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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2000, or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
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Commission File No. 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 87-0380088
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(Address of principal executive offices with zip code)
(801) 328-8700
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock
($0.0001 par value
per share)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No[ ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $92,208,533. calculated using a closing price of
$0.45 per share on March 20, 2001. For purposes of this calculation, the
registrant has included only the number of shares directly held by its officers
and directors as of March 20, 2001, (and not counting shares beneficially owned
on that date) in determining the shares held by non-affiliates. As of March 20,
2001, there were issued and outstanding 210,827,463 shares of the Company's
Class A common stock.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Fonix Corporation
2000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Page
Item 1. Business............................................................3
Item 2. Properties.........................................................19
Item 3. Legal Proceedings..................................................20
Item 4. Submission of Matters to a Vote of Security Holders................21
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................21
Item 6. Selected Financial Data............................................23
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................24
Item 8. Financial Statements and Supplementary Data........................31
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................31
Part III
Item 10. Directors and Executive Officers of the Registrant.................32
Item 11. Executive Compensation.............................................35
Item 12. Security Ownership of Certain
Beneficial Owners and Management...................................42
Item 13. Certain Relationships and Related Transactions.....................44
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................45
PART I
ITEM 1. BUSINESS
THIS ANNUAL REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FORWARD-LOOKING STATEMENTS" AND ELSEWHERE IN THIS ANNUAL REPORT. THE
FOLLOWING DISCUSSION SHOULD BE READ TOGETHER WITH OUR FINANCIAL STATEMENTS AND
RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT.
General
Fonix Corporation, a Delaware corporation ("Fonix" or the "Company"),
engages in marketing and developing proprietary technologies for natural user
interface ("NUI") technologies, applications and solutions. The Company's NUI
technologies, which include text-to-speech ("TTS"), neural network-based
automated speech recognition ("ASR"), speech compression and handwriting
recognition ("HWR"), are integrated into products for commercial and industrial
applications. ASR, TTS, HWR and speech compression technologies are sometimes
collectively referred to as "Core Technologies". The Company develops
commercially available applications and solutions utilizing its Core
Technologies that enable people to interact more easily with computers and
electronic devices in multiple mass-market implementations. The Company believes
its efficient and intuitive method of NUI enhances user productivity and
efficiency in a broad range of markets in server-based and embedded applications
and products.
The Company currently markets its Core Technologies solutions and
applications to software developers, consumer electronics manufacturers,
micro-processor manufacturers, third-party product developers, operating system
developers, network developers and Internet-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. The Company pursues revenue
opportunities through generation of royalty fees, product and technology
licenses, product sales, non-recurring engineering fees, and support agreements.
Manufacturers of consumer electronics products, software developers
and Internet content developers use Fonix Core Technologies to simplify the use
and increase the functionality of their products and services resulting in
broader market opportunities and significant competitive advantage. Fonix
solutions support multiple hardware and software platforms, are environment and
speaker independent, optimize cost and power efficiencies and provide easy
integration within a relatively small memory requirement as well as scalability
for high density capacity.
After initial introductions to the market in the fall of 1999 of ASR
and TTS in software packages geared toward application developers, Fonix
transitioned from a research and product development focus to a market-driven
focus. The operations of the Company, including sales, marketing, engineering,
product development and testing, and business development, have been
restructured to deliver on customer needs and acceptance of NUI applications and
solutions in multiple server-based and embedded products.
In the research report "Wireless Data: Speaking Up" (February 1,
2001), the investment banking firm Robertson Stephens states, "In our opinion,
voice is the next killer application, poised at the start of a major new
technology investment cycle." Fonix is well positioned to serve markets that are
rapidly adopting speech-enabled applications. As footprint size, noise
robustness, recognition accuracy and efficiency of speech technologies becomes
increasingly critical, Fonix expects to provide compelling solutions to meet
highly competitive customer demands.
Page 3 of 51
Fonix Accelerated Application Solutions Technologies (FAAST)
As the worldwide market for NUI technologies and products has
expanded, consumer products manufacturers, software developers and Internet
content developers have demanded decreased development time for NUI solutions
and increased quality of user interface technologies. Fonix has responded to
this demand with the development and release of FAAST, a proprietary development
framework. FAAST provides developers with a speech application framework that
enables rapid development of NUI applications that can be integrated quickly and
efficiently into products. FAAST has been released in versions for both the
server-based and embedded markets.
The FAAST development framework is quickly becoming recognized by
customers as a key ingredient to the successful launch of speech solutions. By
implementing FAAST, developers are provided a dynamic development environment to
integrate best-of-breed NUI technologies with minimal effort. Specifically,
FAAST allows a developer to integrate into products a highly scalable framework
that includes a broad range of key features necessary to create NUI
functionality, such as speech. The FAAST framework includes support for multiple
processors and operating system, highly flexible audio input drivers (i.e.
microphone, HTML, XML, Web, MP3, telephony), output drivers (i.e. speaker, MP3,
file, telephone, buffer), speech APIs (including SAPI and JSAPI), the Fonix
graphical application builder, and the ability to plug-and-play multiple ASR and
TTS engines. Furthermore, the FAAST development framework permits developers to
employ Fonix TTS and ASR or speech components from other sources of their own
choosing, as the needs of their total solution may dictate. Further benefits to
the customer may include a single-source NUI solution, a clear product upgrade
path, reduced integration time for NUI vendor upgrades and maximum product
flexibility.
Marketing and Product Delivery Initiatives
In the second quarter of 2001, Fonix intends to announce a strategic
marketing program designed to assist its channel partners to adopt and integrate
FAAST and Fonix NUI technologies. A Partner Program entitled "Powered by Fonix"
will offer distinct advantages to developers, resellers, and corporate partners.
Developer Partners - Designed to provide developers with a central
location for accessing a wide array of developer tools produced by
Fonix to help them successfully develop, deploy, and manage voice
applications. The Company's primary objective is to provide access to
multiple tools, such as FAAST, that help developers do their job.
Some tools will offer enhanced capabilities, others will offer
increased efficiency, and still others will provide unique
capabilities that Fonix believes might interest developers. While
some tools will be offered in full versions, others will be offered
in evaluation versions so that developers can conveniently try them
before purchasing.
Reseller Partners - Designed to establish and strengthen
relationships with the reseller community, the "Powered by Fonix
Channel Partner Program" will offer benefits designed to strengthen
relationships and promote the sale of Fonix technologies. With
benefits like sales leads, marketing collateral, training, TTS
hosting services, premium support and a secure reseller web site,
Fonix will provide its partners with the tools they need to
successfully implement the Fonix line of NUI solutions.
Corporate Partner - Designed to address the needs of the Company's
corporate customers, the Corporate Partner Program will focus on
service, support and high level relationships directed at maintaining
and recruiting key accounts and strategic partners.
Because the Company is pursuing third party integration of Fonix NUI
technology into mass market, industrial, general business and personal
electronics products and computing solutions, lead time to revenue recognition
will be longer than software products released directly into consumer channels.
The Company's products sold and integrated into customer applications are
subject to both customer production schedules and customer success in marketing
the products and generating product sales.
Page 4 of 51
Marketing and Sales Focus
Fonix has organized marketing and sales groups to address the needs
of emerging market opportunities and to ensure timely delivery of appropriate
applications and solutions.
Marketing. Headed by a vice president, the marketing group is
responsible for corporate communications, public relations and information,
direct product marketing, website operations, sales collateral and product
specification descriptions, corporate and sales presentations, product research
and management, product support, and trade show activity.
Within the marketing group, industries and products receive specific
attention:
Industry market segments - Industry Marketing Directors guide Fonix
product development in each industry, including market trend and
development research, competitive analysis, industry developments,
and technical requirements for required functions and features, and
sales support.
Product Management - Product Managers focus production efforts on
time and specification requirements, product quality assurance,
market introduction and product launch, competitive assurance,
engineering coordination, product upgrade coordination, and sales
support.
Additionally, the marketing group develops direct channel sales
opportunities for fully developed Fonix consumer applications. This includes the
establishment of channel sales partners, products and supporting marketing
processes.
Sales. Headed by a vice president, the sales group is responsible to
develop sales partners, opportunities, and relationships. The sales group is
responsible to develop original equipment manufacturers ("OEM") application
development projects, value-added resellers ("VAR") and other resellers,
enterprise (large corporate) sales, cross-selling opportunities to the Company's
existing customer base, and sales development for both server-based and embedded
markets. Key customer relationships, specifically with existing corporate
partnerships and relationships, are assigned to account representatives who are
responsible to pursue revenue opportunities by meeting customer needs through
product delivery.
Fonix focuses its primary sales efforts on customers and markets with
high margins, broad use, rapid development and market presence. Current sales
strategy is governed by the following general principles:
Focus on revenues - Pursue specific markets where revenues can be
rapidly realized without significant continued research and
development. Pursue opportunities that represent recurring revenue.
Application replication - Focus on specific applications that can be
developed and sold to multiple customers. Pursue integration where
Fonix technologies are directly compatible and can be integrated as
part of existing or new OEM products with minimal additional effort.
Existing marketing channels and significant market share - Partner
with customers who have existing marketing channels and leverage
product sales through those channels. Pursue customers with dominant
or significant market share and who are able to rapidly bring
products to market.
Second-tier customer support - Position Fonix as a provider of
second-tier customer support, providing training and tools for Fonix
customers who operate front line support systems for their end-user
customers.
Market Strategy: Server-Based and Embedded Environments
Page 5 of 51
Fonix products and solutions are sold into two markets based on
processor size and speed, and memory and power capacity. They include
server-based solutions (scaling from desktop/laptop applications to connected
server applications and even to full distributed solutions) and embedded
solutions (smaller processors with limited memory and power capacity).
Server-Based Markets - Interactive voice response solutions and voice
web portal development are two of the most advanced markets for automated
speech, and sales are increasing each year. Current industry revenue estimates
indicate that customized automated call centers, virtual operators, packaged
call center software, custom vertical market dictation systems and general
desktop dictation systems have led server-based speech applications into the
market. Additionally, new product areas for automated speech include network
systems, telephone company email reader services, software document readers,
Internet navigation and screenless access, website text readers and mobile
computing solutions. Currently, server-based markets are trending toward the
convergence of wireless data transmission and connectivity between mobile
computing and fixed-server databases.
The FAAST framework, including Fonix TTS and ASR engines, is marketed
primarily to solution integrators, including OEMs and VARs, who bring together
various applications and products to provide a complete solution to their
end-user customers. Fonix has entered into agreements with several key solution
providers such as Nortel Networks, Nuance Communications, Envox, and Motorola
Mobile Internet Exchange for one or both of these engines.
Fonix continues to focus on product enhancement and application
delivery in the following server-based markets:
Interactive voice response ("IVR") - Telephony applications for
corporate call centers, short messaging services and information
retrieval from server databases are already common. FAAST facilitates
upgrades and shortens development time required for new systems.
Internet Voice Portals - Speech-enabled access to the Internet and
website navigation are rapidly emerging needs. Fonix is developing
and anticipates marketing products for voice portals to the Internet
that may be purchased for use by portal companies, website and
content providers, Internet service providers and browsers.
Website readers - Because over 70% of all web content is text, demand
for products allowing web content to be read to the user is quickly
growing. Fonix has developed a web page reader that can be added to
websites. This voice solution is targeted toward the largest web
content providers worldwide in media, government, business and other
industries.
Network systems command and control and email reader - Fonix provides
TTS which can be seamlessly integrated into network software to
speech-enable software applications.
Embedded Markets - Increasingly efficient and powerful computing
solutions have resulted in the development of new markets by creating smaller,
more convenient devices and applications equipped with personalized functions.
These applications include personal digital assistants (PDAs), cellular phones,
web pads, wireless communication devices, automotive telematics and other
consumer electronics. A significant deterrent to full functionality of these
powerful and small computing devices is the current need for a keyboard, touch
screen and/or a mouse to interface with the device. Recent integration of HWR
technology has helped to increase the demand for these devices and has prepared
markets to pay for ASR and TTS in computing solutions. Other product development
initiatives that may drive additional interest in NUI technologies include
electronic books, wearable computers, smart toys and appliances such as VCRs,
answering machines, wireless climate control systems, and command-and-control
applications.
Fonix ASR and TTS technologies have memory and power requirements
that fall well within tolerances needed to speech-enable applications using
existing 16-bit and 32-bit processors. To capitalize on this distinct
competitive advantage, Fonix is pursuing sales and partnership relationships
with companies offering embedded
Page 6 of 51
products for mass consumer markets, industrial applications, and business
computing solutions. Currently, Fonix has ported its NUI technologies to several
RISC processors including ARM, Epson EOC 33A104 and 208, the Infineon TriCore,
and to Microsoft Windows CE hardware platforms including Intel StrongArm(R),
Hitachi SH3 and SH4, and MIPS core.
Fonix focuses on product development and application delivery in the
following embedded markets:
PDAs such as handheld computers requiring a developed operating
system with multiple functionality for both consumer and enterprise
markets.
Consumer electronics characterized by common processor usage and
typically no formal operating system.
Automotive telematics which require command-and-control speech
applications for common in-car functions and entertainment systems.
Cellular phones which require command-and-control speech applications
for both current market phone functions and future smart phone
applications.
Fonix has identified channel and direct sales opportunities for ASR,
TTS, and HWR technologies in embedded markets.
Chip Manufacturers - Digital signal processor, microprocessor, and
controller manufacturers are highly focused on technology innovations
that will support and drive sales of chips via third-party vendors.
Fonix has ported ASR and TTS to multiple platforms and is leveraging
sales through the third-party software networks. Partners in this
area include Motorola, Intel, Epson and Infineon.
Design and Operating System Developers - Reference platform and
product designers provide opportunity for design-in speech technology
sales. These companies are channels to major consumer electronics
marketers. Current design partners include Doctor Design (Wind River)
and Accelent.
Software Developers and Resellers - Software developers in multiple
markets, including operating systems, increasingly enable their
software products with one or more NUI technologies, resulting in
leveraged product sales and potential royalty revenue opportunities.
Current partners include PurpleSoft, Microsoft and QNX.
Product Developers and Manufacturers - Many companies are seeking NUI
technologies to integrate into a host of consumer electronics
devices, commercial applications, and business solutions. Primary
markets for these applications are in automotive and aviation
telematics, industrial wearable computers, mobile communications
devices and PDAs in both consumer and vertical markets. Current OEM
customers include Panasonic and Thomson Consumer Electronics.
Direct Sales of Embedded Applications - Fonix has developed and sold,
through website and reseller channels, complete software applications
directly to consumers and expects to continue this effort with new
products. Current products include TimeTalk and iSpeak.
Core Technologies and Product Applications
The Company expended $5,871,414 in 2000, $7,909,228 in 1999 and
$13,060,604 in 1998 on product development and research of its NUI technologies.
During 2000, 1999 and 1998, the Company received $656,853, $439,507 and
$236,586, respectively, in revenue from the licensing of NUI technologies. In
addition to these revenues, Fonix received non-refundable license fees totaling
$2,368,138 paid in 1998 by an international microchip manufacturer.
Page 7 of 51
ASR. Fonix researchers have developed and patented what the Company
believes to be a fundamentally unique approach to the analysis of human speech
sounds and the contextual recognition of speech. Fonix ASR technologies attempt
to approximate the techniques employed by the human auditory system and language
understanding, based upon the use of a series of neural networks. The Fonix ASR
technologies use information in speech sound features perceptible to humans but
not discernible by other ASR systems. As presently developed, the phonetic sound
recognition engine is comprised of several components, including audio signal
processing, a feature extraction process, a phoneme estimation process and a
linguistic process based on the neural net technologies. This development has
yielded a proprietary ASR system utilizing a unique method of extracting the
fundamental mathematical elements from the acoustic speech signal, a neural
net-based phoneme (speech sound) identifier, and neural-net architecture for
modeling the many complex elements of human language. The latter component is
known as MULTCONSTM or multi-level temporal constraint satisfaction network.
These developments are the subject of issued and allowed patents as well as
other patent applications that are pending.
The Company believes the reliable recognition of natural, spontaneous
speech spoken by one or more individuals in a variety of common environments by
means of a conveniently placed microphone will significantly improve the
performance, utility and convenience of applications. Such applications include
computer command-and-control, voice-activated navigation of the Internet,
automotive telematics, data input, text generation, telephony transactions,
continuous dictation and others in both embedded and server-based environments.
Fonix has pursued the development of its ASR technologies to produce
practical applications and products by overcoming the limitations of currently
available commercial speech recognition systems and broadening the market
acceptance and use of NUI technologies. Key benefits that help differentiate
Fonix ASR technologies from other currently available competitive products
include:
Significantly reduced computer memory requirements - allow speech
recognition to operate in embedded system environments, or enable
server-based systems to operate with lower memory requirements that
permit significantly more simultaneous users.
Significantly reduced power requirements - make ASR available for use
in smaller computing solutions with limited battery/power capacity
and enable more simultaneous users on server-based systems.
Speaker independence - allows various speakers to use the same system
without training the system to a particular user's voice and dialect.
Noise immunity quality - allows the ASR system to extract ambient
background noise, permitting higher recognition rates in noisy
environments and reduces the need for direct-wired microphones or
headsets.
Rapid porting to multiple computer chip platforms and operating
systems - creates broad product demand in embedded system
environments.
FAAST graphical application software developer kit ("SDK") - uses a
visual, integrated development environment that allows customers to
build applications rapidly with high success rate and few outside
resources, thereby accelerating product time-to-market.
Fonix products currently employing ASR technologies include FAAST
Embedded and FAAST Embedded for Windows CE development frameworks that utilize a
visual interface and graphical representation of elements to facilitate creation
of speech-enabled applications in embedded environments.
TTS. Fonix has developed two TTS engines, one for use with a large or
unlimited vocabulary and the other for use with a customized, smaller
vocabulary. Both engines utilize phonetic splicing to create words, are
exceptionally high quality in their respective domains and have specific market
focus.
The unlimited vocabulary synthetic voice engine can "speak" text of
any length and verbiage. The engine is deployed in both male and female voices
and in multiple languages including American English, U.K. English,
Page 8 of 51
French, German, Spanish, Italian, Dutch, Swedish, Finnish, Icelandic, and
Norwegian for uses which include email reading, web content reading and
streaming and document reading. A key competitive advantage of the unlimited
vocabulary engine is the ability to scale to a very broad range of applications.
Fonix TTS engines are able to deploy over eight times the channel density of the
nearest competitor, thus allowing significant hardware cost savings for
customers. Additionally, this unlimited TTS technology has been compressed to
levels well under five megabytes in memory size to allow use in many embedded
devices.
Custom or limited domain TTS is human quality synthetic speech and
can be deployed for vocabularies of up to 2,000 word blocks. Because the
dictionary for the custom engine is defined, connecting polysyllables or
elements of words that are larger than phonemes creates the application.
Applications for this technology include prompts and confirmation for
command-and-control systems, weather reports, traffic reports, etc. This engine
enjoys a memory size well under one megabyte and very low power requirements and
therefore is ideal for use in embedded, mobile and wireless applications.
Fonix synthetic speech products produce a high-quality,
human-sounding voice that includes full voice inflection, intonation, and
clarity. In addition to the human-like quality of the Fonix TTS, the technology
employed for processing the speech synthesis is significantly more efficient
than other competing technologies allowing Fonix TTS to operate in single-user
embedded environments as well as providing more simultaneous speech channels on
server-based applications.
Fonix products currently employing TTS technologies include:
FAAST TTS 5.1 - A software development framework that delivers TTS to
telephony, voice portal and Internet applications.
FAAST Embedded 1.1 - A software development framework that delivers
TTS and ASR to embedded applications.
iSpeak - A personal text reader for desktop and laptop systems that
reads to the user from any text file out loud in a natural,
human-sounding voice.
TimeTalk - A small software utility program for Pocket PC that reads
time out loud in a pleasant, human-quality voice.
Speak@Me - A TTS converter for audio playback across the Internet
that gives web content providers the ability to deliver audio content
to customers using a Real Audio player plug-in.
HWR. The Fonix HWR system converts natural handwriting into text that
can be read by electronic devices. It recognizes conventional cursive writing,
printing, and a natural, single-stroke alphabet. The single-stroke alphabet is
marketed under the "Allegro" brand name. Because it recognizes natural
handwriting styles as well as predefined high definition characters, the Allegro
system is quicker and requires less training than other similar applications.
In addition to currently available Allegro products, the Company is
also developing applications that will allow HWR to be used as a natural
handwriting interface with many handheld and tablet PC applications. Such
applications are designed to provide character recognition using any graphic pen
or stylus and computer tablet and forwards the characters to whatever
application the user is currently working in.
Employees
As of March 20, 2001, the Company employed 115 people. Of this total,
61 were employed in product development and delivery, 33 were employed in sales
and marketing, and 21 were employed in strategic development, administration and
support.
Page 9 of 51
RECENT DEVELOPMENTS
2000 Annual Meeting of Stockholders
Fonix held its 2000 Annual Meeting of Stockholders on September 28,
2000, at which 130,262,281 shares were represented in person or by proxy. The
stockholders elected Thomas A. Murdock, Roger D. Dudley, John A. Oberteuffer,
William A. Maasberg Jr. and Mark S. Tanner to The Company's board of directors,
and approved the board's selection of Arthur Andersen LLP as the Company's
independent public accountants for the year ended December 31, 2000.
Expansion Activities
Advocast - In 1997 and 1998, Fonix purchased 60,200 shares of Series
A 6% Convertible Preferred Stock (the "Advocast Preferred Stock") of Advocast,
Inc. ("Advocast") for $1,521,755. Subsequent to 1998, Advocast obtained an
additional $1,000,000 in financing from third parties, and continued developing
its technology to the point where it is ready for integration with speech
technologies, such as those available from Fonix.
On February 26, 2001, Fonix agreed to provide an additional $100,000
of financing under the terms of a 6% convertible debenture. The debenture is due
February 26, 2002, and is secured by the intellectual property and operating
assets of Advocast. The debenture is convertible into shares of Advocast common
stock at a rate of $8.62 per share at the option of Fonix. Furthermore, Fonix
has the right to convert its Advocast Preferred Stock into additional principal
under the debenture at a rate of $25 per share of Preferred Stock. If converted,
the resulting balance due under the debenture is subject to the same terms of
conversion into Advocast common stock or becomes due and payable six months
following the original due date of the convertible debenture. Fonix has not yet
advanced any amounts under the debentures.
Advocast and Fonix also entered into an agreement whereby Advocast
will provide consulting services to Fonix for development of Internet
applications of the Company's NUI technologies. The term of the agreement is
three months and may be renewed at the Company's option for an additional three
months. Fonix will pay Advocast $10,000 per month for these consulting services.
To date, Fonix has paid $30,000 to Advocast pursuant to the consulting
agreement.
Audium - In February 2001, the Company and Phone2Networks, Inc. dba
Audium ("Audium") entered into a collaboration agreement to provide an
integrated platform for generating Voice XML solutions for Internet and
telephony systems. Audium is a mobile application service provider that builds
and operates mobile applications that allow access to Internet information and
complete online transactions using any telephone. The collaboration will include
integration of FAAST with Audium's mobile applications development capability.
In connection with the collaboration agreement, in February 2001, the
Company advanced $200,000 to Audium as a bridge loan. The loan bears interest at
a rate of 12 percent per year, is due on or before February 28, 2003 and is
convertible into shares of Audium Series A Convertible Preferred Stock.
Telia - Telia Promotor AB ("Telia"), a wholly owned subsidiary of
Telia AB, a Swedish telecommunications company, has developed multiple language
capability for integration into TTS applications. In October 2000, the Company
entered into a revenue sharing arrangement with Telia that provides that Fonix
will pay a percentage of revenue to Telia for Fonix licenses of TTS technology
that include languages other than American English provided by Telia.
Korea Sales Office - In March 2001, the Company opened an office in
Seoul, Korea, to sell and market Fonix products and solutions in the embedded
and server markets to Korean manufacturers of microprocessor chips and consumer
electronics, and through VARs for retail distribution.
Page 10 of 51
Financing Activities
Convertible Promissory Note and Private Equity Lines of Credit On
June 20, 2000, the Company executed a convertible promissory note (the "2000
Note") with a private investor in the amount of $7,500,000 and was permitted to
draw funds as they were required for operations. During 2000, the Company drew
the entire amount available and recorded $106,348 as interest and financing
expense. Principal and interest were converted into 11,544,775 shares of Class A
common stock. The Company also recorded a beneficial conversion feature in the
amount of $3,447,623 related to borrowings under the promissory note.
On August 8, 2000, the Company entered into a Private Equity Line
Agreement ("Equity Line") with the same investor (the "Equity Line Investor"),
which gives the Company the right to draw down a maximum of $20,000,000 for
operations and other purposes. The initial $7,500,000 was obtained as part of
the convertible promissory note described above. The balance remaining under the
Equity Line is available to the Company through a mechanism of draws and puts of
stock. The Company is entitled to draw funds and to "put" to the Equity Line
Investor shares of Class A common stock in lieu of repayment of the draw. The
number of shares issued is determined by dividing the dollar amount of the draw
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 funds the amounts requested by
the Company within two trading days after the seven trading-day period.
During 2000, draws taken under the Equity Line amounted to $3,973,508
and were converted to 12,492,680 shares of Class A common stock. Subsequent to
December 31, 2000, additional draws amounting to $3,010,000 were converted into
6,770,945 shares of Class A common stock. As of March 20, 2001, $5,516,492 of
credit remains available to be drawn on the Equity Line.
Series F Convertible Preferred Stock In February 2000, Fonix entered
into an agreement with five investors whereby Fonix sold to the investors a
total of 290,000 shares of its Series F convertible preferred stock, in return
for cash of $2,750,000. In May 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,
bringing the total to 316,036 shares of Series F convertible preferred stock
issued. The Series F preferred stock was convertible into shares of Fonix's
Class A common stock during the first 90 days following the closing of the
transaction at a price of $0.75 per share, and thereafter at a price equal to
85% of the average of the three lowest closing bid prices in the 20-day trading
period prior to the conversion of the Series F preferred stock. A registration
statement describing the Class A common stock to be issued upon conversion of
the Series F preferred stock was declared effective February 11, 2000. In 2000,
309,963 shares of Series F preferred stock and related dividends were converted
into 8,342,820 shares of Class A common stock and the Company recorded a
beneficial conversion feature in the amount of $2,750,000 at the date of
issuance. Subsequent to December 31, 2000, the remaining 6,073 shares of Series
F convertible preferred stock and related dividends were converted into 519,067
shares of Class A common stock.
Series D Convertible Preferred Stock During 2000, 217,223 shares of
Series D preferred stock together with related dividends, were converted into
15,436,378 shares of Class A common stock. After the above conversions, 164,500
shares of Series D preferred stock remained outstanding as of December 31, 2000.
Subsequent to December 31, 2000, the remaining shares of Series D preferred
stock and related dividends, were converted into 13,978,440 shares of Class A
common stock.
Registrations on Form S-2 In compliance with registration rights
granted in connection with the Series F Convertible Preferred Stock and certain
aspects of previous convertible preferred stock and debenture transactions,
Fonix registered 56,864,399 shares of its Class A common stock. The registration
statement filed on Form S-2 became effective February 11, 2000, and was later
amended and declared effective December 4, 2000.
In compliance with registration rights granted in connection with the
Equity Line transaction described above, Fonix registered 53,185,889 shares of
its Class A common stock. The registration statement filed on Form
Page 11 of 51
S-2 became effective September 5, 2000, and was later amended and declared
effective December 4, 2000.
Grants of Stock Options
During 2000, Fonix granted options to purchase 7,116,067 shares of
Class A common stock as follows:
Grantee Number of Shares Exercise Prices
- -------------- ---------------- ----------------
Directors and Executive Officers 4,800,000 $0.28 - $1.01
Employees 2,052,400 $0.28 - $1.50
Consultants 263,667 $0.28 - $1.00
The term of all of these stock options is ten years from the date of
grant. During 2000, 675,570 options expired without exercise. As of December 31,
2000, the Company had a total of 19,857,700 options outstanding, of which
18,923,001 were exercisable at a weighted average exercise price of $3.07.
Page 12 of 51
CERTAIN SIGNIFICANT RISK FACTORS
The short- and long-term success of the Company is subject to certain risks,
many of which are substantial in nature and outside the control of the Company.
You should consider carefully the following risk factors, in addition to other
information contained herein. All forward-looking statements contained herein
are deemed by the Company to be covered by and to qualify for the safe harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act"). You should understand that several factors govern whether any
forward-looking statement contained herein will or can be achieved. Any one of
those factors could cause actual results to differ materially from those
projected herein. These forward-looking statements include plans and objectives
of management for future operations, including the strategies, plans and
objectives relating to the products and the future economic performance of the
Company and its subsidiaries discussed above. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of any such statement should not be regarded as a representation by
the Company or any other person that the objectives or plans of the Company will
be achieved.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about Fonix's ability to
continue as a going concern.
Since its inception, Fonix has sustained losses. Such losses continue
due to ongoing operating expenses and a lack of revenues sufficient to offset
operating expenses. Fonix had limited working capital of $180,356 at December
31, 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 significant sales of
its existing products, substantial revenues from new licensing or co-development
contracts or continuing large sales of its securities.
Fonix incurred net losses of $22,761,229, $21,662,419, and
$43,118,782 for the years ended December 31, 2000, 1999 and 1998, respectively.
As of December 31, 2000, Fonix had an accumulated deficit of $143,040,284. As of
December 31, 2000, Fonix owed trade payables of approximately $655,352, of which
$224,436 are more than 60 days past due.
The Company expects to spend significant amounts to enhance its
products and technologies, expand domestic and international sales and
operations and fund research and development. As a result, the Company will need
to generate significant additional revenue to achieve profitability. Even if the
Company does achieve profitability, it may not be able to sustain or increase
profitability on a quarterly or annual basis. If the Company does not achieve
and maintain profitability, the market price for its common stock may further
decline, perhaps substantially.
If Fonix does not receive additional capital when and in the amounts needed in
the near future, its ability to continue as a going concern is in substantial
doubt.
Fonix anticipates incurring substantial sales and marketing, product
development and research and general operating expenses in the future that will
require substantial amounts of additional capital on an ongoing basis. Fonix
will most likely have to obtain such capital from sales of its equity,
convertible equity and/or debt securities. Obtaining future financing may be
costly and will likely be dilutive to existing stockholders. If Fonix is not
able to obtain financing when and in the amounts needed, and on terms that are
acceptable to it, Fonix's operations, financial condition and prospects could be
materially and adversely affected, and Fonix could be forced to curtail its
operations or sell part or all of its assets, including its Core Technologies.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
At present, Fonix's revenues from existing licensing arrangements and
products are not sufficient to offset Fonix's ongoing operating expenses or to
pay in full the Company's current debt obligations. There is substantial
Page 13 of 51
risk, therefore, that the existence and extent of the debt obligations described
above could adversely affect Fonix, its operations and financial condition.
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 issuances of Class A
common stock in connection with the Equity Line:
Introduction
The following table describes the number of shares of Class A common
stock that would be issuable as of March 20, 2001, assuming 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.
Equity Line - Shares
Hypothetical Conversion/ issuable upon put of
Exercise Price remaining $5,516,492
- ------------------------------ -----------------------
$0.25 22,065,968
$0.75 7,355,323
$1.50 3,677,661
$2.25 2,451,774
$3.00 1,838,831
Given the formulas for calculating the shares to be issued under the
Equity Line, there effectively is no limitation on the number of shares of Class
A common stock which may be issued in connection with a put under the Equity
Line. If the market price of the Class A common stock decreases, the number of
shares of Class A common stock issuable in connection with the Equity Line will
increase.
Overall Dilution to Market Price and Relative Voting Power of
Previously Issued Common Stock
The issuance of Class A common stock in connection with the Equity
Line may result in substantial dilution to the equity interests of other holders
of the Company's Class A common stock. Specifically, the issuance of a
significant amount of additional Class A common stock would result in a decrease
of the relative voting control of the Company's Class A common stock issued and
outstanding prior to the issuance of Class A common stock in connection with the
Equity Line. Furthermore, public resales of the Company's Class A common stock
following the issuance of Class A common stock in connection with the Equity
Line likely would depress the prevailing market price of the Company's 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 the
Company's obligation to honor such conversions or exercises could depress the
market price of the Company's Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common
Stock
The formulas for determining the number of shares of Class A common
stock under the Equity 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 the Company's Class A common stock at and
around the time the Company puts shares under the Equity Line, the more Class A
common stock the Equity Line Investor receives. Any increase in the number of
shares of the Company's Class A common stock issued upon conversion or put of
shares 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 the Company's Class A common
stock that likely would result from sales of the Company's Class A common stock
issued in connection with a put under the Equity Line could encourage short
sales of Class A common stock by the Equity Line Investor. Material amounts of
such short selling
Page 14 of 51
could place further downward pressure on the market price of the Company's Class
A common stock.
Limited Effect of Restrictions on Extent of Conversions
Fonix is prohibited from putting shares to the Equity Line Investor
under the Equity Line if such put would result in that investor holding more
than 4.999% of the then outstanding Class A common stock. These restrictions,
however, do not prevent the Equity Line Investor from selling shares of Class A
common stock received in connection with a put, and then receiving additional
shares of Class A common stock in connection with a subsequent put. In this way,
the Equity Line Investor could sell more than 4.999% of the outstanding the
Company's Class A common stock in a relatively short time frame while never
holding more than 4.999% at one time.
Fonix has a limited product offering and many of its key technologies are still
in the product development stage.
Presently, there are a limited number of commercially available
applications or products incorporating the Company's Core Technologies. For the
Company to be ultimately successful, sales from these product offerings must be
substantially greater. 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. The Company has
recently entered into licensing and joint-marketing agreements with Intel and
Microsoft. These agreements provide for joint marketing and application
development for Intel and Microsoft end-users or customers. There can be no
assurance that these collaboration agreements will produce license or other
agreements which will generate material revenues for Fonix.
The market for many of Fonix's technologies and products is largely unproven and
may never develop sufficiently to allow Fonix to capitalize on its technology
and products.
The market for NUI technologies is relatively new and rapidly
evolving. Additionally, Fonix's technologies are new and, in many instances,
represent a significant departure from technologies which already have found a
degree of acceptance in the NUI marketplace. The financial performance of Fonix
will depend, in part, on the future development, growth, and ultimate size of
the market for NUI applications and products generally, and applications and
products incorporating Fonix's technologies and applications. Accordingly, in
order to achieve commercial acceptance of the Core Technologies, Fonix will have
to educate prospective customers, including large, established
telecommunications companies, about the uses and benefits of NUI software in
general and its products in particular. If these efforts fail, or if NUI
software platforms do not achieve commercial acceptance, the Company's business
could be harmed.
The applications and products which incorporate the Fonix Core
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 NUI
technologies including ASR, TTS, HWR, speech compression, speaker identification
and verification, pen and touch screen input, and natural language
understanding. Nevertheless, such a market for Fonix's technologies or for
products incorporating Fonix's technologies may never develop to the point that
profitable operations can be achieved or sustained.
The application and delivery of the Company's Core Technolgies to end users is
dependent upon third party integration and may be subject to delays and
cancellations that are beyond the Company's control.
Because the Company is pursuing third party integration of Fonix NUI
technologies into mass market, industrial, general business and personal
electronics products, and computing solutions, lead time to revenue recognition
will be longer than software products directly released into consumer channels.
Purchase of the Company's products often require a significant expenditure by a
customer. Accordingly, the decision to purchase the Company's products typically
requires significant pre-purchase evaluation. The Company may spend significant
time educating and providing information to prospective customers regarding the
use and benefits of its products and technologies. During this evaluation
period, the Company may expend substantial sale, marketing and management
resources.
Page 15 of 51
Further, the Company's products and technologies sold and integrated
into customer applications are subject to both customer production schedules and
customer success in marketing the products and generating product sales. The
Company's revenues are thus subject to delays and possible cancellation
resulting from customer integration risks and delays.
In cases where the Company's contract with its customers specifies
milestones or acceptance criteria, the Company may not be able to recognize
license or services revenue until these conditions are met. The Company has in
the past and may in the future experience unexpected delays in recognizing
revenue. Consequently, the length of the Company's sales and implementation
cycles and the varying order amounts for its products make it difficult to
predict the quarter in which revenue recognition may occur and may cause license
and services revenue and operating results to vary significantly from period to
period. These factors could cause the Company's stock price to be volatile or to
decline.
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 NUI market sector and, specifically,
the ASR, computer voice and communications industries are characterized by rapid
technological change. Competition in the NUI market is based largely on
marketing ability and resources, distribution channels, technology and product
superiority and product service and support. The development of new technology
or material improvements to existing technologies by Fonix's competitors may
render Fonix's technologies less attractive or even obsolete. Accordingly, the
success of Fonix will depend upon its ability to continually enhance its
technologies and interactive solutions and products to keep pace with or ahead
of technological developments and to address the changing needs of the
marketplace. Some of Fonix's competitors have greater experience in developing,
manufacturing and marketing NUI 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 NUI products expands and matures, Fonix
expects more entrants into this already competitive arena.
Fonix's failure to respond to rapid change in the NUI market could cause the
Company to lose revenue and harm its business.
The NUI industry is relatively new and rapidly evolving. Fonix's
success will depend substantially upon its ability to enhance its existing
technologies and products and to develop and introduce, on a timely and
cost-effective basis, new technologies, products and features that meeting
changing end-user requirements and incorporate technological advancements. If
the Company is unable to develop new products and enhanced functionalities or
technologies to adapt to these changes, or if the Company cannot offset a
decline in revenue from existing technologies and products with sales of new
products, the Company's business would suffer.
Commercial acceptance of the Company's products and technologies will
depend, among other things, on:
o the ability of the Company's products and technologies to meet
and adapt to the needs of its target markets;
o the performance and price of the Company's products and its
competitors' products; and
o the Company's ability to deliver customer services directly and
through its resellers.
Any software defects in the Company's products could harm its business and
result in litigation.
Complex software products such as the Company's may contain errors,
defects and bugs. With the planned release of any product, Fonix may discover
these errors, defects and bugs and, as a result, its products may
Page 16 of 51
take longer than expected to develop. In addition, Fonix may discover that
remedies for errors or bugs may be technologically unfeasible. Delivery of
products with undetected production defects or reliability, quality, or
compatibility problems could damage its reputation. Errors, defects or bugs
could also cause interruptions, delays or a cessation of sales to the Company's
customers. Fonix could be required to expend significant capital and other
resources to remedy these problems. In addition, customers whose businesses are
disrupted by these errors, defects and bugs could bring claims against Fonix
which, even if unsuccessful, would likely be time-consuming and could result in
costly litigation and payment of damages.
In order to increase the Company's international sales, the Company must develop
localized versions of its products. If the Company is unable to do so, it may be
unable to grow its revenue and execute its business strategy.
Fonix intends to expand its international sales, which requires it to
invest significant resources to create and refine different language models for
each particular language or dialect. These language models are required to
create versions of Fonix's products that allow end users to speak the local
language or dialect and be understood. If Fonix fails to develop localized
versions of its products, Fonix's ability to address international market
opportunities and to grow its business will be limited.
Fonix may encounter difficulties in managing its growth, which could prevent it
from executing its business strategy.
Fonix's growth has placed, and continues to place, a significant
strain on its resources. To accommodate this growth, the Company must continue
to upgrade a variety of operational and financial systems, procedures and
controls and hire additional employees to support increased business and product
development activity. This has resulted in increased responsibilities for
Fonix's management. Fonix's systems, procedures and controls may not be adequate
to support its operations. If the Company fails to improve its operational,
financial and management information systems, or to hire, train, motivate or
manage its employees, the Company's business could be harmed.
If the Company is unable to hire and retain technical, sales and marketing and
operational employees, its business could be harmed.
The Company intends to hire additional employees, including software
engineers, sales and marketing employees and operational employees. Competition
for hiring these individuals is intense, especially in the Salt Lake City area
where the Company is headquartered, and it may not be able to attract,
assimilate, or retain additional highly qualified employees in the future. The
failure to attract, integrate, motivate and retain these employees could harm
Fonix's business.
The Company's stock price is volatile, and an investor may not be able to resell
its shares at or above the purchase price.
In recent years, the stock market in general, and the OTC Bulletin
Board and the securities of technology companies in particular, has experienced
extreme price and trading volume fluctuations. These fluctuations have often
been unrelated or disproportionate to the operating performance of individual
companies. These broad market fluctuations may materially adversely affect the
Company's stock price, regardless of its operating results.
Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 2000, 1999 and 1998.
The independent public accountants' reports for Fonix's financial
statements for the years ended December 31, 2000, 1999 and 1998 include an
explanatory paragraph regarding substantial doubt about Fonix's ability to
continue as a going concern. This may have an adverse effect on the Company's
ability to obtain financing to further develop and market its products.
Page 17 of 51
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.
Certain elements of the Company's Core Technologies are the subject of six
patents issued and allowed by the United States Patent and Trademark Office and
13 other patent applications are pending. In addition to its patents, Fonix
relies on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect its proprietary
rights. Such means of protecting Fonix's proprietary rights may not be adequate
because such laws provide only limited protection. Despite precautions that
Fonix takes, it may be possible for unauthorized third parties to duplicate
aspects of the Fonix technologies or the current or future products or
technologies of its business units or to obtain and use information that Fonix
regards as proprietary. Additionally, Fonix's competitors may independently
develop similar or superior technology. Policing unauthorized use of proprietary
rights is difficult, and some international laws do not protect proprietary
rights to the same extent as United States laws. Litigation periodically may be
necessary to enforce Fonix's intellectual property rights, to protect its trade
secrets or to determine the validity and scope of the proprietary rights of
others.
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 developers of NUI technologies
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, Mark Hamilton, R. Brian Moncur, 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, Roger D. Dudley and
William A. Maasberg, Jr. 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
employees, executive employees or independent contractors resigns from Fonix to
join a competitor, to the extent not prohibited by such person's non-competition
and non-disclosure agreement, the loss of such personnel and the employment of
such personnel by a competitor could have a material adverse effect on Fonix.
Fonix does not presently have any key man life insurance on any of its
employees.
Fonix's charter and bylaws and Delaware law contain provisions which may delay
or prevent a change of control of the Company.
Provisions of the Company's charter and bylaws may make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, control of Fonix. These provisions could limit the price
that investors might be willing to pay in the future for shares of Class A
common stock. These provisions include:
Page 18 of 51
o procedures for advance notification of stockholder nominations
and proposals; and
o the ability of the board of directors to alter the Company's our
bylaws without stockholder approval.
In addition, the board of directors has the authority to issue up to
50,000,000 shares of preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The board
utilized this right when approving and issuing the Series A through Series F
preferred stock. The issuance of preferred stock, while providing flexibility in
connection with financings or acquisitions or other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of Fonix's outstanding voting stock.
Fonix may incur a variety of costs to engage in future acquisitions of
companies, products or technologies, and the anticipated benefits of those
acquisitions may never be realized.
The Company may make acquisitions of, or significant investments in,
complementary companies, products or technologies. Any future acquisitions would
be accompanied by risks such as:
o difficulties in assimilating the operations and employees of
acquired companies;
o diversion of management's attention from ongoing business
concerns;
o potential inability to maximize the Company's financial and
strategic position through the successful incorporation of
acquired technology and rights into its products and services;
o additional expense associated with amortization of acquired
assets;
o maintenance of uniform standards, controls, procedures and
policies; and
o impairment of existing relationships with employees, suppliers
and customers as a result of the integration of new management
employees.
Fonix cannot guarantee that it will be able to successfully integrate
any business, products, technologies or employees that it might acquire in the
future, and its failure to do so could harm its business.
Fonix has no dividend history and no intention to pay dividends in the
foreseeable future.
Fonix has never paid dividends on or in connection with any class of
its common stock and does not intend to pay any dividends to common stockholders
for the foreseeable future.
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the
only ones facing Fonix. Additional risks and uncertainties not presently known
to Fonix or that Fonix currently deems immaterial may also impair its business
operations. If any of the foregoing risks actually occur, Fonix's business,
financial condition, or results of operations could be materially adversely
affected. In such case, the trading price of Fonix Class A common stock could
decline.
Page 19 of 51
ITEM 2. PROPERTIES
The Company owns no real property. Commencing in October 1996, the
Company leased a 25,600 square foot facility in Draper, Utah, from an
unaffiliated third party at which it conducts its principal scientific research,
product development and sales and marketing activities. The Company's lease of
that facility is for a term of eight years, with a right to terminate after five
years, at the Company's option. Provided that the Company is not in default
under the lease, the Company has the option to extend the lease for five
additional years. The average base monthly lease payment over the eight-year
life of the lease for that facility is $28,389. Beginning in May 1999, the
Company subleased approximately 10,224 square feet of this space to an unrelated
third party for a monthly rental of $13,961. The sublease expired December 2000.
In addition to the Draper facility, the Company subleases office
space on a month-to-month basis at market rates for its corporate headquarters
and administrative operations in Salt Lake City, Utah, under subleases from SCC
Asset Management, Inc., formerly Studdert Companies Corporation ("SCC"). SCC is
owned and controlled by three individuals, two of whom are executive officers
and directors of the Company. (See "Certain Relationships and Related
Transactions," and "Security Ownership of Certain Beneficial Owners and
Management"). The two executive officers and a former executive officer of the
Company have personally guaranteed these leases in favor of SCC's landlord. The
leases expire December 2002 and February 2003 and require monthly rental
payments of $10,368.
The Company leases approximately 1,377 square feet of office space in
Lexington, Massachusetts, where it conducts sales and marketing for its Core
Technologies and product development for pen/voice products and other
applications. This lease expires November 30, 2002 and requires monthly rental
payments of $2,754.
Effective May 25, 1999, the Company entered into an agreement to
sublease its Cupertino, California facility to an unrelated third party. The
agreement requires the sublessee to pay $35,432 per month through May 31, 2003.
The Company believes that the facilities described above are adequate
for its current needs.
ITEM 3. LEGAL PROCEEDINGS
OGI - On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default, demand for mediation and demand for arbitration with the American
Arbitration Association. In its demand, OGI asserted that 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. In
December 2000, a settlement was reached that required the Company to pay $27,500
in cash and issue 260,145 shares of Class A common stock, valued at $81,295 at
the date of settlement, and required that OGI return equipment loaned to them by
Fonix under the terms of their original agreements.
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
affiliated with Clarke, commenced an action against Fonix in federal court for
the Southern District of New York. Clarke and Perpetual Growth asserted claims
for breach of contract relating to certain financing Fonix received during 1998
and thereafter. Fonix filed a motion to dismiss based upon the court's lack of
personal jurisdiction over Fonix. The court granted Fonix's motion to dismiss.
Clarke and Perpetual Growth thereafter appealed the decision of the New York
court to the United States Court of Appeals for the Second Circuit. The Court of
Appeals affirmed the decision of the trial court. In the interim, Fonix filed a
suit against Clarke and Perpetual Growth in federal court for the Central
District of Utah seeking a declaratory judgment that it did not owe any money to
Clarke and Perpetual Growth. The case was tried to the Utah court in March 2001,
after which the Utah court ruled in favor of Fonix and determined that Clarke
and Perpetual Growth had no claims for "trailing fees" with regard to the
financings which
Page 20 of 51
were the subject of the suit. Clarke and Perpetual Growth have appealed the
decision of the Utah court to the United States Court of Appeals for the Tenth
Circuit. The Company believes that the claims of Clarke and Perpetual Growth are
without merit and will continue to vigorously oppose those claims.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 28, 2000, the Company held its 2000 Annual Meeting of
Stockholders. The following matters were submitted to a vote of security
holders:
Election of Thomas A. Murdock, Roger D. Dudley, John A. Oberteuffer,
William A. Maasberg Jr. and Mark S. Tanner to the Company's board of
directors, approved as follows:
Shares Shares
Name of Director Voted For Voted Against
---------------- --------- -------------
Thomas A. Murdock 129,445,118 726,163
Roger D. Dudley 129,319,052 852,229
John A. Oberteuffer 129,492,751 678,530
William A. Maasberg, Jr. 129,625,436 545,581
Mark S. Tanner 129,656,436 514,845
Appointment of Arthur Andersen LLP as the Company's independent
public accountants for the fiscal year ended December 31, 2000,
approved by a vote of 129,784,384 shares for and 315,764 shares
against.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for Class A common stock as quoted on the Nasdaq
SmallCap Market (until December 3, 1999) and on the OTC Bulletin Board
thereafter for the four quarters of calendar 2000 and 1999. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commissions
and may not represent actual transactions.
Calendar Year 2000 Calendar Year 1999
----------------------- ----------------------
High Low High Low
---- ----- ----- ----
First Quarter $ 2.50 $ 0.25 $ 3.31 $ 0.69
Second Quarter $ 1.81 $ 1.00 $ 0.94 $ 0.25
Third Quarter $ 1.39 $ 0.50 $ 1.19 $ 0.28
Fourth Quarter $ 0.94 $ 0.28 $ 1.00 $ 0.27
As of March 20, 2001, there were 210,827,463 shares of Fonix Class A
common stock outstanding, held by approximately 664 holders of record and 46,550
beneficial holders. This number of beneficial holders represents an estimate of
the number of actual holders of the Company's stock, including beneficial owners
of shares held in "nominee" or "street" name. The actual number of beneficial
owners is not known to the Company.
Page 21 of 51
The Company has never declared any dividend on its Class A common
stock and it is expected that earnings, if any, in future periods will be
retained to further the development and sale of the Company's NUI technologies
and products. No dividends can be paid on the Class A common stock until such
time as all accrued and unpaid dividends on outstanding preferred stock, if any,
have been paid.
Recent Sales of Unregistered Equity Securities
During 2000, the Company issued 316,036 shares of Series F preferred
stock, par value $20 per share, to five investors for $2,750,000. The Company
issued such shares without registration under the Securities Act of 1933 (the
"1933 Act) in reliance on Section 4(2) of the 1933 Act and the rules and
regulations promulgated thereunder. The shares of Series F preferred stock were
issued as restricted securities and the certificates representing the Series F
preferred stock were stamped with a restricted legend to prevent any resale
without registration under the 1933 Act or pursuant to an exemption.
The resales of the Class A common shares underlying the Series F
preferred stock were subsequently registered on a Form S-2 that was initially
declared effective February 11, 2000, and amended and declared effective
December 4, 2000.
On May 25, 2000, the Company issued 250,000 shares of Class A common
stock to a consultant for services rendered in connection with certain financing
transactions. The Company issued such shares without registration under the 1933
Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder. The shares were subsequently registered on a Form S-2
that was declared effective September 5, 2000, and amended and declared
effective December 4, 2000.
On June 30, 2000, the Company issued 612,069 shares of Class A common
stock to a consultant for services rendered in connection with certain financing
transactions. The Company issued such shares without registration under the 1933
Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder. The shares were subsequently registered on a Form S-2
that was declared effective September 5, 2000, and amended and declared
effective December 4, 2000.
Between August 8, 2000 and December 31, 2000, in connection with the
Equity Line Agreement, the Company received $11,473,508 in funds drawn under the
2000 Note and the Equity Line Agreement and issued 24,037,455 shares of Class A
common stock to the Equity Line Investor. The shares were issued without
registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and
the rules and regulations promulgated thereunder.
The resales of the shares were subsequently registered under a
registration statement on Form S-2 which was declared effective September 5,
2000 and amended and declared effective December 4, 2000.
Page 22 of 51
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below is derived from the
Company's consolidated balance sheets and statements of operations as of and for
the years ended December 31, 2000, 1999, 1998, 1997, and 1996. The data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and related notes thereto included in this Report.
For the Year Ended December 31,
2000 1999 1998 1997
----------------- ---------------- ----------------- ----------------
Statement of Operations Data:
Revenues $ 656,853 $ 439,507 $ 2,604,724 $ --
General and administrative expenses 10,722,313 9,498,753 8,817,643 12,947,112
Product development and research 5,871,414 7,909,228 13,060,604 7,066,294
Purchase of in-process research and development 474,000 -- 9,315,000 --
Amortization of intangible assets 2,457,829 2,588,896 1,712,267 --
Other income (expense) (3,991,348) (3,698,789) (6,507,245) (1,558,678)
Loss from continuing operations (22,810,677) (19,949,196) (36,843,475) (21,572,084)
Loss from discontinued operations -- (2,187,080) (6,275,307) --
Gain (loss) on extraordinary items 49,448 473,857 -- (881,864)
Net loss (22,761,229) (21,662,419) (43,118,782) (22,453,948)
Basic and diluted net loss per common share $ (0.16) $ (0.31) $ (0.91) $ (0.59)
Weighted average number of common shares
outstanding 162,684,298 76,753,709 52,511,185 42,320,188
1996
-----------------
Statement of Operations Data:
Revenues $ --
General and administrative expenses 3,530,400
Product development and research 4,758,012
Purchase of in-process research and development --
Amortization of intangible assets --
Other income (expense) 458,904
Loss from continuing operations (7,829,508)
Loss from discontinued operations --
Gain (loss) on extraordinary items --
Net loss (7,829,508)
Basic and diluted net loss per common share $ (0.21)
Weighted average number of common shares
outstanding 36,982,610
As of December 31,
-------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------- ---------------- ----------------- ---------------- -----------------
Balance Sheet Data:
Current assets $ 3,752,210 $ 480,885 $ 20,638,070 $ 21,148,689 $ 23,967,601
Total assets 17,517,373 19,173,147 61,912,791 22,894,566 25,331,270
Current liabilities 3,571,854 5,285,681 35,317,045 20,469,866 19,061,081
Long-term debt, net
of current portion 19,767 3,971,107 -- 52,225 --
Stockholders' equity 13,925,752 8,086,359 24,765,746 2,372,475 6,270,189
Page 23 of 51
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FACTORS AFFECTING FUTURE OPERATING RESULTS" AND UNDER THE HEADING
"CERTAIN SIGNIFICANT RISK FACTORS" IN ITEM 1 PART I OF THIS REPORT, ABOVE.
The following discussion of the results of operations and financial condition
should be read in conjunction with the consolidated financial statements and
notes thereto included elsewhere in this report.
Overview
Since inception, Fonix has devoted substantially all of its resources
to research, development and acquisition of software technologies that enable
intuitive human interaction with computers, consumer electronics, and other
intelligent devices. Through December 31, 2000, the Company has incurred
cumulative losses amounting to $121,047,787, excluding cumulative losses from
discontinued operations of $8,462,387 and net extraordinary items. Such losses
are expected to continue until the effects of recent marketing and sales efforts
begin to take effect, if ever.
In 2000, Fonix management continued to transition its strategic focus
from technology research, development and acquisition into sales and marketing
and product delivery. The Company expended approximately $1,954,752 in 2000 and
$1,125,611 in 1999 in sales and marketing efforts. The Company has made this
transition while continuing to achieve technology upgrades to maintain distinct
competitive technology advantages.
In its current marketing efforts, the Company seeks to form
relationships with third parties who can incorporate NUI technologies into new
or existing products. Such relationships may be structured in any of a variety
of ways including traditional technology licenses, collaboration or joint
marketing agreements 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
products.
Results of Operations
The results of operations disclosed below give effect to the sale of
the Healthcare Solutions Group ("HSG") in September 1999 and the classification
of its net assets and operating activities as discontinued operations.
2000 Compared to 1999
During 2000, the Company recorded revenues of $656,853, an increase
of $217,346 from $439,507 for 1999. The increase in 2000 results primarily from
increased activity in licensing of TTS channels in telephony applications.
Selling, general and administrative expenses were $10,722,313 for
2000 and $9,498,753 for 1999, an increase of $1,223,560. Excluding a
compensation charge in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company, the increase
from 1999 is actually $2,666,860. The increase is due to consulting expense of
$2,294,756 resulting from compensation paid in shares of Class A
Page 24 of 51
common stock for services rendered to the Company by outside consultants. Also
contributing to the increase is other compensation expense in the amount of
$628,000 incurred as a result of the exercise of stock appreciation rights.
Other changes resulting from sales and marketing activity undertaken by the
Company as indicated by the marketing strategy described above were not
significant in 2000, but will impact future periods.
The Company incurred product development and research expenses of
$5,871,414 during 2000, a decrease of $2,037,814 from 1999. This decrease was
due to the ongoing effects of management's cost reduction initiatives
implemented in 1999 and the transition of emphasis from research and development
towards sales and marketing. The Company also experienced decreases in product
development and research costs as it completed development of certain TTS and
ASR products. Ongoing development efforts will be focused on product
applications and solutions utilizing the NUI technologies developed to date.
Net other expense was $3,991,348 for 2000, an increase of $292,559
from 1999. Interest income increased by $44,260 from earnings on the funds held
in escrow in connection with the sale of the HSG. Interest and related finance
charges increased by $367,644 as a result of financing activities undertaken
related to the 2000 Note. Included in interest expense are charges resulting
from beneficial conversion features incurred in connection with the convertible
promissory note in the amount of $3,447,623 in 2000 and the Series C convertible
debentures in the amount of $1,750,000 in 1999.
1999 Compared to 1998
During 1999, the Company recorded revenues of $439,507, a decrease of
$2,165,217 from $2,604,724 for 1998. Revenue in 1998 included licensing fees of
$2,368,138 from an international microchip manufacturer for which the Company
had no further obligation, and product sales and licensing fees of $236,586 from
other customers. The 1999 revenues are primarily from licensing fees from TTS
and HWR technologies and products.
Selling, general and administrative expenses were $9,498,753 for 1999
and $8,817,643 for 1998, an increase of $681,110. A one-time charge to
compensation expense in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company more than
offset reductions achieved in other areas. Absent this charge, selling, general
and administrative expenses decreased by $762,190, 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-related research and development projects.
Amortization of goodwill and purchased Core Technologies was
$2,588,896 for 1999 and $1,712,267 for 1998. The increase of $876,629 results
from amortization for one full year in 1999 compared to amortization for the
portion of 1998 subsequent to the respective acquisition dates of AcuVoice, Inc.
and Papyrus Associates, Inc.
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 5%
Page 25 of 51
convertible debentures issued in January and March 1999.
Selected Quarterly Reports of Operations
The following tables set forth selected unaudited statement of
operations data for each of the quarters in the years ended December 31, 2000
and 1999. This data has been derived from our unaudited financial statements
that have been prepared on the same basis as the audited financial statements
and in the opinion of our management, include all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of the
information when read in connection with the financial statements and the
related notes. Our quarterly operating results have varied substantially in the
past and may vary substantially in the future. You should not draw any
conclusions about our future results for any period from the selected unaudited
statement of operations data for any particular quarter.
For the Quarter Ended
------------------------------------------------------------------------
March 31, September December
2000 June 30, 2000 30, 2000 31, 2000
----------------- ---------------- ----------------- ----------------
(Unaudited)
Net sales $ 56,447 $ 143,825 $ 172,222 $ 284,359
Loss before extraordinary item (5,819,130) (4,778,159) (8,451,438) (3,761,950)
Net loss (5,787,153) (4,731,272) (8,451,438) (3,791,366)
Basic and diluted loss before extraordinary item
per common share $ (0.06) $ (0.03) $ (0.05) $ (0.02)
Basic and diluted loss per common share (0.06) (0.03) (0.05) (0.02)
For the Quarter Ended
------------------------------------------------------------------------
March 31, June 30, 1999 September December
1999 30, 1999 31, 1999
----------------- ---------------- ----------------- ----------------
(Unaudited)
Net sales $ 53,806 $ 231,571 $ 65,707 $ 88,423
Loss before extraordinary item (9,294,861) (6,517,785) (3,395,845) (2,927,785)
Net loss (9,294,861) (6,517,785) (3,023,784) (2,825,989)
Basic and diluted loss before extraordinary item
per common share $ (0.16) $ (0.10) $ (0.06) $ (0.02)
Basic and diluted loss per common share (0.16) (0.10) (0.05) (0.02)
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its
cash requirements during the next 12 months. Research and development,
corporate operations and marketing expenses will continue to require
additional capital. Because the Company presently has only limited revenue
from operations, the Company intends to continue to rely primarily on
financing through the sale of its equity and debt securities to satisfy future
capital requirements until such time as the Company is able to enter into
additional third-party licensing , collaboration or co-marketing arrangements
such that it will be able to finance ongoing operations from license, royalty
and sales revenue. There can be no assurance that the Company will be able to
enter into such agreements. Furthermore, the issuance of equity or debt
securities which are or may become convertible into equity securities
Page 26 of 51
of the Company in connection with such financing could result in substantial
dilution to the stockholders of the Company.
The Company had minimal working capital of $180,356 at December 31,
2000, compared to negative working capital of $4,804,796 at December 31, 1999.
The current ratio was 1.05:1 at December 31, 2000, compared to 0.09:1 at
December 31, 1999. Current assets increased by $3,271,325 to $3,750,210 from
December 31, 1999 to December 31, 2000. Current liabilities decreased by
$1,713,827 to $3,571,854 during the same period. The improvement in working
capital reflects the reclassification of funds held in escrow that were
released in March 2001 as well as reductions in accounts payable and other
liabilities made possible through the private equity line financing. Total
assets were $17,517,373 at December 31, 2000, compared to $19,173,147 at
December 31, 1999, the decrease resulting primarily from amortization of
intangible assets.
Convertible Promissory Note and Private Equity Line of Credit
On June 20, 2000, the Company executed a convertible promissory note
(the "2000 Note") with a private investor in the amount of $7,500,000, which
permitted the Company to draw funds as needed for operating purposes. The note
bore interest at six percent annually, compounded monthly, and was due September
30, 2001. Principal drawn under the terms of the promissory note was designated
as the "Initial Investment Amount" under the Private Equity Line described
below. The investor had 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 $0.75 or 85 percent of the average of the three lowest closing bid
prices of Class A common stock in the 20-day trading period prior to the date of
conversion. During 2000, the Company drew the entire amount available and
recorded $106,348 as interest and financing expense. Principal and interest were
converted into 11,544,775 shares of Class A common stock. The Company also
recorded a beneficial conversion feature in the amount of $3,447,623 related to
borrowings under the promissory note.
On August 8, 2000, the Company entered into a Private Equity Line
Agreement ("Equity Line") with the same investor("Equity Line Investor"), which
gives the Company the right to draw down a maximum of $20,000,000 for operations
and other purposes. The initial $7,500,000 was drawn as part of the convertible
promissory note described above. The balance remaining under the Equity Line is
available to the Company through a mechanism of draws and puts of stock. The
Company is entitled to draw funds and to "put" to the Equity Line Investor
shares of Class A common stock in lieu of repayment of the draw. The number of
shares issued is determined by dividing the dollar amount of the draw 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 funds the amounts requested by the
Company within two trading days after the seven trading-day period.
During 2000, draws taken under the Equity Line, excluding the 2000
Note, amounted to $3,973,508 were converted to 12,492,680 shares of Class A
common stock. Subsequent to December 31, 2000, additional draws amounting to
$3,010,000 were converted into 6,770,945 shares of Class A common stock. As of
March 20, 2001, $5,516,492 credit remains available to be drawn on the Equity
Line.
Series F Convertible 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 in return for payment of $2,750,000. 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, bringing the total to 316,036 shares
of Series F convertible preferred stock issued. 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
Page 27 of 51
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.
In 2000, 309,963 shares of Series F convertible preferred stock,
together with related dividends accrued thereon, were converted into 8,342,820
shares of Class A common 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 convertible preferred stock was issued. Subsequent to December 31, 2000, the
remaining 6,073 shares of Series F convertible preferred stock, together with
related dividends accrued thereon, were converted into 519,067 shares of Class A
common stock.
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, 2000, 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. Some holders of
these notes made demand for payment in September 2000 and the Company made a
counter offer to settle the balances. No final settlement has been reached at
this time.
During 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, 1999, 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.
Class A common stock, warrants and stock options
In July 2000, the Company issued 1,000,000 shares of Class A common
stock (having a market value of $1,015,600 on that date) to unaffiliated
consultants in payment for services rendered. The resulting charge was recorded
as a deferred consulting expense in stockholders' equity and amortized as
general and administrative expense over the subsequent period of service in
2000.
In May 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
consultant in payment for services rendered in connection with financing
transactions. The resulting charge was recorded as general and administrative
expense.
Page 28 of 51
In January 2000, warrants for the purchase of 300,000 shares of Class
A common stock were issued to unaffiliated consultants for services rendered.
The warrants were valued at $45,000 per share using the Black-Scholes pricing
model and the resulting charge was recorded as a deferred consulting expense in
stockholders' equity and amortized as general and administrative expense over
the subsequent period of service in 2000.
In December 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.
As of December 31, 2000, the Company had a total of 3,470,000
warrants outstanding.
During 2000, the Company granted 6,552,400 stock options to employees
at exercise prices ranging from $0.28 to $1.50 per share. The term of all
options granted during the year was ten years from the date of grant. Of the
stock options granted, 5,621,000 vested during 2000 and 931,400 vest over the
subsequent three-year period. As of December 31, 2000, the Company had a total
of 19,857,700 options outstanding, of which 18,923,001 were exercisable.
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. During
February 2000, these stock appreciation rights were exercised at weighted
average exercise price of There are options to purchase 516,339 shares of Class
A common stock outstanding which provide for stock appreciation rights. Of these
options, 126,669 have an exercise price of $6.50 per share, 13,000 have an
exercise price of $3.66 per share and 376,671 have an exercise price of $1.00
per share.
Outlook
Corporate Objectives and Technology Vision
The Company's objective is that its Core Technologies become the
platform for the next generation of NUI applications and products. Most speech
recognition products offered by other companies are based on technologies that
are largely in the public domain and represent nothing particularly "new" or
creative. The Fonix Core Technologies are based on proprietary, patented
technology. Management believes the Company's NUI technologies provide a
superior competitive advantage compared to other technologies available in the
marketplace. In order to accomplish this objective, the Company intends to
proceed as follows:
Substantially Increase Marketing and Sales Activities. The Company
intends to hire additional sales and marketing personnel, both
domestically and internationally, who will focus on the server-based
and embedded markets. To address global opportunities, the Company
will continue to develop or acquire additional NUI products and
technologies for foreign languages and dialects. Fonix will also make
a significant investment in the "Powered by Fonix" Partner Program in
order to build sales and marketing opportunities with software
developers, resellers and corporate partners.
Expand Strategic Relationships. The Company has a number of strategic
collaboration and marketing arrangements with developers and VARs. The
Company intends to expand such relationships and add additional
similar relationships, specifically in the mobile communications, PDA,
IVR and Internet portal markets. Because FAAST is increasingly
recognized as a dynamic development platform, Fonix expects FAAST to
be the product around which many of these relationships are
structures. Further, when the Company is able to
Page 29 of 51
identify "first mover" NUI applications in which it can integrate its
Core Technologies, the Company intends to investigate investment
opportunities in order that the Company can obtain preferred or
priority collaboration rights.
Continue to Develop and Enhance the Core Technologies. The Company
plans to continue to invest significant resources in the development
and acquisition of NUI technologies, developer tools and development
frameworks in order to maintain its competitive advantages.
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 adopted by the Company is not without risk and
shareholders and others interested in the Company and its Class A common stock
should carefully consider the risks set forth under the heading "Certain
Significant Risk Factors" in Item 1, Part I, above.
Page 30 of 51
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements:
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999 F-3
Consolidated Statements of Operations for the Years Ended December 31,
2000, 1999 and 1998 F-4
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2000, 1999 and 1998 F-5
Consolidated Statements of Cash Flows for the Years Ended December
31, 2000, 1999 and 1998 F-7
Notes to Consolidated Financial Statements F-9
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
During the years ended December 31, 2000, 1999 and 1998, and through
the date hereof, there have been no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
Page 31 of 51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the
executive officers and directors of the Company as of March 20, 2001:
Name Age Position
Thomas A. Murdock 57 Director, President &
Chief Executive Officer
Roger D. Dudley 48 Director, Executive Vice President &
Chief Financial Officer
John A. Oberteuffer, Ph.D. 60 Director, Vice President &
Chief Technology Officer
William A. Maasberg, Jr. 61 Director, Chief Operating Officer
Mark S. Tanner 46 Director
All directors hold office until the next annual meeting of the
stockholders of the Company or until their successors have been elected and
qualified. The officers of the Company are elected annually and serve at the
pleasure of the Board of Directors.
THOMAS A. MURDOCK is a co-founder of the Company and has served as an
executive officer and member of the Company's board of directors since
June 1994. He has been the Company's chief executive officer since
January 26, 1999. Mr. Murdock also has served as president of SCC
Asset Management Inc., formerly Studdert Companies Corporation
("SCC"), a related party, since 1992. For much of his career, Mr.
Murdock was a commercial banker and a senior corporate executive with
significant international emphasis and experience. Mr. Murdock also
serves as a director of KLS Enviro Resources, Inc.("KLS"), Advocast,
Inc., an Internet research and development company, and SCC.
ROGER D. DUDLEY is a co-founder of the Company and has served as an
executive officer and member of the Company's board of directors since
June 1994. Mr. Dudley currently serves as the Company's executive vice
president and chief financial officer. After several years at IBM in
marketing and sales, he began his career in the investment banking
industry. He has extensive experience in corporate finance, equity and
debt private placements and asset management. Mr. Dudley also serves
as a director of KLS and SCC.
JOHN A. OBERTEUFFER, Ph.D. has been a director of the Company since
March 1997, vice president since January 1998 and chief technology
officer since March 2001. He is also the founder and president of
Voice Information Associates, Inc. ("VIA"), a consulting group
providing strategic technical, market evaluation, product development
and corporate information to the automated speech recognition
industry. In addition, VIA publishes the monthly newsletter, ASRNews.
Dr. Oberteuffer also is executive director of the American Voice
Input/Output Society ("AVIOS"). He was formerly vice president of
Voice Processing Corp. (now merged with Voice Control Systems, Inc.),
and also was founder and CEO of Iris Graphics, which was acquired by
Seitex Corp. Dr. Oberteuffer received his bachelor's and master's
degrees from Williams College, and his Ph.D. in Physics from
Northwestern University. He was a member of the research staff at
Massachusetts Institute of Technology for five years.
WILLIAM A. MAASBERG, Jr. became a director of the Company in September
1999 and was named chief operating officer February 1, 2000. From
December 1997 through February 1999, Mr. Maasberg was vice president
and general manager of the AMS Division of Eyring Corporation which
manufactures multi-media electronic work instruction software
application. He was also a co-founder and principal in Information
Enabling Technologies, Inc. ("IET"), and LIBRA Corporation ("LIBRA"),
two companies focusing on software application development, and served
in several key executive positions with both IET and LIBRA from May
1976 through November 1997. Mr. Maasberg worked for IBM Corporation
from July 1965 through May 1976 in various capacities. He received his
B.S. Degree from Stanford University
Page 32 of 51
in Electrical Engineering and his M.S. in Electrical Engineering from
the University of Southern California. Mr. Maasberg was re-elected to
the Board of Directors at the Company's 1999 Annual Meeting of
Stockholders.
MARK S. TANNER became a director of the Company in November 1999. Mr.
Tanner is currently self employed as a consultant and was recently the
chief financial officer and senior vice president of finance and
administration for Mrs. Field's Original Cookies, Inc. Mr. Tanner
spent nine years at PepsiCo, where he was chief financial officer for
Pepsi International's operations in Asia, the Middle East, and Africa.
He was vice president of strategic planning for Pepsi North America,
as well as chief financial officer for Pepsi North America's Pepsi
East Operations. Mr. Tanner also spent ten years with United
Technologies Corporation in various capacities, including director of
corporate development. Mr. Tanner holds a B.A. in economics from
Stanford University and an M.B.A. from the University of California at
Los Angeles.
Significant Employees and Consultants
In addition to the officers and directors identified above, the
Company expects the following individuals to make significant contributions to
the Company's business during 2000.
AFARIN BELLISARIO, Sc.D., 50, is vice president and general manager of
wireless solutions. She became an employee of the Company in January
2001 after briefly performing consulting services on behalf of the
Company. Previously, she worked at Intel Capital in areas of investing
in wireless and handheld technologies and devising strategy for
investing in interactive entertainment. Prior to her employment at
Intel, she was with Analog Devices for over seven years in various
executive positions, including senior strategy manager, product line
manager of strategic accounts, and international business development
manager. Other prior experience includes senior positions at Bolt,
Beranek & Newman Communication Inc., and Wang Laboratories. Dr.
Bellisario received her bachelor's and master's of science from New
York Polytechnic, earned her MBA from the MIT Sloan School of
Management, and was awarded her Doctor of Science degree in Acoustics
and Signal Processing from the School of Engineering at MIT.
KURT FLYGARE, 36, is vice president of sales and joined the Company in
January 2001. He was previously senior vice president of sales
business development at NetPartner Inc. Prior to NetPartner, he spent
three years with Baan Company in various executive positions,
including vice president of sales and indirect channel, North America,
and director of sales and business partner alliances, North America.
Previous sales experience includes positions with Corel, Novell, Inc.,
and WordPerfect Corporation. Mr. Flygare received his B.S. in Business
from Brigham Young University.
KIRK M. FELLER, 37, is vice president of marketing and joined the
Company in January 2001. He was previously senior vice president of
marketing at NetPartner Inc. Prior to NetPartner, he co-founded
HighAltitude Sales and Marketing, where he managed and directed sales,
advertising, and marketing efforts. Other prior experience includes
two years with Zebra Technologies as director of channel sales and
marketing, and ten years at WordPerfect Corporation and Novell, Inc.,
where he held various positions, including regional director of
channel sales and marketing. Mr. Feller is a graduate of Brigham Young
University, where he received a B.S. degree in Business.
PAUL S. CLAYSON, 44, is vice president of strategic business
development and joined the Company in June 1998. Mr. Clayson's career
experience has focused on strategically assessing markets, products
and services, opening and establishing those markets and building
organizations and management structures to support their growth. His
work has spanned multiple products, services and markets. He also
served as a senior officer and partner in a private asset management
business in charge of general management, marketing, sales, planning
and product development functions. His work included the creation of
mutual funds, private asset funds for publicly traded securities, and
private investment portfolios. He also served as a senior corporate
officer for the Red Chip Review which publishes research on small cap
publicly
Page 33 of 51
traded companies. He received his education from the University of
Utah and the University of Michigan.
D. LYNN SHEPHERD, 41, is vice president of engineering and has been
employed by the Company since 1997. He was employed by Synergetics
from 1992 to March 13, 1997. Before his employment with Synergetics,
he was employed with Mentorgraphics where he acted as a software
systems architect in automatic semiconductor design. Before
Mentorgraphics, he worked on a contract basis with Signetics, Inc. Mr.
Shepherd graduated from Brigham Young University with a Bachelor of
Science Degree in Electrical Engineering. He also received a Masters
of Business Administration from Brigham Young University.
J. MARK HAMILTON, 41, is vice president of product development and has
been employed by the Company since 1997. Previously, he was employed
by Synergetics from 1996 to March 13, 1997. He has been a project
leader in developing the Company's SDK System and has worked on the
Company's portable voice project. Before his employment with
Synergetics, he was employed by Intelligent Technologies, Inc., where
he helped form the company and designed and developed the educational
software product called IntelliBots for Macintosh and Windows. Mr.
Hamilton graduated from Brigham Young University with a Bachelor of
Science in Electrical Engineering.
R. BRIAN MONCUR, 41, is director of core technologies Implementation
and has been with the Company since 1997. He was previously employed
by Synergetics from 1992 to March 13, 1997. Before his employment with
Synergetics, he was employed by Signetics, Inc. and Mentorgraphics,
where he was a senior process engineer and software development
engineer. Mr. Moncur graduated from Brigham Young University with a
Bachelor of Science degree in chemical engineering.
DOUGLAS A. JENSEN, 40, is director of embedded product development and
has been with the Company since 1997. Previously, he was employed by
Novell as strategic engineer between Novell and Intel. He also worked
for North American Philips. Mr. Jensen graduated from Brigham Young
University with a Bachelor of Science Degree in Electrical
Engineering.
C. HAL HANSEN, 51, is an independent consultant and is co-inventor of
the Company's automated speech recognition technologies. He is
chairman and CEO of Synergetics, IMC2, and Adiva Corporation. For
approximately 14 years, he was employed by Signetics, Inc. in various
capacities, including test equipment engineer, characterization
engineer, product engineer, and electronic specialist. He was involved
in the design, fabrication and release of layout design for PC boards
and interfaces. In 1991, Mr. Hansen founded Synergetics, were he
continues to have direct leadership with respect to new product
development and engineering. IMC2 currently provides consulting in
research and development to the Company in the area of ASR. Mr. Hansen
holds a degree in electronics from the Utah Trade Technical Institute
of Provo, Utah.
TONY R. MARTINEZ, Ph.D., 43, is a senior consulting scientist for the
Company's neural network development. He is an associate professor of
Computer Science at Brigham Young University and currently heads up
the Neural Network and Machine Learning Laboratory in the Brigham
Young University Ph.D./MS program. His principle research is in neural
networks, machine learning, ASOCS, connectionist systems, massively
parallel algorithms and architectures, and non-von Neuman computing
methods. He is associate editor of the Journal of Artificial Neural
Networks. Dr. Martinez received his Ph.D. in computer science at
University of California at Los Angeles in 1986.
KENNETH P. HITE, 35, is a consultant for the Company. He is developing
the pen-voice user interface for the Windows 98 platform which
involves integrating Fonix's HWR and ASR technologies for use in pen
tablet computers. He has 14 years programming experience and has
worked on a contract assignment for Modis Inc. He attended
Northeastern University and has taken courses in management
information systems.
Page 34 of 51
None of the executive officers or directors of the Company is related to any
other officer or director of the Company.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information concerning the
compensation paid to all persons serving as the Company's chief executive
officer and the Company's most highly compensated executive officers other than
its chief executive officer who were serving as executive officers at December
31, 2000, and whose annual compensation exceeded $100,000 during such year
(collectively the "Named Executive Officers"):
Summary Compensation Table
Annual Compensation Long-Term Compensation
------------------------------------- -------------------------
Securities
Other Underlying
Annual Options/
Name and Principal Position Year Salary Bonus SARs(2)
- ------------------------------------- ---- ---------- ---------- -------------------------
Thomas A. Murdock (1) 1998 $425,000 - 550,000/0
Chief Executive Officer & President 1999 $316,574 - 0/0
2000 $320,804 - 1,850,000/0
Roger D. Dudley (1) 1998 $425,000 - 550,000/0
Executive Vice President & Chief 1999 $317,764 - 0/0
Financial Officer 2000 $320,845 - 1,850,000/0
William A. Maasberg, Jr. 2000 $208,411 - 550,000/0
Chief Operating Officer
John A. Oberteuffer 1998 $203,941 - 580,000/0
Vice President & Chief 1999 $199,238 - 0/0
Technology Officer
(Eff. March 2001) 2000 $227,348 - 350,000/0
(1) The Company has executive employment agreements with
Messrs. Murdock and Dudley that were initiated November 1,
1996 and amended effective January 31, 2000 to extend the
term of the agreement and reduce the base compensation. The
material terms of each executive employment agreement with
Messrs. Murdock and Dudley are identical and are as
follows: 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. The
expiration date is December 31, 2005. 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 options to purchase 1,400,000 options
of the Company's Class A common stock at an exercise price
of $1.01. The options expire July 19, 2010.
Each such executive officer also is entitled to customary
insurance benefits, office and support staff and the use of
an automobile. In addition, if any executive is terminated
without cause during the contract term then all salary then
and thereafter due and owing under the executive employment
agreement shall, at the executive's option, be immediately
paid in a lump sum payment to the executive officer and all
stock options, warrants and other similar rights granted by
the Company and then vested or earned shall be immediately
granted to the executive officer without restriction or
limitation of any kind.
Each executive employment agreement contains a
non-disclosure, confidentiality, non-solicitation and
non-competition clause. Under the terms of the
non-competition clause, each executive has agreed that for
a period of one year after the termination of his
employment with the Company that the executive not engage
in any capacity in a business which competes with or may
compete with the Company.
Page 35 of 51
(2) All options granted in 2000, 1999 and 1998 were granted
pursuant to the Company's 1998 Stock Option Plan.
Option Grants in Fiscal Year 2000
Potential Realizable
Value at Assumed
Annual Rates of
Stock Price
Individual Grant Appreciation for
Option Term
- --------------------------------------------------------------------------------------------------- ---------------------------
(a) (b) (c) (d) (e) (f) (g)
Number of
Securities % of Total
Underlying Options to Exercise
Granted Employees Price Expiration
Name (#) in Fiscal Year ($/Share) Date 5% 10%
- ------------------------- ------------ ----------------------- ------------ ------------------ ------------ --------------
Thomas A. Murdock 250,000 3.7% $0.28 01/06/10 $ 44,023 $ 111,562
1,400,000 20.5% $1.01 07/21/10 $ 889,257 $ 2,253,552
200,000 2.9% $0.28 12/27/10 $ 35,218 $ 89,250
Roger D. Dudley 250,000 3.7% $0.28 01/06/10 $ 44,023 $ 111,562
1,400,000 20.5% $1.01 07/21/10 $ 889,257 $ 2,253,552
200,000 2.9% $0.28 12/27/10 $ 35,218 $ 89,250
William A. Maasberg 100,000 1.5% $0.28 01/06/10 $ 17,609 $ 44,625
250,000 3.7% $0.547 07/21/10 $ 86,001 $ 217,944
200,000 2.9% $0.28 12/27/10 $ 35,218 $ 89,250
John A. Oberteuffer, Ph D. 150,000 2.2% $0.28 01/06/10 $ 26,414 $ 66,937
200,000 2.9% $0.28 12/27/10 $ 35,218 $ 89,250
Aggregated Option/SAR Exercises in Last Fiscal Year
and Related December 31, 2000 Option/SAR Values
(a) (b) (c) (d) (e)
Number of Securities Value of
Shares Underlying Unexercised In-the-Money
Acquired Options/SARs Options/SARs at
on Value at December 31, 2000 December 31, 2000
Name Exercise (#) Realized ($) Exercisable/Unexercisable (#) Exercisable/Unexercisable (#)
- -------------------------- ------------- ---------------- -------------------------------- -----------------------------
Thomas A. Murdock 0 $ 0 3,400,000/0 $14,385/$0
Roger D. Dudley 0 $ 0 3,400,000/0 $14,385/$0
William A. Maasberg, Jr. 0 $ 0 500,000/250,000 $ 9,510/$0
John A. Oberteuffer, Ph D. 0 $ 0 910,000/0 $11,135/$0
Board of Directors Meetings, Committees and Director Compensation
The Company's board of directors took action at four duly noticed meetings
of the board during 2000. Each director attended (in person or telephonically)
at least 75% of the meetings of the Company's board of directors. During 2000,
the Company's board of directors had the following committees: Audit Committee,
comprised of Messrs. Dudley, Maasberg and Tanner; and Compensation Committee,
comprised of Messrs. Murdock, Maasberg and Tanner. These standing committees
conducted meetings in conjunction with meetings of
Page 36 of 51
the full board of directors.
Compensation Committee Report on Executive Compensation
Preliminary Note: Notwithstanding anything to the contrary set forth
in any of the previous filings made by the Company under the 1933 Act or the
1934 Act that might incorporate future filings, including, but not limited to,
this Annual Report on Form 10-K, in whole or in part, the following Executive
Compensation Report and the performance graph appearing herein shall not be
deemed to be incorporated by reference into any such future filings.
This Executive Compensation Report discusses the Company's executive
compensation policies and the basis for the compensation paid to the Named
Executive Officers, including the person serving as its chief executive officer
during the year ended December 31, 2000.
Compensation Policy. The Committee's policy with respect to executive
compensation has been designed to:
o Adequately and fairly compensate executive officers in relation
to their responsibilities, capabilities and contributions to the
Company and in a manner that is commensurate with compensation
paid by companies of comparable size or within the Company's
industry;
o Reward executive officers for the achievement of short-term
operating goals and for the enhancement of the long-term value of
the Company; and
o Align the interests of the executive officers with those of the
Company's shareholders with respect to short-term operating goals
and long-term increases in the price of the Company's common
stock.
The components of compensation paid to executive officers consist of:
(a) base salary, (b) incentive compensation in the form of annual bonus payments
and stock options awarded by the Company under the Company's Stock Incentive
Plans and (c) certain other benefits provided to the Company's executive
officers. The Company's Compensation Committee is responsible for reviewing and
approving cash compensation paid by the Company to its executive officers and
members of the Company's senior management team, including annual bonuses and
stock options awarded under the Company's Stock Incentive Plans, selecting the
individuals who will be awarded bonuses and stock options under the Stock
Incentive Plans, and for determining the timing, pricing and amount of all stock
options granted thereunder, each within the terms of the Company's Stock
Incentive Plans.
The Company's executive compensation program historically has
emphasized the use of incentive-based compensation to reward the Company's
executive officers and members of senior management for the achievement of goals
established by the board of directors. The Company uses stock options to provide
an incentive for a substantial number of its officers and employees, including
selected members of management, and to reward such officers and employees for
achieving goals that have been established for the Company. The Company believes
its incentive compensation plan rewards management when the Company and its
shareholders have benefitted from achieving the Company's goals and targeted
research and development objectives, all of which the Compensation Committee
feels will dictate, in large part, the Company's future operating results. The
Compensation Committee believes that its policy of compensating officers and
employees with incentive-based compensation fairly and adequately compensates
those individuals in relation to their responsibilities, capabilities and
contribution to the Company, and in a manner that is commensurate with
compensation paid by companies of comparable size or within the Company's
industry.
Components of Compensation. The primary components of compensation
paid by the Company to its executive officers and senior management personnel,
and the relationship of such components of compensation to the Company's
performance, are discussed below:
o Base Salary. The Compensation Committee periodically reviews and
approves the base salary paid by the Company to its executive
officers and members of the senior management team. Adjustments
to
Page 37 of 51
base salaries are determined based upon a number of factors,
including the Company's performance (to the extent such
performance can fairly be attributed or related to each
executive's performance), as well as the nature of each
executive's responsibilities, capabilities and contributions. In
addition, the Compensation Committee periodically reviews the
base salaries of its senior management personnel in an attempt to
ascertain whether those salaries fairly reflect job
responsibilities and prevailing market conditions and rates of
pay. The Compensation Committee believes that base salaries for
the Company's executive officers have historically been
reasonable in relation to the Company's size and performance in
comparison with the compensation paid by similarly sized
companies or companies within the Company's industry.
o Incentive Compensation. As discussed above, a substantial portion
of each executive officer's compensation package is in the form
of incentive compensation designed to reward the achievement of
short-term operating goals and long-term increases in shareholder
value. The Company's Stock Incentive Plans allow the Board of
Directors or the Compensation Committee to grant stock options to
executive officers and employees for the purchase of shares of
the Company's common stock. Under the terms of the Stock
Incentive Plans, the Board of Directors and the Compensation
Committee have authority, within the terms of the Stock Incentive
Plans, to select the executive officers and employees who will be
granted stock options and to determine the timing, pricing and
number of stock options to be awarded. The Compensation Committee
believes that the stock options granted under the Stock Incentive
Plans reward executive officers only to the extent that
shareholders have benefitted from increases in the value of the
Company's common stock.
o Other Benefits. The Company maintains certain other plans and
arrangements for the benefit of its executive officers and
members of senior management. The Company believes these benefits
are reasonable in relation to the executive compensation
practices of other similarly sized companies or companies within
the Company's industry.
Compensation of the Chief Executive Officer. As described elsewhere
in this Report, the Company has entered into an executive employment agreement
with Mr. Murdock. The material terms of this executive employment agreement are
described above. The Compensation Committee believes that the monthly
compensation under such contract adequately and fairly compensates this
executive officer in relation to his respective responsibilities, capabilities,
contributions and dedication to the Company and secures for the Company the
benefit of his leadership, management and financial skills and capabilities.
Moreover, the Compensation Committee believes that the salary and other benefits
are reasonable in relation to the responsibilities, capabilities, contributions
and dedication of Mr. Murdock to the Company and are warranted to keep them in
line with the compensation earned by chief executive officers employed by
companies of comparable size or within the Company's industry.
Conclusion. The Compensation Committee believes that the concepts
discussed above further the shareholders' interests because a significant part
of executive compensation is based upon the Company achieving its marketing,
sales and product development goals and other specific goals set by the board of
directors. At the same time, the Compensation Committee believes that the
program encourages responsible management of the Company in the short-term. The
Compensation Committee regularly considers plan design so that the total program
is as effective as possible in furthering shareholder interests.
The Compensation Committee bases its review on the experience of its
own members, on information requested from management personnel, and on
discussions with and information compiled by various independent consultants
retained by the Company.
Respectfully submitted,
Compensation Committee:
Thomas A. Murdock
Page 38 of 51
William A. Maasberg, Jr.
Mark S. Tanner
Compensation of Directors
Prior to April 1996, the Company's directors received no compensation
for their service. The Company historically has reimbursed its directors for
actual expenses incurred in traveling to and participating in directors'
meetings, and the Company intends to continue that policy for the foreseeable
future. On March 30, 1996, the Company's board of directors adopted, and the
Company's shareholders subsequently approved, the Company's 1996 Directors'
Stock Option Plan (the "Directors' Plan"). Under the Directors' Plan, members of
the Board as constituted on the date of adoption received options to purchase
200,000 shares of the Company's Class A common stock for each year (or any
portion thereof consisting of at least six months) during which such persons had
served on the board for each of fiscal years 1994 and 1995 and were granted
200,000 shares for each of fiscal years 1996 through 2000, which options vested
after completion of at least six months' service on the board during those
fiscal years. These options have terms of ten years. Similar grants have been
made to the Company's directors under the Company's 1998 Stock Option Plan.
Under the Directors Plan and the 1998 Stock Option Plan, the Company granted the
following stock options to non-employee members of the board during 2000:
Stock Options Granted to Directors During Fiscal Year 2000
Shares Date Exercise
Name(1) Granted Granted Price Per Share
- ----------------- ----------- ------------ ----------------
Mark S. Tanner 200,000 12/27/00 $0.28
(1) Directors who are also Named Executive Officers also received options as
set forth in the table above.
Compliance With Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who beneficially own more than 10%
of a registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than 10% shareholders are required by regulation
of the Securities and Exchange Commission to furnish the Company with copies of
all Section 16(a) forms which they file. Based solely on its review of the
copies of such forms furnished to the Company during the fiscal year ended
December 31, 2000, the Company is aware of the following untimely filings:
Thomas A. Murdock received options to purchase 250,000 shares of the
Company's Class A common stock on January 6, 2000. Mr. Murdock also received
options to purchase 1,400,000 shares of the Company's Class A common stock on
July 21, 2000. On December 27, 2000, Mr. Murdock received options to purchase
200,000 shares of the Company's Class A common stock. The transactions will be
reported on a Form 5 to be filed.
Roger D. Dudley received options to purchase 250,000 shares of the
Company's Class A common stock on January 6, 2000. Mr. Dudley also received
options to purchase 1,400,000 shares of the Company's Class A common stock on
July 21, 2000. On December 27, 2000, Mr. Dudley received options to purchase
200,000 shares of the Company's Class A common stock. The transactions will be
reported on a Form 5 to be filed.
William A. Maasberg, Jr., received options to purchase 100,000 shares
of the Company's Class A common stock on January 6, 2000. Mr. Maasberg also
received options to purchase 250,000 shares of the Company's Class A common
stock on February 1, 2000. On December 27, 2000, Mr. Maasberg received options
to purchase 200,000 shares of the Company's Class A common stock. The
transactions will be reported on a Form 5 to be filed.
Page 39 of 51
John O. Oberteuffer, received options to purchase 150,000 shares of
the Company's Class A common stock on January 6, 2000. Mr. Oberteuffer also
received warrants to purchase 600,000 shares of the Company's Class A common
stock on February 10, 2000. On December 27, 2000, Mr. Oberteuffer received
options to purchase 200,000 shares of the Company's Class A common stock. The
transactions will be reported on a Form 5 to be filed.
Mark S. Tanner received options to purchase 200,000 shares of the
Company's Class A common stock on December 27, 2000. The transaction will be
reported on a Form 5 to be filed.
Page 40 of 51
Stock Performance Graph
The following graph compares the yearly cumulative total returns from
the Company's Class A common stock during the five fiscal year period ended
December 31, 2000 with the cumulative total return on the Media General Index
and the Standard Industrial Classification (SIC) Code Index for that same
period. The comparison assumes $100 was invested on December 31, 1995, in the
Company's Class A common stock and in the common stock of the companies in the
referenced Indexes and further assumes reinvestment of dividends.
COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG FONIX CORPORATION, NASDAQ
MARKET INDEX AND SIC CODE INDEX
[GRAPHIC OMITTED]
1995 1996 1997 1998 1999 2000
Fonix Corporation 100.00 222.65 78.13 33.50 7.50 7.63
SIC Code Index 100.00 103.79 138.75 131.38 237.81 274.18
NASDAQ Market Index 100.00 124.27 152.00 214.39 378.12 237.66
Page 41 of 51
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The following table sets forth, as of March 20, 2001, the number of
shares of Common Stock of the Company beneficially owned by all persons known to
be holders of more than five percent (5%) of the Company's Common Stock and by
the executive officers and directors of the Company individually and as a group.
Unless indicated otherwise, the address of the stockholder is the Company's
principal executive offices, 60 East South Temple Street, Suite 1225, Salt Lake
City, Utah 84111.
Number of
Shares
Name and Address of 5% Beneficial Owners, Beneficially Percent of
Executive Officers and Directors Owned Class(1)
- ------------------------------------------------ ---------------- --------------------
Thomas A. Murdock 11,869,645 (2) 5.6%
Chairman of the Board & Chief
Executive Officer
Roger D. Dudley, 6,248,723 (3) 2.9%
Executive Vice President & Chief
Financial Officer, Director
John A. Oberteuffer, Ph.D., 1,660,000 (4) *
Vice President & Chief Technology Officer,
Director
William A. Maasberg Jr., Chief Operating Officer, 750,000 (4) *
Director
Mark S. Tanner, Director 400,000 (4) *
Officers and Directors as a Group (6 persons) 16,032,758 7.3%
* Less than 1 percent.
(1) Percentages rounded to nearest 1/10th of one percent. Except as
indicated in the footnotes below, each of the persons listed
exercises sole voting and investment power over the shares of Common
Stock listed for each such person in the table.
(2) Includes 8,627,333 shares of Common Stock deposited in a voting trust
(the "Voting Trust") as to which Mr. Murdock is the sole trustee.
Persons who have deposited their shares of Common Stock into the
Voting Trust have dividend and liquidation rights ("Economic Rights")
in proportion to the number of shares of Common Stock they have
deposited in the Voting Trust, but have no voting rights with respect
to such shares. All voting rights associated with the shares
deposited into the Voting Trust are exercisable solely and
exclusively by the Trustee of the Voting Trust. The Voting Trust
expires, unless extended according to its terms, on the earlier of
September 30, 2002, or any of the following events: (i) the Trustee
terminates it; (ii) the participating shareholders unanimously
terminate it; or (iii) the Company is dissolved or liquidated.
Although as the sole trustee of the Voting Trust Mr. Murdock
exercises the voting rights of all of the shares deposited into the
Voting Trust, and accordingly has listed all shares in the table
above, he has no economic or pecuniary interest in any of the shares
deposited into the Voting Trust except for 2,839,976 shares as to
which he directly owns Economic Rights, and 185,793 shares the
Economic Rights as to which are owned by Studdert Companies Corp.
("SCC"), a corporation of which Mr. Murdock is a 1/3 equity owner.
Also includes 2,813 shares owned directly by Mr. Murdock, 11,400
shares owned by a limited liability company of which Mr. Murdock is a
1/3 equity owner, 28,099 shares (including shares
Page 42 of 51
issuable upon the exercise of options) beneficially owned by members
of Mr. Murdock's immediate family residing in the same household and
3,200,000 shares of Common Stock underlying stock options owned by
Mr. Murdock and exercisable presently or within 60 days of March 20,
2001.
(3) Includes (i) 2,848,417 shares owned by Mr. Dudley and deposited into
the Voting Trust, (ii) 185,793 shares owned by SCC as to which Mr.
Dudley shares investment power because of his management position
with and 1/3 ownership of SCC, which shares are deposited into the
Voting Trust; (iii) 2,813 shares owned directly by Mr. Dudley; (iv)
300 shares owned by Mr. Dudley's minor children; (v) 11,400 shares
owned by a limited liability company of which Mr. Dudley is a 1/3
equity owner; and (vi) 3,200,000 shares underlying stock options
exercisable presently or within 60 days of March 20, 2001. Mr. Dudley
became Chief Financial Officer of the Company on March 21, 2000.
(4) Consisting of options which are presently exercisable.
Page 43 of 51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SCC Asset Management Inc.("SCC") (formerly Studdert Companies Corp.)
SCC is a Utah corporation that provides investment and management
services. The officers, directors and owners of SCC are Stephen M. Studdert,
former chairman and CEO of the Company, and Thomas A. Murdock and Roger D.
Dudley, each of whom is a director and executive officer of the Company.
The Company subleases from SCC its corporate headquarters located at
60 East South Temple Street, Salt Lake City, Utah. The sublease is from month to
month pursuant to which the Company has agreed to pay the actual monthly rental
of $10,368 and all common area charges payable under the lease with SCC's
landlord.
John A. Oberteuffer
In February 2000, the Company entered into an agreement to purchase
from John A. Oberteuffer, who is an executive officer and director of the
Company, all of Dr. Oberteuffer's rights and interests in certain methods and
apparatus for integrated voice and pen input for use in computer systems. In
payment for Dr. Oberteuffer's technology, the Company granted Dr. Oberteuffer
600,000 warrants to purchase the Company's Class A common stock at an exercise
price of $1.00 per share. The warrants expire February 10, 2010. Also, the
Company granted Dr. Oberteuffer the right to repurchase the technology from the
Company at fair market value if the Company subsequently determines not to
commercialize the pen/voice technologies or products.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) Documents filed as part of this Form 10-K:
1. Consolidated Financial Statements (included in Part II, Item 8)
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Operations for the Years Ended December 31,
2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the Years Ended December 31,
2000, 1999 and 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules: None
3. Exhibits: The following Exhibits are filed with this Form 10-K
pursuant to Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit
(2)(i) Agreement and Plan of Reorganization among the Company,
Fonix Acquisition Corporation and AcuVoice dated as of
January 13, 1998, incorporated by reference from the
Company's Current Report on Form 8-K, filed March 20, 1998
(2)(ii) Agreement and Plan of Merger among Fonix, Articulate
Acquisition Corporation, and
Page 44 of
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
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
Page 45 of 51
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
(10)(vi) Employment Agreement by and between the Company and Roger D.
Dudley, which is
Page 46 of 51
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)(vii) Series D Convertible Preferred Stock Purchase Agreement
Among Fonix corporation, JNC Opportunity Fund, Ltd.,
Diversified Strategies Fund, L.P., Dominion Capital Fund,
Ltd., Sovereign Partners, LP, Canadian Advantage Limited
Partnership and Thomson Kernaghan & Co. (as agent) dated as
of August 31, 1998, incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998
(10)(xviii) Series E Convertible Preferred Stock Exchange and Purchase
Agreement among Fonix corporation, Sovereign Partners, LP
and Dominion Capital Fund, Ltd., dated as of September 30,
1998, incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1998
Page 47 of 51
(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))
Page 48 of 51
(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
(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)
(22) Subsidiaries of Registrant
(23) Consent of Independent Public Accountants
(B) Reports filed on Form 8-K during the last quarter of the fiscal year ended
December 31, 2000:
NONE
Page 49 of 51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 2nd day of April
2001.
Fonix Corporation
Date: April 2, 2001 By: /s/ Thomas A. Murdock
----------------- -------------------------------------------
Thomas A. Murdock, President and
Chief Executive Officer
Date: April 2, 2001 By: /s/ Roger D. Dudley
---------------- ------------------------------------------------
Roger D. Dudley, Executive Vice President Finance
and Chief Financial Officer
(Principal Financial and Accounting Officer)
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:
/s/ Thomas A. Murdock /s/ William A. Maasberg
- ---------------------------------- ----------------------------------------
Thomas A. Murdock, President and William A. Maasberg, Jr., Director
Chief Executive Officer
April 2, 2001 April 2, 2001
- ---------------------------------- ----------------------------------------
Date Date
/s/ Roger D. Dudley /s/ Mark S. Tanner
- ----------------------------------- ----------------------------------------
Roger D. Dudley, Executive Mark S. Tanner, Director
Vice President, Chief Financial Officer
Director
April 2, 2001 April 2, 2001
- ---------------------------------- ----------------------------------------
Date Date
/s/ John A. Oberteuffer
- ----------------------------------
John A. Oberteuffer, Ph.D., Director
April 2, 2001
Date
Page 50 of 51
EXHIBIT 22
SUBSIDIARIES OF REGISTRANT
1. Fonix Systems Corporation, a Utah corporation, wholly owned by the Company
(merged into Fonix Corporation effective September 1, 1999)
2. Fonix/AcuVoice, Inc., a Utah corporation, wholly owned by the Company
3. Fonix/Articulate, Inc., a Utah corporation, wholly owned by the Company
(merged into Fonix Corporation effective September 1, 1999)
4. Fonix/Papyrus, Inc., a Utah corporation, wholly owned by the Company
Page 51 of 51
TABLE OF CONTENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2000 and 1999 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2000, 1999 and 1998 F-4
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2000, 1999 and 1998 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000, 1999 and 1998 F-7
Notes to Consolidated Financial Statements F-9
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Fonix Corporation:
We have audited the accompanying consolidated balance sheets of Fonix
Corporation (a Delaware corporation) and subsidiaries as of December 31, 2000
and 1999, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2000. 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.
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 provide a reasonable basis for our
opinion.
In our opinion, 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, 2000 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2000 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 incurred significant losses
and negative cash flows from operating activities since its inception. The
Company expects these losses and negative cash flows from operating activities
to continue at least through December 31, 2001. As of December 31, 2000, the
Company has minimal tangible net worth of $983,988, an accumulated deficit of
$143,040,284, minimal working capital of $180,356 and $224,436 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.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
March 29, 2001
Fonix Corporation
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31,
-----------------------------
2000 1999
-------------- --------------
Current assets:
Cash and cash equivalents $ 1,413,627 $ 232,152
Funds held in escrow 2,151,006 -
Accounts receivable, net of allowance for doubtful accounts of $20,000 in 2000 and 1999 131,872 184,901
Prepaid expenses and other current assets 55,705 63,832
-------------- --------------
Total current assets 3,752,210 480,885
Funds held in escrow - 2,038,003
Property and equipment, net of accumulated depreciation of $1,445,288 and $1,938,494, respectively 718,711 1,148,802
Intangible assets, net of accumulated amortization of $6,850,286 and $4,392,457, respectively 12,941,764 15,399,593
Other assets 104,688 105,864
-------------- --------------
Total assets $ 17,517,373 $ 19,173,147
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 655,352 $ 1,359,040
Accrued liabilities 553,448 907,033
Accrued liabilities - related parties 1,564,133 1,814,134
Deferred revenues 677,071 127,849
Notes payable - related parties 77,625 77,625
Capital lease obligation - current portion 44,225 -
Advances on issuance of convertible preferred stock - 1,000,000
-------------- --------------
Total current liabilities 3,571,854 5,285,681
Capital lease obligation, less current portion 19,767 -
Series C convertible debentures - 3,971,107
-------------- --------------
Total liabilities 3,591,621 9,256,788
-------------- --------------
Common stock and related repricing rights subject to redemption; 1,801,802 shares and
repricing rights outstanding in 1999 - 1,830,000
-------------- --------------
Commitments and contingencies (Notes 1,10,12,14, 15 and 18)
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 at December 31, 2000) 500,000 500,000
Series D, 4% cumulative convertible; 164,500 and 381,723 shares outstanding in 2000 and
1999, respectively (aggregate liquidation preference of $3,601,819
at December 31, 2000) 4,288,178 9,095,910
Series F, 6% cumulative convertible; 6,073 shares outstanding in 2000
(aggregate liquidation preference of $128,242 at December 31, 2000) 112,438 -
Common stock, $0.0001 par value; 300,000,000 shares authorized:
Class A voting, 191,296,988 and 123,535,325 shares outstanding in 2000
and 1999, respectively 19,130 12,353
Class B non-voting, none outstanding - -
Additional paid-in capital 148,904,860 112,769,420
Outstanding warrants to purchase Class A common stock 3,141,430 2,850,530
Deferred consulting expenses - (435,051)
Accumulated deficit (143,040,284) (116,706,803)
-------------- --------------
Total stockholders' equity 13,925,752 8,086,359
-------------- --------------
Total liabilities and stockholders' equity $ 17,517,373 $ 19,173,147
============== ==============
See accompanying notes to consolidated financial statements.
F-3
Fonix Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
----------------------------------------------
2000 1999 1998
--------------- -------------- ---------------
Revenues $ 656,853 $ 439,507 $ 2,604,724
Cost of revenues 27,436 24,932 35,440
--------------- -------------- ---------------
Gross margin 629,417 414,575 2,569,284
--------------- -------------- ---------------
Expenses:
Selling, general and administrative 10,722,313 9,498,753 8,817,643
Product development and research 5,871,414 7,909,228 13,060,604
Amortization of intangible assets 2,457,829 2,588,896 1,712,267
Purchased in-process research and development 474,000 - 9,315,000
--------------- -------------- ---------------
Total expenses 19,525,556 19,996,877 32,905,514
--------------- -------------- ---------------
Loss from operations (18,896,139) (19,582,302) (30,336,230)
--------------- -------------- ---------------
Other income (expense):
Interest income 139,283 95,023 1,075,021
Interest expense (4,004,111) (3,636,467) (1,470,689)
Other (126,520) (157,345) -
Cancellation of common stock reset provision - - (6,111,577)
--------------- -------------- ---------------
Total other expense, net (3,991,348) (3,698,789) (6,507,245)
--------------- -------------- ---------------
Loss from continuing operations before income tax benefit (22,887,487) (23,281,091) (36,843,475)
Income tax benefit 76,810 3,331,895 -
--------------- -------------- ---------------
Loss from continuing operations (22,810,677) (19,949,196) (36,843,475)
Discontinued operations:
Operating loss of HealthCare Solutions Group - (5,953,726) (6,275,307)
Gain on disposal of HealthCare Solutions Group, net of income
taxes of $3,100,000 - 3,766,646 -
--------------- -------------- ---------------
Loss before extraordinary item (22,810,677) (22,136,276) (43,118,782)
Extraordinary item - Gain on forgiveness of debt, net of income taxes of
$29,416 in 2000 and $281,895 in 1999 49,448 473,857 -
--------------- -------------- ---------------
Net loss $ (22,761,229) $ (21,662,419) $ (43,118,782)
=============== ============== ===============
Basic and diluted net loss per common share $ (0.16) $ (0.31) $ (0.91)
=============== ============== ===============
See accompanying notes to consolidated financial statements.
F-4
Fonix Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Outstanding
Preferred Stock Common Stock Additional Warrants
-------------------------- --------------------- Paid-in to Purchase
Shares Amount Shares Amount Capital Common Stock
------------ ------------- ------------ -------- ------------ ------------
Balance, December 31, 1997 379,167 $ 5,812,444 43,583,875 $ 4,358 $ 38,637,059 $ 2,936,360
Common stock issued for debt costs - - 35,000 4 50,310 -
Options issued for services - - - - 320,100 -
Common stock issued for patent - - 24,814 3 100,804 -
Warrants issued for cash - - - - - 472,928
Exercise of options and warrants - - 265,000 27 505,333 (360)
Common stock issued for cash - - 4,000,000 400 16,965,754 -
Shares issued for acquisition of AcuVoice, Papyrus
and Articulate - - 10,944,081 1,094 28,686,933 -
Series D preferred stock issued for cash 550,000 10,453,846 - - - -
Series E preferred stock issued for cash 100,000 1,950,000 - - - -
Conversions of preferred stock to common stock (327,428) (8,221,395) 4,081,234 407 8,220,988 -
Shares issued in connection with the relinquishment
of a reset provision 608,334 11,166,678 1,390,476 139 (5,055,240) -
Expiration of warrants - - - - 85,670 (85,670)
Amortization of deferred consulting expense - - - - - -
Dividends on preferred stock - 4,797,249 - - - -
Net loss for the year ended December 31, 1998 - - - - - -
------------ ------------- ------------ ------- ------------ ------------
Balance, December 31, 1998 1,310,073 25,958,822 64,324,480 6,432 88,517,711 3,323,258
Options issued during the year for services - - - - 12,540 -
Extension of option expiration dates - - - - 241,375 -
Conversions of preferred stock (761,683) (18,129,770) 52,981,431 5,298 18,124,472 -
Common stock issued for services - - 1,200,000 120 474,880 -
Common stock issued for principal reduction
on debentures - - 6,000,000 600 3,278,293 -
Common stock returned and canceled - - (970,586) (97) (1,000,819) -
Warrants issued with Series C debentures - - - - - 438,240
Warrants issued for services - - - - - 260,000
Expiration of warrants - - - - 1,170,968 (1,170,968)
Amortization of deferred consulting expenses - - - - - -
Beneficial conversion features on Series C debentures - - - - 1,750,000 -
Preferred stock dividends - 1,766,858 - - - -
Reduction of accrued offering costs - - - - 200,000 -
Net loss for the year ended December 31, 1999 - - - - - -
------------ ------------- ------------ ------- ------------ ------------
Balance, December 31, 1999 548,390 9,595,910 123,535,325 12,353 112,769,420 2,850,530
Conversion of promissory note - - 11,544,775 1,154 7,589,717 -
Beneficial conversion features on promissory note - - - - 3,447,623 -
Conversions of Series C debentures - - 10,385,364 1,039 4,261,025 -
Sale of Series F preferred shares 316,036 2,750,000 - - - -
Beneficial conversion features on Series D
preferred stock - 236,400 - - - -
Conversions of preferred stock to common stock (527,186) (10,622,745) 23,779,198 2,379 10,620,366 -
Reclassification of common stock subject to redemption - - 1,801,802 180 1,829,820 -
Exercise of repricing rights - - 4,568,569 457 (457) -
Issuance of common stock under equity line of credit - - 12,492,680 1,249 3,853,053 -
Shares issued upon settlement of litigation - - 260,145 26 81,269 -
Issuance of common stock for services - - 1,862,069 186 2,016,491 -
Issuance of stock options and warrants for
services and technology - $ - - $ - $ 234,856 $ 530,250
Appreciation of warrants issued for services - - - - - 537,500
Extension of option expiration dates - - - - 52,067 -
Exercise of stock options and stock appreciation rights - - 767,061 77 1,094,790 -
Exercise of warrants - - 300,000 30 392,970 (115,000)
Expiration of warrants - - - - 661,850 (661,850)
Amortization of deferred consulting expenses - - - - - -
Preferred stock dividends - 2,941,051 - - - -
Net loss for the year ended December 31, 2000 - - - - - -
------------ ------------- ------------ -------- ------------ ------------
Balance, December 31, 2000 337,240 $ 4,900,616 191,296,988 $19,130 $148,904,860 $ 3,141,430
============ ============= ============ ======== ============ ============
Deferred
Consulting Accumulated
Expenses Deficit Total
------------ --------------- -------------
Balance, December 31, 1997 $ - $ (45,017,746) $ 2,372,475
Common stock issued for debt costs - - 50,314
Options issued for services (320,100) - -
Common stock issued for patent - - 100,807
Warrants issued for cash - - 472,928
Exercise of options and warrants - - 505,000
Common stock issued for cash - - 16,966,154
Shares issued for acquisition of AcuVoice, Papyrus
and Articulate - - 28,688,027
Series D preferred stock issued for cash - - 10,453,846
Series E preferred stock issued for cash - - 1,950,000
Conversions of preferred stock to common stock - - -
Shares issued in connection with the relinquishment
of a reset provision - - 6,111,577
Expiration of warrants - - -
Amortization of deferred consulting expense 213,400 - 213,400
Dividends on preferred stock - (4,797,249) -
Net loss for the year ended December 31, 1998 - (43,118,782) (43,118,782)
------------ --------------- -------------
Balance, December 31, 1998 (106,700) (92,933,777) 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 (375,000) - 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 (127,500) - 132,500
Expiration of warrants - - -
Amortization of deferred consulting expenses 174,149 - 174,149
Beneficial conversion features on Series C debentures - - 1,750,000
Preferred stock dividends - (2,110,607) (343,749)
Reduction of accrued offering costs - - 200,000
Net loss for the year ended December 31, 1999 - (21,662,419) (21,662,419)
------------ --------------- -------------
Balance, December 31, 1999 (435,051) (116,706,803) 8,086,359
Conversion of promissory note - - 7,590,871
Beneficial conversion features on promissory note - - 3,447,623
Conversions of Series C debentures - - 4,262,064
Sale of Series F preferred shares - - 2,750,000
Beneficial conversion features on Series D
preferred stock - (236,400) -
Conversions of preferred stock to common stock - - -
Reclassification of common stock subject to redemption - - 1,830,000
Exercise of repricing rights - - -
Issuance of common stock under equity line of credit - - 3,854,302
Shares issued upon settlement of litigation - - 81,295
Issuance of common stock for services - - 2,016,677
Issuance of stock options and warrants for
services and technology $ - $ - $ 765,106
Appreciation of warrants issued for services (537,500) - -
Extension of option expiration dates - - 52,067
Exercise of stock options and stock appreciation rights - - 1,094,867
Exercise of warrants - - 278,000
Expiration of warrants - - -
Amortization of deferred consulting expenses 972,551 - 972,551
Preferred stock dividends - (3,335,852) (394,801)
Net loss for the year ended December 31, 2000 - (22,761,229) (22,761,229)
------------ --------------- -------------
Balance, December 31, 2000 $ - $ (143,040,284) $ 13,925,752
============ =============== =============
See accompanying notes to consolidated financial statements.
F-5
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
----------------------------------------------------------
2000 1999 1998
------------------ ----------------- -----------------
Cash flows from operating activities:
Net loss $ (22,761,229) $ (21,662,419) $ (43,118,782)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services 1,328,100 158,600 151,121
Non-cash expense related to issuance of debentures,
warrants, and preferred and common stock 4,725,201 2,411,349 7,118,577
Non-cash compensation expense related to issuance and
extension of stock options 914,922 360,615 213,400
Non-cash portion of purchased in-process research and
development 474,000 - 13,136,000
Loss on disposal of property and equipment 126,520 154,940 -
Gain on sale of HealthCare Solutions Group - (3,766,646) -
Depreciation and amortization 3,093,612 5,256,532 3,285,845
Income tax benefit (76,810) (3,331,895)
Extraordinary gain on forgiveness of debt (49,448) (473,857) -
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable 53,029 (245,432) (148,498)
Prepaid expenses and other current assets 8,127 (5,560) (93,388)
Funds held in escrow (113,003) (38,003) -
Other assets 1,176 944 (80,198)
Accounts payable (543,529) (1,650,337) 2,941,898
Accrued liabilities 120,638 514,312 8,189
Accrued liabilities - related party (250,001) 1,143,185 (311,743)
Deferred revenues 549,222 632,242 81,266
------------------ ----------------- -----------------
Net cash used in operating activities (12,399,473) (20,541,430) (16,816,313)
------------------ ----------------- -----------------
Cash flows from investing activities, net of effects
of acquisitions:
Purchase of property and equipment (239,908) (99,090) (1,305,091)
Proceeds from sale of property and equipment - 50,000 -
Proceeds from sale of HealthCare Solutions Group - 21,805,982 -
Acquisition of subsidiaries, net of cash acquired - - (15,323,173)
Issuance of notes receivable - - (745,000)
Payments received on notes receivable - 245,000 -
------------------ ----------------- -----------------
Net cash provided by (used in) investing activities (239,908) 22,001,892 (17,373,264)
------------------ ----------------- -----------------
Cash flows from financing activities:
Proceeds from issuance of convertible promissory note payable
and convertible debentures, net 7,500,000 6,254,240 -
Proceeds from sale of common stock, net 3,854,302 - 16,966,155
Proceeds from sale of preferred stock, net 1,750,000 - 12,403,846
Proceeds from exercise of stock options 466,866 - 210,000
Proceeds from exercise of warrants 278,000 - 295,000
Proceeds from sale of warrants - 438,240 472,928
Proceeds from other notes payable - 6,953,760 560,000
Proceeds from (payments on) revolving note payable, net - (20,038,193) 1,376,671
Payments on revolving note payable - related parties, net - (7,895,178) (469,869)
Proceeds from sale of common stock and related
repricing rights subject to redemption, net - - 1,830,000
Payments on other notes payable - (7,788,000) -
Principal payments on capital lease obligations (28,312) (60,684) (49,325)
Advances on issuance of convertible preferred stock - 1,000,000 -
Bank overdraft - (138,034) 138,034
------------------ ----------------- -----------------
Net cash provided by (used in) financing activities 13,820,856 (21,273,849) 33,733,440
------------------ ----------------- -----------------
Net increase (decrease) in cash and cash equivalents 1,181,475 (19,813,387) (456,137)
Cash and cash equivalents at beginning of year 232,152 20,045,539 20,501,676
------------------ ----------------- -----------------
Cash and cash equivalents at end of year $ 1,413,627 $ 232,152 $ 20,045,539
================== ================= =================
See accompanying notes to consolidated financial statements.
F-7
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Year Ended December 31,
--------------------------------------
Supplemental disclosure of cash flow information: 2000 1999 1998
------------- ----------- ------------
Cash paid during the year for interest $ 455,047 $ 1,186,695 $ 1,392,987
Cash paid during the year for income taxes $ 2,606 $ - $ -
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Year Ended December 31, 2000:
Accrued preferred stock dividends of $191,051 on Series D and Series F
preferred stock.
Converted 217,223 shares of Series D preferred stock and related
dividends of $255,600 into 15,436,378 shares of Class A common
stock.
Converted 309,963 shares of Series F preferred stock and related
dividends of $34,042 into 8,342,820 shares of Class A common
stock.
Recorded preferred stock dividends of $2,750,000 related to the
beneficial conversion features of Series F convertible preferred
stock.
Converted $7,500,000 of principal and $90,870 of interest from the
convertible promissory note into 11,544,775 shares of Class A
common stock.
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.
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.
A total of $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.
Issued 4,568,569 shares of Class A common stock upon the exercise of
repricing rights associated with the common stock subject to
redemption.
Issued 1,250,000 shares of common stock to an unrelated party for
consulting fees valued at $1,328,100.
Issued 612,069 shares of Class A common stock valued at $688,578 as
payment for liquidation damages and a restructuring fee in
connection with the Series D preferred stock agreement.
Recorded interest expense of $3,447,623 for a beneficial conversion
feature on a promissory note.
Entered into a capital lease obligation for equipment in the amount of
$92,304.
Issued 260,145 shares of Class A common stock having a market value of
$81,295 in settlement of litigation.
Issued 45,000 warrants valued at $11,250 for consulting services.
For the Year Ended December 31, 1999:
Entered into capital lease obligations for equipment in the amount of
$57,332.
Applied advances to employees totaling $59,986 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.
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.
Recorded preferred stock dividends of $997,148 related to the
beneficial conversion features of Series D and Series E preferred
stock.
Accrued preferred stock dividends of $769,710 on Series D and Series E
preferred stock.
Recorded dividends totaling $343,749 relating to the liquidation
damage provisions of Series D and Series E preferred stock and
Series C convertible debentures.
Issued 200,000 shares of Class A common stock to an unrelated party
for consulting fees valued at $100,000.
Converted 626,611 shares of Series D preferred stock and related
dividends of $587,388 into 47,252,275 shares of Class A common
stock.
Converted 135,072 shares of Series E preferred stock and related
dividends of $66,015 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.
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
was deferred at December 31, 1999.
Issued 1,000,000 warrants to three unrelated parties for legal
services valued at $260,000 of which $118,651 was 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.
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 provisions and costs associated
with the issuance of Series D 4% convertible preferred stock.
Recorded preferred stock dividends of $1,000,000 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.
Exchanged 150,000 shares of Series D 4% convertible preferred stock
for 150,000 shares of Series E 4% convertible preferred stock.
Converted 114,928 shares of Series E convertible preferred stock and
related dividends of $15,969 into 2,591,733 shares of common
stock.
Issued 2,692,216 shares of common stock having a market value of
$16,995,972 in connection with the acquisition of AcuVoice, Inc.
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.
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.
Issued notes payable of $348,145 in connection with the acquisition of
certain assets of The MRC Group, Inc.
See accompanying notes to consolidated financial statements.
F-8
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -Fonix Corporation (the "Company" or "Fonix") is engaged in
developing, acquiring and marketing proprietary natural user interface ("NUI")
technologies. The Company's NUI technologies include automated speech
recognition ("ASR"), text-to-speech ("TTS") and handwriting recognition ("HWR").
The Company markets its NUI technologies to embedded and server markets. The
Company has received various patents for certain elements of its core
technologies and has filed applications for other patents covering various
aspects of its technologies. The Company seeks to develop relationships and
strategic alliances with third-party developers and vendors in
telecommunications, computers, electronic devices and related industries,
including producers of application software, operating systems, computers and
microprocessor chips. Revenues are generated through licensing of its NUI
technologies and related applications.
Basis of Presentation - The Company generated revenues of $656,853, incurred a
net loss from continuing operations totaling $22,810,677 and had negative cash
flows from operating activities totaling $12,399,473 for the year ended December
31, 2000. As of December 31, 2000, the Company had minimal tangible net worth of
$983,988, an accumulated deficit of $143,040,284, minimal working capital of
$180,356 and $224,436 of accounts payable over 60 days past due. The Company
expects to continue to incur significant losses and negative cash flows from
operating activities through at least December 31, 2001, primarily due to
significant expenditure requirements associated with marketing and developing
its NUI 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 debt and equity securities and cash flows
from license and royalty arrangements. There can be no assurance that
management's plans will be successful.
The Company was in the development stage from inception (October 1, 1993)
through December 31, 1999.
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, two wholly owned
subsidiaries, Fonix Systems Corporation and Fonix/Articulate, Inc., were merged
into the Company. In September 1999, the Company sold its HealthCare Solutions
Group ("HSG"), consisting primarily of the assets and operations of
Fonix/Articulate, Inc. The results of the operations of the HSG are presented as
discontinued operations (see Note 2).
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 were held in interest-bearing accounts and became available to the Company
on March 2, 2001. These funds were received by the Company on March 29, 2001.
F-8
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 undiscounted cash flows to be generated from the use of the asset
and its eventual disposition over the remaining life of the asset. If
projections indicate that the carrying value of the long-lived asset would not
be recoverable, the discounted carrying value would be reduced by the estimated
excess of the carrying value over the projected cash flows. As of December 31,
2000, management of the Company does not consider any of the Company's
long-lived assets to be impaired. However, should the Company's marketing and
sales plan not materialize in the near term, the realization of the Company's
intangible assets could be severely and negatively impacted. The accompanying
consolidated financial statements have been prepared based on management's
estimates of realizability, which estimates may change due to factors beyond the
control of the Company.
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 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 $5,871,414 in 2000, $7,909,228 in 1999 and $13,060,604
in 1998. During 2000, the Company recorded $474,000 of in-process research and
development costs related to the acquisition of certain technology rights from a
director and executive officer of the Company in exchange for warrants to
purchase 600,000 shares of the Company's Class A common stock (see Note 10). In
1998, the Company recorded $9,315,000 and $3,821,000, respectively, of
in-process research and development
F-9
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
purchased in connection with the acquisitions of AcuVoice, Inc. and Articulate
Systems, Inc. However, as a result of the subsequent disposition of the HSG, the
costs related to Articulate Systems, Inc. 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.
Stock-based Compensation Plans - The Company accounts for its stock-based
compensation issued to employees and directors under Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". Under APB
Opinion No. 25, compensation related to stock options, if any, is recorded if an
option's exercise price on the measurement date is below the fair value of the
company's common stock, and amortized to expense over the vesting period.
Compensation expense for stock awards or purchases, if any, is recognized if the
award or purchase price on the measurement date is below the fair value of the
company's common stock, and is recognized on the date of award or purchase.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock Based Compensation", requires pro forma information regarding net loss and
net loss per common share as if the Company had accounted for its stock options
granted under the fair value method. This pro forma disclosure is presented in
Note 9.
The Company accounts for its stock-based compensation issued to non-employees
using the fair value method in accordance with SFAS No. 123 and related
interpretations. Under SFAS No. 123, stock-based compensation is determined as
either the fair value of the consideration received or the fair value of the
equity instruments issued, whichever is more reliably measurable. The
measurement date for these issuances is the earlier of the date at which a
commitment for performance by the recipient to earn the equity instruments is
reached or the date at which the recipient's performance is complete.
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, 2000, 1999 and 1998, there were outstanding common stock
equivalents to purchase 38,541,003, 56,869,449 and 38,319,638 shares of common
stock, respectively, that were not included in the
F-10
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2000, 1999
and 1998.
2000 1999 1998
---------------------- ---------------------- ----------------------
Loss Loss Loss
per per per
Loss Share Loss Share Loss Share
------------- ------- ------------- ------- ------------- -------
Loss from continuing operations $ (22,810,677) $ (19,949,169) $ (36,843,475)
Preferred stock dividends (3,335,852) (2,110,607) (4,797,249)
------------- ------------- -------------
Net loss from continuing operations
attributable to common
stockholders (26,146,529) $ (0.16) (22,059,803) $ (0.29) (41,640,724) $ (0.79)
Discontinued operations, net of taxes - - (2,187,080) (0.03) (6,275,307) (0.12)
Extraordinary item, net of taxes 49,448 0.00 473,857 0.01 - -
------------- ------- ------------- ------- ------------- -------
Net loss attributable to common
stockholders $ (26,097,081) $ (0.16) $ (23,773,026) $ (0.31) $ (47,916,031) $ (0.91)
============= ======= ============= ======= ============= =======
Weighted average common shares
outstanding 162,684,298 76,753,709 52,511,185
============= ============= =============
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 will not have a
material effect on the Company's consolidated financial statements as the
Company does not currently hold any derivative or hedging instruments.
Reclassifications - Certain reclassifications have been made in the prior years'
consolidated financial statements to conform with the current year presentation.
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. The Company's claim to the escrow shares is
F-11
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pending. The shares held in escrow have been excluded from the calculation of
basic net loss per common share for the years ended December 31, 2000, 1999 and
1998.
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 allocation 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
was based upon assumptions the Company believed to be reasonable at the time.
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, 2000, 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, 2000, 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.
The Company did not make promissory note 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
totaling $1,632,375 upon payment to certain 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 payment and the original fair market value of $1,000,917 associated
with the canceled shares and the $414,991 of promissory note principal forgiven
were reflected as a reduction to goodwill associated with the purchase of
Papyrus.
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 issued 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 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,
F-12
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 shares 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, 2000, 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. - In 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. The remaining amount owing related to this
acquisition of $216,666 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 the HSG to Lernout & Hauspie Speech Products N.V. ("L&H"), an
unrelated third party, for up to $28,000,000. Of this sales price, $21,500,000,
less certain credits of $194,018, was received at closing, and $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,
F-13
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$500,000 was released from the escrow. The remaining $2,000,000 was released
from escrow on March 29, 2001. 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 two
years based on the performance of the 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
the HSG and the obligations related to certain deferred revenues.
Upon the closing of the Sale, the Company discontinued the operations of the
HSG. The results of operations of the HSG have been reported separately as
discontinued operations in the accompanying consolidated statements of
operations. Revenues from the 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.
Pro Forma Financial Statement Data - The following unaudited pro forma financial
statement data for the year ended December 31, 1998 present the results of
operations of the Company as if the acquisitions of AcuVoice and Papyrus had
occurred on January 1, 1998. 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 on January 1, 1998.
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 on
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.
Revenues $ 2,692,916
Net loss (31,462,937)
Basic and diluted net loss per common share (0.55)
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2000 and 1999:
2000 1999
------------- -------------
Computer equipment $ 1,193,942 $ 2,294,766
Furniture and fixtures 851,436 673,909
Leasehold improvements 118,621 118,621
------------- -------------
2,163,999 3,087,296
Less accumulated depreciation and amortization (1,445,288) (1,938,494)
------------- -------------
Net property and equipment $ 718,711 $ 1,148,802
============= =============
4. RELATED-PARTY NOTES PAYABLE
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
F-14
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
(see Note 2). In September 1999, the actions were settled resulting in
cancellation of the promissory notes totaling $1,632,375 upon payment to certain
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. Of the notes payable, $77,625 remain unpaid as of
December 31, 2000. During 2000, the holders of these notes made demand for
payment.
5. CONVERTIBLE DEBENTURES
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 10).
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 to the principal balance of
the debentures.
During 2000, the remaining balance of $3,971,107 of the Series C convertible
debentures was converted into 10,385,364 shares of Class A common stock.
Under its indemnity agreement in favor of the Guarantors, the Company was
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 sales of the shares
pledged by the Guarantors.
Certain events of default outlined in the Series C convertible debenture
agreement provided the holders the right to declare the outstanding balance
immediately due and payable and impose additional penalties and interest until
the
F-15
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The
Company was notified on December 3, 1999, that its Class A common stock had been
delisted from the Nasdaq SmallCap Market (see Note 8). 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 Series C convertible 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.
6. PREFERRED STOCK
The Company's certificate of incorporation allows for the issuance of preferred
stock in such series and having such terms and conditions as the Company's board
of directors may designate.
Series A Convertible Preferred Stock - In 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. The individual
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
converted into 166,667 shares of Series A convertible preferred stock on
September 25, 1997. 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 - In 1997, the Company issued 125,000 of
Series B convertible preferred stock for $2,500,000 less $145,000 in related
offering costs. 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 shares of 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.
In 1997, 97,500 of the Series B convertible preferred stock and dividends earned
thereon were 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. There are no shares of Series B convertible preferred stock outstanding.
F-16
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Series C Convertible Preferred Stock - In 1997, the Company entered into an
agreement with an investor whereby the investor agreed to purchase 187,500
shares of the Company's Series C convertible preferred stock for $3,750,000.
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 shares of 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 a percentage based on the number
of days after the original issue date.
During 1997, the Company issued 17,198 shares of Class A common stock upon
conversion of 2,500 shares 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. There are no shares of Series C convertible
preferred stock outstanding.
Series D Convertible Preferred Stock - During 1998, the Company entered into an
agreement with investors whereby the Company issued 550,000 shares of Series D
convertible preferred stock for $11,000,000. Additionally, the Company issued to
certain investors a total of 608,334 shares of Series D convertible preferred
stock in return for their relinquishment of their contractual right to receive
Reset Shares in connection with the March 1998 private placement offering (see
Note 8), and as a 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. 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. Shares of Series D convertible preferred stock, together with dividends
accrued thereon, could 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 15 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. Any outstanding shares
of Series D convertible preferred stock as of August 31, 2001 automatically
convert at the conversion price most beneficial to the holders on that date.
Using the conversion terms most beneficial to the holders, the Company recorded
a preferred stock dividend of $3,638,147 for the beneficial conversion feature
of the Series D convertible preferred stock.
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 2000
and 1999, 217,223 and 626,611 shares, respectively, of Series D convertible
preferred stock and related dividends were converted into 15,436,378 and
47,252,275 shares, respectively, of Class A common stock. As of December 31,
2000, 164,500 shares of Series D convertible preferred stock remained
outstanding. Subsequent to December 31, 2000, the remaining shares of Series D
convertible preferred stock and related dividends were converted into 13,978,440
shares of Class A common stock.
In June 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
convertible preferred stock in consideration for the waiver of certain rights
and amendment of certain terms relating to the conversion of shares of Series D
convertible preferred
F-17
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
stock, including reducing the conversion rate from 90 percent to 85 percent of
the average of the three lowest per share closing bid prices during the 22
trading days preceding the conversion date. The Company recorded a preferred
stock dividend in the amount of $236,400 for the beneficial conversion feature
resulting from the issuance of the shares.
Series E Convertible Preferred Stock - In 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 have no voting rights. Shares of Series E
convertible preferred stock, together with dividends accrued thereon, could 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
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. There
are no shares of Series E convertible preferred stock outstanding.
Series F Convertible Preferred Stock - In 2000, the Company entered into an
agreement (and subsequent amendment thereto) whereby it sold a total of 316,036
shares of its Series F convertible preferred stock for $2,750,000. Dividends
accrue on the stated value ($20 per share) of Series F convertible preferred
stock at a rate of six percent per year, are payable annually or upon
conversion, in cash or common stock, at the option of the Company, and are
convertible into shares of Class A common stock at any time at the holders'
option. Shares of Series F convertible preferred stock could be converted 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 immediately preceding the conversion date. 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 of the Series F
convertible preferred stock.
In 2000, 309,963 shares of Series F convertible preferred stock and related
dividends were converted into 8,342,820 shares of Class A common stock.
Subsequent to December 31, 2000, the remaining 6,073 shares of Series F
convertible preferred stock and related dividends were converted into 519,067
shares of Class A common stock.
7. CONVERTIBLE PROMISSORY NOTE AND EQUITY LINE OF CREDIT
On June 20, 2000, the Company executed a convertible promissory note (the
"2000 Note") with a private investor in the
F-18
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
amount of $7,500,000, which the Company was permitted to draw funds as needed
for operating purposes. The 2000 Note bore interest at six percent annually,
compounded monthly, and was due September 30, 2001. Principal drawn under the
terms of the 2000 Note was designated as the "Initial Investment Amount" under
the Private Equity Line Agreement described below. The investor had 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 $0.75 or 85
percent of the average of the three lowest closing bid prices of Class A common
stock in the 20-day trading period prior to the date of conversion. During 2000,
the Company drew the entire amount available under the 2000 Note and recorded
$106,348 as interest expense. Principal and interest were converted into
11,544,775 shares of Class A common stock. The Company also recorded a
beneficial conversion feature in the amount of $3,447,623 related to borrowings
under the 2000 Note.
On August 8, 2000, the Company entered into a Private Equity Line Agreement
("Equity Line") with the same investor("Equity Line Investor"), which gives the
Company the right to draw up to $20,000,000 for operations and other purposes.
The Initial Investment Amount of $7,500,000 was drawn as part of the 2000 Note
described above. The balance remaining under the Equity Line is available to the
Company through a mechanism of draws and puts of stock. The Company is entitled
to draw funds and to "put" to the Equity Line Investor shares of Class A common
stock in lieu of repayment of the draw. The number of shares issued is
determined by dividing the dollar amount of the draw 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 funds the amounts requested by the Company within two
trading days after the seven trading-day period.
During 2000, draws taken under the Equity Line, excluding the Initial Investment
Amount, amounted to $3,973,508 and were converted to 12,492,680 shares of Class
A common stock. Subsequent to December 31, 2000, additional draws amounting to
$3,010,000 were converted into 6,770,945 shares of Class A common stock. As of
March 20, 2001, $5,516,492 of credit remains available to be drawn on the Equity
Line.
8. COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION
Common Stock - During 2000, the Company issued 65,959,861 shares of Class A
common stock. Of such shares, 34,164,562 shares were issued upon the conversion
of convertible debentures with related interest and preferred stock with related
dividends, 24,037,455 were issued upon conversion of draws on the Equity Line
and 2000 Note, 1,067,061 shares were issued upon the exercise of warrants,
options and stock appreciation rights, 4,568,569 shares were issued upon
exercise of repricing rights (see below), 260,145 shares were issued upon the
settlement of litigation (see Note 15), and 1,862,069 were issued to consultants
as consideration for services rendered.
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 5 and 10) and
1,200,000 were issued to consultants as consideration for services rendered. The
Company canceled 970,586 shares of Class A common stock that were returned in
connection with the Papyrus settlement (see Note 2). 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 warrants and
F-19
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
options, 35,000 shares were issued in payment of a loan origination fee and
24,814 shares were issued for the purchase of a patent.
In March 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 in March
1998, in return for which the Company issued a total of 3,333,333 shares of
restricted Class A common stock. 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 and other conditions. As of July 27, 1998, the certain conditions
precedent to receiving the additional funding were not met. In separate
transactions in June and August 1998, certain investors paid to the Company a
total of $3,000,000 in return for which the Company issued 666,667 additional
shares of Class A common stock under the terms and conditions set forth in the
offering. No other proceeds are expected to be received by the Company pursuant
to the private placement.
The investors acquired certain "reset rights" in connection with the March 1998
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 related registration statement or the second
funding date did not equal or exceed $5.40 per share. On August 31, 1998, the
Company and the investors in the private placement 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 - Except with respect to the issuances
of the Series A convertible preferred stock, with each issuance of convertible
securities and related warrants, 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, the conversion of draws on the private equity line of credit, and
the exercise of warrants. The Company covenanted to reserve out of its
authorized and unissued shares of Class A common stock (i) 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 (ii) issuable upon the exercise of certain warrants. As of
December 31, 2000, the Company had reserved approximately 44,637,598 shares of
Class A common stock for this purpose.
Voting Trust - As of December 31, 2000, 8,627,333 shares of the Company's
outstanding Class A common stock were held in a 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 - In 1998, the Company entered into a private
placement agreement with an
F-20
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
unaffiliated investor, pursuant to which 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 at $1.67 per share
for 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.
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 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, 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 repricing rights were converted into 4,568,569 shares
of Class A common stock, which shares were subsequently sold by the holder into
the open market. 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.
Delisting from The Nasdaq SmallCap Market - On December 3, 1999, the Company
received notice that its Class A common stock had been delisted from The Nasdaq
SmallCap Market principally because the Company's stock had failed to meet
Nasdaq minimum bid price requirements. 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 triggered an event of default under the terms of the Series C convertible
debentures (see Note 5). Upon the occurrence of such an event of default, the
outstanding principal amount of all of the debentures, together with accrued
interest and all other amounts owing in respect thereof, became immediately due
and payable in cash. However, the holders of the debentures waived this event of
default.
The delisting of the Company's Class A common stock from the Nasdaq SmallCap
Market also triggered an event of default in connection with the Company's
Series D and Series E preferred stock (see Note 6). 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.
9. STOCK OPTIONS AND WARRANTS
Common Stock Options - In 1998, the Company's board of directors and
shareholders 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 was 10,000,000. In 2000, the
Company's board of directors
F-21
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approved an increase in the number of shares under the Plan from 10,000,000 to
20,000,000. As of December 31, 2000, the number of shares available for grant
under this plan was 7,626,944.
In 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. As of December 31, 2000, the number of shares available for grant
under this plan was 2,352,993.
In 1996, the Company's board of directors and shareholders 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 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, 2000, the number of shares available for grant under this plan
was 2,200,000.
In 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, 2000, the number of shares available
for grant under this plan was 773,666.
In 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 as directors in 1998 and 1,400,000 were
for services to be performed as directors in 1999 providing the directors served
six months in 1999. In 1999, the Company granted options to purchase 400,000
shares of Class A common stock to new members of the board of directors, waiving
the requirement that they serve for six months prior to such granting. In 2000,
options to purchase 1,000,000 shares of Class A common stock were granted to
members of the board of directors for services performed as directors during the
year. In 2000 and 1998, options to purchase 3,800,000 and 630,000 shares of
Class A common stock, respectively, were issued to directors who were also
executive officers of the Company for compensation and other service rendered to
the Company. No such options were issued in 1999. All options described above
were issued under the 1998 Plan.
F-22
A summary of options granted under the Company's various stock option plans for
the years ended December 31, 2000, 1999 and 1998 is presented below:
2000 1999 1998
----------------------- ---------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Stock Exercise Stock Exercise Stock Exercise
Options Price Options Price Options Price
----------- ---------- ----------- --------- ------------- ---------
Options outstanding
at beginning of the year 14,355,900 $ 4.06 15,877,782 $ 4.10 10,565,000 $ 5.38
Granted 7,116,067 0.65 1,294,000 1.31 6,414,782 2.08
Exercised (938,697) 1.00 - - (35,000) 6.00
Forfeited (675,570) 4.59 (2,815,882) 3.01 (1,067,000) 4.56
----------- ----------- ------------
Options outstanding
at end of the year 19,857,700 2.97 14,355,900 4.06 15,877,782 4.10
=========== =========== ============
Options exercisable
at end of the year 18,923,001 3.07 13,484,237 4.20 9,524,766 5.11
=========== =========== ============
Weighted average fair value of
options granted during the year $ 0.64 $ 1.31 $ 1.98
A summary of options outstanding and options exercisable under the Company's
various stock option plans at December 31, 2000 is presented below:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------ --------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Everage Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ------------ ------------- -------------- ---------------- -------------- --------------
$0.28-1.00 5,129,659 9.0 years $ 0.47 4,424,459 $ 0.46
1.01-1.78 5,432,800 8.8 years 1.12 5,236,634 1.12
2.97-4.06 3,580,334 5.5 years 3.99 3,547,001 4.00
5.06-6.50 5,394,907 6.6 years 6.27 5,394,907 6.27
7.13-8.50 320,000 6.2 years 7.17 320,000 7.17
------------- --------------
$0.28-8.50 19,857,700 7.6 years $ 2.97 18,923,001 $ 3.07
============= ==============
F-23
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2000, 1999, and 1998:
2000 1999 1998
Net loss attributable to common stockholders: ---------------- ---------------- ----------------
As reported $ 26,097,081 $ 23,773,026 $ 47,916,031
Pro forma 30,602,028 28,567,009 56,576,232
Basic and diluted net loss per common share: $ (0.91)
As reported $ (0.16) $ (0.31) (1.08)
Pro forma (0.19) (0.37)
The fair value of options and warrants is estimated on the date granted using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during 2000, 1999 and 1998:
2000 1999 1998
------ ------ -----
Risk-free interest rate 6.08% 5.70% 4.80%
Expected dividend yield 0.0% 0.0% 0.0%
Expected exercise lives 5 years 5 years 5 years
Expected volatility 130% 102% 85%
The estimated fair value of options granted is subject to the assumptions
made, and if the assumptions were to change the estimated fair value amounts
could be significantly different.
Warrants - A summary of warrants granted by the Company during the years ended
December 31, 2000, 1999 and 1998 is presented below:
2000 1999 1998
--------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------- ----------- ------------- -------------- ------------ -------------
Outstanding at beginning of the year 3,025,000 $ 2.71 1,925,000 $ 13.08 1,175,000 $ 6.39
Granted 945,000 0.93 2,250,000 0.66 1,200,000 16.94
Exercised (300,000) 0.93 - - (230,000) 1.28
Forfeited (200,000) 8.13 (1,150,000) 16.06 (220,000) 9.14
Outstanding at end of the year 3,470,000 2.06 3,025,000 2.71 1,925,000 13.08
============== ============= ============
Warrants exercisable at end of the
year 3,470,000 $ 2.06 2,525,000 $ 3.16 1,925,000 $ 13.08
============== ============= ============
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. In 2000, stock
F-24
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
appreciation rights related to 400,000 outstanding stock options with a
weighted average exercise price of $1.18 were exercised resulting in the
recording of $628,000 of selling, general and administrative expense. There
are options to purchase 516,339 shares of Class A common stock outstanding
which provide for stock appreciation rights. Of these options, 126,669 have an
exercise price of $6.50 per share, 13,000 have an exercise price of $3.66 per
share and 376,671 have an exercise price of $1.00 per share.
10. RELATED-PARTY TRANSACTIONS
Purchase of Technology Rights- 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 payment 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 expire on 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 technologies.
Guarantees of Company Obligations and Related Indemnity Agreement - In 1998
and 1999, two executive officers and directors and a former executive officer
and director of the Company (the "Guarantors") guaranteed certain obligations
of the Company, including obligations under the Series C debentures and
certain real estate leases.
In March 1999, 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 would not have been 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 were
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 1999 Series C debenture issuance, the holders of the
Series C debentures notified the Company and the Guarantors that a default had
occurred under certain terms of the stock pledge agreement and that the
holders had 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, 1999 (see Note 5). 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 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
F-25
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
reimburse the Guarantors for expenses resulting from these sales.
During 1999, two executive officers of the Company advanced funds totaling
$317,159 related to sales of shares of the Company's stock owned by them that
was pledged as collateral under certain borrowing agreements. The balance was
subsequently repaid in full in 1999. 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 in 1999.
SCC Asset Management Inc. - SCC Asset Management ("SCC"), formerly Studdert
Companies Corp., 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 is a former director and executive officer of the
Company.
The Company rents office space under subleases from SCC. Payments under the
leases are guaranteed by three officers, owners and directors of SCC noted
above. The subleases require monthly payments of $10,368. Payments for the
sublease and related expenses amounted to $111,196 in 2000, $124,416 in 1999
and $117,228 in 1998.
Synergetics - Until March 1999, the Company engaged Synergetics, Inc.
("Synergetics") to provide assistance to Fonix in the development of its ASR
technologies (see Note 12). Through December 1998, a director and the chief
executive officer of the Company was also a director of Synergetics. 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.
Other Transactions - On December 23, 1999, the Company issued warrants to
purchase 250,000 of the Company's Class A common stock to a law firm having a
weighted-average exercise price of $0.31 and a term of five years. During
2000, 1999 and 1998, the Company paid approximately $505,000, $902,000, and
$746,000, respectively, to the law firm for services provided to the Company.
The Company believes the terms of the related-party transactions are at least
as favorable as terms that could be obtained from unaffiliated third parties
in similar transactions.
11. 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 2000 or 1999.
F-26
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. PRODUCT DEVELOPMENT AND RESEARCH
Synergetics - Prior to March 1997, the Company's scientific research and
development activities were conducted solely by a Synergetics, pursuant to
product development and assignment contracts (collectively, the "Synergetics
Agreement"). Under that arrangement, Synergetics provided personnel and
facilities, and the Company financed the Synergetics research and development
activities on an as-required basis and the Company was obligated to pay to
Synergetics a royalty of 10 percent (the "Royalty") of net revenues from sales
of products incorporating Synergetics' "VoiceBox" technology as well as
technology derivatives thereof. Synergetics compensated its developers and
others contributing to the development effort, in part, by granting "Project
Shares" to share in a portion of the Royalty received by Synergetics. On April
6, 1998, the Company and Synergetics entered into a Royalty Modification
Agreement whereby the Company agreed to offer an aggregate of 4,800,000
non-transferable common stock purchase warrants to the holders of the Project
Shares in consideration for which Synergetics agreed to cancel any further
obligation on the part of the Company to pay the Royalty. The exercise price
of the warrants was to be $10 per share and the warrants would not be
exercisable until the first to occur of (1) the date that the per share
closing bid price of the Class A common stock was equal to or greater than
$37.50 per share for a period of 15 consecutive trading days, or (2) September
30, 2000. In 2000, the Company and Synergetics entered into a Restated Royalty
Modification Agreement whereby the Company paid Synergetics $28,000 to cancel
the obligation of the Company to pay the Royalty. 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 $28,000 in 2000, $50,455 in 1999, and $1,128,433 in
1998, for research and development efforts.
Adiva- During 1998 and 1999, the Company utilized the research and development
services of Adiva. The president of Adiva is also the president of Synergetics
and IMC-2. In 2000, the Company terminated its relationship with Adiva and made
a final payment of $85,000 in settlement of the relationship. The Company
incurred expenses of $85,000 in 2000, $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. In February 2001, the Company and IMC-2
agreed to extend the contract on a month-to-month basis. Under the terms of
the agreement, the Company expended $264,000 in 2000, $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 databases on the Internet through the use of interactive
video and voice technologies. Under the terms of the arrangement the Company
paid $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 ("Advocast 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
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Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
value. As a result, the Company has not recorded a value for the Advocast
shares in the accompanying consolidated financial statements. The chief
executive officer of the Company is a director of Advocast.
Subsequent to 1998, Advocast obtained in excess of $1,000,000 in financing
from third parties. These funds allowed Advocast to further develop its
technology for integration with speech technologies, such as those available
from Fonix.
On February 26, 2001, Fonix agreed to provide an additional $100,000 of
financing under the terms of a 6% convertible debenture. The debenture is due
February 26, 2002, and is secured by the intellectual property and operating
assets of Advocast. The debenture is convertible into shares of Advocast
common stock at a rate of $8.62 per share at the option of Fonix. Furthermore,
Fonix has the right to convert its Advocast Preferred Stock into additional
principal under the debenture at a rate of $25 per share of Advocast Preferred
Stock. If converted, the resulting balance due under the debenture is subject
to the same terms of conversion into Advocast common stock or becomes due and
payable six months following the original due date of the convertible
debenture. Fonix has not yet advanced any amounts under the debentures.
Advocast and Fonix also entered into an agreement whereby Advocast will
provide consulting services to Fonix for development of Internet applications
of the Company's NUI technologies. The term of the agreement is three months
and may be renewed at the Company's option for an additional three months.
Fonix will pay Advocast $10,000 per month for these consulting services. To
date, Fonix has paid $30,000 to Advocast pursuant to the consulting agreement.
13. INCOME TAXES
At December 31, 2000 and 1999, net deferred income tax assets, before
considering the valuation allowance, totaled $30,159,421 and $25,104,947,
respectively. The amount of and ultimate realization of the benefits from the
deferred income tax assets is dependent, in part, upon the tax laws in effect,
the Company's future earnings, and other future events, the effects of which
cannot be determined. The Company has established a valuation allowance for
all deferred income tax assets not offset by deferred income tax liabilities
due to the uncertainty of their realization. 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 $5,073,474 for 2000
and $4,202,930 for 1999.
At December 31, 2000, the Company has unused federal net operating loss
carryforwards available of approximately $72,570,000 and unused state net
operating loss carryforwards of approximately $63,845,000 which may be applied
against future taxable income, if any, and which expire in various years from
2008 through 2020. The Internal Revenue Code contains provisions which likely
will 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.
F-28
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The temporary differences and carryforwards which give rise to the deferred
income tax assets (liabilities) as of December 31, 2000 and 1999 are as
follows:
Deferred income tax assets: 2000 1999
Net operating loss carryforwards: ---------------- -------------------
Federal $ 24,673,999 $ 20,365,190
State 2,106,874 2,065,175
Research and development credits 2,224,742 1,818,176
Accrued liabilities 798,240 811,892
Deferred revenues 274,689 15,138
Other 80,877 29,376
---------------- -------------------
Total deferred income tax assets before valuation
allowance 30,159,421 25,104,947
Valuation allowance (30,159,421) (25,085,947)
---------------- -------------------
Net deferred income tax assets - 19,000
---------------- -------------------
Deferred income tax liabilities:
Other - (19,000)
---------------- -------------------
Total deferred income tax liabilities - (19,000)
---------------- -------------------
$ - $ -
================ ===================
A reconciliation of income taxes at the federal statutory rate to the
Company's effective rate is as follows:
Year Ended December 31,
-------------------------------------------
2000 1999 1998
------------ ------------- -------------
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
Non-deductible items (14.8) (9.0) (11.2)
Valuation allowance (22.2) (14.0) (26.1)
------------ ------------- -------------
Effective income tax rate 0.3% 14.3% - %
14. COMMITMENTS AND CONTINGENCIES
Executive Employment Agreements - The Company has employment agreements with two
executive officers that were initiated November 1, 1996 and amended effective
January 31, 2000 to extend the term of the agreements and reduce the base
compensation. The current annual base salary for each executive officer is
$309,400 and may be adjusted in future years as deemed appropriate by the
Company's board of directors. The expiration date of the agreements is December
31, 2005. 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 options to purchase 1,400,000 shares of the Company's Class A common
stock at an exercise price of $1.01. These options vested immediately and expire
on July 19, 2010.
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
F-29
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and thereafter payable within 30 days of termination.
Another executive officer of the Company resigned in January 1999 and his
employment agreement was canceled. He subsequently entered into a separation
agreement pursuant to which he was paid $250,000 per year for the years ended
January 31, 2000 and 2001, and $100,000 for the year ending January 31, 2002.
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 percent 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 six 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.
Other Employment Agreements - In January 1998, the Company entered into an
employment contract with an employee which was to expire in January 2001. The
annual salary under this agreement was $180,000, but was reduced 30 percent by
mutual agreement effective February 1999, in connection with cost reductions
initiated by the Company. This reduce level of compensation continued through
June 30, 2000, on which date the employment contract was terminated.
On January 23, 2001, the Company entered into an employment agreement with an
employee under which the employee is paid an annual salary of $225,000 and
received options to purchase 600,000 shares of the Company's Class A common
stock at an exercise price of $0.49 per share. Vesting of the options occurs
over the term of the contract as follows: 100,000 on January 23, 2001, 100,000
on November 30, 2001, 200,000 on November 30, 2002, and 200,000 on November 30,
2003. The agreement expires November 30, 2003.
Professional Services Agreements - In July 2000, the Company entered into
professional services agreements with two consulting firms. In connection with
these agreements, the Company issued a total of 1,000,000 shares of Class A
common stock. The stock was valued at $1,015,600 using the fair value of the
Class A common stock on the date each contract commenced and was recorded as
deferred consulting expense and amortized into general and administrative
expense over the period of service.
In May 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 in connection with equity financing
transactions.
In January 2000, the Company issued warrants to purchase 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 vested as follows: 100,000 warrants on March 21, 2000,
100,000 warrants on September 30, 2000, and 100,000 warrants on December 31,
2000.
In December 1999, the Company entered into professional services agreements
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 which amount was recorded as deferred consulting expense
and amortized into general and administrative expense over the period of
service in 2000 and 1999.
In December 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 option
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Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pricing model assuming a risk-free interest rate of 6.33 percent, expected
dividend yield of 0 percent; expected exercise life of five years, and
expected volatility of 130 percent. The resulting amount was recorded as
deferred consulting expense and amortized into general and administrative
expense over the period of service in 2000.
In May 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
option pricing model and the resulting charge recorded as deferred consulting
expense and was subsequently recognized as expense over the life of the
agreement.
Telia - Telia Promotor AB ("Telia"), a wholly owned subsidiary of Telia AB, a
Swedish telecommunications company, has developed multiple language capability
for integration into TTS applications. In October 2000, the Company entered
into a revenue sharing arrangement with Telia that provides that Fonix will
pay a percentage of revenue to Telia for Fonix licenses of TTS technology that
include languages other than American English provided by Telia.
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, 2000, were as follows:
Years ending December 31,
2001 $ 860,626
2002 856,689
2003 512,700
2004 293,664
-------------
$ 2,523,679
=============
The Company incurred rental expense, net of subleases, of $413,382, $764,930,
and $829,523 during 2000, 1999 and 1998, 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 required the sublessee to pay $13,961 per month, or
approximately 40 percent of the Company's monthly obligation under the primary
lease agreement. The sublease agreement expired December 31, 2000.
Effective May 25, 1999, the Company entered into an agreement to sublease its
Cupertino, California facility to an unrelated third party. The agreement
requires the sublessee to pay $35,432 per month through May 31, 2003.
Forgiveness of Trade Payables and Accrued Interest - The Company negotiated
reductions in amounts due various trade vendors amounting to $78,864 in 2000
and $526,697 in 1999. Additionally, the Company negotiated reductions in
accrued interest owed to certain note holders amounting to $229,055 in 1999.
These amounts have been accounted for as an extraordinary item in the
accompanying consolidated statements of operations.
15. 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
F-31
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. In December 2000, a settlement
was reached that required the Company to pay $27,500 in cash and issue 260,145
shares of Class A common stock, valued at $81,295 at the date of settlement, and
required that OGI return equipment loaned to them by Fonix under the terms of
their original agreements.
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
affiliated with Clarke, commenced an action against Fonix in federal court for
the Southern District of New York. Clarke and Perpetual Growth asserted claims
for breach of contract relating to certain financing Fonix received during 1998
and thereafter. Fonix filed a motion to dismiss based upon the court's lack of
personal jurisdiction over Fonix. The court granted Fonix's motion to dismiss,
on a conditional basis, subject to the right of Clarke and Perpetual Growth to
produce additional evidence which would establish jurisdiction of the New York
court over Fonix. Clarke and Perpetual Growth filed a motion with the New York
court that sought to establish a factual and legal basis for the New York
court's exercise of jurisdiction over Fonix. However, the court denied that
motion. Clarke and Perpetual Growth thereafter appealed the decision of the New
York court to the United States Court of Appeals for the Second Circuit. The
Court of Appeals affirmed the decision of the trial court. In the interim, Fonix
filed a suit against Clarke and Perpetual Growth in federal court for the
Central District of Utah seeking a declaratory judgment that it did not owe any
money to Clarke and Perpetual Growth. The case was tried to the Utah court in
March 2001, after which the Utah court ruled in favor of Fonix and determined
that Clarke and Perpetual Growth had no claims for "trailing fees" with regard
to the financings which were the subject of the suit. Clarke and Perpetual
Growth have appealed the decision of the Utah court to the United States Court
of Appeals for the Tenth Circuit. The Company believes that the claims of Clarke
and Perpetual Growth are without merit and will continue to vigorously oppose
those claims.
Other - 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.
16. EMPLOYEE PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan covering essentially all of its
full-time employees. Under the plan, employees may reduce their salaries, in
amounts allowed by law, and contribute the salary reduction amount to the plan
on a pretax basis. The plan also allows the Company to make matching and profit
sharing contributions as determined by the board of directors. To date, no
matching or profit sharing contributions have been made by the Company.
17. SIGNIFICANT CUSTOMERS
All of the Company's revenues for 2000, 1999 and 1998 were sourced from the
United States. Of the $656,853 revenues in 2000, $125,000 was from Motorola, and
$87,250 from NuvoMedia, Inc. 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. No other customer accounted for more
than 10 percent of the Company's total revenues for the years presented.
18. SUBSEQUENT EVENTS
Expansion Activities
Audium - In February 2001, The Company and Phone2Networks, Inc. dba Audium
("Audium") entered into a
F-32
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
collaboration agreement to provide an integrated platform for generating Voice
XML solutions for Internet and telephony systems. Audium is a mobile
application service provider that builds and operates mobile applications that
allow access to Internet information and complete online transactions using
any telephone. The collaboration will include integration of FAAST with
Audium's mobile applications development capability.
In connection with the collaboration agreement, in February, 2001, the Company
advanced $200,000 to Audium as a bridge loan. The loan bears interest at a
rate of 12 percent per year, is due on or before February 28, 2003 and is
convertible into shares of Audium Series A Convertible Preferred Stock.
Korea Sales Office - In March 2001, the Company opened a sales office in
Seoul, Korea, to market its NUI technologies and applications to Korean
manufacturers of microprocessor chips, consumer electronics and other
electronic devices.
Issuance and Exercise of Stock Options - Subsequent to December 31, 2000, the
Company granted a total of 1,535,000 stock options to various employees of the
Company. These options have a 10-year life and exercise prices between $0.30
and $0.73 per share.
F-33