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, 2001, or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
------ ----------
Commission File No. 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 87-0380088
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
180 W. Election Road, Suite 210
Draper, Utah 84020
(Address of principal executive offices with zip code)
(801) 553-6600
(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 $42,534,564. calculated using a closing price of
$0.093 per share on March 26, 2002. For purposes of this calculation, the
registrant has included only the number of shares directly held by its officers
and directors as of March 26, 2002 (and not counting shares beneficially owned
on that date), in determining the shares held by non-affiliates. As of March 26,
2002, there were issued and outstanding 463,280,512 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
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Page
Item 1. Business...........................................................3
Item 2. Properties........................................................17
Item 3. Legal Proceedings.................................................18
Item 4. Submission of Matters to a Vote of Security Holders...............18
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...............................................20
Item 6. Selected Financial Data...........................................21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................22
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 Company...................32
Item 11. Executive Compensation............................................35
Item 12. Security Ownership of Certain Beneficial
Owners and Management.............................................42
Item 13. Certain Relationships and Related Transactions....................43
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...44
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 THE COMPANY'S FINANCIAL
STATEMENTS AND RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT.
General
Fonix Corporation, a Delaware corporation ("Fonix" or the
"Company"), delivers speech solutions that empower people to interact
conversationally with information systems and computing devices using natural
language. The Company's speech-enabling technologies, which include
text-to-speech ("TTS") and neural network-based automated speech recognition
("ASR"), are integrated into products for commercial, industrial and consumer
applications. ASR and TTS technologies are sometimes collectively referred to in
this report as "Core Technologies". The Company believes its efficient and
intuitive speech-enabling technologies enhance user productivity and efficiency
in a broad range of markets including embedded applications for automotive and
wireless devices, computer telephony and server applications, and personal
software for consumer applications.
The Company currently markets solutions and applications that
utilize its Core Technologies to software developers, consumer electronics
manufacturers, micro-processor manufacturers, third-party product developers,
operating system developers, network developers and Internet-related companies
as well as directly to consumers. The Company currently focuses its marketing
efforts toward embedded systems for automotive applications and wireless and
mobile electronic devices, server-based solutions for Internet and telephony
voice-activated applications, and personal software for consumer applications
through retail distribution channels. The Company pursues revenue opportunities
through generation of royalty fees, product and technology licenses, product
sales, non-recurring engineering fees, and support agreements.
Speech-enabling technologies are a value-added interface solution
for computing and communications devices. The Company believes that
manufacturers of consumer electronics products, software developers and Internet
content developers use the Company's Core Technologies and solutions 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 for embedded
applications and enhances scalability for high channel capacity for computer
telephony and server-based systems.
The Company believes that it is well positioned to serve markets
that are rapidly adopting speech-enabled applications. As memory requirements,
noise robustness, recognition accuracy and efficiency of speech solutions become
increasingly critical, Fonix expects to provide compelling solutions to meet
highly competitive customer demands.
Market Focus
Page 3
Fonix products and solutions are sold into three broad markets: 1)
embedded automotive applications and wireless and mobile devices, 2) computer
telephony and server solutions, and 3) personal software for consumer
applications. Solutions and applications are distinguished between each market
based on processor size and speed, memory and power capacity and utility to
consumers. For example, wireless and mobile applications utilize embedded
solutions featuring very small processors with limited memory and power
capacity. Computer telephony and server solutions are server-based and scale
from desktop/laptop applications to connected server applications to full
distributed solutions. Personal software for consumer applications adapt
solutions developed in embedded and server-based environments to provide utility
to users of personal computers and handheld computing devices.
EMBEDDED AUTOMOTIVE APPLICATIONS AND WIRELESS AND MOBILE DEVICES.
Devices in this category include personal digital assistants ("PDAs"), cellular
phones, web pads, wireless communication devices, automotive command and control
functions and telematics, and other consumer electronics. The Company believes
that in many cases, a significant deterrent to full functionality of these
powerful and small computing devices is the current need for a keyboard, touch
screen and/or mouse to interface with the device. The Company also believes that
speech-enabling applications provide a user-intuitive interface that will
increase the utility of these devices and improve access to information. Other
product development initiatives that may drive additional interest in
speech-enabling 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 within tolerances needed to speech-enable these devices which use
existing 32-bit or greater processors. To capitalize on this distinct
competitive advantage, Fonix has ported its speech-enabling technologies to
several processors including ARM, Epson EOC 33A104 and 208, Infineon TriCore,
Texas Instruments 55xx and OMP, Intel StrongArm(R), Hitachi SH3 and SH4, and NEC
MIPS core. Fonix has also ported on various operating systems including
Microsoft Windows CE, QSSL QNX, Linux and WindRiver VxWorks.
Fonix has identified certain channel and direct sales opportunities
for ASR and TTS technologies in wireless and mobile device 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 speech-enabling technologies,
resulting in leveraged product sales. Current partners include
PurpleSoft, Microsoft and QNX.
Product Developers and Manufacturers - Many companies are seeking
speech-enabling 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. KME Panasonic is a current OEM customer.
On December 14, 2001, the Company acquired the rights to certain TTS
technology from Force Computers, Inc. (see Recent Developments, below). This
technology ("DECtalk TM TTS") consists of a small- footprint TTS that
complements the Company's existing TTS technology. The acquisition of DECtalk
TTS
Page 4
positions Fonix to take greater advantage of opportunities in embedded
applications, especially those where memory capacity is limited. Additionally,
the acquired technology is already well established as a leading solution in
assistive applications with existing customers and market channels. Fonix will
continue to cultivate these opportunities and relationships while developing new
applications from the DECtalk TTS.
COMPUTER TELEPHONY AND SERVER-BASED SOLUTIONS. Fonix focuses on
product enhancement and delivery in computer telephony and server-based
applications such as:
Interactive voice response ("IVR") - Telephony applications for
corporate call centers, short messaging services and information
retrieval from server databases are already common. Fonix s.Manager
development framework 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
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 and
commercial enterprises.
Network systems command and control and e-mail reader - Fonix
provides TTS which can be seamlessly integrated into network
software to speech-enable software applications.
Markets targeted for the development and delivery of these solutions
include:
General Systems Integrators and Value-added Resellers that implement
solutions for customers for market segments in computer telephony
and server applications;
Military and Government Systems Integrators and Value-added
Resellers that implement solutions for customers in support of
government agencies and organizations;
Enterprise Solution Providers that develop software infrastructure
for large companies; and
Telephone Service Providers that provide telephone services and
products built around those services.
Currently, the Company believes that server-based markets are trending toward
the convergence of wireless data transmission and connectivity between mobile
computing and fixed-server databases. Fonix has entered into agreements with key
solution providers in these markets such as Nortel Networks, Nuance
Communications, Envox, and Motorola Mobile Internet Exchange.
PERSONAL SOFTWARE FOR CONSUMER APPLICATIONS. Adaptations of certain
applications developed for embedded and server-based solutions have utility to
consumers for home computing and other personal uses. These adapted applications
are sold through retail distribution channels via the Internet, retail computer
stores and catalog outlets. As speech becomes a common means of interacting with
computers, Fonix believes that demand for such applications will increase
dramatically. Because speech applications are not widely available in these
markets, Fonix may help create the market for these products in many cases, and
expects to be well-positioned to sell its products into these markets.
Personal software for consumer applications is currently available
for personal computers and PDAs using the Pocket PC operating system. Current
product offerings include the following:
Page 5
iSpeak - A PC based application for reading text out loud in a male
or female voice, in various languages.
TimeTalk - A Windows PC and Pocket PC based application using Fonix
TTS that speaks the time in intervals, voice and language selected
by the user.
TimeTalk Alert - A Pocket PC based application that utilizes Fonix
TTS to remind the user of upcoming appointments or scheduled events
from the user's calendar.
Fonix Commander - A Pocket PC based application using Fonix TTS and
ASR that allows the user to navigate through programs and locate
files in the user's PDA using voice commands.
SpeakThis - An Internet based application that uses Fonix TTS that
allows users to activate a button on a SpeakThis-enabled website to
have the text read to them out loud in a variety of voices and
languages. Versions are available to individuals to speech-enable a
website and to website developers to speech-enable an entire
website.
Primary market channels targeted for distribution of these products
include:
Hardware bundles - manufacturers and distributors of personal
computers, PDAs, MP3 players and other handheld computing devices
include pre-installed software on their products or packaged
software with their product for easy access for the user to order
and download on line or to contact the Company for a keycode.
Internet sales - Certain applications can be ordered, paid for and
downloaded through the Internet from the Company's website and other
locations.
Retail outlets - Computer stores and retail outlets sell all types
of applications including PDAs and personal computers. Fonix expects
to reach these outlets by partnering with one or more distributors.
Catalogs - Computer catalogs reach targeted consumers and offer a
wide variety of application and products.
Market and Sales Strategy
Fonix has identified market opportunities in each of the broad
categories described above. In January 2002, the Company began to organize new
business units to provide standard solutions within these markets. The business
units will be supported by dedicated sales professionals and product development
engineers.
Sales efforts focus on developing sales partners, opportunities, and
relationships. Among these opportunities are OEM application development
projects, value-added resellers ("VAR") and other resellers, enterprise (large
corporate) sales, and cross-selling opportunities to the Company's existing
customer base. Key customer relationships are assigned to account
representatives who are responsible to pursue revenue opportunities.
Fonix focuses its efforts on providing solutions and applications to
customers with existing significant market share and markets that it believes
have high margins, broad use and rapid development. Current strategy is governed
by the following general principles:
Focus on revenues - Pursue specific markets where revenues,
particularly recurring revenues, can be rapidly realized without
significant continued research and development.
Page 6
Standard and re-usable common solutions - Focus on common solutions
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.
Fonix Speech Manager Development Framework - "s.Manager"
As the worldwide market for speech-enabling technologies and
products expands, consumer products manufacturers and software and Internet
content developers have demanded increased and efficient time-to-market and
decreased development time for speech-enabling solutions as well as increased
quality of user interface. To address these market demands, Fonix provides its
customers with a speech technology development framework - the Fonix Speech
Manager or "s.Manager" (formerly known as Fonix Accelerated Application
Solutions Technologies or "FAAST").
The s.Manager framework provides developers with a development
framework that enables rapid creation of speech-enabling applications that can
be integrated quickly and efficiently into products. Specifically, s.Manager
allows a developer to integrate into products a highly scalable framework that
includes a broad range of key features necessary to create speech-enabling
functionality such as highly flexible audio input drivers, output drivers,
speech application program integrators, and the Fonix graphical application
builder, as well as the ability to plug-and-play multiple ASR and TTS engines.
Furthermore, the s.Manager framework is designed to permit developers to employ
speech components from any source, as solution needs may dictate. Fonix
s.Manager framework has been released in versions for both embedded and
server-based markets.
"Powered by Fonix" Marketing Initiative
In 2001, Fonix announced a strategic marketing program designed to
assist its channel partners to adopt and integrate Fonix s.Manager and
speech-enabling technologies. The "Powered by Fonix" program offers 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 developers successfully develop, deploy, and manage
voice applications. The Company provides access to multiple tools,
such as s.Manager, that help developers do their job. Some tools
offer enhanced capabilities; others offer increased efficiency; and
still others provide unique capabilities that Fonix believes
interest developers. While some tools are offered in full versions,
others are offered in evaluation versions so developers may try them
before purchasing.
Reseller Partners - Designed to establish and strengthen
relationships with the reseller community, the "Powered by Fonix
Channel Partner Program" offers benefits designed to strengthen
relationships and promote the sale of Fonix technologies. Fonix
provides its partners with the tools they need to successfully
implement the Fonix line of speech-enabling solutions with benefits
like sales leads, marketing collateral, training, TTS hosting
services, premium support and a secure reseller web site.
Page 7
Corporate Partner - Designed to address the needs of the Company's
corporate customers, the Corporate Partner Program focuses 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
speech-enabling technology into mass market, industrial, general business and
personal electronics products and computing solutions, lead time to revenue
recognition will be longer than that for software products released directly
into consumer channels. The Company's products sold and integrated into customer
applications are subject both to customer production schedules and customer
success in developing and marketing the products and generating product sales.
Taking advantage of its innovative speech applications and
solutions, the Company markets personal software for consumer applications that
are available through the Fonix website and traditional retail channels such as
computer superstores and catalogs. As additional applications evolve from the
embedded and server-based markets, the Company plans to develop and release new
products, and applications will be developed and released through these
channels.
Employees
As of March 26, 2002, the Company employed 139 people. Of this
total, 77 were employed in product development and delivery, 28 were employed in
sales and marketing, and 34 were employed in strategic development,
administration and support.
RECENT DEVELOPMENTS
Force Computers, Inc. Transaction
On December 14, 2001, Fonix entered into an Asset Purchase Agreement
with Force Computers, Inc., under which the Company purchased tangible and
intangible assets and agreed to pay Force $150,000 in cash at closing, and
$1,280,000 in the form of a non-interest-bearing promissory note. Payments due
under the promissory note are payable at intervals through December 9, 2002. To
date, the Company has made all payments when due.
Grants of Stock Options
During 2001, Fonix granted options to purchase 8,134,950 shares of
Class A common stock as follows:
Grantee Number of Shares Exercise Prices
- ------- ---------------- ---------------
Directors and Executive Officers 2,500,000 $ 0.14
Employees 5,126,950 $ 0.07 to $ 0.73
Consultants 508,000 $ 0.19 to $ 0.40
Page 8
The term of all of these stock options is ten years from the date of
grant and all were granted at the quoted market price on the date of grant.
During 2001, 3,878,837 options expired without exercise. As of December 31,
2001, the Company had a total of 24,078,813 options outstanding, of which
16,981,906 were exercisable at a weighted average exercise price of $2.50.
Page 9
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. 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.
The Company's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about its ability to
continue as a going concern.
Since inception, the Company has sustained substantial losses. Such
losses continue due to ongoing operating expenses and a lack of revenues
sufficient to offset operating expenses. The Company had negative working
capital of $6,102,151 at December 31, 2001. The Company has raised capital to
fund ongoing operations by private sales of the Company's securities, some of
which sales have been highly dilutive and involve considerable expense. In the
Company's present circumstances, there is substantial doubt about its ability to
continue as a going concern absent significant sales of the Company's existing
products, substantial revenues from new licensing or co-development contracts,
or continuing large sales of its securities.
The Company incurred net losses of $24,566,807, $22,761,229, and
$21,662,419 for the years ended December 31, 2001, 2000 and 1999, respectively.
As of December 31, 2001, the Company had an accumulated deficit of $167,616,372,
and owed trade payables of $1,062,237, of which $255,104 were 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 further research and development. As a result, it 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 it does not achieve and
maintain profitability, the market price for the Company's common stock may
further decline, perhaps substantially, and the Company may have to curtail or
cease its operations.
If the Company 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.
The Company 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.
It 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 the Company is
not able to obtain financing when and in the amounts needed, and on terms that
are acceptable, the Company's operations, financial condition and prospects
could be materially and adversely affected, and it could be forced to curtail
some or all of its operations or sell part or all of its assets, including its
Core Technologies.
Page 10
Continuing debt obligations could impair the Company's ability to continue as a
going concern.
As of December 31, 2001, the Company had debt obligations of
$4,539,503. At present, the Company's revenues from existing licensing
arrangements and products are not sufficient to offset its ongoing operating
expenses or to pay in full its current debt obligations. There is substantial
risk, therefore, that the existence and extent of the debt obligations described
above could adversely affect the Company, its operations and financial
condition.
Holders of the Company's 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 Lines.
Introduction
The following table describes the number of shares of Class A common
stock that would be issuable as of March 26, 2002, assuming that the full
remaining amounts of the Private Equity Line and the Second Private Equity Line
(collectively, the "Equity Lines") 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 Lines- Shares
issuable upon put of
Hypothetical Conversion/ remaining available credit
Exercise Price totaling $2,191,493
- ----------------------------------- --------------------------
$0.05 43,829,860
$0.10 21,914,930
$0.25 8,765,972
$0.50 4,382,986
$1.00 2,191,493
$2.00 1,095,747
Given the formulas for calculating the shares to be issued under the
Equity Lines, 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 Lines. 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
Lines will increase proportionate to the decrease in the stock price.
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
Lines 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 Lines. Furthermore, public resales of Class A common stock following the
issuance of Class A common stock in connection with the Equity Lines likely
would depress the prevailing market price of its 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 its
Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common
Stock
Page 11
The formulas for determining the number of shares of Class A common
stock under the Equity Lines are based, in part, on the market price of the
Class A common stock and 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 Lines, 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.
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 its Class A common stock
issued in connection with a put under the Equity Lines could encourage short
sales of Class A common stock by the Equity Line investor. Material amounts of
such short selling 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
The Company is prohibited from putting shares to the Equity Line
investor under the Equity Lines 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 Class A common stock in a relatively short time frame
while never holding more than 4.999% at one time.
The Company 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 its business strategy is to
achieve revenues through appropriate strategic alliances, co-development
arrangements, and license arrangements with third parties. The Company has
entered into licensing and joint-marketing agreements with Intel and Microsoft.
These agreements provide for joint marketing and application development for
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 the Company.
The market for many of the Company's technologies and products is largely
unproven and may never develop sufficiently to allow it to capitalize on its
technology and products.
The market for speech-enabled technologies is relatively new and
rapidly evolving. Additionally, the Company's technologies are new and, in many
instances, represent a significant departure from technologies which already
have found a degree of acceptance in the speech-enabled technologies
marketplace. The Company's financial performance will depend, in part, on the
future development, growth, and ultimate size of the market for speech-enabled
applications and products generally, and applications and products incorporating
its technologies and applications. Accordingly, in order to achieve commercial
acceptance of the Core Technologies, the Company will have to educate
prospective customers, including large, established telecommunications
companies, about the uses and benefits of speech-enabled software in general and
its products in particular. If these efforts fail, or if speech-enabled software
platforms do not achieve commercial acceptance, the Company's business could be
harmed.
Page 12
The applications and products which incorporate the Company's 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. The Company believes that there is a
substantial potential market for applications and products incorporating
advanced speech-enabled technologies including ASR, TTS, speech compression,
speaker identification and verification, pen and touch screen input, and natural
language understanding. Nevertheless, such a market for the Company's
technologies or for products incorporating its technologies may never develop to
the point that profitable operations can be achieved or sustained.
Speech-enabling technologies may not achieve widespread acceptance by businesses
or telecommunications carriers, which could limit the Company's ability to grow
its business.
The market for speech-enabled technologies is relatively new and
rapidly evolving. The Company's ability to increase revenue in the future
depends on the acceptance of speech-enabling technologies by both its customers
and their end users. The adoption of speech-enabling technologies could be
hindered by the perceived costs of this new technology, as well as the
reluctance of enterprises that have invested substantial resources in existing
applications to replace their current systems with this new technology.
Accordingly, in order to achieve commercial acceptance, the Company will have to
educate prospective customers, including large, established telecommunications
companies, about the uses and benefits of speech-enabling technologies in
general and its products in particular. If these efforts fail, or if
speech-enabling technology platforms do not achieve commercial acceptance, its
business would not develop.
Continued development of the market for the Company's products also
will depend upon the following factors over which the Company has little or no
control:
. widespread deployment of speech-enabling applications by third
parties, which is driven by consumer demand for services having a
voice user interface;
. demand for new uses and applications of speech-enabling
technology, including adoption of speech-enabled interfaces by
companies that operate web sites;
. adoption of industry standards for speech-enabling and related
technologies; and
. continuing improvements in hardware technology that may reduce
the costs of speech-enabling technology solutions.
The application and delivery of the Company's Core Technologies to end users is
dependent upon third- party integration and may be subject to delays and
cancellations that are beyond its control.
Because the Company is pursuing third-party integration of its
speech-enabled 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 requires a
significant expenditure by a customer. Accordingly, the decision to purchase its
products typically requires significant pre-purchase evaluation. The Company
spends significant time educating and providing information to prospective
customers regarding the use and benefits of its products and technologies.
During this evaluation period, it may expend substantial sales, marketing and
management resources.
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.
Page 13
In cases where the Company's contract with its customers specifies
milestones or acceptance criteria, it 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 the Company's ability to achieve profitable operations.
The computer hardware and software industries are highly and
intensely competitive. In particular, the speech-enabled technologies market
sector and, specifically, the ASR, computer voice and communications industries
are characterized by rapid technological change. Competition in the
speech-enabled technologies 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 the Company's competitors may render its
technologies less attractive or even obsolete. Accordingly, the Company's
success 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. Barriers to
entry in the software industry are low, and as the market for various
speech-enabled products expands and matures, the Company expects more entrants
into this already competitive arena.
The Company's products can have a long sales cycle and, as a result, its
quarterly operating results and its stock price may fluctuate.
The sales cycles for the Company's products are generally six to
twelve months but may be shorter or longer depending on the size and complexity
of the order, the amount of services to be provided and whether the sale is made
directly by the Company or indirectly through a VAR or systems integrator. The
length of the sales cycles could adversely impact the Company's operating
results.
The Company's current and potential competitors, some of whom have greater
resources and experience than it does, may develop products and technologies
that may cause a decline in demand for, and the prices of, the Company's
products.
A number of companies have developed, or are expected to develop,
products that compete with the Company's products and technologies. Competitors
in the voice interface software market include AT&T, IBM, Locus Dialogue, Lucent
Technologies, Philips Electronics, SpeechWorks International, Nuance, ScanSoft
and Voice Signal. The Company expects additional competition from other
companies such as Microsoft, which has made investments in and acquired voice
interface technology companies. Furthermore, the Company's competitors may
combine with each other, and other companies may enter its markets by acquiring
or entering into strategic relationships with its competitors. Current and
potential competitors have established, or may establish, cooperative
relationships among themselves or with third parties to increase the abilities
of their speech and language technology products to address the needs of the
Company's prospective customers.
Many of the Company's current and potential competitors have longer
operating histories, significantly greater financial, technical, product
development and marketing resources, greater name recognition and larger
customer bases than the Company does. The Company's present or future
competitors may be able to develop products comparable or superior to those it
offers, adapt more quickly to new technologies, evolving industry trends and
standards, or customer requirements than it does, or devote greater resources to
the development, promotion and
Page 14
sale of their products than it does. Accordingly, the Company may not be able to
compete effectively in its markets, and competition may intensify and may harm
the Company's business.
The Company's failure to respond to rapid change in the speech-enabled
technologies market could cause the Company to lose revenue and harm its
business.
The speech-enabled technologies industry is relatively new and
rapidly evolving. The Company'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 meet 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 it cannot
offset a decline in revenue from existing technologies and products with sales
of new products, the Company's business will suffer.
Commercial acceptance of the Company's products and technologies
will depend, among other things, on:
o the ability of its products and technologies to meet and adapt to
the needs of its target markets;
o the performance and price of its products and its competitors'
products; and
o its 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, the Company may
discover these errors, defects and bugs and, as a result, products may take
longer to develop than expected. In addition, the Company may discover that
remedies for errors or bugs may be technologically infeasible. Delivery of
products with undetected production defects or reliability, quality, or
compatibility problems could damage the Company's reputation. Errors, defects or
bugs could also cause interruptions, delays or a cessation of sales to its
customers. The Company 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 us 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
increase the foreign language capacities of its products. If it is unable to do
so, it may be unable to grow its revenue and execute its business strategy.
The Company intends to expand its international sales, which
requires a significant investment to create and refine different language models
for each particular language or dialect. These language models are required to
create versions of products that allow end users to speak the local language or
dialect and be understood. If the Company fails to develop additional foreign
language capacity of its products, its ability to address international market
opportunities and to grow its business will be limited.
The Company may encounter difficulties in managing its growth, which could
prevent it from executing its business strategy.
The Company'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 the Company's management. The Company's systems, procedures
and controls may not be adequate to support its operations. If the Company fails
to improve its
Page 15
operational, financial and managerial information systems, or to hire, train,
motivate or manage its employees, its business could be harmed.
The Company 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, such as the recent purchase
of assets from Force Computers, Inc. discussed elsewhere herein, although no
material acquisitions or investments are currently pending. Any future
acquisitions would be accompanied by risks such as:
o difficulties in assimilating the operations and employees of
acquired companies;
o diversion of the Company's management's attention from ongoing
business concerns;
o the Company's potential inability to maximize its 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 and implementation 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.
The Company 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.
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
its 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 its
stock price, regardless of operating results.
The Company's independent public accountants have included a "going concern"
paragraph in their reports for the years ended December 31, 2001, 2000 and 1999.
The independent public accountants' reports for the Company's
financial statements for the years ended December 31, 2001, 2000 and 1999
include an explanatory paragraph regarding substantial doubt about the
Page 16
Company'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.
The Company's operations and financial condition could be adversely affected by
its failure or inability to protect its intellectual property or if its
technologies are found to infringe the intellectual property of a third party.
Dependence on proprietary technology
The Company's success is heavily dependent upon its proprietary
technology. Certain elements of the Company's Core Technologies are the subject
of seven patents issued and allowed by the United States Patent and Trademark
Office and 10 other patent applications which are pending. In addition to its
patents, the Company 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 the Company's proprietary
rights may not be adequate because such laws provide only limited protection.
Despite precautions that the Company takes, it may be possible for unauthorized
third parties to duplicate aspects of its technologies or the current or future
products or technologies of its business units or to obtain and use information
that it regards as proprietary. Additionally, its 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 the Company's intellectual property rights, to protect its
trade secrets or to determine the validity and scope of the proprietary rights
of others.
Risks of the Company's infringement upon the technology of unrelated
parties or entities
The Company 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 its technologies. The Company expects that developers of
speech-enabled 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. Responding to
any such claims, whether or not they are found to have merit, could be time
consuming, result in costly litigation, cause development delays, or require us
to enter into royalty or license 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 its business, operating results, and
financial condition.
The Company is subject to the risk that certain key personnel, including key
scientific employees and independent contractors named below, on whom it
depends, in part, for the Company's operations, will cease to be involved with
the Company.
The Company is dependent on the knowledge, skill and expertise of
several key scientific and business development employees, including John A.
Oberteuffer, Ph.D., Dale Lynn Shepherd, Mark Hamilton, R. Brian Moncur, Doug
Jensen, Edward A. Bruckert, K. H. Loken-Kim, John E. Holmgren, Kirk Flygare and
Kirk Feller.; independent contractors including C. Hal Hansen, Tony R. Martinez,
Ph.D., Kenneth P. Hite and Rolf-Juergen Bruess; 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 its future business efforts. Although it 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 the Company'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 the Company. The Company does not
presently have any key man life insurance on any of the its employees except Mr.
Dudley, for whom it carries a policy with a face amount of $4 million. The
Company is the named beneficiary.
Page 17
The Company's charter and bylaws and Delaware law contain provisions which may
delay or prevent a change of control.
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 it. 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:
o procedures for advance notification of stockholder nominations
and proposals; and
o the ability of the board of directors to alter the Company's
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 of
directors 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 the Company's outstanding voting stock.
The Company has no dividend history and has no intention to pay dividends in the
foreseeable future.
The Company 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 the
Company and its business.
The risks and uncertainties described in this section are not the
only ones facing the Company. Additional risks and uncertainties not presently
known to the Company or that it currently deems immaterial may also impair its
business operations. If any of the foregoing risks actually occur, its business,
financial condition, or results of operations could be materially adversely
affected. In such case, the trading price of its Class A common stock could
decline.
ITEM 2. PROPERTIES
The Company owns no real property. Commencing in October 1996, the
Company leased a 25,600 square foot facility in Draper, Utah, from an
unaffiliated third party at which it conducts its principal scientific research,
product development and sales and marketing activities. The Company's lease of
that facility is for a term of eight years, with a right to terminate after five
years, which right the Company did not exercise in 2001. 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.
In addition to the Draper facility, the Company subleases office
space at market rates 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
Page 18
applications. This lease expires November 30, 2002 and requires monthly rental
payments of $2,754. The Company has given the lessor proper notification of its
intent to terminate the lease early and currently occupies the space on a
month-to-month basis.
Effective May 25, 1999, the Company entered into an agreement to
sublease a Cupertino, California facility to an unrelated third party. The
agreement requires the sublessee to pay the monthly rent of $35,432 directly to
the lessor through the end of the lease term on May 31, 2003. In the event the
sublessee fails to make timely payments, the Company could be required to cover
deficiencies in payments.
The Company believes that the facilities described above are
adequate for its current operating needs.
ITEM 3. LEGAL PROCEEDINGS
In November 1998, Fonix filed a suit against John R. Clarke and
Perpetual Growth Fund, a company affiliated with Clarke, in Federal District
Court for the Central District of Utah seeking a declaratory judgment that it
did not owe any money to Clarke and Perpetual Growth relating to certain
financing received by the Company during 1998 and thereafter. The case was tried
in March 2001, after which the 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 federal district court to the United States
Court of Appeals for the Tenth Circuit, but the appellate court has not yet
rendered a decision. 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 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, liquidity or results of
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 18, 2001, the Company held its Annual Meeting of
Shareholders in Salt Lake City, Utah. The record date for the meeting was June
14, 2001, on which date there were 219,569,513 shares of the Company's Class A
common stock outstanding.
The first matter voted upon at the meeting was the election of
directors. The following directors were elected:
SHARES SHARES
DIRECTOR VOTED IN FAVOR VOTED AGAINST
- -------- -------------- -------------
Thomas A. Murdock 166,729,551 2,643,424
Roger D. Dudley 166,683,380 2,689,595
John A. Oberteuffer, Ph.D 167,239,336 2,133,639
William A. Maasberg, Jr. 167,229,061 2,143,914
Mark S. Tanner 166,899,913 2,473,062
The second matter voted upon at the meeting was the approval of
Arthur Andersen LLP as independent auditors for the Company. The results of the
voting were 168,253,560 shares voted in favor, 835,205 shares against, and
284,210 shares withheld or abstaining.
Page 19
The third matter voted upon at the meeting was the approval of a
proposed amendment to the Company's Certificate of Incorporation to increase the
authorized capital stock of the Company to include 500,000,000 shares of Class A
Common Stock. The results of the voting were 162,266,907 shares voted in favor,
6,663,363 shares against, and 442,705 shares withheld or abstaining.
Page 20
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 OTC Bulletin
Board for the four quarters of calendar 2001 and 2000. The quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commissions and may
not represent actual transactions.
Calendar Year 2001 Calendar Year 2000
----------------------- ----------------------
High Low High Low
---- ----- ----- ----
First Quarter $0.95 $0.31 $ 2.50 $ 0.25
Second Quarter $0.61 $0.28 $ 1.81 $ 1.00
Third Quarter $0.32 $0.06 $ 1.39 $ 0.50
Fourth Quarter $0.24 $0.07 $ 0.94 $ 0.28
As of March 26 2002, there were 463,280,512, 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.
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 speech- enabling
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
For the year ended December 31, 2001, the Company received
$5,510,000 in funds drawn under the Equity Line, less commissions and fees of
$165,300, and issued 26,353,141 shares of Class A common stock to the Equity
Line investor. Subsequent to December 31, 2001, the Company received $2,756,836
in funds drawn under the Equity Line, less commissions and fees of $82,705, and
issued 29,187,136 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 Securities Act of 1933, as amended (the "1933 Act"), and the
rules and regulations promulgated thereunder. The resales of the shares were
subsequently registered under registration statements on Form S-2.
Between May 25, 2001 and December 31, 2001, the Company received
$13,425,000 in funds drawn under the Second Equity Line, less commissions and
fees of $497,750, and issued 118,013,005 shares of Class A common stock to the
Equity Line investor. Subsequent to December 31, 2001, the Company received
$4,643,164 in funds drawn under the Second Equity Line, less commissions and
fees of $139,295, and issued 83,897,735 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 registration statements on Form S-2.
Page 21
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial information 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, 2001, 2000, 1999, 1998 and
1997. 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,
2001 2000 1999 1998 1997
-------------- ------------- ------------- ------------- ------------
Statement of Operations Data:
Revenues $ 607,644 $ 656,853 $ 439,507 $ 2,604,724 $ --
Selling, general and administrative expenses 11,651,565 10,722,313 9,498,753 8,817,643 12,947,112
Product development and research 8,119,924 5,871,414 7,909,228 13,060,604 7,066,294
Amortization of intangible assets 2,453,491 2,457,829 2,588,896 1,712,267 --
Impairment loss on handwriting recognition technology 2,056,295 -- -- -- --
Purchased in-process research and development -- 474,000 -- 9,315,000 --
Other expense, net (173,221) (3,991,348) (3,698,789) (6,507,245) (1,558,678)
Loss from continuing operations (24,566,807) (22,810,677) (19,949,196) (36,843,475) (21,572,084)
Equity in loss of affiliate (534,138) -- -- -- --
Loss from discontinued operations -- -- (2,187,080) (6,275,307) --
Gain (loss) on extraordinary items -- 49,448 473,857 -- (881,864)
Net loss (24,566,807) (22,761,229) (21,662,419) (43,118,782) (22,453,948)
Basic and diluted net loss per common share $ (0.10) $ (0.16) $ (0.31) $ (0.91) $ (0.59)
Basic and diluted weighted average number of common 239,131,247 162,684,298 76,753,709 52,511,185 42,320,188
shares outstanding
As of December 31,
------------------------------------------------------------------------
2001 2000 1999 1998 1997
------------ ------------ -------------- -------------- ------------
Balance Sheet Data:
Current assets $ 1,244,767 $ 3,752,210 $ 480,885 $ 20,638,070 $ 21,148,689
Total assets 15,068,538 17,517,373 19,173,147 61,912,791 22,894,566
Current liabilities 7,346,918 3,571,854 5,285,681 35,317,045 20,469,866
Long-term debt, net of current portion -- 19,767 3,971,107 -- 52,225
Stockholders' equity 7,721,620 13,925,752 8,086,359 24,765,746 2,372,475
Page 22
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, 2001, the Company has incurred
significant cumulative losses and losses are expected to continue until the
effects of recent marketing and sales efforts begin to take effect, if ever. The
Company continues to emphasize product delivery and sales while achieving
technology upgrades to maintain its perceived competitive advantages.
In its current marketing efforts, the Company seeks to form
relationships with third parties who can incorporate speech-enabling
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.
Significant Accounting Policies
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of sales and expenses during the reporting period. Significant accounting
policies and areas where substantial judgements are made include:
Intangible and Long-lived Assets - Intangible assets consist of
goodwill, purchased Core Technologies, customer relationships,
trademarks and patents. Amortization is computed on a straight-line
basis over the estimated useful lives, ranging from five to ten
years.
The carrying values of the Company's intangible and long-lived
assets are reviewed for impairment whenever events or changes in
circumstances indicate that they 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
Page 23
value of the long-lived asset would not be recoverable, the carrying
value would be reduced by the estimated excess of the carrying value
over the projected discounted cash flows.
During the fourth quarter of 2001, management of the Company
determined that goodwill recorded in connection with its handwriting
recognition ("HWR") technology was impaired due to the expiration or
termination of related license agreements and insufficient funding
to further develop or market the technology or pursue other
prospects for future revenue generation. Accordingly, the
unamortized balance of $2,056,295 was charged to expense in 2001.
Management did not consider any of the Company's other intangible or
long-lived assets to be impaired at December 31, 2001. However,
should the Company's marketing and sales plans 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.
In July 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 changes the
accounting for goodwill and intangible assets with indefinite lives
from an amortization method to an impairment-only approach.
Accordingly, effective January 1, 2002, amortization of goodwill and
intangible assets with indefinite lives will discontinue. Other
intangible assets will continue to be amortized over their useful
lives. The Company amortized $1,029,545 of goodwill for each of the
years ended December 31, 2001, 2000 and 1999. Effective January 1,
2002, the Company will apply the requirements of SFAS No. 142, and
management will perform an impairment test of goodwill and
intangible assets with indefinite lives. The effect of the
application of those requirements on the Company's financial
position and results of operations has not been determined, but it
could be material. Any transitional impairment loss will be
recognized as a cumulative change in accounting principle.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long- Lived Assets." This statement
establishes financial accounting and reporting standards for the
impairment or disposal of long-lived assets. SFAS No. 144 is
effective for financial statements issued for fiscal years beginning
after December 15, 2001. The application of these requirements is
not expected to have a material effect on the Company's financial
position and results of operations.
Revenue Recognition - The Company recognizes revenues in accordance
with the provisions of Statement of Position No. 97-2, "Software
Revenue Recognition" and related interpretations. 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 license, royalties and maintenance are recognized upon
shipment of the software if there are no significant post-contract
obligations. If significant post-contract 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 from license, royalties and maintenance consists of
costs to distribute the product (including the cost of the media on
which it is delivered), installation and support personnel
compensation, licensed technology and other related costs. Cost of
service revenues consists of personnel compensation, licensed
technology and other related costs.
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
Page 24
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 quoted fair value of the
Company's common stock, and is recognized on the date of award or
purchase. 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.
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.
The estimated fair value of stock-based compensation issued to
non-employees is subject to assumptions made regarding risk-free
interest rates, expected exercise lives and volatility. Actual
results could differ from these estimates.
Imputed Interest Expense and Income - Interest is imputed on
long-term debt obligations and notes receivable where management has
determined that the contractual interest rates are below the market
rate for instruments with similar risk characteristics.
Results of Operations
2001 Compared to 2000
During 2001, the Company recorded revenues of $607,644, a decrease
of $49,209 from $656,853 for 2000. The decrease in 2001 was due in part to the
poor economic conditions in the telecommunications sector of the economy, where
much of the Company's revenue has been generated in the past. Furthermore, sales
and marketing efforts have not yet increased revenues, in spite of considerable
progress in developing partnerships in key markets. Also, certain advance
payments received for royalties have not yet been recognized.
Selling, general and administrative expenses were $11,651,565 for
2001 and $10,722,313 for 2000, an increase of $929,252. The change is a result
of increases of $1,492,025 in compensation-related expenses due to personnel
added for sales and marketing efforts, $199,012 in occupancy costs, $496,518 in
legal fees related to acquisition, regulatory filing, litigation and other
general corporate activities, $480,452 in travel-related expenses and $421,550
in promotion and advertising expenses resulting from increased sales and
marketing efforts. These increases were offset, in part, by a decrease of
$2,033,024 in consulting and outside services incurred in 2000 but not repeated
in 2001 and a decrease of $51,731 in other operating expenses.
The Company incurred research and product development expenses of
$8,119,924 during 2001, an increase of $2,248,510 from 2000. The greatest
portion of this increase was a result of $2,043,181 in additional
compensation-related expenses incurred by adding engineering and product
development personnel for development of product applications and solutions. In
addition to this increase, $299,864 of additional expenses were incurred by
consultants and outside services in development of speech-enabling applications
and solutions for customers. Future development efforts will continue to focus
on product applications and solutions utilizing the speech-enabling technologies
developed to date.
In 2001, the Company recognized an impairment of goodwill related to
HWR technology that was acquired in 1998. Without immediate customer prospects,
the Company has chosen not to provide further funding to
Page 25
develop the market or the HWR technology at this time. Accordingly, management
has determined that the related goodwill is impaired and the unamortized balance
of $2,056,295 was expensed in 2001 . Even though the value of this technology
has been reduced to $0 for financial reporting purposes, the Company will
continue to evaluate opportunities for licensing this technology to others in
the future.
Net other expense was $173,221 for 2001, a decrease of $3,818,127
from 2000. Financing activities in 2001 were accomplished through equity lines
of credit rather than debt securities or preferred stock. Accordingly, interest
expense incurred in 2001 was $3,968,773 less than in 2000. A beneficial
conversion feature of $3,447,623 was recorded in 2000 in connection with the
issuance of a convertible promissory note, along with other interest incurred on
the obligation. Interest income decreased by $58,910 due to lower cash balances
maintained throughout the year.
2000 Compared to 1999
The results of operations disclosed below give effect to the sale of
the Company's Healthcare Solutions Group ("HSG") in September 1999 and the
classification of the HSG's net assets and operating activities as discontinued
operations.
During 2000, the Company recorded revenues of $656,853, an increase
of $217,346 from $439,507 for 1999. The increase in 2000 resulted 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 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.
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 debt financing activities. Included
in interest expense are charges resulting from beneficial conversion features
incurred in connection with a 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.
Selected Quarterly Operations Data
The following tables set forth selected unaudited statement of
operations data for each of the quarters in the years ended December 31, 2001
and 2000. This data has been derived from the Company's unaudited financial
statements that have been prepared on the same basis as the audited financial
statements and in the opinion of 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. The Company's quarterly operating results have varied
substantially in the past and may vary substantially in the future.
Page 26
Conclusions about the Company's future results for any period should not be
drawn from the selected unaudited statement of operations data, either for any
particular quarter or taken as a whole.
For the Quarter Ended
---------------------------------------------------------------
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
--------------- ------------- --------------- --------------
(Unaudited)
Net sales $ 132,713 $ 107,568 $ 265,646 $ 101,717
Loss before equity in loss of affiliate and
extraordinary item (4,248,617) (6,349,338) (5,744,452) (7,690,262)
Net loss (4,248,617) (6,543,765) (5,931,343) (7,843,082)
Basic and diluted loss before extraordinary
item per common share (0.02) (0.03) (0.02) (0.03)
Basic and diluted loss per common share (0.02) (0.03) (0.02) (0.03)
For the Quarter Ended
---------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2000 2000 2000 2000
-------------- -------------- ---------------- ----------------
(Unaudited)
Net sales $ 56,447 $ 143,825 $ 172,222 $ 284,359
Loss before equity in loss of affiliate and
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)
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 of the Company in connection with such
financing could result in substantial additional dilution to the stockholders of
the Company.
Page 27
The Company had negative working capital of $6,102,151 at December
31, 2001, compared to minimal working capital of $180,356 at December 31, 2000.
The current ratio was 1:5.9 at December 31, 2001, compared to 1.05:1 at December
31, 2000. Current assets decreased by $2,507,443 from December 31, 2000 to
December 31, 2001. Current liabilities increased by $3,775,064 to $7,346,918
during the same period. The change in working capital reflects, in part, the use
of the funds released from an escrow relating to the sale of the HSG in March
2001, plus an increase in current obligations related to notes payable issued in
connection with the purchase of assets from Force Computers, Inc. and the
investment in Audium Corporation. Total assets were $15,068,538 at December 31,
2001, compared to $17,517,373 at December 31, 2000, the decrease resulting
primarily from amortization of intangible assets.
Convertible Notes Receivable
Through November 30, 2001, the Company loaned $455,000 under the
terms of convertible promissory notes to an unrelated entity (the "Borrower")
with whom the Company is engaged in development activities. The notes were
unsecured, bore interest at an annual rate of 7.5 percent, and were to mature
120 days from the issuance date of each note. The Borrower is a provider of
natural-language-understanding solutions for CRM applications. Fonix
speech-enabling technology is a component of these solutions.
On December 1, 2001, the Company established a revolving line of
credit and convertible promissory note that permits the Borrower to draw up to
$1,000,000 for operations and other purposes, including the amounts loaned under
the initial convertible promissory notes. Effective February 1, 2002, the line
of credit and convertible promissory note were increased to $2,000,000. Draws
are subject to the approval of Fonix, bear interest at an annual rate of seven
percent, which interest is payable quarterly beginning June 30, 2002, and are
secured by intellectual property and other assets of the Borrower. The unpaid
principal, together with interest accrued thereon, is due and payable on
December 31, 2002, and is convertible into common shares of the Borrower at the
Company's option. Based upon borrowings through December 31, 2001, such
conversion would represent approximately a five percent ownership of the
Borrower.
In December, the Borrower drew an additional $175,000 on the
convertible promissory note, bringing the total outstanding balance to $630,000
as of December 31, 2001. Subsequent to December 31, 2001 through March 26, 2002,
the Borrower drew an additional $505,000 under the terms of the convertible
promissory note.
Investment In Audium Corporation
In February 2001, the Company entered into a collaboration agreement
with Audium Corporation 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 to complete online transactions using any telephone.
The collaboration includes integration of the Company's technologies with
Audium's mobile applications development capability.
Note Receivable - In connection with the collaboration agreement
with Audium, in February and May 2001, the Company advanced an aggregate of
$400,000 to Audium as a bridge loan (the "Audium Note"). The loan bears interest
at a rate of 5 percent per year, has a term of four years and is convertible
into shares of Audium Series A Convertible Preferred Stock ("Audium Preferred
Stock"). The Audium Note is convertible into shares of Audium Preferred Stock at
a price of $1.46 per share in the event of (i) Audium raising an additional
$2,000,000 prior to October 6, 2002, (ii) Audium's merger or consolidation,
(iii) a qualified public offering of Audium common stock, (iv) an event of
default under a note payable from Fonix (see Fonix Note below), or (v) Audium's
aggregate gross revenues for the months of January through June 2003 exceeding
$1,000,000. The Audium Note is secured by Audium's intellectual property.
Further, at the closing, Audium granted the Company a fully paid, worldwide,
non- exclusive license to Audium's software to make, manufacture, and use the
software and any derivative works if Audium declares bankruptcy or ceases to do
business.
Page 28
Management determined that a 12 percent annual interest rate better
reflects the risk characteristics of the Audium Note. Accordingly, interest was
imputed at 12 percent and the Audium Note was recorded at its original present
value of $302,909. For the year ended December 31, 2001, the Company recorded
interest income of $29,663, including contractual and imputed interest. As of
December 31, 2001, the balance of the Audium Note was $322,309, net of the
unaccreted discount.
Investment - On April 11, 2001, the Company closed a stock purchase
agreement with Audium, wherein the Company agreed to purchase up to $2,800,000
of Audium Preferred Stock at a price of $1.46 per share. At closing the Company
paid $200,000 in cash and gave Audium a non-interest bearing note (the "Fonix
Note") for the remaining $2,600,000 (see below). Each share of Audium Preferred
Stock is convertible into one share of Audium's common stock. The stock purchase
agreement also entitles Fonix to elect one member of Audium's board of
directors. Audium also granted Fonix certain registration rights which become
effective after the closing of a public offering by Audium.
On April 11, 2001, and through December 31, 2001, the Company's
investment in Audium represented 26.7 percent of the Audium's voting stock. As a
result, the Company accounts for its investment in Audium using the equity
method of accounting. Accordingly, the Company recognized a loss of $534,138 in
the consolidated statements of operations consisting of $259,414 related to the
Company's share of Audium's net loss for the period from April 11, 2001 through
December 31, 2001 and $274,724 for the amortization of the difference between
the purchase price of the Audium Preferred Stock and the Company's portion of
Audium's net stockholders' deficit that is amortized on a straight-line basis
over a period of eight years.
A summary of the results of Audium's operations for the period from
April 11, 2001 through December 31, 2001 and net assets (liabilities) as of
December 31, 2001 is as follows:
(Unaudited)
Net sales $ 434,859
Loss from operations 959,285
Net loss 971,583
Current assets 591,646
Total assets 832,670
Current liabilities 604,677
Total liabilities 1,027,272
Net assets (liabilities) (194,602)
Note Payable - The Fonix Note is payable in 13 monthly installments
of $200,000 beginning on June 1, 2001, and bears no interest unless an event of
default occurs, in which case it will bear interest at 12 percent per year. No
events of default have occurred to date.
At closing, Audium issued 14 share certificates to Fonix, each
certificate for 136,986 shares of Audium Preferred Stock, and delivered one
certificate in exchange for the initial payment of $200,000. The remaining
certificates are held by Audium as collateral for the Fonix Note under the terms
of a security agreement. For each monthly payment of $200,000 or multiple
payments that aggregate $200,000, Audium will release to Fonix one certificate
for 136,986 shares of Audium Preferred Stock.
Through September 30, 2001, three payments of $200,000 were made on
the Fonix Note. Effective October 1, 2001, the terms of the Fonix Note were
modified to reduce the monthly payments to the following amounts: $75,000 for
September 2001, $100,000 for October 2001, $125,000 for November 2001 and
$150,000 for December 2001 and January 2002. Thereafter, monthly payments of
$200,000 are scheduled through August 2002.
Page 29
No other terms of the original Fonix Note were affected by the modification.
Subsequent to December 31, 2001, payments amounting to $550,000 have been made
as required by the modified terms.
Management determined that a 12 percent annual interest rate
reflects the risk characteristics of the Fonix Note. Accordingly, interest has
been imputed at 12 percent and the Company recorded a present value of
$2,370,348 for the note payable. For the year ended December 31, 2001, the
Company recorded interest expense of $164,405 related to this note.
Promissory Note
On December 14, 2001, the Company entered into an Asset Purchase
Agreement with Force Computers, Inc. As part of the consideration for the
purchase price Fonix issued a non-interest bearing promissory note in the amount
of $1,280,000. Management determined that a seven percent annual interest rate
reflects the risk characteristics of the this promissory note. Accordingly,
interest has been imputed at seven percent and the Company recorded a discount
of $40,245 for the note payable. From the purchase date through December 31,
2001, the Company recorded interest expense of $4,098 related to this promissory
note.
As collateral for the promissory note, 7,000,000 shares of the
Company's Class A common stock were placed into escrow. Under the terms of the
escrow, the shares will not be released to Force unless the Company is
delinquent or late with respect to any payment under the Note. Also, under the
terms of the Asset Purchase Agreement, Fonix is required to deposit all receipts
from customers acquired in this transaction into a joint depository account.
Fonix has the right to withdraw such funds; however, in the event of default on
any payments to Force under the terms of the promissory note, Force has the
right to withdraw funds from the depository account until the deficiency in
payment is covered, at which time, Fonix may again have use of the funds. To
date, required payments have been made when due.
Notes Payable
The Company had unsecured demand notes payable to former
stockholders of an acquired entity in the aggregate amount of $77,625
outstanding as of December 31, 2001. During 2000, certain holders of these notes
made demand for payment. The Company is attempting to negotiate a reduced payoff
of these notes.
Preferred Stock
During 2001, 164,500 shares of Series D convertible preferred stock
and related accrued dividends were converted into 13,978,440 shares of Class A
common stock. As of December 31, 2001, there were no shares of Series D
preferred stock outstanding.
During 2001, 6,073 shares of Series F convertible preferred stock
and related accrued dividends were converted into 519,067 shares of Class A
common stock. As of December 31, 2001, there were no shares of Series F
preferred stock outstanding.
Equity Lines of Credit
On August 8, 2000, the Company entered into a Private Equity Line
Agreement ("Equity Line") with a private investor ("Equity Line Investor") that
gives the Company the right to draw up to $12,500,000 for operations and other
purposes, 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 put notice is
Page 30
tendered. The Equity Line Investor is required to fund the amounts requested by
the Company within two trading days after the seven trading-day period.
During 2001, draws against the Equity Line in the amount of
$5,510,000 were converted into 26,353,141 shares of Class A common stock.
Subsequent to December 31, 2001, additional draws amounting to $2,756,836 were
converted into 29,187,136 shares of Class A common stock. As of March 26, 2002,
$259,657 remain available to be drawn on the Equity Line.
On April 6, 2001, the Company entered into a second private equity
line agreement (the "Second Equity Line") with the same Equity Line Investor.
Under the Second Equity Line, the Company has the right to draw against an
equity line of credit up to $20,000,000 under terms that are substantially
similar to the terms of the initial Equity Line.
From the inception of the Second Equity Line through December 31,
2001, draws taken under the Second Equity Line amounted to $13,425,000 and were
converted to 118,013,005 shares of Class A common stock. Subsequent to December
31, 2001, additional draws amounting to $4,643,164 were converted into
83,897,735 shares of Class A common stock. As of March 26, 2002, $1,931,836
remain available to be drawn on the Second Equity Line.
Stock Options and Warrants
During 2001, the Company granted options to purchase 8,134,950
shares of Class A common stock at exercise prices ranging from $0.07 to $0.73
per share. All options were granted at the quoted market price at the date of
grant. Of the options granted during this period, 1,233,000 vested immediately,
625,000 vest over 18 months, and the balance of 6,276,950 vest over the three
years following issuance. If not exercised, all options expire within ten years
from the date of grant. As of December 31, 2001, the Company had options
outstanding to purchase 24,078,813 shares of Class A common stock.
The Company's option plans provide for stock appreciation rights
that allow the grantee to receive shares of its 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. As of December 31,
2001, there are options to purchase 33,334 shares of Class A common stock
outstanding which provide for stock appreciation rights. These options have an
exercise price of $1.00 per share. If not exercised by September 2002, the
options with these rights will expire.
As of March 26, 2002, the Company had warrants to purchase a total
of 2,675,000 shares of Class A common stock outstanding.
Summary of Contractual Obligations
The following summary reflects payments due under long-term
obligations as of December 31, 2001:
Contractual Obligations Payments Due By Year
Total Less Than One One to Three
Notes payable $ 2,907,625 $ 2,907,625 $ --
Capital lease obligations 20,310 20,310 --
Operating lease obligations 1,693,255 881,224 812,031
------------- -------------- -----------------
Total contractual cash obligations $ 4,621,190 $ 3,809,159 $ 812,031
============= ============== =================
Page 31
Other
The Company presently has no plans to purchase new research and
development or office facilities.
Page 32
Outlook
Corporate Objectives and Technology Vision
The Company's objective is that its Core Technologies become the
platform for the next generation of speech-enabling 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 technology that is protected by various patents and trade secrets.
Management believes the Company's speech-enabling 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 automotive
embedded and wireless mobile markets, computer telephony and server
solution markets and personal software for consumer applications. To
address global opportunities, the Company will continue to develop
or acquire additional speech-enabling 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. As s.Manager
becomes increasingly recognized as a dynamic development platform,
Fonix expects s.Manager to be the product around which many of these
relationships are structured. Further, when the Company is able to
identify "first mover" speech-enabling 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 speech-enabling technologies, developer tools and
development frameworks to maintain its competitive advantages.
As the Company proceeds to implement its strategy and to reach its
objectives, it anticipates further development of complementary technologies,
added product and applications development expertise, access to market channels
and additional opportunities for strategic alliances in other industry segments.
The strategy adopted by the Company has significant 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 33
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, 2001 and 2000 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Cash Flows for the Years Ended December
31, 2001, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-8
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
During the years ended December 31, 2001, 2000 and 1999, and through
the date hereof, there have been no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
Page 34
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 26, 2002:
Name Age Position
Thomas A. Murdock (1)* 58 Director, President & Chief Executive Officer
Roger D. Dudley (2)* 49 Director, Executive Vice President & Chief Financial Officer
John A. Oberteuffer, Ph.D. 61 Director, Vice President & Chief Technology Officer
William A. Maasberg, Jr (1) (2) 62 Director, Chief Operating Officer
Mark S. Tanner (1) (2) 47 Director
(1) Member, Compensation Committee
(2) Member, Audit Committee
* Committee Chairman
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") 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 and Audium Corporation.
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 the founder and former
president of Voice Information Associates, Inc. ("VIA"), a
consulting group that publishes the monthly newsletter, ASRNews.
Dr. Oberteuffer also is president 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
Page 35
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
in Electrical Engineering and his M.S. in Electrical Engineering
from the University of Southern California.
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. Fields' Original Cookies,
Inc. Mr. Tanner spent nine years at PepsiCo, where he was chief
financial officer for Pepsi International's operations in Asia,
the Middle East, and Africa. He was vice president of strategic
planning for Pepsi North America, as well as chief financial
officer for Pepsi North America's Pepsi East Operations. Mr.
Tanner also spent ten years with United Technologies Corporation
in various capacities, including director of corporate
development. Mr. Tanner holds a B.A. in economics from Stanford
University and an M.B.A. in Finance and Accounting 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 2002.
ROLF-JUERGEN BRUESS is senior advisor for strategic implementation
and marketing. He has over 20 years of senior and management
experience in semiconductors, communications, consumer and
automotive electronics, strategic technical marketing and sales
with Siemens AG and Mannesmann VDO. He managed 1,500 world-wide
engineering and sales personnel achieving $750 million in annual
sales.
KURT FLYGARE 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 is vice president and general manager of consumer
applications 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.
D. LYNN SHEPHERD is vice president and general manager of embedded
automotive and wireless and mobile applications 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.
Page 36
J. MARK HAMILTON is vice president and general manager of computer
telephony and server solutions 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 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 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.
JOHN E. HOLMGREN is director of business development and has been
employed by Fonix since August 2001. Previously, he worked with
Lucent Speech Solutions group as manager of business development,
focused on developing and marketing speech products for ISV,
enterprise and service provider markets. He also fulfilled similar
business development and product manager functions for other units
of Lucent Technologies, Bell Labs and AT&T Direct Services Division.
Mr Holmgren graduated from the University of Wisconsin with a
Bachelor of Science in Psychology and from Stanford University with
a Ph.D. in Mathematical Psychology.
K.H. LOKEN-KIM is vice president and general manager of Fonix Asia
and has been employed by Fonix since 1998. Previously, he was
employed as a senior researcher at Fujitsu Laboratories in Akashi,
Japan, where he was in charge of multimodal human-computer
information processing research projects. He has over 20 years of
related experience in telecommunications, including a four-year
assignment at the Advanced Telecommunications Research Institute.
Mr. Loken-Kim has a Bachelor of Arts in Metallurgical Engineering
from Han Yang University in Seoul, Korea, a Master of Science in
Industrial Engineering from North Carolina A&T State University, and
a Ph.D. in Industrial Engineering from North Carolina State
University.
EDWARD A. BRUCKERT is an advisory scientist and has been employed
by Fonix since December 2001. Previously, he was employed by
Force Computers, Inc. and Digital Equipment Corporation as the
technical leader for the DECtalk text-to-speech product. His
experience includes 31 years of work in speech synthesis and
hardware engineering. Mr. Bruckert graduated from the University
of Massachusetts with a Bachelor of Science in Electrical
Engineering and a Bachelor of Science in Computing Engineering.
C. HAL HANSEN 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.
Page 37
TONY R. MARTINEZ, Ph.D. is a senior consulting scientist for the
Company's neural network development. He is an associate
professor of Computer Science at Brigham Young University and
currently heads up the Neural Network and Machine Learning
Laboratory in the Brigham Young University Ph.D./MS program. His
principal research is in neural networks, machine learning,
ASOCS, connectionist systems, massively parallel algorithms and
architectures, and non-von Neuman computing methods. He is
associate editor of the Journal of Artificial Neural Networks.
Dr. Martinez received his Ph.D. in computer science at University
of California at Los Angeles in 1986.
KENNETH P. HITE 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.
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, 2001 and whose annual compensation exceeded $100,000 during such year
(collectively the "Named Executive Officers"):
Summary Compensation Table
Annual Compensation Long-Term Compensation
Other
Annual Securities Underlying
Name and Principal Position Year Salary Bonus Options/ SARs(5)
- --------------------------- ----- ---------- ---------------- --------------------
Thomas A. Murdock (1) 1999 $316,574 - 0/0
Chief Executive Officer & President 2000 $320,804 - 1,850,000/0
2001 $315,057 - 700,000/0
Roger D. Dudley (1) 1999 $317,764 - 0/0
Executive Vice President & Chief 2000 $320,845 - 1,850,000/0
Financial Officer 2001 $314,895 - 700,000/0
William A. Maasberg, Jr. 2000 $208,411 - 550,000/0
Chief Operating Officer 2001 $226,584 - 450,000/0
John A. Oberteuffer 1999 $199,238 - 0/0
Vice President & Chief 2000 $227,348 - 350,000/0
Technology Officer 2001 $234,716 - 450,000/0
(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
Page 38
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 the executive will not engage in any
capacity in a business which competes with or may compete
with the Company.
(2) The Company has an employment agreement with Mr. Maasberg
that was effective February 1, 2000. The terms of the
agreement establish the annual base salary of $225,000,
which may be adjusted upward in future years as deemed
appropriate by the board of directors. Mr. Maasberg is
entitled to customary insurance benefits, office and support
staff. In addition, if any executive is terminated without
cause during the contract term then all salary then and
thereafter due and owing under the 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. The expiration date is January 31,
2003.
The employment agreement contains a non-disclosure,
confidentiality, non-solicitation and non- competition
clause. Under the terms of the non-competition clause, Mr.
Maasberg has agreed that for a period of 18 months after the
termination of his employment with the Company the executive
will not engage in any capacity in a business which competes
with or may compete with the Company.
(3) The Company has an employment agreement with Mr. Oberteuffer
that was effective February 1, 2000 and subsequently amended
effective April 1, 2001. The terms of the agreement
establish the annual base salary of $235,000, which may be
adjusted upward in future years as deemed appropriate by the
board of directors. Mr. Oberteuffer is entitled to customary
insurance benefits, office and support staff, and the use of
an automobile. In addition, if any executive is terminated
without cause during the contract term then all salary then
and thereafter due and owing under the employment agreement
shall, at the executive's option, be immediately paid in a
lump sum payment to the executive officer and all stock
options, warrants and other similar rights granted by the
Company and then vested or earned shall be immediately
granted to the executive officer without restriction or
limitation of any kind. The expiration date is January 31,
2003.
The employment agreement contains a non-disclosure,
confidentiality, non-solicitation and non- competition
clause. Under the terms of the non-competition clause, Mr.
Oberteuffer has agreed that for a period of 18 months after
the termination of his employment with the Company the
executive will not engage in any capacity in a business
which competes with or may compete with the Company.
Page 39
(4) All options granted in 2001, 2000 and 1999 were granted
pursuant to the Company's 1998 Stock Option Plan.
Page 40
Option Grants in Fiscal Year 2001
Potential Realizable
Value at Assumed
Annual Rates of
Stock Price
Appreciation for
Individual Grant Option Term
(a) (b) (c) (d) (e) (f) (g)
Number of
Securities % of Total
Underlying Options to Exercise
Options Employees Price Expiration
Name Granted (#) in Fiscal Year ($/Share) Date 5% 10%
- ------------------------ --------------- --------------- --------- -------------- ---------- ---------------
Thomas A. Murdock 700,000 8.6% $0.14 12/07/11 $61,632 $156,187
Roger D. Dudley 700,000 8.6% $0.14 12/07/11 $61,632 $156,187
William A. Maasberg 450,000 5.5% $0.14 12/07/11 $39,620 $100,406
John A. Oberteuffer, Ph D. 450,000 5.5% $0.14 12/07/11 $39,620 $100,406
Aggregated Option/SAR Exercises in Last Fiscal Year
and Related December 31, 2001 Option/SAR Values
(a) (b) (c) (d) (e)
Number of Securities Value of
Shares Underlying Unexercised In-the-Money
Acquired Options/SARs Options/SARs at
on Value at December 31, 2001 December 31, 2001
Name Exercise (#) Realized ($) Exercisable/Unexercisable ( #) Exercisable/Unexercisable ( #)
- ------------------------- ------------- ------------ -------------------------------- ---------------------------------
Thomas A. Murdock 0 $ 0 3,600,000/500,000 $0/$0
Roger D. Dudley 0 $ 0 3,600,000/500,000 $0/$0
William A. Maasberg, Jr. 0 $ 0 950,000/250,000 $0/$0
John A. Oberteuffer, Ph D. 0 $ 0 1,110,000/250,000 $0/$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) all of the meetings of the Company's board of directors. During
2001, the Company's board of directors had the following committees: Audit
Committee, comprised of Messrs. Dudley (chairman), Maasberg and Tanner; and
Compensation Committee, comprised of Messrs. Murdock (chairman), Maasberg and
Tanner. These standing committees conducted meetings in conjunction with
meetings of the full board of directors.
Page 41
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
Securities Exchange Act of 1934, as amended, 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, 2001.
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. Subject to the terms of employment agreements with
certain executive officers, the Compensation Committee
periodically reviews and approves the base salary paid by the
Company to its executive officers and members of the senior
management team. Adjustments to base salaries are
Page 42
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 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 Class A 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,
Page 43
Compensation Committee:
Thomas A. Murdock
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 2001:
Stock Options Granted to Directors During Fiscal Year 2001
Shares Date Exercise
Name(1) Granted Granted Price Per Share
- ---- ------- ------- ---------------
Mark S. Tanner 200,000 12/07/01 $0.14
(1) Directors who are also Named Executive Officers received options as set
forth elsewhere in this report.
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, 2001, the Company is aware of the following untimely filings:
Thomas A. Murdock received options to purchase 700,000 shares of the
Company's Class A common stock on December 7, 2001. The transactions will be
reported on a Form 5 to be filed.
Roger D. Dudley received options to purchase 700,000 shares of the
Company's Class A common stock on December 7, 2001. The transactions will be
reported on a Form 5 to be filed.
William A. Maasberg, Jr., received options to purchase 450,000
shares of the Company's Class A common stock on December 7, 2001. The
transactions will be reported on a Form 5 to be filed.
Page 44
John O. Oberteuffer, received options to purchase 450,000 shares of
the Company's Class A common stock on December 7, 2001. 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 7, 2001. The transaction will be
reported on a Form 5 to be filed.
Page 45
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, 2001 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, 1996, 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]
1996 1997 1998 1999 2000 2001
- ---------------------------------------------------------------------------------------------------------
Fonix Corporation 100.00 35.09 15.05 3.37 3.42 1.17
SIC Code Index 100.00 133.68 126.58 229.12 264.16 77.11
NASDAQ Market Index 100.00 122.32 172.52 304.29 191.25 152.46
Page 46
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
The following table sets forth, as of March 26, 2002, the number of
shares of Common Stock of the Company beneficially owned by all persons known to
be holders of more than five percent 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, 180 West Election Road, Suite 200, Draper, Utah
84020.
Number of
Shares
Name and Address of 5% Beneficial Owners, Beneficially Percent of
Executive Officers and Directors Owned Class(1)
Thomas A. Murdock 12,269,645(2) 2.6%
Chairman of the Board & Chief
Executive Officer
Roger D. Dudley, 6,648,723(3) 1.4%
Executive Vice President & Chief
Financial Officer, Director
John A. Oberteuffer, Ph.D., 1,910,000 (4) *
Vice President & Chief Technology Officer,
Director
William A. Maasberg Jr., Chief Operating Officer, 1,150,000(4) *
Director
Mark S. Tanner, Director 800,000(4) *
Officers and Directors as a Group (5 persons) 22,778,368 4.8%
* 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
Page 47
as to which are owned by SCC Asset Management, Inc. ("SCC"), a
corporation of which Mr. Murdock is a 1/3 equity owner. Also
includes 2,813 shares owned directly by Mr. Murdock, 11,400 shares
owned by a limited liability company of which Mr. Murdock is a 1/3
equity owner, 28,099 shares (including shares issuable upon the
exercise of options) beneficially owned by members of Mr. Murdock's
immediate family residing in the same household, and 3,600,000
shares of Common Stock underlying stock options owned by Mr. Murdock
and exercisable presently or within 60 days of March 26, 2002. Does
not include 1,250,000 options which are not exercisable presently or
within 60 days of March 26, 2002.
(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) 3,600,000 shares underlying stock options
exercisable presently or within 60 days of March 26, 2002. Does not
include 1,250,000 options which are not exercisable presently or
within 60 days of March 26, 2002.
(4) Consisting of options or warrants which are presently exercisable.
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 office space located at 60 East South
Temple Street, Salt Lake City, Utah. The subleases, which expire in December
2002 and February 2003, require the Company 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, 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.
Page 48
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, 2001 and 2000
Consolidated Statements of Operations for the Years Ended December 31,
2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Consolidated Financial Statements
2. Financial Statement Schedules: None
3. Exhibits: The following Exhibits are filed with this Form 10-K
pursuant to Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit
(2)(i) Agreement and Plan of Reorganization among
the Company, Fonix Acquisition Corporation
and AcuVoice dated as of January 13, 1998,
incorporated by reference from the Company's
Current Report on Form 8-K, filed March 20,
1998
(2)(ii) Agreement and Plan of Merger among Fonix,
Articulate Acquisition Corporation, and
Articulate, dated as of July 31, 1998,
incorporated by reference from the Company's
Current Report on Form 8-K, filed September
17, 1998
(2)(iii) Agreement and Plan of Merger among Fonix,
Papyrus Acquisition Corporation, and
Papyrus Associates, Inc., dated as of
September 10, 1998, incorporated by
reference from the Company's Current Report
on Form 8-K, filed November 13, 1998
(3)(i) Articles of Incorporation of the Company
which are incorporated by reference from the
Company's Registration Statement on Form
S-18 dated as of September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of
Incorporation dated as of March 21, 1994,
which is incorporated by reference from the
Company's Annual Report for the Fiscal Year
Ended December 31, 1994 on Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of
Incorporation dated as of May 13, 1994,
which is incorporated by reference from the
Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of
Incorporation dated as of September 24,
1997, which is incorporated by reference
from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1997
Page 49
(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 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
Page 50
(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
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
Page 51
(10)(x) Common stock Purchase Agreement among the
Company and JNC Opportunity Fund Ltd. and
Diversified Strategies Fund, LP, dated as of
March 9, 1998, which is incorporated by
reference from the Company's Annual Report
on Form 10-K for the year ended December 31,
1997
(10)(xi) Common stock Purchase Agreement between the
Company and Thomson Kernaghan & Co., dated
as of March 9, 1998, which is incorporated
by reference from the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997
(10)(xii) Royalty Modification Agreement among the
Company and Synergetics, dated as of April
6, 1998, which is incorporated by reference
from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xiii) Purchase Agreement with John Oberteuffer and
the Company dated April 9, 1998, which
is incorporated by reference from the
Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(xiv) Employment Agreement by and between the
Company and John A. Oberteuffer, which is
incorporated by reference from the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xv) First Amendment to Master Agreement for
Joint Collaboration between the Company and
Siemens, dated February 13, 1998, which is
incorporated by reference from the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xvi) Second Amendment to Master Agreement for
Joint Collaboration between the Company
and Siemens, dated March 13, 1998, which is
incorporated by reference from the
Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(xvii) Series D Convertible Preferred Stock
Purchase Agreement Among Fonix corporation,
JNC Opportunity Fund, Ltd., Diversified
Strategies Fund, L.P., Dominion Capital
Fund, Ltd., Sovereign Partners, LP, Canadian
Advantage Limited Partnership and Thomson
Kernaghan & Co. (as agent) dated as of
August 31, 1998, incorporated by reference
from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1998
(10)(xviii) Series E Convertible Preferred Stock
Exchange and Purchase Agreement among Fonix
corporation, Sovereign Partners, LP and
Dominion Capital Fund, Ltd., dated as of
September 30, 1998, incorporated by
reference from the Company's Quarterly
Report on Form 10-Q for the period ended
September 30, 1998
(10)(xix) Securities Purchase Agreement among Fonix
Corporation and JNC Strategic Fund, dated
December 21, 1998 for 1,801,802 shares of
common stock and Repricing Rights,
incorporated by reference from Amendment No.
1 to Registration Statement on Form S-3
(File No. 333-67573)
(10)(xx) Securities Purchase Agreement among Fonix
Corporation and the investors identified
therein dated January 29, 1999, as
supplemented on March 3, 1999, concerning
sales of $6,500,000 principal amount of
Series C 5% Convertible Debentures,
incorporated by reference from Amendment No.
1 to Registration Statement on Form S-3
(File No. 333-67573)
Page 52
(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))
(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
Page 53
(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)
(10)(xxxv) Audium Stock Purchase Agreement between
Fonix Corporation and Audium Corporation,
dated as of April 5, 2001, filed with the
Commission on April 17, 2001
(10)(xxxvi) Certificate of Designation of Audium Series
A Preferred Stock, filed with the Commission
on April 17, 2001.
(10)(xxxvii) Form of Promissory Note from Fonix
Corporation to Audium Corporation for
$2,600,000, dated as of April 5, 2001, filed
with the Commission on April 17, 2001.
(10)(xxxviii) Security Agreement between Fonix Corporation
as the Debtor and Audium Corporation
as the Secured Party, dated as of April 5,
2001, filed with the Commission on April 17,
2001.
(10)(xxxix) Registration Rights Agreement between Fonix
Corporation and Audium Corporation, dated as
of April 5, 2001, filed with the Commission
on April 17, 2001.
(10)(xl) Security Agreement between Audium
Corporation as the Debtor and Fonix
Corporation as the Secured Party, dated as
of April 5, 2001, filed with the Commission
on April 17, 2001.
(10)(xli) Form of Promissory Note from Audium
Corporation to Fonix Corporation for
$400,000, filed with the Commission on April
17, 2001.
(10)(xlii) License Agreement between Fonix Corporation
and Audium Corporation, dated as o April 5,
2001, filed with the Commission on April 17,
2001.
(10)(xliii) Second Private Equity Line Agreement between
Fonix Corporation and Queen LLC, dated April
6, 2001, filed with the Commission on April
17, 2001.
(10)(xliv) Registration Rights Agreement between Fonix
Corporation and Queen LLC, dated April
6, 2001, filed with the Commission on April
17, 2001.
(22) Subsidiaries of Registrant
(23) Consent of Independent Public Accountants
(99) Letter from Fonix Corporation to Securities
and Exchange Commission dated March 27, 2002
Page 54
(B) Reports filed on Form 8-K during the last quarter of the fiscal year ended
December 31, 2001:
NONE
Page 55
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 27th day of March
2002.
Fonix Corporation
Date: March 27, 2002 By: /s/ Thomas A. Murdock
---------------- ---------------------------------------
Thomas A. Murdock, President and
Chief Executive Officer
Date: March 27, 2002 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
March 27, 2002 March 27, 2002
- -------------- --------------
Date Date
/s/ Roger D. Dudley /s/ Mark S. Tanner
- ---------------------------- ---------------------------------------
Roger D. Dudley, Executive Vice Mark S. Tanner, Director
President, Director
March 27, 2002 March 27, 2002
- -------------- --------------
Date Date
/s/ John A. Oberteuffer
- -----------------------------------
John A. Oberteuffer, Ph.D., Director
March 27, 2002
Date
Page 56
TABLE OF CONTENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-8
F-1
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, 2001
and 2000, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2001. 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, 2001 and 2000, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2001 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, 2002. As of December 31, 2001, the
Company has negative tangible net worth of $2,087,421, an accumulated deficit of
$167,616,372, negative working capital of $6,102,151, accounts payable of
$255,104 over 60 days past due, and limited remaining capital capacity of
$5,991,493 available through the Company's two equity lines of credit. 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
February 26, 2002
F-2
Fonix Corporation
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31, December 31,
2001 2000
--------------- ---------------
Current assets:
Cash and cash equivalents $ 201,401 $ 1,413,627
Subscriptions receivable 852,970 -
Funds held in escrow - 2,151,006
Accounts receivable, net of allowance for doubtful accounts of $0 and $20,000, respectively 58,170 131,872
Inventory 37,154 -
Prepaid expenses and other current assets 95,072 55,705
--------------- ---------------
Total current assets 1,244,767 3,752,210
Property and equipment, net of accumulated depreciation of $1,314,960 and $1,445,288, respectively 903,159 718,711
Convertible note receivable 630,000 -
Investment in and note receivable from affiliate, net of unamortized discount of $77,691 2,358,519 -
Intangible assets, net of accumulated amortization of $7,757,321 and $6,850,286, respectively 9,809,041 12,941,764
Other assets 123,052 104,688
--------------- ---------------
Total assets $ 15,068,538 $ 17,517,373
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable to affiliate, net of unamortized discount of $65,247 $ 1,484,753 $ -
Note payable, net of unamortized discount of $40,245 1,239,755 -
Notes payable - related parties 77,625 77,625
Accounts payable 1,062,237 655,352
Accrued liabilities 961,299 553,448
Accrued liabilities - related parties 1,451,633 1,564,133
Deferred revenues 1,049,849 677,071
Capital lease obligation, current portion 19,767 44,225
--------------- ---------------
Total current liabilities 7,346,918 3,571,854
Capital lease obligation, net of current portion - 19,767
--------------- ---------------
Total liabilities 7,346,918 3,591,621
--------------- ---------------
Commitments and contingencies (Notes 1, 5, 6, 13, 14, 16 and 17)
Stockholders' equity:
Preferred stock, $0.0001 par value; 50,000,000 shares authorized; Series
A, convertible; 166,667 shares outstanding
(aggregate liquidation preference of $6,055,012 at December 31, 2001 and 2000) 500,000 500,000
Series D, 4% cumulative convertible; 164,500 shares outstanding in 2000
(aggregate liquidation preference of $3,601,819 in 2000) - 4,288,178
Series F, 6% cumulative convertible; 6,073 shares outstanding in 2000
(aggregate liquidation preference of $128,242 in 2000) - 112,438
Common stock, $0.0001 par value; 500,000,000 shares authorized;
Class A voting, 350,195,641 and 191,296,988 shares outstanding, respectively 35,020 19,130
Class B non-voting, no shares outstanding - -
Additional paid-in capital 171,985,508 148,904,860
Outstanding warrants to purchase Class A common stock 2,832,400 3,141,430
Deferred consulting expenses (17,777) -
Cumulative foreign currency translation adjustment 2,841 -
Accumulated deficit (167,616,372) (143,040,284)
--------------- ---------------
Total stockholders' equity 7,721,620 13,925,752
--------------- ---------------
Total liabilities and stockholders' equity $ 15,068,538 $ 17,517,373
=============== ===============
See accompanying notes to consolidated financial statements.
F-3
Fonix Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
Fonix Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
Years Ended December 31,
---------------------------------------------------------------
2001 2000 1999
------------------- -------------------- -------------------
Revenues:
Licenses, royalties and maintenance $ 478,444 $ 567,621 $ 439,507
Services 129,200 89,232 -
------------------- -------------------- -------------------
607,644 656,853 439,507
------------------- -------------------- -------------------
Cost of revenues:
Licenses, royalties and maintenance 138,308 27,436 24,932
Services 47,509 - -
------------------- -------------------- -------------------
185,817 27,436 24,932
------------------- -------------------- -------------------
Gross profit 421,827 629,417 414,575
------------------- -------------------- -------------------
Expenses:
Selling, general and administrative 11,651,565 10,722,313 9,498,753
Product development and research 8,119,924 5,871,414 7,909,228
Amortization of intangible assets 2,453,491 2,457,829 2,588,896
Impairment loss on handwriting recognition technology 2,056,295 - -
Purchased in-process research and development - 474,000 -
------------------- -------------------- -------------------
Total expenses 24,281,275 19,525,556 19,996,877
------------------- -------------------- -------------------
Loss from operations (23,859,448) (18,896,139) (19,582,302)
------------------- -------------------- -------------------
Other income (expense):
Interest income 80,373 139,283 95,023
Interest expense (185,802) (4,004,111) (3,636,467)
Other (67,792) (126,520) (157,345)
------------------- -------------------- -------------------
Total other expense, net (173,221) (3,991,348) (3,698,789)
------------------- -------------------- -------------------
Loss from continuing operations before equity in net loss of
affiliate and income tax benefit (24,032,669) (22,887,487) (23,281,091)
Equity in net loss of affiliate (534,138) - -
Income tax benefit - 76,810 3,331,895
------------------- -------------------- -------------------
Loss from continuing operations (24,566,807) (22,810,677) (19,949,196)
Discontinued operations:
Operating loss of HealthCare Solutions Group - - (5,953,726)
Gain on disposal of HealthCare Solutions Group,
net of income taxes of $3,100,000 - - 3,766,646
------------------- -------------------- -------------------
Loss before extraordinary item (24,566,807) (22,810,677) (22,136,276)
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 (24,566,807) (22,761,229) (21,662,419)
Other comprehensive income - foreign currency translation 2,841 - -
------------------- -------------------- -------------------
Comprehensive loss $ (24,563,966) $ (22,761,229) $ (21,662,419)
=================== ==================== ===================
Basic and diluted net loss per common share $ (0.10) $ (0.16) $ (0.31)
=================== ==================== ===================
See accompanying notes to consolidated financial statements.
F-4
Fonix Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Fonix Corporation
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Outstanding
Additional Warrants
Preferred Stock Common Stock Paid-in to Purchase
--------------------------- -----------------------
Shares Amount Shares Amount Capital Common Stock
------------ ------------- ------------ ---------- ------------- -------------
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
Conversions of preferred stock to common stock (170,573) (4,409,897) 14,497,507 1,449 4,408,448 -
Issuance of common stock under equity
lines of credit - - 144,366,146 14,437 18,257,513 -
Issuance of stock options for services - - - - 33,360 -
Exercise of stock options - - 35,000 4 9,797 -
Issuance of warrants - - - - - 62,500
Expiration of warrants - - - - 371,530 (371,530)
Amortization of deferred consulting expenses - - - - - -
Preferred stock dividends - 9,281 - - - -
Cumulative foreign currency translation
adjustment - - - - - -
Net loss for the year ended December 31, 2001 - - - - - -
------------ ------------- ------------ ---------- ------------- ------------
BALANCE, DECEMBER 31, 2001 166,667 $ 500,000 350,195,641 $ 35,020 $ 171,985,508 $ 2,832,400
============ ============= ============ ========== ============= ============
Cumulative
Foreign
Deferred Currency
Consulting Translation Accumulated
Expenses Adjustment Deficit Total
------------- -------------- -------------- ----------------
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
Conversions of preferred stock to common stock - - - -
Issuance of common stock under equity
lines of credit - - - 18,271,950
Issuance of stock options for services (30,000) - 3,360
Exercise of stock options - - - 9,801
Issuance of warrants - - - 62,500
Expiration of warrants - - - -
Amortization of deferred consulting expenses 12,223 - - 12,223
Preferred stock dividends - - (9,281) -
Cumulative foreign currency translation
adjustment - 2,841 - 2,841
Net loss for the year ended December 31, 2001 - - (24,566,807) (24,566,807)
------------- -------------- -------------- ----------------
BALANCE, DECEMBER 31, 2001 $ (17,777) $ 2,841 $ (167,616,372) $ 7,721,620
============= ============== ============== ================
See accompanying notes to consolidated financial statements.
F-5
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------------------------------
2001 2000 1999
------------- ------------- ----------------
Cash flows from operating activities:
Net loss $(24,566,807) $(22,761,229) $ (21,662,419)
Adjustments to reconcile net loss to net cash
used in operating activities:
Issuance of common stock for services - 1,328,100 158,600
Non-cash expense related to issuance of debentures,
warrants, preferred and common stock 62,500 4,725,201 2,411,349
Non-cash compensation expense related to issuance and
extension of stock options 15,583 914,922 360,615
Non-cash portion of purchased in-process research and development - 474,000 -
Accretion of discount on note receivable from affiliate (19,400) - -
Accretion of discount on note payable from affiliate 164,405 - -
Loss on disposal of property and equipment 68,736 126,520 154,940
Impairment loss on handwriting recognition technology 2,056,295 - -
Gain on sale of HealthCare Solutions Group - - (3,766,646)
Depreciation and amortization 2,850,362 3,093,612 5,256,532
Equity in net loss of affiliate 534,138 - -
Income tax benefit - (76,810) (3,331,895)
Gain on forgiveness of debt - (49,448) (473,857)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable 92,268 53,029 (245,432)
Inventory (37,154) - -
Prepaid expenses and other current assets (39,367) 8,127 (5,560)
Funds held in escrow 2,151,006 (113,003) (38,003)
Other assets (18,364) 1,176 944
Accounts payable 406,885 (543,529) (1,650,337)
Accrued liabilities 407,851 120,638 514,312
Accrued liabilities - related party (112,500) (250,001) 1,143,185
Deferred revenues 372,778 549,222 632,242
Cumulative foreign currency translation adjustment 2,841 - -
------------- ------------- ----------------
Net cash used in operating activities (15,607,944) (12,399,473) (20,541,430)
------------- ------------- ----------------
Cash flows from investing activities, net of effects of acquisitions:
Issuance of note receivable (630,000) - -
Purchase of property and equipment (586,106) (239,908) (99,090)
Issuance of note receivable from affiliate (302,909) - -
Investment in affiliate (200,000) - -
Purchase of assets from Force Computers, Inc. (220,223) - -
Proceeds from sale of property and equipment 400 - 50,000
Payments received on notes receivable - - 245,000
Proceeds from sale of HealthCare Solutions Group - - 21,805,982
------------- ------------- ----------------
Net cash provided by (used in) investing activities (1,938,838) (239,908) 22,001,892
------------- ------------- ----------------
Cash flows from financing activities:
Proceeds from sale of Class A common stock, net 17,418,980 3,854,302 -
Payments on note payable to affiliate (1,050,000) - -
Principal payments on capital lease obligation (44,225) (28,312) (60,684)
Proceeds from exercise of stock options and warrants 9,801 744,866 -
Proceeds from issuance of convertible promissory note payable
and convertible debentures, net - 7,500,000 6,254,240
Proceeds from sale of preferred stock, net - 1,750,000 -
Payments on revolving note payable, net - - (20,038,193)
Payments on revolving note payable - related parties, net - - (7,895,178)
Advances on proceeds from issuance of Series F preferred stock - - 1,000,000
Payments on other notes payable - - (834,240)
Proceeds from sale of warrants - - 438,240
Bank overdraft - - (138,034)
------------- ------------- ----------------
Net cash provided by (used in) financing activities 16,334,556 13,820,856 (21,273,849)
------------- ------------- ----------------
Net (decrease) increase in cash and cash equivalents (1,212,226) 1,181,475 (19,813,387)
Cash and cash equivalents at beginning of the year 1,413,627 232,152 20,045,539
------------- ------------- ----------------
Cash and cash equivalents at end of the year $ 201,401 $ 1,413,627 $ 232,152
============= ============= ================
See accompanying notes to consolidated financial statements.
F-6
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Fonix Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years Ended December 31,
--------------------------------------------
Supplemental disclosure of cash flow information: 2001 2000 1999
-------------- -------------- --------------
Cash paid during the year for interest $ 171,494 $ 455,047 $ 1,186,695
Cash paid during the year for income taxes 2,986 2,606 -
Supplemental schedule of non-cash investing and financing activities:
For the year ended December 31, 2001:
Preferred stock dividends of $9,281 were accrued on Series D and Series
F preferred stock.
Converted 164,500 shares of Series D preferred stock and related
dividends of $320,949 into 13,978,440 shares of Class A common stock.
Converted 6,073 shares of Series F preferred stock and related dividends
of $6,853 into 519,067 shares of Class A common stock.
Issued warrants for the purchase of 250,000 shares of Class A common
stock as consideration for a perpetual, nonexclusive technology license valued
at $62,500.
Issued a non-interest bearing promissory note in the amount of
$2,600,000 to purchase 1,780,818 shares of Series A preferred stock of Audium
Corporation.
Issued a non-interest bearing promissory note in the amount of
$1,280,000 to purchase tangible and intangible assets from Force Computers, Inc.
Entered into a capital lease obligation for equipment in the amount of
$29,064.
Issued a note payable for purchase of equipment in the amount of
$19,039.
Issued 73,100 shares of Class A common stock for $852,970 in
subscription receivable.
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.
Converted $3,971,107 in principal of Series C convertible debentures and
related interest of $290,957 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 Class A 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.
Dividends totaling $514,800 were accrued relating to the liquidation
damage provision of the Series D preferred stock.
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 thesedebentures. 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 $997,146 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.
See accompanying notes to consolidated financial statements.
F-7
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - Fonix Corporation and subsidiaries (collectively, the
"Company"or "Fonix") is engaged in developing, acquiring and marketing
proprietary speech-enabling technologies. The Company's speech-enabling
technologies include automated speech recognition ("ASR") and text-to-speech
("TTS"). The Company offers its speech-enabling technologies to markets for
embedded automotive and wireless and mobile devices, computer telephony and
server solutions and personal software for consumer applications. 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 speech-enabling technologies, maintenance
contracts and services.
Basis of Presentation - The Company generated revenues of $607,644, incurred a
net loss of $24,566,807 and had negative cash flows from operating activities
totaling $15,607,944 for the year ended December 31, 2001. As of December 31,
2001, the Company had negative tangible net worth of $2,087,421, an accumulated
deficit of $167,616,372, negative working capital of $6,102,151 and $255,104 of
accounts payable over 60 days past due. The Company has limited capital capacity
of $5,991,493 available through its two equity lines of credit. The Company
expects to continue to incur significant losses and negative cash flows from
operating activities through at least December 31, 2002, primarily due to
significant expenditure requirements associated with marketing and developing
its speech-enabling 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.
Consolidation - The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries, Fonix Korea Sales
Group, Ltd. Fonix/AcuVoice, Inc. and Fonix/Papyrus, Inc. All significant
intercompany balances and transactions have been eliminated in consolidation.
Investments in 20 to 50 percent owned affiliates are accounted for on the equity
method (see Note 5).
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.
Subscriptions Receivable - Proceeds from certain sales of the Company's equity
securities prior to December 31, 2001 had not been received by the Company as of
year end. The cash proceeds were subsequently received in January 2002.
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 following and are amortized
on a straight-line basis over the estimated useful lives indicated:
Useful Life 2001 2000
----------- ---- ----
Goodwill 8 to 10 years $ 4,926,902 $ 8,435,590
Core technologies 8 to 10 years 12,127,000 11,192,000
Customer relationships 10 years 306,000 --
Trademarks 10 years 42,000 --
Patents 5 years 164,460 164,460
-------------- ----------------
17,566,362 19,792,050
Less accumulated amortization (7,757,321) (6,850,286)
------------- ---------------
Net intangible assets $ 9,809,041 $ 12,941,764
============= ===============
Valuation of Long-lived Assets - The carrying values of the Company's long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that they may not be recoverable. 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 carrying value would be reduced by the estimated excess of
the carrying value over the projected discounted cash flows.
During the fourth quarter of 2001, management of the Company determined that
goodwill recorded in connection with its handwriting recognition technology was
impaired. Without immediate customer prospects or current license agreements,
management has chosen not to provide further funding to develop or market the
handwriting recognition technology. Accordingly, the unamortized balance of
$2,056,295 was recorded as an expense in 2001.
Management does not consider any of the Company's other long-lived assets to be
impaired at December 31, 2001. However, should the Company's marketing and sales
plans 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. See "Recently Enacted Accounting Standards" below.
Revenue Recognition - The Company recognizes revenue in accordance with the
provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and
related interpretations. The Company generates revenue from licensing the rights
to its software products to end users and from royalties. The Company also
generates revenue from the sale of consulting and development services.
F-9
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue from license, royalties and maintenance is recognized upon shipment of
the software if there are no significant post-contract obligations. If
post-contract obligations exist, revenue is recognized when those obligations
have been satisfied. Revenue from consulting and development services is
recognized as the services are completed.
Cost of revenue from license, royalties and maintenance consists of costs to
distribute the product (including the cost of the media on which it is
delivered), support personnel compensation, licensed technology and other
related costs. Cost of service revenue consists of personnel compensation,
licensed technology and other related costs.
Product Development and Research - All expenditures for product development and
research are charged to expense as incurred. 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 Class A common
stock (see Note 13).
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 12.
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 occasionally may 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
F-10
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2001, 2000 and 1999, there were outstanding common stock
equivalents to purchase 27,120,480 shares, 38,541,003 shares and 56,869,449
shares of common stock, respectively, that were not included in the computation
of diluted net loss per common share as their effect would have been anti-
dilutive, thereby decreasing the net loss per common share.
The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the years ended December 31, 2001, 2000
and 1999.
2001 2000 1999
---------------------------- ---------------------------- ---------------------------
Loss Loss Loss
Loss Per Share Loss Per Share Loss Per Share
-------------- ----------- -------------- ----------- -------------- -----------
Loss from continuing operations $ (24,566,807) $ (22,810,677) $ (19,949,196)
Preferred stock dividends (9,281) (3,335,852) (2,110,607)
-------------- -------------- --------------
Net loss from continuing operations
attributable to common
shareholders (24,576,088) $ (0.10) (26,146,529) $ (0.16) (22,059,803) $ (0.29)
Discontinued operations, net of taxes -- -- -- -- (2,187,080) (0.03)
Extraordinary item, net of taxes -- -- 49,448 -- 473,857 0.01
-------------- ----------- -------------- ----------- -------------- -----------
Net loss attributable to common
stockholders $ (24,576,088) $ (0.10) $ (26,097,081) $ (0.16) $ (23,773,026) $ (0.31)
============== =========== ============== =========== ============== ===========
Weighted average common shares
outstanding 239,131,247 162,684,298 76,753,709
============== ============== ==============
Imputed Interest Expense and Income - Interest is imputed on long-term debt
obligations and notes receivable where management has determined that the
contractual interest rates are below the market rate for instruments with
similar risk characteristics (see Notes 5 and 6).
Inventory - Inventory, consisting primarily of retail products, is stated at the
lower of cost (first-in, first-out method) or market value.
Foreign Currency Translation - The functional currency of the Company's Korean
subsidiary is the South Korean won. Consequently, assets and liabilities of the
Korean operations are translated into United States dollars using current
exchange rates at the end of the year. All revenue is invoiced in South Korean
won and revenues and expenses are translated into United States dollars using
weighted-average exchange rates for the year.
Comprehensive Income - Other comprehensive income presented in the accompanying
F-11
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
consolidated financial statements consists of cumulative foreign currency
translation adjustments. The Company had no items of comprehensive income or
loss prior to April 1, 2001.
Recently Enacted Accounting Standards - In July 2001, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 eliminates the
"pooling-of-interests" method of accounting for acquisitions and requires
separate accounting for certain intangibles acquired in such transactions. The
application of this standard is not expected to have an impact on the Company's
financial position or results of operations.
SFAS No. 142 changes the accounting for goodwill and intangible assets with
indefinite lives from an amortization method to an impairment-only approach.
Accordingly, effective January 1, 2002, amortization of goodwill and intangible
assets with indefinite lives will discontinue. Other intangible assets will
continue to be amortized over their useful lives. The Company amortized
$1,029,545 of goodwill for each of the years ended December 31, 2001, 2000 and
1999.
Effective January 1, 2002, the Company will apply the requirements of SFAS No.
142, and management will perform an impairment test of goodwill and intangible
assets with indefinite lives. The effect of the application of those
requirements on the Company's financial position and results of operations has
not been determined, but it could be material to the Company's financial
position and results of operations. Any transitional impairment loss will be
recognized as a cumulative change in accounting principle.
In August 2001, the FASB issued SFAS No. 143 , "Accounting for Asset Retirement
Obligations." This statement establishes financial accounting and reporting
standards for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
financial statements issued for fiscal years beginning after June 15, 2002. The
adoption of this statement is not expected to have a material effect on the
Company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement establishes financial accounting
and reporting standards for the impairment or disposal of long-lived assets.
SFAS No. 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001. The application of these requirements is not
expected to have a material effect on the Company's financial position or
results of operations.
Reclassifications - Certain reclassifications have been made in the prior years'
consolidated financial statements to conform with the current year presentation.
2. ACQUISITION AND DISCONTINUED OPERATIONS
DECtalk Assets - On December 14, 2001, the Company entered into an Asset
Purchase Agreement with Force Computers, Inc., under which the Company purchased
from Force tangible and intangible assets (the "DECtalk Assets"). The Company
agreed to pay $150,000 in cash at closing and $1,280,000 in the form of a
non-interest- bearing promissory note (see Note 6). Payments due under the
promissory note are payable at intervals through December 9, 2002.
F-12
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The purchase price of $1,459,978, including direct acquisition costs of $70,223
is allocated as follows:
Purchased core technology $ 935,000
Customer relationships 306,000
Trademark 42,000
Goodwill 94,062
Furniture and equipment 64,350
Accounts receivable 18,566
-------------
Total purchase price $ 1,459,978
=============
Sale of the HealthCare Solutions Group - On September 1, 1999, the Company
completed a sale of the operations and a significant portion of the assets of
the HSG, to Lernout & Hauspie Speech Products N.V. ("L&H"), for up to
$28,000,000 (the "Sale"). 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. All of the funds were released from escrow by
March 29, 2001. Another $4,000,000 of the sales price was 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. To date, no earnout has been received and,
because of the bankruptcy filing of L&H, it is unlikely that any earnout will be
received in the future. 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 1999 consolidated statement of
operations. Revenues from the HSG's operations were $1,726,262 for the period
from January 1, 1999 through September 1, 1999, the date of the Sale. These
amounts have not been included in revenues in the accompanying 1999 consolidated
statement of operations, but are included in the operating loss from
discontinued operations.
3. CONVERTIBLE NOTES RECEIVABLE
Through November 30, 2001, the Company loaned $455,000 under the terms of
convertible promissory notes to an unrelated entity (the "Borrower") with whom
the Company is engaged in development activities. The notes were unsecured, bore
interest at an annual rate of 7.5 percent, and were to mature 120 days from the
issuance date of each note. The Borrower is a provider of
natural-language-understanding solutions for CRM applications. Fonix speech-
enabling technology is a component of these solutions.
On December 1, 2001, the Company established a revolving line of credit and
convertible promissory note that permits the Borrower to draw up to $1,000,000
for operations and other purposes, including the amounts loaned under the
initial convertible promissory notes. Effective February 1, 2002, the line of
credit and convertible promissory nore were increased to $2,000,000. Draws on
the line of credit bear interest at an annual rate of seven percent, which
interest is payable quarterly beginning June 30, 2002, and are secured by
intellectual property and other assets of the Borrower. The unpaid principal,
together with interest accrued thereon, is due and payable on December 31, 2002,
and is convertible into common shares of the Borrower at the Company's option.
Based upon borrowings through December 31, 2001, such conversion would represent
approximately five percent of the ownership of the Borrower.
In December 2001, the Borrower drew an additional $175,000 on the line of
credit, bringing the total outstanding balance to $630,000 through December 31,
2001. Subsequent to December 31, 2001 through February 26, 2002, the Borrower
drew an additional $395,000 under the terms of the credit line.
F-13
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2001 and 2000:
2001 2000
--------------- ---------------
Computer equipment $ 1,166,731 $ 1,193,942
Furniture and fixtures 959,069 851,436
Leasehold improvements 92,319 118,621
--------------- -------------
2,218,119 2,163,999
Less accumulated depreciation and amortization (1,314,960) (1,445,288)
--------------- --------------
Net property and equipment $ 903,159 $ 718,711
=============== ==============
5. INVESTMENT IN AFFILIATE
In February 2001, the Company entered into a collaboration agreement with Audium
Corporation ("Audium") 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 to complete online transactions using any telephone.
The collaboration includes integration of the Company's technologies with
Audium's mobile applications development capability.
Note Receivable - In connection with the collaboration agreement with Audium, in
February and May 2001, the Company advanced an aggregate of $400,000 to Audium
as a bridge loan (the "Audium Note"). The loan bears interest at a rate of 5
percent per year, has a term of four years and is convertible into shares of
Audium Series A Convertible Preferred Stock ("Audium Preferred Stock"). The
Audium Note is convertible into shares of Audium Preferred Stock at a price of
$1.46 per share in the event of (i) Audium raising an additional $2,000,000
prior to October 6, 2002, (ii) Audium's merger or consolidation, (iii) a
qualified public offering of Audium common stock, (iv) an event of default under
a note payable from Fonix (see Fonix Note below), or (v) Audium's aggregate
gross revenues for the months of January through June 2003 exceeding $1,000,000.
The Audium Note is secured by Audium's intellectual property. Further, at the
closing, Audium granted the Company a fully paid, worldwide, non-exclusive
license to Audium's software to make, manufacture, and use the software and any
derivative works if Audium declares bankruptcy or ceases to do business.
Management determined that a 12 percent annual interest rate better reflects the
risk characteristics of the Audium Note. Accordingly, interest was imputed at 12
percent and the Audium Note was recorded at its original present value of
$302,909. For the year ended December 31, 2001, the Company recorded interest
income of $29,663, including contractual and imputed interest. As of December
31, 2001, the balance of the Audium Note was $322,309, net of the unaccreted
discount.
Investment in Affiliate - On April 11, 2001, the Company closed a stock purchase
agreement with Audium, wherein the Company agreed to purchase up to $2,800,000
of Audium Preferred Stock at a price of $1.46 per share. At closing, the Company
paid $200,000 in cash and gave Audium a non-interest bearing note (the "Fonix
Note") for the remaining $2,600,000.
Each share of Audium Preferred Stock is convertible into one share of Audium's
common stock. Holders of Audium Preferred Stock are entitled to eight percent
cumulative dividends, a liquidation preference in excess of the original
purchase price plus any declared but unpaid dividends, anti-dilution rights,
and voting rights equal to the corresponding number of common shares. The stock
purchase agreement also entitles Fonix to elect one
F-14
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
member of Audium's board of directors. Audium also granted Fonix certain
registration rights after the closing of a public offering by Audium.
On April 11, 2001, and through December 31, 2001, the Company's investment in
Audium represented 26.7 percent of the Audium's voting stock. As a result, the
Company accounts for its investment in Audium using the equity method of
accounting. Accordingly, the Company recognized a loss of $534,138 in the
accompanying consolidated statements of operations consisting of $259,414
to reflect the Company's share of Audium's net loss for the period from April
11, 2001 through December 31, 2001 and $274,724 for the amortization of the
difference between the purchase price of the Audium Preferred Stock and the
Company's portion of Audium's net stockholders' deficit that is amortized on a
straight-line basis over a period of eight years.
A summary of the results of Audium's operations for the period from April 11,
2001 through December 31, 2001 and net assets (liabilities) as of December 31,
2001 is as follows:
(Unaudited)
Net sales $ 434,859
Loss from operations 959,285
Net loss 971,583
Current assets 591,646
Total assets 832,670
Current liabilities 604,677
Total liabilities 1,027,272
Net assets (liabilities) (194,602)
Note Payable to Affiliate - The Fonix Note is payable in 13 monthly installments
of $200,000 beginning on June 1, 2001, and bears no interest unless an event of
default occurs, in which case it will bear interest at 12 percent per year. No
events of default have occurred to date.
At closing, Audium issued 14 share certificates to Fonix, each certificate for
136,986 shares of Audium Preferred Stock, and delivered one certificate in
exchange for the initial payment of $200,000. The remaining certificates are
held by Audium as collateral for the Fonix Note under the terms of a security
agreement. For each monthly payment of $200,000 or multiple payments that
aggregate $200,000, Audium will release to Fonix one certificate for 136,986
shares of Audium Preferred Stock.
Through September 30, 2001, three payments of $200,000 were made on the Fonix
Note. Effective October 1, 2001, the terms of the Fonix Note were modified to
reduce the monthly payments to the following amounts: $75,000 for September
2001, $100,000 for October 2001, $125,000 for November 2001 and $150,000 for
December 2001 and January 2002. Thereafter, monthly payments of $200,000 are
scheduled through August 2002. No other terms of the original Fonix Note were
affected by the modification. Subsequent to December 31, 2001, payments
amounting to $350,000 have been made as required by the modified terms.
Management determined that a 12 percent annual interest rate reflects the risk
characteristics of the Fonix Note. Accordingly, interest has been imputed at 12
percent and the Company recorded a present value of $2,370,348 for the note
payable. For the year ended December 31, 2001, the Company recorded interest
expense of $164,405 related to this note.
F-15
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. PROMISSORY NOTE
As discussed in Note 2, the Company entered into an Asset Purchase Agreement
with Force Computers, Inc. ("Force") As part of the consideration for the
purchase price Fonix issued a non-interest bearing promissory note in the amount
of $1,280,000. Management determined that a seven percent annual interest rate
reflects the risk characteristics of this promissory note. Accordingly,
interest has been imputed at seven percent and the Company recorded a discount
of $40,245 for the note payable. From the purchase date through December 31,
2001, the Company recorded interest expense of $4,098 related to this promissory
note.
As collateral for the promissory note, 7,000,000 shares of the Company's Class A
common stock were placed into escrow. Under the terms of the escrow, the shares
will not be released to Force unless the Company is delinquent or late with
respect to any payment under the Note. Also, under the terms of the Asset
Purchase Agreement, Fonix is required to deposit all receipts from customers
acquired in this transaction into a joint depository account. Fonix has the
right to withdraw such funds; however, in the event of default on any payments
to Force under the terms of the promissory note, Force has the right to withdraw
funds from the depository account until the deficiency in payment is covered, at
which time, Fonix may again have use of the funds. To date, required payments
have been made when due.
7. RELATED-PARTY NOTES PAYABLE
In connection with the acquisition of certain entities in 1998, the Company
issued unsecured demand notes payable to former stockholders of the acquired
entities in the aggregate amount of $1,710,000. Demands for payment on the notes
were made as follows: $1,190,000 on February 28, 1999, $180,000 on April 30,
1999 and $340,000 on September 30, 1999, and bore interest at six percent after
their due date. The Company did not make payments on the due dates pending the
result of certain legal actions undertaken by the Company. In September 1999,
the actions were settled resulting in cancellation of certain of the promissory
notes totaling $1,632,375 upon payment to certain former 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 the notes payable,
$77,625 remain unpaid as of December 31, 2001. During 2000, the holders of these
notes made demand for payment and the Company is negotiating with the holders of
these notes to reduce the outstanding balance.
8. 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
F-16
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 13).
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. Under its indemnity agreement with 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 expenses incurred by the Guarantors as a result of the sales of
the shares pledged by the Guarantors.
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.
9. 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 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
shares in connection with a March 1998 private
F-17
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
placement offering and as a cost of the Series D convertible preferred stock
placement. Dividends accrued on the stated value ($20 per share) of Series D
convertible preferred stock at the rate of four percent per year, were payable
annually or upon conversion, in cash or Class A common stock, at the option of
the Company, and were 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 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 D convertible preferred stock had 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. 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
D convertible preferred stock converted to common stock. 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 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 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. In 2001, 2000 and
1999, 164,500 shares, 217,223 shares and 626,611 shares, respectively, of Series
D convertible preferred stock and related dividends were converted into
13,978,440 shares, 15,436,378 shares and 47,252,275 shares, respectively, of
Class A common stock. As of December 31, 2001, no shares of Series D convertible
preferred stock remain outstanding.
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 had 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.
F-18
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 a related amendment thereto whereby it sold a total of 316,036
shares of its Series F convertible preferred stock for $2,750,000. Dividends
accrued on the stated value ($20 per share) of Series F convertible preferred
stock at a rate of six percent per year, were payable annually or upon
conversion, in cash or common stock, at the option of the Company, and were
convertible into shares of Class A common stock at any time at the holders'
option. 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 2001 and 2000, 6,073 shares and 309,963 shares, respectively, of Series F
convertible preferred stock and related dividends were converted into 519,067
shares and 8,342,820 shares, respectively, of Class A common stock.
10. CONVERTIBLE PROMISSORY NOTE AND EQUITY LINES OF CREDIT
Convertible Promissory Note - In June 2000, the Company executed a convertible
promissory note (the "2000 Note") with a private investor in the amount of
$7,500,000, against 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 as interest expense in the amount of $3,447,623
related to borrowings under the 2000 Note.
Equity Line of Credit - In August 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.
From its inception through December 31, 2000, draws taken under the Equity Line,
excluding the Initial Investment Amount, amounting to $3,973,508 were converted
into 12,492,680 shares of Class A common stock. During 2001, draws amounting to
$5,510,000, less commissions and related fees of $165,300, were converted into
26,353,141 shares of Class A common stock. Subsequent to December 31, 2001,
additional draws amounting to $156,836, less commissions and fees of $4,705,
were converted into 2,292,920 shares of Class A common stock. As of February
F-19
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
26, 2002, $2,859,657 of credit remains available to be drawn on the Equity Line.
Second Equity Line of Credit - In April 2001, the Company entered into a second
private equity line agreement (the "Second Equity Line") with the Equity Line
Investor. Under the Second Equity Line, the Company has the right to draw up to
$20,000,000 under terms substantially identical to the initial Equity Line.
From the inception of the Second Equity Line through December 31, 2001, draws
under the Second Equity Line amounting to $13,425,000, less commissions and fees
of $497,750, were converted to 118,013,005 shares of Class A common stock.
Subsequent to December 31, 2001, additional draws amounting to $3,443,164, less
commissions and fees of $103,295, were converted into 51,769,221 shares of Class
A common stock. As of February 26, 2002, $3,131,836 remains available to be
drawn on the Second Equity Line.
11. COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION
Common Stock - During 2001, the Company issued 158,898,653 shares of Class A
common stock. Of such shares, 14,497,507 shares were issued upon the conversion
of preferred stock with related dividends, 144,366,146 shares were issued upon
conversion of draws on the equity lines, and 35,000 shares were issued upon the
exercise of options. At the annual meeting of shareholders held on July 18,
2001, the shareholders of the Company approved an increase in the number of
common shares authorized from 300,000,000 to 500,000,000.
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 17), 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 8 and 13) 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 settlement with the former shareholders of and acquired
entity (see Note 7). 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.
In connection with a 1998 acquisition, 1,985,000 shares of Class A common stock
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, 2001, 2000 and 1999.
Voting Trust - As of December 31, 2001, 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
F-20
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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.
12. 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 approved an increase in the number of shares under
the Plan from 10,000,000 to 20,000,000. As of December 31, 2001, the number of
shares available for grant under this plan was 2,760,831.
F-21
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2001, the number of shares available for grant
under this plan was 2,362,993.
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, 2001, the number of shares available for grant under this plan
was 2,800,000.
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, 2001, the number of shares available
for grant under this plan was 773,666.
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 2001
and 2000, options to purchase 1,500,000 shares and 3,800,000 shares,
respectively, of Class A common stock, were issued to directors who were also
executive officers of the Company for compensation and other services rendered
to the Company. No such options were issued in 1999.
A summary of options granted under the Company's various stock option plans for
the years ended December 31, 2001, 2000 and 1999 is presented below:
2001 2000 1999
------ ------ -----
Weighted Weighted Weighted
Average Average Average
Stock Exercise Stock Exercise Stock Exercise
Options Price Options Price Options Price
------------ --------- ------------ ---------- ------------ ----------
Outstanding at beginning of the year 19,857,700 $ 2.97 14,355,900 $ 4.06 15,877,782 $ 4.10
Granted 8,134,950 0.22 7,116,067 0.65 1,294,000 1.31
Exercised (35,000) 0.39 (938,697) 1.00 -- --
Forfeited or canceled (3,878,837) 4.23 (675,570) 4.59 (2,815,882) 3.01
------------ ------------ ------------
Outstanding at end of the year 24,078,813 1.84 19,857,700 2.97 14,355,900 4.06
============ ============ ============
Exercisable at the end of the year 16,981,906 2.50 18,923,001 3.07 13,484,237 4.20
============ ============ ============
F-22
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of options outstanding and options exercisable under the Company's
various stock option plans at December 31, 2001 is presented below:
Options Outstanding Options Exercisable
-------------------------------------------------------------------------- --------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
------ ----------- ---- ----- ----------- -----
$ 0.07-1.00 12,887,110 8.9 years $ 0.32 5,881,866 $ 0.41
1.01-1.78 5,028,800 7.9 years 1.12 4,937,137 1.12
2.97-4.06 1,893,000 4.6 years 3.95 1,893,000 3.95
5.06-6.00 801,000 5.9 years 5.68 801,000 5.68
6.50-8.50 3,468,903 5.5 years 6.51 3,468,903 6.51
---------- ------------
$ 0.07-8.50 24,078,813 7.8 years 1.84 16,981,906 2.50
========== ============
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, 2001, 2000, and 1999:
2001 2000 1999
------ ------ -----
Net loss attributable to common stockholders:
As reported $ 24,576,088 $ 26,097,081 $ 23,773,026
Pro forma 25,336,697 30,602,028 28,567,009
Basic and diluted net loss per common share:
As reported $ (0.10) $ (0.16) $ (0.31)
Pro forma (0.11) (0.19) (0.37)
The weighted average fair value of options granted during the years ended
December 31, 2001, 2000 and 1999 were $0.27, $0.64 and $1.31, respectively.
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 2001, 2000 and 1999:
2001 2000 1999
------ ------ -----
Risk-free interest rate 4.66% 6.08% 5.70%
Expected dividend yield 0.0% 0.0% 0.0%
Expected exercise lives 5 years 5 years 5 years
Expected volatility 130% 130% 102%
The estimated fair value of options granted is subject to the assumptions
made, and if the assumptions were to change the estimated fair value amounts
could be significantly different.
F-23
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants - A summary of warrants granted by the Company during the years ended
December 31, 2001, 2000 and 1999 is presented below:
2001 2000 1999
------------------------ ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ---------- ----------- ---------- ------------ -----------
Outstanding at beginning of the year 3,470,000 $ 2.06 3,025,000 $ 2.71 1,925,000 $ 13.08
Granted 250,000 0.33 945,000 0.93 2,250,000 0.66
Exercised -- -- (300,000) 0.93 -- --
Forfeited (845,000) 0.92 (200,000) 8.13 (1,150,000) 16.06
----------- ----------- ------------
Outstanding at end of the year 2,875,000 2.22 3,470,000 2.06 3,025,000 2.71
=========== =========== ============
Exercisable at end of the year 2,875,000 2.22 3,470,000 2.06 2,525,000 3.16
=========== \ =========== ============
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 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. As of December 31, 2001, there are options to purchase 33,334 shares
of Class A common stock outstanding which provide for stock appreciation
rights, all of which have an exercise price of $1.00 per share. If not
exercised by September 2002, the remaining options with these rights will
expire.
13. 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
F-24
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 would 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 8). Under its
indemnity agreement with the Guarantors, the Company issued 6,000,000
replacement shares to the Guarantors for the shares sold and reimbursed the
Guarantors for resulting costs. Accordingly, the Company recorded an expense
of $1,296,600 during 1999.
In December 1998, the Guarantors guaranteed certain additional obligations of
the Company. As security for some of the guarantees, the Guarantors also
pledged shares of Class A common stock beneficially owned by them. In March
1999, 143,230 of the shares pledged to a bank were sold by the bank and the
proceeds were used to pay Company credit card balances and the related accrued
interest in full totaling $244,824. In May 1999, 100,000 of the shares pledged
to another creditor of the Company were sold by the creditor and the proceeds,
totaling $72,335, were used to pay amounts owed by the Company. The Company
recorded an expense of $146,700 during 1999 to reimburse the Guarantors for
expenses resulting from these sales.
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, Inc. ("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 $149,261 in 2001, $111,196 in 2000 and $124,416 in 1999.
Other Transactions - In December 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
2001, 2000 and 1999, the Company paid approximately $847,000, $505,000, and
$902,000, respectively, to the law firm for services provided to the Company.
14. RESEARCH AND PRODUCT DEVELOPMENT
Synergetics - Prior to March 1997, the Company's scientific research and
development activities were conducted solely by 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
F-25
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 no expenses in 2001, $28,000 in 2000 and $50,455 in 1999 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 IMC2. 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 and $63,395 in 1999 for
services provided by Adiva.
IMC2 - In March 1998, the Company entered into a professional services
agreement with IMC2, a research and development entity, to provide assistance
to the Company in the continuing development of specific ASR technologies. The
president of IMC2 is also the president of Synergetics and Adiva. The
agreement was for an initial term of 36 months and required the Company to
make monthly payments of $22,000. In February 2001, the Company and IMC2
agreed to extend the contract on a month-to-month basis. Under the terms of
the agreement, the Company expended $391,000 in 2001, $264,000 in 2000 and
$264,000 in 1999 for research and development efforts provided by IMC2.
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, Advocast issued 60,200 shares of Advocast Series A 6%
convertible preferred stock ("Advocast Preferred Stock") to the Company and
the chief executive officer of the Company became a director of Advocast. The
Advocast Preferred Stock, if converted to Advocast common stock, represented
less than 20 percent of the total outstanding shares of Advocast voting common
stock. Advocast is a development stage company with minimal operations and no
market for its stock. As a result, there was substantial uncertainty as to the
value of the Advocast Preferred Stock and the Company did not record a value
for the Advocast shares in its consolidated financial statements.
On February 26, 2001, Fonix agreed to provide to Advocast an additional
$100,000 of financing under the terms of a six percent secured convertible
debenture due February 26, 2002. Fonix advanced $57,498 under the
debenture. The debenture was convertible into shares of Advocast common
stock at a rate of $8.62 per share at the option of Fonix. Furthermore,
Fonix had 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 was subject
F-26
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to the same terms of conversion into Advocast common stock or became due and
payable six months following the original due date of the convertible
debenture. Advocast and Fonix also agreed that Advocast would provide
consulting services to Fonix for development of Internet applications
of the Company's technologies. The term of the agreement was three months and
could be renewed at the Company's option for an additional three months. Fonix
paid $30,000 to Advocast pursuant to the consulting agreement.
On June 18, 2001, Fonix canceled the debenture, terminated the consulting
agreement, agreed that Advocast could redeem the Advocast Preferred Stock
owned by Fonix and issued warrants to Advocast for the purchase of 250,000
shares of Fonix Class A common stock at an exercise price of $0.33 per share
in return for a perpetual, fully paid-up, nonexclusive license to certain
technology developed by Advocast for Internet speech applications. The
warrants were valued at $62,500 using the Black-Scholes option pricing model
and were recorded as product development costs at the date of the transaction.
Fonix has no further obligation to provide funding, management consultation
and development services or technology to Advocast.
15. INCOME TAXES
At December 31, 2001 and 2000, net deferred income tax assets, before
considering the valuation allowance, totaled $37,549,884 and $30,159,421,
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 $7,390,463 for 2001 and
$5,073,474 for 2000.
At December 31, 2001, the Company has unused federal net operating loss
carryforwards available of approximately $91,290,000 and unused state net
operating loss carryforwards of approximately $82,570,000 which may be applied
against future taxable income, if any, and which expire in various years from
2008 through 2021. 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.
The temporary differences and carryforwards which give rise to the deferred
income tax assets as of December 31, 2001 and 2000 are as follows:
Deferred income tax assets: 2001 2000
--------------- ----------------
Net operating loss carryforwards:
Federal $ 31,039,516 $24,673,999
24,673,999 24,673,999
State 2,724,704 2,106,874
Research and development credits 2,366,311 2,224,742
Accrued liabilities 800,197 798,240
Deferred revenues 389,515 274,689
Other 229,641 80,877
--------------- ----------------
Total deferred income tax assets 37,549,884 30,159,421
Valuation allowance (37,549,884) (30,159,421)
--------------- ----------------
Net deferred income tax assets $ -- $ --
--------------- ----------------
F-27
Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of income taxes at the federal statutory rate to the
Company's effective rate is as follows:
Year Ended December 31,
2001 2000 1999
----------- --------- ---------
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 (7.8) (14.8) (9.0)
(22.2)
Valuation allowance (22.2) (14.0)
----------- ---------
Effective income tax rate 0.0% 0.3% 14.3%
=========== ========= =========
16. 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 upward in future years as deemed appropriate
by the Company's board of directors. The expiration date of the agreements is
December 31, 2005. In July 2000, as 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 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 ended January 31, 2002.
The Company has no further obligations to the former executive.
During 2000, the Company entered into employment contracts with two other
executive officers which expire in January 31, 2003. The minimum annual
salaries required by these agreements total $460,000. The executive
employees are also entitled to other normal benefits extended to executives
and employees of 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 was to occur, the executive officers' services are terminated by
the Company for any reason other than cause, death or retirement, the
executive officers shall be entitled to receive an amount in cash equal to
all base salary then and thereafter payable within 30 days of termination.
The agreements contain a non-disclosure, confidentiality, non-solicitation
and non-competition clause. Under the terms of the non-competition clause,
each
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Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
executive has agreed that for a period of 18 months after the termination of
his employment with the Company the executive will not engage in any capacity
in a business which competes with or may compete with the Company.
Other Employment Agreements - 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 was to occurr 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 was to expire
November 30, 2003, but was terminated by mutual agreement.
Professional Services Agreements - In 2001, the Company entered into a
professional services agreement with a marketing consultant. The terms of the
agreement require monthly payments of $20,000 for a period of 24 months. Also,
in connection with the agreement, the Company issued options to purchase
500,000 shares of Class A common stock. The options were valued at $0.06 per
share using the Black-Scholes option pricing model assuming a risk-free
interest rate of 4.62 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 is being
amortized into general and administrative expense over the period of service.
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 as 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 during the year ended 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 as 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 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 as general and administrative expense over the period of service
in 2000.
Babel Infovox AB ("Infovox") is a Swedish telecommunications company that has
developed multiple language capability for integration into TTS applications.
In October 2000, the Company entered into a revenue sharing arrangement with
Infovox that provides that Fonix will pay a percentage of revenue to Infovox
for Fonix licenses of TTS technology that include languages other than
American English provided by Infovox. In connection with
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Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
this agreement, the Company has made prepayments of $20,000, against which
payment due to Infovox are credited. Through December 31, 2001, the Company
had credited $2,898 against this prepayment.
Operating Lease Agreements - The Company leases certain facilities and
equipment used in its operations. The amount of commitments for non-cancelable
operating leases in effect at December 31, 2001, were as follows:
Year ending December 31,
2002 $ 881,224
2003 517,379
2004 294,652
-------------
$ 1,693,255
The Company incurred rental expense, net of subleases, of $627,304, $413,382
and $764,930 during 2001, 2000 and 1999, 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.
17. LITIGATION
Oregon Graduate Institute - On July 28, 1999, Oregon Graduate Institute
("OGI") filed a notice of default, demand for mediation and demand for
arbitration with the American Arbitration Association. In its demand, OGI
asserted that the Company was in default under three separate agreements
between the Company and OGI in the total amount of $175,000. 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 previously
loaned by Fonix.
Clarke - In November 1998, Fonix filed a suit against John R. Clarke and
Perpetual Growth Fund, a company affiliated with Clarke, 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 relating to certain
financing Fonix received during 1998 and thereafter. The case was tried
in March 2001, after which the 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 to the United States Court of
Appeals for the Tenth Circuit, but that court has not yet rendered a
decision. The Company believes that the claims of Clarke and Perpetual
Growth are without merit and will continue to vigorously oppose those
claims.
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Fonix Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other - The Company is involved in various claims and proceedings arising in
the ordinary course of business. Management believes, after consultation with
legal counsel, that the ultimate disposition of these matters will not
materially impact the consolidated financial position, liquidity or results of
operations of the Company.
18. EMPLOYEE PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan covering essentially all of its
full-time employees. Under the plan, employees may reduce their salaries, in
amounts allowed by law, and contribute the salary reduction amount to the plan
on a pretax basis. The plan also allows the Company to make matching and
profit sharing contributions as determined by the board of directors. To date,
no matching or profit sharing contributions have been made by the Company.
19. SIGNIFICANT CUSTOMERS
Of the Company's revenue for 2001, $593,371 was from sources in the United
States and $14,273 from South Korea. All of the Company's revenues for 2000
and 1999 were sourced from the United States. In 2001, no single customer
generated more than 10 percent of the Company's total revenue. Of the $656,853
of revenues in 2000, $125,000 was from Motorola, and $87,250 was from
NuvoMedia, Inc. Of the $439,507 of revenues in 1999, $209,401 was from one
customer, General Magic. No other customer accounted for more than 10 percent
of the Company's total revenues for the years presented.
20. SUBSEQUENT EVENT
Stock Options - Subsequent to December 31, 2001, through February 26, 2002,
the Company granted 5,042,000 options to employees, officers and directors
under Company option plans. The options were granted at the quoted market
price on the date of the grant and have exercise prices ranging from $0.05 to
$0.11 per share. Of the options granted, 1,000,000 vest immediately and the
balance vest over three years.
F-31