As filed with the Securities and Exchange Commission on November 22,
2000
Registration Statement No. 333-43428
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-2
AMENDMENT NO. 2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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Fonix Corporation
(Exact name of registrant as specified in its charter)
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DELAWARE 22-2994719
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
60 East South Temple Street, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
(Address, including zip code, and
telephone number, including area code,
of registrant's principal
executive offices)
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THOMAS A. MURDOCK
PRESIDENT, CEO
Fonix Corporation
60 East South Temple Street
Salt Lake City, Utah 84111
(801) 328-8700
(Name, address, including zip code, and
telephone number, including area code,
of agent for service)
COPY TO:
JEFFREY M. JONES, ESQ.
DURHAM JONES & PINEGAR, P.C.
111 EAST BROADWAY, SUITE 900
SALT LAKE CITY, UTAH 84111
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: from time to
time after the effective date of this Registration Statement as determined by
market conditions.
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If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] _______.
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ________.
If delivery of the Prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
<TABLE>
<CAPTION>
========================================================================================================================
Proposed Proposed
Maximum Maximum
Amount Aggregate Aggregate Amount of
Title of Class of Securities To be Price Offering Registration
to be Registered Registered (1) Per Share Price Fee
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Class A Common Stock, 2,700,000 shares (2) $1.10 (3) $ 2,970,000 (3) $ 784 (3)
$.0001 par value per share
Class A Common Stock, 9,408,704 shares (4) $1.10 (5) $10,349,574 (3) $ 2,732 (3)
$.0001 par value per share
Class A Common Stock, 11,601,096 shares (6) $1.10 (5) $12,761,206 (3) $ 3,369 (3)
$.0001 par value per share
Class A Common Stock, 2,400,000 shares (7) $1.10 (5) $ 2,640,000 (3) $ 697 (3)
$.0001 par value per share
Class A Common Stock, 26,082,420 shares (8) $1.10 (3) $28,690,662 (3) $ 7,574 (2)
$.0001 par value per share
Class A Common Stock, 131,600 shares (9) $1.10 (3) $ 144,760 (3) $ 38 (2)
$.0001 par value per share
Class A Common Stock, 250,000 shares (10) $1.10 (3) $ 275,000 (3) $ 73 (2)
$.0001 par value per share
Class A Common Stock, 612,069 shares (11) $1.10 (3) $ 673,276 (3) $ 178 (2)
$.0001 par value per share
------------------ ------------- -------------
Totals 53,185,889 shares $58,504,478 $ 15,445 (12)
================= ============= =============
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</TABLE>
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(1) All shares offered for resale by the Selling Stockholders.
(2) Comprised of approximately 2,700,000 shares of Class A common stock issued
upon conversion of the Company's Series D 4% Convertible Preferred Stock,
which shares are in excess of those covered by a registration statement on
Form S-3 declared effective as of August 11, 1999, which was filed to
register shares of Class A common stock issued upon conversion of the
Series D Preferred Stock.
(3) The fee was estimated pursuant to Rule 457(c) under the Act on the basis of
the average of the bid and asked price of Fonix's Class A common stock as
reported on the OTC Bulletin Board on August 29, 2000.
(4) Comprised of (i) 8,703,704 shares of Class A common stock, representing
200% of the shares issuable upon a hypothetical conversion of $3,290,000
stated principal amount of 164,500 shares of Series D Preferred Stock
assuming such hypothetical conversion occurred August 29, 2000, and (ii)
705,000 shares of Class A common stock, representing 200% of the shares of
Class A common stock issuable as payment of dividends accrued on 164,500
shares of Series D Preferred Stock, assuming a hypothetical conversion on
August 29, 2000.
(5) Fee calculated pursuant to Rule 457(g)(3).
(6) Comprised of (i) 10,000,000 shares of Class A common stock issuable
pursuant to the conversion right granted to the Equity Line Investor under
the Note, assuming a hypothetical conversion of the full $7,500,000
principal amount of the Note on August 29, 2000, and (ii) 1,601,096 shares
of Class A common stock, representing 200% of the shares issuable upon
hypothetical conversion of all of the accrued interest on the Note through
June 30, 2001, assuming a hypothetical conversion on August 29, 2000, of
the full amount of accrued interest through June 30, 2001.
(7) Comprised of shares of Class A common stock issuable to the Equity Line
Investor for failure to have the Registration Statement declared effective
by October 15, 2000, assuming such failure continues for three months after
October 15, 2000.
(8) Comprised of 200% of the shares of Class A common stock issuable pursuant
to the Equity Line Agreement, assuming a hypothetical put by the Company of
$12,500,000, the remainder of the Maximum Put Amount on August 29, 2000.
(9) Represents shares of Class A common stock issuable upon exercise of
warrants to purchase up to an aggregate amount of 131,600 shares of Fonix's
common stock at an exercise price that shall be 120% of the prevailing
market price at the time of exercise, expiring three years after the issue
date thereof, which warrants may be issued to the holders of the Series D
Preferred Stock.
(10) Represents shares of Class A common stock issued to an unaffiliated third
party as payment for consulting services.
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<PAGE>
(11) Represents shares of Class A common stock issued to the holder of the
unconverted Series D 4% Convertible Preferred Stock for waiver of certain
rights and for renegotiation of certain terms of the Series D preferred
stock.
(12) Fee of $20,633 paid on initial filing. No additional fee required.
Pursuant to Rule 416, there are also registered hereby such additional
indeterminate number of shares of such Class A common stock as may become
issuable as dividends or to prevent dilution resulting from stock splits, stock
dividends or similar transactions.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a)
OF THE ACT, MAY DETERMINE.
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Prospectus
The information in this prospectus is not complete, and it may change. This
prospectus is included in a registration statement that Fonix filed with the
Securities and Exchange Commission. The Selling Stockholders cannot sell these
securities until that registration statement becomes effective. This prospectus
is not an offer to sell these securities or the solicitation of an offer to buy
these securities in any state where an offer to sell or the solicitation of an
offer to buy is not permitted. [GRAPHIC OMITTED]
Fonix Corporation
53,185,889
Class A Common Stock, par value $.0001 per share
This prospectus covers the sale of up to 53,185,889 shares of Fonix Class A
common stock (the "Shares"). Eight stockholders of Fonix Corporation are
offering all of the Shares covered by this prospectus. The Selling Stockholders
will receive all of the proceeds from the sale of the Shares and Fonix will
receive none of those proceeds.
Investment in the Shares involves a high degree of risk. You should
consider carefully the risk factors beginning on page 9 of this prospectus
before purchasing any of the Shares offered by this prospectus.
Fonix Class A common stock is quoted on the OTC Bulletin Board and trades
under the symbol "FONX". Nevertheless, the Selling Stockholders do not have to
sell the Shares in transactions reported on the OTC Bulletin Board, and may
offer their Shares through any type of public or private transactions.
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The Securities and Exchange Commission and State Securities Regulators have
not approved or disapproved the Shares, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
November 15, 2000
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Fonix has not registered the Shares for sale by the Selling Stockholders
under the securities laws of any state. Brokers or dealers effecting
transactions in the Shares should confirm that the Shares have been registered
under the securities laws of the state or states in which sales of the Shares
occur as of the time of such sales, or that there is an available exemption from
the registration requirements of the securities laws of such states.
This prospectus is not an offer to sell any securities other than the
Shares. This prospectus is not an offer to sell securities in any circumstances
in which such an offer is unlawful.
Fonix has not authorized anyone, including any salesperson or broker, to
give oral or written information about this offering, Fonix or the Shares that
is different from the information included or incorporated by reference in this
prospectus. You should not assume that the information in this prospectus, or
any supplement to this prospectus, is accurate at any date other than the date
indicated on the cover page of this prospectus or any supplement to it.
Table of contents
Summary about Fonix and this offering..........................................2
Recent developments............................................................5
Important information incorporated by reference................................5
Where to get additional information............................................6
Explanation about forward-looking information..................................7
Risk factors...................................................................8
Information about Fonix Corporation ..........................................14
Management's discussion and analysis of financial condition and
results of operations....................................................14
Special note regarding forward-looking statements.............................23
Market price of and dividends on the Company's Class A common stock...........23
Selected financial data.......................................................24
Index to financial statements of Fonix Corporation............................25
Changes in and disagreements with accountants on accounting and
financial disclosure.....................................................26
Use of proceeds...............................................................26
Selling security holders......................................................26
Plan of distribution..........................................................32
Legal matters.................................................................33
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Summary about Fonix and this offering
Fonix
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
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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 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 shareware 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.
This offering
The Shares covered by this prospectus are the shares of Class A common
stock issued or issuable by Fonix upon the conversion of certain Series D 4%
Convertible Preferred Stock (the "Series D preferred stock"), the exercise of
warrants issued or issuable in connection with the Series D preferred stock, and
the shares of Class A common stock issuable pursuant to an equity line of credit
agreement between Fonix and one of the selling shareholders. The details
regarding the Series D preferred stock and the equity line of credit agreement,
as well as the Shares covered by this prospectus are as follows:
Under an agreement dated August 31, 1998, Fonix issued a total of 1,108,334
shares of its Series D preferred stock. In return for 500,000 shares of the
Series D preferred stock, Fonix received a total of $10,000,000 in funding from
four investors. That funding was used primarily to finance the Articulate
Systems, Inc. acquisition. As part of the same transaction, Fonix issued 608,334
shares of the Series D preferred stock in exchange for the agreement of seven
investors to cancel their right to receive "reset shares" of Fonix common stock
in connection with a private placement of Fonix common stock completed in March
1998.
Under a second agreement dated September 30, 1998, Fonix issued a total of
250,000 shares of its Series E 4% Convertible Preferred Stock (the "Series E
preferred stock"). For 100,000 shares of the Series E preferred stock, Fonix
received $2,000,000 of additional funding from two investors, which also were
purchasers of Series D preferred stock. The purchasers of the Series E preferred
stock surrendered a total of 150,000 shares of Series D preferred stock,
one-for-one, for the other 150,000 shares of Series E preferred stock.
Subsequently, on November 13, 1998, Fonix sold 50,000 additional shares of
Series D preferred stock on the same terms and conditions as the August 31, 1998
agreement.
Both the Series D preferred stock and the Series E preferred stock are
convertible into shares of Fonix Class A common stock according to one of three
separate conversion formulas. The converting preferred stock holder chooses the
conversion formula at the time of conversion. Under one conversion option, the
preferred stock holder receives both Class A common stock and Class A common
stock purchase warrants upon conversion of the preferred stock. Fonix will not
issue warrants if the converting holder selects either of the other two
conversion formulas. As part of the Series D and Series E transactions, Fonix
agreed that it would register the shares of Class A common stock issuable upon
conversion of the Series D and Series E or the exercise of any warrants issued
upon conversion for public resales by the converting or exercising holder.
Fonix filed a registration statement covering the shares of Class A common
stock underlying the Series D preferred stock and the Series E preferred stock,
which was declared effective on August 11, 1999. Subsequently, all of the Series
E preferred stock and all but 164,500 shares of the Series D preferred stock
were converted into shares of
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the Company's Class A common stock. The holders of the Series D and Series E
preferred stock sold the majority of the Class A common stock received upon
conversion and as payment of dividends accrued on the Series D and Series E
preferred stock under the previous registration statement. However, due to the
passage of time, the accrual of dividend shares over time, and the performance
of the stock price of the Company's Class A common stock, the Series D preferred
stock has been converted and is presently convertible into more shares than
remain available under the previous registration statement.
Accordingly, this registration statement, and the related prospectus,
cover, in part, approximately 2,700,000 shares of Class A common stock issued in
connection with prior conversions of Series D preferred stock and dividends
accrued thereon, together with the shares underlying the remaining 164,500
shares of Series D preferred stock and shares issuable for dividends accrued
thereon to date.
Additionally, on August 8, 2000, the Company entered into a Private Equity
Line Agreement (the "Equity Line Agreement") with Queen LLC, a private investor
(the "Equity Line Investor"). Under the Equity Line Agreement, the Company has
the right to draw down from the Equity Line Investor against an equity line of
credit (the "Equity Line") up to $20 million. The initial draw of $7.5 million
is secured by a Promissory Note (the "Note"), bearing interest at a rate of 6%,
compounded monthly, with interest accruing on each amount funded as of the date
of the advancement of such funds by the Equity Line Investor. The Note is due
June 30, 2001. Under the Note, the Equity Line Investor has the right (the
"Conversion Right") to convert at its option all or a portion of the outstanding
principal and interest into shares of the Company's Class A common stock as
follows:
- The number of shares of Class A common stock to be issued is determined by
dividing the amount of principal and accrued interest being converted by
the lesser of (a) $0.75 or (b) 85% of the average of the three lowest
closing bid prices of the Company's Class A Common Stock in the 20 day
trading period prior to the exercise of the Conversion Right, and rounding
to the nearest whole share.
The remaining $12.5 million is available to the Company through a mechanism
of drawdowns and puts of stock. The Company is entitled under the Equity Line
Agreement to drawdown certain funds and to put to the Equity Line Investor
shares of its Class A common stock in lieu of repayment of the drawdown. The
number of shares to be issued is determined by dividing the amount of the
drawdown by 90% of the average of the two lowest closing bid prices of the
Company's Class A common stock over the seven trading days after the put notice
is tendered. The Equity Line Investor is required under the Equity Line
Agreement to tender the funds requested by the Company within two trading days
after the seven-day period used to determine the market price.
In connection with the Equity Line Agreement, Fonix granted registration
rights to the Equity Line Investor, in connection with which, Fonix has filed
this registration statement. Fonix was required to file a registration statement
covering the shares to be issued under the Equity Line Agreement and the Note
within 30 days of the execution of the Equity Line Agreement, and to use its
best efforts to cause the registration statement to be declared effective by
October 15, 2000. The registration statement was declared effective on September
5, 2000.
As of November 15, 2000, the Company had drawn the full $7,500,000 on the
Note, and the Equity Line Investor had converted principal of $7,500,000 and
interest of $90,879 into 11,544,775 shares of Class A common stock.
Additionally, as of November 15, 2000, the Company has drawn down $800,000 on
the equity line, which resulted in the issuance of 1,751,505 shares of the
Company's Class A common stock .
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Finally, this registration statement, and the related prospectus, register
the sale of 250,000 shares of Class A common stock issued by the Company to a
third party as payment for consulting services rendered to the Company, and
612,069 to the holder of the unconverted Series D 4% Convertible Preferred Stock
in consideration for waiver of certain rights and for renegotiation of certain
terms relating to conversion of the Series D preferred stock.
Recent developments
Stock Options
During the nine months ended September 30, 2000, the Company granted
options under its 1998 Stock Option Plan to purchase 5,867,067 shares of Class A
common stock at exercise prices ranging from $0.28 to $1.50 per share. The term
of all options granted during this six month period is ten years from the date
of grant. Of the stock options issued, options to purchase 2,339,000 shares
vested March 31, 2000, and the balance vest over the three years following
issuance. As of September 30, 2000, the Company had a total of 196,140,834
options to purchase Class A common shares outstanding.
Consulting Agreement
In August 2000, the Company issued 1,000,000 shares of Class A common stock
to advisors and consultants as consideration for services rendered. The shares
were valued at $1,015,600 based upon the market value of the shares on the date
of issuance and have been recorded as general and administrative expenses over
the two-month period of the contracted services.
Periodic public reporting
On April 14, 2000, the Company filed its 1999 annual report on Form 10-K
with the Securities and Exchange Commission. The annual report included audited
consolidated financial statements as of December 31, 1999 and 1998, and for each
of the three years in the period ended December 31, 1999, as well as other
required information.
On May 14, 2000, the Company filed its quarterly report on Form 10-Q for
the three months ended March 31, 2000. The quarterly report included unaudited
condensed consolidated financial statements for the three months ended March 31,
2000 and 1999, as well as other information required to be presented.
On August 14, 2000, the Company filed its quarterly report on Form 10-Q for
the six months ended June 30, 2000. The quarterly report included unaudited
condensed consolidated financial statements for the six months ended June 30,
2000 and 1999, as well as other information required to be presented.
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On November 14, 2000, the Company filed its quarterly report on Form 10-Q
for the nine months ended September 30, 2000. The quarterly report included
unaudited condensed consolidated financial statements for the nine months ended
September 30, 2000 and 1999, as well as other information required to be
presented.
For a free copy of these filings, please contact Fonix at:
Fonix Corporation, Investor Relations
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
Fax (801) 328-8778
e-mail: [email protected]
Additionally, both the annual and quarterly reports are available at the
Securities and Exchange Commission's website at http://www.sec.gov.
Important information incorporated by reference
For purposes of this prospectus, the Commission allows Fonix to
"incorporate by reference" certain information Fonix has filed with the
Commission, which means that Fonix is disclosing important information to you by
referring you to other information Fonix has filed with the Commission. The
information Fonix incorporates by reference is considered part of this
prospectus. Fonix specifically is incorporating by reference the following
documents:
o Annual Report on Form 10-K for the year ended December 31, 1999, filed
with the Commission on April 14, 2000
o Quarterly Report on Form 10-Q for the three months ended March 31,
2000, filed with the Commission on May 14, 2000
o Quarterly Report on Form 10-Q for the six months ended June 30, 2000,
filed with the Commission on August 14, 2000
o Quarterly Report on Form 10-Q for the nine months ended September 30,
2000, filed with the Commission on November 14, 2000
o Current Report on Form 8-K, dated December 22, 1998, filed with the
Commission on January 7, 1999
o Current Report on Form 8-K, dated March 30, 2000, filed with the
Commission on March 30, 2000
You can request a free copy of any of the filings listed above by writing,
calling, e-mailing, or faxing a request to Fonix at:
Fonix Corporation, Investor Relations
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(801) 328-8700
(801) 328-8778 Fax
e-mail: [email protected]
Alternatively, certain of the documents incorporated by reference are available
at the Commission's website at http://www.sec.gov.
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This prospectus is part of a registration statement that Fonix filed with
the Commission. This prospectus does not contain all of the information included
in the registration statement, as certain items are omitted in accordance with
the rules and regulations of the Commission. Statements or descriptions
contained in this prospectus about any agreements or other documents provide, in
Fonix's belief, all information about such agreements or documents that is
material to a decision to invest in the Fonix Shares, but not all terms of all
such agreements and documents are described. If you want more information, Fonix
refers you to the copy of such agreement or document filed as an exhibit to the
registration statement or the reports and other materials incorporated by
reference into this prospectus. The registration statement, including all of its
exhibits and schedules, may be inspected without charge at the office of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and you can obtain
copies of all or any part of it from the Commission, although the Commission
charges for such copies.
Where to get additional information
Federal securities law requires Fonix to file information with the
Securities and Exchange Commission concerning its business and operations.
Accordingly, Fonix files annual, quarterly and special reports, proxy statements
and other information with the Commission. You can inspect and copy this
information at the public reference facility maintained by the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. You
can also do so at the following regional offices of the Commission:
o New York Regional Office, Seven World Trade Center, Suite 1300, New
York, New York 10048
o Chicago Regional Office, Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661
You can get additional information about the operation of the Commission's
public reference facilities by calling the Commission at 1-800-SEC-0330. The
Commission also maintains a web site (http://www.sec.gov) at which you can read
or download Fonix's reports, proxy and information statements and other
information. Reports and other information concerning Fonix also may be
inspected at the National Association of Securities Dealers, Inc., 1735 K
Street, N.W., Washington, D.C. 20006.
Explanation about forward-looking information
This prospectus, including information contained in documents that are
incorporated by reference in this prospectus, contains "forward-looking
statements," as that term is defined by federal securities laws, that relate to
the financial condition, results of operations, plans, objectives, future
performance and business of Fonix. These statements are frequently preceded by,
followed by or include the words "believes," "expects," "anticipates,"
"estimates" or similar expressions. These forward-looking statements involve
certain risks and uncertainties, and whether those risks and uncertainties occur
or develop adversely, Fonix's actual results may differ materially from those
contemplated by such forward-looking statements. In the section of the
prospectus entitled "Risk Factors" Fonix has summarized a number of the risks
and uncertainties that could affect the actual outcome of the forward-looking
statements included in this prospectus. Fonix advises you not to place undue
reliance on such forward-looking statements in light of the material risks and
uncertainties to which they are subject.
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Risk factors
An investment in Fonix Class A common stock involves a high degree of risk
and should not be made by persons who cannot afford the loss of their entire
investment. You should carefully consider the risks described below in addition
to the other information presented in this prospectus or incorporated by
reference into this prospectus before deciding to invest in the Shares covered
by this prospectus.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise substantial 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
$5,075,667 at September 30, 2000. 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. 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, and $18,969,863
for the nine months ended September 30, 2000. As of September 30, 2000, Fonix
had an accumulated deficit of $139,100,968. For the year ended December 31,
1999, Fonix recorded revenues of $439,507. For the nine months ended September
30, 2000, Fonix recorded revenues of $372, 494. For the years ended December 31,
1999 and 1998, Fonix recorded combined revenues from the licensing of TTS and
HWR technologies 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.
Until that time, the Company must rely on funds raised through debt and
equity placements, and the current Equity Line of Credit.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
As of November 17, 2000, Fonix owed trade payables in the aggregate amount
of approximately $940,621, of which $550,363 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
substantial amounts of 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.
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Fonix anticipates incurring substantial product development and research
and general operating expenses for the foreseeable future which will require
substantial amounts of additional capital on an ongoing basis. These capital
needs are in addition to the amounts required to repay the debt discussed above.
Fonix most likely will have to obtain such capital from sales of its equity,
convertible equity and debt securities. Obtaining future financing may be costly
and will be dilutive to existing stockholders. If Fonix is not able to obtain
financing when and in the amounts needed, and on terms that are acceptable to
it, Fonix's operations, financial condition and prospects could be materially
and adversely affected, and Fonix could be forced to curtail its operations or
sell part or all of its assets, including its Core Technologies.
Holders of Fonix Class A common stock are subject to the risk of additional and
substantial dilution to their interests as a result of the conversion of
presently issued preferred stock and other securities convertible into common
stock and issuances of Class A common stock in connection with the Equity Line
and the Note.
Introduction
Fonix currently has three series of preferred stock outstanding: Series A,
Series D, and Series F. 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 and
Series F preferred stock are convertible into Fonix Class A common stock
according to one of three separate conversion formulas for the Series D
preferred stock and one of two formulas for the Series F preferred stock, one of
which is based, in part, on the market price of Class A common stock during the
several week period leading up to the conversion date. Fonix previously had a
fourth series of preferred stock outstanding, its Series E preferred stock, with
terms similar to those of the Series D, but all shares of the Series E preferred
stock have been converted into shares of Class A common stock. Of the 316,036
shares of Series F preferred stock issued, 309,528 have been converted into
8,317,791 shares of Class A common stock.
At November 15, 2000, the remaining 164,500 shares of Series D preferred
stock would convert into 5,652,921 shares of Class A common stock, representing
3.14% 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 November 15, 2000.
At November 15, 2000, the remaining 6,508 shares of Series F preferred
stock would convert 236,798 shares of Class A common stock, representing 0.14%
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 F preferred stock at the date of conversion,
as well as shares of Class A common stock issued upon conversion of the Series F
preferred stock prior to November 15, 2000.
The following table describes the number of shares of Class A common stock
that would be issuable as of November 15, 2000, assuming that all of the
presently outstanding shares of the Series D preferred stock and Series F
preferred stock were converted, and that the full amount of the Equity Line had
been put to the Equity Line investor , 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 or interest and also
excludes differences among the various methods of calculating the applicable
conversion or exercise price.
<TABLE>
<CAPTION>
Shares of Class A Common Stock Issuable Upon Conversion of
------------------------- ----------------------------------------------------------------------------------
Shares issuable Total Class A
Hypothetical Conversion/ Series D upon put of Series F Common Stock
Exercise Price Preferred Stock remaining Preferred Stock Issuable
$22,500,000
------------------------- ------------------------------------------------------------- ----------------
<S> <C> <C> <C> <C> <C>
$0.25 13,160,000 50,000,000 520,640 63,680,640
$0.75 4,386,667 16,666,667 173,547 21,226,881
$1.50 2,193,334 8,333,333 173,547 10,700,214
$2.25 1,462,222 5,555,556 173,547 7,191,325
$3.00 1,096,667 4,166,667 173,547 5,436,881
</TABLE>
9
Given the structure of the conversion formulas applicable to the Series D
preferred stock and the Series F preferred stock, and the formulas for
calculating the shares to be issued under the Equity Line and the Note, there
effectively is no limitation on the number of shares of Class A common stock
into which such convertible securities may be converted or issued in connection
with a put under the Equity Line or the exercise of the Company's Conversion
Right under the Note. If 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 and the Series F preferred stock and issuable in connection with the
Equity Line and the Note will increase.
Overall Dilution to Market Price and Relative Voting Power of Previously
Issued Common Stock
The conversion of the Series D preferred stock and the Series F preferred
stock and the issuance of Class A common stock in connection with the Equity
Line and the Note may result in substantial dilution to the equity interests of
other holders of Fonix Class A common stock. Specifically, the issuance of a
significant amount of additional Fonix Class A common stock would result in a
decrease of the relative voting control of Fonix Class A common stock issued and
outstanding prior to the conversion of the Series D preferred stock and the
Series F preferred stock and the issuance of Class A common stock in connection
with the Equity Line. Furthermore, public resales of Fonix Class A common stock
following the conversion of the Series D preferred stock and the Series F
preferred stock and the issuance of Class A common stock in connection with the
Equity Line likely would depress the prevailing market price of Fonix Class A
common stock. Even prior to the time of actual conversions, exercises and public
resales, the market "overhang" resulting from the mere existence of Fonix's
obligation to honor such conversions or exercises could depress the market price
of Fonix Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common Stock
The outstanding shares of Series D preferred stock and the Series F
preferred stock are convertible at a floating price that may and likely will be
below the market price of Fonix Class A common stock prevailing at the time of
conversion or exercise. Similarly, the formulas for determining the number of
shares of Class A common stock under the Equity Line and the Note are based, in
part, on the market price of the Class A common stock and likely will include a
discount from the market price. As a result, the lower the market price of Fonix
Class A common stock at and around the time the holder converts or the Company
puts shares under the Equity Line or exercises the Conversion Right under the
Note, the more Fonix Class A common stock the holder of such convertible
securities or the Equity Line investor receives. Any increase in the number of
shares of Fonix Class A common stock issued upon conversion or put of shares
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<PAGE>
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 and the Series F preferred stock or
in connection with a put under the Equity Line or exercise of the Conversion
Right under the Note could encourage short sales of Class A common stock by the
holders of the Series D preferred stock and the Series F preferred stock and the
Equity Line investor. 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 and the Series F preferred
stock are prohibited from converting their preferred stock into more than 4.999%
of the then outstanding Fonix Class A common stock. Fonix is similarly
prohibited from putting shares to the Equity Line investor if such put would
result in that investor holding more than 4.999% of the then outstanding Fonix
Class A common stock. These restrictions, however, do not prevent such holders
or investor 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 or receiving
additional put shares. In this way, individual holders of Series D preferred
stock and the Series F preferred stock and the Equity Line Investor 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 one 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 Series F preferred
stock, and the Note, the Company has the option to pay dividends on the
preferred stock and interest on the outstanding principal amount of the Note in
shares of the Company's Class A common stock. The dividends accrue from the date
of the purchase of the preferred stock, and interest accrues from the date of
the advance by the Equity Line Investor. As such, a decision by the Company to
pay such dividends and interest in shares of Class A common stock could result
in a substantial increase in the number of shares issued and outstanding and
could result in a decrease of the relative voting control of Fonix Class A
common stock issued and outstanding prior to such payment of dividends and
interest.
Fonix is in its initial commercialization of its key technologies, products, and
solutions.
There presently are a limited number of commercially available applications
or products incorporating the Fonix 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 purchase 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 collaboration or licensing agreements with an
international microchip manufacturer, Intel, Microsoft, Vocalis, and Nuvo-Media,
the Company has recently entered into licensing and joint-marketing agreements
with Kyushu Matsushita Electric Co., Ltd., Concierge, Inc., and Nuance. These
agreements are based on joint marketing and application development for specific
end-users or customers. There can be no assurance that these collaboration or
manufacturing agreements will produce license or other agreements which will
generate material revenues for Fonix.
The market for many of Fonix's technologies is largely unproven and may never
develop sufficiently to allow Fonix to capitalize on its technology and
products.
The market for HCI technologies, including ASR, 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
11
<PAGE>
found a degree of acceptance in the human-computer interface 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 the Core Technologies or for products incorporating the Core Technologies
may never develop to the point that profitable operations can be achieved or
sustained.
Competition from other industry participants and rapid technological change
could impede Fonix's ability to achieve profitable operations.
The computer hardware and software industries are highly and intensely
competitive. In particular, the HCI market sector and specifically the ASR,
computer voice and communications industries are characterized by rapid
technological change. Competition in the market sector of HCI technology is
based largely on marketing ability and resources, distribution channels,
technology and product superiority and product service and support. The
development of new technology or material improvements to existing technologies
by Fonix's competitors may render Fonix's Core Technologies less attractive or
even obsolete. Accordingly, the success of Fonix will depend upon its ability to
continually enhance its Core Technologies and interactive solutions and products
to keep pace with or ahead of technological developments and to address the
changing needs of the marketplace. Some of Fonix's competitors have greater
experience in developing, manufacturing and marketing human-computer interface
technologies, applications and products, and some have far greater financial and
other resources than Fonix, or its potential licensees and co-developers, as
well as broader name-recognition, more-established technology reputations, and
mature distribution channels for their products and technologies. Barriers to
entry in the software industry are low, and as the market for various
human-computer interface 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 report for the years ended December 31, 1999, 1998, and 1997.
The independent public accountants' report for Fonix's financial statements
for the years 1999, 1998, and 1997 includes 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.
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
12
<PAGE>
proprietary rights is difficult, and some international laws do not protect
proprietary rights to the same extent as United States laws. Litigation
periodically may be necessary to enforce Fonix's intellectual property rights,
to protect its trade secrets or to determine the validity and scope of the
proprietary rights of others.
Risks of infringement by Fonix upon the technology of unrelated parties or
entities
Fonix is not aware and does not believe that any of its technologies or
products infringe the proprietary rights of third parties. Nevertheless, third
parties may claim infringement with respect to its current or future
technologies or products or products manufactured by others and incorporating
Fonix's technologies. Fonix expects that participants in the human-computer
interface 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 have 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.
13
<PAGE>
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the only ones
facing Fonix. Additional risks and uncertainties not presently known to Fonix or
that Fonix currently deems immaterial may also impair its business operations.
If any of the foregoing risks actually occur, Fonix's business, financial
condition, or results of operations could be materially adversely affected. In
such case, the trading price of Fonix Class A common stock could decline and you
may lose all or part of your investment.
14
<PAGE>
Information about Fonix Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
THIS STATEMENT OF MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED IN THE COMPANY'S ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999.
Overview
Corporate Summary
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
electronic devices. Through September 30, 2000, the Company has incurred
cumulative losses amounting to $117,285,837, excluding cumulative losses from
discontinued operations of $8,462,387 and net extraordinary losses of $298,595.
Losses are expected to continue until the effects of marketing and sales efforts
begin to take effect, if ever.
Beginning in 1999 and continuing through 2000, Fonix management transformed
the Company's strategic focus from technology research, development and
acquisition to sales and marketing and product delivery. For the nine months
ended September 30, 2000, the Company expended $1,506,546 in sales and marketing
activities. The Company is making this transition while continuing to achieve
technology upgrades in order to maintain distinct competitive technological
advantages.
In its current marketing efforts, the Company seeks to form relationships
with third parties who can incorporate human user interface ("HUI") 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.
In February 1999, in connection with this 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 align with operating
needs; and
4. Asset acquisition - Acquisition of new operating assets was
significantly restricted.
Implementation of these measures reduced the monthly deficit in cash flows
from operating activities from approximately $3 million in early 1999 to less
than $1 million in December 1999. For the nine months ended September 30, 2000,
the average monthly deficit in cash flows from operating activities was
$1,031,000 as compared to $1,915,000 for the same period in 1999.
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.
15
<PAGE>
("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 discussed below give effect to the sale of the HSG and
the classification of its net assets and operating activities as discontinued
operations
Three months ended September 30, 2000, compared with three months ended
September 30, 1999
During the three months ended September 30, 2000, the Company recorded
revenues of $172,222, reflecting a increase of $106,515 from the same period in
the previous year. Ongoing sales and licensing activities have increased in 2000
from 1999. Revenues in 2000 and 1999 have been generated through sales and
licensing of the Company's products and technologies.
Selling, general and administrative expenses were $3,050,235 and $2,864,400
for the three months ended September 30, 2000 and 1999, respectively. The net
increase of $185,835 was primarily a result of non-cash consulting arrangements
amounting to $1,015,600. Excluding these costs, selling, general and
administrative expenses actually decreased by approximately $830,000 for the
three months ended September 30, 2000, as compared to the same period for 1999.
The decrease resulted primarily from a charge of $1,296,000 to
compensation-related expenses in 1999 related to the indemnification of certain
officers for expenses they incurred on behalf of the Company which expenses were
not repeated in 2000. This decrease from 1999 to 2000 was offset by increases of
$403,970 in recurring compensation related expenses , $45,874 in travel
expenses, and $95,562 in promotions and advertising expense, all related to
increased activity in sales, marketing and strategic development. Increases of
$145,131 in other operating expenses related to the annual shareholders' meeting
held in September 2000, and a decrease of $163,489 in legal and accounting fees
accounted for the balance of the difference from 1999 to 2000.
The Company incurred product development and research expenses of
$1,406,949 during the three months ended September 30, 2000, a decrease of
$500,019 from the same period in the previous year. This decrease is due to the
transition in strategic focus and the resulting cost reduction program initiated
in February 1999. A decrease of $279,000 in compensation related expenses
reflects cost reduction measures. Also, decreases amounting to $241,654 in other
operating expenses resulted from one-time software license fees incurred in
1999.
The Company incurred losses from operations of $4,898,954 and $5,344,189
during the three months ended September 30, 2000 and 1999, respectively. While
operating losses for the three months ended September 30, 2000, decreased by
$445,235 from those incurred in the three months ended September 30, 1999, an
even greater reduction in the cash
flow deficit resulted from reduced cash expenditures.
Nine months ended September 30, 2000, compared with nine months ended September
30, 1999
16
<PAGE>
During the nine months ended September 30, 2000, the Company recorded
revenues of $372,494, reflecting an increase of $21,411 from the same period in
the previous year. Revenues in 2000 and 1999 were generated through sales and
licensing of the Company's products and technologies.
Selling, general and administrative expenses were $8,844,156 and $7,537,577
for the nine months ended September 30, 2000 and 1999, respectively. Included in
these expenses for the nine months ended September 30, 2000, were
compensation-related charges in the amount of $816,667 resulting from the
exercise of stock appreciation rights and revaluation of options previously
granted for which terms were revised. Also included were charges related to
warrants and shares issued to consultants and advisors assisting in the planning
and development of the Company's strategic focus and finance-related matters
totaling $2,588,534. Excluding these charges, selling, general and
administrative expenses incurred in ongoing operations actually decreased by
$1,281,955. This net decrease reflected ongoing cost reduction efforts that have
resulted in decreases in compensation-related expenses of $104,425, legal and
accounting expenses of $650,927, occupancy expenses of $214,967, consulting
expenses of $220,661, and other operating expenses of $250,159. These decreases
were partially offset by an increase of $116,402 in travel related expenses
attributable to increased sales and marketing activities and an increase of
$145,131 in other operating expenses related to the annual shareholder meeting
held in September 2000.
The Company incurred product development and research expenses of
$4,336,069 during the nine months ended September 30, 2000, a decrease of
$1,942,249 from the same period in the previous year. This decrease was due
primarily to the transition in strategic focus and the resulting cost reduction
program initiated in February 1999. Decreases of $1,256,638 in
compensation-related expenses, $121,086 in occupancy costs, $251,872 in
consulting expenses and $208,024 in other operating expenses reflect cost
reduction measures.
The Company incurred purchased in-process research and development expense
of $474,000 resulting from the purchase of the rights to certain technology from
an executive officer and director of the Company. The executive officer received
warrants to purchase 600,000 shares of Class A common stock at an exercise price
of $1.00 per share.
The Company incurred losses from operations of $15,116,595 and $15,448,414
during the nine months ended September 30, 2000 and 1999, respectively. While
operating losses for the nine months ended September 30, 2000, decreased from
those incurred in the nine months ended September 30, 1999, a more significant
reduction was realized in the negative cash flow of the Company as a result of
the disposal of the HSG and decreases in cash outlays for operating expenses
described above.
Net other expense was $3,932,132 for the nine months ended September 30, 2000, a
decrease of $490,865 from the nine months ended September 30, 1999. This
decrease was due primarily to lower interest and finance charges incurred in the
nine months ended September 30, 2000, than were incurred during the
corresponding period of 1999.
Year Ended December 31, 1999, Compared to Year Ended December 31, 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.
17
<PAGE>
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 a full year
of amortization in 1999 compared to a portion of the year in 1998 from the
respective acquisition dates of AcuVoice and Papyrus to the end of the year.
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.
Year Ended December 31, 1998, Compared to Year Ended December 31, 1997
During 1998, the Company recorded revenues of $2,604,724, of which
$2,368,138 was a non-refundable license fee from an international microchip
manufacturer for which the Company has no further obligation of any kind. The
balance of revenues reflect sales and licensing fees related to TTS 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 research and development 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
18
<PAGE>
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 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 a total of approximately $567,000 will be required to
complete the AcuVoice projects. Management also estimates that the AcuVoice
projects are substantially complete as of November 15, 2000, and that the
release date will be in December 2000.
Liquidity and Capital Resources
From its inception, the Company's principal source of capital has been
private and other exempt sales of its debt and equity securities. Because the
Company has limited revenue from operations, it relies primarily on financing
through the sale of its equity and debt securities to satisfy capital
requirements. Such reliance will continue until such time as sufficient revenue
is generated through third-party licensing or co-development arrangements to
satisfy its ongoing operating requirements. There can be no assurance that the
Company will be able to secure this funding or that the terms of such financing
will be favorable to the Company. Furthermore, the issuance of equity or debt
securities which are or may become convertible into equity securities of the
Company may result in substantial dilution to the stockholders of the Company.
Total assets were $17,559,511 at September 30, 2000, compared to
$19,173,147 at December 31, 1999. Current assets increased by $410,843 to
$891,728 at September 30, 2000, from $480,885 at December 31, 1999. Current
liabilities increased by $681,714 to $5,967,395 during the same period. The
Company had negative working capital of $5,075,667 as of September 30, 2000,
compared to negative working capital of $4,804,796 at December 31, 1999. The
change in working capital from December 31, 1999, to September 30, 2000,
reflects $7,500,000 received and the $5,538,085 subsequently converted into
equity under the terms of a convertible promissory note.
19
<PAGE>
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 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. 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 the year ended December 31, 1999, the Company paid, or otherwise
reduced through agreement, notes payable to various 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.
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.
During the nine months ended September 30, 2000, 217,223 shares of
Series D convertible preferred stock together with related accrued dividends of
$255,600 were converted into 15,436,378 shares of Class A common stock. As of
November 15, 2000, 164,500 shares of Series D preferred stock remained
outstanding.
The Class A common shares underlying the original issue of the Series D
preferred stock were covered in a registration statement which was declared
effective on August 11, 1999. However, in the ensuing months, due to the accrual
of dividends and the decline in the price of the Company's Class A common stock,
the Class A common shares converted and convertible from the Series D preferred
stock exceeded the number of shares
20
<PAGE>
available under the registration statement. Under the terms of the Series D
preferred stock agreement, the holders of approximately 2,700,000 unregistered
shares were entitled to liquidated damages in the amount of 2% of the original
value of the Series D shares every 30 days while such shares were not registered
for resale. During the nine months ended September 30, 2000, the Company
recorded a preferred stock dividend in the amount of $80,000 related to such
liquidated damages. On September 5, 2000, a registration statement describing
these shares was declared effective by the SEC, and is amended by registration
statement of which this prospectus is a part.
Similarly, the holder of the remaining 164,500 shares of Series D
preferred stock was entitled to liquidated damages based upon the same
calculation until the underlying Class A common shares were registered for
resale. However, under the terms of a letter agreement dated June 30, 2000, the
holder of the Series D shares waived the liquidated damages and revised certain
terms of conversion of the Series D shares to provide a minimum conversion rate
of $0.75 until December 31, 2000. The Company issued 612,069 shares of Class A
common stock valued at $688,578 on June 30, 2000, in consideration for the
waiver and revision in terms. Of that amount, $394,800 was recorded as a
preferred dividend and the balance of $293,778 was recorded in other operating
expense. The Class A common shares issued to the holder of the Series D
preferred shares and the Class A common shares underlying the outstanding Series
D shares were also included in the registration statement that was declared
effective on September 5, 2000 by the SEC, and is amended by registration
statement of which this prospectus is a part.
Effective February 1, 2000, the Company entered into an agreement with
five investors whereby it sold a total of 290,000 shares of its Series F
convertible preferred stock for $2,750,000 in cash. 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 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 preferred stock. Using the conversion terms most beneficial to the
holders, 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
preferred stock was issued.
On May 22, 2000, the Series F investors and the Company agreed to amend
the Series F Stock Purchase Agreement adding a sixth investor and increasing the
number of Series F preferred shares issued by 26,036 shares. Other terms and
provisions of the Series F preferred stock remained the same.
During the nine months ended September 30, 2000, 309,281 shares of
Series F preferred stock together with dividends accrued thereon were converted
into 8,307,782 shares of Class A common stock. Subsequently, an additional 247
shares of Series F preferred stock were converted into 10,009 shares of Class A
common stock. As of November 15, 6,508 shares of Series F preferred stock
remained outstanding.
Equity Line of Credit
On August 8, 2000, the Company entered into a Private Equity Line
Agreement (the "Equity Line Agreement") with a private investor (the "Equity
Line Investor") that gives the Company the right to draw up to $20 million for
operations and other purposes. In connection with the Equity Line
21
<PAGE>
Agreement, up to $7.5 million may be drawn by the Company under the terms of a
convertible promissory note dated June 20, 2000. The note bears interest at six
percent annually, compounded monthly, and is due September 30, 2001. Under the
terms of the promissory note, the Equity Line Investor has the right to convert,
at its option, all or any portion of the outstanding principal and interest into
shares of Class A common stock at the lesser of (a) $0.75 or (b) 85 percent of
the average of the three lowest closing bid prices of Class A common stock in
the twenty-day trading period prior to the date of the conversion.
The balance available under the Equity Line Agreement after offsetting
draws under the promissory note described above is available to the Company
through a mechanism of drawdowns and puts of stock. The Company is entitled to
drawdown funds and to put to the Equity Line Investor shares of Class A common
stock in lieu of repayment of the drawdown. The number of shares issued is
determined by dividing the dollar amount of the drawdown by 90 percent of the
average of the two lowest closing bid prices of Class A common stock over the
seven trading-day period following the date the Company tenders the put notice.
The Equity Line Investor is required to fund the amounts requested by the
Company within two trading days after the seven trading-day period.
As of September 30, 2000, the Company had drawn $7,500,000 on the
convertible promissory note and recorded $279,586 and $516,937 as interest and
financing expense for the three months and nine months ended September 30, 2000,
respectively. Principal of $5,538,085 and interest of $87,582 accrued thereon
have been converted into 7,709,138 shares of Class A common stock. During the
three and nine months ended September 30, 2000, the Company recorded, as
interest expense a beneficial conversion feature in the amount of $3,336,388 and
$3,546,083 related to borrowings under this promissory note.
Subsequent to September 30, 2000, the remaining balance of $1,961,915
on the promissory note and accrued interest of $3,288 were converted into
3,835,637 shares of Class A common stock. Also subsequent to September 30, 2000,
an additional $800,000 was drawn on the equity line which resulted in the
issuance of 1,751,505 shares of Class A common stock.
A registration statement describing the Class A common stock issuable
in connection with draws on the Equity Line Agreement was declared effective on
September 5, 2000, by the Securities and Exchange Commission (the "SEC").
Stock Options
During the nine months ended September 30, 2000, the Company granted
options under the 1998 Plan to purchase 5,867,067 shares of Class A common stock
at exercise prices ranging from $0.28 to $1.50 per share. The term of all
options granted during this period is ten years from the date of grant. Of the
stock options issued, options to purchase 2,339,000 shares vested March 31,
2000, and the balance vest over the three years following issuance. Subsequent
to September 30, 2000, the Company granted options under the 1998 Plan to
purchase 77,000 shares of its Class A common stock at exercise prices ranging
from $0.70 to $0.91 per share.
22
<PAGE>
Also during the nine months ended September 30, 2000, options to
purchase 384,864 shares of Class A common stock were exercised resulting in cash
proceeds of $327,793. During the same period, 228,364 shares of Class A common
stock were issued as a result of the exercise of stock appreciation rights.
Subsequent to September 30, 2000, options to purchase 153,833 shares of Class A
common stock were issued resulting in cash proceeds to the Company of $139,073.
As of November 15, 2000, the Company had a total of 19,064,001 options
to purchase Class A common shares outstanding.
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, exercise prices ranging from
$0.28 to $1.25 per share and vest as follows: 100,000 in March 2000 and 200,000
in September 2000. The warrants were valued at $45,000 using the Black-Scholes
pricing model and were issued in satisfaction of an obligation that was recorded
in December 1999.
In February 2000, the Company entered into an agreement to purchase
from an 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 consideration for this technology, the Company
granted the executive officer warrants to purchase 600,000 shares of the
Company's Class A common stock at an exercise price of $1.00 per share. The
warrants are immediately exercisable and expire February 10, 2010. The warrants
were valued at $0.79 per share using the Black-Scholes pricing model and were
recorded as purchased in-process research and development. 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.
During the nine months ended September 30, 2000, warrants for the
purchase of 200,000 shares of Class A common stock were exercised resulting in
cash proceeds of $250,000. No warrants were issued or exercised between
September 30, 2000, and November 15, 2000. As of November 15, 2000, warrants for
the purchase of 3,425,000 shares of Class A common stock remain outstanding.
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.
On February 14, 2000, the Repricing Rights were exercised, resulting in
the issuance of 4,568,569 shares of Class A common stock. 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
23
<PAGE>
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 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 6,000,000 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 Guarantors' 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 had been converted to 10,385,364 shares of the
Company's Class A common stock.
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.
24
<PAGE>
Other transactions
In August 2000, the Company issued 1,000,000 shares of Class A common
stock to advisors and consultants as consideration for services rendered. The
shares were valued at $1,015,600 based upon the market value of the shares on
the date of issuance and will be recorded as general and administrative expenses
over the two-month period of the contracted services.
On June 30, 2000, the Company issued 612,069 shares of Class A common
stock (having a market value of $688,578 on that date) to the holder of the
unconverted Series D preferred stock in consideration for waiver of certain
rights and for renegotiation of certain terms relating to conversion of such
Series D preferred stock.
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 May 8, 2000, the Company issued 250,000 shares of Class A common
stock (having a market value of $312,500 on that date) to an unaffiliated third
party 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.
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 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.
25
<PAGE>
Outlook
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 and/or
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, where possible.
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, in the Company's 1999 Annual Report on Form
10-K.
Special Note Regarding Forward-Looking Statements
Certain statements contained herein under, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Outlook,"
including statements concerning (i) the Company's strategy, (ii) the Company's
expansion plans, (iii) the market for and potential applications of the
Company's technologies, (iv) the results of product development and research
efforts, and (v) the growth of the Company's business contain certain
forward-looking statements concerning the Company's operations, economic
performance and financial condition. Because such statements involve risks and
uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements. Factors that could cause such
differences include, but are not necessarily limited to, those discussed in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
Market Price of and Dividends on the Company's Class A Common Stock
Market information
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for the Company's Class A common stock as quoted on the
OTC Bulletin Board for the first three quarters of calendar 2000 and the fourth
quarter of calendar 1999, and the Nasdaq SmallCap Market for the first three
quarters of 1999 and the four quarters of 1998 and 1997. The quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commissions and may
not represent actual transactions.
26
<PAGE>
<TABLE>
<CAPTION>
Calendar Year
2000 1999 1998 1997
--------- -------- --------- ---------
High Low High Low High Low High Low
---- --- ----- --- ---- ----- ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First Quarter $ 2.50 $ 0.25 $ 3.31 $ 0.69 $ 6.50 $ 3.50 $ 9.00 $7.13
Second Quarter $ 1.81 $ 1.00 $ 0.94 $ 0.25 $ 6.34 $ 3.00 $ 8.75 $6.50
Third Quarter $ 1.39 $ 0.50 $ 1.19 $ 0.28 $ 4.00 $ 1.12 $ 7.44 $ 6.50
Fourth Quarter $ 1.00 $ 0.27 $ 2.63 $ 0.94 $ 7.00 $ 2.88
</TABLE>
The high and low sales prices for the Company's Class A common stock on
November 15, 2000, were $0.66 and $0.59, respectively.
The Company has never declared any dividends on its Class A common
stock and it is expected that earnings, if any, in future periods will be
retained to further the development and sale of the Company's technologies and
products. No dividends can be paid on the common stock of the Company until such
time as all accrued and unpaid dividends on the Company's preferred stock have
been paid.
Selected Financial Data
The selected consolidated financial data set forth below is derived
from the Company's consolidated balance sheets and statements of operations as
of and for the years ended December 31, 1999, 1998, 1997, 1996 and 1995 after
giving effect to the sale of the HSG and the classification of its operating
activities and net assets as discontinued operations. The data set forth below
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and related notes thereto included in the Company's Annual Report on
Form 10-K, which is incorporated herein by reference, and a copy of which is
available from Fonix's Investor Relations Department at the address provided on
page 6 of this prospectus.
27
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31,
1999 1998 1997 1996 1995
--------------- --------------- -------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues $ 439,507 $ 2,604,724 $ -- $ -- $ --
Selling, general and administrative 9,498,753 8,817,643 12,947,112 3,530,400 3,553,665
Product development and research 7,909,228 13,060,604 7,066,294 4,758,012 2,704,165
Amortization of goodwill and purchased core
technology 2,588,896 1,712,267 -- -- --
Purchased in-process research and development -- 9,315,000 -- -- --
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 loss from continuing operations
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>
<TABLE>
<CAPTION>
Nine Months Ended September
30,
------------------------------
2000 1999
-------------- ---------------
<S> <C> <C>
Revenues $ 372,494 $ 351,083
Selling, general and administrative 8,844,156 7,537,577
Product development and research 4,336,069 6,278,318
Amortization of goodwill and purchased core technology 1,821,409 1,962,443
Purchased in-process research and development 474,000 --
Loss from operations (15,116,595) (15,448,414)
Other expense, net (3,932,132) (4,422,997)
Loss from continuing operations (19,048,727) (19,871,411)
Gain from discontinued operations -- 662,920
Gain on extraordinary items 78,864 372,061
Net loss (18,969,863) (18,836,430)
Basic and diluted loss from continuing operations per
common share $ (0.14) $ (0.31)
Weighted average number of common shares outstanding 157,181,840 68,678,645
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
As of
September As of December 31,
---------------------------------------------------------------------
30, 2000 1999 1998 1997 1996 1995
-------------- ------------ ------------- ------------- ------------ ---------------
Balance Sheet Data:
<S> <C> <C> <C> <C> <C> <C>
Current assets $ 891,728 $ 480,885 $ 20,638,070 $ 21,148,689 $23,967,601 $ 7,912,728
Total assets 17,559,511 19,173,147 61,912,791 22,894,566 25,331,270 7,984,306
Current liabilities 5,967,395 5,285,681 35,317,045 20,469,866 19,061,081 6,674,572
Long-term debt, net of 19,727 3,971,107 -- 52,225 -- --
current portion
Stockholders' equity 11,572,389 8,086,359 24,765,746 2,372,475 6,270,189 1,309,734
</TABLE>
Index to Financial Statements of Fonix Corporation
Audited Financial Statements as of December 31, 1999 and 1998, and for Each of
the Three Years in the Period Ended December 31, 1999
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
29
<PAGE>
Notes to Consolidated Financial Statements F-11
Interim Unaudited Condensed Consolidated Financial Statements as of September
30, 2000, and December 31, 1999, and for the Three and Nine Months Ended June
30, 2000 and 1999
Condensed Consolidated Balance Sheets (Unaudited) Q-2
Condensed Consolidated Statements of Operations (Unaudited) Q-3
Condensed Consolidated Statements of Cash Flows (Unaudited) Q-4
Notes to Condensed Consolidated Financial Statements (Unaudited) Q-6
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).
Use of proceeds
All of the shares of Class A common stock underlying the Series D
preferred stock and issued in connection with the Equity Line, if and when sold,
are being offered and sold by the Selling Stockholders or their pledgees,
donees, transferees or other successors in interest. Fonix will not receive any
proceeds from those sales.
Selling Security Holders
The selling stockholders are eight separate investment entities that
are not affiliated in any way with Fonix or any of its affiliates, and neither
the selling stockholders nor any of their affiliates have any relationship of
any type with Fonix and its affiliates other than the presently established
investment relationships between the selling stockholders, on the one hand, and
Fonix, on the other hand. Six of the selling stockholders have received or may
receive shares of Fonix Class A common stock when they have converted or when
they will convert preferred stock that Fonix sold to them on August 31, 1998,
and November 13, 1998. The other selling stockholder, Queen LLC ("Queen") has
received or may receive shares of Fonix Class A common stock in connection with
the Equity Line when the Company puts its Class A common shares to Queen. The
following summary describes how the selling stockholders have received or may
receive the Shares.
March 1998 private placement
In March 1998, Fonix sold 3,333,333 shares of its Class A common stock
to the selling stockholders and one additional investor related to some of the
selling stockholders. In connection with the sale of those shares, the selling
stockholders acquired "reset" rights obligating Fonix to issue to them
additional shares of Class A common stock, referred to in this prospectus as
Reset Shares, for no additional consideration if the average market price of
Fonix's Class A common stock for the 60-day period preceding July 27, 1998 did
not equal or exceed $5.40 per share. In separate transactions in June and August
1998, certain of the selling stockholders provided $3,000,000 of additional
equity financing to Fonix, in return for which Fonix issued to them 666,667
additional shares of Class A common stock.
Series D preferred stock
Fonix and the selling stockholders entered into a Series D Preferred
Stock Purchase Agreement dated August 31, 1998 ("Series D Agreement"). Under the
Series D Agreement, Fonix issued a total of 500,000 shares of its Series D 4%
Convertible Preferred Stock to five of the selling stockholders in return for
the payment by them of a total of
30
<PAGE>
$10,000,000. Additionally, Fonix issued to all of the selling stockholders, pro
rata according to the number of shares of Class A common stock acquired by them
in the March 1998 private placement, a total of 608,334 shares of Series D
preferred stock in return for their relinquishment of their contractual right to
receive Reset Shares. In connection with the same transaction, Fonix agreed to
and did issue a total of 1,390,476 Reset Shares of Class A common stock in
respect of the $3,000,000 invested in June and August 1998 by certain of the
selling stockholders. Subsequently, on November 13, 1998, Fonix sold 50,000
additional shares of Series D preferred stock to two of the selling stockholders
on the same terms and conditions as the August 31, 1998 agreement.
Each share of Series D preferred stock has a "stated" or principal
value of $20, on which amount dividends accrue at the rate of 4% per annum and
are payable annually in cash or Class A common stock at the option of Fonix. The
Series D preferred stock is convertible into Class A common stock at anytime
after the earlier of November 29, 1998 or the date the registration statement of
which this prospectus is a part is declared effective by the Commission. Holders
of Series D preferred stock, however, may not convert during each month more
than 25% of the total number of shares of Series D preferred stock originally
issued to such holder on a cumulative basis. For example, during the first month
a holder may convert up to 25% of the total preferred stock issued to it, and
during the following month that same holder may convert, on an aggregate to date
basis, up to 50% of the total number of shares of Series D preferred stock held
by it. Additionally, any holder of Series D preferred stock may convert up to
50% of the number of shares of Series D preferred stock originally issued to it
per month, on a cumulative basis, if both of the following conditions are
satisfied:
o the average daily trading volume of Fonix Class A common stock
is more than 500,000 shares for the 10-trading-day period
before the conversion; and
o the average per share closing bid price for such
10-trading-day period has not decreased by more than 5% from
the closing bid price on the trading day immediately preceding
the first day of such 10-trading- day period.
Each share of Series D preferred stock is convertible into that number
of shares of Class A common stock as is determined by dividing $20 by the lesser
of any of the following at the option of the converting holder:
1. $3.50, or
2. the lesser of
o $2.3375, which is 110% of the average per share closing
bid price for the 15 trading days immediately preceding
August 31, 1998; or
o 90% of the average of the 3 lowest per share closing
bid prices during the 22 trading days immediately
preceding the conversion date.
If the converting holder elects conversion option 1, in addition to the shares
of Class A common stock issued upon the conversion, the converting holder will
receive a warrant to purchase 0.8 shares of Class A common stock. Those warrants
will have an exercise price that will be 120% of the per share closing bid price
of Fonix Class A common stock on the date the warrants are issued and will have
a 3-year term. Any shares of Series D preferred stock not converted as of August
31, 2001 will automatically be converted into Class A common stock according to
whichever of the conversion formulas above yields the greatest number of shares
of Class A common stock.
As of November 15, 2000, 843,835 shares of Series D preferred stock had
been converted into 62,688,649 shares of Class A common stock, including amounts
issued as payment of dividends accrued on the Series D preferred stock
converted.
Additionally, Fonix entered into a registration rights agreement with
the purchasers of the Series D preferred stock under which Fonix must register
the Class A common stock issuable upon conversion of the Series D preferred
stock, payment of stock dividends on the Series D preferred stock and exercise
of any warrants issued upon conversion
31
<PAGE>
of the Series D preferred stock. Fonix also covenanted to reserve out of its
authorized and unissued shares of Class A common stock no less than that number
of shares that would be issuable upon the conversion of the Series D preferred
stock and any dividends payable in stock on the preferred stock and the exercise
of the warrants, if any.
Fonix filed a registration statement covering the shares underlying the
Series D preferred stock and the Series E preferred stock, which was declared
effective on August 11, 1999. Subsequently, all of the Series E preferred stock
and all but 164,500 shares of the Series D preferred stock were converted into
shares of the Company's Class A common stock. The holders of the Series D and
Series E preferred stock sold the majority of the Class A common stock received
upon conversion and as payment of dividends accrued on the Series D and Series E
preferred stock under the previous registration statement. However, due to the
passage of time, the accrual of dividend shares over time, and the performance
of the stock price of the Company's Class A common stock, the Series D preferred
stock has been converted and is presently convertible into more shares than
remain available under the previous registration statement. Additionally, in
July 2000, the Company issued 612,069 shares of its Class A common stock to the
holder of the unconverted Series D preferred stock in consideration for waiver
of certain rights and renegotiation of certain terms pertaining to the Series D
preferred stock.
Accordingly, this registration statement, and the related prospectus,
cover, in part, approximately 2,700,000 shares of Class A common stock issued in
connection with prior conversions of Series D preferred stock and dividends
accrued thereon, the shares of Class A common stock underlying the remaining
164,500 shares of Series D preferred stock and shares issuable for dividends
accrued thereon to date, and the 612,069 shares of Class A common stock issued
in connection with the renegotiation of the Series D preferred stock terms.
Equity Line of Credit
Additionally, on August 8, 2000, the Company entered into a Private
Equity Line Agreement (the "Equity Line Agreement") with Queen LLC, a private
investor (the "Equity Line Investor"). Under the Equity Line Agreement, the
Company has the right to draw down from the Equity Line Investor up to $20
million. The initial $7.5 million are secured by a Promissory Note (the "Note"),
bearing interest at a rate of 6%, compounded monthly, with interest accruing on
each amount funded as of the date of the advancement of such funds by the Equity
Line Investor. The Note is due June 30, 2001. Under the Note, the Equity Line
Investor has the right (the "Conversion Right") to convert at its option all or
a portion of the outstanding principal and interest into shares of its Class A
common stock as follows:
- The number of shares of Class A common stock to be issued is determined
by dividing the amount of principal and accrued interest being
converted by the lesser of (a) $0.75 or (b) 85% of the average of the
three lowest closing bid prices of the Company's Class A Common Stock
in the 20 day trading period prior to the exercise of the Conversion
Right, and rounding to the nearest whole share.
The remaining $12.5 million is available to the Company through a
mechanism of drawdowns and puts of stock. The Company is entitled under the
Equity Line Agreement to drawdown certain funds and to put to the Equity Line
Investor shares of its Class A common stock in lieu of repayment of the
drawdown. The number of shares to be issued is determined by dividing the amount
of the drawdown by 90% of the average of the two lowest closing bid prices of
the Company's Class A common stock over a seven trading day period consisting of
the seven trading days after the put notice is tendered. The Equity Line
Investor is required under the Equity Line Agreement to tender the funds
requested by the Company within two trading days after the seven-day period used
to determine the market price.
In connection with the Equity Line Agreement, Fonix granted
registration rights to the Equity Line Investor, in connection with which, Fonix
has filed this registration statement. Fonix is required to file a registration
statement covering the shares to be issued under the Equity Line Agreement
within thirty days of the execution of the Equity Line Agreement, and to use its
best efforts to cause the registration statement to be declared effective by
October 15, 2000.
The registration statement was declared effective on September 5, 2000.
32
<PAGE>
As of November 15, 2000, the Company had drawn the full $7,500,000 on
the Note, and the Equity Line Investor had converted principal of $7,500,000 and
interest of $90,879 into 11,544,775 shares of Class A common stock.
Additionally, as of November 15, 2000, the Company has drawn down $800,000 on
the equity line, which resulted in the issuance of 1,751,505 shares of the
Company's Class A common stock .
Consulting Agreement
The Company issued 250,000 shares of its Class A common stock to an
unaffiliated third party as payment for consulting services. The Company also
agreed to register the sale of these shares into the market, and such shares of
Class A common stock are covered by this registration statement and the related
prospectus.
The following table provides information about the actual and potential
ownership of shares of Fonix Class A common stock by the Selling Stockholders in
connection with the Series D preferred stock offering and the Equity Line of
Credit and the Note as of November 15, 2000, and the number of such shares
included for sale in this Prospectus. The number of shares of Class A common
stock issuable upon conversion of the Series D preferred stock and under the
Equity Line varies according to the market price at and immediately preceding
the conversion date. Solely for purposes of estimating the number of shares of
Class A common stock that would be issuable to the Selling Stockholders as set
forth in the table below, Fonix and the Selling Stockholders have assumed a
hypothetical conversion of all of the remaining Series D preferred stock owned
by the Selling Stockholders as of November 15, 2000, on which date the
conversion price would have been $0. 58. Similarly, Fonix and the Selling
Stockholders have assumed a hypothetical put by Fonix of the full remaining
$11,700,000 under the Equity Line as of November 15, on which date the
conversion price would have been $0.58. The actual conversion price and the
number of Shares issuable upon such conversions or put by the Company could
differ substantially.
Additionally, the majority of the shares listed below as received upon
conversion of the Series D preferred stock and Series E preferred stock have
been or may be sold by the selling stockholder under the prior registration
statement on Form S-3 which was declared effective August 11, 1999. As noted
above, that registration statement registered the sale of 68,358,424 shares
issuable in connection with the Series D preferred stock and Series E preferred
stock financings. To date, all of the shares of the Series E preferred stock
have been converted into 8,320,890 shares of Class A common stock, and 843,835
shares of Series D preferred stock have been converted into 62,688,649 shares of
Class A common stock. Accordingly, there remain approximately 2,700,000 shares
of Class A common stock which have been received pursuant to prior conversions,
as well as the shares of Class A common stock underlying the remaining 164,500
shares of Series D preferred common stock, together with shares issuable as
dividends accrued and accruing on those shares, which are covered by this
prospectus. Although each of the investors in the Series D and Series E
preferred stock is identified as a selling stockholder in this prospectus and in
the table below, one or more of such selling shareholders may have sold all of
the shares of Class A common stock received in connection with the conversion of
the Series D and Series E preferred stock, and as such, may not sell any shares
under this prospectus.
Under the terms and conditions of the Series D preferred stock and the
Equity Line Agreement, a Selling Stockholder is prohibited from converting such
preferred stock or having shares put to them under the Equity Line to the extent
such conversion by such person or put by the Company would result in that person
beneficially owning more than 4.999% of the then outstanding shares of Fonix
Class A common stock following such conversion. This restriction may be waived
by a Selling Stockholder as to itself, but not as to other holders of such
preferred stock, and only upon
33
<PAGE>
not less than 75 days' notice to Fonix. This restriction does not prevent such
holders from either waiving such limitation or converting or receiving put
shares and selling some of their convertible security position and thereafter
converting the rest or another significant portion of their holding or receiving
additional put shares. In this way, individual holders of the Series D preferred
stock and the Equity Line investor could sell more than 4.999% of the
outstanding Fonix Class A common stock in a relatively short time frame while
never beneficially owning more than 4.999% of the outstanding Fonix Class A
common stock at a time. For purposes of calculating the number of shares of
Class A common stock issuable to each Selling Stockholder assuming a full
conversion of all the Series D preferred stock held by it and a put of the full
amount under the Equity Line, as set forth below, the effect of such 4.999%
limitation has been disregarded. The number of shares issuable to each of the
Selling Stockholders as described in the table below therefore may exceed the
actual number of shares such Selling Stockholders may be entitled to
beneficially own upon conversion of the Series D preferred stock or under the
Equity Line. The following information is not determinative of any Selling
Stockholder's beneficial ownership of Fonix Class A common stock pursuant to
Rule 13d-3 or any other provision under the Securities Exchange Act of 1934, as
amended.
<TABLE>
<CAPTION>
Shares of
Class A Percentage
Common Stock of Class A
Owned by or Common Number of Percentage
Issuable to Stock Owned Shares of of Class A
Selling By or Number of Class A Common Stock
Stockholders Issuable to Shares of Common Stock Beneficially
Name of Selling Stockholders From Series D Selling Class A Owned After Owned After
or Equity Stockholders Common Stock Offering the Offering
Line Prior to Prior to Offered
Offering Offering (1) Hereby (2)
-------------------------------------- --------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Diversified Strategies Fund, L.P. 1,679,805 (3) 1.01% 1,679,805 (4) (5) (5)
Dominion Capital Fund Ltd 20,154,989 (6) 11.18% 15,832,576 (7) (5) (5)
Sovereign Partners LP 23,450,624 (8) 13.01% 19,452,146 (9) (5) (5)
JNC Opportunity Fund Ltd. 23,500,513 (10) 13.39% 5,316,421 (11) (5) (5)
Canadian Advantage Limited 2,897,407 (12) 1.61% 2,897,407 (13) (5) (5)
Partnership
Queen LLC 33,608,780 (14) 15.84% 33,608,780 (14) (5) (5)
Endeavour Capital Fund, S.A. 4,643,237 (15) 2.58% 4,643,237 (15) (5) (5)
JNC Straregic Fund Ltd. 250,000 (16) 0.14% 250,000 (16) (5) (5)
</TABLE>
(1) As noted above, the Selling Stockholders are prohibited by the terms
of the Series D preferred stock and the Equity Line Agreement from
converting such preferred stock or having shares put to them under
the Equity Line to the extent that such conversion by such person or
put of shares by the Company would result in that person beneficially
owning more than 4.999% of the then outstanding shares of Fonix Class
A common stock following such conversion. The percentages set forth
are not determinative of any Selling Stockholder's beneficial
ownership of Fonix Class A common stock pursuant to Rule 13d-3 or any
other provision under the Securities Exchange Act of 1934, as
amended.
(2) The registration statement of which this prospectus is a part covers
up to 53,185,889 shares of Class A common stock issued under the
Equity Offering and issuable upon the conversion of the Series D
preferred stock, as payment in shares of Fonix Class A common stock
payable as dividends on the Series D preferred stock, and issuable
under the Equity Line. Because the specific circumstances of the
conversions of the Series D preferred stock and issuances under the
Equity Line are unascertainable at this time, the precise total
number of shares of Fonix Class A common stock offered by each
Selling Stockholder cannot be fixed. The numbers set forth below
represent the number of shares of Fonix Class A common stock that
have been issued and that would be issuable, and hence offered
hereby, assuming the conversion of the remaining 164,500 shares of
the Series D preferred stock, together with the approximately
2,700,000 shares of Class A common stock issued pursuant to
conversions of Series D preferred stock which exceeded the shares
registered under the prior registration statement, and a put of the
full amount under the Equity Line as of November 15, 2000. The actual
number of shares of Fonix Class A common stock offered hereby may
differ according to the actual number of shares issued upon such
conversions.
(3) Includes:
1,679,805 shares of Class A common stock issued upon conversion
of 20,278 shares of Series D preferred stock as of
November 15, 2000, together with shares issued as
payment of dividends accrued thereon.
34
<PAGE>
(4) Includes:
1,679,805 shares of Class A common stock issued upon conversion
of 20,278 shares of Series D preferred stock as of
November 15, 2000, together with shares issued as
payment of dividends accrued thereon.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, there is no guarantee that this
investor will sell any shares under this prospectus.
The number listed above refers to all shares of Class A
common stock received by this investor upon prior
conversion of its shares of Series D preferred stock.
(5) There is no assurance that the Selling Stockholders will sell any or
all of the shares offered hereby.
(6) Includes:
4,322,413 shares of Class A common stock issued upon conversion
of 125,000 shares of Series E preferred stock as of
November 15, 2000, together with shares issued as
payment of dividends accrued thereon; and
15,832,576 shares of Class A common stock issued upon
conversion of 187,500 shares of Series D
preferred stock as of November 15, 2000,
together with shares issued as payment of
dividends accrued thereon.
(7) Includes:
15,832,576 shares of Class A common stock issued upon
conversion of 187,500 shares of Series D
preferred stock as of November 15, 2000,
together with shares issued as payment of
dividends accrued thereon.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, there is no guarantee that this
investor will sell any shares under this prospectus.
The number listed above refers to all shares of Class A
common stock received by this investor upon prior
conversion of its shares of Series D preferred stock.
(8) Includes:
3,998,478 shares of Class A common stock issued upon conversion
of 125,000 shares of Series E preferred stock as of
November 15, 2000, together with shares issued as
payment of dividends accrued thereon; and
19,452,146 shares of Class A common stock issued upon
conversion of 243,139 shares of Series D
preferred stock as of November 15, 2000,
together with shares issued as payment of
dividends accrued thereon.
(9) Includes:
19,452,146 shares of Class A common stock issued upon
conversion of 243,139 shares of Series D
preferred stock as of November 15, 2000,
together with shares issued as payment of
dividends accrued thereon.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, there is no guarantee that this
investor will sell any shares under this prospectus.
The number listed above refers to all shares of Class A
common stock received by this investor upon prior
conversion of its shares of Series D preferred stock.
(10) Includes:
18,184,092 shares of Class A common stock issued upon conversion
of 268,000 shares of Series D preferred stock,
together with shares issued as payment of dividends
accrued thereon; and
4,704,352 shares of Class A common stock issuable upon
a hypothetical conversion of 164,500 shares
of Series D preferred stock owned by the
Selling Stockholder as of November 15, 2000,
together with shares issuable as payment of
dividends accrued thereon; and
612,069 shares of Class A common stock issued in exchange for
waiver of certain rights and renegotiation of certain
terms of the Series D preferred stock.
(11) Includes:
4,704,352 shares of Class A common stock issuable upon
a hypothetical conversion of 164,500 shares
of Series D preferred stock owned by the
Selling Stockholder as of November 15, 2000,
together with shares issuable as payment of
dividends accrued thereon; and
612,069 shares of Class A common stock issued in exchange for
waiver of certain rights and renegotiation of certain
terms of the Series D preferred stock.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, the number of shares which this
investor could sell under this prospectus could include
some or all of the approximately 2,700,000 shares which
have been issued in connection with prior conversions
of the Series D preferred stock, but there is no
guarantee that this investor owns any of such shares.
The number of shares listed above refers to all shares
of Class A common stock received by this investor upon
prior conversion of its shares of Series D preferred
stock, together with those shares issuable upon a
hypothetical conversion of 164,500 shares of Series D
preferred stock.
(12) Includes:
2,897,407 shares of Class A common stock issued upon conversion
of 57,111 shares of Series D preferred stock, together
with shares issued as payment of dividends accrued
thereon.
(13) Includes:
35
<PAGE>
2,897,407 shares of Class A common stock issued upon conversion
of 57,111 shares of Series D preferred stock, together
with shares issued as payment of dividends accrued
thereon.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, there is no guarantee that this
investor will sell any shares under this prospectus.
The number listed above refers to all shares of Class A
common stock received by this investor upon prior
conversion of its shares of Series D preferred stock.
(14) Includes:
11,544,775 shares of Class A common stock
issued in connection with the
exercise of the conversion right
under the Note as of November 15,
2000, of the full $7,500,000 face
amount of the Note, together with
interest accrued thereon;
1,751,505 shares of Class A common stock issued in connection
with a puts by the Company under the Equity Line
totaling $800,000; and
20,312,500 shares of Class A common stock issuable in connection
with a hypothetical put as of November 15, 2000, by the
Company of the remaining $11,700,000 to this investor.
(15) Includes:
4,643,237 shares of Class A common stock issued upon conversion
of 52,722 shares of Series D preferred stock, together
with shares issued as payment of dividends accrued
thereon.
As noted above, there remain approximately 2,700,000
shares of Class A common stock issued upon conversion
of Series D preferred stock which are covered by this
prospectus. This investor may own all, some, or none of
such shares. As such, there is no guarantee that this
investor will sell any shares under this prospectus.
The number listed above refers to all shares of Class A
common stock received by this investor upon prior
conversion of its shares of Series D preferred stock.
(16) Includes:
250,000 shares of Class A common stock issued as payment for
consulting services rendered to the Company.
The following table lists the natural persons who control each of the
Selling Stockholders.
Selling Stockholder Name of Natural Person Who Controls
---------------------------------------- ---------------------------------------
Dominion Capital Fund, Ltd. Nina Ray and Carl O' Connell
Sovereign Partners, LP Steven M. Hicks and Daniel Pickett
Diversified Strategies Fund, L.P. Neil T. Chau and James Q. Chau
JNC Opportunity Fund Ltd. Neil T. Chau and James Q. Chau
Queen LLC David Sims
Canadian Advantage Limited Partnership Mark Valentine and Ian McKinnon
Endeavour Capital Fund, S.A. Shmuli Margulies
JNC Strategic Fund Ltd. Neil T. Chau and James Q. Chau
Plan of distribution
Once the registration statement of which this prospectus is part becomes
effective with the Commission, the Shares covered by this prospectus may be
offered and sold from time to time by the Selling Stockholders or their
pledgees, donees, transferees or successors in interest. Such sales may be made
on the OTC Bulletin Board, in the over-the-counter market or otherwise, at
prices and under terms then prevailing or at prices related to the then current
market price, or in negotiated transactions. The Shares may be sold by any means
permitted under law, including one or more of the following:
36
<PAGE>
o a block trade in which a broker-dealer engaged by the Selling
Stockholder will attempt to sell the Shares as agent, but may position
and resell a portion of the block as principal to facilitate the
transaction;
o purchases by a broker-dealer as principal and resale by such
broker-dealer for its account under this prospectus;
o an over-the-counter distribution in accordance with the rules of the
OTC Bulletin Board;
o ordinary brokerage transactions in which the broker solicits
purchasers; and
o privately negotiated transactions.
In effecting sales, broker-dealers engaged by the Selling Stockholders may
arrange for other broker-dealers to participate in the resales.
In connection with distributions of the Shares or otherwise, the Selling
Stockholders may enter into hedging transactions with broker-dealers. In
connection with such transactions, broker-dealers may engage in short sales of
the Shares covered by this prospectus in the course of hedging the positions
they assume with the Selling Stockholders. The Selling Stockholders may also
sell the Shares short and redeliver the Shares to close out such short
positions. The Selling Stockholders may also enter into option or other
transactions with broker-dealers which require the delivery to the broker-dealer
of the Shares, which the broker-dealer may resell or otherwise transfer under
this prospectus. The Selling Stockholders may also loan or pledge the Shares
registered hereunder to a broker-dealer and the broker-dealer may sell the
shares so loaned or upon a default the broker-dealer may effect sales of the
pledged shares pursuant to this prospectus.
Broker-dealers or agents may receive compensation in the form of
commissions, discounts or concessions from the Selling Stockholders in amounts
to be negotiated in connection with the sale. Such broker-dealers and any other
participating broker-dealers may be deemed to be "underwriters" within the
meaning of the Securities Act, in connection with such sales and any such
commission, discount or concession may be deemed to be underwriting discounts or
commissions under the Securities Act.
Fonix has advised the Selling Stockholders that the anti-manipulation rules
under the Securities Exchange Act of 1934 may apply to sales of shares in the
market and to the activities of the Selling Stockholders and their affiliates.
In addition, Fonix will make copies of this prospectus available to the Selling
Stockholders and has informed them of the need for delivery of copies of this
prospectus to purchasers at or prior to the time of any sale of the Shares
offered hereby.
All costs, expenses and fees in connection with the registration of the
shares will be borne by Fonix. Commissions and discounts, if any, attributable
to the sales of the Shares will be borne by the Selling Stockholders. The
Selling Stockholders may agree to indemnify any broker-dealer or agent that
participates in transactions involving sales of the Shares against certain
liabilities, including liabilities arising under the Securities Act of 1933.
Fonix will not receive any proceeds from the sale of the Shares.
Fonix has agreed with the Selling Stockholders to keep the registration
statement of which this prospectus constitutes a part effective for a period of
3 years. Trading of any unsold shares after the expiration of such period will
be subject to compliance with all applicable securities laws, including Rule
144.
The Selling Stockholders are not obligated to sell any or all of the Shares
covered by this prospectus.
In order to comply with the securities laws of certain states, the Shares
will be sold in such jurisdictions only through registered or licensed brokers
or dealers. In addition, the sale and issuance of Shares may be subject to the
notice filing requirements of certain states.
Legal matters
37
<PAGE>
The validity of the Shares offered hereby will be passed upon for Fonix by
Durham Jones & Pinegar, P.C., 111 East Broadway, Suite 900, Salt Lake City, Utah
84111.
38
<PAGE>
Table of Contents
Summary about Fonix and this offering..........................................2
Recent developments............................................................5
Important information incorporated by reference................................5
Where to get additional information............................................6
Explanation about forward-looking information..................................7
Risk factors...................................................................8
Information about Fonix Corporation...........................................14
Management's discussion and analysis of financial condition
and results of operations................................................14
Special note regarding forward looking statements.............................23
Market price of and dividends on the Company's Class A
common stock.............................................................23
Selected financial data.......................................................24
Index to financial statements of Fonix Corporation............................25
Changes in and disagreements with accountants on
accounting and financial disclosure......................................26
Use of proceeds...............................................................26
Selling stockholders..........................................................26
Plan of distribution..........................................................32
Legal matters.................................................................33
--------------------
Fonix Corporation
53,185,889
SHARES
CLASS A COMMON STOCK
--------------------
PROSPECTUS
-------------------
November 15, 2000
39
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the various expenses to be incurred in
connection with the sale and distribution of the securities being registered
hereby, all of which will be borne by the Company. All amounts shown are
estimates except the Securities and Exchange Commission registration fee.
Filing Fee - Securities and Exchange Commission $ 21,210
Legal fees and expenses of the Company 30,000
Accounting fees and expenses 42,500
Blue Sky fees and expenses --
Printing expenses 500
Miscellaneous expenses 5,000
----------
Total Expenses $ 99,210
==========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Subsection (a) of Section 145 of the General Corporation Law of the
State of Delaware empowers a corporation to indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that he is or was a director, officer, employee or agent of
the corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit or proceeding if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe his conduct was unlawful.
Subsection (b) of Section 145 empowers a corporation to indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action or suit by right of the corporation to
procure a judgment in its favor by reason of the fact that such person acted in
any of the capacities set forth above, against expenses (including attorneys'
fees) actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
corporation, except that no indemnification may be made in respect to any claim
issue or matter as to which such person shall have been adjudged to be liable to
the corporation unless and only to the extent that the Court of Chancery or the
court in which such action or suit was brought shall determine upon application
that, despite the adjudication of liability but in view of all the circumstances
of the case, such person is fairly and reasonably entitled to indemnity for such
expenses which the Court of Chancery or such other court shall deem proper.
II-1
<PAGE>
Section 145 further provides that to the extent a director or officer
of a corporation has been successful on the merits or otherwise in the defense
of any such action, suit or proceeding referred to in subsections (a) and (b) of
Section 145 or in the defense of any claim, issue or matter therein, he shall be
indemnified against expenses (including attorneys' fees) actually and reasonably
incurred by him in connection therewith; that the indemnification provided for
by Section 145 shall not be deemed exclusive of any other rights which the
indemnified party may be entitled; that indemnification provided by Section 145
shall, unless otherwise provided when authorized or ratified, continue as to a
person who has ceased to be a director, officer, employee or agent and shall
inure to the benefit of such person's heirs, executors and administrators; and
empowers the corporation to purchase and maintain insurance on behalf of a
director or officer of the corporation against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the corporation would have the power to indemnify him
against such liabilities under Section 145.
Section 102(b)(7) of the General Corporation Law or the State of
Delaware provides that a certificate of incorporation may contain a provision
eliminating or limiting the personal liability of a director to the corporation
or its stockholders for monetary damages for breach of fiduciary duty as a
director, provided that such provision shall not eliminate or limit the
liability of the director (i) for any breach of the director's duty of loyalty
to the corporation or its stockholders, (ii) for acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
(iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any
transaction from which the director derived an improper personal benefit.
Article Ninth of the registrant's Charter provides that, the registrant
shall, "to the fullest extent permitted by Section 145 of the General
Corporation Law of the State of Delaware, as the same may be amended and
supplemented, indemnify any and all persons whom it shall have power to
indemnify under said section from and against any and all of the expenses,
liabilities or other matters referred to in or covered by said section, and the
indemnification provided for herein shall not be deemed exclusive of any other
rights to which those indemnified may be entitled under any By-Law, agreement,
vote of stockholders or disinterested Directors or otherwise, both as to action
in his official capacity and as to action in another capacity while holding such
office, and shall continue as to a person who has ceased to be director,
officer, employee or agent and shall inure to the benefit of the heirs,
executors and administrators of such a person."
Article VII, Section 7 of the registrant's Bylaws further provides that
the registrant "shall indemnify its officers, directors, employees and agents to
the extent permitted by the General Corporation Law of Delaware."
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
II-2
<PAGE>
ITEM 16. LIST OF EXHIBITS.
5 Opinion of Durham Jones & Pinegar, P.C.*
23.1 Consent of Durham Jones & Pinegar, P.C., included in Exhibit 5 filed
previously.*
23.2 Consent of Arthur Andersen LLP
23.3 Consent of Pritchett, Siler & Hardy P.C.
24 Power of Attorney (See page II-5 of this Registration Statement)
99.1 Securities Purchase Agreement by and among Fonix Corporation and JNC
Strategic Fund Ltd., dated December 21, 1998*
99.2 Securities Purchase Agreement among Fonix Corporation and the investors
identified therein dated January 29, 1999, as supplemented on March 3,
1999*
99.3 Amended and Restated Securities Purchase Agreement among Fonix
Corporation and the investors identified therein dated May 22, 2000*
99.4 Equity Line Agreement between Fonix Corporation and Queen LLC, dated
August 8, 2000.*
-------------------
*filed previously
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933, as amended (the "Securities Act");
(ii) To reflect in the prospectus any facts or events arising
after the effective date of this Registration Statement (or the most
recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in this Registration Statement. Notwithstanding the foregoing, any
increase or decrease in the volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any derivation from the low or high end of the
estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more than 20
percent change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the Registration Statement;
and
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in this Registration
Statement or any material change to such information in this
Registration Statement; provided, however, that paragraphs (1)(i) and
II-3
<PAGE>
(1)(ii) do not apply if the information required to be included in a
post-effective amendment by those paragraphs is contained in periodic
reports filed by the Company pursuant to Section 13 or Section 15(d) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
that are incorporated by reference in this Registration Statement.
(2) That, for the purposes of determining any liability under the
Securities Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at the time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
The Company hereby undertakes that, for purposes of determining any
liability under the Securities Act, each filing of the Company's annual report
pursuant to Section 13(a) or 15(d) of the Exchange Act (and, where applicable,
each filing of an employee benefit plan's annual report pursuant to Section
15(d) of the Exchange Act) that is incorporated by reference in this
Registration Statement shall be deemed to be a new registration statement
relating to the securities offered therein and the offering of such securities
at the time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Corporation pursuant to the indemnification provisions described herein, or
otherwise, the Company has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Company of expenses incurred or paid by a director, officer or
controlling person of the Company in the successful defense of any action, suit
or proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Company will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the city of Salt Lake City, State of Utah, on this 20th day of
November, 2000.
Fonix Corporation
By:/s/ Thomas A. Murdock
---------------------------
Thomas A. Murdock
President, Chief Executive
Officer
II-5
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the date indicated.
Signature Title Date
------------ ---------------------- ------
/s/ Thomas A. Murdock Chief Executive Officer, President,
-------------------------- Chairman of the Board of Directors
Thomas A. Murdock (Principal Executive Officer) November 20, 2000
/s/ Roger D. Dudley Executive Vice President, Chief November 20, 2000
-------------------------- Financial Officer, and Director
Roger D. Dudley (Principal Financial Officer and
Principal Accounting Officer)
/s/ John A. Oberteuffer Director November 20, 2000
--------------------------
John A. Oberteuffer, Ph.D.
/s/ William A. Maasberg, Jr. Director November 20, 2000
--------------------------
William A. Maasberg Jr.
/s/ Mark L. Tanner Director November 20, 2000
--------------------------
Mark L. Tanner
II-6
<PAGE>
EXHIBIT INDEX
5 Opinion of Durham Jones & Pinegar, P.C.*
23.1 Consent of Durham Jones & Pinegar, P.C., included in Exhibit 5 filed
previously.*
23.2 Consent of Arthur Andersen LLP
23.3 Consent Pritchett, Siler & Hardy P.C.
24 Power of Attorney (See page II-5 of this Registration Statement)
99.1 Securities Purchase Agreement by and among Fonix Corporation and JNC
Strategic Fund Ltd., dated December 21, 1998*
99.2 Securities Purchase Agreement among Fonix Corporation and the investors
identified therein dated January 29, 1999, as supplemented on March 3,
1999*
99.3 Amended and Restated Securities Purchase Agreement among Fonix
Corporation and the investors identified therein dated May 22, 2000*
99.4 Equity Line Agreement between Fonix Corporation and Queen LLC, dated
August 8, 2000.*
-----------------
*previously filed
II-7
<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
Interim Unaudited Condensed Consolidated Financial Statements as of June 30,
2000, and December 31, 1999, and for the Three and Six Months Ended June 30,
2000 and 1999
Condensed Consolidated Balance Sheets (Unaudited) - As of September 30, 2000
and December 31, 1999...................................................Q-2
Condensed Consolidated Statements of Operations (Unaudited) for the
Three and Nine Months Ended September 30, 2000 and 1999 and for
the CumulativePeriod from October 1, 1993 (Date of Inception)
through September 30, 2000..............................................Q-3
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months Ended September 30, 2000 and 1999 and for the
Cumulative Period from October 1, 1993 (Date of Inception)
through September 30, 2000..............................................Q-4
Notes to Condensed Consolidated Financial Statements (Unaudited).............Q-6
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Fonix Corporation:
We have audited the accompanying consolidated balance sheets of Fonix
Corporation (a Delaware corporation in the development stage) and subsidiaries
as of December 31, 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
<PAGE>
Condensed Consolidated Balance Sheets (Unaudited) - As of September 30, 2000
and December 31, 1999...................................................Q-2
Condensed Consolidated Statements of Operations (Unaudited) for the
Three and Nine Months Ended September 30, 2000 and 1999 and for
the CumulativePeriod from October 1, 1993 (Date of Inception)
through September 30, 2000..............................................Q-3
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months Ended September 30, 2000 and 1999 and for the
Cumulative Period from October 1, 1993 (Date of Inception)
through September 30, 2000..............................................Q-4
Notes to Condensed Consolidated Financial Statements (Unaudited).............Q-6
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
2000 1999
--------------- ---------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 637,736 $ 232,152
Accounts receivable, net of allowance for doubtful accounts of $20,000
in 2000 and 1999 54,626 184,901
Prepaid expenses 183,692 51,747
Interest and other receivables 15,674 10,539
Inventory - 1,546
--------------- ---------------
Total current assets 891,728 480,885
Funds held in escrow 2,120,078 2,038,003
Property and equipment, net of accumulated depreciation of $2,433,827 and
$1,938,494, respectively 886,803 1,148,802
Intangible assets, net of accumulated amortization of $6,236,129 and
$4,392,457, respectively 13,555,921 15,399,593
Other assets 104,981 105,864
--------------- ---------------
Total assets $ 17,559,511 $ 19,173,147
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Advances $ - $ 1,000,000
Note payable 1,961,915 -
Notes payable - related parties 77,625 77,625
Accounts payable 822,672 1,359,040
Accrued liabilities 735,101 857,033
Accrued liabilities - related parties 1,626,633 1,814,134
Capital lease obligation, current portion 44,135 -
Income taxes payable 22,394 50,000
Deferred revenues 676,920 127,849
--------------- ---------------
Total current liabilities 5,967,395 5,285,681
Capital lease obligation, net of current portion 19,727 -
Series C 5% convertible debentures - 3,971,107
--------------- ---------------
Total liabilities 5,987,122 9,256,788
--------------- ---------------
Common stock and related repricing rights subject to redemption;
1,801,802 shares and repricing rights outstanding in 1999
(aggregate redemption value of $2,500,000) - 1,830,000
--------------- ---------------
Commitments and contingencies (Notes 11 and 12)
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; 164,500 and 381,723
shares outstanding, respectively
(aggregate liquidation preference of $3,568,188) 4,022,214 9,095,910
Series F, 6% cumulative convertible; 6,755 shares outstanding
(aggregate liquidation preference of $140,550) 140,550 -
Common stock, $.0001 par value; 300,000,000 shares authorized;
Class A voting, 174,519,655 and 123,535,325 shares
outstanding, respectively 17,452 12,353
Class B non-voting, none outstanding - -
Additional paid-in capital 142,862,961 112,769,420
Outstanding warrants 3,130,180 2,850,530
Deferred consulting expense - (435,051)
Deficit accumulated during the development stage (139,100,968) (116,706,803)
--------------- ---------------
Total stockholders' equity 11,572,389 8,086,359
--------------- ---------------
Total liabilities and stockholders' equity $ 17,559,511 $ 19,173,147
=============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-2
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Three Months Ended Nine Months Ended (Inception) to
September 30, September 30, September 30,
---------------------------- -------------------------
2000 1999 2000 1999 2000
------------- ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C> <C>
Revenues $ 172,222 $ 65,707 $ 372,494 $ 351,083 $ 3,416,725
Cost of revenues 6,856 7,919 13,455 21,159 73,827
------------- ------------ -------------- ------------ -------------
Gross margin 165,366 57,788 359,039 329,924 3,342,898
------------- ------------ -------------- ------------ -------------
Expenses:
Selling, general and administrative 3,050,235 2,864,400 8,844,156 7,537,577 49,407,222
Product development and research 1,406,949 1,906,968 4,336,069 6,278,318 43,243,194
Amortization of goodwill and purchased core technology 607,136 630,609 1,821,409 1,962,443 6,122,572
Purchased in-process research and development - - 474,000 - 9,789,000
------------- ------------ -------------- ------------ -------------
Total expenses 5,064,320 5,401,977 15,475,634 15,778,338 108,561,988
------------- ------------ -------------- ------------ -------------
Loss from operations (4,898,954) (5,344,189) (15,116,595) (15,448,414) (105,219,090)
------------- ------------ -------------- ------------ -------------
Other income (expense):
Interest income 35,134 26,198 98,371 46,752 3,860,482
Interest expense (3,617,249) (1,577,413) (4,097,989) (4,314,809) (13,057,688)
Other 29,631 (154,940) 67,486 (154,940) (89,859)
Cancellation of common stock reset provision - - - - (6,111,577)
------------- ------------ -------------- ------------ -------------
Total other income (expense), net (3,552,484) (1,706,155) (3,932,132) (4,422,997) (15,398,642)
------------- ------------ -------------- ------------ -------------
Loss from continuing operations before income tax benefit (8,451,438) (7,050,344) (19,048,727) (19,871,411) (120,617,732)
Income tax benefit - - - - 3,331,895
------------- ------------ -------------- ------------ -------------
Loss from continuing operations (8,451,438) (7,050,344) (19,048,727) (19,871,411) (117,285,837)
Discontinued operations:
Operating loss of HealthCare Solutions Group - (2,962,147) - (5,953,726) (12,229,033)
Gain on disposal of HealthCare Solutions Group,
net of income taxes of $3,100,000 - 6,616,646 - 6,616,646 3,766,646
------------- ------------ -------------- ------------ -------------
Loss before extraordinary items (8,451,438) (3,395,845) (19,048,727) (19,208,491) (125,748,224)
Extraordinary items:
Loss on extinguishment of debt - - - - (881,864)
Gain on forgiveness of debt 372,061 78,864 372,061 583,269
------------- ------------ -------------- ------------ -------------
Net loss $(8,451,438) $(3,023,784) $(18,969,863) (18,836,430 $(126,046,819)
============= ============ ============== ============ =============
Basic and diluted net loss per common share $ (0.05) $ (0.05) $ (0.14) $ (0.31)
============= ============ ============== ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-3
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
October 1,
1993
Nine Months Ended (Inception) to
September 30, September 30,
-----------------------------
2000 1999 2000
------------- ------------- --------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(18,969,863) $(18,836,430) $(126,046,819)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 1,328,100 100,000 6,974,254
Issuance of common stock for patent - - 100,807
Non-cash expense related to issuance of debentures,
warrants, preferred and common stock 5,286,411 2,270,000 17,776,674
Non-cash compensation expense related to issuance
of stock options 842,856 119,240 3,699,771
Non-cash expense related to issuance of notes payable
and accrued expense for services - - 857,000
Non-cash exchange of notes receivable for services - - 150,000
Non-cash portion of purchased in-process research and
development - - 13,136,000
Loss on disposal of property and equipment - 154,940 154,940
Gain on sale of HealthCare Solutions Group - (6,616,646) (3,766,646)
Write-off of assets received in acquisition - - 1,281
Depreciation and amortization 2,339,005 4,423,595 11,370,991
Income tax provision - - (3,331,895)
Extraordinary loss on extinguishment of debt - - 881,864
Extraordinary gain on forgiveness of debt (78,864) (372,061) (583,269)
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable 130,275 (391,982) (263,655)
Employee advances - (755) (59,986)
Interest and other receivables (5,135) (4,436) (12,881)
Inventory 1,546 (7,509) (25,836)
Prepaid assets (131,945) 40,465 (182,792)
Cash held in escrow (82,075) - (120,078)
Other assets 883 270 (118,018)
Accounts payable (457,504) (1,558,666) 2,905,895
Accrued liabilities 181,609 1,632,083 1,337,710
Accrued liabilities - related party (187,501) 1,249,271 1,103,443
Income taxes payable (27,606) - (27,606)
Deferred revenues 549,071 568,115 1,262,579
------------- ------------- --------------
Net cash used in operating activities (9,280,737) (17,230,506) (72,826,272)
------------- ------------- --------------
Cash flows from investing activities, net of effects
of acquisitions:
Proceeds from sale of HealthCare Solutions Group - 21,305,982 21,805,982
Acquisition of subsidiaries, net of cash acquired - - (15,323,173)
Proceeds from sale of property and equipment - 50,000 50,000
Purchase of property and equipment (141,160) (99,089) (3,576,720)
Investment in intangible assets - - (164,460)
Issuance of notes receivable - - (3,228,600)
Payments received on notes receivable - 245,000 2,128,600
------------- ------------- --------------
Net cash provided by (used in) investing activities (141,160) 21,501,893 1,691,629
------------- ------------- --------------
Cash flows from financing activities:
Bank overdraft - (138,034) -
Convertible promissory note and advances 7,500,000 - 8,500,000
Net payments on revolving note payable - (20,038,193) (49,250)
Net payments on revolving note payable
- related parties - (7,895,178) (7,813,537)
Proceeds from other notes payable - 6,953,760 9,865,427
Payments on other notes payable - (7,788,000) (9,567,806)
Principal payments on capital lease obligation (28,312) (55,504) (181,702)
Proceeds from issuance of convertible debentures, net - 6,254,240 9,439,240
Proceeds from sale of warrants - 438,240 1,511,168
Proceeds from sale of common stock, net - - 38,175,700
Proceeds from exercise of warrants 278,000 - 278,000
Proceeds from exercise of stock options 327,793 - 327,793
Proceeds from sale of preferred stock, net 1,750,000 - 19,457,346
Proceeds from sale of common stock and related
repricing rights subject to redemption, net - - 1,830,000
------------- ------------- --------------
Net cash provided by (used in) financing activities 9,827,481 (22,268,669) 71,772,379
------------- ------------- --------------
Net (decrease) increase in cash and cash equivalents 405,584 (17,997,282) 637,736
Cash and cash equivalents at beginning of period 232,152 20,045,539 -
------------- ------------- --------------
Cash and cash equivalents at end of period $ 637,736 $ 2,048,257 $ 637,736
============= ============= ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Q-4
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Nine Months Ended (Inception) to
September 30, September 30,
--------------------------
Supplemental disclosure of cash flow information: 2000 1999 2000
------------- ----------- -------------
<S> <C> <C> <C>
Cash paid during the period for interest $ 41,164 $ 1,068,882 $ 4,657,865
Cash paid during the period for income taxes $ 27,606 $ - $ 27,606
</TABLE>
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Nine Months Ended September 30, 2000:
Preferred stock dividends of $674,302 were accrued on Series D and
Series F preferred stock.
217,223 shares of Series D preferred stock and related dividends of
$255,600 were converted into 15,436,378 shares of Class A common
stock.
309,281 shares of Series F preferred stock and related dividends of
$2,783,375, including $2,750,000 related to the beneficial conversion
feature recorded upon issuance, were converted into 8,307,782 shares
of Class A common stock.
Principal of $5,538,085 from a convertible promissory note and $87,582
of interest accrued thereon were converted into 7,709,138 shares of
Class A common stock.
The Company issued 600,000 warrants valued at $474,000 to an executive
officer and director of the Company as consideration for the rights to
certain pen and voice input technology.
The Company issued 228,364 shares of Class A common stock to two
former directors of the Company upon the exercise of 400,000 options
as stock appreciation rights.
$3,971,107 in principal of Series C convertible debentures and related
interest of $290,957 were converted into 10,385,364 shares of Class A
common stock.
The Company issued 4,568,569 shares of Class A common stock upon the
exercise of repricing rights associated with the common stock subject
to redemption.
The Company issued 1,250,000 shares of common stock to unrelated
parties for consulting fees valued at $1,328,100.
The Company accrued preferred stock dividends totaling $514,800
resulting from liquidated damages on Series D preferred stock.
The Company issued 612,069 shares of Class A common stock valued at
$688,578 as payment for liquidated damages of $394,800 and a
restructuring fee of $213,778 on the Series D preferred stock.
The Company recorded interest expense of $3,546,083 resulting from the
beneficial conversion feature on funds drawn on the promissory note
and the equity line of credit.
The Company entered into a capital lease obligation for equipment in
the amount of $92,174.
For the Nine Months Ended September 30, 1999:
The Company entered into capital lease obligations for equipment in
the amount of $57,332.
Advances to employees totaling $59,986 were applied as payments on a
related-party note payable.
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.
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.
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.
The Company 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 liquidated damages and retire Series C convertible
debentures in the amounts of $750,000 and $2,528,893, respectively.
Preferred stock dividends of $997,146 were recorded related to the
beneficial conversion features of Series D and Series E convertible
preferred stock.
Preferred stock dividends of $635,160 were accrued on Series D and
Series E convertible preferred stock.
Preferred stock dividends totaling $828,212 were accrued relating to
the liquidated 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.
131,667 shares of Series D convertible preferred stock and related
dividends of $96,193 were converted into 8,468,129 shares of Class A
common stock.
135,072 shares of Series E convertible preferred stock and related
dividends of $66,015 were converted into 5,729,156 shares of Class A
common stock.
In connection with the sale of HealthCare Solutions Group, $2,500,000
of the sales price was placed into an escrow account.
A revolving note payable in the amount of $50,000 was paid by a former
employee and is included as an account payable.
Promissory notes held by certain shareholders were reduced by $414,991
in settlement of litigation.
See accompanying notes to condensed consolidated financial statements.
Q-5
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements of Fonix Corporation and subsidiaries (collectively, the
"Company" or "Fonix") have been prepared by the Company pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the following disclosures are adequate to make the
information presented not misleading.
These condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) that, in the opinion of
management, are necessary to present fairly the financial position and results
of operations of the Company for the periods presented. The Company's business
strategy is not without risk, and readers of these condensed consolidated
financial statements should carefully consider the risks set forth under the
heading "Certain Significant Risk Factors" in the Company's 1999 Annual Report
on Form 10-K.
Operating results for the three months and nine months ended September 30, 2000
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2000. The Company suggests that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1999, and its Quarterly Report on Form 10-Q
for the quarters ended March 31, 2000 and June 30, 2000.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
At September 30, 2000 and 1999, there were outstanding common stock equivalents
to purchase 30,530,110 and 90,535,319 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.
Q-6
<PAGE>
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three and nine months ended
September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended September 30,
2000 1999
----------------------------- -----------------------------
Per Share Per Share
Amount Amount Amount Amount
---------------- --------- --------------- ---------
<S> <C> <C> <C> <C>
Net loss from continuing operations $ (8,451,438) $ (7,050,344)
Preferred stock dividends (76,236) (1,031,288)
---------------- ---------------
Net loss from continuing operations
attributable to common stockholders (8,527,674) $ (0.05) (8,081,632) $ (0.11)
Discontinued operations, net of income taxes -- -- 3,654,499 0.05
Extraordinary items, net of income taxes -- -- 372,061 0.01
---------------- --------- --------------- ---------
Net loss attributable to common
stockholders $ (8,527,674) $ (0.05) $ (4,055,072) $ (0.05)
================ ========= =============== =========
Weighted average common shares
outstanding 165,210,595 76,479,555
================ ===============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
2000 1999
----------------------------- -----------------------------
Per Share Per Share
Amount Amount Amount Amount
---------------- --------- --------------- ---------
<S> <C> <C> <C> <C>
Net loss from continuing operations $ (19,048,727) $ (19,871,411)
Preferred stock dividends (3,424,302) (2,460,518)
---------------- ---------------
Net loss from continuing operations
attributable to common stockholders (22,473,029) $ (0.14) (22,331,929) $ (0.33)
Discontinued operations, net of income taxes -- -- 662,920 0.01
Extraordinary items, net of income taxes 78,864 -- 372,061 0.01
---------------- --------- --------------- ---------
Net loss attributable to
common stockholders $ (22,394,165) $ (0.14) $ (21,296,948) $ (0.31)
================ ========= =============== =========
Weighted average common shares
outstanding 157,181,840 68,678,645
================ ===============
</TABLE>
Reclassifications - Certain reclassifications have been made in the prior period
condensed consolidated financial statements to conform with the current period
presentation.
Q-7
<PAGE>
2. DISCONTINUED OPERATIONS
On September 1, 1999, the Company completed the sale of the operations and a
significant portion of the assets of its HealthCare Solutions Group ("HSG") to
Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third party. 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 1999 and inception to date condensed consolidated
statements of operations.
3. INTANGIBLE ASSETS
Intangible assets consist of purchased core technology and goodwill in
connection with the acquisitions of AcuVoice, Inc. ("AcuVoice") and the Papyrus
companies (collectively "Papyrus"), and direct costs incurred by the Company in
applying for patents covering its technologies. Amortization is computed on a
straight-line basis over the estimated useful lives ranging from five to eight
years. Total accumulated amortization was $6,236,129 and $4,392,457 at September
30, 2000, and December 31, 1999, respectively.
The carrying values of the Company's long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that they may
not be recoverable. In that event, 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 the projections indicated that the cost in
excess of the net asset would not be recoverable, the Company's carrying value
of the asset would be reduced by the estimated excess of the value over the
projected cash flows. The Company assesses impairment of long-lived assets at
the lowest level for which there are identifiable cash flows that are
independent of other groups of assets. As of September 30, 2000, the Company
does not believe any of its long-lived assets are impaired. However, the amount
of goodwill and other long-lived assets considered realizable could be reduced
in the near term based on changing conditions and the Company's ability to fund
further marketing and development of its products and technologies.
4. RELATED-PARTY NOTES PAYABLE
In connection with the acquisition of Papyrus in 1998, the Company issued demand
notes payable to former Papyrus stockholders in the aggregate amount of
$1,710,000. In April 1999, the Company entered into agreements with five former
Papyrus stockholders to reduce the aggregate amounts payable to them under these
notes from $1,632,375 to $1,111,284, which amount was paid in September 1999. A
balance of $77,625 remains outstanding as of September 30, 2000. The note
holders have made no demand for payment of the notes.
5. EQUITY LINE OF CREDIT AND CONVERTIBLE PROMISSORY NOTE
On August 8, 2000, the Company entered into a Private Equity Line Agreement (the
"Equity Line Agreement") with a private investor (the "Equity Line Investor")
that gives the Company the right to draw up to $20 million for operations and
other purposes. In connection with the Equity Line Agreement, up to $7.5 million
may be drawn by the Company under the terms of a convertible promissory note
dated June 20, 2000. The note bears interest at six percent annually, compounded
monthly, and is due September 30, 2001. Under the terms of the promissory note,
the Equity Line Investor has the right to convert, at its option, all or any
portion of the outstanding principal and interest into shares of Class A common
stock at the lesser of (a) $0.75 or (b) 85 percent of the average of the three
lowest closing bid prices of Class A common stock in the twenty-day trading
period prior to the date of the conversion.
The balance available under the Equity Line Agreement after offsetting draws
under the promissory note described above is available to the Company through a
mechanism of drawdowns and puts of stock. The Company is entitled to drawdown
funds and to put to the Equity Line Investor shares of Class A common stock in
lieu of repayment of the drawdown. The number of shares issued is determined by
dividing the dollar amount of the drawdown by 90 percent of the average of the
two lowest closing bid prices of Class A common stock over the seven trading-day
Q-8
<PAGE>
period following the date the Company tenders the put notice. The Equity Line
Investor is required to fund the amounts requested by the Company within two
trading days after the seven trading-day period.
As of September 30, 2000, the Company had drawn $7,500,000 on the convertible
promissory note and recorded $279,586 and $516,937 as interest and financing
expense for the three and nine months ended September 30, 2000, respectively.
Principal of $5,538,085 and interest of $87,582 accrued thereon have been
converted into 7,709,138 shares of Class A common stock. During the three and
nine months ended September 30, 2000, the Company recorded a beneficial
conversion feature in the amount of $3,336,388 and $3,546,083, respectively
related to borrowings under the convertible promissory note.
Subsequent to September 30, 2000, the remaining balance of $1,961,915 on the
promissory note and accrued interest of $3,288 were converted into 3,835,637
shares of Class A common stock. Also subsequent to September 30, 2000, an
additional $800,000 was drawn on the equity line which resulted in the issuance
of 1,751,505 shares of Class A common stock.
A registration statement describing the Class A common stock issuable in
connection with draws on the Equity Line Agreement was declared effective on
September 5, 2000, by the Securities and Exchange Commission (the "SEC").
6. SERIES C CONVERTIBLE DEBENTURES
During the nine months ended September 30, 2000, holders of the Company's Series
C convertible debentures converted $3,971,107 of principal together with
interest accrued thereon into 10,385,364 shares of Class A common stock.
7. PREFERRED STOCK
Series D Preferred Stock - During the nine months ended September 30, 2000,
217,223 shares of Series D convertible preferred stock together with related
accrued dividends of $255,600 were converted into 15,436,378 shares of Class A
common stock. As of September 30, 2000, 164,500 shares of Series D preferred
stock remained outstanding.
The Class A common shares underlying the original issue of the Series D
preferred stock were covered in a registration statement which was declared
effective on August 11, 1999. However, in the ensuing months, due to the accrual
of dividends and the decline in the price of the Company's Class A common stock,
the Class A common shares converted and convertible from the Series D preferred
stock exceeded the number of shares available under the registration statement.
Under the terms of the Series D preferred stock agreement, the holders of
approximately 2,700,000 unregistered shares were entitled to liquidated damages
in the amount of two percent of the original value of the Series D shares every
30 days while such shares were not registered for resale. During the nine months
ended September 30, 2000, the Company recorded a preferred stock dividend in the
amount of $80,000 related to such liquidated damages. On September 5, 2000, a
registration statement describing these shares was declared effective by the
SEC.
Similarly, the holder of the remaining 164,500 shares of Series D preferred
stock was entitled to liquidated damages based upon the same calculation until
the underlying Class A common shares were registered for resale. However, under
the terms of a letter agreement dated June 30, 2000, the holder of the Series D
shares waived the liquidated damages and revised certain terms of conversion of
the Series D shares to provide a minimum conversion rate of $0.75 until December
31, 2000. The Company issued 612,069 shares of Class A common stock valued at
$688,578 on June 30, 2000, in consideration for the waiver and revision in
terms. Of that amount, $394,800 was recorded as a preferred dividend and the
balance of $293,778 was recorded in other operating expense. The Class A common
shares issued to the holder of the Series D preferred shares and the Class A
common shares underlying the outstanding Series D shares were also included in
the registration statement that was declared effective on September 5, 2000 by
the SEC.
Series F Preferred Stock - Effective February 1, 2000, the Company entered into
an agreement with five investors whereby it sold a total of 290,000 shares of
its Series F convertible preferred stock for $2,750,000 in cash.
Q-9
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Dividends accrued on the stated value ($20 per share) of Series F convertible
preferred stock at a rate of six percent (6%) 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 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 preferred stock. Using the conversion
terms most beneficial to the holders, 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 preferred stock was issued.
On May 22, 2000, the Series F investors and the Company agreed to amend the
Series F Stock Purchase Agreement adding a sixth investor and increasing the
number of Series F preferred shares issued by 26,036 shares. Other terms and
provisions of the Series F preferred stock remained the same.
During the nine months ended September 30, 2000, 309,281 shares of Series F
preferred stock together with dividends accrued thereon were converted into
8,307,782 shares of Class A common stock. As of September 30, 2000, 6,755 shares
of Series F preferred stock remained outstanding.
8. COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION
Class A Common Stock - During the nine months ended September 30, 2000,
47,019,300 shares of Class A common stock were issued in connection with
conversions of debentures and preferred stock (see Notes 6 and 7). Also during
the same period, 913,228 shares of Class A common stock were issued as a result
of the exercise of stock options, stock appreciation rights and warrants.
On May 8, 2000, the Company issued 250,000 shares of Class A common stock
(having a market value of $312,500 at that date) to an unrelated third party in
consideration for services rendered.
On June 30, 2000, the Company issued 612,069 shares of Class A common stock
(having a market value of $688,578 on that date) to the holder of the shares of
Series D preferred stock in consideration for the waiver of certain rights and
amendment of certain terms relating to conversion of such Series D preferred
stock (see Note 7).
Common Stock Subject to Redemption - In connection with a private offering of
Class A common stock completed in December 1998, the purchaser of 1,801,802
shares of Class A common stock received an equal number of repricing rights (the
"Repricing Rights"), which provided for the issuance of shares of Class A common
stock based upon fluctuations of the market price of the stock. Also included in
the private offering were certain repurchase rights (the "Repurchase Rights")
which could, upon the occurrence of certain events, have required the Company to
repurchase all or a portion of the holder's Class A common shares or Repricing
Rights received in the private offering.
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 of Class A common stock subject to
the Repurchase Rights were sold. Because the Company has no further obligation
under the Repricing Rights or the Repurchase Rights as a result of these
transactions, $1,830,000 recorded as "common stock and related repricing rights
subject to redemption" in the Company's December 31, 1999 balance has been
reclassified to Stockholders' Equity as an increase to Class A common stock and
additional paid-in capital.
Common Stock Options - On January 31, 2000, the board of directors approved an
increase of 10,000,000 shares to be available under the Company's 1998 Employee
Incentive and Stock Option Plan (the "1998 Plan"). A registration statement on
Form S-8 covering these additional shares was filed with the SEC and declared
effective on February 14, 2000. During the nine months ended September 30, 2000,
the Company granted 5,867,067 options under the 1998 Plan to purchase shares of
Class A common stock at exercise prices ranging from $0.28 to $1.50 per share.
The term of all options granted during this period is ten years from the date of
grant. Of the stock options granted, options to purchase 2,339,000 shares vested
March 31, 2000, and the balance vest over the three years following issuance. Of
the total granted, 197,000 were issued to consultants for services performed for
the
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Company and were recorded as consulting expense in the amount of $53,190, based
upon the fair market value determined using the Black-Scholes option pricing
model. The remainder of the options were granted to employees and had a weighted
average fair market value of $0.30 per share using the Black-Scholes option
pricing model. Had compensation expense for these options been recorded in
accordance with the method prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation", the Company's net loss would have been $25,951,981,
or $0.17 per share, for the nine months ended September 30, 2000. As of
September 30, 2000, the Company had options to purchase a total of 19,140,834
shares of Class A common stock outstanding.
Warrants - On January 19, 2000, the Company issued warrants for the purchase of
300,000 shares of Class A common stock for services previously rendered by a
professional services firm. The warrants have a three-year life, exercise prices
ranging from $0.28 to $1.25 per share and vest as follows: 100,000 in March 2000
and 200,000 in September 2000. The warrants were valued at $45,000 using the
Black-Scholes option pricing model and were issued in satisfaction of an
obligation that was recorded in December 1999.
In February 2000, the Company entered into an agreement with an executive
officer and director of the Company to purchase all of his rights and interests
in certain methods and apparatus for integrated voice and pen input for use in
computer systems. In consideration for this technology, the Company granted the
executive officer warrants to purchase 600,000 shares of the Company's Class A
common stock at an exercise price of $1.00 per share. The warrants were
immediately exercisable and expire February 10, 2010. The warrants were valued
at $0.79 per share and were recorded as purchased in-process research and
development. 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 related technologies or products.
On May 3, 2000, warrants for the purchase of 200,000 shares of Class A common
stock were exercised at a price of $1.25 per share, resulting in cash proceeds
of $250,000.
As of September 30, 2000, the Company had warrants to purchase a total of
3,425,000 shares of Class A common stock outstanding.
9. RELATED-PARTY TRANSACTIONS
The Company rents office space from Studdert Companies Corporation ("SCC") under
a sublease that is guaranteed by two officers and directors of the Company who
are also officers, owners and directors of SCC. The sublease monthly payments
are $10,368. The Company believes the terms of the sublease are at least as
favorable as the terms that could have been obtained from an unaffiliated third
party in a similar transaction.
10. PRODUCT DEVELOPMENT AND RESEARCH AGREEMENTS
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 to conduct research and product development activities.
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
incorporating Synergetics' "VoiceBox" technology as well as technology derived
therefrom. 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 Class A 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 or issue the 4,800,000
warrants. The Company has paid the
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Cancellation Amount to Synergetics and the Royalty and warrant obligations have
been canceled. The Company has no further obligations to Synergetics.
IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2 Corporation ("IMC2"), a research and development entity, to assist in
the continuing development of specific automated speech recognition
technologies. The president of IMC2 is also the president of Synergetics. The
professional services agreement is for a term of 36 months and requires the
Company to make monthly payments of $22,000. Under the terms of the agreement,
the Company expended a total of $66,000 in each of the three-month periods ended
September 30, 2000 and 1999, and $198,000 in each of the nine-month periods
ended September 30, 2000 and 1999.
11. COMMITMENTS AND CONTINGENCIES
Executive Employment Agreements - On November 1, 1996, the Company entered into
employment contracts with two executive officers which contracts would have
expired on December 31, 2001, but which were amended effective January 31, 2000,
to extend the expiration date to December 31, 2005. As amended, the annual base
salary for each executive officer is $309,400 and may be adjusted upward in
future years as deemed appropriate by the board of directors. As bonus
compensation for extending the term of each agreement at a compensation level
less than provided in the original agreement, each executive was granted
1,400,000 options under the 1998 Plan, effective July 19, 2000, at an exercise
price of $1.05.
On November 1, 1996, the Company entered into an employment contract with
another executive officer. In January 1999, that executive officer resigned as
the Company's chief executive officer and entered into a separation agreement
pursuant to which the former executive officer will be paid $250,000 per year
through January 31, 2001 and $100,000 for the 12 months ending January 31, 2002,
and his employment contract was canceled.
In January 1998, the Company entered into an employment contract with another
executive officer which expires in January 2001. The minimum annual salary
required by this agreement was $225,000, but was reduced 30% by mutual agreement
effective February 1999, in connection with cost reductions initiated by the
Company. In the event that, during the contract term, both a change of control
occurs and, within nine months after such change in control occurs, the
executive officer's services are terminated by the Company for any reason other
than cause, death or retirement, the executive officer shall be entitled to
receive an amount in cash equal to all base salary then and thereafter payable
within 30 days of termination.
12. 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. The Company and OGI have tentatively agreed to settle the
arbitration proceeding on terms favorable to the Company. There can be no
assurance that the arbitration proceeding will be settled until a definitive
settlement and release agreement is signed by the parties.
The Company is involved in other lawsuits, claims and actions arising in the
ordinary course of business. In the opinion of management, after consultation
with legal counsel, the ultimate disposition of these matters will not
materially affect the consolidated financial position or results of operations
of the Company.
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