UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 2002
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
---------- ---------
Commission file number 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 22-2994719
(State of Incorporation) (I.R.S. Employer Identification No.)
180 W. Election Road, Suite 200
Draper, UT 84020
(Address of principal executive offices, including zip code)
(801) 553-6600
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X or No
As of August 7, 2002, 484,475,556 shares of Class A voting common
stock, par value $0.0001 per share, were issued and outstanding.
FONIX CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - As of June 30, 2002 and December 31, 2001 2
Condensed Consolidated Statements of Operations and Comprehensive Loss for the
three months and six months ended June 30, 2002 and 2001 3
Condensed Consolidated Statements of Cash Flows for the three months and six months ended
June 30, 2002 and 2001 4
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Matters - Change in Certifying Public Accountants 26
Item 6. Exhibits and Reports on Form 8-K 27
1
Fonix Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
June 30, December 31,
2002 2001
---------------- ----------------
Current assets:
Cash and cash equivalents $ 38,913 $ 201,401
Subscriptions receivable - 852,970
Accounts receivable, net of allowance for doubtful accounts of $0 96,592 58,170
Other receivables 73,352 25,119
Inventory 28,080 37,154
Prepaid expenses 169,764 69,953
---------------- ----------------
Total current assets 406,701 1,244,767
Property and equipment, net of accumulated depreciation of $1,491,553
and $1,314,960, respectively 811,490 903,159
Convertible note receivable 1,435,000 630,000
Investment in and note receivable from affiliate, net of unamortized discount of $68,655 1,934,609 2,358,519
Intangible assets, net of accumulated amortization of $6,234,000 and
$5,461,722, respectively 6,406,222 7,177,737
Goodwill, net of accumulated amortization of $2,295,599, in 2002 and 2001 2,631,304 2,631,304
Other assets 359,199 123,052
---------------- ----------------
Total assets $ 13,984,525 $ 15,068,538
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Advance on equity line of credit $ 182,676 $ -
Note payable to affiliate, net of unamortized discount of $31,054 968,946 1,484,753
Note payable, net of unamortized discount of $12,102 397,898 1,239,755
Notes payable - related parties 435,933 77,625
Accounts payable 1,664,292 1,062,237
Accrued liabilities 2,622,858 961,299
Accrued liabilities - related parties 1,443,300 1,451,633
Deferred revenues 1,134,792 1,049,849
Other current liabilities 21,881 19,767
---------------- ----------------
Total current liabilities 8,872,575 7,346,918
---------------- ----------------
Commitments and contingencies (Notes 1, 3, 5, and 6)
Stockholders' equity:
Preferred stock, $.0001 par value; 50,000,000 shares authorized; Series A,
convertible; 166,667 shares outstanding
(aggregate liquidation preference of $6,055,012) 500,000 500,000
Common stock, $.0001 par value; 800,000,000 shares authorized;
Class A voting, 484,475,556 and 350,195,641 shares outstanding, respectively 48,448 35,020
Class B non-voting, none outstanding
Additional paid-in capital 181,754,780 171,985,508
Outstanding warrants to purchase Class A common stock 2,136,400 2,832,400
Deferred consulting expenses (5,833) (17,777)
Cumulative foreign currency translation adjustment (25,396) 2,841
Accumulated deficit (179,296,449) (167,616,372)
---------------- ----------------
Total stockholders' equity 5,111,950 7,721,620
---------------- ----------------
Total liabilities and stockholders' equity $ 13,984,525 $ 15,068,538
================ ================
See accompanying notes to condensed consolidated financial statements.
2
Fonix Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ----------------------------
2002 2001 2002 2001
-------------- -------------- ------------- -------------
Revenues $ 679,197 $ 107,568 $ 977,981 $ 240,281
Cost of revenues 140,325 12,522 158,330 19,521
-------------- -------------- ------------- -------------
Gross margin 538,872 95,046 819,651 220,760
-------------- -------------- ------------- -------------
Expenses:
Selling, general and administrative 3,383,999 3,306,801 6,577,793 5,453,702
Product development and research 2,590,988 2,483,627 4,718,252 4,139,276
Amortization of intangible assets 380,775 607,136 761,550 1,214,273
-------------- -------------- ------------- -------------
Total expenses 6,355,762 6,397,564 12,057,595 10,807,251
-------------- -------------- ------------- -------------
Loss from operations (5,816,890) (6,302,518) (11,237,944) (10,586,491)
-------------- -------------- ------------- -------------
Other income (expense):
Interest income 68,386 19,276 96,321 57,524
Interest expense (47,759) (66,096) (105,508) (68,988)
-------------- -------------- ------------- -------------
Total other income (expense), net 20,627 (46,820) (9,187) (11,464)
-------------- -------------- ------------- -------------
Loss before equity in net loss of affiliate (5,796,263) (6,349,338) (11,247,131) (10,597,955)
Equity in net loss of affiliate (204,640) (194,427) (432,946) (194,427)
-------------- -------------- ------------- -------------
Net loss (6,000,903) (6,543,765) (11,680,077) (10,792,382)
Other comprehensive loss - foreign currency translation (27,365) (2,048) (28,237) (2,048)
-------------- -------------- ------------- -------------
Comprehensive loss $ (6,028,268) $ (6,545,813) $ (11,708,314) $ (10,794,430)
============== ============== ============= =============
Basic and diluted net loss per common share $ (0.01) $ (0.03) $ (0.03) $ (0.05)
============== ============== ============= =============
See accompanying notes to condensed consolidated financial statements.
3
Fonix Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
Six Months Ended
June 30,
------------------------------
2002 2001
-------------- --------------
Cash flows from operating activities:
Net loss $ (11,680,077) $ (10,792,382)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash expense related to issuance of debentures, warrants, preferred and
common stock - 62,500
Additional Compensation expense related to issue of stock options and common stock 11,944 -
Accretion of discount on note receivable from affiliate (9,036) (3,628)
Accretion of discount on note payable from affiliate 34,193 40,690
Accretion of discount on note payable 28,143 -
Depreciation and amortization 952,027 1,430,243
Equity in net loss of affiliate 432,946 194,427
Changes in assets and liabilities:
Accounts receivable (38,422) 19,372
Inventory 9,074 (24,467)
Prepaid expenses and other current assets (148,044) (101,265)
Funds held in escrow - 2,151,006
Other assets (236,147) (18,695)
Accounts payable 602,055 291,897
Accrued liabilities 1,661,559 515,054
Accrued liabilities - related party (8,333) (62,500)
Other Current Liabilities 21,881 -
Deferred revenues 84,943 422,101
Cumulative foreign currency translation adjustment (26,199) (2,048)
-------------- --------------
Net cash used in operating activities (8,307,493) (5,877,695)
-------------- --------------
Cash flows from investing activities:
Purchase of property and equipment (90,880) (507,242)
Issuance of notes receivable (805,000) (302,909)
Investment in Affiliate - (200,000)
-------------- --------------
Net cash used in investing activities (895,880) (1,010,151)
-------------- --------------
Cash flows from financing activities:
Proceeds of note payable to related parties 358,307 -
Principal payments on capital lease obligation (19,767) (21,562)
Proceeds from sale of Class A common stock, net 10,122,345 6,601,950
Proceeds from exercise of stock options - 9,801
Payments on note payable to affiliate (550,000) (200,000)
Payments on note payable (870,000) -
-------------- --------------
Net cash provided by financing activities 9,040,885 6,390,189
-------------- --------------
Net increase in cash and cash equivalents (162,488) (497,657)
Cash and cash equivalents at beginning of period 201,401 1,413,627
-------------- --------------
Cash and cash equivalents at end of period $ 38,913 $ 915,970
============== ==============
See accompanying notes to condensed consolidated financial statements.
4
Fonix Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Six Months Ended June 30,
------------------------------
2002 2001
------------- --------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 79,547 $ 43,384
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Six Months Ended June 30, 2002:
Warrants for the purchase of 450,000 shares of Class A common stock,
valued at $696,000, expired.
For the Six Months Ended June 30, 2001:
Preferred stock dividends of $9,281 were accrued on Series D and Series F
preferred stock.
164,500 shares of Series D preferred stock and related dividends of
$320,949 were converted into 13,978,440 shares of Class A common
stock.
6,073 shares of Series F preferred stock and related dividends of $6,853
were converted into 519,067 shares of Class A common stock.
Warrants for the purchase of 250,000 shares of Class A common stock
valued at $62,500 were issued in payment for a perpetual, nonexclusive
technology license.
A non-interest bearing promissory note was issued in the amount of
$2,600,000 to purchase 1,780,818 shares of Series A preferred stock of
Audium Corporation.
See accompanying notes to condensed consolidated financial statements.
5
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements of Fonix Corporation and subsidiaries (collectively, the
"Company" or "Fonix") have been prepared by the Company pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the following disclosures are adequate to make the
information presented not misleading.
These condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) that, in the opinion of
management, are necessary to present fairly the financial position and results
of operations of the Company for the periods presented. The Company's business
strategy is not without risk, and readers of these condensed consolidated
financial statements should carefully consider the risks set forth under the
heading "Certain Significant Risk Factors" in the Company's 2001 Annual Report
on Form 10-K.
Operating results for the six months ended June 30, 2002, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2002. The Company suggests that these condensed consolidated financial
statements be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's 2001 Annual Report on Form 10-K.
The Company has incurred significant losses since inception. The Company
incurred negative cash flows from operating activities of $8,307,493 during the
six months ended June 30, 2002. Sales of products based on the Company's
technologies have not been sufficient to finance ongoing operations. As of June
30, 2002, the Company had negative working capital of $8,465,874 and an
accumulated deficit of $179,296,449. The Company has drawn all capital available
under its equity lines of credit. Accordingly, there is substantial doubt about
the Company's ability to continue as a going concern. The Company's continued
existence is dependent upon several factors, including the Company's success in
(1) increasing license, royalty, product, and services revenues, (2) raising
sufficient additional debt or equity funding and (3) minimizing or decreasing
operating costs.
Net Loss Per Common Share - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
As of June 30, 2002 and 2001, there were outstanding common stock equivalents to
purchase 32,189,576 and 25,177,817 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 tables are reconciliations of the net loss numerator of basic and
diluted net loss per common share for the three months and six months ended June
30, 2002 and 2001:
Three months ended June 30,
2002 2001
-------------------------- --------------------------
Per Share Per Share
Amount Amount Amount Amount
-------------- -------- ------------- ---------
Net loss attributable to
common stockholders $ (6,000,903) $ (0.01) $ (6,543,765) $ (0.03)
Weighted average common shares
outstanding 471,938,769 213,416,041
6
Six months ended June 30,
-------------------------
2002 2001
------------------------------------- --------------------------------
Per Share Per Share
Amount Amount Amount Amount
Net loss $ (11,680,077) $(10,792,382)
Preferred stock dividends - (9,281)
-------------------- ----------
Net loss attributable to common
stockholders $ (11,680,077) $ (0.03 ) $ (10,801,663) $ (0.05)
=================== ========= ============== ========
Weighted average common shares
outstanding 431,443,574 207,611,230
==================== ==============
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 3 and 5).
Comprehensive Loss - Other comprehensive loss presented in the accompanying
condensed consolidated financial statements consists of cumulative foreign
currency translation adjustments. The Company had no items of comprehensive loss
prior to April 1, 2001.
Recently Enacted Accounting Standards - In July 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("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 did
not have an impact on the Company's financial position and 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.
Effective January 1, 2002, the Company adopted the requirements of SFAS No. 142.
Accordingly, effective January 1, 2002, amortization of goodwill and intangible
assets with indefinite lives was discontinued. Other intangible assets will
continue to be amortized over their respective useful lives.
During 2002, the Company engaged an independent valuation firm to assess its
goodwill and intangible assets with indefinite lives for impairment. The
resulting appraisal indicated no impairment and the application of the test for
impairment required by SFAS No. 142 had no effect on the Company's financial
position or results of operations, except for the change in amortization of
goodwill and intangible assets with indefinite lives.
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. The Company's adoption of this
statement on January 1, 2002, did not 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. The
adoption of this statement on January 1, 2002, did not have a material effect on
the Company's financial position or results of operations.
7
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Among other provisions, this statement modifies the criteria for classification
of gains or losses on debt extinguishments such that they are not required to
classified as extraordinary items if they do not meet the criteria for
classification as extraordinary items in APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Company will be required to apply the provisions of this
standard to transactions occurring after December 31, 2002. The adoption of this
standard in 2003 is not expected to have a material effect on the Company's
financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The statement requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company will
be required to apply this statement prospectively for any exit or disposal
activities initiated after December 31, 2002. The adoption of this standard 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 period
condensed consolidated financial statements to conform with the current period
presentation.
2. CONVERTIBLE NOTES RECEIVABLE
On December 1, 2001, the Company, as the lender, established a revolving line of
credit and received a convertible promissory note from Unveil Technologies, Inc.
("Unveil"), that permits Unveil to draw up to $2,000,000 for operations and
other purposes. Unveil is a developer of natural language understanding
solutions for customer resource management (CRM) applications. Fonix intends to
obtain a license to Unveil's applications when completed and has made the loan
to Unveil to facilitate and expedite the development and commercialization of
Uneveil's speech-enabled CRM software. Draws on the line of credit bear interest
at an annual rate of seven percent, which interest is payable quarterly
beginning September 30, 2002. The balance due under the line of credit is
secured by Unveil's CRM software and source code therefor and other assets of
Unveil. The Company is a senior creditor to Unveil. The unpaid principal,
together with interest accrued thereon, is due and payable on December 31, 2002,
and is convertible into common shares of Unveil at the Company's option. Based
upon borrowings through June 30, 2002, such conversion at that date would have
represented approximately 12 percent of the ownership of Unveil.
During the six months ended June 30, 2002, Unveil drew $805,000 on the line of
credit, bringing total draws on the line of credit to $1,435,000 as of June 30,
2002. Subsequent to June 30, 2002, Unveil drew an additional $15,000.
3. 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 five
percent per year and has a term of four years. The Audium Note is convertible
into shares of Audium Series A Convertible Preferred Stock ("Audium Preferred
Stock") and is secured by Audium's intellectual property.
Management determined that a 12 percent annual interest rate better reflects the
risk characteristics of the Audium
8
Note. Accordingly, interest was imputed at 12 percent and the Audium Note was
recorded at its original present value of $302,909. For the three months and six
months ended June 30, 2002, the Company recorded interest income of $9,519 and
$19,038, respectively, including contractual and imputed interest. As of June
30, 2002, the balance of the Audium Note was $331,345, net of the unaccreted
discount of $68,655.
Investment in Affiliate - In April 2001, the Company entered into 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.
At closing, Audium issued 14 Audium Preferred Share certificates to Fonix, each
certificate for 136,986 shares, 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 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.
The investment in Audium does not provide the Company with rights to any
technology developed by Audium, but the Company must obtain a license should it
choose to do so. The Company would not own an interest sufficient to control
Audium, even if it were to convert the Audium Note to Audium Preferred Stock,
and still would not benefit directly from the research and development being
done by Audium. As a result, the Company has determined that it is appropriate
to account for its investment, which represents 26.7 percent of Audium's voting
stock, under the equity method and not as a research and development
arrangement. Accordingly, for the three months and six months ended June 30,
2002, the Company recognized losses consisting of the following:
Three Months Six Months
Ended June 30, Ended June 30,
2002 2002
----------------------- ----------------------
Company share of Audium net loss $ 113,065 $ 249,798
Amortization of difference between purchase price of Audium Preferred
Stock and Company's share of Audium's net stockholders' deficit $ 91,574 $ 183,148
----------------------- ----------------------
Total equity in loss of affiliate $ 204,639 $ 432,946
======================= ======================
The difference between the total purchase price of the Audium Preferred Stock
and the Company's portion of Audium's net stockholders' deficit at the time of
the purchase was $2,930,379, which was allocated to completed core technology.
The excess purchase price allocated to the completed core technology is being
amortized on a straight- line basis over a period of eight years.
The fair value of this investment is determined based on Audium's estimated
future net cash flows considering the status of Audium's product development.
The Company evaluates this investment for impairment annually and more
frequently if indications of decline in value exist. An impairment loss that is
other than temporary is recognized during the period it is determined to exist.
An impairment is determined to be other-than-temporary if estimated future net
cash flows are less than the carrying value of the investment. If projections
indicate that the carrying value of the investment will not be recoverable, the
carrying value is reduced by the estimated excess of the carrying value over the
estimated discounted cash flows. There is a reasonable possibility that in the
near future estimated future cash flows from the investment in Audium could
change and that the effect of the change could be material to the Company's
financial position or results of operation. No impairment loss has been
determined to exist through June 30, 2002 or subsequently nor has such a loss
been recognized with respect to the investment in Audium.
Note Payable to Affiliate - The Fonix Note bears no interest unless an event of
default occurs, in which case it will
9
bear interest at 12 percent per year. No events of default have occurred to
date.
Through June 30, 2002, payments amounting to $1,800,000 were made as required by
the modified terms. The remaining balance of $1,000,000 due Audium will be paid
in monthly installments through January 2003.
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 three months and six months ended June 30, 2002, the Company
recorded interest expense of $19,426 and $55,428, respectively, related to this
note.
4. INTANGIBLE ASSETS
Intangible assets consist of purchased core technology, customer relationships,
trademarks, patents and goodwill arising from the purchase of assets from Force
Computers, Inc., and the acquisition of AcuVoice, Inc. Also included are direct
costs incurred by the Company in applying for patents covering its internally
developed technologies. Amortization is computed on a straight-line basis over
the estimated useful lives ranging from five to ten years. As of June 30, 2002
and December 31, 2001, intangible assets consisted of the following:
At June 30, 2002 At December 31, 2002
------------------------------------------ --------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
--------------------- ---------------- --------------------- -------------------
Purchased core technologies $ 12,127,000 $ (6,062,450) $ 12,127,000 $ (5,316,200)
Customer relationships 306,000 (15,300) 306,000 -
Patents 164,460 (155,487) 164,460 (145,523)
--------------------- ---------------- --------------------- -------------------
Total $ 12,597,460 $ (6,233,237) $ 12,597,460 $ (5,461,722)
===================== ================ ===================== ===================
The Company has trademarks not subject to amortization, recorded at a carrying
value of $42,000 at June 30, 2002 and December 31, 2001. This asset is
considered to have an indefinite useful life.
Estimated future amortization expense for intangible assets subject to
amortization:
For the Year Ended December 31, Amount
- -------------------------------- ------
2002 $ 777,996
2003 1,555,992
2004 1,555,992
2005 1,555,992
2006 1,555,992
Accumulated amortization on goodwill was $2,295,599 at June 30, 2002 and
December 31, 2001. In accordance with the provisions of SFAS No. 142, the
Company no longer amortizes goodwill.
The carrying values of the Company's long-lived assets is reviewed for
impairment whenever events or changes in circumstances indicate that they may
not be recoverable. If such an event were to occur, 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 were
to 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 2002, the
Company engaged an independent valuation firm to assess its goodwill and
intangible assets
10
with indefinite lives for impairment. The resulting appraisal indicated no
impairment, and therefore management of the Company did not consider goodwill or
other intangible assets to be impaired. However, should the Company's marketing
and sales plans not materialize in the near term, the realization of the
Company's goodwill and other intangible assets could be severely and negatively
impacted. The accompanying condensed 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" in Note 1). Upon initial application of SFAS No. 142, the
Company reassessed the useful lives of its intangible assets and determined that
no changes to estimated useful lives were necessary as of June 30, 2002.
Amortization of goodwill and the effects on net loss and basic and diluted loss
per share of excluding such goodwill amortization from the six months ended June
30, 2002 and 2001 and from the years ended December 31, 2001, 2000 and 1999 is
as follows:
For the Six Months Ended For the Years Ended December 31,
-------------------------------- --------------- -------------- --------------
June 30, 2002 June 30, 2001 2001 2000 1999
---------------- --------------- --------------- -------------- --------------
Reported loss before extraordinary item $ (11,680,077) $ (10,792,382) $ (24,566,807) $ (22,810,677) $(22,136,276)
Add back goodwill amortization - 514,773 1,029,545 1,029,545 1,189,896
Adjustment to impairment loss
on handwriting recognition technology - - (1,546,455) - -
---------------- --------------- --------------- -------------- --------------
Adjusted loss before extraordinary item (11,680,077) (10,277,609) (25,083,717) (21,781,132) (20,946,380)
Extraordinary item - gain on forgiveness - - - 49,448 473,857
of debt
---------------- --------------- --------------- -------------- --------------
Adjusted net loss $ (11,680,077) $ (10,277,609) $ (25,083,717) $(21,731,684) $(20,472,523)
================ =============== =============== ============== ==============
Basic and diluted earnings per share, as reported:
Loss before extraordinary item $ (0.03) $ (0.05) $ (0.10) $ (0.16) $ (0.32)
Net loss $ (0.03) $ (0.05) $ (0.10) $ (0.16) $ (0.31)
Basic and diluted earnings per share,
excluding goodwill amortization:
Loss before extraordinary item $ (0.03) $ (0.05) $ (0.10) $ (0.15) $ (0.30)
Net loss $ (0.03) $ (0.05) $ (0.10) $ (0.15) $ (0.29)
5. PROMISSORY NOTE
In December 2001, the Company entered into an Asset Purchase Agreement with
Force Computers, Inc. ("Force"). As part of the purchase price Fonix issued a
non-interest bearing promissory note in the amount of $1,280,000 (the "Force
Note"). Installment payments under the Force Note are due over the 12 month
period following the date of purchase. Management determined that a seven
percent annual interest rate reflects the risk characteristics of the Force
Note. Accordingly, interest has been imputed at seven percent and the Company
recorded a discount of $40,245. For the three months and six months ended June
30, 2002, the Company recorded interest expense of $8,688 and $28,372,
respectively, related to the Force Note.
As collateral for the Force Note, 7,000,000 shares of the Company's Class A
common stock were placed into escrow. To date, all required payments have been
made. As of June 30, 2002, payments amounting to $410,000 remained outstanding
under the Force Note, including a payment of $160,000 that was due June 12,
2002. Subsequent to June 30, 2002, the June 12 installment payment was made.
6. NOTES PAYABLE - RELATED PARTIES
Certain executives officers of the Company (the "Lenders") sold shares of the
Company's Class A common stock owned by them and advanced the resulting proceeds
amounting to $333,308 to the Company under the terms of a revolving line of
credit and related promissory note. The funds were advanced for use in Company
operations. The advances bear interest at 10 percent per annum, payable on a
semi-annual basis. The entire principal, along with unpaid accrued interest and
any other unpaid charges or related fees, is due and payable on June 10, 2003.
Any time after December 11, 2002, all or part of the outstanding balance and
unpaid interest may be converted at the option of the Lenders into shares of
Class A common stock of the Company. The conversion price is the average closing
bid
11
price of the shares at the time of the advances. If converted, the conversion
amount is divided by the conversion price to determine the number of shares to
be issued to the Lenders. To the extent the market price of the Company's shares
is below the conversion price at the time of conversion, the Lenders are
entitled to receive additional shares equal to the gross dollar value received
from the original sale of the shares. A beneficial conversion feature of $14,917
was recorded as interest expense in connection with this transaction. The
Lenders may also receive additional compensation as determined appropropriate by
the Board of Directors.
The advances were secured by the Company's intellectual property rights, which
security interest was released when the increase in authorized capital of
300,000,000 shares of Class A common stock was approved by the Company's
shareholders at the Fonix Annual Meeting on July 12, 2002.
7. EQUITY LINES OF CREDIT
Equity Line of Credit - On August 8, 2000, the Company entered into a Private
Equity Line Agreement (the "Initial Equity Line") with a private investor (the
"Equity Line Investor"), which gave the Company the right to draw up to
$20,000,000 for Company operations and other purposes through a mechanism of
draws and puts of stock. The Company was 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 was determined by dividing the dollar
amount of the draws 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 tendered the put notice to the Equity Line Investor. The Equity
Line Investor funded the amounts requested by the Company within two trading
days after the seven trading-day period.
On May 8, 2002, the Company and the Equity Line Investor amended the Initial
Equity Line to increase the balance available under the Equity Line from
$20,000,000 to $22,000,000. Accordingly, as of May 8, 2002, $2,000,000 was
available to be drawn under the Equity Line.
During the six months ended June 30, 2002, draws under the Initial Equity Line
amounting to $3,633,817 were converted into 40,692,920 shares of Class A common
stock. From inception of the Initial Equity Line through June 30, 2002, draws
amounting to $20,617,324 were converted into 91,083,516 shares of Class A common
stock. As of August 7, 2002, $1,382,676 remains unutilized under the Initial
Equity Line, as amended; however, no registered shares remain available to
facilitate a draw of this amount. Therefore, this amount is unavailable to the
Company at this time.
Second Equity Line of Credit - On April 6, 2001, the Company entered into a
second 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.
During the six months ended June 30, 2002, draws amounting to $5,728,846 were
converted into 93,586,995 shares of Class A common stock. From inception of the
Second Equity Line through June 30, 2002, draws amounting to $19,153,846 were
converted into 211,600,000 shares of Class A common stock. As of August 7, 2002,
$846,154 remains unutilized under the Second Equity Line; however, no registered
shares remain available to facilitate a draw of this amount. Therefore, this
amount is unavailable to the Company at this time.
Third Equity Line of Credit - On June 27, 2002, the Company entered into a third
equity line agreement (the "Third Equity Line") with the Equity Line Investor.
Under the Third Equity Line, the Company has the right to draw up to $20,000,000
under terms substantially identical to the Initial Equity Line. On June 27,
2002, the Company filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-2 to register the resale of up
to 200,000,000 shares of the Company's Class A common stock by the Equity Line
Investor. As of August 7, 2002, the registration statement had not been declared
effective by the Commission, and as such, the Company was unable to draw funds
under the Third Equity Line as of that date. Prior to June 30, 2002, the Equity
Line Investor advanced the Company $182,676 against future draws on the Third
Equity Line. As of August 7, 2002, no shares had been issued under the Third
Equity Line.
Subscriptions Receivable - Proceeds from certain draws on the equity lines prior
to December 31, 2001 had not been received by the Company as of those dates. The
cash proceeds in the amount of $852,970 were subsequently
12
received in January 2002.
8. COMMON STOCK, STOCK OPTIONS AND WARRANTS
Class A Common Stock - During the six months ended June 30, 2002, 134,279,915
shares of Class A common stock were issued in connection with draws on the
equity lines (see Note 7). No shares of Class A common stock were issued as a
result of the exercise of stock options or warrants during the same period.
Stock Options - During the six months ended June 30, 2002, the Company granted
options to employees to purchase 5,229,000 shares of Class A common stock and
granted options to directors to purchase 1,000,000 shares of Class A common
stock. The options have exercise prices ranging from $0.05 to $0.11 per share,
which were the quoted fair market price of the stock on the dates of grant. Of
the options granted during this six-month period, 5,229,000 vest over the three
years following issuance and 1,000,000 vested immediately. These options expire
within ten years from the date of grant if not exercised. Using the
Black-Scholes pricing model, the weighted average fair value of the employee and
director options were $0.08 and $0.04 per share, respectively. As of June 30,
2002, the Company had a total of 29,597,909 options to purchase Class A common
shares outstanding.
The Company's option plans provide for stock appreciation rights that allow the
grantee to receive shares of the Company's Class A common stock equivalent in
value to the difference between the designated exercise price and the fair
market value of the Company's stock at the date of exercise. As of June 30,
2002, 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.
Warrants - As of August 7, 2002, the Company had warrants to purchase a total of
2,425,000 shares of Class A common stock outstanding that expire beginning in
2002 through 2010. Warrants issued for services were recorded at their fair
value determined using the Black-Scholes pricing model. The resulting values
were recorded in operating expenses in the periods covered by the services
rendered.
9. FONIX UK, LTD.
On May 30, 2002, the Company established Fonix UK, Ltd., a United Kingdom
subsidiary, ("Fonix UK"). Fonix UK will facilitate the Company's development,
marketing and investment opportunities in Europe. To date, Fonix UK has no
operations.
10. SUBSEQUENT EVENTS
On July 12, 2002, the Company held its Annual Meeting of Shareholders in Boston,
Massachusetts. The record date for the meeting was May 24, 2002, on which date
there were 482,805,888 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 399,431,186 11,146,172
Roger D. Dudley 399,361,304 11,216,084
John A. Oberteuffer, Ph.D 404,903,223 5,674,135
William A. Maasberg, Jr. 403,439,549 7,137,809
Mark S. Tanner 403,604,229 6,973,129
13
The second 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 800,000,000 shares of Class A
Common Stock. The results of the voting were 397,433,216 shares in favor,
11,766,861 shares against, and 1,377,311 shares withheld or abstaining.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This quarterly report on Form 10-Q contains, in addition to historical
information, forward-looking statements that involve substantial risks and
uncertainties. Actual results could differ materially from the results the
Company anticipates and which are discussed in the forward-looking statements.
Factors that could cause or contribute to such differences are discussed in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
To date the Company has earned only limited revenue from operations and intends
to continue to rely primarily on financing through the sale of its equity and
debt securities to satisfy future capital requirements.
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 June 30, 2002, 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 incurred negative cash flows from operating activities of $8,307,493
during the six months ended June 30, 2002. Sales and licensing of products based
on the Company's technologies have not been sufficient to finance ongoing
operations. As of June 30, 2002, the Company had negative working capital of
$8,465,874 and an accumulated deficit of $179,296,449. The Company has drawn all
capital available under its initial and second equity lines. While a third
equity line is in place, it is unavailable to the Company until a registration
statement covering the underlying securities is declared effective. The
Company's continued existence is dependent upon several factors, including the
Company's success in (1) increasing license, royalty, product, and services
revenues, (2) raising sufficient additional equity and debt funding and (3)
minimizing and reducting operating costs. Until sufficient revenues are
generated from operating activities, the Company expects to continue to fund its
operations through the sale of its equity and debt securities.
The Company continues to emphasize technologies and 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 condensed 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. A complete discussion of
significant accounting policies and areas where substantial judgements by
management are made is included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2001.
Recently Enacted Accounting Standards - In July 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("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 did
not have an impact on the Company's financial position and results of
operations.
15
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 was discontinued. Other intangible assets will
continue to be amortized over their useful lives.
Effective January 1, 2002, the Company adopted the requirements of SFAS No. 142.
During 2002, the Company engaged an independent valuation firm to assess its
goodwill and intangible assets with indefinite lives for impairment. The
resulting appraisal indicated no impairment and the application of the test for
impairment required by SFAS No. 142 had no effect on the Company's financial
position or results of operations, except for the change in amortization of
goodwill and intangible assets with indefinite lives.
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. The Company's adoption of this
statement on January 1, 2002, did not 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. The
Company's adoption of this statement on January 1, 2002, did not have a material
effect on the Company's financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Among other provisions, this statement modifies the criteria for classification
of gains or losses on debt extinguishments such that they are not required to
classified as extraordinary items if they do not meet the criteria for
classification as extraordinary items in APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Company will be required to apply the provisions of this
standard to transactions occurring after December 31, 2002. The Company's
adoption of this standard in 2003 is not expected to have a material effect on
the Company's financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The statement requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company will
be required to apply this statement prospectively for any exit or disposal
activities initiated after December 31, 2002. The Company's adoption of this
standard is not expected to have a material effect on the Company's financial
position or 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 our software products to end users and from royalties. The Company
also generates service revenues from the sale of consulting and development
services.
Revenues of all types are recognized when contingencies such as conditions of
acceptance of functionality, rights of return, price protection, etc. are
confirmed or can be reasonably estimated, as appropriate. Revenues from
development and consulting services are recognized as the services are completed
and accepted. Revenue for hardware units delivered is recognized when delivery
is verified and collection assured. Revenue for products distributed through
wholesale channels and resellers is recognized upon verification of final
sell-through to end users, after consideration of rights of return.
Revenues from licenses and royalties are recognized upon shipment of the
software by the Company or by the vendor. If significant post-contract
obligations exist, revenues are recognized when those obligations have been
satisfied. Revenues from maintenance contracts are recognized over the term of
the contract.
16
Revenues applicable to multiple-element fee arrangements are allocated among the
elements such as license agreements and post-contract obligations according to
vendor-specific objective evidence. These elements vary based upon factors such
as the type of license, volume of units licensed and other related factors.
Results of Operations
Three months ended June 30, 2002, compared with three months ended June 30, 2001
During the three months ended June 30, 2002, the Company recorded revenues of
$679,197, reflecting an increase of $571,629 over the same period in the
previous year. Cost of revenues were $140,325, an increase of $127,803,
resulting from increased cost of services performed in custom engineering
activities and cost of hardware sales related to revenue generated in assistive
markets through the Company's original equipment manufacturer ("OEM") sales
channels that were new to the Company in 2002.
Selling, general and administrative expenses were $3,383,999 and $3,306,800 for
the three months ended June 30, 2002 and 2001, respectively. The increase of
$77,199 includes increases of $142,527 in compensation-related expenses, $87,606
in consultants, outside services and promotional expenses, $33,159 in occupancy
charges and $24,277 in other operating expenses, all of which are related to
increases in sales, marketing and business development personnel, and efforts
related to increased marketing and promotional activities. Administrative
expenses were also increased by $54,779 for costs related to the preparation of
filings and materials for the annual shareholders meeting that were incurred in
the third quarter of 2001. These increases were offset by decreases of $179,220
in legal and accounting fees resulting from fewer regulatory filings completed
during the period and $82,468 in travel and entertainment expenses.
Product development and research expenses were $2,590,988 and $2,483,627 for the
three months ended June 30, 2002 and 2001, respectively, reflecting an increase
of $107,361. Increased internal resources and development expertise resulted in
an increase of $321,788 in conpensation-related expenses. This internal capacity
allowed the Company to reduce its reliance on external service providers in the
second quarter resulting in a decrease of $132,308 in consultant and outside
service expenses and $72,577 in other operating expenses related to the purchase
of software licenses and related services.
Amortization of intangible assets was $380,775 and $607,137, for the three
months ended June 30, 2002 and 2001, respectively. The decrease of $226,362 is a
result of the write down of certain intangible assets in 2001 and the change in
accounting for amortization of goodwill dictated by SFAS No. 142. Based on the
value of current intangible assets, the Company expects amortization expense to
be approximately $762,000 for the remainder of 2002 and $1,524,000 per year
thereafter until the underlying assets have been completely amortized.
Six months ended June 30, 2002, compared with six months ended June 30, 2001
During the six months ended June 30, 2002, the Company recorded revenues of
$977,981, reflecting an increase of $737,700 over the same period in the
previous year. Cost of revenues were $158,330, an increase of $138,809,
resulting from increased cost of services performed in custom engineering
activities and increased cost of hardwares sales related to the revenue
generated in assistive markets through the Company's OEM sales channels that are
new to the Company in 2002.
Selling, general and administrative expenses were $6,577,793 and $5,453,702 for
the six months ended June 30, 2002 and 2001, respectively. The increase of
$1,124,091 includes increases of $447,419 in compensation-related expenses,
$193,903 in consultants, outside services and promotional expenses, $73,083 in
occupancy charges and $481,293 in other operating expenses that are all related
to increases in sales, marketing and business development personnel, and efforts
related to increased marketing and promotional activities as well as expansion
into assistive markets. Administrative expenses were also increased by $120,000
in consulting fees related to strategic planning and financing efforts and
$53,510 for costs related to the preparation of filings and materials for the
annual shareholders meeting that were incurred in the third quarter of 2001.
These increases were offset by decreases of $154,879 in legal and accounting
fees resulting from fewer regulatory filings completed during the period and
$99,771 in travel and entertainment expenses.
17
Product development and research expenses were $4,718,252 and $4,139,276 for the
six months ended June 30, 2002 and 2001, respectively, reflecting an increase of
$578,976. Increases of $669,567 in compensation-related expenses and $45,697 in
consultants and outside services reflect the Company's efforts to increase its
capacity to develop speech-enabling solutions as well as the cost of additional
employees added in connection with the acquisition from Force Computers. These
increases were offset by a decrease of $137,138 in occupancy and other operating
expenses resulting from reductions in the purchase of software licenses and
related services.
Amortization of intangible assets was $761,550 and $1,214,273, for the six
months ended June 30, 2002 and 2001, respectively. The decrease of $452,723 is a
result of the write down of certain intangible assets in 2001 and the change in
accounting for amortization of goodwill dictated by SFAS No. 142. Based on the
value of current intangible assets, the Company expects amortization expense to
be approximately $778,000 for the remainder of 2002 and $1,556,000 per year
thereafter until the underlying assets have been completely amortized.
Liquidity and Capital Resources
While the Company anticipates that revenues will increase during the next 12
months, it must raise additional funds to be able to satisfy its cash
requirements. 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 which generate revenues such that it will be able to
finance ongoing operations from license, royalty and services revenues. There
can be no assurance that the Company will be able to generate substantial
revenues from 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 and declining market value of the
Company's shares may limit the amount available in this manner. The Company
currently has drawn all available funds on existing equity lines, but has
recently entered into a third equity line with the same investor under which the
Company issue up to 200,000,000 shares of Class A common stock when the
registration of such shares is declared effective. The Company currently has no
alternative plans for funding operations other than issuance of debt and equity
securities, but it continues to explore other options for additional funding for
its operations. The Company's shareholders recently approved an increase of
300,000,000 common shares in authorized capital in order to facilitate the
current funding process.
Net cash used in operating activities of $8,307,493 for the six months ended
June 30, 2002, resulted principally from the net loss incurred of $11,680,077
offset by non-cash expenses pertaining to depreciation and amortization of
$952,027 and equity in net loss of affiliate of $432,946. Payments to vendors
and employees have also been delayed since June 2002 resulting in an increase of
$2,263,614 in accounts payable and accrued liabilities outstanding. Net cash
used in investing activities of $895,880 for the six months ended June 30, 2002
consisted primarily of advances under a convertible note payable of $805,000.
Net cash used in operating and investing activities was offset by net cash
provided by financing activities of $9,040,887 consisting primarily of the
receipt of $10,122,346 in cash related draws under the Company's equity lines of
credit offset, in part, by $1,420,000 in payments on notes payable.
The Company had negative working capital of $8,465,874 at June 30, 2002,
compared to negative working capital of $6,102,151 at December 31, 2001. Current
assets decreased by $838,066 to $406,701 from December 31, 2001, to June 30,
2002. Current liabilities increased by $1,525,657 to $8,872,575 during the same
period. The change in working capital from December 31, 2001 to June 30, 2002,
was primarily attributable to the timing of payments on operating obligations
such as accounts payable and accrued liabilities, and receipts of funding under
the Company's equity lines of credit. Total assets were $13,984,525 at June 30,
2002, compared to $15,068,538 at December 31, 2001.
Convertible Note Receivable and Line of Credit
On December 1, 2001, the Company, as the lender, established a revolving line of
credit and received a convertible promissory note from Unveil Technologies, Inc.
("Unveil"), that permits Unveil to draw up to $2,000,000 for operations and
other purposes. Unveil is a developer of natural language understanding
solutions for customer
18
resource management (CRM) applications. Fonix intends to obtain a license to
Unveil's applications when completed and has made the loan to Unveil to
facilitate and expedite the development and commercialization of Uneveil's
speech-enabled CRM software. Draws on the line of credit bear interest at an
annual rate of seven percent, which interest is payable quarterly beginning
September 30, 2002. The balance due under the line of credit is secured by
Unveil's CRM software and source code therefor and other assets of Unveil. The
Company is a senior creditor to Unveil. The unpaid principal, together with
interest accrued thereon, is due and payable on December 31, 2002, and is
convertible into common shares of Unveil at the Company's option. Based upon
borrowings through June 30, 2002, such conversion at that date would have
represented approximately 12 percent of the ownership of Unveil.
During the six months ended June 30, 2002, Unveil drew $805,000 on the line of
credit, bringing total draws on the line of credit to $1,435,000 as of June 30,
2002. Subsequent to June 30, 2002, Unveil drew an additional $15,000.
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 five
percent per year and has a term of four years. The Audium Note is convertible
into shares of Audium Series A Convertible Preferred Stock ("Audium Preferred
Stock") and is secured by Audium's intellectual property.
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 three months and six months ended June 30, 2002, the Company
recorded interest income of $9,519 and $19,038, respectively, including
contractual and imputed interest. As of June 30, 2002, the balance of the Audium
Note was $331,345, net of the unaccreted discount of $68,655.
Investment in Affiliate - In April 2001, the Company entered into 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.
At closing, Audium issued 14 Audium Preferred Share certificates to Fonix, each
certificate for 136,986 shares, 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 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.
The investment in Audium does not provide the Company with rights to any
technology developed by Audium, but the Company must obtain a license should it
choose to do so. The Company would not own an interest sufficient to control
Audium, even if it were to convert its notes receivable to Audium Series A
Convertible Preferred Stock, and still would not benefit directly from the
research and development being done by Audium. As a result, the Company has
determined that it is appropriate to account for its investment, which
represents 26.7 percent of Audium's voting stock, under the equity method and
not as a research and development arrangement. Accordingly, for the three months
and six months ended June 30, 2002, the Company recognized losses consisting of
the following:
19
Three Months Six Months Ended
Ended June 30, 2002 June 30, 2002
------------------ ------------------
Company share of Audium net loss $ 113,065 $ 249,798
Amortization of difference between purchase price of Audium Preferred
Stock and Company's share of Audium's net stockholders' deficit $ 91,574 $ 183,148
----------------- -----------------
Total equity in loss of affiliate $ 204,639 $ 432,946
================= =================
The difference between the total purchase price of the Audium Preferred Stock
and the Company's portion of Audium's net stockholders' deficit at the time of
the purchase was $2,930,379 and is amortized on a straight-line basis over a
period of eight years.
The difference between the total purchase price of the Audium Preferred Stock
and the Company's portion of Audium's net stockholders' deficit at the time of
the purchase was $2,930,379, which was allocated to completed core technology.
The excess purchase price allocated to the completed core technology is being
amortized on a straight- line basis over a period of eight years.
The fair value of this investment is determined based on Audium's estimated
future net cash flows considering the status of Audium's product development.
The Company evaluates this investment for impairment annually and more
frequently if indications of decline in value exist. An impairment loss that is
other than temporary is recognized during the period it is determined to exist.
An impairment is determined to be other-than-temporary if estimated future net
cash flows are less than the carrying value of the investment. If projections
indicate that the carrying value of the investment will not be recoverable, the
carrying value is reduced by the estimated excess of the carrying value over the
estimated discounted cash flows. There is a reasonable possibility that in the
near future estimated future cash flows from the investment in Audium could
change and that the effect of the change could be material to the Company's
financial position or results of operation. No impairment loss has been
determined to exist through June 30, 2002 or subsequently nor has such a loss
been recognized with respect to the investment in Audium.
Note Payable to Affiliate - The Fonix Note 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.
Through June 30, 2002, payments amounting to $1,800,000 were made as required by
the modified terms. The remaining balance of $1,000,000 due Audium will be paid
in monthly installments through January 2003.
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 three months and six months ended June 30, 2002, the Company
recorded interest expense of $19,426 and $55,428, respectively, related to this
note.
Promissory Note
In December 2001, the Company entered into an Asset Purchase Agreement with
Force Computers, Inc. ("Force"). As part of the purchase price Fonix issued a
non-interest bearing promissory note in the amount of $1,280,000 (the "Force
Note"). Installment payments under the Force Note are due over the 12 month
period following the date of purchase. Management determined that a seven
percent annual interest rate reflects the risk characteristics of the Force
Note. Accordingly, interest has been imputed at seven percent and the Company
recorded a discount of $40,245. For the three months and six months ended June
30, 2002, the Company recorded interest expense of $8,688 and $28,372,
respectively, related to the Force Note.
As collateral for the Force Note, 7,000,000 shares of the Company's Class A
common stock were placed into escrow. To date, all required payments have been
made. As of June 30, 2002, payments amounting to $410,000 remained outstanding
under the Force Note, including a payment of $160,000 that was due June 12,
2002. Subsequent to June 30, 2002, the June 12 installment payment was made.
Notes Payable - Related Parties
Certain executives officers of the Company (the "Lenders") sold shares of the
Company's Class A common stock
20
owned by them and advanced the resulting proceeds amounting to $333,308 to the
Company under the terms of a revolving line of credit and related promissory
note. The funds were advanced for use in Company operations. The advances bear
interest at 10 percent per annum, payable on a semi-annual basis. The entire
principal, along with unpaid accrued interest and any other unpaid charges or
related fees, is due and payable on June 10, 2003. Any time after December 11,
2002, all or part of the outstanding balance and unpaid interest may be
converted at the option of the Lenders into shares of Class A common stock of
the Company. The conversion price is the average closing bid price of the shares
at the time of the advances. If converted, the conversion amount is divided by
the conversion price to determine the number of shares to be issued to the
Lenders. To the extent the market price of the Company's shares is below the
conversion price at the time of conversion, the Lenders are entitled to receive
additional shares equal to the gross dollar value received from the original
sale of the shares. A beneficial conversion feature of $14,917 was recorded as
interest expense in connection with this transaction. The Lenders may also
receive additional compensation as determined appropropriate by the Board of
Directors.
The advances were secured by the Company's intellectual property rights, which
security interest was released when the increase in authorized capital of
300,000,000 shares of Class A common stock was approved by the Company's
shareholders at the Fonix Annual Meeting on July 12, 2002.
The Company also had unsecured demand notes payable to former stockholders of an
acquired entity in the aggregate amount of $77,625 outstanding as of June 30,
2002. During 2000, certain holders of these notes made demand for payment. The
Company is attempting to negotiate a reduced payoff of these notes. The notes
remain unpaid and no additional demands for payment have been received by the
Company.
Equity Lines of Credit
During the six months ended June 30, 2002, 40,692,920 shares of Class A common
stock were issued in connection with draws of $3,633,817 against the Initial
Equity Line (see Note 7 of the Condensed Consolidated Financial Statements) On
May 8, 2002, the Company and the Equity Line Investor amended the Initial Equity
Line agreement to increase the balance available under the Initial Equity Line
from $20,000,000 to $22,000,000. Accordingly, as of May 8, 2002, an additional
$2,000,000 was available to be drawn under the Initial Equity Line. From
inception of the Initial Equity Line through June 30, 2002, 91,083,516 shares of
Class A common stock have been issued in connection with draws of $20,617,324.
As of August 7, 2002, $1,382,676 remains unutilized under the Initial Equity
Line, as amended; however, no registered shares remain available to facilitate
a draw of this amount. Therefore, this amount is unavailable to the Company at
this time.
During the six months ended June 30, 2002, 93,586,995 shares of Class A common
stock were issued in connection with draws of $5,728,846 against the Second
Equity Line (see Note 7 of the Condensed Consolidated Financial Statements).
From inception of the Second Equity Line through June 30, 2002, 211,600,000
shares of Class A common stock were issued in connection with draws of
$19,153,846. As of August 7, 2002, $846,154 remains unutilized under the Second
Equity Line; however, no registered shares remain available to facilitate a draw
of this amount. Therefore, this amount is unavailable to the Company at this
time.
The following table summarizes the transactions completed under the equity lines
to date:
Average Number of
Weighted Average Shares Issued Per Total Shares Issued
Equity Line Conversion Price Draw Under Equity Line
- ----------- ---------------- ------------------ --------------------
Initial Equity Line $ 0.228 4,554,176 91,083,516
Second Equity Line $ 0.091 11,775,556 211,600,000
On June 27, 2002, the Company entered into a the Third Equity Line Agreement
with the Equity Line Investor. Under the Third Equity Line, the Company has the
right to draw up to $20,000,000 under terms substantially identical to the
previous equity lines. On June 27, 2002, the Company filed with the Commission a
registration statement on Form S-2 to register the resale of up to 200,000,000
shares of the Company's Class A common stock by the Equity Line Investor. As of
August 7, 2002, the registration statement had not been declared effective by
the
21
Commission, and as such, the Company was unable to draw funds under the Third
Equity Line as of that date. Prior to June 30, 2002, the Equity Line Investor
advanced the Company $182,676 against future draws on the Third Equity Line. As
of August 7, 2002, no shares had been issued under the Third Equity Line.
Stock Options and Warrants
During the six months ended June 30, 2002, the Company granted options to
employees to purchase 5,229,000 shares of Class A common stock and granted
options to directors to purchase 1,000,000 shares of Class A common stock. The
options have exercise prices ranging from $0.05 to $0.11 per share, which were
the quoted fair market price of the stock on the dates of grant. Of the options
granted during this six-month period, 5,229,000 vest over the three years
following issuance and 1,000,000 vested immediately. These options expire within
ten years from the date of grant if not exercised. Using the Black-Scholes
pricing model, the weighted average fair value of the employee and director
options were $0.08 and $0.04 per share, respectively. As of June 30, 2002, the
Company had a total of 29,597,909 options to purchase Class A common shares
outstanding.
The Company's option plans provide for stock appreciation rights that allow the
grantee to receive shares of the Company's Class A common stock equivalent in
value to the difference between the designated exercise price and the fair
market value of the Company's stock at the date of exercise. As of June 30,
2002, 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 August 7, 2002, the Company had warrants to purchase a total of 2,425,000
shares of Class A common stock outstanding that expire beginning in 2002 through
2010. Warrants issued for services were recorded at their fair value determined
using the Black-Scholes pricing model. The resulting values were recorded in
operating expenses in the periods covered by the services rendered.
Other
The Company presently has no plans to purchase new research and development or
office facilities.
22
Outlook
Corporate Objectives and Technology Vision
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.
The Company is now delivering standard speech-enabled solutions and applications
for specific market segments, namely: mobile and wireless handheld computing
devices, automotive solutions, TTS applications for computer telephony, and
speech software applications. These solutions and applications are built on the
Company's Core Technologies. Management expects to deliver efficient, reusable
and scaleable standard solutions to increase revenue margins and leverage the
Company's Core Technologies across multiple platforms and operating systems for
wireless and mobile computing devices and computer telephony systems. The Fonix
Core Technologies are based on proprietary technology that is protected by
various patents and trade secrets. Management believes that the Company's
speech-enabling technologies and solutions provide superior competitive
advantages compared to other speech technologies and products available in the
marketplace. Specifically, the Fonix Core Technologies provide the following
competitive advantages:
o Fonix neural net-based technologies require less memory storage.
For example, the combined Fonix ASR & TTS technologies require
approximately one megabyte (MB), while the nearest competitor
requires approximately three MB for comparable applications. This
benefit lowers the cost of the Fonix solution compared to that of
our competitors.
o Fonix neural net-based technologies require less processing power
as measured in MIPS (million instructions per second). Fonix
technologies require a less expensive micro-processor (CPU) and
allow for more applications to run concurrently on a comparable
CPU.
o Fonix neural net-based technologies provide a higher recognition
accuracy in noisy environments, such as inside of an operating
vehicle.
o Fonix neural net-based technologies do not require the user to
train the system to their individual voice.
o Fonix neural net-based architecture provides higher and more
robust system reliability.
o Fonix neural net-based technologies allow customers (OEMs, VARs,
and end users) to modify vocabularies in real-time.
o Fonix neural net-based technologies provide a lower porting-cost
and require less time to integrate speech-enabling solutions to
operating systems ("OS") and CPUs.
o To date, Fonix has ported to nine different multiple operating
systems and twelve different CPUs, while many competitors support
only a limited number of OS and CPU platforms.
o Fonix TTS human-like "voices" have very high understandability in
noisy environments.
In order to accomplish the objective of delivering efficient, resuable and
scalable standard solutions to increase revenue margins and leverage our Core
Technologies, 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 significant
investments in reseller, co-operative, and market development funded
programs in order to build sales and marketing opportunities with
software developers, resellers, wholesale distribution channels 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 computer
23
telephony markets. Fonix partners, OEMs, and VARs can accelerate time
to market by incorporating Fonix s.Manager, a proprietary dynamic
development platform. 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 development of
standard solution and products, acquisition of speech-enabling
technologies and properties, developer tools and development
frameworks to maintain the competitive advantages found in its Core
Technologies.
The Company has entered into and is seeking to enter into collaboration or joint
marketing agreements, co- development relationships, and strategic alliances
with well-known technology and consumer product manufacturers, integrators, and
value-added resellers ("VARs"). Management believes that the best way to
generate material recurring revenues is for the Company to enter into contracts
with integrators and VARs who will introduce it to potential end users of
products that incorporate our Core Technologies. Typically, these types of
agreements require joint marketing and development efforts by both Fonix and the
integrators or VARs. The Company spends significant time educating and providing
information to both third party integrators and VARs and their prospective
customers regarding the use and benefits of Fonix Core Technologies. During this
evaluation period, the Company may expend substantial sales, marketing and
management resources, all of which is not recoverable unless the prospective
customer of the third party integrator or VAR enters into an agreement with the
Company or the third party which has integrated Fonix Core Technologies into its
products, which agreement ultimately results in the receipt of revenue by the
Company.
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 risks 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 the
Company's 2001 Annual Report on Form 10-K, Item 1, Part I.
24
PART II - OTHER INFORMATION
Item 1. 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 trial 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 appealed the decision of the trial 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. If the appellate court reverses the decision of the trial court and
finds that we owe additional funds to Clarke and/or Perpetual Growth, that
ruling could have a material adverse effect on our financial position.
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 2. Changes in Securities
c. Unregistered sales of equity securities during the quarter (other than in
reliance on Regulation S).
Recent Sales of Unregistered Securities. During the three months ended June 30,
2002, the Company issued equity securities that were not registered under the
Securities Act of 1933, as amended (the "1933 Act"), other than unregistered
sales in reliance on Regulation S under the Act, as follows:
For the three months ended June 30, 2002, the Company received
$876,981 in funds drawn under the Initial Equity Line (see Note 7 of
the Condensed Consolidated Financial Statements), less commissions
and fees of $26,309, and issued 11,505,784 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 a registration statement on Form
S-2.
For the three months ended June 30, 2002, the Company received
$1,085,682 in funds drawn under the Second Equity Line (see Note 7 of
the Condensed Consolidated Financial Statements), less commissions
and fees of $32,570, and issued 9,689,260 shares of Class A common
stock to the Equity Line Investor. The shares were issued without
registration under the 1933 Act in reliance on Section 4(2) of the
1933 Act and the rules and regulations promulgated thereunder. The
resales of the shares were subsequently registered under a
registration statement on Form S-2.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
To date, all of the Company's revenues have been denominated in United States
dollars and received primarily from customers in the United States. The
Company's exposure to foreign currency exchange rate changes has been
insignificant. The Company expects, however, that future product license and
services revenue may also be derived from international markets and may be
denominated in the currency of the applicable market. As a result, operating
results may become subject to significant fluctuations based upon changes in the
exchange rate of certain currencies in relation to the U.S. dollar. Furthermore,
to the extent that the Company engages in international sales denominated in
U.S. dollars, an increase in the value of the U.S. dollar relative to foreign
currencies could make the Company's products less competitive in international
markets. Although the Company will continue to monitor its exposure to currency
fluctuations, it cannot assure that exchange rate fluctuations will not
adversely affect financial results in the future.
Item 4. Submission of Matters to a Vote of Security Holders
25
On July 12, 2002, the Company held its Annual Meeting of Shareholders in Boston,
Massachusetts. The record date for the meeting was May 24, 2002, on which date
there were 482,805,888 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 399,431,186 11,146,172
Roger D. Dudley 399,361,304 11,216,084
John A. Oberteuffer, Ph.D 404,903,223 5,674,135
William A. Maasberg, Jr. 403,439,549 7,137,809
Mark S. Tanner 403,604,229 6,973,129
The second 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 800,000,000 shares of Class A
Common Stock. The results of the voting were 397,433,216 shares in favor,
11,766,861 shares against, and 1,377,311 shares withheld or abstaining.
Item 5. Other Matters
Change in Certifying Public Accountants
On July 16, 2002, the Company engaged the accounting firm of Hansen
Barnett & Maxwell ("HBM") as the Company's independent public accountants to
review the Company's interim financial statements and to audit its financial
statements beginning with the fiscal year ending December 31, 2002. The Company
terminated its relationship with and dismissed its former independent public
accountant, Arthur Andersen LLP ("Andersen"), effective with the appointment of
HBM. The dismissal of Andersen and the appointment of HBM as the Company's new
independent public accountant were approved by the Company's Audit Committee and
Board of Directors on July 12, 2002.
During the period from the date of Andersen's engagement as the
Company's independent public accountants to July 16, 2002, the Company did not
consult with HBM on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
During the most recent fiscal years ended December 31, 2001 and 2000,
and the interim period subsequent to December 31, 2001, through the date of
dismissal of Andersen, there were no disagreements with Andersen on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure that would have caused Andersen to make references
in their report to such disagreements.
Andersen's report on the financial statements of the Company for the
year ended December 31, 2001, contained no adverse opinion or disclaimer of
opinion and was not modified as to audit scope or accounting principles, except
that Andersen's report dated February 26, 2002, contained an explanatory
paragraph regarding the Company's ability to continue as a going concern.
Similarly, Andersen's report on the financial statements of the Company for the
year ended December 31, 2000, contained no adverse opinion or disclaimer of
opinion and was not modified as to audit scope or accounting principles, except
that Andersen's report dated March 29, 2001, contained an explanatory paragraph
regarding the Company's ability to continue as a going concern.
The Company filed with the Commission a current report on Form 8-K on
July 17, 2002, disclosing the termination of its engagement with Andersen, its
engagement of HBM, and other information required to be disclosed. The Company
provided Andersen with a copy of the current report and requested that Andersen
furnish a
26
letter addressed to the Commission stating whether Andersen agrees with the
above statements. In response, a representative of Andersen advised the Company
that Andersen would no longer provide letters relating to its termination as a
audit client's independent public accountant, and that Andersen's inability to
provide such letters had been discussed with the Staff at the Commission.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits: The following Exhibits are filed with this Form 10-Q
pursuant to Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit
(2)(i) Agreement and Plan of Reorganization among the
Company, Fonix Acquisition Corporation and AcuVoice
dated as of January 13, 1998, incorporated by
reference from the Company's Current Report on Form
8-K, filed March 20, 1998
(2)(ii) Agreement and Plan of Merger among Fonix, Articulate
Acquisition Corporation, and Articulate, dated as of
July 31, 1998, incorporated by reference from the
Company's Current Report on Form 8-K, filed September
17, 1998
(2)(iii) Agreement and Plan of Merger among Fonix, Papyrus
Acquisition Corporation, and Papyrus Associates,
Inc., dated as of September 10, 1998, incorporated by
reference from the Company's Current Report on Form
8-K, filed November 13, 1998
(3)(i) Articles of Incorporation of the Company which are
incorporated by reference from the Company's
Registration Statement on Form S-18 dated as of
September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of
Incorporation dated as of March 21, 1994, which is
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of
Incorporation dated as of May 13, 1994, which is
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994
on Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of
Incorporation dated as of September 24, 1997,
which is incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(3)(v) The Company's Bylaws, as amended, which are
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(4)(i) Description of the Company's common stock and other
securities and specimen certificates representing
such securities which are incorporated by reference
from the Company's Registration Statement on Form
S-18 dated as of September 12, 1989, as amended
(4)(ii) Certificate of Designation of Rights and Preferences
of Series A Preferred Stock, filed with the Secretary
of State of Delaware on September 24, 1997, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(4)(iii) Certificate of Designation of Rights and Preferences
of Series B Convertible Preferred Stock, filed with
the Secretary of State of Delaware on October 27,
1997, which is
incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the period ended
27
September 30, 1997
(4)(iv) Certificate of Designation of Rights and Preferences
of 5% Series C Convertible Preferred Stock, filed
with the Secretary of State of Delaware on October
24, 1997, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(4)(v) Certificate of Designation of Rights and Preferences
of Series D 4% Convertible Preferred Stock, filed
with the secretary of State of Delaware on August 27,
1998, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1998
(4)(vi) Certificate of Designation of Rights and Preferences
of Series E 4% Convertible Preferred Stock, filed
with the secretary of State of Delaware on October
15, 1998, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1998
(9)(i) Voting Trust Agreement dated as of December 10, 1993
by and among Phonic Technologies, Inc., Stephen M.
Studdert, Thomas A. Murdock and Roger D. Dudley,
which is incorporated by reference from the Company's
Current Report on Form 8-K dated as of June 17, 1994
(9)(ii) Amendment of Voting Trust Agreement by and among the
Company, Stephen M. Studdert, Thomas A. Murdock,
Roger D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as
Trustee, dated as of October 23, 1995, incorporated
by reference from the Company's Current Report on
Form 8-K dated as of October 23, 1995
(9)(iii) Second Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of July 2, 1996, incorporated by
reference from the Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996
(9)(iv) Third Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of September 20, 1996,
incorporated by reference from the Annual Report on
Form 10-KSB for the fiscal year ended December 31,
1996
(9)(v) Fourth Amendment of Voting Trust Agreement by and
among the Company, Stephen M. Studdert, Thomas A.
Murdock, Roger D. Dudley, Beesmark Investments, L.C.,
Studdert Companies Corporation, and Thomas A. Murdock
as Trustee, dated as of September 20, 1996,
incorporated by reference from the Annual Report on
Form 10-KSB for the fiscal 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
28
(10)(iii) Memorandum of Understanding dated as of March 13,
1997, by and among the Company, Synergetics, Inc. and
C. Hal Hansen, which is incorporated by reference
from the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996
(10)(iv) Employment Agreement by and between the Company and
Stephen M. Studdert, which is incorporated by
reference from the Company's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1996
(10)(v) Employment Agreement by and between the Company and
Thomas A. Murdock, which is incorporated by reference
from the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996
(10)(vi) Employment Agreement by and between the Company and
Roger D. Dudley, which is incorporated by reference
from the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996
(10)(vii) Restated Master Agreement for Joint Collaboration
between the Company and Siemens, dated November 14,
1997, as revised, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(viii) Restated First Statement of Work and License
Agreement between the Company and Siemens, dated
February 11, 1998, as revised, which is incorporated
by reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(ix) Master Technology Collaboration Agreement between the
Company and OGI, dated October 14, 1997, which is
incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31,
1997
(10)(x) Common stock Purchase Agreement among the Company and
JNC Opportunity Fund Ltd. and Diversified Strategies
Fund, LP, dated as of March 9, 1998, which is
incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31,
1997
(10)(xi) Common stock Purchase Agreement between the Company
and Thomson Kernaghan & Co., dated as of March 9,
1998, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xii) Royalty Modification Agreement among the Company and
Synergetics, dated as of April 6, 1998, which is
incorporated by reference from the Company's Annual
Report on Form 10-K for the year ended December 31,
1997
(10)(xiii) Purchase Agreement with John Oberteuffer and the
Company dated April 9, 1998, which 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
29
(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)
(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))
30
(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
(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 of
31
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.
10(xlv) Amendment to Equity Line Agreement between Fonix
Corporation and Queen LLC, dated May 8, 2002, filed
with the Commission May 9, 2002.
10(xlvi) Third Private Equity Line Agreement between Fonix
Corporation and Queen LLC, dated June 27, 2002,
filed with the Commission June 27, 2002.
99.1 Certification of President and Chief Financial
Officer Pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
(B) Reports filed on Form 8-K during the three-month period ended June 30, 2002:
On June 10, 2002, the Company filed a Current Report on Form 8-K to announce a
loan and repayment agreement between the Company and Thomas A. Murdock and Roger
D. Dudley, two if its executive officers and directors.
On July 17, 2002, the Company filed a current report on Form 8-K with the
Commission relating to its engagement of Hansen Barnett & Maxwell as its
independent public accountants to review the Company's interim financial
statements and to audit the Company's financial statements beginning with its
fiscal year ending December 31, 2002. The current report also disclosed the
termination of the Company's engagement of Arthur Andersen LLP as its
independent public accountant, effective upon the engagement of Hansen Barnett &
Maxwell.
32
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Fonix Corporation
Date: August 8, 2002 /s/ Roger D. Dudley
------------------------------------------
Roger D. Dudley, Executive Vice President,
Chief Financial Officer
(Principal financial officer)
33