<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30,
2000.
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
-------- -------
Commission file number 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 22-2994719
(State of Incorporation) (I.R.S. Employer Identification No.)
60 East South Temple Street, Suite 1225
Salt Lake City, UT 84111
--------------------------
(Address of principal executive offices, including zip code)
(801) 328-0161
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X or No
------ -------
As of November 8, 2000, 180,270,639 shares of Class A voting common
stock, par value $.0001 per share, were issued and outstanding.
<PAGE>
FONIX CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) - As of September 30, 2000
and December 31, 1999.....................................................3
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................................................4
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................................................5
Notes to Condensed Consolidated Financial Statements (Unaudited)...............7
Item 2. Management's Discussion and Analysis or Plan of Operation............14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...................................................19
Item 2. Changes in Securities...............................................19
Item 4. Submission of Matters to Vote of Security Holders...................19
Item 6. Exhibits and Reports on Form 8-K....................................20
<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.
3
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Three Months Ended Nine Months Ended (Inception) to
September 30, September 30, September 30,
---------------------------- -------------------------
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.
4
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
October 1,
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.
5
<PAGE>
Fonix Corporation and Subsidiaries
[A Development Stage Company]
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
<TABLE>
<CAPTION>
October 1,
1993
Nine Months Ended (Inception) to
September 30, September 30,
--------------------------
Supplemental disclosure of cash flow information: 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.
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.
7
<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.
8
<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
9
<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.
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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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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This quarterly report on Form 10-Q contains, in addition to historical
information, forward-looking statements that involve substantial risks and
uncertainties. The Company's actual results could differ materially from the
results anticipated by the Company and discussed in the forward-looking
statements. Factors that could cause or contribute to such differences are
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
Overview
Since inception, Fonix has devoted substantially all of its resources to
research, development and acquisition of software technologies that enable
intuitive human interaction with computers, consumer electronics, and other
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 reflect 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 $1,615,000 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.
("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.
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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
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.
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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.
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
presently has limited revenue from operations, it will rely primarily on
financing through the sale of its equity and debt securities to satisfy future
capital requirements 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.
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 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
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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 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").
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 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.
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.
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
(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
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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.
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 nine 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 19,140,834 options to purchase
Class A common shares outstanding.
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.
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 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. As of September 30, 2000, warrants for the purchase of 3,425,000
shares of Class A common stock remain outstanding.
Other
The Company presently has no plans to purchase new research and development or
office facilities.
Outlook
The Company believes that its core technologies, namely, automatic speech
recognition, text-to-speech and handwriting recognition (the "Core
Technologies"), will be the platform for the next generation of automatic speech
technologies and products. Most speech recognition products offered by other
companies are based on technologies
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that are largely in the public domain and represent nothing particularly "new"
or creative. The Company's Core Technologies are based on proprietary, patented
technology. The Company will continue to seek patent protection of the Core
Technologies as well as technologies and inventions derived from the know how,
assets and rights acquired from past acquisitions. Management believes the
Company's HUI technologies provide a competitive advantage compared to other
technologies available in the marketplace.
As the Company proceeds to implement its strategy and to reach its objectives,
it 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 stockholders 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 the Company's 1999
Annual Report on Form 10-K, Item 1, Part I.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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.
Item 2. Changes in Securities
c. Unregistered sales of equity securities during the quarter (other than
in reliance on Regulation S).
Recent Sales of Unregistered Securities. During the three months ended September
30, 2000, the Company issued no equity securities that were not registered under
the Securities Act of 1933, as amended.
Item 4. Submission of Matters to a Vote of Security Holders
On September 28, 2000, the Company held its Annual Meeting of Shareholders in
San Jose, California. The following directors were elected at the meeting:
SHARES SHARES
DIRECTOR VOTED FOR VOTED AGAINST
-------- --------- -------------
Thomas A. Murdock 129,445,118 726,163
Roger D. Dudley 129,319,052 852,229
John A. Oberteuffer, Ph.D 129,492,751 678,530
William A. Maasberg, Jr. 129,625,436 545,581
Mark S. Tanner 129,656,436 514,845
The only other matter voted upon at the meeting was the approval of Arthur
Andersen LLP as independent auditors for the Company. The results of the voting
were 129,784,384 shares for, 315,764 shares against, and 51,133 shares withheld
or abstaining.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits: The following Exhibits are filed with this Form 10-Q
pursuant to Item 601(a) of Regulation S-K:
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Exhibit No. Description of Exhibit
(2)(i) Agreement and Plan of Reorganization among the Company,
Fonix Acquisition Corporation and AcuVoice dated as of
January 13, 1998, incorporated by reference from the
Company's Current Report on Form 8-K, filed March 20, 1998
(2)(ii) Agreement and Plan of Merger among Fonix, Articulate
Acquisition Corporation, and Articulate, dated as of July
31, 1998, incorporated by reference from the Company's
Current Report on Form 8-K, filed September 17, 1998
(2)(iii) Agreement and Plan of Merger among Fonix, Papyrus
Acquisition Corporation, and Papyrus Associates, Inc., dated
as of September 10, 1998, incorporated by reference from the
Company's Current Report on Form 8-K, filed November 13,
1998
(3)(i) Articles of Incorporation of the Company which are
incorporated by reference from the Company's Registration
Statement on Form S-18 dated as of September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of Incorporation
dated as of March 21, 1994, which is incorporated by
reference from the Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of Incorporation
dated as of May 13, 1994, which is incorporated by reference
from the Company's Annual Report for the Fiscal Year Ended
December 31, 1994 on Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of Incorporation
dated as of September 24, 1997, which is incorporated by
reference from the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1997
(3)(v) The Company's Bylaws, as amended, which are incorporated by
reference from the Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
(4)(i) Description of the Company's common stock and other
securities and specimen certificates representing such
securities which are incorporated by reference from the
Company's Registration Statement on Form S-18 dated as of
September 12, 1989, as amended
(4)(ii) Certificate of Designation of Rights and Preferences of
Series A Preferred Stock, filed with the Secretary of State
of Delaware on September 24, 1997, which is incorporated by
reference from the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1997
(4)(iii) Certificate of Designation of Rights and Preferences of
Series B Convertible Preferred Stock, filed with the
Secretary of State of Delaware on October 27, 1997, which is
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1997
(4)(iv) Certificate of Designation of Rights and Preferences of 5%
Series C Convertible Preferred Stock, filed with the
Secretary of State of Delaware on October 24, 1997, which is
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1997
(4)(v) Certificate of Designation of Rights and Preferences of
Series D 4% Convertible Preferred Stock, filed with the
secretary of State of Delaware on August 27, 1998, which is
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incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1998
(4)(vi) Certificate of Designation of Rights and Preferences of
Series E 4% Convertible Preferred Stock, filed with the
secretary of State of Delaware on October 15, 1998, which is
incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1998
(9)(i) Voting Trust Agreement dated as of December 10, 1993 by and
among Phonic Technologies, Inc., Stephen M. Studdert, Thomas
A. Murdock and Roger D. Dudley, which is incorporated by
reference from the Company's Current Report on Form 8-K
dated as of June 17, 1994
(9)(ii) Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock, Roger D.
Dudley, Beesmark Investments, L.C., Studdert Companies
Corporation, and Thomas A. Murdock as Trustee, dated as of
October 23, 1995, incorporated by reference from the
Company's Current Report on Form 8-K dated as of October 23,
1995
(9)(iii) Second Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock, Roger D.
Dudley, Beesmark Investments, L.C., Studdert Companies
Corporation, and Thomas A. Murdock as Trustee, dated as of
July 2, 1996, incorporated by reference from the Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1996
(9)(iv) Third Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock, Roger D.
Dudley, Beesmark Investments, L.C., Studdert Companies
Corporation, and Thomas A. Murdock as Trustee, dated as of
September 20, 1996, incorporated by reference from the
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1996
(9)(v) Fourth Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock, Roger D.
Dudley, Beesmark Investments, L.C., Studdert Companies
Corporation, and Thomas A. Murdock as Trustee, dated as of
September 20, 1996, incorporated by reference from the
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1996
(10)(i) Product Development and Assignment Agreement dated as of
October 16, 1993 between Phonic Technologies, Inc. and
Synergetics, Inc., which is incorporated by reference from
the Company's Current Report on Form 8-K dated as of June
17, 1994
(10)(ii) Re-Stated Product Development and Assignment Agreement dated
as of March 30, 1995, between Fonix Corporation and
Synergetics, Inc., which is incorporated by reference from
the Company's Annual Report for the Fiscal Year Ended
December 31, 1994 on Form 10-KSB
(10)(iii)Memorandum of Understanding dated as of March 13, 1997, by
and among the Company, Synergetics, Inc. and C. Hal Hansen,
which is incorporated by reference from the Company's Annual
Report on Form 10-KSB for the fiscal year ended December 31,
1996
(10)(iv) Employment Agreement by and between the Company and Stephen
M. Studdert, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1996
(10)(v) Employment Agreement by and between the Company and Thomas
A. Murdock, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1996
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<PAGE>
(10)(vi) Employment Agreement by and between the Company and Roger D.
Dudley, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1996
(10)(vii)Restated Master Agreement for Joint Collaboration between
the Company and Siemens, dated November 14, 1997, as
revised, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997
(10)(viii)Restated First Statement of Work and License Agreement
between the Company and Siemens, dated February 11, 1998, as
revised, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997
(10)(ix) Master Technology Collaboration Agreement between the
Company and OGI, dated October 14, 1997, which is
incorporated by reference from the Company's Annual Report
on Form 10-K for the year ended December 31, 1997
(10)(x) Common stock Purchase Agreement among the Company and JNC
Opportunity Fund Ltd. and Diversified Strategies Fund, LP,
dated as of March 9, 1998, which is incorporated by
reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1997
(10)(xi) Common stock Purchase Agreement between the Company and
Thomson Kernaghan & Co., dated as of March 9, 1998, which is
incorporated by reference from the Company's Annual Report
on Form 10-K for the year ended December 31, 1997
(10)(xii)Royalty Modification Agreement among the Company and
Synergetics, dated as of April 6, 1998, which is
incorporated by reference from the Company's Annual Report
on Form 10-K for the year ended December 31, 1997
(10)(xiii)Purchase Agreement with John Oberteuffer and the Company
dated April 9, 1998, which is incorporated by reference from
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997
(10)(xiv)Employment Agreement by and between the Company and John A.
Oberteuffer, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997
(10)(xv) First Amendment to Master Agreement for Joint Collaboration
between the Company and Siemens, dated February 13, 1998,
which is incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31, 1997
(10)(xvi)Second Amendment to Master Agreement for Joint Collaboration
between the Company and Siemens, dated March 13, 1998, which
is incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31, 1997
(10)(xvii)Series D Convertible Preferred Stock Purchase Agreement
Among Fonix corporation, JNC Opportunity Fund, Ltd.,
Diversified Strategies Fund, L.P., Dominion Capital Fund,
Ltd., Sovereign Partners, LP, Canadian Advantage Limited
Partnership and Thomson Kernaghan & Co. (as agent) dated as
of August 31, 1998, incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998
(10)(xviii)Series E Convertible Preferred Stock Exchange and Purchase
Agreement among Fonix corporation, Sovereign Partners, LP
and Dominion Capital Fund, Ltd., dated as of September 30,
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<PAGE>
1998, incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1998
(10)(xix)Securities Purchase Agreement among Fonix Corporation and
JNC Strategic Fund, dated December 21, 1998 for 1,801,802
shares of common stock and Repricing Rights, incorporated by
reference from Amendment No. 1 to Registration Statement on
Form S-3 (File No. 333-67573)
(10)(xx) Securities Purchase Agreement among Fonix Corporation and
the investors identified therein dated January 29, 1999, as
supplemented on March 3, 1999, concerning sales of
$6,500,000 principal amount of Series C 5% Convertible
Debentures, incorporated by reference from Amendment No. 1
to Registration Statement on Form S-3 (File No. 333- 67573)
(10)(xxi)Asset Purchase Agreement - Acquisition of Certain Assets of
Fonix Corporation and Fonix/ASI Corporation by Lernout &
Hauspie Speech Products N.V., dated as of May 19, 1999,
which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(a))
(10)(xxii)Escrow Agreement, dated as of September 1, 1999, which is
incorporated by reference from the Company's Current Report
on Form 8-K, filed with the Commission on September 16, 1999
(therein designated as Exhibit 10(b))
(10)(xxiii)Technology Option Agreement, dated as of May 19, 1999,
which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(c))
(10)(xxiv)Assignment and Assumption Agreement, dated as of September
1, 1999, which is incorporated by reference from the
Company's Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein designated as
Exhibit 10(d))
(10)(xxv)License Agreement by and between Fonix/ASI Corporation and
Lernout & Hauspie Speech Products N.V., dated as of May 19,
1999, which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(e))
(10)(xxvi)Loan Agreement, dated as of April 22, 1999, which is
incorporated by reference from the Company's Current Report
on Form 8-K, filed with the Commission on September 16, 1999
(therein designated as Exhibit 10(f))
(10)(xxvii)Amendment to Loan Agreement, dated as of May 12, 1999,
which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(g))
(10)(xxviii)Second Amendment to Loan Agreement, dated as of May 19,
1999, which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(h))
(10)(xxix)Loan Agreement, dated as of May 19, 1999, which is
incorporated by reference from the Company's Current Report
on Form 8-K, filed with the Commission on September 16, 1999
(therein designated as Exhibit 10(i))
(10)(xxx)First Amendment to Loan Agreement, dated as of August 12,
1999, which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit 10(j))
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<PAGE>
(10)(xxxi)Agreement, dated as of July 31, 1999, which is incorporated
by reference from the Company's Current Report on Form 8-K,
filed with the Commission on September 16, 1999 (therein
designated as Exhibit 10(k))
(10)(xxxii)Series F Convertible Preferred Stock Purchase Agreement,
Among Fonix Corporation, Sovereign Partners, LP, Dominion
Capital Fund, LTD., Dominion Investment Fund, LLC, Canadian
Advantage, L.P., and Queen LLC, dated as of February 1,
2000, which is incorporated by reference from the Company's
Annual Report on Form 10-K for the year ended December 31,
1999.
(10)(xxxiii)Amended and Restated Series F Convertible Preferred Stock
Purchase Agreement among Fonix Corporation and the investors
identified therein dated May 22, 2000, which is incorporated
by reference from the Company's Rule 424(b) Registration
Statement on Form S-2, filed with the Commission on June 16,
2000 (therein designated as Exhibit 99.3)
(10)(xxxiv)Equity Line Agreement between Fonix Corporation and Queen
LLC, dated August 8, 2000, which is incorporated by
reference from the Company's Registration Statement on Form
S-2, filed with the Commission on August 10, 2000 (therein
designated as Exhibit 99.4)
(27) Financial Data Schedule
(B) Reports filed on Form 8-K during the three-month period ended
September 30, 2000: NONE
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Fonix Corporation
Date: November 14, 2000 /s/ Roger D. Dudley
--------------------------- --------------------------------
Roger D. Dudley, Executive Vice President,
Chief Financial Officer
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