<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 1999
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
-------- --------
Commission file number 0-23862
fonix corporation
(Exact name of registrant as specified in its charter)
Delaware 22-2994719
(State of incorporation) (I.R.S. Employer Identification No.)
60 East South Temple Street, Suite 1225
Salt Lake City, Utah 84111
(Address of principal executive offices and zip code)
(801) 328-8700
(Registrant's telephone number, including area code)
(Former address of registrant)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or Section 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X or No
As of November 22, 1999, 96,814,658 shares of the issuer's Class A Common Stock
and 1,985,000 shares of Class B Non-Voting Common Stock, par value $.0001 per
share, were issued and outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Interim unaudited condensed consolidated financial statements as
required by Rule 10-01 of Regulation S-X follow immediately.
2
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
September 30 December 31,
1999 1998
------------ ------------
Current assets:
<S> <C> <C>
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 106,538 107,945
Net long term assets of discontinued operations - 19,584,455
------------ ------------
Total assets $ 22,398,084 $ 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 $2500,000 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.
3
<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 38,197,067
Product development and research 1,906,968 4,296,938 6,278,318 9,958,433 37,681,038
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 - 3,821,000 - 13,136,000 13,136,000
--------------- ------------- ------------- -------------- --------------
Total expenses 5,401,977 11,290,966 15,778,338 30,307,534 92,688,815
--------------- ------------- ------------- -------------- --------------
Loss from operations (5,344,189) (11,202,838) (15,448,414) (27,771,310) (89,789,607)
--------------- ------------- ------------- -------------- --------------
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) (17,388,076) (19,871,411) (33,987,567) (101,980,325)
Discontinued operations:
Operating loss from discontinued HealthCare
Solutions Group (2,962,147) (1,205,049) (5,953,726) (1,205,049) (8,408,033)
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.
4
<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,
Nine Months Ended 1993
September 30, (Inception) to
--------------------------- September 30,
1999 1998 1999
------------ ------------- ------------
Cash flows from operating activities:
<S> <C> <C> <C>
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.
5
<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.
6
<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 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:
7
<PAGE>
<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 (the "Sale") of its HealthCare Solutions Group
("HSG") to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third
party, for $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 transaction and the remaining $4,000,000 is to be paid as
an earnout in two installments of
8
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
$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 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.
On September 2, 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 2, 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 an extraordinary item 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 Company operated the Articulate business through
its 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.
9
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 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).
10
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 notes were payable in various
amounts through September 30, 1999. 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 4), notes payable to various related parties
totaling $8,818,355, plus accrued interest.
In September 1999, the Company paid other notes payable to unrelated parties
aggregating $610,000 plus accrued interest.
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 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.
In March 1999 the holders of the Debentures notified 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 has been allocated to penalties attributable to default
provisions of the stock pledge agreement and recorded as interest expense by the
Company in the accompanying condensed consolidated statements of operations for
the three and nine months ended September 30, 1999. An additional $2,528,893 of
the proceeds was applied as a reduction of the principal balance of the
Debentures as of September 30,
11
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June 29, 1999, the Company received notice from the Nasdaq Stock Market
("Nasdaq") indicating that unless the minimum bid price for the Company's common
stock returned to at least $1.00 per share for at least ten consecutive trading
days prior to September 29, 1999, the Company's shares would be delisted from
the Nasdaq SmallCap Market on October 1, 1999 (see Note 13). The Company filed
an appeal with Nasdaq and participated in a hearing on the listing issue before
Nasdaq on October 28, 1999. A decision from the hearing panel has not been
received by the Company and its common stock continues to be listed on Nasdaq.
If the Company's common stock is delisted from the Nasdaq SmallCap Market and is
not relisted within three trading days, an event of default would result under
the terms of the Debentures. Upon the occurrence of an event of default, the
unpaid principal amount of the Debentures, together with accrued interest, would
become immediately due and payable.
9. STOCKHOLDERS' EQUITY
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
8,468,129 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 February 3, 1999, certain holders of Series D and Series E preferred stock
forwarded conversion notices to the Company converting (1) 27,500 shares of
Series D preferred stock and related dividends into 315,379 shares of common
stock and (2) 77,500 shares of Series E preferred stock and related dividends
into 1,955,346 shares of common stock. Due to an error in the conversion
calculations and a subsequent delay in receiving further clarifying instructions
from the holders, the common shares issuable upon such conversions were never
issued to the Series D and Series E holders, although the Company's records
reflected that such shares had been issued. Subsequently, because the common
stock had not been received, the Series D and Series E holders rescinded the
February 3 conversions. The effects of this recission have been retroactively
reflected in the accompanying condensed consolidated financial statements.
Should the Company's stock be delisted from Nasdaq and not relisted within three
trading days, the terms of the Series D preferred stock require the Company 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.
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 were
issued to replace shares beneficially owned by the three individuals and sold by
the holders of the Debentures and Series D and E preferred shares (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 4). 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.
12
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 $1.30 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. 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
------------- ---------------
Expenses:
<S> <C> <C>
Base rent $ 93,312 $ 83,788
Leasehold improvements $ - $ 35,247
</TABLE>
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. 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.
As of September 30, 1999, the holders of the Debentures notified 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. Of this total,
$406,250 has been allocated to pay penalties attributable to default provisions
of the stock pledge agreement and recorded as interest expense by the Company in
the accompanying condensed consolidated statements of operations and $343,750,
related to provisions of the Series D and Series E Preferred Stock has been
recorded as preferred dividends for the three months and nine months ended
September 30, 1999. An additional $2,528,893 of the proceeds has been applied as
a reduction of the principle balance of the Debentures as of September 30, 1999.
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.
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.
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.
15
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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.
Potential Delisting of the Company's Common Stock by Nasdaq - The Company's
common stock currently trades on the Nasdaq SmallCap Market which requires, for
continued listing, a minimum bid price of at least $1.00 per share. At June 29,
1999, the Company's common stock had traded below $1.00 for more than 30
consecutive trading days. On June 29, 1999, the Company received a letter from
Nasdaq indicating that unless the minimum bid price for the Company's common
stock returned to at least $1.00 per share for at least 10 consecutive trading
days prior to September 29, 1999, the Company's shares would be delisted from
the Nasdaq SmallCap Market on October 1, 1999. The Company requested a hearing
with respect to the Nasdaq notice and at that hearing on October 28, 1999,
further requested that Nasdaq defer a decision to delist the Company's common
stock while the Company completes its plans to improve its equity and
operations. The Company has not received a response from Nasdaq regarding its
request and the Company's common stock continues to be listed for trading on the
Nasdaq SmallCap Market.
If the Company's common stock is delisted from the Nasdaq SmallCap Market, the
Company believes that its common stock would qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's common
stock, even if the Company's shares are thereafter traded on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically.
If the Company's common stock is delisted from the Nasdaq SmallCap Market and is
not relisted within three trading days, an event of default would result under
the terms of the Debentures. Upon the occurrence of an event of default, the
unpaid principal amount of the Debentures, together with accrued interest would
become immediately due and payable. Also, if the Company's common stock is
delisted from the Nasdaq SmallCap Market and is not relisted within three
trading days, the terms of the Series D preferred stock require the Company 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 that the
stock is delisted.
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.
16
<PAGE>
Fonix Corporation and Subsidiaries
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
&&&Jeff, do we need disclosure of:
OGI arbitration dispute re fees owed??
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.
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 new independent member of 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 144,933 shares of Series D preferred stock, together with related
dividends, were converted into 13,247,677 shares of the Company's common stock.
After the above conversions 731,734 shares of Series D preferred stock remain
outstanding.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS, IN ADDITION TO HISTORICAL
INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE
RESULTS ANTICIPATED BY THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE
DISCUSSED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998.
Overview
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, technology access fees, product and technology license
royalties, product sales and product support maintenance contracts. The Company
markets its products and core technologies to software developers, hardware
manufacturers (including producers of computer processors or chips), third party
product developers, operating system developers, network and share-ware
developers and Internet and web related companies. The Company focuses marketing
toward both embedded systems applications and server-based solutions.
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 small footprint.
Competitive Advantages of Core Technologies
Fonix core technologies enjoy key competitive advantages that differentiate them
from other speech and handwriting development 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 Fonix automated speech
recognition 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 automated speech recognition systems. They 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 completely novel 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
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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, all based on its ASR technologies, 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 footprints do not encumber as much operating
space 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 enable more simultaneous users on
server-based systems.
3. Speaker independence allowing any individual speaker to use the same
system without the system being trained to that 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.
5. Highly reduced need for near-field and/or tethered microphones
(headsets).
6. Rapid porting to multiple IC platforms (chips) and operating
systems to create broad product demand.
7. 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 resource help thereby accelerating
product time to market.
Thus, 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." In the last two fiscal years, the Company
has expended $9,958,433 and $13,620,748, respectively, on research and
development activities. Since its inception (October 1, 1993), the Company has
spent $37,681,038 on research and development of ASR. 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 vocabulary true human-quality
synthetic voice with full prosody and an unlimited vocabulary text-to-speech
engine initially developed by AcuVoice, Inc. ("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' 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 are plagued with problems of speech quality,
because their unit is not an actual recording, but a computer's version of what
a human voice sounds like. Poor speech quality also occurs because the
parametric unit consists, for the most part, of a single phoneme, such as the
"t" in the word "time." 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
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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.
The business operations previously conducted by AcuVoice are now part of Fonix
operations. During the nine months ended September 30, 1999, the Company
received in the aggregate, $348,726 in revenue from licensing or sale of the
AcuVoice technologies and products compared to pro-forma revenue of $283,321 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 as 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 its popular smart cell phone.
Allegro is also the subject of a sales agreement with Lucent Technologies for
use in its Inferno operating system. Papyrus has also developed cursive
handwriting recognition software which recognizes naturally-written whole words.
This cursive technology is only available as a licensed product to OEM
customers. Both the Allegro and the cursive handwriting recognition software are
user independent and require no training 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 technology products is a newly
emerging market. 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 footprint requirements,
non-extendable technology, 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 which
enjoy 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 Companys' 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
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channels.
5. Generally position Fonix as a provider of second tier customer
support, providing training and tools for Fonix costumers 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 Companys' 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 Companys' 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 two general and distinctive markets: (1)
Embedded Markets and (2) Server-based Markets.
Embedded Markets
Increasingly efficient and powerful computing solutions have rapidly developed
new markets by creating smaller, more convenient devices loaded with
personalized functions. These devices include PDA's (personal digital
assistants), cellular phones, web pads, wireless communications devices, and
other consumer electronics. A significant 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 fuel the drive 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 even
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 drive most ASR and TTS engines. This created a significant problem for
embedded markets. Adding the hardware necessary to boost memory and computing
power would drive the price of devices higher than consumer markets would
tolerate.
Because of proprietary engineering innovations, Fonix ASR and TTS technologies
have a memory footprint 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 general business strategy objectives. These
strategically focused embedded markets include:
1. Chip Manufacturers. 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 operating 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
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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 is currently releasing version 1 of its FAAST (Fonix
Accelerated Application Speech Technology) for Servers. FAAST for Servers
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.
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 highly robust web 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 their 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 product 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 transitioned the Research and Development
("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.
Fonix product managers are marketing oriented project managers who are charged
with direct profit and loss responsibilities. These responsibilities begin with
market research and with product definition and specification then end with
delivery of quality products which address real needs identified by the
marketplace, on schedule and within
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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.
Current Fonix products with assigned product managers include:
1. FAAST for Embedded Markets. FAAST for Embedded Markets includes a
Graphical Development Environment that will allow customers to create
and optimize speech applications and generate the code that will run
directly on the target embedded platform of choice. Fonix is
initially delivering this technology on the Intel StrongARM, ARM,
MIPs Core, Epson E0C33, and Infineon TriCore chips with standalone
and Windows CE versions.
2. FAAST for Server Markets. FAAST for Server Markets is an SDK targeted
to tightly integrate Fonix ASR and TTS technologies on large
platforms that will service hundreds of concurrent users. This
technology is primarily targeted to applications that provide voice
in and out for the Internet.
3. Embedded Command and Control Solutions. Fonix also works directly
with manufacturers of products to integrate speech in and out and
handwriting into those products which include PDA's, cell phones,
automobile command and control and other applications.
4. Internet Voice Portal Solutions. Utilizing the FAAST for Server
product, Fonix provides the technology to voice enable the Internet
for devices which may not have a screen or keyboard, such as PDA's,
cell phones, or automotive applications. A prime market for this
product is providing Internet access to the handicapped.
5. Telephony TTS Solutions. Fonix AV1700 and AV2001 are products with a
significant and growing share of the Telephony TTS market.
6. Closed Caption. Fonix is applying ASR technology to automatically
create closed caption text for television programs, movies,
commercials, and training videos.
7. Multcons Solutions, part of the Fonix commitment to deliver improved
ASR technology for the future, Fonix continues to develop its
proprietary neural network architecture for application into future
products.
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.
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
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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.
Results of Operations
Three months ended September 30, 1999 compared with three months ended September
30, 1998
During the three months ended September 30, 1999, the Company recorded revenues
of $65,707 from the sale of its Interactive Technologies Solutions Group
products, a decrease of $29,793 over the same period in the previous year. The
decrease is due to a reorganization and redirection of the sales and marketing
staff in the 1999 period.
Selling, general and administrative expenses were $2,864,400 and $2,672,252 for
the three months ended September 30, 1999 and 1998, respectively. Salaries,
wages and related costs were $1,949,422 and $988,412 for the three months ended
September 30, 1999 and 1998, respectively, an increase of $961,010. This
increase is attributable to $1,296,600 in additional compensation to two
executive officers and a former executive officer related to the indemnification
of income taxes resulting from the sale of shares beneficially owned by the
three individuals for payment of Company obligations offset in part by
management's cost reduction initiatives implemented in February 1999. Legal and
accounting expenses decreased $85,626. This decrease is attributed primarily to
the costs of legal and accounting services related to the acquisition of
Articulate and Papyrus and the preparation of registration statements in 1998 in
addition to a reduction in legal fees expended for litigation and patent
registration matters. Marketing expenses decreased $37,853 and consulting and
outside services decreased by $239,491. These decreases are attributable to
management's cost reduction initiatives implemented in February 1999. . The
Company incurred product development and research expenses of $1,906,968 during
the three months ended September 30, 1999, a decrease of $2,389,970 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
three months ended September 30, 1999 and 1998, the Company expended a total of
approximately $100,000 and $50,000, respectively, in connection with the
development of the AcuVoice purchased in-process research and development
projects.
Amortization of goodwill and purchased core technologies were $630,609 and
$500,776 for the three months ended September 30, 1999 and 1998, respectively,
representing an increase of $129,833. This increase is primarily attributable to
the amortization of intangible assets acquired in connection with the
acquisitions of Papyrus.
The Company incurred losses from operations of $5,344,189 and $11,202,838 during
the three months ended September 30, 1999 and 1998, respectively. The decrease
in losses from operations is due primarily to management's cost reduction
initiatives implemented in February 1999, and purchased in process research and
development costs incurred in the acquisition of Articulate in 1998. The Company
anticipates that its investment in ongoing scientific product development and
research will continue at decreased levels for the remainder of fiscal 1999,
assuming availability of working capital.
Net other expense was $1,706,155 for the three months ended September 30, 1999,
a decrease of $4,479,083 over the three months ended September 30, 1998. The
decrease was due primarily to costs attributed to the cancellation of common
stock reset provisions that occurred in 1998 and to a reduction in interest
income of $266,043 from certificates of deposit that were converted to cash to
retire a bank line of credit in January 1999, offset in part by an increase in
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interest expense of $1,211,511 attributable to the issuance of the Series C
Convertible Debentures issued in January and March 1999.
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 its first revenues of $2,472,285, of
which, $2,368,138 was paid by Siemens as a non-refundable license fee for which
the Company had no further obligation of any kind. The 1999 revenues are
primarily from sales and licensing fees related to the 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 additional compensation to two
executive officers and a former executive officer related to the indemnification
of income taxes resulting from the sale of shares beneficially owned by the
three individuals 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 and to the salaries of
Papyrus personnel acquired in late 1998 offset in part by management's cost
reduction initiatives implemented in February 1999. 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. 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 research and development
projects.
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.
The Company incurred losses from operations of $15,448,414 and $27,771,310
during the nine months ended September 30, 1999 and 1998, respectively. The
decrease in losses from operations is due primarily to the $13,136,000 charge
for in-process research and development costs during the nine months ended
September 30, 1998 and a decrease in product development and research, offset in
part by increases in selling, general and administrative expenses and
amortization expense. The Company anticipates that its investment in ongoing
scientific product development and research will continue at decreased levels
for the remainder of fiscal 1999, assuming availability of working capital.
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 in part by an
increase in interest expense of $3,354,006 attributable to the issuance of the
Series C Convertible Debentures issued in January and March 1999.
In-Process Research and Development
At the dates 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
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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
and Articulate acquired in-process research and development projects,
respectively, 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 are the same as anticipated at the date of acquisition.
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its cash
requirements during the next 12 months. The scientific research and development,
corporate operations and marketing expenses will continue to require additional
capital. In addition, the Company's recent acquisitions of AcuVoice and Papyrus
place further requirements on the Company's limited cash resources. Because the
Company presently has only limited revenue from operations, the Company intends
to continue to rely primarily on financing through the sale of its equity and
debt securities or sales of existing technologies or businesses to satisfy
future capital requirements until such time as the Company is able to enter into
additional third party licensing or co-development arrangements such that it
will be able to finance ongoing operations out of license, royalty and sales
revenue. There can be no assurance that the Company will be able to enter into
such agreements. Furthermore, the issuance of equity securities or other
securities which are or may become convertible into equity securities of the
Company in connection with such financing (or in connection with acquisitions)
would result in dilution to the stockholders of the Company which could be
substantial.
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
("HSG") to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third
party, for $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 transaction and the remaining $4,000,000 is to be 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 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..
The Company had positive working capital of $612,111 at September 30, 1999
compared to negative working capital of $14,678,975 at December 31, 1998. The
current ratio was 1.14:1 at September 30, 1999 compared to 0.59:1 at December
31, 1998. Current assets decreased by $15,804,991 to $4,910,215 from December
31, 1998 to September 30, 1999. Current liabilities decreased by $31,096,077 to
$4,298,104 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, notes payable to related parties and deferred
revenues 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 $61,989,927 at December 31, 1998.
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 an extraordinary item in the accompanying condensed
consolidated statements of operations.
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
27
<PAGE>
$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.
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 notes were payable in various
amounts through September 30, 1999. 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.
In September 1999, the Company paid other notes payable to unrelated parties
aggregating $610,000 plus accrued interest.
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.
On January 29, 1999, the Company entered into a Securities Purchase Agreement
with four investors pursuant to which the Company sold its Series C Debentures
in the aggregate principal amount of $4,000,000. The outstanding principal
amount of the Debentures is convertible at any time at the option of the holders
into shares of the Company's common stock at a conversion price equal to the
lesser of $1.25 or 80 percent of the average of the closing bid price of the
Company's common stock for the five trading days immediately preceding the
conversion date. The Company recorded $687,500 as interest expense upon the
issuance of the Debentures in connection with this beneficial conversion
feature. The Company also issued 400,000 warrants to purchase an equal number of
the Company's common shares at a strike price of $1.25 per share in connection
with this financing. The warrants are exercisable for a period of three years
from the date of grant. The estimated fair value of the warrants of $192,000, as
computed under the Black-Scholes pricing model, was recorded as interest expense
upon the issuance of the Debentures. On March 3, 1999, the Company executed a
supplemental agreement pursuant to which the Company agreed to sell another
$2,500,000 principal amount of the Debentures on the same terms and conditions
as the January 29, 1999 agreement, except no additional warrants were issued.
The Company recorded $1,062,500 as interest expense upon the issuance of the
supplemental Debentures in connection with the beneficial conversion feature.
The obligations of the Company for repayment of the Debentures, as well as its
obligation to register the common stock underlying the potential conversion of
the Debentures and the exercise of the warrants issued in these transactions,
are personally guaranteed by two officers and directors and a former officer and
director of the Company (the "Guarantors"). In connection with the March 3, 1999
funding, the Company agreed to grant a lien on the patent covering the Company's
Automated Speech Recognition ("ASR") technologies as collateral for repayment of
the Debentures. However, to date no lien on the patent has been granted. The
Guarantors guaranteed the obligations of the Company under the Debentures and
pledged 6,000,000 shares of common stock of the Company beneficially owned by
them as collateral security for their obligations under their guarantees.
Subsequent to the March 3, 1999 funding, the holders of the Debentures notified
the Company and the Guarantors that the Guarantors were in default under the
terms of the pledge and that the holders intended to exercise their rights to
sell some or all of the pledged shares of the Guarantors.
The Guarantors guaranteed certain other obligations of the Company. As security
for some of the guarantees, the Guarantors have 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 in full a note
payable to an unrelated third party in the amount of $588,000 that had
previously been guaranteed by the Guarantors.
27
<PAGE>
On June 29, 1999, the Company received notice from the Nasdaq Stock Market
("Nasdaq") indicating that unless the minimum bid price for the Company's common
stock returned to at least $1.00 per share for at least ten consecutive trading
days prior to September 29, 1999, the Company's shares would be delisted from
Nasdaq on October 1, 1999. If the Company's common stock is delisted from Nasdaq
and is not relisted within three trading days, an event of default would result
under the terms of the Debentures. Upon the occurrence of an event of default,
the full $6,500,000 principal amount of all of the Debentures, together with
accrued interest and all other amounts owing in respect thereof, would become
immediately due and payable in cash. To date, the Company's common stock
continues to be listed for trading on Nasdaq.
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 common stock. After the above conversions
876,667 shares of Series D preferred stock remain outstanding.
On February 3, 1999, certain holders of Series D and Series E preferred stock
forwarded conversion notices to the Company converting (1) 27,500 shares of
Series D preferred stock and related dividends into 315,379 shares of common
stock and (2) 77,500 shares of Series E preferred stock and related dividends
into 1,955,346 shares of common stock. Due to an error in the conversion
calculations and a subsequent delay in receiving further clarifying instructions
from the holders, the common shares issuable upon such conversions were never
issued to the Series D and Series E holders, although the Company's records
reflected that such shares had been issued. Subsequently, because the common
stock had not been received, the Series D and Series E holders rescinded the
February 3 conversions. The effects of this recission have been retroactively
reflected in the accompanying condensed consolidated financial statements.
Should the Company's stock be delisted from Nasdaq and not relisted within three
trading days, the terms of the Series D preferred stock require the Company 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.
The Company issued 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 will be issued to replace shares beneficially
owned by the three individuals and sold by the holders of the Debentures and
Series D and E preferred shares.
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. 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.
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 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.
28
<PAGE>
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.
The Company presently has no plans to purchase any new research and development
assets or office facilities.
Potential Delisting of the Company's Common Stock by Nasdaq - The Company's
common stock currently trades on the Nasdaq SmallCap Market which requires, for
continued listing, a minimum bid price of at least $1.00 per share. At June 29,
1999, the Company's common stock had traded below $1.00 for more than 30
consecutive trading days. On June 29, 1999, the Company received a letter from
Nasdaq indicating that unless the minimum bid price for the Company's common
stock returned to at least $1.00 per share for at least 10 consecutive trading
days prior to September 29, 1999, the Company's shares would be delisted from
the Nasdaq SmallCap Market on October 1, 1999. The Company requested a hearing
with respect to the Nasdaq notice and at that hearing on October 28, 1999,
further requested that Nasdaq defer a decision to delist the Company's common
stock while the Company completes its plans to improve its equity and
operations. The Company has not received a response from Nasdaq regarding its
request and the Company's common stock continues to be listed for trading on the
Nasdaq SmallCap Market.
If the Company's common stock is delisted from the Nasdaq SmallCap Market, the
Company believes that its common stock would qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's common
stock, even if the Company's shares are thereafter traded on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically.
If the Company's common stock is delisted from the Nasdaq SmallCap Market and is
not relisted within three trading days, an event of default would result under
the terms of the Debentures. Upon the occurrence of an event of default, the
unpaid principal amount of the Debentures, together with accrued interest would
become immediately due and payable. Also, if the Company's common stock is
delisted from the Nasdaq SmallCap Market and is not relisted within three
trading days, the terms of the Series D preferred stock require the Company 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 that the
stock is delisted.
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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse purportedly owns, commenced an action against the Company in
federal court for the Southern District of New York. Clarke and Perpetual
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<PAGE>
Growth asserted claims for breach of contract relating to certain financing the
Company received during 1998. Specifically, Clarke and Perpetual Growth alleged
that they entered into a contract with the Company under which the Company
agreed to pay them a commission of five percent of all financing provided to
Fonix by Southridge Capital Management or its affiliates. Clarke and Perpetual
claim that they are entitled to commissions with respect to approximately
$3,000,000 of equity financing to the Company in July and August 1998, and the
Company's offerings of Series D and Series E preferred stock, totaling together
$12,000,000, in August and September 1998.
The Company believes that the Clarke lawsuit is without merit and filed a motion
to dismiss based upon the court's lack of personal jurisdiction over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal. The Company has filed a suit against Clarke
and Perpetual Growth in federal court for the Central District of Utah seeking a
declaratory judgment that it does not owe any money to Clarke and Perpetual
Growth. Now that the action in New York has been dismissed, the Company intends
to vigorously pursue the Utah action. However, the lawsuit in New York could be
reinstated on appeal and Clarke and Perpetual Growth could prevail in that
lawsuit, in which case the Company may be required to pay significant amounts of
money damages awarded by the court.
Papyrus - After the Papyrus acquisition closed in October 1998, the Company
investigated some of the representations and warranties made by Papyrus to
induce the Company to acquire Papyrus. The Company determined that certain of
the representations made by Papyrus and their executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against Papyrus in
the United States District Court for the District of Utah, Central Division,
wherein the Company alleged claims for misrepresentation, negligent
misrepresentation, breach of contract, breach of the implied covenant of good
faith and fair dealing and rescission. On March 11, 1999, three of the former
shareholders of Papyrus filed an action against the Company in the United States
District Court for the District of Massachusetts, alleging a default under the
terms of the promissory notes issued to them in connection with the Papyrus
acquisition. On April 2, 1999, the three former Papyrus shareholders filed an
amended complaint against the Company seeking additional remedies including
violation of Massachusetts unfair and deceptive acts and practices statutes and
copyright infringement. On April 8, 1999, a fourth former Papyrus shareholder
filed an action against the Company alleging a default under the terms of the
promissory notes issued to him in connection with the Papyrus acquisition and
seeking additional remedies including violation of Massachusetts unfair and
deceptive acts and practices statutes and copyright infringement. On April 13,
1999, a fifth former Papyrus shareholder filed a similar action in
Massachusetts. Subsequently, the Company has entered into agreements with the
five former Papyrus shareholders for dismissal of the actions and cancellation
of the promissory notes upon payment to the former shareholders of $1,188,909
(the "Settlement Payment") and return for cancellation by the Company of 970,586
shares of restricted common stock issued to the five former shareholders in
connection with the acquisition. The Company agreed to pay the Settlement
Payment on or before August 31, 1999 or, if the definitive proxy soliciting
consents from the shareholders of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets or the Company and the five
former Papyrus shareholders are free to pursue their respective claims.
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 $175,000.00. 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 $250,000.00. The Company anticipates that the American
Arbitration Association will conduct a scheduling conference within the next
twenty days of which dates for the proceeding, including the arbitration
hearing, will be set.
In addition to the above, the Company is involved in various lawsuits, claims
and actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these matters will not materially affect the consolidated financial position or
results of operations of the Company.
Item 2. CHANGES IN SECURITIES
Series D and E Preferred Stock - During the 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 common
stock. After the above conversions, 876,667 shares of Series D preferred stock
remain outstanding.
Common Stock Issued - On June 2, 1999, the Company issued 200,000 shares of
common stock (having a market value of $100,000 on that date) to an unrelated
individual in payment for consulting services rendered.
In September 1999, five former Papyrus shareholders returned 970,586 shares of
common stock to the Company under an agreement in which the five shareholders
agreed to reduce the total shares they had received from the Company in
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<PAGE>
the 1998 acquisition of Papyrus from 3,111,114 shares to 2,140,528 shares. The
original cost of $1,000,917 associated with the issuance of these shares is
reflected as a reduction of goodwill previously recorded at the time of the
acquisition.
Item 4. Submission of Vote of Security Holders
At the Company's annual meeting of shareholders held on October 29, 1999, the
following actions were submitted to and approved by vote of the majority of the
issued and outstanding shares of the Company:
1. Election of directors;
2. Approval of the Company's issuance of its Series D 4%
preferred stock and Series E 4% preferred stock to seven
institutional investors, which preferred stock may be
convertible into more than 20% of the total number of
shares of the Company's Class A common issued and
outstanding prior to the commencement of such series of
transactions.;
3. Approval of the Company's amendments to its 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; and a further amendment 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;
4. Approval of the Board of Directors' selection of Arthur
Andersen LLP, as the Company's independent public
accountant's for the fiscal year ended Decembing 31, 1999.
A total of 46,623,763 shares ( approximately 63%) of the issued and
outstanding shares of the Company were represented by proxy or in person at the
meeting. These shares were voted on the matters described above as follows:
1. For the directors as follows:
<TABLE>
<CAPTION>
# Shares Abstaining/
Name # Shares For # Shares Against Withheld
- - ------------------------- ------------ ---------------- --------------------
<S> <C> <C> <C>
William A. Maasberg, Jr. 47,381,620 7,831,673 578,098
John A. Oberteuffer 47,411,770 7,783,378 523,148
Thomas A. Murdock 47,356,820 8,562,673 578,098
Roger D. Dudley 47,045,370 8,579,348 660,148
</TABLE>
2. For the approval of the Company's issuance of its Series D 4%
preferred stock and Series E 4% preferred stock as follows:
# Shares For # Shares Against # Shares Abstaining Not Voted
- - ------------ ---------------- ------------------- -----------
57,192,593 12,397,825 1,139,347 25,180,523
3. For the approval of the Company's amendments to its 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.
# Shares For # Shares Against # Shares Abstaining
- - ------------ ---------------- -------------------
57,192,593 1,015,071 1,389,754
4. For the approval of an amendment to the Company's
certificate of incorporation that would increase the authorized capital of teh
Company to include 300,000 shares of Common Stock, par value $.0001 per share,
and 50,000,000 shares of Preferred Stock, par value $.0001 per share.
31
<PAGE>
# Shares For # Shares Against # Shares Abstaining Not Voted
- - ------------ ---------------- ------------------- -----------
20,086,173 12,969,230 1,261,492 25,180,523
5 For approval of the Board of Directors' selection of Arthur
Andersen, LLP as the independent certified public accountants of the Company as
follows:
# Shares For # Shares Against # Shares Abstaining
- - ------------ ---------------- -------------------
59,101,639 298,317 97,462
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits: The following Exhibits are filed with this Form 10-K
pursuant to Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit
(2)(i) Agreement and Plan of Reorganization among the
Company, fonix Acquisition Corporation
and AcuVoice dated as of January 13, 1998,
incorporated by reference from the Company's
Current Report on Form 8-K, filed March 20, 1998
(2)(ii) Agreement and Plan of Merger among the Company,
ASI Acquisition Corporation and
Articulate Systems, Inc., dated as of July 31,
1998, incorporated by reference from the
Company's Current Report on Form 8-K, filed
September 17, 1998
(2)(iii) Amendment No. 1 to Agreement and Plan of Merger
Agreement and Plan of Merger among the Company,
ASI Acquisition Corporation and Articulate
Systems, Inc., dated as of September 2, 1998,
incorporated by reference from the Company's
Current Report on Form 8-K, filed September 17,
1998
(3)(i) Articles of Incorporation of the Company which
are incorporated by reference from the Company's
Registration Statement on Form S-18 dated as of
September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of
Incorporation dated as of March 21, 1994, which
is incorporated by reference from the Company's
Annual Report for the Fiscal Year Ended
December 31, 1994 on Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of
Incorporation dated as of May 13, 1994, which
is incorporated by reference from the Company's
Annual Report for the Fiscal Year Ended
December 31, 1994 on Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of
Incorporation dated as of September 24, 1997,
which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for
the period ended September 30, 1997
(3)(v) The Company's Bylaws, as amended, which are
incorporated by reference from the Company's
Annual Report for the Fiscal Year Ended December
31, 1994 on Form 10-KSB
(4)(i) Certificate of Designation of Rights and
Preferences of Series D 4% Convertible Preferred
Stock, filed with the Secretary of State of
Delaware on August 27, 1998, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period
ended September 30, 1998
(4)(ii) Certificate of Designation of Rights and
Preferences of Series E 4% Convertible Preferred
Stock, filed with the Secretary of State of
Delaware on October 15, 1998, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period
ended September 30, 1998
32
<PAGE>
(10)(i) Product Development and Assignment Agreement
dated as of October 16, 1993 between
Phonic Technologies, Inc. and Synergetics, Inc.,
which is incorporated by reference from
the Company's Current Report on Form 8-K dated
as of June 17, 1994
(10)(ii) Re-Stated Product Development and Assignment
Agreement dated as of March 30, 1995,
between fonix Corporation and Synergetics, Inc.,
which is incorporated by reference from
the Company's Annual Report for the Fiscal Year
Ended December 31, 1994 on Form 10-KSB
(10)(iii) Memorandum of Understanding dated as of March 13,
1997, by and among the Company, Synergetics, Inc.
and C. Hal Hansen, which is incorporated by
reference from the Company's Annual Report on
Form 10-KSB for the fiscal year ended December
31, 1996
(10)(iv) Employment Agreement by and between the Company
and Stephen M. Studdert, which is
incorporated by reference from the Company's
Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(v) Employment Agreement by and between the Company
and Thomas A. Murdock, which is
incorporated by reference from the Company's
Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(vi) Employment Agreement by and between the Company
and Roger D. Dudley, which is
incorporated by reference from the Company's
Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(vii) Restated Master Agreement for Joint
Collaboration between the Company and
Siemens, dated November 14, 1997, as
revised, which is incorporated by
reference from the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997
(10)(viii) Restated First Statement of Work and License
Agreement between the Company and Siemens, dated
February 11, 1998, which is incorporated by
reference from the Company's Quarterly Report on
Form 10-Q for the period ended June 30, 1999
(10)(ix) Master Technology Collaboration Agreement between
the Company and OGI, dated October
14, 1997, which is incorporated by reference from
the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(x) Common Stock Purchase Agreement among the Company
and JNC Opportunity Fund Ltd.
and Diversified Strategies Fund, LP, dated as of
March 9, 1998, which is incorporated by
reference from the Company's Annual Report on
Form 10-K for the year ended December 31, 1997
(10)(xi) Common Stock Purchase Agreement between the
Company and Thomson Kernaghan & Co.,
dated as of March 9, 1998, which is incorporated
by reference from the Company's Annual
Report on Form 10-K for the year ended December
31, 1997
(10)(xii) Royalty Modification Agreement among the Company
and Synergetics, dated as of April
6, 1998, which is incorporated by reference from
the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xiii) Purchase Agreement with John Oberteuffer and the
Company dated April 9, 1998, which
is incorporated by reference from the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xiv) Employment Agreement by and between the Company
and John A. Oberteuffer, which is
33
<PAGE>
incorporated by reference from the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xv) First Amendment to Master Agreement for Joint
Collaboration between the Company and
Siemens, dated February 13, 1998, which is
incorporated by reference from the Company's
Annual Report on Form 10-K for the year ended
December 31, 1997
(10)(xvi) Second Amendment to Master Agreement for Joint
Collaboration between the Company and Siemens,
dated March 13, 1998, which is incorporated by
reference from the Company's Annual Report on
Form 10-K for the year ended December 31, 1997
(10)(xvii) Series D Convertible Preferred Stock Purchase
Agreement Among fonix corporation, JNC
Opportunity Fund, Ltd., Diversified Strategies
Fund, L.P., Dominion Capital Fund, Ltd.,
Sovereign Partners, LP, Canadian Advantage
Limited Partnership and Thomson Kernaghan & Co.
(as agent) dated as of August 31, 1998, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period
ended June 30, 1999
(10)(xviii) Series E Convertible Preferred Stock Exchange and
Purchase Agreement among fonix corporation,
Sovereign Partners, LP and Dominion Capital Fund,
Ltd., dated as of September 30, 1998, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period
ended June 30, 1999
(10)(xix) Asset Purchase Agreement - Acquisition of Certain
Assets of Fonix Corporaion and Fonix/ASI
Corporation by Lernout & Hauspie Speech Products
N.V., dated as of May 19, 1999,which is
incorporated by reference from the Company's
Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein
designated as Exhibit 10(a))
(10)(xx) Escrow Agreement, dated as of September 1, 1999,
which is incorporated by reference from
the Company's Current Report on Form 8-K, filed
with the Commission on September 16,
1999 (therein designated as Exhibit 10(b))
(10)(xxi) Technology Option Agreement, dated as of May 19,
1999, which is incorporated by
reference from the Company's Current Report on
Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit
10(c))
(10)(xxii) Assignment and Assumption Agreement, dated as of
September 1, 1999, which is
incorporated by reference from the Company's
Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein
designated as Exhibit 10(d))
(10)(xxiii) License Agreement by and between Fonix/ASI
Corporation and Lernout & Hauspie Speech Products
N.V., dated as of May 19, 1999, which is
incorporated by reference from the Company's
Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein
designated as Exhibit 10(e))
(10)(xxiv) Loan Agreement, dated as of April 22, 1999, which
is incorporated by reference from the
Company's Current Report on Form 8-K, filed with
the Commission on September 16, 1999
(therein designated as Exhibit 10(f))
(10)(xxv) Amendment to Loan Agreement, dated as of May 12,
1999, which is incorporated by
reference from the Company's Current Report on
Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit
10(g))
(10)(xxvi) Second Amendment to Loan Agreement, dated as of
May 19, 1999,which is incorporated by reference
from the Company's Current Report on Form 8-K,
filed with the Commission on September 16, 1999
(therein designated as Exhibit 10(h))
34
<PAGE>
(10)(xxvii) Loan Agreement, dated as of May 19, 1999,which is
incorporated by reference from the Company's
Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein
designated as Exhibit 10(i))
(10)(xxviii) First Amendment to Loan Agreement, dated as of
August 12, 1999,which is incorporated by
reference from the Company's Current Report on
Form 8-K, filed with the Commission on September
16, 1999 (therein designated as Exhibit 10(j))
(10)(xxix) Agreement, dated as of July 31, 1999, which is
incorporated by reference from the
Company's Current Report on Form 8-K, filed with
the Commission on September 16, 1999
(therein designated as Exhibit 10(k))
(27) Financial Data Schedule
(b) Reports filed on Form 8-K during the three-month period ended September 30,
1998:
(i) On September 16, 1999, the Company filed a Current Report
on Form 8-K, dated September 1, 1999, containing Item 2
disclosure pertaining to the Company's sale of the
operations and a significant portion of the assets of its
HealthCare Solutions Group, headquartered in Woburn
Massachusetts, to Lernout and Hauspie Speech Products N.V.,
a Belgian corporation with its principal place of business
in Ieper, Belgium.
35
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Fonix Corporation
Date:November 22, 1999 By: /s/ Douglas L. Rex
--------------------- --------------------------------------
Douglas L. Rex, Chief Financial Officer
36
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