<PAGE>
SCHEDULE 14A
(Rule 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934
Filed by the Registrant [X]
Filed by a party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary proxy statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
[X] Definitive proxy statement
[ ] Definitive additional materials.
[ ] Soliciting material pursuant to Rule 14a-11(c) or Rule 14a-12.
Fonix Corporation
................................................................................
(Name of Registrant as Specified in Its Charter)
................................................................................
(Name of Person(s) Filing Proxy Statement If Other Than The Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
1) Title of each class of securities to which transaction applies:
..............................................................
2) Aggregate number of securities to which transaction applies:
..............................................................
3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11 (Set forth the
amount on which the filing fee is calculated and state how it
was determined):
4) Proposed maximum aggregate value of transaction:
..............................................................
5) Total fee paid:
..............................................................
[ ] Fee paid previously with preliminary materials
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee
was paid previously. Identify the previous filing by registration
statement number, or the Form or Schedule and the date of its filing.
1) Amount Previously Paid:.......................................
2) Form, Schedule or Registration Statement No...................
3) Filing Party:.................................................
4) Date Filed:...................................................
- --------------------------------------------------------------------------------
<PAGE>
Fonix Corporation
60 East South Temple Street, Suite 1225
Salt Lake City, Utah 84111
NOTICE AND PROXY STATEMENT FOR ACTION TO BE
TAKEN BY WRITTEN CONSENT IN LIEU OF MEETING
To the Stockholders:
Attached hereto is a Proxy Statement which solicits the written
consent of the stockholders of Fonix Corporation, a Delaware corporation (the
"Company"), to authorize and approve the sale (the "Sale") by the Company of the
operations and a significant portion of the assets of its HealthCare Solutions
Group to Lernout & Hauspie Speech Products N.V., a Belgian corporation with its
principal place of business in Ieper, Belgium. The terms of the Sale are
described in detail in the attached Proxy Statement.
Attached to the Proxy Statement as Appendix A is the Stockholder
consent resolution (the "Consent Resolution"), which provides for authorization
and approval of the Sale. The procedure for indicating authorization and
approval of the Sale is described in detail in the attached Proxy Statement.
Pursuant to Section 228 of the General Corporation Law of Delaware,
once the Company receives the written consents from holders of a majority of the
Company's issued and outstanding stock as of July 9, 1999, the Company will
deliver such written consents to its registered office in Delaware, and the Sale
shall be deemed to have been approved by the Company's stockholders. The Company
will then distribute a notice to each of the Company's stockholders who did not
provide written consent authorizing and approving the Sale of the taking of the
action by written consent of the stockholders. No meeting will be held to vote
on this corporate action.
You are requested to fill out, date, sign and return the enclosed
Stockholder Consent Resolution Signature Page, which is solicited by the Board
of Directors of the Company as described in the accompanying Proxy Statement.
Your consent is important. Please sign and date the enclosed Stockholder Consent
Resolution Signature Page and return it promptly in the enclosed return
envelope. The return envelope requires no postage if mailed in the United
States. If mailed elsewhere, foreign postage must be affixed. Your consent as
evidenced by your signing and returning the Stockholder Consent Resolution
Signature Page is irrevocable once it is received by the Company's Registrar and
Transfer Agent as explained in the Proxy Statement.
By Order of the Board of Directors,
---------------------------------------
Thomas A. Murdock, Chief Executive Officer
Salt Lake City, Utah
August 13, 1999
<PAGE>
Fonix Corporation
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
PROXY STATEMENT
FOR STOCKHOLDER ACTION BY WRITTEN CONSENT
This Proxy Statement (the "Proxy Statement") has been prepared by the
Board of Directors of Fonix Corporation, a Delaware corporation (the "Company"),
and is being furnished in connection with the solicitation by the Board of
Directors of the Company of the written consent of the stockholders of the
Company to authorize and approve the sale (the "Sale") by the Company of the
operations and a significant portion of the assets of its HealthCare Solutions
Group to Lernout & Hauspie Speech Products N.V., a Belgian corporation with its
principal place of business in Ieper, Belgium. The Company intends to distribute
this Proxy Statement and the accompanying materials to its stockholders on
August 17, 1999. The mailing address of the Company's principal executive
offices is 60 East South Temple, Suite 1225, Salt Lake City, Utah 84111.
The Sale is described in detail in this Proxy Statement.
Attached to the Proxy Statement as Appendix A is the Stockholder
consent resolution (the "Consent Resolution"), which provides for the
authorization and approval of the Sale. The procedure for indicating approval of
the Sale is described in detail in this Proxy Statement.
General Information
Voting Rights
The matter which is being submitted for Stockholder approval is to be
acted upon by written consent, without a meeting, rather than by a vote held at
a meeting. The holders of the Company's issued and outstanding common stock are
entitled to consent in writing to the matter being considered. The execution of
the Stockholder Consent Resolution Signature Page by the holders of a majority
of the issued and outstanding shares of the Company's common stock is required
to authorize and approve the Sale. No dissenters' rights or rights of appraisal
are available to Stockholders pursuant to the Sale.
Only the holders of record of shares of the Company's common stock at
the close of business on July 9, 1999 (the "Record Date") are entitled to
execute the Consent Resolution. At the close of business on the Record Date,
there were 70,860,752 shares of common stock issued and outstanding held by
approximately 413 holders of record. In deciding the matter described in this
Proxy Statement, a holder of common stock on the Record Date shall be entitled
to provide one consent for each share of common stock then registered in such
holder's name. The holders of the common stock as of the Record Date are
hereinafter referred to as the "Stockholders."
Solicitation of Written Consents
Under Delaware law and under the Company's Certificate of
Incorporation and Article II, Section 11 of the Bylaws of the Company, any
action which may be taken at any annual or special meeting of the Stockholders
may be taken without a meeting, without prior notice and without a vote, if a
consent in writing, setting forth the action so taken, is signed by the holders
of outstanding stock having not less than the minimum number of votes that would
be necessary to authorize or take such action at a meeting at which all shares
entitled to vote thereon were present and voted. The matter being considered by
the Stockholders is being submitted for action by written consent rather than by
votes cast at a meeting. Attached to this Proxy Statement as Appendix A is the
text of the Consent Resolution being submitted for Stockholder adoption by
written consent. The Consent Resolution will be effective on the date that the
Company
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<PAGE>
receives signed Consent Resolution Signature Pages representing the consents of
the holders of a majority of the Company's issued and outstanding common stock
as of the Record Date.
Stockholders are being requested to indicate approval of and consent
to the adoption of the Consent Resolution by filling out, signing, and dating
the enclosed Consent Resolution Signature Page. Execution of the Consent
Resolution Signature Page will constitute your approval, as a Stockholder of the
Company, of the Sale. The discussion and description of the Sale in this Proxy
Statement are qualified in their entirety by reference to the full text of the
Consent Resolution. Stockholders who do not approve, and consent to the adoption
of, the Consent Resolution by execution of the Consent Resolution Signature Page
will nonetheless be bound by the Consent Resolution if sufficient written
consents are received by the Company on or before the Effective Date to approve
the Consent Resolution.
The Board of Directors requests that each Stockholder fill out,
execute, date, and mail or deliver the Consent Resolution Signature Page to the
Registrar and Transfer Agent of the Company at the following address:
Continental Stock Transfer & Trust Co.
2 Broadway, 19th Floor
New York, NY 10004
Attn: Gail Konsker
An addressed envelope is enclosed for your convenience in returning the Consent
Resolution Signature Page. Each Stockholder should indicate on the Consent
Resolution Signature Page the number of shares of the Company's common stock
which the Stockholder is voting. The Consent Resolution Signature Page should be
returned as soon as possible for receipt by the Registrar and Transfer Agent no
later than August 30, 1999.
The Company will pay the entire cost of the preparation and mailing
of this Proxy Statement and all other costs of this solicitation. Certain of the
Company's Directors, officers, or employees may also solicit written consents by
mail, telephone, telegraph, or personal interview but no additional compensation
will be paid to them by the Company for doing so.
Written consents irrevocable
Any Consent Resolution Signature Page executed and delivered by a
Stockholder shall be deemed by the Company to constitute that Stockholder's
approval of and written consent to the adoption of the Consent Resolution. Once
the Company's Registrar and Transfer Agent receives the executed Consent
Resolution Signature Page, such consent may not be revoked.
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<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of August 6, 1999, the number of
shares of Common Stock of the Company beneficially owned by all persons known to
be holders of more than five percent (5%) of the Company's Common Stock and by
the executive officers and directors of the Company individually and as a group.
Unless indicated otherwise, the address of the stockholder is the Company's
principal executive offices, 60 East South Temple Street, Suite 1225, Salt Lake
City, Utah 84111.
<TABLE>
<CAPTION>
Number of
Shares
Name and Address of 5% Beneficial Owners, Beneficially Percent of
Executive Officers and Directors Owned Class(1)
<S> <C> <C>
Thomas A. Murdock 11,799,084(2) 16.4%
Chairman of the Board and Chief
Executive Officer
Alan C. Ashton, Ph.D. 12,329,167(3)(4) 17.4%
c/o Beesmark Investments, L.C.
5% Beneficial Owner
261 East 1200 South
Orem, Utah 84097
Beesmark Investments, L.C. 11,729,167(4) 16.7%
5% Beneficial Owner
261 East 1200 South
Orem, Utah 84097
Roger D. Dudley, 4,965,389(5) 6.9%
Executive Vice President,
Director
Stephen M. Studdert, Director 4,940,819(6) 6.9%
10252 Oak Creek Lane
Highland, Utah 84003
Joseph Verner Reed, Director 1,220,000(7) 1.7%
73 Sterling Road
Greenwich, Connecticut 06831
Rick D. Nydegger, Director 600,000 *
10217 North Oak Creek Lane
Highland, Utah 84003
John A. Oberteuffer, Ph.D., 380,000 *
Vice President, Director
600 West Cummings Park, Suite 4650
Woburn, MA 01801
Reginald K. Brack, Director 426,500(8) *
Douglas L. Rex, Chief Financial Officer 402,900(9) *
Officers and Directors as a Group (8 persons) 17,557,510 22.9%
</TABLE>
* Less than 1 percent.
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<PAGE>
(1) Percentages rounded to nearest 1/10th of one percent. Except as
indicated in the footnotes below, each of the persons listed exercises
sole voting and investment power over the shares of Common Stock listed
for each such person in the table.
(2) Includes 10,406,772 shares of Common Stock deposited in a voting trust
(the "Voting Trust") as to which Mr. Murdock is the sole trustee.
Persons who have deposited their shares of Common Stock into the Voting
Trust have dividend and liquidation rights ("Economic Rights") in
proportion to the number of shares of Common Stock they have deposited
in the Voting Trust, but have no voting rights with respect to such
shares. All voting rights associated with the shares deposited into the
Voting Trust are exercisable solely and exclusively by the Trustee of
the Voting Trust. The Voting Trust expires, unless extended according
to its terms, on the earlier of September 30, 1999 or any of the
following events: (i) the Trustee terminates it; (ii) the participating
shareholders unanimously terminate it; or (iii) the Company is
dissolved or liquidated. Although as the sole trustee of the Voting
Trust Mr. Murdock exercises the voting rights of all of the shares
deposited into the Voting Trust, and accordingly has listed all shares
in the table above, he has no economic or pecuniary interest in any of
the shares deposited into the Voting Trust except for 3,415,083 shares
as to which he directly owns Economic Rights, and 185,793 shares the
Economic Rights as to which are owned by Studdert Companies Corp.
("SCC"), a corporation of which Mr. Murdock is a 1/3 equity owner. Also
includes 2,813 shares owned directly by Mr. Murdock, 11,400 shares
owned by a limited liability company of which Mr. Murdock is a 1/3
equity owner, 28,099 shares (including shares issuable upon the
exercise of options) beneficially owned by members of Mr. Murdock's
immediate family residing in the same household and 1,350,000 shares of
Common Stock underlying stock options owned by Mr. Murdock and
exercisable presently or within 60 days of June 1, 1999.
(3) Includes all Common Stock beneficially owned by Beesmark Investments,
L.C. ("Beesmark"), but only to the extent that Dr. Ashton is one of
three managers of Beesmark, and, as such, is deemed to share investment
power with respect to shares beneficially owned by Beesmark. Also
includes 600,000 shares of Common Stock underlying stock options
exercisable by Dr. Ashton presently or within 60 days of June 1, 1999.
(4) Beesmark's beneficial ownership includes 166,667 shares of Common Stock
presently issuable upon the conversion of shares of Series A Preferred
Stock. The managers of Beesmark are Alan C. Ashton, Karen Ashton, and
Ralph Rasmussen. As managers of Beesmark, they each are deemed to share
voting control over shares beneficially owned by Beesmark. Mrs. Ashton
and Mr. Rasmussen beneficially own no shares other those deemed to be
owned by them her as control persons of Beesmark, and, consequently,
their beneficial ownership is not separately reported.
(5) Includes (i) 3,415,083 shares owned by Mr. Dudley and deposited into
the Voting Trust, (ii) 185,793 shares owned by SCC as to which Mr.
Dudley shares investment power because of his management position with
and 1/3 ownership of SCC, which shares are deposited into the Voting
Trust; (iii) 2,813 shares owned directly by Mr. Dudley; (iv) 300 shares
owned by Mr. Dudley's minor children; (v) 11,400 shares owned by a
limited liability company of which Mr. Dudley is a 1/3 equity owner;
and (vi) 1,350,000 shares underlying stock options exercisable
presently or within 60 days of June 1, 1999.
(6) Includes (i) 3,390,813 shares owned by Mr. Studdert and deposited into
the Voting Trust, (ii) 185,793 shares owned by SCC as to which Mr.
Studdert shares investment power because of his management position
with and 1/3 ownership of SCC, which shares are deposited into the
Voting Trust; (iii) 2,813 shares owned directly by Mr. Studdert; (iv)
11,400 shares owned by a limited liability company of which Mr.
Studdert is a 1/3 equity owner and controls; and (v) 1,350,000 shares
underlying stock options exercisable presently or within 60 days of
June 1, 1999.
(7) Includes 1,200,000 shares of Common Stock underlying presently
exercisable stock options.
(8) Includes (i) 26,000 shares owned directly by Mr. Brack; (ii) 500 shares
owned by Mr. Brack's son; and 400,000 shares underlying presently
exercisable stock options.
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<PAGE>
(9) Includes (i) 2,400 shares owned by Mr. Rex's spouse; (ii)500 shares
owned by an entity owned and controlled by him; and (iii) 400,000
shares underlying presently exercisable stock options.
INFORMATION WITH RESPECT TO THE COMPANY
Business of the Company
Overview
The Company is a development-stage company that 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 than traditional methods such as the
keyboard. Specifically, the Company has developed proprietary automated speech
recognition and related technologies such as text-to-speech (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. The Company 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.
In March 1998, the Company acquired AcuVoice, Inc. ("AcuVoice"), a
California corporation and award winning developer of text-to-speech
technologies. AcuVoice had developed and marketed its text-to-speech or speech
synthesis technologies and products directly to end-users, systems integrators
and original equipment manufacturers ("OEMs") for use in the telecommunications,
multi-media, education and assistive technology markets. The acquisition of
AcuVoice by the Company resulted in the introduction of Fonix-branded products
to the market for the first time in the Company's history. The transaction by
which the Company acquired AcuVoice is referred to in this report as the
AcuVoice Acquisition.
In October 1998, the Company acquired Papyrus Associates, Inc., a
Pennsylvania corporation ("PAI"), and Papyrus Development Corporation, a
Massachusetts corporation ("PDC" and together with PAI, "Papyrus"). The
acquisition of PDC and PAI by the Company is referred to in this Proxy Statement
as the Papyrus Acquisition. PAI develops and markets printing and cursive
handwriting recognition software for personal digital assistants ("PDAs"), pen
tablets and mobile phones. The Papyrus technology is marketed under the
trademark Allegro(TM). PAI's software and technology are an integral part of the
Psion PDA. PDC is a systems integration provider with expertise and intellectual
property in embedded systems and enhanced Internet applications.
The Company markets technologies it has developed, together with
text-to-speech technologies and products acquired from AcuVoice, and handwriting
recognition products and applications acquired from Papyrus, through its
Interactive Technologies Solutions Group. The present marketing direction for
the Interactive Technologies Solutions Group is to form relationships with third
parties who can incorporate the Company's technologies and the other
technologies available to the group into new or existing products. 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 the
Company presently has such relationships and with which it may have similar
relationships in the future include developers of application software,
operating systems, computer, microprocessor chips, consumer electronics,
automobile, and telephony products.
In September 1998, the Company acquired Articulate Systems, Inc.
("Articulate"), a Delaware corporation and leading developer of specialized
speech recognition applications used in the health care industry . This
transaction is referred to in this report as the Articulate Acquisition.
Articulate's market focus, prior to and following the acquisition, is providing
solutions for healthcare organizations for cost effective and rapid capture,
transcription and management of dictated clinical information across a network.
Specifically, Articulate develops, markets and supports an integrated
dictation/transcription solutions process called PowerScribe(R) to healthcare
organizations utilizing advanced continuous speech recognition technology to
significantly automate medical reporting. The PowerScribe system is intended to
be user friendly to physicians and other medical professionals, to significantly
reduce transcription costs and report turnaround time, and to provide other key
benefits without sacrificing dictation accuracy or physician acceptance.
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<PAGE>
Articulate entered into its first sales contracts for its first product,
PowerScribeRAD, a product designed specifically for radiologists, in January
1998. Articulate's first contracts for its second product, PowerScribe EM for
emergency medicine physicians, were signed in January 1999. 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 (the "HSG"), the
division which offers the PowerScribe products and related services, to Lernout
& Hauspie Speech Products N.V. ("Lernout & Hauspie" or "L&H"). The sale of the
HSG is the subject of this Proxy Statement. See "Stockholder Consent Resolution:
Sale of Healthcare Solutions Group."
The executive offices of the Company are located at 60 East South
Temple Street, Suite 1225, Salt Lake City, Utah 84111, and its telephone number
is (801) 328-8700. The principal executive offices of the HealthCare Solutions
Group are located at 600 West Cummings Park, Suite 4500, Woburn, Massachusetts
01801. The executive offices of the Interactive Technologies Solutions Group are
located at 180 West Election Drive, Draper, Utah 84020. The Company also
maintains a facility in Cupertino, California.
Technology and Product Overview
Automated Speech Recognition
Presently available traditional voice recognition 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 speech recognition systems during that
period. This improvement includes vocabulary size, recognition accuracy and
continuous speech recognition ability. Currently available speech recognition
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.
Despite the nominal advances in performance of such presently
available systems, there are significant limitations inherent in all of these
systems, each of which continues to use traditional approaches generally based
on Hidden Markov Models ("HMM") technology. These traditional approaches have
not advanced appreciably since the late 1980s. Applications based on such
traditional speech recognition systems for personal computers all require
close-talking microphones in relatively low noise environments and a formal
speaking style to achieve acceptable accuracy. In so-called continuous dictation
systems, significant adaptation to user speech, speaking style, and content area
also are required. These traditional systems are generally restricted to speech
recognition for a single individual dictating in a quiet environment; presently
available telephony-based systems are even more limited in general
functionality.
The present industry standard methodology, the HMM, uses a general
template or pattern matching technique based on statistical language models.
Massachusetts Institute of Technology researcher Dr. Victor Zue has noted that
speech-recognition systems based on such technology
"utilize little or no specific-speech knowledge, but rely instead
primarily on general-purpose pattern- recognition algorithms. While
such techniques are adequate for a small class of well-constrained
speech recognition problems, their extendibility to multiple
speakers, large vocabularies, and/or continuous speech is highly
questionable. In fact, even for the applications that these devices
are designed to serve, their performance typically falls far short of
human performance."
HMM's widely recognized weaknesses are many: (i) it does not meet the
needs for many mass market implementations, (ii) it has limited input feature
types, (iii) it accounts for only limited context, (iv) it has limited ability
to generalize acoustic and language structure, (v) it requires training data
from the end-user for acceptable performance, (vi) models become extremely large
and complex as vocabulary grows, and (vii) there is a lack of hardware parallel
processing capability.
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<PAGE>
In contrast to HMM, the Company's 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 automated speech
recognition 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.
The Company 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 on traditional 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 access
and consumer electronic devices controlled by natural language.
Thus, the Company believes that its ASRT offers unique speech
processing techniques that will complement and significantly enhance currently
available speech recognition systems. Through its Interactive Technologies
Solutions Group, the Company intends to continue to license its ASRT, to
continue to co-develop the ASRT with research and development groups in industry
and academia and ultimately to market a suite of Fonix-branded technologies and
products. In the long term, the Company anticipates that automated speech
recognition systems employing the Company's unique ASRT will set the industry
standard for all automated speech recognition applications because of its
anticipated capacities to overcome the weaknesses of HMM. In addition, the
Company expects that certain elements of its Core Technologies will have
industry-leading applications in non-speech recognition industries, market
segments and disciplines such as artificial intelligence and data compression.
Although these plans represent management's beliefs and expectations based on
its current understanding of the market and its experience in the industry,
there can be no assurance that actual results will meet these expectations. In
the last two fiscal years, the Company has expended $13,620,748 and $7,066,294
on research and development activities. Since its inception (October 1, 1993)
through March 31, 1999, the Company had spent $34,529,320 on research and
development of the ASRT. The Company expects that a substantial part of its
capital resources will continue to be devoted to research and development of the
ASRT and other proprietary technologies for the foreseeable future.
Interactive Technologies Solutions Group Products
The Interactive Technologies Solutions Group 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 Interactive Technologies Solutions Group 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 the Company 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. Interactive Technologies Group products include
AcuVoice AV 1700 and AV 2001 text-to-speech systems, and handwriting recognition
products.
Embedded Technologies
The Company has developed an application development tool, the Fonix
Advanced Application Speech Toolkit (FAAST(TM)) which allows developers to
simulate, prototype and create code for embedded applications using Fonix'
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human computer interaction technologies. This system currently supports the
Company's speech recognition for command and control applications and Fonix
AcuVoice text-to-speech 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 Hitachi SH3 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 by the Company to
support the development of embedded systems applications for several companies
including consumer electronic, automotive, and cell phone devices.
Core Speech Recognition Technologies
Since 1994, the Company 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 proprietary ASR 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.
Text-to-Speech (Speech Synthesis)
In 1986 AcuVoice began to develop and market a new approach to
synthesized speech, a system using actual recordings of "units" of human speech
(i.e., the sound pulsation). Since the unit of speech consists of more than one
phoneme (sound), AcuVoice's approach has been called a "large segment
concatenative speech synthesis" approach. Other companies such as DEC and AT&T
began in the early 1960s and continue until the present to use a system called
"parametric speech synthesis." Parametric systems are plagued with problems of
speech quality, because their unit is not an actual recording, but a computer's
version of what a human voice sounds like. Poor speech quality also occurs
because the parametric unit consists, for the most part, of a single phoneme,
such as the "t" in the word "time."
Although as early as 1994 AcuVoice released versatile prototypes of
its system, it was not until early 1996 that the AcuVoice Speech Synthesizer was
ready for sale into the telecommunications, multi-media, educational and
assistive technology markets. Presently AcuVoice products are sold to end-users,
systems integrators and OEMs.
The Company text-to-speech products include those developed by
AcuVoice and those developed by the Company. 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 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.
Handwriting Recognition
Prior to the Papyrus Acquisition in October 1998, PAI developed and
began selling handwriting recognition software including the Allegro handwriting
recognition software. The Allegro handwriting recognition software is a single
letter recognition system like the popular Graffiti handwriting recognition
software for the PalmPilot PDA. 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. Allegro is sold by Purple Software in England
for the Psion Series 5 hand-held PC. This software has also been licensed to
Philips for its popular smart cell phone. Allegro is also the subject of a sales
agreement with Lucent Technologies for use in its Inferno operating system.
Papyrus has also developed 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 of the software.
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HealthCare Solutions Group Products
The three PowerScribe products now being sold by the HealthCare
Solutions Group are PowerScribeRAD, PowerScribeRAD Software Development Kit
("SDK")TM, and PowerScribeEM. PowerScribe products use state-of-the- art
continuous speech recognition engines licensed from Dragon Systems, Inc., which
enables 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.
PowerScribeRAD for Radiology Reporting
PowerScribeRAD enables the full automation of the radiology reporting
process and replaces existing digital dictation and transcription systems.
PowerScribeRAD permits the dictation of radiology reports directly into text,
with edit, approve, and sign functions accomplished within a matter of minutes;
thereby significantly reducing transcription costs and report turnaround time.
Once reports are dictated, they may be automatically stored in the Radiology
Information System ("RIS"), the Hospital Information System ("HIS") or
PowerScribeRAD's own report repository.
PowerScribeEM for Emergency Medicine Reporting
PowerScribeEM is a completely integrated emergency medicine dictation
and transcription system which allows emergency department professionals to
dictate their reports directly into text in the first total solution for
capturing and documenting emergency medicine clinical encounters. PowerScribeEM
minimizes training and the need for healthcare professionals to modify their
work styles. PowerScribe includes post-processing of the text for organization
into a typical structured emergency medicine report. PowerScribeEM seamlessly
handles the overall workflow of an emergency department. Once reports are
dictated, reports are either automatically stored in the HIS or in PowerScribe's
own report repository for further analysis at a later date.
PowerScribe Radiology SDK for User Development Applications
The PowerScribe Radiology SDK allows users to integrate the full
functionality of the PowerScribeRAD system into the user's own radiology
applications. For radiology environments such as a RIS or Picture Archival
Communication System ("PACS") the PowerScribe SDK allows users to develop a
completely integrated dictation and transcription system utilizing continuous
speech recognition. Using this SDK, the PowerScribeRAD client functionality can
be embedded into the user's application while also customizing the user
interface and report workflow to meet specific application needs. The
PowerScribeRAD SDK supports multiple development environments including
Microsoft(R) Visual Basic, C++ and the Microsoft(R) Internet Explorer
environment. The SDK includes an Active-X composite control along with sample
code and developer documentation.
Recent Developments
Consistent with the objectives, vision and strategy of the Company
outlined above, the Company entered into several key transactions in 1998 and
the first two quarters of 1999. These are discussed briefly in the following
section.
Acquisition of AcuVoice
The AcuVoice Acquisition was effected by an exchange of restricted
shares of the Company's common stock and cash for the issued and outstanding
common stock of AcuVoice. A total of 2,692,216 shares of the Company's common
stock (having a market value of $16,995,772) were issued in exchange for
AcuVoice common stock and a total of $8,000,232 was paid in cash (including
amounts paid in lieu of fractional shares). Of the 2,692,216 shares of the
Company's stock issued, 80,000 shares were placed in an escrow against which any
claims for breach of warranty by
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the Company against AcuVoice could be asserted. The closing was deemed to have
occurred on March 13, 1998, although certain acts such as the payment of
consideration to some AcuVoice stockholders and the filing of articles of merger
occurred after that date. After the AcuVoice Acquisition, the former
shareholders of AcuVoice, consisting of 52 persons, beneficially owned 5.25% of
the total of 51,303,739 shares of the Company's common stock then issued and
outstanding.
Before the acquisition, AcuVoice released the first versatile
prototypes of its system in 1994. By early 1996, the AcuVoice Speech Synthesizer
was ready for sale into the telecommunications, multi-media, educational and
assistive technology markets. Companies that have purchased developer kits from
AcuVoice and are now developing products for the market include IBM, General
Motors, Kurzweil Educational Systems, Pratt & Whitney, Octel Communications,
Andersen Consulting, NEC, Dialogic and Bell Atlantic. Companies that have
developed products using AcuVoice developer kits, and now are selling or using
products containing AcuVoice text-to-speech include AT&T, Motorola, Northern
Telecom, Lucky Goldstar (Korea), Aumtech Inc., Mail Call, Inc., IMG, Hurdman
Communications (Better Business Bureau), SmartDial, Signet, Concierge, Ultimate
Technology, FirstCall, XL Vision, Applied Future Technologies and Productivity
Works.
To the Company's knowledge, no other company has succeeded in
developing a versatile system of large segment concatenative synthesis. However,
the AcuVoice speech synthesis products compete with other concatenative and
parametric speech synthesis products.
AcuVoice's competitors offer a range of voices (male, female, child)
and languages. AcuVoice presently offers only a male voice which speaks American
English. However, AcuVoice is developing a female voice, and is working to
expand language capacity to major languages other than English.
The Company believes that the AcuVoice text-to-speech technologies
are an important and complementary addition to the ASRT the Company has
developed to date and will develop in the future. For example, because both
voice synthesis and voice recognition technologies are dependent upon the
analysis of human speech patterns, those technologies share many similar
challenges, and a solution in one arena often will be portable to the other.
Additionally, the Company believes that a state-of-the-art voice synthesis
technology, coupled with the ASRT, will substantially increase the marketability
of both technologies by broadening the potential product applications, thereby
increasing the pool of potential licensees of the technologies.
Acquisition of Articulate and Certain Assets of MRC
The Articulate Acquisition was effected through a merger of
Articulate into a wholly owned subsidiary of the Company that closed on
September 2, 1998. In connection with the Company's acquisition of Articulate,
the Company incurred new debt obligations to 13 former shareholders of
Articulate in the aggregate amount of $4,747,339. These debt obligations are in
the form of demand notes payable at any time after November 1, 1998, and bear
interest at the annual rate of 8.5%. The due dates of these obligations
subsequently were extended to dates ranging from April 1999 to October 1999,
and, in some cases, the Company has agreed to pay interest at rates exceeding
8.5% per year. In connection with certain of these loans, the Company paid
$50,000 in December 1998 and March 1999, $75,000 in April 1999, and $675,000 in
May1999, which were applied to principal and accrued interest. No additional
demands for payment have been made on these notes. The Company and the payees of
these obligations have agreed that the unpaid balances due will be paid out of
the proceeds of the Sale. After the acquisition, the Company also agreed to pay
several Articulate employees incentive compensation for continued employment in
the aggregate amount of $857,000, in connection with which the Company issued
8.5% demand notes for $452,900 and recorded an accrued liability of $404,100 for
the balance. The notes issued to the Articulate employees are presently payable
on demand, but, as of the date hereof, the Company has not received any demand
for payment of the notes by the former Articulate employees. The $404,100
accrued liability was payable on or before January 31, 1999. The payees with
respect to this obligation have agreed to an extension of the payment date to
August 31, 1999. After the merger, the former shareholders of Articulate,
constituting 62 persons, beneficially owned 8.8% of the total 58,586,633 shares
of the Company's common stock then issued and outstanding.
At the time the Company acquired Articulate, MRC marketed Articulate's
PowerScribeRAD and
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PowerScribeEM products to hospitals and medical centers. The Company intended to
continue to use MRC to market its PowerScribe products after the acquisition.
However, shortly after the acquisition the Company learned that MRC had agreed
to be acquired by Medquist, Inc., which, the Company believes, had little or no
interest in marketing the PowerScribe products. Thereafter, the Company
commenced negotiations to acquire certain assets of MRC relating to MRC's sales,
marketing and service of the PowerScribe products. On December 31, 1998, the
Company entered into an Asset Acquisition Agreement with MRC pursuant to which
it acquired certain fixed assets, license agreements, intellectual property,
advertising materials and other property used by MRC to market, sell and service
the PowerScribe products. In consideration of the assets described above, the
Company agreed to pay MRC at closing $219,833, less amounts then owed to the
Company, plus $133,333 per month for each of the three months immediately
following the closing, less certain credits.
Acquisition of Papyrus
In connection with the Company's acquisition of Papyrus Associates,
Inc., and Papyrus Development Corp. (collectively, "Papyrus"), in October 1998,
the Company incurred debt obligations in the form of promissory notes to the
former shareholders of Papyrus in the aggregate amount of $1,710,000. With
respect to $1,632,375 of the notes, the holders thereof have agreed to accept an
aggregate payment of $1,188,909 in full satisfaction of the notes, if paid
before August 31, 1999, or if this Proxy Statement has been distributed to
shareholders of the Company prior to August 31, 1999, then upon closing of the
Sale.
After the Papyrus Acquisition, the former shareholders of PAI and
PDC, constituting 10 persons, beneficially owned less than 1% of the total
61,697,747 shares of the Company's common stock then issued and outstanding. Of
the 3,111,114 shares of the stock issued in the Papyrus Acquisition, 311,106
shares were placed in an escrow against which any claims by the Company for
breach of warranty against Papyrus could be asserted. After the Papyrus
Acquisition closed, 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 the executive
officers of Papyrus were not accurate. At about the same time, the Company began
negotiations with the former executive officers of Papyrus. On February 26,
1998, the Company filed an action against Papyrus in the United States District
Court for the District of Utah, Central Division (the "Utah Action"). In the
Utah Action, 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 8, 1999, a fourth former Papyrus shareholder 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 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. The Company has
entered into agreements with the five former Papyrus shareholders for dismissal
of the Massachusetts actions and the Utah Action upon payment to the former
shareholders of $1,188,909 (the "Settlement Payment"), an amount equal to
approximately 75% of the balance due them under the notes issued to them in the
Papyrus Acquisition, and return for cancellation by the Company of approximately
970,000 shares of restricted common stock issued in the Papyrus Acquisition.
This represents approximately 30% of the total number of shares of the Company's
common stock originally issued to these shareholders in the Papyrus Acquisition.
The Company must pay the Settlement Payment before August 31, 1999, or if this
Proxy Statement has been distributed to shareholders of the Company prior to
August 31, 1999, then upon closing of the Sale. If it does not, the Company and
the five former Papyrus shareholders are free to pursue their respective claims.
Status of Acquisition Activities
In addition to the transactions involving AcuVoice, Articulate and
Papyrus in 1998, the Company also was in negotiations to acquire several other
speech technology companies in 1998. The Company has now terminated all such
acquisition discussions. The Company advanced money during 1998 to some of those
acquisition candidates in anticipation of the completion of an acquisition
transaction. The Company presently is pursuing the return of such loaned funds
which amount, in the aggregate, is $245,000.
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Financing Activities
Series D and Series E Preferred Stock
In March 1998, the Company completed a private placement (the "March
1998 Offering") of 6,666,666 shares of its restricted common stock to seven
separate investment funds. The total purchase price to be paid by the investors
pursuant to the March 1998 Offering was $30,000,000. Of that amount, $15,000,000
was paid to the Company on March 12, 1998, in return for which the Company
issued a total of 3,333,333 shares of restricted stock, pro rata to the
investors in proportion to the total amount of the purchase price paid by them.
Finders' fees of $870,000 were paid in connection with the $15,000,000 received.
The proceeds of that offering were used to fund the AcuVoice Acquisition and for
operating capital. The remainder of the purchase price was to be paid by the
investors on July 27, 1998 (60 days after the effectiveness of a registration
statement that the Company filed with the Securities and Exchange Commission
covering the common stock issued and issuable to the investors (the "Second
Funding Date")), provided that, as of such date, certain conditions were
satisfied. Additionally, the investors in the March 1998 Offering acquired
certain "reset" rights pursuant to which the investors would receive additional
shares of restricted common stock if the average market price of the Company's
common stock for the 60-day periods following the initial closing date and the
Second Funding Date did not equal or exceed $5.40 per share. On August 31, 1998,
the Company and the investors in the March 1998 Offering restructured the reset
provision whereby the Company issued 608,334 shares of Series D 4% Convertible
Preferred Stock ("Series D") and 1,390,476 shares of common stock for (i) the
relinquishment of the investors' contractual right to receive reset shares in
connection with the $15,000,000 received in March 1998, and an additional
$3,000,000 received in June and August 1998. On that same date, the Company
issued 500,000 additional shares of Series D in consideration for the investment
of $10,000,000 of additional funds by the investors. These proceeds were used
primarily to finance the Articulate Acquisition.
Effective September 30, 1998, the Company entered into an agreement
with two of the investors in the March 1998 Offering whereby the Company issued
100,000 shares of the Company's Series E 4% Convertible Preferred Stock ("Series
E") for $2,000,000. Additionally, the Company issued to the purchasers of the
Series E a total of 150,000 additional shares of Series E in exchange for which
those purchasers surrendered a total of 150,000 shares of Series D.
Subsequently, on November 13, 1998, the Company sold 50,000
additional shares of Series D on the same terms and conditions as the August 31,
1998 agreement.
Each share of Series D and Series E is convertible into that number
of shares of common stock as determined by dividing $20 by the lesser of any of
the following (at the option of the converting holder):
1. $3.50, or
2. the lesser of
o $2.3375 (for the Series D) or $1.4369 (for the
Series E) which amounts constitute 110% of the
average per share closing bid prices for the 15
trading days immediately preceding the dates of
the Series D and Series E Agreements,
respectively; or
o 90% of the average of the three lowest per share
closing bid prices during the 22 trading days
immediately preceding the conversion date.
If the converting holder elects conversion option 1, in addition to
the shares of common stock issued upon the conversion, the converting holder
will receive a warrant to purchase 0.8 shares of common stock. Those warrants
will have an exercise price that will be 120% of the per share closing bid price
of the common stock on the date the warrants are issued and will have a 3 year
term. Any shares of Series D or Series E not converted as of August 31, 2001
will automatically be converted to common stock according to whichever of the
conversion formulas described above yields the greatest number of shares of
common stock.
As part of the Series D and Series E transactions, the Company agreed
that it would register the shares of
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common stock issuable upon conversion of the Series D and Series E or the
exercise of any warrants issued upon conversion for public resales by the
converting or exercising holder. On November 19, 1998, the Company filed a
registration statement with the Securities and Exchange Commission on Form S-3
to register the sale by the holders of the Series D and Series E of up to
58,623,442 shares of the Company's common stock (File No. 333-67573). The shares
covered by the registration statement are the shares of common stock issued or
issuable by the Company upon the conversion of the Series D or Series E, or the
exercise of the warrants, if any warrants are issued. That registration
statement has not yet been declared effective.
When the registration statement is declared effective, the selling
stockholders will be able to sell the Company's shares issued upon conversion of
the Series D and Series E preferred stock in public transactions or otherwise,
on the Nasdaq SmallCap Market or in privately negotiated transactions. Those
resales may be at the then-prevailing market price or at any other price the
selling stockholders may negotiate.
December 1998 Private Placement of Common Stock
On December 22, 1998, the Company completed a private placement of
1,801,802 shares of common stock. Additionally, for each share of common stock
issued, the Company issued one "Repricing Right" that entitles the holder
thereof to receive upon exercise additional shares of the Company's common stock
for no additional consideration according to a formula that is related to the
then-prevailing market price of the Company's common stock. The Company also
issued 200,000 common stock purchase warrants in connection with this
transaction. The number of additional shares of common stock issuable upon
exercise of the Repricing Rights is determined by multiplying the number of
Repricing Rights exercised by the following fraction:
(Repricing Price - Market Price)
--------------------------------
Market Price
"Market Price" means the lowest closing bid price of common stock, as quoted on
the Nasdaq Small Cap Market, during the 15 consecutive trading days immediately
preceding the exercise date. "Repricing Price" means:
$1.3875 from March 22, 1999 to and including April 21, 1999,
$1.3986 from April 22, 1999 to and including May 21, 1999,
$1.4097 from May 22, 1999 to and including June 20, 1999,
$1.4208 from June 21, 1999 to and including July 20, 1999, and
$1.4319 at any time after July 20, 1999 until the expiration of the
Repricing Rights.
The investor that purchased the common stock in the December 1998
private placement has the right, upon the occurrence of a "Major Transaction" or
"Triggering Event" as those terms are defined in the transaction documents to
require the Company to repurchase all or a portion of such holder's common
shares or Repricing Rights at a price equal to (i) for each common share with an
associated Repricing Right, the greater of (A) 125% of the purchase price and
(B) the sum of (I) the purchase price and (II) the product of (x) the Repricing
Rate of the Repricing Right on the date of such holder's delivery of a notice of
repurchase and (y) the last reported sale price of the common stock on the date
of such holder's delivery of a notice of repurchase, (ii) for each Repricing
Right without the associated share of common stock, the product of (x) the
Repricing Rate of the Repricing Right on the date such holder's delivery of a
notice of repurchase and (y) the last reported sale price of the common stock on
the date of such holder's delivery of a notice of repurchase and (iii) for each
common share without an associated Repricing Right, 125% of the purchase price.
One of the several events described in the transaction documents as a
"Triggering Event"is the suspension from listing or delisting of the common
stock from The Nasdaq SmallCap Market for a period of three trading days. In
March 1999, trading in the Company's common stock was temporarily halted for
more than three days. Trading resumed within five trading days, and the Company
has not been notified that the holders of the common stock and Repricing Rights
desire to exercise any repurchase rights they may have.
Series C 5% Convertible Debentures
On January 29, 1999, the Company entered into a Securities Purchase
Agreement with four investors pursuant
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to which the Company sold its Series C 5% Convertible 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
stock 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 its 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 individuals who are executive
officers and directors and one individual who is a director of the Company. 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 technologies as
collateral for repayment of the debentures. However, to date no lien on the
patent has been granted.
Loan Agreements
On April 22, 1999, the Company, Articulate and L&H entered into a
loan agreement, (the "April Loan"), under which L&H has lent $1,100,000 to the
Company and Articulate at an interest rate of two percent above a defined prime
rate. The principal and accrued interest are due on the earlier of September 30,
1999, or the date the sale of the operations and a significant portion of the
assets of the HSG (the "Sale") is consummated. Repayment of the April Loan is
secured by the intellectual property of the HSG. In connection with the April
Loan, the Company issued to L&H a warrant which allows L&H to purchase 250,000
shares of common stock of the Company at a price of approximately $0.60 per
share. The warrant expires October 18, 1999. In connection with the issuance of
the warrant, the Company recorded a deferred finance charge totaling $35,959 to
be amortized over the term of the April Loan. The fair value of the warrants was
determined as of the date of grant using the Black-Scholes pricing model
assuming the following: dividend yield of 0%; expected volatility of 85%; risk
free interest rate of 5.1%; and an expected life of six months.
On May 19, 1999, Articulate and L&H entered into an additional loan
agreement (the "May Loan"), under which L&H has lent $4,900,000 to Articulate
at an interest rate of two percent above a defined prime rate. The Company
guaranteed the May Loan and pledged the Company's common stock of Articulate.
The principal and accrued interest are due on the earlier of September 30, 1999
or the date the Sale is consummated. L&H received a warrant in connection with
the May Loan which allows L&H to purchase 600,000 shares of common stock of the
Company at a price of $0.70 per share. The warrant expires May 17, 2001. In
connection with the issuance of the warrant, the Company recorded a deferred
finance charge totaling $210,280 to be amortized over the term of the May Loan.
The fair value of the warrants was determined as of the date of grant using the
Black-Scholes pricing model assuming the following: dividend yield of 0%;
expected volatility of 85%; risk free interest rate of 5.1%; and an expected
life of two years.
On August 12, 1999 the Company and L&H entered into a modification
agreement regarding the May Loan which provided that L&H would increase the
principal amount of the May Loan by the amount of $1,200,000. This additional
loan advance will be subject to all of the existing terms of the May Loan and
will be disbursed upon a fulfillment of certain conditions.
Grants Of Stock Options
During the year ended December 31, 1998, the Company granted options
to purchase 6,414,782 shares of common stock. Of such options, 450,000 (having
an exercise price of $5.16 per share) and 1,200,000 (having an exercise price of
$1.18 per share) were granted to three individuals who are executive officers
and directors of the
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<PAGE>
Company; 1,600,000 (having an exercise price of $1.18 per share) were granted to
directors and 400,000 (having an exercise price of $1.18 per share) were granted
to two officers of the Company, 360,000, 1,595,000, and 617,950 options were
granted to a director and various employees at exercise prices of $3.34, $1.00,
and $6.50 per share, respectively, and 100,000 options were granted to an
unrelated party for services with an exercise price of $3.75 per share. The term
of all of these stock options is ten years from the date of grant. Additionally,
the Company agreed to issue options to purchase 91,832 shares of common stock in
exchange for stock options granted in connection with the acquisition of
Articulate. Of these options, 58,678 are exercisable at a price of $0.83 per
share and have expiration dates ranging from June 1, 2000 to November 2, 2002.
During the year ended December 31, 1998, 35,000 options previously outstanding
were exercised, and 1,067,000 options previously outstanding were forfeited.
During the three months ended March 31, 1999, the Company granted
753,000 stock options to employees and 9,500 stock options to two consultants at
exercise prices ranging from $1.28 to $1.78 per share. The term of all options
granted during this three month period is ten years from the date of grant. Of
the stock options issued, 725,834 vested immediately, 18,334 vest six months
after issuance and 18,332 vest one year after issuance. The weighted average
fair value of the options granted to employees during the three months ended
March 31, 1999 was $1.31 per share using the Black-Scholes pricing model. Had
compensation expense 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 $11,406,432 or $0.18 per share. As of
March 31, 1999, the Company had a total of 16,419,282 options outstanding.
The Synergetics Transaction
Prior to March 1997, the Company's scientific research and
development activities were conducted solely by a third party, Synergetics, Inc.
("Synergetics"), pursuant to product development and assignment contracts
(collectively, the "Synergetics Agreement"). Under that arrangement, Synergetics
provided personnel and facilities, and the Company financed the scientific
research and development activities on an as-required basis. There was no
minimum requirement or maximum limit with respect to the amount of funding the
Company was obligated to provide to Synergetics and the Company was obligated to
use its best efforts in raising all of the necessary funding for the development
of the ASRT. Moreover, under the Synergetics Agreement, the Company was
obligated to pay to Synergetics a royalty of 10% (the "Royalty") of net revenues
from sales of products incorporating Synergetics' "VoiceBox" technology as well
as technologies derivatives thereof. Synergetics compensated its developers and
others contributing to the development effort by granting project shares to
share in royalty payments received by Synergetics ("Project Shares"). On March
13, 1997, the Company and Synergetics reached an agreement in principle to
modify the Synergetics Agreement (the "Modification Terms") with regard to the
development and assignment of the ASRT. On April 6, 1998, the Company and
Synergetics entered into a Royalty Modification Agreement to finalize the
Modification Terms. Under the terms of the Royalty Modification Agreement, the
Company agreed to offer an aggregate of 4,800,000 non-transferable common stock
purchase warrants to the holders of the Project Shares in consideration for
which Synergetics agreed to cancel any further obligation on the part of the
Company to pay the Royalty. The exercise price of the warrants is $10 per share.
The Company has agreed to register the shares of common stock underlying the
warrants. No warrants will be offered to the holders of the Project Shares until
such time as the registration statement relating to such shares has been
declared effective by the Securities and Exchange Commission. After issuance,
the warrants will not be exercisable until the first to occur of (i) the date
that the per share closing bid price of the common stock is equal to or greater
than $37.50 per share for a period of 15 consecutive trading days, or (ii)
September 30, 2000. In addition, the warrants will become immediately
exercisable in the event of a merger or similar transaction in which the Company
is not the surviving entity or the sale of substantially all of the Company
assets.
Termination of Financing Relationship
For several years, the Company maintained a relationship with a major
regional federally insured financial institution pursuant to which the Company
borrowed against its own funds on deposit with the institution. Borrowings under
this arrangement accrued interest at a rate approximately 1% greater than the
rate of interest earned by the Company on its funds on deposit with the
institution. In order to reduce interest expenses, on January 8, 1999, the
Company applied its deposit account in the amount of $20,024,109 against the
unpaid loan balance of $20,046,776, resulting in an unpaid loan balance of
$22,667, which amount subsequently was paid by the Company.
15
<PAGE>
Resignation of Stephen M. Studdert as Chief Executive Officer, Chairman, and
Director
On January 26, 1999, Stephen M. Studdert resigned as the Company's
Chief Executive Officer. On April 30, 1999, Mr. Studdert resigned as Chairman of
the Board of Directors of the Company, and on July 15, 1999, he resigned his
position as a member of the Board. Also on April 30, 1999, Thomas A. Murdock,
the Chief Executive Officer of the Company, was elected Chairman of the Board of
Directors. In connection with Mr. Studdert's resignation, the Company entered
into a separation agreement with Mr. Studdert under which Mr. Studdert released
the Company from all claims and obligations under his Employment Agreement, and
the Company agreed to pay Mr. Studdert $250,000 per year through January 31,
2001, and $100,000 for the year ended January 31, 2002.
Cost Reduction Plan
On January 28, 1999, the Company announced a plan to reduce overall
monthly operating expenses by approximately $8,000,000 for all of 1999. The
Company has taken steps to implement these reductions by terminating certain
consulting relationships, reducing personnel, realizing cost efficiencies from
the integration of acquired business units and the reduction of salary of all
officers and certain employees of the Company. The Company believes such cost
reductions were necessary and appropriate in light of ongoing operating
requirements and limited revenues to date to offset such expenses.
Potential delisting of the Company's common stock from the Nasdaq SmallCap
Market
On June 29, 1999, the Company received a letter from Nasdaq,
notifying the Company that unless the minimum bid price for the Company's common
stock returned to at least $1.00 per share or more for at least ten consecutive
trading days before September 29, 1999, the Company's common stock would be
delisted from the Nasdaq SmallCap Market on October 1, 1999. The Company has the
right to appeal Nasdaq'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 Series C 5% Convertible
Debentures (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.
16
<PAGE>
Properties of the Company
The Company owns no real property. Commencing in October 1996, the
Company leased a 25,600 square foot facility in Draper, Utah, from an
unaffiliated third party at which it conducts its principal scientific research
and development activities and operates its Interactive Technologies Solutions
Group. The Company's lease of that facility is for a term of 8 years. Provided
that the Company is not in default under the lease, the Company has the option
to extend the lease for 5 additional years. The average base monthly lease
payment over the 8-year life of the lease for that facility is $28,389.
Effective May 14, 1999, the Company entered into an agreement to sublease 10,244
square feet of its Draper, Utah facility to an unrelated third party. The
agreement requires the sublessee to pay 40 percent of the Company's 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.
In addition to the Draper facility, the Company sub-leases office
space on a month-to-month basis at market rates for its corporate headquarters
and administrative operations in Salt Lake City, Utah, from SCC. SCC is owned
and controlled by three individuals who are executive officers and directors of
the Company. The three executive officers of the Company have personally
guaranteed this lease in favor of SCC's landlord. The base monthly rental for
the sub-leased space during 1998 was approximately $10,369, plus reimbursable
direct expenses for the use of telephone, facsimile, photocopy and other
business equipment. The Company anticipates continuing the month-to-month
sublease agreement with SCC for 1999 whereby the Company will pay the actual
monthly rental and common area fees incurred by SCC.
The Company also leases approximately 10,000 square feet of office
space in Cupertino, California. The lease on this space is for 5 additional
years, with rent of $24,412 per month. Effective May 25, 1999, the Company
entered into an agreement to sublease approximately 8,000 square feet of the
Cupertino space to an unrelated third party. The remaining approximately 2,000
square feet occupied by the Company is to be turned over to the sublessee no
sooner than six months and no later than nine months from the commencement of
the sublease. The agreement requires the sublessee to pay approximately 80% of
the Company's obligation under the primary lease through the six- to nine-month
period of reduced occupancy by the Company and 100% thereafter through May 31,
2003. Following the sublease of the remaining 2,000 square feet, the Company
plans to move to a smaller facility in the same area.
In March 1999, the Company entered into an agreement to lease office
space in Cleveland, Ohio for sales and installation personnel. The lease is for
three years at a monthly rate of $4,260 and became effective May 1, 1999.
The Company leases approximately 16,810 square feet of office space
in Woburn, Massachusetts, at which it conducts the operations of its Health Care
Solutions Group. This lease extends through November 1999, and monthly rents are
$22,343. If the Sale, as discussed more fully in the section "Stockholder
Consent Resolution: Sale of the HealthCare Solutions Group" is approved by the
Stockholders of the company and closes, this lease is to be assumed by the party
purchasing the HSG.
The Company believes that the facilities described above are adequate
for its current needs.
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 the Company 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.
17
<PAGE>
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 pursue the Utah action. However, on appeal, the lawsuit in
New York could be reinstated, and Clarke and Perpetual Growth could prevail in
that lawsuit, or in the suit filed in Utah, 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 appear to be
false. At about the same time, the Company began negotiations with the former
executive officers of Papyrus. 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
approximately 970,000 shares of restricted common stock issued to the five
former shareholders in the acquisition. The Company must pay the Settlement
Payment on or before August 31, 1999. Alternatively, if this Proxy Statement has
been submitted to the Company's shareholders on or before August 31, 1999, the
Settlement Payment will be due upon closing of the Sale. If the Company does not
do so, 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, 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.
Market Price of and Dividends on the Company's Common Stock
Market information
Fonix common stock is listed on the Nasdaq SmallCap Market under the trading
symbol FONX. The following table shows the range of high and low sales price
information for the Company's common stock as quoted on Nasdaq for the four
quarters of calendar 1998 and 1997. The quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commissions and may not represent actual
transactions.
18
<PAGE>
<TABLE>
<CAPTION>
Calendar Year 1999 Calendar Year 1998 Calendar Year 1997
----------------------- ----------------------- ----------------------
High Low High Low High Low
---- --- ---- ----- ----- ----
<S> <C> <C> <C> <C> <C> <C>
First Quarter $ 3.31 $ 0.69 $ 6.50 $ 3.50 $ 9.00 $ 7.13
Second Quarter $ 0.94 $ 0.25 $ 6.34 $ 3.00 $ 8.75 $ 6.50
Third Quarter - - $ 4.00 $ 1.12 $ 7.44 $ 6.50
Fourth Quarter - - $ 2.63 $ 0.94 $ 7.00 $ 2.88
</TABLE>
The high and low sales prices for the Company's common stock on
August 11, 1999, were $1.031 and $0.500, respectively.
The Company has never declared any dividends on its common stock and
it is expected that earnings, if any, in future periods will be retained to
further the development and sale of the Company's human-computer interaction
technologies and products. No dividends can be paid on the common stock of the
Company until such time as all accrued and unpaid dividends on the Company's
preferred stock have been paid.
19
<PAGE>
Selected Financial Data
The selected consolidated financial data set forth below is derived
from the Company's consolidated balance sheets and statements of operations as
of and for the years ended December 31, 1998, 1997, 1996, 1995 and 1994. The
data set forth below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
consolidated financial statements and related notes thereto included in
Amendment No. 1 to the Company's Annual Report on Form 10-K, filed with the
Securities and Exchange Commission on August 11, 1999.
<TABLE>
<CAPTION>
For the Year Ended December 31,
1998 1997 1996 1995 1994
-------------- ---------------- ------------- -------------- --------------
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Revenues $ 2,889,684 $ -- $ -- $ -- $ -- -
General and administrative expenses 12,612,015 12,947,112 3,530,400 3,553,665 1,339,987
Research and development expenses 13,620,748 7,066,294 4,758,012 2,704,165 2,522,090
Purchase of in-process research and development 13,136,000 -- -- -- --
Loss from operations (36,555,423) (20,013,406) (8,288,412) (6,257,830) (3,862,077)
Other income (expense) (6,563,359) (1,558,678) 458,904 (88,067) (52,262)
Gain (loss) on extraordinary item -- (881,864) -- 30,548 --
Net loss (43,118,782) (22,453,948) (7,829,508) (6,315,349) (3,914,339)
Basic and diluted net loss per common share $ (0.91) $ (0.59) $ (0.21) $ (0.30) $ (0.28)
Weighted average number of common shares
outstanding 52,511,185 42,320,188 36,982,610 21,343,349 14,095,000
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------- -------------- -------------- -------------- --------------
Balance Sheet Data:
<S> <C> <C> <C> <C> <C>
Current assets $ 20,715,206 $ 21,148,689 $ 23,967,601 $ 7,912,728 $ 2,150,286
Total assets 61,989,927 22,894,566 25,331,270 7,984,306 2,150,286
Current liabilities 35,394,181 20,469,866 19,061,081 6,674,572 4,117,995
Long-term debt, net of current portion -- 52,225 -- -- --
Stockholders' equity (deficit) 24,765,746 2,372,475 6,270,189 1,309,734 (1,967,709)
</TABLE>
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AS OF MARCH 31, 1999
THIS PROXY STATEMENT CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED IN THE COMPANY'S ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998.
Overview
The Company 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, the Company has developed proprietary
automated speech recognition and related technologies such as text-to-speech
(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. The Company 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.
Outlook
Corporate Objectives, Technology Vision and Acquisition Strategy
The Company has positioned itself as a developer of "next generation"
speech and human-computer interface technologies that will provide multiple
product solutions for business, consumer and service applications. The Company's
management team has assembled leading talents in the ASR, TTS, handwriting
recognition and other arenas related to these technologies. The Board of
Directors and management have developed a business strategy that identifies the
Company's strengths and objectives, outlines a vision of the next major market
opportunities in the computer, telephony and electronics industries and
articulates a corporate and technology strategy that includes strategic
alliances, collaborative development agreements, strategic acquisitions and,
ultimately, marketing a suite of Fonix-branded products.
The Company believes that its Core Technologies will be the platform
for the next generation of automated speech technology and products. Most speech
recognition products offered by other companies are based on technologies such
as HMM, that are largely in the public domain and represent nothing particularly
"new" or creative. The Fonix Core Technologies are based on proprietary,
patented technology. The Company will continue to seek patent protection of the
Core Technologies as well as technologies and inventions derived from the
knowhow, technologies and products obtained with the acquisition of AcuVoice,
Articulate and Papyrus. Management believes this strategy will set the Company's
advanced human computer interaction products apart from the competition.
The Company is determined to become a multi-market, multi-product
enterprise offering advanced speech and human-computer interface technologies
for business, consumer and service applications. Advanced human-computer
interface technologies and multi-modal systems include:
o speech recognition and synthesis
o speaker identification and verification
o handwriting recognition
o pen and touch screen input
o natural language understanding
21
<PAGE>
Anticipated products incorporating such advanced multi-modal human computer
interface technology include the following:
o PCs and PDAs
o cellular phones
o automotive and home environment speech controls
o automated information and transaction kiosks
o telephone systems with natural dialogue and gesture
controls
o smart consumer appliances and electronics
o speech and pen-based computers utilizing handwriting and
cursive recognition
o interactive education and entertainment systems
o redesigned appliances
o toys and games
This next generation technology presents important product and
service opportunities for companies like the Company in a variety of industry
segments, including:
o semiconductors
o health care
o telecommunications
o computers
o software
o consumer electronics
o entertainment
o automotive
The Company is a technology company. Since its inception, the Company
has focused on the development of its Core Technologies and related
complementary technologies, including those technologies obtained in connection
with the acquisitions of AcuVoice, Articulate and Papyrus. The Company will
pursue the development of advanced speech and computer-interface technologies
that will enhance or may be enhanced by its own Core Technologies. The Company
will pursue this development through strategic alliances, such as the Siemens
agreement in the telecommunications industry, and through collaborative research
arrangements such as its agreements with Oregon Graduate Institute and Brigham
Young University.
As the Company proceeds to implement its strategy and to reach its
objectives, it anticipates that it will continue to realize several benefits for
itself and for its shareholders. In addition, the Company expects further
development of complementary technologies, added product and applications
development expertise, access to market channels and additional opportunities
for strategic alliances in other industry segments.
The strategy described above is not without risk, and shareholders
and others interested in the Company and its common stock should carefully
consider the risks contained the Company's Annual Report on Form 10-K for the
year ended December 31, 1998.
Results of Operations
Three months ended March 31, 1999 compared with three months ended
March 31, 1998
During the three months ended March 31, 1999, the Company recorded
revenues of $1,110,332, a decrease of $185,453 over the same period in the
previous year. In the 1998 comparable period the Company received its first
revenues of $1,295,785, of which, $1,291,712 was paid by Siemens as a
non-refundable license fee. The 1999 revenues are primarily from sales and
licensing fees related to the PowerScribe dictation product and TTS technologies
and products.
22
<PAGE>
The Company incurred product development and research expenses of
$2,971,279 during the three months ended March 31, 1999, an increase of $270,076
over the same period in the previous year. This increase was due primarily to
the addition of product development and research personnel, equipment,
facilities and the operations of the Interactive Technologies and HealthCare
Solutions Groups. The Company anticipates similar or increased product
development and research costs as it continues to develop and market the
applications and products offered by its HealthCare Solutions and Interactive
Technologies Solutions Groups. During the three months ended March 31, 1999, the
Company expended a total of approximately $280,000 in connection with the
development of the AcuVoice and Articulate purchased in-process research and
development projects. No amounts were expended in connection with these projects
during the three months ended March 31, 1998.
Selling, general and administrative expenses were $3,675,561 and
$1,380,080 , respectively, for the three months ended March 31, 1999 and 1998.
Salaries, wages and related costs were $2,093,626 and $716,550 for the three
months ended March 31 1999 and 1998, respectively, an increase of $1,377,076.
This increase is attributable to increases in personnel costs resulting from the
acquisitions of AcuVoice, Articulate and Papyrus. Legal and accounting expenses
increased $238,692, marketing expenses increased $336,668 and consulting and
outside services increased by $94,094.
Amortization of goodwill and purchased core technologies were
$1,287,581 and $98,783 , respectively, for the three months ended March 31, 1999
and 1998 representing an increase of $1,188,798. 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 $7,049,528 and
$12,199,281 during the three months ended March 31, 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 three months ended
March 31, 1998, offset in part by increases in 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 increased levels for at least the remainder of fiscal 1999, assuming
availability of working capital.
Net other expense was $2,245,333 for the three months ended March 31,
1999, an increase of $2,204,886 over the three months ended March 31, 1998. This
increase was due primarily to increased interest expense of $1,955,455 due to
financing costs associated with the issuance of the Series C 5% Convertible
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 March 31, 1999, the Company
has expended a total of approximately $190,000 and $500,000 in connection with
the AcuVoice and Articulate acquired in-process research and development
projects, respectively, and management estimates that a total of approximately
$810,000 and $500,000 will be required to complete the AcuVoice and Articulate
projects, respectively. Management estimates that the AcuVoice and Articulate
projects are 80 percent and 87 percent complete, respectively, as of March 31,
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 twelve 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
23
<PAGE>
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 acceptable third party licensing or co-development arrangements such
that it will be able to finance ongoing operations out of license, royalty and
sales revenue. There can be no assurance that the Company will be able to enter
into 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.
The Company had negative working capital of $13,903,731 at March 31,
1999 compared to negative working capital of $14,678,975 at December 31, 1998.
The current ratio was 0.10 at March 31, 1999, compared to 0.59 at December 31,
1998. Current assets decreased by $19,221,364 to $1,493,842 from December 31,
1998 to March 31, 1999. Current liabilities decreased by $19,996,608 to
$15,397,573 during the same period. The increase in working capital from
December 31, 1998 to March 31, 1999, was primarily attributable to the payment
of notes payable and other accrued liabilities from the proceeds of the Series C
5% Convertible Debentures. Total assets were $41,261,363 at March 31,1999
compared to $61,989,927 at December 31, 1998.
During the three months ended March 31, 1999, the Company granted
753,000 stock options to various employees and 9,500 stock options to two
consultants at exercise prices ranging from $1.28 to $1.78 per share. The term
of all options granted during this three month period is ten years from date of
grant. As of March 31, 1999, the Company had a total of 16,419,282 options
outstanding.
From its inception, the Company's principal source of capital has
been private and other exempt sales of the Company's debt and equity securities.
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 holder into shares of the Company's common stock
at a conversion price equal to the lesser of $1.25 or 80% 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 also issued 400,000
warrants in connection with this financing. The warrants entitle the holders to
purchase up to 400,000 shares of the Company common stock at an exercise price
of $1.25 per share. On March 3, 1999, the Company executed a Supplemental
Agreement pursuant to which the Company agreed to sell an additional $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. Gross
proceeds to the Company from these two transactions were $6,500,000.
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, were personally guaranteed by Thomas A. Murdock, Roger D. Dudley
(each of whom are executive officers and directors of the Company) and Stephen
M. Studdert (director of the Company) (collectively, "Guarantors"). The personal
guarantees of these Guarantors were secured by a pledge of 6,000,000 shares of
The Company's common stock beneficially owned by them and held in the name of
Thomas A. Murdock, Trustee. In connection with the Supplemental Agreement, the
Company agreed to pledge as collateral for repayment of the Debentures, a lien
on the patent covering certain ASR technologies. At the present time the Company
has not executed a security agreement in favor of the investors describing the
patent. In connection with the guaranty and the pledge of The Company's common
stock given by Guarantors, the Company agreed to indemnify and hold them
harmless in the event of a default that results in any payment or other
liability or damage incurred by any of them. In consideration for the guaranty
and pledge by Guarantors, the Company also agreed to grant each of them common
stock purchase warrants to purchase 666,666 shares of common stock at a price of
$1.59 per share. However, the Guarantors have declined the grant of these
warrants. On or about April 6, 1999, the holders of the Debentures notified the
Company and Guarantors that 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. At the present time, the Company has no knowledge of
sales of Guarantors' shares by the holders of the debentures. However, if the
holders proceed to sell some or all of Guarantors' shares, the Company may be
obligated under its indemnity agreement in favor of Guarantors to issue shares
to the Guarantors in replacement of all shares sold by the holders and to
reimburse Guarantors for any income tax liability incurred as a result of the
holders' sales of Guarantors' shares.
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During the three months ended March 31, 1999, 17,500 shares of Series
D Convertible Preferred Stock and 45,072 shares of Series E Convertible
Preferred Stock and related dividends were converted into 426,464 shares and
1,086,531 shares, respectively, of the Company's common stock.
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. 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 March 31, 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. The weighted average outstanding balance
during the three months ended March 31, 1999 was $50,000. The weighted average
interest rate was 9.75 percent during this period. This note is payable on
demand, matures April 1, 2007, bears interest at a bank's prime rate plus 2.0
percent (9.75 percent at March 31, 1999) and requires interest to be paid
monthly.
At March 31, 1999, the Company had a note payable to a lender in the
amount of $560,000 which bears interest at 18 percent per annum, which interest
is payable monthly. The note payable was originally due January 2, 1999 and is
secured by certain accounts receivable of the Company's HealthCare Solutions
Group. The Company has extended the due date through August 31, 1999 by paying
the lender accrued interest plus a fee of $5,880 per month and by increasing the
balance due to $588,000. The Company anticipates that it will request additional
extensions of the due date if the Sale has not closed by August 31, 1999.
However, the Company has agreed to pay the loan out of the Sale of the HSG to
L&H. The note is personally guaranteed by two officers and a member of the Board
of Directors of the Company.
At March 31, 1999, the Company had unsecured demand notes payable
outstanding to former Articulate stockholders in the aggregate amount of
$4,658,980 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 and the holder agreed to
extend the date on which demand could be made to March 15, 1999 and increase the
interest rate to 11 percent per year. No additional demand has been given 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 three months ended March 31, 1999 and subsequent to
March 31, 1999, the Company made partial payments of $50,000 and $175,000,
respectively, on a $2,535,235 note and agreed to pay the balance in connection
with the Sale of the HSG to L&H.
At March 31, 1999, the Company had unsecured demand notes payable
outstanding to former Articulate employees in the aggregate amount of $452,900
and an accrued liability 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 by
the former Articulate employees.
At March 31, 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 at the
closing of the Sale of the HSG to L&H.
At March 31, 1999, the Company had an unsecured revolving note
payable in the amount of $184,839 in principal and $5,929 in accrued interest to
SMD, a company owned by two individuals who are executive officers and directors
and one individual who is a director of the Company and who each beneficially
own more than 10 percent of
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the Company's common stock. The weighted average balance outstanding during the
three months ended March 31, 1999 was $53,398. 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 March 31, 1999 was
$184,839. In 1999, advances to the three individuals in the amount of $59,986
were applied as a partial payment of this note.
In December 1998, two individuals who are executive officers and
directors and one individual who is a director of the Company ("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 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. These amounts are now included in the unsecured
revolving note payable to SMD described above.
At March 31, 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. This note is payable on
demand.
At March 31, 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 June 30, 1999.
At March 31, 1999, the Company had an unsecured note payable to an
officer of the Company in the amount of $43,691 which bears interest at an
annual rate of 10 percent and is due on or before July 31, 1999. Subsequent to
March 31, 1999, this same officer advanced an additional $25,000 to the Company
under similar terms.
On April 22, 1999, the Company, Articulate and L&H entered into a
loan agreement, (the "April Loan"), the terms of which provided that L&H would
lend $1,100,000 to the Company at an interest rate of two percent above a
defined prime rate. The Company has received the full amount of the April Loan.
The principal and accrued interest are due on the earlier of September 30, 1999,
or the date the Sale is consummated, and is secured by the intellectual property
of the HSG.
On May 19, 1999, Articulate and L&H entered into an additional loan
agreement (the "May Loan"), the terms of which provided that L&H would lend
$4,900,000 to Articulate at an interest rate of two percent above a defined
prime rate. Articulate has received the full amount of the May Loan. The May
Loan was guaranteed by the Company and is secured by the Company's common stock
of Articulate. The principal and accrued interest are due on the earlier of
September 30, 1999 or the date the Sale is consummated.
On August 12, 1999, the Company and L&H entered into a modification
agreement regarding the May Loan which provided that L&H would increase the
principal amount of the May Loan by the amount of $1,200,000. This additional
loan advance will be subject to all of the existing terms of the May Loan and
will be disbursed upon a fulfillment of certain conditions.
The Company anticipates that it will need to raise additional funds
to satisfy its cash requirements during the next twelve months. Even taking into
account expected revenues from the HSG (prior to the Sale) and Interactive
Technologies Solutions Group, the Company's ongoing operating expenses will
remain higher than revenues from operations at least through the first three
quarters of 1999. Accordingly, the Company expects to incur significant losses
until such time as it is able to enter into substantial licensing and
co-development agreements and receive substantial revenues from such
arrangements or from the operations of its recently acquired subsidiaries, of
which there can be no assurance. Scientific research and development, corporate
operations and marketing expenses will continue to require additional capital.
The Company therefore intends to continue to rely primarily on financing through
sales of its equity and debt securities 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 revenues. There can be no
assurance that the Company will be able to sell its equity and debt securities
such that sufficient operating capital will be available when and in the amounts
needed. Furthermore, the issuance of equity securities or other securities which
are or may become convertible to the equity securities of the
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Company in connection with such financing (or in connection with acquisitions)
will result in dilution to the stockholders of the Company which could be
substantial.
The Company presently has no plans to purchase any new research and
development or office facilities.
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. The
Company 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, the Company tests and
evaluates its technologies and software and hardware products. The Company
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,
the Company 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, the Company 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 the Company's technologies or
products experience Year 2000 problems, those persons could assert claims for
damages.
The Company uses third-party equipment and software that may not be
Year 2000 compliant. The Company 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, the Company
presently believes that all software provided by third parties that is critical
to its business is Year 2000 compliant. If this third-party equipment or
software does not operate properly with regard to the Year 2000 issue, The
Company may incur unexpected expenses to remedy any problems. Such costs may
materially adversely affect the Company's business, operating results, and
financial condition. In addition, if The Company's key systems, or a significant
number of its systems, fail as a result of Year 2000 problems the Company could
incur substantial costs and disruption of its business. The Company may also
experience delays in implementing Year 2000 compliant software products. Any of
these problems may materially adversely affect the Company's business, operating
results or financial condition.
In addition, the purchasing patterns of the Company'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 the Company's technologies or to purchase
other products of the Company. This may adversely affect the Company's business,
operating results, and financial condition.
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 for the year ended December 31, 1998.
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
Subsequent to the year ended December 31, 1997, in February 1998, the
Company appointed Arthur Andersen LLP ("Andersen") to replace Deloitte & Touche
LLP ("Deloitte") as independent auditors of the Company for the fiscal year
ended December 31, 1997. Deloitte resigned as the Company's independent auditors
on February 23, 1998.
The report of Deloitte on the Company's consolidated financial
statements for the year ended December 31, 1996, contained no adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principle, except that Deloitte's report on the consolidated
financial statements for the year ended December 31, 1996 included an
explanatory paragraph with respect to the Company being in the development stage
and its having suffered recurring losses which raise substantial doubt about its
ability to continue as a going concern.
The decision to engage Andersen as the Company's independent auditors
was approved by the Company's board of directors.
In connection with the audit for the year ended December 31, 1996,
and through March 31, 1999, the Company has had no disagreements with Deloitte
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements if not resolved
to the satisfaction of Deloitte would have caused it to make reference thereto
in its report on the consolidated financial statements for such year.
During the years ended December 31, 1996, 1997, and 1998, and through
March 31, 1999, there have been no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
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STOCKHOLDER CONSENT RESOLUTION:
APPROVAL OF SALE OF HEALTHCARE SOLUTIONS GROUP
The Board of Directors have recommended to the officers of the
Company, and the officers of the Company have entered into an agreement for the
sale by the Company of the operations and a significant portion of the assets of
its HealthCare Solutions Group ("HSG"), headquartered in Woburn Massachusetts,
to Lernout and Hauspie Speech Products N.V., a Belgian corporation with its
principal place of business in Ieper, Belgium ("L&H"). The Company created the
HSG by acquiring Articulate Systems, Inc. ("Articulate"), in September 1998, and
the PowerScribe business unit of The MRC Group in December 1998.
Information about L&H and the HSG
L&H is a global leader in advanced speech and language solutions for
vertical markets, computers, automobiles, telecommunications, embedded products,
consumer goods and the Internet. L&H is attempting to make the speech user
interface the keystone of simple, convenient interaction between humans and
technology, and is using advanced translation technology to break down language
barriers. L&H provides a wide range of offerings, including: customized
solutions for corporations; core speech technologies marketed to original
equipment manufacturers; end user and retail applications for continuous speech
products in horizontal and vertical markets; and document creation, human and
machine translation services, Internet translation offerings, and linguistic
tools. L&H's products and services originate in four basic areas: automatic
speech recognition, text-to-speech, digital speech and music compression, and
text-to-text (translation).
The HSG is a leader in the application of advanced speech recognition
technology to the healthcare market with its PowerScribe (R) ("PowerScribe")
line of integrated dictation/transcription systems. The HSG produces and sells
its PowerScribe dictation system to hospitals for radiology and emergency
medicine applications. The HSG also supports and services the PowerScribe
systems within the United States. PowerScribe, the winner of a 1998 Microsoft
Healthcare Solution Award, cost-effectively and rapidly captures, transcribes,
and manages dictated clinical information across a computer network.
Summary of the transaction
On May 19, 1999, the Company entered into an Asset Purchase Agreement
(the "Agreement") with L&H for the sale (the "Sale") of the operations and a
significant portion of the assets of the HSG. The transaction calls for L&H to
purchase the HSG for $24,000,000 with $19,000,000 in cash to be paid at closing
and $5,000,000 of which will be escrowed for 18 months for potential
indemnification of L&H against certain matters, including, but not limited to,
breaches of representations, warranties, covenants and agreements made by the
Company in the Agreement. If the closing of the Sale occurs before September 3,
1999, then the escrowed amount will be reduced to $2,500,000. If the closing
occurs after September 3, 1999, and if the Company grants L&H a perpetual,
royalty-free, non-exclusive license to certain of its handwriting technology,
then the escrowed amount will be reduced to $2,500,000.In addition to the
$24,000,000, additional consideration may be paid over two years following the
closing, as follows: (i) if L&H generates gross revenues of $9,000,000 from
sales or licensing of PowerScribe branded products and services, together with
products and services that include or incorporate PowerScribe technology (the
"PowerScribe Products") during the first year it sells or licenses the
PowerScribe Products, L&H will pay an additional $2,000,000 to the Company; and
(ii) if L&H generates $20,000,000 of gross revenues from the sales or licensing
of the PowerScribe Products during the second consecutive year it sells or
licenses the PowerScribe Products, L&H will pay an additional $2,000,000 to the
Company. The amount of consideration to be paid for the HSG was determined based
on a discounted earnings multiple of the three-year projected operations of the
HSG.
The Company will not issue or receive any securities in connection
with the sale of the HSG.
The Sale is subject to certain exclusivity provisions set forth in
the Agreement, under which the Company is required to use its best efforts to
prevent its officers, directors, employees, and agents from discussing the Sale
with any parties other than L&H, or from entering into discussions with any
other entity regarding the sale of the HSG, except as specifically provided in
the Agreement. Additionally, the Sale is conditioned, among other things, on the
ratification
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and approval of the Sale by the holders of a majority of the issued and
outstanding shares of common stock of the Company. Similarly, if the Company's
Board of Directors withdraws or modifies its recommendation to the Company's
stockholders to enter into the transaction, either party may terminate the
Agreement. Another condition to the Sale is that L&H is able to hire not fewer
than 30 of the Company's employees who work in the HSG, and that such employees
enter into noncompetition agreements with L&H. See "Material contracts between
the Company and L&H - Noncompetition and Proprietary Information Agreements"
below. As of August 6, 1999, the HSG employs 47 individuals.
In the event the Sale is not consummated because the Company is
unable to obtain stockholder consent or breaches any of its covenants,
representations or warranties or discloses information to a third party in
contemplation of sale to such third party, or because the Company's Board of
Directors withdraws or modifies its recommendation to the Company's
Stockholders, then the Company is obligated to pay up to $600,000 of the
expenses incurred by L&H in connection with the contemplated Sale. In the event
the Sale is not consummated because L&H breaches any of its covenants,
representations or warranties, then L&H is obligated to pay up to $600,000 of
the expenses incurred by the Company in connection with the contemplated Sale.
Additionally, such failure to consummate the Sale would impact the due dates of
certain loans from L&H to the Company. See "Material contracts between the
Company and L&H Loan Agreements" below.
Business plan of the Company
The Company's business plan is to produce and market a suite of
Fonix-branded technologies for high value end-user products and applications and
to license these technologies through strategic alliances. Potential partners
include Internet content and service providers, consumer electronic
manufacturers and independent software vendors. These partners can incorporate
the Company's technology solutions to simplify the use of their own products.
Multiple hardware and software platforms can be supported via the the Company's
FAASTTM application development tool for embedded systems.
Because of the Company's focus on forming new strategic partnerships
and licensing opportunities for the development of its products and
applications, the Board of Directors of the Company felt that the sale of the
HSG would allow the Company to focus on its core competencies and to employ more
efficiently its automated speech, speech synthesis, and handwriting interface
technologies in handheld computers, Internet applications, and embedded systems.
In keeping with this focus, a portion of the sale proceeds will be used to
permit the Company to focus on licensing opportunities for its core technologies
and related applications currently available and in development, including the
following:
o Voice Internet/Web access and navigation to retrieve information and
execute e-commerce transactions such as stock trades and quotes,
news, weather, sports, travel and entertainment reservations.
o Speech and handwriting technologies for embedded systems in mobile
consumer electronics including personal digital assistants, smart
phones, and automobile navigation systems.
o Integrated pen and voice input for the next generation of computing
devices and intelligent appliances such as palmPCs, tablets, smart
phones and kiosks.
o Automated dictation and transcription speech recognition for use in
natural, open environments without individual training requirements
to facilitate personal dictation, meeting and conference
transcription, and live closed captioning.
Use of proceeds
The Company anticipates that it will use a majority of the proceeds
from the Sale to pay several of its outstanding debt obligations and certain
accounts payable. Specifically, the Company anticipates using $7,200,000 of the
proceeds to pay off the April and May Loans to L&H; $5,000,000 into escrow
pursuant to an escrow agreement to be entered into in relation with the Sale
(see "Material Contracts between the Company and L&H - Escrow Agreement");
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approximately $8,177,000 to pay outstanding notes payable and related accrued
interest payable; approximately $1,440,000 to pay certain HSG employees for
extraordinary services performed prior to the Sale; approximately $260,000 for
fees for professional services; and approximately $250,000 for state and federal
income taxes arising in connection with the Sale. The Company plans to use the
remaining $1,673,000 as working capital. If the escrow amount is reduced from
$5,000,000 to $2,500,000, then the Company plans to use the additional
$2,500,000 as working capital.
Because the Sale is for cash, and because the Company will not issue
any securities or receive any securities of L&H in connection with the
transaction, the transaction creates no material differences in the rights of
the stockholders of the Company.
Accounting treatment of the Sale
The Sale will be accounted for as an asset sale.
Income tax consequences
The following description of federal income tax consequences is based
on the Internal Revenue Code of 1986, as amended (the "Code"), the applicable
Treasury Regulations promulgated thereunder, judicial authority and current
administrative rulings and practices in effect at the time of preparation of
this Proxy Statement. This discussion is for general information only, and does
not discuss consequences which may apply to special classes of taxpayers (e.g.
non-resident aliens, broker-dealers, tax exempt entities, or insurance
companies). Stockholders are urged to consult their own tax advisors to
determine the particular consequences to them.
Under applicable income tax regulations, the sale of the HSG assets
will be a taxable event in which the excess of the sales price over the
Company's basis in the assets sold will be a taxable gain. The Company and its
HSG subsidiary have sufficient net operating losses to offset the taxable gain
for Federal income tax purposes. However, alternative minimum income tax
regulations and state income tax regulations will result in an income tax
liability approximating $250,000. In order to minimize Massachusetts income
taxes, the Company and Articulate may consider merging Articulate with and into
the Company prior to the closing of the Sale. In such event, at the closing of
the Sale the Company would convey all of the assets of the HSG to L&H rather
than the Company and Articulate.
Debt obligations of the Company
During the last half of 1998 and during 1999, the Company incurred
substantial amounts of debt which, coupled with the Company's ongoing operating
expenses, could hamper the Company's ability to continue as a going concern
unless the Company is immediately able to generate significant revenues or to
raise a substantial amount of capital to pay that debt. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations as of
March 31, 1999." Much of the Company's debt is payable on demand. The Company
does not presently have sufficient operating capital or revenues to allow the
Company to satisfy these obligations if demand for payment is made and the
Company cannot renegotiate the terms of the debt or otherwise persuade its
creditors to withdraw their demand. In such event, the Company's financial
condition and operations could be adversely affected. The following discussion
summarizes the extent and nature of such recently incurred debt.
In connection with the Company's acquisition of Articulate in
September 1998, the Company incurred new debt obligations to 13 former
shareholders of Articulate in the aggregate amount of $4,747,339. These debt
obligations are in the form of demand notes payable at any time after November
1, 1998, and bear interest at the annual rate of 8.5%. The due dates of these
obligations subsequently were extended to dates ranging from April 1999 to
October 1999, and, in some cases, the Company has agreed to pay interest at
rates exceeding 8.5% per year. In connection with certain of these loans, the
Company paid $50,000 in March 1999, $75,000 in April 1999, and $675,000 in
May1999, which were applied to principal and accrued interest. No additional
demands for payment have been made on this note. The Company and the payees of
these obligations have agreed that the unpaid balances due will be paid out of
the proceeds of the Sale. After the acquisition of Articulate, the Company also
agreed to pay several Articulate employees incentive compensation for continued
employment in the aggregate amount of $857,000, in connection with which the
Company
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<PAGE>
issued 8.5% demand notes for $452,900 and recorded an accrued liability of
$404,100 for the balance. The notes issued to the Articulate employees are
presently payable on demand, but, as of the date hereof, the Company has not
received any demand for payment of the notes by the former Articulate employees.
The $404,100 accrued liability was payable on or before January 31, 1999. The
payees with respect to this obligation have agreed to an extension of the
payment date to August 31, 1999, and the Company intends to pay all of these
obligations out of the proceeds of the Sale.
In connection with the Company's acquisition of Papyrus Associates,
Inc., and Papyrus Development Corp. (collectively, "Papyrus"), in October 1998,
the Company incurred debt obligations in the form of promissory notes to the
former shareholders of Papyrus in the aggregate amount of $1,710,000. With
respect to $1,632,375 of the notes, the holders thereof have agreed to accept an
aggregate payment of $1,188,909 in full satisfaction of the notes, if paid
before August 31, 1999, or if this Proxy Statement has been distributed to the
shareholders of the Company before August 31, 1999, then at the time of the
closing of the Sale. The Company intends to pay all of these obligations out of
the proceeds of the Sale.
On December 2, 1998, the Company borrowed $560,000 from an
unaffiliated private lender. The loan accrues interest at the rate of 18% per
year, is secured by certain accounts receivable and was due January 2, 1999. The
Company has subsequently extended the due date of this loan from month to month
by paying the lender the accrued interest plus a fee of $5,880. The loan balance
has also been increased to $588,000 and is due August 31, 1999. However, the
Company anticipates that it will request and pay for an extension of the due
date for one or more additional months beyond that date if the Sale has not
closed by that date. The Company intends to pay this obligation out of the
proceeds of the Sale.
On April 22, 1999, the Company, Articulate and L&H entered into a
loan agreement, (the "April Loan"), the terms of which provided that L&H would
lend $1,100,000 to the Company and Articulate at an interest rate of two percent
above a defined prime rate. The Company and Articulate have received the full
amount of the April Loan. The principal and accrued interest are due on the
earlier of September 30,1999, or the date the Sale is consummated, and is
secured by the intellectual property of the HSG
On May 19, 1999, Articulate and L&H entered into an additional loan
agreement (the "May Loan"), the terms of which provided that L&H would lend
$4,900,000 to Articulate at an interest rate of two percent above a defined
prime rate. On August 12, 1999, Articulate and L&H agreed to increase the
principal balance of the May Loan by $1,200,000. The May Loan is secured by the
Company's common stock of Articulate and Articulate has received $4,900,000 of
the May Loan amount. The principal and accrued interest are due on the earlier
of September 30, 1999, or the date the Sale is consummated.
In addition to these notes, the Company presently owes trade payables
in the aggregate amount of approximately $3,000,000, some of which are more than
120 days overdue.
The Company anticipates that substantially all of its outstanding
note obligations will be paid from the proceeds of the Sale.
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 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 stock 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
32
<PAGE>
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 its
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
individuals who are executive officers and directors and one individual who is a
director of the Company. 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 Technologies ("ASRT") as collateral for repayment of the
debentures. However, to date no lien on the patent has been granted.
There are no dividends in arrears on any of the Company's securities
and no defaults in principal or interest in respect to the Company's outstanding
debt securities.
Compliance with statutory requirements
In connection with the Sale, the Company and L&H each filed a
Notification and Report Form pursuant to the Antitrust Improvements Act of 1976.
The Federal antitrust laws, including the Antitrust Improvements Act and Section
7A of the Clayton Act (more commonly known as the Hart-Scott-Rodino Act),
provide for the prior notification of transactions such as the Sale to both the
Federal Trade Commission and to the Antitrust Division of the United States
Department of Justice. No such transaction may be consummated without complying
with the notification procedures and awaiting the expiration of a statutorily
defined waiting period, typically 30 days from the filing of the notification.
The 30-day waiting period for this transaction commenced on June 22, 1999 and
the Company and L&H received early termination of the waiting period on July 13,
1999.
Material contracts between the Company and L&H
Prior to the Sale, the Company had no affiliation or contractual
relations with L&H. The following documents between the Company and L&H were
entered into in connection with the Sale and are collateral agreements to the
Sale.
Escrow Agreement
In connection with the Agreement, the Company and L&H will enter into
an escrow agreement (the "Escrow Agreement") at the closing of the Sale, with
State Street Bank and Trust Company to be appointed as escrow agent. The Escrow
Agreement will provide for the escrow of $5,000,000 or $2,500,000 (the "Escrow
Amount") of the purchase price. If the closing of the Sale occurs before
September 3, 1999, then the Escrow Amount will be $2,500,000. If the closing of
the Sale occurs after September 3, 1999 and if the Company grants L&H perpetual,
reoyalty-free, non-exclusive license to certain of its handwriting technology,
then the Escrow Amount will be $2,500,000. Under all other circumstances, the
Escrow Amount will be $5,000,000. Under the Agreement, the Company agreed to
indemnify L&H against certain matters including, but not limited to, breaches of
representations, warranties, covenants and agreements made by the Company in the
Agreement. The Escrow Amount is to be used to cover any claims for
indemnification by L&H against the Company under the Agreement. If after 18
months following the closing of the Sale any portion of the Escrow Amount
remains in the escrow account, such funds are to be released to the Company.
Technology Option Agreement
Concurrent with entering into and as further consideration paid
under, the Agreement, the Company and L&H entered into a related agreement (the
"Technology Option Agreement") designed to help maintain the continuity of the
business of the HSG through the date of the Sale. The Technology Option
Agreement grants to L&H the option to acquire and assume all of the Company's
right, title, and interest to a License Agreement dated July 7, 1998, (the
"Dragon License") between Dragon Systems, Inc. ("Dragon") and Articulate and the
option to be appointed as a non-exclusive worldwide distributor of the HSG's
products which use or incorporate Dragon's technology. The Company is prohibited
under the Technology Option Agreement from disclosing or providing to L&H or any
third party access to any of Dragon's confidential information. On August 12,
1999, L&H exercised its option under the Technology
33
<PAGE>
Option Agreement to be appointed a non-exclusive worldwide distributor of HSG
products which use or incorporate Dragon's technology.
Assignment and Assumption Agreement
Additionally, at L&H's option, the Company and L&H may enter into an
assignment and assumption agreement (the "Assignment and Assumption Agreement").
Under the Assignment and Assumption Agreement, the Company will assign to L&H
all of its rights, duties, and obligations under the Dragon License.
Additionally, L&H will agree to assume all of Articulate's rights, duties, and
obligations under the Dragon License.
License Agreement
Concurrent with entering into the Agreement, the Company and L&H also
entered into a License Agreement (the "License Agreement") for the licensing to
L&H of the Company's technology and software, particularly the software and
tools used to develop PowerScribe. The License Agreement sets forth the software
licensed by the Company to L&H, details the royalties and payments to be made by
L&H, and sets forth certain warranties and technical support obligations of the
Company. Under the License Agreement, the Company also granted to L&H a
non-exclusive, non-transferrable, royalty-free license to use and to authorize
unrelated third parties to use certain licensed marks of the Company, including
PowerScribe, PowerScribe for Radiology, and PowerScribe EM. Unless terminated
pursuant to its terms, the term of the License Agreement is for a period of
twenty years from the date of the Agreement. The Company also agreed to
indemnify L&H against any claim that the licensed software infringes any
third-party patent, copyright, trademark, trade secret, or other intellectual
property right.
Noncompetition and Proprietary Information Agreements
Prior to the Sale, many of the Company's employees who worked in the
HSG became knowledgeable and experienced in one or more aspects of the HSG's
business, and the growth and success of the HSG's business has been due in part
to the services and unique talents of such employees. Recognizing this, and in
connection with the Sale, L&H anticipates offering employment opportunities to
at least 30 such employees of the Company. As a precondition to such employment,
and because such employees will continue to have access to business activities,
business plans, personnel, financial status and other confidential and
proprietary information, L&H intends to require that such employees enter into
noncompetition and proprietary information agreements (the "Noncompetition
Agreements") with L&H. The Noncompetition Agreements govern the use by the
employees of proprietary information and restrict the ability of such employees
from competing against L&H for a certain time following the termination of their
employment with L&H. It is anticipated that approximately thirty employees of
the HSG will enter into the Noncompetition Agreements with L&H.
Loan Agreements
On April 22, 1999, the Company, Articulate and L&H entered into a
loan agreement, (the "April Loan"), under which L&H has lent $1,100,000 to the
Company and Articulate at an interest rate of two percent above a defined prime
rate. The principal and accrued interest are due on the earlier of September
30,1999, or the date the Sale is consummated, and the April Loan is secured by
the intellectual property of the HSG. In connection with the April Loan, the
Company issued to L&H a warrant which allows L&H to purchase 250,000 shares of
common stock of the Company at a price of approximately $0.60 per share. The
warrant expires October 18, 1999. In connection with the issuance of the
warrant, the Company recorded a deferred finance charge totaling $35,959 to be
amortized over the term of the April Loan. The fair value of the warrants was
determined as of the date of grant using the Black-Scholes pricing model
assuming the following: dividend yield of 0%; expected volatility of 85%; risk
free interest rate of 5.1%; and an expected life of six months.
On May 19, 1999, Articulate and L&H entered into an additional loan
agreement (the "May Loan"), under which L&H has lent $4,900,000 to Articulate
for use by the Company at an interest rate of two percent above a defined prime
rate. On August 12, 1999, Articulate and L&H agreed to increase the principal
balance of the May Loan by $1,200,000, subject to certain conditions. The May
Loan is secured by the common stock of ASI owned by the
34
<PAGE>
Company. The principal and accrued interest are due on the earlier of September
30, 1999 or the date the Sale is consummated. L&H received a warrant in
connection with the May Loan which allows L&H to purchase 600,000 shares of
common stock of the Company at a price of $0.70 per share. The warrant expires
May 17, 2001. In connection with the issuance of the warrant, the Company
recorded a deferred finance charge totaling $210,280 to be amortized over the
term of the May Loan. The fair value of the warrants was determined as of the
date of grant using the Black- Scholes pricing model assuming the following:
dividend yield of 0%; expected volatility of 85%; risk free interest rate of
5.1%; and an expected life of two years.
Marketing Support Agreement
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
Articulate products under the Technology Option Agreement. At the same time,
Articulate 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 Articulate (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 had occurred
on July 1, 1999. The payments, not less than zero, determined by subtracting (a)
four hundred thousand dollars ($400,000) from (b) the aggregate amounts paid to
the Company prior to the date of the Marketing Support Agreement that constitute
prepaid sales order amounts, maintenance amounts and license amounts, as if the
Sale had occurred on July 1, 1999, shall reduce the purchase price of the HSG by
that amount. If the closing of the Sale does not occur by September 3, 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 and Articulate under the Assigned Contracts. L&H also
agrees to engage Articulate 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 and Articulate under the Assigned
Contract and (ii) otherwise market and sell Articulate's products and certain
products of L&H.
Information regarding stock price
On May 18, 1999, the day prior to the public announcement of the sale
of the HSG to L&H, the high and low sale prices for the Company's common stock
on the Nasdaq SmallCap Market were $0.781 and $0.565, respectively.
Disposition of property
In connection with the Sale, L&H will acquire the following assets
and property (the "Property") from the Company:
- software and software codes;
- inventory of PowerScribe Products and related products and
materials;
- office and business furniture and equipment;
- certain business records;
- intellectual property of the HSG;
- contract rights of the HSG; and
- certain trade accounts receivable, prepaid expenses, and
other current assets.
35
<PAGE>
The consideration to be paid for the Property is included in and part
of the consideration paid for the Sale. The parties to the Asset Purchase
Agreement have not yet allocated the consideration to be paid, and are not
required to do so under the Asset Purchase Agreement until the closing of the
Sale.
The parties arrived at the determination of the purchase price to be
paid for the HSG, including the Property, through arms length negotiations. The
boards of directors of both the Company and L&H concluded that the amount of
consideration to be paid was fair and appropriate.
Pro forma financial information
The following unaudited pro forma condensed consolidated statement of
operations data for the year ended December 31, 1998 and as of and for the three
months ended March 31, 1999 present the condensed consolidated financial
statements of the Company as if the Sale had occurred as of January 1, 1998 (the
first day of the most recently completed fiscal year). The unaudited pro forma
condensed consolidated balance sheet data as of March 31, 1999 assumes the Sale
occurred on that date.
36
<PAGE>
Pro Forma Selected Financial Data
<TABLE>
<CAPTION>
For the Year
For the Three Ended
Months Ended December 31,
March 31, 1999 1998
------------------- ------------------
Statement of Operations Data:
<S> <C> <C>
Revenues $ 53,806 $ 2,604,724
Selling, general and administrative 2,745,068 8,817,643
Product development and research 2,512,826 13,060,604
Purchased in-process research and development - 9,315,000
Loss from operations (5,866,988) (30,336,230)
Other expense, net (2,083,892) (6,367,444)
Net loss (7,950,880) (36,703,674)
Basic and diluted net loss per common share $ (0.14) $ (0.79)
Weighted average number of common shares outstanding 64,476,886 52,511,185
</TABLE>
<TABLE>
<CAPTION>
As of
March 31, 1999
--------------
Balance Sheet Data:
<S> <C>
Current assets $ 14,754,877
Total assets 35,580,468
Current liabilities 6,148,219
Long-term debt, net of current portion 6,500,000
Stockholders' equity 21,102,249
</TABLE>
Pro Forma Per Share Data
<TABLE>
<CAPTION>
As of March 31, 1999
-------------------------------
Historical Pro Forma
-------------- ---------------
<S> <C> <C>
Book value per share $0.27 $0.32
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended For the Year Ended
March 31, 1999 December 31, 1998
---------------------------------------- --------------------------------------
Historical Pro Forma Historical Pro Forma
------------------- ------------------- ----------------- -------------------
<S> <C> <C> <C> <C>
Cash dividends declared per share - - - -
Net loss per common share $(0.16) $(0.14) $(0.91) $(0.79)
</TABLE>
Pro Forma Financial Statements
37
<PAGE>
[A Development Stage Company]
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year Ended December 31, 1998
<TABLE>
<CAPTION>
Fonix Pro Forma
Corporation Adjustments Consolidated
(Note 1) (Note 2) (a) Pro Forma
-------------------- -------------------- ---------------------
<S> <C> <C> <C>
Revenues $ 2,889,684 $ (284,960) $ 2,604,724
Cost of revenues 76,344 (40,904) 35,440
-------------------- -------------------- ---------------------
Gross margin 2,813,340 (244,056) 2,569,284
-------------------- -------------------- ---------------------
Expenses:
Product development and research 13,620,748 (560,144) 13,060,604
Purchased in-process research and development 13,136,000 (3,821,000) 9,315,000
Selling, general and administrative 10,070,862 (1,253,219) 8,817,643
Amortization of goodwill and purchased core
technology 2,541,153 (828,886) 1,712,267
-------------------- -------------------- ---------------------
Total expenses 39,368,763 (6,463,249) 32,905,514
-------------------- -------------------- ---------------------
Loss from operations (36,555,423) 6,219,193 (30,336,230)
-------------------- -------------------- ---------------------
Other income (expense):
Interest expense, net (451,782) 195,915 (255,867)
Cancellation of common stock reset provision (6,111,577) - (6,111,577)
-------------------- -------------------- ---------------------
Total other expense, net (6,563,359) 195,915 (6,367,444)
-------------------- -------------------- ---------------------
Net loss (43,118,782) 6,415,108 (36,703,674)
Preferred stock dividends (4,797,249) - (4,797,249)
-------------------- -------------------- ---------------------
Net loss attributable to common stockholders $(47,916,031) $ 6,415,108 $ (41,500,923)
==================== ==================== =====================
Basic and diluted net loss per common share $ (0.91) $ (0.79)
==================== =====================
Weighted average common shares outstanding 52,511,185 52,511,185
==================== =====================
</TABLE>
See accompanying notes to unaudited pro forma condensed
consolidated financial statements
P-1
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 1999
<TABLE>
<CAPTION>
Fonix Pro Forma
Corporation Adjustments Consolidated
(Note 1) (Note 2) (a) Pro Forma
-------------------- ------------------- -----------------
<S> <C> <C> <C>
Revenues $ 1,110,332 $ (1,056,526) $ 53,806
Cost of revenues 225,439 (220,148) 5,291
-------------------- ------------------- -----------------
Gross margin 884,893 (836,378) 48,515
-------------------- ------------------- -----------------
Expenses:
Selling, general and administrative 3,675,561 (930,493) 2,745,068
Product development and research 2,971,279 (458,453) 2,512,826
Amortization of goodwill and purchased
core technology 1,287,581 (629,972) 657,609
-------------------- ------------------- -----------------
Total expenses 7,934,421 (2,018,918) 5,915,503
-------------------- ------------------- -----------------
Loss from operations (7,049,528) 1,182,540 (5,866,988)
Interest expense, net (2,245,333) 161,441 (2,083,892)
-------------------- ------------------- -----------------
Net loss (9,294,861) 1,343,981 (7,950,880)
Preferred stock dividends (1,127,561) - (1,127,561)
-------------------- ------------------- -----------------
Net loss attributable to common stockholders $ (10,422,422) $ 1,343,981 $ (9,078,441)
==================== =================== =================
Basic and diluted net loss per common share $ (0.16) $ (0.14)
==================== =================
Weighted average common shares outstanding 64,476,886 64,476,886
==================== =================
</TABLE>
See accompanying notes to unaudited pro forma condensed
consolidated financial statements
P-2
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 1999
<TABLE>
<CAPTION>
Fonix Pro Forma
Corporation Adjustments Consolidated
ASSETS (Note 1) (Note 2) Pro Forma
- ------ ------------ --------------- -------------
<S> <C> <C> <C><C>
Current assets:
Cash and cash equivalents $ 76,885 $ 19,000,000 (c)$ 8,909,670
(10,167,215) (d)
Cash in escrow - 5,000,000 (c) 5,000,000
Accounts receivable 1,146,727 (444,578) (e) 702,149
Prepaid expenses 145,924 (23,958) (e) 121,966
Inventory 88,070 (78,186) (e) 9,884
Interest and other receivables 33,127 (25,028) (e) 8,099
Employee advances 3,109 - 3,109
------------- --------------- -------------
Total current assets 1,493,842 13,261,035 14,754,877
Property and equipment 2,166,005 (219,347) (e) 1,946,658
Intangible assets 37,471,697 (18,700,240) (e) 18,771,457
Other assets 129,819 (22,343) (e) 107,476
------------- --------------- -------------
Total assets $ 41,261,363 $ (5,680,895) $ 35,580,468
============= =============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Bank overdraft $ 167,882 $ - $ 167,882
Revolving notes payable 50,000 (50,000) (d) -
Notes payable - related parties 7,170,410 (7,170,410) (d) -
Notes payable - other 560,000 (560,000) (d) -
Accounts payable 3,708,273 - 3,708,273
Accrued liabilities 1,691,058 (292,560) (d) 1,648,498
250,000 (f)
Accrued liabilities - related parties 1,159,139 (594,245) (d) 564,894
Deferred revenues 846,429 (826,429) (e) 20,000
Capital lease obligation - current portion 44,382 (5,710) (e) 38,672
------------- --------------- -------------
Total current liabilities 15,397,573 (9,249,354) 6,148,219
Capital lease obligation, net of current portion 28,340 (28,340) (e) -
Series C 5% Convertible Debentures 6,500,000 - 6,500,000
------------- --------------- -------------
Total liabilities 21,925,913 (9,277,694) 12,648,219
------------- --------------- -------------
Common stock and related repricing rights subject to redemption;
1,801,802 shares and repricing rights outstanding
(aggregate redemption value of $25,000,000) 1,830,000 - 1,830,000
------------- --------------- -------------
Commitments and contingencies
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; 990,834 shares
outstanding
(aggregate liquidation preference of $20,293,495) 22,902,972 - 22,902,972
Series E, 4% cumulative convertible; 90,000 shares
outstanding
(aggregate liquidation preference of $1,827,249) 2,153,357 - 2,153,357
Common stock, $.0001 par value; 100,000,000 shares
authorized;
65,837,475 shares outstanding 6,584 - 6,584
Additional paid-in capital 91,872,264 - 91,872,264
Outstanding warrants 3,453,147 - 3,453,147
Deferred consulting expense (26,675) - (26,675)
Deficit accumulated during the development stage (103,356,199) 3,596,799 (g) (99,759,400)
------------- --------------- -------------
Total stockholders' equity 17,505,450 3,596,799 21,102,249
------------- --------------- -------------
Total liabilities and stockholders' equity $41,261,363 $ (5,680,895) $ 35,580,468
============= =============== =============
</TABLE>
See accompanying notes to unaudited pro forma condensed
consolidated financial statements
P-3
<PAGE>
FONIX CORPORATION AND SUBSIDIARIES
[A DEVELOPMENT STAGE COMPANY]
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATING
STATEMENTS OF OPERATIONS
NOTE 1. BASIS OF PRESENTATION
In September 1998, the Company acquired Articulate Systems, Inc. ("Articulate").
Articulate was a provider of sophisticated voice recognition products to
specialized segments of the health care industry. On December 31, 1998, the
Company acquired certain assets of The MRC Group, Inc. ("MRC") relating to MRC's
selling, marketing and servicing of HealthCare Solutions Group products. The
operations of both of these acquisitions are currently being provided by the
Company's HealthCare Solutions Group.
On May 19, 1999, the Company entered into an asset purchase agreement (the
"Agreement") to sell the operations and a significant portion of the assets of
its HealthCare Solutions Group to Lernout & Hauspie N.V. ("L&H"), a Belgian
corporation with its principal business in Ieper, Belgium. Under the terms of
the Agreement, the Company will receive $24,000,000, with $19,000,000 in cash to
be paid at closing and $5,000,000 to be escrowed for a period of 18 months for
potential indemnification of L&H against certain matters, including but not
limited to, breaches of representations, warranties, covenants and agreements
made by the Company in the Agreement. Additionally, under a defined earnout
formula, the Company may receive future consideration of up to $4,000,000 to be
paid over a two-year period following the closing.
The accompanying unaudited pro forma condensed consolidated statements of
operations for the year ended December 31, 1998 and the three months ended March
31, 1999 present the results of operations of the Company as if the sale of the
operations and a significant portion of the assets of the HealthCare Solutions
Group had occurred as of January 1, 1998 (the first day of the most recently
completed fiscal year). The unaudited pro forma condensed consolidated balance
sheet as of March 31, 1999 presents the balance sheet as if the sale of the
operations and a significant portion of the assets of the HealthCare Solutions
Group had occurred as of that date.
The first column of the accompanying unaudited pro forma condensed consolidated
statements of operations include the historical condensed consolidated
operations of the Company as reported on its Report on Form 10-K for the year
ended December 31, 1998 and the condensed consolidated operations of the Company
as reported on its Report on Form 10-Q for the three months ended March 31,
1999. The first column of the accompanying unaudited pro forma condensed
consolidated balance sheet includes the historical condensed consolidated
balance sheet of the Company as of March 31, 1999 as reported on its report on
Form 10-Q for the period then ended.
The accompanying unaudited pro forma condensed consolidated financial statements
should be read in conjunction with the consolidated financial statements and the
notes thereto included in the Company's annual report on Form 10-K for the year
ended December 31, 1998 and the historical unaudited condensed consolidated
financial statements of the Company and the notes thereto included in the
Company's quarterly report on Form 10-Q for the period ended March 31, 1999.
The unaudited pro forma condensed consolidated financial statements are for
illustrative purposes only. Such information does not purport to be indicative
of the results which would actually have been effected on the date and for the
periods indicated, nor is it indicative of actual or future operating results or
financial position that may occur.
NOTE 2. PRO FORMA ADJUSTMENTS
(a) Disposition of the historical operations of the HealthCare Solutions
Group for the period from September 2, 1998 (the date of acquisition)
to December 31, 1998, which are included in the operating results of
Fonix Corporation for the year ended December 31, 1998.
P-4
<PAGE>
(b) Disposition of the historical operations of the HealthCare Solutions
Group for the period from January 1, 1999 to March 31, 1999 which are
included in the operating results of Fonix Corporation for the three
month period ended March 31, 1999.
(c) Proceeds from the sale of the operations and a significant portion of
the assets of the Company's HealthCare Solutions Group to L&H. Amount
does not include up to $4,000,000 which may be received in future
consideration in accordance with the earnout provision of the
Agreement.
(d) Contractual disposition of certain accrued liabilities and notes
payable together with the related accrued interest. Amount does not
include $6,000,000 to be used to repay funds advanced to the Company
from L&H under two separate loan agreements as these loan agreements
were entered into subsequent to March 31, 1999.
(e) Disposition of certain assets and liabilities acquired by L&H in
accordance with the Agreement.
(f) Estimation of federal and state income tax liability resulting from
the Sale.
(g) Estimation of after-tax gain resulting from the Sale.
P-5
<PAGE>
SHAREHOLDER PROPOSALS
Any shareholder proposal intended to be considered for inclusion in
the proxy statement for presentation in connection with the 1999 Annual Meeting
of Shareholders must have been received by the Company by December 31, 1998. No
such proposals were received.
The enclosed Stockholder Consent Resolution is furnished for you to
specify your choices with respect to the matters referred to in the accompanying
notice and described in this Proxy Statement. If you wish to consent in
accordance with the Board's recommendations, please fill out, sign, date and
return the Stockholder Consent Resolution Signature Page in the enclosed
envelope which requires no postage if mailed in the United States. A prompt
return of the Stockholder Consent Resolution Signature Page will be appreciated.
By Order of the Board of Directors
-------------------------------------
Thomas A. Murdock
President and Chief Executive Officer
39
<PAGE>
APPENDIX A
CONSENT RESOLUTIONS
OF THE STOCKHOLDERS
OF
Fonix Corporation
A DELAWARE CORPORATION
(SALE OF HEALTHCARE SOLUTIONS GROUP)
Pursuant to Section 228 of the General Corporation Law of the State
of Delaware, the undersigned, being the holder(s) of _____ shares of the issued
and outstanding common stock of Fonix Corporation (the "Company"), a Delaware
corporation, hereby consent to and approve the following corporate action as if
it had taken place at a meeting of the stockholders of the Company:
WHEREAS, the Board of Directors of the Company has determined that it
is in the best interest of the Company and its stockholders to continue to focus
the Company's efforts and resources in developing its core technologies,
including voice internet/web access and navigation; speech and handwriting
technologies for embedded systems; integrated pen and voice input for computing
devices; and automated dictation and transcription speech recognition; and
WHEREAS, the Board of Directors has negotiated with Lernout & Hauspie
Speech Products N.V. ("L&H"), a Belgian corporation with its principal place of
business in Ieper, Belgium, the sale to and purchase by L&H (the "Sale") of the
operations and a significant portion of the assets of the Company's Healthcare
Solutions Group (the "HSG"), which is headquartered in Woburn, Massachusetts;
and
WHEREAS, the proceeds of the proposed Sale would provide funding to
pay certain debts and obligations of the Company and working capital to enable
to Company to continue to focus on marketing and developing its core
technologies; and
WHEREAS, the Board of Directors of the Company has determined that it
is in the best interests of the Company and its stockholders to sell the
operations and a significant portion of the HSG to L&H for $24,000,000 to be
paid at closing and a possible $4,000,000 to be paid in two installments of
$2,000,000 each over a two-year period based on performance of the HSG (the
"Earnout"), together with additional terms and conditions as set forth in the
Asset Purchase Agreement - Acquisition of Certain Assets of Fonix Corporation
and Fonix/ASI Corporation by Lernout & Hauspie Speech Products N.V. (the "Asset
Purchase Agreement"), dated as of May 19, 1999; and
1
<PAGE>
WHEREAS, the Board of Directors has determined that it is in the best
interests of the Company to pay compensation to certain employees of the HSG for
extraordinary services from the proceeds of the sale of the HSG, payable
$1,440,000 in cash at the closing of the Sale and $800,000 in cash, when and if
the Earnout is paid; and
WHEREAS, L&H desires to purchase the operations and a significant
portion of the assets of the HSG substantially for the terms set forth above and
in the Asset Purchase Agreement; and
WHEREAS, the Asset Purchase Agreement between the Company and L&H
requires the Company to seek approval of the Sale by the holders of at least a
majority of the issued and outstanding shares of common stock of the Company.
NOW, THEREFORE, the undersigned holder(s) of shares of common stock
of the Company hereby consent(s), authorize(s), and approve(s) as follows:
RESOLVED, that the actions taken by the officers of the Company
during negotiation of the proposed Sale are hereby approved and
ratified;
FURTHER RESOLVED, that the Sale according to the terms set forth
above, together with all other terms and conditions as set forth in
the Asset Purchase Agreement, is hereby authorized and approved; and
FURTHER RESOLVED, that the officers are, and each of them hereby is,
authorized to take all additional actions, and to execute and deliver
all documents necessary to finalize the Sale and to pay compensation
to certain employees of the HSG for extraordinary services in the
aggregate of $2,240,000.
Once signed by the holders of at least a majority of the outstanding
shares of common stock of the Company, these Resolutions shall be delivered to
the Company at its registered office in Delaware, as required by Section 228 of
the General Corporation Law of the State of Delaware, and to its principal
executive offices in Salt Lake City, Utah. Such Resolutions are to be included
in the corporate records, and shall have the same force and effect as an action
taken at a meeting of the stockholders of the Company.
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CONSENT RESOLUTIONS
OF THE STOCKHOLDERS
OF
FONIX CORPORATION
SIGNATURE PAGE
Date: Signature:
------------------- ----------------------------------
Name:
---------------------------------------
(Please print)
Number of Shares Held:
----------------------
You are requested to fill out, date, sign and return this enclosed
Stockholder Consent Resolution Signature Page, which is solicited by the Board
of Directors of the Company as described in the accompanying Proxy Statement.
Your consent is important. Please sign and date this Stockholder Consent
Resolution Signature Page and return it promptly in the enclosed return
envelope. The return envelope requires no postage if mailed in the United
States. If mailed elsewhere, foreign postage must be affixed. Your consent as
evidenced by your signing and returning this Stockholder Consent Resolution
Signature Page is irrevocable once it is received by the Company's Registrar and
Transfer Agent as explained in the Proxy Statement.
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