<PAGE>
As filed with the Securities and Exchange Commission on December 29, 1999
Registration Statement No. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM S-2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
----------------------
Fonix Corporation
(Exact name of registrant as specified in its charter)
----------------------
DELAWARE 22-2994719
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
60 East South Temple Street, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
(Address, including zip code, and
telephone number, including area code,
of registrant's principal
executive offices)
----------------------
THOMAS A. MURDOCK
PRESIDENT
Fonix Corporation
60 East South Temple Street
Salt Lake City, Utah 84111
(801) 328-8700
(Name, address, including zip code, and
telephone number, including area code,
of agent for service)
COPY TO:
JEFFREY M. JONES, ESQ.
DURHAM JONES & PINEGAR, P.C.
50 SOUTH MAIN STREET, SUITE 800
SALT LAKE CITY, UTAH 84144
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: from time to
time after the effective date of this Registration Statement as determined by
market conditions.
----------------------
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If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] _______.
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ________.
If delivery of the Prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
========================================================================================================================
Proposed Proposed
Maximum Maximum
Amount Aggregate Aggregate Amount of
Title of Class of Securities To be Price Offering Registration
to be Registered Registered Per Share Price Fee
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class A Common Stock, 1,801,802 shares (1) $0.32 (2) $ 576,577 (2) $ 152 (2)
$.0001 par value per share
Class A Common Stock, 200,000 shares (3) $0.32 (4) $ 64,000 (2) $ 17 (2)
$.0001 par value per share
Class A Common Stock, 13,596,398 shares (5) $0.32 (4) $ 4,350,847 (2) $ 1,149 (2)
$.0001 par value per share
Class A Common Stock, 33,718,107 shares (6) $0.32 (2) $10,789,794 (2) $ 2,849 (2)
$.0001 par value per share
Class A Common Stock, 400,000 shares (7) $0.32 (4) $ 128,000 (2) $ 34 (2)
$.0001 par value per share
------------------ ------------ --------- ---
Totals 49,716,307 shares $16,585,871 $ 4,201
================= ============== ==========
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) All shares offered for resale by the Selling Stockholders.
(2) The fee is estimated pursuant to Rule 457(c) under the Act on the basis
of the average of the bid and asked price of Fonix's Class A common
stock as reported on the OTC Bulletin Board on December 22, 1999.
(3) Represents shares issuable upon exercise of warrants issued to the
Selling Stockholders in connection with the 1,801,802 shares of Class A
common stock to purchase up to an aggregate amount of 200,000 shares of
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<PAGE>
Fonix's Class A common stock, based on a hypothetical conversion on
December 13, 1999, at an exercise price of $1.665 per share.
(4) Fee calculated pursuant to Rule 457(g)(3).
(5) Represents 200% of the shares issuable upon the exercise by the Selling
Stockholders of all of the Repricing Rights issued to the Selling
Stockholders in connection with the 1,801,802 shares of Class A common
stock, assuming such exercise occurred on December 13, 1999.
(6) Represents shares of Class A common stock issuable upon the conversion
by the Selling Stockholders of the Series C 5% Debentures, and includes
(i) 33,832,648 shares representing 200% of the shares issuable upon a
hypothetical conversion of all of the Debentures, assuming such
conversion occurred on December 13, 1999, and (ii) 2,000,000 shares
representing shares issuable upon the optional payment by the Company
of interest accrued on the outstanding principal amount of the
Debentures.
(7) Represents shares of Class A common stock issuable upon exercise of
warrants issued to the Selling Stockholders in connection with the
Debentures to purchase up to an aggregate amount of 400,000 shares of
Fonix's common stock, based on a hypothetical conversion on December
13, 1999, at an exercise price of $1.25 per share.
Pursuant to Rule 416, there are also registered hereby such additional
indeterminate number of shares of such Class A common stock as may become
issuable as dividends or to prevent dilution resulting from stock splits, stock
dividends or similar transactions.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a)
OF THE ACT, MAY DETERMINE.
================================================================================
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<PAGE>
Prospectus Subject to Completion dated December 29, 1999
The information in this prospectus is not complete, and it may change. This
prospectus is included in a registration statement that Fonix filed with the
Securities and Exchange Commission. The Selling Stockholders cannot sell these
securities until that registration statement becomes effective. This prospectus
is not an offer to sell these securities or the solicitation of an offer to buy
these securities in any state where an offer to sell or the solicitation of an
offer to buy is not permitted. [GRAPHIC OMITTED]
Fonix Corporation
49,716,307
Class A Common Stock, par value $.0001 per share
This prospectus covers the sale of up to 49,716,307 shares of Fonix Class A
common stock (the "Shares"). Four stockholders of Fonix Corporation are offering
all of the Shares covered by this prospectus. The Selling Stockholders will
receive all of the proceeds from the sale of the Shares and Fonix will receive
none of those proceeds.
Investment in the Shares involves a high degree of risk. You should
consider carefully the risk factors beginning on page 9 of this prospectus
before purchasing any of the Shares offered by this prospectus.
Fonix Class A common stock is quoted on the OTC Bulletin Board and trades
under the symbol "FONX". Nevertheless, the Selling Stockholders do not have to
sell the Shares in transactions reported on the OTC Bulletin Board, and may
offer their Shares through any type of public or private transactions.
--------------------
The Securities and Exchange Commission and State Securities Regulators have
not approved or disapproved the Shares, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
_ , 1999
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Fonix has not registered the Shares for sale by the Selling Stockholders
under the securities laws of any state. Brokers or dealers effecting
transactions in the Shares should confirm that the Shares have been registered
under the securities laws of the state or states in which sales of the Shares
occur as of the time of such sales, or that there is an available exemption from
the registration requirements of the securities laws of such states.
This prospectus is not an offer to sell any securities other than the
Shares. This prospectus is not an offer to sell securities in any circumstances
in which such an offer is unlawful.
Fonix has not authorized anyone, including any salesperson or broker, to
give oral or written information about this offering, Fonix or the Shares that
is different from the information included or incorporated by reference in this
prospectus. You should not assume that the information in this prospectus, or
any supplement to this prospectus, is accurate at any date other than the date
indicated on the cover page of this prospectus or any supplement to it.
Table of contents
Summary about Fonix and this offering..........................................2
Recent developments............................................................5
Important information incorporated by reference................................6
Where to get additional information............................................7
Explanation about forward-looking information..................................8
Risk factors...................................................................9
Information about Fonix Corporation ..........................................19
Management's discussion and analysis of financial condition and
results of operations.........................................................19
Special note regarding forward looking statements.............................31
Market price of and dividends on the Company's Class A common stock...........31
Selected financial data.......................................................32
Index to financial statements of Fonix Corporation............................33
Changes in and disagreements with accountants on accounting and
financial disclosure..........................................................34
Use of proceeds...............................................................34
Selling security holders......................................................35
Plan of distribution..........................................................40
Legal matters.................................................................42
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Summary about Fonix and this offering
Fonix
Fonix 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, Fonix has developed proprietary automated speech-recognition and
related technologies such as text-to-speech, which refers to computer software
which can read computer-based text using a synthetic voice, and speech
compression, which refers to computer software which can reduce the amount of
data required to store or transmit digitally recorded speech while preserving
its content and quality. 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.
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<PAGE>
In March 1998, Fonix expanded its suite of human-computer interaction
technologies by acquiring AcuVoice, Inc. ("AcuVoice"), a Cupertino,
California-based developer of text-to-speech technologies. In September 1998,
Fonix acquired Articulate Systems, Inc. ("Articulate"), a leading developer of
specialized speech recognition applications used in the health care industry. In
October 1998, Fonix acquired Papyrus Associates, Inc. and Papyrus Development
Corporation, which are referred to collectively in this prospectus as Papyrus,
developers of printing and cursive handwriting recognition products and
technologies. Articulate and Papyrus are located in Woburn, Massachusetts.
On May 19, 1999, Fonix signed an agreement to sell the operations and a
significant portion of the assets of its HealthCare Solutions Group, which
consisted primarily of the operations of Articulate, to Lernout & Hauspie Speech
Products N.V., an unrelated third party. The sale was approved by a majority of
Fonix's stockholders, and closed September 1, 1999. The proceeds from the sale
were used to reduce certain of the Company's liabilities and provided working
capital to allow Fonix to focus on marketing and developing technologies and
products offered by its Interactive Technologies Solutions Group as follows:
o Voice Internet/web access and navigation to retrieve information and
execute electronic commerce transactions such as stock trades and
quotes, news, weather, sports, travel, and entertainment reservations;
o Speech and handwriting applications for embedded systems in mobile
consumer electronics including personal data assistants ("PDAs"), 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; and
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.
Fonix markets the 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 objective of the
Interactive Technologies Solutions Group is to form relationships with third
parties who can incorporate Fonix technologies 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
Fonix 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, telephony and other technology products.
Fonix's principal executive offices are located at 60 East South Temple
Street, Suite 1225, Salt Lake City, Utah 84111. Its telephone number is (801)
328-8700. References to Fonix in this prospectus include Fonix and its wholly
owned subsidiaries.
This offering
On December 21, 1998, the Company completed a private placement (the
"Equity Offering") 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 Class A common stock for no additional consideration according to a
formula that is related to the then-prevailing market price of the Company's
Class A common stock. The Company also issued warrants to purchase 200,000
shares of the Company's Class A common stock at an exercise price of $1.665 per
share in connection with this transaction. The warrants have an exercise period
of three years.
3
<PAGE>
Additionally, on January 29, 1999, the Company entered into a Securities
Purchase Agreement with four investors pursuant to which the Company agreed to
issue its Series C 5% Convertible Debentures (the "Debentures") in the aggregate
principal amount of $4,000,000. The outstanding principal amount of Debentures
is convertible at any time at the option of the holder into shares of the
Company's Class A common stock at a conversion price equal to the lesser of
$1.25 or the average of the closing bid price of the Company's Class A common
stock for the five trading days immediately preceding the conversion date
multiplied by 80%, subject to adjustment. The Company also issued warrants to
purchase 400,000 shares of the Company's Class A common stock at an exercise
price of $1.25 per share in connection with this financing. The warrants have an
exercise period of three years. On March 3, 1999, the Company executed a
Supplemental Agreement pursuant to which the Company agreed to sell another
$2,500,000 principal amount of the Debentures on the same terms and conditions
as the January 29, 1999 agreement, except no additional warrants were issued.
Interest on the Debentures is payable, at the Company's option, in shares of the
Company's Class A common stock. (The January and March 1999 offerings are
collectively referred to as the "Debt Offering.")
In connection with the Debt Offering, two officers and directors and one
former officer and director of the Company (together, the "Guarantors") pledged
6,000,000 shares of the Company's Class A common stock beneficially owned by
them as collateral security for the Company's obligations regarding the
Debentures. Subsequent to the March 1999 funding, the holders of the Debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the pledge and that the holders intended to exercise their
rights to sell some or all of the pledged shares. The holders of the Debentures
subsequently informed the Company and the Guarantors that the 6,000,000 pledged
shares were sold, and that proceeds from the sale of the shares were used to pay
penalties attributable to default provisions of the stock pledge agreement and
to reduce the principal balance of the Debentures. As of December 29, 1999, the
outstanding principal amount of Debentures is $3,971,107.
In connection with the Equity Offering and the Debt Offering, the Company
agreed to register the shares of Class A common stock issued in the Equity
Offering, the repricing shares available in connection with the Equity Offering,
the shares of Class A common stock underlying the warrants in the Equity
Offering, the shares of Class A common stock underlying the reduced principal
amount of Debentures in the Debt Offering, and the shares of Class A common
stock underlying the warrants in the Debt Offering. The Shares covered by this
prospectus are the shares of common stock issued or issuable by the Company
under the Equity Offering, the exercise of the Repricing Rights, the exercise of
the warrants, and the conversion of the Debentures.
Subsequent to the Equity Offering and the Debt Offering, at Fonix's 1999
Annual Meeting of Stockholders, the stockholders approved an amendment to
Fonix's Certificate of Incorporation that created a new class of common stock
designated as Class B Non-Voting Common Stock, redesignated Fonix's then-current
common stock as Class A common stock, and changed each share of then-existing
common stock into a share of Class A common stock. The Class B shares were
authorized to provide for the conversion of 1,935,000 common shares issued in
the acquisition of Articulate Systems, Inc., to a non-voting class of stock as
provided in the acquisition agreement, and are not involved in this offering. As
such, the shares held by the investor in the Equity Offering, together with the
shares underlying the Debentures and the warrants issued in connection with the
Equity Offering and the Debt Offering are Class A common shares.
The shares of Class A common stock covered by this prospectus are
designated as "Shares" to distinguish them from other shares of Fonix Class A
common stock referred to herein which are not covered by this prospectus.
Once the registration statement of which this prospectus is part becomes
effective with the Securities and Exchange Commission, the Selling Stockholders
will be able to sell the Shares in public transactions or otherwise, on the OTC
Bulletin Board 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.
4
<PAGE>
Recent developments
Addition of William A. Maasberg Jr. and Mark S. Tanner to Fonix's Board of
Directors
William A. Maasberg Jr. became a member of Fonix's Board of Directors in
September 1999. From December 1997 through February 1999, Mr. Maasberg was a
Vice President and General Manager of the AMS Division of Eyring Corporation
("Eyring"). The AMS Division is the manufacturer of Eyring's multi-media
electronic work instruction software application. He was also a co-founder and
principal in Information Enabling Technologies, Inc. ("ETI"), and LIBRA
Corporation ("LIBRA"), two companies focusing on software application
development, and served in several key executive positions with both ETI and
LIBRA from May 1976 through November 1997. Mr. Maasberg worked for IBM
Corporation from July 1965 through May 1976 in various capacities. He received
his BS Degree from Stanford University in Electrical Engineering and his MS in
Electrical Engineering from the University of Southern California. Mr. Maasberg
was re-elected to the Board of Directors at the Company's 1999 Annual Meeting of
Stockholders.
Additionally, Mark S. Tanner was appointed to Fonix's Board of Directors in
November 1999. Mr. Tanner is currently the chief financial officer and senior
vice president of finance and administration for Mrs. Fields Original Cookies,
Inc. Mr. Tanner spent nine years at PepsiCo, where he was chief financial
officer for Pepsi International's operations in Asia, the Middle East, and
Africa. He was vice president of strategic planning for Pepsi North America, as
well as chief financial officer for Pepsi North America's Pepsi East Operations.
Mr. Tanner also spent ten years with United Technologies Corporation in various
capacities, including director of corporate development. Mr. Tanner holds a BA
in economics from Stanford University, and an MBA from the University of
California at Los Angeles.
Sale of HealthCare Solutions Group
On September 1, 1999, Fonix completed the sale of the operations and a
significant portion of the assets of its HealthCare Solutions Group to Lernout &
Hauspie Speech Products N.V., an unrelated third party, for up to $28,000,000.
At the closing of this transaction, $21,500,000, less certain credits of
$194,018 was paid,$2,500,000 was deposited into an 18-month escrow account in
connection with the representations and warranties made by Fonix in the sales
transaction. Any remaining amount up to $4,000,000 is an earnout contingent on
the performance of the HealthCare Solutions Group over the next two years. The
Company will not record the contingent earnout, if any, until successful
completion of the earnout period. The sale was approved by a majority of Fonix's
stockholders. The proceeds from the sale were used to reduce certain of the
Company's liabilities and to provide working capital to allow Fonix to focus on
marketing and development opportunities for its Interactive Technology Solutions
Group.
Delisting of the Company's Class A 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. Such action would
also trigger certain rights of the holders of the Company's Series C 5%
Convertible Debentures and repurchase rights. In September 1999, the Company
appealed the Nasdaq decision to delist the Company's common stock. Nasdaq held a
hearing on the Company's appeal on October 28, 1999.
On December 3, 1999, the Company received notice that its stock had been
delisted from the Nasdaq SmallCap Market as of December 3, 1999, in part because
the stock price had been below $1.00 per share since approximately March 1999.
The Company is currently evaluating its options, including the possibility of
appealing the delisting decision. However, the Company's common stock is
currently trading on the OTC Bulletin Board. See "Risk Factors - Delisting from
the Nasdaq SmallCap Market could have an adverse effect on the liquidity of the
Company's Class A common stock and has triggered certain rights of the holders
of the Company's Debentures and Repurchase Rights."
5
<PAGE>
1999 Annual Meeting of Stockholders
Fonix held its 1999 Annual Meeting of Stockholders October 29, 1999, at
which 59,497,418 shares were represented in person or by proxy. The stockholders
approved amendments to the Company's certificate of incorporation that (A)
created a new class of common stock designated as Class B Non-Voting Common
Stock (the "Class B Shares") with 1,985,000 Class B Shares authorized; and (B)
redesignated the Company's then-current common stock as Class A Common Stock and
changed each share of then-outstanding common stock into a share of Class A
Common Stock. Additionally, the stockholders approved an amendment to the
Company's certificate of incorporation that increased the number of Class A
common shares authorized to be issued from 100,000,000 to 300,000,000 and
increased the number of authorized preferred shares from 20,000,000 to
50,000,000. The Class B shares were authorized to provide for the conversion of
1,935,000 common shares issued in the acquisition of Articulate to a non-voting
class of stock as provided in the acquisition agreement. The Company does not
intend to register its Class B shares. The stockholders also approved a series
of transactions in which the Company issued its Series D 4% preferred stock and
Series E 4% preferred stock. Finally, the stockholders elected Thomas A.
Murdock, Roger D. Dudley, John A Oberteuffer, and William A. Maasberg Jr. to
Fonix's Board of Directors, and approved the Board's selection of Arthur
Andersen LLP as Fonix's independent public accountants for the fiscal year
ending December 31, 1999.
Recent financing activities
Fonix has recently entered into an agreement with four investors whereby
Fonix intends to sell to the investors a total of 250,000 shares of its Series F
6% Convertible Preferred Stock (the "Series F Preferred Stock"), in return for
payment of $5,000,000. It is anticipated that the Series F Preferred Stock will
be convertible into shares of Fonix's Class A common stock during the first six
months following the closing of the transaction at a price of $0.75 per share,
and thereafter at a price equal to 90% of the average of the three lowest
closing bid prices in the twenty-day trading period prior to the conversion of
the Series F Preferred Stock. Fonix anticipates that the investors will receive
registration rights which will require Fonix to file a registration statement
covering the shares underlying the Series F Preferred Stock, and that Fonix will
have the option of redeeming any outstanding Series F Preferred Stock. Although
Fonix has received approximately $1,000,000 as an advance in connection with
this financing, the securities purchase agreement has not been signed.
Accordingly, the terms may differ from those set forth in this paragraph.
Important information incorporated by reference
For purposes of this prospectus, the Commission allows Fonix to
"incorporate by reference" information Fonix has filed and will file with the
Commission, which means that Fonix is disclosing important information to you by
referring you to other information Fonix has filed with the Commission. The
information Fonix incorporates by reference is considered part of this
prospectus. Later information that Fonix will file with the Commission
automatically will update and supersede the information included in this
prospectus. Fonix specifically is incorporating by reference the following
documents:
o Annual Report on Form 10-K for the fiscal year ended December 31, 1998,
filed with the Commission on April 15, 1999, together with Amendment
No. 1 to the Annual Report on Form 10-K, filed with the Commission on
August 9, 1999 (except for Item 8 which has been updated to reflect the
sale of a business segment and the classification of its net assets and
operating activities as discontinued operations, and is included
herein)
o Current Report on Form 8-K, dated December 22, 1998, filed with the
Commission on January 7, 1999
o Quarterly Report on Form 10-Q, for the period ended March 31, 1999,
filed with the Commission on May 19, 1999, together with Amendment No.
1 to the Quarterly Report on Form 10-Q filed with the Commission on
August 9, 1999
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o Quarterly Report on Form 10-Q, for the period ended June 30, 1999,
filed with the Commission on August 19, 1999
o Current Report on Form 8-K, dated September 1, 1999, filed with the
Commission on September 16, 1999, together with Amendment No. 1 to the
Current Report on Form 8-K filed with the Commission on November 15,
1999
o Quarterly Report on Form 10-Q for the period ended September 30, 1999,
filed with the Commission on November 22, 1999, together with Amendment
No. 1 to the Quarterly Report on Form 10-Q filed with the Commission on
December 29, 1999
o The description of Fonix's common stock included in Fonix's
Registration Statement on Form 8-A, filed with the Commission on April
1, 1994
You can request a free copy of any of the filings listed above by writing,
calling, e-mailing, or faxing a request to Fonix at:
Fonix Corporation, Investor Relations
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
(801) 328-8778 Fax
e-mail: [email protected]
Alternatively, certain of the documents incorporated by reference are available
at the Commission's website at http://www.sec.gov.
This prospectus is part of a registration statement that Fonix filed with
the Commission. This prospectus does not contain all of the information included
in the registration statement, as certain items are omitted in accordance with
the rules and regulations of the Commission. Statements or descriptions
contained in this prospectus about any agreements or other documents provide, in
Fonix's belief, all information about such agreements or documents that is
material to a decision to invest in the Fonix Shares, but not all terms of all
such agreements and documents are described. If you want more information, Fonix
refers you to the copy of such agreement or document filed as an exhibit to the
registration statement or the reports and other materials incorporated by
reference into this prospectus. The registration statement, including all of its
exhibits and schedules, may be inspected without charge at the office of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and you can obtain
copies of all or any part of it from the Commission, although the Commission
charges for such copies.
Where to get additional information
Federal securities law requires Fonix to file information with the
Securities and Exchange Commission concerning its business and operations.
Accordingly, Fonix files annual, quarterly and special reports, proxy statements
and other information with the Commission. You can inspect and copy this
information at the public reference facility maintained by the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. You
can also do so at the following regional offices of the Commission:
o New York Regional Office, Seven World Trade Center, Suite 1300,
New York, New York 10048
o Chicago Regional Office, Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661
You can get additional information about the operation of the Commission's
public reference facilities by calling the Commission at 1-800-SEC-0330. The
Commission also maintains a web site (http://www.sec.gov) at which you can read
or download Fonix's reports, proxy and information statements and other
information. Reports and other
7
<PAGE>
information concerning Fonix also may be inspected at the National Association
of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
Explanation about forward-looking information
This prospectus, including information contained in documents that are
incorporated by reference in this prospectus, contains "forward-looking
statements," as that term is defined by federal securities laws, that relate to
the financial condition, results of operations, plans, objectives, future
performance and business of Fonix. These statements are frequently preceded by,
followed by or include the words "believes," "expects," "anticipates,"
"estimates" or similar expressions. These forward-looking statements involve
certain risks and uncertainties, and whether those risks and uncertainties occur
or develop adversely, Fonix's actual results may differ materially from those
contemplated by such forward-looking statements. In the section of the
prospectus entitled "Risk Factors" Fonix has summarized a number of the risks
and uncertainties that could affect the actual outcome of the forward- looking
statements included in this prospectus. Fonix advises you not to place undue
reliance on such forward-looking statements in light of the material risks and
uncertainties to which they are subject.
8
<PAGE>
Risk factors
An investment in Fonix Class A common stock involves a high degree of risk
and should not be made by persons who cannot afford the loss of their entire
investment. You should carefully consider the risks described below in addition
to the other information presented in this prospectus or incorporated by
reference into this prospectus before deciding to invest in the Shares covered
by this prospectus.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about Fonix's ability to
continue as a going concern.
Since its inception, Fonix has sustained ongoing losses. Such losses are
presently continuing due to acquisitions made in 1998, ongoing operating
expenses, and a lack of revenues sufficient to offset the increased operating
expenses. Because past and current expenses exceed revenues, Fonix had negative
working capital of $4,400,201 at September 30, 1999, and has raised capital to
fund ongoing operations by private sales of its securities, the terms of which
transactions have been highly dilutive and involve considerable expense.
Furthermore, in recent months, the financial condition of the Company has
required the Company to negotiate with its creditors to reduce the amount or
extend the due date of certain obligations. In its present circumstances, there
is substantial doubt about Fonix's ability to continue as a going concern absent
immediate and significant sales of its existing products, substantial revenues
from new licensing or co-development contracts or a relatively large sale of its
securities in the near term.
Fonix incurred net losses of $18,836,430, for the nine months ended
September 30, 1999, and net losses of $43,118,782 and $22,453,948 for the years
ended December 31, 1998 and 1997, respectively. As of September 30, 1999, Fonix
had negative working capital of $4,400,201 and an accumulated deficit of
$114,230,725. For the nine months ended September 30, 1999, Fonix recorded
revenues of $351,083. For the year ended December 31, 1998, Fonix recorded
revenues from the operations of the AcuVoice and Articulate businesses in the
amount of $236,586 and $284,960, respectively. The 1999 revenues are primarily
from sales and licensing fees related to the Company's text-to-speech
technologies and products. Other than these revenues, Fonix's only revenues to
date resulted from one-time non-refundable license fees totaling $2,368,138 paid
by Siemens Aktiengesellschaft ("Siemens") for the use of technologies in
integrated circuits suitable for telecommunications applications, and for which
Fonix had no further obligation whatsoever.
Fonix expects continuing losses from operations until such time as:
o current and additional licensing or co-development arrangements with
third parties produce revenues sufficient to offset Fonix's ongoing
operating expenses; or
o revenues from the Interactive Technologies Solutions Group technologies
and products increase to levels sufficient to exceed Fonix's operating
expenses.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
During the last half of 1998, Fonix incurred substantial amounts of debt in
connection with the acquisitions of Articulate and Papyrus. Most of this debt
was paid with the proceeds of the sale of the operations and substantially all
of the assets of the Company's HealthCare Solutions Group to Lernout & Hauspie
Speech Products N.V. on September 1, 1999. Some of Fonix's remaining debt is
payable on demand. Fonix does not presently have sufficient operating capital or
revenues to allow Fonix to satisfy these obligations if demand for payment is
made and Fonix cannot renegotiate the terms of the debt or otherwise persuade
its creditors to withdraw their demand. In such event, Fonix's financial
condition and operations could be adversely affected. The following discussion
summarizes the extent and nature of such remaining debt.
In connection with Fonix's acquisition of Articulate in September 1998,
Fonix agreed to pay several Articulate employees incentive compensation for
continued employment in the aggregate amount of $857,000, in connection with
which Fonix issued 8.5% demand notes for $452,900 and recorded an accrued
liability of $404,100 for the
9
<PAGE>
balance. The principal balance of the notes issued to the Articulate employees
was paid out of the proceeds of the sale of the HealthCare Solutions Group.
However, accrued interest on the notes of $70,352 was not paid and the Company
has requested that the Articulate employees forgive the accrued interest.
Negotiations with the Articulate employees continue. The unpaid and accrued
interest is presently payable on demand. However, as of the date hereof, Fonix
has not received any demand for payment of the accrued interest.
In connection with Fonix's acquisition of Papyrus in October 1998, Fonix
incurred debt obligations in the form of promissory notes to the former
stockholders of Papyrus in the aggregate amount of $1,710,000. Fonix paid or
obtained forgiveness of $1,632,375 of this indebtedness in September 1999. The
balance of $77,625 is presently payable on demand, but as of the date hereof,
Fonix has not received a demand for payment.
The Debt Offering also constitutes debt obligations of the Company,
although such obligations are convertible into shares of the Company's Class A
common stock. The outstanding principal amount of the Debentures, together with
interest accrued thereon, is convertible at any time at the option of the holder
into shares of the Company's Class A common stock. To the extent that the
outstanding principal amount of the Debentures is not reduced by conversions
into Class A common stock, the Debentures and all accrued and unpaid interest
thereon are due on January 29, 2002.
In addition to these notes and obligations, Fonix presently owes trade
payables in the aggregate amount of approximately $1,602,440, of which
$1,337,130 are more than 90 days overdue.
All of these debt obligations are in addition to Fonix's regularly
recurring operating expenses. At present, Fonix's revenues from existing
licensing arrangements and products are not sufficient to offset Fonix's ongoing
operating expenses or to pay substantial amounts of Fonix's presently due debt.
There is substantial risk, therefore, that the existence and extent of the debt
obligations described above could adversely affect Fonix, its operations and
financial condition.
Fonix could be obligated to repurchase the shares of Class A common stock and
the Repricing Rights from the investor in the Equity Offering.
Under the terms of the Equity Offering, the holder of the 1,801,802 Class A
common shares and the Repricing Rights may, upon the occurrence of certain
events, require the Company to repurchase all or a portion of the holder's Class
A common shares or repricing rights received in the Equity Offering, as follows:
o For each Class A common share with a repricing right, the greater of
$1.3875 or the sum of $1.11 plus the product of the Repricing Rate
multiplied by the last reported sale price.
o For each Repricing Right without the associated Class A common share,
the product of the Repricing Rate multiplied by the last reported sale
price.
o For each Class A common share without the associated Repricing Right,
$1.3875.
For each of the above examples, the Repricing Rate is determined by
calculating the following fraction:
(Repricing Price - Market Price)
--------------------------------
Market Price
As of December 13, 1999, the Repricing Price was $1.4319, and the market price
was $0.30.
The events which trigger the repurchase rights include a failure by the
Company to have a registration statement registering the Class A common shares
and the shares underlying the Repricing Rights in the Equity Offering declared
effective by June 19, 1999, or the delisting of the Class A common stock from
the Nasdaq SmallCap Market. Because both of these events have occurred, the
investor in the Equity Offering had the right to exercise the
10
<PAGE>
repurchase option. However, the investor waived its right to exercise its
Repurchase Rights as a result of the delisting of the Class A common stock from
the Nasdaq SmallCap Market, and deferred until March 1, 2000, its right to
require repurchase as a result of the Company's failure to register the shares
underlying the Repurchase Rights and Class A common stock. If such shares are
not registered before March 1, 2000, the investor may exercise the Repurchase
Rights.
If the Repurchase Rights were exercised as of December 13, 1999, and
assuming that the Company was required to repurchase all such shares and
repricing rights, the Company's obligation under the Repurchase Rights would
have been $2,774,000. Presently, the Company does not have sufficient cash or
other liquid assets to pay the amount which would be due if the holder of the
Class A common shares and the Repricing Rights exercised its repurchase rights.
If Fonix does not receive additional capital when and in the amounts needed in
the near future, its ability to continue as a going concern is in substantial
doubt.
Fonix anticipates incurring substantial product development and research
and general operating expenses for the foreseeable future which will require
substantial amounts of additional capital on an ongoing basis. These capital
needs are in addition to the amounts required to repay the debt discussed above.
Fonix most likely will have to obtain such capital from sales of its equity,
convertible equity and debt securities. Obtaining future financing may be costly
and will be dilutive to existing stockholders. If Fonix is not able to obtain
financing when and in the amounts needed, and on terms that are acceptable to
it, Fonix's operations, financial condition and prospects could be materially
and adversely affected, and Fonix could be forced to curtail its operations or
sell part or all of its assets, including its core technologies.
Holders of Fonix Class A common stock are subject to the risk of additional and
substantial dilution to their interests as a result of the conversion of
presently issued preferred stock and other securities convertible into common
stock.
Introduction
Fonix presently has two series of preferred stock outstanding: Series A and
Series D. All of Fonix's presently outstanding preferred stock is convertible
into shares of Fonix Class A common stock. The Series A preferred stock was
issued in October 1995 and is convertible, one-for-one into 166,667 shares of
Fonix Class A common stock at the option of the holder. The Series D preferred
stock is convertible into Fonix Class A common stock according to one of three
separate conversion formulas, one of which is based, in part, on the market
price of Fonix Class A common stock during the several week period leading up to
the conversion date. Fonix previously had a third series of preferred stock
outstanding, its Series E preferred stock, with terms similar to those of the
Series D, but all of the shares of the Series E have been converted into shares
of Fonix Class A common stock. A registration statement covering the shares of
Class A common stock underlying the Series D and Series E preferred stock,
together with warrants issued with the Series D and Series E preferred stock,
was declared effective on August 12, 1999.
In addition to the Series D preferred stock, Fonix has other contractual
obligations to issue additional shares of its common stock that are dependent on
the prevailing market price of Fonix Class A common stock. Specifically, on
December 21, 1998, Fonix completed the Equity Offering of 1,801,802 shares of
common stock. The investor that participated in the Equity Offering also
acquired certain rights (the "Repricing Rights") that entitle the holder to
receive that number of additional shares of Fonix Class A common stock for no
additional consideration according to a conversion formula described in more
detail in the section of the prospectus entitled "Selling Stockholders."
In addition to the Repricing Rights, Fonix has issued other securities that
are convertible into Class A common stock according to a conversion formula that
is determined by reference to the market price of the common stock at and around
the time of conversion. Specifically, on January 29, 1999, Fonix and four
investors entered into a securities purchase agreement which was subsequently
supplemented on March 3, 1999, wherein Fonix agreed to
11
<PAGE>
issue the Debentures in the aggregate principal amount of $6,500,000 in the Debt
Offering. Included among the investors that purchased the Debentures are some of
the holders of the Repricing Rights.
The outstanding principal amount of the Debentures is convertible at any
time at the option of the holder into shares of Class A common stock according
to a conversion formula described in more detail in the section of this
prospectus entitled "Selling Stockholders."
In connection with the Equity Offering and the Debt Offering, Fonix issued
to the investors 200,000 and 400,000 Class A common stock purchase warrants,
respectively, having an exercise price of $1.665 and $1.25 per share,
respectively, and having a term of three years.
The following table identifies the number of outstanding shares of the
Series D preferred stock, the total number of Repricing Rights outstanding and
the total principal amount of the Debentures outstanding, and the total number
of shares of Class A common stock issuable assuming the hypothetical conversion
or exercise of all such preferred stock, Repricing Rights or Debentures as of
December 13, 1999. For purposes of this table, Fonix has assumed that the
holders of the Series D preferred stock would have elected that conversion price
that would yield the greatest number of shares of Class A common stock upon
conversion. All calculations exclude the issuance of shares of Class A common
stock as payment of dividends accrued on the Series D preferred stock and
interest on the Debentures at the date of conversion, as well as shares of Class
A common stock issued upon conversion of the Series D preferred stock prior to
December 13, 1999.
<TABLE>
<CAPTION>
Number of Convertible Shares of Class A Percent of Class A
Securities Outstanding/ Common Stock Common Stock Owned
Principal Amount of Issuable Upon By Holders After
Convertible Security Debentures Conversion or Conversion
Exercise
- --------------------------- ---------------------- --------------------- -----------------------
<S> <C> <C> <C>
Series D Preferred Stock 381,723 27,661,087 18.20%
Repricing Rights 1,801,802 6,798,199 5.18%
Debentures $3,971,107 15,859,054 9.92%
---------------------- ---------------------
Total 75,367,205 37.74%
=====================
</TABLE>
The following table describes the number of shares of Class A common stock
that would be issuable assuming all of the presently issued and outstanding
shares of Series D preferred stock were converted, the Repricing Rights were
exercised on the terms most beneficial to the holder, and the Debentures were
converted, and further assuming that the applicable conversion or exercise
prices at the time of such conversion or exercise were the following amounts
(the table excludes effect of the issuance of shares of common stock upon
payment of accrued dividends and also excludes differences among the various
methods of calculating the applicable conversion or exercise price):
<TABLE>
<CAPTION>
Shares of Class A Common Stock Issuable Upon Conversion
or Exercise of
- -------------------------- ----------------------------------------------------------- --------------------
Total Class A
Hypothetical Conversion/ Series D Repricing Common Stock
Exercise Price Preferred Stock Rights Debentures Issuable
- -------------------------- ----------------- ----------------- ----------------- --------------------
<S> <C> <C> <C> <C> <C>
$0.25 30,537,840 8,518,199 15,884,428 54,940,467
$0.75 10,179,280 1,638,198 5,294,809 17,112,287
$1.50 5,089,640 0 2,647,405 7,737,045
$2.25 3,393,093 0 1,764,936 5,158,030
$3.00 2,544,820 0 1,323,702 3,868,522
</TABLE>
12
<PAGE>
Given the structure of the conversion formulas applicable to the Series D
preferred stock, and the other convertible securities described above, there
effectively is no limitation on the number of shares of Fonix Class A common
stock into which such convertible securities may be converted or exercised. As
the market price of the Fonix Class A common stock decreases, the number of
shares of Fonix Class A common stock underlying the Series D preferred stock and
such other convertible securities continues to increase. The following specific
risk factors relative to this dilution should be considered before deciding to
purchase the Shares offered by this prospectus.
Overall Dilution to Market Price and Relative Voting Power of Previously
Issued Common Stock
The conversion of the Series D preferred stock, the exercise of the
Repricing Rights and the conversion of the Debentures may result in substantial
dilution to the equity interests of other holders of Fonix Class A common stock.
Specifically, the issuance of a significant amount of additional Fonix Class A
common stock would result in a decrease of the relative voting control of Fonix
Class A common stock issued and outstanding prior to the conversion of the
Series D preferred stock, the exercise of the Repricing Rights and the
conversion of the Debentures. Furthermore, public resales of Fonix Class A
common stock following the conversion of the Series D preferred stock, the
exercise of the Repricing Rights or the conversion of the Debentures likely
would depress the prevailing market price of Fonix Class A common stock. Even
prior to the time of actual conversions, exercises and public resales, the
market "overhang" resulting from the mere existence of Fonix's obligation to
honor such conversions or exercises could depress the market price of Fonix
Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common Stock
The Debentures and outstanding shares of Series D preferred stock are
convertible, and the Repricing Rights are exercisable, at a floating price that
may and likely will be below the market price of Fonix Class A common stock
prevailing at the time of conversion or exercise. As a result, the lower the
market price of Fonix Class A common stock at and around the time the holder
converts or exercises, the more Fonix Class A common stock the holder of such
convertible securities receives. Any increase in the number of shares of Fonix
Class A common stock issued upon conversion or exercise as a result of decreases
in the prevailing market price would compound the risks of dilution described in
the preceding paragraph of this risk factor.
Increased Potential for Short Sales
Downward pressure on the market price of Fonix Class A common stock that
likely would result from sales of Fonix Class A common stock issued on
conversion of the Series D preferred stock, the exercise of the Repricing Rights
or the conversion of the Debentures could encourage short sales of Class A
common stock by the holders of the Series D preferred stock, the Repricing
Rights, the Debentures or others. Material amounts of such short selling could
place further downward pressure on the market price of Fonix Class A common
stock.
Limited Effect of Restrictions on Extent of Conversions
The holders of the Series D preferred stock, the Repricing Rights and the
Debentures are prohibited from converting their preferred stock or exercising
their Repricing Rights into more than 4.999% of the then outstanding Fonix Class
A common stock. This restriction, however, does not prevent such holders from
either waiving such limitation or converting or exercising and selling some of
their convertible security position and thereafter converting or exercising the
rest or another significant portion of their holding. In this way, individual
holders of Series D preferred stock and Repricing Rights could sell more than
4.999% of the outstanding Fonix Class A common stock in a relatively short time
frame while never holding more than 4.999% at a time.
Similarly, the holders of the Debentures have agreed to limit their
aggregate daily sales of Fonix's common stock received upon conversion of the
Debentures to 10,000 shares per day unless the conversion price exceeds certain
minimums, in which case the holders of the Debentures may sell up to the greater
of 100,000 shares or 10% of the previous day's trading volume per day.
Nevertheless, the holders of the Debentures could, in a short period of time,
13
<PAGE>
sell large quantities of shares of Class A common stock into the market,
compounding the risks of dilution described earlier in this risk factor.
Payment of dividends and interest in shares of Class A common stock may
result in further dilution
Under the terms of the Series D preferred stock and the Debentures, the
Company has the option to pay dividends and interest on the preferred stock and
Debentures, respectively, in shares of the Company's Class A common stock. The
dividends and interest accrue from the date of the purchase of the preferred
stock and Debentures, respectively. As such, a decision by the Company to pay
such dividends and interest in shares of Class A common stock could result in a
substantial increase in the number of shares issued and outstanding and could
result in a decrease of the relative voting control of Fonix Class A common
stock issued and outstanding prior to such payment of dividends and interest.
Recent financing activities may result in further dilution
Additionally, Fonix has recently entered into an agreement with four
investors whereby Fonix will sell to the investors a total of 250,000 shares of
its Series F 6% Convertible Preferred Stock (the "Series F Preferred Stock"), in
return for payment of $5,000,000. The Series F Preferred Stock is convertible
into shares of Fonix's Class A common stock during the first six months
following the closing of the transaction at a price of $0.75 per share, and
thereafter at a price equal to 90% of the average of the three lowest closing
bid prices in the twenty-day trading period prior to the conversion of the
Series F Preferred Stock. The investors will receive registration rights which
will require Fonix to file a registration statement covering the shares
underlying the Series F Preferred Stock. Fonix will have the option of redeeming
any outstanding Series F Preferred Stock. Although Fonix has received
approximately $1,000,000 in connection with this financing, the securities
purchase agreement has not been signed.
Accordingly, the terms may differ from those set forth in this paragraph.
Because the conversion price for the Series F Preferred Stock is connected
with the market price of the Class A common stock, any depression in the market
price could result in a substantial increase in the number of shares issued on
conversion of the Series F Preferred Stock. Specifically, the issuance of a
significant amount of additional Fonix Class A common stock would result in a
decrease of the relative voting control of Fonix Class A common stock issued and
outstanding prior to the conversion of the Series F Preferred Stock.
Furthermore, public resales of Fonix Class A common stock following the
conversion of the Series F Preferred Stock likely would depress the prevailing
market price of Fonix Class A common stock. Even prior to the time of actual
conversions, the market "overhang" resulting from the mere existence of Fonix's
obligation to honor such conversions could depress the market price of Fonix
Class A common stock.
If Fonix has difficulty capitalizing on recent acquisitions, its operations and
financial prospects could be adversely affected.
In 1998, Fonix completed the acquisitions of AcuVoice, Articulate, and
Papyrus. Notwithstanding the sale of the HealthCare Solutions Group, Fonix's
acquisitions of AcuVoice and Papyrus present risks including at least the
following:
o Fonix may have difficulty financing ongoing operations of acquired
businesses to the extent such businesses are not generating positive
cash flows;
o Fonix may have difficulty combining or integrating the technology,
operations, management or work force of the acquired businesses with
Fonix's or its subsidiaries' existing operations;
o Fonix may have difficulty retaining the key personnel of the acquired
businesses;
o Fonix may have difficulty expanding Fonix's financial and management
controls and reporting systems and procedures to the acquired
businesses;
14
<PAGE>
o Fonix may have difficulty maintaining uniform standards, controls,
procedures, and policies across its entire organization, including the
acquired businesses; and
o There may be increased commitment of management resources and related
expenses resulting from efforts to integrate and manage acquired
businesses located at a distance from Fonix's principal executive
offices and research facilities.
Fonix has only a limited product offering and many of its key technologies are
still in the development stage.
There presently are only a limited number of commercially available
applications or products incorporating the Fonix technologies. Fonix markets its
automated speech recognition, text-to-speech, and handwriting recognition
technologies and products for embedded applications, and Internet and telephony
applications. However, the marketing of these technologies and products is in
its initial start-up phase with no material funding commitments or meaningful
sales. These product offerings are still relatively limited and have not
generated significant revenues to date. An additional element of Fonix's
business strategy is to achieve revenues through appropriate strategic
alliances, co-development arrangements, and license arrangements with third
parties. In addition to a master collaboration agreement with Infineon (formerly
the semi-conductor group of Siemens AG), the Company has recently entered into
licensing and joint-marketing agreements with Intel and Microsoft. These
agreements are based on joint marketing and application development for specific
end-users or customers. There can be no assurance that these collaboration or
manufacturing agreements will produce license or other agreements which will
generate material revenues for Fonix.
The market for many of Fonix's technologies is largely unproven and may never
develop sufficiently to allow Fonix to capitalize on its technology and
products.
The market for human-computer interaction technologies, including automated
speech recognition technologies, text-to-speech and handwriting recognition, is
relatively new. Additionally, Fonix's technologies are new and, in many
instances, represent a significant departure from technologies which already
have found a degree of acceptance in the human-computer interaction marketplace.
The financial performance of Fonix will depend, in part, on the future
development, growth, and ultimate size of the market for human-computer
interaction applications and products generally, and applications and products
incorporating Fonix's technologies and applications. The applications and
products which incorporate Fonix's technologies will be competing with more
conventional means of information processing such as data entry, access by
keyboard or touch-tone telephone, or professional dictation services. Fonix
believes that there is a substantial potential market for applications and
products incorporating advanced human-computer interface technologies including
speech recognition, speech synthesis, speech compression, speaker identification
and verification, handwriting recognition, pen and touch screen input, and
natural language understanding. Nevertheless, such a market for Fonix's
technologies or for products incorporating Fonix's technologies may never
develop to the point that profitable operations can be achieved or sustained.
Competition from other industry participants and rapid technological change
could impede Fonix's ability to achieve profitable operations.
The computer hardware and software industries are highly and intensely
competitive. In particular, the human computer interaction market sector and
specifically the speech recognition, computer voice and communications
industries are characterized by rapid technological change. Competition in the
market sector of human-computer interaction technology is based largely on
marketing ability and resources, distribution channels, technology and product
superiority and product service and support. The development of new technology
or material improvements to existing technologies by Fonix's competitors may
render Fonix's technologies less attractive or even obsolete. Accordingly, the
success of Fonix will depend upon its ability to continually enhance its
technologies and interactive solutions and products to keep pace with or ahead
of technological developments and to address the changing needs of the
marketplace. Some of Fonix's competitors have greater experience in developing,
manufacturing and marketing human computer interface technologies, applications
and products, and some have far
15
<PAGE>
greater financial and other resources than Fonix, or its potential licensees and
co-developers, as well as broader name-recognition, more-established technology
reputations, and mature distribution channels for their products and
technologies. Barriers to entry in the software industry are low, and as the
market for various human computer interaction products expands and matures,
Fonix expects more entrants into this already competitive arena.
Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 1998, 1997 and 1996.
The independent public accountants' reports for Fonix's financial
statements for the years 1998, 1997, and 1996 include an explanatory paragraph
regarding substantial doubt about Fonix's ability to continue as a going
concern.
This may have an adverse effect on the Company's ability to obtain financing.
Delisting from the Nasdaq SmallCap Market could have an adverse effect on the
liquidity of the Company's Class A common stock and has triggered certain rights
of the holders of the Company's Debentures and Repurchase Rights.
Until recently, the Company's Class A common stock traded on the Nasdaq
SmallCap market which requires, for continued listing, a minimum bid price of at
least $1.00 per share. At June 29, 1999, the Company's Class A common stock had
traded below $1.00 for more than thirty consecutive trading days. On June 29,
1999, the Company received a letter from Nasdaq indicating that unless the
minimum bid price for the Company's Class A common stock returned to at least
$1.00 per share for at least ten consecutive trading days prior to September 29,
1999, the Company's shares would be delisted from the Nasdaq SmallCap Market on
October 1, 1999. The Company appealed Nasdaq's notice and listing determination
in September 1999. Nasdaq held a hearing on the matter on October 28, 1999.
On December 3, 1999, the Company received notice that its Class A common
stock had been delisted from the Nasdaq SmallCap Market, in part because the
stock price had been below $1.00 per share since approximately March 1999. The
Company is currently evaluating its options, including the possibility of
appealing the delisting decision. However, the Company's Class A common stock is
currently trading on the OTC Bulletin Board.
The result of delisting from the Nasdaq SmallCap Market could be a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Class A common stock continues to trade on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
Class A common stock to purchase or sell shares as quickly and as inexpensively
as they have done historically.
Additionally, the delisting of the Company's Class A common stock from the
Nasdaq SmallCap Market was an event of default under the terms of the Debentures
and the Equity Offering. Upon the occurrence of an event of default, the full
$3,971,107 principal amount of all of the Debentures currently outstanding,
together with accrued interest and all other amounts owing in respect thereof,
became immediately due and payable in cash. However, the holders of the
Debentures have waived this event of default. 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 had not waived the default.
Finally, the delisting of the Company's Class A common stock from the
Nasdaq SmallCap Market was a triggering event giving rise to certain repurchase
rights in connection with the Equity Offering. The investor has the right to
require Fonix to repurchase some or all of the investor's Class A common shares
and Repricing Rights received in the Equity Offering. However, the Equity
Offering investor has waived this event of default. 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 repurchase rights had not waived the default.
16
<PAGE>
Fonix's operations and financial condition could be adversely affected by
Fonix's failure or inability to protect its intellectual property or if Fonix's
technologies are found to infringe the intellectual property of a third party.
Dependence on proprietary technology
Fonix's success is heavily dependent upon its proprietary technology. On
June 17, 1997, the United States Patent and Trademark Office issued U.S. Patent
No. 5,640,490 entitled "A User Independent, Real-time Speech Recognition System
and Method" (the "'490 Patent"). The patent has a 20-year life running from the
November 4, 1994 filing date, and has been assigned to Fonix. This patent covers
certain elements of the Fonix voice recognition technologies. Fonix has acquired
two other patents and has filed ten additional United States and foreign patent
applications. In addition to its patents, Fonix relies on a combination of
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. Such means of
protecting Fonix's proprietary rights may not be adequate because such laws
provide only limited protection. Despite precautions that Fonix takes, it may be
possible for unauthorized third parties to duplicate aspects of the Fonix
technologies or the current or future products or technologies of its business
units or to obtain and use information that Fonix regards as proprietary.
Additionally, Fonix's competitors may independently develop similar or superior
technology. Policing unauthorized use of proprietary rights is difficult, and
some international laws do not protect proprietary rights to the same extent as
United States laws. Litigation periodically may be necessary to enforce Fonix's
intellectual property rights, to protect its trade secrets or to determine the
validity and scope of the proprietary rights of others.
The Company has agreed to pledge the '490 Patent as additional security for
the repayment of the Debentures. While the Company has not executed a pledge
agreement in favor of the holders of the Debentures, it may be required to do so
in the future. A breach of the Company's obligations under such Debentures could
result in a loss of the Company's control of or rights under the '490 Patent.
Risks of infringement by Fonix upon the technology of unrelated parties or
entities
Fonix is not aware and does not believe that any of its technologies or
products infringe the proprietary rights of third parties. Nevertheless, third
parties may claim infringement with respect to its current or future
technologies or products or products manufactured by others and incorporating
Fonix's technologies. Fonix expects that participants in the human-computer
interaction industry increasingly will be subject to infringement claims as the
number of products and competitors in the industry grows and the functionality
of products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming, result in costly litigation, cause
development delays, or require Fonix to enter into royalty or licensing
agreements. Royalty or license agreements may not be available on acceptable
terms or at all. As a result, infringement claims could have a material adverse
affect on Fonix's business, operating results, and financial condition.
Fonix is subject to the risk that certain key personnel, including key
scientific employees and independent contractors named below, on whom Fonix
depends, in part, for its operations, will cease to be involved with Fonix.
Fonix is dependent on the knowledge, skill and expertise of several key
scientific employees and independent contractors, including John A. Oberteuffer,
Ph.D., C. Hal Hansen, Dale Lynn Shepherd, R. Brian Moncur, and Tony R. Martinez,
Ph.D., and its executive officers, Thomas A. Murdock and Roger D. Dudley. The
loss of any of the key personnel listed above could materially and adversely
affect Fonix's future business efforts. Although Fonix has taken reasonable
steps to protect its intellectual property rights including obtaining
non-competition and non-disclosure agreements from all of its employees and
independent contractors, if one or more of Fonix's key scientific or executive
employees or independent contractors resigns from Fonix to join a competitor, to
the extent not prohibited by such person's non-competition and non-disclosure
agreement, the loss of such personnel and the employment of such personnel by a
competitor could have a material adverse effect on Fonix. Fonix does not
presently have any key man life insurance on any of its employees.
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Mediation and arbitration between the Company and the Oregon Graduate Institute
could adversely affect Fonix if Fonix is found to be in default of certain
agreements.
On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default, demand for mediation and demand for arbitration with the American
Arbitration Association. In its demand, OGI asserted that Fonix had defaulted
under three separate agreements between Fonix and OGI in the total amount of
$175,000. On or about September 23, 1999, the Company responded to OGI's demand
and denied the existence of a default under the three agreements identified by
OGI. Moreover, the Company asserted a counterclaim against OGI in an amount not
less than $250,000. The arbitrator appointed by the American Arbitration
Association will conduct a scheduling conference in January 2000 to set dates
for the proceeding, including the date of the arbitration hearing.
Fonix believes the OGI arbitration claims are without merit, and intends to
press its counterclaim against OGI. However, if Fonix is found to have defaulted
under one or more of the agreements with OGI, Fonix may be required to pay the
asserted amount of damages arising from the default or other amounts awarded in
the arbitration. At a minimum, the ongoing nature of the action will result in
some diversion of management time and effort from the operation of the business.
In addition to the legal matters described above, Fonix is involved in
other litigation that is routine or does not involve material liabilities and
therefore is not separately discussed in this prospectus.
Year 2000 problems could adversely affect Fonix.
Many computer systems and software products are coded to accept only two
digit entries in the date code field. These date code fields will need to accept
four digit entries to distinguish 21st century dates from 20th century dates. As
a result, many companies' software and computer systems will need to be upgraded
or replaced in order to comply with such Year 2000 requirements. Fonix is
subject to the risk that problems encountered with Year 2000 issues, either in
its internal systems, technologies and products, or in external systems could
adversely affect its operations and financial condition.
In the ordinary course of its business, Fonix tests and evaluates its
technologies and software and hardware products. Fonix believes that all of its
technologies and products generally are Year 2000 compliant, meaning that the
use or occurrence of dates on or after January 1, 2000 will not materially
affect the performance of such technologies or products with respect to four
digit date dependent data or the ability of such products to correctly create,
store, process, and output information related to such data. However, Fonix may
learn that certain of its technologies or products do not contain all necessary
software routines and codes necessary for the accurate calculation, display,
storage, and manipulation of data involving dates. In addition, Fonix has
warranted or expects to warrant that the use or occurrence of dates on or after
January 1, 2000 will not adversely affect the performance of its technologies or
products with respect to four digit date dependent data or the ability to
create, store, process, and output information related to such data. If the end
users of any of Fonix's technologies or products experience Year 2000 problems,
those persons could assert claims for damages.
Fonix uses third-party equipment and software that the Company believes to
be Year 2000 compliant. The Company has substantially completed a review of key
products provided by outside vendors to determine if those products comply with
Year 2000 requirements and presently believes that all software provided by
third parties that is critical to its business is Year 2000 compliant. The
Company has also completed a review of all internal systems for Year 2000
compliance and presently believes the internal systems are Year 2000 compliant.
If, however, 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 Fonix's business, operating results or financial condition.
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In addition, the purchasing patterns of Fonix's licensees, potential licensees,
customers and potential customers may be affected by Year 2000 issues. Many
companies are expending significant resources to correct their current software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to license the Company's technologies or to purchase other Fonix
products. This may adversely affect the Company's business, operating results,
and financial condition.
Fonix has no dividend history and no intention to pay dividends in the
foreseeable future.
Fonix has never paid dividends on or in connection with any class of its
common stock and does not intend to pay any dividends to common stockholders for
the foreseeable future.
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the only ones
facing Fonix. Additional risks and uncertainties not presently known to Fonix or
that Fonix currently deems immaterial may also impair its business operations.
If any of the foregoing risks actually occur, Fonix's business, financial
condition, or results of operations could be materially adversely affected. In
such case, the trading price of Fonix Class A common stock could decline and you
may lose all or part of your investment.
Information about Fonix Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
THIS STATEMENT OF MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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, AS AMENDED, FOR THE YEAR ENDED DECEMBER
31, 1998.
Overview
Corporate Summary
Fonix is a development stage company engaged in marketing and developing of
proprietary human/computer interaction technologies. Specifically, the Company
has developed neural network-based automated speech recognition ("ASR"), as well
as text-to-speech ("TTS"), handwriting recognition ("HWR") and speech
compression technologies packaged in products salable to a wide range of
customers. (ASR, TTS, HWR and speech compression technologies are sometimes
collectively referred to as "core technologies".) The Company expects to
continue to make commercially available products utilizing its core technologies
which enable computers and electronic devices to interact with people on human
terms rather than humans conforming to the process of a machine. The Company
believes this new efficient, intuitive and natural method of human/computer
interaction will eventually replace traditional interaction tools such as the
keyboard and mouse in a broad range of mass market, industrial, embedded and
server-based applications.
Fonix is pursuing revenue opportunities through generation of non-recurring
engineering fees, product and technology license royalties, product sales and
product support maintenance contracts. The Company markets its products and core
technologies to software developers, consumer electronic manufacturers
(including producers of computer processors or chips), third party product
developers, operating system developers, network and share-ware
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developers and Internet and web related companies. The Company focuses marketing
toward both embedded systems applications and server-based solutions for
Internet and telephony voice activated applications.
Manufacturers of consumer electronic products, software development and
Internet content use Fonix core technologies to simplify the use of their
products and increase product functionality resulting in broader market
opportunities and significant competitive advantage. Unlike traditional
stand-alone consumer speech and language technologies, Fonix solutions support
multiple platforms, are environment and speaker independent, while providing
easy integration within a relatively small memory requirement.
Competitive Advantages of Core Technologies
Fonix core technologies have key competitive advantages that differentiate
them from other speech and handwriting technology companies.
ASR. Fonix researchers have developed and patented what the Company
believes to be a fundamentally new and unique approach to the analysis of human
speech sounds and the contextual recognition of speech. The core ASR
technologies attempt to approximate the techniques employed by the human
auditory system and language understanding centers in the human brain. The ASR
technologies use information in speech sounds perceptible to humans but not
discernible by current ASR systems. The ASR technologies also employ neural
network 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 phonetic sound recognition engine is comprised of several
components including audio signal processing, a feature extraction process, a
phoneme estimation process, and a linguistic process based on proprietary neural
net technologies that are designed to interpret human speech contextually. 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 neural-net architecture for back-end language modeling. The latter
component is known as MULTCONS or multi-level temporal constraint satisfaction
network. These developments have been the subject of two issued patents and
several pending patents. In addition, the Company has acquired a related patent
covering the front-end recognition process.
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 will significantly improve the
performance, utility and convenience of applications such as computer command
and control, voice activated navigation of the Internet, data input, text
generation, telephony transactions, continuous dictation, and other applications
in both embedded and server based applications.
Fonix has pursued the development of these ASR technologies to produce
salable products and gain market share by overcoming the limitations of
currently available commercial ASR systems and broadening the market acceptance
and use of human/computer interaction technologies. Key benefits resulting from
Fonix proprietary ASR technologies which differentiate Fonix ASR products and
technologies from other currently available competitive products include:
1. Significantly reduced computer memory requirements allowing speech
recognition to operate in embedded system environments, or enabling
server-based systems to operate with significantly more simultaneous users
because memory requirements do not encumber as much operating system
resources as competitive traditional systems.
2. Significantly reduced power requirements making Fonix technologies
available for use in a host of smaller computing solutions with limited
battery/power capacity and enabling more simultaneous users on server-based
systems.
3. Speaker independence allowing various speakers to use the same system
without the system being trained to a particular user's voice and dialect.
4. Excellent noise cancellation qualities allowing the ASR system to extract
ambient background noise, thus allowing higher recognition rates in noisy
environments.
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5. Highly reduced need for headsets or tethered microphones.
6. Rapid porting to multiple computer chip platforms and operating systems
to create broad product demand.
7. The Fonix Accelerated Applications Speech Technology (FAAST) product is
a leading edge, visual, integrated development environment which allows
customers to build applications in a rapid time frame with a high rate of
success and little outside resources thereby accelerating product time to
market.
The Company believes that its ASR technologies offer unique speech
processing techniques that will improve a broad range of computing solutions and
accelerate and enhance integration of human/computer interaction technologies
into products, applications, solutions and devices.
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. See
"Certain Significant Risk Factors." During 1997, 1998, and the nine months ended
September 30, 1999, the Company has expended $7,066,294, $12,109,065, and
$5,289,038, respectively, on ASR research and development activities. Since its
inception (October 1, 1993), the Company has spent $35,365,904 on research and
development ("R&D") of its ASR technologies. The Company expects that a
substantial part of its capital resources will continue to be devoted to
research and development of ASR technologies and other proprietary technologies
for the foreseeable future.
TTS. Fonix text-to-speech products include a small, proprietary
vocabulary-true human-quality synthetic voice with full prosody and an unlimited
vocabulary text-to-speech engine initially developed by AcuVoice and purchased
by Fonix in 1998. All TTS products are sold under the Fonix brand name.
The Company's TTS products began as 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 often consists of more than one phoneme
(sound), Fonix'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 method called "parametric speech
synthesis." Parametric systems have 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." Fonix synthetic speech products have been recognized as high quality,
human sounding engines which include full voice inflection, intonation and
clarity. Fonix' large vocabulary TTS ("LVTTS") engine won awards as "best
text-to-speech" product at the Computer Technology Expo '97 and '98 and the best
of show award at AVIOS '97. Presently LVTTS products are sold to end-users,
systems integrators and OEMs in telecommunications, multi-media, educational and
assistive technology markets.
The products include the Fonix AV 1700 TTS system for end-user desktop and
laptop system use. The Fonix 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.
During the nine months ended September 30, 1999, the Company received in
the aggregate, $348,726 in revenue from licensing or sale of the TTS
technologies and products compared to pro-forma revenue of $246,382 for the
comparable nine month period of 1998.
HWR. In October 1998, Fonix acquired Papyrus Associates, Inc. ("Papyrus"),
including its 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 involving lower case letter
making. 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 use with its line of
smart cell phones. 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
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licensed product to OEM customers. Both the Allegro and the cursive handwriting
recognition software are user independent and require no training on the
software.
During the nine months ended September 30, 1999, the Company received
$2,357 in revenue from licensing or sale of the handwriting recognition
technologies compared to pro-forma revenue of $190,147 for the comparable nine
month period of 1998.
Market Strategy
The world-wide market for ASR, TTS and HWR technologies and products is
newly emerging. Currently, only a small portion of prospective applications for
these human/computer interaction technologies has reached the critical point of
commercial viability. Among the largest current markets developing or employing
speech technologies are applications in the telephony and call centers,
automatic desktop dictation software, telematic, personal hand-held
communication solutions, Internet voice portals and research and development
markets. Historically, development of speech products in an emerging market has
been affected by declining margins, large memory requirements, non-extendable
technology, operating system platform dependence, lack of integration and
non-recurring engineering dependence. Recently, several forces have driven
market trends toward accelerated demand for speech including technology
convergence (more speech products companies and proliferation of the world wide
web), explosive growth in mobile personal communications and organization
devices, and legislative concerns for consumer safety and handicap access to
technology.
The Company has strategically sought markets for its core technologies with
high margins, broad use, rapid development and market emergence/presence. Fonix
has also strategically avoided markets with low margins which are commodity
driven, subject to continuous price compression and require massive, costly
customer support systems.
The Company's current marketing strategy is governed by the following
general principles:
1. Specific focus on markets where current revenues can be realized through a
market driven approach and away from markets focusing on continued research
and development.
2. Pursuit of customers who enjoy dominant or significant market share in
their respective markets and who display financial ability and marketing
organization to rapidly bring products to market.
3. Pursuit of integration into customer products where Fonix technology is
directly compatible and can go to market with minimal additional
development engineering.
4. Partner with customers who have existing marketing channels in place and
leverage product sales through those channels.
5. Generally position Fonix as a provider of second tier customer support,
providing training and tools for Fonix customers who create excellent front
line support systems for their end-user customers.
Because the Company is pursuing integration into mass market, industrial,
general business and personal electronic products and computing solutions, lead
time to revenue generation is longer than retail, commodity driven software
products. The Company's products sold and integrated into customer applications
are subject to both customer production schedules and customer success in
marketing the products and generating product sales. The Company's revenues are
thus subject to delays and possible cancellation resulting from customer
integration delays.
To bring the Company's proprietary technologies to market, Fonix has
focused marketing and product development into embedded markets and server-based
markets.
Embedded Markets
Increasingly efficient and powerful computing solutions have rapidly
developed new markets by creating smaller, more convenient devices equipped with
personalized functions. These devices include PDAs (personal digital
assistants), cellular phones, web pads, wireless communications devices, and
other consumer electronics. A significant
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deterrent to full functionality of powerful yet small computing devices is the
current need for a keyboard and/or a mouse to interface with the device. Recent
integration of HWR technology has helped to increase the demand for natural,
intuitive human/computer interactions with these devices and has helped markets
to emerge ready to pay for speech recognition and synthetic speech in computing
solutions. The next step to greater human/computer interaction is to integrate
speech into these products. Other product developments are driving additional
interest in human/computer technologies including new products (electronic
books, wearable computers), testing of smart appliances and toys (VCRs,
answering machines, wireless phones, climate control systems) and automotive
applications (command and control, hands free cellular phones and voice
activated navigation systems).
Historically, micro processors did not contain enough memory or computing
power (MIPS) to operate most ASR and TTS applications. This created a
significant problem for embedded markets. Adding the hardware necessary to boost
memory and computing power would increase the price of devices higher than
consumer markets would tolerate.
Because of proprietary engineering innovations, Fonix ASR and TTS
technologies have memory and power requirements that fall well within tolerances
needed to speech enable applications using existing 16 bit and 32 bit
processors. To capitalize on this distinct competitive advantage, Fonix is
pursuing sales and partnership relationships with companies offering embedded
products for mass consumer markets, industrial applications and business
computing solutions.
Fonix has identified key embedded market segments which it believes will
provide long term, sustainable revenue flow using proprietary ASR, TTS and HWR
technologies and which meet Fonix's general business strategy objectives. These
strategically focused embedded markets include:
1. Chip Manufacturers. Digital signal processor ("DSP") and micro processor
manufacturers are currently highly focused on technology innovations which
will support and drive sales of chips through third party vendors. Because
Fonix ASR and TTS technologies have demonstrated the ability to operate in
these environments, Fonix is pursuing relationships with these
manufacturers to leverage their existing marketing channels.
2. Design and Development Contractors. Firms designing reference platforms and
real products and developing functions operating on those platforms through
contracts with major mass market product suppliers provide a strong market
for Fonix with channels to major consumer electronics marketers.
3. Software Developers. Many software developers in multiple markets provide
opportunity for Fonix to enhance software sales for these companies by
enabling their software products with one or more human/computer
interaction technologies, leading to leveraged product sales and royalty
revenue for Fonix.
4. Third Party Product Developers. Many companies are currently seeking ASR,
TTS and HWR technologies to integrate into a host of consumer electronic
devices, commercial applications and business solutions. Fonix evaluates
each prospective opportunity and the tradeoff between revenue potential and
development time required. Primary markets for these applications are in
automotive and aviation telematics, industrial wearable computers, mobile
communications devices and PDA's.
Server-Based Markets
Telephony/call center solutions and shrink-wrap desktop dictation software
sales are two of the most advanced emerging markets for automated speech.
Current industry revenue estimates indicate that customized automated call
centers, virtual operators, packaged call center software, custom vertical
market dictation systems and general desktop dictation systems have led
server-based speech applications into the market. Because speech products have
now reached a point of both acceptable product quality and initial market
acceptance, several additional industries are currently researching and
developing plans for integration of ASR, TTS and HWR. These new product areas
including network systems, telephone company e-mail reader services, software
document readers, Internet navigation and screenless Internet access, web site
text readers, mobile computing solutions and many more.
The Company is addressing this market opportunity from the strengths of its
core technologies. Fonix has released version 1 of its FAAST (Fonix Accelerated
Application Speech Technology) for Servers. FAAST for Servers
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provides application developers with a tool enabling rapid development of ASR
and TTS which can be quickly and cleanly ported into their product. FAAST for
Servers is targeted to currently emerging and newly developing markets expected
to utilize speech applications in the near and mid-term future.
In addition, the Company is focused on direct product development in
server-based markets. This focus is employed in three primary areas:
1. Internet Voice Portals. Speech enabled access to the Internet and web site
navigation is a rapidly emerging need. Fonix is developing and will soon
implement products for voice portals to the Internet which may be purchased
for use by portal companies, web sites and content providers, Internet
service providers, and browsers.
2. TTS for Reading Web Sites. Since over 70% of all web content is text,
demand for products allowing web content to be read to the user is rapidly
growing. Fonix has developed a web page reader which can be added to web
sites. Working in concert with established audio players, this product is
targeted toward the largest web content providers worldwide in media,
government, business and other industries.
3. Network Systems Command and Control and E-mail Reader. Fonix provides both
ASR and TTS which can be seamlessly integrated into network software to
speech-enable software applications.
4. Video Captioning. The Company has developed a means to effectively use ASR
to create automatic forced alignment and automatic closed and open
captioning for video aftermarket editing services. Future versions of this
product will include real-time live closed captioning systems utilizing
Fonix continuous ASR. Major video software developers and marketers and
large scale video editing and production facilities are prime targets for
this product.
Fonix Product Development and Delivery Focus
The focus of Fonix management is to transition a technology research
development team focused on invention and proof of concept into a team which
delivers quality products on schedule and within budget, while at the same time
continuing to achieve technology upgrades to maintain distinct competitive
technology advantages.
To accelerate the delivery of Fonix technologies into the market as bona
fide products, Fonix management has reconfigured the R&D-oriented development
organization into a Product Delivery/R&D matrix organization. The new structure
consists of the traditional R&D-oriented organization overlaid by product teams
led by product managers who are marketing-oriented and charged with direct
profit and loss responsibilities. These responsibilities begin with market
research and with product definition and specification and end with delivery of
quality products which address real needs identified by the marketplace, on
schedule and within budget. As identified by industry experience, this is a
demanding but necessary role, and has been found industry wide to be
indispensable in transforming a company from the R&D phase into the product
delivery phase.
Results of Operations
The results of operations disclosed below give effect to the sale of the HSG and
the classification of its net assets and operating activities as discontinued
operations.
Twelve months ended December 31, 1998 compared with the twelve months ended
December 31, 1997
During 1998, the Company recorded revenues of $2,604,724, of which
$2,368,138 was a non-refundable license fee from Siemens for which the Company
has no further obligation of any kind. The remainder of such revenues were from
sales and licensing fees related to the text-to-speech voice synthesis
technology.
During 1998, the Company incurred product development and research expenses
of $13,060,604, an increase of $5,994,310 over the $7,066,294 incurred in 1997.
This increase was due primarily to the addition of product development and
research personnel, increased use of independent contractors, equipment,
facilities and the operations of AcuVoice and Papyrus. Additionally, the Company
expensed purchased in-process R&D totaling approximately $9,315,000 during 1998,
in connection with the acquisition of AcuVoice.
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Selling, general and administrative expenses remained relatively flat at
$10,529,910 and $12,947,112 respectively, for 1998 and 1997. Salaries, wages and
related costs were $3,085,259 and $2,216,400 for 1998 and 1997, respectively, an
increase of $868,859. This increase is attributable to increases in personnel
attributable to the acquisitions of Articulate and Papyrus. Legal and accounting
expenses increased $1,169,770 primarily due to the acquisitions of AcuVoice,
Articulate and Papyrus. A $1,794,228 increase in depreciation and amortization
is primarily attributable to the amortization of intangible assets acquired in
connection with the acquisitions of AcuVoice and Papyrus.
Additionally, consulting and outside services decreased by $6,739,461.
Net other expense was $6,507,245 for 1998, an increase of $4,948,567 over
the previous year. This increase was primarily due to a $6,111,577 expense
recorded in connection with the settlement of a reset provision associated with
a private placement of the Company's Class A common stock. This increase was
offset in part by a reduction in interest expense of $1,287,599 from the
previous year, primarily due to extinguishment of certain debt instruments
during 1998.
Nine months ended September 30, 1999 compared with nine months ended September
30, 1998
During the nine months ended September 30, 1999, the Company recorded
revenues of $351,083, a decrease of $2,216,702 over the same period in the
previous year. In the 1998 period, the Company received revenues of $2,368,138
from Siemens as a non-refundable license fee for which the Company had no
further obligation of any kind. The 1999 revenues are primarily from sales and
licensing fees related to the TTS technologies and products.
Selling, general and administrative expenses were $7,537,577 and $6,112,765
for the nine months ended September 30, 1999 and 1998, respectively. Salaries,
wages and related costs were $4,090,525 and $2,584,164 for the nine months ended
September 30, 1999 and 1998, respectively, an increase of $1,506,361. This
increase is attributable to $1,296,600 in expenses related to the
indemnification of income tax liabilities resulting from the sale of shares
beneficially owned by two executive officers and one former executive officer
for payment of Company obligations and to management's redirection of labor
resources from core development and research activities to selling, business
development and marketing activities, offset in part by management's cost
reduction initiatives implemented in February 1999. Additionally, legal and
accounting expenses increased $207,505, the increase is attributed primarily to
the costs of services related to the sale of the HSG assets to L&H and to the
costs of securities filings. Further, marketing expenses decreased $20,837 and
consulting and outside services decreased by $98,178. These decreases are
attributable to management's cost reduction initiatives implemented in February
1999.
The Company incurred product development and research expenses of
$6,278,318 during the nine months ended September 30, 1999, a decrease of
$3,680,115 over the same period in the previous year. This decrease was due
primarily to management's cost reduction initiatives implemented in February
1999. The Company anticipates similar decreases in product development and
research costs as it begins to complete the development of certain TTS products.
During the nine months ended September 30, 1999 and 1998, the Company expended a
total of approximately $250,000 and $80,000, respectively, in connection with
the development of the AcuVoice purchased in-process R&D projects. The Company
anticipates that its investment in ongoing product development and research will
continue at decreased levels for the remainder of 1999 and 2000, assuming
availability of working capital.
Amortization of goodwill and purchased core technologies was $1,962,443 and
$1,100,336 for the nine months ended September 30, 1999 and 1998, respectively,
representing an increase of $862,107. This increase is primarily attributable to
the amortization of intangible assets acquired in connection with the
acquisitions of AcuVoice and Papyrus.
Net other expense was $4,422,997 for the nine months ended September 30,
1999, a decrease of $1,793,260 over the nine months ended September 30, 1998.
This decrease was due primarily to $6,111,577 in costs attributed to the
cancellation of common stock reset provisions that occurred in 1998 and to a
reduction in interest income of $809,371 from certificates of deposit that were
converted to cash to retire a bank line of credit in January 1999, offset
25
<PAGE>
in part by an increase in interest expense of $3,354,006 attributable to the
Series C 5% convertible debentures issued in January and March 1999.
In-Process Research and Development
At the date of acquisition of AcuVoice, management estimated that the
acquired in-process research and development projects of AcuVoice were
approximately 75 percent complete and that an additional $1.0 million would be
required to develop these projects to commercial viability. Additionally,
management anticipated release dates of the fourth quarter of 1999 for the
AcuVoice projects. As of September 30, 1999, the Company has expended a total of
approximately $380,000 in connection with the AcuVoice acquired in-process
research and development projects, and management estimates that a total of
approximately $620,000 will be required to complete the AcuVoice projects.
Management also estimates that the AcuVoice projects are 85 percent complete as
of September 30, 1999, and that the release dates will be in the second quarter
of 2000.
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its cash
requirements during the next 12 months. The research and development, corporate
operations and marketing expenses will continue to require additional capital.
Because the Company presently has only limited revenue from operations, the
Company intends to continue to rely primarily on financing through the sale of
its equity and debt securities or sales of existing technologies or businesses
to satisfy future capital requirements until such time as the Company is able to
enter into additional third-party licensing or co-development arrangements such
that it will be able to finance ongoing operations out of license, royalty and
sales revenue. There can be no assurance that the Company will be able to enter
into such agreements. Furthermore, the issuance of equity securities or other
securities which are or may become convertible into equity securities of the
Company in connection with such financing would result in dilution to the
stockholders of the Company which could be substantial.
The Company had negative working capital of $4,400,201 at September 30,
1999 compared to negative working capital of $14,678,975 at December 31, 1998.
The current ratio was 0.35:1 at September 30, 1999 compared to 0.59:1 at
December 31, 1998. Current assets decreased by $18,277,855 to $2,410,215 from
December 31, 1998 to September 30, 1999. Current liabilities decreased by
$28,506,629 to $6,810,416 during the same period. The increase in working
capital from December 31, 1998 to September 30, 1999, was primarily attributable
to decreases in accounts and notes payable and notes payable to related parties,
offset in part by increases in accrued liabilities, income taxes payable and
decreases in cash and notes receivable. Total assets were $22,398,084 at
September 30,1999 compared to $61,912,791 at December 31, 1998.
Delisting of the Company's Common Stock by Nasdaq
Until recently, the Company's Class A common stock traded on the Nasdaq
SmallCap Market which requires, for continued listing, a minimum bid price of at
least $1.00 per share. At June 29, 1999, the Company's Class A common stock had
traded below $1.00 for more than 30 consecutive trading days. On June 29, 1999,
the Company received a letter from Nasdaq indicating that unless the minimum bid
price for the Company's Class A common stock returned to at least $1.00 per
share for at least 10 consecutive trading days prior to September 29, 1999, the
Company's shares would be delisted from the Nasdaq SmallCap Market on October 1,
1999. The Company appealed the Nasdaq notice and a hearing was held on October
28, 1999.
On December 3, 1999, the Company received notice that its stock had
been delisted from the Nasdaq SmallCap Market as of December 3, 1999, in part
because the stock price had been below $1.00 per share since approximately March
1999. The Company is currently evaluating its options, including the possibility
of appealing the delisting decision. However, the Company's Class A common stock
is currently trading on the OTC Bulletin Board.
26
<PAGE>
The result of delisting from the Nasdaq SmallCap Market could be a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Company's shares continue to trade on the OTC Bulletin Board.
Further, delisting could reduce the ability of holders of the Company's Class A
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically.
The delisting of the Company's common stock from the Nasdaq SmallCap
Market was an event of default under the terms of the Debentures and the
Repurchase Rights. Upon the occurrence of this event of default, the unpaid
principal amount of the Debentures, together with accrued interest thereon, was
immediately due and payable. However, the holders of the Debentures and the
Repurchase Rights have waived this event of default.
Sale of the HealthCare Solutions Group
In September 1999, the Company completed the sale of the operations and
a significant portion of the assets (the "Sale") of its HealthCare Solutions
Group (the "HSG") to Lernout & Hauspie Speech Products N.V. ("L&H"), an
unrelated third party, for up to $28,000,000. Of this sales price, $21,500,000,
less certain credits of $194,018, was paid at closing, $2,500,000 is being held
in an 18 month escrow account in connection with the representations and
warranties made by the Company at the time of the Sale. Any remaining amount up
to $4,000,000 is an earnout contingent on the performance of the HSG over the
next two years. The Company will not record the contingent earnout, if any,
until successful completion of the earnout period. The proceeds from the Sale
were used to reduce a significant portion of the Company's liabilities and to
provide working capital for the Company's marketing and distribution
opportunities for its Interactive Technology Solutions Group. The assets sold
include inventory, property and equipment, certain prepaid expenses, purchased
core technology and other assets of HSG. Additionally, L&H assumed the capital
and operating lease obligations related to the HSG and the obligations related
to certain of the Company's deferred revenues.
Notes Payable
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 the Papyrus companies. The Company determined that
certain of the representations made by Papyrus and its executive officers
appeared to be inaccurate. On February 26, 1999, the Company filed an action
against the former stockholders of Papyrus alleging misrepresentation and breach
of contract. In March and April 1999, five of the former stockholders of Papyrus
filed actions against the Company alleging default under the terms of the
promissory notes issued to them in connection with the Papyrus acquisition and
certain other claims. Subsequently, the Company entered into agreements with the
five former Papyrus stockholders for dismissal of the actions and cancellation
of the promissory notes upon payment to the former stockholders of $1,217,384
(the "Settlement Payment") and return of 970,586 shares of restricted common
stock previously issued to the five former stockholders in connection with the
acquisition of Papyrus. The Company paid the Settlement Payment in September
1999 and the lawsuits described above have been dismissed. The 970,586 shares
were effectively canceled in September 1999 in connection with the Settlement
Payment. The original fair market value of $1,000,917 associated with the
canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus Associates, Inc. As of September 30, 1999, the Company had
unsecured notes payable to former Papyrus stockholders in the aggregate amount
of $77,625, which notes were issued in connection with the acquisition of
Papyrus. The holders of these notes have not made demand for payment.
During the nine months ended September 30, 1999, the Company paid, or
otherwise reduced through agreement notes payable to various related parties
totaling $8,818,355, plus accrued interest. Additionally, the Company paid other
notes payable to unrelated parties aggregating $560,000 plus accrued interest.
Additionally, a revolving note payable in the amount of $50,000 was paid by a
former employee and is included as an account payable. A revolving note payable
in the amount of $19,988,193 at December 31, 1998, plus accrued interest, was
paid in full in January 1999 with the proceeds from a certificate of deposit
that secured the note and $22,667 in cash.
In September 1999, the Company negotiated reductions of $221,376 in
amounts due various trade vendors. Additionally, the Company negotiated
reductions of $150,685 in accrued interest owed to certain note holders. These
27
<PAGE>
amounts have been accounted for as extraordinary items in the 1999 condensed
consolidated statements of operations.
December 1998 Equity Offering
In connection with the Company's Equity Offering in December 1998, the
holder of the 1,801,802 Class A common shares and the Repricing Rights may, upon
the occurrence of certain events, require the Company to repurchase all or a
portion of the holder's Class A common shares or repricing rights received in
the Equity Offering, as follows:
o For each Class A common share with a repricing right, the
greater of $1.3875 or the sum of $1.11 plus the product of the
Repricing Rate multiplied by the last reported sale price.
o For each Repricing Right without the associated Class A common
share, the product of the Repricing Rate multiplied by the
last reported sale price.
o For each Class A common share without the associated
Repricing Right, $1.3875.
For each of the above examples, the Repricing Rate is determined by
calculating the following fraction:
(Repricing Price - Market Price)
--------------------------------
Market Price
As of December 13, 1999, the Repricing Price was $1.4319, and the market price
was $0.30.
The events which trigger the Repurchase Rights include a failure by the
Company to have a registration statement registering the Class A common shares
and the shares underlying the Repricing Rights in the Equity Offering declared
effective by June 19, 1999, or the delisting of the Class A common stock from
the Nasdaq SmallCap Market. Because both of these events have occurred, the
investor in the Equity Offering had the right to exercise the repurchase option.
However, the Equity Offering investor waived its right to exercise the
repurchase option as a result of the delisting of the Class A common stock from
the Nasdaq SmallCap Market and deferred until March 1, 2000, its right to
require repurchase as a result of the Company's failure to register the shares
underlying the Repurchase Rights and Class A common stock. If such shares are
not registered before March 1, 2000, the Equity Offering investor may exercise
the Repurchase Rights. Presently, the Company does not have sufficient cash or
other liquid assets to pay the amount which would be due if the holder of the
Class A common shares and the Repricing Rights exercised its Repurchase Rights.
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) $1.25 or (2) 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. However, in the event that the Company fails to
file and have declared effective the registration statement registering the
shares underlying the Debentures, the holders of the Debentures may elect
penalty provisions to (a) reduce the conversion price by 2.5% per month until
the registration statement is declared effective, or (b) receive 2.5% of the
outstanding principal amount of Debentures per month, in cash. To date, the
Company has not filed the registration statement or had it declared effective as
required. However, all holders waived the penalty provisions through June 30,
1999. Additionally, some holders of the Debentures agreed to a partial waiver of
their penalty provisions through September 30, 1999. The holders of the
Debentures have agreed to waive the penalty provisions, contingent on the
registration statement being declared effective by February 29, 2000.
28
<PAGE>
In the event that the registration statement is not declared effective by that
date, the penalty provisions automatically apply, retroactive to October 1,
1999.
The outstanding principal amount of the Debentures bears interest at a
rate of 5%, payable on March 31, June 30, September 30, and December 31, and on
each conversion date, of each year during the term of the Debentures. In
addition, the interest on the outstanding principal amount of the Debentures
may, at the Company's option, be paid in shares of the Company's Class A common
stock calculated based upon the Debenture Conversion Price on the date such
interest becomes due. The Company has not paid interest on the Debentures at any
time since they were issued. Under the terms of the Debentures, the investors
could charge penalties for such failure. However, the investors have waived all
such penalties accruing prior to October 1, 1999.
The Company recorded $687,500 as interest expense upon the issuance of
the Debentures in connection with this beneficial conversion feature. The
Company also issued 400,000 warrants to purchase an equal number of the
Company's common shares at a strike price of $1.25 per share in connection with
this financing. The warrants are exercisable for a period of three years from
the date of grant. The estimated fair value of the warrants of $192,000, as
computed under the Black-Scholes pricing model, was recorded as interest expense
upon the issuance of the Debentures. On March 3, 1999, the Company executed a
supplemental agreement pursuant to which the Company agreed to sell another
$2,500,000 principal amount of the Debentures on the same terms and conditions
as the January 29, 1999 agreement, except no additional warrants were issued.
The Company recorded $1,062,500 as interest expense upon the issuance of the
supplemental Debentures in connection with the beneficial conversion feature.
The obligations of the Company for repayment of the Debentures, as well as its
obligation to register the common stock underlying the potential conversion of
the Debentures and the exercise of the warrants issued in these transactions,
were personally guaranteed by two officers and directors and a former officer
and director of the Company (the "Guarantors"). In connection with the March 3,
1999 funding, the Company agreed to grant a lien on the patent covering the
Company's ASR technologies as collateral for repayment of the Debentures.
However, to date no lien on the patent has been granted. The Guarantors
guaranteed the obligations of the Company under the Debentures and pledged
6,000,000 shares of common stock of the Company beneficially owned by them as
collateral security for their obligations under their guarantees.
Subsequent to the March 3, 1999 funding, the holders of the Debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the stock pledge agreement and that the holders intended to
exercise their rights to sell some or all of the pledged shares of the
Guarantors. The holders of the Debentures have subsequently informed the Company
that they have sold the 6,000,000 shares pledged by the Guarantors and that
proceeds from the sale of the pledged shares aggregated $3,278,893. Of this
total, $406,250 was allocated to penalties attributable to default provisions of
the stock pledge agreement and recorded as interest expense and $343,750 related
to penalty provisions of the Series D preferred stock and recorded as preferred
stock dividends. Both of these amounts were recorded by the Company during the
three months ended September 30, 1999. The remaining $2,528,893 of the proceeds
was applied as a reduction of the principal balance of the Debentures as of
September 30, 1999. Under its indemnity agreement with the Guarantors, the
Company will issue 6,000,000 replacement shares to the Guarantors for the shares
sold by the holders and reimburse the Guarantors for any costs incurred as a
result of the holders' sales of the Guarantors' shares. Accordingly, the Company
recorded an expense of $1,296,600 during the nine months ended September 30,
1999.
Guarantors
In addition to guaranteeing obligations relating to the Debentures, the
Guarantors guaranteed certain other obligations of the Company. As security for
some of the guarantees, the Guarantors 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. In May 1999, 100,000 of the shares
previously pledged by the Guarantors to another creditor of the Company were
sold by the creditor and the proceeds, totaling $72,335, were used to pay
amounts owed by the Company. In September 1999, the Company paid a note payable
to an
29
<PAGE>
unrelated third party in the amount of $560,000 that had previously been
guaranteed by the Guarantors. As of September 30, 1999, no guarantees remain
outstanding.
Series D and Series E preferred stock
During the nine months ended September 30, 1999, 131,667 shares of
Series D preferred stock and 135,072 shares of Series E preferred stock,
together with related dividends on each, were converted into 8,468,129 shares
and 5,729,156 shares, respectively, of the Company's Class A common stock. After
the above conversions, 876,667 shares of Series D preferred stock remained
outstanding as of September 30, 1999. Subsequent to September 30, 1999, a total
of 494,944 shares of Series D preferred stock, together with related dividends,
were converted into 34,591,946 shares of the Company's Class A common stock. As
of December 13, 1999, 381,723 shares of Series D preferred stock remain
outstanding.
Class A common stock, stock options, and warrants
On June 2, 1999, the Company issued 200,000 shares of common stock
(having a market value of $100,000 on that date) to an unrelated individual in
payment for consulting services rendered.
During the nine months ended September 30, 1999, the Company granted
754,500 stock options to employees at exercise prices ranging from $0.59 to
$1.78 per share. Additionally, 9,500 stock options were granted to two
consultants for services provided to the Company. The fair market value of the
consultant options was $1.30 per share, or $12,540 in total, using the
Black-Scholes pricing model and was charged to product development and research
expense. The term of all options granted during this nine month period is ten
years from the date of grant. Of the stock options issued, 726,334 vested
immediately, 18,834 vest six months after issuance and 18,832 vest one year
after issuance. As of September 30, 1999, the Company had a total of 15,536,582
options outstanding.
During the nine months ended September 30, 1999, the Company granted
warrants to L&H in connection with loans made to the Company in April and May
1999 totaling $6,000,000. These warrants allow L&H to purchase 850,000 shares of
Class A common stock of the Company at exercise prices ranging from $0.60 to
$0.70 per share. Of these warrants, 250,000 expired October 18, 1999, without
being exercised. The remaining 600,000 warrants expire May 17, 2001.
On February 11, 1998, the Company entered into a First Statement of
Work and License Agreement with Siemens under which the Company and Siemens are
jointly pursuing the development of Siemens' integrated circuits incorporating
ASR and other related technologies for use in certain telecommunications
applications. In connection with the license agreement Siemens purchased
warrants to acquire 1,000,000 shares of restricted common stock at an average
exercise price of $20 per share with expiration dates ranging from December 31,
1998 to December 31, 1999. As of September 30, 1999, 800,000 of the warrants
originally issued had expired and 200,000 of the warrants remain outstanding at
an average exercise price of $30 per share.
As of September 30, 1999, the Company had a total of 2,475,000 warrants
outstanding.
The Company presently has no plans to purchase any new research and
development assets 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 ("Y2K")
requirements. Fonix is subject to the risk that problems encountered with Y2K
issues, either in its internal systems, technologies and products, or in
external systems, could adversely affect its operations and financial condition.
30
<PAGE>
In the ordinary course of its business, Fonix tests and evaluates its
technologies and software and hardware products. The Company believes that its
technologies and products are Y2K 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 Company's
technologies or products experience Y2K problems, those persons could assert
claims for damages.
Fonix uses third-party equipment and software that the Company believes
to be Y2K compliant. The Company has substantially completed a review of key
products provided by outside vendors to determine if those products comply with
Y2K requirements and presently believes that all software provided by third
parties that is critical to its business is Y2K compliant. The Company has also
completed a review of all internal systems for Y2K compliance and presently
believes the internal systems are Y2K compliant. If, however, this third-party
equipment or software does not operate properly with regard to the Y2K 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 Y2K problems the Company could incur
substantial costs and disruption of its business. The Company may also
experience delays in implementing Y2K compliant software products. Any of these
problems may materially adversely affect Fonix's business, operating results or
financial condition.
In addition, the purchasing patterns of Fonix's licensees, potential
licensees, customers and potential customers may be affected by Y2K issues. Many
companies are expending significant resources to correct their current software
systems for Y2K compliance. These expenditures may result in reduced funds
available to license the Company's technologies or to purchase other Fonix
products. 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 product development and research
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.
Market Price of and Dividends on the Company's Class A Common Stock
Market information
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for the Company's Class A common stock as quoted on the
Nasdaq SmallCap Market for the four quarters of calendar 1998 and 1997, as well
as for the first three quarters of calendar 1999, and the fourth quarter of
calendar 1999 through December 13. The quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commissions and may not represent actual
transactions.
31
<PAGE>
<TABLE>
<CAPTION>
Calendar Year
1999 1998 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 $ 1.19 $ 0.28 $ 4.00 $ 1.12 $ 7.44 $6.50
Fourth Quarter $ 1.00 $0.27 $ 2.63 $ 0.94 $ 7.00 $2.88
</TABLE>
The high and low sales prices for the Company's Class A common stock on
December 13, 1999, were $ 0.38 and $0.30, respectively.
The Company has never declared any dividends on its Class A 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 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.
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 after
giving effect to the sale of the HSG and the classification of its operating
activities and net assets as discontinued operations. 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 the Company's Annual Report on
Form 10-K, which is incorporated herein by reference, and a copy of which is
available from Fonix's Investor Relations Department at the address provided on
page 6 of this prospectus.
<TABLE>
<CAPTION>
For the Year Ended December 31,
1998 1997 1996 1995 1994
------------- ------------- ------------ ------------ ------------
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Revenues $ 2,604,724 $ -- $ -- $ -- $ --
Selling, general and administrative expenses 10,529,910 12,947,112 3,530,400 3,553,665 1,339,987
Product development and research 13,060,604 7,066,294 4,758,012 2,704,165 2,522,090
Purchased in-process research and development 9,315,000 -- -- -- --
Loss from operations (30,336,230) (20,013,406) (8,288,412) (6,257,830) (3,862,077)
Other income (expense) (6,507,245) (1,558,678) 458,904 (88,067) (52,262)
Loss from continuing operations (36,843,475) (21,572,084) (7,829,508) (6,345,897) (3,914,339)
Basic and diluted loss from continuing operations per
common share $ (0.70) $ (0.51) $ (0.21) $ (0.30) $ (0.28)
share
Weighted average number of common shares outstanding 52,511,185 42,320,188 36,982,610 21,343,349 14,095,000
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30
---------------------------------
1999 1998
--------------- ----------------
<S> <C> <C>
Revenues $ 351,083 $ 2,567,785
Selling, general and administrative 7,537,577 6,112,765
Product development and research 6,278,318 9,958,433
Amortization of goodwill and purchased core technology 1,962,443 1,100,336
Purchased in-process research and development -- 9,315,000
Loss from operations (15,448,414) (23,950,310)
Other income (expense) (4,422,997) (6,216,257)
Loss from continuing operations (19,871,411) (30,166,567)
Basic and diluted loss from continuing operations per
common share $ (0.29) $ (0.60)
Weighted average number of common shares outstanding 68,678,645 50,385,408
</TABLE>
<TABLE>
<CAPTION>
As of
September
30, 1999 As of December 31,
------------ ----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ -------------- --------------- -------------- -------------- --------------
Balance Sheet Data:
<S> <C> <C> <C> <C> <C> <C>
Current assets $ 2,410,215 $ 20,638,070 $ 21,148,689 $ 23,967,601 $ 7,912,728 $ 2,150,286
Total assets 22,398,084 61,912,791 22,894,566 25,331,270 7,984,306 2,150,286
Current liabilities 6,810,416 35,317,045 20,469,866 19,061,081 6,674,572 4,117,995
Long-term debt, net of current portion 3,971,107 -- 52,225 -- -- --
Stockholders' equity (deficit) 9,786,559 24,765,746 2,372,475 6,270,189 1,309,734 (1,967,709)
</TABLE>
Index to Financial Statements of Fonix Corporation
Audited Financial Statements as of December 31, 1998 and 1997, and for Each of
the Three Years in the Period Ended December 31, 1998
Report of Independent Public Accountants (Arthur Andersen LLP) F-2
Report of Independent Public Accountants (Deloitte & Touche LLP) F-3
Report of Independent Public Accountants (Pritchett, Siler & Hardy, P.C.) F-4
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-5
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996 and for the Period from October 1, 1993 (Date
of Inception) to December 31, 1998 F-6
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 and for the Period from October
1, 1993 (Date of Inception) to December 31, 1998 F-7
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996 and for the Period from October 1, 1993 (Date
of Inception) to December 31, 1998 F-10
Notes to Consolidated Financial Statements F-12
Interim Unaudited Condensed Consolidated Financial Statements as of September
30, 1999, and December 31, 1998, and for the Nine Months Ended September 30,
1999 and 1998
33
<PAGE>
Condensed Consolidated Balance Sheets (Unaudited) Q-2
Condensed Consolidated Statements of Operations (Unaudited) Q-3
Condensed Consolidated Statements of Cash Flows (Unaudited) Q-4
Notes to Condensed Consolidated Financial Statements (Unaudited) Q-6
Pro Forma Financial Statements
Unaudited Pro Forma Condensed Consolidated Statement of Operations for the
Year Ended December 30, 1998 PF-2
Notes to Unaudited Pro Forma Condensed Consolidated Financial Statements PF-3
Changes in and disagreements with accountants on accounting and financial
disclosure.
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. Fonix's board of directors has
chosen to engage Andersen as Fonix's independent auditors for the fiscal year
ending December 31, 1999, and that decision was approved by Fonix's stockholders
at the 1999 Annual Meeting of Stockholders on October 29, 1999.
In connection with the audit for the year ended December 31, 1996, and
through the date hereof, 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
the date hereof, there have been no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
Use of proceeds
All of the Equity Offering shares, and the shares underlying the
Repricing Rights and the Debentures, if and when sold, are being offered and
sold by the Selling Stockholders or their pledgees, donees, transferees or other
successors in interest. Fonix will not receive any proceeds from those sales.
Fonix will, however, receive the proceeds of the payment of the exercise price
upon the exercise of the warrants, if any are exercised. The Company will use
such proceeds, if and when received, for working capital.
34
<PAGE>
Selling Security Holders
The Selling Stockholders are four separate investment entities that are
not affiliated in any way with Fonix or any of its affiliates, and neither the
Selling Stockholders nor any of their affiliates have any relationship of any
type with Fonix and its affiliates other than the presently established
investment relationships between the Selling Stockholders, on the one hand, and
Fonix, on the other hand. The Selling Stockholders have received the shares sold
to them pursuant to a securities purchase agreement on December 21, 1998, and
they have received or may receive additional shares when they have exercised or
when they will exercise the Repricing Rights included in the Equity Offering,
and when they have converted or when they will convert the convertible
Debentures sold to them on January 29 and March 3, 1999. The Selling
Stockholders also may obtain shares when they exercise warrants they received in
connection with the Equity Offering and the Debt Offering. The following summary
describes how the Selling Stockholders have received or may receive the shares.
December 1998 Equity Offering
On December 21, 1998, the Company completed a private placement to one
investor of 1,801,802 shares of the Company's Class A common stock.
Additionally, for each share of Class A common stock issued, the Company issued
one "Repricing Right" that entitles the holder thereof to receive upon exercise
that number of additional shares (the "Repricing Common Shares") of the
Company's Class A common stock for no additional consideration at a repricing
rate (the "Repricing Rate"), which shall be determined by multiplying the number
of Repricing Rights exercised by the following fraction:
(Repricing Price - Market Price)
--------------------------------
Market Price
As of December 13, 1999, the Repricing Price was $1.4319, and the market price
was $0.30.
The Repricing Rights will expire nine months after the effective date
of this registration statement covering the common stock issued on December 21,
1998, and issuable upon exercise of the Repricing Rights (subject to further
extension in certain cases). In the above fraction, "Market Price" means the
lowest closing bid price of the Company's Class A common stock, as quoted on the
Nasdaq SmallCap Market or the OTC Bulletin Board, during the 15 consecutive
trading days immediately preceding the exercise date. "Repricing Price" means
$1.4319 until the expiration of the Repricing Rights.
Additionally, the investor in the Equity Offering received warrants
(the "Equity Offering Warrants") to purchase 200,000 shares (the "Equity Warrant
Shares") of the Company's Class A common stock at a price of $1.665 per share
(subject to certain anti-dilutive adjustments). The Equity Offering Warrants are
exercisable at any time prior to and including December 21, 2001.
Under the terms of the Equity Offering, the holder of the 1,801,802
Class A common shares and the Repricing Rights may, upon the occurrence of
certain events, require the Company to repurchase all or a portion of the
holder's Class A common shares or repricing rights received in the Equity
Offering, as follows:
o For each Class A common share with a repricing right, the
greater of $1.3875 or the sum of $1.11 plus the product of the
Repricing Rate multiplied by the last reported sale price.
o For each Repricing Right without the associated Class A common
share, the product of the Repricing Rate multiplied by the
last reported sale price.
o For each Class A common share without the associated
Repricing Right, $1.3875.
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<PAGE>
The events which trigger the repurchase rights include a failure by the
Company to have a registration statement registering the Class A common shares
and the shares underlying the Repricing Rights in the Equity Offering declared
effective by June 19, 1999, or the delisting of the Class A common stock from
the Nasdaq SmallCap Market. Because both of these events have occurred, the
investor in the Equity Offering had the right to exercise the Repurchase Rights.
However, the Equity Offering investor waived its right to exercise the
repurchase option as a result of the delisting of the Company's Class A common
stock from the Nasdaq SmallCap Market, and deferred until March 1, 2000, its
right to require repurchase as a result of the Company's failure to register the
shares underlying the Repurchase Rights and Class A common stock. If such shares
are not registered before March 1, 2000, the investor may exercise the
Repurchase Rights.
In connection with the Equity Offering, Fonix agreed to call a meeting
of its stockholders and to use its best efforts to obtain the approval of its
stockholders necessary to increase the authorized capital of the Company in an
amount sufficient for the Company to satisfy all of its obligations with respect
to the Class A common stock issued, the Repricing Shares, and the shares
underlying the Equity Offering Warrants, but in all events at least 150,000,000
shares of common stock. The Company's annual meeting of stockholders was held on
Friday, October 29, 1999, and the increasing of the Company's capitalization was
one of the issues submitted for a vote of and approved by the stockholders. The
Company also entered into a registration rights agreement with the investor
under which, once the Company has fulfilled its obligation regarding the
increase of capitalization, Fonix must register the Class A common stock issued,
the shares underlying the Repricing Rights, and the shares underlying the Equity
Offering Warrants. Fonix also covenanted to reserve out of its authorized and
unissued shares no less than that number of shares that would be needed to
provide for the issuance in full of:
(A) the Repricing Common Shares, assuming that all such Repricing
Rights are exercised from and after July 20, 1999, and that the market price
measured on the applicable exercise date is the lesser of (x) $0.655
(constituting 50% of $1.31, the market price on December 21, 1998), and (y)
$0.53 (the actual market price on July 20, 1999); and
(B) the Warrant Shares (without regard, in the case of (A) above, to
any limitations on the exercise of the Repricing Rights).
In the event that the Company fails to deliver within three trading days the
Repricing Common Shares, the Selling Stockholder exercising the Repricing Right
shall be entitled to rescind the exercise of the Repricing Right. Additionally,
in the event of the Company's failure to deliver the Repricing Common Shares,
(1) The Company shall pay to such Selling Stockholder, in cash, as
liquidated damages and not as a penalty, $2,500 for each day after the third
trading day until such Repricing Common Shares are delivered; and
(2) If after such third trading day the Selling Stockholder purchases
in an open market transaction or otherwise the shares of Class A common stock to
deliver in satisfaction of a sale by such Selling Stockholder of the shares of
Class A common stock which the holder anticipated receiving upon such exercise
(a "Buy-In"), then the Company shall pay in cash to the holder (in addition to
any remedies available to or elected by the Selling Stockholder), the amount by
which (A) the Selling Stockholder's total purchase price (including brokerage
commissions, if any) for the shares of Class A common stock so purchased exceeds
(B) the Aggregate Closing Bid Price for which such exercise was not honored in a
timely manner.
The January and March 1999 Debt Offering
On January 29, 1999, the Company entered into a Securities Purchase
Agreement with four investors (including the investor from the Equity Offering)
pursuant to which the Company agreed to issue the Debentures in the aggregate
principal amount of $4,000,000. The outstanding principal amount of those
Debentures is convertible at any time at the option of the holder into shares of
the Company's Class A common stock at a conversion price (the "Debenture
Conversion Price") equal to the lesser of (1) $1.25; or (2) The average of the
closing bid price of the Company's Class A common stock for the five trading
days immediately preceding the conversion date multiplied
36
<PAGE>
by 80%. However, in the event that the Company fails to file and have declared
effective the registration statement registering the shares underlying the
Debentures, the holders of the Debentures may elect penalty provisions to (a)
reduce the conversion price by 2.5% per month until the registration statement
is declared effective, or (b) receive 2.5% of the outstanding principal amount
of Debentures per month, in cash. To date, the Company has not filed the
registration statement or had it declared effective as required. However, all
holders waived the penalty provisions through June 30, 1999. Additionally, some
holders of the Debentures agreed to a partial waiver of their penalty provisions
through September 30, 1999. The holders of the Debentures have agreed to waive
the penalty provisions, contingent on the registration statement being declared
effective by February 29, 2000. In the event that the registration statement is
not declared effective by that date, the penalty provisions automatically apply,
retroactive to October 1, 1999.
The outstanding principal amount of the Debentures bears interest at a
rate of 5%, payable on March 31, June 30, September 30, and December 31, and on
each conversion date, of each year during the term of the Debentures. In
addition, the interest on the outstanding principal amount of the Debentures
may, at the Company's option, be paid in shares of the Company's Class A common
stock calculated based upon the Debenture Conversion Price on the date such
interest becomes due. The Company has not paid interest on the Debentures at any
time since they were issued. Under the terms of the Debentures, the investors
could charge penalties for such failure. However, the investors have waived all
such penalties accruing prior to October 1, 1999.
On December 3, 1999, the Company received notice that its Class A
common stock had been delisted from the Nasdaq SmallCap Market. The delisting
was an event of default under the terms of the Debentures. Upon the occurrence
of this event of default, the outstanding principal amount of the Debentures,
together with accrued interest, became immediately due and payable in cash.
However, the holders of the Debentures waived this event of default.
In connection with the sale of the Debentures, the Company issued to
the investors a total of 400,000 common stock purchase warrants (the "Debt
Offering Warrants") having an exercise price of $1.25 per share, and having a
term of three years. On March 3, 1999, the Company executed a Supplemental
Agreement pursuant to which the Company agreed to sell another $2,500,000
principal amount of the Debentures on the same terms and conditions as the
January 29, 1999, agreement. No additional warrants were issued in connection
with the March 1999 agreement.
In connection with the Debt Offering, the Company agreed to use its
best efforts to obtain the approval of its stockholders (A) necessary to
increase the authorized capitalization of the Company in an amount sufficient
for the Company to satisfy all of its obligations under the Debentures and the
Debt Offering Warrants, but in all events at least 150,000,000 shares of Class A
common stock, and (B) required to waive the restriction under applicable stock
exchange rules limiting the issuance of Class A common stock in an amount that
would exceed 20% of the issued and outstanding Class A common stock of the
Company. The Company also entered into a registration rights agreement with the
investor under which once the Company had fulfilled its obligations with respect
to obtaining stockholder approval, Fonix must register the Class A common stock
underlying the Debentures and the shares underlying the Debt Offering Warrants.
Fonix also covenanted to reserve out of its authorized and unissued shares no
less than that number of shares that would be needed to provide for the issuance
in full of:
1. 200% of the number of shares of Class A common stock issuable
upon conversion in full of the Debentures, assuming such
conversion occurred on the date the Debentures were issued
(the "Original Issue Date"), the Filing Date, or the 30th day
following the Original Issue Date (the "Filing Date"), or the
90th day following the Original Issue Date (the "Effectiveness
Date"), whichever yields the lowest conversion price (the
"Conversion Price");
2. The number of shares of Class A common stock issuable upon
exercise in full of the Debt Offering Warrants; and
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<PAGE>
3. The number of shares of Class A common stock issuable upon
payment of interest on the Debentures, assuming all of the
Debentures issued on the Closing Date are outstanding for
three years and all interest is paid in shares of Class A
common stock.
In connection with the Debt Offering, two officers and directors and
one former officer and director of the Company (together, the "Guarantors")
pledged 6,000,000 shares of the Company's Class A common stock beneficially
owned by them as collateral security for the Company's obligations regarding the
Debentures. Subsequent to the March 1999 funding, the holders of the Debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the pledge and that the holders intended to exercise their
rights to sell some or all of the pledged shares. The holders of the Debentures
subsequently informed the Company and the Guarantors that the 6,000,000 pledged
shares were sold, and that proceeds from the sale of the shares were used to pay
penalties attributable to default provisions of the stock pledge agreement and
to reduce the principal balance of the Debentures. As of December 13, 1999, the
outstanding principal amount of Debentures is $3,971,107.
The following table provides information about the actual and potential
ownership of shares of Fonix Class A common stock by the Selling Stockholders in
connection with the Equity Offering and the Debt Offering as of December 13,
1999, and the number of such shares included for sale in this Prospectus. The
number of shares of Class A common stock issuable upon conversion of the
Repricing Rights and the Debentures varies according to the market price at and
immediately preceding the conversion date. Solely for purposes of estimating the
number of shares of Class A common stock that would be issuable to the Selling
Stockholders as set forth in the table below, Fonix and the Selling Stockholders
have assumed a hypothetical conversion of all of the Repricing Rights and the
Debentures owned by the Selling Stockholders as of December 13, 1999, on which
date the market price for figuring the conversion price would have been $0.30
for the Repricing Rights, and the conversion price would have been $0.2504 for
the Debentures. The actual conversion price and the number of Shares issuable
upon such conversion could differ substantially. Under the terms and conditions
of the Repricing Rights and the Debentures, a Selling Stockholder is prohibited
from converting such preferred stock to the extent such conversion by such
person would result in that person beneficially owning more than 4.999% of the
then outstanding shares of Fonix Class A common stock following such conversion.
This restriction may be waived by a Selling Stockholder as to itself, but not as
to other holders of such preferred stock, and only upon not less than 75 days'
notice to Fonix. This restriction does not prevent such holders from either
waiving such limitation or converting and selling some of their convertible
security position and thereafter converting or exercising the rest or another
significant portion of their holding. In this way, individual holders of the
Repricing Rights and the Debentures could sell more than 4.999% of the
outstanding Fonix Class A common stock in a relatively short time frame while
never beneficially owning more than 4.999% of the outstanding Fonix Class A
common stock at a time. For purposes of calculating the number of shares of
Class A common stock issuable to each Selling Stockholder assuming a full
conversion of all the Repricing Rights and Debentures held by it as set forth
below, the effect of such 4.999% limitation has been disregarded. The number of
shares issuable to each of the Selling Stockholders as described in the table
below therefore exceeds the actual number of shares such Selling Stockholders
may be entitled to beneficially own upon conversion of the Repricing Rights and
Debentures. The following information is not determinative of any Selling
Stockholder's beneficial ownership of Fonix Class A common stock pursuant to
Rule 13d-3 or any other provision under the Securities Exchange Act of 1934, as
amended.
38
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Shares of Class Class A
A Common Common Stock Number of
Stock Owned Owned By or Shares of Percentage of
by or Issuable Issuable to Number of Class A Class A
to Selling Selling Shares of Class Common Common Stock
Stockholders Stockholders A Common Stock Owned Beneficially
Prior to Prior to Stock Offered After Owned After
Name of Selling Stockholders Offering Offering Hereby (1) Offering the Offering
- -------------------------------------- ---------------- ---------------- --------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
JNC Strategic Fund Ltd. 8,800,001 (2) 6.61% 8,800,001 (3) (4) (4)
Dominion Capital Fund Ltd 20,532,231 (5) 14.17% 3,167,214 (6) (4) (4)
Sovereign Partners LP 25,120,097 (7) 16.81% 4,258,908 (8) (4) (4)
Dominion Investment Fund LLC 1,030,740 (9) 0.82% 1,030,740 (10) (4) (4)
JNC Opportunity Fund Ltd. 41,514,055 (11) 24.94% 8,513,593 (12) (4) (4)
- ---------------------
</TABLE>
(1) The registration statement of which this prospectus is a part covers
up to 49,216,307 shares of common stock issued under the Equity
Offering and issuable upon the conversion of the Repricing Rights and
the Debentures, as payment in shares of Fonix Class A common stock
payable as interest on the Debentures, and issuable upon the exercise
of warrants issued in connection with the Equity Offering and the
Debt Offering. Because the specific circumstances of the conversions
of the Repricing Rights and the Debentures are unascertainable at
this time, the precise total number of shares of Fonix Class A common
stock offered by each Selling Stockholder cannot be fixed. The
numbers set forth below represent the number of shares of Fonix Class
A common stock that have been issued and that would be issuable, and
hence offered hereby, assuming the conversion of all of the Repricing
Rights and the Debentures as of December 13, 1999. The actual number
of shares of Fonix Class A common stock offered hereby may differ
according to the actual number of shares issued upon such
conversions.
(2) Includes:
1,801,802 shares of common stock issued in connection with the
Equity Offering on December 21, 1998;
6,798,199 shares of common stock issuable upon a hypothetical
conversion of Repricing Rights, assuming such Repricing
Rights were converted in full as of December 13, 1999;
200,000 shares of common stock issuable upon a hypothetical
conversion of all of the Equity Warrants, assuming such
warrants were converted in full on December 13, 1999;
(3) Includes:
1,801,802 shares of common stock issued in connection with the
Equity Offering on December 21, 1998;
6,798,199 shares of common stock issuable upon a hypothetical
conversion of Repricing Rights, assuming such Repricing
Rights were converted in full as of December 13, 1999;
200,000 shares of common stock issuable upon a hypothetical
conversion of all of the Equity Warrants, assuming such
warrants were converted in full on December 13, 1999;
(4) There is no assurance that the Selling Stockholders will sell any or
all of the shares offered hereby.
(5) Includes:
4,323,413 shares of common stock issued upon conversion of
125,000 shares of Series E preferred stock as of
December 13, 1999, together with shares issued as
payment of dividends accrued thereon.
12,278,137 shares of common stock issued upon
conversion of 187,500 shares of Series D
preferred stock as of December 13, 1999,
together with shares issued as payment of
dividends accrued thereon.
725,652 shares of common stock issuable upon a hypothetical
conversion of 10,014 shares of Series D preferred stock
owned by the Selling Stockholder as of December 13,
1999;
37,815 shares of common stock issuable as interest upon the
conversion of 10,014 shares of Series D preferred
stock, assuming such preferred stock was converted in
full as of December 13, 1999;
2,961,418 shares of common stock issuable upon the hypothetical
conversion of $741,539 principal amount of Fonix's
Series C 5% Convertible Debentures, assuming such
principal amount were converted in full as of December
13, 1999;
130,796 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal amount
of Series C 5% Convertible Debentures owned by the
Selling Stockholder; and
75,000 shares of common stock issuable upon the hypothetical
exercise of a warrant issued in connection with the
sale of the Series C 5% Convertible Debentures.
(6) Includes:
2,961,418 shares of common stock issuable upon a hypothetical
conversion of $741,539 principal amount of Series C 5%
Convertible Debentures, assuming such Debentures were
converted in full on December 13, 1999;
130,796 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal
amount of Series C 5% Convertible Debentures owned
by the Selling Stockholder; and 75,000 shares of
common stock issuable upon a hypothetical conversion
of 75,000 warrants, assuming such warrants were
converted in full on December 13, 1999.
(7) Includes:
3,998,478 shares of common stock issued upon conversion of
125,000 shares of Series E preferred stock as of
December 13, 1999, together with shares issued as
payment of dividends accrued thereon;
13,147,020 shares of common stock issued upon
conversion of 199,000 shares of Series D
preferred stock as of December 13, 1999,
together with shares issued as payment of
dividends accrued thereon;
3,565,870 shares of common stock issuable upon a hypothetical
conversion of 49,209 shares of Series D preferred stock
owned by theSelling Stockholder as of December 13,
1999;
185,821 shares of common stock issuable as interest upon the
conversion of 49,209 shares of Series D preferred
stock, assuming such preferred stock was converted in
full as of December 13, 1999;
3,948,514 shares of common stock issuable upon the hypothetical
conversion of $988,718 principal amount of Fonix's
Series C 5% Convertible Debentures, assuming such
principal amount were converted in full as of December
13, 1999;
174,394 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal amount
of Series C 5% Convertible Debentures owned by the
Selling Stockholder; and
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<PAGE>
100,000 shares of common stock issuable upon the hypothetical
exercise of a warrant issued in connection with the
sale of the Series C 5% Convertible Debentures.
(8) Includes:
3,948,514 shares of common stock issuable upon the hypothetical
conversion of $988,718 principal amount of Fonix's
Series C 5% Convertible Debentures, assuming such
principal amount were converted in full as of December
13, 1999;
174,394 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal amount
of Series C 5% Convertible Debentures owned by the
Selling Stockholder; and
100,000 shares of common stock issuable upon the hypothetical
exercise of a warrant issued in connection with the
sale of the Series C 5% Convertible Debentures.
(9) Includes:
987,141 shares of common stock issuable upon a hypothetical
conversion of $247,180 principal amount of Series C 5%
Convertible Debentures, assuming such Debentures were
converted in full on December 13, 1999; and
43,599 shares of common stock issuable upon a hypothetical
conversion of 25,000 warrants, assuming such warrants
were converted in full on December 13, 1999.
(10) Includes:
987,141 shares of common stock issuable upon a hypothetical
conversion of $247,180 principal amount of Series C 5%
Convertible Debentures, assuming such Debentures were
converted in full on December 13, 1999; and
43,599 shares of common stock issuable upon a hypothetical
conversion of 25,000 warrants, assuming such warrants
were converted in full on December 13, 1999.
(11) Includes:
8,413,083 shares of common stock issued upon
conversion of 110,000 shares of Series D
preferred stock as of December 13, 1999,
together with shares issued as payment of
dividends accrued thereon;
23,369,565 shares of common stock issuable upon a hypothetical
conversion of 322,500 shares of Series D preferred
stock owned by the Selling Stockholder as of December
13, 1999;
1,217,814 shares of common stock issuable as interest upon the
conversion of 322,500 shares of Series D preferred
stock, assuming such preferred stock was converted in
full as of December 13, 1999;
7,961,941 shares of common stock issuable upon a hypothetical
conversion of $1,993,670 principal amount of Series C
5% Convertible Debentures, assuming such Debentures
were converted in full on December 13, 1999;
351,652 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal amount
of Series C 5% Convertible Debentures owned by the
Selling Stockholder; and
200,000 shares of common stock issuable upon a hypothetical
conversion of all of the Debt Warrants, assuming such
warrants were converted in full on December 13, 1999.
(12) Includes:
7,961,941 shares of common stock issuable upon a hypothetical
conversion of $1,993,670 principal amount of Series C
5% Convertible Debentures, assuming such Debentures
were converted in full on December 13, 1999;
351,652 shares of common stock issuable as interest upon the
hypothetical conversion of the entire principal amount
of Series C 5% Convertible Debentures owned by the
Selling Stockholder; and
200,000 shares of common stock issuable upon a hypothetical
conversion of all of the Debt Warrants, assuming such
warrants were converted in full on December 13, 1999.
The following table lists the natural persons who control each of the
Selling Stockholders.
Selling Stockholder Name of Natural Person Who Controls
- --------------------------------------- -------------------------------------
Dominion Capital Fund, Ltd. Nina Ray and Carl O' Connell
Sovereign Partners, LP Steven M. Hicks and Daniel Pickett
JNC Strategic Fund Ltd Neil T. Chau and James Q. Chau
JNC Opportunity Fund Ltd. Neil T. Chau and James Q. Chau
Dominion Investment Fund LLC David Sins
Plan of distribution
Once the registration statement of which this prospectus is part becomes
effective with the Commission, the Shares covered by this prospectus may be
offered and sold from time to time by the Selling Stockholders or their
pledgees, donees, transferees or successors in interest. Such sales may be made
on the OTC Bulletin Board, in the
40
<PAGE>
over-the-counter market or otherwise, at prices and under terms then prevailing
or at prices related to the then current market price, or in negotiated
transactions. The Shares may be sold by any means permitted under law, including
one or more of the following:
o a block trade in which a broker-dealer engaged by the Selling
Stockholder will attempt to sell the Shares as agent, but may
position and resell a portion of the block as principal to facilitate
the transaction;
o purchases by a broker-dealer as principal and resale by such
broker-dealer for its account under this prospectus;
o an over-the-counter distribution in accordance with the rules of the
OTC Bulletin Board;
o ordinary brokerage transactions in which the broker solicits
purchasers; and
o privately negotiated transactions.
In effecting sales, broker-dealers engaged by the Selling Stockholders may
arrange for other broker-dealers to participate in the resales.
In connection with distributions of the Shares or otherwise, the Selling
Stockholders may enter into hedging transactions with broker-dealers. In
connection with such transactions, broker-dealers may engage in short sales of
the Shares covered by this prospectus in the course of hedging the positions
they assume with the Selling Stockholders. The Selling Stockholders may also
sell the Shares short and redeliver the Shares to close out such short
positions. The Selling Stockholders may also enter into option or other
transactions with broker-dealers which require the delivery to the broker-dealer
of the Shares, which the broker-dealer may resell or otherwise transfer under
this prospectus. The Selling Stockholders may also loan or pledge the Shares
registered hereunder to a broker-dealer and the broker-dealer may sell the
shares so loaned or upon a default the broker-dealer may effect sales of the
pledged shares pursuant to this prospectus.
Broker-dealers or agents may receive compensation in the form of
commissions, discounts or concessions from the Selling Stockholders in amounts
to be negotiated in connection with the sale. Such broker-dealers and any other
participating broker-dealers may be deemed to be "underwriters" within the
meaning of the Securities Act, in connection with such sales and any such
commission, discount or concession may be deemed to be underwriting discounts or
commissions under the Securities Act.
Fonix has advised the Selling Stockholders that the anti-manipulation rules
under the Securities Exchange Act of 1934 may apply to sales of shares in the
market and to the activities of the Selling Stockholders and their affiliates.
In addition, Fonix will make copies of this prospectus available to the Selling
Stockholders and has informed them of the need for delivery of copies of this
prospectus to purchasers at or prior to the time of any sale of the Shares
offered hereby.
All costs, expenses and fees in connection with the registration of the
shares will be borne by Fonix. Commissions and discounts, if any, attributable
to the sales of the Shares will be borne by the Selling Stockholders. The
Selling Stockholders may agree to indemnify any broker-dealer or agent that
participates in transactions involving sales of the Shares against certain
liabilities, including liabilities arising under the Securities Act of 1933.
Fonix will not receive any proceeds from the sale of the Shares.
Fonix has agreed with the Selling Stockholders to keep the registration
statement of which this prospectus constitutes a part effective for a period of
3 years. Trading of any unsold shares after the expiration of such period will
be subject to compliance with all applicable securities laws, including Rule
144.
The Selling Stockholders are not obligated to sell any or all of the Shares
covered by this prospectus.
41
<PAGE>
In order to comply with the securities laws of certain states, the Shares
will be sold in such jurisdictions only through registered or licensed brokers
or dealers. In addition, the sale and issuance of Shares may be subject to the
notice filing requirements of certain states.
Legal matters
The validity of the Shares offered hereby will be passed upon for Fonix by
Durham Jones & Pinegar, P.C., 50 South Main Street, Suite 800, Salt Lake City,
Utah 84144.
42
<PAGE>
Table of Contents
Summary about Fonix and this offering.........................................2
Recent developments...........................................................5
Important information incorporated by reference...............................6
Where to get additional information...........................................7
Explanation about forward-looking information.................................8
Risk factors..................................................................9
Information about Fonix Corporation...........................................19
Management's discussion and analysis of financial condition
and results of operations................................................19
Special note regarding forward looking statements.............................31
Market price of and dividends on the Company's Class A
common stock.............................................................31
Selected financial data.......................................................32
Index to financial statements of Fonix Corporation............................33
Changes in and disagreements with accountants on
accounting and financial disclosure......................................34
Use of proceeds...............................................................34
Selling stockholders..........................................................35
Plan of distribution..........................................................40
Legal matters.................................................................42
--------------------
Fonix Corporation
49,716,307
SHARES
COMMON STOCK
--------------------
PROSPECTUS
-------------------
______________, 1999
43
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the various expenses to be incurred in
connection with the sale and distribution of the securities being registered
hereby, all of which will be borne by the Company. All amounts shown are
estimates except the Securities and Exchange Commission registration fee.
Filing Fee - Securities and Exchange Commission $ 4,201
Legal fees and expenses of the Company 30,000
Accounting fees and expenses 25,000
Blue Sky fees and expenses --
Printing expenses 500
Miscellaneous expenses 5,000
----------
Total Expenses $ 64,701
==========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Subsection (a) of Section 145 of the General Corporation Law of the
State of Delaware empowers a corporation to indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that he is or was a director, officer, employee or agent of
the corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe his conduct was unlawful.
Subsection (b) of Section 145 empowers a corporation to indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action or suit by right of the corporation to
procure a judgment in its favor by reason of the fact that such person acted in
any of the capacities set forth above, against expenses (including attorneys'
fees) actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation, except that no indemnification may be made in respect to any claim
issue or matter as to which such person shall have been adjudged to be liable to
the corporation unless and only to the extent that the Court of Chancery or the
court in which such action or suit was brought shall determine upon application
that, despite the adjudication of liability but in view of all the circumstances
of the case, such person is fairly and reasonably entitled to indemnity for such
expenses which the Court of Chancery or such other court shall deem proper.
II-1
<PAGE>
Section 145 further provides that to the extent a director or officer
of a corporation has been successful on the merits or otherwise in the defense
of any such action, suit or proceeding referred to in subsections (a) and (b) of
Section 145 or in the defense of any claim, issue or matter therein, he shall be
indemnified against expenses (including attorneys' fees) actually and reasonably
incurred by him in connection therewith; that the indemnification provided for
by Section 145 shall not be deemed exclusive of any other rights which the
indemnified party may be entitled; that indemnification provided by Section 145
shall, unless otherwise provided when authorized or ratified, continue as to a
person who has ceased to be a director, officer, employee or agent and shall
inure to the benefit of such person's heirs, executors and administrators; and
empowers the corporation to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the corporation would have the power to indemnify him
against such liabilities under Section 145.
Section 102(b)(7) of the General Corporation Law or the State of
Delaware provides that a certificate of incorporation may contain a provision
eliminating or limiting the personal liability of a director to the corporation
or its stockholders for monetary damages for breach of fiduciary duty as a
director, provided that such provision shall not eliminate or limit the
liability of the director (i) for any breach of the director's duty of loyalty
to the corporation or its stockholders, (ii) for acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
(iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any
transaction from which the director derived an improper personal benefit.
Article Ninth of the registrant's Charter provides that, the registrant
shall, "to the fullest extent permitted by Section 145 of the General
Corporation Law of the State of Delaware, as the same may be amended and
supplemented, indemnify any and all persons whom it shall have power to
indemnify under said section from and against any and all of the expenses,
liabilities or other matters referred to in or covered by said section, and the
indemnification provided for herein shall not be deemed exclusive of any other
rights to which those indemnified may be entitled under any By-Law, agreement,
vote of stockholders or disinterested Directors or otherwise, both as to action
in his official capacity and as to action in another capacity while holding such
office, and shall continue as to a person who has ceased to be director,
officer, employee or agent and shall inure to the benefit of the heirs,
executors and administrators of such a person."
Article VII, Section 7 of the registrant's Bylaws further provides that
the registrant "shall indemnify its officers, directors, employees and agents to
the extent permitted by the General Corporation Law of Delaware."
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
II-2
<PAGE>
ITEM 16. LIST OF EXHIBITS.
5 Opinion of Durham, Evans, Jones & Pinegar, P.C.*
23.1 Consent of Durham, Evans, Jones & Pinegar, P.C., included in Exhibit 5
filed herewith.
23.2 Consent of Arthur Andersen LLP
23.3 Consent of Deloitte & Touche LLP
23.4 Consent of Pritchett, Siler & Hardy P.C.
24 Power of Attorney (See page II-5 of this Registration Statement)
99.1 Securities Purchase Agreement by and among Fonix Corporation and JNC
Strategic Fund Ltd., dated December 21, 1998**
99.2 Securities Purchase Agreement among Fonix Corporation and the investors
identified therein dated January 29, 1999, as supplemented on March 3,
1999**
- -------------------
* To be filed by amendment.
** Filed previously.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933, as amended (the "Securities Act");
(ii) To reflect in the prospectus any facts or events arising
after the effective date of this Registration Statement (or the most
recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in this Registration Statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any derivation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more than 20
percent change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the Registration Statement;
and
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in this Registration
Statement or any material change to such information in this
Registration Statement; provided, however, that paragraphs (1)(i) and
(1)(ii) do not apply if the information required to be included in a
post-effective amendment by those paragraphs is contained in periodic
reports filed by the Company pursuant to Section 13 or Section 15(d)
II-3
<PAGE>
of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), that are incorporated by reference in this Registration
Statement.
(2) That, for the purposes of determining any liability under the
Securities Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at the time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
The Company hereby undertakes that, for purposes of determining any
liability under the Securities Act, each filing of the Company's annual report
pursuant to Section 13(a) or 15(d) of the Exchange Act (and, where applicable,
each filing of an employee benefit plan's annual report pursuant to Section
15(d) of the Exchange Act) that is incorporated by reference in this
Registration Statement shall be deemed to be a new registration statement
relating to the securities offered therein and the offering of such securities
at the time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Corporation pursuant to the indemnification provisions described herein, or
otherwise, the Company has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Company of expenses incurred or paid by a director, officer or
controlling person of the Company in the successful defense of any action, suit
or proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Company will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the city of Salt Lake City, State of Utah, on this 29th day of
December, 1999.
Fonix Corporation
By:/s/ Thomas A. Murdock
---------------------------
Thomas A. Murdock
President, Chief Executive
Officer
II-5
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
Signature Title Date
- ------------ ---------------------- ------
/s/ Thomas A. Murdock Chief Executive Officer, President, 12/29/99
- -------------------------- Chairman of the Board of Directors
Thomas A. Murdock (Principal Executive Officer)
/s/ Thomas A. Murdock* Executive Vice President Finance 12/29/99
- -------------------------- and Director
Roger D. Dudley (Principal Financial Officer)
/s/ Thomas A. Murdock* Chief Financial Officer (Principal 12/29/99
- -------------------------- Accounting Officer)
Douglas L. Rex
/s/ Thomas A. Murdock* Director 12/29/99
- --------------------------
John A. Oberteuffer, Ph.D.
/s/ Thomas A. Murdock* Director 12/29/99
- --------------------------
William A. Maasberg Jr.
/s/ Thomas A. Murdock* Director 12/29/99
- --------------------------
Mark L. Tanner
* As Attorney-in-fact
II-6
<PAGE>
EXHIBIT INDEX
5 Opinion of Durham, Evans, Jones & Pinegar, P.C.*
23.1 Consent of Durham, Evans, Jones & Pinegar, P.C., included in Exhibit 5
filed herewith.
23.2 Consent of Arthur Andersen LLP
23.3 Consent of Deloitte & Touche LLP
24.4 Consent Pritchett, Siler & Hardy P.C.
24 Power of Attorney (See page II-5 of this Registration Statement)
99.1 Securities Purchase Agreement by and among Fonix Corporation and JNC
Strategic Fund Ltd., dated December 21, 1998**
99.2 Securities Purchase Agreement among Fonix Corporation and the investors
identified therein dated January 29, 1999, as supplemented on March 3,
1999**
- -----------------
* To be filed by amendment.
** Previously filed.
II-7
<PAGE>
TABLE OF CONTENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (ARTHUR ANDERSEN LLP)...............F-2
INDEPENDENT AUDITORS' REPORT (DELOITTE & TOUCHE LLP).........................F-3
INDEPENDENT AUDITORS' REPORT (PRITCHETT, SILER & HARDY, P.C.)................F-4
FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1998 and 1997.................F-5
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996 and for the Period from October 1, 1993
(Date of Inception) to December 31, 1998..................................F-6
Consolidated Statements of Stockholders' Equity for the Years ended
December 31, 1998, 1997 and 1996 and for the Period from October
1, 1993 (Date of Inception) to December 31, 1998..........................F-7
Consolidated Statements of Cash Flows for the Years Ended December
31, 1998, 1997 and 1996 and for the Period from October 1, 1993
(Date of Inception) to December 31, 1998.................................F-10
Notes to Consolidated Financial Statements..................................F-12
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Fonix Corporation:
We have audited the accompanying consolidated balance sheets of Fonix
Corporation (a Delaware corporation in the development stage) and subsidiaries
as of December 31, 1998 and 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended and for
the period from inception (October 1, 1993) to December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements of the Company for the year
ended December 31, 1996 and for the period from inception (October 1, 1993) to
December 31, 1996, were audited by other auditors whose report dated March 28,
1997, expressed an unqualified opinion on those statements and included an
explanatory paragraph regarding the Company's ability to continue as a going
concern. The consolidated financial statements for the period from inception
(October 1, 1993) to December 31, 1996 reflect a net loss of $19,841,807 of the
total inception to date net loss of $85,414,537. The other auditors' report has
been furnished to us, and our opinion, insofar as it relates to the amounts
included for such prior periods, is based solely on the report of such other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors for the
cumulative information for the period from inception (October 1, 1993) to
December 31, 1996, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Fonix Corporation and subsidiaries as of December 31, 1998 and 1997 and the
results of their operations and their cash flows for the years then ended and
for the period from inception (October 1, 1993) to December 31, 1998 in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has generated no significant
recurring revenues through December 31,1998 and has incurred significant
recurring losses since its inception. The Company expects these losses to
continue at least through December 31, 1999. As of December 31, 1998, the
Company has an accumulated deficit of $92,933,777, negative working capital of
$14,678,975, demand and other notes currently due of $29,438,218 (some of which
are in default) and $1,965,490 of accounts payable over 60 days past due. These
matters raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans with respect to these matters are also
described in Note 1. The accompanying consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
April 14, 1999 (except with respect
to the matter described in Note 21, as
to which the date is December 17, 1999)
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
and Shareholders of
Fonix Corporation
Salt Lake City, Utah
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Fonix Corporation and subsidiary (a
development stage company) (the Company) for the year ended December 31, 1996,
and for the period from October 1, 1993 (date of inception) to December 31,
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The Company's consolidated financial statements
for the period from October 1, 1993 (date of inception) to December 31, 1995
were audited by other auditors whose report, dated March 4, 1996, expressed an
unqualified opinion on those statements and included an explanatory paragraph
regarding the Company's ability to continue as a going concern. The financial
statements for the period October 1, 1993 (date of inception) through December
31, 1995 reflect a net loss of $12,012,299 of the total inception to date net
loss. The other auditors' report has been furnished to us, and our opinion,
insofar as it relates to the amounts included for such prior periods, is based
solely on the report of such other auditors.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audit and the report of other auditors, such
financial statements present fairly, in all material respects, the results of
the Company's operations and its cash flows for the year ended December 31,
1996, and for the period from October 1, 1993 (date of inception) to December
31, 1996, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company is a development
stage enterprise engaged in developing automated speech recognition
technologies. As discussed in Note 1 to the consolidated financial statements,
the Company's operating losses since inception raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Salt Lake City, Utah
March 28, 1997
F-3
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Fonix Corporation
Salt Lake City, Utah
We have audited the consolidated statements of operations, stockholders' equity
and cash flows of Fonix Corporation and subsidiary [a development stage company]
for the year ended December 31, 1995, and for the period from October 1, 1993
(date of inception) to December 31, 1995 (these financial statements are not
presented separately herein). These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
Fonix Corporation and subsidiary (a development stage company) for the period
from October 1, 1993 (date of inception) to December 31, 1995 in conformity with
generally accepted accounting principles.
The consolidated financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company is still in the
development stage and has suffered recurring losses which raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ PRITCHETT, SILER & HARDY, P.C.
PRITCHETT, SILER & HARDY, P.C.
Salt Lake City, Utah
March 4, 1996
F-4
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
December 31, December 31,
1998 1997
------------- -------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 20,045,539 $ 20,501,676
Notes receivable 245,000 600,000
Accounts receivable, net of allowance for doubtful accounts of $8,000 219,908 -
Employee advances 67,231 -
Interest and other receivables 3,722 14,919
Inventory 4,804 -
Prepaid expenses 51,866 32,094
------------- -------------
Total current assets 20,638,070 21,148,689
Property and equipment, net of accumulated depreciation of $1,168,023 and $464,100, respectively 2,145,031 1,567,279
Intangible assets, net of accumulated amortization of $1,770,668 and $25,509, respectively 19,437,290 138,951
Other assets 107,945 39,647
Net long term assets of discontinued operations 19,584,455 -
------------- -------------
Total assets $ 61,912,791 $ 22,894,566
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ 138,034 $ -
Revolving notes payable 20,038,193 18,612,272
Notes payable - related parties 8,491,880 551,510
Notes payable - other 560,000 -
Accounts payable 3,536,074 291,638
Accrued liabilities 981,774 505,619
Accrued liabilities - related parties 900,004 459,502
Deferred revenues 20,000 -
Capital lease obligation - current portion 52,225 49,325
Net current liabilities of discontinued operations 598,861 -
------------- -------------
Total current liabilities 35,317,045 20,469,866
Capital lease obligation, net of current portion - 52,225
------------- -------------
Total liabilities 35,317,045 20,522,091
------------- -------------
Common stock and related repricing rights subject to redemption; 1,801,802 shares and
repricing rights outstanding in 1998 (aggregate redemption value of $2,500,000) 1,830,000 -
------------- -------------
Commitments and contingencies (Notes 1, 7, 12, 14, 16, 17 and 20)
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 B, 5% cumulative convertible; 27,500 shares outstanding in 1997
(aggregate liquidation preference of $555,197) - 667,659
Series C, 5% cumulative convertible; 185,000 shares outstanding in 1997
(aggregate liquidation preference of $3,734,550) - 4,644,785
Series D, 4% cumulative convertible; 1,008,334 shares outstanding in 1998
(aggregate liquidation preference of $20,441,828) 22,200,936 -
Series E, 4% cumulative convertible; 135,072 shares outstanding in 1998
(aggregate liquidation preference of $2,739,403) 3,257,886 -
Common stock, $.0001 par value; 100,000,000 shares authorized;
64,324,480 and 43,583,875 shares outstanding, respectively 6,432 4,358
Additional paid-in capital 88,517,711 38,637,059
Outstanding warrants 3,323,258 2,936,360
Deferred consulting expense (106,700) -
Deficit accumulated during the development stage (92,933,777) (45,017,746)
------------- -------------
Total stockholders' equity 24,765,746 2,372,475
------------- -------------
Total liabilities and stockholders' equity $ 61,912,791 $ 22,894,566
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
October 1,
1993
(Inception) to
Years Ended December 31, December 31,
----------------------------------------------------------
1998 1997 1996 1998
------------------- ------------------- ------------------ -------------------
<S> <C> <C> <C> <C>
Revenues $ 2,604,724 $ - $ - $ 2,604,724
Cost of revenues 35,440 - - 35,440
------------------- ------------------- ------------------ -------------------
Gross margin 2,569,284 - - 2,569,284
------------------- ------------------- ------------------ -------------------
Expenses:
Product development and research 13,060,604 7,066,294 4,758,012 30,997,897
Purchased in-process research and development 9,315,000 - - 9,315,000
Selling, general and administrative 10,529,910 12,947,112 3,530,400 32,776,580
------------------- ------------------- ------------------ -------------------
Total expenses 32,905,514 20,013,406 8,288,412 73,089,477
------------------- ------------------- ------------------ -------------------
Loss from operations (30,336,230) (20,013,406) (8,288,412) (70,520,193)
------------------- ------------------- ------------------ -------------------
Other income (expense):
Interest income 1,075,021 1,199,610 1,180,259 3,667,088
Interest expense (1,470,689) (2,758,288) (721,355) (5,323,232)
Cancellation of common stock reset provision (6,111,577) - - (6,111,577)
------------------- ------------------- ------------------ -------------------
Total other income (expense), net (6,507,245) (1,558,678) 458,904 (7,767,721)
------------------- ------------------- ------------------ -------------------
Loss from continuing operations (36,843,475) (21,572,084) (7,829,508) (78,287,914)
Discontinued operations:
Operating loss of HealthCare
Solutions Group (6,275,307) - - (6,275,307)
------------------- ------------------- ------------------ -------------------
Loss before extraordinary items (43,118,782) (21,572,084) (7,829,508) (84,563,221)
Extraordinary items:
Loss on extinguishment of debt - (881,864) - (881,864)
Gain on forgiveness of debt - - - 30,548
------------------- ------------------- ------------------ -------------------
Net loss $ (43,118,782) $ (22,453,948) $ (7,829,508) $ (85,414,537)
=================== =================== ================== ===================
Basic and diluted net loss per common share $ (0.91) $ (0.59) $ (0.21)
=================== =================== ==================
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A Series B Series C
Preferred Stock Preferred Stock Preferred Stock
--------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992 - $ - - $ - - $ -
Reverse stock split one share for ninety shares - - - - - -
Restatement for reverse acquisition of fonix
corporation by Phonic Technologies, Inc. - - - - - -
------ ------ ------ ------ ------ ------
Balance, October 1, 1993 (date of inception) - - - - - -
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - - - -
------ ------ ------ ------ ------ ------
Balance, December 31, 1993 - - - - - -
Acquisition of Taris, Inc. - - - - - -
Shares issued for services at $.14 to $.18 per share - - - - - -
Shares issued for services at $.25 per share - - - - - -
Shares issued for conversion of notes payable
and interest payable at $.04 per share - - - - - -
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 - - - - - -
Net loss for the year ended December 31, 1994 - - - - - -
------ ------ ------ ------ ------ ------
Balance, December 31, 1994 - - - - - -
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $ 267,714 - - - - - -
Shares issued during the year for services
rendered and cancellation of accounts payable
at $.55 to $1.55 per share - - - - - -
Warrants issued during the year for cancellation
of accounts payable at $.033
per warrant (additional compensation expense
of $2,282,900 or $.62 per share was recorded) - - - - - -
Shares issued during the year upon conversion of
warrants for cancellation of accounts
payable at $.35 per share - - - - - -
Warrants issued during the year for cash at $.0033 to
$.10 per warrant, less offering costs of$5,040 - - - - - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share - - - - - -
Forgiveness of debt with related parties - - - - - -
Net loss for the year ended December 31, 1995 - - - - - -
------ ------ ------ ------ ------ ------
Balance, December 31, 1995 - - - - - -
</TABLE>
<TABLE>
<CAPTION>
Series D Series E
Preferred Stock Preferred Stock Common Stock
--------------- --------------- ------------------------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992 - $ - - $ - 37,045,000 $ 3,704
Reverse stock split one share for ninety shares - - - - (36,633,389) (3,663)
Restatement for reverse acquisition of fonix
corporation by Phonic Technologies, Inc. - - - - 9,983,638 999
------ ------ ------ ------ ------------- -------------
Balance, October 1, 1993 (date of inception) - - - - 10,395,249 1,040
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - - - -
------ ------ ------ ------ ------------- -------------
Balance, December 31, 1993 - - - - 10,395,249 1,040
Acquisition of Taris, Inc. - - - - 411,611 41
Shares issued for services at $.14 to $.18 per share - - - - 1,650,000 165
Shares issued for services at $.25 per share - - - - 20,000 2
Shares issued for conversion of notes payable
and interest payable at $.04 per share - - - - 3,900,000 390
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 - - - - 1,819,293 181
Net loss for the year ended December 31, 1994 - - - - - -
------ ------ ------ ------ ------------- -------------
Balance, December 31, 1994 - - - - 18,196,153 1,819
Shares issued during the year for cash at $.45 to $2.50
per share, less offering costs of $ 267,714 - - - - 6,442,538 645
Shares issued during the year for services
rendered and cancellation of accounts payable
at $.55 to $1.55 per share - - - - 516,630 52
Warrants issued during the year for
cancellation of accounts payable at $.033
per warrant (additional compensation expense
of $2,282,900 or $.62 per share was recorded) - - - - - -
Shares issued during the year upon conversion of
warrants for cancellation of
accounts payable at $.35 per share - - - - 3,700,000 370
Warrants issued during the year for cash at $.0033 to
$.10 per warrant, less offering costs of$5,040 - - - - - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share - - - - 550,000 55
Forgiveness of debt with related parties - - - - - -
Net loss for the year ended December 31, 1995 - - - - - -
------ ------ ------ ------ ------------- -------------
Balance, December 31, 1995 - - - - 29,405,321 2,941
</TABLE>
<TABLE>
<CAPTION>
Deficit
Deferred Accumulated
Additional Consult- During the
Paid-in Outstanding ing Development
Capital Warrants Expense Stage Total
------------- ----------- -------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1992 $ 136,659 $ - $ - $ (29,495) $ 110,868
Reverse stock split one share for ninety shares 3,663 - - - -
Restatement for reverse acquisition of fonix
corporation by Phonic Technologies, Inc. (141,362) - - 29,495 (110,868)
------------- ----------- -------- ------------- -----------
Balance, October 1, 1993 (date of inception) (1,040) - - - -
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - (1,782,611) (1,782,611)
------------- ----------- -------- ------------- -----------
Balance, December 31, 1993 (1,040) - - (1,782,611) (1,782,611)
Acquisition of Taris, Inc. 1,240 - - - 1,281
Shares issued for services at $.14 to $.18 per share 249,835 - - - 250,000
Shares issued for services at $.25 per share 4,998 - - - 5,000
Shares issued for conversion of notes payable
and interest payable at $.04 per share 156,515 - - - 156,905
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 3,315,874 - - - 3,316,055
Net loss for the year ended December 31, 1994 - - - (3,914,339) (3,914,339)
------------- ----------- -------- ------------- -----------
Balance, December 31, 1994 3,727,422 - - (5,696,950) (1,967,709)
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $267,714 4,509,542 - - - 4,510,187
Shares issued during the year for services
rendered and cancellation of accounts payable
at $.55 to $1.55 per share 355,319 - - - 355,371
Warrants issued during the year for
cancellation of accounts payable at $.033
per warrant (additional compensation expense
of $2,282,900 or $.62 per share was recorded) - 2,405,000 - - 2,405,000
Shares issued during the year upon conversion of
warrants for cancellation of accounts
payable at $.35 per share 3,699,630 (2,405,000) - - 1,295,000
Warrants issued during the year for cash at $.0033 to
$.10 per warrant, less offering costs of$5,040 - 45,360 - - 45,360
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share 519,945 (45,000) - - 475,000
Forgiveness of debt with related parties 506,874 - - - 506,874
Net loss for the year ended December 31, 1995 - - - (6,315,349) (6,315,349)
------------- ----------- -------- ------------- -----------
Balance, December 31, 1995 13,318,732 360 - (12,012,291) 1,309,734
</TABLE>
See accompanying notes to consolidated financial statements
F-7
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A Series B Series C
Preferred Stock Preferred Stock Preferred Stock
--------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share - $ - - $ - - $ -
Shares issued during the year upon conversion
of warrants for cash at $.50 per share - - - - - -
Shares issued during the year for cash at $.48
to $3.38 per share, less offering costs of
$2,033,286 - - - - - -
Net loss for the year ended December 31, 1996 - - - - - -
------------ ------------ ------------ ------------ ------------ -----------
Balance, December 31, 1996 - - - - - -
Shares issued for services at $3.75 to $5.31
per share - - - - - -
Shares issued for services at $6.50 to
$8.38 per share - - - - - -
Warrants issued during the year for services - - - - - -
Shares issued upon the exercise of warrants
for services at $2.00 per share - - - - - -
Shares issued during the year for cash at
$2.50 per share - - - - - -
Warrants issued during the year in connection
with the issuance of a convertible debenture
and convertible preferred stock - - - - - -
Shares issued upon conversion of convertible
debenture to common shares - - - - - -
Series B preferred shares issued for
extinguishment of convertible debenture at
$20 stated value per share - - 108,911 2,178,213 - -
Sale of Series C preferred shares and
warrants, less cash fees of $201,500 - - - - 187,500 2,948,500
Sale of Series B preferred shares for cash,
less cash fees of $145,000 - - 125,000 2,355,000 - -
Capital contribution in connection with
put options - - - - - -
Beneficial conversion features of Series B
convertible debenture - - - - - -
Series A preferred shares issued upon
conversion of convertible debenture at
$3 per share 166,667 500,000 - - - -
Conversion of Series B and Series C
preferred shares to common shares - - (206,411) (4,828,488) (2,500) (62,772)
Shares issued during the year in connection
with exercise of options at $2.97 per share - - - - - -
Shares issued during the year in connection
with the exercise of warrants at $.50
per share - - - - - -
Accretion of Series C preferred stock - - - - - 600,000
Dividends on preferred stock - $ - - $ 962,934 - $ 1,159,057
Net loss for the year ended December 31, 1997 - - - - - -
------------ ------------ ------------ ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
Series D Series E
Preferred Stock Preferred Stock Common Stock
--------------- --------------- -----------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share - $ - - $ - 420,000 $ 42
Shares issued during the year upon conversion
of warrants for cash at $.50 per share - - - - 60,000 6
Shares issued during the year for cash at $.48
to $3.38 per share, less offering costs of
$2,033,286 - - - - 11,741,242 1,174
Net loss for the year ended December 31, 1996 - - - - - -
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1996 - - - - 41,626,563 4,163
Shares issued for services at $3.75 to $5.31
per share - - - - 87,500 9
Shares issued for services at $6.50 to
$8.38 per share - - - - 505,000 50
Warrants issued during the year for services - - - - - -
Shares issued upon the exercise of warrants
for services at $2.00 per share - - - - 150,000 15
Shares issued during the year for cash at
$2.50 per share - - - - 150,000 15
Warrants issued during the year in connection
with the issuance of a convertible debenture
and convertible preferred stock - - - - - -
Shares issued upon conversion of convertible
debenture to common shares - - - - 145,747 15
Series B preferred shares issued for
extinguishment of convertible debenture at
$20 stated value per share - - - - - -
Sale of Series C preferred shares and
warrants, less cash fees of $201,500 - - - - - -
Sale of Series B preferred shares for cash,
less cash fees of $145,000 - - - - - -
Capital contribution in connection with
put options - - - - - -
Beneficial conversion features of Series B
convertible debenture - - - - - -
Series A preferred shares issued upon
conversion of convertible debenture at
$3 per share - - - - - -
Conversion of Series B and Series C
preferred shares to common shares - - - - 804,065 80
Shares issued during the year in connection
with exercise of options at $2.97 per share - - - - 15,000 1
Shares issued during the year in connection
with the exercise of warrants at $.50 - - - - 100,000 10
per share
Accretion of Series C preferred stock - - - - - -
Dividends on preferred stock - $ - - $ - - $ -
Net loss for the year ended December 31, 1997 - - - - - -
------------ ------------ ------------ ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
Deficit
Deferred Accumulated
Additional Consult- During the
Paid-in Outstanding ing Development
Capital Warrants Expense Stage Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share 901,478 $ - $ - $ - $ 901,520
Shares issued during the year upon conversion
of warrants for cash at $.50 per share 29,994 - - - 30,000
Shares issued during the year for cash at $.48
to $3.38 per share, less offering costs of
$2,033,286 11,857,269 - - - 11,858,443
Net loss for the year ended December 31, 1996 - - - (7,829,508) (7,829,508)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1996 26,107,473 360 - (19,841,807) 6,270,189
Shares issued for services at $3.75 to $5.31
per share 366,710 - - - 366,719
Shares issued for services at $6.50 to
$8.38 per share 3,426,202 - - - 3,426,252
Warrants issued during the year for services - 1,165,500 - - 1,165,500
Shares issued upon the exercise of warrants
for services at $2.00 per share 689,085 (389,100) - - 300,000
Shares issued during the year for cash at
$2.50 per share 1,256,235 - - - 1,256,250
Warrants issued during the year in connection
with the issuance of a convertible debenture
and convertible preferred stock - 1,559,600 - - 1,559,600
Shares issued upon conversion of convertible
debenture to common shares 857,835 - - - 857,850
Series B preferred shares issued for
extinguishment of convertible debenture at
$20 stated value per share - - - - 2,178,213
Sale of Series C preferred shares and
warrants, less cash fees of $201,500 - 600,000 - - 3,548,500
Sale of Series B preferred shares for cash,
less cash fees of $145,000 - - - - 2,355,000
Capital contribution in connection with
put options 500,000 - - - 500,000
Beneficial conversion features of Series B
convertible debenture 427,850 - - - 427,850
Series A preferred shares issued upon
conversion of convertible debenture at
$3 per share - - - - 500,000
Conversion of Series B and Series C
preferred shares to common shares 4,891,180 - - - -
Shares issued during the year in connection
with exercise of options at $2.97 per share 44,499 - - - 44,500
Shares issued during the year in connection
with the exercise of warrants at $.50 49,900 - - - 50,000
per share
Accretion of Series C preferred stock - - - (600,000) -
Dividends on preferred stock $ - $ - $ - $(2,121,991) $ -
Net loss for the year ended December 31, 1997 - - - (22,453,948) (22,453,948)
------------ ------------ ------------ ------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A Series B Series C
Preferred Stock Preferred Stock Preferred Stock
--------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 166,667 500,000 27,500 667,659 185,000 4,644,785
Shares issued for debt costs at $1.44 per share - - - - - -
Options issued during the year for services - - - - - -
Shares issued during the year for patent - - - - - -
Warrants issued during the year for cash - - - - - -
Shares issued upon the exercise of options
and warrants - - - - - -
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 - - - - - -
Shares issued during the year in connection
with the acquisitions of AcuVoice, Articulate
and Papyrus - - - - - -
Sale of Series D preferred shares, less
issuance costs of $546,154 - - - - - -
Sale of Series E preferred shares, less
issuance costs of $50,000 - - - - - -
Exchange of Series D for Series E preferred
stock - - - - - -
Conversions of preferred stock to common
stock - - (27,500) (676,190) (185,000) (4,767,913)
Shares issued in connection with the
relinquishment of a reset provision - - - - - -
Expiration of warrants - - - - - -
Amortization of deferred consulting
expense - - - - - -
Dividends on preferred stock - - - 8,531 - 123,128
Net loss for the year ended December
31, 1998 - - - - - -
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 166,667 $ 500,000 - $ - - $ -
============ ============ ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Series D Series E
Preferred Stock Preferred Stock Common Stock
--------------- --------------- -----------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 - - - - 43,583,875 4,358
Shares issued for debt costs at $1.44 per share - - - - 35,000 4
Options issued during the year for services - - - - - -
Shares issued during the year for patent - - - - 24,814 3
Warrants issued during the year for cash - - - - - -
Shares issued upon the exercise of options
and warrants - - - - 265,000 27
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 - - - - 4,000,000 400
Shares issued during the year in connection
with the acquisitions of AcuVoice, Articulate
and Papyrus - - - - 10,944,081 1,094
Sale of Series D preferred shares, less
issuance costs of $546,154 500,000 10,453,846 - - - -
Sale of Series E preferred shares, less
issuance costs of $50,000 - - 100,000 1,950,000 - -
Exchange of Series D for Series E preferred
stock (150,000) (3,079,167) 150,000 3,079,167 - -
Conversions of preferred stock to common
stock - - (114,928) (2,777,292) 4,081,234 407)
Shares issued in connection with the
relinquishment of a reset provision 608,334 11,166,668 - - 1,390,476 139
Expiration of warrants - - - - - -
Amortization of deferred consulting
expense - - - - - -
Dividends on preferred stock - 3,659,579 - 1,006,011 - -
Net loss for the year ended December
31, 1998 - - - - - -
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 1,008,334 $22,200,936 135,072 $3,257,886 $64,324,480 $ 6,432
============ ============ ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Deficit
Deferred Accumulated
Additional Consult- During the
Paid-in Outstanding ing Development
Capital Warrants Expense Stage Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 38,637,059 2,936,360 - (45,017,746) 2,372,475
Shares issued for debt costs at $1.44 per share 50,310 - - - 50,314
Options issued during the year for services 320,100 - (320,100) - -
Shares issued during the year for patent 100,804 - - - 100,807
Warrants issued during the year for cash - 472,928 - - 472,928
Shares issued upon the exercise of options
and warrabnts 505,333 360) - - 505,000
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 16,965,754 - - - 16,966,154
Shares issued during the year in connection with
the acquisitions of AcuVoice, Articulate
and Papyrus 28,686,933 - - - 28,688,027
Sale of Series D preferred shares, less
issuance costs of $546,154 - - - - 10,453,846
Sale of Series E preferred shares, less
issuance costs of $50,000 - - - - 1,950,000
Exchange of Series D for Series E
preferred stock - - - - -
Conversions of preferred stock to common stock 8,220,988 - - - -
Shares issued in connection with the
relinquishment of a reset provision (5,055,240) - - - 6,111,577
Expiration of warrants 85,670 (85,670) - - -
Amortization of deferred consulting expense - - 213,400 - 213,400
Dividends on preferred stock - - - (4,797,249) -
Net loss for the year ended December 31, 1998 - - - (43,118,782) (43,118,782)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 $88,517,711 $3,323,258 $(106,700) $(92,933,777) $ 24,765,746
============ ============ ============ ============ =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
October 1,
1993
Years Ended December 31, (Inception) to
---------------------------------------------- December 31,
1998 1997 1996 1998
--------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (43,118,782) $(22,453,948) $ (7,829,508) $ (85,414,537)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 50,314 4,112,970 901,520 5,487,554
Issuance of common stock for patent 100,807 -- -- 100,807
Non-cash expense related to issuance of debentures,
warrants, preferred and common stock 6,111,577 3,967,337 -- 10,078,914
Non-cash compensation expense related to issuance
of stock options 213,400 -- -- 2,496,300
Non-cash expense related to issuance of notes payable
and accrued expense for services 857,000 -- -- 857,000
Non-cash exchange of notes receivable for services 150,000 -- -- 150,000
Non-cash portion of purchased in-process research and
development 13,136,000 -- -- 13,136,000
Write-off of assets received in acquisition -- -- -- 1,281
Depreciation and amortization 3,285,845 405,209 83,183 3,775,454
Extraordinary loss on extinguishment of debt -- 881,864 -- 881,864
Extraordinary gain on forgiveness of debt -- -- -- (30,548)
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable (148,498) -- -- (148,498)
Employee advances (67,231) -- -- (67,231)
Interest and other receivables 9,436 142,724 (131,419) (5,483)
Inventory (20,221) -- -- (20,221)
Prepaid assets (15,372) (27,922) (4,172) (47,466)
Other assets (80,198) (8,735) (30,912) (119,845)
Accounts payable 2,941,898 128,638 42,702 5,013,736
Accrued liabilities 8,189 (922,367) 83,053 641,789
Accrued liabilities - related party (311,743) 47,759 1,500,918 147,759
Deferred revenues 81,266 -- -- 81,266
--------------- ------------- ------------- --------------
Net cash used in operating activities (16,816,313) (13,726,471) (5,384,635) (43,004,105)
--------------- ------------- ------------- --------------
Cash flows from investing activities, net of effects of
acquisitions:
Acquisition of subsidiaries, net of cash acquired (15,323,173) -- -- (15,323,173)
Purchase of property and equipment (1,305,091) (671,401) (1,311,236) (3,336,470)
Investment in intangible assets -- (107,281) (33,126) (164,460)
Issuance of notes receivable (745,000) (1,483,600) (963,106) (3,228,600)
Payments received on notes receivable -- 1,883,600 -- 1,883,600
--------------- ------------- ------------- --------------
Net cash used in investing activities (17,373,264) (378,682) (2,307,468) (20,169,103)
--------------- ------------- ------------- --------------
Cash flows from financing activities:
Bank overdraft 138,034 -- -- 138,034
Net proceeds from revolving note payable 1,376,671 2,234,914 10,759,836 19,988,943
Net proceeds (payments) from revolving note
payable - related parties (469,869) 551,510 -- 81,641
Proceeds from other notes payable 560,000 -- -- 2,911,667
Payments on other notes payable -- -- -- (1,779,806)
Principal payments on capital lease obligation (49,325) (43,381) -- (92,706)
Proceeds from issuance of convertible debentures, net -- 2,685,000 -- 3,185,000
Proceeds from sale of warrants 472,928 600,000 -- 1,072,928
Proceeds from sale of common stock, net 17,471,155 469,500 11,888,443 38,175,700
Proceeds from sale of preferred stock, net 12,403,846 5,303,500 -- 17,707,346
Proceeds from sale of common stock and related
repricing rights subject to redemption, net 1,830,000 -- -- 1,830,000
--------------- ------------- ------------- --------------
Net cash provided by financing activities 33,733,440 11,801,043 22,648,279 83,218,747
--------------- ------------- ------------- --------------
Net (decrease) increase in cash and cash equivalents (456,137) (2,304,110) 14,956,176 20,045,539
Cash and cash equivalents at beginning of period 20,501,676 22,805,786 7,849,610 --
--------------- ------------- ------------- --------------
Cash and cash equivalents at end of period $ 20,045,539 $ 20,501,676 $ 22,805,786 $ 20,045,539
============== ============= ============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-10
<PAGE>
Fonix Corporation
[A Development Stage Company]
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Supplemental disclosure of cash flow information:
<TABLE>
<CAPTION>
October 1,
1993
Years Ended December 31, (Inception) to
----------------------------------------------- December 31,
1998 1997 1996 1998
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Cash paid during the period for interest $ 1,392,987 $ 1,148,553 $ 638,302 $ 3,430,006
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Year Ended December 31, 1998:
Preferred stock dividends of $3,461,543 were recorded related to the
beneficial conversion features of convertible preferred stock.
Preferred stock dividends of $335,706 were accrued on convertible preferred
stock.
A total of 27,500 shares of Series B convertible preferred stock and
related dividends of $8,531 were converted into 193,582 shares of common
stock.
A total of 185,000 shares of Series C convertible preferred stock and
related dividends of $123,129 were converted into 1,295,919 shares of
common stock.
TheCompany issued 1,390,476 shares of common stock and 608,334 shares of
Series D 4% convertible preferred stock in connection with the cancellation
of an existing reset provision and costs associated with the issuance of
Series D 4% convertible preferred stock.
Preferred stock dividends of $1,000,000 were recorded related to the
issuance of 1,390,476 common shares and 608,334 shares of Series D 4%
convertible preferred stock in connection with the cancellation of an
existing reset provision.
The Company exchanged 150,000 shares of Series D 4% convertible preferred
stock for 150,000 shares of Series E 4% convertible preferred stock.
A total of 114,928 shares of Series E convertible preferred stock and
related dividends of $15,969 were converted into 2,591,733 shares of common
stock.
The Company issued 2,692,216 shares of common stock (having a market value
of $16,995,972) in connection with the acquisition of AcuVoice, Inc.
The Company issued 5,140,751 shares of common stock (having a market value
of $8,353,720) and notes payable of $4,747,339 in connection with the
acquisition of Articulate Systems, Inc.
The Company issued 3,111,114 shares of common stock (having a market value
of $3,208,336) and notes payable of $1,710,000 in connection with the
acquisition of Papyrus.
The Company issued notes payable of $348,145 in connection with the
acquisition of certain assets of The MRC Group, Inc.
For the Year Ended December 31, 1997:
A $500,000 Series A convertible debenture was converted into 166,667 shares
of Series A preferred stock.
Series B convertible debentures in the amount of $850,000 and related
accrued interest of $7,850 were converted into 145,747 shares of common
stock.
Series B convertible debentures in the amount of $2,150,000 and related
accrued interest of $28,213 were converted into 108,911 shares of Series B
convertible preferred stock.
Dividends of $2,721,991 were recorded related to the beneficial conversion
features and accretion of Series B and Series C convertible preferred
stock.
206,411 shares of Series B convertible preferred stock and related
dividends of $13,422 were converted into 786,867 shares of common stock.
2,500 shares of Series C convertible preferred stock and related dividends
of $472 were converted into 17,198 shares of common stock.
Accounts payable of $144,931 was converted into a capital lease obligation
of the same amount.
For the Year Ended December 31, 1996:
The Company issued 420,000 shares of common stock to unrelated parties for
finders' fees of $901,520.
See accompanying notes to consolidated financial statements.
F-11
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -The Company's primary focus to date has been the
development of its human computer interface technologies including: sound
recognition engine, neural network, audio signal processor, and command
processing engine for use in its core automated speech recognition ("ASR")
technologies and the development of its text-to-speech ("TTS") technologies,
handwriting recognition technologies, and speech embedded and speech
verification technologies.
The Company is also developing pen-voice technologies, a combination of
handwriting and ASR. The Company has received a patent and continues to seek
additional United States and foreign patent protection for various aspects of
its technologies through the filing of domestic and international applications.
The U.S. Patent and Trademark Office issued the initial patent to the Company
describing 36 claims on June 17, 1997. Additionally, Fonix has acquired other
patents and has filed additional patent applications. The Company licenses its
technologies to and has entered into co-development relationships and strategic
alliances with third parties that are participants in the computer and
electronic devices industry (including producers of application software,
operating systems, computers and microprocessor chips) or are research and
development entities, including academia and industrial and commercial speech
product developers. The Company intends for the foreseeable future to continue
this practice and will seek to generate revenues from its proprietary
technologies from product sales, licensing royalties and strategic partnerships
and alliances. To date, the Company has entered into a strategic partnership and
one license agreement relating to its ASR technologies. The Company generated
its first revenue from its ASR technologies in February 1998 under a license
agreement (see Note 13). Additionally, in 1998, the Company recorded minimal
revenues from sales of its TTS technologies and PowerScribe medical speech
recognition and dictation products. Although the Company has completed
development of the key components of its core technologies, there can be no
assurance that Fonix will be able to sell, license or otherwise market its
technologies to third parties in order to generate sufficient recurring revenues
to pay its operating costs and complete the development of its technologies.
Fonix Corporation (known as Taris, Inc. prior to its acquisition of Phonic
Technologies, Inc., as described below) (the "Company") was organized under the
laws of the state of Delaware on September 12, 1985. Taris, Inc. was a public
company with no operations. Prior to June 17, 1994, Taris, Inc. effected a
reverse stock split of one share for ninety shares. The financial statements
have been adjusted to reflect the stock split as though it had happened January
1, 1993. Phonic Technologies, Inc. ("PTI"), a Utah corporation and the Company's
predecessor in interest with respect to some of the Company's technology, was
organized on October 1, 1993 (the Company's date of inception) for the purpose
of developing proprietary ASR technologies. On June 17, 1994, Fonix Corporation
("Fonix") entered into a merger agreement with PTI whereby Fonix issued
10,395,249 shares of its common stock for all of the issued and outstanding
common shares of PTI. Upon completion of the merger, PTI stockholders owned in
excess of 90 percent of the outstanding common stock of Fonix. The transaction
was accounted for as a reverse acquisition as though PTI acquired Fonix. The
financial statements, therefore, reflect the operations of Fonix since the
acquisition on June 17, 1994 and PTI since October 1, 1993.
Development Stage Presentation - Fonix is a development stage company. The
Company generated revenues of $2,604,724 and incurred net losses totaling
$43,118,782 for the year ended December 31, 1998 (see Note 21). The Company has
incurred cumulative losses of $85,414,537 for the period from inception to
December 31, 1998. The Company has an accumulated deficit of $92,933,777,
negative working capital of $14,678,975, demand and other notes currently due of
$29,438,218 (of which $1,335,030 is due upon demand or is in default) and
$1,965,490 of accounts payable over 60 days past due as of December 31, 1998.
The net loss for 1998 and the accumulated deficit as of December 31, 1998
include charges of $9,315,000 and $3,821,000 related to the Company's
acquisition of in-process product research and development in connection with
its acquisitions of AcuVoice, Inc. and Articulate Systems, Inc., respectively.
Although the Company generated its first revenue in February 1998, the Company
expects to continue to incur significant losses through at least December 31,
1999, primarily due to significant expenditure requirements associated with the
marketing and development of its proprietary ASR and related technologies. These
factors, as well as the risk factors set out elsewhere in the Company's Annual
Report on Form 10-K, raise substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any
F-12
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
adjustments that might result from the outcome of this uncertainty. Management
plans to fund the operations of the Company through proceeds from sales of debt
and equity securities and, if necessary, the sale of certain of its technologies
(see Note 20). There can be no assurance that management's plans will be
successful.
Consolidation - The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries, Fonix Systems
Corporation, Fonix/AcuVoice, Inc., Fonix/Articulate, Inc. and Fonix/Papyrus,
Inc. All significant intercompany balances and transactions have been eliminated
in consolidation.
Cash and Cash Equivalents - The Company considers all highly liquid short-term
investments with a maturity of three months or less to be cash equivalents.
Inventory - Inventory, consisting primarily of microphones and related
accessories, is stated at the lower of cost (first-in, first -out method) or
market value.
Property and Equipment - Property and equipment are stated at cost. Depreciation
is computed for financial statement purposes on a straight-line basis over the
estimated useful lives of the assets as follows:
Furniture and fixtures 5 years
Computer equipment 3 to 5 years
Leasehold improvements 18 months to 8 years
Leasehold improvements are amortized over the shorter of the useful life of the
applicable asset or the remaining lease term. Maintenance and repairs are
charged to expense as incurred and major improvements are capitalized. Gains or
losses on sales or retirements are included in the consolidated statements of
operations in the year of disposition.
Intangible Assets - Intangible assets consist of the purchase cost of completed
technology and goodwill in connection with the acquisitions of AcuVoice, Inc.,
Articulate Systems, Inc., Papyrus Development Corporation, Papyrus Associates,
Inc. and certain assets of The MRC Group, Inc. (see Notes 2 and 21) and direct
costs incurred by the Company in applying for patents covering its technologies.
Amortization is computed on a straight-line basis over the estimated useful
lives of the completed technology, goodwill and patents ranging from five to
eight years. The patent covering the Company's core technologies is pledged as
collateral for repayment of the Company's Series C 5 % Convertible Debentures
that were issued subsequent to December 31, 1998 (see Note 20).
Revenue Recognition - The Company recognizes revenues in accordance with the
provisions of Statement of Position No. 97-2, "Software Revenue Recognition".
The Company generates revenues from licensing the rights to its software
products to end users and from royalties. The Company also generates service
revenues from the sale of consulting and development services.
Revenues from software license agreements are recognized upon shipment of the
software if there are no significant post delivery obligations. If post delivery
obligations exist, revenues are recognized upon customer acceptance. Revenues
from development and consulting services are recognized upon customer
acceptance.
Cost of revenues consists of costs to distribute the product (including the cost
of the media on which it is delivered), installation and support personnel
salaries and licensed technology and related costs.
Research and Development - All expenditures for research and development are
charged to expense as incurred. The Company incurred total research and
development expenses of $13,060,604, $7,066,294 and $4,758,012 for the years
ended December 31, 1998, 1997 and 1996, respectively. The Company expensed
$13,136,000 of research and
F-13
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
development costs purchased in connection with the acquisitions of AcuVoice,
Inc. and Articulate Systems, Inc. (see Notes 2 and 21).
Income Taxes - The Company recognizes deferred income tax assets or liabilities
for the expected future tax consequences of events that have been recognized in
the financial statements or tax returns. Under this method, deferred income tax
assets or liabilities are determined based upon the difference between the
financial and income tax bases of assets and liabilities using enacted tax rates
expected to apply when differences are expected to be settled or realized.
Concentration of Credit Risks - The Company's cash and cash equivalents are
maintained in bank deposit accounts which exceed federally insured limits. The
Company has not experienced any losses with respect to these deposits and
believes it is not exposed to any significant credit risk on cash and cash
equivalents. In the normal course of business, the Company provides credit terms
to its customers. Accordingly, the Company performs on-going credit evaluations
of its customers and maintains allowances for possible losses, which when
realized, have been within the range of management's expectations.
Accounting Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosures of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments - The book value of the Company's financial
instruments approximates fair value. The estimated fair values have been
determined using appropriate market information and valuation methodologies.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the year.
At December 31, 1998, 1997 and 1996, there were outstanding common stock
equivalents to purchase 38,319,638, 13,395,948 and 2,450,000 shares of common
stock, respectively, that were not included in the computation of diluted net
loss per common share as their effect would have been anti-dilutive, thereby
decreasing the net loss per common share.
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the years ended December 31, 1998, 1997
and 1996 (see Note 21).
F-14
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ------------------------ -------------------------
Loss Loss Loss
Loss Per Share Loss Per Share Loss Per Share
------------- --------- ------------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Loss from continuing operations $(36,843,475) $(21,572,084) $(7,829,508)
Preferred stock dividends (4,797,249) (2,721,991) -
------------- ------------- ------------
Net loss from continuing operations
attributable to common
stockholders (41,640,724) $ (0.79) (24,294,075) $ (0.57) (7,829,508) $ (0.21)
Discontinued operations (6,275,307) (0.12) - - - -
Extraordinary items - - (881,864) (0.02) - -
------------- -------- ------------- -------- ------------ --------
Net loss attributable to common
stockholders $(47,916,031) $ (0.91) $(25,175,939) $ (0.59) $(7,829,508) $ (0.21)
============= ======== ============= ======== ============ ========
Weighted average common shares
outstanding 52,511,185 42,320,188 36,982,610
============ ============= ============
</TABLE>
Recently Enacted Accounting Standards - Effective January 1, 1998, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." This statement established standards for reporting and
display of comprehensive income and its components in financial statements. The
adoption of this statement had no effect on the Company's consolidated financial
statement presentation.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 established new standards for public companies to report information about
their operating segments, products and services, geographic areas and major
customers. The Company has adopted SFAS No. 131 beginning with the year ended
December 31, 1998 (see Note 19).
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes accounting and reporting standards requiring that derivative
instruments be recorded in the balance sheet as either an asset or liability
measured at its fair value and that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999.
The adoption of this statement in not expected to have a material effect on the
Company's consolidated financial statements as the Company does not currently
hold any derivative or hedging instruments.
2. ACQUISITIONS
AcuVoice, Inc. - In March 1998, the Company created a wholly owned subsidiary
(Fonix/AcuVoice, Inc.) that acquired AcuVoice, Inc. ("AcuVoice"). AcuVoice
developed and marketed TTS technologies and products directly to end-users,
systems integrators and original equipment manufacturers for use in the
telecommunications, multi-media, education and assistive technology markets.
These same products and services are now provided by the Company's Interactive
Technologies Solutions Group. The Company issued 2,692,216 shares of restricted
common stock (having a market value of $16,995,972 on that date) and paid cash
of approximately $8,000,000 for all of the then outstanding common shares of
AcuVoice. The acquisition was accounted for as a purchase.
Of the 2,692,216 shares of stock issued, 80,000 shares were placed in escrow
against which any claims for breach of warranty against the former shareholders
of AcuVoice could be asserted by the Company. On March 12, 1999, the Company
submitted a claim for the shares deposited into the escrow account based on the
Company's assertion of
F-15
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
misrepresentations made to the Company (see Note 16). The shares held in escrow
have been excluded from the calculation of basic net loss per common share for
the year ended December 31,1998.
The purchase price allocations to tangible assets included $253,881 of cash,
$13,728 of accounts receivable, $9,902 of fixed assets and $800 of prepaid
expenses. The purchase price allocations to liabilities assumed included $22,929
of accounts payable and accrued expenses and $599,250 of notes payable.
The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of AcuVoice was $25,339,840, of which $11,192,000
was capitalized as the purchase cost of the completed technology, $4,832,840 was
capitalized as goodwill and $9,315,000 was expensed as purchased in-process
research and development.
The valuation of the acquired in-process research and development included, but
was not limited to, an analysis of (1) the market for AcuVoice products and
technologies; (2) the completion costs for the projects; (3) the expected cash
flows attributed to the projects; and (4) the risks associated with achieving
such cash flows. The assumptions used in valuing the in-process research and
development were based upon assumptions the Company believed to be reasonable
but which are inherently uncertain and unpredictable. For these reasons, actual
results may vary from projected results.
Papyrus Associates, Inc. and Papyrus Development Corporation - In October 1998,
the Company created a wholly owned subsidiary (Fonix/Papyrus, Inc.) that
acquired Papyrus Associates, Inc. ("PAI"), and Papyrus Development Corporation
("PDC") (together with PAI, "Papyrus"). PAI developed, marketed and supported
printing and cursive handwriting recognition software for "personal digital
assistants", pen tablets and mobile phones under the trademark, Allegro(TM). PDC
was a systems integration provider with expertise and intellectual property in
imbedded systems and enhanced Internet applications. These same products and
services are now provided by the Company's Interactive Technologies Solutions
Group. The Company issued 3,111,114 shares of restricted common stock (having a
market value of $3,208,336 on that date) and promissory notes aggregating
$1,710,000 with due dates from February 28, 1999 to September 30, 1999 for all
of the then outstanding common shares of PAI and PDC.
Of the 3,111,114 shares of common stock issued, 311,106 shares were placed in
escrow against which any claims for breach of warranty against the former
shareholders of Papyrus could be asserted by the Company. The shares held in
escrow have been excluded from the calculation of basic net loss per common
share for the year ended December 31, 1998. The acquisition was accounted for as
a purchase.
The purchase price allocation to tangible assets included $10,342 of cash and
$7,629 of accounts receivable. The purchase price allocation to liabilities
assumed included $118,293 of accounts payable and accrued liabilities. The
excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of Papyrus was $5,018,658 and was capitalized as
goodwill.
The Company incurred $821,197 in research and development expenses related to
services performed by Papyrus prior to the date of the acquisition.
Articulate Systems, Inc. - See discussion of the September 1999 disposition of
the HeathCare Solutions Group ("HSG"), of which Articulate Systems, Inc. was a
part, at Note 21.
In 1998, the Company created a wholly owned subsidiary ("Fonix/Articulate") that
acquired Articulate Systems, Inc. ("Articulate") in September 1998. Articulate
was a provider of sophisticated voice recognition products to specialized
segments of the health care industry. These same products and services are now
provided by HSG. The Company delivered 5,140,751 shares of restricted common
stock (having a market value of $8,353,720 on that date), a cash payment of
$7,787,249 and 8.5 percent demand notes in the aggregate amount of $4,747,339
for all the then outstanding common shares of Articulate. Additionally, the
Company issued 98,132 stock options in exchange for all Articulate stock options
outstanding on the date of acquisition at an exchange rate based on the relative
fair value of the
F-16
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
companies' stocks. The estimated fair value of the options issued was $130,000
using the Black-Scholes option pricing model with weighted average assumptions
of a risk-free rate of 5.1 percent, expected life of 2.5 years, expected
volatility of 85 percent and an expected dividend yield of 0 percent. Subsequent
to the acquisition, the Company agreed to pay several Articulate employees
incentive compensation for continued employment in the aggregate amount of
$857,000. The Company issued 8.5 percent demand notes for $452,900 and recorded
an accrued liability of $404,100 for the balance of this obligation. The demand
notes issued to both the Articulate stockholders and the Articulate employees
were payable after November 1, 1998 (see Note 7). The $404,100 accrued liability
is payable on or before January 31, 1999. The Articulate acquisition was
accounted for as a purchase.
Of the 5,140,751 shares of common stock issued, 315,575 shares were placed in
escrow against which any claims for breach of warranty against the former
shareholders of Articulate could be asserted by the Company and 1,985,000 shares
were placed in escrow to be converted to a new class of non-voting common stock
upon approval of the establishment of such a class of stock by the shareholders
of the Company. The shares held in escrow have been excluded from the
calculation of basic net loss per common share for the year ended December
31,1998.
The purchase price allocations to tangible assets included $286,954 of cash,
$62,835 of accounts receivable, $57,165 of inventory, $14,043 of prepaid
expenses and $117,540 of fixed assets. The purchase price allocations to
liabilities assumed included $310,008 of accounts payable and accrued expenses,
$1,900,000 of notes payable and $929,690 of deferred revenue.
The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of Articulate was $23,584,256, of which $13,945,000
was capitalized as the purchase cost of completed technology, $5,818,256 was
capitalized as goodwill and other intangibles and $3,821,000 was expensed as
purchased in-process research and development.
The valuation of the acquired in-process research and development included, but
was not limited to, an analysis of (1) the market for Articulate products and
technologies; (2) the completion costs for the projects; (3) the expected cash
flows attributed to the projects; and (4) the risks associated with achieving
such cash flows. The assumptions used in valuing the in-process research and
development were based upon assumptions the Company believed to be reasonable
but which are inherently uncertain and unpredictable. For these reasons, actual
results may vary from projected results.
The MRC Group, Inc. - See discussion of the September 1999 disposition of HSG,
of which the MRC Group, Inc. was a part, at Note 21.
On December 31, 1998, the Company acquired certain assets of the MRC Group, Inc.
("MRC") relating to MRC's selling, marketing and servicing of the PowerScribe(R)
products. In consideration for the assets, the Company agreed to pay MRC
$219,833 less certain amounts then owed to the Company, plus $133,333 per month
for each of the three months immediately following the closing, less certain
credits. Subsequent to December 31, 1998, the remaining amounts owing related to
this acquisition are $216,666.
The purchase price allocations to tangible assets included $142,852 of accounts
receivable and $40,000 of fixed assets. The purchase price allocations to
liabilities assumed included $311,588 of accrued expenses and $849,742 of
deferred revenue. Additionally, $152,839 of accounts receivable and $987,531 of
deferred revenue from Articulate were eliminated in purchase accounting.
The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of MRC was $314,761 which was capitalized as
goodwill.
Proforma Financial Statement Data - The following unaudited pro forma financial
statement data for the years ended December 31, 1998 and 1997 present the
results of operations of the Company as if the acquisitions of AcuVoice,
F-17
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Articulate and Papyrus had occurred at the beginning of each year. The pro forma
results have been prepared for comparative purposes only and do not purport to
be indicative of future results or what would have occurred had the acquisitions
been made at the beginning of the applicable year. Purchased in-process research
and development related to the acquisition of AcuVoice of $9,315,000 was
recorded at the date of the acquisition and is not presented in the following
unaudited pro forma financial statement data since it is a non-recurring charge
directly attributable to the acquisition. Pro forma financial information for
the acquisition of Articulate has not been included in the following pro forma
financial statement data as the operations and substantially all the assets of
the HSG were sold September 2, 1999 (see Note 21). Additionally, the historical
operating results of Articulate from the date of acquisition through December
31, 1998 have been excluded from the pro forma financial information.
Additionally, The results of operations of MRC are not included in the unaudited
pro forma financial statement data as the acquisition did not constitute the
purchase of a business.
<TABLE>
<CAPTION>
For the Year Ended December 31,
--------------------------------
1998 1997
---------------- --------------
<S> <C> <C>
Revenues $ 2,692,916 $ 1,134,590
Loss before extraordinary items (31,462,937) (15,939,441)
Net loss (31,462,937) (16,821,305)
Basic and diluted net loss per common share (0.55) (0.34)
</TABLE>
3. CERTIFICATE OF DEPOSIT
At December 31, 1998 and 1997, the Company maintained a $20,000,000 short-term
certificate of deposit at a bank which is included in cash and cash equivalents.
The certificate bore interest at 4.0 percent and 5.5 percent at December 31,
1998 and 1997, respectively. Interest was payable monthly. This certificate was
pledged as collateral on a revolving note payable (see Note 6). On January 8,
1999, this certificate of deposit matured and was not renewed. Proceeds from the
certificate were applied to reduce the related revolving note payable balance.
4. NOTES RECEIVABLE
At December 31, 1998, the Company had a note receivable from a research and
development entity in the amount of $20,000 which was repaid subsequent to
December 31, 1998.
As of December 31, 1998, the Company had a six percent short-term, unsecured,
demand note receivable from an unrelated entity in the amount of $225,000, which
note was issued in connection with the Company's intended acquisition of the
entity. Because the acquisition was not pursued, subsequent to December 31,
1998, the Company demanded and received payment of the $225,000 note.
At December 31, 1997, the Company had a short-term, unsecured, non-interest
bearing note receivable from AcuVoice in the amount of $500,000. When AcuVoice
was acquired effective March 13, 1998, this note receivable was eliminated in
connection with the acquisition. Additionally, at December 31, 1997, the Company
had a short-term, unsecured, demand note receivable from an unrelated entity in
the amount of $100,000. During 1998, the Company determined this note was
uncollectible and expensed the related amount.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 1998 and 1997
(see Note 21):
F-18
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Computer equipment $ 2,329,755 $ 1,321,016
Furniture and fixtures 778,479 640,992
Leasehold improvements 204,820 69,371
------------ ------------
Less accumulated depreciation and amortization 3,313,054 2,031,379
(1,168,023) (464,100)
------------ ------------
Net property and equipment $ 2,145,031 $ 1,567,279
</TABLE>
6. REVOLVING AND OTHER NOTES PAYABLE
At December 31, 1998 and 1997, the Company had a revolving note payable to a
bank in the amount of $19,988,193 and $18,612,272, respectively. Borrowings
under the revolving note payable were limited to $20,000,000. The weighted
average outstanding balance during 1998 and 1997 was $18,590,642 and
$18,861,104, respectively. The weighted average interest rate was 6.40 percent
and 5.94 percent during 1998 and 1997, respectively. This note was due January
8, 1999, bore an interest rate of 6.00 percent at December 31,1998, and was
secured by a certificate of deposit in the amount of $20,000,000 (see Note 3).
This revolving note was renegotiated quarterly and interest was payable monthly.
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 December 31, 1998, the Company has an unsecured revolving note payable to a
bank in the amount of $50,000. Loaned amounts under the revolving note payable
are limited to $50,000. The weighted average outstanding balance during the year
ended December 31, 1998 was $14,384. The weighted average interest rate was 9.4
percent during 1998. 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 December
31, 1998) and requires interest to be paid monthly.
At December 31, 1998, the Company has a note payable to a lender in the amount
of $560,000 which bears interest at 18 percent, which interest is payable
monthly. The note payable was due January 2, 1999 and is secured by certain
accounts receivable. The Company has subsequently extended the due date from
month to month by paying the lender accrued interest plus a fee of $5,600. The
loan balance is currently due May 28, 1999. The Company anticipates that it will
request additional extensions of the due date. In connection with the issuance
of the note payable, the Company issued 35,000 shares of common stock (having a
fair value of $50,314 on the date of issuance) in payment for a loan origination
fee. This amount is included in interest expense in the accompanying
consolidated statement of operations. The note is personally guaranteed by two
officers and directors and the chairman of the board of directors of the
Company. The Company has entered into an indemnity agreement with the three
directors relating to this and other guarantees and pledges (see Note 12).
F-19
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. RELATED-PARTY NOTES PAYABLE
At December 31, 1998, the Company has unsecured demand notes payable outstanding
to the former Articulate stockholders in the aggregate amount of $4,708,980.
These notes were issued in connection with the Articulate acquisition (see Note
2). These notes were payable on demand any time after November 31, 1998. In
December 1998, the holder of $ 407,971 of the notes demanded payment. In
connection with this demand, the Company paid the holder $50,000 representing a
partial payment and the holder agreed to extend the date to March 15, 1999 and
increase the interest rate to 11 percent per annum. No additional demand has
been given for this note. Additionally in 1998, the Company negotiated
extensions on $3,521,726 of the notes which adjusted the interest rate to 10
percent and extended the due dates to May 30, 1999. No demand has been given for
the remaining balance of notes.
Subsequent to the Articulate acquisition, the Company agreed to pay several
Articulate employees incentive compensation for continued employment in the
aggregate amount of $857,000. The Company issued demand notes for $452,900 and
recorded an accrued liability of $404,100 for the balance of this obligation
(see Note 2). 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 and they have verbally agreed to extend the due
dates of these notes to April 30, 1999, and the Company has also verbally agreed
to pay interest at nine percent per annum after the November 1, 1998 due date.
The Company has not paid the $404,100 of accrued liability which was due on or
before January 31, 1999.
In connection with the acquisition of certain liabilities of Articulate (see
Note 2), the Company executed and delivered a $1,500,000 unsecured demand note
payable to a company which is a stockholder of the Company. This demand note
bore interest at an annual rate of 10 percent and was payable upon demand after
November 1, 1998. The Company obtained an extension of the due date from the
holder of the note and on February 2, 1999, this note and related interest were
paid in full.
At December 31, 1998, the Company has unsecured demand notes payable to former
Papyrus stockholders in the aggregate amount of $1,710,000, which notes were
issued in connection with the Papyrus acquisition. The notes are payable as
follows: $1,190,000 due by February 28, 1999, $180,000 due on April 30, 1999 and
$340,000 due on September 30, 1999, and bear interest at six percent per annum
after their due date. The Company has not made any payments on these notes and
is negotiating with the former shareholders of Papyrus to resolve issues raised
in a legal action filed by the Company against certain former shareholders of
Papyrus (see Note 17).
The Company has an unsecured revolving note payable to a company owned by three
individuals who are executive officers and directors of the Company and who each
beneficially own more than 10 percent of the Company's common stock. At December
31, 1998 and 1997, $0 and $551,510 in principal and $2,482 and $22,243 in
accrued interest were outstanding under this revolving note payable,
respectively. The weighted average balance outstanding during the borrowing
period was $73,811 in 1998 and $555,407 in 1997. 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 was $551,510 in 1998 and $1,550,000 in
1997. In connection with this revolving note, the Company paid a loan
origination fee of $93,000 in 1997. The Company believes the terms of the
related-party revolving note payable are at least as favorable as the terms that
could have been obtained from an unrelated third party in a similar transaction.
At December 31, 1998, the Company has an unsecured, non-interest bearing demand
note payable in the amount of $100,000 to Synergetics, Inc. ("Synergetics"), a
research and development entity (see Note 12). This note is payable on demand.
At December 31, 1998, the Company has 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. Subsequent to December 31, 1998, the
holder of this note agreed to extend the due date to June 30, 1999.
F-20
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain of this above debt was paid from the proceeds of the sale of HSG (see
Note 21).
8. CONVERTIBLE DEBENTURES
Series A Convertible Debenture - On October 23, 1995, the Company entered into a
Securities Purchase Agreement (the "Securities Purchase Agreement") with
Beesmark Investments, L.C., a Utah limited liability company controlled by an
individual who assumed a position on the Company's board of directors in
connection with the execution of the Securities Purchase Agreement. Under the
Securities Purchase Agreement, the Company issued a Series A Convertible
Debenture in the amount of $500,000. The debenture bore interest at five percent
and was originally due October 23, 1996. The debenture was ultimately converted
into 166,667 shares of Series A Preferred Stock on September 25, 1997.
Series B Convertible Debentures - On June 18, 1997, the Company entered into a
Convertible Debenture Purchase Agreement (the "Agreement") whereby an unrelated
investment entity agreed to purchase up to an aggregate principal amount of
$10,000,000 of the Company's Series B Convertible Debentures. The debentures
were due June 18, 2007, bore interest at five percent and were convertible into
shares of the Company's common stock at anytime after issuance at the holder's
option. The debentures were convertible into shares of the Company's common
stock at the lesser of $6.81 or the average of the per share market value for
the five trading days immediately preceding the conversion date multiplied by 90
percent for any conversion on or prior to the 120th day after the original issue
date and 87.5 percent for any conversion thereafter. On June 18, 1997, the
Company received $3,000,000 in proceeds related to the issuance of Series B
Convertible Debentures. Using the conversion terms most beneficial to the
investor, the Company recorded a prepaid financing cost of approximately
$427,900 to be amortized as additional interest expense over the 120 day period
commencing June 18, 1997. As part of the same transaction, the Company also
issued to the investor a warrant to purchase up to 250,000 shares of common
stock at any time prior to June 18, 2002, at the exercise price of $8.28 per
share. The Company recorded the fair value of the warrants, totaling $897,750,
as a charge to interest expense. 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 percent; expected volatility of 65 percent; risk
free interest rate of 5.9 percent and an expected life to exercise of five
years. On July 31, 1997 and September 26,1997, $500,000 and $350,000 of the
Series B Convertible Debentures together with interest earned thereon were
converted into 87,498 and 58,249 shares of common stock, respectively.
Effective September 30, 1997, the Company and the Series B Convertible Debenture
holders agreed to modify the Agreement to provide that the holders exchange all
the outstanding debentures in the amount of $2,150,000 and accrued interest
thereon in the amount of $28,213 into 108,911 shares of Series B Convertible
Preferred Stock that would have essentially the same terms as the debentures and
that any additional purchases under the Agreement would be for the purchase of
Series B Convertible Preferred Stock. In connection with the extinguishment of
the Series B Convertible Debenture and the issuance of Series B Convertible
Preferred Stock, the Company recorded all unamortized prepaid financing costs as
a loss on extinguishment of debt. Also in connection with this modification, the
Company issued an additional warrant to purchase up to 175,000 shares of common
stock at any time prior to October 24, 2002, at an exercise price of $7.48 per
share. In connection with the issuance of that warrant, the Company recorded the
fair value of the warrant, totaling $661,850 as an additional loss on
extinguishment of debt. The fair value of the warrants was determined as of the
date of the grant using the Black-Scholes pricing model assuming the following:
dividend yield of 0 percent; expected volatility of 65 percent; risk free
interest rate of 5.8 percent and expected life to exercise of 5 years.
9. PREFERRED STOCK
In 1995, the Company's board of directors adopted a resolution to amend the
certificate of incorporation to provide for the issuance of preferred stock and
give the board of directors authority to fix the rights, preferences and
restrictions of any series of preferred stock. At the same time, the board of
directors authorized, subject to approval by the Company's shareholders of the
amendment to the certificate of incorporation, a class of Series A Convertible
Preferred
F-21
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock. The Series A Convertible Preferred Stock authorized in 1995 was issued
shortly thereafter. In August 1997, a majority of the shareholders of the
Company approved the amendment to the Company's certificate of incorporation
authorizing and approving the issuance of preferred stock in such series and
having such terms and conditions as the Company's board of directors may
designate. The amendment became effective September 24, 1997. Thereafter, the
Company's board of directors adopted resolutions establishing Series B
Convertible Preferred Stock, Series C Convertible Preferred Stock, Series D
Convertible Preferred Stock and Series E Convertible Preferred Stock in
connection with certain capital fund-raising in 1997 and 1998, as described
below.
Series A Convertible Preferred Stock - In September 1997, the Series A
Convertible Debenture was converted into 166,667 shares of Series A Convertible
Preferred Stock. The holder of the Series A Convertible Preferred Stock has the
same voting rights as common stockholders, has the right to elect one person to
the board of directors and receives a one time preferential dividend of $2.905
per share of Series A Convertible Preferred Stock prior to the payment of any
dividend on any class or series of stock. At the option of the holder, each
share of Series A Convertible Preferred Stock is convertible into one share of
common stock and in the event that the common stock price has equaled or
exceeded $10 for a fifteen day period, the Series A Convertible Preferred Stock
shares are automatically converted into common stock. In the event of
liquidation, the holder is entitled to a liquidating distribution of $36.33 per
share and a conversion of Series A Convertible Preferred Stock at an amount
equal to 1.5 shares of common stock for each share of Series A Convertible
Preferred Stock.
Series B Convertible Preferred Stock - Effective September 30, 1997, the Company
and the Series B Convertible Debenture holders agreed to exchange all then
outstanding Series B debentures in the aggregate amount of $2,150,000 and
accrued interest thereon in the amount of $28,213 into 108,911 shares of Series
B Convertible Preferred Stock. Dividends accrue on the stated value ($20 per
share) of Series B Convertible Preferred Stock at a rate of five percent per
year, are payable quarterly in cash or common stock, at the option of the
Company, and are convertible into shares of the Company's common stock at any
time after issuance at the holders' option. In the event of liquidation, the
holders of the Series B Convertible Preferred Stock are entitled to an amount
equal to the stated value plus accrued but unpaid dividends whether declared or
not. The holders of Series B Convertible Preferred Stock have no voting rights.
The Series B Convertible Preferred Stock, together with dividends accrued
thereon, may be converted into shares of the Company's common stock at the
lesser of $6.81 or the average of the per share market value for the five
trading days immediately preceding the conversion date multiplied by 90 percent
for any conversion on or prior to the 120th day after the original issue date
and 87.5 percent for any conversion thereafter. Using the conversion terms most
beneficial to the holder, the Company recorded a dividend of $219,614 which
represents a discount of 10 percent, which is available to the holder upon
issuance. The additional 2.5 percent discount of $68,509 was amortized as a
dividend over the remaining days in the original 120 day vesting period of the
Series B Convertible Debentures. Prior to the actual issuance of the Series B
Convertible Preferred Stock in exchange for the outstanding balance under the
debenture, the holder converted the balance of $2,150,000, and related
dividends, into 431,679 shares of common stock.
On October 24, 1997, the Company sold an additional 125,000 shares of Series B
Convertible Preferred Stock for $2,500,000 less $145,000 in related offering
costs. Using the conversion terms most beneficial to the holder, the Company
recorded a dividend of $576,667 which represents a discount of 10 percent, which
is available to the holder on or before 120 days subsequent to closing. A 2.5
percent discount of $87,905 was amortized as a dividend over 120 days. As a
condition for issuing preferred stock, the holder was granted a put option by
SMD, L.L.C. ("SMD"), a company which is controlled by three shareholders who are
officers or directors of Fonix. The put option requires SMD to purchase the
Series B Convertible Preferred Stock from the holder at the holder's option but
only in the event that the common stock of Fonix is removed from listing on the
NASDAQ Small Cap Market or any other national securities exchange. In addition,
Fonix has not entered into any type of agreement which would require Fonix to
reimburse SMD should SMD be required to purchase the Series B Convertible
Preferred Stock from the holder. In connection with this put option, the Company
recorded a financing expense and a corresponding capital contribution of
$125,000. As of December 31, 1997, 97,500 of the Series B Convertible Preferred
Stock and dividends earned thereon had been
F-22
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
converted into 355,188 shares of common stock. In January 1998, the remaining
27,500 shares of Series B Convertible Preferred Stock and dividends earned
thereon were converted into 193,582 shares of common stock.
Series C Convertible Preferred Stock - Effective September 30, 1997, the Company
entered into an agreement with an unrelated investment entity whereby that
entity agreed to purchase 187,500 shares of the Company's Series C Convertible
Preferred Stock for $3,750,000. The cash purchase price was received in October
1997. Dividends accrue on the stated value ($20 per share) of Series C
Convertible Preferred Stock at a rate of five percent per year, are payable
quarterly in cash or common stock, at the option of the Company, and are
convertible into shares of the Company's common stock at anytime after issuance
at the holders' option. In the event of liquidation, the holders of the Series C
Convertible Preferred Stock are entitled to an amount equal to the stated value
($20 per share) plus accrued but unpaid dividends whether declared or not. The
holders of Series C Convertible Preferred Stock have no voting rights. The
Series C Convertible Preferred Stock, together with dividends accrued thereon,
may be converted into shares of the Company's common stock at the lesser of
$5.98 or the average of the five lowest closing bid prices for the 15 trading
days preceding the date of any conversion notice multiplied by 91 percent for
any conversion on or prior to the 120th day after the original issue date, 90
percent for any conversion between 121 and 180 days and 88 percent for any
conversion thereafter. Using the conversion terms most beneficial to the holder,
the Company recorded a dividend of $1,060,718 which represents a discount of
nine percent, which is available to the holder on or before 120 days subsequent
to closing. The additional three percent discount of $164,002 was amortized as a
dividend over 180 days. As a condition for issuing preferred stock, the Series C
Convertible Preferred Stockholder was granted a put option by SMD. The put
option requires SMD to purchase the Series C Convertible Preferred Stock from
the holder at the holder's option but only in the event that the common stock of
Fonix is removed from listing on the NASDAQ Small Cap Market or any other
national securities exchange. In addition, Fonix has not entered into any type
of agreement which would require Fonix to reimburse SMD should SMD be required
to purchase the preferred stock from the holder. In connection with this put
option, the Company recorded a financing expense and a corresponding capital
contribution of $375,000. Associated with the issuance of the Series C
Convertible Preferred Stock, the Company issued a warrant to purchase up to
200,000 shares of common stock at any time prior to October 24, 2000, at the
exercise price of $7.18 per share. The Company recorded the fair value of the
warrant of $600,000 as determined as of October 24,1997 using the Black-Scholes
pricing model assuming the following: dividend yield of 0 percent; expected
volatility of 65 percent; risk free interest rate of 5.8 percent and expected
life to exercise of 3 years. During the year ended December 31, 1997, the
Company issued 17,198 shares of common stock upon conversion of 2,500 shares of
Series C Convertible Preferred Stock and related accrued dividends. During 1998,
the balance of 185,000 shares of Series C Convertible Preferred Stock and
related dividends were converted into 1,295,919 shares of the Company's common
stock.
Series D Convertible Preferred Stock - On August 31, 1998, the Company entered
into an agreement with investors whereby the Company issued 500,000 shares of
the Company's Series D Convertible Preferred Stock for $10,000,000.
Additionally, the Company issued to certain investors a total of 608,334 shares
of Series D Convertible Preferred Stock (i) in return for their relinquishment
of their contractual right to receive Reset Shares in connection with the March
1998 offering (see Note 10), and as (ii) an additional cost of raising the
$10,000,000 from the Series D Convertible Preferred Stock placement. Dividends
accrue on the stated value ($20 per share) of Series D Convertible Preferred
Stock at the rate of four percent per year, are payable annually or upon
conversion, in cash or common stock, at the option of the Company, and are
convertible into shares of the Company's common stock at the holder's option any
time. Each month the holders of the Series D Convertible Preferred Stock may not
convert more than 25 percent of the total number of shares of Series D
Convertible Preferred Stock originally issued to such holders on a cumulative
basis. For example, during the first month a holder may convert up to 25 percent
of the total Series D Convertible Preferred Stock issued to the holder, and
during the following month that same holder may convert, on an aggregate to date
basis, up to 50 percent of the total number of shares of Series D Convertible
Preferred Stock held by the holder. Additionally, each month, the holders may
convert up to 50 percent of the total number of shares of Series D Convertible
Preferred Stock originally issued to such holders on a cumulative basis, if both
of the following conditions are satisfied: the average daily trading volume of
the Company's common stock is more than 500,000 shares for the 10-trading-day
period before the conversion; and the average per share closing bid price for
such 10-trading-day period has not decreased by more
F-23
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
than five percent during that 10-trading-day period. Any outstanding shares of
Series D Convertible Preferred Stock as of August 31, 2001 automatically will be
converted at the conversion price most beneficial to the holders on such date.
In the event of liquidation, the holders of the Series D Convertible Preferred
Stock are entitled to an amount equal to the stated value ($20 per share) plus
accrued but unpaid dividends whether declared or not. The holders of Series D
Convertible Preferred Stock have no voting rights. The Series D Convertible
Preferred Stock, together with dividends accrued thereon, may be converted into
shares of the Company's common stock at the lesser of: $3.50 per share; or the
lesser of 110 percent of the average per share closing bid price for the fifteen
trading days immediately preceding the date of issuance of the Series D
Convertible Preferred shares; or 90 percent of the average of the three lowest
per share closing bid prices during the 22 trading days immediately preceding
the conversion date. In the event that the holders convert at the $3.50 per
share price, the Company is obligated to issue warrants to purchase 0.8 shares
of common stock for each share of Series D Convertible Preferred Stock converted
to common stock. Using the conversion terms most beneficial to the holder, the
Company is amortizing a beneficial conversion feature of $3,638,147 as a
dividend over a 180 day-period. Subsequent to December 31, 1998, 45,000 shares
of Series D Convertible Preferred Stock and related dividends were converted
into 741,749 shares of common stock.
Series E Convertible Preferred Stock - Effective as of September 30, 1998, the
Company entered into an agreement with two of the investors who purchased the
Series D Convertible Preferred Stock whereby the Company issued 100,000 shares
of the Company's Series E Convertible Preferred Stock for $2,000,000.
Additionally, the Company issued to the purchasers of the Series E Convertible
Preferred Stock a total of 150,000 additional shares of Series E Convertible
Preferred Stock in exchange for which those purchasers surrendered a total of
150,000 shares of Series D Convertible Preferred Stock. Dividends accrue on the
stated value ($20 per share) of Series E Convertible Preferred Stock at a rate
of four percent per year, are payable annually or upon conversion, in cash or
common stock, at the option of the Company, and are convertible into shares of
the Company's common stock at any time at the holder's option. Any outstanding
shares of Series E Convertible Preferred Stock as of September 30, 2001 are
automatically converted at the conversion price most beneficial to the holders
on such date. In the event of liquidation, the holders of the Series E
Convertible Preferred Stock are entitled to an amount equal to the stated value
($20 per share) plus accrued but unpaid dividends whether declared or not. The
holders of Series E Convertible Preferred Stock have no voting rights. The
Series E Convertible Preferred Stock, together with dividends accrued thereon,
may be converted into shares of the Company's common stock at the lesser of:
$3.50 per share; or the lesser of 110 percent of the average per share closing
bid price for the 15 trading days immediately preceding the date of issuance of
the Series E Convertible Preferred shares; or 90 percent of the average of the
three lowest per share closing bid prices during the 22 trading days immediately
preceding the conversion date. If the Investors convert at the $3.50 per share
price, the Company is obligated to issue warrants to purchase 0.8 shares of
common stock for each share of Series E Convertible Preferred Stock converted to
common stock. Using the conversion terms most beneficial to the holder, the
Company recorded a preferred stock dividend of $968,047 for the beneficial
conversion feature of the Series E Convertible Preferred Stock. As of December
31, 1998, 114,928 shares of Series E Convertible Preferred Stock and related
dividends had been converted into 2,591,733 shares of common stock. Subsequent
to December 31, 1998, 122,572 shares of Series E Convertible Preferred Stock and
related dividends were converted into 3,042,145 shares of common stock.
10. COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION
Common Stock - During the year ended December 31, 1998, the Company issued
20,740,605 shares of common stock. Of such shares, 4,000,000 shares were issued
in connection with a private placement transaction, 10,944,081 shares were
issued in connection with the acquisitions of AcuVoice, Articulate and Papyrus
(see Note 2) (of which 2,691,681 shares are held in escrow), 4,081,234 shares
were issued upon the conversion of preferred stock and related dividends,
1,390,476 shares were issued in connection with the restructuring of reset
rights, 265,000 shares were issued upon the exercise of previously granted
warrants and options, 35,000 shares were issued in payment of a loan origination
fee (see Note 6) and 24,814 shares were issued for the purchase of a patent.
On March 12, 1998, the Company completed a private placement offering of up to
6,666,666 shares of its restricted
F-24
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
common stock. The total purchase price to be paid by the investors pursuant to
the offering was $30,000,000. Of that amount, $15,000,000 was received by the
Company on March 12, 1998, in return for which the Company issued a total of
3,333,333 shares of restricted common stock. Finders' fees of $870,000 were paid
in connection with the $15,000,000 received. 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) provided that certain conditions were satisfied. As of the
July 27, 1998, the certain conditions precedent to receiving the additional
funding were not met. In separate transactions in June and August 1998, certain
investors paid to the Company a total of $3,000,000 in return for which the
Company issued 666,667 additional shares under the terms and conditions set
forth in the offering. Finders' fees of $163,846 were incurred in connection
with the $3,000,000 received. No other payment has been received by the Company
pursuant to the offering, and the Company does not expect any further payment to
be made.
The investors acquired certain "reset rights" in connection with the offering
pursuant to which the investors would receive additional shares of restricted
common stock ("Reset Shares") for no additional consideration if the average
market price of the Company's common stock for the 60-day period following the
effective date of the related registration statement or the second funding date
did not equal or exceed $5.40 per share. On August 31, 1998, the Company and the
investors in the offering restructured the reset provision whereby the Company
issued 608,334 shares of Series D Convertible Preferred Stock 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 the $3,000,000 received in June and August 1998, and (ii) a
financing cost in connection with the issuance of 500,000 shares of Series D
Convertible Preferred Stock. The Company recorded an expense of $6,111,577 for
the difference between the Company's original obligation to issue reset shares
and the fair value of the shares that were actually issued in settlement for the
relinquishment of the reset provision and recorded a preferred stock dividend of
$1,000,000 related to financing costs in connection with the issuance of 500,000
shares of Series D Convertible Preferred Stock.
Registration Rights and Reserved Shares - During 1997, 1998 and 1999, the
Company entered into registration rights agreements with investors under which
the Company agreed to register the common stock issuable upon the conversion of
all series of preferred stock and debentures and the exercise of warrants. The
Company covenanted to reserve out of its authorized and unissued shares of
common stock no less than that number of shares that would be issuable upon the
conversion of all series of preferred stock and debentures and any dividends and
interest then payable in stock thereon and the exercise of warrants. As of
December 31, 1998, the Company has reserved 31,887,259 shares of common stock
for this purpose. Nevertheless, the Company does not presently have sufficient
authorized capital to enable it to issue all of the common stock it would be
required to issue if all the presently issued and outstanding convertible
preferred stock debentures, options, warrants, and other convertible securities
were converted or exercised. The Company is in the process of attempting to
obtain shareholder approval of an amendment to the Company's certificate of
incorporation that would sufficiently increase the Company's authorized capital,
including common stock.
Voting Trust - As of December 31, 1998, 25,657,749 shares of the Company's
outstanding common stock were held in a voting trust (the "Voting Trust") as to
which the President and Chief Executive Officer of the Company is the sole
trustee. Persons who have deposited their shares of the Company's common stock
into the Voting Trust have dividend and liquidation rights in proportion to the
number of shares of the Company's 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 stockholders unanimously terminate it; or (iii) the Company is
dissolved or liquidated.
Common Stock Subject to Redemption - On December 21, 1998, the Company entered
into a private placement securities agreement. Pursuant to the agreement, the
Company received $1,980,000 in net proceeds in exchange for 1,801,802 shares of
redeemable common stock, an equal number of "Repricing Rights" and warrants to
purchase
F-25
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
200,000 shares of common stock. Each Repricing Right entitles the holder to
receive a number of additional shares of common stock for no additional
consideration according to a formula ("Repricing Rights") based on the lowest
closing bid price of the Company's common stock, as quoted by the NASDAQ Stock
Market, during the 15 consecutive trading days immediately preceding the
exercise date and a repricing price, as defined, ranging from $1.3875 to $1.4319
depending upon the date of the exercise. The repricing rights became exercisable
on March 21, 1999.
Each holder of redeemable common stock has the right ("Repurchase Right"), based
on certain conditions, to require the Company to repurchase all or a portion of
the holder's common shares or repricing rights. The Repurchase Rights may only
be exercised simultaneously with or after the occurrence of a major transaction
or triggering event as defined in the private placement agreement. Major
transactions and triggering events consist of, among others, certain
consolidations, mergers or other business combinations, the sale or transfer of
all or substantially all the Company's assets, a purchase, tender or exchange
offering of more than 40 percent of the Company's outstanding common stock made
and accepted, the failure to have a related registration statement declared
effective prior to 180 days after the closing date or a suspension from listing
or delisting of the Company's common stock for a period of three days.
The repurchase price for the common stock is $1.3875 per share. The repurchase
price for the Repricing Rights is based on a formula using the Repricing Rate
and the last reported sale price of the Company's common stock on the date of
the exercise of the repurchase right.
The warrants have an exercise price of $1.67 per share and a term of three
years. The Company assigned a fair value of $150,000 to the warrants as
determined on December 21, 1998 using the Black-Scholes pricing model assuming a
dividend yield of 0 percent, expected volatility of 85 percent, a risk free
interest rate of 4.5 percent and an expected life of 3 years.
F-26
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 1997, the Company issued 1,957,312 shares of
common stock. Of such shares, 150,000 were issued to an unrelated private
investor, 265,000 were issued upon the exercise of previously granted warrants
and options, 145,747 were issued upon conversion of convertible debentures,
804,065 were issued upon the conversion of preferred stock and 592,500 were
issued to unaffiliated individuals for services rendered valued at $3,812,971
based on the fair market value of the shares at the time of issuance.
During the year ended December 31,1996, the Company issued 11,741,242 shares of
common stock to unrelated private investors pursuant to various stock purchase
agreements and 60,000 shares were issued upon the exercise of warrant. In
connection with these stock issuances, the Company issued 420,000 shares of
common stock valued at $901,520 as payment of finders' fees to unrelated third
parties.
11. STOCK OPTIONS AND WARRANTS
Common Stock Options - On June 1, 1998, the Company's board of directors
approved the 1998 Stock Option and Incentive Plan for directors, employees and
other persons acting on behalf of the Company, under which the aggregate number
of shares authorized for issuance is 10,000,000. The Company's shareholders
approved the plan on July 14, 1998. The plan is administered by a committee
consisting of two or more directors of the Company. The exercise price for
options granted under the plan is the closing market price of the common stock
on the date the options are granted. The option term is ten years from the date
of grant. As of December 31, 1998, the number of shares available for grants
under this plan is 3,585,218.
On March 10, 1997, the Company's board of directors approved the 1997 Stock
Option and Incentive Plan for directors, employees and other persons acting on
behalf of the Company, under which the aggregate number of shares authorized for
issuance is 7,500,000. The plan is administered by a committee consisting of two
or more directors of the Company. The exercise price of such options is the
closing market price of the stock on the date the options are granted. The
option term is ten years from the date of grant. As of December 31, 1998, the
number of shares available for grants under this plan is 1,812,000.
In April 1996, the Company's board of directors approved the 1996 Directors'
Stock Option Plan, under which the aggregate number of shares authorized for
issuance is 5,400,000. The shareholders of the Company approved the plan at
their annual meeting in July 1996. The plan is administered by a committee
consisting of two or more directors of the Company. The plan provides that each
director shall receive options to purchase 200,000 shares of common stock for
services rendered as a director during each entire calendar year or portion of a
calendar year in excess of six months. The exercise price of such options is the
closing market price of the stock on the date the options are granted. The
option term is ten years from date of grant. As of December 31, 1998, the number
of shares available for granting under this plan is 1,800,000.
In December 1998, the Company granted options to purchase 2,800,000 shares of
common stock to members of the board of directors. Of the 2,800,000 shares,
1,400,000 were for services performed in 1998 and 1,400,000 were for services to
be performed in 1999 providing the directors serve six months in 1999.
In April 1996, the Company's board of directors approved a Long-Term Stock
Investment and Incentive Plan for officers, key employees and other persons
acting on behalf of the Company under which the aggregate number of shares
authorized for issuance is 900,000 shares. The exercise price of these options
is the closing market price of the stock on the date the options are granted.
The term of the plan is ten years and options are subject to a three-year
vesting schedule, pursuant to which one-third of the total number of options
granted may be exercised each year. As of December 31, 1998, the number of
shares available for grant under this plan is 725,000.
F-27
<PAGE>
A summary of options granted under the Company's various stock option plans for
the years ended December 31, 1998, 1997 and 1996 is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Stock Exercise Stock Exercise Stock Exercise
Options Price Options Price Options Price
------------ ----------- ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Total options outstanding
at beginning of year 10,565,000 $ 5.38 4,626,000 $ 4.07 - $ -
Granted 6,414,782 2.08 6,009,000 6.38 4,626,000 4.07
Exercised (35,000) 6.00 (15,000) 2.97 - -
Forfeited (1,067,000) 4.56 (30,000) 7.66 - -
Canceled - - (25,000) - - -
------------ ------------- ------------
Total options outstanding
at end of year 15,877,782 4.10 10,565,000 5.38 4,626,000 4.07
============ ============= ============
Total options exercisable
at end of year 9,524,766 5.11 5,392,675 5.05 2,000,000 4.06
============ ============= ============
Weighted average fair
value of options granted
during the year $ 1.98 $ 6.38 $ 4.07
</TABLE>
A summary of options outstanding and options exercisable under the Company's
various stock option plans at December 31, 1998 is presented below:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------- ---------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ---------- ------------- ------------- ------------ ------------------- -----------------
<S> <C> <C> <C> <C> <C>
$0.08-1.18 4,886,832 9.9 years $ 1.11 425,422 $ 1.13
2.97-4.06 4,199,000 7.5 years 3.98 3,917,669 4.02
5.00-6.50 6,471,950 8.7 years 6.28 4,865,008 6.21
7.13-8.50 320,000 8.2 years 7.17 316,667 7.16
---------- ---------
$0.08-8.50 15,877,782 8.7 years $ 4.10 9,524,766 $ 5.11
</TABLE>
The Company accounts for its stock option plans as they relate to employees and
directors under Accounting Principles Board Opinion No. 25, and therefore, no
compensation expense has been recognized in the accompanying consolidated
statements of operations. Had compensation expense for these options been
determined in accordance with the method prescribed by SFAS No. 123, "Accounting
for Stock Based Compensation", the Company's net loss per common share
F-28
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
would have been increased to the pro forma amounts indicated below for the years
ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- -------------------
Net loss attributable to common stockholders:
<S> <C> <C> <C>
As reported $47,916,031 $ 25,175,939 $ 7,829,508
Pro forma 56,576,232 48,870,670 20,289,706
Basic and diluted net loss per common share:
As reported $ (0.91) $ (0.59) $ (0.21)
Pro forma (1.08) (1.15) (0.55)
</TABLE>
The fair value of options and warrants is estimated on the date granted using
the Black-Scholes pricing model with the following weighted-average assumptions
used for grants during 1998, 1997 and 1996: Risk-free interest rate of 4.8
percent, 5.6 percent and 6.5 percent for 1998, 1997 and 1996, respectively;
expected dividend yield of 0 percent for 1998, 1997 and 1996; expected exercise
lives of 5 years, 5 years and 10 years for 1998, 1997 and 1996, respectively;
expected volatility of 85 percent, 75 percent and 103 percent for 1998, 1997 and
1996, respectively. The estimated fair value of options granted is subject to
the assumptions made, and if the assumptions were to change the estimated fair
value amounts could be significantly different.
Warrants - A summary of warrants granted by the Company during the years ended
December 31, 1998, 1997 and 1996 is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ----------- ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Total outstanding at beginning of year 1,175,000 $ 6.39 450,000 $ 1.63 410,000 $ 0.93
Granted 1,200,000 16.94 975,000 6.92 100,000 3.24
Exercised (230,000) 1.28 (250,000) 1.40 (60,000) 0.50
Forfeited (220,000) 9.14 - -
---------- ---------- --------
Total outstanding at end of year 1,925,000 13.08 1,175,000 6.39 450,000 1.63
========== ========== ========
Total exercisable at end of year 1,925,000 13.08 1,175,000 6.39 450,000 1.63
========== ========== ========
</TABLE>
12. RELATED-PARTY TRANSACTIONS
Employee Advances - The Company advanced funds to certain executives and
employees totaling $67,231 as of December 31, 1998. Subsequent to that date,
certain executives of the Company have advanced funds totaling approximately
$306,000 to the Company. These advances have been used to reduce current
obligations of the Company.
Guarantee of Company Obligations and Related Indemnity Agreement -Two of the
executive officers and directors and the chairman of the board of directors of
the Company (the "Guarantors") have guaranteed certain obligations of the
Company. As security for some of the guarantees, the Guarantors have also
pledged shares of Fonix common stock beneficially owned by them. The guaranteed
obligations and the related pledged Fonix shares are summarized as follows:
F-29
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Amount Shares
Guaranteed Pledged
----------------- ----------------
<S> <C> <C>
As of December 31, 1998:
Revolving bank note in excess of the
pledged certificate of deposit,
credit cards payable, and accrued interest $ 222,380 3,500,000
Note payable 560,000 -
Guarantees issued after December 31, 1998:
Series C 5% Convertible Debentures 6,500,000 6,000,000
Accounts payable - legal fees 147,000 100,000
</TABLE>
In consideration for the pledge of Fonix common shares as collateral for the
Series C 5% Convertible Debentures, the board of directors authorized the
issuance, to the guarantors of one common stock purchase warrant for every three
shares pledged. The common stock purchase warrants have a term of 10 years and
an exercise price of 125 percent of the closing bid price of the Company's
common stock on January 29, 1999, the date of issuance of the debentures. The
warrants are not exercisable for at least six months after the date of issuance.
In addition, the Company has agreed to indemnify the Guarantors if they are
required to pay any sums for the benefit of the Company under their guaranty of
the Series C 5% Convertible Debentures. The indemnity agreement provides that
the Company will issue shares of the Company's common stock of sufficient value
to reimburse the guarantors in full, plus interest at 10 percent per annum, for
all costs associated with meeting the guarantee commitment, including any income
taxes resulting therefrom.
Subsequent to December 31, 1998, 143,230 of the pledged shares were sold by the
bank and the proceeds were used to pay the outstanding balance related to the
credit cards.
Studdert Companies Corp. - Studdert Companies Corp. ("SCC") is a Utah
corporation that provides investment and management services. The officers,
directors and owners of SCC are directors and executive officers of the Company
and each of whom beneficially owns more than 10 percent of the Company's issued
and outstanding common stock. Between June 1994, when the Company commenced its
present business of developing its ASR technologies, and April 30, 1996, the
Company did not pay or award any compensation in any form directly to the
Company's executive officers. Rather, in June 1994, the Company entered into an
Independent Consulting Agreement (the "SCC Agreement") with SCC pursuant to
which SCC rendered certain management and financial services to the Company.
Pursuant to the SCC Agreement, between January and July 1995, SCC invoiced the
Company for services rendered. By July 1995, the Company owed SCC approximately
$1,417,000 pursuant to the terms of the SCC Agreement. On July 31, 1995, the
Company issued warrants to purchase up to 3,700,000 shares of the Company's
common stock to SCC. The purchase price of the warrants was $.033 per share of
common stock, or an aggregate of $122,100. On August 11, 1995, SCC exercised the
warrants at an exercise price of $0.35 per share. Both the $122,100 purchase
price and the $1,295,000 aggregate exercise price for the warrants were
satisfied by the cancellation of amounts invoiced to the Company by SCC pursuant
to the SCC Agreement during the fiscal year ended December 31, 1994 and the
period between January 1, 1995 and August 11, 1995. Such cancellation was
accomplished on a dollar-for-dollar basis.
Between August 1995 and October 1995, SCC continued to invoice the Company for
its $50,000 monthly management fee. On October 23, 1995, the Company entered
into an investment agreement (the "Beesmark Agreement") with Beesmark. In
connection with the Company's execution of the Beesmark Agreement, SCC and the
Company agreed that any then accrued but unpaid balance due to SCC for
management services rendered under the SCC Agreement would be placed on
"conditional status" and deferred until the Company successfully completed
certain developmental milestones set forth in the Beesmark Agreement, at which
time such amounts would be due and payable in full. With respect to management
services to be rendered by SCC after the closing of the Beesmark Agreement, SCC
agreed that the Company would pay only $30,000 of the monthly invoiced $50,000,
the balance to be placed on conditional status.
F-30
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Thus, of the total $600,000 invoiced to the Company by SCC during the year ended
December 31, 1995, the Company paid SCC $90,000 in cash; $257,000 of accrued but
unpaid amounts were placed on conditional status under the Beesmark Agreement;
and $253,000 was canceled in partial payment of the exercise price of the SCC
Warrants. In addition to the amounts invoiced by SCC for management fees during
the 1995 fiscal year, the Company also reimbursed SCC for actual expenses
incurred in the amount of $337,405. Thus, at December 31, 1995, the Company owed
SCC $257,000 in management fees, all of which was on conditional status under
the terms of the Beesmark Agreement and was payable to SCC only in the event
that the Company achieved the developmental milestones set forth in the Beesmark
Agreement. At December 31, 1995, the Company also owed SCC $3,825 for expenses
incurred. Additionally, during the year ended December 31, 1995, SCC charged a
total of $70,915 in capital raising fees to the Company. Of that amount, $49,576
was written off by SCC in connection with the Beesmark Agreement, and $21,339
was paid to SCC.
Between January 1, 1996 and April 30, 1996, SCC invoiced the Company for
services under the SCC Agreement in the amount of $200,000. Of that amount,
$80,000 was placed on conditional status pursuant to the Beesmark Agreement and
$120,000 was paid to SCC. On April 30, 1996, the disinterested members of the
Company's board of directors authorized the Company to enter into an agreement
with SCC modifying the SCC Agreement effective May 1, 1996. Under the SCC
Agreement, as modified, SCC no longer invoiced the Company for management
services, but continued to invoice the Company for reimbursement of actual
expenses incurred on the Company's behalf. SCC and the Company agreed that any
amounts invoiced under the SCC Agreement but placed on conditional status
pursuant to the Beesmark Agreement would remain outstanding obligations of the
Company payable only if the Company achieved the milestones specified in the
Beesmark Agreement. The Company further agreed to pay any then accrued but
unpaid amounts invoiced under the SCC Agreement, including amounts owed and
carried over from the year ended December 31, 1995, which amounts totaled
$5,862, as well as outstanding amounts for expenses incurred. In September 1996,
Beesmark made the last of the funding payments provided for under the terms of
the Beesmark Agreement. On February 10, 1997, the Company paid to SCC the entire
balance due to SCC for accrued management fees in the amount of $337,000. Thus,
during the year ended December 31, 1996, the Company paid to SCC a total of
$120,000 for management fees and SCC was reimbursed for actual expenses incurred
on the Company's behalf in the amount of $740,052. During 1996, the Company made
no payments to SCC for capital raising activities. The Company and SCC have
agreed to extend the SCC Agreement, at least insofar as the Company has agreed
to reimburse SCC for actual expenses incurred on behalf of the Company through
December 1998.
The Company paid no compensation in any form directly to any of its executive
officers during fiscal 1995 and until April 1, 1996. However, as the principals
of SCC, during such periods, the Company's executive officers received a portion
of the amounts paid by the Company to SCC under the SCC Agreement.
Related-party transactions with SCC not otherwise disclosed herein as of and for
the years ended December 31, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
Expenses:
<S> <C> <C> <C>
Management fees $ - $ - $ 200,000
Rent 117,228 77,203 52,000
Liabilities:
Accounts payable - - 411,743
Accrued liabilities - 459,502 1,350,000
</TABLE>
The Company rents office space under a month-to-month lease from SCC and the
lease from SCC is guaranteed by the three officers, owners and directors of SCC.
The lease requires monthly payments of $10,368. The Company believes the terms
of the related-party lease are at least as favorable as the terms that could
have been obtained from an
F-31
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
unaffiliated third party in a similar transaction.
Beesmark Investments, L.C. - On October 23, 1995, the Company, Beesmark and a
director entered into the Beesmark Agreement. The director did not occupy such
position when the Beesmark Agreement was negotiated and executed. The director
also is a co-manager of and has an indirect pecuniary interest in a portion of
Beesmark's assets. Pursuant to the Beesmark Agreement, Beesmark agreed to
provide a total of $6,050,000 of funding to the Company over a period of
approximately 11 months, provided that during that time the Company was able to
timely meet, to Beesmark's satisfaction, specified developmental milestones. In
return for the funding provided to Beesmark, the Company agreed to issue
11,562,500 shares of common stock at a price of $0.48 per share and a $500,000
Series A Convertible Subordinated Debenture that is convertible into either
166,667 shares of Series A Convertible Preferred Stock or 166,667 shares of the
Company's common stock. During the year ended December 31, 1996, Beesmark paid
all installments payable by Beesmark under the Beesmark Agreement, and the
Company issued, in the increments specified, all of the securities issuable to
Beesmark under the Beesmark Agreement.
SMD, L.L.C. - From September 4, 1997, through October 15, 1997 and again on
December 31, 1997, the Company, borrowed funds from SMD, L.L.C., a company owned
by three directors and executive officers of the Company (each of whom
beneficially owns more than 10 percent of the Company's issued and outstanding
common stock) pursuant to a revolving, unsecured promissory note, bearing
interest at the rate of 12 percent per annum. The aggregate of all amounts
loaned under the note was $2,000,000 and the highest outstanding balance at any
one time was $1,550,000. All amounts were repaid, together with $5,542 in
interest in 1998. The loan and its terms were approved by the independent
members of the board of directors of the Company.
K.L.S. Enviro Resources, Inc. - Between May 1996 and August 1996, as part of the
Company's short-term cash management policy, the Company entered into a series
of loan transactions with KLSE, an entity which then was unaffiliated with the
Company. The Company was introduced to KLSE by an unaffiliated third party. As
of August 12, 1996, the Company had loaned to KLSE a total of $1,900,000, which
loans were due upon demand, bore interest at the rate of 12 percent per annum,
required the payment of certain loan origination fees, and were secured by
substantially all of the assets of KLSE, except its real property. The first of
the loans from the Company in the amount of $710,000 was made on May 16, 1996
and the last advance prior to August 12, 1996, in the amount of $590,000, was
made on July 16, 1996. Pursuant to the terms of the promissory note representing
the $710,000 advanced by the Company to KLSE in May 1996, all or part of the
balance due under that note was convertible at the option of the holder of the
note to 2,366,667 shares of the restricted common stock of KLSE at the rate of
$.30 per share. Similarly, the remaining $1,190,000 owed to the Company,
represented by four separate promissory notes, was convertible into a total of
2,975,000 shares of KLSE restricted common stock at the rate of $.40 per share.
KLSE also entered into a registration rights agreement with the Company. In
connection with that course of financing, a director and executive officer of
the Company assumed a position on KLSE's board of directors, effective July 10,
1996.
On September 30, 1996, SMD advanced debt financing (the "SMD Loan") to KLSE (see
below) in the amount of $1,673,730. The SMD Loan was due on demand, bore
interest at the rate of 12 percent per annum and was secured by the assets of
KLSE, except its real property. The proceeds of the SMD Loan enabled KLSE to pay
the Company $1,673,700 in satisfaction of all then-outstanding balances due the
Company except a balance of $272,156 due and owing under the first promissory
note from KLSE to the Company in the amount of $710,000. In return for the
provision of the SMD Loan to KLSE, SMD acquired warrants to purchase 6,600,000
shares of KLSE restricted Common Stock at the exercise price of $.40 per share.
These warrants have never been exercised.
Based upon certain changed circumstances at KLSE, on October 29, 1996, the
Company made an additional loan of $200,000 to KLSE. That additional advance was
repaid in full, with accrued interest, by KLSE on December 24, 1996. Also, on
December 31, 1996 the Company sold for cash and assigned $270,000 of the balance
due under the $710,000 promissory note to Ballard Investment Company, a Utah
limited partnership unaffiliated with the Company. Also, on December 31, 1996,
KLSE paid the Company the balance of approximately $10,500 due and owing under
the $710,000
F-32
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
promissory note. Since December 31, 1996, KLSE has not been indebted to the
Company in any amount nor has the Company had any beneficial interest in KLSE.
Synergetics - Through December 1998, a director and the chief executive officer
of the Company was also one of seven directors of Synergetics, Inc. In addition,
three executive officers and directors of the Company owned shares of the common
stock of Synergetics, although such share ownership in the aggregate constituted
less than 5 percent of the total shares of Synergetics common stock issued and
outstanding. Effective December 31,1998, the chief executive officer and
director of the Company resigned from the board of Synergetics and the three
executive officers and directors relinquished all ownership of Synergetics
shares. The Company engages Synergetics to provide assistance to Fonix in the
development of its ASR technologies (see Note 14).
Voice Information Associates, Inc. - A director and executive officer of the
Company is also the founder and president of Voice Information Associates, Inc.
("VIA"), a consulting group providing strategic technical, market evaluation,
product development and corporate information to the speech recognition
industry. During 1997, the Company paid approximately $110,000 in consulting
fees to VIA for services provided to the Company. No payments were made by the
Company to VIA in 1998.
Other Transactions - During 1996, disinterested members of the Company's board
of directors authorized the Company to reimburse certain officers for all taxes
payable by the officers in conjunction with the 1995 exercise of 3,700,000
warrants by a company owned by the officers. The total amount authorized to be
reimbursed was $1,150,000 in 1997 and $1,350,000 in 1996. During the years ended
December 31, 1998 and 1997, the Company paid $340,516 and $2,159,484,
respectively, of the authorized reimbursements.
13. STATEMENT OF WORK
On February 11, 1998, the Company entered into a First Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") under which the Company and Siemens are jointly pursuing the
development of Siemens' integrated circuits incorporating ASR and other related
technologies for use in certain telecommunications applications. On February 20,
1998, the Company received $2,691,066 in cash from Siemens. Of that amount: (1)
$1,291,712 was paid to the Company as a non-refundable payment to license
certain ASR technologies for which the Company has no further obligation; (2)
$322,928 was paid to purchase warrants to acquire 1,000,000 shares of restricted
common stock at an average exercise price of $20 per share with expiration dates
ranging from December 31, 1998 to December 31, 1999; and (3) $1,076,426 was paid
to the Company to acquire, if Siemens so elected, shares of the Company's
restricted common stock or to become a non-refundable license payment. In June
1998, Siemens elected to apply the $1,076,426 portion as a non-refundable
payment to license certain ASR technologies for which the Company has no further
obligation. The Company recorded the $2,368,138 license payments as revenue
during the year ended December 31, 1998.
14. PRODUCT DEVELOPMENT AND RESEARCH
Synergetics - In October 1993, the Company entered into an agreement with
Synergetics (the "Synergetics Agreement"), a research and development entity,
whereby Synergetics was to develop certain technologies related to the Company's
ASR technologies. The Chief Executive Officer of the Company was one of seven
members of the board of directors of Synergetics, and three executive officers
and directors and 10 percent beneficial owners of the Company owned less than
five percent of the common stock of Synergetics. Under the terms of the
Synergetics Agreement, as subsequently modified, the Company acquired
intellectual property rights, technologies and technology rights that were
developed by Synergetics. The Company agreed to provide all funding necessary
for Synergetics to develop commercially viable technologies. There was no
minimum requirement or maximum limit with respect to the amount of the funding
to be provided by the Company. However, under the terms of the Synergetics
Agreement, the Company was obligated to use
F-33
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
its best efforts in raising the necessary funding for the engineering,
development and marketing of the ASR technologies. As part of the Synergetics
Agreement, the Company agreed to pay Synergetics a royalty of 10 percent of net
revenues from sales of the Company's products incorporating Synergetics'
"VoiceBox" speech recognition technologies or technologies derived therefrom
(the "Royalty"). As of December 31, 1998, the Company had not yet licensed or
sold its technologies, and consequently, had not made any royalty payments.
Under the terms of the Synergetics Agreement, the Company paid to Synergetics
$1,128,433, $2,819,427, and $4,758,012 in 1998, 1997 and 1996, respectively, for
research and development efforts.
Until March 1997, Synergetics had compensated its engineers, employees, members
of its development team, and other financial backers (collectively, the
"Developers"), in part, with the issuance of "Project Shares" granting the
holders of such shares the right, within limits, to share pro rata in future
royalty payments. In addition to issuance of Project Shares, Synergetics had
made advances to some members of its project team on a non-recourse basis.
Repayment of the advances was secured by future disbursements under the Project
Shares.
On March 13, 1997, the Company and Synergetics signed a Memorandum of
Understanding (the "MOU") which manifested their agreement in principle that the
Royalty should be canceled in exchange for the offering and issuance by the
Company of warrants to purchase up to 4,800,000 shares of the Company's common
stock. Certain of the employees and independent contractors then engaged by
Synergetics became full-time employees or independent contractors of the
Company. The majority shareholder and president of Synergetics became a
full-time consultant to the Company. Since March 14, 1997, the Company has been
conducting the majority of the research and development of the ASR technologies
at its own research facility staffed by its own employees, including some
Developers who have been employees of the Company since March 14, 1997.
On April 6, 1998, the Company and Synergetics entered into a Royalty
Modification Agreement, which provides for the Company to make an offer of
exchange of the Company's warrants to purchase common stock with a $10 per share
exercise price for the project shares at a rate of one warrant to purchase 800
common shares for each project share. The warrants would not be exercisable
until the earlier of (1) the date the Company's common stock is trading for a
period of 15 consecutive trading days at a minimum of $37.50 per share or (2)
September 30, 2000. The offer of the warrants cannot be made by the Company
until a registration statement covering the total number of warrants issuable
upon the exercise of the warrants has been declared effective by the U.S.
Securities and Exchange Commission. Upon the tender to Synergetics of any
Project Shares the related Royalty commitment will be canceled. Pending
completion of the registration statement and issuance of the warrant, the
Company will not pay any royalties to Synergetics.
IMC-2 - In March 1998, the Company entered into a professional services
agreement with IMC-2, a research and development entity, to provide assistance
to Fonix in the continuing development of specific ASR technologies. The
president of IMC-2 is also the president of Synergetics and Adiva. The agreement
is for a term of 36 months and requires the Company to make monthly payments of
$22,000. Future noncancellable payments under this agreement are $264,000,
$264,000 and $44,000 for the years ended December 31, 1999, 2000 and 2001. Under
the terms of the agreement, Fonix expended $220,000 in 1998 for research and
development efforts.
Adiva- During 1998, the Company utilized the research and development services
of Adiva. The president of Adiva is also the president of Synergetics and IMC-2.
During 1998, the Company expended $600,174 for services provided.
Advocast - In July 1997, the Company entered into an arrangement with Advocast,
Inc. ("Advocast") an Internet research and development entity, whereby Advocast
assisted Fonix in development of technologies to create and locate searchable
data bases on the Internet through the use of interactive video and voice
technologies. Under the terms of the arrangement Fonix paid $816,750 and
$705,005 in 1998 and 1997, respectively, for research and development efforts.
On November 25, 1998, in consideration for the research and development payments
received from Fonix through that date, Advocast issued 60,200 shares of Advocast
Series A 6% Convertible Preferred Stock. The Advocast shares, if
F-34
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
converted, represent less than 20 percent of the total outstanding shares of
Advocast voting common stock. Advocast is a development stage company with
minimal operations and there is substantial uncertainty as to the value of the
Advocast shares. The Company has therefore determined that there is not
sufficient marketability in Advocast shares to determine their value. As a
result, the Company has not recorded a value for the Advocast shares in the
accompanying consolidated financial statements.
15. INCOME TAXES
At December 31, 1998 and 1997, net deferred income tax assets, before
considering the valuation allowance, totaled $24,325,269 and $15,746,597,
respectively. The amount of and ultimate realization of the benefits from the
deferred income tax assets is dependent, in part, upon the tax laws in effect,
the Company's future earnings, and other future events, the effects of which
cannot be determined. The Company has established a valuation allowance for all
deferred income tax assets not offset by deferred income tax liabilities due to
the uncertainty of their realization. Accordingly, there is no benefit for
income taxes in the accompanying consolidated statements of operations. The net
change in the valuation allowance was an increase of $8,529,870 for the year
ended December 31, 1998.
The Company has available at December 31, 1998, unused federal net operating
loss carryforwards of approximately $62,916,000 and unused state net operating
loss carryforwards of approximately $63,295,000 which may be applied against
future taxable income, if any, and which expire in various years from 2008
through 2018. The Internal Revenue Code contains provisions which likely could
reduce or limit the availability and utilization of these net operating loss
carryforwards. For example, limitations are imposed on the utilization of net
operating loss carryforwards if certain ownership changes have taken place or
will take place. The Company has not performed an analysis to determine whether
any such limitations have occurred.
The temporary differences and carryforwards which give rise to the deferred
income tax assets (liabilities) as of December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
-------------- ---------------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards:
Federal $ 21,391,555 $ 14,030,670
State 2,088,746 1,312,988
Research and development credits 694,239 275,927
Accrued bonus liabilities 150,729 127,012
-------------- ---------------
Total deferred income tax assets before valuation allowance 24,325,269 15,746,597
Valuation allowance (24,176,653) (15,646,783)
-------------- ---------------
Net deferred income tax assets 148,616 99,814
-------------- ---------------
Deferred income tax liabilities:
Depreciation (148,316) (99,514)
Intangibles (300) (300)
-------------- ---------------
Total deferred income tax liabilities (148,616) (99,814)
-------------- ---------------
$ - $ -
============== ===============
</TABLE>
F-35
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of income taxes at the federal statutory rate to the Company's
effective rate is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1998 1997 1996
------- -------- ---------
<S> <C> <C> <C>
Federal statutory income tax rate 34.0 % 34.0 % 34.0 %
State and local income tax rate,
net of federal benefit 3.3 3.3 3.3
Valuation allowance (37.3) (37.3) (37.3)
------- -------- ---------
Effective income tax rate - % - % - %
======= ======== =========
</TABLE>
16. COMMITMENTS AND CONTINGENCIES
Employment Agreements - In January 1998, the Company entered into employment
contracts with two employees which expire in January 2001. The minimum annual
salary payments required by these contracts total $405,000. In connection with
these agreements, these individuals were granted options to purchase 360,000
shares of the Company's common stock at $3.34 per share. These options have a
ten-year life and are subject to a three-year vesting schedule, pursuant to
which one-third of the total number of options granted may be exercised each
year. One-third of the options are vested on the date of grant. In the event
that, during the contract term, both a change of control occurs, and within six
months after such change in control occurs, the executive's employment is
terminated by the Company for any reason other than cause, death or retirement,
the executive shall be entitled to receive an amount in cash equal to all base
salary then and thereafter payable within thirty days of termination. In January
1999, the Company announced a major cost reduction program for the Company's
1999 operating year wherein the compensation of two employees referred to above
was reduced 30 percent effective February 1999.
Executive Employment Agreements - On November 1, 1996, the Company entered into
employment contracts with three executive officers (one of whom is no longer an
executive officer) which expire on December 31, 2001. The annual base salary
compensation for each executive officer for the years ended December 31, 1999,
2000 and 2001 is $425,000, $550,000 and $750,000, respectively.
Additionally, each executive officer is entitled to annual performance-based
incentive compensation payable on or before December 31 of each calendar year
during the contract term. During the first three years of the contract term, the
performance-based incentive compensation is determined in relation to the market
price of the Company's common stock, adjusted for stock dividends and splits. If
the price of the Company's common stock maintains an average price equal to or
greater than the level set forth below over a period of any three consecutive
months during the calendar year, the performance-based incentive compensation
will be paid in the corresponding percentage amount of annual base salary for
each year as follows:
<TABLE>
<CAPTION>
Quarterly Average Stock Price Percentage Bonus
<S> <C> <C>
$10.00 30%
$12.50 35%
$15.00 40%
$20.00 45%
$25.00+ 50%
</TABLE>
The annual base salary and performance-based incentive compensation for the
final two contract years will be subject to review by the Company's board of
directors.
F-36
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the event that, during the contract term, both a change of control occurs,
and within six months after such change in control occurs, the executive's
employment is terminated by the Company for any reason other than cause, death,
or retirement, the executive shall be entitled to receive an amount in cash
equal to all base salary then and thereafter payable within thirty days of
termination.
In January 1999, the Company announced a major cost reduction program for the
Company's 1999 operating year wherein the compensation of the two remaining
officers will be reduced to $297,500 commencing February 1999. At the same time,
Stephen M. Studdert resigned as the Company's Chief Executive Officer and
entered into a separation agreement pursuant to which Mr. Studdert will be paid
$250,000 per year through January 31, 2001 and $100,000 for the year ended
January 31, 2002. Additionally, his employment contract was canceled.
Professional Services Agreement - Effective May 7, 1998, the Company entered
into a one-year professional services agreement with a public relations firm.
The minimum monthly retainer is $15,000 per month. In connection with this
agreement, the firm was granted options to purchase 100,000 shares of the
Company's common stock at $3.75 per share. The options have a ten-year term and
are fully vested. In connection with this transaction, the Company recorded
$320,100 of consulting expense, of which $106,700 is deferred as of December 31,
1998, to be recognized ratably over the life of the agreement.
Operating Lease Agreements - The Company leases certain facilities and equipment
used in its operations. The amount of commitments for noncancellable operating
leases in effect at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Years ending December 31,
- -------------------------
<S> <C> <C>
1999 $ 1,043,342
2000 677,073
2001 685,275
2002 696,162
2003 507,308
Thereafter 293,664
----------
Total $ 3,902,824
</TABLE>
The Company incurred rental expense of $868,110, $416,798 and $103,139 during
1998, 1997 and 1996, respectively, related to these leases.
In March 1999, the Company entered into an agreement to lease approximately
3,780 square feet of office space in Cleveland, Ohio for sales and installation
personnel. The lease is for three years at a monthly rate of $4,260 and is
effective May 1, 1999.
Certain of these operating leases, with commitments totaling $284,400, $54,060,
$52,100 and $17,040 for years ending December 31, 1999, 2000, 2001 and 2002,
respectively, were assumed by the purchaser in connection with the sale of HSG
(see Note 21).
Capital Lease Obligation - Future minimum lease payments of $56,260 for
equipment held under a capital lease arrangement as of December 31, 1998 are due
in 1999. The present value of these future minimum lease payments is $52,225.
Total assets held under the capital lease arrangement were $150,208 with
accumulated depreciation of $48,737 as of December 31, 1998.
AcuVoice - In connection with the AcuVoice acquisition, AcuVoice and its founder
made certain representations and
F-37
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
warranties to the Company. One of those representations focused on the scope of
a license agreement previously entered into by AcuVoice and General Magic for
use by General Magic of AcuVoice's text-to-speech software in General Magic's
Serengeti product. After the AcuVoice acquisition closed, the Company determined
that AcuVoice and its founder had breached the representation concerning the
General Magic license agreement. Under the terms of the AcuVoice acquisition
agreement, on March 12, 1999, the Company submitted a claim for the 80,000
shares deposited into the escrow account by the former stockholders of AcuVoice.
The founder, as agent for the former stockholders of AcuVoice, denied the claim.
The Company is presently preparing, a response to the founder's denial of the
claim. If the founder continues to deny the claim after review of the Company's
response, the Company will seek to arb its claim pursuant to the terms of the
AcuVoice acquisition agreement. The Company is presently considering other
possible remedies against the founder and the other former directors of
AcuVoice.
General Magic, Inc. - On September 23, 1997, AcuVoice entered into a license
agreement with General Magic, Inc. ("General Magic") wherein AcuVoice granted
General Magic a perpetual, irrevocable, worldwide license in a specific field of
use to use, reproduce, publicly display and distribute AcuVoice's TTS software
in connection with General Magic's voice accessed integrated network service,
also known as the Serengeti product. The license is exclusive for the first
three years and non-exclusive thereafter. Under the terms of the license
agreement, the Company is entitled to royalty payments based upon monthly
subscriber revenue from the use of the integrated network service. Additionally,
the Company granted an option to General Magic to purchase the then current TTS
source code and all source code documentation for a cash payment of $2,500,000
and $2,500,000 in General Magic common stock.
17. LITIGATION
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse purportedly owns, commenced an action against Fonix in federal
court for the Southern District of New York. Clarke and Perpetual Growth assert
claims for breach of contract relating to certain financing Fonix received
during 1998. Specifically, Clarke and Perpetual Growth allege that they entered
into a contract with Fonix under which Fonix agreed to pay them a commission of
five percent of all financing provided to Fonix by Southridge Capital Management
or its affiliates. Clarke and Perpetual claim that they are entitled to
commissions with respect to approximately $3,000,000 of equity financing to
Fonix in July and August 1998, and Fonix's offerings of Series D and Series E
preferred stock, totaling together $12,000,000, in August and September 1998.
Fonix believes that the Clarke lawsuit is without merit and filed a motion to
dismiss based upon the court's lack of personal jurisdiction over Fonix. The
court granted Fonix's motion to dismiss, on a conditional basis, subject to the
right of Clarke and Perpetual Growth to produce additional evidence which would
establish jurisdiction of the New York court over Fonix. Clarke and Perpetual
Growth filed a motion with the New York court that sought to establish a factual
and legal basis for the New York court's exercise of jurisdiction over Fonix.
However, the court denied that motion. In the interim, Fonix 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, Fonix
intends to vigorously pursue the Utah action. However, Clarke and Perpetual
Growth could prevail in the lawsuit, in which case Fonix may be required to pay
significant amounts of money damages or other amounts awarded by the court. At a
minimum, the ongoing nature of this action will result in some diversion of
management time and effort from the operation of the business.
Papyrus - 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 their executive officers were false. At about the same time, the
Company began negotiations with the former executive officers of Papyrus, which
negotiations, among other things, included discussions regarding rescission of
the Papyrus acquisition. On February 26, 1999, 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
F-38
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 (the "Massachusetts
Action"), 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. Subsequently, the Company has entered into
agreements with the four former Papyrus shareholders for dismissal of the
actions and cancellation of the promissory notes upon payment to the former
shareholders of $1,122,209 (the "Settlement Payment") an amount equal to
approximately 73 percent of the balance due them under the notes issued to them
in the Papyrus acquisition, and return for cancellation by the Company of
970,586 shares of restricted common stock issued to them in the Papyrus
acquisition. The Company must pay the Settlement Payment before May 16, 1999. If
it does not, the Company and the four 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 (see Note 2). The Company has completed discovery in the
action pending against Apple and is awaiting the scheduling of a trial.
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.
The Company sold its rights with respect to this matter of litigation as part of
the sale of HSG (see Note 21).
18. EMPLOYEE PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan covering essentially all of its
full-time employees. Under the plan, employees may reduce their salaries, in
amounts allowed by law, and contribute the salary reduction amount to the plan
on a pretax basis. The plan also allows the Company to make matching and profit
sharing contributions as determined by the board of directors. To date, no
matching or profit sharing contributions have been made by the Company.
19. REPORTABLE SEGMENTS
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement requires disclosures related
to components of a company for which separate financial information is available
and evaluated regularly by the Company's chief operating decision makers in
deciding how to allocate resources and in assessing performance. As a result of
the sale of HSG in September 1999 (see Note 21), management believes that the
Company has only one operating segment because the Company's remaining core
business consists only of operations derived from the Interactive Technologies
Solutions Group ("ITSG"). ITSG includes the development of relationships with
third parties who can incorporate Fonix technologies into their own products or
product development efforts. These products include speech recognition
technology licensing including speech-to-text and text-to-speech applications.
All of the Company's revenues for 1998 were sourced from the United States. Of
the $2,604,724 in revenues for 1998,
F-39
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$2,368,138 was from one customer, Siemens, in connection with non-refundable
license payments under a Statement of Work and License Agreement. The remaining
amount of revenue was primarily from the sale of speech-to-text applications and
licenses.
20. SUBSEQUENT EVENTS
Related Party Notes Payable - Subsequent to December 31, 1998, the Company
issued unsecured notes payable to an executive officer in the amount of $68,691
for cash used as working capital by the Company. These notes bear interest at 10
percent and are due on July 31, 1999.
Recent Financing Activities - 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 holder 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 also issued 400,000
warrants in connection with this financing. 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 obligations of the Company for repayment of
the debentures, as well as its obligation to register the common stock
underlying the potential conversion of the debentures and the exercise of the
warrants issued in these transactions, are personally guaranteed by the
Guarantors. These personal guarantees are secured by a pledge of 6,000,000
shares of Fonix common stock beneficially owned by them. The Company has entered
into an indemnity agreement with the Guarantors relating to this and other
guarantees and pledges (see Note 12). In connection with second funding, the
Company agreed to pledge, as collateral for repayment of the debentures, a lien
on the patent covering the Company's ASR technologies.
Subsequent to the second funding, the holders of the debentures notified the
Company and the Guarantors that the Guarantors were in default under the terms
of the pledge and that the holders intended to exercise their rights to sell
some or all of the pledged shares of the Guarantors. At the present time, the
Company has no knowledge of sales of the Guarantors' shares by the holders.
However, if the holders proceed to sell some or all of the Guarantors' shares,
the Company may be obligated, under its indemnity agreement, to issue
replacement shares to the Guarantors for all shares sold by the holders and
reimburse Guarantors for any costs incurred as a result of the holders' sales of
Guarantors' shares.
One of several events described in the Securities Purchase Agreement as a
"Triggering Event"is the suspension from listing or delisting of the Company's
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 Series C 5% Convertible Debentures
desire to exercise any rights they may have under the agreement.
Issuance of Stock Options - On February 15, 1999, the Company granted an
aggregate of 762,500 stock options to various employees of the Company. These
options have a ten-year life, an exercise price of $1.53 per share and vested on
the grant date.
21. SALE OF THE HEALTHCARE SOLUTIONS GROUP
In September 1999, the Company completed the sale of the operations and a
significant portion of the assets (the "Sale") of its HSG to Lernout & Hauspie
Speech Products N.V. ("L&H"), an unrelated third party, for up to $28,000,000.
Of this sales price, $21,500,000, less certain credits of $194,018, was paid at
closing, $2,500,000 is being held in an 18 month escrow account in connection
with the representations and warrantees made by the Company in the sales
F-40
<PAGE>
Fonix Corporation
[A Development Stage Company]
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
transaction and the remaining $4,000,000 is to be contingently paid as an
earnout in two installments of $2,000,000 each over the next two years based on
the performance of HSG. The proceeds from the sale were used to reduce a
significant portion of the Company's liabilities and to provide working capital
for the Company's marketing and distribution opportunities for its Interactive
Technology Solutions Group. The assets sold included inventory, property and
equipment, certain prepaid expenses, purchased core technology and other assets.
Additionally, L&H assumed the capital and operating lease obligations related to
HSG and the obligations related to certain deferred revenues.
Upon the closing of the Sale, the Company discontinued the operations of HSG.
The results of operations of HSG have been reported separately as discontinued
operations in the accompanying condensed consolidated statements of operations.
Prior year results have been restated to provide comparability. The net assets
(liabilities) of HSG in the December 31, 1998 consolidated balance sheet consist
of the following:
<TABLE>
<CAPTION>
<S> <C>
Inventory $ 72,582
Other receivables 4,554
Deferred revenues (675,997)
--------------
Net current assets (liabilities) $ (598,861)
==============
Property and equipment, net of
accumulated depreciation of $27,367 $ 182,981
Intangible assets, net of accumulated
amortization of $828,886 19,379,131
Other assets 22,343
--------------
Net long-term assets $ 19,584,455
</TABLE>
Revenues from HSG's operations were $284,960 for the period from the date of
acquisition through December 31, 1998. These amounts have not been included in
revenues reported in the accompanying consolidated statement of operations for
the year ended December 31, 1998.
F-41
<PAGE>
Table of Contents
Interim unaudited condensed consolidated financial statements as of September
30, 1999, and December 31, 1998, and for the nine months ended September 30,
1999 and 1998
Condensed Consolidated Balance Sheets (Unaudited) Q-2
Condensed Consolidated Statements of Operations (Unaudited) Q-3
Condensed Consolidated Statements of Cash Flows (Unaudited) Q-4
Notes to Condensed Consolidated Financial Statements (Unaudited) Q-6
Q-1
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
September 30, December 31,
1999 1998
--------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,048,257 $ 20,045,539
Notes receivable - 245,000
Accounts receivable, net of allowance for doubtful accounts of
$74,000 and $8,000, respectively 331,451 219,908
Prepaid expenses 7,901 51,866
Inventory 1,894 4,804
Interest and other receivables 20,712 3,722
Employee advances - 67,231
--------------- ------------
Total current assets 2,410,215 20,638,070
Cash held in escrow 2,500,000 -
Property and equipment, net of accumulated depreciation of $1,740,234
and $1,168,023, respectively 1,347,061 2,145,031
Intangible assets, net of accumulated amortization of $3,757,780 and
$1,770,668, respectively 16,034,270 19,437,290
Other assets 106,536 107,945
Net long term assets of discontinued operations - 19,584,455
--------------- ------------
Total assets $ 22,398,082 $ 61,912,791
=============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ - $ 138,034
Revolving notes payable - 20,038,193
Notes payable - related parties 77,625 8,491,880
Notes payable - other - 560,000
Capital lease obligation 5,180 52,225
Accounts payable 1,756,032 3,536,074
Accrued liabilities 2,659,267 981,774
Accrued liabilities - related parties 1,998,590 900,004
Income taxes payable 250,000 -
Deferred revenues 63,722 20,000
Net current liabilities of discontinued operations - 598,861
--------------- ------------
Total current liabilities 6,810,416 35,317,045
Series C 5% convertible debentures 3,971,107 -
--------------- ------------
Total liabilities 10,781,523 35,317,045
--------------- ------------
Common stock and related repricing rights subject to redemption; 1,801,802 shares and
repricing rights outstanding (aggregate redemption value of $2,500,000) 1,830,000 1,830,000
--------------- ------------
Commitments and contingencies (Notes 8, 9, and 15)
Stockholders' equity:
Preferred stock, $.0001 par value; 20,000,000 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; 876,667 and 958,334 shares
outstanding, respectively
(aggregate liquidation preference of $18,299,103) 20,705,530 22,200,936
Series E, 4% cumulative convertible; 250,000 shares outstanding in 1998 - 3,257,886
Common stock, $.0001 par value; 100,000,000 shares authorized;
83,750,179 and 64,324,480 shares outstanding, respectively 8,375 6,432
Additional paid-in capital 99,217,980 88,517,711
Outstanding warrants 3,585,399 3,323,258
Deferred consulting expense - (106,700)
Deficit accumulated during the development stage (114,230,725) (92,933,777)
--------------- ------------
Total stockholders' equity 9,786,559 24,765,746
--------------- ------------
Total liabilities and stockholders' equity $ 22,398,082 $61,912,791
=============== ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-2
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Three Months Ended Nine Months Ended (Inception) to
September 30, September 30, September 30,
-------------------------- --------------------------
1999 1998 1999 1998 1999
------------ ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Revenues $ 65,707 $ 95,500 $ 351,083 $ 2,567,785 $ 2,955,807
Cost of revenues 7,919 7,372 21,159 31,561 56,599
------------ ------------- ------------- ------------- -------------
Gross margin 57,788 88,128 329,924 2,536,224 2,899,208
------------ ------------- ------------- ------------- -------------
Expenses:
Selling, general and administrative 2,864,400 2,672,252 7,537,577 6,112,765 38,601,890
Product development and research 1,906,968 4,296,938 6,278,318 9,958,433 37,276,215
Amortization of goodwill and purchased core
technology 630,609 500,776 1,962,443 1,100,336 3,674,710
Purchased in-process research and development - - - 9,315,000 9,315,000
------------ ------------- ------------- ------------- -------------
Total expenses 5,401,977 7,469,966 15,778,338 26,486,534 88,867,815
------------ ------------- ------------- ------------- -------------
Loss from operations (5,344,189) (7,381,838) (15,448,414) (23,950,310) (85,968,607)
------------ ------------- ------------- ------------ -------------
Other income (expense):
Interest income 26,198 292,241 46,752 856,123 3,713,840
Interest expense (1,577,413) (365,902) (4,314,809) (960,803) (9,638,041)
Other expense (154,940) - (154,940) - (154,940)
Cancellation of common stock reset provision - (6,111,577) - (6,111,577) (6,111,577)
------------ ------------- ------------- ------------- -------------
Total other income (expense), net (1,706,155) (6,185,238) (4,422,997) (6,216,257) (12,190,718)
------------ ------------- ------------- ------------- -------------
Loss from continuing operations (7,050,344) (13,567,076) (19,871,411) (30,166,567) (98,159,325)
Discontinued operations:
Operating loss of HealthCare
Solutions Group (2,962,147) (5,026,049) (5,953,726) (5,026,049) (12,229,033)
Gain on disposal of HealthCare Solutions Group,
net of income taxes of $250,000 6,616,646 - 6,616,646 - 6,616,646
------------ ------------- ------------- ------------- -------------
Loss before extraordinary items (3,395,845) (18,593,125) (19,208,491) (35,192,616) (103,771,712)
Extraordinary items:
Loss on extinguishment of debt - - - - (881,864)
Gain on forgiveness of accounts payable and
accrued interest 372,061 - 372,061 - 402,609
------------ ------------- ------------- ------------- -------------
Net loss $(3,023,784) $(18,593,125) $(18,836,430) $ (35,192,616) $(104,250,967)
============ ============ =========== ============= =============
Basic and diluted net loss per common share $ (0.05) $ (0.39) $ (0.31) $ (0.75)
============ =========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-3
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
October 1,
1993
Nine Months Ended (Inception) to
September 30, September 30,
-------------------------------
1999 1998 1999
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (18,836,430) $(35,192,616) $(104,250,967)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 100,000 - 5,587,554
Issuance of common stock for patent - 100,807 100,807
Non-cash expense related to issuance of notes payable,
debentures, warrants, preferred and common stock 2,270,000 6,111,577 12,348,914
Non-cash compensation expense related to issuance
of stock options 119,240 133,375 2,615,540
Non-cash expense related to issuance of notes payable
and accrued expense for services - 857,000 857,000
Non-cash exchange of notes receivable for services - 150,000 150,000
Non-cash portion of purchased in-process research and
development - 12,635,768 13,136,000
Loss on disposal of property and equipment 154,940 (88) 154,940
Gain on sale of HealthCare Solutions Group (6,616,646) - (6,615,365)
Depreciation and amortization 4,423,595 1,802,814 8,199,049
Extraordinary loss on extinguishment of debt - - 881,864
Extraordinary gain on forgiveness of accounts payable and
accrued interest (372,061) - (402,609)
Changes in assets and liabilities, net of effects of
acquisitions and disposition:
Accounts receivable (391,982) (183,418) (540,480)
Employee advances (755) - (67,986)
Interest and other receivables (4,436) (74,009) (9,919)
Inventory (7,509) (8,358) (27,730)
Prepaid assets 40,465 (100,281) (7,001)
Other assets 270 (80,212) (119,575)
Accounts payable (1,558,666) 2,381,610 3,455,070
Accrued liabilities 1,632,083 482,568 2,273,872
Accrued liabilities - related party 1,249,271 (370,966) 1,397,030
Deferred revenues 568,115 2,126 649,381
-------------- ------------- --------------
Net cash used in operating activities (17,230,506) (11,352,303) (60,234,611)
-------------- ------------- --------------
Cash flows from investing activities, net of effects
of acquisitions and disposition:
Proceeds from sale of HealthCare Solutions Group 21,305,982 - 21,305,982
Acquisition of subsidiaries, net of cash acquired - (14,738,495) (15,323,173)
Proceeds from sale of property and equipment 50,000 500 50,000
Purchase of property and equipment (99,089) (1,240,540) (3,435,559)
Investment in intangible assets - (94,789) (164,460)
Issuance of notes receivable - (1,322,139) (3,228,600)
Payments received on notes receivable 245,000 - 2,128,600
-------------- ------------- --------------
Net cash provided by (used in) investing activities 21,501,893 (17,395,463) 1,332,790
-------------- ------------- --------------
Cash flows from financing activities:
Bank overdraft (138,034) 178,757 -
Net proceeds (payments) from revolving note payable (20,038,193) 1,422,264 (49,250)
Net proceeds (payments) from revolving note payable -
related parties (7,895,178) (514,296) (7,813,537)
Net proceeds from other notes payable 6,953,760 100,000 9,865,427
Payments on other notes payable (7,788,000) (49,250) (9,567,806)
Principal payments on capital lease obligations (55,504) (36,284) (148,210)
Proceeds from issuance of convertible debentures, net 6,254,240 - 9,439,240
Proceeds from sale of warrants 438,240 322,928 1,511,168
Proceeds from sale of common stock, net - 17,471,155 38,175,700
Proceeds from sale of preferred stock, net - 9,403,846 17,707,346
Proceeds from sale of common stock and related repricing rights
subject to redemption, net - - 1,830,000
-------------- ------------- --------------
Net cash (used in) provided by financing activities (22,268,669) 28,299,120 60,950,078
-------------- ------------- --------------
Net (decrease) increase in cash and cash equivalents (17,997,282) (448,646) 2,048,257
Cash and cash equivalents at beginning of period 20,045,539 20,501,676 -
-------------- ------------- --------------
Cash and cash equivalents at end of period $ 2,048,257 $ 20,053,030 $ 2,048,257
============== ============= ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-4
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Nine Months Ended (Inception) to
September 30, September 30,
---------------------------
Supplemental disclosure of cash flow information: 1999 1998 1999
------------ ------------- ------------
<S> <C> <C> <C>
Cash paid during the period for interest $ 1,068,882 $ 747,629 $ 4,498,888
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Nine Months Ended September 30, 1999:
The Company entered into capital lease obligations for equipment in the
amount of $57,332.
Advances to employees totaling $59,986 were applied as payments on a
related-party note payable.
A total of 143,230 shares of common stock previously pledged to a bank by
certain officers and directors of the Company as collateral for Company
credit card debt were sold by the bank and the proceeds were used to pay
the debt and the related accrued interest in full totaling $244,824.
A total of 100,000 shares of common stock previously pledged to a law firm
by certain officers and directors of the Company as collateral for legal
work were sold by the law firm and the proceeds were used to pay for legal
services totaling $72,335.
A total of 970,586 shares of common stock previously held by certain
shareholders and originally valued at $1,000,916 were returned to the
Company in settlement of litigation.
The Company issued 6,000,000 shares of common stock valued at $3,278,893 to
the guarantors of the Series C convertible debentures as indemnification
for the sale of their shares by the holders of the Series C convertible
debentures held as collateral for these debentures. The proceeds of
$3,278,893 received by the holders were used to pay liquidation damages and
retire Series C convertible debentures in the amounts of $750,000 and
$2,528,893, respectively.
Preferred stock dividends of $997,146 were recorded related to the
beneficial conversion features of Series D and Series E preferred stock.
Preferred stock dividends of $635,160 were accrued on Series D and Series E
preferred stock.
Dividends totaling $828,212 were accrued relating to the liquidation damage
provisions of Series D and Series E preferred stock and Series C
convertible debentures.
The Company issued 200,000 shares of common stock to an unrelated party for
consulting fees valued at $100,000.
A total of 131,667 shares of Series D preferred stock and related dividends
of $96,193 were converted into 8,468,129 shares of common stock.
A total of 135,072 shares of Series E preferred stock and related dividends
of $66,015 were converted into 5,729,156 shares of common stock.
In connection with the sale of HealthCare Solutions Group, $2,500,000 of
the sales price was placed into an escrow account.
A revolving note payable in the amount of $50,000 was paid by a former
employee and is included as an account payable.
Promissory notes held by certain shareholders were reduced by $414,991 in
settlement of litigation.
For the Nine Months Ended September 30, 1998:
The Company had a stock subscription receivable in the amount of $2,000,000
in connection with the issuance of 100,000 shares of Series E 4%
Convertible Preferred Stock that was consummated as of September 30, 1998.
This receivable was collected subsequent to period end.
Preferred Stock Dividends of $1,553,001 were recorded related to the
beneficial conversion features of Series D and Series E 4% Convertible
Preferred Stock.
The Company issued 1,390,476 shares of common stock and 608,334 shares of
Series D 4% Convertible Preferred Stock in connection with the cancellation
of existing reset provisions and costs associated with the issuance of
Series D 4% Convertible Preferred Stock.
Preferred Stock Dividends of $1,000,000 were recorded related to the
issuance of 1,390,476 common shares and 608,334 shares of Series D 4%
Convertible Preferred Stock in connection with the cancellation of existing
reset provisions.
Preferred Stock Dividends of $73,889 were accrued on Series D 4%
Convertible Preferred Stock.
The Company exchanged 150,000 shares of Series D 4% Convertible Preferred
Stock for 150,000 shares of Series E 4% Convertible Preferred Stock.
The Company issued 5,140,751 shares of common stock (having a market value
of $8,353,720) and notes payable of $4,747,339 in connection with the
acquisition of Articulate Systems, Inc.
Preferred Stock Dividends of $131,660 were recorded related to the
beneficial conversion features of Series B and Series C Convertible
Preferred Stock.
A total of 27,500 shares of Series B Preferred Stock and related dividends
of $8,531 were converted into 193,582 shares of common stock.
A total of 185,000 shares of Series C Preferred Stock and related dividends
of $123,129 were converted into 1,295,919 shares of common stock.
The Company issued 2,692,216 shares of common stock (having a market value
of $16,995,972) in connection with the acquisition of AcuVoice, Inc.
See accompanying notes to condensed consolidated financial statements.
Q-5
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements of Fonix Corporation and subsidiaries (collectively, the
"Company" or "Fonix") have been prepared by the Company pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the following disclosures are adequate to make the information presented
not misleading.
These condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) that, in the opinion of
management, are necessary to present fairly the financial position and results
of operations of the Company as of the balance sheet dates and for the periods
presented.
Operating results for the three and nine months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. The Company suggests that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K (Amendment No. 1) for the year ended December 31, 1998.
Recently Enacted Accounting Standards - In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards requiring that
derivative instruments be recorded in the balance sheet as either an asset or
liability measured at its fair value and that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000. The adoption of this statement is not expected to have a material
effect on the Company's consolidated financial statements as the Company does
not currently hold any derivative or hedging instruments.
Reclassifications - Certain reclassifications have been made in the prior period
condensed consolidated financial statements to conform with the current period
presentation.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
At September 30, 1999 and 1998, there were outstanding common stock equivalents
to purchase 90,535,319 and 38,413,473 shares of common stock, respectively, that
were not included in the computation of diluted net loss per common share as
their effect would have been anti-dilutive, thereby decreasing the net loss per
common share. Net loss per common share amounts have been restated for all
periods presented to reflect basic and diluted per share presentations.
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three and nine months ended September
30, 1999 and 1998:
Q-6
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended September 30,
-------------------------------------------------------------------------
1999 1998
-------------------------------- ------------------------------------
Per share Per share
Loss Amount Loss Amount
-------------------------------- ------------------------------------
<S> <C> <C> <C> <C>
Loss from continuing operations $ (7,050,344) $ (17,388,076)
Preferred stock dividends (1,031,288) (2,626,890)
--------------- ---------------
Net loss from continuing operations
attributable to common stockholders (8,081,632) $ (0.11) (20,014,966) $ (0.37)
Discontinued operations 3,654,499 0.05 (1,205,049) (0.02)
Extraordinary items 372,061 0.01 - -
---------------- ------------ --------------- --------------------
Loss attributable to common stockholders $ (4,055,072) $ (0.05) $ (21,220,015) $ (0.39)
================ ============ ================ =====================
Weighted average common shares
outstanding 76,479,555 54,020,736
================ ================
</TABLE>
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------------
Per share Per share
Loss Amount Loss Amount
------------------------------------- -------------------------------------
<S> <C> <C> <C> <C>
Loss from continuing operations $ (19,871,411) $ (33,987,567)
Preferred stock dividends (2,460,518) (2,626,890)
----------------- -----------------
Net loss from continuing operations
attributable to common stockholders (22,331,929) $ (0.33) (36,614,457) $ (0.73)
Discontinued operations 662,920 0.01 (1,205,049) (0.02)
Extraordinary items 372,061 0.01 - -
----------------- ------------- ---------------- -----------------
Loss attributable to common stockholders $ (21,296,948) $ (0.32) $ (37,819,506) $ (0.75)
================= ============= ================ =================
Weighted average common shares
outstanding 68,678,645 50,385,468
================ ================
</TABLE>
2. SALE OF THE HEALTHCARE SOLUTIONS GROUP
In September 1999, the Company completed the sale of the operations and a
significant portion of the assets of its HealthCare Solutions Group (the "HSG")
to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third party, for
up to $28,000,000. At the closing of this transaction, $21,500,000, less certain
credits of $194,018 was paid and $2,500,000 was deposited into an 18-month
escrow account in connection with the representations and warranties made by
Fonix in the sales transaction. Any remaining amount up to $4,000,000 is an
earnout contingent on the
Q-7
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
performance of the HSG over the next two years. The Company will not record the
contingent earnout, if any, until successful completion of the earnout period.
The sale was approved by a majority of Fonix's stockholders. The proceeds from
the sale were used to reduce certain of the Company's liabilities and to provide
working capital to allow Fonix to focus on marketing and development
opportunities for its Interactive Technology Solutions Group. The assets sold
include inventory, property and equipment, certain prepaid expenses, purchased
core technology and other assets of the HSG. Additionally, L&H assumed the
capital lease obligations related to the HSG and the obligations related to
certain of the Company's deferred revenues.
On September 1, 1999, upon the closing of the Sale, the Company discontinued the
operations of the HSG. The results of operations of the HSG have been reported
separately as discontinued operations in the accompanying condensed consolidated
statements of operations. Prior year results have been restated to provide
comparability. The net assets (liabilities) of the HSG in the December 31, 1998
condensed consolidated balance sheet consist of the following:
<TABLE>
<CAPTION>
<S> <C>
Inventory $ 72,582
Other receivables 4,554
Deferred revenues (675,997)
--------------
Net current assets (liabilities) $ (598,861)
=============
Property and equipment, net of
accumulated depreciation of $27,367 $ 182,981
Intangible assets, net of accumulated
amortization of $828,886 19,379,131
Other assets 22,343
--------------
Net long-term assets $ 19,584,455
==============
</TABLE>
Revenues from HSG's operations were $1,726,262 for the period from January 1,
1999 to September 1, 1999 and $103,517 for the nine months ended September 30,
1998. These amounts have not been included in revenues reported in the
accompanying condensed consolidated statements of operations.
3. FORGIVENESS OF TRADE PAYABLES AND ACCRUED INTEREST
In September 1999, the Company negotiated reductions of $221,376 in amounts due
various trade vendors. Additionally, the Company negotiated reductions of
$150,685 in accrued interest owed to certain note holders. These amounts have
been accounted for as extraordinary items in the accompanying condensed
consolidated statements of operations.
4. ACQUISITIONS
The Company acquired AcuVoice, Inc. ("AcuVoice") in March 1998. AcuVoice
developed and marketed text-to-speech ("TTS") technologies and products directly
to end-users, systems integrators and original equipment manufacturers for use
in the telecommunications, multi-media, education and assistive technology
markets. In addition, the Company acquired PAI and Papyrus Development
Corporation ("PDC") (together with PAI, "Papyrus") in October 1998. PAI
developed, marketed and supported printing and cursive handwriting recognition
software for "personal digital assistants", pen tablets and mobile phones under
the trademark, Allegro(TM). PDC was a systems integration provider with
expertise and intellectual property in embedded systems and enhanced Internet
applications. The products and services formerly provided by AcuVoice and
Papyrus are now provided by the Company's Interactive Technologies Solutions
Group ("ITSG").
The Company also acquired Articulate Systems, Inc. ("Articulate") in September
1998. Articulate was a provider of voice recognition products to specialized
segments of the healthcare industry under the PowerScribe(R) trade name. The
Q-8
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Company operated the Articulate business through the HSG. The operations and
substantially all the assets of the HSG were sold on September 2, 1999 (see Note
2). All of the acquisitions discussed above were accounted for as purchases.
The following unaudited pro forma financial statement data for the three and
nine months ended September 30, 1998 present the results of operations of the
Company as if the acquisitions of AcuVoice and Papyrus had occurred at January
1, 1998. The pro forma results have been prepared for comparative purposes only
and do not purport to be indicative of what would have occurred had the
acquisitions been made at January 1, 1998, or of future results. Purchased in-
process research and development related to the acquisition of AcuVoice of
$9,315,000 was expensed at the date of the AcuVoice acquisition and is not
presented in the following pro forma financial statement data since it is a
non-recurring charge directly attributable to the acquisition. Pro forma
financial information for the acquisition of Articulate has not been included in
the following pro forma financial statement as the operations and substantially
all the assets of the HSG were sold September 2, 1999 (see Note 2).
Additionally, the historical operating results of Articulate from the date of
acquisition through September 30, 1998 have been excluded from the pro forma
information.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30,1998 September 30, 1998
------------------- -------------------
<S> <C> <C>
Revenues $ 145,185 $ 2,804,667
Net loss from continuing operations (13,932,394) (22,211,826)
Net loss from continuing operations
attributable to common stockholders (16,559,284) (24,970,376)
Basic and diluted net loss
per common share (0.31) (0.49)
</TABLE>
5. PAPYRUS SETTLEMENT
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 the Papyrus companies. The Company determined that certain of the
representations made by Papyrus and its executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against the former
shareholders of Papyrus alleging misrepresentation and breach of contract. In
March and April 1999, five of the former shareholders of Papyrus filed actions
against the Company alleging default under the terms of the promissory notes
issued to them in connection with the Papyrus acquisition and certain other
claims. Subsequently, the Company 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 $1,217,384 (the
"Settlement Payment") and return of 970,586 shares of restricted common stock
previously issued to the five former shareholders in connection with the
acquisition of Papyrus. The Company paid the Settlement Payment in September
1999 and the lawsuits described above have been dismissed.
6. INTANGIBLE ASSETS
Intangible assets consist of purchased core technology and goodwill arising from
the acquisitions of AcuVoice and Papyrus and direct costs incurred by the
Company in applying for patents covering its technologies. Amortization is
computed on a straight-line basis over the estimated useful lives ranging from
five to eight years. Total accumulated amortization was $3,757,780 and
$1,770,668 at September 30, 1999 and December 31, 1998, respectively, excluding
amortization of $828,886 related to HSG at December 31, 1998. The unamortized
portion of the purchased core
Q-9
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
technology and goodwill related to the purchase of Articulate have been as a
result of the Sale. Additionally, the amount of goodwill associated with the
purchase of PAI was reduced by $1,415,908 in connection with the settlement
payment in September 1999 (see Note 5).
7. RELATED-PARTY AND OTHER NOTES PAYABLE
As of September 30, 1999, the Company had unsecured notes payable to former
Papyrus stockholders in the aggregate amount of $77,625, which notes were issued
in connection with the acquisition of Papyrus. The holders of these notes have
not made demand for payment.
During the nine months ended September 30, 1999, the Company paid, or otherwise
reduced through agreement (see Note 5), notes payable to various related parties
totaling $8,414,255, plus accrued interest.
In September 1999, the Company paid other notes payable to unrelated parties
aggregating $588,000 plus accrued interest. Additionally, a revolving note
payable in the amount of $50,000 was paid by a former employee and is included
as an account payable.
A revolving note payable in the amount of $19,988,193 at December 31, 1998, plus
accrued interest, was paid in full in January 1999.
8. SERIES C 5% CONVERTIBLE DEBENTURES
On January 29, 1999, the Company entered into a Securities Purchase Agreement
with four investors pursuant to which the Company sold its Series C 5%,
Convertible Debentures (the "Debentures") in the aggregate principal amount of
$4,000,000. The outstanding principal amount of the Debentures is convertible at
any time at the option of the holders into shares of the Company's common stock
at a conversion price, subject to adjustment, equal to the lesser of $1.25 or 80
percent of the average of the closing bid price of the Company's common stock
for the five trading days immediately preceding the conversion date. The Company
recorded $687,500 as interest expense upon the issuance of the Debentures in
connection with this beneficial conversion feature. The Company also issued
400,000 warrants to purchase an equal number of the Company's common shares at a
strike price of $1.25 per share in connection with this financing. The warrants
are exercisable for a period of three years from the date of grant. The
estimated fair value of the warrants of $192,000, as computed under the
Black-Scholes pricing model, was recorded as interest expense upon the issuance
of the Debentures. On March 3, 1999, the Company executed a supplemental
agreement pursuant to which the Company agreed to sell another $2,500,000
principal amount of 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 additional
Debentures in connection with the beneficial conversion feature. The obligations
of the Company for repayment of the Debentures, as well as its obligation to
register the common stock underlying the potential conversion of the Debentures
and the exercise of the warrants issued in these transactions, are personally
guaranteed by the Guarantors (see Note 10). In connection with the March 3, 1999
funding, the Company agreed to grant a lien on the patent covering the Company's
Automated Speech Recognition ("ASR") technologies as collateral for repayment of
the debentures. However, to date no lien on the patent has been granted. The
Guarantors guaranteed the obligations of the Company under the Debentures and
pledged 6,000,000 shares of common stock of the Company beneficially owned by
them as collateral security for their obligations under their guarantee.
The outstanding principal amount of the Debentures bears interest at a rate of
5%, payable on March 31, June 30, September 30, and December 31, and on each
conversion date, of each year during the term of the Debentures. In addition,
the interest on the outstanding principal amount of the Debentures may, at the
Company's option, be paid in shares of the Company's Class A common stock
calculated based upon the Debenture Conversion Price on the date such
Q-10
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
interest becomes due. The Company has not paid interest on the Debentures at any
time since they were issued. Under the terms of the Debentures, the investors
could charge penalties for such failure. However, the investors have waived all
such penalties accruing prior to October 1, 1999.
Under the terms of the Debentures, in the event that the Company fails to file
and have declared effective the registration statement registering the shares
underlying the Debentures, the holders of the Debentures may elect penalty
provisions to (a) reduce the conversion price by 2.5% per month until the
registration statement is declared effective, or (b) receive 2.5% of the
outstanding principal amount of Debentures per month, in cash. To date, the
Company has not filed the registration statement or had it declared effective as
required. However, all holders waived the penalty provisions through June 30,
1999. Additionally, some holders of the Debentures agreed to a partial waiver of
their penalty provisions through September 30, 1999. The holders of the
Debentures have agreed to waive the penalty provisions, contingent on the
registration statement being declared effective by February 29, 2000. In the
event that the registration statement is not declared effective by that date,
the penalty provisions automatically apply, retroactive to October 1, 1999.
Subsequent to the March 3, 1999, funding, the holders of the Debentures notified
the Company and the Guarantors that the Guarantors were in default of certain
terms of the stock pledge agreement executed by the Guarantors in favor of the
holders as a result of the Company's failure to register the resale of the
shares underlying the Debentures, and that the holders may therefore exercise
their right to sell the shares pledged by the Guarantors. The holders of the
Debentures have subsequently informed the Company that they have sold the
6,000,000 shares pledged by the Guarantors and that proceeds from the sale of
the pledged shares has aggregated $3,278,893. Of this total, $406,250 related to
penalties attributable to default provisions of the stock pledge agreement and
recorded was as interest expense and $343,750 related to provisions of the
Series D Preferred Stock and has been recorded as preferred stock dividends.
Both of these amounts were recorded during the three months ended September 30,
1999. The remaining $2,528,893 of the proceeds was applied as a reduction of the
principal balance of the Debentures as of September 30, 1999. Additional
interest payable under the provisions of the stock pledge and related
indemnification agreements has been recorded by the Company as an accrued
liability in the amount of $731,250. Under its indemnity agreement in favor of
the Guarantors, the Company will issue 6,000,000 replacement shares to the
Guarantors for the shares sold by the holders and reimburse the Guarantors for
any costs incurred as a result of the holders' sales of the Guarantors' shares
(see Note 10).
On December 3, 1999, the Company received notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market. The delisting was an event of
default under the terms of the Debentures. Upon the occurrence of this event of
default, the outstanding principal amount of the Debentures, together with
accrued interest, became immediately due and payable in cash. However, the
holders of the Debentures waived this event of default.
9. STOCKHOLDERS' EQUITY
Common Stock Subject to Redemption - On December 21, 1998, the Company entered
into a private placement securities agreement. Pursuant to the agreement, the
Company received $1,980,000 in net proceeds in exchange for 1,801,802 shares of
redeemable common stock, an equal number of "Repricing Rights," Repurchase
Rights, and warrants to purchase 200,000 shares of common stock. Each Repricing
Right entitles the holder to receive a number of additional shares of common
stock for no additional consideration according to a formula ("Repricing
Rights") based on the lowest closing bid price of the Company's common stock
during the 15 consecutive trading days immediately preceding the exercise date
and a repricing price, as defined, ranging from $1.3875 to $1.4319 depending
upon the date of the exercise. The repricing rights became exercisable on March
21, 1999.
Each holder of the Repurchase Rights has the right, based on certain conditions,
to require the Company to repurchase all or a portion of the holder's common
shares or Repricing Rights. The Repurchase Rights may only be exercised
simultaneously with or after the occurrence of a major transaction or triggering
event. Major transactions and triggering
Q-11
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
events consist of, among others, certain consolidations, mergers or other
business combinations, the sale or transfer of all or substantially all the
Company's assets, a purchase, tender or exchange offering of more than 40
percent of the Company's outstanding common stock made and accepted, the failure
to have a related registration statement declared effective prior to June 19,
1999 or a suspension from listing or delisting of the Company's common stock for
a period of more than three days. As a registration statement registering the
shares and the shares underlying the Repricing Rights was no declared effective
by June 19, 1999, and the Company's Class A common stock has been delisted from
the Nasdaq SmallCap Market, the holders had the right to exercise the Repurchase
Right. However, the holder has waived its right to exercise the repurchase
option as a result of the delisting of the Class A common stock from the Nasdaq
SmallCap Market and deferred until March 1, 2000, its right to require
repurchase as a result of the Company's failure to register the shares
underlying the Repurchase Rights and the Class A common stock. If such shares
are not registered before March 1, 2000, the holder may exercise the Repurchase
Rights.
The repurchase price for the common stock is $1.3875 per share. The repurchase
price for the Repricing Rights is based on a formula using the Repricing Rate
and the last reported sale price of the Company's common stock on the date of
the exercise of the repurchase right.
Series D and E Preferred Stock - During the nine months ended September 30,
1999, 131,667 shares of Series D preferred stock and 135,072 shares of Series E
preferred stock, together with related dividends on each, were converted into
8,467,129 shares and 5,729,156 shares, respectively, of the Company's common
stock. After the above conversions 876,667 shares of Series D preferred stock
remain outstanding.
On December 3, 1999, the Company received notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market, in part because the stock
price had been below $1.00 per share since approximately March 1999 (see Note
15). However, the Company's Class A common stock is currently trading on the OTC
Bulletin Board.
The delisting of the Company's Class A common stock from the Nasdaq SmallCap
Market was an event of default under the terms of the Series D preferred stock.
Upon the occurrence of an event of default, the Company was required to pay to
each holder of Series D preferred stock a fee of two percent of the purchase
price of the Series D preferred stock in cash for each month during which the
stock is delisted. However, the holders of the Series D preferred stock have
waived this event of default.
Common Stock - The Company incurred an obligation to issue 6,000,000 shares of
common stock to two individuals who are executive officers and directors and one
individual who is a former officer and director of the Company in satisfaction
of an indemnification agreement wherein the Company was required to pay any sums
the three individuals paid for the benefit of the Company. The shares are to be
issued to replace shares beneficially owned by the three individuals and sold by
the holders of the Debentures and Series D preferred stock (see Note 10).
On June 2, 1999, the Company issued 200,000 shares of common stock (having a
market value of $100,000 on that date) to an unrelated individual in payment for
consulting services rendered.
In April 1999, five former PAI shareholders agreed to cancel 970,586 shares of
common stock to the Company reducing the total shares they had received from the
Company in the 1998 acquisition of PAI from 3,111,114 shares to 2,140,528
shares. The shares were effectively canceled in September 1999 in connection
with the Settlement Payment (see Note 5). The original fair market value of
$1,000,917 associated with the canceled shares is reflected as a reduction to
goodwill associated with the purchase of PAI.
Q-12
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
As of September 30, 1999
Common Stock Options - During the nine months ended September 30, 1999, the
Company granted 754,500 stock options to employees at exercise prices ranging
from $0.59 to $1.78 per share. Additionally, 9,500 stock options were granted to
two consultants for services provided to the Company. The fair market value of
the consultant options was $1.32 per share, or $12,540 in total, using the
Black-Scholes pricing model and was charged to product development and research
expense. The term of all options granted during this nine month period is ten
years from the date of grant. Of the stock options issued, 726,334 vested
immediately, 18,834 vest six months after issuance and 18,832 vest one year
after issuance. The weighted average fair value of the options granted to
employees during the nine months ended September 30, 1999 was $1.31 per share
using the Black-Scholes pricing model. Had compensation expense for the issuance
of these options been recorded in accordance with the method prescribed by SFAS
No. 123, "Accounting for Stock-Based Compensation", the Company's net loss from
continuing operations attributable to common stockholders would have been
$22,281,723 or $0.32 per share for the nine months ended September 30, 1999. As
of September 30, 1999, the Company had a total of 15,536,582 options
outstanding.
Effective May 7, 1998, the Company entered into a one-year professional services
agreement with a public relations firm. The minimum monthly retainer was $15,000
per month. In connection with this agreement, the firm was granted options to
purchase 100,000 shares of the Company's common stock at $3.75 per share. In May
1999, the Company negotiated a termination of this agreement for a cash payment
of approximately $33,000 and the grant of options was rescinded.
Common Stock Warrants - During the nine months ended September 30, 1999, the
Company granted warrants to L&H in connection with loans made to the Company in
April and May 1999 totaling $6,000,000. These warrants allow L&H to purchase
850,000 shares of common stock of the Company at exercise prices ranging from
$0.60 to $0.70 per share. Of these warrants, 250,000 expired October 18, 1999
without being exercised. The remaining 600,000 warrants expire May 17, 2001. The
fair value of the warrants was $0.14 and $0.35 per share for the 250,000 and
600,000 warrants, respectively, using the Black-Scholes pricing model. The value
of the warrants totaled $246,240 and was amortized as a financing expense over
the term of the loans.
On February 11, 1998, the Company entered into a First Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") under which the Company and Siemens are jointly pursuing the
development of Siemens' integrated circuits incorporating ASR and other related
technologies for use in certain telecommunications applications. In connection
with the license agreement Siemens purchased warrants to acquire 1,000,000
shares of restricted common stock at an average exercise price of $20 per share
with expiration dates ranging from December 31, 1998 to December 31, 1999. As of
September 30, 1999, 800,000 of the warrants originally issued had expired and
200,000 of the warrants remain outstanding at an average exercise price of
$30.00 per share.
As of September 30, 1999, the Company had a total of 2,475,000 warrants
outstanding.
10. RELATED-PARTY TRANSACTIONS
Related-party transactions with entities owned by two individuals who are
executive officers and directors and one individual who is a former officer and
director of the Company for the nine months ended September 30, 1999 and 1998
were as follows:
<TABLE>
<CAPTION>
1999 1998
------------- ---------------
<S> <C> <C>
Expenses:
Base rent $ 93,312 $ 83,788
Leasehold improvements $ - $ 35,247
</TABLE>
Q-13
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company rents office space under a month-to-month lease from Studdert
Companies Corporation ("SCC"). SCC is owned by the three individuals described
above. The lease from SCC is guaranteed by the three individuals. The lease
requires monthly payments of $10,368. The Company believes the terms of the
related-party lease are at least as favorable to the Company as the terms that
could have been obtained from an unaffiliated third party in a similar
transaction.
Guaranty of Company Obligations and Related Indemnity Agreement - The Guarantors
have guaranteed certain obligations of the Company (see Note 8), including the
Company's obligations under the Debentures. As security for some of the
guarantees, the Guarantors pledged shares of Fonix common stock beneficially
owned by them. In September 1999, the Company paid in full a note payable to an
unrelated third party that had previously been guaranteed by the Guarantors. The
Guarantors pledged 6,000,000 shares of the Company's common stock beneficially
owned by them as collateral security for the Company's obligations regarding the
Debentures.
The Company agreed to indemnify the Guarantors if they were required to pay any
sums for the benefit of the Company under their guaranty of provisions of the
Debentures. The indemnity agreement provides that the Company will issue shares
of the Company's common stock of sufficient value to reimburse the Guarantors in
full, plus interest at 10 percent per annum, for all costs associated with
meeting the guarantee commitment, including any income taxes resulting
therefrom. Additionally, in consideration for the pledge of the Company's common
shares as collateral for the Debentures, the Board of Directors authorized the
issuance to the Guarantors of one common stock purchase warrant for every three
shares pledged. However, subsequent to the Board of Directors' authorization,
the Guarantors declined to accept the warrants and they were not issued.
Subsequent to the March 3, 1999, funding, the holders of the Debentures notified
the Company and the Guarantors that the Guarantors were in default of certain
terms of the stock pledge agreement as a result of the Company's failure to
register in a timely manner the resale of the shares underlying the Debentures,
and that the holders may exercise their right to sell the shares pledged by the
Guarantors. The holders of the Debentures have subsequently informed the Company
that proceeds from the sale of the 6,000,000 pledged shares has aggregated
$3,278,893. Under its indemnity agreement in favor of the Guarantors, the
Company is obligated to issue 6,000,000 replacement shares to the Guarantors for
the shares sold by the holders of the Debentures. Additionally, the Company has
recorded a related party liability of $1,296,600 as a reimbursement to the
Guarantors for the income taxes incurred by the Guarantors as a result of the
holders' sales of the Guarantors' shares.
In December 1998, the Guarantors guaranteed certain additional 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. In May 1999, 100,000 of
the shares previously pledged by the Guarantors to another creditor of the
Company were sold by the creditor and the proceeds, totaling $72,335, were used
to pay amounts owed by the Company.
As of September 30, 1999, no guarantees remain outstanding. However, the Company
anticipates that in the future the Guarantors may request that the Company
provide indemnity and/or compensation for the guarantees, advances and/or
pledges by the Guarantors for the benefit of the Company. To the extent such
requests, if any, are reasonable and of a nature similar to what the Company
would grant to unrelated parties in similar transactions, the Company presently
anticipates that it will submit any such requests to the Board of Directors for
consideration.
Q-14
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11. PRODUCT DEVELOPMENT AND RESEARCH
Synergetics - In October 1993, the Company entered into an agreement with
Synergetics, a research and development entity, to develop certain technologies
related to the Company's ASR technologies. Under the terms of the Synergetics
agreement, the Company expended $186,455 during the nine months ended September
30, 1999 for product development and research efforts. No amounts were expended
during the three months ended September 30, 1999.
IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2, a research and development entity, to provide assistance to the
Company in the development of specific ASR technologies. The President of IMC2
is also the President of Synergetics. The professional services agreement is for
a term of 36 months and requires the Company to make monthly payments of
$22,000. Under the terms of the agreement, the Company expended $66,000 and
$198,000 during the three and nine months ended September 30, 1999,
respectively.
Adiva- Beginning in 1998, the Company utilized the research and development
services of Adiva. The president of Adiva is also the president of Synergetics
and IMC2. The Company expended $63,395 during the nine months ended September
30, 1999 for research and development efforts. No amounts were expended during
the three months ended September 30, 1999.
12. COMMITMENTS AND CONTINGENCIES
Employment Agreements - In January 1998, the Company entered into employment
contracts with two employees which expire in January 2001. The minimum annual
salary payments required by these contracts total $405,000. In January 1999, the
Company announced a cost reduction program for the Company's 1999 operating year
wherein the two employees referred to above agreed that their compensation would
be reduced 30 percent effective February 1999.
Executive Employment Agreements - On November 1, 1996, the Company entered into
employment contracts with three executive officers (one of whom is no longer an
executive officer) which expire on December 31, 2001. The annual base salary
pursuant to the contracts with each executive officer for the year ended
December 31, 1999 is $425,000. In January 1999, the Company announced a cost
reduction program for the Company's 1999 operating year wherein the two
remaining executive officers agreed that their annual compensation would be
reduced to $297,500 commencing February 1999. At the same time, Stephen M.
Studdert resigned as the Company's Chief Executive Officer. His employment
agreement was canceled and he entered into a separation agreement pursuant to
which he will be paid $250,000 per year through January 31, 2001 and $100,000
for the year ended January 31, 2002.
Sublease of Office Facilities - Effective May 14, 1999, the Company entered into
an agreement to sublease 10,224 square feet of its Draper, Utah facility to an
unrelated third party. The agreement requires the sublessee to pay $13,961 per
month, or approximately 40 percent of the Company's monthly obligation under the
primary lease agreement through December 31, 2000. The sublessee has the option
to extend the term by two additional three-month periods.
Effective May 25, 1999, the Company entered into an agreement to sublease 8,048
square feet of a total 10,048 square feet of its Cupertino, California facility
to an unrelated third party. The remaining 2,000 square feet occupied by the
Company may be turned over to the sublessee no sooner than six months nor later
than nine months from the commencement of the sublease. The agreement requires
the sublessee to pay $28,346 per month, or approximately 80 percent of the
Company's obligation under the primary lease agreement through the six to nine
month period of reduced occupancy by the Company and 100 percent thereafter
through May 31, 2003.
Operating Lease - In March 1999, the Company entered into an agreement to lease
office space in Cleveland, Ohio for sales and installation personnel of the HSG.
The lease is for three years at a monthly rate of $4,260 and became effective
May 1, 1999. Future aggregate minimum obligations under this operating lease are
$144,840. Under the terms of the sale of the HSG, L&H assumed this operating
lease obligation in September 1999.
Q-15
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Capital Lease Obligations - In January 1999, the Company entered into a
noncancelable capital lease arrangement for telephone equipment at its HSG
facility in Woburn, Massachusetts. In May 1999, the Company entered into a
noncancelable capital lease arrangement for telephone equipment at its HSG
facility in Cleveland, Ohio. Future aggregate minimum obligations under these
capital leases, net of amounts representing interest, aggregate approximately
$51,000. Under the terms of the sale of the HSG, L&H assumed these capital lease
obligations in September 1999.
Royalty Agreements - The Company has entered into various technology license
agreements. Generally, the agreements require the Company to pay royalties at
specified dollar amounts in connection with each product sold that utilizes
technologies licensed by the Company under these agreements. Royalty expense is
accrued at the time product revenues incorporating the licensed technologies are
recognized. There were no sales of products incorporating these licensed
technologies during the nine months ended September 30, 1998. Royalty expenses
of $37,238 and $100,763, all related to the HSG, were incurred during the three
and nine months ended September 30, 1999, respectively, and have been included
in the loss from discontinued operations.
13. LITIGATION
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse purportedly owns, commenced an action against the Company in
federal court for the Southern District of New York. Clarke and Perpetual Growth
asserted claims for breach of contract relating to certain financing the Company
received during 1998. Specifically, Clarke and Perpetual Growth alleged that
they entered into a contract with the Company under which the Company agreed to
pay them a commission of five percent of all financing provided to Fonix by
Southridge Capital Management or its affiliates. Clarke and Perpetual claim that
they are entitled to commissions with respect to approximately $3,000,000 of
equity financing to the Company in July and August 1998, and the Company's
offerings of Series D and Series E preferred stock, totaling together
$12,000,000, in August and September 1998.
The Company believes that the Clarke lawsuit is without merit and filed a motion
to dismiss based upon the court's lack of personal jurisdiction over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth appealed the dismissal and their appeal has been denied. 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 and the appeal denied, the Company intends to vigorously pursue the
Utah action. However, the lawsuit in New York could be reinstated on appeal and
Clarke and Perpetual Growth could prevail in that lawsuit, in which case the
Company may be required to pay significant amounts of money damages awarded by
the court.
OGI - On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default, demand for mediation and demand for arbitration with the American
Arbitration Association. In its demand, OGI asserted that Fonix was in default
under three separate agreements between the Company and OGI in the total amount
of $175,000. On or about September 23, 1999, the Company responded to OGI's
demand and denied the existence of a default under the three agreements
identified by OGI. Moreover, the Company asserted a counterclaim against OGI in
an amount not less than $250,000. The arbitrator appointed by the American
Arbitration Association will conduct a scheduling conference in January 2000 to
set dates for the proceeding, including the date of the arbitration hearing.
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.
Q-16
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
14. REPORTABLE SEGMENTS
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement requires disclosures related
to components of a company for which separate financial information is available
and evaluated regularly by the Company's chief operating decision makers in
deciding how to allocate resources and in assessing performance. As a result of
the sale of the HSG in September 1999 (see Note 2), management believes that the
Company has only one operating segment because the Company's remaining core
business consists only of operations derived from the Interactive Technologies
Solutions Group.
15. SUBSEQUENT EVENTS
Shareholders Meeting - At the Company's annual shareholder meeting held October
29, 1999, 59,497,418 shares were represented in person or by proxy. The
shareholders approved amendments to the Company's certificate of incorporation
that (A) created a new class of common stock designated as Class B Non-Voting
Common Stock with 1,985,000 Class B shares authorized; and (B) redesignated the
Company's current common stock as Class A Common Stock and changed each share of
existing common stock into a share of Class A Common Stock. Additionally, the
shareholders approved an amendment to the Company's certificate of incorporation
that increased the number of common shares authorized to be issued from
100,000,000 to 300,000,000 and increased the number of authorized preferred
shares from 20,000,000 to 50,000,000. The Class B shares were authorized to
provide for the conversion of 1,935,000 common shares issued in the acquisition
of Articulate Systems, Inc., to a non-voting class of stock as provided in the
acquisition agreement. The Company does not intend to register its Class B
Non-Voting Common Stock. The shareholders also approved a series of transactions
pursuant to which the Company issued its Series D 4% preferred stock and Series
E 4% preferred stock.
Appointment of Director - Effective October 29, 1999, Mark S. Tanner was
appointed as a member of the Company's Board of Directors. Mr. Tanner becomes
the second independent member appointed to the Board of Directors during 1999.
Previously, on September 2, 1999, William A. Maasberg, Jr. was appointed as an
independent member of the Company's Board of Directors.
Conversion of Series D Preferred Stock - Subsequent to September 30, 1999, a
total of 494,944 shares of Series D preferred stock, together with related
dividends, were converted into 38,785,1425 shares of the Company's common stock.
After the above conversions 381,723 shares of Series D preferred stock remain
outstanding.
Delisting from the Nasdaq SmallCap Market - Until recently, the Company's Class
A common stock traded on the Nasdaq SmallCap market which requires, for
continued listing, a minimum bid price of at least $1.00 per share. At June 29,
1999, the Company's Class A common stock had traded below $1.00 for more than
thirty consecutive trading days. On June 29, 1999, the Company received a letter
from Nasdaq indicating that unless the minimum bid price for the Company's Class
A common stock returned to at least $1.00 per share for at least ten consecutive
trading days prior to September 29, 1999, the Company's shares would be delisted
from the Nasdaq SmallCap Market on October 1, 1999. The Company appealed
Nasdaq's notice and listing determination in September 1999. Nasdaq held a
hearing on the matter on October 28, 1999.
On December 3, 1999, the Company received notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market, in part because the stock
price had been below $1.00 per share since approximately March 1999. The Company
is currently evaluating its options, including the possibility of appealing the
delisting decision. However, the Company's Class A common stock is currently
trading on the OTC Bulletin Board.
Additionally, the delisting of the Company's Class A common stock from the
Nasdaq SmallCap Market was an event of default under the terms of the
Debentures. Upon the occurrence of an event of default, the outstanding
principal amount of all of the Debentures, together with accrued interest and
all other amounts owing in respect thereof, became immediately due and payable
in cash. However, the holders of the Debentures have waived this event of
default.
Q-17
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Finally, the delisting of the Company's Class A common stock from the Nasdaq
SmallCap Market was a triggering event giving rise to certain repurchase rights
in connection with the Company's Series D and Series E preferred stock. The
holders of the Repurchase Rights had the right to require Fonix to repurchase
some or all of the investor's Class A common shares and Repricing Rights.
However, the holders have waived this event of default.
Recent Financing Activities -Fonix has recently entered into an agreement with
four investors whereby Fonix intends to sell to the investors a total of 250,000
shares of its Series F 6% Convertible Preferred Stock (the "Series F Preferred
Stock"), in return for payment of $5,000,000. It is anticipated that the Series
F Preferred Stock will be convertible into shares of Fonix's Class A common
stock during the first six months following the closing of the transaction at a
price of $0.75 per share, and thereafter at a price equal to 90% of the average
of the three lowest closing bid prices in the twenty-day trading period prior to
the conversion of the Series F Preferred Stock. Fonix anticipates that the
investors will receive registration rights which will require Fonix to file a
registration statement covering the shares underlying the Series F Preferred
Stock, and that Fonix will have the option of redeeming any outstanding Series F
Preferred Stock. Although Fonix has received approximately $1,000,000 as an
advance in connection with this financing, the securities purchase agreement has
not been signed. Accordingly, the terms may differ from those set forth in this
paragraph.
Q-18
<PAGE>
Index to Pro Forma Financials
Unaudited Pro Forma Condensed Consolidated Statement of Operations
for the Year Ended December 30, 1998 PF-2
Notes to Unaudited Pro Forma Condensed Consolidated Financial Statements PF-3
PF-1
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
Unaudited Pro Forma Condensed Consolidated Statement of Operations
For the Year Ended December 31, 1998
<TABLE>
<CAPTION>
Pro Forma
Fonix AcuVoice Papyrus Adjustments Consolidated
Corporation (Note 2 a) (Note 2 b) (Note 2) Pro Forma
------------- ------------ ----------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 2,604,724 $ 46,735 $ 259,839 $ - $ 2,911,298
Cost of revenues 35,440 7,466 51,500 - 94,406
------------ ------------ ----------- ----------- ------------
Gross Profit 2,569,284 39,269 208,339 - 2,816,892
------------ ------------ ----------- ----------- ------------
Operating costs and expenses:
Product development and research 13,060,604 34,546 - - 13,095,150
Selling, general and administrative 10,529,910 156,501 1,064,624 924,770 (c ) 12,675,805
Purchased in-process research and development 9,315,000 - - (9,315,000)(d ) -
------------ ------------ ----------- ----------- ------------
Total operating costs and expenses 32,905,514 191,047 1,064,624 (8,390,230) 25,770,955
------------ ------------ ----------- ----------- ------------
Loss from operations (30,336,230) (151,778) (856,285) 8,390,230 (22,954,063)
Other income (expense)
Interest income 1,075,021 7,766 - - 1,082,787
Interest expense (1,470,689) (7,941) - - (1,478,630)
Cancellation of common stock reset provision (6,111,577) - - - (6,111,577)
------------ ------------ ----------- ----------- ------------
Loss from continuing operations (36,843,475) (151,953) (856,285) 8,390,230 (29,461,483)
-
Preferred stock dividends (4,797,249) - - - (4,797,249)
------------ ------------ ----------- ----------- ------------
Net loss from continuing operations attributable
to common stockholders $(41,640,724) $ (151,953) $ (856,285) $ 8,390,230 $(34,258,732)
============ ============ =========== =========== ============
Basic and diluted net loss from continuing operations
per common share $ (0.79) $ (0.65)
============ ============
Weighted average common shares outstanding 52,511,185 52,511,185
============ ============
</TABLE>
See accompanying notes to Unaudited Pro Forma Condensed
Consolidated Statement of Operations
PF-2
<PAGE>
FONIX CORPORATION AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
Acquisition of AcuVoice -In March 1998, the Company acquired AcuVoice, Inc.
("AcuVoice"). AcuVoice developed and marketed text-to-speech technologies and
products directly to end-users, systems integrators and original equipment
manufacturers for use in the telecommunications, multi-media, education and
assistive technology markets. These same products and services are now provided
by the Company's Interactive Technologies Solutions Group. The acquisition was
accounted for as a purchase.
Acquisition of Papyrus - In October 1998, the Company acquired Papyrus
Associates, Inc. ("PAI"), and Papyrus Development Corporation ("PDC") (together
with PAI, "Papyrus"). PAI developed, marketed and supported printing and cursive
handwriting recognition software for "personal digital assistants", pen tablets
and mobile phones under the trademark, Allegro. PDC was a systems integration
provider with expertise and intellectual property in imbedded systems and
enhanced Internet applications. These same products and services are now
provided by the Company's Interactive Technologies Solutions Group. The
acquisition was accounted for as a purchase.
HealthCare Solutions Group - In September 1998, the Company acquired Articulate
Systems, Inc. ("Articulate"). Articulate was a provider of voice recognition
products to specialized segments of the healthcare industry. On December 31,
1998, the Company acquired certain assets of the MRC Group, Inc. ("MRC") related
to MRC's selling, marketing and servicing Articulate products. The products and
services of Articulate and MRC were provided by the Company's HealthCare
Solutions Group ("HSG"). These acquisitions were accounted for as purchases.
On September 1, 1999, the Company sold the operations and a substantial portion
of the assets of its HSG to Lernout & Hauspie Speech Products N.V. ("L&H"), an
unrelated third party, for up to $28,000,000. At the closing of the transaction,
$21,500,000, less certain credits of $194,018 was paid and $2,500,000 was
deposited into escrow account in connection with the representations and
warranties made by Fonix in the sales transaction. Any remaining amount, up to
$4,000,000, is an earnout and contingent on the performance of HSG over the next
two years.
Pro Forma Financial Statements - The accompanying unaudited pro forma condensed
consolidated statement of operations for the year ended December 31, 1998
present the results of operations of the Company as if the acquisitions of
AcuVoice and Papyrus had occurred at the beginning of 1998. The pro forma
results have been prepared for illustrative purposes only and do not purport to
be indicative of future results or what would have occurred had the acquisitions
actually been made at the beginning of 1998.
Due to the sale of HSG, the operations and net assets of HSG are accounted for
as discontinued operations. Consequently, pro forma presentation is not included
in the accompanying pro forma condensed consolidated statement of operations for
the year ended December 31, 1998.
Proforma financial statements as of September 30, 1999 and for the nine months
then ended are not included as the effects of the acquisitions and disposition
have been included in the Fonix Corporation historical financial statements for
these periods.
PF-3
<PAGE>
The accompanying unaudited pro forma 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/A for the year
ended December 31, 1998 and Forms 10-Q (as amended) for the periods ended
September 30, 1999, June 30, 1999 and March 31, 1999. The historical financial
statements of AcuVoice, Inc. and the notes thereto included in the Company's
Current Report on Form 8-K/A filed on May 21, 1998.
NOTE 2. PRO FORMA ADJUSTMENTS
(a) The historical operations of AcuVoice from December 1, 1998 through
February 28, 1999 adjusted for the 18-day period from March 14, 1998 to
March 31, 19998 wherein the operations of AcuVoice are included in the
Fonix Corporation historical financial statements. This adjustment is
made so as to not be duplicative when consolidating with the historical
operations of AcuVoice. AcuVoice's fiscal year ended November 30 and
Fonix Corporation's fiscal year ended December 31. The operations of
AcuVoice subsequent to its acquisition on March 14, 1998 have been
included in the Fonix Corporation historical financial statements for
the year ended December 31, 1998.
(b) The historical operations of Papyrus from January 1, 1998 through
October 29, 1998. The operations of Papyrus subsequent to its
acquisition on October 29, 1998 have been included in the Fonix
Corporation historical financial statements for the year ended
December 31, 1998.
(c) Amortization of $11,192,000 in purchased core technology and
$4,832,840 in goodwill associated with the acquisition of AcuVoice and
amortization of $5,018,658 in goodwill associated with the acquisition
of Papyrus.
(d) Purchased in-process research and development in the amount of
$9,315,000 was expensed at the date of the acquisition of AcuVoice.
This expense is a non recurring charge directly attributable to the
acquisition and is therefore eliminated from the proforma condensed
consolidating statement of operations for the year ended December 31,
1998.
PF-4
CONSENT OF INDEPENDENT PUBLIC ACCOUTANTS
As independent public accountants, we hereby consent to the use of our report
dated April 14, 1999 (except with respect to the matter described in Note 21, as
to which the date is December 29, 1999) and to all references to our firm
included in this registration statement on Form S-2. Our report dated April 14,
1999 included in Fonix Corporation's Form 10-K (Amendment No. 1) for the year
ended December 31, 1998 is no longer appropriate since restated financial
statements have been presented giving effect to the sale of a business segment
and the classification of its net assets and operating activities as
discontinued operations.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Salt Lake City, Utah
December 29, 1999
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Fonix Corporation on
Form S-2 of our report dated March 28, 1997, appearing in the Prospectus, which
is part of this Registration Statement.
DELOITTE & TOUCHE LLP
Salt Lake City, Utah
December 29, 1999
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-2 for Fonix Corporation, of our report dated
March 4, 1996, relating to the financial statements of Fonix Corporation for the
period from the date of inception on October 1, 1993 through December 31, 1995
(which financial statements are not separately presented herein, which appears
in such Prospectus.
/s/ Pritchett, Siler & Hardy, P.C.
Pritchett, Siler & Hardy, P.C.
Salt Lake City, Utah
December 29, 1999
