentures. Upon the occurrence of an event of
default, the full $6,500,000 principal amount of all of the Debentures, together
with accrued interest and all other amounts owing in respect thereof, would
become immediately due and payable in cash. The requirement to pay such amounts
would deplete the Company's existing cash, and would require the Company to
incur additional debt, thus further increasing the Company's debt obligations.
There can be no assurance that the Company would be able to borrow the amounts
needed to pay the holders of the Debentures or that such financing, if it were
available to the Company, would be available on terms satisfactory to the
Company. Presently, the Company does not have sufficient cash or other liquid
assets to pay the amount which would be due if the holders of the Debentures
declared a default thereunder.
Finally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted within three trading days, the terms of the Series D
and Series E Preferred Stock require the Company to pay to each holder of Series
D or Series E Preferred Stock a fee of two percent of the purchase price of the
Series D or Series E Preferred Stock, to be paid in cash, for each month that
the stock is delisted. The requirement to pay such amounts would deplete the
Company's existing cash, and would require the Company to incur additional debt,
thus further increasing the Company's debt obligations. There can be no
assurance that the Company would be able to borrow the amounts needed to pay the
holders of the Series D or Series E Preferred Stock or that such financing, if
it were available to the Company, would be available on terms satisfactory to
the Company. Presently, the Company does not have sufficient cash or other
liquid assets to pay the amount which would be due.
15
<PAGE>
14. LITIGATION
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse purportedly owns, commenced an action against the Company in
federal court for the Southern District of New York. Clarke and Perpetual Growth
asserted claims for breach of contract relating to certain financing the Company
received during 1998. Specifically, Clarke and Perpetual Growth alleged that
they entered into a contract with the Company under which the Company agreed to
pay them a commission of five percent of all financing provided to Fonix by
Southridge Capital Management or its affiliates. Clarke and Perpetual claim that
they are entitled to commissions with respect to approximately $3,000,000 of
equity financing to the Company in July and August 1998, and the Company's
offerings of Series D and Series E preferred stock, totaling together
$12,000,000, in August and September 1998.
The Company believes that the Clarke lawsuit is without merit and filed a motion
to dismiss based upon the court's lack of personal jurisdiction over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal. The Company has filed a suit against Clarke
and Perpetual Growth in federal court for the Central District of Utah seeking a
declaratory judgment that it does not owe any money to Clarke and Perpetual
Growth. Now that the action in New York has been dismissed, the Company intends
to vigorously pursue the Utah action. However, the lawsuit in New York could be
reinstated on appeal and Clarke and Perpetual Growth could prevail in that
lawsuit, in which case the Company may be required to pay significant amounts of
money damages awarded by the court.
Papyrus - After the Papyrus acquisition closed in October 1998, the Company
investigated some of the representations and warranties made by Papyrus to
induce the Company to acquire Papyrus. The Company determined that certain of
the representations made by Papyrus and their executive officers appeared to be
false. On February 26, 1999, the Company filed an action against Papyrus in the
United States District Court for the District of Utah, Central Division, wherein
the Company alleged claims for misrepresentation, negligent misrepresentation,
breach of contract, breach of the implied covenant of good faith and fair
dealing and rescission. On March 11, 1999, three of the former shareholders of
Papyrus filed an action against the Company in the United States District Court
for the District of Massachusetts, alleging a default under the terms of the
promissory notes issued to them in connection with the Papyrus acquisition. On
April 2, 1999, the three former Papyrus shareholders filed an amended complaint
against the Company seeking additional remedies including violation of
Massachusetts unfair and deceptive acts and practices statutes and copyright
infringement. On April 8, 1999, a fourth former Papyrus shareholder filed an
action against the Company alleging a default under the terms of the promissory
notes issued to him in connection with the Papyrus acquisition and seeking
additional remedies including violation of Massachusetts unfair and deceptive
acts and practices statutes and copyright infringement. On April 13, 1999, a
fifth former Papyrus shareholder filed a similar action in Massachusetts.
Subsequently, the Company has entered into agreements with the five former
Papyrus shareholders for dismissal of the actions and cancellation of the
promissory notes upon payment to the former shareholders of $1,188,909 (the
"Settlement Payment") and return for cancellation by the Company of 970,586
shares of restricted common stock issued to the five former shareholders in
connection with the acquisition. The Company agreed to pay the Settlement
Payment on or before August 31, 1999 or, if the definitive proxy soliciting
consents from the shareholders of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets (see Note 3) or the Company
and the five former Papyrus shareholders are free to pursue their respective
claims.
Apple Computer, Inc. - In February 1993, Articulate received a patent (the "303
patent") for a product which would allow the user of an Apple MacIntosh to
create spoken commands which the computer would recognize and respond to. Soon
after the 303 patent was issued, Articulate put Apple Computer, Inc. ("Apple")
on notice that Apple's "PlainTalk" product infringed the 303 patent. When Apple
ignored Articulate's notices, Articulate sued Apple. Apple responded to the suit
by suing Articulate and Dragon Systems, Inc., which suit was subsequently
dismissed. The Company acquired Articulate's claims against Apple in the
Articulate acquisition. The Company has completed discovery in the action
pending against Apple and is awaiting the scheduling of a trial. If the Company
closes the sale of the HSG (see Note 3) the Company's rights in and to this
litigation will be acquired by L&H.
In addition to the above, the Company is involved in various lawsuits, claims
and actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these matters will not materially affect the consolidated financial position or
results of operations of the Company.
16
<PAGE>
15. REPORTABLE SEGMENTS
The Company is organized into two business segments based primarily on the
nature of the Company's products and customers. Each segment is separately
managed because its customers require different technology solutions and
marketing strategies.
The Company's HSG includes the development, manufacture, sale, installation and
maintenance of a voice recognition product to the healthcare industry marketed
under the PowerScribe(R) trademark. The Company's Interactive Technologies
Solutions Group ("ITSG") includes the development of relationships with third
parties which can incorporate the Company's products and technologies into their
own products or product development efforts. These products and technologies
include ASR, handwriting and TTS applications.
The following tables reflect selected financial information relating to each
business segment for the three and six months ended June 30, 1999 and 1998, and
as of June 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
Three Months June 30, Six Months Ended June 30,
1999 1998 1999 1998
---------------- ----------------- ------------------ ----------------
<S> <C> <C> <C> <C>
Revenues:
HSG $ 423,481 $ - $ 1,480,007 $ -
ITSG 231,570 1,176,500 285,376 2,472,285
---------------- ----------------- ------------------ ----------------
$ 655,051 $ 1,176,500 $ 1,765,383 $ 2,472,285
================ ================= ================== ================
Gross margin:
HSG $ 302,032 $ - $ 1,138,410 $ -
ITSG 223,621 1,176,500 272,136 2,472,285
---------------- ----------------- ------------------ ----------------
528,653 1,176,500 1,410,546 2,472,285
---------------- ----------------- ------------------ ----------------
Product development and research
expenses:
HSG 488,383 - 946,836 -
ITSG 1,858,524 2,960,292 4,371,350 5,661,495
---------------- ----------------- ------------------ ----------------
2,346,907 2,960,292 5,318,186 5,661,495
---------------- ----------------- ------------------ ----------------
Selling, general and administrative
expenses:
HSG 946,800 - 1,877,292 -
ITSG 1,928,110 2,084,622 4,673,180 3,464,702
---------------- ----------------- ------------------ ----------------
2,874,910 2,084,622 6,550,472 3,464,702
---------------- ----------------- ------------------ ----------------
Amortization of goodwill and purchased
core technology:
HSG 638,279 - 1,259,943 -
ITSG 649,302 500,776 1,315,219 599,559
---------------- ----------------- ------------------ ----------------
1,287,581 500,776 2,575,162 599,559
---------------- ----------------- ------------------ ----------------
Purchased in-process research and
development:
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
HSG - - - -
ITSG - - - 9,315,000
---------------- ----------------- ------------------ ----------------
- - - 9,315,000
---------------- ----------------- ------------------ ----------------
Loss from operations:
HSG (1,771,430) - (2,945,661) -
ITSG (4,212,315) (4,369,190) (10,087,613) (16,568,471)
---------------- ----------------- ------------------ ----------------
$ (5,983,745) $ (4,369,190) $ (13,033,274) $ (16,568,471)
================ ================= ================== ================
</TABLE>
<TABLE>
<CAPTION>
As of June As of December
30, 1999 31, 1998
---------------- ----------------
<S> <C> <C>
Assets:
HSG $ 19,704,628 $ 19,760,394
ITSG 20,323,687 42,229,533
----------------- ----------------
$ 40,028,315 $ 61,989,927
================= ================
</TABLE>
16. SUBSEQUENT EVENTS
Resignation of Stephen M. Studdert, Director - Effective July 15, 1999, Stephen
M. Studdert resigned as a member of the Board of Directors of the Company.
Marketing Support Agreement for HSG products - Effective July 31, 1999, the
Company and L&H entered into an agreement pursuant to which L&H exercised its
option to become a distributor of HSG products under the Technology Option
Agreement executed May 19, 1999. At the same time, the Company transferred and
assigned to L&H certain pending sales orders, all license agreements, client and
customer contracts relating to ongoing maintenance and service obligations and
the right to use and exploit for L&H's benefit all of the existing sale leads
and opportunities of the HSG (the "Assigned Contracts"). The Company further
granted L&H the right to receive all payments due and owing under the Assigned
Contracts as if the sale of the HSG to L&H had occurred on July 1, 1999. Any
payments due L&H from the Assigned Contracts but paid to the Company prior to
the date of the Marketing Support Agreement, less $400,000 (but not less than
zero), shall reduce the purchase price of the HSG by that amount. If the closing
of the sale of HSG to L&H does not occur by September 3, 1999, such prepaid
amounts, less the credit of up to $400,000, are immediately due and payable. The
Company and L&H further agreed that L&H would assume all of the obligations of
the Company under the Assigned Contracts. L&H also agreed to engage the Company
to provide marketing, sales, product implementation and installation and
customer support services on behalf of L&H in order to (i) fulfill all of the
obligations of the Company under the Assigned Contracts and (ii) otherwise
market and sell HSG's products and certain products of L&H.
Guarantee of Company Obligations - In August 1999, the Company had unsecured
advances from a bank in the form of a bank overdraft in the approximate amount
of $100,000 that were personally guaranteed by an officer of the Company.
Subsequent to the granting of the guarantee the overdraft has been reduced to
approximately $3,000.
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 SUCH FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE
DISCUSSED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998.
Overview
Fonix is a development-stage company engaged in marketing and development of
proprietary automated speech recognition ("ASR"), text-to-speech ("TTS") and
handwriting recognition technologies and products which may be licensed in whole
or in part to third parties. The Company aims to make commercially available a
comprehensive package of products and technologies that allow humans to interact
with computer and other electronic products in a more efficient, intuitive and
natural way rather than through traditional methods such as the keyboard.
Specifically, Fonix has developed proprietary ASR and related technologies such
as TTS (speech synthesis), handwriting recognition and speech compression. These
technologies, as developed to date, use speech recognition techniques that
include the use of a proprietary neural network method. Neural networks are
computer-based methods which simulate the way the human brain processes
information. Fonix licenses its technologies to and has entered into co-
development relationships and strategic alliances with third parties including
producers of application software, operating systems, computers and
microprocessor chips.
Automated Speech Recognition
Presently available traditional ASR technologies have been used in a variety of
products for industrial, telecommunications, business and personal applications.
Speech recognition algorithms in software have been developed and refined over
the past several years. However, the increase in processing speed and memory
capacity of personal computers has accounted for much of the improvement in
traditional ASR systems during that period. This improvement includes vocabulary
size, recognition accuracy and continuous speech recognition ability. Currently
available ASR systems for personal computers include speech command systems for
navigating the Windows(R) interface and inexpensive, discrete word dictation
systems offered by Dragon Systems, IBM, Lernout & Hauspie and others. Recently,
general and specific vocabulary continuous speech dictation systems also have
been introduced by Philips, IBM, Dragon Systems and others. In addition,
telephony applications with menu choice systems and small vocabulary dialogue
systems have been demonstrated by Nuance, Nortel and others.
Fonix researchers have developed what the Company believes to be a fundamentally
new approach to the analysis of human speech sounds and the contextual
recognition of speech. The core Fonix automated speech recognition technologies
(the "ASRT" or "Core Technologies") attempt to approximate the techniques
employed by the human auditory system and language understanding centers in the
human brain. The ASRT use information in speech sounds perceptible to humans but
not discernible by current ASR systems. They also employ neural net technologies
(artificial intelligence techniques) for identifying speech components and word
sequences contextually, similar to the way in which scientists believe
information is processed by the human brain. As presently developed, the ASRT
are comprised of several components including a phonetic sound representation
recognition engine, audio signal processing, a feature extraction process, a
phoneme estimation process, and a linguistic process consisting of two
components, one of which is expert- or rule-based and one of which is based on
proprietary neural net technologies, that are designed to interpret human speech
contextually.
Fonix believes the reliable recognition of natural, spontaneous speech spoken by
one or more individuals in a variety of common environments by means of a
conveniently placed microphone, all based on its ASRT, will significantly
improve the performance, utility and convenience of applications currently based
only on traditional Hidden Markov Models ("HMM") technology such as computer
interface navigation, data input, text generation, telephony transactions,
continuous dictation and other applications. Additionally, the Company believes
that its ASRT will make possible major new speech recognition applications such
as the transcription of business meetings and conversations, real-time
speech-to-speech language translation, natural dialogues with computers for
information
19
<PAGE>
access and consumer electronic devices controlled by natural language.
HealthCare Solutions Group Products
The three PowerScribe products now being sold by the HealthCare Solutions Group
("HSG") are PowerScribeRAD, PowerScribeRAD Software Development Kit and
PowerScribeEM. PowerScribe products use state-of-the-art continuous speech
recognition engines licensed from Dragon Systems, which enable a user to dictate
naturally and continuously without having to pause between words. PowerScribe
incorporates customized medical language models gleaned from millions of words
sampled from medical specialty departments across North America.
PowerScribe products have been designed as mission-critical applications to
operate as an open and scalable continuous speech reporting and charting system.
PowerScribe products utilize core technologies from Microsoft's Back Office(R)
applications development suite and rely on Windows NT(R), Open Database
Connectivity (ODBC) and SQL Server(R) as the foundation operational elements.
During the six months ended June 30, 1999, the Company received in the
aggregate, $1,480,007 in revenue from sales of the PowerScribe Radiology product
marketed by the HSG.
On May 19, 1999, the Company entered into an agreement to sell the operations
and a significant portion of the assets of its HSG to L&H, an unrelated third
party, for $28,000,000, of which $24,000,000 is to be paid at closing, and the
remaining $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years based on agreed upon performance milestones of the
HSG for those subsequent two years. The sale is subject to approval by Fonix's
shareholders, and is scheduled to close during the third quarter of 1999. The
proceeds from the sale will be used to reduce certain of the Company's
liabilities and to provide working capital to allow Fonix to focus on marketing
and development opportunities for its Interactive Technology Solutions Group.
Interactive Technology Solutions Group Products
The Interactive Technologies Solutions Group ("ITSG") offers products and
technologies which include automated speech recognition, text-to-speech, and
handwriting recognition for a variety of hardware and software platforms. The
marketing direction for the ITSG is to form relationships with third parties who
can incorporate the Company's technologies into their own products or product
development efforts. Such relationships may be structured in any of a variety of
ways including traditional technology licenses, co-development relationships
through joint ventures or otherwise, and strategic alliances. The third parties
with whom Fonix presently has such relationships and with which it may have
similar relationships in the future include participants in the application
software, operating systems, computer, microprocessor chips, consumer
electronics, automobile, telephony and health care technology market sectors.
ITSG products include FAAST, AcuVoice AV 1700 and AV 2001 TTS systems, and
handwriting recognition products.
Embedded Technologies
Fonix has developed an application development tool, the Fonix Advanced
Application Speech Toolkit (FASSTtm) which allows developers to simulate,
prototype and create code for embedded applications using the Company's TTS and
ASRT. This system currently supports the Company's speech recognition for
command and control applications and Fonix/AcuVoice TTS engines for both very
high quality limited vocabulary and high quality unlimited vocabulary
applications. The system is designed to support a number of popular
microprocessors and operating systems for embedded applications. Currently,
FAAST supports the Infineon (formerly Siemens) TriCore micro-controller, the
Intel StrongArm RISC processor, Epson EOC-33 micro-controller, MIPS RISC core
and the Hitachi SH#3 RISC processor. The beta version of the FAAST system became
available for developers in June 1999. A beta version of the system is currently
being used internally at Fonix to support the development of embedded systems
applications for several companies which manufacture and sell consumer
electronic, automotive, and cell phone devices.
Speech Technologies
Since 1994 Fonix has pursued the development of a "3rd Generation" automated
speech recognition technology to overcome the limitations of currently available
commercial speech recognition systems. This development has yielded a
20
<PAGE>
proprietary ASRT system utilizing a unique front-end analysis of the acoustic
speech signal, a neural net based phoneme identifier, and a completely novel
neural net architecture for back-end language modeling. The latter component is
the MULTCONS or multi-level constraint satisfaction network. These developments
have been the subject of two issued patents. In addition, the Company has
acquired a related patent covering portions of this technology. Portions of this
technology are currently being employed in Fonix embedded systems applications.
The Company's TTS products include those developed by AcuVoice and those
developed by Fonix. All are sold under the AcuVoice brand name. The products
include the AcuVoice AV 1700 TTS system for end-user desktop and laptop system
use. The AcuVoice AV 2001 SDK is a software development kit ("SDK") for
developers of telephony applications. Run-time software licenses for the AV 2001
are offered for applications developed with the SDK. The SDK supports major
computer telephony platforms.
During the six months ended June 30, 1999, the Company received in the
aggregate, $285,376 in revenue from licensing or sale of the AcuVoice
technologies and products.
Handwriting Recognition
The Company markets the Allegro handwriting recognition software developed by
Papyrus. Allegro is a single letter recognition system like the popular Graffiti
handwriting recognition software for the PalmPilot PDA (Personal Dictation
Assistant). However, Allegro's alphabet is all natural in appearance as lower
case letters. Because the letters are written in the standard way in almost all
instances, the Allegro system is easy to use and requires practically no
learning. The Company also markets cursive handwriting recognition software
which recognizes naturally-written whole words. This cursive technology is only
available as a licensed product to OEM customers. Both the Allegro and the
cursive handwriting recognition software are user independent and require no
training on the software.
During the six months ended June 30, 1999, the Company received no revenue from
licensing or sale of the handwriting recognition technologies.
Resignation of Stephen M. Studdert, Director
On April 30, 1999, Stephen M. Studdert resigned as Chairman of the Board of
Directors of Fonix. On July 15, 1999, Mr. Studdert resigned as a member of the
Board of Directors of the Company.
Year 2000 Issue
Many computer systems and software products are coded to accept only two digit
entries in the date code field. These date code fields will need to accept four
digit entries to distinguish 21st century dates from 20th century dates. As a
result, many companies' software and computer systems will need to be upgraded
or replaced in order to comply with such Year 2000 requirements. Fonix is
subject to the risk that problems encountered with Year 2000 issues, either in
its internal systems, technologies and products, or in external systems could
adversely affect its operations and financial condition.
In the ordinary course of its business, Fonix tests and evaluates its
technologies and software and hardware products. Fonix believes that its
technologies and products generally are Year 2000 compliant, meaning that the
use or occurrence of dates on or after January 1, 2000 will not materially
affect the performance of such technologies or products with respect to four
digit date dependent data or the ability of such products to correctly create,
store, process, and output information related to such data. However, Fonix may
learn that certain of its technologies or products do not contain all necessary
software routines and codes necessary for the accurate calculation, display,
storage, and manipulation of data involving dates. In addition, Fonix has
warranted or expects to warrant that the use or occurrence of dates on or after
January 1, 2000 will not adversely affect the performance of its technologies or
products with respect to four digit date dependent data or the ability to
create, store, process, and output information related to such data. If the end
users of any of Fonix's technologies or products experience Year 2000 problems,
those persons could assert claims for damages.
21
<PAGE>
Fonix uses third-party equipment and software that may not be Year 2000
compliant. Fonix is presently conducting a review of key products provided by
outside vendors to determine if their products are Year 2000 compliant. Although
that process is not yet completed, Fonix presently believes that all software
provided by third parties that is critical to its business is Year 2000
compliant. Fonix has completed its review of most products and systems and
expects to complete its review of all internal systems for Year 2000 compliance
by September 30, 1999. If this third-party equipment or software does not
operate properly with regard to the Year 2000 issue, Fonix may incur unexpected
expenses to remedy any problems. Such costs may materially adversely affect
Fonix's business, operating results, and financial condition. In addition, if
Fonix's key systems, or a significant number of its systems, fail as a result of
Year 2000 problems Fonix could incur substantial costs and disruption of its
business. Fonix may also experience delays in implementing Year 2000 compliant
software products. Any of these problems may materially adversely affect Fonix's
business, operating results or financial condition.
In addition, the purchasing patterns of Fonix's licensees, potential licensees,
customers and potential customers may be affected by Year 2000 issues. Many
companies are expending significant resources to correct their current software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to license Fonix technologies or to purchase other Fonix products.
This may adversely affect Fonix's business, operating results, and financial
condition.
Results of Operations
Three months ended June 30, 1999 compared with three months ended June 30, 1998
During the three months ended June 30, 1999, the Company recorded revenues of
$655,051, a decrease of $521,449 over the same period in the previous year. In
the 1998 period the Company received $1,076,426 from Siemens as a non-refundable
license fee for which the Company had no further obligation of any kind. The
1999 revenues are primarily from sales and licensing fees related to the
PowerScribe dictation product and TTS technologies and products.
Selling, general and administrative expenses were $2,874,910 and $2,084,622 for
the three months ended June 30, 1999 and 1998, respectively. Salaries, wages and
related costs were $1,289,949 and $879,201 for the three months ended June 30,
1999 and 1998, respectively, an increase of $410,748. This increase is
attributable to increases in personnel costs resulting from the acquisitions of
AcuVoice, Articulate and Papyrus. Legal and accounting expenses increased
$136,110. This increase is attributed primarily to the costs of legal and
accounting services related to the issuance of the Series C 5% Convertible
Debentures (the "Debentures") and the potential sale of the HSG assets to L&H.
Marketing expenses increased $842,411 and consulting and outside services
increased by $72,030. The increase in Marketing expenses was due to the
acquisition of the PowerScribe Products marketing personnel of MRC, the creation
of a marketing group for the TTS products and an increase in the marketing
effort for the ITSG.
The Company incurred product development and research expenses of $2,346,907
during the three months ended June 30, 1999, a decrease of $613,385 over the
same period in the previous year. This decrease was due primarily to
management's cost reduction initiatives implemented in February 1999. The
Company anticipates similar decreases in product development and research costs
as it begins to complete the development of certain TTS products and completes
the sale the HSG to L&H. During the three months ended June 30, 1999 and 1998,
the Company expended a total of approximately $320,000 and $30,000,
respectively, in connection with the development of the AcuVoice and Articulate
purchased in-process research and development projects.
Amortization of goodwill and purchased core technologies were $1,287,581 and
$500,776 for the three months ended June 30, 1999 and 1998, respectively,
representing an increase of $786,805. This increase is primarily attributable to
the amortization of intangible assets acquired in connection with the
acquisitions of Articulate and Papyrus.
The Company incurred losses from operations of $5,983,745 and $4,369,190 during
the three months ended June 30, 1999 and 1998, respectively. The increase in
losses from operations is due primarily to increases in selling, general and
administrative expenses and amortization expense, offset in part by decreases in
product development and research costs. The Company anticipates that its
investment in ongoing scientific product development and research will continue
at present or decreased levels for the remainder of fiscal 1999, assuming
availability of working capital.
22
<PAGE>
Net other expense was $534,042 for the three months ended June 30, 1999, an
increase of $543,470 over the three months ended June 30, 1998. This increase
was due primarily to an increase in interest expense of $251,065 related to
financing costs associated with the issuance of the Debentures and to a
reduction in interest income of $292,405 from certificates of deposit that were
converted to cash to retire a bank line of credit in January 1999.
Six months ended June 30, 1999 compared with six months ended June 30, 1998
During the six months ended June 30, 1999, the Company recorded revenues of
$1,765,383, a decrease of $706,902 over the same period in the previous year. In
the 1998 period the Company received its first revenues of $2,472,285, of which,
$2,368,138 was paid by Siemens as a non-refundable license fee for which the
Company had no further obligation of any kind. The 1999 revenues are primarily
from sales and licensing fees related to the PowerScribe dictation product and
TTS technologies and products.
Selling, general and administrative expenses were $6,550,472 and $3,464,702 for
the six months ended June 30, 1999 and 1998, respectively. Salaries, wages and
related costs were $3,348,575 and $1,526,389 for the six months ended June 30,
1999 and 1998, respectively, an increase of $1,822,186. This increase is
attributable to increases in personnel costs resulting from the acquisitions of
AcuVoice, Articulate and Papyrus. Legal and accounting expenses increased
$374,802. This increase is attributed primarily to the costs of legal and
accounting services related to the issuance of the Debentures, and the potential
sale of the HSG assets to L&H. Marketing expenses increased $1,966,616 and
consulting and outside services increased by $166,134. The increase in Marketing
expenses was due to the acquisition of the PowerScribe products marketing
personnel of MRC, the creation of a marketing group for the TTS products and an
increase in the marketing effort for the ITSG.
The Company incurred product development and research expenses of $5,318,186
during the six months ended June 30, 1999, a decrease of $343,309 over the same
period in the previous year. This decrease was due primarily to management's
cost reduction initiatives implemented in February 1999. The Company anticipates
similar decreases in product development and research costs as it begins to
complete the development of certain TTS and completes the sale of the HSG to
L&H. During the six months ended June 30, 1999 and 1998, the Company expended a
total of approximately $600,000 and $60,000, respectively, in connection with
the development of the AcuVoice and Articulate purchased in-process research and
development projects.
Amortization of goodwill and purchased core technologies were $2,575,162 and
$599,559 for the six months ended June 30, 1999 and 1998, respectively,
representing an increase of $1,975,603. This increase is primarily attributable
to the amortization of intangible assets acquired in connection with the
acquisitions of AcuVoice, Articulate and Papyrus.
The Company incurred losses from operations of $13,033,274 and $16,568,471
during the six months ended June 30, 1999 and 1998, respectively. The decrease
in losses from operations is due primarily to the $9,315,000 charge for
in-process research and development costs during the six months ended June 30,
1998, offset in part by increases in selling, general and administrative
expenses and amortization expense. The Company anticipates that its investment
in ongoing scientific product development and research will continue at present
or decreased levels for the remainder of fiscal 1999, assuming availability of
working capital.
Net other expense was $2,779,375 for the six months ended June 30, 1999, an
increase of $2,748,356 over the six months ended June 30, 1998. This increase
was due primarily to an increase in interest expense of $2,206,520 related to
financing costs associated with the issuance of the Debentures.
In-Process Research and Development
At the dates of acquisition of AcuVoice and Articulate, management estimated
that each of the acquired in-process research and development projects of
AcuVoice and Articulate were approximately 75 percent complete and that an
additional $1.0 million would be required to develop each of these projects to
commercial viability. Additionally, management anticipated release dates of the
fourth quarter of 1999 for the AcuVoice projects, and the first quarter of 2000
for the Articulate projects. As of June 30, 1999, the Company has expended a
total of approximately $280,000 and $720,000 in connection with the AcuVoice and
Articulate acquired in-process research and development projects, respectively,
23
<PAGE>
and management estimates that a total of approximately $720,000 and $280,000
will be required to complete the AcuVoice and Articulate projects, respectively.
Management also estimates that the AcuVoice and Articulate projects are 82
percent and 93 percent complete, respectively, as of June 30, 1999, and that the
release dates are the same as anticipated at the date of acquisition.
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its cash
requirements during the next 12 months. The scientific research and development,
corporate operations and marketing expenses will continue to require additional
capital. In addition, the Company's recent acquisitions of AcuVoice, Articulate,
and Papyrus place further requirements on the Company's limited cash resources.
Because the Company presently has only limited revenue from operations, the
Company intends to continue to rely primarily on financing through the sale of
its equity and debt securities or sales of existing technologies or businesses
to satisfy future capital requirements until such time as the Company is able to
enter into additional 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 such agreements. Furthermore, the issuance of equity securities or other
securities which are or may become convertible into equity securities of the
Company in connection with such financing (or in connection with acquisitions)
would result in dilution to the stockholders of the Company which could be
substantial.
On May 19, 1999, the Company entered into an agreement to sell the operations
and a significant portion of the assets of its HSG to L&H, an unrelated third
party, for $28,000,000, of which $24,000,000 is to be paid at closing, and the
remaining $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years subject to the achievement of certain performance
milestones of the HSG. The sale is subject to approval by Fonix's shareholders,
and is scheduled to close during the third quarter of 1999. The proceeds from
the sale will be used to reduce certain of the Company's liabilities and to
provide working capital to allow Fonix to focus on marketing and development
opportunities for its ITSG.
The Company had negative working capital of $18,554,002 at June 30, 1999
compared to negative working capital of $14,678,975 at December 31, 1998. The
current ratio was 0.09:1 at June 30, 1999 compared to 0.59:1 at December 31,
1998. Current assets decreased by $18,977,855 to $1,737,351 from December 31,
1998 to June 30, 1999. Current liabilities decreased by $15,102,828 to
$20,291,353 during the same period. The decrease in working capital from
December 31, 1998 to June 30, 1999, was primarily attributable to increases in
accounts and notes payable, accrued liabilities and deferred revenues offset in
part by decreases in related party notes payable. Total assets were $40,028,315
at June 30,1999 compared to $61,989,927 at December 31, 1998.
During the six months ended June 30, 1999, the Company granted 754,500 stock
options to employees and 9,500 stock options to two consultants at exercise
prices ranging from $0.59 to $1.78 per share. The term of all options granted
during this six month period is ten years from date of grant. As of June 30,
1999, the Company had a total of 16,139,282 options outstanding.
During the six months ended June 30, 1999, the Company granted warrants to L&H
in connection with loans totaling $5,700,000 which L&H made to the Company in
April and May 1999. The warrants allow L&H to purchase 850,000 shares of common
stock of the Company at exercise prices ranging from $0.60 to $0.70 per share.
Of these warrants 250,000 expire October 18, 1999 and 600,000 expire May 17,
2001.
On January 29, 1999, the Company entered into a Securities Purchase Agreement
with four investors pursuant to which the Company sold its Debentures in the
aggregate principal amount of $4,000,000. The outstanding principal amount of
the Debentures is convertible at any time at the option of the holders into
shares of the Company's common stock at a conversion price equal to the lesser
of $1.25 or 80 percent of the average of the closing bid price of the Company's
common stock for the five trading days immediately preceding the conversion
date. The Company recorded $687,500 as interest expense upon the issuance of the
Debentures in connection with this beneficial conversion feature. The Company
also issued 400,000 warrants to purchase an equal number of the Company's common
shares at a strike price of $1.25 per share in connection with this financing.
The warrants are exercisable for a period of three years from the date of grant.
The estimated fair value of the warrants of $192,000, as computed under the
Black-Scholes pricing model, was
24
<PAGE>
recorded as interest expense upon the issuance of the Debentures. On March 3,
1999, the Company executed a supplemental agreement pursuant to which the
Company agreed to sell another $2,500,000 principal amount of the Debentures on
the same terms and conditions as the January 29, 1999 agreement, except no
additional warrants were issued. The Company recorded $1,062,500 as interest
expense upon the issuance of the supplemental Debentures in connection with the
beneficial conversion feature. The obligations of the Company for repayment of
the Debentures, as well as its obligation to register the common stock
underlying the potential conversion of the Debentures and the exercise of the
warrants issued in these transactions, are personally guaranteed by two officers
and directors and a former officer and director of the Company (the
"Guarantors"). In connection with the March 3, 1999 funding, the Company agreed
to grant a lien on the patent covering the Company's Automated Speech
Recognition ("ASR") technologies as collateral for repayment of the Debentures.
However, to date no lien on the patent has been granted. The Guarantors
guaranteed the obligations of the Company under the Debentures and pledged
6,000,000 shares of common stock of the Company beneficially owned by them as
collateral security for their obligations under their guarantees.
Subsequent to the March 3, 1999 funding, the holders of the Debentures notified
the Company and the Guarantors that the Guarantors were in default under the
terms of the pledge and that the holders intended to exercise their rights to
sell some or all of the pledged shares of the Guarantors. At the present time,
the Company has no knowledge of sales of the Guarantors' shares by the holders.
However, if the holders proceed to sell some or all of the Guarantors' shares,
the Company may be obligated, under its indemnity agreement in favor of the
Guarantors, to issue replacement shares to the Guarantors for all shares sold by
the holders and reimburse the Guarantors for any costs incurred as a result of
the holders' sales of the Guarantors' shares.
On June 29, 1999, the Company received notice from the Nasdaq Stock Market
indicating that unless the minimum bid price for the Company's common stock
returned to at least $1.00 per share for at least ten consecutive trading days
prior to September 29, 1999, the Company's shares would be delisted from the
Nasdaq SmallCap Market on October 1, 1999. If the Company's common stock is
delisted from the Nasdaq SmallCap Market and is not relisted within three
trading days, an event of default would result under the terms of the
Debentures. Upon the occurrence of an event of default, the full $6,500,000
principal amount of all of the Debentures, together with accrued interest and
all other amounts owing in respect thereof, would become immediately due and
payable in cash.
During the six months ended June 30, 1999, 36,000 shares of Series D Convertible
Preferred Stock and 91,572 shares of Series E Convertible Preferred Stock,
together with related dividends on each, were converted into 1,288,479 and
3,246,183 shares, respectively, of the Company's common stock. After the above
conversions, 972,334 shares of Series D and 43,500 shares of Series E
Convertible Preferred Stock remain outstanding.
If the Company's common stock is delisted from the Nasdaq SmallCap Market and is
not relisted within three trading days, the terms of the Series D and Series E
Preferred Stock require the Company to pay to each holder of Series D or Series
E Preferred Stock a fee of two percent of the purchase price of the Series D or
Series E Preferred Stock in cash for each month that the stock is delisted.
At June 30, 1999, the Company had an unsecured revolving note payable to a bank
in the amount of $50,000. Amounts loaned under the revolving note payable are
limited to $50,000. This note is payable on demand, matures April 1, 2007, bears
interest at the bank's prime rate (7.75 percent at June 30, 1999) plus 2.0
percent and requires interest to be paid monthly. The weighted average
outstanding balance during the six months ended June 30, 1999 was $50,000. The
weighted average interest rate was 9.75 percent during this period.
At June 30, 1999, the Company had a note payable to a lender in the amount of
$588,000 which bears interest at 18 percent per year, which interest is payable
monthly. The note payable was originally due January 2, 1999 and is secured by
certain accounts receivable of the Company. The Company has extended the due
date on a monthly basis, currently to August 31, 1999, by paying the lender or
capitalizing accrued interest plus a fee of 1% of the loan balance each month.
The Company anticipates that this loan will be paid in full upon the closing of
the sale of the HSG to L&H. The Company further anticipates that it will request
additional extensions of the due date if the sale of the HSG to L&H has not
closed by August 31, 1999. The note is personally guaranteed by two officers and
directors and a former officer and director of the Company. The Company
anticipates that it will enter into an indemnity agreement with the guarantors
relating to this and other guarantees and pledges.
At June 30, 1999, the Company had a notes payable to L&H in the amount of
$1,100,000. The note was payable in full including accrued interest on July 28,
25
<PAGE>
1999 and bears interest at the prime rate as published in The Wall Street
Journal under the heading "Money Rates" (7.75 percent at June 30, 1999) plus 2.0
percent. The loan is secured by all the assets of Fonix/ASI, a wholly owned
subsidiary of the Company, including its intellectual property rights
represented by patents, copyrights and trademarks. L&H agreed to extend the due
date to the earlier of the closing of the sale of the HSG to L&H or September
30, 1999.
At June 30, 1999, the Company had a second note payable to L&H in the amount of
$4,600,000. This note was payable in full including accrued interest on July 28,
1999 and bears interest on the same terms as the loan of $1,100,000 described in
the preceding paragraph. The loan is secured by all the assets of Fonix/ASI
including its intellectual property rights represented by patents, copyrights
and trademarks. The loan is further secured by all the Company's stock of
Fonix/ASI. L&H agreed to extend the due date to the earlier of the closing of
the sale of the HSG to L&H or September 30, 1999. This note was authorized for a
total of $4,900,000 and the additional $300,000 was received by the Company in
July 1999. On August 12, 1999, L&H agreed to increase this loan by an additional
$1,200,000 subject to the existing terms of the loan. The Company received funds
from this loan on August 13, 1999.
The cost of warrants issued to L&H in connection with the above two notes
determined under the Black-Scholes pricing model was $246,240 and is being
amortized as a financing expense over the period of the loans. As of June 30,
1999 the unamortized financing expense was $100,444.
At June 30, 1999, the Company had unsecured demand notes payable to former
Articulate stockholders in the aggregate amount of $4,063,597 related to the
acquisition of Articulate in 1998. These notes were payable on demand any time
after November 30, 1998. In December 1998, the holder of a $407,971 note
demanded payment. In connection with this demand, the Company paid the holder a
partial payment of $50,000 in 1998, extended the date on which demand could be
made to March 15, 1999 and increased the interest rate to 11 percent per year.
No additional demand has been received for payment of this note. In 1998, the
Company also negotiated extensions of $986,481 of the notes to May 30, 1999 and
adjusted the interest rate to 10 percent per year. During the six months ended
June 30, 1999, the Company made partial payments totaling $800,000 on a
$2,535,235 note and agreed to pay the balance of all of these notes in
connection with the sale of the HSG to L&H.
At June 30, 1999, the Company had unsecured demand notes payable to former
Articulate employees in the aggregate amount of $452,900 and accrued liabilities
of $404,100 to the same employees. Both amounts are related to incentive
compensation granted the employees for continued employment with the Company
after the acquisition of Articulate in 1998. The demand notes bear interest at
an annual rate of 8.5 percent and were payable upon demand after November 1,
1998. None of the holders of these notes has demanded payment. The Company has
agreed to pay interest on these notes at 9 percent per year after November 1,
1998. No demand for payment has been made for the $404,100 of accrued
liabilities by the former Articulate employees.
At June 30, 1999, the Company had unsecured demand notes payable to former
Papyrus stockholders in the aggregate amount of $1,710,000, which notes were
issued in connection with the acquisition of Papyrus in 1998. The notes were
payable in various installments from February 28, 1999 through September 30,
1999. In April 1999, the Company entered into agreements with five former
Papyrus shareholders to reduce the aggregate amounts payable to them under these
notes from $1,632,375 to $1,188,909, which amounts will be paid in connection
with the sale of the HSG to L&H. The aggregate remaining balance of $77,625 of
the notes payable to former shareholders of Papyrus will also be paid in
connection with the closing of the sale of the HSG to L&H.
At June 30, 1999, the Company had an unsecured revolving note payable in the
amount of $257,965 in principal and $7,173 in accrued interest to SMD, a company
owned by two individuals who are executive officers and directors and one
individual who is a former officer and director of the Company and who each
beneficially own more than 10 percent of the Company's common stock. The
weighted average balance outstanding during the six months ended June 30, 1999
was $134,217. This revolving note is payable on demand and bears interest at an
annual rate of 12 percent. The maximum amount outstanding under this revolving
note during the period ended June 30, 1999 was $257,965. In 1999, advances to
the three individuals in the amount of $59,986 were applied as a partial payment
of this note.
The Guarantors guaranteed certain obligations of the Company. As security for
some of the guarantees, the Guarantors also pledged shares of the Company's
common stock beneficially owned by them. In March 1999, 143,230 of the shares
26
<PAGE>
previously pledged by the Guarantors to a bank were sold by the bank and the
proceeds were used to pay Company credit card balances and the related accrued
interest in full totaling $244,824. In May 1999, 100,000 of the shares
previously pledged by the Guarantors to another creditor of the Company were
sold by the creditor and the proceeds, totaling $72,335, were used to pay
amounts owed by the Company. These respective amounts are now included in the
unsecured revolving note payable to SMD described above.
At June 30, 1999, the Company had an unsecured, non-interest bearing demand note
payable in the amount of $100,000 to Synergetics, a research and development
entity. This note is payable on demand. No demand has been received by the
Company.
At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $20,000, which bears interest at an annual rate of 10
percent and was due December 31, 1998. The holder of this note agreed to extend
the due date to September 30, 1999.
At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $68,691 which bears interest at an annual rate of 10
percent and was due on or before July 31, 1999. The holder of this note agreed
to extend the due date to August 31, 1999.
The Company presently has no plans to purchase any new research and development
or office facilities.
Potential Delisting of the Company's Common Stock by Nasdaq - Potential
delisting from the Nasdaq SmallCap Market could have an adverse effect on the
liquidity of the Company's common stock and would trigger certain rights of
holders of the Company's Debentures and Preferred Stock.
The Company's common stock currently trades on the Nasdaq SmallCap Market which
requires, for continued listing, a minimum bid price of at least $1.00 per
share. At June 29, 1999, the Company's common stock had traded below $1.00 for
more than 30 consecutive trading days. On June 29, 1999, the Company received a
letter from the Nasdaq stock market indicating that unless the minimum bid price
for the Company's common stock returned to at least $1.00 per share for at least
ten consecutive trading days prior to September 29, 1999, the Company's shares
would be delisted from the Nasdaq SmallCap Market on October 1, 1999. The
Company has the right to appeal the Nasdaq stock market's notice and/or listing
determination on or before September 29, 1999.
If the Company's common stock is delisted from the Nasdaq SmallCap Market, the
Company believes that its common stock would qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's common
stock, even if the Company's shares are thereafter traded on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically.
Additionally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted within three trading days, an event of default would
result under the terms of the Debentures. Upon the occurrence of an event of
default, the full $6,500,000 principal amount of all of the Debentures, together
with accrued interest and all other amounts owing in respect thereof, would
become immediately due and payable in cash. The requirement to pay such amounts
would deplete the Company's existing cash, and would require the Company to
incur additional debt, thus further increasing the Company's debt obligations.
There can be no assurance that the Company would be able to borrow the amounts
needed to pay the holders of the Debentures or that such financing, if it were
available to the Company, would be available on terms satisfactory to the
Company. Presently, the Company does not have sufficient cash or other liquid
assets to pay the amount which would be due if the holders of the Debentures
declared a default thereunder.
Finally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted within three trading days, the terms of the Series D
and Series E Preferred Stock require the Company to pay to each holder of Series
D or Series E Preferred Stock a fee of two percent of the purchase price of the
Series D or Series E Preferred Stock, to be paid in cash, for each month that
the stock is delisted. The requirement to pay such amounts would deplete the
Company's existing cash, and would require the Company to incur additional debt,
thus further increasing the Company's debt obligations. There can be no
assurance that the Company would be able to borrow the amounts needed to pay the
27
<PAGE>
holders of the Series D or Series E Preferred Stock or that such financing, if
it were available to the Company, would be available on terms satisfactory to
the Company. Presently, the Company does not have sufficient cash or other
liquid assets to pay the amount which would be due.
Special Note Regarding Forward-Looking Statements
Certain statements contained herein under, "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Outlook," including
statements concerning (i) the Company's strategy, (ii) the Company's expansion
plans, (iii) the market for and potential applications of the Company's
technologies, (iv) the results of research and development efforts, and (v) the
growth of the Company's business contain certain forward- looking statements
concerning the Company's operations, economic performance and financial
condition. Because such statements involve risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause such differences include,
but are not necessarily limited to, those discussed in the Company's Annual
Report on Form 10-K, as amended, for the year ended December 31, 1998.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse purportedly owns, commenced an action against the Company in
federal court for the Southern District of New York. Clarke and Perpetual Growth
asserted claims for breach of contract relating to certain financing the Company
received during 1998. Specifically, Clarke and Perpetual Growth alleged that
they entered into a contract with the Company under which the Company agreed to
pay them a commission of five percent of all financing provided to Fonix by
Southridge Capital Management or its affiliates. Clarke and Perpetual claim that
they are entitled to commissions with respect to approximately $3,000,000 of
equity financing to the Company in July and August 1998, and the Company's
offerings of Series D and Series E preferred stock, totaling together
$12,000,000, in August and September 1998.
The Company believes that the Clarke lawsuit is without merit and filed a motion
to dismiss based upon the court's lack of personal jurisdiction over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal. The Company has filed a suit against Clarke
and Perpetual Growth in federal court for the Central District of Utah seeking a
declaratory judgment that it does not owe any money to Clarke and Perpetual
Growth. Now that the action in New York has been dismissed, the Company intends
to vigorously pursue the Utah action. However, the lawsuit in New York could be
reinstated on appeal and Clarke and Perpetual Growth could prevail in that
lawsuit, in which case the Company may be required to pay significant amounts of
money damages awarded by the court.
Papyrus - After the Papyrus acquisition closed in October 1998, the Company
investigated some of the representations and warranties made by Papyrus to
induce the Company to acquire Papyrus. The Company determined that certain of
the representations made by Papyrus and their executive officers appeared to be
false. On February 26, 1999, the Company filed an action against Papyrus in the
United States District Court for the District of Utah, Central Division, wherein
the Company alleged claims for misrepresentation, negligent misrepresentation,
breach of contract, breach of the implied covenant of good faith and fair
dealing and rescission. On March 11, 1999, three of the former shareholders of
Papyrus filed an action against the Company in the United States District Court
for the District of Massachusetts, alleging a default under the terms of the
promissory notes issued to them in connection with the Papyrus acquisition. On
April 2, 1999, the three former Papyrus shareholders filed an amended complaint
against the Company seeking additional remedies including violation of
Massachusetts unfair and deceptive acts and practices statutes and copyright
infringement. On April 8, 1999, a fourth former Papyrus shareholder filed an
action against the Company alleging a default under the terms of the promissory
notes issued to him in connection with the Papyrus acquisition and seeking
additional remedies including violation of Massachusetts unfair and deceptive
acts and practices statutes and copyright infringement. On April 13, 1999, a
fifth former Papyrus shareholder filed a similar action in Massachusetts.
Subsequently, the Company has entered into agreements with the five former
28
<PAGE>
Papyrus shareholders for dismissal of the actions and cancellation of the
promissory notes upon payment to the former shareholders of $1,188,909 (the
"Settlement Payment") and return for cancellation by the Company of 970,586
shares of restricted common stock issued to the five former shareholders in
connection with the acquisition. The Company agreed to pay the Settlement
Payment on or before August 31, 1999 or, if the definitive proxy soliciting
consents from the shareholders of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets (see Note 3) or the Company
and the five former Papyrus shareholders are free to pursue their respective
claims.
In addition to the above, the Company is involved in various lawsuits, claims
and actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these matters will not materially affect the consolidated financial position or
results of operations of the Company.
Item 2. CHANGES IN SECURITIES
Series D and E Preferred Stock - During the six months ended June 30, 1999,
36,000 shares of Series D Convertible Preferred Stock and 91,572 shares of
Series E Convertible Preferred Stock, together with related dividends on each,
were converted into 1,288,479 shares and 3,246,183 shares, respectively, of the
Company's common stock. After the above conversions, 972,334 shares of Series D
and 43,500 shares of Series E Convertible Preferred Stock remain outstanding.
Common Stock Issued - On June 2, 1999, the Company issued 200,000 shares of
common stock (having a market value of $100,000 on that date) to an unrelated
individual in payment for consulting services rendered.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits: The following Exhibits are filed with this Form 10-Q pursuant to
Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit
(2) Agreement and Plan of Reorganization among the
Company, fonix Acquisition Corporation and AcuVoice
dated as of January 13, 1998, incorporated by
reference from the Company's Current Report on Form
8-K, filed March 20, 1998
(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
(3)(iii) 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) Certificate of Amendment of Certificate of
Incorporation dated as of September 24, 1997, which
is incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(3)(v) 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)(i) 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
29
<PAGE>
(4)(ii) Certificate of Designation of Rights and Preferences
of Series A Preferred Stock, filed with the Secretary
of State of Delaware on September 24, 1997, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(4)(iii) Certificate of Designation of Rights and Preferences
of Series B Convertible Preferred Stock, filed with
the Secretary of State of Delaware on October 27,
1997, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(4)(iv) Certificate of Designation of Rights and Preferences
of 5% Series C Convertible Preferred Stock, filed
with the Secretary of State of Delaware on October
24, 1997, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(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
(10)(vii) Convertible Debenture Purchase Agreement
dated as of June 18, 1997 between the
Company and Southbrook International
Investments, Ltd., incorporated by reference
from Amendment No. 1 to the Quarterly Report
on Form 10-Q for the period ended June 30,
1997
(10)(viii) Amended and Restated Purchase Agreement effective as
of September 30, 1997 and dated as of October 24,
1997 by and between the Company and Southbrook
International Investments, Ltd., which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(10)(ix) Convertible Preferred Stock Purchase Agreement
effective as of September 30, 1997 and dated as of
October 24, 1997 by and among the Company and JNC
Opportunity Fund Ltd. and Diversified Strategies
Fund, L.P., which is incorporated by reference from
the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(10)(x) Restated Master Agreement for Joint Collaboration
between the Company and Siemens, dated November 14,
1997, as revised, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
30
<PAGE>
(10)(xi) Restated First Statement of Work and License
Agreement between the Company and Siemens, dated
February 11, 1998, as revised, which is incorporated
by reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xii) Master Technology Collaboration Agreement
between the Company and OGI, dated October
14, 1997, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(xiii) Common Stock Purchase Agreement among the Company and
JNC Opportunity Fund Ltd. and Diversified Strategies
Fund, LP, dated as of March 9, 1998, which is
incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31,
1997
(10)(xiv) Common Stock Purchase Agreement between the Company
and Thomson Kernaghan & Co., dated as of March 9,
1998, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xv) Royalty Modification Agreement among the Company and
Synergetics, dated as of April 6, 1998, which is
incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31,
1997
(10)(xvi) Purchase Agreement with John Oberteuffer and the
Company dated April 9, 1998, which is incorporated by
reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xvii) Employment Agreement by and between the Company and
John A. Oberteuffer, which is incorporated by
reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xviii) First Amendment to Master Agreement for Joint
Collaboration between the Company and Siemens, dated
February 13, 1998, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(xix) Second Amendment to Master Agreement for Joint
Collaboration between the Company and Siemens, dated
March 13, 1998, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(27) Financial Data Schedule
31
<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 18, 1998 /s/ Douglas L. Rex
------------------------------ ---------------------------------------
Douglas L. Rex, Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000855585
<NAME> FONIX CORPORATION
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 490,614
<SECURITIES> 0
<RECEIVABLES> 1,048,742
<ALLOWANCES> 0
<INVENTORY> 121,968
<CURRENT-ASSETS> 1,737,351
<PP&E> 3,648,411
<DEPRECIATION> 1,668,089
<TOTAL-ASSETS> 40,028,315
<CURRENT-LIABILITIES> 20,291,353
<BONDS> 0
0
24,246,095
<COMMON> 6,906
<OTHER-SE> (12,892,424)
<TOTAL-LIABILITY-AND-EQUITY> 40,028,315
<SALES> 1,765,383
<TOTAL-REVENUES> 1,765,383
<CGS> 354,837
<TOTAL-COSTS> 354,837
<OTHER-EXPENSES> 14,443,820
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,801,421
<INCOME-PRETAX> (15,812,649)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,812,649)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,812,649)
<EPS-BASIC> (0.26)
<EPS-DILUTED> (0.26)
</TABLE>
