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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1999, or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______________ to
_____________.
Commission File No. 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 87-0380088
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(Address of principal executive offices with zip code)
(801) 328-8700
(Registrant's telephone number, including area code)
Securities registered pursuant to
Section 12(b) of the Act: None
Securities registered pursuant to
Section 12(g) of the Act: Class A Common Stock ($0.0001 par value per
share)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 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] No[ ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $247,408,499 calculated using a closing price of
$1.59 per share on April 10, 2000. For purposes of this calculation, the
registrant has included only the number of shares directly held by its officers
and directors as of April 10, 2000, (and not counting shares beneficially owned
on that date) in determining the shares held by non-affiliates. As of April 10,
2000, there were issued and outstanding 163,994,614 shares of the Company's
Class A common stock.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
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1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Page
Item 1. Business............................................................3
Item 2. Properties.........................................................22
Item 3. Legal Proceedings..................................................23
Item 4. Submission of Matters to a Vote of Security Holders................23
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................23
Item 6. Selected Financial Data............................................25
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................26
Item 8. Financial Statements and Supplementary Data........................34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................34
Part III
Item 10. Directors and Executive Officers of the Registrant.................34
Item 11. Executive Compensation.............................................37
Item 12. Security Ownership of Certain Beneficial Owners and Management.....42
Item 13. Certain Relationships and Related Transactions.....................44
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....47
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ITEM 1. BUSINESS
General
Fonix Corporation, a Delaware corporation ("Fonix" or the "Company")
is a development stage company engaged in marketing and developing proprietary
human-computer interface ("HCI") technologies and solutions. Specifically, the
Company has developed neural network-based automated speech recognition ("ASR"),
text-to-speech ("TTS"), handwriting recognition ("HWR") and speech compression
technologies that are integrated into products for commercial and industrial
applications and 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 applications and products
utilizing its Core Technologies which enable people to interact with computers
and electronic devices on human terms rather than conforming to the process of a
machine. The Company believes its efficient, intuitive and natural method of HCI
will enhance traditional interaction tools such as the keyboard and mouse in a
broad range of mass market, consumer, industrial, embedded and server-based
applications and products.
Fonix is pursuing revenue opportunities through generation of
non-recurring engineering fees, product and technology license and royalty fees,
product sales and product support maintenance contracts. The Company currently
markets its products and Core Technologies to software developers, consumer
electronics manufacturers, micro-processor manufacturers, third-party product
developers, operating system developers, network and share-ware developers and
Internet and web-related companies. The Company focuses its marketing efforts
toward both embedded systems applications for mobile electronic devices and
consumer products, and server-based solutions for Internet and telephony
voice-activated applications.
Manufacturers of consumer electronics products, software development
and Internet content developers use Fonix Core Technologies to simplify the use
of their products and increase product functionality resulting in broader market
opportunities and significant competitive advantage. Fonix solutions support
multiple platforms, are environment and speaker independent and provide easy
integration within a relatively small memory requirement.
Core Technologies
Fonix Core Technologies have key competitive advantages that
differentiate them from other speech and handwriting technology companies.
ASR. Fonix researchers have developed and patented what the Company
believes to be a fundamentally unique approach to the analysis of human speech
sounds and the contextual recognition of speech. The ASR technologies attempt to
approximate the techniques employed by the human auditory system and language
understanding, based upon the use of a series of neural networks. The Fonix ASR
technologies use information in speech sounds perceptible to humans but not
discernible by other ASR systems. The ASR technologies employ neural network
technologies (artificial intelligence techniques) for identifying speech
components and word sequences contextually. 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 the neural net technologies. This development
has yielded a proprietary ASR system utilizing a unique method of extracting the
fundamental mathematical elements from the acoustic speech signal, a neural
net-based phoneme (speech sound) identifier, and a neural-net architecture for
modeling the many complex elements of human language. The latter component is
known as MULTCONSTM or multi-level temporal constraint satisfaction network.
These developments have been the subject of two issued patents and 13 pending
patent applications. In addition, the Company has acquired a related patent
covering the front-end recognition process.
The Company believes the reliable recognition of natural, spontaneous
speech spoken by one or more individuals in a variety of common environments by
means of a conveniently placed microphone will significantly improve the
performance, utility and convenience of applications such as computer command
and control, voice activated navigation of the Internet, automotive
applications, data input, text generation, telephony transactions, continuous
dictation, and other applications in both embedded and server based
applications.
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Fonix has pursued the development of these ASR technologies to
produce salable products by overcoming the limitations of currently available
commercial ASR systems and broadening the market acceptance and use of HCI
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 that allows speech
recognition to operate in embedded system environments, or enabling
server-based systems to operate with significantly more simultaneous
users due to lower memory requirements.
2. Significantly reduced power requirements that makes Fonix
technologies available for use in a host of smaller computing
solutions with limited battery/power capacity and enabling more
simultaneous users on server-based systems.
3. Speaker independence that allows various speakers to use the same
system without the system being trained to a particular user's voice
and dialect.
4. Excellent noise cancellation qualities that allows the ASR system to
extract ambient background noise, permitting higher recognition rates
in noisy environments and reduces the need for direct-wired
microphones or headsets.
5. Rapid porting to multiple computer chip platforms and operating
systems that creates broad embedded product demand.
6. Leading edge, visual, integrated development environment using the
Fonix Accelerated Applications Speech Technology (FAAST) software
developer kit ("SDK"), that allows customers to build applications in
a rapid time frame with a high rate of success and few outside
resources, thereby accelerating product time to market.
The Company believes that its ASR technologies offer unique speech
processing techniques that will improve a broad range of computing solutions and
accelerate and enhance integration of HCI technologies into products,
applications, solutions and devices.
The Company expended $6,823,612 in 1999, $12,109,065 in 1998, and
$7,066,294 in 1997 on ASR research and development ("R&D") activities. Since its
inception (October 1, 1993), the Company has spent $36,869,970 on R&D of ASR
technologies. The Company recognized revenue of $2,368,138 in 1998 resulting
from a licensing agreement for ASR technology with an international microchip
manufacturer. Otherwise, no ASR-related revenue has been generated to date and
the Company expects that a substantial part of its capital resources will
continue to be devoted to product development and marketing R&D of ASR
technologies in the future.
TTS. Fonix text-to-speech products include a defined, proprietary
vocabulary-true human-quality synthetic voice with full prosody and an unlimited
vocabulary text-to-speech engine.
The Company's TTS products use actual recordings of "units" of human
speech (i.e., the sound pulsation). Since the unit of speech often consists of
more than one phoneme (sound), Fonix's approach has been called a "large segment
concatenative speech synthesis" approach. Since the early 1960's, other
companies such as DEC and AT&T have used a method called "parametric speech
synthesis." In contrast to these parametric systems, Fonix synthetic speech
products produce a high quality, human sounding voice that includes full voice
inflection, intonation and clarity. Fonix' large vocabulary TTS ("LVTTS") engine
won awards as "best text-to-speech" product at the Computer Technology Expo '97
and '98 and the best of show award at AVIOS '97. Presently LVTTS products are
sold to end-users, systems integrators and OEMs in call centers, Internet
applications, telecommunications, multi-media, educational and assistive
technology markets.
TTS products include the Fonix AV 1700 TTS system for end-user
desktop and laptop system use. The Fonix AV 2001 SDK is a tool 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, including Microsoft Windows 95m, Windows 98 and Windows NT,
Solaris Sparc and Solaris X86, and AIX.
During 1999, the Company recognized $397,873 in revenue from
licensing or sale of the TTS technologies and products.
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HWR. Fonix handwriting recognition products are marketed under the
Allegro brand name. The Allegro HWR software is a single letter recognition
system like the Graffiti handwriting recognition software for the PalmPilot(R)
PDA. However, Allegro's alphabet is all natural in appearance involving lower
case letter. The Allegro system is easy to use and requires little training.
Allegro is sold by Purple Software, under license from the Company, for the
Psion Series 5(R) hand-held PC. It has also been integrated into NuvoMedia's
Rocketbook(R) for handwriting features in its electronic book program. This
software has also been licensed to Philips for use with its smart cell phones.
Fonix also offers cursive HWR software which recognizes naturally-written whole
words. The cursive HWR 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 1999, the Company received $41,634 in revenue from the
licensing of the HWR technologies.
Integration of HCI Technologies. During 1999, the Company created
SDK's for developing applications that utilize some or all Core Technologies.
FAAST for Embedded and FAAST for Server allows the rapid development of ASR, TTS
and HWR programs into a single application. One such product development effort
that has been undertaken by the Company is a pen/voice application that permits
simultaneous input and editing of both handwriting and speech for hand-held
devices.
Market Strategy
The world-wide market for HCI technologies and products is emerging.
Currently, only a small portion of prospective applications for HCI technologies
has reached the critical point of commercial viability. Among the largest
current markets developing or employing speech technologies are embedded and
server-based applications in telephony and call centers, automatic desktop
dictation software, personal hand-held communication devices, Internet voice
portals and R&D markets. Historically, development of speech products in an
emerging market has been affected by declining margins, large memory
requirements, non-extendable technology, operating system platform dependence,
lack of integration and non-recurring engineering dependence. Recently, several
market trends have accelerated demand for speech applications 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 access to
technology by handicapped or disabled individuals.
The Company has strategically sought markets for its Core
Technologies with high margins, broad use, rapid development and market
emergence/presence. Fonix has also strategically avoided markets with low
margins which are commodity driven, subject to continuous price compression and
require costly customer support systems. The Company's current marketing
strategy is governed by the following general principles:
1. Focus on revenues - Pursue specific markets where revenues can be
realized in the short term through a market driven approach and away
from markets focusing on continued R&D. Also pursue opportunities
that represent recurring revenue streams rather than one-time
development or engineering fees.
2. Integration with minimal additional development engineering - Pursue
integration into customer products where Fonix technology is directly
compatible and can go to market as part of existing or new products
with minimal additional development engineering.
3. Existing marketing channels and significant market share - Partner
with customers who have existing marketing channels in place and
leverage product sales through those channels. Also, pursue customers
who enjoy dominant or significant market share in their respective
markets and who display the financial ability and marketing power to
rapidly bring products to market.
4. Second tier customer support - Position Fonix generally as a provider
of second tier customer support, providing training and tools for
Fonix customers who operate excellent front line support systems for
their end-user customers.
Because the Company is pursuing integration into mass market,
industrial, general business and personal electronics products and computing
solutions, lead time to revenue recognition is longer than for retail, commodity
driven software products. The Company's products sold and integrated into
customer applications are subject to both
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customer production schedules and customer success in marketing the products and
generating product sales. The Company's revenues are thus subject to delays and
possible cancellation resulting from customer integration delays.
Embedded Markets
Increasingly efficient and powerful computing solutions have rapidly
developed new markets by creating smaller, more convenient devices equipped with
personalized functions. These devices include PDAs (personal digital
assistants), cellular phones, web pads, wireless communications devices, and
other consumer electronics. A significant deterrent to full functionality of
these powerful, yet small computing devices is the current need for a keyboard
and/or a mouse to interface with the device. Recent integration of HWR
technology has helped to increase the demand for natural, intuitive HCI with
these devices and has prepared markets to pay for speech recognition and
synthetic speech in computing solutions. Other product development initiatives
that may drive additional interest in HCI include electronic books, wearable
computers, testing of smart appliances and toys (VCRs, answering machines,
wireless phones, and climate control systems) and command and control
applications (automotive, hands free cellular phones and voice activated
navigation systems).
Historically, micro processors for mobile computing devices did not
contain enough memory or computing power (MIPS) to operate most ASR and TTS
applications. Adding the hardware necessary to boost memory and computing power
increased the price of such devices to unacceptable levels. However, Fonix ASR
and TTS technologies have memory and power requirements that fall well within
tolerances needed to speech enable applications using existing 16 bit and 32 bit
processors. To capitalize on this distinct competitive advantage, Fonix is
pursuing sales and partnership relationships with companies offering embedded
products for mass consumer markets, industrial applications and business
computing solutions. Currently, Fonix has ported its HCI technologies to several
RISC processors including ARM, Epson EOC 33A104 and 204, and the Infineon
TriCore, and to Microsoft Windows CE hardware platforms including Intel
StrongARM, Hitachi SH3 and SH4, and MIPs core.
The Company has addressed these market opportunities by releasing
FAAST 1.0 for Embedded. FAAST for Embedded provides application developers with
a tool enabling rapid development of ASR and TTS applications that can be
quickly and efficiently ported into their product.
Fonix has identified key embedded market segments which it believes
will provide long term, sustainable revenue and earnings flow as follows:
1. Chip Manufacturers. Digital signal processor ("DSP") and micro
processor manufacturers are currently highly focused on technology
innovations which will support and drive sales of chips through
third-party vendors. Fonix ASR and TTS technologies have demonstrated
ability to operate in these environments.
2. Design Developers. Firms designing reference platforms and products
and developing functions operating on those platforms through
contracts with major mass market product suppliers provide a strong
market opportunity for Fonix because they are channels to major
consumer electronics marketers.
3. Software Developers. Software developers in multiple markets
increasingly enable their software products with one or more HCI
technologies, resulting in leveraged product sales and potential
royalty revenue for Fonix.
4. Third-Party Product Developers. Many companies are currently seeking
HCI technologies to integrate into a host of consumer electronics
devices, commercial applications and business solutions. Primary
markets for these applications are in automotive and aviation
telematics, industrial wearable computers, mobile communications
devices and PDAs.
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. Additionally, new product
areas for automated speech include network systems, telephone company e-mail
reader services, software document readers, Internet navigation and screenless
Internet access, web site text readers and mobile computing solutions.
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The Company has addressed these market opportunities by releasing
FAAST 1.0 for Servers. FAAST for Servers provides application developers with a
tool enabling rapid development of ASR and TTS applications that can be quickly
and efficiently ported into their product.
In addition, the Company is focused on direct product development in
server-based markets in three primary areas:
1. Internet Voice Portals. Speech enabled access to the Internet and web
site navigation is a rapidly emerging need. Fonix is developing and
will soon implement products for voice portals to the Internet which
may be purchased for use by portal companies, web sites and content
providers, Internet service providers and browsers.
2. TTS for Reading Web Sites. Since over 70% of all web content is text,
demand for products allowing web content to be read to the user is
rapidly growing. Fonix has developed a web page reader which can be
added to web sites. This voice solution is targeted toward the
largest web content providers worldwide in media, government,
business and other industries.
3. Network Systems Command and Control and E-mail Reader. Fonix provides
both ASR and TTS which can be seamlessly integrated into network
software to speech-enable software applications.
Fonix Product Development and Delivery Focus
To accelerate the delivery of Fonix technologies, Fonix has
transitioned from an R&D-oriented organization into a product delivery matrix
organization. Company focus and organization consists of product teams led by
product managers who are marketing-oriented and charged with direct profit and
loss responsibilities. These responsibilities begin with market research, and
product definition and specification and end with delivery of quality products
which address needs identified by the marketplace, on schedule and within
budget.
Fonix has organized its product development efforts into the
following product management teams to facilitate delivery of its products to the
embedded and server markets described above:
1. FAAST 1.0 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. Fonix is initially delivering this
technology on the Intel StrongArm(R), MIPs Core, Epson EOC 33A104 and
208, Hitachi SH3 and SH4, and Infineon TriCore with standalone and
Microsoft Windows CE versions.
2. FAAST 1.0 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. TTS Solutions focus on both small and unlimited vocabulary
applications using Fonix AV1700 and AV2001 for the telephony TTS
market.
4. Embedded Command and Control Solutions work directly with
manufacturers of products to integrate HCI into PDA's, cell phones,
automobile command and control and other applications.
5. Internet Voice Portal Solutions utilize the FAAST for Server product
to provide 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.
6. Integrated Pen/Voice Solution provide simultaneous HWR and ASR input
for hand-held, mobile computing devices.
Employees
As of April 10, 2000, the Company employed 89 people. Of this total,
46 were employed in product development and delivery, 15 were employed in sales
and marketing and 28 were employed in strategic development, administration and
support.
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RECENT DEVELOPMENTS
Changes in the Company's Board of Directors and Executive Officers
Stephen M. Studdert resigned as the Company's chief executive officer
on January 26, 1999, as chairman of the board of directors on April 10, 1999 and
as a director on July 31, 1999. In connection with his resignation as chief
executive officer, the Company entered into a separation agreement with Mr.
Studdert pursuant to which Mr. Studdert released the Company from all claims and
obligations under his employment agreement, and the Company agreed to pay Mr.
Studdert $250,000 in 1999, $250,000 in 2000 and $100,000 in 2001.
Joseph Verner Reed, Reginald K. Brack and Rick D. Nydegger resigned
from the board of directors effective September 3, 1999.
William A. Maasberg Jr. became a member of Fonix's board of directors
on September 3, 1999. From December 1997 through February 1999, Mr. Maasberg was
a Vice President and General Manager of the AMS Division of Eyring Corporation.
The AMS Division manufactures multi-media electronic work instruction software
applications. He was also a co-founder and principal in Information Enabling
Technologies, Inc. ("IET"), and LIBRA Corporation ("LIBRA"), two companies
focusing on software application development, and served in several key
executive positions with both IET and LIBRA from May 1976 through November 1997.
Mr. Maasberg worked for IBM Corporation from July 1965 through May 1976 in
various capacities. He received his BS Degree from Stanford University in
Electrical Engineering and his MS in Electrical Engineering from the University
of Southern California. Mr. Maasberg was re-elected to the board of directors at
the Company's 1999 Annual Meeting of Stockholders and became chief operating
officer for the Company on March 21, 2000.
Mark S. Tanner was appointed to Fonix's board of directors on
November 9, 1999. Mr. Tanner is currently the chief financial officer and senior
vice president of finance and administration for Mrs. Fields' Original Cookies,
Inc. Mr. Tanner spent nine years at PepsiCo, where he was chief financial
officer for Pepsi International's operations in Asia, the Middle East, and
Africa. He was vice president of strategic planning for Pepsi North America, as
well as chief financial officer for Pepsi North America's Pepsi East Operations.
Mr. Tanner also spent ten years with United Technologies Corporation in various
capacities, including director of corporate development. Mr. Tanner holds a BA
in economics from Stanford University and an MBA from the University of
California at Los Angeles.
Sale of HealthCare Solutions Group
On September 1, 1999, Fonix completed the sale of the operations and
a significant portion of the assets of its HealthCare Solutions Group to Lernout
& Hauspie Speech Products N.V., an unrelated third party, for up to $28,000,000.
At the closing of this transaction, $21,500,000, less certain credits of
$194,018 was paid, and $2,500,000 was deposited into an 18-month escrow account
in connection with the representations and warranties made by Fonix in the sales
transaction. The remaining $4,000,000 of the sales price is payable as an
earnout contingent on the performance of the HealthCare Solutions Group over the
next two years. Through December 31, 1999, $500,000 had been released from the
escrow. The Company will not record the contingent earnout, if any, until it is
earned. The sale was approved by a majority of Fonix's stockholders. The
proceeds from the sale were used to reduce certain of the Company's liabilities
and to provide working capital to allow Fonix to focus on marketing and
development opportunities.
1999 Annual Meeting of Stockholders
Fonix held its 1999 Annual Meeting of Stockholders on October 29,
1999, at which 59,497,418 shares were represented in person or by proxy. The
stockholders approved amendments to the Company's Certificate of Incorporation
that (1) created a new class of common stock designated as Class B Non-Voting
Common Stock (the "Class B Shares") with 1,985,000 Class B shares authorized;
and (2) redesignated the Company's then-current common stock as Class A Common
Stock and changed each share of then-outstanding
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common stock into a share of Class A Common Stock. Additionally, the
stockholders approved an amendment to the Company's Certificate of Incorporation
that increased the number of authorized common shares 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 1,985,000 common shares issued in connection with the acquisition
of Articulate Systems, Inc. ("Articulate") to a non-voting class of stock as
provided in the Articulate acquisition agreement. The Company does not intend to
register its Class B shares. The stockholders also approved a series of
transactions in which the Company issued its Series D preferred stock and Series
E preferred stock. Finally, the stockholders elected Thomas A. Murdock, Roger D.
Dudley, John A. Oberteuffer, and William A. Maasberg Jr. to Fonix's board of
directors, and approved the board's selection of Arthur Andersen LLP as Fonix's
independent public accountants for the year ended December 31, 1999.
Delisting of the Company's Class A common stock from the Nasdaq SmallCap Market
On June 29, 1999, the Company received a letter from Nasdaq notifying
the Company that unless the minimum bid price for the Company's common stock
returned to $1.00 per share or more for at least ten consecutive trading days
before September 29, 1999, the Company's common stock would be delisted from the
Nasdaq SmallCap Market on October 1, 1999. In September 1999, the Company
appealed the Nasdaq decision to delist the Company's common stock. Nasdaq held a
hearing on the Company's appeal on October 28, 1999. On December 3, 1999, the
Company received notice that its stock had been delisted from the Nasdaq
SmallCap Market as of December 3, 1999. The Company's common stock is currently
trading on the OTC Bulletin Board. See "Risk Factors - Delisting from the Nasdaq
SmallCap Market could have an adverse effect on the liquidity of the Company's
Class A common stock and has triggered certain rights of the holders of the
Company's Debentures and Repurchase Rights."
Financing Activities
Series D and Series E Preferred Stock During 1999, 626,611 shares of
Series D preferred stock and 135,072 shares of Series E preferred stock,
together with related dividends on each, were converted into 47,252,275 shares
and 5,729,156 shares, respectively, of Class A common stock. After the above
conversions, 381,723 shares of Series D preferred stock and no shares of Series
E preferred stock remained outstanding as of December 31, 1999. Subsequent to
December 31, 1999, a total of 217,223 shares of Series D preferred stock,
together with related dividends, were converted into 15,436,378 shares of Class
A common stock. As of April 10, 2000, 164,500 shares of Series D preferred stock
remain outstanding. In connection with the sales of the Series D and Series E
preferred stock, the Company agreed to register the sale of shares received on a
conversion of the Series D and Series E preferred stock. If the number of shares
of the Company's Class A common stock currently issuable upon a hypothetical
conversion of the remaining Series D preferred stock exceeds those authorized
for issuance, the Company would be required to file an additional registration
statement to cover the remaining shares.
December 1998 Private Placement of Common Stock In connection with a
private offering of Class A common stock completed in December 1998 (the "Equity
Offering"), the purchaser of 1,801,802 Class A common shares received an equal
number of Repricing Rights as well as warrants to purchase 200,000 shares of
Class A common stock at an exercise price of $1.665 per share. The Repricing
Rights provide for the issuance of shares of Class A common stock based upon
agreed upon rates that vary depending upon the market price of the stock. Also
included were certain Repurchase Rights that may, upon the occurrence of certain
events, require the Company to repurchase all or a portion of the holder's Class
A common shares or Repricing Rights received in the Equity Offering. A
registration statement covering the shares underlying the Equity Offering was
declared effective February 11, 2000. Subsequently, the Repricing Rights were
exercised, resulting in the issuance of 4,568,569 shares of Class A common stock
on February 14, 2000. The Equity Offering shares and the shares issued upon
exercise of the Repricing Rights were sold, thereby extinguishing the Company's
obligation to repurchase the shares or the Repricing Rights.
Series C Convertible Debentures On January 29, 1999, the Company
entered into a Securities Purchase Agreement with four investors pursuant to
which the Company agreed to issue its Series C convertible debentures in the
aggregate principal amount of $4,000,000. The outstanding principal amount of
the debentures is convertible at
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any time at the option of the holder into shares of Class A common stock at a
conversion price equal to the lesser of $1.25 or the average of the closing bid
price of Class A common stock for the five trading days immediately preceding
the conversion date multiplied by 80%, subject to adjustment. The Company also
issued warrants to purchase 400,000 shares of Class A common stock at an
exercise price of $1.25 per share in connection with this financing. The
warrants have an exercise period of three years. On March 3, 1999, the Company
executed a Supplemental Agreement pursuant to which the Company agreed to sell
another $2,500,000 principal amount of the debentures on the same terms and
conditions as the January 29, 1999 agreement, except no additional warrants were
issued. Interest on the Debentures is payable quarterly in shares of the
Company's Class A common stock or cash, at the Company's option. (The January
and March 1999 offerings of debentures are collectively referred to as the "Debt
Offering.")
In connection with the Debt Offering, two officers and directors and
one former officer and director of the Company (together, the "Guarantors")
pledged 6,000,000 shares of the Company's Class A common stock beneficially
owned by them as collateral security for the Company's obligations under the
debentures. Subsequent to the March 1999 funding, the holders of the debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the pledge and that the holders intended to exercise their
rights to sell some or all of the pledged shares. The holders of the debentures
subsequently informed the Company and the Guarantors that the 6,000,000 pledged
shares were sold, and that proceeds from the sale of the pledged shares were
used to pay penalties attributable to default provisions of the stock pledge
agreement and to reduce the principal balance of the debentures. The aggregate
proceeds from the sale of the pledged shares was $3,278,893. Of this amount,
$406,250 was allocated to penalties attributable to default provisions of the
stock pledge agreement and recorded as interest expense and $343,750 related to
penalty provisions of the Series D preferred stock (held by a related group of
investors) and recorded as preferred stock dividends. Both of these amounts were
recorded by the Company during 1999. The remaining $2,528,893 was applied as a
reduction of the principal balance of the Debentures as of September 30, 1999.
As of April 10, 2000, the remaining principal balance of the debentures of
$3,971,107 plus interest had been converted into 10,385,364 shares of Class A
common stock.
Series F Convertible Preferred Stock Effective February 1, 2000,
Fonix entered into an agreement with four investors whereby Fonix sold to the
investors a total of 290,000 shares of its Series F convertible preferred stock,
in return for cash of $2,750,000. The Series F preferred stock was convertible
into shares of Fonix's Class A common stock during the first 90 days following
the closing of the transaction at a price of $0.75 per share, and thereafter at
a price equal to 85% of the average of the three lowest closing bid prices in
the 20-day trading period prior to the conversion of the Series F preferred
stock. A registration statement describing the Class A common stock to be issued
upon conversion of the Series F preferred stock was declared effective February
11, 2000.
Through April 10, 2000, all 290,000 shares of Series F preferred
stock together with related dividends were converted into 7,764,948 shares of
Class A common stock and the Company recorded a beneficial conversion feature in
the amount of $2,750,000 at the date of issuance.
Registration on Form S-2 In compliance with registration rights
granted in connection with the Equity Offering, Debt Offering and Series F
Preferred Stock transactions described above, Fonix registered 56,864,399 shares
of its Class A common stock. The registration statement filed on Form S-2 became
effective February 11, 2000.
Series G Convertible Preferred Stock Fonix has recently entered into
an agreement with investors whereby Fonix intends to sell up to 250,000 shares
of its Series G 5% convertible preferred stock, in return for cash payments of
up to $5,000,000. Although the terms of the sale have not been finalized, it is
anticipated that the Series G preferred stock will be convertible into shares of
Fonix's Class A common stock at a price of $1.50 per share during the first 90
days following the closing of the transaction, and thereafter at a price equal
to 85% of the average of the three lowest closing bid prices in the twenty-day
trading period prior to the conversion of the Series G preferred stock. The
purchasers of the Series G preferred stock will receive registration rights
which will require Fonix to file a registration statement covering the Class A
common stock underlying the Series G preferred stock. Fonix will also have the
option of redeeming outstanding Series G preferred stock. Through April 10,
2000, Fonix received approximately $1,250,000 as advances in connection with
this financing,
Page 10 of 47
<PAGE>
although the securities purchase agreement has not been signed. Accordingly,
final terms may differ from those described above.
Addition of Shares to 1998 Stock Option and Incentive Plan
At a meeting of the board of directors on January 31, 2000, the board
voted to increase the number of shares of Class A common stock subject to the
1998 Stock Option and Incentive Plan (the "Plan") by 10,000,000 shares. The Plan
was adopted on June 1, 1998, and approved by the shareholders of the Company on
July 14, 1998. As initially approved by the shareholders, the Plan contained
10,000,000 shares. Prior to increasing the number of shares available under the
Plan on January 31, 2000, a total of 7,708,782 options had been granted to
employees, directors, and other eligible participants. The additional 10,000,000
shares were registered on Form S-8 effective February 15, 2000.
Grants of Stock Options
During 1999, Fonix granted options to purchase 1,294,000 shares of
Class A common stock as follows:
<TABLE>
<CAPTION>
Grantee Number of Shares Exercise Price
- -------- ---------------- --------------
<S> <C> <C>
Directors 400,000 $0.406
Employee 100,000 $3.250
Employee 25,000 $1.531
Employees 25,000 $1.630
Employees 673,000 $1.531
Employees 5,000 $1.781
Employees 50,000 $1.281
Employees 1,500 $0.594
Employees 5,000 $1.375
Unrelated consultants 9,500 $1.531
</TABLE>
The term of all of these stock options is ten years from the date of
grant. During 1999, 2,815,882 options expired without exercise. As of December
31, 1999, the Company had a total of 14,355,900 options outstanding, of which
13,484,237 were exercisable on or before December 31, 1999.
The Synergetics Transaction
Prior to March 1997, the Company's scientific research and
development activities were conducted solely by a third party, Synergetics, Inc.
("Synergetics"), pursuant to product development and assignment contracts
(collectively, the "Synergetics Agreement"). Under that arrangement, Synergetics
provided personnel and facilities, and the Company financed the Synergetics
research and development activities on an as-required basis and the Company was
obligated to pay to Synergetics a royalty of 10% (the "Royalty") of net revenues
from sales of products incorporating Synergetics' "VoiceBox" technology as well
as technology derivatives thereof. Synergetics compensated its developers and
others contributing to the development effort, in part, by granting "Project
Shares" to share in a portion of the Royalty received by Synergetics. On April
6, 1998, the Company and Synergetics entered into a Royalty Modification
Agreement whereby the Company agreed to offer an aggregate of 4,800,000
non-transferable common stock purchase warrants to the holders of the Project
Shares in consideration for which Synergetics agreed to cancel any further
obligation on the part of the Company to pay the Royalty. The exercise price of
the warrants was to be $10 per share and the warrants would not be exercisable
until the first to occur of (1) the date that the per share closing bid price of
the Class A common stock was equal to or greater than $37.50 per share for a
period of 15 consecutive trading days, or (2) September 30, 2000.
Effective March 31, 2000, the Company and Synergetics entered into a
Restated Royalty Modification Agreement whereby the Company agreed to pay
Synergetics $28,000 (the "Cancellation Amount") to cancel the obligation of the
Company to pay the Royalty. The Company has paid the Cancellation Amount to
Synergetics and teh Royalty has been canceled. The Company has no further
obligations to Synergetics, including the prior obligation to issue 4,800,000
warrants.
Termination of Financing Relationship
For several years, the Company maintained a relationship with a bank
pursuant to which the Company borrowed against its own funds on deposit with the
bank. Borrowings under this arrangement accrued interest at a
Page 11 of 47
<PAGE>
rate approximately 1% greater than the rate of interest earned by the Company on
its funds on deposit with the bank. In order to reduce interest expenses, on
January 8, 1999, the Company applied its deposit account in the amount of
$20,024,109 against the unpaid loan balance of $20,046,776, resulting in an
unpaid loan balance of $22,667, which amount subsequently was paid by the
Company.
CERTAIN SIGNIFICANT RISK FACTORS
The short- and long-term success of the Company is subject to certain risks,
many of which are substantial in nature and outside the control of the Company.
You should consider carefully the following risk factors, in addition to other
information contained herein. All forward-looking statements contained herein
are deemed by the Company to be covered by and to qualify for the safe harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act"). You should understand that several factors govern whether any
forward-looking statement contained herein will or can be achieved. Any one of
those factors could cause actual results to differ materially from those
projected herein. These forward-looking statements include plans and objectives
of management for future operations, including the strategies, plans and
objectives relating to the products and the future economic performance of the
Company and its subsidiaries discussed above. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of any such statement should not be regarded as a representation by
the Company or any other person that the objectives or plans of the Company will
be achieved.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about Fonix's ability to
continue as a going concern.
Since its inception, Fonix has sustained losses. Such losses continue
due to acquisitions made in 1998, ongoing operating expenses, and a lack of
revenues sufficient to offset operating expenses. Fonix had negative working
capital of $4,804,796 at December 31, 1999. Fonix has raised capital to fund
ongoing operations by private sales of its securities, some of which have been
highly dilutive and involve considerable expense. Furthermore, in recent months,
the financial condition of the Company has required the Company to negotiate
with its creditors to reduce the amount or extend the due date of certain
obligations. In its present circumstances, there is substantial doubt about
Fonix's ability to continue as a going concern absent immediate and significant
sales of its existing products, substantial revenues from new licensing or
co-development contracts or a relatively large sale of its securities in the
near term.
Fonix incurred net losses of $21,662,419, $43,118,782 and $22,453,948
for the years ended December 31, 1999, 1998 and 1997, respectively. As of
December 31, 1999, Fonix had an accumulated deficit of $116,706,803 For the year
ended December 31, 1999, Fonix recorded revenues of $439,507. For the years
ended December 31, 1999 and 1998, Fonix recorded combined revenues from the
operations of the TTS and HWR businesses in the amount of $439,507 and $236,586,
respectively. Other than these revenues, Fonix's only revenues to date resulted
from non-refundable license fees totaling $2,368,138 paid in 1998 by an
international microchip manufacturer for the use of certain technologies in
integrated circuits suitable for telecommunications applications, and for which
Fonix has no further obligation whatsoever.
Fonix expects continuing losses from operations until such time as:
o current and additional co-development arrangements with
third parties produce revenues sufficient to offset Fonix's
ongoing operating expenses; and/or
o revenues from the licensing of Core Technologies and
products increase to levels sufficient to exceed Fonix's
operating expenses.
Page 12 of 47
<PAGE>
Until that time, the Company must rely on funds raised through debt
and equity placements.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
As of April 10, 2000, Fonix owed trade payables in the aggregate
amount of approximately $789,774, of which $755,454 are more than 90 days
overdue. At present, Fonix's revenues from existing licensing arrangements and
products are not sufficient to offset Fonix's ongoing operating expenses or to
pay Fonix's current debt as described above. There is substantial risk,
therefore, that the existence and extent of the debt obligations described above
could adversely affect Fonix, its operations and financial condition.
If Fonix does not receive additional capital when and in the amounts needed in
the near future, its ability to continue as a going concern is in substantial
doubt.
Fonix anticipates incurring substantial sales and marketing, product
development and research and general operating expenses in the future that will
require substantial amounts of additional capital on an ongoing basis. These
capital needs are in addition to the amounts required to repay the debt
discussed above. Fonix will most likely have to obtain such capital from sales
of its equity, convertible equity and debt securities. Obtaining future
financing may be costly and will likely be dilutive to existing stockholders. If
Fonix is not able to obtain financing when and in the amounts needed, and on
terms that are acceptable to it, Fonix's operations, financial condition and
prospects could be materially and adversely affected, and Fonix could be forced
to curtail its operations or sell part or all of its assets, including its Core
Technologies.
Holders of Fonix Class A common stock are subject to the risk of additional
dilution to their interests as a result of the conversion of presently issued
preferred stock.
Introduction
Page 13 of 47
<PAGE>
Fonix currently has two series of preferred stock outstanding: Series
A and Series D. All of Fonix's presently outstanding preferred stock is
convertible into shares of Fonix Class A common stock. The Series A preferred
stock was issued in October 1995 and is convertible, one-for-one into 166,667
shares of Class A common stock at the option of the holder. The Series D
preferred stock is convertible into Class A common stock according to one of
three separate conversion formulas, one of which is based, in part, on the
market price of Fonix Class A common stock during the several week period
leading up to the conversion date. Fonix previously had two other series of
preferred stock outstanding, Series E and Series F preferred stock, with terms
similar to those of the Series D, but all shares of the Series E and Series F
preferred stock have been converted into shares of Class A common stock.
At April 10, 200, the remaining 164,500 shares of Series D preferred
stock would convert into 2,333,333 shares of Class A common stock, representing
1.40% of all shares of Class A common stock then outstanding. However, this
calculation excludes the issuance of shares of Class A common stock as payment
of dividends accrued on the Series D preferred stock at the date of conversion,
as well as shares of Class A common stock issued upon conversion of the Series D
preferred stock prior to April 10, 2000.
The following table describes the number of shares of Class A common
stock that would be issuable as of April 10, 2000, assuming all 164,500 shares
of the Series D preferred stock presently issued and outstanding shares were
converted, and further assuming that the applicable conversion or exercise
prices at the time of such conversion or exercise were the following amounts.
The table excludes the effect of the issuance of shares of Class A common stock
upon payment of accrued dividends and also excludes differences among the
various methods of calculating the applicable conversion or exercise price.
------------------ ------------------------
Shares of Class A
Common Stock
Issuable Upon
Hypothetical Conversion or
Conversion/ Exercise of Series
Exercise Price D Preferred Stock
------------------ ------------------------
$0.25 13,160,000
$0.75 4,386,667
$1.50 2,193,333
$2.25 1,462,222
$3.00 1,096,667
Given the structure of the conversion formulas applicable to the Series D
preferred stock, there effectively
Page 14 of 47
<PAGE>
is no limitation on the number of shares of Class A common stock into which such
convertible securities may be converted or exercised. As the market price of the
Class A common stock decreases, the number of shares of Class A common stock
underlying the Series D preferred stock continues to increase.
Overall Dilution to Market Price and Relative Voting Power of
Previously Issued Common Stock
The conversion of the Series D preferred stock may result in
substantial dilution to the equity interests of other holders of Class A common
stock. Specifically, the issuance of a significant amount of additional Class A
common stock would result in a decrease of the relative voting control of Class
A common stock issued and outstanding prior to the conversion of the Series D
preferred stock. Furthermore, public resales of Class A common stock following
the conversion of the Series D preferred stock likely would depress the
prevailing market price of Class A common stock. Even prior to the time of
actual conversions, exercises and public resales, the market "overhang"
resulting from the mere existence of Fonix's obligation to honor such
conversions or exercises could depress the market price of Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common
Stock
The outstanding shares of Series D preferred stock are convertible at
a floating price that may and likely will be below the market price of Class A
common stock prevailing at the time of conversion or exercise. As a result, the
lower the market price of Class A common stock at and around the time the holder
converts or exercises, the more Class A common stock the holder of such
convertible securities receives. Any increase in the number of shares of Class A
common stock issued upon conversion or exercise as a result of decreases in the
prevailing market price would compound the risks of dilution described in the
preceding paragraph of this risk factor.
Increased Potential for Short Sales
Downward pressure on the market price of Fonix Class A common stock
that likely would result from sales of Fonix Class A common stock issued on
conversion of the Series D preferred stock could encourage short sales of Class
A common stock by the holders of the Series D preferred stock or others.
Material amounts of such short selling could place further downward pressure on
the market price of Fonix Class A common stock.
Limited Effect of Restrictions on Extent of Conversions
The holders of the Series D preferred stock are prohibited from
converting their preferred stock into more than 4.999% of the then outstanding
Fonix Class A common stock. This restriction, however, does not prevent such
holders from either waiving such limitation or converting or exercising and
selling some of their convertible security position and thereafter converting or
exercising the rest or another significant portion of their holding. In this
way, individual holders of Series D preferred stock could sell more than 4.999%
of the outstanding Fonix Class A common stock in a relatively short time frame
while never holding more than 4.999% at a time.
Payment of dividends and interest in shares of Class A common stock
may result in further dilution
Under the terms of the Series D preferred stock, the Company has the
option to pay dividends on the preferred stock in shares of the Company's Class
A common stock. Dividends accrue from the date of the purchase of the Series D
preferred stock. As such, a decision by the Company to pay such dividends in
shares of Class A common stock could result in a substantial increase in the
number of shares issued and outstanding and could result in a decrease of the
relative voting control of Fonix Class A common stock issued and outstanding
prior to such payment of dividends.
If Fonix has difficulty capitalizing on acquisitions, its operations and
financial prospects could be adversely affected.
Page 15 of 147
<PAGE>
In 1998, Fonix completed the acquisitions of AcuVoice, Inc.,
("AcuVoice") Articulate, and the Papyrus Companies (collectively "Papyrus").
Notwithstanding the sale in 1999 of the HealthCare Solutions Group (consisting
principally of the assets acquired from Articulate), Fonix's acquisitions of
AcuVoice and Papyrus present risks including at least the following:
o Fonix may have difficulty financing ongoing operations of
acquired businesses to the extent such businesses are not
generating positive cash flows;
o Fonix may have difficulty combining or integrating the
technology, operations, management or work force of the
acquired businesses with Fonix's existing operations;
o Fonix may have difficulty retaining the key personnel of the
acquired businesses;
o Fonix may have difficulty maintaining uniform standards,
controls, procedures, and policies across its entire
organization, including the acquired businesses; and
o There may be increased commitment of management resources
and related expenses resulting from efforts to integrate and
manage acquired businesses located at a distance from
Fonix's principal executive offices and research facilities.
Fonix has a limited product offering and many of its key technologies are still
in the product development stage.
There presently are only a limited number of commercially available
applications or products incorporating the Core Technologies. Fonix markets its
HCI technologies and products for embedded applications, and Internet and
telephony applications. However, the marketing of these technologies and
products is in its initial start-up phase with no material funding commitments
or meaningful sales. These product offerings are still relatively limited and
have not generated significant revenues to date. An additional element of
Fonix's business strategy is to achieve revenues through appropriate strategic
alliances, co-development arrangements, and license arrangements with third
parties. In addition to a master collaboration agreement with an international
microchip manufacturer, the Company has recently entered into licensing and
joint-marketing agreements with Intel and Microsoft. These agreements provide
for joint marketing and application development for Intel and Microsoft
end-users or customers. There can be no assurance that these collaboration
agreements will produce license or other agreements which will generate material
revenues for Fonix.
The market for many of Fonix's technologies is largely unproven and may never
develop sufficiently to allow Fonix to capitalize on its technology and
products.
The market for HCI technologies, including ASR technologies, TTS and
HWR, is relatively new. Additionally, Fonix's technologies are new and, in many
instances, represent a significant departure from technologies which already
have found a degree of acceptance in the HCI marketplace. The financial
performance of Fonix will depend, in part, on the future development, growth,
and ultimate size of the market for HCI applications and products generally, and
applications and products incorporating Fonix's technologies and applications.
The applications and products which incorporate Fonix's technologies will be
competing with more conventional means of information processing such as data
entry, access by keyboard or touch-tone telephone, or professional dictation
services. Fonix believes that there is a substantial potential market for
applications and products incorporating advanced HCI technologies including
speech recognition, speech synthesis, speech compression, speaker identification
and verification, handwriting recognition, pen and touch screen input, and
natural language understanding. Nevertheless, such a market for Fonix's
technologies or for products incorporating Fonix's technologies may never
develop to the point that profitable operations can be achieved or sustained.
Competition from other industry participants and rapid technological change
could impede Fonix's ability to achieve profitable operations.
Page 16 of 147
<PAGE>
The computer hardware and software industries are highly and
intensely competitive. In particular, the HCI market sector and specifically the
ASR, computer voice and communications industries are characterized by rapid
technological change. Competition in the HCI market is based largely on
marketing ability and resources, distribution channels, technology and product
superiority and product service and support. The development of new technology
or material improvements to existing technologies by Fonix's competitors may
render Fonix's technologies less attractive or even obsolete. Accordingly, the
success of Fonix will depend upon its ability to continually enhance its
technologies and interactive solutions and products to keep pace with or ahead
of technological developments and to address the changing needs of the
marketplace. Some of Fonix's competitors have greater experience in developing,
manufacturing and marketing HCI technologies, applications and products, and
some have far greater financial and other resources than Fonix, or its potential
licensees and co-developers, as well as broader name-recognition,
more-established technology reputations, and mature distribution channels for
their products and technologies. Barriers to entry in the software industry are
low, and as the market for various HCI products expands and matures, Fonix
expects more entrants into this already competitive arena.
Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 1999, 1998 and 1997.
The independent public accountants' reports for Fonix's financial
statements for the years ended December 31, 1999, 1998, and 1997 include an
explanatory paragraph regarding substantial doubt about Fonix's ability to
continue as a going concern. This may have an adverse effect on the Company's
ability to obtain financing.
Delisting from the Nasdaq SmallCap Market could have an adverse effect on the
liquidity of the Company's Class A common stock.
Until recently, the Company's Class A common stock traded on the
Nasdaq SmallCap market. On December 3, 1999, the Company received notice that
its Class A common stock had been delisted from the Nasdaq SmallCap Market. The
Company's Class A common stock is currently trading on the OTC Bulletin Board.
The result of delisting from the Nasdaq SmallCap Market could be a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Class A common stock continues to trade on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
Class A common stock to purchase or sell shares as quickly and as inexpensively
as they have done historically and adversely affect the Company's ability to
attract additional equity financing.
Fonix's operations and financial condition could be adversely affected by
Fonix's failure or inability to protect its intellectual property or if Fonix's
technologies are found to infringe the intellectual property of a third party.
Dependence on proprietary technology
Fonix's success is heavily dependent upon its proprietary technology.
On June 17, 1997, the United States Patent and Trademark Office issued U.S.
Patent No. 5,640,490 entitled "A User Independent, Real-time Speech Recognition
System and Method" (the "'490 Patent"). The 490 patent has a 20-year life
running from the November 4, 1994 filing date, and has been assigned to Fonix.
This patent covers certain elements of the Fonix ASR technologies. Fonix has
acquired two other patents and has filed 13 additional United States and foreign
patent applications. In addition to its patents, Fonix relies on a combination
of copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. Such means of
protecting Fonix's proprietary rights may not be adequate because such laws
provide only limited protection. Despite precautions that Fonix takes, it may be
possible for unauthorized third parties to duplicate aspects of the Fonix
technologies or the current or future products or technologies of its business
units or to obtain and use information that Fonix regards as proprietary.
Additionally, Fonix's competitors may independently develop similar or superior
technology. Policing unauthorized use of proprietary rights is difficult, and
some international laws do not protect proprietary rights to the same extent as
United States laws. Litigation periodically may be necessary to enforce
Page 17 of 47
<PAGE>
Fonix's intellectual property rights, to protect its trade secrets or to
determine the validity and scope of the proprietary rights of others.
Risks of infringement by Fonix upon the technology of unrelated
parties or entities
Fonix is not aware and does not believe that any of its technologies
or products infringe the proprietary rights of third parties. Nevertheless,
third parties may claim infringement with respect to its current or future
technologies or products or products manufactured by others and incorporating
Fonix's technologies. Fonix expects that participants in the HCI industry
increasingly will be subject to infringement claims as the number of products
and competitors in the industry grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time consuming, result in costly litigation, cause development delays,
or require Fonix to enter into royalty or licensing agreements. Royalty or
license agreements may not be available on acceptable terms or at all. As a
result, infringement claims could have a material adverse affect on Fonix's
business, operating results, and financial condition.
Fonix is subject to the risk that certain key personnel, including key
scientific employees and independent contractors named below, on whom Fonix
depends, in part, for its operations, will cease to be involved with Fonix.
Fonix is dependent on the knowledge, skill and expertise of several
key scientific employees, including John A. Oberteuffer, Ph.D., Dale Lynn
Shepherd, R. Brian Moncur, Mark Hamilton and Doug Jensen; independent
contractors including C. Hal Hansen, Tony R. Martinez, Ph.D., and Kenneth P.
Hite; and executive officers, including Thomas A. Murdock and Roger D. Dudley.
The loss of any of the key personnel listed above could materially and adversely
affect Fonix's future business efforts. Although Fonix has taken reasonable
steps to protect its intellectual property rights including obtaining
non-competition and non-disclosure agreements from all of its employees and
independent contractors, if one or more of Fonix's key scientific, executive
employees or independent contractors resigns from Fonix to join a competitor, to
the extent not prohibited by such person's non-competition and non-disclosure
agreement, the loss of such personnel and the employment of such personnel by a
competitor could have a material adverse effect on Fonix. Fonix does not
presently have any key man life insurance on any of its employees.
Fonix has no dividend history and no intention to pay dividends in the
foreseeable future.
Fonix has never paid dividends on or in connection with any class of
its common stock and does not intend to pay any dividends to common stockholders
for the foreseeable future.
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the
only ones facing Fonix. Additional risks and uncertainties not presently known
to Fonix or that Fonix currently deems immaterial may also impair its business
operations. If any of the foregoing risks actually occur, Fonix's business,
financial condition, or results of operations could be materially adversely
affected. In such case, the trading price of Fonix Class A common stock could
decline.
ITEM 2. PROPERTIES
The Company owns no real property. Commencing in October 1996, the Company
leased a 25,600 square foot facility in Draper, Utah, from an unaffiliated third
party at which it conducts its principal scientific research, product
development and sales and marketing activities. The Company's lease of that
facility is for a term of 8 years, with a right to terminate after five years,
at the Company's option. Provided that the Company is not in default under the
lease, the Company has the option to extend the lease for 5 additional years.
The average base monthly lease payment over the 8-year life of the lease for
that facility is $28,389. Beginning in May 1999, the Company subleased
approximately 10,240 square feet of this space to an unrelated third party for a
monthly rental of $13,961.
Page 18 of 47
<PAGE>
The sublease expires December 2000, but may be renewed for up to two additional
three-month periods at the option of the sublessee.
The Company also leases approximately 10,000 square feet of office space in
Cupertino, California. The lease on this space is for 5 years, with rent of
$24,412 per month. Beginning June, 1999, the Company subleased this space to an
unaffiliated party who assumed the terms and payments under the lease. Two
executive officers of the Company have personally guaranteed payment on this
lease until the assignment is effective.
In addition to the Draper facility, the Company subleases office space at market
rates for its corporate headquarters and administrative operations in Salt Lake
City, Utah, under subleases from Studdert Companies Corporation ("SCC"). SCC is
owned and controlled by three individuals, two of whom are executive officers
and directors of the Company. [See "Certain Relationships and Related
Transactions," and "Security Ownership of Certain Beneficial Owners and
Management"]. The two executive officers and a former executive officer of the
Company have personally guaranteed these leases in favor of SCC's landlord. The
leases expire December 2002 and February 2003 and require monthly rental
payments of $10,369.
The Company leases approximately 1,377 square feet of office space in Lexington,
Massachusetts, where it conducts sales and marketing for its HWR technologies
and product development for pen/voice products. This lease expires November 30,
2002 and requires monthly rental payments of $2,754.
The Company believes that the facilities described above are adequate for its
current needs.
ITEM 3. LEGAL PROCEEDINGS
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 the Company was in
default under three separate agreements between the Company and OGI in the total
amount of $175,000. On 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 before the American
Arbitration Association against OGI in an amount not less than $250,000. Neither
OGI nor the Company have yet undertaken any discovery. However, a hearing date
has been set for August 8, 2000. The Company believes the OGI arbitration claim
is without merit, and management intends to vigorously press its counterclaim
against OGI.
In addition to the proceeding commenced by OGI, the Company is
involved in various lawsuits, claims, and proceedings arising in the ordinary
course of business. Management believes the ultimate disposition of such matters
will not materially affect the consolidated financial position or results of
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 29, 1999, the Company held its 1999 Annual Meeting of Stockholders.
The following matters were submitted to a vote of security holders:
Election of Thomas A. Murdock, Roger D. Dudley, John A Oberteuffer,
and William A. Maasberg Jr. to the Company's Board of Directors,
approved as follows:
Number of Number of Number of
Name of Director Shares For Shares Against Not Voted
----------------- ---------- -------------- ----------
William A. Maasberg Jr. 47,381,620 7,831,673 4,284,125
John A. Oberteuffer 47,411,770 7,783,378 4,302,270
Thomas A. Murdock 47,356,820 8,562,673 3,577,925
Roger D. Dudley 47,045,370 8,579,348 3,872,700
Appointment of Arthur Andersen LLP as the Company's independent public
accountants for the fiscal year ended December 31, 1999, approved by a
vote of 59,101,639 shares for, 298,317 shares against, and 97,462
shares withheld.
Amendment to the Company's certificate of incorporation that created a
new class of common stock designated as Class B Non-Voting Common
Stock (the "Class B Shares") with 1,985,000 Class B Shares authorized;
approved by a vote of 57,192,593 shares for, 1,015,071 shares against,
and 1,289,754 shares withheld. The Class B shares were authorized to
provide for the conversion of 1,985,000 common shares issued in the
acquisition of Articulate to a non-voting class of stock as provided
in the acquisition agreement.
Redesignation of the Company's then-current common stock as Class A
Common Stock and changed each share of then-outstanding common stock
into a share of Class A Common Stock approved by a vote of 57,192,593
shares for, 1,015,071 shares against, and 1,289,754 shares withheld.
Amendment to the Company's certificate of incorporation that increased
the number of Class A common shares authorized to be issued from
100,000,000 to 300,000,000 and increased the number of authorized
preferred shares from 20,000,000 to 50,000,000, approved by a vote of
20,086,173 shares for, 12,969,230 shares against, 1,261,492 shares
abstaining, and 25,180,523 brokler non-votes.
A series of transactions in which the Company issued its Series D 4%
preferred stock and Series E 4% preferred stock, approved by a vote of
20,779,723 shares for, 12,397,825 shares against, 1,139,347 shares
abstaining and 25, 180,523 shares not voted.
Page 19 of 47
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for Class A common stock as quoted on the Nasdaq (until
December 3, 1999) and on the OTC Bulletin Board thereafter for the four quarters
of calendar 1999 and 1998. The quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commissions and may not represent actual
transactions.
<TABLE>
<CAPTION>
Calendar Year 1999 Calendar Year 1998
----------------------- ----------------------
High Low High Low
---- ----- ----- ----
<S> <C> <C> <C> <C>
First Quarter $ 3.31 $ 0.69 $ 6.50 $ 3.50
Second Quarter $ 0.94 $ 0.25 $ 6.34 $ 3.00
Third Quarter $ 1.19 $ 0.28 $ 4.00 $ 1.12
Fourth Quarter $1.00 $ 0.27 $ 2.63 $ 0.94
</TABLE>
As of April 10, 2000, there were 164,194,614 shares of Fonix Class A
common stock outstanding, held by approximately 564 holders of record and 10,820
beneficial holders. This number of beneficial holders represents an estimate of
the number of actual holders of the Company's stock, including beneficial owners
of shares held in "nominee" or "street" name. The actual number of beneficial
owners is not known to the Company.
The Company has never declared any dividend on its Class A common
stock and it is expected that earnings, if any, in future periods will be
retained to further the development and sale of the Company's HCI technologies
and products. No dividends can be paid on the Class A common stock until such
time as all accrued and unpaid dividends on outstanding preferred stock, if any,
have been paid.
Recent Sales of Unregistered Equity Securities
On January 29, 1999, the Company sold debentures in the aggregate
principal amount of $4,000,000 to four investors. The outstanding principal
amount of the debentures is convertible at any time at the option of the holders
into shares of Class A common stock at a conversion price equal to the lesser of
$1.25 or 80% of the average of the closing bid price of the Class A common stock
for the five trading days immediately preceding the conversion date. The Company
also issued warrants to purchase 400,000 shares of Class A common stock in
connection with this financing. The warrants are exercisable at a price of $1.25
per share and have a three-year term. On March 3, 1999, the Company executed a
Supplemental Agreement with the same four investors, pursuant to which the
Company sold $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 issued all of the debentures without registration under the
Securities Act of 1933, as amended (the "1933 Act"), in reliance on Section 4(2)
or Regulation D. The debentures were issued as restricted securities and the
debentures were stamped with a restrictive legend to prevent any resale without
registration under the 1933 Act or pursuant to an exemption.
On February 1, 2000, the Company issued 290,000 shares of Series F
preferred stock, par value $20 per share, to five investors for $2,750,000. The
Company issued such shares without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder. The shares of Series F preferred stock were issued as restricted
securities and the certificates representing the Series F preferred stock were
stamped with a restrictive legend to prevent any resale without registration
under the 1933 Act or pursuant to an exemption.
The Class A common shares underlying the debentures and the Series F
preferred stock were subsequently registered on Form S-2 that was declared
effective February 11, 2000.
On June 2, 1999, the Company issued 200,000 shares of Class A common
stock to an unrelated individual
Page 20 of 47
<PAGE>
in payment for consulting services rendered. The Company issued such shares
without registration under the 1933 Act in reliance on Section 4(2) or
Regulation D. Such shares of Class A common stock were issued as restricted
securities, and the certificates representing such shares were stamped with a
restrictive legend to prevent any resale without registration under the 1933 Act
or pursuant to an exemption.
In two separate transactions, on December 2 and December 29, 1999,
the Company issued 500,000 shares of Class A common stock each to separate
entities not affiliated with the Company in payment for consulting services
rendered. The Company issued such shares without registration under the 1933 Act
in reliance on Section 4(2) or Regulation D. Such shares of Class A common stock
were registered on Form S-8 effective February 14, 2000.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below is derived from the
Company's consolidated balance sheets and statements of operations as of and for
the years ended December 31, 1999, 1998, 1997, 1996 and 1995. The data set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the consolidated financial
statements and related notes thereto included in this Report.
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------- -------------- ------------ ------------- --------------
1999 1998 1997 1996 1995
-------------- -------------- ------------ ------------- --------------
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Revenues $ 439,507 $ 2,604,724 $ -- $ -- $ -
General and administrative expenses 9,498,753 8,817,643 12,947,112 3,530,400 3,553,665
Research and development expenses 7,909,228 13,060,604 7,066,294 4,758,012 2,704,165
Purchase of in-process research and -- 9,315,000 -- -- --
development
Amortization of goodwill and purchased 1,712,267
core technology 2,588,896 -- -- --
Other income (expense) (3,698,789) (6,507,245) (1,558,678) 458,904 (88,067)
Loss from continuing operations (19,949,196) (36,843,475) (21,572,084) (7,829,508) (6,345,897)
Loss from discontinued operations (2,187,080) (6,275,307) -- -- --
Gain (loss) on extraordinary items 473,857 -- (881,864) -- 30,548
Net loss (21,662,419) (43,118,782) (22,453,948) (7,829,508) (6,315,349)
Basic and diluted net loss per common share $ (0.31) $ (0.91) $ (0.59) $ (0.21) $ (0.30)
Weighted average number of common shares
outstanding 76,753,709 52,511,185 42,320,188 36,982,610 21,343,349
</TABLE>
Page 21 of 47
<PAGE>
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ -------------- ------------- ------------- -------------
Balance Sheet Data:
<S> <C> <C> <C> <C> <C>
Current assets $ 480,885 $ 20,638,070 $ 21,148,689 $ 23,967,601 $ 7,912,728
Total assets 19,173,147 61,912,791 22,894,566 25,331,270 7,984,306
Current liabilities 5,285,681 35,317,045 20,469,866 19,061,081 6,674,572
Long-term debt, net of current 3,971,107 -- 52,225 -- --
portion
Stockholders' equity 8,086,359 24,765,746 2,372,475 6,270,189 1,309,734
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FACTORS AFFECTING FUTURE OPERATING RESULTS" AND UNDER THE HEADING
"CERTAIN SIGNIFICANT RISK FACTORS" IN ITEM 1 PART I OF THIS REPORT, ABOVE.
The following discussion of the results of operations and financial condition
should be read in conjunction with the consolidated financial statements and
notes thereto included elsewhere in this report.
Overview
Since inception, Fonix has devoted substantially all of its resources
to research, development and acquisition of software technologies that enable
intuitive human interaction with computers, consumer electronics, and other
intelligent devices. Through December 31, 1999, the Company has incurred
cumulative losses amounting to $98,237,110, excluding cumulative losses from
discontinued operations of $8,462,387 and net extraordinary items. Such losses
are expected to continue until the effects of recent marketing and sales efforts
begin to take effect, if ever.
In 1999, Fonix management began to transition its strategic focus
from technology research, development and acquisition into sales and marketing
and product delivery. In 1999, the Company expended $1,125,611 in sales and
marketing efforts. The Company has made this transition while continuing to
achieve technology upgrades to maintain distinct competitive technology
advantages.
In its current marketing efforts, the Company seeks to form
relationships with third parties who can incorporate HCI technologies into new
or existing products. Such relationships may be structured in any of a variety
of ways including traditional technology licenses, co-development relationships
through joint ventures or otherwise, and strategic alliances. The third parties
with whom Fonix presently has such relationships and with which it may have
similar relationships in the future include developers of application software,
operating systems, computers, microprocessor chips, consumer electronics,
automobiles, telephony and other technology products.
Page 22 of 47
<PAGE>
In February 1999, in connection with its transition in strategic
focus, the Company undertook an aggressive program of cost reduction emphasized
in four areas of operations:
1. Salaries, wages and related costs - Salaries greater than $50,000
per year were reduced 20 to 30 percent;
2. Third-party consultants - Reliance on third-party consultants was
reduced in the areas of research and development, marketing and
public relations;
3. Occupancy costs - Office space was reduced to accommodate current
operating needs;
4. Asset acquisition - Acquisition of new operating assets was
significantly restricted.
Implementation of these measures has reduced the monthly deficit in
cash flows from operating activities from $3 million in early 1999 to less than
$1 million in December 1999. Additional reductions are expected as these
measures reach full effect, but will be offset by increased expenses in sales
and marketing and ongoing product development.
On May 19, 1999, Fonix signed an agreement to sell the operations and
a significant portion of the assets of its HealthCare Solutions Group ("HSG"),
which consisted primarily of the operations of Articulate Systems, Inc.
("Articulate"), to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated
third party. The sale closed September 1, 1999. The proceeds from the sale were
used to reduce certain of the Company's liabilities and provided working capital
to allow Fonix to focus on marketing and developing technologies and products.
Results of Operations
The results of operations disclosed below give effect to the sale of
the HSG and the classification of its net assets and operating activities as
discontinued operations.
1999 Compared to 1998
During 1999, the Company recorded revenues of $439,507, a decrease of
$2,165,217 from $2,604,724 for 1998. Revenue in 1998 included licensing fees of
$2,368,138 from an international microchip manufacturer for which the Company
had no further obligation, and product sales and licensing fees of $236,586 from
other customers. The 1999 revenues are primarily from licensing fees from TTS
and HWR technologies and products.
Selling, general and administrative expenses were $9,498,753 for 1999
and $8,817,643 for 1998, an increase of $681,110. A one-time charge to
compensation expense in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company more than
offsets reductions achieved in other areas. Absent this charge, selling, general
and administrative expenses decreased by $762,490, due primarily to the cost
reduction measures undertaken by the Company in February 1999. Decreases in
salaries and related costs of $85,613 and in consulting expenses of $61,842 are
direct results of such measures. Also, a reduction in acquisition activity from
1998 to 1999 resulted in a decrease of $213,346 in legal and investor-related
expenses.
The Company incurred product development and research expenses of
$7,909,228 during 1999, a decrease of $5,151,376 from 1998. This decrease was
due primarily to management's cost reduction initiatives implemented in February
1999 and the transition of emphasis from research and development towards sales
and marketing. The Company anticipates further decreases in product development
and research costs as it nears completion of development of certain TTS and ASR
products. During 1999 and 1998, the Company expended a total of approximately
$303,000 and $130,000, respectively, in connection with ongoing development of
the AcuVoice purchased in-process R&D projects. The Company anticipates that its
investment in product development and research will continue at decreased levels
for 2000, assuming availability of working capital.
Amortization of goodwill and purchased Core Technologies was
$2,588,896 for 1999 and $1,712,267 for 1998. The increase of $876,629 results
from amortization for one full year in 1999 compared to amortization for the
portion of 1998 from the respective acquisition dates of AcuVoice and Papyrus to
the end of the year.
Page 23 of 47
<PAGE>
Net other expense was $3,698,789 for 1999, a decrease of $2,808,456
from 1998, resulting from changes in several areas. Interest income decreased by
$979,998 primarily due to certificates of deposit that were converted to cash to
retire a bank line of credit in January 1999. Cancellation of certain common
stock reset provisions resulted in an expense of $6,111,577 in 1998 but did not
affect 1999. Finally, interest expense increased by $2,165,778 primarily as a
result of beneficial conversion features recorded on convertible securities
issued in 1999, interest charges incurred on advances from the purchaser of the
HSG and interest charges on the Series C convertible debentures issued in
January and March 1999.
1998 Compared to 1997
During 1998, the Company recorded revenues of $2,604,724, of which
$2,368,138 was a non-refundable license fee from Siemens for which the Company
has no further obligation of any kind. The balance of revenues reflect sales
and licensing fees related to TTS voice synthesis technology.
During 1998, the Company incurred product development and research
expenses of $13,060,604, an increase of $5,994,310 over the $7,066,294
incurred in 1997. This increase was due primarily to the addition of product
development and research personnel, increased use of independent contractors,
equipment, facilities and the operations of AcuVoice and Papyrus.
Additionally, the Company expensed purchased in-process R&D totaling
approximately $9,315,000 during 1998, in connection with the acquisition of
AcuVoice.
Selling, general and administrative expenses were $8,817,643 in 1998
representing a decrease of $4,129,469 from 1997. This decrease resulted
primarily from a reduction in consulting and outside services amounting to
$6,739,461, offset by an increase in salaries, wages and related benefits of
$858,713, due to the increased workforce from the AcuVoice and Papyrus
acquisitions, and an increase in legal fees of $1,169,770, incurred
primarily in connection with acquisitions of AcuVoice, Articulate and Papyrus.
Goodwill and purchased core technology resulting from the
acquisitions of AcuVoice and Papyrus was amortized to operations for the first
time in 1998. An expense of $1,712,267 reflects amortization from the date of
acquisitions to the end of the year.
Net other expense was $6,507,245 for 1998, an increase of $4,948,567
over the previous year. This increase was primarily due to a $6,111,577
expense recorded in connection with the settlement of a reset provision
associated with a private placement of Class A common stock. This increase was
offset in part by a reduction in interest expense of $1,287,599 from 1998,
primarily due to extinguishment of certain debt instruments.
In-Process Research and Development
At the date of acquisition of AcuVoice, management estimated that the
acquired in-process R&D 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. As of December 31, 1999, the Company
has expended a total of approximately $433,000 in connection with the AcuVoice
acquired in-process research and development projects, and management
estimates that a total of approximately $567,000 will be required to complete
the AcuVoice projects. Management also estimates that the AcuVoice projects
are 88 percent complete as of December 31, 1999, and that the release dates
will be in the second quarter of 2000.
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its
cash requirements during the next 12 months. Research and development,
corporate operations and marketing expenses will continue to require
additional capital. Because the Company presently has only limited revenue
from operations, the Company intends to continue to rely primarily on
financing through the sale of its equity and debt securities 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.
Page 24 of 47
<PAGE>
Furthermore, the issuance of equity or debt securities which are or may become
convertible into equity securities of the Company in connection with such
financing could result in substantial dilution to the stockholders of the
Company.
The Company had negative working capital of $4,804,796 at December
31, 1999, compared to negative working capital of $14,678,975 at December 31,
1998. The current ratio was 0.09:1 at December 31, 1999, compared to 0.58:1 at
December 31, 1998. Current assets decreased by $20,157,185 to $480,885 from
December 31, 1998 to December 31, 1999. Current liabilities decreased by
$30,031,364 to $5,285,681 during the same period. The improvement in working
capital reflects the payoff of the revolving line of credit with the
certificates of deposit that occurred in January 1999, and the reduction in
notes payable to related parties and accounts payable from the proceeds of the
sale of the HSG that was completed on September 1, 1999. Total assets were
$19,173,147 at December 31,1999, compared to $61,912,791 at December 31, 1998.
Delisting of the Company's Common Stock by Nasdaq
Until recently, the Company's Class A common stock traded on the
Nasdaq SmallCap Market. On December 3, 1999, the Company received notice that
its stock had been delisted from the Nasdaq SmallCap Market as of December 3,
1999. Consequently, the Company's Class A common stock is currently trading on
the OTC Bulletin Board.
The delisting from the Nasdaq SmallCap Market could result in a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Company's shares continue to trade on the OTC Bulletin Board.
Further, delisting could reduce the ability of holders of the Company's Class A
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically and inhibit the ability of the Company to attract
additional equity capital.
Sale of the HealthCare Solutions Group
On September 1, 1999, the Company completed the Sale of the
HSG to L&H for up to $28,000,000. Of this sales price, $21,500,000, less certain
credits of $194,018, was paid at closing, $2,500,000 was held in an 18 month
escrow account in connection with the representations and warranties made by the
Company at the time of the Sale. Of the amount originally held in escrow,
$500,000 was released to the Company prior to December 31, 1999. Any remaining
amount up to $4,000,000 is payable as an earnout contingent on the performance
of the HSG over the next two years. The Company will not record the contingent
earnout, if any, until successful completion of the earnout requirements. 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 HCI technologies. The assets sold
included inventory, property and equipment, certain prepaid expenses, purchased
technology and other assets of the HSG. Additionally, L&H assumed the capital
and operating lease obligations related to the HSG and the obligations related
to certain of the Company's deferred revenues.
Notes Payable
After the Papyrus acquisition closed in October 1998, the Company
investigated the representations and warranties made by Papyrus to induce the
Company to acquire the Papyrus companies. The Company determined that certain of
the representations made by Papyrus and its executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against the former
stockholders of Papyrus alleging misrepresentation and breach of contract. In
March and April 1999, five of the former stockholders of Papyrus filed actions
against the Company alleging default under the terms of the promissory notes
issued to them in connection with the Papyrus acquisition and certain other
claims. Subsequently, the Company entered into agreements with the five former
Papyrus stockholders for dismissal of the actions and cancellation of the
promissory notes upon payment to the former stockholders of $1,217,384 (the
"Settlement Payment") and return of 970,586 shares of restricted common stock
previously issued to the five former stockholders in connection with the
acquisition of
Page 25 of 47
<PAGE>
Papyrus. The Company paid the Settlement Payment in September 1999 and the
lawsuits described above have been dismissed. The 970,586 shares were
effectively canceled in September 1999 in connection with the Settlement
Payment. The original fair market value of $1,000,917 associated with the
canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus Associates, Inc. As of December 31, 1999, the Company had
unsecured notes payable to former Papyrus stockholders in the aggregate amount
of $77,625, which notes were issued in connection with the acquisition of
Papyrus. The holders of these notes have not made demand for payment.
During 1999, the Company paid, or otherwise reduced through agreement
notes payable to various related parties totaling $8,482,946, plus accrued
interest. Additionally, the Company paid other notes payable to other parties
aggregating $560,000, plus accrued interest. Additionally, a revolving note
payable in the amount of $50,000 was paid by a former employee and is included
as an account payable. A revolving note payable in the amount of $19,988,193 at
December 31, 1998, plus accrued interest, was paid in full in January 1999 with
the proceeds from a certificate of deposit that secured the note and $22,667 in
cash.
In the fourth quarter of 1999, the Company negotiated reductions of
$526,697 in amounts due various trade vendors. Additionally, the Company
negotiated reductions of $229,055 in accrued interest owed to certain note
holders. These amounts were considered forgiveness of debt and have been
accounted for as extraordinary items in the 1999 consolidated statement of
operations.
December 1998 Equity Offering
In connection with a private offering of Class A common stock
completed in December 1998 (the "Equity Offering"), the purchaser of 1,801,802
Class A common shares received an equal number of Repricing Rights as well as
warrants to purchase 200,000 shares of Class A common stock at an exercise price
of $1.665 per share. The Repricing Rights provide for the issuance of shares of
Class A common stock based upon rates that vary depending upon the market price
of the stock. Also included were certain Repurchase Rights that may, upon the
occurrence of certain events, require the Company to repurchase all or a portion
of the holder's Class A common shares or Repricing Rights received in the Equity
Offering. A registration statement covering the shares underlying the Equity
Offering was declared effective February 11, 2000.
Subsequently, the Repricing Rights were exercised, resulting in the
issuance of 4,568,569 shares of Class A common stock on February 14, 2000. The
Equity Offering shares and the shares issued upon exercise of the Repricing
Rights were sold, thereby extinguishing the Company's obligation to repurchase
the shares or the Repricing Rights.
Series C 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
convertible debentures in the aggregate principal amount of $4,000,000. The
outstanding principal amount of the debentures was convertible at any time at
the option of the holders into shares of the Company's Class A common stock at a
conversion price equal to the lesser of (1) $1.25 or (2) 80% of the average of
the closing bid price of the Company's Class A 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 the
beneficial conversion feature. The Company also issued 400,000 warrants to
purchase an equal number of the Company's Class A common shares at a strike
Page 26 of 47
<PAGE>
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 supplemental issuance 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 Class A common stock underlying the
potential conversion of the debentures and the exercise of the warrants issued
in these transactions, were personally guaranteed by two officers and directors
and a former officer and director of the Company (the "Guarantors"). The
Guarantors 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 guarantee and the stock pledge agreement and that they
had sold the 6,000,000 shares pledged by the Guarantors. The aggregate proceeds
from the sale of the pledged shares were $3,278,893. Of this total, $406,250 was
allocated to penalties attributable to default provisions of the stock pledge
agreement and recorded as interest expense and $343,750 related to penalty
provisions of the Series D preferred stock (held by a related group of
investors) and recorded as preferred stock dividends. The remaining $2,528,893
was applied as a reduction of the principal balance of the debentures as of
September 30, 1999. Under its indemnity agreement with the Guarantors, the
Company agreed to issue 6,000,00 replacement shares to the Guarantors for the
shares sold by the holders of the debentures and reimburse the Guarantors for
any costs incurred as a result of the holders' sales of the Guarnators' shares.
In 1999, the Company estimated and recorded expenses amounting to $1,296,600
pursuant to the indemnity agreement.
As of December 31, 1999, the remaining outstanding balance on the
debentures was $3,971,107. As of April 10, 2000, all remaining principal and
interest due on the debentures have been converted to 10,385,364 shares of the
Company's Class A common stock.
Page 27 of 47
<PAGE>
Guarantors
In addition to guaranteeing obligations relating to the debentures,
the Guarantors guaranteed certain other obligations of the Company. As security
for some of the guarantees, the Guarantors pledged shares of the Company's Class
A common stock beneficially owned by them. In March 1999, 143,230 of the shares
previously pledged by the Guarantors to a bank were sold by the bank and the
proceeds were used to pay Company credit card balances and the related accrued
interest in full totaling $244,824. In May 1999, 100,000 of the shares
previously pledged by the Guarantors to another creditor of the Company were
sold by the creditor and the proceeds, totaling $72,335, were used to pay
amounts owed by the Company. In September 1999, the Company paid a note payable
to an unrelated third party in the amount of $560,000 that had previously been
guaranteed by the Guarantors. As of December 31, 1999, guarantees remained
outstanding in respect of certain real property subleases.
Series D and Series E Preferred Stock
During 1999, 626,611 shares of Series D preferred stock and 135,072
shares of Series E preferred stock, together with related dividends on each,
were converted into 47,252,275 shares and 5,729,156 shares, respectively, of the
Company's Class A common stock. After the above conversions, 381,723 shares of
Series D preferred stock and no shares of Series E preferred stock remained
outstanding as of December 31, 1999. Subsequent to December 31, 1999, a total of
217,223 shares of Series D preferred stock, together with related dividends,
were converted into 15,436,378 shares of Class A common stock. As of April 10,
2000, 164,500 shares of Series D preferred stock remained outstanding. In
connection with the sales of the Series D and Series E preferred stock, the
Company entered into registration rights agreements with the holders of the
Series D and Series E preferred stock and agreed to register the sale of shares
received on a conversion of the Series D and Series E preferred stock. If the
number of shares currently issuable upon a hypothetical conversion of the
remaining Series D preferred stock exceeds those authorized for sale, the
Company will be required to file an additional registration statement to cover
the remaining shares.
Class A common stock, stock options, and warrants
On June 2, 1999, the Company issued 200,000 shares of Class A common
stock (having a market value of $100,000 on that date) to an unaffiliated
individual in payment for consulting services rendered.
On December 23, 1999, the Company issued warrants to purchase
1,000,000 shares of the Company's Class A common stock to professional advisors
and consultants. The warrants were valued at $0.26 per share using the
Black-Scholes pricing model and the resulting charge was recorded as a deferred
consulting expense in stockholders' equity to be amortized as general and
administrative expense over the subsequent period of service. Also in December
1999, 1,000,000 shares of Class A common stock were issued to other
advisors and consultants as consideration for services rendered. The shares were
valued at $375,000 based upon the market value of the shares on the date of
issuance and recorded as general and administrative expenses.
During 1999, the Company granted 884,500 stock options to employees
at exercise prices ranging from $0.59 to $3.25 per share. The term of all
options granted during the year was ten years from the date of grant. Of the
stock options granted, 698,000 vested immediately and 186,500 vest over the
subsequent three-year period. As of December 31, 1999, the Company had a total
of 14,355,900 options outstanding.
The Company's option plans provide for stock appreciation rights that
allow the grantee to receive shares of the Company's Class A common stock
equivalent in value to the difference between the designated exercise price and
the fair market value of the Company's stock at the date of exercise. At
December 31, 1999, there were stock appreciation rights related to 400,000
shares outstanding with a weighted average exercise price of $1.18. Subsequent
to December 31, 1999, these stock appreciation rights were exercised at weighted
average exercise price of $1.18
During 1999, the Company granted warrants to L&H in connection with
loans made to the Company in April and May 1999 totaling $6,000,000. These
warrants allow L&H to purchase 850,000 shares of Class A
Page 28 of 47
<PAGE>
common stock of the Company at exercise prices ranging from $0.60 to $0.70 per
share. The warrants were valued at $246,240 using the Black-Scholes pricing
model and were recorded as a charge to interest expense. Of these warrants,
250,000 expired October 18, 1999, without being exercised. The remaining 600,000
warrants expire May 17, 2001.
As of December 31, 1999, the Company had a total of 3,025,000
warrants outstanding.
Outlook
Corporate Objectives and Technology Vision
The Company believes that its Core Technologies will be the platform
for the next generation of automated speech technologies and products. Most
speech recognition products offered by other companies are based on technologies
that are largely in the public domain and represent nothing particularly "new"
or creative. The Fonix Core Technologies are based on proprietary, patented
technology. The Company will continue to seek patent protection of the Core
Technologies as well as technologies and inventions derived from the know how,
assets and rights acquired from AcuVoice and Papyrus. Management believes the
Company's HCI technologies provide a competitive advantage vis-a-vis other
technologies available in the marketplace.
As the Company proceeds to implement its strategy and to reach its
objectives, the Company anticipates further development of complementary
technologies, added product and applications development expertise, access to
market channels and additional opportunities for strategic alliances in other
industry segments. The strategy described above is not without risk, and
shareholders and others interested in the Company and its common stock should
carefully consider the risks set forth under the heading "Certain Significant
Risk Factors" in Item 1, Part I, above.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements:
Report of Independent Public Accountants (Arthur
Andersen LLP) F-2
Report of Independent Public Accountants (Pritchett,
Siler & Hardy, P.C.) F-3
Consolidated Balance Sheets as of December 31, 1999
and 1998 F-4
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<PAGE>
Consolidated Statements of Operations for the Years
Ended December 31, 1999, 1998 and 1997 and for
the Period from October 1, 1993 (Date of Inception)
to December 31, 1999 F-5
Consolidated Statements of Stockholders' Equity for
the Years Ended December 31, 1999, 1998 and 1997
and for the Period from October 1, 1993 (Date of
Inception) to December 31, 1999 F-6
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1999, 1998 and 1997 and for
the Period from October 1, 1993 (Date of Inception)
to December 31, 1999 F-9
Notes to Consolidated Financial Statements F-11
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
During the years ended December 31, 1999, 1998, and 1997, and through
the date hereof, there have been no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
Page 30 of 47
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the
executive officers and directors of the Company as of April 10, 1999:
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Thomas A. Murdock 56 Director, President and Chief Executive Officer
Roger D. Dudley 47 Director, Executive Vice President, Chief Financial Officer
John A. Oberteuffer, Ph.D. 59 Director, Vice President, Technology
William A. Maasberg, Jr. 60 Director, Chief Operating Officer
Mark S. Tanner 45 Director
</TABLE>
All directors hold office until the next annual meeting of the
stockholders of the Company or until their successors have been elected and
qualified. The officers of the Company are elected annually and serve at the
pleasure of the Board of Directors.
THOMAS A. MURDOCK is a co-founder of the Company and has served as an
executive officer and member of the Company's board of directors since
June 1994. He has been the Company's chief executive officer since
January 26, 1999. Mr. Murdock also has served as president of Studdert
Companies Corporation ("SCC"), a related party, since 1992. For much
of his career, Mr. Murdock was a commercial banker and a senior
corporate executive with significant international emphasis and
experience. Mr. Murdock also serves as a director of KLS
Enviro Resources, Inc., of Advocast, Inc., an Internet research and
development company, and SCC.
ROGER D. DUDLEY is a co-founder of the Company and has served as an
executive officer and member of the Company's board of directors since
June 1994. Mr. Dudley currently serves as the Company's executive vice
president and chief financial officer. After several years at IBM in
marketing and sales, he began his career in the investment banking
industry. He has extensive experience in corporate finance, equity and
debt private placements and asset management. Mr. Dudley also serves
as a director of KLS Enviro Resources, Inc. and SCC.
JOHN A. OBERTEUFFER, Ph.D. has been a director of the Company since
March 1997 and vice president technology since January 1998. He is
also the founder and president of Voice Information Associates, Inc.
("VIA"), a consulting group providing strategic technical, market
evaluation, product development and corporate information to the
automated speech recognition industry. In addition, VIA publishes the
monthly newsletter, ASRNews. Dr. Oberteuffer also is executive
director of the American Voice Input/Output Society ("AVIOS"). He was
formerly vice president of Voice Processing Corp. (now merged with
Voice Control Systems, Inc.), and also was founder and CEO of Iris
Graphics, which was acquired by Seitex Corp. Dr. Oberteuffer received
his bachelor's and master's degrees from Williams College, and his
Ph.D. in Physics from Northwestern University. He was a member of the
research staff at Massachusetts Institute of Technology for five
years.
WILLIAM A. MAASBERG, Jr. became a director of the Company in September
1999 and was named chief operating officer February 1, 2000. From
December 1997 through February 1999, Mr. Maasberg was vice president
and general manager of the AMS Division of Eyring Corporation. The AMS
Division manufactures multi-media electronic work instruction software
application. He was also a co-founder and principal in Information
Enabling Technologies, Inc. ("ETI"), and LIBRA Corporation ("LIBRA"),
two companies focusing on software application development, and served
in several key executive positions with both ETI and LIBRA from May
1976 through November 1997. Mr. Maasberg worked for IBM Corporation
from July 1965 through May 1976 in various capacities. He received his
B.S. Degree from Stanford University in Electrical Engineering and his
M.S. in Electrical Engineering from the University of
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<PAGE>
Southern California. Mr. Maasberg was re-elected to the Board of
Directors at the Company's 1999 Annual Meeting of Stockholders.
MARK S. TANNER became a director of the Company in November 1999. Mr.
Tanner is currently the chief financial officer and senior vice
president of finance and administration for Mrs. Fields Original
Cookies, Inc. Mr. Tanner spent nine years at PepsiCo, where he was
chief financial officer for Pepsi International's operations in Asia,
the Middle East, and Africa. He was vice president of strategic
planning for Pepsi North America, as well as chief financial officer
for Pepsi North America's Pepsi East Operations. Mr. Tanner also spent
ten years with United Technologies Corporation in various capacities,
including director of corporate development. Mr. Tanner holds a B.A.
in economics from Stanford University and an M.B.A. from the
University of California at Los Angeles.
Significant Employees and Consultants
In addition to the officers and directors identified above, the
Company expects the following individuals to make significant contributions to
the Company's business during 2000.
PAUL S. CLAYSON, 43, is Vice President of Strategic Business
Development and has been employed by the Company since June 1998. Mr.
Clayson's career experience has focused on strategically assessing
markets, products and services, opening and establishing those markets
and building organizations and management structures to support their
growth. His work has spanned multiple products, services and markets.
He also served as a senior officer and partner in a private asset
management business in charge of general management, marketing, sales,
planning and product development functions. His work included the
creation of mutual funds, private asset funds for publicly traded
securities, and private investment portfolios. He also served as a
senior corporate officer for the Red Chip Review which publishes
research on small cap publicly traded companies. He received his
education from the University of Utah and the University of Michigan.
DALE LYNN SHEPHERD, 40, is vice president of engineering and has been
employed by the Company since 1997. He was employed by Synergetics
from 1992 to March 13, 1997. Before his employment with Synergetics,
he was employed with Mentorgraphics where he acted as a software
systems architect in automatic semiconductor design. Before
Mentorgraphics, he worked on a contract basis with Signetics, Inc. Mr.
Shepherd graduated from Brigham Young University with a Bachelor of
Science Degree in Electrical Engineering. He also received a Masters
of Business Administration from Brigham Young University.
R. BRIAN MONCUR, 40, is director of core technologies implementation
and has been with the Company since 1997. He was previously employed
by Synergetics from 1992 to March 13, 1997. Before his employment with
Synergetics, he was employed by Signetics, Inc. and Mentorgraphics,
where he was a senior process engineer and software development
engineer. Mr. Moncur graduated from Brigham Young University with a
Bachelor of Science degree in chemical engineering.
JAMES MARK HAMILTON, 40, is director of engineering and has been
employed by the Company since 1997. Previously, he was employed by
Synergetics from 1996 to March 13, 1997. He has been a project leader
in developing the Company's SDK System and has worked on the Company's
portable voice project. Before his employment with Synergetics, he was
employed by Intelligent Technologies, Inc., where he helped form the
company and designed and developed the educational software product
called IntelliBots for Macintosh and Windows. Mr. Hamilton graduated
from Brigham Young University with a Bachelor of Science in Electrical
Engineering.
DOUG JENSEN, 39, is director of embedded product development and has
been with the Company since 1997. Previously, he was employed by
Novell as strategic engineer between Novell and Intel. He also
Page 32 of 47
<PAGE>
worked for North American Philips. Mr. Jensen graduated from Brigham
Young University with a Bachelor of Science Degree in Electrical
Engineering.
CARL HAL HANSEN, 50, is an independent consultant and is co-inventor
of the Company's automated speech recognition technologies ("ASRT").
He is chairman and CEO of Synergetics, IMC2, and Adiva Corporation.
For approximately 14 years, he was employed by Signetics, Inc. in
various capacities, including test equipment engineer,
characterization engineer, product engineer, and electronic
specialist. He was involved in the design, fabrication and release of
layout design for PC boards and interfaces. In 1991, Mr. Hansen
founded Synergetics, were he continues to have direct leadership with
respect to new product development and engineering. IMC2 currently
provides consulting in research and development to the Company in the
area of ASR. Mr. Hansen holds a degree in electronics from the Utah
Trade Technical Institute of Provo, Utah.
TONY R. MARTINEZ, Ph.D., 42, is a senior consulting scientist for the
Company's neural network development. He is an associate professor of
Computer Science at Brigham Young University and currently heads up
the Neural Network and Machine Learning Laboratory in the Brigham
Young University Ph.D./MS program. His principal research is in neural
networks, machine learning, ASOCS, connectionist systems, massively
parallel algorithms and architectures, and non-von Neuman computing
methods. He is associate editor of the Journal of Artificial Neural
Networks. Dr. Martinez received his Ph.D. in computer science at
University of California at Los Angeles in 1986.
KENNETH P. HITE, 34, is a consultant for the Company. He is developing
the pen-voice user interface for the Windows 98 platform which
involves integrating Fonix's HWR and ASR technologies for use in pen
tablet computers. He has 14 years programming experience. and has
worked on a contract assignment for Modis Inc. He attended
Northeastern University and has taken several courses in management
information systems.
None of the executive officers or directors of the Company is related to any
other officer or director of the Company.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information concerning the
compensation paid to all persons serving as the Company's chief executive
officer and the Company's most highly compensated executive officers other than
its chief executive officer who were serving as executive officers at December
31, 1999, and whose annual compensation exceeded $100,000 during such year
(collectively the "Named Executive Officers"):
Page 33 of 47
<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
----------------------------------------------- ----------------------------
Securities
Other Underlying
Annual Options/
Name and Principal Position Year Salary Bonus SARs(2)
--------- ------------ ----------- ----------------------------
<S> <C> <C> <C> <C>
Thomas A. Murdock (1) 1997 $305,385 - 400,000/0
CEO (6/94 to 4/96 and 1998 $425,000 - 550,000/0
1/26/99 - present) and 1999 $316,574 - 0/0
President
Roger D. Dudley (1) 1997 $305,385 - 400,000/0
Executive Vice President, Chief 1998 $425,000 - 550,000/0
Financial Officer (Effective 3/21/00) 1999 $317,764 - 0/0
Douglas L. Rex 1998 $157,685 - 200,000/0
Chief Financial officer 1999 $166,322 - 0/0
(Through 3/21/00)
John A. Oberteuffer 1998 $203,941 - 580,000/0
Vice President Technology 1999 $199,238 - 0/0
</TABLE>
(1) The Company has executive employment agreements with
Messrs. Murdock and Dudley. The material terms of each
executive employment agreement with Messrs. Murdock and
Dudley are identical and are as follows: The term of each
employment contract is from November 1, 1996 through
December 31, 2001. Annual base compensation for each
executive for the first three years of such term is
$250,000 from November 1, 1996 through December 31, 1996;
$325,000 from January 1, 1997 through December 31, 1997;
and $425,000 from January 1, 1998 through December 31,
1999. The annual base compensation for the final two years
of the employment agreement is $550,000 from January 1,
2000 through December 31, 2000; and $750,000 from January
1, 2001 through December 31, 2001. However, for these final
two contract years, annual base compensation and the
performance-based incentive compensation will be subject to
review by the Company's board of directors based upon
either or both of the market price of the Company's common
stock and profits derived by the Company from annual
revenues from operations. Notwithstanding the foregoing,
Messrs. Murdock and Dudley voluntarily reduced their base
compensation to $297,500 commencing January 1, 1999 as part
of the Company's overall efforts to reduce expenses. On
January 31, 2000, these contracts were extended at the
current base compensation through December 2005, subject to
subsequent adjustments as approved by the board of
directors.
Each such executive officer also is entitled to customary
insurance benefits, office and support staff and the use of
an automobile. In addition, if any executive is terminated
without cause during the contract term then all salary then
and thereafter due and owing under the executive employment
agreement shall, at the executive's option, be immediately
paid in a lump sum payment to the executive officer and all
stock options, warrants and other similar rights granted by
the Company and then vested or earned shall be immediately
granted to the executive officer without restriction or
limitation of any kind.
Page 34 of 47
<PAGE>
Each executive employment agreement contains a
non-disclosure, confidentiality, non-solicitation and
non-competition clause. Under the terms of the
non-competition clause, each executive has agreed that for
a period of one year after the termination of his
employment with the Company that the executive not engage
in any capacity in a business which competes with or may
compete with the Company.
(2) All options granted in 1999 and 1998 were granted pursuant
to the Company's 1998 Stock Option Plan. All options
granted in 1997 were granted pursuant to the Company's 1997
Stock Option Plan.
Board of Directors Meetings, Committees and Director Compensation
The Company's board of directors took action at six duly noticed
meetings of the Board during 1999. Each director attended (in person or
telephonically) at least 75% of the meetings of the Company's board of
directors. During 1999, the Company's board of directors had the following
committees: Audit Committee, comprised of Messrs. Dudley, Maasberg (as of
September 3, 1999) and Tanner (as of November 9, 1999); and Compensation
Committee, comprised of Messrs. Murdock, Maasberg (as of September 3, 1999) and
Tanner (as of November 9, 1999). These standing committees conducted meetings in
conjunction with meetings of the full board of directors.
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<PAGE>
Compensation Committee Report on Executive Compensation
Preliminary Note: Notwithstanding anything to the contrary set forth
in any of the previous filings made by the Company under the 1933 Act or the
1934 Act that might incorporate future filings, including, but not limited to,
this Annual Report on Form 10-K, in whole or in part, the following Executive
Compensation Report and the performance graph appearing herein shall not be
deemed to be incorporated by reference into any such future filings.
This Executive Compensation Report discusses the Company's executive
compensation policies and the basis for the compensation paid to the Named
Executive Officers, including the persons serving as its chief executive officer
during the year ended December 31, 1999.
Compensation Policy. The Committee's policy with respect to executive
compensation has been designed to:
o Adequately and fairly compensate executive officers in
relation to their responsibilities, capabilities and
contributions to the Company and in a manner that is
commensurate with compensation paid by companies of
comparable size or within the Company's industry;
o Reward executive officers for the achievement of short-term
operating goals and for the enhancement of the long-term
value of the Company; and
o Align the interests of the executive officers with those of
the Company's shareholders with respect to short-term
operating goals and long-term increases in the price of the
Company's common stock.
The components of compensation paid to executive officers consist of:
(a) base salary, (b) incentive compensation in the form of annual bonus payments
and stock options awarded by the Company under the Company's Stock Incentive
Plans and (c) certain other benefits provided to the Company's executive
officers. The Company's Compensation Committee is responsible for reviewing and
approving cash compensation paid by the Company to its executive officers and
members of the Company's senior management team, including annual bonuses and
stock options awarded under the Company's Stock Incentive Plans, selecting the
individuals who will be awarded bonuses and stock options under the Stock
Incentive Plans, and for determining the timing, pricing and amount of all stock
options granted thereunder, each within the terms of the Company's Stock
Incentive Plans.
The Company's executive compensation program historically has
emphasized the use of incentive-based compensation to reward the Company's
executive officers and members of senior management for the achievement of goals
established by the board of directors. The Company uses stock options to provide
an incentive for a substantial number of its officers and employees, including
selected members of management, and to reward such officers and employees for
achieving goals that have been established for the Company. The Company believes
its incentive compensation plan rewards management when the Company and its
shareholders have benefitted from achieving the Company's goals and targeted
research and development objectives, all of which the Compensation Committee
feels will dictate, in large part, the Company's future operating results. The
Compensation Committee believes that its policy of compensating officers and
employees with incentive-based compensation fairly and adequately compensates
those individuals in relation to their responsibilities, capabilities and
contribution to the Company, and in a manner that is commensurate with
compensation paid by companies of comparable size or within the Company's
industry.
Components of Compensation. The primary components of compensation
paid by the Company to its executive officers and senior management personnel,
and the relationship of such components of compensation to the Company's
performance, are discussed below:
o Base Salary. The Compensation Committee periodically reviews
and approves the base salary paid by the Company to its
executive officers and members of the senior management
team. Adjustments to base salaries are determined based upon
a number of factors, including the
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<PAGE>
Company's performance (to the extent such performance can
fairly be attributed or related to each executive's
performance), as well as the nature of each executive's
responsibilities, capabilities and contributions. In
addition, the Compensation Committee periodically reviews
the base salaries of its senior management personnel in an
attempt to ascertain whether those salaries fairly reflect
job responsibilities and prevailing market conditions and
rates of pay. The Compensation Committee believes that base
salaries for the Company's executive officers have
historically been reasonable in relation to the Company's
size and performance in comparison with the compensation
paid by similarly sized companies or companies within the
Company's industry.
o Incentive Compensation. As discussed above, a substantial
portion of each executive officer's compensation package is
in the form of incentive compensation designed to reward the
achievement of short-term operating goals and long-term
increases in shareholder value. The Company's Stock
Incentive Plans allow the Board of Directors or the
Compensation Committee to grant stock options to executive
officers and employees for the purchase of shares of the
Company's common stock. Under the terms of the Stock
Incentive Plans, the Board of Directors and the Compensation
Committee have authority, within the terms of the Stock
Incentive Plans, to select the executive officers and
employees who will be granted stock options and to determine
the timing, pricing and number of stock options to be
awarded. The Compensation Committee believes that the stock
options granted under the Stock Incentive Plans reward
executive officers only to the extent that shareholders have
benefitted from increases in the value of the Company's
common stock.
o Other Benefits. The Company maintains certain other plans
and arrangements for the benefit of its executive officers
and members of senior management. The Company believes these
benefits are reasonable in relation to the executive
compensation practices of other similarly sized companies or
companies within the Company's industry.
Compensation of the Chief Executive Officer. As described elsewhere
in this Report, the Company has entered into an executive employment agreement
with Mr. Murdock. The material terms of this executive employment agreement are
described above. The Compensation Committee believes that the monthly
compensation under such contract adequately and fairly compensates this
executive officer in relation to his respective responsibilities, capabilities,
contributions and dedication to the Company and secures for the Company the
benefit of his leadership, management and financial skills and capabilities.
Moreover, the Compensation Committee believes that the salary and other benefits
are reasonable in relation to the responsibilities, capabilities, contributions
and dedication of Mr. Murdock to the Company and are warranted to keep them in
line with the compensation earned by chief executive officers employed by
companies of comparable size or within the Company's industry.
Conclusion. The Compensation Committee believes that the concepts
discussed above further the shareholders' interests because a significant part
of executive compensation is based upon the Company achieving its marketing,
sales and product development goals and other specific goals set by the board of
directors. At the same time, the Compensation Committee believes that the
program encourages responsible management of the Company in the short-term. The
Compensation Committee regularly considers plan design so that the total program
is as effective as possible in furthering shareholder interests.
The Compensation Committee bases its review on the experience of its
own members, on information requested from management personnel, and on
discussions with and information compiled by various independent consultants
retained by the Company.
Respectfully submitted,
Compensation Committee:
Thomas A. Murdock
William A. Maasberg, Jr.
Mark S. Tanner
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<PAGE>
Compensation of Directors
Prior to April 1996, the Company's directors received no compensation
for their service. The Company historically has reimbursed its directors for
actual expenses incurred in traveling to and participating in directors'
meetings, and the Company intends to continue that policy for the foreseeable
future. On March 30, 1996, the Company's board of directors adopted, and the
Company's shareholders subsequently approved, the Company's 1996 Directors'
Stock Option Plan (the "Directors' Plan"). Under the Directors' Plan, members of
the Board as constituted on the date of adoption received options to purchase
200,000 shares of the Company's Class A common stock for each year (or any
portion thereof consisting of at least six months) during which such persons had
served on the board for each of fiscal years 1994 and 1995 and were granted
200,000 shares for each of fiscal years 1996 through 1999, which options vested
after completion of at least six months' service on the board during those
fiscal years. These options have terms of ten years. Similar grants have been
made to the Company's directors under the Company's 1998 Stock Option Plan.
Under the Directors Plan and the 1998 Stock Option Plan, the Company granted no
stock options to members of the board during 1999.
Stock Options Granted to Directors During Fiscal Year 1999
<TABLE>
<CAPTION>
Shares Date Exercise Shares Vested
Name(1) Granted Granted Price Per Share at December 31, 1999
- ---- ------- ------- --------------- --------------------
<S> <C> <C> <C> <C>
William A. Maasberg, Jr. 200,000 09/03/99 $0.406 200,000
Mark S. Tanner 200,000 11/09/99 $0.406 200,000
</TABLE>
(1) Directors who are also Named Executive Officers also received options as
set forth in the table above.
Compliance With Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who beneficially own more than 10%
of a registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than 10 % shareholders are required by
regulation of the Securities and Exchange Commission to furnish the Company with
copies of all Section 16(a) forms which they file. Based solely on its review of
the copies of such forms furnished to the Company during the fiscal year ended
December 31, 1999 the Company is aware of the following untimely filings:
Thomas A. Murdock, Roger D. Dudley, and Stephen M. Studdert
(the "Guarantors") are in the process of preparing and filing year-end Forms 5
for 1999. The transactions to be reported include the sales by holders of shares
pledged by the Guarantors, as described below, about which the Guarantors were
not aware until after the Form 4 reporting deadline for such transactions had
expired.
The Guarantors pledged shares of Fonix Class A common stock to
guarantee payment by the Company of certain expenses. Such pledged shares were
sold in the second quarter of 1999. The sales by the pledgee will be reported on
the Forms 5 to be filed by the Guarantors.
The Guarantors also pledged shares in connection with the Company's
offering of its Series C 5% Convertible Debentures. Such pledged shares were
sold during the second and third quarters of 1999. The sales by the pledgees
will be reported on Forms 5 to be filed by the Guarantors.
All sales of such pledged shares were conducted by third party
pledgees beyond the control of the Guarantors. As of the date of this report,
the Guarantors have not received a complete accounting of such sales.
Stock Performance Graph
The following graph compares the yearly cumulative total returns from
the Company's Class A common stock during the five fiscal year period ended
December 31, 1999 with the cumulative total return on the Media General Index
and the Standard Industrial Classification (SIC) Code Index for that same
period. The comparison assumes $100 was invested on January 1, 1994, in the
Company's Class A common stock and in the common stock of the companies in the
referenced Indexes and further assumes reinvestment of dividends.
[GRAPH OMITTED]
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998 1999
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
FONIX CORPORATION 100.00 236.97 527.61 185.13 79.38 17.77
SIC CODE INDEX 100.00 91.12 94.57 126.42 119.91 216.68
NASDAQ MARKET INDEX 100.00 129.71 161.18 197.16 278.08 490.46
</TABLE>
Page 38 of 47
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth, as of April 10, 2000, the number of shares of
common stock of the Company beneficially owned by all persons known to be
holders of more than 5% of the Company's common stock and by the executive
officers and directors of the Company individually and as a group. Unless
indicated otherwise, the address of the shareholder is the Company's principal
executive offices, 60 East South Temple Street, Suite 1225, Salt Lake City, Utah
84111.
<TABLE>
<CAPTION>
Number of
Shares
Name and Address of 5% Beneficial Owners, Beneficially Percent of
Executive Officers and Directors Owned Class(1)
- ----------------------------------------- --------------- ------------
<S> <C> <C>
Thomas A. Murdock 10,099,084(2)(6) 6.1%
Chairman f the Board and Chief
Executive Officer
Alan C. Ashton, Ph.D. 9,624,167(3)(4) 5.9%
c/o Beesmark Investments, L.C.
5% Beneficial Owner
261 East 1200 South
Orem, Utah 84097
Beesmark Investments, L.C. 9,624,167(4) 5.9%
5% Beneficial Owner
261 East 1200 South
Orem, Utah 84097
Roger D. Dudley, 4,398,723(5)(6) 2.7%
Executive Vice President,
Chief Financial Officer,
Director
John A. Oberteuffer, Ph.D., 710,000 (7) *
Vice President, Director
600 West Cummings Park, Suite 4650
Woburn, MA 01801
Douglas L. Rex, 457,900(8) *
Chief Financial Officer(8)
William A. Maasberg Jr., 200,000(7) *
Chief Operating Officer,
Director
Mark S. Tanner, Director 200,000(7) *
Officers and Directors as a
Group (6 persons) 14,054,305 8.4%
- -----------------------
</TABLE>
* Less than 1 percent.
(1) Percentages rounded to nearest 1/10th of one percent. Except as indicated
Page 39 of 47
<PAGE>
in the footnotes below, each of the persons listed exercises sole voting
and investment power over the shares of Common Stock listed for each such
person in the table.
(2) Includes 8,706,771 shares of Common Stock deposited in a voting trust (the
"Voting Trust") as to which Mr. Murdock is the sole trustee. Persons who
have deposited their shares of Common Stock into the Voting Trust have
dividend and liquidation rights ("Economic Rights") in proportion to the
number of shares of Common Stock they have deposited in the Voting Trust,
but have no voting rights with respect to such shares. All voting rights
associated with the shares deposited into the Voting Trust are exercisable
solely and exclusively by the Trustee of the Voting Trust. The Voting Trust
expires, unless extended according to its terms, on the earlier of
September 30, 2002, or any of the following events: (i) the Trustee
terminates it; (ii) the participating shareholders unanimously terminate
it; or (iii) the Company is dissolved or liquidated. Although as the sole
trustee of the Voting Trust Mr. Murdock exercises the voting rights of all
of the shares deposited into the Voting Trust, and accordingly has listed
all shares in the table above, he has no economic or pecuniary interest in
any of the shares deposited into the Voting Trust except for 2,848,415
shares as to which he directly owns Economic Rights, and 185,793 shares the
Economic Rights as to which are owned by Studdert Companies Corp. ("SCC"),
a corporation of which Mr. Murdock is a 1/3 equity owner. Also includes
2,813 shares owned directly by Mr. Murdock, 11,400 shares owned by a
limited liability company of which Mr. Murdock is a 1/3 equity owner,
28,099 shares (including shares issuable upon the exercise of options)
beneficially owned by members of Mr. Murdock's immediate family residing in
the same household and 1,350,000 shares of Common Stock underlying stock
options owned by Mr. Murdock and exercisable presently or within 60 days of
April 10, 2000.
(3) Includes all Common Stock beneficially owned by Beesmark Investments, L.C.
("Beesmark"), but only to the extent that Dr. Ashton is one of three
managers of Beesmark, and, as such, is deemed to share investment power
with respect to shares beneficially owned by Beesmark.
(4) Beesmark's beneficial ownership includes 166,667 shares of Common Stock
presently issuable upon the conversion of shares of Series A Preferred
Stock. The owners of Beesmark are Alan C. Ashton and Karen Ashton. As
owners of Beesmark, they each are deemed to share voting control over
shares beneficially owned by Beesmark. Mrs. Ashton is beneficially owns no
shares other those deemed to be owned by her as a control person of
Beesmark, and, consequently, her beneficial ownership is not separately
reported.
(5) Includes (i) 2,848,417 shares owned by Mr. Dudley and deposited into the
Voting Trust, (ii) 185,793 shares owned by SCC as to which Mr. Dudley
shares investment power because of his management position with and 1/3
ownership of SCC, which shares are deposited into the Voting Trust; (iii)
2,813 shares owned directly by Mr. Dudley; (iv) 300 shares owned by Mr.
Dudley's minor children; (v) 11,400 shares owned by a limited liability
company of which Mr. Dudley is a 1/3 equity owner; and (vi) 1,350,000
shares underlying stock options exercisable presently or within 60 days of
April 10, 2000. Mr. Dudley became Chief Financial Officer of the Company on
March 21, 2000.
(6) During 1999, Messrs. Murdock and Dudley pledged their beneficial interest
in 4,000,000 of their shares of the Class A common stock of the Company in
connection with certain obligations of the Company, and such pledged shares
were sold by the pledgees. The Company has an obligation to issue 4,000,000
replacement shares to Messrs. Murdock and Dudley in connection with those
pledged shares sold.
(7) Consisting of options which are presently exercisable.
(8) Includes (i) 2,400 shares owned by Mr. Rex's spouse; (ii)500 shares owned
by an entity owned and controlled by him; and (iii) 455,000 shares
underlying presently exercisable stock options. Mr. Rex is no longer an
officer of the Company.
Page 40 of 47
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Studdert Companies Corp. (SCC)
SCC is a Utah corporation that provides investment and management
services. The officers, directors and owners of SCC are Stephen M. Studdert,
former chairman and CEO of the Company, and Thomas A. Murdock and Roger D.
Dudley, each of whom is a director and executive officer of the Company.
The Company subleases from SCC its corporate headquarters located at
60 East South Temple Street, Salt Lake City, Utah. The sublease is from month to
month pursuant to which the Company has agreed to pay the actual monthly rental
of $10,368 and all common area charges payable under the lease with SCC's
landlord.
Indemnity Agreement Related to Debenture Offering
In connection with the Company's January and March 1999 offering of its
debentures, Stephen M. Studdert, Thomas A. Murdock and Roger D. Dudley entered
into stock pledge agreements, whereby each personally guaranteed the performance
and obligations of the Company under the Debentures, and pledged 6,000,000
shares of common stock of the Company owned by them as security for their
obligations under the guaranty. The Company entered into an Indemnity Agreement
under which it agreed that, in the event of a default by the Company under the
terms of the debenture offering, if any or all of Messrs. Studdert, Murdock, or
Dudley were required to pay money or forfeit any of their pledged shares, the
Company would replace shares so forfeited and repay the obligation and liability
of each of Messrs. Studdert, Murdock, or Dudley by paying cash in amounts equal
to the out-of-pocket expenses of Messrs. Studdert, Murdock, and Dudley.
Additionally, the disinterested members of the Company's board of directors
agreed that, in consideration of the pledge, the Company would issue to each of
Messrs. Studdert, Murdock and Dudley warrants to purchase 666,666 shares of
common stock at an exercise price of $1.59 per share. The warrants have a
10-year term. Subsequently, Messrs. Studdert, Murdock and Dudley agreed to
indefinitely suspend their rights to receive these warrants.
Page 41 of 47
<PAGE>
However, subsequent to the March 1999 funding, the holders of the
debentures notified the Company and the Guarantors that the Guarantors were in
default under the terms of the pledge and that the holders intended to exercise
their rights to sell some or all of the pledged shares. The holders of the
debentures subsequently informed the Company and the Guarantors that the
6,000,000 pledged shares were sold. Under its indemnity agreement with the
Guarantors, the Company agreed to issue 6,000,000 replacement shares to the
Guarantors for the shares sold by the holders of the debentures and to reimburse
the Guarantors for any costs incurred as a result of the holders' sales of the
Guarantors' shares. In 1999, the Company estimated and recorded expenses
amounting to $1,296,600 pursuant to the indemnity agreement.
John A. Oberteuffer
In February 2000, the Company entered into an agreement to purchase
from John A. Oberteuffer, who is an executive officer and director of the
Company, all of Dr. Oberteuffer's rights and interests in certain methods and
apparatus for integrated voice and pen input for use in computer systems. In
payment for Dr. Oberteuffer's technology, the Company granted Dr. Oberteuffer
600,000 warrants to purchase the Company's Class A common stock at an exercise
price of $1.00 per share. The warrants expire February 10, 2010. Also, the
Company granted Dr. Oberteuffer the right to repurchase the technology from the
Company at fair market value if the Company subsequently determines not to
commercialize the pen/voice technologies or products.
Loans and Advances to the Company
During 1999, Messrs. Murdock, Dudley and Studdert advanced funds in
the aggregate amount of $317,159 related to sales of the Company's stock owned
by them that was pledged as collateral under certain borrowing agreements. The
balance was subsequently repaid in full. Also, Mr. Dudley advanced an additional
$68,691 to the Company for operating expenses, all of which was subsequently
repaid to him. There were no amounts owed to these individuals at December 31,
1999.
Stock Pledges for Payment of Legal Fees
The Company and Messrs. Murdock and Dudley entered into an agreement with a New
York law firm regarding payment of the Company's legal fees owed to that firm.
Under the agreement, Mr. Murdock, as trustee, entered into a stock pledge
agreement pledging 100,000 shares of the Company's common stock beneficially
owned by Messrs. Murdock and Dudley, and Messrs. Murdock and Dudley guaranteed
the full payment of the Company's legal fees to the law firm, together with any
other indebtedness of the Company to the law firm. At the time Messrs. Murdock
and Dudley agreed to guarantee the payment, the Company owed fees in the
approximate amount of $142,875 to the law firm. Subsequently, the law firm sold
the shares held as collateral to satisfy the outstanding obligation. Messrs.
Murdock and Dudley were reimbursed in cash for the value of the shares at teh
time of the sale by the law firm.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) Documents filed as part of this Form 10-K:
1. Consolidated Financial Statements (included in Part II, Item 8)
Page 42 of 47
<PAGE>
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Operations for the Years Ended
December 31, 1999, 1998 and 1997 and for the Period from October
1, 1993 (Date of Inception) to December 31, 1999
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1999, 1998 and 1997 and for the Period from
October 1, 1993 (Date of Inception) to December 31, 1999
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997 and for the Period from October
1, 1993 (Date of Inception) to December 31, 1999
Notes to Consolidated Financial Statements
2. Financial Statement Schedules: None
3. 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 Fonix, Articulate
Acquisition Corporation, and Articulate, 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) Agreement and Plan of Merger among Fonix, Papyrus
Acquisition Corporation, and Papyrus Associates, Inc.,
dated as of September 10, 1998, incorporated by
reference from the Company's Current Report on Form
8-K, filed November 13, 1998
(3)(i) Articles of Incorporation of the Company which are
incorporated by reference from the Company's
Registration Statement on Form S-18 dated as of
September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of
Incorporation dated as of March 21, 1994, which is
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of
Incorporation dated as of May 13, 1994, which is
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of
Incorporation dated as of September 24, 1997, which is
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30,
1997
(3)(v) The Company's Bylaws, as amended, which are
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(4)(i) Description of the Company's common stock and other
securities and specimen certificates representing such
securities which are incorporated by reference from the
Company's Registration Statement on Form S-18 dated as
of September 12, 1989, as amended
Page 43 of 47
<PAGE>
(4)(ii) Certificate of Designation of Rights and Preferences
of Series A Preferred Stock, filed with the Secretary
of State of Delaware on September 24, 1997, which is
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30,
1997
(4)(iii) Certificate of Designation of Rights and
Preferences of Series B Convertible Preferred Stock,
filed with the Secretary of State of Delaware on
October 27, 1997, which is incorporated by reference
from the Company's Quarterly Report on Form 10-Q for
the period ended September 30, 1997
(4)(iv) Certificate of Designation of Rights and Preferences
of 5% Series C Convertible Preferred Stock, filed with
the Secretary of State of Delaware on October 24, 1997,
which is incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(4)(v) 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)(vi) 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
(9)(i) Voting Trust Agreement dated as of December 10, 1993
by and among Phonic Technologies, Inc., Stephen M.
Studdert, Thomas A. Murdock and Roger D. Dudley, which
is incorporated by reference from the Company's Current
Report on Form 8-K dated as of June 17, 1994
(9)(ii) Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock, Roger
D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as
Trustee, dated as of October 23, 1995, incorporated by
reference from the Company's Current Report on Form 8-K
dated as of October 23, 1995
(9)(iii) Second Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of July 2, 1996, incorporated by
reference from the Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(9)(iv) Third Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of September 20, 1996,
incorporated by reference from the Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996
(9)(v) Fourth Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of September 20, 1996,
incorporated by reference from the Annual Report on
Form 10-KSB for the fiscal
Page 44 of 47
<PAGE>
year ended December 31, 1996
(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, 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)(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
Page 45 of 47
<PAGE>
is incorporated by reference from the Company's
AnnualReport 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 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)(vii) 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,
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30,
1998
(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, incorporated by
reference from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1998
(10)(xix) Securities Purchase Agreement among Fonix
Corporation and JNC Strategic Fund, dated December 21,
1998 for 1,801,802 shares of common stock and Repricing
Rights, incorporated by reference from Amendment No. 1
to Registration Statement on Form S-3 (File No.
333-67573)
(10)(xx) Securities Purchase Agreement among Fonix
Corporation and the investors identified therein dated
January 29, 1999, as supplemented on March 3, 1999,
concerning sales of $6,500,000 principal amount of
Series C 5% Convertible Debentures, incorporated by
reference from Amendment No. 1 to Registration
Statement on Form S-3 (File No. 333- 67573)
(10)(xxi) 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)(xxii) 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)(xxiii) 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)(xxiv) 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)(xxv) 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)(xxvi) 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)(xxvii) 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)(xxviii) 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))
(10)(xxix) 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)(xxx) 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)(xxxi) 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))
(10)(xxxii) Series F. Convertible Preferred Stock Purchase
Agreement, Among Fonix Corporation, Sovereign
Partners, LP, Dominion Capital Fund, LTD., Dominion
Investment Fund, LLC, Canadian Advantage, L.P., and
Queen LLC, dated as of February 1, 2000
(22) Subsidiaries of Registrant
(23)(i) Consent of Arthur Andersen LLP
(23)(ii) Consent of Pritchett Siler & Hardy, P.C.
(27) Financial Data Schedule
(B) Reports filed on Form 8-K during the last quarter of the fiscal year ended
December 31, 1999:
On November 15, 1999, the Company filed Amendment No. 1 to a Current
Report filed on Form 8-K on September 16, 1999 pertaining to the sale
and a significant portion of the assets of the Company's HealthCare
Solutions Group. The amendment was filed to submit certain pro forma
financial information required by Item 7 of Form 8-K.
Page 46 of 47
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 14th day of April
2000.
Fonix Corporation
Date: April 14, 2000 By: /s/ Thomas A. Murdock
-------------------- ---------------------------------------
Thomas A. Murdock, President and
Chief Executive Officer
Date: April 14, 2000 By: /s/ Roger D. Dudley
-------------------- ---------------------------------------
Roger D. Dudley, Executive Vice
President Finance and Chief Financial
Officer (Principal Financial and
Accounting Officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:
/s/ Thomas A. Murdock /s/ William A. Maasberg, Jr.
- --------------------------------- ----------------------------------------
Thomas A. Murdock, President and William A. Maasberg, Jr., Director
Chief Executive Officer
April 14, 2000 April 14, 2000
- ------------------------------ --------------------------------------
Date Date
/s/ Roger D. Dudley /s/ Mark S. Tanner
- --------------------------------- ----------------------------------------
Roger D. Dudley, Executive Vice Mark S. Tanner, Director
President, Director
April 14, 2000 April 14, 2000
- ------------------------------ --------------------------------------
Date Date
/s/ John A. Oberteuffer
- ------------------------------
John A. Oberteuffer, Ph.D., Director
April 14, 2000
- ------------------------------
Date
Page 47 of 47
<PAGE>
TABLE OF CONTENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (ARTHUR ANDERSEN LLP) F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (PRITCHETT, SILER &
HARDY, P.C.) F-3
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-4
Consolidated Statements of Operations for the Years Ended December 31,
1999, 1998 and 1997 and for the Period from October 1, 1993 (Date
of Inception) to December 31, 1999 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997 and for the Period from October
1, 1993 (Date of Inception) to December 31, 1999 F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1999, 1998 and 1997 and for the Period from October 1, 1993 (Date
of Inception) to December 31, 1999 F-9
Notes to Consolidated Financial Statements F-11
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Fonix Corporation:
We have audited the accompanying consolidated balance sheets of Fonix
Corporation (a Delaware corporation in the development stage) and subsidiaries
as of December 31, 1999 and 1998 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1999 and for the period from inception (October 1,
1993) to December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The consolidated financial statements
of the Company for the period from inception (October 1, 1993) to December 31,
1995 were audited by other auditors whose report, dated March 4, 1996, expressed
an unqualified opinion on those statements and included an explanatory paragraph
regarding the Company's ability to continue as a going concern. The consolidated
financial statements for the period from inception (October 1, 1993) to December
31, 1995 reflect a net loss of $12,012,299 of the total inception to date net
loss of $107,076,956. The other auditors' report has been furnished to us, and
our opinion, insofar as it relates to the amounts included for such prior
periods, is based solely on the report of such other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors for the
cumulative information for the period from inception (October 1, 1993) to
December 31, 1995, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Fonix Corporation and subsidiaries as of December 31, 1999 and 1998 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, and for the period from inception (October
1, 1993) to December 31, 1999 in conformity with accounting principles generally
accepted in the United States.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has not generated significant
revenues through December 31, 1999 and has incurred significant losses since its
inception. The Company expects these losses to continue at least through
December 31, 2000. As of December 31, 1999, the Company has an accumulated
deficit of $116,706,803, negative working capital of $4,804,796, and $981,301 of
accounts payable over 60 days past due. These matters raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
with respect to these matters are also described in Note 1. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
April 10, 2000
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors
Fonix Corporation
Salt Lake City, Utah
We have audited the consolidated statements of operations, stockholders' equity
and cash flows of Fonix Corporation and subsidiary [a development stage company]
for the period from October 1, 1993 (date of inception) to December 31, 1995
(these financial statements are not presented separately herein). These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
Fonix Corporation and subsidiary (a development stage company) for the period
from October 1, 1993 (date of inception) to December 31, 1995 in conformity with
generally accepted accounting principles.
The consolidated financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company is in the development
stage and has suffered recurring losses which raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/ Pritchett, Siler & Hardy, P.C.
PRITCHETT, SILER & HARDY, P.C.
Salt Lake City, Utah
March 4, 1996
<PAGE>
Fonix Corporation
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
December 31, December 31,
1999 1998
--------------------- -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 232,152 $ 20,045,539
Notes receivable - 245,000
Accounts receivable, net of allowance for doubtful accounts of
$20,000 and $8,000, respectively 184,901 219,908
Prepaid expenses 51,747 51,866
Interest and other receivables 1,546 3,722
Inventory 10,539 4,804
Employee advances - 67,231
--------------------- -----------------
Total current assets 480,885 20,638,070
Funds held in escrow 2,038,003 -
Property and equipment, net of accumulated depreciation of $1,938,494
and $1,168,023, respectively 1,148,802 2,145,031
Intangible assets, net of accumulated amortization of $ 4,392,457
and $1,770,668, respectively 15,399,593 19,437,290
Other assets 105,864 107,945
Net long-term assets of discontinued operations - 19,584,455
--------------------- -----------------
Total assets $ 19,173,147 $ 61,912,791
===================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft $ - $ 138,034
Advances 1,000,000 -
Revolving notes payable - 20,038,193
Notes payable - related parties 77,625 8,491,880
Notes payable - other - 560,000
Accounts payable 1,359,040 3,536,074
Accrued liabilities 857,033 981,774
Accrued liabilities - related parties 1,814,134 900,004
Income taxes payable 50,000 -
Deferred revenues 127,849 20,000
Capital lease obligation - 52,225
Net current liabilities of discontinued operations - 598,861
--------------------- -----------------
Total current liabilities 5,285,681 35,317,045
Series C convertible debentures 3,971,107 -
--------------------- -----------------
Total liabilities 9,256,788 35,317,045
--------------------- -----------------
Common stock and related repricing rights subject to redemption;
1,801,802 shares and repricing rights outstanding in 1999
and 1998 (aggregate redemption value of $2,500,000) 1,830,000 1,830,000
--------------------- -----------------
Commitments and contingencies (Notes 1, 12, 14, 16, 17 and 20)
Stockholders' equity:
Preferred stock, $.0001 par value; 50,000,000 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; 381,723 and 1,008,334
shares outstanding in 1999 and 1998, respectively
(aggregate liquidation preference of $8,043,579) 9,095,910 22,200,936
Series E, 4% cumulative convertible; 135,072 shares
outstanding in 1998 - 3,257,886
Common stock, $0.0001 par value; 300,000,000 shares authorized
Class A voting, 123,535,325 and 64,324,480 shares
outstanding in 1999 and 1998, respectively 12,353 6,432
Class B non-voting, none outstanding - -
Additional paid-in capital 112,769,420 88,517,711
Outstanding warrants 2,850,530 3,323,258
Deferred consulting expense (435,051) (106,700)
Deficit accumulated during the development stage (116,706,803) (92,933,777)
--------------------- -----------------
Total stockholders' equity 8,086,359 24,765,746
--------------------- -----------------
Total liabilities and stockholders' equity $ 19,173,147 $ 61,912,791
===================== =================
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
Fonix Corporation
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
October 1,
1993
(Inception) to
Years Ended December 31, December 31,
------------------------------ -------------
1999 1998 1997 1999
-------------- --------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues $ 439,507 $ 2,604,724 $ - $ 3,044,231
Cost of revenues 24,932 35,440 - 60,372
-------------- --------------- ------------- --------------
Gross margin 414,575 2,569,284 - 2,983,859
-------------- --------------- ------------- --------------
Expenses:
Selling, general and administrative 9,498,753 8,817,643 12,947,112 40,563,066
Product development and research 7,909,228 13,060,604 7,066,294 38,907,125
Amortization of goodwill and purchased
core technology 2,588,896 1,712,267 - 4,301,163
Purchased in-process research and
development - 9,315,000 - 9,315,000
-------------- --------------- ------------- --------------
Total expenses 19,996,877 32,905,514 20,013,406 93,086,354
-------------- --------------- ------------- --------------
Loss from operations (19,582,302) (30,336,230) (20,013,406) (90,102,495)
-------------- --------------- ------------- --------------
Other income (expense):
Interest income 95,023 1,075,021 1,199,610 3,762,111
Interest expense (3,636,467) (1,470,689) (2,758,288) (8,959,699)
Other (157,345) - - (157,345)
Cancellation of common stock reset
provision - (6,111,577) - (6,111,577)
-------------- --------------- ------------- --------------
Total other income (expense), net (3,698,789) (6,507,245) (1,558,678) (11,466,510)
-------------- --------------- ------------- --------------
Loss from continuing operations before
income tax benefit (23,281,091) (36,843,475) (21,572,084) (101,569,005)
Income tax benefit 3,331,895 - - 3,331,895
-------------- --------------- ------------- --------------
Loss from continuing operations (19,949,196) (36,843,475) (21,572,084) (98,237,110)
Discontinued operations:
Operating loss of HealthCare Solutions
Group (5,953,726) (6,275,307) - (12,229,033)
Gain on disposal of HealthCare Solutions
Group, net of income taxes of
$3,100,000 3,766,646 - - 3,766,646
-------------- --------------- ------------- --------------
Loss before extraordinary items (22,136,276) (43,118,782) (21,572,084) (106,699,497)
Extraordinary items:
Loss on extinguishment of debt - - (881,864) (881,864)
Gain on forgiveness of debt, net of
income taxes of $281,895 473,857 - - 504,405
-------------- --------------- ------------- --------------
Net loss $ (21,662,419) $ (43,118,782) $(22,453,948) $(107,076,956)
============== =============== ============= ==============
Basic and diluted net loss per common share $ (0.31) $ (0.91) $ (0.59)
============== =============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
Fonix Corporation
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A Series B
Preferred Stock Preferred Stock
--------------------------- ----------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance, October 1, 1993 (date of inception) - $ - - $ -
Net loss for the period October 1, 1993 - - - -
(date of inception) to December 31, 1993
------------ ------------ ------------ ------------
Balance, December 31, 1993 - - - -
Acquisition of Taris, Inc. - - - -
Shares issued for services at $.14 to $.18 per share - - - -
Shares issued for services at $.25 per share - - - -
Shares issued for conversion of notes payable
and interest payable at $.04 per share - - - -
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 - - - -
Net loss for the year ended December 31, 1994 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1994 - - - -
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $267,714 - - - -
Shares issued during the year for services rendered
and cancellation of accounts payable at $.55 to
$1.55 per share - - - -
Warrants issued during the year for cancellation
of accounts payable at $.033 per warrant
(additional compensation expense of $2,282,900
or $.62 per share was recorded) - - - -
Shares issued during the year upon conversion of
warrants for cancellation of accounts payable
at $.35 per share - - - -
Warrants issued during the year for cash at $.0033
to $.10 per warrant, less offering costs of $5,040 - - - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share - - - -
Forgiveness of debt with related parties - - - -
Net loss for the year ended December 31, 1995 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1995 - - - -
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share - - - -
Shares issued during the year upon conversion
of warrants for cash at $.50 per share - - - -
Shares issued during the year for cash at $.48 to
$3.38 per share, less offering costs of $2,033,286 - - - -
Net loss for the year ended December 31, 1996 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1996 - - - -
Shares issued for services at $3.75 to $5.31 per share - - - -
Shares issued for services at $6.50 to $8.38 per share - - - -
Warrants issued during the year for services - - - -
Shares issued upon the exercise of warrants
for services at $2.00 per share - - - -
Shares issued during the year for cash at $2.50
per share - $ - - $ -
Warrants issued during the year in connection with
the issuance of a convertible debenture and
convertible preferred stock - - - -
Shares issued upon conversion of convertible
debenture to common shares - - - -
Series B preferred shares issued for extinguishment
of convertible debenture at $20 stated value
per share - - 108,911 2,178,213
Sale of Series C preferred shares and warrants,
less cash fees of $201,500 - - - -
Sale of Series B preferred shares for cash, less cash
fees of $145,000 - - 125,000 2,355,000
Capital contribution in connection with put options - - - -
Beneficial conversion features of Series B convertible
debenture - - - -
Series A preferred shares issued upon conversion
of convertible debenture at $3 per share 166,667 500,000 - -
Conversion of Series B and Series C preferred shares
to common shares - - (206,411) (4,828,488)
Shares issued during the year in connection with
exercise of options at $2.97 per share - - - -
Shares issued during the year in connection with the
exercise of warrants at $.50 per share - - - -
Accretion of Series C preferred stock - - - -
Dividends on preferred stock - - - 962,934
Net loss for the year ended December 31, 1997 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1997 166,667 500,000 27,500 667,659
Shares issued for debt costs at $1.44 per share - - - -
Options issued during the year for services - - - -
Shares issued during the year for patent - - - -
Warrants issued during the year for cash - - - -
Shares issued upon the exercise of options and warrants - - - -
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 - - - -
Shares issued for acquisition of AcuVoice, Articulate
and Papyrus - - - -
Sale of Series D preferred shares, less issuance costs
of $546,154 - - - -
Sale of Series E preferred shares, less issuance costs
of $50,000 - - - -
Exchange of Series D for Series E preferred stock - - - -
Conversions of preferred stock to common stock - - (27,500) (676,190)
Shares issued for relinquishment of a reset provision - - - -
Expiration of warrants - - - -
Amortization of deferred consulting expense - $ - - $ -
Dividends on preferred stock - - - 8,531
Net loss for the year ended December 31, 1998 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1998 166,667 500,000 - -
Options issued during the year for services - - - -
Extension of option expiration dates - - - -
Conversions of preferred stock - - - -
Common stock issued for services - - - -
Common stock issued for principal reduction on
debentures - - - -
Common stock returned and canceled - - - -
Warrants issued with Series C debentures - - - -
Warrants issued for services - - - -
Warrants expired - - - -
Amortization of deferred consulting expense - - - -
Beneficial conversion features on Series C debentures - - - -
Preferred stock dividends - - - -
Reduction of accrued offering costs - - - -
Net loss for the year ended December 31, 1999 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1999 166,667 $ 500,000 - $ -
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Series C Series D
Preferred Stock Preferred Stock
--------------------------- ----------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance, October 1, 1993 (date of inception) - $ - - $ -
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1993 - - - -
Acquisition of Taris, Inc. - - - -
Shares issued for services at $.14 to $.18 per share - - - -
Shares issued for services at $.25 per share - - - -
Shares issued for conversion of notes payable
and interest payable at $.04 per share - - - -
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 - - - -
Net loss for the year ended December 31, 1994 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1994 - - - -
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $267,714 - - - -
Shares issued during the year for services rendered
and cancellation of accounts payable at $.55 to
$1.55 per share - - - -
Warrants issued during the year for cancellation of
accounts payable at $.033 per warrant (additional
compensation expense of $2,282,900 or $.62 per
share was recorded) - - - -
Shares issued during the year upon conversion of
warrants for cancellation of accounts payable
at $.35 per share - - - -
Warrants issued during the year for cash at $.0033
to $.10 per warrant, less offering costs of $5,040 - - - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share - - - -
Forgiveness of debt with related parties - - - -
Net loss for the year ended December 31, 1995 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1995 - - - -
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share - - - -
Shares issued during the year upon conversion
of warrants for cash at $.50 per share - - - -
Shares issued during the year for cash at $.48 to
$3.38 per share, less offering costs of $2,033,286 - - - -
Net loss for the year ended December 31, 1996 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1996 - - - -
Shares issued for services at $3.75 to $5.31 per share - - - -
Shares issued for services at $6.50 to $8.38 per share - - - -
Warrants issued during the year for services - - - -
Shares issued upon the exercise of warrants
for services at $2.00 per share - - - -
Shares issued during the year for cash at $2.50
per share - $ - - $ -
Warrants issued during the year in connection with
the issuance of a convertible debenture and
convertible preferred stock - - - -
Shares issued upon conversion of convertible
debenture to common shares - - - -
Series B preferred shares issued for extinguishment
of convertible debenture at $20 stated value per
share - - - -
Sale of Series C preferred shares and warrants,
less cash fees of $201,500 187,500 2,948,500 - -
Sale of Series B preferred shares for cash, less cash
fees of $145,000 - - - -
Capital contribution in connection with put options - - - -
Beneficial conversion features of Series B convertible
debenture - - - -
Series A preferred shares issued upon conversion
of convertible debenture at $3 per share - - - -
Conversion of Series B and Series C preferred shares
to common shares (2,500) (62,772) - -
Shares issued during the year in connection with
exercise of options at $2.97 per share - - - -
Shares issued during the year in connection with the
exercise of warrants at $.50 per share - - - -
Accretion of Series C preferred stock - 600,000 - -
Dividends on preferred stock - 1,159,057 - -
Net loss for the year ended December 31, 1997 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1997 185,000 4,644,785 - -
Shares issued for debt costs at $1.44 per share - - - -
Options issued during the year for services - - - -
Shares issued during the year for patent - - - -
Warrants issued during the year for cash - - - -
Shares issued upon the exercise of options and warrants - - - -
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 - - - -
Shares issued for acquisition of AcuVoice, Articulate
and Papyrus - - - -
Sale of Series D preferred shares, less issuance costs
of $546,154 - - 550,000 10,453,846
Sale of Series E preferred shares, less issuance costs
of $50,000 - - - -
Exchange of Series D for Series E preferred stock - - (150,000) (3,079,167)
Conversions of preferred stock to common stock (185,000) (4,767,913) - -
Shares issued for relinquishment of a reset provision - - 608,334 11,166,678
Expiration of warrants - - - -
Amortization of deferred consulting expense - $ - - $ -
Dividends on preferred stock - 123,128 - 3,659,579
Net loss for the year ended December 31, 1998 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1998 - - 1,008,334 22,200,936
Options issued during the year for services - - - -
Extension of option expiration dates - - - -
Conversions of preferred stock - - (626,611) (14,831,523)
Common stock issued for services - - - -
Common stock issued for principal reduction on debentures - - - -
Common stock returned and canceled - - - -
Warrants issued with Series C debentures - - - -
Warrants issued for services - - - -
Warrants expired - - - -
Amortization of deferred consulting expense - - - -
Beneficial conversion features on Series C debentures - - - -
Preferred stock dividends - - - 1,726,497
Reduction of accrued offering costs - - - -
Net loss for the year ended December 31, 1999 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1999 - $ - 381,723 $ 9,095,910
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Series E Class A
Preferred Stock Common Stock
--------------------------- ----------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance, October 1, 1993 (date of inception) - $ - 10,395,249 $ 1,040
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1993 - - 10,395,249 1,040
Acquisition of Taris, Inc. - - 411,611 41
Shares issued for services at $.14 to $.18 per share - - 1,650,000 165
Shares issued for services at $.25 per share - - 20,000 2
Shares issued for conversion of notes payable
and interest payable at $.04 per share - - 3,900,000 390
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 - - 1,819,293 181
Net loss for the year ended December 31, 1994 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1994 - - 18,196,153 1,819
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $267,714 - - 6,442,538 645
Shares issued during the year for services rendered
and cancellation of accounts payable at $.55 to
$1.55 per share - - 516,630 52
Warrants issued during the year for cancellation of
accounts payable at $.033 per warrant
(additional compensation expense of $2,282,900
or $.62 per share was recorded) - - - -
Shares issued during the year upon conversion of
warrants for cancellation of accounts payable
at $.35 per share - - 3,700,000 370
Warrants issued during the year for cash at $.0033
to $.10 per warrant, less offering costs of $5,040 - - - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share - - 550,000 55
Forgiveness of debt with related parties - - - -
Net loss for the year ended December 31, 1995 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1995 - - 29,405,321 2,941
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share - - 420,000 42
Shares issued during the year upon conversion
of warrants for cash at $.50 per share - - 60,000 6
Shares issued during the year for cash at $.48 to
$3.38 per share, less offering costs of $2,033,286 - - 11,741,242 1,174
Net loss for the year ended December 31, 1996 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1996 - - 41,626,563 4,163
Shares issued for services at $3.75 to $5.31 per share - - 87,500 9
Shares issued for services at $6.50 to $8.38 per share - - 505,000 50
Warrants issued during the year for services - - - -
Shares issued upon the exercise of warrants
for services at $2.00 per share - - 150,000 15
Shares issued during the year for cash at $2.50
per share - $ - 150,000 $ 15
Warrants issued during the year in connection with
the issuance of a convertible debenture and
convertible preferred stock - - - -
Shares issued upon conversion of convertible
debenture to common shares - - 145,747 15
Series B preferred shares issued for extinguishment
of convertible debenture at $20 stated value per
share - - - -
Sale of Series C preferred shares and warrants,
less cash fees of $201,500 - - - -
Sale of Series B preferred shares for cash, less cash
fees of $145,000 - - - -
Capital contribution in connection with put options - - - -
Beneficial conversion features of Series B convertible
debenture - - - -
Series A preferred shares issued upon conversion
of convertible debenture at $3 per share - - - -
Conversion of Series B and Series C preferred shares
to common shares - - 804,065 80
Shares issued during the year in connection with
exercise of options at $2.97 per share - - 15,000 1
Shares issued during the year in connection with the
exercise of warrants at $.50 per share - - 100,000 10
Accretion of Series C preferred stock - - - -
Dividends on preferred stock - - - -
Net loss for the year ended December 31, 1997 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1997 - - 43,583,875 4,358
Shares issued for debt costs at $1.44 per share - - 35,000 4
Options issued during the year for services - - - -
Shares issued during the year for patent - - 24,814 3
Warrants issued during the year for cash - - - -
Shares issued upon the exercise of options and warrants - - 265,000 27
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 - - 4,000,000 400
Shares issued for acquisition of AcuVoice,
Articulate and Papyrus - - 10,944,081 1,094
Sale of Series D preferred shares, less issuance costs
of $546,154 - - - -
Sale of Series E preferred shares, less issuance costs
of $50,000 100,000 1,950,000 - -
Exchange of Series D for Series E preferred stock 150,000 3,079,167 - -
Conversions of preferred stock to common stock (114,928) (2,777,292) 4,081,234 407
Shares issued for relinquishment of a reset provision - - 1,390,476 139
Expiration of warrants - - - -
Amortization of deferred consulting expense - $ - - $ -
Dividends on preferred stock - 1,006,011 - -
Net loss for the year ended December 31, 1998 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1998 135,072 3,257,886 64,324,480 6,432
Options issued during the year for services - - - -
Extension of option expiration dates - - - -
Conversions of preferred stock (135,072) (3,298,247) 52,981,431 5,298
Common stock issued for services - - 1,200,000 120
Common stock issued for principal reduction on debentures - - 6,000,000 600
Common stock returned and canceled - - (970,586) (97)
Warrants issued with Series C debentures - - - -
Warrants issued for services - - - -
Warrants expired - - - -
Amortization of deferred consulting expense - - - -
Beneficial conversion features on Series C debentures - - - -
Preferred stock dividends - 40,361 - -
Reduction of accrued offering costs - - - -
Net loss for the year ended December 31, 1999 - - - -
------------ ------------ ------------ ------------
Balance, December 31, 1999 - $ - 123,535,325 $ 12,353
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Deficit
Accumulated
Additional Deferred During the
Paid-in Outstanding Consulting Development
Capital Warrants Expense Stage
------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Balance, October 1, 1993 (date of inception) $ (1,040) $ - $ - $ -
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 - - - (1,782,611)
------------ ------------ ------------ --------------
Balance, December 31, 1993 (1,040) - - (1,782,611)
Acquisition of Taris, Inc. 1,240 - - -
Shares issued for services at $.14 to $.18 per share 249,835 - - -
Shares issued for services at $.25 per share 4,998 - - -
Shares issued for conversion of notes payable
and interest payable at $.04 per share 156,515 - - -
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 3,315,874 - - -
Net loss for the year ended December 31, 1994 - - - (3,914,339)
------------ ------------ ------------ --------------
Balance, December 31, 1994 3,727,422 - - (5,696,950)
Shares issued during the year for cash at $.45 to
$2.50 per share, less offering costs of $267,714 4,509,542 - - -
Shares issued during the year for services rendered
and cancellation of accounts payable at $.55 to
$1.55 per share 355,319 - - -
Warrants issued during the year for cancellation of
accounts payable at $.033 per warrant (additional
compensation expense of $2,282,900 or $.62 per
share was recorded) - 2,405,000 - -
Shares issued during the year upon conversion of
warrants for cancellation of accounts payable
at $.35 per share 3,699,630 (2,405,000) - -
Warrants issued during the year for cash at $.0033
to $.10 per warrant, less offering costs of $5,040 - 45,360 - -
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share 519,945 (45,000) - -
Forgiveness of debt with related parties 506,874 - - -
Net loss for the year ended December 31, 1995 - - - (6,315,349)
------------ ------------ ------------ --------------
Balance, December 31, 1995 13,318,732 360 - (12,012,299)
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share 901,478 - - -
Shares issued during the year upon conversion
of warrants for cash at $.50 per share 29,994 - - -
Shares issued during the year for cash at $.48 to
$3.38 per share, less offering costs of $2,033,286 11,857,269 - - -
Net loss for the year ended December 31, 1996 - - - (7,829,508)
------------ ------------ ------------ --------------
Balance, December 31, 1996 26,107,473 360 - (19,841,807)
Shares issued for services at $3.75 to $5.31 per share 386,710 - - -
Shares issued for services at $6.50 to $8.38 per share 3,426,202 - - -
Warrants issued during the year for services - 1,165,500 - -
Shares issued upon the exercise of warrants
for services at $2.00 per share 689,085 (389,100) - -
Shares issued during the year for cash at $2.50
per share $ 1,256,235 $ - $ - $ -
Warrants issued during the year in connection with
the issuance of a convertible debenture and
convertible preferred stock - 1,559,600 - -
Shares issued upon conversion of convertible
debenture to common shares 857,835 - - -
Series B preferred shares issued for extinguishment
of convertible debenture at $20 stated value per
share - - - -
Sale of Series C preferred shares and warrants,
less cash fees of $201,500 - 600,000 - -
Sale of Series B preferred shares for cash, less cash
fees of $145,000 - - - -
Capital contribution in connection with put options 500,000 - - -
Beneficial conversion features of Series B convertible
debenture 427,850 - - -
Series A preferred shares issued upon conversion
of convertible debenture at $3 per share - - - -
Conversion of Series B and Series C preferred shares
to common shares 4,891,180 - - -
Shares issued during the year in connection with
exercise of options at $2.97 per share 44,499 - - -
Shares issued during the year in connection with the
exercise of warrants at $.50 per share 49,990 - - -
Accretion of Series C preferred stock - - - (600,000)
Dividends on preferred stock - - - (2,121,991)
Net loss for the year ended December 31, 1997 - - - (22,453,948)
------------ ------------ ------------ --------------
Balance, December 31, 1997 38,637,059 2,936,360 - (45,017,746)
Shares issued for debt costs at $1.44 per share 50,310 - - -
Options issued during the year for services 320,100 - (320,100) -
Shares issued during the year for patent 100,804 - - -
Warrants issued during the year for cash - 472,928 - -
Shares issued upon the exercise of options and warrants 505,333 (360) - -
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 16,965,754 - - -
Shares issued for acquisition of AcuVoice,
Articulate and Papyrus 28,686,933 - - -
Sale of Series D preferred shares, less issuance costs
of $546,154 - - - -
Sale of Series E preferred shares, less issuance costs
of $50,000 - - - -
Exchange of Series D for Series E preferred stock - - - -
Conversions of preferred stock to common stock 8,220,988 - - -
Shares issued for relinquishment of a reset provision (5,055,240) - - -
Expiration of warrants 85,670 (85,670) - -
Amortization of deferred consulting expense $ - $ - $ 213,400 $ -
Dividends on preferred stock - - - (4,797,249)
Net loss for the year ended December 31, 1998 - - - (43,118,782)
------------ ------------ ------------ -------------
Balance, December 31, 1998 88,517,711 3,323,258 (106,700) (92,933,777)
Options issued during the year for services 12,540 - - -
Extension of option expiration dates 241,375 - - -
Conversions of preferred stock 18,124,472 - - -
Common stock issued for services 474,880 - (375,000) -
Common stock issued for principal reduction on debentures 3,278,293 - - -
Common stock returned and canceled (1,000,819) - - -
Warrants issued with Series C debentures - 438,240 - -
Warrants issued for services - 260,000 (127,500) -
Warrants expired 1,170,968 (1,170,968) - -
Amortization of deferred consulting expense - - 174,149 -
Beneficial conversion features on Series C debentures 1,750,000 - - -
Preferred stock dividends - - - (2,110,607)
Reduction of accrued offering costs 200,000 - - -
Net loss for the year ended December 31, 1999 - - - (21,662,419)
------------ ------------ ------------ -------------
Balance, December 31, 1999 $112,769,420 $ 2,850,530 $ (435,051) $(116,706,803)
============ ============ ============ =============
</TABLE>
<TABLE>
<CAPTION>
Total
------------
<S> <C>
Balance, October 1, 1993 (date of inception) $ -
Net loss for the period October 1, 1993
(date of inception) to December 31, 1993 (1,782,611)
------------
Balance, December 31, 1993 (1,782,611)
Acquisition of Taris, Inc. 1,281
Shares issued for services at $.14 to $.18 per share 250,000
Shares issued for services at $.25 per share 5,000
Shares issued for conversion of notes payable
and interest payable at $.04 per share 156,905
Shares issued for cash at $1.19 to $3.13 per
share, less offering costs of $368,450 3,316,055
Net loss for the year ended December 31, 1994 (3,914,339)
------------
Balance, December 31, 1994 (1,967,709)
Shares issued during the year for cash at $.45 to $2.50 per share, less offering
costs of $267,714 4,510,187
Shares issued during the year for services rendered and cancellation of accounts
payable at $.55 to $1.55 per share 355,371
Warrants issued during the year for cancellation of accounts payable at $.033
per warrant (additional compensation expense of $2,282,900 or $.62 per share
was recorded) 2,405,000
Shares issued during the year upon conversion of warrants for cancellation of
accounts payable at $.35 per share 1,295,000
Warrants issued during the year for cash at $.0033 to $.10 per warrant, less
offering costs of $5,040 45,360
Shares issued during the year upon conversion of
warrants for cash at $.50 to $1.00 per share 475,000
Forgiveness of debt with related parties 506,874
Net loss for the year ended December 31, 1995 (6,315,349)
------------
Balance, December 31, 1995 1,309,734
Shares issued during the year for finders' fees
at $1.52 to $2.72 per share 901,520
Shares issued during the year upon conversion
of warrants for cash at $.50 per share 30,000
Shares issued during the year for cash at $.48 to $3.38 per share, less offering
costs of $2,033,286 11,858,443
Net loss for the year ended December 31, 1996 (7,829,508)
------------
Balance, December 31, 1996 6,270,189
Shares issued for services at $3.75 to $5.31 per share 386,719
Shares issued for services at $6.50 to $8.38 per share 3,426,252
Warrants issued during the year for services 1,165,500
Shares issued upon the exercise of warrants
for services at $2.00 per share 300,000
Shares issued during the year for cash at $2.50
per share $ 1,256,250
Warrants issued during the year in connection with the issuance of a convertible
debenture and convertible preferred stock 1,559,600
Shares issued upon conversion of convertible
debenture to common shares 857,850
Series B preferred shares issued for extinguishment of convertible debenture at
$20 stated value per share 2,178,213
Sale of Series C preferred shares and warrants,
less cash fees of $201,500 3,548,500
Sale of Series B preferred shares for cash, less cash
fees of $145,000 2,355,000
Capital contribution in connection with put options 500,000
Beneficial conversion features of Series B convertible
debenture 427,850
Series A preferred shares issued upon conversion
of convertible debenture at $3 per share 500,000
Conversion of Series B and Series C preferred shares
to common shares -
Shares issued during the year in connection with
exercise of options at $2.97 per share 44,500
Shares issued during the year in connection with the
exercise of warrants at $.50 per share 50,000
Accretion of Series C preferred stock -
Dividends on preferred stock -
Net loss for the year ended December 31, 1997 (22,453,948)
------------
Balance, December 31, 1997 2,372,475
Shares issued for debt costs at $1.44 per share 50,314
Options issued during the year for services -
Shares issued during the year for patent 100,807
Warrants issued during the year for cash 472,928
Shares issued upon the exercise of options and warrants 505,000
Shares issued during the year for cash at $4.50
per share, less issuance costs of $1,033,846 16,966,154
Shares issued for acquisition of AcuVoice, Articulate and Papyrus 28,688,027
Sale of Series D preferred shares, less issuance costs
of $546,154 10,453,846
Sale of Series E preferred shares, less issuance costs
of $50,000 1,950,000
Exchange of Series D for Series E preferred stock -
Conversions of preferred stock to common stock -
Shares issued for relinquishment of a reset provision 6,111,577
Expiration of warrants -
Amortization of deferred consulting expense $ 213,400
Dividends on preferred stock -
Net loss for the year ended December 31, 1998 (43,118,782)
------------
Balance, December 31, 1998 24,765,746
Options issued during the year for services 12,540
Extension of option expiration dates 241,375
Conversions of preferred stock -
Common stock issued for services 100,000
Common stock issued for principal reduction on debentures 3,278,893
Common stock returned and canceled (1,000,916)
Warrants issued with Series C debentures 438,240
Warrants issued for services 132,500
Warrants expired -
Amortization of deferred consulting expense 174,149
Beneficial conversion features on Series C debentures 1,750,000
Preferred stock dividends (343,749)
Reduction of accrued offering costs 200,000
Net loss for the year ended December 31, 1999 (21,662,419)
------------
Balance, December 31, 1999 $ 8,086,359
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
Fonix Corporation
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
October 1,
1993
(Inception) to
Years Ended December 31, December 31,
-------------------------------------------
1999 1998 1997 1999
-------------- -------------- -------------- ----------------
Cash flows from operating activities:
<S> <C> <C> <C> <C>
Net loss $ (21,662,419) $ (43,118,782) $ (22,453,948) $ (107,076,956)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 158,600 50,314 4,112,970 5,646,154
Issuance of common stock for patent - 100,807 - 100,807
Non-cash expense related to issuance of
debentures,warrants, preferred and
common stock 2,411,349 6,111,577 3,967,337 12,490,263
Non-cash compensation expense related to
issuance and extension of stock options 360,615 213,400 - 2,856,915
Non-cash expense related to issuance of
notes payable and accrued expense for
services - 857,000 - 857,000
Non-cash exchange of notes receivable for
services - 150,000 - 150,000
Non-cash portion of purchased in-process
research and development - 13,136,000 - 13,136,000
Loss on disposal of property and equipment 154,940 - - 154,940
Gain on sale of HealthCare Solutions Group (3,766,646) - - (3,766,646)
Write-off of assets received in acquisition - - - 1,281
Depreciation and amortization 5,256,532 3,285,845 405,209 9,031,986
Income tax benefit (3,331,895) - - (3,331,895)
Extraordinary loss on extinguishment of debt - - 881,864 881,864
Extraordinary gain on forgiveness of debt (473,857) - - (504,405)
Changes in assets and liabilities, net of
effects of acquisitions:
Accounts receivable (245,432) (148,498) - (393,930)
Employee advances 7,245 (67,231) - (59,986)
Interest and other receivables (2,263) 9,436 142,724 (7,746)
Inventory (7,161) (20,221) - (27,382)
Prepaid assets (3,381) (15,372) (27,922) (50,847)
Cash held in escrow (38,003) - - (38,003)
Other assets 944 (80,198) (8,735) (118,901)
Accounts payable (1,650,337) 2,941,898 128,638 3,363,399
Accrued liabilities 514,312 8,189 (922,367) 1,156,101
Accrued liabilities - related party 1,143,185 (311,743) 47,759 1,290,944
Deferred revenues 632,242 81,266 - 713,508
-------------- -------------- -------------- ----------------
Net cash used in operating activities (20,541,430) (16,816,313) (13,726,471) (63,545,535)
-------------- -------------- -------------- ----------------
Cash flows from investing activities, net of
effects of acquisitions:
Proceeds from sale of HealthCare Solutions
Group 21,805,982 - - 21,805,982
Acquisition of subsidiaries, net of cash
acquired - (15,323,173) - (15,323,173)
Proceeds from sale of property and equipment 50,000 - - 50,000
Purchase of property and equipment (99,090) (1,305,091) (671,401) (3,435,560)
Investment in intangible assets - - (107,281) (164,460)
Issuance of notes receivable - (745,000) (1,483,600) (3,228,600)
Payments received on notes receivable 245,000 - 1,883,600 2,128,600
-------------- -------------- -------------- ----------------
Net cash provided by (used in) investing
activities 22,001,892 (17,373,264) (378,682) 1,832,789
-------------- -------------- -------------- ----------------
Cash flows from financing activities:
Bank overdraft (138,034) 138,034 - -
Advance 1,000,000 - - 1,000,000
Net proceeds from revolving note payable (20,038,193) 1,376,671 2,234,914 (49,250)
Net proceeds (payments) from revolving note
payable - relatedparties (7,895,178) (469,869) 551,510 (7,813,537)
Proceeds from other notes payable 6,953,760 560,000 - 9,865,427
Payments on other notes payable (7,788,000) - - (9,567,806)
Principal payments on capital lease obligation (60,684) (49,325) (43,381) (153,390)
Proceeds from issuance of convertible
debentures, net 6,254,240 - 2,685,000 9,439,240
Proceeds from sale of warrants 438,240 472,928 600,000 1,511,168
Proceeds from sale of common stock, net - 17,471,155 469,500 38,175,700
Proceeds from sale of preferred stock, net - 12,403,846 5,303,500 17,707,346
Proceeds from sale of common stock and
related repricing rights subject to
redemption, net - 1,830,000 - 1,830,000
-------------- -------------- -------------- ----------------
Net cash provided by (used in ) financing
activities (21,273,849) 33,733,440 11,801,043 61,944,898
----------------------------- -------------- ----------------
Net (decrease) increase in cash and cash
equivalents (19,813,387) (456,137) (2,304,110) 232,152
Cash and cash equivalents at beginning of period 20,045,539 20,501,676 22,805,786 -
-------------- -------------- -------------- ----------------
Cash and cash equivalents at end of period $ 232,152 $ 20,045,539 $ 20,501,676 $ 232,152
============== ============== ============== ================
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE>
Fonix Corporation
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
<TABLE>
<CAPTION>
October 1, 1993
(Inception) to
Years Ended December 31, December 31,
------------------------------------------
Supplemental disclosure of cash flow information: 1999 1998 1997 1999
------------ ------------- ------------- ------------
<S> <C> <C> <C> <C>
Cash paid during the period for interest $ 1,075,882 $ 1,392,987 $ 1,148,553 $ 4,505,888
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Year Ended December 31, 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 Class A 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 Class A 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 Class A common stock previously held by
certain shareholders and originally valued at $1,000,916 were returned to the
Company in settlement of litigation.
TheCompany issued 6,000,000 shares of Class A 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 $997,148 were recorded related to the
beneficial conversion features of Series D and Series E preferred stock.
Preferred stock dividends of $769,710 were accrued on Series D and Series E
preferred stock.
Dividends totaling $343,749 were recorded 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 Class A common stock to an unrelated
party for consulting fees valued at $100,000.
A total of 626,611 shares of Series D preferred stock and related dividends
of $587,388 were converted into 47,252,275 shares of Class A 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 Class A common stock.
Of the sales proceeds from the sale of the HealthCare Solutions Group,
$2,500,000 was placed in an escrow account, $500,000 of which was subsequently
released.
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.
The Company issued 1,000,000 shares of Class A common stock to two
unrelated parties for consulting fees valued at $375,000 of which $316,400 has
been deferred at December 31, 1999.
The Company issued 1,000,000 warrants to three unrelated parties for legal
services valued at $260,000 of which $118,651 has been deferred at December 31,
1999.
For the Year Ended December 31, 1998:
Preferred stock dividends of $3,461,543 were recorded related to the
beneficial conversion features of convertible preferred stock.
Preferred stock dividends of $335,706 were accrued on convertible preferred
stock.
A total of 27,500 shares of Series B convertible preferred stock and
related dividends of $8,531 were converted into 193,582 shares of common stock.
A total of 185,000 shares of Series C convertible preferred stock and
related dividends of $123,129 were converted into 1,295,919 shares of common
stock.
TheCompany issued 1,390,476 shares of common stock and 608,334 shares of
Series D 4% convertible preferred stock in connection with the cancellation of
an existing reset provision and costs associated with the issuance of Series D
4% convertible preferred stock.
Preferred stock dividends of $1,000,000 were recorded related to the
issuance of 1,390,476 common shares and 608,334 shares of Series D 4%
convertible preferred stock in connection with the cancellation of an existing
reset provision.
The Company exchanged 150,000 shares of Series D 4% convertible preferred
stock for 150,000 shares of Series E 4% convertible preferred stock.
A total of 114,928 shares of Series E convertible preferred stock and
related dividends of $15,969 were converted into 2,591,733 shares of common
stock.
The Company issued 2,692,216 shares of common stock (having a market value
of $16,995,972) in connection with the acquisition of AcuVoice, Inc.
The Company issued 5,140,751 shares of common stock (having a market value
of $8,353,720) and notes payable of $4,747,339 in connection with the
acquisition of Articulate Systems, Inc.
The Company issued 3,111,114 shares of common stock (having a market value
of $3,208,336) and notes payable of $1,710,000 in connection with the
acquisition of Papyrus.
The Company issued notes payable of $348,145 in connection with the
acquisition of certain assets of The MRC Group, Inc.
For the Year Ended December 31, 1997:
A $500,000 Series A convertible debenture was converted into 166,667 shares
of Series A preferred stock.
Series B convertible debentures in the amount of $850,000 and related
accrued interest of $7,850 were converted into 145,747 shares of common stock.
Series B convertible debentures in the amount of $2,150,000 and related
accrued interest of $28,213 were converted into 108,911 shares of Series B
convertible preferred stock.
Dividends of $2,721,991 were recorded related to the beneficial conversion
features and accretion of Series B and Series C convertible preferred stock.
206,411 shares of Series B convertible preferred stock and related
dividends of $13,422 were converted into 786,867 shares of common stock.
2,500 shares of Series C convertible preferred stock and related dividends
of $472 were converted into 17,198 shares of common stock.
Accounts payable of $144,931 was converted into a capital lease obligation
of the same amount.
See accompanying notes to consolidated financial statements.
F-10
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -Fonix Corporation (the "Company") is a development stage
company engaged in developing, acquiring and marketing proprietary
human/computer interface technologies. The core technologies developed or
acquired to date include automated speech recognition ("ASR"), text-to-speech
("TTS"), and handwriting recognition ("HWR") technologies for embedded (original
equipment manufacturer, hereafter "OEM") and server markets. The Company has
received a patent for certain elements of its core technologies and has filed
applications for other patents covering various aspects of its technology. The
Company seeks to develop relationships and strategic alliances with third-party
developers and vendors that are participants in the computer and electronic
devices industry (including producers of application software, operating
systems, computers and microprocessor chips). As of December 31, 1999, the
Company has entered into one strategic partnership and license agreement
relating to its ASR technologies. Other revenues are generated through licensing
of its TTS and HWR technologies. Although the Company has completed development
of the key components of its core technologies, there can be no assurance that
it will be able to sell, license or otherwise market its technologies to third
parties in order to generate sufficient recurring revenues to pay its operating
costs and complete the development of its technologies.
Fonix Corporation (known as Taris, Inc. prior to its acquisition of Phonic
Technologies, Inc. ("PTI"), as described below) was organized under the laws of
the state of Delaware on September 12, 1985. Taris, Inc. was a public company
with no operations. Prior to June 17, 1994, Taris, Inc. effected a reverse stock
split of one share for 90 shares. The financial statements have been adjusted to
reflect the stock split as though it had happened January 1, 1993. PTI, a Utah
corporation and the Company's predecessor in interest with respect to some of
the Company's ASR technology, was organized on October 1, 1993 (the Company's
date of inception) for the purpose of developing proprietary ASR technologies.
On June 17, 1994, Fonix Corporation entered into a merger agreement with PTI
whereby Fonix issued 10,395,249 shares of its common stock for all of the issued
and outstanding common shares of PTI. Upon completion of the merger, PTI
stockholders owned in excess of 90 percent of the outstanding common stock of
Fonix. The transaction was accounted for as a reverse acquisition as though PTI
acquired Fonix. The financial statements, therefore, reflect the operations of
Fonix since the acquisition on June 17, 1994 and PTI since October 1, 1993.
Development Stage Presentation - The Company is in the development stage and
generated revenues of $439,507 and incurred a net loss from continuing
operations totaling $19,949,196 for the year ended December 31, 1999. The
Company has incurred cumulative losses from continuing operations of $98,237,110
for the period from inception to December 31, 1999. The Company has an
accumulated deficit of $116,706,803, negative working capital of $4,804,796, and
$981,301 of accounts payable over 60 days past due as of December 31, 1999. The
Company expects to continue to incur significant losses through at least
December 31, 2000, primarily due to significant expenditure requirements
associated with the marketing and development of its ASR and related
technologies. These factors, as well as the risk factors set out elsewhere in
the Company's Annual Report on Form 10-K, raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty. Management plans to fund the operations of the Company through
proceeds from sales of its debt and equity securities and cash flows from
license and royalty arrangements. There can be no assurance that management's
plans will be successful.
Consolidation - The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries, Fonix/AcuVoice, Inc.,
and Fonix/Papyrus, Inc. All significant intercompany balances and transactions
have been eliminated in consolidation. During 1999, other wholly owned
subsidiaries, Fonix Systems Corporation and Fonix/Articulate, Inc., were merged
into the Company. As discussed more thoroughly in
F-11
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2, the HealthCare Solutions Group ("HSG"), consisting primarily of the
assets and operations of Fonix/Articulate, Inc., is presented as discontinued
operations.
Cash and Cash Equivalents - The Company considers all highly liquid, short-term
investments with a maturity of three months or less to be cash equivalents.
Funds Held in Escrow - Funds held in escrow pursuant to terms of the sale of the
HSG (see Note 2) are held in interest-bearing accounts and become available to
the Company at the end of the 18-month period following the closing of the sale
(March 2001).
Inventory - Inventory, consisting primarily of microphones and related
accessories, is stated at the lower of cost (first-in, first -out method) or
market value.
Property and Equipment - Property and equipment are stated at cost. Depreciation
is computed on a straight-line basis over the estimated useful lives of the
assets as follows:
Furniture and fixtures 5 years
Computer equipment 3 to 5 years
Leasehold improvements 18 months to 8 years
Leasehold improvements are amortized over the shorter of the useful life of the
applicable asset or the remaining lease term. Maintenance and repairs are
charged to expense as incurred and major improvements are capitalized. Gains or
losses on sales or retirements are included in the consolidated statements of
operations in the year of disposition.
Intangible Assets - Intangible assets consist of the purchase cost of completed
technology and goodwill in connection with the acquisitions of AcuVoice, Inc.,
Papyrus Development Corporation, and Papyrus Associates, Inc. (see Note 2) and
direct costs incurred by the Company in applying for patents covering its
technologies. Amortization is computed on a straight-line basis over the
estimated useful lives of the completed technology, goodwill and patents ranging
from five to eight years.
Valuation of Long-lived Assets - The carrying value of the Company's long-lived
assets is reviewed for impairment whenever events or changes in circumstances
indicate that it may not be recoverable. If such an event occurred, the Company
would project cash flows to be generated from the use of the asset and its
eventual disposition over the remaining life of the asset. If such projections
indicate that the cost in excess of the net asset would not be recoverable, the
Company's carrying value of such asset would be reduced by the estimated excess
of such value over the projected cash flows.
Revenue Recognition - The Company recognizes revenues in accordance with the
provisions of Statement of Position No. 97-2, "Software Revenue Recognition".
The Company generates revenues from licensing the rights to its software
products to end users and from royalties. The Company also generates service
revenues from the sale of consulting and development services.
Revenues from software license agreements are recognized upon shipment of the
software if there are no significant
F-12
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
postcontract obligations. If postcontract obligations exist, revenues are
recognized when those obligations have been satisfied. Revenues from development
and consulting services are recognized as the services are completed.
Cost of revenues consists of costs to distribute the product (including the cost
of the media on which it is delivered), installation and support personnel
salaries and licensed technology and related costs.
Research and Development - All expenditures for research and development are
charged to expense as incurred. The Company incurred total research and
development expenses of $ 7,909,228 in 1999, $13,060,604 in 1998 and $7,066,294
in 1997. In 1998, the Company also recorded $9,315,000 of in-process research
and development purchased in connection with the acquisition of AcuVoice, Inc.
The Company also recorded $3,821,000 of in-process research and development
costs in connection with the acquisition of Articulate Systems, Inc. ("ASI") in
1998. However, as a result of the subsequent disposition of the operations and
assets of ASI, these costs are reflected in discontinued operations (see Note
2).
Income Taxes - The Company recognizes deferred income tax assets or liabilities
for the expected future tax consequences of events that have been recognized in
the financial statements or tax returns. Deferred income tax assets or
liabilities are determined based upon the difference between the financial and
income tax bases of assets and liabilities using enacted tax rates expected to
apply when differences are expected to be settled or realized.
Concentration of Credit Risks - The Company's cash and cash equivalents are
maintained in bank deposit accounts which exceed federally insured limits. Cash
equivalents consist of highly liquid securities with maturities of three months
or less when purchased. The Company has not experienced any losses with respect
to these deposits. In the normal course of business, the Company provides credit
terms to its customers. Accordingly, the Company performs on-going credit
evaluations of its customers and maintains allowances for possible losses, which
when realized, have been within the range of management's expectations.
Accounting Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.
Fair Value of Financial Instruments - The book values of the Company's assets
and liabilities approximate their fair values. The estimated fair values have
been determined using appropriate market information and valuation
methodologies.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the year.
At December 31, 1999, 1998 and 1997, there were outstanding common stock
equivalents to purchase 56,869,449, 38,319,638 and 13,395,948 shares of common
stock, respectively, that were not included in the computation of diluted net
loss per common share as their effect would have been anti-dilutive, thereby
decreasing the net loss per common share.
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the years ended December 31, 1999, 1998
and 1997.
F-13
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1999 1998 1997
--------------------------- -------------------------- --------------------------
Loss Loss Loss
Loss Per Share Loss Per Share Loss Per Share
---- --------- ---- --------- ---- ---------
<S> <C> <C> <C> <C> <C> <C>
Loss from continuing operations $(19,949,196) $(36,843,475) $(21,572,084)
Preferred stock dividends (2,110,607) (4,797,249) (2,721,991)
------------- ------------- -------------
Net loss from continuing operations
attributable to common
stockholders (22,059,803) $ (0.29) (41,640,724) $ (0.79) (24,294,075) $ (0.57)
Discontinued operations, net of taxes (2,187,080) (0.03) (6,275,307) (0.12) - -
Extraordinary items, net of taxes 473,857 0.01 - - (881,864) (0.02)
-------------- --------- ------------- ---------- -------------- ---------
Net loss attributable to common
stockholders $(23,773,026) $ (0.31) $(47,916,031) $ (0.91) $(25,175,939) $ (0.59)
============== ========= ============= ========== ============== =========
Weighted average common shares
outstanding 76,753,709 52,511,185 42,320,188
============== ============= ==============
</TABLE>
Stock-based Compensation - The Company uses the intrinsic value method to
account for stock-based compensation plans. Under this method, compensation cost
is recognized for stock option awards only if the quoted market price is greater
than the amount the optionee must pay to acquire the stock. Pro forma
disclosures using the fair value-based method required by Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation"
are presented in Note 11.
Recently Enacted Accounting Standards - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement establishes accounting and reporting
standards requiring that derivative instruments be recorded in the balance sheet
as either an asset or liability measured at their fair values and that changes
in the fair values 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.
2. ACQUISITIONS AND DISCONTINUED OPERATIONS
AcuVoice, Inc. - In March 1998, the Company created a wholly owned subsidiary
(Fonix/AcuVoice, Inc.) that acquired AcuVoice, Inc. ("AcuVoice"). AcuVoice
developed and marketed TTS technologies and products directly to end users,
systems integrators and original equipment manufacturers for use in the
telecommunications, multi-media, education and assistive technology markets.
These same products and services are now provided by the Company. The Company
issued 2,692,216 shares of restricted Class A common stock (having a market
value of $16,995,972 on that date) and paid cash of approximately $8,000,000 for
all of the then outstanding common shares of AcuVoice. The acquisition was
accounted for as a purchase.
Of the 2,692,216 shares of Class A common stock issued, 80,000 shares were
placed in escrow against which any claims for breach of warranty against the
former shareholders of AcuVoice could be asserted by the Company. On March 12,
1999, the Company submitted a claim for the shares deposited into the escrow
account based on the Company's assertion of misrepresentations made to the
Company (see Note 16). The shares held in escrow have been excluded from the
calculation of basic net loss per common share for the years ended December 31,
1999 and 1998.
F-14
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The purchase price allocation to tangible assets included $253,881 of cash,
$13,728 of accounts receivable, $9,902 of property and equipment and $800 of
prepaid expenses. The purchase price allocations to liabilities assumed included
$22,929 of accounts payable and accrued expenses and $599,250 of notes payable.
The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of AcuVoice was $25,339,840, of which $11,192,000
was capitalized as the purchase cost of the completed technology, $4,832,840 was
capitalized as goodwill and $9,315,000 was expensed as in-process research and
development.
The valuation of the acquired in-process research and development included, but
was not limited to, an analysis of (1) the market for AcuVoice products and
technologies; (2) the completion costs for the projects; (3) the expected cash
flows attributed to the projects; and (4) the risks associated with achieving
the expected cash flows. The value of the in-process research and development
was based upon assumptions the Company believed to be reasonable but which were
inherently uncertain and unpredictable. At the date of acquisition of AcuVoice,
management estimated that the acquired in-process research and development
projects of AcuVoice were approximately 75 percent complete and that an
additional $1.0 million would be required to develop these projects to
commercial viability. As of December 31, 1999, the Company has expended a total
of approximately $433,000 in connection with the AcuVoice acquired in-process
research and development projects, and management estimates that an additional
amount of approximately $567,000 will be required to complete the AcuVoice
projects. Management currently estimates that the AcuVoice projects are 88
percent complete as of December 31, 1999, and anticipates release in the second
quarter of 2000.
Papyrus Associates, Inc. and Papyrus Development Corporation - In October 1998,
the Company created a wholly owned subsidiary (Fonix/Papyrus, Inc.) that
acquired Papyrus Associates, Inc. ("PAI") and Papyrus Development Corporation
("PDC," together with PAI, "Papyrus"). PAI developed, marketed and supported
printing and cursive handwriting recognition software for "personal digital
assistants", pen tablets and mobile phones under the trademark, Allegro(TM). PDC
was a systems integration provider with expertise and intellectual property in
embedded systems and enhanced Internet applications. Fonix now provides these
products and technologies. The Company issued 3,111,114 shares of restricted
Class A common stock (having a market value of $3,208,336 on that date) and
promissory notes aggregating $1,710,000, in connection with this purchase.
Of the 3,111,114 shares of Class A common stock issued, 311,106 shares were
placed in escrow against which any claims for breach of warranty against the
former shareholders of Papyrus could be asserted by the Company. As of December
31, 1999, 15,482 shares remain in escrow. The shares held in escrow have been
excluded from the calculation of basic net loss per common share for the years
ended December 31, 1999 and 1998. The acquisition was accounted for as a
purchase.
The purchase price allocation to tangible assets included $10,342 of cash and
$7,629 of accounts receivable. The purchase price allocation to liabilities
assumed included $118,293 of accounts payable and accrued liabilities. The
excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of Papyrus was $5,018,658 and was capitalized as
goodwill.
Articulate Systems, Inc. - In 1998, the Company created a wholly owned
subsidiary ("Fonix/Articulate") that acquired Articulate Systems, Inc.
("Articulate") in September 1998. Articulate was a provider of sophisticated
voice recognition products to specialized segments of the health care industry.
The Company delivered 5,140,751 shares of restricted Class A common stock
(having a market value of $8,353,720 on that date), a cash payment of $7,787,249
and 8.5 percent demand notes in the aggregate amount of $4,747,339 for all of
the then outstanding common shares of Articulate. Additionally, the Company
issued 98,132 stock options in exchange for all Articulate stock options
outstanding on the date of acquisition at an exchange rate based on the relative
fair value of
F-15
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the companies' stocks. The estimated fair value of the options issued was
$130,000 using the Black-Scholes option pricing model with weighted average
assumptions of a risk-free rate of 5.1 percent, expected life of 2.5 years,
expected volatility of 85 percent and an expected dividend yield of 0 percent.
Subsequent to the acquisition, the Company agreed to pay several Articulate
employees incentive compensation for continued employment in the aggregate
amount of $857,000. The Company issued 8.5 percent demand notes for $452,900 and
recorded an accrued liability of $404,100 for the balance of this obligation,
both of which were paid in 1999. The Articulate acquisition was accounted for as
a purchase.
Of the 5,140,751 shares of Class A common stock issued, 315,575 shares were
placed in escrow against which any claims for breach of warranty against the
former shareholders of Articulate could be asserted by the Company and 1,985,000
shares were placed in escrow to be converted at a later date to Class B
Non-Voting common stock, subject to approval by the shareholders of the Company.
By vote of the shareholders at the annual meeting held October 29, 1999, the
issuance of 1,985,000 share of Class B Non-Voting common stock was approved. The
Class B shares are authorized, but have not yet been exchanged for the
corresponding Class A shares held in escrow. The shares held in escrow have been
excluded from the calculation of basic net loss per common share for the year
ended December 31, 1999 and 1998.
The purchase price allocation to tangible assets included $286,954 of cash,
$62,835 of accounts receivable, $57,165 of inventory, $14,043 of prepaid
expenses and $117,540 of property and equipment. The purchase price allocation
to liabilities assumed included $310,008 of accounts payable and accrued
expenses, $1,900,000 of notes payable and $929,690 of deferred revenue.
The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of Articulate was $23,584,256, of which $13,945,000
was capitalized as the purchase cost of completed technology, $5,818,256 was
capitalized as goodwill and other intangibles and $3,821,000 was expensed as
in-process research and development. The valuation of the acquired in-process
research and development was based upon assumptions the Company believed to be
reasonable at the time.
Effective September 1, 1999, the Company sold the operations and certain assets
of the HSG, of which Articulate was a part (see below).
The MRC Group, Inc. - On December 31, 1998, the Company acquired certain assets
of the MRC Group, Inc. ("MRC") relating to MRC's selling, marketing and
servicing of certain of Articulate's products. In consideration for the assets,
the Company agreed to pay MRC $219,833 less certain amounts then owed to the
Company, plus $133,333 per month for each of the three months immediately
following the closing, less certain credits. As of December 31, 1998, the
remaining amount owing related to this acquisition was $216,666, which was paid
in 1999.
The purchase price allocation to tangible assets included $142,852 of accounts
receivable and $40,000 of property and equipment. The purchase price allocation
to liabilities assumed included $311,588 of accrued expenses and $849,742 of
deferred revenue. Additionally, $152,839 of accounts receivable and $987,531 of
deferred revenue from Articulate were eliminated in purchase accounting. The
excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of MRC was $314,761 which was capitalized as
goodwill.
Effective September 1, 1999, the Company sold the operations and certain assets
of HSG, of which MRC was a part (see below).
Sale of the HealthCare Solutions Group - On September 1, 1999, the Company
completed the sale of the operations and a significant portion of the assets
(the "Sale") of HSG to Lernout & Hauspie Speech Products N.V.
F-16
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("L&H"), an unrelated third party, for up to $28,000,000. Of this sales price,
$21,500,000, less certain credits of $194,018, was received at closing,
$2,500,000 was held in an 18 month escrow account in connection with the
representations and warranties made by the Company in the sales transaction.
Subsequent to the closing, $500,000 was released from the escrow. Another
$4,000,000 of the sales price is to be contingently paid as an earnout in two
installments of $2,000,000 each over the next two years based on the performance
of HSG. The proceeds received 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 development opportunities. The assets sold included
inventory, property and equipment, certain prepaid expenses, purchased core
technology and other assets. Additionally, L&H assumed the capital and operating
lease obligations related to HSG and the obligations related to certain deferred
revenues.
Upon the closing of the Sale, the Company discontinued the operations of HSG.
The results of operations of HSG have been reported separately as discontinued
operations in the accompanying consolidated statements of operations. Prior year
results have been restated to provide comparability. The net assets
(liabilities) of HSG in the December 31, 1998 consolidated balance sheet consist
of the following:
<TABLE>
<CAPTION>
<S> <C>
Inventory $ 72,582
Other receivables 4,554
Deferred revenues (675,997)
--------------
Net current assets (liabilities) $ (598,861)
==============
Property and equipment, net of
accumulated depreciation of $27,367 $ 182,981
Intangible assets, net of accumulated
amortization of $828,886 19,379,131
Other assets 22,343
--------------
Net long-term assets $ 19,584,455
</TABLE>
Revenues from HSG's operations were $284,960 for the period from acquisition
through December 31, 1998 and $1,726,262 from January 1, 1999 through September
1, 1999, the date of the Sale. These amounts have not been included in revenues
in the accompanying consolidated statements of operations, but are included in
the operating loss from discontinued operations.
Proforma Financial Statement Data - The following unaudited pro forma financial
statement data for the years ended December 31, 1998 and 1997 present the
results of operations of the Company as if the acquisitions of AcuVoice and
Papyrus had occurred at the beginning of each year. The pro forma results have
been prepared for comparative purposes only and do not purport to be indicative
of future results or what would have occurred had the acquisitions been made at
the beginning of the applicable year. Purchased in-process research and
development of $9,315,000 related to the acquisition of AcuVoice was recorded at
the date of the acquisition and is not presented in the following unaudited pro
forma financial statement data since it is a non-recurring charge directly
attributable to the acquisition. Historical and pro forma financial information
for the acquisition of Articulate and MRC have not been included in the
following pro forma financial statement data as the operations and substantially
all assets related to Articulate were sold September 1, 1999. The results of
operations of MRC are not included in the unaudited pro forma financial
statement data as the acquisition did not constitute the purchase of a business.
F-17
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
For the Year Ended December 31,
---------------------------------------
1998 1997
----------------- -------------------
<S> <C> <C>
Revenues $ 2,692,916 $ 1,134,590
Loss before extraordinary items (31,462,937) (15,939,441)
Net loss (31,462,937) (16,821,305)
Basic and diluted net loss per common share (0.55) (0.34)
</TABLE>
3. CERTIFICATE OF DEPOSIT
Included in cash and cash equivalents at December 31, 1998 is a $20,000,000
short-term bank certificate of deposit. The certificate earned interest at an
annual rate of four percent at December 31,1998, payable monthly. The
certificate was pledged as collateral on a revolving note payable (see Note 6).
On January 8, 1999, the certificate matured and was not renewed. Proceeds from
the certificate were applied to reduce the related revolving note payable
balance.
4. NOTES RECEIVABLE
At December 31, 1998, the Company had a note receivable from a research and
development entity in the amount of $20,000 which was repaid on January 5, 1999.
As of December 31, 1998, the Company had a six percent short-term, unsecured,
demand note receivable from an unrelated entity in the amount of $225,000. The
note was issued in connection with the Company's intended acquisition of the
entity. Because the acquisition was not consummated, the Company demanded
payment and received $225,000 on March 4, 1999.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
-------------- ----------------
<S> <C> <C>
Computer equipment $ 2,294,766 $ 2,329,755
Furniture and fixtures 673,909 778,479
Leasehold improvements 118,621 204,820
------------- -----------------
3,087,296 3,313,054
Less accumulated depreciation and amortization (1,938,494) (1,168,023)
------------- -----------------
Net property and equipment $ 1,148,802 $ 2,145,031
============= =================
</TABLE>
6. REVOLVING AND OTHER NOTES PAYABLE
At December 31, 1998, the Company had a revolving note payable to a bank bearing
interest at six percent in the amount of $19,988,193. The weighted average
outstanding balance was $18,590,642 and the weighted average
F-18
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
interest rate was 6.40 percent during 1998. The Company paid the note in full,
including accrued interest, on January 8, 1999, with proceeds from the
certificate of deposit that secured the note and $22,667 in cash.
At December 31, 1998, the Company had an unsecured revolving note payable to a
bank in the amount of $50,000. The weighted average outstanding balance during
1998 was $14,384, and the weighted average interest rate was 9.4 percent. On
September 20, 1999, this note and related interest were paid in full by a former
employee and the related amounts are included in accounts payable at December
31, 1999.
At December 31, 1998, the Company had a note payable to a lender in the amount
of $560,000 which bore interest at 18 percent, payable monthly. In connection
with the issuance of the note payable, the Company issued 35,000 shares of Class
A common stock (having a fair value of $50,314 on the date of issuance) in
payment for a loan origination fee. This amount is included in interest expense
in the accompanying consolidated statements of operations. The note payable was
due January 2, 1999, but was extended from month to month by paying the lender
accrued interest plus a fee of $5,600. On September 1, 1999, the note and
related interest were paid in full.
7. RELATED-PARTY NOTES PAYABLE
At December 31, 1998, the Company had unsecured demand notes payable to the
former Articulate stockholders in the aggregate amount of $4,708,980. These
notes were issued in connection with the Articulate acquisition (see Note 2). On
September 30, 1999, all outstanding amounts and related interest were paid in
full.
Subsequent to the Articulate acquisition, the Company agreed to pay several
Articulate employees incentive compensation for continued employment in the
aggregate amount of $857,000. The Company issued demand notes for $452,900 and
recorded an accrued liability of $404,100 for the balance of this obligation
(see Note 2). On September 3, 1999, these notes, the related interest and the
accrued liability were paid in full.
In connection with the acquisition of certain liabilities of Articulate (see
Note 2), the Company executed and delivered a $1,500,000 unsecured demand note
payable to a company which is a stockholder of the Company. This demand note
bore interest at an annual rate of 10 percent and was payable upon demand after
November 1, 1998. The Company obtained an extension of the due date from the
holder of the note and on February 2, 1999, this note and related interest were
paid in full.
At December 31, 1998, the Company had unsecured demand notes payable to former
Papyrus stockholders in the aggregate amount of $1,710,000, which notes were
issued in connection with the Papyrus acquisition. Demands for payment on the
notes were made as follows: $1,190,000 on February 28, 1999, $180,000 on April
30, 1999 and $340,000 on September 30, 1999, and bore interest at six percent
after their due date. The Company did not make payments on the due dates pending
the result of certain legal actions undertaken by the Company. In September
1999, the actions were settled resulting in cancellation of the promissory notes
upon payment to the former Papyrus shareholders of $1,217,384 and the return of
970,586 shares of restricted Class A common stock previously issued in
connection with the acquisition of Papyrus. The 970,586 shares were effectively
canceled in September 1999 in connection with the settlement of the lawsuits
then pending and the original fair market value of $1,000,917 associated with
the canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus Associates, Inc. Of the notes payable, $77,625 remained
unpaid as of December 31, 1999. The holders of these notes have not made demand
for payment.
The Company had an unsecured revolving note payable to a company owned by two
executive officers and directors and a former executive officer and director of
the Company. The Company believes the terms of the related-party revolving note
payable were at least as favorable as the terms that could have been obtained
from an unrelated third
F-19
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
party in a similar transaction.
At December 31, 1998, the Company had an unsecured, non-interest bearing demand
note payable in the amount of $100,000 to Synergetics, Inc., a research and
development entity (see Note 12). On September 2, 1999, this note and related
interest were paid in full.
At December 31, 1998, the Company had an unsecured note payable to an officer of
the Company in the amount of $20,000, which bore interest at an annual rate of
10 percent. On September 2, 1999, this note and related interest were paid in
full.
During 1999, two executive officers of the company advanced funds totaling
$317,159 related to sales of the Company's stock owned by them that was pledged
as collateral under certain borrowing agreements. The balance was subsequently
repaid in full. Also, an executive officer of the Company advanced an additional
$68,691 to the Company for operating expenses, all of which was subsequently
repaid to him. There were no amounts owed to these individuals at December 31,
1999.
8. CONVERTIBLE DEBENTURES
Series A Convertible Debentures - On October 23, 1995, the Company entered into
an agreement with Beesmark Investments, L.C., a Utah limited liability company
controlled by an individual who assumed a position on the Company's board of
directors in connection with the execution of the agreement. He later resigned
from the board. Under the agreement, the Company issued Series A convertible
debentures in the amount of $500,000. The debentures bore interest at five
percent and were originally due October 23, 1996. The debentures were ultimately
converted into 166,667 shares of Series A convertible preferred stock on
September 25, 1997 (see Note 9).
Series B Convertible Debentures - On June 18, 1997, the Company entered into a
convertible debenture purchase agreement whereby an unrelated investment entity
agreed to purchase up to an aggregate principal amount of $10,000,000 of Series
B convertible debentures. The debentures were due June 18, 2007, bore interest
at five percent and were convertible into shares of the Company's common stock
at the holders' option at the lesser of $6.81 or the average of the per share
market value for the five trading days immediately preceding the conversion date
multiplied by 90 percent for any conversion on or prior to the 120th day after
the original issue date and 87.5 percent for any conversion thereafter. The
Company received $3,000,000 in proceeds related to the issuance of Series B
convertible debentures. Using the conversion terms most beneficial to the
holders of the debentures, the Company recorded a debt discount of approximately
$427,900 which was amortized as additional interest expense over the 120 day
period commencing June 18, 1997. As part of the same transaction, the Company
also issued to the investors a warrant to purchase up to 250,000 shares of Class
A common stock at any time prior to June 18, 2002, at the exercise price of
$8.28 per share. The Company recorded the fair value of the warrants, totaling
$897,750, as a charge to interest expense. The fair value of the warrants was
determined as of the date of grant using the Black-Scholes pricing model
assuming the following: dividend yield of 0 percent; expected volatility of 65
percent; risk free interest rate of 5.9 percent and an expected life to exercise
of five years. On July 31, 1997 and September 26, 1997, $500,000 and $350,000 of
the Series B convertible debentures together with interest earned thereon were
converted into 87,498 and 58,249 shares of Class A common stock, respectively.
Effective September 30, 1997, the Company and the Series B convertible debenture
holders modified the agreement such that the holders exchanged all the then
outstanding debentures in the amount of $2,150,000 and accrued interest thereon
in the amount of $28,213 into 108,911 shares of Series B convertible preferred
stock which had essentially the same terms as the debentures and agreed that any
additional purchases under the agreement would be for Series B convertible
preferred stock. In connection with the extinguishment of the
F-20
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Series B convertible debentures and the issuance of Series B convertible
preferred stock (see Note 9), the Company recorded all unamortized debt discount
as a loss on extinguishment of debt. However, prior to the actual issuance of
the Series B preferred stock in exchange for the outstanding balance under the
debentures, the holders converted the balance of $2,150,000 and related
dividends into 431,769 shares of Class A common stock. Also in connection with
this modification, the Company issued an additional warrant to purchase up to
175,000 shares of Class A common stock at any time prior to October 24, 2002, at
an exercise price of $7.48 per share. In connection with the issuance of that
warrant, the Company recorded the fair value of the warrant, totaling $661,850
as an additional loss on extinguishment of debt. The fair value of the warrants
was determined as of the date of the grant using the Black-Scholes pricing model
assuming the following: dividend yield of 0 percent; expected volatility of 65
percent; risk free interest rate of 5.8 percent and expected life to exercise of
5 years.
Series C Convertible Debentures - On January 29, 1999, the Company entered into
an agreement with four investors pursuant to which the Company sold its Series C
convertible debentures in the aggregate principal amount of $4,000,000. The
outstanding principal amount of the debentures was convertible at any time at
the option of the holders into shares of Class A 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 Class A 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 the beneficial conversion
feature. The Company also issued 400,000 warrants in connection with this
financing. The warrants are exercisable for a period of three years from the
date of grant. The estimated fair value of the warrants of $192,000, as computed
under the Black-Scholes pricing model, was recorded as interest expense upon the
issuance of the debentures. On March 3, 1999, the Company executed a
supplemental agreement pursuant to which the Company agreed to sell another
$2,500,000 principal amount of Series C convertible debentures on the same terms
and conditions as the January 29, 1999 agreement, except no additional warrants
were issued. The obligations of the Company for repayment of the debentures, as
well as its obligation to register the common stock underlying the potential
conversion of the debentures and the exercise of the warrants issued in these
transactions, were personally guaranteed by two executive officers and directors
and one former executive officer and director (the "Guarantors"). These personal
guarantees were secured by a pledge of 6,000,000 shares of Fonix Class A common
stock beneficially owned by the Guarantors. The Company entered into an
indemnity agreement with the Guarantors relating to this and other guarantees
and pledges (see Note 12).
Subsequent to the March 3, 1999 funding, the holders of the Series C convertible
debentures notified the Company and the Guarantors that a default had occurred
under 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 had exercised their right to sell the shares
pledged by the Guarantors. The Company was informed that proceeds from the sale
of the 6,000,000 pledged shares amounted to $3,278,893. Of this total, $406,250
was allocated to penalties attributable to default provisions of the stock
pledge agreement and recorded by the Company as interest expense and $343,750
related to penalty provisions of the Series D preferred stock (held by a related
group of investors) and recorded by the Company as preferred stock dividends.
The remaining $2,528,893 was applied as a reduction of the principal balance of
the debentures. As of December 31, 1999, the remaining balance of the Series C
convertible debentures was $3,971,107. Subsequent to December 31, 1999, the
remaining balance, together with interest accrued thereon, was converted into
10,385,364 shares of Class A common stock.
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 expenses incurred by the Guarantors as a result of the holders' sales of the
Guarantors' shares.
Certain events of default outlined in the Series C convertible debenture
agreement provided the holders the right to
F-21
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
declare the outstanding balance immediately due and payable and impose
additional penalties and interest until the default is cured. Specified events
of default included suspension from listing or delisting of the Company's Class
A common stock from The Nasdaq SmallCap Market for a period of three trading
days and failure to register the underlying common stock with the Securities and
Exchange Commission by June 30, 1999. In March 1999, trading in the Company's
common stock was temporarily halted for five days. Following a series of notices
and appeals, the Company was notified on December 3, 1999, that its Class A
common stock had been delisted from the Nasdaq SmallCap Market (see Note 10).
The Company's Class A common stock is currently trading on the OTC Bulletin
Board. Furthermore, the Company had not registered the underlying shares by the
date specified. The holders of the debentures agreed to waive their right to
additional penalties and interest and their right to declare the balance due
provided the underlying shares were registered with the Securities and Exchange
Commission on or before February 29, 2000. A registration statement for the
shares was declared effective February 11, 2000, thereby satisfying the terms of
the waiver.
9. PREFERRED STOCK
In August 1997, a majority of the shareholders of the Company approved an
amendment to the Company's certificate of incorporation authorizing and
approving the issuance of preferred stock in such series and having such terms
and conditions as the Company's board of directors may designate. The amendment
became effective September 24, 1997. Thereafter, the Company's board of
directors adopted resolutions establishing various series of preferred stock in
connection with certain capital fund-raising in 1999, 1998 and 1997, as
described below.
Series A Convertible Preferred Stock - In September 1997, Series A convertible
debentures totaling $500,000 were converted into 166,667 shares of Series A
convertible preferred stock. Holders of the Series A convertible preferred stock
have the same voting rights as common stockholders, have the right to elect one
person to the board of directors and are entitled to receive a one time
preferential dividend of $2.905 per share of Series A convertible preferred
stock prior to the payment of any dividend on any class or series of stock. At
the option of the holder, each share of Series A convertible preferred stock is
convertible into one share of Class A common stock and in the event that the
common stock price has equaled or exceeded $10 for a 15 day period, the Series A
convertible preferred stock shares are automatically converted into Class A
common stock. In the event of liquidation, the holder is entitled to a
liquidating distribution of $36.33 per share and a conversion of Series A
convertible preferred stock at an amount equal to 1.5 shares of common stock for
each share of Series A convertible preferred stock.
Series B Convertible Preferred Stock - Effective September 30, 1997, the Company
and the Series B convertible debenture holders agreed to exchange all then
outstanding Series B debentures in the aggregate amount of $2,150,000 and
accrued interest thereon in the amount of $28,213 into 108,911 shares of Series
B convertible preferred stock. Dividends accrued on the stated value ($20 per
share) of Series B convertible preferred stock at a rate of five percent per
year, were payable quarterly in cash or Class A common stock, at the option of
the Company, and were convertible into shares of Class A common stock at any
time after issuance at the holders' option. In the event of liquidation, the
holders of the Series B convertible preferred stock were entitled to an amount
equal to the stated value plus accrued but unpaid dividends whether declared or
not. The holders of Series B convertible preferred stock had no voting rights.
The Series B convertible preferred stock, together with dividends accrued
thereon, could be converted into shares of Class A common stock at the lesser of
$6.81 or the average of the per share market value for the five trading days
immediately preceding the conversion date multiplied by 90 percent for any
conversion on or prior to the 120th day after the original issue date and 87.5
percent for any conversion thereafter. Using the conversion terms most
beneficial to the holders, the Company recorded a dividend of $219,614 which
represented a discount of 10 percent, which was available to the holders upon
issuance. The additional 2.5 percent discount of $68,509 was amortized as a
dividend over the remaining days in the original 120 day vesting period of the
Series B convertible debentures. Prior to the actual issuance of the Series B
convertible
F-22
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
preferred stock in exchange for the outstanding balance under the debentures,
the holders converted the balance of $2,150,000, and related dividends, into
431,679 shares of Class A common stock.
On October 24, 1997, the Company sold an additional 125,000 shares of Series B
convertible preferred stock for $2,500,000 less $145,000 in related offering
costs. Using the conversion terms most beneficial to the holders, the Company
recorded a dividend of $576,667 which represented a discount of 10 percent,
which was available to the holders on or before 120 days subsequent to closing.
A 2.5 percent discount of $87,905 was amortized as a dividend over 120 days. As
a condition for issuing preferred stock, the holders were granted a put option
by SMD, L.L.C. ("SMD"), a company which is controlled by three shareholders who
are current or former officers and directors of the Company. The put option
required SMD to purchase the Series B convertible preferred stock from the
holders at the holders' option but only in the event that the Class A common
stock of the Company was removed from listing on the NASDAQ Small Cap Market or
any other national securities exchange. The holders did not exercise the put
option. In connection with this put option, the Company recorded a financing
expense and a corresponding capital contribution of $125,000. As of December 31,
1997, 97,500 of the Series B convertible preferred stock and dividends earned
thereon had been converted into 355,188 shares of Class A common stock. In
January 1998, the remaining 27,500 shares of Series B convertible preferred
stock and dividends earned thereon were converted into 193,582 shares of Class A
common stock. As of December 31, 1999 and 1998, there are no shares of Series B
convertible preferred stock outstanding.
Series C Convertible Preferred Stock - Effective September 30, 1997, the Company
entered into an agreement with an unrelated investment entity whereby that
entity agreed to purchase 187,500 shares of the Company's Series C convertible
preferred stock for $3,750,000, which was received in October 1997. Dividends
accrued on the stated value ($20 per share) of Series C convertible preferred
stock at a rate of five percent per year, were payable quarterly in cash or
Class A common stock, at the option of the Company, and were convertible into
shares of Class A common stock at anytime after issuance at the holders' option.
In the event of liquidation, the holders of the Series C convertible preferred
stock were entitled to an amount equal to the stated value ($20 per share) plus
accrued but unpaid dividends whether declared or not. The holders of Series C
convertible preferred stock had no voting rights. The Series C convertible
preferred stock, together with dividends accrued thereon, could be converted
into shares of Class A common stock at the lesser of $5.98 or the average of the
five lowest closing bid prices for the 15 trading days preceding the date of any
conversion notice multiplied by 91 percent for any conversion on or prior to the
120th day after the original issue date, 90 percent for any conversion between
121 and 180 days and 88 percent for any conversion thereafter. Using the
conversion terms most beneficial to the holder, the Company recorded a dividend
of $1,060,718 which represented a discount of nine percent, which was available
to the holder on or before 120 days subsequent to closing. The additional three
percent discount of $164,002 was amortized as a dividend over 180 days. As a
condition for issuing preferred stock, the holder of the Series C convertible
preferred stock was granted a put option by SMD. The put option required SMD to
purchase the Series C convertible preferred stock from the holder at the
holder's option but only in the event that Class A common stock was removed from
listing on the NASDAQ Small Cap Market or any other national securities
exchange. In connection with this put option, the Company recorded a financing
expense and a corresponding capital contribution of $375,000. Associated with
the issuance of the Series C convertible preferred stock, the Company issued a
warrant to purchase up to 200,000 shares of Class A common stock at any time
prior to October 24, 2000, at the exercise price of $7.18 per share. The Company
recorded the fair value of the warrant of $600,000 as determined as of October
24,1997 using the Black-Scholes pricing model assuming the following: dividend
yield of 0 percent; expected volatility of 65 percent; risk free interest rate
of 5.8 percent and expected life to exercise of 3 years. During the year ended
December 31, 1997, the Company issued 17,198 shares of Class A common stock upon
conversion of 2,500 shares
F-23
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of Series C convertible preferred stock and related accrued dividends. During
1998, the remaining 185,000 shares of Series C convertible preferred stock and
related dividends were converted into 1,295,919 shares of Class A common stock.
As of December 31, 1999, there are no shares of Series C convertible preferred
stock outstanding.
Series D Convertible Preferred Stock - On August 31, 1998, the Company entered
into an agreement with investors whereby the Company issued 500,000 shares of
Series D convertible preferred stock for $10,000,000. Additionally, the Company
issued to certain investors a total of 608,334 shares of Series D convertible
preferred stock (i) in return for their relinquishment of their contractual
right to receive Reset Shares in connection with the March 1998 offering (see
Note 10), and as (ii) an additional cost of raising the $10,000,000 from the
Series D convertible preferred stock placement. Dividends accrue on the stated
value ($20 per share) of Series D convertible preferred stock at the rate of
four percent per year, are payable annually or upon conversion, in cash or Class
A common stock, at the option of the Company, and are convertible into shares of
Class A common stock at the holders' option any time. Each month the holders of
the Series D convertible preferred stock may not convert more than 25 percent of
the total number of shares of Series D convertible preferred stock originally
issued to such holders, on a cumulative basis. For example, during the first
month, a holder may convert up to 25 percent of the total Series D convertible
preferred stock issued to the holder, and during the following month that same
holder may convert, on an aggregate to date basis, up to 50 percent of the total
number of shares of Series D convertible preferred stock held by the holder.
Additionally, each month thereafter a holder may convert up to 50 percent of the
total number of shares of Series D convertible preferred stock originally issued
to such holder on a cumulative basis, if both of the following conditions are
satisfied: the average daily trading volume of Class A common stock is more than
500,000 shares for the 10-trading-day period before the conversion; and the
average per share closing bid price for such 10- trading-day period has not
decreased by more than five percent during that 10-trading-day period. Any
outstanding shares of Series D convertible preferred stock as of August 31, 2001
automatically will be converted at the conversion price most beneficial to the
holders on such date. In the event of liquidation, the holders of the Series D
convertible preferred stock are entitled to an amount equal to the stated value
($20 per share) plus accrued but unpaid dividends whether declared or not. The
holders of Series D convertible preferred stock have no voting rights. The
Series D convertible preferred stock, together with dividends accrued thereon,
may be converted into shares of Class A common stock at the lesser of: $3.50 per
share; or the lesser of 110 percent of the average per share closing bid price
for the fifteen trading days immediately preceding the date of issuance of the
shares of Series D convertible preferred stock; or 90 percent of the average of
the three lowest per share closing bid prices during the 22 trading days
immediately preceding the conversion date. In the event that the holders convert
at the $3.50 per share price, the Company is obligated to issue warrants to
purchase 0.8 shares of Class A common stock for each share of Series D
convertible preferred stock converted to common stock. Using the conversion
terms most beneficial to the holders, the Company amortized a beneficial
conversion feature of $3,638,147 as a dividend over a 180 day-period. In 1998,
150,000 shares of Series D convertible preferred stock were exchanged for
150,000 shares of Series E convertible preferred stock (see below). In 1999,
626,611 shares of Series D convertible preferred stock and related dividends
were converted into 47,252,275 shares of Class A common stock. As of December
31, 1999, 381,723 shares of Series D convertible preferred stock remain
outstanding.
In connection with the sales of the Series D preferred stock, the Company
entered into registration rights agreements with the Series D investors and
agreed to register the sale of shares received on a conversion of the Series D
preferred stock. If the number of shares of Class A common stock currently
issuable upon a hypothetical conversion of the remaining shares of Series D
preferred stock exceed those registered for issuance, the Company would be
required to file an additional registration statement to cover the remaining
shares.
Subsequent to December 31, 1999 through April 10, 2000, 217,223 shares of Series
D preferred stock, together with dividend accrued thereon, were converted into
15,436,378 shares of Class A common stock.
F-24
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Series E Convertible Preferred Stock - Effective as of September 30, 1998, the
Company entered into an agreement with two of the purchasers of the Series D
convertible preferred stock whereby the Company issued 100,000 shares of the
Company's Series E convertible preferred stock for $2,000,000. Additionally, the
Company issued to the purchasers of the Series E convertible preferred stock a
total of 150,000 additional shares of Series E convertible preferred stock in
exchange for a total of 150,000 shares of Series D convertible preferred stock.
Dividends accrued on the stated value ($20 per share) of Series E convertible
preferred stock at a rate of four percent per year, were payable annually or
upon conversion, in cash or common stock, at the option of the Company, and were
convertible into shares of Class A common stock at any time at the holders'
option. In the event of liquidation, the holders of the Series E convertible
preferred stock were entitled to an amount equal to the stated value ($20 per
share) plus accrued but unpaid dividends whether declared or not. The holders of
Series E convertible preferred stock had no voting rights. The Series E
convertible preferred stock, together with dividends accrued thereon, was
convertable into shares of Class A common stock at the lesser of: $3.50 per
share; or the lesser of 110 percent of the average per share closing bid price
for the 15 trading days immediately preceding the date of issuance of the Series
E convertible preferred stock; or 90 percent of the average of the three lowest
per share closing bid prices during the 22 trading days immediately preceding
the conversion date. If the holders had converted at the $3.50 per share price,
the Company was obligated to issue warrants to purchase 0.8 shares of Class A
common stock for each share of Series E convertible preferred stock converted to
common stock. Using the conversion terms most beneficial to the holders, the
Company recorded a preferred stock dividend of $968,047 for the beneficial
conversion feature of the Series E convertible preferred stock. In 1998, 114,928
shares of Series E convertible preferred stock and related dividends were
converted into 2,591,733 shares of Class A common stock. In 1999, the remaining
135,072 shares of Series E convertible preferred stock and related dividends
were converted into 5,729,156 shares of Class A common stock. As of December 31,
1999, no shares of Series E convertible preferred stock remained outstanding.
Series F Convertible Preferred Stock - Effective February 1, 2000, the Company
entered into an agreement with four investors whereby it sold a total of 290,000
shares of its Series F convertible preferred stock to a group of investors in
return for payment of $2,750,000. Dividends accrued on the stated value ($20 per
share) of Series F convertible preferred stock at a rate of six percent per
year, were payable annually or upon conversion, in cash or common stock, at the
option of the Company, and were convertible into shares of Class A common stock
at any time at the holders' option. The Series F convertible preferred stock was
convertible into shares of Class A common stock at a price of $0.75 per share
during the first 90 days following the close of the transaction, and thereafter
at a price equal to 85 percent of the average of the three lowest closing bid
prices in the 20-day trading period prior to the conversion of the Series F
convertible preferred stock. Through December 31, 1999, the Company had received
$1,000,000 in cash advances in connection with this financing.
Subsequent to February 1, 2000, all shares of Series F convertible preferred
stock, together with related dividends accrued thereon, were converted into
7,764,948 shares of Class A common stock. Using the conversion terms most
beneficial to the holder, the Company recorded a preferred stock dividend of
$2,750,000 for the beneficial conversion feature related to these shares on the
date the Series F convertible preferred stock was issued.
10. COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION
Common Stock - During 1999, the Company issued 60,181,431 shares of Class A
common stock. Of such shares, 52,981,431 shares were issued upon the conversion
of preferred stock and related dividends, 6,000,000 were issued as replacement
shares under an indemnification agreement in favor of the Guarantors (see Notes
8 and 12) and 1,200,000 were issued to consultants as consideration for services
rendered. The Company canceled 970,586 shares
F-25
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of Class A common stock that were returned in connection with the Papyrus
settlement (see Note 16). At the annual meeting of shareholders held on October
29, 1999, issuance of Class B non-voting common stock was approved by the
shareholders of the Company. Also approved was an increase in the number of
common shares authorized from 100,000,000 to 300,000,000 and in the number of
preferred shares authorized from 20,000,000 to 50,000,000.
During 1998, the Company issued 20,740,605 shares of Class A common stock. Of
such shares, 4,000,000 shares were issued in connection with a private placement
transaction, 10,944,081 shares were issued in connection with the acquisitions
of AcuVoice, Articulate and Papyrus (see Note 2), 4,081,234 shares were issued
upon the conversion of Series B and C convertible preferred stock and related
dividends, 1,390,476 shares were issued in connection with the restructuring of
reset rights, 265,000 shares were issued upon the exercise of previously granted
warrants and options, 35,000 shares were issued in payment of a loan origination
fee (see Note 6) and 24,814 shares were issued for the purchase of a patent.
On March 12, 1998, the Company agreed to a private placement of up to 6,666,666
shares of its restricted Class A common stock for a total purchase price of
$30,000,000. Of that amount, $15,000,000 was received by the Company on March
12, 1998, in return for which the Company issued a total of 3,333,333 shares of
restricted Class A common stock. Finders' fees of $870,000 were paid in
connection with the $15,000,000 received. The remainder of the purchase price
was to be paid by the investors on July 27, 1998 subject to the effectiveness of
a registration statement covering the Class A common stock issued and issuable
in the offering. As of the July 27, 1998, the conditions precedent to receiving
the additional funding were not met. In separate transactions in June and August
1998, certain investors paid to the Company a total of $3,000,000 in return for
which the Company issued 666,667 additional shares of Class A common stock under
the terms and conditions set forth in the offering. Finders' fees of $163,846
were incurred in connection with the $3,000,000 received. No other proceeds have
been received by the Company pursuant to the offering, and the Company does not
expect any further proceeds to be received.
The investors acquired certain "reset rights" in connection with the offering
pursuant to which the investors would receive additional shares of common stock
("Reset Shares") for no additional consideration if the average market price of
the Company's Class A common stock for the 60-day period following the effective
date of the registration statement or the second funding date did not equal or
exceed $5.40 per share. On August 31, 1998, the Company and the investors in the
offering restructured the reset provision whereby the Company issued 608,334
shares of Series D convertible preferred stock and 1,390,476 shares of Class A
common stock for (i) the relinquishment of the investors' contractual right to
receive Reset Shares in connection with the $15,000,000 received in March 1998,
and the $3,000,000 received in June and August 1998, and (ii) a financing cost
in connection with the issuance of 500,000 shares of Series D convertible
preferred stock. The Company recorded an expense of $6,111,577 for the
difference between the Company's original obligation to issue Reset Shares and
the fair value of the shares that were actually issued in settlement for the
relinquishment of the reset rights and recorded a preferred stock dividend of
$1,000,000 related to financing costs in connection with the issuance of 500,000
shares of Series D convertible preferred stock.
Registration Rights and Reserved Shares - During 1999, 1998 and 1997, the
Company entered into registration rights agreements with investors under which
the Company agreed to register the Class A common stock issuable upon the
conversion of all series of preferred stock and debentures and the exercise of
warrants. The Company covenanted to reserve out of its authorized and unissued
shares of Class A common stock no less than 200% of that number of shares that
would be issuable upon the conversion of all series of preferred stock and
debentures and any dividends and interest then payable in stock thereon and the
exercise of warrants. As of April 10, 2000, the Company has reserved
approximately 5,000,000 shares of Class A common stock for this purpose.
F-26
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Voting Trust - As of December 31, 1999, 10,306,772 shares of the Company's
outstanding Class A common stock were held in a voting trust (the "Voting
Trust") as to which the president and chief executive officer of the Company is
the sole trustee. Persons who have deposited their shares of the Company's Class
A common stock into the Voting Trust have dividend and liquidation rights in
proportion to the number of shares of the Company's Class A common stock they
have deposited in the Voting Trust, but have no voting rights with respect to
such shares. All voting rights associated with the shares deposited into the
Voting Trust are exercisable solely and exclusively by the trustee of the Voting
Trust. The Voting Trust expires, unless extended according to its terms, on the
earlier of September 30, 2002 or any of the following events: (i) the trustee
terminates it; (ii) the participating stockholders unanimously terminate it; or
(iii) the Company is dissolved or liquidated.
Common Stock Subject to Redemption - On December 21, 1998, the Company entered
into a private placement agreement. Pursuant to the agreement, the Company
received $1,980,000 in net proceeds in exchange for 1,801,802 shares of Class A
common stock, an equal number of "Repricing Rights", both subject to certain
Repurchase Rights, and warrants to purchase 200,000 shares of Class A common
stock.
Each Repricing Right entitled the holder to receive a number of additional
shares of Class A common stock for no additional consideration according to a
formula based on the lowest closing bid price of the Company's Class A common
stock, as quoted by the NASDAQ SmallCap Market, during the 15 consecutive
trading days immediately preceding the exercise date and a repricing price, as
defined, ranging from $1.3875 to $1.4319 depending upon the date of the
exercise. The Repricing Rights became exercisable on March 21, 1999.
Each holder of the Class A common stock described above had the right
("Repurchase Right"), based on certain conditions, to require the Company to
repurchase all or a portion of the holder's common shares and Repricing Rights.
The Repurchase Rights could only be exercised simultaneously with or after the
occurrence of a major transaction or triggering event as defined in the private
placement securities agreement. Such events included certain consolidations,
mergers or other business combinations, sale or transfer of all or substantially
all the Company's assets, purchase, tender or exchange offering of more than 40
percent of the Company's outstanding Class A common stock made and accepted,
failure to have a registration statement describing the Class A common stock
declared effective prior to 180 days after the closing date or suspension from
listing or delisting of the Company's Class A common stock for a period of three
days. The repurchase price for the Class A common stock was $1.3875 per share.
On February 14, 2000, the holder of the Repricing Rights converted its rights
into 4,568,569 shares of Class A common stock and subsequently sold all the
shares. Simultaneously, the initial shares subject to the Repurchase Rights were
sold. Consequently, the Company has no further obligation under the Repricing
Rights or the Repurchase Rights.
The warrants issued in this transaction have an exercise price of $1.67 per
share and a term of three years. The Company assigned a fair value of $150,000
to the warrants as determined on December 21, 1998 using the Black-Scholes
pricing model assuming a dividend yield of 0 percent, expected volatility of 85
percent, a risk free interest rate of 4.5 percent and an expected life of 3
years.
During 1997, the Company issued 1,957,312 shares of Class A common stock. Of
such shares, 150,000 were issued to an unrelated private investor, 265,000 were
issued upon the exercise of previously granted warrants and options, 145,747
were issued upon conversion of convertible debentures, 804,065 were issued upon
the conversion of preferred stock and 592,500 were issued to unaffiliated
individuals for services rendered valued at $3,812,971 based on the fair market
value of the shares at the time of issuance.
F-27
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Delisting from the Nasdaq SmallCap Market - Until December 3, 1999, the
Company's Class A common stock traded on the Nasdaq SmallCap Market which
requires, for continued listing, a minimum bid price of at least $1.00 per
share. At June 29, 1999, the Company's Class A common stock had traded below
$1.00 for more than 30 consecutive trading days. On June 29, 1999, the Company
received a letter from Nasdaq indicating that unless the minimum bid price for
the Company's Class A common stock returned to at least $1.00 per share for at
least 10 consecutive trading days prior to September 29, 1999, the Company's
shares would be delisted from the Nasdaq SmallCap Market on October 1, 1999. The
Company appealed Nasdaq's notice and listing determination in September 1999.
Nasdaq held a hearing on the matter on October 28, 1999.
On December 3, 1999, the Company received notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market. The Company's Class A common
stock is currently trading on the OTC Bulletin Board.
The delisting of the Company's Class A common stock from the Nasdaq SmallCap
Market was an event of default under the terms of the Series C convertible
debentures. Upon the occurrence of an event of default, the outstanding
principal amount of all of the Series C convertible debentures, together with
accrued interest and all other amounts owing in respect thereof, became
immediately due and payable in cash. However, the holders of the Series C
convertible debentures waived this event of default.
The delisting of the Company's Class A common stock from the Nasdaq SmallCap
Market was also a triggering event giving rise to certain repurchase rights in
connection with the Company's Series D and Series E preferred stock. The holders
of the Repurchase Rights had the right to require the Company to repurchase some
or all of the holders' Class A common shares and Repricing Rights. However, the
holders waived this event of default.
11. STOCK OPTIONS AND WARRANTS
Common Stock Options -On June 1, 1998, the Company's board of directors approved
the 1998 Stock Option and Incentive Plan for directors, employees and other
persons acting on behalf of the Company, under which the aggregate number of
shares authorized for issuance is 10,000,000. The Company's shareholders
approved the plan on July 14, 1998. The plan is administered by a committee
consisting of two or more directors of the Company. The exercise price for
options granted under the plan is the closing market price of the Class A common
stock on the date the options are granted. The option term is 10 years from the
date of grant. As of December 31, 1999, the number of shares available for grant
under this plan was 4,216,441.
In December 1998, the Company granted options to purchase 2,800,000 shares of
Class A common stock to members of the board of directors. Of the 2,800,000
shares, 1,400,000 were for services performed in 1998 and 1,400,000 were for
services to be performed in 1999 providing the directors served six months in
1999. In 1999, the Company granted 400,000 options to new members of the board
of directors, waiving the requirement that they serve for six months prior to
such granting.
On March 10, 1997, the Company's board of directors approved the 1997 Stock
Option and Incentive Plan for directors, employees and other persons acting on
behalf of the Company, under which the aggregate number of shares authorized for
issuance is 7,500,000. The plan is administered by a committee consisting of two
or more directors of the Company. The exercise price of such options is the
closing market price of the Class A common stock on the date the options are
granted. The option term is 10 years from the date of grant. As of December 31,
1999, the number of shares available for grant under this plan was 2,238,993.
In April 1996, the Company's board of directors approved the 1996 Directors'
Stock Option Plan, under which the aggregate number of shares of Class A common
stock authorized for issuance is 5,400,000. The shareholders of the
F-28
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company approved the plan at their annual meeting in July 1996. The plan is
administered by a committee consisting of two or more directors of the Company.
The plan provides that each director shall receive options to purchase 200,000
shares of Class A common stock for services rendered as a director during each
entire calendar year or portion of a calendar year in excess of six months. The
exercise price of such options is the closing market price of the Class A common
stock on the date the options are granted. The option term is 10 years from date
of grant. As of December 31, 1999, the number of shares available for grant
under this plan was 2,200,000.
In April 1996, the Company's board of directors approved a Long-Term Stock
Investment and Incentive Plan for officers, key employees and other persons
acting on behalf of the Company under which the aggregate number of shares
authorized for issuance is 900,000. The exercise price of these options is the
closing market price of the Class A common stock on the date the options are
granted. The term of the plan is 10 years and options are subject to a
three-year vesting schedule, pursuant to which one-third of the total number of
options granted may be exercised each year. As of December 31, 1999, the number
of shares available for grant under this plan was 788,666.
A summary of options granted under the Company's various stock option plans for
the years ended December 31, 1999, 1998 and 1997 is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
------------------------ ------------------------ -----------------------
Weighted Weighted Weighted
Average Average Average
Stock Exercise Stock Exercise Stock Exercise
Options Price Options Price Options Price
----------- --------- ----------- --------- ------------ --------
Total options outstanding
<S> <C> <C> <C> <C> <C> <C>
at beginning of year 15,877,782 $ 4.10 10,565,000 $ 5.38 4,626,000 $ 4.07
Granted 1,294,000 1.31 6,414,782 2.08 6,009,000 6.38
Exercised - - (35,000) 6.00 (15,000) 2.97
Forfeited (2,815,882) 3.01 (1,067,000) 4.56 (55,000) 6.45
----------- ----------- ------------
Total options outstanding
at end of year 14,355,900 4.06 15,877,782 4.10 10,565,000 5.38
=========== =========== ============
Total options exercisable
at end of year 13,484,237 4.20 9,524,766 5.11 5,392,675 5.05
=========== =========== ============
Weighted average fair
value of options granted
during the year $ 1.31 $ 1.98 $ 6.38
</TABLE>
F-29
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of options outstanding and options exercisable under the Company's
various stock option plans at December 31, 1999 is presented below:
<TABLE>
<CAPTION>
Options Oustanding Options Exercisable
- ----------------------------------------------------- --------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ---------- ----------- ----------- -------- ------------ -----------
<S> <C> <C> <C> <C> <C>
$0.40-1.18 3,932,157 9.0 years $ 1.05 3,332,158 $ 1.03
1.28-1.78 592,834 9.1 years 1.52 547,835 1.53
2.97-4.06 3,755,334 6.6 years 3.96 3,570,335 3.99
5.06-6.50 5,755,575 7.7 years 6.28 5,713,909 5.97
7.13-8.50 320,000 7.2 years 7.17 320,000 7.17
----------- ------------
$0.40-8.50 14,355,900 7.8 years $ 4.06 13,484,237 $ 4.20
=========== ============
</TABLE>
The Company accounts for its stock option plans as they relate to employees and
directors under Accounting Principles Board Opinion No. 25, and therefore, no
compensation expense has been recognized in the accompanying consolidated
statements of operations. Had compensation expense for these options been
determined in accordance with the method prescribed by SFAS No. 123, "Accounting
for Stock-Based Compensation", the Company's net loss per common share would
have been increased to the pro forma amounts indicated below for the years ended
December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- ------------- --------------
Net loss attributable to common stockholders:
<S> <C> <C> <C>
As reported $ 23,773,026 $ 47,916,031 $ 25,175,939
Pro forma 28,567,009 56,576,232 48,870,670
Basic and diluted net loss per common share:
As reported $ (0.31) $ (0.91) $ (0.59)
Pro forma (0.37) (1.08) (1.15)
</TABLE>
The fair value of options and warrants is estimated on the date granted using
the Black-Scholes pricing model with the following weighted-average assumptions
used for grants during 1999, 1998 and 1997: Risk-free interest rate of 5.7
percent, 4.8 percent and 5.6 percent for 1999, 1998 and 1997, respectively;
expected dividend yield of 0 percent for 1999, 1998 and 1997; expected exercise
lives of 5 years for 1999, 1998 and 1997, ; expected volatility of 102 percent,
85 percent and 75 percent for 1999, 1998 and 1997, respectively. The estimated
fair value of options granted is subject to the assumptions made, and if the
assumptions were to change the estimated fair value amounts could be
significantly different.
F-30
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants - A summary of warrants granted by the Company during the years ended
December 31, 1999, 1998 and 1997 is presented below:
<TABLE>
<CAPTION>
1999 1998 1997
------------------------- ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ---------- ----------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Total outstanding at beginning of year 1,925,000 $ 13.08 1,175,000 $ 6.39 450,000 $ 1.63
Granted 2,250,000 0.66 1,200,000 16.94 975,000 6.92
Exercised - - (230,000) 1.28 (250,000) 1.40
Forfeited (1,150,000) 16.06 (220,000) 9.14 -
----------- ----------- -----------
Total outstanding at end of year 3,025,000 2.71 1,925,000 13.08 1,175,000 6.39
=========== =========== ===========
Total exercisable at end of year 2,525,000 $ 3.16 1,925,000 $ 13.08 1,175,000 $ 6.39
=========== =========== ===========
</TABLE>
Stock Appreciation Rights - The option plans described above also provide for
stock appreciation rights that allow the grantee to receive shares of Class A
common stock equivalent in value to the difference between the designated
exercise price and the fair market value of Class A common stock at the date of
exercise. At December 31, 1999, there were stock appreciation rights related to
400,000 outstanding stock options with a weighted average exercise price of
$1.18. Subsequent to December 31, 1999, these stock appreciation rights were
exercised resulting in the recording of $628,000 of selling, general and
administrative expense.
12. RELATED-PARTY TRANSACTIONS
Guarantee of Company Obligations and Related Indemnity Agreement -Two executive
officers and directors and a former executive officer and director of the
Company (the "Guarantors") have guaranteed obligations of the Company, including
obligations under the Series C debentures and certain real estate leases.
The Guarantors pledged 6,000,000 shares of Class A common stock as collateral
security for the Series C convertible debentures. In consideration for this
pledge, the board of directors authorized the issuance of warrants to the
Guarantors to purchase one share of Class A common stock for every three shares
pledged. The purchase warrants would have a term of 10 years and an exercise
price of 125 percent of the closing bid price of the Company's common stock on
January 29, 1999, the date of issuance of the debentures. The warrants are not
exercisable for at least six months after the date of issuance. The Guarantors
subsequently deferred receipt of the warrants, but retained the right to accept
them at some later date. Accordingly, no warrants have yet been issued pursuant
to this transaction. The Company also agreed to indemnify the Guarantors if they
are required to pay any sums for the benefit of the Company under their guaranty
of the Series C convertible debentures. The indemnity agreement provides that
the Company will issue shares of Class A common stock of sufficient value to
reimburse the guarantors in full, plus interest at 10 percent per annum, for all
costs associated with meeting the guarantee commitment, including any income
taxes resulting therefrom.
Subsequent to the March 3, 1999 funding, the holders of the Series C convertible
debentures notified the Company and the Guarantors that a default had occurred
under certain terms of the stock pledge agreement and that the holders sold the
6,000,000 shares pledged by the Guarantors. The proceeds from the sale of the
pledged shares were applied to certain penalties incurred on the Series D
preferred stock (held by a related group of investors) and the remainder was
applied to reduce the principal balance of the Series C convertible debentures
as of September 30,
F-31
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1999 (see Note 8). Under its indemnity agreement with the Guarantors, the
Company issued 6,000,000 replacement shares to the Guarantors for the shares
sold and reimbursed the Guarantors for resulting costs. Accordingly, the Company
recorded an expense of $1,296,600 during 1999.
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 Class A common stock beneficially owned by them. In March 1999,
143,230 of the shares pledged 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 pledged 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 recorded an
expense of $146,700 during 1999 to reimburse the Guarantors for expenses
resulting from these sales.
Studdert Companies Corp. - Studdert Companies Corp. ("SCC") is a Utah
corporation that previously provided investment and management services to the
Company. Two of the officers, directors and owners of SCC are directors and
executive officers of the Company. A third officer, director and owner of SCC
was a director and executive officer of the Company. In June 1994, the Company
entered into an Independent Consulting Agreement (the "SCC Agreement") with SCC
pursuant to which SCC rendered services to the Company.
Under the terms of the SCC Agreement from June 1994 to April 1996, the Company
paid a monthly fee of $50,000 to SCC for management and other services rendered
on behalf of the Company, including compensation and benefits for three
executive officers of the Company who were also officers and directors of SCC at
the time. The Company did not pay or award any form of compensation directly to
these executive officers. Through this period, the Company incurred charges for
services rendered and reimbursable expenses payable to SCC amounting to
$2,554,405, all of which was paid on or before February 10, 1997. Of this
amount, $1,417,000 was paid by issuance of Class A common stock. The stock was
issued through exercise of a warrant for 3,700,000 shares of Class A common
stock purchased by SCC for $.033 per share with an exercise price of $.35 per
share. The $122,100 purchase price and the $1,295,000 exercise price of the
warrants were satisfied by the cancellation of the amounts owed to SCC. The
balance of $1,137,405 was paid in cash during 1995, 1996 and 1997, as agreed.
Beginning May 1, 1996, the SCC Agreement was modified to cover only reimbursable
expenses incurred by SCC on behalf of the Company. Thereafter, compensation and
benefits were paid directly to the executive officers according to the terms of
their respective employment contracts with the Company. The Company continues to
rent office space under subleases from SCC. Payments under the leases are
guaranteed by three officers, owners and directors of SCC, two of whom are
executive officers and directors of the Company. The subleases require monthly
payments of $10,368. The Company believes the terms of the subleases are at
least as favorable as terms that could be obtained from an unaffiliated third
party in a similar transaction. Accordingly, SCC was reimbursed for expenses and
lease payments in the amount of $124,416 in 1999, $117,228 in 1998 and $77,203
in 1997.
SMD, L.L.C. - From September 4, 1997, through October 15, 1997 and again on
December 31, 1997, the Company, borrowed funds from SMD, L.L.C., a company owned
by two directors and executive officers and a former director and executive
officer of the Company pursuant to a revolving, unsecured promissory note,
bearing interest at the rate of 12 percent per annum. The aggregate of all
amounts loaned under the note was $2,000,000 and the highest outstanding balance
at any one time was $1,550,000. All amounts were repaid, together with $5,542 in
interest in 1998. The loan and its terms were approved by the independent
members of the board of directors of the Company.
F-32
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Synergetics - Through December 1998, a director and the chief executive officer
of the Company was also a director of Synergetics, Inc. In addition, two
executive officers and directors and a former director and executive officer of
the Company owned shares of the common stock of Synergetics, although such share
ownership in the aggregate constituted less than 5 percent of the total shares
of Synergetics common stock issued and outstanding. Effective December 31, 1998,
the chief executive officer and director of the Company resigned from the board
of Synergetics and the three executive officers and directors relinquished all
ownership of Synergetics shares. Until March 1999, the Company engaged
Synergetics to provide assistance to Fonix in the development of its ASR
technologies (see Note 14).
Voice Information Associates, Inc. - A director and executive officer of the
Company is also the founder and president of Voice Information Associates, Inc.
("VIA"), a consulting group providing strategic technical, market evaluation,
product development and corporate information to the speech recognition
industry. During 1997, the Company paid approximately $110,000 in consulting
fees to VIA for services provided to the Company. No payments were made by the
Company to VIA in 1999 and 1998.
Other Transactions - During 1996, disinterested members of the Company's board
of directors authorized the Company to reimburse certain officers for all taxes
payable by the officers in conjunction with the 1995 exercise of 3,700,000
warrants by SCC, a company owned by the officers. The total amount authorized to
be reimbursed was $1,150,000 in 1997 and $1,350,000 in 1996. No reimbursement
was paid in 1999, $340,516 was paid in 1998 and $2,159,484 was paid in 1997.
On December 23, 1999, the Company issued 250,000 warrants to a law firm having a
weighted average exercise price of $0.31 and a term of five years. During 1999,
1998, and 1997, the Company paid approximately $902,000, $746,000 and $394,000,
respectively, to the law firm for services provided to the Company.
13. STATEMENT OF WORK
On February 11, 1998, the Company entered into a First Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") under which the Company and Siemens were jointly pursuing the
development of Siemens' integrated circuits incorporating ASR and other related
technologies for use in certain telecommunications applications. On February 20,
1998, the Company received $2,691,066 in cash from Siemens. Of that amount: (1)
$1,291,712 was paid to the Company as a non-refundable payment to license
certain ASR technologies for which the Company has no further obligation; (2)
$322,928 was paid to purchase warrants to acquire 1,000,000 shares of restricted
Class A common stock at an average exercise price of $20 per share with
expiration dates ranging from December 31, 1998 to December 31, 1999; and (3)
$1,076,426 was paid to the Company to acquire, if Siemens so elected, shares of
restricted Class A common stock or to become a non-refundable license payment.
In June 1998, Siemens elected to apply the $1,076,426 portion as a
non-refundable payment to license certain ASR technologies for which the Company
has no further obligation. The Company recorded the $2,368,138 license payments
as revenue during the year ended December 31, 1998. No amounts were owed or paid
by Siemens in 1999.
14. PRODUCT DEVELOPMENT AND RESEARCH
Synergetics - Prior to March 1997, the Company's scientific research and
development activities were conducted solely by a third party, Synergetics,
Inc., pursuant to product development and assignment contracts (collectively,
the "Synergetics Agreement"). Under that arrangement, Synergetics provided
personnel and facilities, and the Company financed the Synergetics research and
development activities on an as-required basis and the Company was obligated to
pay to Synergetics a royalty of 10 percent (the "Royalty") of net revenues from
sales of products
F-33
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
incorporating Synergetics' "VoiceBox" technology as well as technology
derivatives thereof. Synergetics compensated its developers and others
contributing to the development effort, in part, by granting "Project Shares" to
share in a portion of the Royalty received by Synergetics. On April 6, 1998, the
Company and Synergetics entered into a Royalty Modification Agreement whereby
the Company agreed to offer an aggregate of 4,800,000 non-transferable common
stock purchase warrants to the holders of the Project Shares in consideration
for which Synergetics agreed to cancel any further obligation on the part of the
Company to pay the Royalty. The exercise price of the warrants was to be $10 per
share and the warrants would not be exercisable until the first to occur of (1)
the date that the per share closing bid price of the Class A common stock was
equal to or greater than $37.50 per share for a period of 15 consecutive trading
days, or (2) September 30, 2000. Effective March 31, 2000, the Company and
Synergetics entered into a Restated Royalty Modification Agreement whereby the
Company agreed to pay Synergetics $28,000 (the "Cancellation Amount") to cancel
the obligation of the Company to pay the Royalty. The Company has paid the
Cancellation Amount to Synergetics and the Royalty has been canceled. The
Company has no further obligations to Synergetics, including prior obligations
to issue 4,800,000 warrants.
Under the terms of the Synergetics Agreement, as modified, the Company incurred
expenses totaling $50,455 in 1999, $1,128,433 in 1998 and $2,819,427, in 1997,
for research and development efforts.
Adiva- During 1998, the Company utilized the research and development services
of Adiva. The president of Adiva is also the president of Synergetics and IMC-2.
The Company incurred expenses of $63,395 in 1999 and $600,174 in 1998 for
services provided by Adiva.
IMC-2 - In March 1998, the Company entered into a professional services
agreement with IMC-2, a research and development entity, to provide assistance
to the Company in the continuing development of specific ASR technologies. The
president of IMC-2 is also the president of Synergetics and Adiva. The agreement
is for a term of 36 months and requires the Company to make monthly payments of
$22,000. Future noncancellable payments under this agreement are $264,000 and
$44,000 for the years ended December 31, 2000 and 2001. Under the terms of the
agreement, the Company expended $264,000 in 1999 and $220,000 in 1998, for
research and development efforts.
Advocast - In July 1997, the Company entered into an arrangement with Advocast,
Inc. ("Advocast"), an Internet research and development entity, whereby Advocast
assisted the Company in development of technologies to create and locate
searchable data bases on the Internet through the use of interactive video and
voice technologies. Under the terms of the arrangement the Company paid $0 in
1999, $816,750 in 1998 and $705,005 in 1997, for Advocast research and
development efforts.
On November 25, 1998, in consideration for the research and development payments
received from Fonix through that date, Advocast issued 60,200 shares of Advocast
Series A 6% convertible preferred stock to the Company. The Advocast shares, if
converted to Advocast common stock, represent less than 20 percent of the total
outstanding shares of Advocast voting common stock. Advocast is a development
stage company with minimal operations and there is substantial uncertainty as to
the value of the Advocast shares. The Company has therefore determined that
there is not sufficient marketability in Advocast shares to determine their
value. As a result, the Company has not recorded a value for the Advocast shares
in the accompanying consolidated financial statements.
15. INCOME TAXES
At December 31, 1999 and 1998, net deferred income tax assets, before
considering the valuation allowance, totaled $25,104,947 and $21,031,633,
respectively. The amount of and ultimate realization of the benefits from the
deferred income tax assets is dependent, in part, upon the tax laws in effect,
the Company's future earnings, and other future events, the effects of which
cannot be determined. The Company has established a valuation allowance
F-34
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for all deferred income tax assets not offset by deferred income tax liabilities
due to the uncertainty of their realization. The benefit for income taxes in the
accompanying consolidated statement of operations for 1999 represents net
operating loss carryforwards utilized to offset income tax liabilities
associated with the sale of the HSG and the gain on forgiveness of debt. The net
change in the valuation allowance was an increase of $4,202,930 for 1999.
At December 31, 1999, the Company has unused federal net operating loss
carryforwards available of approximately $59,898,000 and unused state net
operating loss carryforwards of approximately $62,581,000 which may be applied
against future taxable income, if any, and which expire in various years from
2008 through 2019. The Internal Revenue Code contains provisions which likely
could reduce or limit the availability and utilization of these net operating
loss carryforwards. For example, limitations are imposed on the utilization of
net operating loss carryforwards if certain ownership changes have taken place
or will take place. The Company has not performed an analysis to determine
whether any such limitations have occurred.
The temporary differences and carryforwards which give rise to the deferred
income tax assets (liabilities) as of December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Deferred income tax assets: 1999 1998
------------------- -----------------
<S> <C> <C>
Net operating loss carryforwards:
Federal $ 20,365,190 $ 18,526,707
State 2,065,175 1,810,687
Research and development credits 1,818,176 694,239
Accrued liabilities 811,892 -
Other 44,514 -
------------------- -----------------
Total deferred income tax assets before valuation allowance 25,104,947 21,031,633
Valuation allowance (25,085,947) (20,883,017)
------------------- -----------------
Net deferred income tax assets 19,000 148,616
------------------- -----------------
Deferred income tax liabilities:
Depreciation (19,000) (148,316)
Intangibles - (300)
------------------- -----------------
Total deferred income tax liabilities (19,000) (148,616)
------------------- -----------------
$ - $ -
=================== =================
</TABLE>
A reconciliation of income taxes at the federal statutory rate to the Company's
effective rate is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Federal statutory income tax rate 34.0% 34.0% 34.0%
State and local income tax rate,
net of federal benefit 3.3 3.3 3.3
Permanent differences (9.0) (11.2) -
Valuation allowance (14.0) (26.1) (37.3)
------ ------ ------
Effective income tax rate 14.3% -% -%
====== ====== ======
</TABLE>
F-35
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. COMMITMENTS AND CONTINGENCIES
Employment Agreements - In January 1998, the Company entered into employment
contracts with two employees which expire in January 2001. The aggregate minimum
annual salary payments required by these contracts total $405,000. In connection
with these agreements, these individuals were granted options to purchase
360,000 shares of the Company's Class A common stock at $3.34 per share. These
options have a 10-year life and are subject to a three-year vesting schedule,
pursuant to which one-third of the total number of options granted may be
exercised each year. One-third of the options are vested on the date of grant.
In the event that, during the contract term, both a change of control occurs,
and within six months after such change in control occurs, the employee's
employment is terminated by the Company for any reason other than cause, death
or retirement, the employee shall be entitled to receive an amount in cash equal
to all base salary then and thereafter payable within 30 days of termination. In
January 1999, the Company announced a major cost reduction program for the
Company's 1999 operating year wherein the compensation of two employees referred
to above was reduced 30 percent effective February 1999.
Executive Employment Agreements - On November 1, 1996, the Company entered into
employment contracts with three executive officers (one of whom is no longer an
executive officer) which expire on December 31, 2001. In January 1999, the
contracts were modified as a part of a major cost reduction program announced
for the Company. At the same time, one of the execitive officers 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 for the years ending January 31, 2000 and 2001, and $100,000 for the
year ending January 31, 2002. Under the January 1999 modifications, the two
remaining officers' salaries were reduced to $297,500 commencing February 1999.
In January 2000, the board of directors extended the two remaining contracts at
the reduced base compensation until December 31, 2005. Subsequent adjustments in
base compensation, if any, will be approved by the board of directors.
In the event that, during the contract term, both a change of control occurs,
and within six months after such change in control occurs, the executive's
employment is terminated by the Company for any reason other than cause, death,
or retirement, the executive shall be entitled to receive an amount in cash
equal to all base salary then and thereafter payable within 30 days of
termination.
Professional Services Agreements - 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 Class A
common stock at $3.75 per share. The options have a 10-year term and are fully
vested. In connection with this transaction, the options were valued at $320,100
using the Black-Scholes pricing model and the resulting charge recorded as
consulting expense, of which $106,700 is deferred as of December 31, 1998, and
was subsequently recognized over the life of the agreement in 1999.
In December 1999, the Company entered into a professional services agreement
with two consulting firms. In connection with these agreements, the Company
issued 1,000,000 shares of Class A common stock. The stock was valued at
$375,000 using the fair value of the Class A common stock on the date each
contract commenced. The resulting charge was recorded as deferred consulting
expense which is a reduction in stockholders' equity and will be amortized into
general and administrative expense over the subsequent period of service in
2000.
On December 23, 1999, the Company issued warrants to purchase 1,000,000 shares
of Class A common stock to professional advisors and consultants. The warrants
were valued at $0.26 per share using the Black-Scholes pricing model assuming a
risk-free interest rate of 6.33 percent, expected dividend yield of 0 percent;
expected exercise life
F-36
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of five years, and expected volatility of 130 percent. The resulting charge was
recorded as deferred consulting expense which is a reduction in stockholders'
equity and will be amortized into general and administrative expense over the
subsequent period of service in 2000.
Operating Lease Agreements - The Company leases certain facilities and equipment
used in its operations. The amount of commitments for noncancelable operating
leases in effect at December 31, 1999, were as follows:
Years ending December 31,
2000 $ 847,272
2001 857,532
2002 851,697
2003 512,700
2004 293,664
Total $ 3,362,865
The Company incurred rental expense of $764,930, $829,523 and $416,798 during
1999, 1998 and 1997, respectively, related to these leases.
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.
AcuVoice - In connection with the AcuVoice acquisition, AcuVoice and its founder
made certain representations and warranties to the Company. One of those
representations focused on the scope of a license agreement previously entered
into by AcuVoice and General Magic for use by General Magic of AcuVoice's
text-to-speech software in General Magic's Serengeti product. After the AcuVoice
acquisition closed, the Company determined that AcuVoice and its founder had
breached the representation concerning the General Magic license agreement.
Under the terms of the AcuVoice acquisition agreement, on March 12, 1999, the
Company submitted a claim for the 80,000 shares deposited into the escrow
account by the former stockholders of AcuVoice. The founder, as agent for the
former stockholders of AcuVoice, denied the claim. The Company is presently
preparing a response to the founder's denial of the claim. If the founder
continues to deny the claim after review of the Company's response, the Company
will seek to arbitrate its claim pursuant to the terms of the AcuVoice
acquisition agreement. The Company is presently considering other possible
remedies against the founder and the other former directors of AcuVoice.
Forgiveness of Trade Payables and Accrued Interest - During 1999, the Company
negotiated reductions of $526,697 in amounts due various trade vendors.
Additionally, the Company negotiated reductions of $229,055 in accrued interest
owed to certain note holders. These amounts have been accounted for as
extraordinary items in the
F-37
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
accompanying consolidated statements of operations.
17. LITIGATION
Oregon Graduate Institute - 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 the
Company was in default under three separate agreements between the Company and
OGI in the total amount of $175,000. On 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
before the American Arbitration Association against OGI in an amount not less
than $250,000. Neither OGI nor the Company have undertaken any discovery.
However, a hearing date has been set for August 8, 2000. The Company believes
the OGI arbitration claim is without merit, and management intends to vigorously
press its counterclaim against OGI.
Papyrus - After the Papyrus acquisition closed, the Company investigated some of
the representations and warranties made by Papyrus to induce the Company to
acquire Papyrus. The Company determined that certain of the representations made
by Papyrus and their executive officers were inaccurate. At about the same time,
the Company began negotiations with the former executive officers of Papyrus,
which negotiations, among other things, included discussions regarding
rescission of the Papyrus acquisition. On February 26, 1999, the Company filed
an action against Papyrus in the United States District Court for the District
of Utah, Central Division (the "Utah Action"). In the Utah Action, the Company
alleged claims for misrepresentation, negligent misrepresentation, breach of
contract, breach of the implied covenant of good faith and fair dealing and
rescission. On March 11, 1999, three of the former shareholders of Papyrus filed
an action against the Company in the United States District Court for the
District of Massachusetts (the "Massachusetts Action"), alleging a default under
the terms of the promissory notes issued to them in connection with the Papyrus
Acquisition. On April 2, 1999, the three former Papyrus shareholders filed an
amended complaint against the Company seeking additional remedies including
violation of Massachusetts unfair and deceptive acts and practices statutes and
copyright infringement. On April 8, 1999, a fourth former Papyrus shareholder
filed an action against the Company alleging a default under the terms of the
promissory notes issued to him in connection with the Papyrus acquisition and
seeking additional remedies including violation of Massachusetts unfair and
deceptive acts and practices statutes and copyright infringement. Subsequently,
the Company has entered into agreements with the four former Papyrus
shareholders for dismissal of the actions and cancellation of the promissory
notes upon payment to the former shareholders of $1,122,209 (the "Settlement
Payment") an amount equal to approximately 73 percent of the balance due them
under the notes issued to them in the Papyrus acquisition, and return for
cancellation by the Company of 970,586 shares of restricted Class A common stock
issued to them in the Papyrus acquisition. Payment was made in September 1999,
the shares were returned and canceled and the lawsuits have been dismissed. The
cancellation of returned shares is reflected in the accompanying consolidated
financial statements as a reduction of goodwill.
Other - In addition to the proceeding commenced by OGI, the Company is involved
in various lawsuits, claims and proceedings arising in the ordinary course of
business. Management believes the ultimate disposition of such matters will not
materially affect the consolidated financial position or results of operations
of the Company.
18. EMPLOYEE PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan covering essentially all of its
full-time employees. Under the plan, employees may reduce their salaries, in
amounts allowed by law, and contribute the salary reduction amount to the plan
on a pretax basis. The plan also allows the Company to make matching and profit
sharing contributions as determined by the board of directors. To date, no
matching or profit sharing contributions have been made by the
F-38
<PAGE>
Fonix Corporation
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company.
19. SIGNIFICANT CUSTOMERS
All of the Company's revenues for 1999 and 1998 were sourced from the United
States. Of the $439,507 in revenues for 1999, $209,401 was from one customer,
General Magic. Of the $2,604,724 in revenues for 1998, $2,368,138 was from one
customer, Siemens. The remaining revenues in 1998 were primarily from the sale
of TTS and HWR applications and licenses, with no single customer representing
more than 10 percent of the Company's total revenues.
20. SUBSEQUENT EVENTS
Series F Convertible Preferred Stock - Subsequent to December 31, 1999, the
Company received an additional $1,750,000 in cash in connection with the sale of
290,000 shares of Series F preferred stock, bringing the total cash received to
$2,750,000 (see Note 9).
Series G Convertible Preferred Stock -The Company has recently entered into an
agreement with investors whereby it intends to sell to the investors up to
250,000 shares of its Series G convertible preferred stock, in return for
payment of up to $5,000,000. It is anticipated that the Series G preferred stock
will be convertible into shares of Class A common stock at a price of $1.50 per
share during the first 90 days following the closing of the transaction, and
thereafter at a price equal to 85% of the average of the three lowest closing
bid prices in the 20-day trading period prior to the conversion of the Series G
preferred stock. The Company anticipates that the investors will receive
registration rights which will require the Company to file a registration
statement covering the shares underlying the Series G preferred stock, and that
the Company will have the option of redeeming any outstanding Series G preferred
stock. Although the Company has received approximately $1,250,000 through April
10, 2000 as advances in connection with this financing, the securities purchase
agreement has not been signed. Accordingly, the terms may ultimately differ from
those described.
Issuance and Exercise of Stock Options - Subsequent to December 31, 1999, the
Company granted a total of 2,529,400 stock options to various employees of the
Company. These options have 10-year lives and exercise prices of $0.28 per
share, except 1,500 options at $0.88 per share and 250,000 options at $0.55 per
share. Of these options, 2,339,000 vest on March 31, 2000 and the balance vest
over the three years subsequent to issuance. Subsequent to December 31, 1999
through April 10, 2000, 502,228 shares of Class A common stock have been issued
pursuant to the exercise of stock options and stock appreciation rights.
In February 2000, the Company entered into an agreement to purchase froman
executive officer and director of the Company all of his rights and interests in
certain methods and apparatus for integrated voice and pen input for use in
computer systems. In payment for this technology, the Company granted the
executive officer 600,000 warrants to purchase the Company's Class A common
stock at an exercise price of $1.00 per share. The warrants expire February 10,
2010. Also, the Company granted the executive officer the right to repurchase
the technology from the Company at fair market value if the Company subsequently
determines not to commercialize the pen/voice technologies or products.
Issuance of Warrants - On January 19, 2000, the Company issued warrants for the
purchase of 300,000 shares of Class A common stock for services rendered by a
professional services firm. The warrants have a three year life, an exercise
prices ranging from $0.28 to $1.50 per share and vest as follows: 100,000
warrants on March 21, 2000, 100,000 warrants on September 30, 2000, and 100,000
warrants on December 31, 2000.
F-39
SERIES F CONVERTIBLE PREFERRED STOCK
PURCHASE AGREEMENT
Among
Fonix Corporation,
SOVEREIGN PARTNERS, LP,
DOMINION CAPITAL FUND, LTD,
DOMINION INVESTMENT FUND, LLC,
CANADIAN ADVANTAGE, L.P.,
and
QUEEN LLC
FEBRUARY 1, 2000
------------------------------
<PAGE>
SERIES F CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT, dated
as of February 1, 2000 (this "Agreement"), between Fonix Corporation, a Delaware
corporation (the "Company"), Dominion Capital Fund, Ltd., a [__________]
corporation ("Dominion"), Sovereign Partners, LP, a [____________] corporation
("Sovereign"), Canadian Advantage, LP, a [_____________] corporation ("Canadian
Advantage"), Dominion Investment Fund, LLC, a [____________] limited liability
company ("Dominion Investment"), and Queen LLC, a [____________] limited
liability company ("Queen") (Dominion, Sovereign, Canadian Advantage, Dominion
Investment, and Queen are each referred to as a "Purchaser" and collectively as
the "Purchasers").
Recitals
A. The Purchasers each desire to purchase, and the Company desires to
issue and sell to each of them shares of Series F 6% Convertible Preferred
Stock, $.0001 par value per share ("Series F Preferred") (or a total of 290,000
shares) for an aggregate purchase price of $2,750,000, in the share amounts set
forth on Appendix A hereto according to the terms and conditions set forth
below.
Agreement
IN CONSIDERATION of the mutual covenants and agreements set
forth herein and for other good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties agree as follows:
ARTICLE I.
CERTAIN DEFINITIONS
Section 1. Certain Definitions. As used in this Agreement,
unless the context requires a different meaning, the following terms have the
meanings indicated in this Section 1.1:
"Affiliate" means, with respect to any Person, any Person that, directly or
indirectly, controls, is controlled by, or is under common control with, such
Person. For purposes of this definition, "control" (including, with correlative
meanings, the terms "controlled by" and "under common control with") shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of such Person, whether through the
ownership of voting securities or by contract or otherwise.
"Agreement" shall have the meaning set forth in the recitals hereto.
"Business Day" means any day except Saturday, Sunday and any day which
shall be a Federal legal holiday or a day on which banking institutions in the
State of Delaware are authorized or required by law or other government actions
to close.
"Certificate of Designation" shall have the meaning set forth in Section
2.1(a).
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<PAGE>
"Closing" shall have the meaning set forth in Section 2.1(b).
"Closing Date" shall have the meaning set forth in Section 2.1(b).
"Commission" means the Securities and Exchange Commission.
"Common Stock" means the Company's Class A common stock, par value $.0001
per share.
"Company" shall have the meaning set forth in the recitals hereto.
"Conversion Price" shall have the meaning set forth in the Certificate of
Designation.
"Conversion Ratio" shall have the meaning set forth in the Certificate of
Designation.
"Disclosure Materials" means, collectively, the SEC Documents and the
Schedules to this Agreement and all other information furnished by or on behalf
of the Company relating to or concerning the Company and provided to the
Purchasers or their agents and counsel in connection with the transactions
contemplated by this Agreement.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Initial Reserve" shall have the meaning set forth in Section 3.1(d).
"Intellectual Property Rights" shall have the meaning set forth in Section
3.1(q).
"Legal Opinion" means the legal opinion letter of Durham Jones & Pinegar,
P.C., outside counsel to the Company, addressed to the Purchasers, dated the
Closing Date and in form and substance acceptable to the Purchasers.
"Lien" means, with respect to any asset, any mortgage, lien, pledge, right
of first refusal, charge, security interest or encumbrance of any kind in or on
such asset or the revenues or income thereon or therefrom.
"Material Adverse Effect" shall have the meaning set forth in Section
3.1(b).
"Original Issue Date" shall mean the first issuance of any Shares,
regardless of the number of transfers of any particular Share and regardless of
the number of certificates which may be issued to evidence any particular Share.
"Per Share Market Value" shall have the meaning set forth in the
Certificate of Designation.
-2-
<PAGE>
"Person" means an individual or a corporation, partnership, trust,
incorporated or unincorporated association, joint venture, limited liability
company, joint stock company, government (or an agency or political subdivision
thereof) or other entity of any kind.
"Preferred Stock" shall have the meaning set forth in the recitals hereto.
"Purchaser(s)" shall have the meaning set forth in the recitals hereto.
"Required Approvals" shall have the meaning set forth in Section 3.1(f).
"Registrable Securities" means the shares of Common Stock issuable (a) upon
conversion in full of the Preferred Shares, and (b) as payment in full of
dividends on the Preferred Shares; provided, however that in order to account
for the fact that the number of shares of Common Stock that are issuable upon
conversion of Preferred Shares is determined in part upon the market price of
the Common Stock at the time of conversion or exercise, Registrable Securities
contemplated by clause of this definition shall be deemed to include not less
than, and the initial Registration Statement to be filed hereunder shall cover
no less than, 200% of the number of shares of Common Stock issuable upon
conversion in full of the Preferred Shares assuming such conversion were to have
occurred on the Original Issue Date. The Company shall be required to file
additional Registration Statements to the extent the actual number of shares of
Common Stock into which the Preferred Shares are convertible (together with
dividends thereon) exceeds the number of shares of Common Stock initially
registered in accordance with the immediately prior sentence (the Company shall
have 20 days to file such additional Registration Statement after notice of the
requirement thereof, which the Holders may give at such time when the number of
shares of Common Stock as are issuable as payment of dividends in respect of the
Preferred Stock and upon conversion of the Preferred Stock exceeds 75% of the
number of shares of Common Stock then covered by an effective Registration
Statement.
"SEC Documents" shall have the meaning set forth in Section 3.1(c).
"Securities" means, collectively, the Shares and the Underlying Shares
"Securities Act" means the Securities Act of 1933, as amended.
"Shares" means the shares of Preferred Stock to be purchased or issued
pursuant to this Agreement.
"Stated Value" means $20.00.
"Subsequent Financing" shall have the meaning set forth in Section 4.9.
"Subsequent Financing Notice" shall have the meaning set forth in Section
4.9.
"Subsidiaries" shall have the meaning set forth in Section 3.1(a).
-3-
<PAGE>
"Trading Day" shall have the meaning set forth in the Certificate of
Designation.
"Transaction Documents" means collectively, this Agreement, and the
Certificate of Designation.
"Underlying Shares" means the shares of Common Stock issuable upon
conversion of the Shares and as payment of dividends thereon in accordance with
the terms of the Certificate of Designation.
"Underlying Securities Registration Statement" means a registration
statement under the Securities Act prepared by the Company and filed with the
Commission, covering the resale of the Underlying Shares and naming the holder
or holders of such Underlying Shares as "selling stockholders" thereunder.
ARTICLE II.
PURCHASE OF SHARES
Section 2.1 Purchase and Exchange of Shares; Closing.
(a) Subject to the terms and conditions set forth below, the
Company shall sell to the Purchasers, and the Purchasers shall purchase an
aggregate of two hundred ninety thousand (290,000) Shares) for the aggregate
purchase price of two million seven hundred fifty thousand ($2,750,000) (the
"Purchase Price") in the amounts set forth in Appendix A hereto. The Shares
issued pursuant to this Agreement shall have the respective rights, preferences
and privileges set forth in Exhibit A (the "Certificate of Designation").
(b) The closing of the purchase and sale of the Shares (the
"Closing") shall take place at the offices of Durham Jones & Pinegar, P.C., 50
South Main Street, Suite 800, Salt Lake City, Utah 84144. The date of the
Closing is hereinafter referred to as the "Closing Date."
(c) At the Closing the parties shall deliver the following:
(i) the Company shall deliver or cause to be delivered (A) stock certificates
representing two hundred ninety thousand (290,000) Shares, registered according
to instructions to be provided by the Purchasers at or before the Closing, and
(B) a Legal Opinion addressed to the Purchasers; (ii) the Purchasers shall
deliver or cause to be delivered (x) two million seven hundred fifty thousand
dollars ($2,750,000) in United States dollars in presently available funds
according to wire instructions to be provided by the Company at or before
Closing, minus any funds advanced prior to the Closing; and (iii) each party
hereto shall deliver or cause to be delivered all other executed instruments,
agreements and certificates as are required to be delivered by or on their
behalf at the Closing.
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<PAGE>
ARTICLE III.
REPRESENTATIONS AND WARRANTIES
Section 3.1 Representations and Warranties of the Company. The
Company hereby represents and warrants to the Purchasers as follows:
(a) Organization and Qualification. The Company is a
corporation, duly incorporated, validly existing and in good standing under the
laws of the jurisdiction of its incorporation, with the requisite corporate
power and authority to own and use its properties and assets and to carry on its
business as currently conducted. The Company has no subsidiaries other than as
set forth in Schedule 3.1(a) (collectively, the "Subsidiaries"). Each of the
Subsidiaries is a corporation, duly incorporated, validly existing and in good
standing under the laws of the jurisdiction of its incorporation, with the
requisite corporate power and authority to own and use its properties and assets
and to carry on its business as currently conducted. Each of the Company and the
Subsidiaries is duly qualified to do business and is in good standing as a
foreign corporation in each jurisdiction in which the nature of the business
conducted or property owned by it makes such qualification necessary, except
where the failure to be so qualified or in good standing, as the case may be,
could not, individually or in the aggregate, (x) adversely affect the legality,
validity or enforceability of the Shares or any Transaction Document, (y) have a
material adverse effect on the results of operations, assets, prospects, or
condition (financial or otherwise) of the Company and the Subsidiaries, taken as
a whole or (z) adversely impair the Company's ability to perform fully on a
timely basis its obligations under any Transaction Document (a "Material Adverse
Effect").
(b) Authorization; Enforcement. The Company has the requisite
corporate power and authority to enter into and to consummate the transactions
contemplated by the Transaction Documents and to otherwise carry out its
obligations thereunder. The execution and delivery of each Transaction Document
by the Company and the consummation by it of the transactions contemplated
thereby have been duly authorized by all necessary action on the part of the
Company. Each Transaction Document has been duly executed by the Company and,
when delivered in accordance with the terms hereof, each Transaction Document
shall constitute the legal, valid and binding obligation of the Company
enforceable against the Company in accordance with its terms, except as such
enforceability may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium, liquidation or similar laws relating to, or
affecting generally the enforcement of, creditors' rights and remedies or by
other equitable principles of general application. Neither the Company nor any
Subsidiary is in violation of any provision of its respective certificate or
articles of incorporation, bylaws or other charter documents.
(c) Capitalization. The authorized, issued and outstanding
capital stock of the Company is set forth in Schedule 3.1(c). No shares of
Common Stock are entitled to preemptive or similar rights. Except as
specifically disclosed in Schedule 3.1(c), there are no outstanding options,
warrants, rights to subscribe to, calls or commitments of any character
whatsoever relating to, or, except as a result of the purchase and sale of the
Shares, securities, rights or obligations convertible into or exchangeable for,
or giving any Person any right to subscribe for
-5-
<PAGE>
or acquire, any shares of Common Stock, or contracts, commitments,
understandings, or arrangements by which the Company or any Subsidiary is or may
become bound to issue additional shares of Common Stock or securities or rights
convertible or exchangeable into shares of Common Stock. To the knowledge of the
Company, except as specifically disclosed in the SEC Documents or Schedule
3.1(c), no Person or group of Persons beneficially owns (as determined pursuant
to Rule 13d-3 promulgated under the Exchange Act) or has the right to acquire by
agreement with or by obligation binding upon the Company beneficial ownership of
in excess of 5% of the Common Stock.
(d) Issuance of Securities. The Shares are duly authorized
and, when issued in accordance with the terms hereof, shall be validly issued,
fully paid and nonassessable, free and clear of all Liens. Subject to Section
4.7, the Company has and at all times while any Shares are outstanding shall use
its best efforts to maintain an adequate reserve of duly authorized shares of
Common Stock to enable it to perform its conversion, exercise and other
obligations under this Agreement and the Certificate of Designation which
reserve, subject to Section 4.7, shall be no less than the sum of (i) 200% of
(A) the number of shares of Common Stock as would be issuable upon conversion in
full of the Shares, were such conversion effected on the Original Issue Date,
and (B) the number of shares of Common Stock as are issuable as payment of
dividends on the Shares (assuming such dividends are to be paid in Common Stock)
(such sum, the "Initial Reserve"). If at any time the sum of the number of
shares of Common Stock issuable (a) upon conversion in full of the then
outstanding Shares and (b) as the payment of dividends on the Shares (assuming
all such dividends are to be paid in Common Stock) exceeds 85% of the Initial
Reserve, then the Company shall use its best efforts to duly reserve 200% of the
number of shares of Common Stock equal to such excess to fulfill such
obligations. This obligation shall similarly apply to successive excesses. When
issued in accordance with the Certificate of Designation, the Underlying Shares
will be duly authorized, validly issued, fully paid and nonassessable, and free
and clear of all Liens.
(e) No Conflicts. The execution, delivery and performance of
the Transaction Documents by the Company and the consummation by the Company of
the transactions contemplated thereby do not and will not (i) conflict with or
violate any provision of its certificate of incorporation, bylaws or other
charter documents (each as amended through the date hereof), (ii) subject to
obtaining the consents referred to in Section 3.1(f), conflict with, or
constitute a default (or an event which with notice or lapse of time or both
would become a default) under, or give to others any rights of termination,
amendment, acceleration or cancellation of, any agreement, indenture or
instrument (evidencing a Company debt or otherwise) to which the Company is a
party or by which any property or asset of the Company is bound or affected, or
(iii) result in a violation of any law, rule, regulation, order, judgment,
injunction, decree or other restriction of any court or governmental authority
to which the Company is subject (including federal and state securities laws and
regulations), or by which any property or asset of the Company is bound or
affected; except in the case of each of clauses (ii) and (iii), as could not,
individually or in the aggregate, have or result in a Material Adverse Effect.
The business of the Company is not being conducted in violation of any law,
ordinance or regulation of any governmental authority, except for violations
which, individually and in the aggregate, could not have or result in a Material
Adverse Effect.
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<PAGE>
(f) Consents and Approvals. Neither the Company nor any
Subsidiary is required to obtain any consent, waiver, authorization or order of,
or make any filing or registration with, any court or other federal, state,
local, foreign or other governmental authority or other Person in connection
with the execution, delivery and performance by the Company of the Transaction
Documents, other than (i) the filing of the Certificate of Designation with the
Secretary of State of Delaware, (ii) the filing of one or more Underlying
Securities Registration Statements with the Commission and the making of
applicable blue-sky filings under state securities laws with respect to the
Securities and the transactions contemplated hereby, (iii) the application for
the listing of the Underlying Shares on the Nasdaq SmallCap Market (and on each
other national securities exchange, market or trading facility on which the
Common Stock is then listed), and (iv) other than, in all other cases, where the
failure to obtain such consent, waiver, authorization or order, or to give or
make such notice or filing, could not, individually or in the aggregate, have or
result in a Material Adverse Effect (the "Required Approvals").
(g) Litigation; Proceedings. Except as specifically disclosed
in the Disclosure Materials, there is no action, suit, notice of violation,
proceeding or investigation pending or, to the best knowledge of the Company,
threatened against or affecting the Company or any of its Subsidiaries or any of
their respective properties before or by any court, governmental or
administrative agency or regulatory authority (federal, state, county, local or
foreign) which (i) adversely affects or challenges the legality, validity or
enforceability of any Transaction Document or the Securities or (ii) could,
individually or in the aggregate, have or result in a Material Adverse Effect.
(h) No Default or Violation. Neither the Company nor any
Subsidiary (i) is in default under or in violation of (or has received notice of
a claim that it is in default under or that it is in violation of) any
indenture, loan or credit agreement or any other agreement or instrument to
which it is a party or by which it or any of its properties is bound, (ii) is in
violation of any order of any court, arbitrator or governmental body, or (iii)
is in violation of any statute, rule or regulation of any governmental
authority, except as could not, individually or in the aggregate, have or result
in a Material Adverse Effect or, except in the case of clause (i) above, as has
not been waived pursuant to an effective waiver.
(i) Private Offering. Assuming the accuracy of the
representations and warranties of the Purchasers contained in Sections
3.2(b)-3.2(f), the offering, issuance or sale of the Securities as contemplated
hereunder are exempt from the registration requirements of the Securities Act.
(j) Certain Fees. Except for finders fees, which fees will be
paid by the Company, no fees or commissions will be payable by the Company to
any broker, financial advisor, finder, investment banker, placement agent, or
bank with respect to the transactions contemplated hereby. The Purchasers shall
have no obligation with respect to such fees or with respect to any claims made
by or on behalf of other Persons for fees of a type contemplated in this Section
that may be due in connection with the transactions contemplated hereby. The
Company shall indemnify and hold harmless Purchasers, their respective
employees, officers, directors, agents, and partners, and their respective
Affiliates, from and against all claims, losses,
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damages, costs (including the costs of preparation and attorney's fees) and
expenses suffered in respect of any such claimed or existing fees, as and when
incurred.
(k) SEC Documents; Financial Statements; No Adverse Change.
The Company has filed all reports required to be filed by it under the Exchange
Act, including pursuant to Section 13(a) or 15(d) thereof, for the three years
preceding the date hereof (or such shorter period as the Company was required by
law to file such material) (the foregoing materials being collectively referred
to herein as the "SEC Documents") on a timely basis or has received a valid
extension of such time of filing and has filed any such SEC Documents prior to
the expiration of any such extension. As of their respective dates, the SEC
Documents complied in all material respects with the requirements of the
Securities Act and the Exchange Act and the rules and regulations of the
Commission promulgated thereunder, and none of the SEC Documents, when filed,
contained any untrue statement of a material fact or omitted to state a material
fact required to be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading. The financial statements of the Company included in the SEC
Documents comply in all material respects with applicable accounting
requirements and the rules and regulations of the Commission with respect
thereto. Such financial statements have been prepared in accordance with
generally accepted accounting principles applied on a consistent basis during
the periods involved, except as may be otherwise specified in such financial
statements or the notes thereto, and fairly present in all material respects the
financial position of the Company as of and for the dates thereof and the
results of operations, retained earnings and cash flows for the periods then
ended, subject, in the case of unaudited statements, to normal year-end audit
adjustments. Since the date of the financial statements included in the
Company's Quarterly Report on Form 10-Q for the period ended September 30, 1999,
as amended to the date hereof, (a) there has been no event, occurrence or
development that has had or that could have or result in a Material Adverse
Effect, (b) there has been no material change in the Company's accounting
principles, practices or methods and (c) the Company has conducted its business
only in the ordinary course of such business. The Company last filed audited
financial statements with the Commission on April 15, 1999, and has not received
any comments from the Commission in respect thereof.
(l) Seniority. Except for the Company's Series A Preferred
Stock and the Series D Preferred Stock, no class of equity securities of the
Company is senior to the Shares in right of payment, whether with respect to
dividends or upon liquidation, dissolution or otherwise.
(m) Form S-2 Eligibility. The Company is, and at the Closing
Date will be, eligible to register securities for resale with the Commission
under Form S-2 promulgated under the Securities Act.
(n) Investment Company. The Company is not, and is not an
"Affiliate person" of, an "investment company" within the meaning of the
Investment Company Act of 1940, as amended.
(o) Listing and Maintenance Requirements Compliance. Other
than as previously disclosed in writing to the Purchasers, the Company has not
in the two years prior to the date hereof received written notice from any stock
exchange, market or trading facility on
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which the Common Stock is or has been listed (or on which it is or has been
quoted) to the effect that the Company is not in compliance with the listing or
maintenance requirements of such exchange, market or trading facility. The
Company has provided to the Purchasers true and complete copies of all such
notices contemplated by this Section.
(p) Patents and Trademarks. The Company has, or has rights to
use, all patents, patent applications, trademarks, trademark applications,
service marks, trade names, copyrights, licenses, trade secrets and other
intellectual property rights which are necessary for use in connection with its
business or which the failure to so have would have a Material Adverse Effect
(collectively, the "Intellectual Property Rights"). To the best knowledge of the
Company, none of the Intellectual Property Rights infringe on any rights of any
other Person, and the Company either owns or has duly licensed or otherwise
acquired all necessary rights with respect to the Intellectual Property Rights.
The Company has not received any notice from any third party of any claim of
infringement by the Company of any of the Intellectual Property Rights, and has
no reason to believe there is any basis for any such claim. To the best
knowledge of the Company, there is no existing infringement by another Person on
any of the Intellectual Property Rights.
(q) Disclosure. All information relating to or concerning the
Company set forth in the Transaction Documents or the Disclosure Materials
(other than the SEC Documents) is true and correct in all material respects and
does not fail to state any material fact necessary in order to make the
statements herein or therein, in light of the circumstances under which they
were made, not misleading. The Company confirms that it has not provided to the
Purchasers or any of their representatives, agents or counsel any information
that constitutes or might constitute material nonpublic information. The Company
understands and confirms that the Purchasers shall be relying on the foregoing
representation in effecting transactions in securities of the Company.
Section 3.2 Representations and Warranties of the Purchasers. The
Purchasers hereby jointly and not severally represent and warrant to the Company
as follows:
(a) Organization; Authority. Such Purchaser is an entity
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization with the requisite power and authority to enter
into and to consummate the transactions contemplated by the Transaction
Documents and to carry out its obligations thereunder. The acquisition of the
Securities to be acquired hereunder and the payment of the purchase price
therefor by such Purchaser have been duly authorized by all necessary action on
the part of such Purchaser. This Agreement has been duly executed by such
Purchaser and, when delivered by such Purchaser in accordance with the terms
hereof, shall constitute the valid and legally binding obligation of such
Purchaser, enforceable against it in accordance with its terms, subject to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors' rights
generally and to general principles of equity.
(b) Investment Intent. Such Purchaser is acquiring the
Securities to be acquired hereunder for its own account for investment purposes
only and not with a view to or for distributing or reselling such Securities or
any part thereof or interest therein, without
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prejudice, however, to such Purchaser's right, subject to the provisions of this
Agreement, at all times to sell or otherwise dispose of all or any part of such
Securities pursuant to an effective registration statement under the Securities
Act and in compliance with applicable state securities laws or under an
exemption from such registration.
(c) Purchaser Status. At the time such Purchaser was offered
the Securities to be acquired hereunder by such Purchaser, it was, at the date
hereof, it is, and at the Closing Date, it will be, an "accredited investor" as
defined in Rule 501(a) under the Securities Act.
(d) Experience of Purchaser. Such Purchaser, either alone or
together with its representatives, has such knowledge, sophistication and
experience in business and financial matters so as to be capable of evaluating
the merits and risks of the prospective investment in the Securities, and has so
evaluated the merits and risks of such investment.
(e) Ability of Purchaser to Bear Risk of Investment. Such
Purchaser acknowledges that an investment in the Securities is speculative and
involves a high degree of risk. Such Purchaser is able to bear the economic risk
of an investment in the Securities to be acquired hereunder by such Purchaser,
and, at the present time, is able to afford a complete loss of such investment.
(f) Access to Public Information. Such Purchaser acknowledges
receipt of the Disclosure Materials and further acknowledges that it has been
afforded (i) the opportunity to ask such questions as it has deemed necessary
of, and to receive answers from, representatives of the Company concerning the
terms and conditions of the offering of the Securities, and the merits and risks
of investing in the Securities, (ii) access to public information about the
Company and the Company's financial condition, results of operations, business,
properties, management and prospects sufficient to enable it to evaluate its
investment and (iii) the opportunity to obtain such additional public
information which the Company possesses or can acquire without unreasonable
effort or expense that is necessary to make an informed investment decision with
respect to the investment and to verify the accuracy and completeness of the
information contained in the Disclosure Materials. Neither such inquiries nor
any other investigation conducted by or on behalf of such Purchaser or its
representatives, agents or counsel shall modify, amend or affect such
Purchaser's right to rely on the truth, accuracy and completeness of the
Disclosure Materials and the Company's representations and warranties contained
in the Transaction Documents.
(g) Reliance. Such Purchaser understands and acknowledges that
(i) the Securities to be acquired by it hereunder are being offered and sold to
it without registration under the Securities Act in a private placement that is
exempt from the registration provisions of the Securities Act and (ii) the
availability of such exemption, depends in part on, and the Company will rely
upon the accuracy and truthfulness of, the foregoing representations and such
Purchaser hereby consents to such reliance.
The Company acknowledges and agrees that Purchasers makes no
representations or warranties with respect to transactions contemplated hereby
other than those specifically set forth in this Section 3.2.
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ARTICLE IV.
OTHER AGREEMENTS OF THE PARTIES
Section 4.1 Transfer Restrictions. (a) The Securities may only be
disposed of pursuant to an effective registration statement under the Securities
Act, to the Company or pursuant to an available exemption from or in a
transaction not subject to the registration requirements thereof. In connection
with any transfer of any Securities other than pursuant to an effective
registration statement or to the Company, the Company may require the transferor
thereof to provide to the Company an opinion of counsel selected by the
transferor, the form and substance of which opinion shall be reasonably
satisfactory to the Company, to the effect that such transfer does not require
registration under the Securities Act. Notwithstanding the foregoing, the
Company hereby consents to and agrees to register (i) any transfer of Securities
by the Purchasers to an Affiliate of the Purchasers, or any transfers among any
such Affiliates, and (ii) any transfer by the Purchasers to any investment
entity under common management with the Purchasers, provided in each case of
clauses (i) and (ii) the transferee certifies to the Company that it is an
"accredited investor" as defined in Rule 501(a) under the Securities Act. Any
such transferee shall have the rights of the Purchasers under this Agreement.
(b) The Purchasers agree to the imprinting, so long as is
required by this Section 4.1(b), of the following legend (or such substantially
similar legend as is acceptable to the Purchasers and their counsel, the parties
agreeing that any unacceptable legended Securities shall be replaced promptly by
and at the Company's cost) on the Securities:
NEITHER THESE SECURITIES NOR THE SECURITIES INTO WHICH THESE SECURITIES
ARE CONVERTIBLE HAVE BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE
COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON
AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS
AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR
SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A
TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE
SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS.
[ONLY FOR UNDERLYING SHARES TO THE EXTENT THE RESALE THEREOF IS NOT
COVERED BY AN EFFECTIVE REGISTRATION STATEMENT AT THE TIME OF
CONVERSION, ISSUANCE OR EXERCISE] THE SHARES REPRESENTED BY THIS
CERTIFICATE HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE
COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON
AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS
AMENDED (THE "SECURITIES ACT"), AND, ACCORDINGLY, MAY NOT BE OFFERED OR
SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A
TRANSACTION NOT SUBJECT TO, THE REGISTRATION
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REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH
APPLICABLE STATE SECURITIES LAWS.
Underlying Shares shall not contain the legend set forth above or any
other restrictive legend if the conversion of Shares or other issuances of
Underlying Shares, as the case may be, occurs at any time while an Underlying
Securities Registration Statement is effective under the Securities Act or, in
the event there is not an effective Underlying Securities Registration Statement
at such time, if in the opinion of counsel to the Company such legend is not
required under applicable requirements of the Securities Act (including judicial
interpretations and pronouncements issued by the staff of the Commission). The
Company agrees that it will provide the Purchasers, upon request, with a
certificate or certificates representing Underlying Shares, free from such
legend at such time as such legend is no longer required hereunder. The Company
may not make any notation on its records or give instructions to any transfer
agent of the Company which enlarge the restrictions of transfer set forth in
this Section 4.1(b).
Section 4.2 Acknowledgment of Dilution. The Company acknowledges that
the issuance of Underlying Shares upon conversion of the Shares and as payment
of dividends thereon may result in dilution of the outstanding shares of Common
Stock, which dilution may be substantial under certain market conditions. The
Company further acknowledges that its obligation to issue Underlying Shares in
accordance with the Certificate of Designation is unconditional and absolute
regardless of the effect of any such dilution.
Section 4.3 Furnishing of Information. As long as the Purchasers own
Securities, the Company covenants to timely file (or obtain extensions in
respect thereof and file within the applicable grace period) all reports
required to be filed by the Company after the date hereof pursuant to Section
13(a) or 15(d) of the Exchange Act. If at any time prior to the date on which
the Purchasers may resell all of their Underlying Shares without volume
restrictions pursuant to Rule 144(k) promulgated under the Securities Act (as
determined by counsel to the Company pursuant to a written opinion letter to
such effect, addressed and acceptable to the Company's transfer agent for the
benefit of and enforceable by the Purchasers) the Company is not required to
file reports pursuant to such sections, it will prepare and furnish to the
Purchasers and make publicly available in accordance with Rule 144(c)
promulgated under the Securities Act annual and quarterly financial statements,
together with a discussion and analysis of such financial statements in form and
substance substantially similar to those that would otherwise be required to be
included in reports required by Section 13(a) or 15(d) of the Exchange Act in
the time period that such filings would have been required to have been made
under the Exchange Act. The Company further covenants that it will take such
further action as any holder of Securities may reasonably request, all to the
extent required from time to time to enable such Person to sell Securities
without registration under the Securities Act within the limitation of the
exemptions provided by Rule 144 promulgated under the Securities Act, including
the legal opinion referenced above in this Section. Upon the request of any such
Person, the Company shall deliver to such Person a written certification of a
duly authorized officer as to whether it has complied with such requirements.
Section 4.4 Use of Disclosure Materials. The Company consents to
the use of the Disclosure Materials and any information provided by or on behalf
of the Company pursuant to
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Section 4.3, and any amendments and supplements thereto, by the Purchasers in
connection with resales of the Securities other than pursuant to an effective
registration statement.
Section 4.5 Blue Sky Laws. The Company shall qualify the Underlying
Shares under the securities or Blue Sky laws of such jurisdictions as the
Purchasers may reasonably request and shall continue such qualification at all
times until the Purchasers notify the Company in writing that they no longer own
Securities; provided, however, that neither the Company nor its Subsidiaries
shall be required in connection therewith to qualify as a foreign corporation
where they are not now so qualified or to take any action that would subject the
Company to general service of process in any such jurisdiction where it is not
then so subject.
Section 4.6 Integration. The Company shall not and shall use its best
efforts to ensure that no Affiliate shall sell, offer for sale or solicit offers
to buy or otherwise negotiate in respect of any security (as defined in Section
2 of the Securities Act) that would be integrated with the offer or sale of the
Securities in a manner that would require the registration under the Securities
Act of the issue, offer or sale of the Securities to the Purchasers.
Section 4.7 Increase in Authorized Shares. At such time as the Company
would be, if a notice of conversion were to be delivered on such date, precluded
from (a) converting in full all of the Shares or all of the then issued and
outstanding shares of the Company's Series F Preferred Stock that remain
unconverted at such date (and paying any accrued but unpaid dividends in respect
thereof in shares of Common Stock) due to the unavailability of a sufficient
number of shares of authorized but unissued or re-acquired Common Stock, the
Board of Directors of the Company shall promptly (and in any case within 30
Business Days from such date) prepare and mail to the shareholders of the
Company proxy materials requesting authorization to amend the Company's
certificate of incorporation to increase the number of shares of Common Stock
which the Company is authorized to issue to at least a number of shares equal to
the sum of (i) all shares of Common Stock then outstanding, (ii) the number of
shares of Common Stock issuable on account of all outstanding warrants, options
and convertible securities (other than the Preferred Stock) and on account of
all shares reserved under any stock option, stock purchase, warrant or similar
plan, and (iii) 200% of the number of Underlying Shares as would then be
issuable upon a conversion in full of the then outstanding Shares and shares of
Series F Preferred Stock and as payment of all future dividends thereon in
shares of Common Stock in accordance with the terms of this Agreement and the
Certificate of Designation. In connection therewith, the Board of Directors
shall (x) adopt proper resolutions authorizing such increase, (y) recommend to
and otherwise use its best efforts to promptly and duly obtain shareholder
approval to carry out such resolutions (and hold a special meeting of the
shareholders no later than the 60th day after delivery of the proxy materials
relating to such meeting) and (z) within 5 Business Days of obtaining such
shareholder authorization, file an appropriate amendment to the Company's
certificate of incorporation to evidence such increase. If the shareholders fail
to approve such increase, the Company does not receive shareholder approval for
such increase or the Company fails to file an appropriate amendment in the time
provided therefor by the immediately preceding sentence, then the provisions of
Section 5(a)(iii)(B) of the Certificate of Designation shall apply.
Section 4.8 Right of First Refusal.
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(a) The Company shall not, directly or indirectly, without the
prior written consent of the Preferred Stock Investors, as that term is defined
below, offer, sell, grant any option to purchase, or otherwise dispose of (or
announce any offer, sale, grant or any option to purchase or other disposition)
any of its or its Affiliates' equity or equity-equivalent securities or any
instrument that permits the holder thereof to acquire shares of Common Stock at
any time over the life of the security or investment at a price that is less
than the market price of the Common Stock at the time of issuance of such
security or instrument (a "Subsequent Placement") for a period of one hundred
eighty (180) days after the Original Issue Date, except (i) the granting of
options or warrants to employees, officers and directors, and the issuance of
shares upon exercise of options granted, under any stock option plan heretofore
or hereinafter duly adopted by the Company, (ii) shares issued upon exercise of
any currently outstanding warrants or options in each case disclosed in Schedule
3.1(c), (iii) shares of Common Stock issued upon conversion of the Shares or
shares of the Series F Preferred Stock, as payment of dividends in respect
thereof, in accordance with their respective terms, (iv) shares of Common Stock
issued in connection with the capitalization or creation of a joint venture with
a strategic partner (a Person whose business is primarily that of investing and
selling of securities shall not be deemed a strategic partner), (v) shares of
Common Stock issued to pay part or all of the purchase price for the acquisition
by the Company of a Person (which, for purposes of this clause (v), shall not
include an individual or group of individuals) and (vi) shares of Common Stock
issued in a bona fide public offering by the Company of its (and not of any of
its stockholders') securities, unless (A) the Company delivers to each Preferred
Stock Investor a written notice (the "Subsequent Placement Notice") of its
intention effect such Subsequent Placement, which Subsequent Placement Notice
shall describe in reasonable detail the proposed terms of such Subsequent
Placement, the amount of proceeds intended to be raised thereunder, the Person
with whom such Subsequent Placement shall be affected (if known to the Company),
and attached to which shall be a term sheet or similar document relating thereto
and (B) no Preferred Stock Investor shall have notified the Company by 5:00 p.m.
(Salt Lake City time) on the third (3rd) Trading Day after its receipt of the
Subsequent Placement Notice of its willingness to provide (or to cause its sole
designee to provide), subject to completion of mutually acceptable
documentation, financing to the Company on substantially the terms set forth in
the Subsequent Placement Notice. If no Preferred Stock Investor shall notify the
Company of its intention to enter into such negotiations within such time
period, the Company may effect the Subsequent Placement substantially upon the
terms and to the Persons (or Affiliates of such Persons) set forth in the
Subsequent Placement Notice (if such Persons are set forth in the Subsequent
Placement Notice); provided, that the Company shall provide each Preferred Stock
Investor with a second Subsequent Placement Notice, and the Preferred Stock
Investors shall again have the right of first refusal set forth above in this
Section 4.8, if the Subsequent Placement subject to the initial Subsequent
Placement Notice shall not have been consummated for any reason on the terms set
forth in such Subsequent Placement Notice within thirty (30) Trading Days after
the date of the initial Subsequent Placement Notice with the Person (or an
Affiliate of such Person) (if any) identified in the Subsequent Placement
Notice. If the Preferred Stock Investors shall indicate a willingness to provide
financing in excess of the amount set forth in the Subsequent Placement Notice,
then each Preferred Stock Investor shall be entitled to provide financing
pursuant to such Subsequent Placement Notice up to an amount equal to such
Purchaser's pro rata portion of the total number of the Series F Preferred Stock
and the Shares purchased under
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this Agreement, but the Company shall not be required to accept financing from
the Preferred Stock Investors in an amount in excess of the amount set forth in
the Subsequent Placement Notice.
(b) Except for Underlying Shares, and other "Registrable
Securities," the Company shall not, for a period of not less than 90 Trading
Days after the date that the Underlying Securities Registration Statement is
declared effective by the Commission, without the prior written consent of the
Preferred Stock Investors, (i) issue or sell any of its or any of its
Affiliates' equity or equity-equivalent securities pursuant to Regulation S
promulgated under the Securities Act, or (ii) register for resale any securities
of the Company. Any days that a Preferred Stock Investor is not permitted to
sell Underlying Shares under the Underlying Securities Registration Statement
shall be added to such 90 Trading Day period for the purposes of (i) and (ii)
above.
(c) For purposes of this Section 4.8, "Preferred Stock
Investor" shall mean the holder of any then issued and outstanding shares of
Series F Preferred Stock or Shares, provided that to the extent of any conflict
under this Section 4.8, the holders of the Series F Preferred Stock shall have
priority.
Section 4.9 Listing of Underlying Shares. The Company shall (a) not
later than the time prescribed by the rules and regulations of the Nasdaq
SmallCap Market, prepare and file with the Nasdaq SmallCap Market (as well as
any other national securities exchange, market or trading facility on which the
Common Stock is then listed) an additional shares listing application covering
at least the sum of two times the number of Underlying Shares as would be
issuable upon a conversion in full of (and as payment of dividends in respect
of) the Shares, assuming such conversion occurred on the Original Issue Date or
the Filing Date (whichever yields a lower Conversion Price), (b) take all steps
necessary to cause the such shares to be approved for listing on the Nasdaq
SmallCap Market (as well as on any other national securities exchange, market or
trading facility on which the Common Stock is then listed) as soon as possible
thereafter, and (c) provide to the Purchaser evidence of such listing, and the
Company shall maintain the listing of its Common Stock on such exchange or
market. In addition, if at any time the number of shares of Common Stock
issuable on conversion of all then outstanding Shares, on account of accrued and
unpaid dividends thereon is greater than the number of shares of Common Stock
theretofore listed with the Nasdaq SmallCap Market (and any such other national
securities exchange, market or trading facility), the Company shall promptly
take such action (including the actions described in the preceding sentence) to
file an additional shares listing application with the Nasdaq SmallCap Market
(and any such other national securities exchange, market or trading facility)
covering at least a number of shares equal to the sum of 200% of (A) the number
of Underlying Shares as would then be issuable upon a conversion in full of the
Shares and (B) the number of Underlying Shares as would be issuable as payment
of dividends on the Shares.
Section 4.10 Notice of Breaches. Each of the Company and the Purchasers
shall give prompt written notice to the other of any breach by it of any
representation, warranty or other agreement contained in any Transaction
Document, as well as any events or occurrences arising after the date hereof,
which would reasonably be likely to cause any representation or warranty or
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other agreement of such party, as the case may be, contained in the Transaction
Document to be incorrect or breached as of such Closing Date. However, no
disclosure by either party pursuant to this Section shall be deemed to cure any
breach of any representation, warranty or other agreement contained in any
Transaction Document. Notwithstanding the generality of the foregoing, the
Company shall promptly notify the Purchasers of any notice or claim (written or
oral) that it receives from any lender of the Company to the effect that the
consummation of the transactions contemplated by the Transaction Documents
violates or would violate any written agreement or understanding between such
lender and the Company, and the Company shall promptly furnish by facsimile to
the Purchasers a copy of any written statement in support of or relating to such
claim or notice.
Section 4.11 Conversion procedures. Exhibit "C" sets forth all
procedures, required information and instructions that are required to be
followed in order to permit holders of Shares to smoothly and expeditiously
exercise their rights to convert Shares and which are not specifically set forth
in the Certificate of Designation, including the form of legal opinion, if
necessary, that shall be rendered to the Company's transfer agent to effect the
delivery of Underlying Shares in compliance with the terms hereof and of the
Certificate of Designation. If the Company changes its transfer agent at any
time prior to the conversion of all of the Shares held by the Purchasers, the
Company shall deliver any transfer agent instructions contained in Exhibit "C"
to such replacement transfer agent and cause such transfer agent to comply
therewith.
Section 4.12 Conversion and Exercise Obligations of the Company. The
Company shall honor conversions of the Shares and shall deliver Underlying
Shares upon such conversions and exercises in accordance with the respective
terms and conditions and time periods set forth in the Certificate of
Designation.
Section 4.13 Use of Proceeds. The Company shall use the proceeds
from the sale of the Shares to the Purchasers as follows: $2,650,000 for working
capital to pay operating expenses and $100,000 for fees and expenses incurred on
connection with the offering of the Shares.
Section 4.14 Transfer of Intellectual Property Rights. Except in the
ordinary course of the Company's business consistent with past practice or in
connection with the sale of all or substantially all of the assets of the
Company, the Company shall not transfer, sell or otherwise dispose of, any
Intellectual Property Rights, or allow the Intellectual Property Rights to
become subject to any Liens, or fail to renew such Intellectual Property Rights
(if renewable and would otherwise expire).
Section 4.15 Certain Conversion Restrictions. In no event (except (i)
with respect to an automatic conversion of the Preferred Stock as provided in
Section 5(a)(ii) of the Certificate of Designation, (ii) if the Company is in
default of any of its obligations hereunder or any of the Transaction Documents,
as defined in Section 7 of the Certificate of Designation, or (iii) except as
otherwise set forth in the Certificate of Designation) shall any Holder be
entitled to convert any Preferred Stock to the extent that, after such
conversion, the sum of (1) the number of shares of Common Stock beneficially
owned by such Holder and its affiliates (other than the shares of Common Stock
which may be deemed beneficially owned through the ownership of the
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unconverted portion of the Preferred Stock), and (2) the number of shares of
Common Stock issuable upon the conversion of the Preferred Stock with respect to
which the determination of this proviso is being made, would result in
beneficial ownership by the Holder and its affiliates of more than 4.99% of the
outstanding shares of Common Stock. For purposes of the immediately preceding
sentence, beneficial ownership shall be determined in accordance with section
13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
except as otherwise provided in clause (1) of the preceding sentence. To the
extent that the limitation contained in this paragraph applies, the
determination of whether shares of Preferred Stock are convertible (in relation
to other securities owned by a Holder) and of which shares of Preferred Stock
are convertible shall be in the sole discretion of the Holder, and the
submission of shares of Preferred Stock for conversion shall be deemed to be the
Holder's determination of whether such shares of Preferred Stock are convertible
(in relation to other securities owned by the Holder) and of which portion of
such shares of Preferred Stock are convertible, in each case subject to such
aggregate percentage limitation, and the Company shall have no obligation to
verify or confirm the accuracy of such determination. Nothing contained in this
paragraph shall be deemed to restrict the right of the Holder to convert shares
of Preferred Stock at such time as such conversion will not violate the
provisions of this paragraph. The provisions of this paragraph will not apply to
any conversion pursuant to Section 5 (a)(ii) of the Certificate of Designation,
and may be waived by a Holder (but only as to itself and not to any other
Holder) upon not less than 75 days prior notice to the Company (in which case,
the Holder shall make such filings with the Commission, including under Rule 13D
or 13G, as are required by applicable law), and the provisions of this Section
shall continue to apply until such 75th day (or later, if stated in the notice
of waiver). Other Holders shall be unaffected by any such waiver.
Section 4.16 Mandatory Redemption. If, at any time the Company denies
the right of a holder of Series F Preferred to effect a conversion of its shares
of Series F Preferred into Common Stock or otherwise dishonors or rejects any
Conversion Notice delivered in accordance with the terms of this Agreement or
the Certificate of Designations, except in circumstances where (i) the Company
has obtained an order from a court having jurisdiction over the holder, which
order expressly allows the Company to deny conversion or dishonor or reject a
conversion notice, and (ii) such holder has received notice of and an
opportunity to oppose any motion of the Company seeking such order, then such
holder shall have the right, by written notice to the Company, to require the
Company to promptly redeem the holder's outstanding shares of Series F Preferred
for cash at the Mandatory Redemption Amount. The Mandatory Redemption Amount
will be payable to such holder in cash within five (5) business days from the
date such holder gives the Company written notice that it is exercising its
rights under this paragraph.
Section 4.17 Restrictions. Subject to the completeness and accuracy of
the Buyer's representations and warranties herein and provided that all of the
qualifications and requirements of Regulation S under the Securities Act of 1933
("Regulation S") are met, upon the conversion of any Series F Preferred by a
person who is not a U.S. Person as defined in Regulation S (a "non-U.S.
Person"), the Company shall, at its expense, take all necessary action
(including the issuance of an opinion of counsel) to assure that the Company's
transfer agent shall issue stock certificates without restrictive legend or stop
orders, other than as required for compliance with applicable statutes and laws,
including but not limited to securities laws, in the name of the Buyer (or its
nominee (being a non-U.S. Person) or such non-U.S. Persons as may be designated
-17-
<PAGE>
by the Buyer) and in such denominations to be specified at conversion
representing the number of shares of Common Stock issuable upon such conversion,
as applicable. The Company warrants that no instructions (other than these
instructions or instructions to impose a "stop transfer" instruction with
respect to the Series F Preferred until the end of the Restricted Period) have
been or will be given to the transfer agent and that the Shares will not be
subject to any transfer limitations other than those imposed by applicable
securities laws.
ARTICLE V.
CONDITIONS; TERMINATION
Section 5.1 Conditions Precedent.
(a) Conditions Precedent to the Obligation of the Company to
Sell the Shares. The obligation of the Company to sell the Shares hereunder to a
Purchaser is subject to the satisfaction or waiver by the Company, at or before
the Closing, of each of the following conditions:
(1) Accuracy of the Purchasers' Representations and
Warranties. The representations and warranties of the Purchasers shall be true
and correct in all material respects as of the date when made and as of the
Closing Date, as though made on and as of such date; and
(2) Performance by the Purchasers. The Purchasers
shall have performed, satisfied and complied in all material respects with all
covenants, agreements and conditions required by the Transaction Documents to be
performed, satisfied or complied with by it at or prior to the Closing.
(b) Conditions Precedent to the Obligation of the Purchasers
to Purchase the Shares. The obligation of the Purchasers to acquire and pay for
the Shares to be acquired by it hereunder is subject to the satisfaction or
waiver by the Purchasers, at or before the Closing, of each of the following
conditions:
(1) Accuracy of the Company's Representations and
Warranties. The representations and warranties of the Company set forth herein
shall be true and correct in all material respects as of the date when made and
as of the Closing Date as though made on and as of such date;
(2) Performance by the Company. The Company shall
have performed, satisfied and complied in all material respects with all
covenants, agreements and conditions required by the Transaction Documents to be
performed, satisfied or complied with by the Company at or prior to the Closing;
(3) No Prohibitions. The purchase of and payment
for the Shares to be purchased by the Purchasers (and upon conversion thereof,
the Underlying Shares) hereunder (i) shall not be prohibited or enjoined
(temporarily or permanently) by any applicable law or governmental regulation
and (ii) shall not subject the Purchasers to any penalty, or in its judgment,
other onerous condition under or pursuant to any applicable law or governmental
-18-
<PAGE>
regulation that would materially reduce the benefits to the Purchasers of the
purchase of the Shares or the Underlying Shares (provided, however, that such
regulation, law or onerous condition was not in effect in such form at the date
of this Agreement);
(4) Adverse Changes. No event or series of events
which, individually or in the aggregate, could have or result in a Material
Adverse Effect shall have occurred between the date of execution hereof and the
Closing;
(5) No Suspensions of Trading in Common Stock.
Trading in the Common Stock shall not have been suspended from trading on the
Nasdaq SmallCap Market or any subsequent exchange, market, or trading facility
at any time between the date hereof and the Closing;
(6) Listing of Common Stock. The Common Stock
shall have at all times between the date hereof and the Closing Date been listed
for trading on the Nasdaq SmallCap Market or the OTC Bulletin Board;
(7) Reserved.
(8) Required Approvals. All Required Approvals
shall have been obtained; and
(9) Certificate of Designation. The Certificate of
Designation shall have been duly filed with the Secretary of State of Delaware,
and the Company shall have delivered a copy thereof to the Purchasers certified
as filed by the office of the Secretary of State of Delaware.
Section 5.2 Termination.
(a) Termination by Mutual Consent. This Agreement and the
transactions contemplated hereby may be terminated at any time prior to Closing
by the mutual consent of the Company and the Purchasers.
(b) Termination by the Company or the Purchasers. This
Agreement and the transactions contemplated hereby with respect to the
Purchasers may be terminated prior to Closing by either the Company or the
Purchasers, by giving written notice of such termination to the other party, if:
(1) there shall be in effect any statute, rule, law
or regulation that prohibits the consummation of the Closing or the
transaction contemplated by the Transaction Documents or if the
consummation of the Closing Documents would violate any non-appealable
final judgment, order, decree, ruling or injunction of any court of or
governmental authority having competent jurisdiction; or
(2) there shall have been an amendment to Regulation
D promulgated under the Securities Act or an interpretive release
promulgated or issued thereunder,
-19-
<PAGE>
which, in the judgment of the terminating party, could have or result
in a Material Adverse Effect.
(c) Termination by the Company. This Agreement and the
transactions contemplated hereby may be terminated prior to Closing as to the
Purchasers by the Company, by giving written notice of such termination to the
Purchasers, if the Purchasers have breached in any material respect any
representation, warranty, covenant or agreement contained in any Transaction
Document and such breach is not cured within five (5) Business Days following
receipt by the Purchasers of notice of such breach.
(d) Termination by the Purchasers. This Agreement and the
transactions contemplated hereby may be terminated as to the Purchasers prior to
Closing by the Purchasers, by giving written notice of such termination to the
Company, if:
(1) the Company has breached in any material respects
any representation, warranty, covenant or agreement contained in any
Transaction Document and such breach is not cured within one (1)
Business Day following receipt by the Company of notice of such breach;
(2) there has occurred an event or series of events
which, individually or in the aggregate, could have or result in a
Material Adverse Effect which is not disclosed fully in the Disclosure
Materials;
(3) trading in the Common Stock has been suspended or
the Common Stock has failed to be listed for trading on the OTC
Bulletin Board or on any subsequent exchange, market, or trading
facility.
ARTICLE VI.
MISCELLANEOUS
Section 6.1 Fees and Expenses. Each party shall pay the fees and
expenses of its advisers, counsel, accountants and other experts, if any, and
all other expenses incurred by such party incident to the negotiation,
preparation, execution, delivery and performance of this Agreement. The Company
shall pay all stamp and other taxes and duties levied in connection with the
issuance of the Shares pursuant hereto. The Purchasers shall be responsible for
their own respective tax liability that may arise as a result of the investment
hereunder or the transactions contemplated by this Agreement.
Section 6.2 Entire Agreement; Amendments, Exhibits and Schedules. This
Agreement, together with the Exhibits and Schedules hereto, and the Certificate
of Designation contain the entire understanding of the parties with respect to
the subject matter hereof and supersede all prior agreements and understandings,
oral or written, with respect to such matters. The Exhibits and Schedules to
this Agreement are hereby incorporated herein and made a part hereof for all
purposes as if fully set forth herein.
-20-
<PAGE>
Section 6.3 Notices. Any and all notices or other communications or
deliveries required or permitted to be provided hereunder shall be in writing
and shall be deemed given and effective on the earliest of (i) the date of
transmission, if such notice or communication is delivered via facsimile at the
facsimile telephone number specified in this Section prior to 5:00 p.m. (Salt
Lake City time) on a Business Day, (ii) the Business Day after the date of
transmission, if such notice or communication is delivered via facsimile at the
facsimile telephone number specified in the Purchase Agreement later than 5:00
p.m. (Salt Lake City time) on any date and earlier than 11:59 p.m. (Salt Lake
City time) on such date, (iii) the Business Day following the date of mailing,
if sent by nationally recognized overnight courier service, or (iv) upon actual
receipt by the party to whom such notice is required to be given. The address
for such notices and communications shall be as follows:
If to the Company: Fonix Corporation
60 East South Temple Street
Suite 1225
Salt Lake City, Utah 84111
Facsimile No.: (801) 328-8778
Attn: Roger D. Dudley,
Executive Vice President
With copies to: Durham Jones & Pinegar, P.C.
Suite 800 Key Bank Tower
50 South Main Street
Salt Lake City, Utah 84144
Facsimile No.: (801) 538-2425
Attn: Jeffrey M. Jones, Esq.
If to Dominion, Sovereign, Dominion Capital Fund, Ltd.
Canadian Advantage, Sovereign Partners, LP
Dominion Investment, or Canadian Advantage, LP
Queen: Dominion Investment Fund, LLC
Queen LLC
c/o Thomson Kernaghan & Co.
365 Bay Street
Toronto, Canada
Fax (416) 860-3610
Attention: ______________
With copies to: Krieger & Prager
39 Broadway, Suite 1440
New York, New York 10006
Fax: (212) 363-2999
Attn. Samuel M. Krieger, Esq.
or such other address as may be designated in writing hereafter, in the same
manner, by such Person.
-21-
<PAGE>
Section 6.4 Amendments; Waivers. No provision of this Agreement may be
waived or amended except in a written instrument signed, in the case of an
amendment, by both the Company and the Purchasers, or, in the case of a waiver,
by the party against whom enforcement of any such waiver is sought, provided
however that Section 6.7 and to the extent it affects such sections, this
Section 6.4 may not be waived or amended without the prior written consent of
any party identified therein as a third party beneficiary. No waiver of any
default with respect to any provision, condition or requirement of this
Agreement shall be deemed to be a continuing waiver in the future or a waiver of
any other provision, condition or requirement hereof, nor shall any delay or
omission of either party to exercise any right hereunder in any manner impair
the exercise of any such right accruing to it thereafter.
Section 6.5 Headings. The headings herein are for convenience only, do
not constitute a part of this Agreement and shall not be deemed to limit or
affect any of the provisions hereof.
Section 6.6 Successors and Assigns. This Agreement shall be binding
upon and inure to the benefit of the parties and their successors and permitted
assigns, including any Persons to whom the Purchasers transfer Shares. The
assignment by a party of this Agreement or any rights hereunder shall not affect
the obligations of such party under this Agreement.
Section 6.7 No Third-Party Beneficiaries. This Agreement is intended
for the benefit of the parties hereto and their respective permitted successors
and assigns and, other than with respect to permitted assignees under Section
6.6, is not for the benefit of, nor may any provision hereof be enforced by, any
other Person.
Section 6.8 Governing Law; Venue. This Agreement shall be governed by
and construed and enforced in accordance with the internal laws of the State of
Delaware without regard to the principles of conflicts of law thereof.
Additionally, any action arising out of the interpretation of or performance
under this Agreement by either party shall be brought in a court of competent
jurisdiction in the State of Delaware.
Section 6.9 Survival. The representations, warranties, agreements
and covenants contained in this Agreement shall survive the Closing and the and
conversion of the Shares.
Section 6.10 Execution. This Agreement may be executed in two or more
counterparts, all of which when taken together shall be considered one and the
same agreement, and shall become effective when counterparts have been signed by
each party and delivered to the other parties, it being understood that all
parties need not sign the same counterpart. In the event that any signature is
delivered by facsimile transmission, such signature shall create a valid and
binding obligation of the party executing (or on whose behalf such signature is
executed) the same with the same force and effect as if such facsimile signature
page were an original thereof.
Section 6.11 Publicity. The Company and the Purchasers shall consult
with each other in issuing any press releases or otherwise making public
statements with respect to the transactions contemplated hereby and no party
shall issue any such press release or otherwise make any such public statement
without the prior written consent of the other party, which consent shall not be
unreasonably withheld or delayed, except that no prior consent shall be
-22-
<PAGE>
required if such disclosure is required by law, in which such case the
disclosing party shall provide the other parties with prior notice of such
public statement. Notwithstanding the foregoing, the Company shall not publicly
disclose the name of the Purchasers without the prior written consent of the
Purchasers, except to the extent required by law, in which case the Company
shall provide the Purchasers with prior written notice of such public
disclosure.
Section 6.12 Severability. In case any one or more of the provisions of
this Agreement shall be invalid or unenforceable in any respect, the validity
and enforceability of the remaining terms and provisions of this Agreement shall
not in any way be affected or impaired thereby and the parties will attempt to
agree upon a valid and enforceable provision which shall be a reasonable
substitute therefor, and upon so agreeing, shall incorporate such substitute
provision in this Agreement.
Section 6.13 Remedies. Each of the parties to this Agreement
acknowledges and agrees that the other parties would be damaged irreparably in
the event any of the provisions of this Agreement are not performed in
accordance with their specific terms or otherwise are breached. Accordingly,
each of the parties hereto agrees that the other parties shall be entitled to an
injunction or injunctions to prevent breaches of the provisions of this
Agreement and to enforce specifically this Agreement and the terms and
provisions of this Agreement in any action instituted in any court of the United
States of America or any state thereof having jurisdiction over the parties to
this Agreement and the matter, in addition to any other remedy to which they may
be entitled, at law or in equity.
Section 6.14 Rights in Bankruptcy. The holder of any shares of Series F
Preferred shall be entitled to exercise its conversion privilege with respect to
the Series F Preferred notwithstanding the commencement of any case under 11
U.S.C. section 101 et seq. (the "Bankruptcy Code"). In the event the Company is
a debtor under the Bankruptcy Code, the Company hereby waives, to the fullest
extent permitted, any rights to relief it may have under 11 U.S.C. section 362
in respect of the conversion of the Series F Preferred.
Section 6.15 Information. The Company will authorize its transfer agent
to give information relating to the Company directly to the Purchasers or the
Purchasers' representatives upon the request of the Purchasers or any such
representative, to the extent such information relates to (i) the status of
shares of Common Stock issued or claimed to be issued to the Purchasers in
connection with a Notice of Conversion, or (ii) the number of outstanding shares
of Common Stock of all stockholders as of a current or other specified date. The
Company will provide the Purchasers with a copy of the authorization so given to
the transfer agent.
[SIGNATURE PAGES FOLLOW]
-23-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Series
F Convertible Preferred Stock Purchase Agreement to be duly executed as of the
date first indicated above.
FONIX CORPORATION DOMINION CAPITAL FUND, LTD
By: /s/ Roger D. Dudley By: /s/ David K. Sims
Name: Name: David K. Sims
Title: Title: Director
SOVEREIGN PARTNERS, LP
By: /s/ [Signature illegible]
Name:
Title:
CANADIAN ADVANTAGE, LP
By: /s/ M. McKinnon
Name: M. McKinnon
Title:
DOMINION INVESTMENT FUND, LLC
By: /s/ [Signature illegible]
Name: Navigator Management, Ltd.
Title: Director
QUEEN LLC
By: /s/ [Signature illegible]
Name: Navigator Management, Ltd.
Title: Director
-24-
<PAGE>
SCHEDULE 3.1(a)
SUBSIDIARIES
1. fonix systems corporation, a Utah corporation, wholly owned by the Company.
2. fonix/AcuVoice, Inc., a Utah corporation, wholly owned by the Company.
3. ASI Acquisition Corporation, a Utah corporation, wholly owned by the
Company.
4. Papyrus Acquisition Corporation, a Utah corporation, wholly owned by the
Company.
-25-
<PAGE>
SCHEDULE 3.1(c)
CAPITALIZATION
The Company has an authorized capitalization consisting of 300,000,000 shares of
Common Stock, par value $.0001 per share, and 5,000,000 shares of Preferred
Stock, par value $.0001 per shares. As of the date hereof, the Company has
issued and outstanding 139,102,720 shares of Common Stock. 3,325,000 shares of
Common Stock are subject to issuance upon the conversion or exercise of
presently issued and outstanding warrants and options of the Company. 16,698,233
shares of Common Stock are reserved for issuance under the Company's existing
stock option plans. 166,667 shares of Series A Preferred Stock have been issued
and 166,667 shares are outstanding, which shares are convertible into 166,667
shares of Common Stock. 310,000 shares of Series D 4% Convertible Preferred
Stock are issued and outstanding, which are convertible into shares of Common
Stock according to a formula that is determined, in part, by reference to the
prevailing market price of the Series D Preferred Stock. Assuming that all of
the issued and outstanding shares of Series D Preferred were to be converted as
of February 1, 2000, the Company would issue a total of 25,871,936 shares of
Common Stock, including shares issued as accrued dividends. Except as set forth
above, as of the date of this Agreement, there are no outstanding options,
warrants, rights to subscribe to, calls or commitments of any character
whatsoever relating to, or, except as a result of the purchase and sale of the
Shares, securities, rights or obligations convertible into or exchangeable for,
or giving any Person any right to subscribe for or acquire, any shares of Common
Stock, or contracts, commitments, understandings, or arrangements by which the
Company or any Subsidiary is or may become bound to issue additional shares of
Common Stock or securities or rights convertible or exchangeable into shares of
Common Stock, except as disclosed herein.
5% Beneficial Owners
The Company is aware of the following persons or groups who beneficially own
more than 5% of the Company's issued and outstanding Common Stock:
Stephen M. Studdert
Thomas A. Murdock
Roger D. Dudley
Beesmark Investments, L.C.
-26-
<PAGE>
APPENDIX A
Investor Shares Received
Sovereign Partners, LP 71,275
Dominion Capital Fund, Ltd 64,543
Canadian Advantage, L.P. 11,325
Dominion Investment Fund LLC 5,357
Queen LLC 137,500
-27-
EXHIBIT 22
SUBSIDIARIES OF REGISTRANT
1. Fonix Systems Corporation, a Utah corporation, wholly owned by the
Company (merged into Fonix Corporation effective September 1, 1999)
2. Fonix/AcuVoice, Inc., a Utah corporation, wholly owned by the Company
3. Fonix/Articulate, Inc., a Utah corporation, wholly owned by the
Company (merged into Fonix Corporation effective September 1, 1999)
4. Fonix/Papyrus, Inc., a Utah corporation, wholly owned by the Company
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in Registration Statement Nos. 333-31425, 333-40603, 333-50625, and
333-67573 on Form S-3; and 333-11549, 333-25925, 333-37137, 333-74769, and
333-30488 on Form S-8 of Fonix Corporation of our report dated April 10, 2000
included in Fonix Corporation's Form 10-K for the year ended December 31, 1999.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
April 10, 2000
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference of our report dated March 4,
1996 included in this Form 10-K of Fonix Corporation for the year ended December
31, 1999 (relating to the financial statements of Fonix Corporation for the
period from the date of inception on October 1, 1993 through December 31, 1995,
which financial statements are not separately presented in the Form 10-K), into
the Company's previously filed Registration Statements File Nos. 333-31425,
333-40603, 333-50625, and 333-67573 on Form S-3 and 333-11549, 333-25925,
333-37137, 333-74769, and 333-30488 on Form S-8.
/s/ Pritchett, Siler & Hardy, P.C.
PRITCHETT, SILER & HARDY, P.C.
Salt Lake City, Utah
April 14, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 232,152
<SECURITIES> 0
<RECEIVABLES> 206,447
<ALLOWANCES> 20,000
<INVENTORY> 10,539
<CURRENT-ASSETS> 480,885
<PP&E> 3,087,296
<DEPRECIATION> 1,938,494
<TOTAL-ASSETS> 19,173,147
<CURRENT-LIABILITIES> 5,285,681
<BONDS> 0
0
9,595,910
<COMMON> 12,353
<OTHER-SE> (1,521,904)
<TOTAL-LIABILITY-AND-EQUITY> 19,173,147
<SALES> 439,507
<TOTAL-REVENUES> 439,507
<CGS> 24,932
<TOTAL-COSTS> 24,932
<OTHER-EXPENSES> 19,966,877
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,636,467
<INCOME-PRETAX> (23,281,091)
<INCOME-TAX> 3,331,895
<INCOME-CONTINUING> (19,949,196)
<DISCONTINUED> (2,187,080)
<EXTRAORDINARY> 473,857
<CHANGES> 0
<NET-INCOME> (21,662,419)
<EPS-BASIC> (0.31)
<EPS-DILUTED> (0.31)
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