UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 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 November 13, 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 September 30,
2002 and December 31, 2001 2
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the three months and nine months
ended September 30, 2002 and 2001 3
Condensed Consolidated Statements of Cash Flows for the three
months and nine months ended September 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
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Evaluation of Disclosure Controls and Procedures 31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities 32
Item 3. Defaults Upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Matters - Change in Certifying Public Accountants 33
Item 6. Exhibits and Reports on Form 8-K 33
1
Fonix Corporation and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
September 30, December 31,
2002 2001
--------------- ---------------
Current assets:
Cash and cash equivalents $ 18,170 $ 201,401
Subscriptions receivable - 852,970
Accounts receivable, net of allowance for doubtful accounts of $25,960 and
$0, respectively 140,781 58,170
Other receivables 38,797 25,119
Inventory 62,942 37,154
Prepaid expenses 166,804 69,953
--------------- ---------------
Total current assets 427,494 1,244,767
Property and equipment, net of accumulated depreciation of $1,601,557 and
$1,314,960, respectively 695,261 903,159
Convertible note receivable - 630,000
Investment in and note receivable from affiliate, net of unamortized discount of
$63,708 and $77,691, respectively 1,084,833 1,535,244
Intangible assets, net of accumulated amortization of $260,312 and
$145,526, respectively 1,230,730 1,345,520
Goodwill, net of accumulated amortization of $2,295,599, in 2002 and 2001 2,631,304 2,631,304
Other assets 124,556 123,052
--------------- ---------------
Total assets $ 6,194,178 $ 8,413,046
=============== ===============
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 and
$65,247, respectively 956,446 1,484,753
Note payable, net of unamortized discount of $12,102 and $40,245, respectively 237,898 1,239,755
Notes payable - related parties 436,688 77,625
Notes payable - other 75,000 -
Accounts payable 3,096,049 1,062,237
Accrued liabilities 5,557,770 961,299
Accrued liabilities - related parties 1,443,300 1,451,633
Deferred revenues 1,085,588 1,049,849
Other current liabilities 21,158 19,767
--------------- ---------------
Total current liabilities 13,092,573 7,346,918
--------------- ---------------
Commitments and contingencies (Notes 1, 2, 3, 5, 6, 7, 8, 10 and 12)
Stockholders' equity:
Preferred stock, $.0001 par value; 50,000,000 shares authorized; Series A,
convertible; 166,667 shares outstanding
(aggregate liquidation preference of $6,055,012) 500,000 500,000
Common stock, $.0001 par value; 500,000,000 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 182,528,680 171,985,508
Outstanding warrants to purchased Class A common stock 1,360,000 2,832,400
Deferred consulting expenses (2,778) (17,777)
Cumulative foreign currency translation adjustment (18,865) 2,841
Accumulated deficit (191,313,880) (174,271,864)
--------------- ---------------
Total stockholders' equity (6,898,395) 1,066,128
--------------- ---------------
Total liabilities and stockholders' equity $ 6,194,178 $ 8,413,046
=============== ===============
See accompanying notes to condensed consolidated financial statements.
2
Fonix Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------
2002 2001 2002 2001
-------------- -------------- ------------- -------------
Revenues $ 834,076 $ 265,646 $ 1,812,057 $ 505,927
Cost of revenues 207,360 435,880 417,888 1,156,106
-------------- -------------- ------------- -------------
Gross margin 626,716 (170,234) 1,394,169 (650,179)
-------------- -------------- ------------- -------------
Expenses:
Selling, general and administrative 3,057,282 3,068,307 9,624,347 8,520,803
Product development and research 2,032,806 2,196,362 6,751,058 6,335,639
Amortization of intangible assets 13,014 257,386 39,042 772,159
Impairment loss on convertible note receivable 1,523,842 - 1,523,842 -
-------------- -------------- ------------- -------------
Total expenses 6,626,944 5,522,055 17,938,289 15,628,601
-------------- -------------- ------------- -------------
Loss from operations (6,000,228) (5,692,289) (16,544,120) (16,278,780)
-------------- -------------- ------------- -------------
Other income (expense):
Interest income 37,744 8,065 134,065 65,589
Interest expense (62,056) (60,228) (167,564) (129,216)
-------------- -------------- ------------- -------------
Total other income (expense), net (24,312) (52,163) (33,499) (63,627)
-------------- -------------- ------------- -------------
Loss before equity in net loss of affiliate (6,024,540) (5,744,452) (16,577,619) (16,342,407)
Equity in net loss of affiliate (130,950) (186,891) (464,394) (381,318)
-------------- -------------- ------------- -------------
Net loss (6,155,490) (5,931,343) (17,042,013) (16,723,725)
Other comprehensive income (loss) - foreign
currency translation 6,531 1,672 (21,706) (376)
-------------- -------------- ------------- -------------
Comprehensive loss $ (6,148,959) $ (5,929,671) $ (17,063,719) $ (16,724,101)
============== ============== ============= =============
Basic and diluted net loss per common share $ (0.01) $ (0.02) $ (0.04) $ (0.08)
============== ============== ============= =============
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
Nine Months Ended
June 30,
------------------------------
2002 2001
-------------- --------------
Cash flows from operating activities:
Net loss $ (17,042,013) $ (16,723,725)
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
Non-cash compensation expense related to issuance of stock options - 10,027
Additional Compensation expense related to issue of stock options and common stock 12,499 -
Accretion of discount on note receivable from affiliate (13,983) (14,883)
Accretion of discount on note payable from affiliate 34,193 119,977
Accretion of discount on note payable 28,143 -
Impairment loss on convertible note receivable and related accrued interest 1,523,842 -
Loss on disposal of property and equipment - 453
Depreciation and amortization 401,385 2,145,750
Equity in net loss of affiliate 464,394 381,318
Changes in assets and liabilities:
Accounts receivable (82,611) (56,005)
Interest and other receivables (112,639) -
Inventory (25,788) (66,745)
Prepaid expenses and other current assets (71,732) (96,778)
Funds held in escrow - 2,151,006
Other assets (1,504) (18,644)
Accounts payable 2,033,812 506,969
Accrued liabilities 4,596,472 763,342
Accrued liabilities - related party (8,333) (87,500)
Other Current Liabilities 1,392 -
Deferred revenues 35,739 397,100
Cumulative foreign currency translation adjustment (21,706) (376)
-------------- --------------
Net cash used in operating activities (8,248,438) (10,526,214)
-------------- --------------
Cash flows from investing activities:
Purchase of property and equipment (78,699) (574,701)
Proceeds from disoposal of property and equipment - 400
Issuance of notes receivable from affiliate - (302,909)
Issuance of notes receivable (820,000) (150,000)
Investment in Affiliate - (200,000)
-------------- --------------
Net cash used in investing activities (898,699) (1,227,210)
-------------- --------------
Cash flows from financing activities:
Proceeds from sale of Class A common stock, net 10,122,346 11,918,450
Proceeds of note payable to related parties 359,060 -
Proceeds from other notes payable 75,000 -
Principal payments on capital lease obligation - (32,753)
Proceeds from exercise of stock options - 9,801
Payments on note payable to affiliate (562,500) (675,000)
Payments on note payable (1,030,000) -
-------------- --------------
Net cash provided by financing activities 8,963,906 11,220,498
-------------- --------------
Net increase in cash and cash equivalents (183,231) (532,926)
Cash and cash equivalents at beginning of period 201,401 1,413,627
-------------- --------------
Cash and cash equivalents at end of period $ 18,170 $ 880,701
============== ==============
See accompanying notes to condensed consolidated financial statements.
4
Fonix Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Nine Months Ended
September 30,
------------------------------
2002 2001
------------- --------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 117,326 $ 123,700
Supplemental Schedule of Non-cash Investing and Financing Activities:
For the Nine Months Ended September 30, 2002:
Issued 13,394,216 shares of Class A common stock for $1,064,970 in
subscriptions receivable.
Warrants for the purchase of 625,000 shares of Class A common stock
expired in the amount of $1,472,400.
For the Nine Months Ended September 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 (the "SEC"). Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America 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 nine months ended September 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.
Business Conditions - The Company's revenues increased from $265,646 for the
three months ended September 30, 2001 to $834,076 for the three months ended
September 30, 2002, and from $505,927 for the nine months ended September 30,
2001 to $1,812,057 for the nine months ended September 30, 2002. However, the
Company has incurred significant losses since inception, including a loss of
$18,232,340 for the nine months ended September 30, 2002. The Company incurred
negative cash flows from operating activities of $8,248,438 during the nine
months ended September 30, 2002. Sales of products and revenue from licenses
based on the Company's technologies have not been sufficient to finance ongoing
operations. As of September 30, 2002, the Company had negative working capital
of $12,665,079 and an accumulated deficit of $191,313,880. The Company has drawn
all capital available under its first two equity lines of credit. The Company
will not be able to make draws under its third equity line of credit until a
registration statement covering the shares of common stock to be issued in
connection with that third equity line is declared effective by the SEC. The
Company filed the registration statement for the third equity line on June 27,
2002. 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. The
accompanying condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.
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 September 30, 2002 and 2001, there were outstanding common stock
equivalents to purchase 30,896,570 and 22,750,815 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.
5
The following tables are reconciliations of the net loss numerator of basic and
diluted net loss per common share for the three months and nine months ended
September 30, 2002 and 2001:
Three months ended September 30,
--------------------------------
2002 2001
------ -----
Per Share Per Share
Amount Amount Amount Amount
Net loss attributable to common
stockholders $ (6,155,490) $ (0.01) $ (5,931,343) $ (0.02)
============ ======== ============= ========
Weighted-average common shares
outstanding 482,410,556 239,108,716
============= =============
Nine months ended September 30,
-------------------------------
2002 2001
----------------------------- ----------------------------
Per Share Per Share
Amount Amount Amount Amount
Net loss $ (17,042,013) $(16,723,725)
Preferred stock dividends - (9,281)
--------------- -------------
Net loss attributable to common
stockholders $ (17,042,013) $ (0.04 ) $(16,733,006) $ (0.08)
=============== ========= ============= ========
Weighted-average common shares
outstanding 448,619,260 218,225,768
=============== =============
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).
Other Comprehensive Income (Loss) - Other comprehensive income (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 Houlihan Valuation Advisors, an independent
valuation firm, to assess the
6
Company's 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 described in the preceding
paragraph.
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. See Note 2.
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 be
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.
Revenue Recognition - The Company recognizes revenues in accordance with the
provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and
related interpretations. The Company generates revenues from licensing the
rights to its software products to end users and from royalties. It 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 and price protection are confirmed
or can be reasonably estimated, as appropriate. Revenues from development and
consulting services are recognized on a completed-contract basis when the
services are completed and accepted by the customer. The completed-contract
method is used because the contracts are either short-term in duration or the
Company is unable to make reasonably dependable estimates of the costs of the
contracts. Revenue for hardware units delivered is recognized when delivery is
verified and collection assured.
Revenue for products distributed through wholesale and retail channels and
resellers is recognized upon verification of final sell-through to end users,
after consideration of rights of return and price protection. Revenue for these
products is recognized when the right of return on such products has expired,
typically when the end user purchases the product from the retail outlet. Once
the end user opens the package, it is not returnable unless the medium is
defective. Price protection is offered to distributors in the event we reduce
the price on any specific product. Such price protection is generally offered
for a specific time period in which the distributor must make a claim. Resulting
revenue recognized reflects the reduced price. Slotting fees paid by the Company
for favorable placement in retail outlets are recorded as a reduction in gross
revenues.
8
When arrangements to license software products do not require significant
production, modification or customization of software, revenues from licenses
and royalties are recognized when persuasive evidence of a licensing arrangement
exists, delivery of the software has occurred, the fee is fixed or determinable
and collectibility is probable. Post-contract obligations, if any, generally
consist of one year of support including such services as customer calls, bug
fixes, and upgrades. Related revenue is recognized over the period covered by
the agreement. Revenues from maintenance and support contracts are also
recognized over the term of the related contracts.
Revenues applicable to multiple-element fee arrangements are bifurcated among
the elements such as license agreements and support and upgrade obligations
using vendor-specific objective evidence of fair value. Such evidence consists
primarily of pricing of multiple elements as if sold as separate products or
arrangements. These elements vary based upon factors such as the type of
license, volume of units licensed, and other related factors.
Deferred revenue at September 30, 2002, and December 31, 2001, consisted of the
following:
September 30, December 31,
Description Criteria for Recognition 2002 2002
- ----------- ------------------------ --------------- ---------------
Deferred unit royalties Delivery of units to end users or
and licence fees expiration of contract $ 938,891 $ 945,814
Engineering projects not Completion of work and acceptance
completed of completed work by customer 125,000 62,500
Deferred customer Expiration of period covered by
support support agreement 21,697 41,535
--------------- ---------------
Total deferred revenue $ 1,085,588 $ 1,049,849
=============== ===============
Cost of revenues from license, royalties and maintenance consists of costs to
distribute the product (including the cost of the media on which it is
delivered), installation and support personnel compensation, amortization of
capitalized speech software costs, licensed technology and other related costs.
Cost of service revenues consists of personnel compensation and other related
costs.
Speech software technology development and production costs - All costs incurred
to establish the technological feasibility of speech software technology to be
sold, leased or otherwise marketed are charged to product development and
research expense. Technological feasibility is established when a product design
and a working model of the software product have been completed and confirmed by
testing. Costs to produce or purchase speech software technology incurred
subsequent to establishing technological feasibility are capitalized.
Capitalization of speech software costs ceases when the product is available for
general release to customers. Costs to perform consulting or development
services applications are charged to cost of revenues in the period in which the
corresponding revenues are recognized. Cost of maintenance and customer support
are charged to expense when related revenue is recognized or when these costs
are incurred, whichever occurs first.
Capitalized speech software technology costs are amortized on a
product-by-product basis. Amortization is recognized from the date the product
is available for general release to customers as the greater of (a) the ratio
that current gross revenue for a product bears to total current and anticipated
future gross revenues for that product or (b) the straight-line method over the
remaining estimated economic life of the products. Amortization is charged to
cost of revenues.
The Company assesses unamortized capitalized speech software costs for possible
write down on a quarterly basis based on net realizable value of each related
product. Net realizable value is determined based on the estimated future gross
revenues from a product reduced by the estimated future cost of completing and
disposing of the product, including the cost of performing maintenance and
customer support. The amount by which the unamortized capitalized costs of a
speech software product exceed the net realizable value of that asset are
written off.
9
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 permitted 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 Unveil's speech-enabled CRM software. Draws on the line of credit bear
interest at an annual rate of seven percent, which interest was payable
quarterly beginning June 30, 2002. The Company extended the interest due date to
December 31, 2002. The balance due under the line of credit is secured by
Unveil's CRM software and related source code 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 September 30, 2002, such conversion at that date would have
represented approximately 12 percent of the issued and outstanding common stock
of Unveil.
During the nine months ended September 30, 2002, Unveil drew $820,000 on the
line of credit, bringing total draws on the line of credit to $1,450,000 as of
September 30, 2002. Due to limited resources available to the Company,
additional requests for funding by Unveil under the line of credit have not been
met. This limitation in funding has resulted in a deterioration of Unveil's
financial condition and has caused Unveil to slow its development process.
Accordingly, due to Unveil's financial condition, the Company recorded an
impairment loss as of September 30, 2002 in the amount of $1,523,842, consisting
of the outstanding balance on the line of credit plus accrued interest thereon
as of that date. The Company intends to pursue its rights to the collateral
under the note receivable if the outstanding balance is not paid on December 31,
2002, but may continue to advance available funds to Unveil to permit continued
development and commercialization of the CRM software. Future amounts advanced
to Unveil, if any, will be included in product research and development expenses
in the periods incurred. The Company advanced $60,000 to Unveil in October 2002
for such development expenses that will be reflected in the results of
operations for the fourth quarter of 2002.
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 appropriately
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 nine months ended September 30,
2002, the Company recorded interest income of $10,089 and $29,127 ,
respectively, including contractual and imputed interest. As of September 30,
2002, the balance of the Audium Note was $336,292, net of the unaccreted
discount of $63,708. 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.
10
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. To date, payments aggregating $1,815,000 have been made and certificates
representing 1,232,874 shares have been released to the Company.
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 does not own an interest sufficient to control
Audium, even if it were to convert the Audium Note to Audium Preferred Stock.
Accordingly, Fonix does 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 nine months ended
September 30, 2002, the Company recognized losses consisting of the following:
Three Months Nine months
Ended Ended
September 30, September 30,
2002 2002
------------------- -------------------
Company share of Audium net loss $ 89,123 $ 338,918
Amortization of difference between purchase price of Audium Preferred
Stock and Company's share of Audium's net stockholders' deficit $ 41,825 $ 125,476
------------------- -------------------
Total equity in loss of affiliate $ 130,948 $ 464,394
=================== ===================
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. At December 31, 2001, the Company evaluated the
estimated future net cash flows, given the status of Audium's product
development. From this evaluation , the Company determined that an impairment
loss of $823,275 should be recorded. No subsequent impairment loss has been
recorded.
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. The
Company owes Audium $987,500 under the Fonix Note. The Company is currently
negotiating a new payment schedule for payment of this amount. If the Company is
not able to agree on a new payment schedule, then Audium may declare a default
under the Fonix Note and exercise its rights under the Fonix Note, including the
right to foreclose on approximately 684,930 shares of Audium Preferred Stock
held as collateral for the Fonix Note. No events of default have occurred to
date.
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 nine months ended September 30, 2002, the
Company recorded interest expense of $29,875 and $85,303, respectively, related
to this note.
11
4. INTANGIBLE ASSETS
The Company adopted the provisions of SFAS No. 142 on January 1, 2002. Under the
new standard, goodwill and intangible assets deemed to have indefinite lives are
no longer amortized, but are subject to annual impairment tests. Other
intangible assets will continue to be amortized over their estimated useful
lives. The Company has performed the required impairment tests of goodwill and
indefinite-lived intangible assets. There was no impairment of goodwill or
intangible assets upon the Company's adoption of SFAS No. 142. Upon the
Company's adoption of SFAS No. 142, the Company also reassessed the estimated
useful lives of intangible assets subject to amortization.
Intangible assets consist of speech software 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 speech software technologies. As of September 30, 2002, and December
31, 2001, amortized intangible assets consisted of the following:
September 30, 2002 December 31, 2001
------------------------------------ -------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
----------------- ------------------ ------------------ -----------------
Speech software technology $ 978,582 $ (78,298) $ 978,582 -0-
Customer relationships 306,000 (20,400) 306,000 -0-
Patents 164,460 (161,614) 164,460 (145,522)
----------------- ------------------ ------------------ -----------------
Total $ 1,449,042 $ (260,312) $ 1,449,042 $ (145,522)
================= ================== ================== =================
In addition, the Company has trademarks not subject to amortization, recorded at
a carrying value of $42,000 at September 30, 2002, and December 31, 2001. This
asset is considered to have an indefinite useful life.
Except for capitalized speech software technology that is amortized on the basis
described in Note 1, amortization of intangible assets is computed on a
straight-line basis over their estimated useful lives, which range from one to
ten years. As of January 1, 2002, the weighted-average estimated amortization
periods were as follows: total - 9.2 years; speech software technology - 8.5
years; customer relationships - 10.0 years; and patents - 0.8 years. Intangible
assets subject to amortization will not have any significant residual value at
the end of their estimated useful lives. Estimated future amortization expense
for intangible assets subject to amortization for each of the following five
years is as follows:
For the Year Ended December 31, Amount
- -------------------------------- ------
2002 $ 41,972
2003 134,996
2004 134,996
2005 134,996
2006 124,100
Accumulated amortization of goodwill was $2,295,599 at both September 30, 2002,
and December 31, 2001. In accordance with the provisions of SFAS No. 142, the
Company no longer amortizes goodwill.
The amortization expense for capitalized speech software technology is included
in cost of revenue. For the nine months ended September 30, 2002 and 2001, the
amortization expense included in cost of revenues was $78,297 and $1,050,455,
respectively. During the three months ended December 31, 2001, the Company
recognized an impairment loss on its speech software technology amounting to
$5,832,217, which was also included in cost of revenues for that period.
The carrying values of the Company's long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that they may
not be recoverable. If such an event 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,
12
the carrying value of long-lived assets, other than speech software technology,
would be reduced by the estimated excess of the carrying value over the
projected discounted cash flows. Speech software technology would be accounted
for as described in Note 1.
At December 31, 2001 the Company assessed the unamortized amount of capitalized
speech software costs for possible write down based on the net realizable value
of the technology. Though revenues have steadily increased, there can be no
assurance that this growth is sustainable. Because the Company could not be
certain that future gross revenues would exceed the future costs of completing
and disposing of the product, the Company recorded an impairment loss of
$5,832,217 at that date. No subsequent write down has been recorded.
During 2002, the Company engaged Houlihan Valuation Advisors, an independent
valuation firm, to assess the Company's goodwill and intangible assets 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. 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 September 30, 2002.
Goodwill amortization expense was $772,159 during the nine months ended
September 30, 200, and $1,029,545, $1,029,545 and $1,189,896 during the years
ended December 31, 2001, 2000, and 1999, respectively. The effects on loss
before extraordinary item, net loss and basic and diluted loss per share of
excluding such goodwill amortization from the nine months ended September 30,
2002 and 2001, and from the years ended December 31, 2001, 2000, and 1999 is as
follows:
For the Nine months Ended For the Years Ended December 31,
------------------------------- ----------------------------------------------
September 30, September 30, 2001 2000 1999
2002 2001
--------------- --------------- --------------- --------------- --------------
Loss before extraordinary item, as
reported $ (17,042,013) $ (16,723,725) $ (31,222,299) $ (22,810,677) $ (22,136,276)
Loss before extraordinary item,
excluding goodwill amortization $ (17,042,013) $ (16,723,725) $ (30,192,754) $ (21,781,132) $ (20,946,380)
=============== =============== =============== =============== ==============
Net loss, as reported $ (17,042,013) $ (16,723,725) $ (31,222,299) $ (22,761,229) $ (21,662,419)
Add back goodwill amortization - 772,159 1,029,545 1,029,545 1,189,896
--------------- --------------- --------------- --------------- --------------
Net loss, excluding goodwill
amortization $ (17,042,013) $ (15,951,566) $ (30,192,754) $ (21,731,684) $ (20,472,523)
=============== =============== =============== =============== ==============
Basic and diluted loss per share:
Loss before extraordinary item,
as reported $ (0.04) $ (0.08) $ (0.13) $ (0.16) $ (0.32)
Loss before extraordinary item,
excluding goodwill amortization $ (0.04) $ (0.08) $ (0.13) $ (0.15) $ (0.30)
=============== =============== =============== =============== ==============
Net loss, as reported (0.04) $ (0.08) $ (0.13) $ (0.16) $ (0.31)
Net loss, excluding goodwill $ (0.04) $ (0.07) $ (0.13) $ (0.15) $ (0.29)
amortization
=============== =============== =============== =============== ==============
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
13
Force Note. Accordingly, interest has been imputed at seven percent, and the
Company recorded a discount of $40,245. For the three months and nine months
ended September 30, 2002, the Company recorded interest expense of $5,258 and
$33,630, 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 September 30, 2002, payments amounting to $250,000 remained
outstanding under the Force Note.
6. NOTES PAYABLE - RELATED PARTIES
Two executive 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, and are 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
appropriate by the Board of Directors. In October 2002, the Lenders pledged
1,234,622 shares of the Company's Class A common stock to the Equity Line
Investor in connection with an advance of $182,676 to the Company under
the Third Equity Line (see Note 7 below). The Equity Line Investor
subsequently sold the pledged shares and applied the proceeds in reduction of
the advance. The value of the pledged shares of $74,077 was treated as an
additional advance from the Lenders.
The aggregate advances of $407,385 are secured by the Company's intellectual
property rights.
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 nine months ended September 30, 2002, 40,692,920 shares of Class A
common stock were issued in connection with draws under the Initial Equity Line
of $3,633,817. From inception of the Initial Equity Line through September 30,
2002, 91,083,516 shares of Class A common stock were issued in connection with
draws of $20,617,324. As of November 11, 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 nine months ended September 30, 2002, 93,586,995 shares of Class A
common stock were issued in connection with draws amounting to $5,728,846. From
inception of the Second Equity Line through September 30, 2002, 211,600,000
shares of Class A common stock were issued in connection with draws of
$19,153,846. As of November 11, 2002, $846,154 remains unutilized under the
Second Equity Line; however, no registered shares
14
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 SEC 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 November 11, 2002, the registration
statement had not been declared effective by the SEC, and as such, the Company
was unable to draw funds under the Third Equity Line as of that date. Prior to
September 30, 2002, the Equity Line Investor advanced the Company $182,676
against future draws on the Third Equity Line. As of November 11, 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 received in January
2002.
8. COMMON STOCK, STOCK OPTIONS AND WARRANTS
Class A Common Stock - During the nine months ended September 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 nine months ended September 30, 2002, the Company
granted options to employees to purchase5,239,000 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 nine-month period, 5,239,000 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 September
30, 2002, the Company had a total of 28,479,903 options to purchase Class A
common shares outstanding.
Warrants - As of November 11, 2002, the Company had warrants to purchase a total
of 2,250,000 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. Warrants for the purchase of 300,000 shares of Class A common stock
were issued in January 2000 for consulting services rendered. The warrants were
issued at $47,000 using the Black-Scholes pricing model assuming risk-free
interest rate of 5.7%, expected exercise life of 5 years, and volatility of
102%. The warrants were issued with exercise prices ranging from $0.28 to $1.25,
vested during the year ended December 31, 2000 and expire January 2003.
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 sales,
marketing and product development opportunities in Europe. To date, Fonix UK has
no operations.
10. COMMITMENTS AND CONTINGENCIES
Until the registration statement covering shares for the Third Equity Line is
declared effective by the SEC, the Company is unable to draw funds from the
Third Equity Line. Consequently, the Company's cash resources are limited to
collections from customers and loans, which are not sufficient to cover
operating expenses (see Note 12). As a result, payments to employees and vendors
have been delayed since June 2002. Employees have been paid through June 15,
2002. Subsequent to June 30, 2002, advances have been made to certain employees
on the basis of
15
financial need as determined by the individual circumstances of each employee.
Payments amounting to approximately $156,000 have been made on this basis
through November 11, 2002. Forty-one employees of Fonix have quit or been
terminated between July 1, 2002 and November 11, 2002. No stoppage in work has
occurred as a result of nonpayment or delayed payment of compensation to date,
nor have deliveries to customers been effected. Certain payments to vendors
deemed to be critical to our ongoing operations have been made. To date, no
critical services have been stopped as a result of nonpayment or delayed
payment. At November 11, 2002, unpaid compensation payable to current and former
employees amounted to approximately $3,996,000 and vendor accounts payable
amount to approximately $2,485,000. The Company has not been declared in default
under the terms of any material agreements.
11. ANNUAL SHAREHOLDERS' MEETING
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.
12. SUBSEQUENT EVENTS
On October 11, 2002, the Company entered into a Securities Purchase Agreement
with Breckenridge Fund, LLC ("Breckenridge"), an unaffiliated third party, for
the sale of the Company's Series D 12% Convertible Debentures (the "Debentures")
in the aggregate principal amount of $1,500,000. The outstanding principal
amount of the Debentures is convertible at any time at the option of the holder
into shares of the Company common stock at a conversion price equal to the
average of the two lowest closing bid prices of the Company's Class A common
stock for the twenty trading days immediately preceding the conversion date
multiplied by 90%. The Debentures are due April 9, 2003. On the earlier of
December 20, 2002, or 45 days after the effective date of this registration
statement and prospectus (the "Initial Payment Date") and each 30-day
anniversary of the Initial Payment Date, the Company is required to make
principal payments of $250,000, plus accrued interest.
In connection with the sale of the Debentures, the Company issued, as collateral
to secure its performance under the Debenture, 83,333,333 shares of Class A
common stock (the "Collateral Shares"), which were placed into an escrow
pursuant to an escrow agreement. Under the escrow agreement, the Collateral
Shares will not be released to Breckenridge unless the Company is delinquent
with respect to payments under the Debenture. Additionally, as further
consideration for the sale of the Debentures, the Company issued 7,777,778
shares to Breckenridge (the "Additional Shares").
In connection with the sale of the Debentures, the Company agreed to register
the resale of shares of our Class A
16
common stock underlying the Debentures, the Collateral Shares, and the
Additional Shares. The Company will file a registration statement to register
those resales.
17
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 September 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's revenues increased from $265,646 for the three months ended
September 30, 2001 to $834,076 for the three months ended September 30, 2002,
and from $505,927 for the nine months ended September 30, 2001 to $1,812,057 for
the nine months ended September 30, 2002. However, the Company incurred negative
cash flows from operating activities of $8,248,438 during the nine months ended
September 30, 2002. Sales and licensing of products based on the Company's
technologies have not been sufficient to finance ongoing operations. As of
September 30, 2002, the Company had negative working capital of $12,665,079 and
an accumulated deficit of $191,313,880. 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 by the SEC. 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 has experienced slower development of markets for speech
applications than had been anticipated due to several factors. First, the
limited resources with which the Company has been operating (due to the delay in
accessing funds from the third equity line) have hampered the Company's ability
to aggressively support marketing and sales as originally anticipated.
Additionally, time and resources required to develop certain applications have
been greater than originally anticipated, and, with limited resources available,
the Company has not been able to expedite such development. Further, the ongoing
U.S. economic slowdown has slowed customer acceptance in target markets,
especially in the telecommunications sector where previously expected recovery
has yet to materialize, but has deteriorated further. Each of these factors had
a significant impact on the Company's ability to achieve significant growth in
the markets it has chosen to develop. The occurence of these conditions has
caused the Company to (i) reduce its emphasis on consumer applications because
of the significant resources required to develop retail markets, (ii) reduce its
development and marketing efforts in the computer telephony and server-based
markets, and (iii) increase its emphasis and focus on mobile and wireless
applications, automotive speech interface solutions and assistive markets, where
management believes the Company enjoys the greatest technological and market
advantage.
Through its current marketing efforts, the Company seeks to form relationships
with third parties who can incorporate the Company's 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 the Company 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.
18
The Company is currently in negotiation with customers and potential customers
to enter into additional third-party licensing, collaboration, co-marketing and
distribution arrangements.
In order to assess future gross revenues, the Company has evaluated the life
cycle of its products and the periods in which it will receive revenues from
them. Widespread deployment of speech applications, solutions and interface
products is growing, especially for the speech solutions the Company develops
and markets. However, certain speech products, specifically those which are
useful in the tele-communciations segment, have been severely impacted by
declining market conditions over the past 18 to 24 months. Nevertheless, speech
applications and interface solutions useful in devices such as smart-phones,
PDAs, cell phones, assistive devices for the sight-impaired, and other mobile
and wireless devices are beginning to enjoy user acceptance and market demand.
The Company's experience has indicated that original equipment manufacturers
("OEMs"), value added resellers ("VARs"), software developers and other users
typically integrate a new application or interface product such as speech
initially into only one or two products. Then, as market and user acceptance of
the technology increases, as applications are proven reliable, and as cost of
production and delivery decreases on a per-unit basis, the applications
typically are expanded into broader product lines. As a result, initial sales
volumes in early OEM integration periods are expected to be low, but will grow
at a stubstantial pace in subsequent periods as (i) OEM customers expand product
offerings and (ii) the customers of OEMs commit to and release speech
applications in their products. The Company expects growth to continue for four
to six years, but expects the rate of growth to slow as the market matures
toward the end of that period.
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.
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 Houlihan Valuation Advisors, an independent
valuation firm, to assess the Company's 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 described in the preceding paragraph.
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
19
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 its software products to end users and from royalties. It 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 and price protection are confirmed
or can be reasonably estimated, as appropriate. Revenues from development and
consulting services are recognized on a completed-contract basis when the
services are completed and accepted by the customer. The completed-contract
method is used because the contracts are either short-term in duration or the
Company is unable to make reasonably dependable estimates of the costs of the
contracts. Revenue for hardware units delivered is recognized when delivery is
verified and collection assured.
Revenue for products distributed through wholesale and retail channels and
resellers is recognized upon verification of final sell-through to end users,
after consideration of rights of return and price protection. Revenue for these
products is recognized when the right of return on such products has expired,
typically when the end user purchases the product from the retail outlet. Once
the end user opens the package, it is not returnable unless the medium is
defective. Price protection is offered to distributors in the event we reduce
the price on any specific product. Such price protection is generally offered
for a specific time period in which the distributor must make a claim. Resulting
revenue recognized reflects the reduced price. Slotting fees paid by the Company
for favorable placement in retail outlets are recorded as a reduction in gross
revenues.
When arrangements to license software products do not require significant
production, modification or customization of software, reveneus from licenses
and royalties are recognized when persuasive evidence of a licensing arrangement
exists, delivery of the software has occurred, the fee is fixed or determinable
and collectibility is probable. Post-contract obligations, if any, generally
consist of one year of support including such services as customer calls, bug
fixes, and upgrades. Related revenue is recognized over the period covered by
the agreement. Revenues from maintenance and support contracts are also
recognized over the term of the related contracts.
Revenues applicable to multiple-element fee arrangements are bifurcated among
the elements such as license agreements and support and upgrade obligations
using vendor-specific objective evidence of fair value. Such evidence consists
primarily of pricing of multiple elements as if sold as separate products or
arrangements. These elements vary based upon factors such as the type of
license, volume of units licensed, and other related factors.
20
Deferred revenue at September 30, 2002, and December 31, 2001, consisted of the
following:
September 30, December 31,
Description Criteria for Recognition 2002 2002
- ----------- --------------------------------- --------------- ---------------
Deferred unit royalties Delivery of units to end users or
and licence fees expiration of contract $ 938,891 $ 945,814
Engineering projects not Completion of work and acceptance
completed of completed work by customer 125,000 62,500
Deferred customer Expiration of period covered by
support support agreement 21,697 41,535
--------------- ---------------
Total deferred revenue $ 1,085,588 $ 1,049,849
=============== ===============
Cost of revenues from license, royalties and maintenance consists of costs to
distribute the product (including the cost of the media on which it is
delivered), installation and support personnel compensation, amortization of
capitalized speech software costs, licensed technology and other related costs.
Cost of service revenues consists of personnel compensation, licensed technology
and other related costs.
Speech software technology development and production costs - All costs incurred
to establish the technological feasibility of speech software technology to be
sold, leased or otherwise marketed are charged to product development and
research expense. Technological feasibility is established when a product design
and a working model of the software product have been completed and confirmed by
testing. Costs to produce or purchase speech software technology incurred
subsequent to establishing technological feasibility are capitalized.
Capitalization of speech software costs ceases when the product is available for
general release to customers. Costs to perform consulting or development
services applications are charged to cost of revenues in the period in which the
corresponding revenues are recognized. Cost of maintenance and customer support
are charged to expense when related revenue is recognized or when these costs
are incurred, whichever occurs first.
Capitalized speech software technology costs are amortized on a
product-by-product basis. Amortization is recognized from the date the product
is available for general release to customers as the greater of (a) the ratio
that current gross revenue for a product bears to total current and anticipated
future gross revenues for that product or (b) the straight-line method over the
remaining estimated economic life of the products. Amortization is charged to
cost of revenues.
The Company assesses unamortized capitalized speech software costs for possible
write down on a quarterly basis based on net realizable value of each related
product. Net realizable value is determined based on the estimated future gross
revenues from a product reduced by the estimated future cost of completing and
disposing of the product, including the cost of performing maintenance and
customer support. The amount by which the unamortized capitalized costs of a
speech software product exceed the net realizable value of that asset are
written off.
Results of Operations
Three months ended September 30, 2002, compared with three months ended
September 30, 2001
During the three months ended September 30, 2002, the Company recorded revenues
of $834,076, reflecting an increase of $568,430 over the same period in the
previous year. The increase in revenue is related to the licensing of TTS
applications to customers in assistive markets made possible through the
acquisition of assets and technology rights in December 2001. Also reflected in
the increase were $172,420 in hardware sales through resellers in assistive
markets, and $208,489 in fees for engineering projects completed during the
period.
Cost of revenues were $207,360 for the three months ended September 30, 2002, an
increase of $228,520, over the corresponding period in 2001. The increase is not
as significant as the rise in revenue because of the nominal cost of
21
delivering royalties and licenses and the amortization of capitalized speech
software component of cost of revenues which did not change significantly from
2001 to 2002. The cost of hardware sales is the largest portion represented in
the increase because such sales were new to the Company in 2002, as noted above.
Selling, general and administrative expenses were $3,057,282 and $3,068,307 for
the three months ended September 30, 2002 and 2001, respectively. The decrease
of $11,025 includes increases of $214,295 in compensation-related expenses and
$250,731 in other operating expenses related to increased sales and marketing
personnel. These increases were offset by decreases of $160,897 in travel due to
limited resources, $187,511 in legal and professional fees due to reduced
litigation and regulatory filings, $75,770 in investor relations expenses due to
the timing of the annual meeting of shareholders, and $44,493 in consulting fees
due to reduction of reliance on outside services
Product development and research expenses were $2,032,806 and $2,196,362 for the
three months ended September 30, 2002 and 2001, respectively, reflecting a
decrease of $163,556. The decrease reflects reductions of $241,932 in consulting
fees due to decreased reliance on outside services, $36,874 in other operating
expenses due to reduced expenses required to complete development projects.
These decreases were offset by increases of $101,810 in compensation related
expenses due to increased reliance on internal resources and development
expertise and $20,950 in occupancy costs to accommodate the development staff.
Amortization of intangible assets, excluding the portion classified as cost of
revenues, was $13,014 and $257,386 for the three months ended September 30, 2002
and 2001, respectively. The decrease of $244,372 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 of speech software
technology to be approximately $40,000, including $26,000 to be charged to cost
of revenues, for the remainder of 2002 and $135,000 per year thereafter,
including $104,000 to be charged to cost of revenues, until the underlying
assets have been completely amortized.
At September 30, 2002, the Company recorded an impairment loss in the amount of
$1,523,842 on its convertible note receivable from Unveil Corporation. Because
of the Company's current inability to meet Unveil's requests for additional
funding and Unveil's inability to raise other capital or generate funds from its
own operations, management believes that Unveil's financial condition has
declined and recognition of the impairment is appropriate at this time. The
Company may, as additional funds become available, provide additional advances
to Unveil to assist in the development of its CRM software. Such funds will be
recorded as product research and development expenses in the period expended.
Nine months ended September 30, 2002, compared with nine months ended September
30, 2001
During the nine months ended September 30, 2002, the Company recorded revenues
of $1,812,057, reflecting an increase of $1,306,130, or 258%, over the same
period in the previous year. The increase in revenue is related to the licensing
of TTS applications to customers in assistive markets made possible through the
acquisition of assets and technology rights in December 2001. Also reflected in
the increase were $289,710 in hardware sales through resellers in assistive
markets, and $249,149 in fees for engineering projects completed during the
period.
Cost of revenues were $417,888, a decrease of $738,218, resulting from
increased cost of services performed in custom engineering activities, increased
amortization of capitalized speech software costs acquired in December 2001, 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. Cost of royalty and licensing revenues increased due to the increase in
amortization of capitalized speech software costs. Additional increases resulted
from the cost of completing engineering projects and delivering hardware
products to assistive markets.
Selling, general and administrative expenses were $9,624,347 and $8,520,803 for
the nine months ended September 30, 2002 and 2001, respectively. The increase of
$1,103,544 includes increases of $661,713 in compensation- related expenses due
to increased sales and marketing staff and strategic planning personnel,
$252,330 in consultants, outside services and promotional expenses due to
increased marketing efforts as well as consultations regarding financing
alternatives, $78,132 in occupancy charges due to increased sales and marketing
personnel, and $775,540 in other operating expenses related to increases in
sales, marketing and business development personnel,
22
and efforts related to increased marketing and promotional activities as well as
expansion into assistive markets. These increases were offset by decreases of
$342,391 in legal and professional fees due to reduced litigation and regulatory
filing needs, $260,668 in travel-related expenses due to limited funds available
for travel, and $61,587 in investor communication expenses due to reduced press
releases and other related communications.
Product development and research expenses were $6,751,058 and $6,335,639 for the
nine months ended September 30, 2002 and 2001, respectively, reflecting an
increase of $415,419. Increases of $771,378 in compensation-related expenses
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 decreases of $196,235 in consulting expenses due to reduced reliance
on outside services for development efforts, $135,641 in occupancy, travel and
other operating expenses resulting from reductions in the purchase of software
licenses and related services due to limited funds.
Amortization of intangible assets, excluding the portion classified as cost of
revenues, was $39,042 and $772,159 for the nine months ended September 30, 2002
and 2001, respectively. The decrease of $733,117 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 of speech software
technology to be approximately $40,000, including $26,000 to be charged to cost
of revenues, for the remainder of 2002 and $135,000 per year thereafter,
including $104,000 to be charged to cost of revenues, until the underlying
assets have been completely amortized.
At September 30, 2002, the Company recorded an impairment loss in the amount of
$1,523,842 on its convertible note receivable from Unveil Corporation. Because
of the Company's current inability to meet Unveil's requests for additional
funding and Unveil's inability to raise other capital or generate funds from its
own operations, management believes that Unveil's financial condition has
declined and recognition of the impairment is appropriate at this time. The
Company may, as additional funds become available, provide additional advances
to Unveil to assist in the development of its CRM software. Such funds will be
recorded as product research and development expenses in the period expended.
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 two 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 by the SEC. 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.
Until the registration statement covering the shares related to the third equity
line is declared effective by the Commission, the Company is unable to draw
funds from the third equity line. Consequently, cash resources are limited to
collections from customers and loan proceeds, which are not sufficient to cover
operating expenses. As a result, payments to employees and vendors have been
delayed since June 2002. Employees have been paid through June 15, 2002.
Subsequent to June 30, 2002, advances have been made to certain employees on the
basis of financial need as determined by the individual circumstances of each
employee. Payments amounting to
23
approximately $156,000 have been made on this basis through November 11, 2002.
Since July 1, 2002, 41 employees of Fonix have quit, been terminated or been
place on leave without pay. No stoppage in work has occurred as a result of
nonpayment or delayed payment of compensation to date, nor have deliveries to
customers been effected. Certain payments to vendors deemed to be critical to
our ongoing operations have been made. To date, no critical services have been
stopped as a result of nonpayment or delayed payment. At November 11, 2002,
unpaid compensation payable to current and former employees amounts to
approximately $3,996,000 and vendor accounts payable amount to approximately
$2,485,000. The Company has not been declared in default under the terms of any
material agreements.
In order to meet certain ongoing operating obligations, on October 11, 2002, the
Company entered into an agreement with Breckenridge Fund, LLC, an unaffiliated
third party, for the sale of the Company's Series D 12% Convertible Debentures
in an aggregate principal amount of $1,500,000. The Debentures are due April 9,
2003. On the earlier of December 20, 2002, or 45 days after the effective date
of the registration statement covering the shares related to the Third Equity
Line and the related prospectus (the "Initial Payment Date") and each 30-day
anniversary of the Initial Payment Date, the Company is required to make
principal payments of $250,000, plus accrued interest. See additional
description of Series D Convertible Debenture below.
Net cash used in operating activities of $8,248,438 for the nine months ended
September 30, 2002, resulted principally from the net loss incurred of
$17,042,013 offset by non-cash expenses pertaining to depreciation and
amortization of $401,385, impairment loss on convertible note receivable of
$1,523,842 and equity in net loss of affiliate of $464,394, as well as increases
in accounts payable and accrued expenses of $6,630,284. Net cash used in
investing activities of $898,699 for the nine months ended September 30, 2002,
consisted primarily of advances under a convertible note receivable of $820,000.
Net cash used in operating and investing activities was offset by net cash
provided by financing activities of $8,963,909, 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 $1,592,500 in payments on notes payable.
The Company had negative working capital of $12,665,079 at September 30, 2002,
compared to negative working capital of $6,102,151 at December 31, 2001. Current
assets decreased by $817,272 to $427,495 from December 31, 2001, to September
30, 2002. Current liabilities increased by $5,745,656 to $13,092,574 during the
same period. The change in working capital from December 31, 2001 to September
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 $6,194,178
at September 30, 2002, compared to $8,413,046 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 permitted 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 was payable
quarterly beginning June 30, 2002. The Company extended the interest due date to
December 31, 2002. The balance due under the line of credit is secured by
Unveil's CRM software and related source code 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 September 30, 2002, such conversion at that date would have
represented approximately 12 percent of the issued and outstanding common stock
of Unveil.
During the nine months ended September 30, 2002, Unveil drew $820,000 on the
line of credit, bringing total draws on the line of credit to $1,450,000 as of
September 30, 2002. Due to limited resources available to the Company,
additional requests for funding by Unveil under the line of credit have not been
met. This limitation in funding has resulted in a deterioration of Unveil's
financial condition and has caused Unveil to slow its development process.
Accordingly, due to Unveil's financial condition, the Company recorded an
impairment loss as of September 30, 2002 in the amount of $1,523,842, consisting
of the outstanding balance on the line of credit plus accrued interest
24
thereon as of that date. The Company intends to pursue its rights to the
collateral under the note receivable if the balance is not repaid by December
31, 2002, but may continue to advance available funds to Unveil to permit
continued development and commercialization of the CRM software. Future amounts
advanced to Unveil, if any, will be included in product research and development
expenses in the periods incurred. The Company advanced $60,000 to Unveil in
October 2002 for such development expenses that will be reflected in the results
of operations for the fourth quarter of 2002.
Investment In Audium Corporation
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 appropriately
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 nine months ended September 30,
2002, the Company recorded interest income of $10,089 and $29,127, respectively,
including contractual and imputed interest. As of September 30, 2002, the
balance of the Audium Note was $336,292, net of the unaccreted discount of
$63,708. 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. To date, payments aggregating $1,815,000 have been made and certificates
representing 1,232,874 shares have been released to the Company.
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 does not own an interest sufficient to control
Audium, even if it were to convert the Audium Note to Audium Preferred Stock.
Accordingly, Fonix does 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 nine months ended
September 30, 2002, the Company recognized losses consisting of the following:
Three Months Nine months
Ended Ended
September 30, September 30,
2002 2002
------------------- -------------------
Company share of Audium net loss $ 89,123 $ 338,918
Amortization of difference between purchase price of Audium Preferred
Stock and Company's share of Audium's net stockholders' deficit $ 41,825 $ 125,476
------------------- -------------------
Total equity in loss of affiliate $ 130,948 $ 464,394
=================== ===================
25
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. At December 31, 2001, the Company evaluated the
estimated future net cash flows, given the status of Audium's product
development. From this evaluation , the Company determined that an impairment
loss of $823,275 should be recorded. No subsequent impairment loss has been
recorded.
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. The
Company owes Audium $987,500 under the Fonix Note. The Company is currently
negotiating a new payment schedule for payment of this amount. If the Company is
not able to agree on a new payment schedule, then Audium may declare a default
under the Fonix Note and exercise its rights under the Fonix Note, including the
right to foreclose on approximately 684,930 shares of Audium Preferred Stock
held as collateral for the Fonix Note. No events of default have occurred to
date.
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 nine months ended September 30, 2002, the
Company recorded interest expense of $29,875 and $85,303, 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 nine months ended
September 30, 2002, the Company recorded interest expense of $5,258 and$33,630,
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 September 30, 2002, payments amounting to $250,000 remained
outstanding under the Force Note.
Notes Payable - Related Parties
Two executive 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 price of the shares at the time of the advances. If converted, the
conversion amount is divided by the conversion price to
26
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. In October
2002, the Lenders pledged 1,234,622 shares of the Company's Class A common stock
to the Equity Line Investor in connection with an advance of $182,676 to
the Company under the Third Equity Line (see Note 7 below). The Equity Line
Investor subsequently sold the pledged shares and applied the proceeds in
reduction of the advance. The value of the pledged shares of $74,077 was
treated as an additional advance from the Lenders.
The aggregate advances of $407,385 from the Lenders are secured by the Company's
intellectual property rights
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 September
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 nine months ended September 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 September 30,
2002, 91,083,516 shares of Class A common stock have been issued in connection
with draws of $20,617,324. As of November 11, 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 nine months ended September 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 September 30,
2002, 211,600,000 shares of Class A common stock were issued in connection with
draws of $19,153,846. As of November 11, 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:
Weighted Average Number
Average of Shares Issued Total Shares Issued
Equity Line Conversion Price Per 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
November 11, 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 September 30, 2002, the Equity Line
Investor advanced the Company $182,676 against future draws on the Third Equity
Line. As of November 11, 2002, no shares had been issued under the Third Equity
Line.
Stock Options and Warrants
During the nine months ended September 30, 2002, the Company granted options to
employees to purchase 5,239,000 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 nine-month period, 5,239,000 vest over the three years
following issuance and 1,000,000 vested immediately. These options expire within
ten
27
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 September 30, 2002, the Company
had a total of 28,479,903 options to purchase Class A common shares outstanding.
As of November 11, 2002, the Company had warrants to purchase a total of
2,250,000 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. Warrants for the purchase of 300,000 shares of Class A common stock
were issued in January 2000 for consulting services rendered. The warrants were
issued at $47,000 using the Black-Scholes pricing model assuming risk-free
interest rate of 5.7%, expected exercise life of 5 years, and volatility of
102%. The warrants were issued with exercise prices ranging from $0.28 to $1.25,
vested during the year ended December 31, 2000 and expire January 2003.
Related-Party Transaction
In February 2000, the Company entered into an agreement to purchase from John A.
Oberteuffer, an executive officer and director of the Company, all of Dr.
Oberteuffer's rights and interests in certain methods and apparatus for
integrated voice and pen input for use in computer systems. In payment for Dr.
Oberteuffer's technology, the Company granted Dr. Oberteuffer 600,000 warrants
to purchase our Class A common stock at an exercise price of $1.00 per share.
The warrants were valued using the Black-Scholes method of valuation and
resulted in a value of $0.79 per warrant for the 600,000 warrants, or an
aggregate value of $474,000. The warrants expire February 10, 2010. Also, the
Company granted Dr. Oberteuffer the right to repurchase the technology from the
Company at fair market value if the Company subsequently determined not to
commercialize the pen/voice technologies or products.
In February 2000, the Company was actively pursuing development and licensing
opportunities in handwriting recognition ("HWR") and desired to procure the
rights to Dr. Oberteuffer's in-process development. However, there was no
assurance at the time that the development of the project would result in
revenue opportunities when completed, so the cost was charged to in-process
research and development at that time.
The Company has since determined that there is no substantial benefit to
pursuing the market for HWR technology, including the technology acquired from
Dr. Oberteuffer and as such, the balance of goodwill from all HWR acquisitions
was written off in 2001. The Company's decision to cease efforts to
commercialize HWR technologies may trigger Dr. Oberteuffer's right to repurchase
the pen/voice technologies acquired from the Company.
Other
The Company presently has no plans to purchase new research and development or
office facilities.
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")
(collectively referred to as "Core Technologies"), 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, 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 and leverage the Company's Core Technologies across
multiple platforms and operating systems for wireless and mobile computing
devices. 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
28
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 users 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, reusable and
scalable standard solutions to increase revenue margins and leverage our Core
Technologies, but subject to the Company's ability to draw upon its Third
Equity Line in the near term in amounts sufficient to finance the following
objectives, 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 embedded and
wireless mobile markets for automotive solutions, hand-held computing
devices and assistive device markets, and will market personal software
for consumer applications through third party distribution
arrangements. 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 mobile communications, PDA, assistive
and consumer appliance 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 to 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
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,
29
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.
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. Evaluation of Disclosure Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. The Company's
chief executive officer and chief financial officer, after evaluating the
effectiveness of the Company's "disclosure controls and procedures" (as defined
in the Securities Exchange Act of 1934, Rules 13a-14(c) and 15-d-14(c)) as of a
date (the "Evaluation Date") within 90 days before the filing date of this
quarterly report, have concluded that, as of the Evaluation Date, the Company's
disclosure controls and procedures were adequate and designed to ensure that
material information relating to the Company and its consolidated subsidiaries
would be made known to them by others within those entities.
(b) Changes in Internal Controls. There were no significant changes in
the Company's internal controls, or, to the Company's knowledge, in other
factors that could significantly affect these controls subsequent to the
Evaluation Date.
30
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, which affirmed the trial court's ruling. Accordingly, the decision of
the trial court has become final.
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 September
30, 2002, the Company issued no equity securities that were not registered under
the Securities Act of 1933, as amended (the "1933 Act").
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
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.
31
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 in connection therewith.
The Company provided Andersen with a copy of the current report and requested
that Andersen furnish a 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.
Resignation of Mark S. Tanner
Effective July 27, 2002, Mark S. Tanner resigned as a member of our Board of
Directors.
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
32
Papyrus Associates, Inc., dated as of September 10, 1998, incorporated by reference from
the Company's Current Report on Form 8-K, filed November 13, 1998
(3)(i) Articles of Incorporation of the Company which are
incorporated by reference from the Company's
Registration Statement on Form S-18 dated as of
September 12, 1989
(3)(ii) Certificate of Amendment of Certificate of Incorporation dated as of March 21, 1994,
which is incorporated by reference from the Company's Annual Report for the Fiscal Year
Ended December 31, 1994 on Form 10-KSB
(3)(iii) Certificate of Amendment of Certificate of Incorporation dated as of May 13, 1994,
which is incorporated by reference from the Company's Annual Report for the Fiscal
Year Ended December 31, 1994 on Form 10-KSB
(3)(iv) Certificate of Amendment of Certificate of Incorporation dated as of September 24, 1997,
which is incorporated by reference from the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1997
(3)(v) The Company's Bylaws, as amended, which are incorporated by reference from the
Company's Annual Report for the Fiscal Year Ended December 31, 1994 on Form
10-KSB
(4)(i) Description of the Company's common stock and other securities and specimen
certificates representing such securities which are incorporated by reference from the
Company's Registration Statement on Form S-18 dated as of September 12, 1989, as
amended
(4)(ii) Certificate of Designation of Rights and Preferences of Series A Preferred Stock, filed
with the Secretary of State of Delaware on September 24, 1997, which is incorporated by
reference from the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1997
(4)(iii) Certificate of Designation of Rights and Preferences
of Series B Convertible Preferred Stock, filed with
the Secretary of State of Delaware on October 27,
1997, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(4)(iv) Certificate of Designation of Rights and Preferences
of 5% Series C Convertible Preferred Stock, filed
with the Secretary of State of Delaware on October
24, 1997, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997
(4)(v) Certificate of Designation of Rights and Preferences
of Series D 4% Convertible Preferred Stock, filed
with the secretary of State of Delaware on August 27,
1998, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1998
(4)(vi) Certificate of Designation of Rights and Preferences
of Series E 4% Convertible Preferred Stock, filed
with the secretary of State of Delaware on October
15, 1998, which is incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the
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
33
(9)(ii) Amendment of Voting Trust Agreement by and among the Company, Stephen M.
Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as Trustee, dated as of October 23,
1995, incorporated by reference from the Company's Current Report on Form 8-K dated
as of October 23, 1995
(9)(iii) Second Amendment of Voting Trust Agreement by and among the Company, Stephen M.
Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as Trustee, dated as of July 2, 1996,
incorporated by reference from the Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1996
(9)(iv) Third Amendment of Voting Trust Agreement by and among the Company, Stephen M.
Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as Trustee, dated as of September 20,
1996, incorporated by reference from the Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1996
(9)(v) Fourth Amendment of Voting Trust Agreement by and among the Company, Stephen M.
Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert
Companies Corporation, and Thomas A. Murdock as Trustee, dated as of September 20,
1996, incorporated by reference from the Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1996
(10)(i) Product Development and Assignment Agreement dated as of October 16, 1993 between
Phonic Technologies, Inc. and Synergetics, Inc., which is incorporated by reference from
the Company's Current Report on Form 8-K dated as of June 17, 1994
(10)(ii) Re-Stated Product Development and Assignment
Agreement dated as of March 30, 1995, between Fonix
Corporation and Synergetics, Inc., which is
incorporated by reference from the Company's Annual
Report for the Fiscal Year Ended December 31, 1994 on
Form 10-KSB
(10)(iii) Memorandum of Understanding dated as of March 13, 1997, by and among the Company,
Synergetics, Inc. and C. Hal Hansen, which is incorporated by reference from the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996
(10)(iv) Employment Agreement by and between the Company and Stephen M. Studdert, which is
incorporated by reference from the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(v) Employment Agreement by and between the Company and Thomas A. Murdock, which is
incorporated by reference from the Company's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1996
(10)(vi) Employment Agreement by and between the Company and Roger D. Dudley, which is
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
34
(10)(ix) Master Technology Collaboration Agreement between the Company and OGI, dated
October 14, 1997, which is incorporated by reference from the Company's Annual Report
on Form 10-K for the year ended December 31, 1997
(10)(x) Common stock Purchase Agreement among the Company and JNC Opportunity Fund
Ltd. and Diversified Strategies Fund, LP, dated as of March 9, 1998, which is
incorporated by reference from the Company's Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xi) Common stock Purchase Agreement between the Company and Thomson Kernaghan &
Co., dated as of March 9, 1998, which is incorporated by reference from the Company's
Annual Report on Form 10-K for the year ended December 31, 1997
(10)(xii) Royalty Modification Agreement among the Company and Synergetics, dated as of April
6, 1998, which is incorporated by reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xiii) Purchase Agreement with John Oberteuffer and the
Company dated April 9, 1998, which is incorporated by
reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1997
(10)(xiv) Employment Agreement by and between the Company and John A. Oberteuffer, which is
incorporated by reference from the Company's Annual Report on Form 10-K for the year
ended December 31, 1997
(10)(xv) First Amendment to Master Agreement for Joint Collaboration between the Company and
Siemens, dated February 13, 1998, which is incorporated by reference from the
Company's Annual Report on Form 10-K for the year ended December 31, 1997
(10)(xvi) Second Amendment to Master Agreement for Joint
Collaboration between the Company and Siemens, dated
March 13, 1998, which is incorporated by reference
from the Company's Annual Report on Form 10-K for the
year ended December 31, 1997
(10)(vii) Series D Convertible Preferred Stock Purchase Agreement Among Fonix corporation,
JNC Opportunity Fund, Ltd., Diversified Strategies Fund, L.P., Dominion Capital Fund,
Ltd., Sovereign Partners, LP, Canadian Advantage Limited Partnership and Thomson
Kernaghan & Co. (as agent) dated as of August 31, 1998, incorporated by reference from
the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998
(10)(xviii) Series E Convertible Preferred Stock Exchange and
Purchase Agreement among Fonix corporation, Sovereign
Partners, LP and Dominion Capital Fund, Ltd., dated
as of September 30, 1998, incorporated by reference
from the Company's Quarterly Report on Form 10-Q for
the period ended September 30, 1998
(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)
35
(10)(xxi) Asset Purchase Agreement - Acquisition of Certain
Assets of Fonix Corporation and Fonix/ASI Corporation
by Lernout & Hauspie Speech Products N.V., dated as
of May 19, 1999, which is incorporated by reference
from the Company's Current Report on Form 8- K, filed
with the Commission on September 16, 1999 (therein
designated as Exhibit 10(a))
(10)(xxii) Escrow Agreement, dated as of September 1, 1999,
which is incorporated by reference from the Company's
Current Report on Form 8-K, filed with the Commission
on September 16, 1999 (therein designated as Exhibit
10(b))
(10)(xxiii) Technology Option Agreement, dated as of May 19,
1999, which is incorporated by reference from the
Company's Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein designated
as Exhibit 10(c))
(10)(xxiv) Assignment and Assumption Agreement, dated as of
September 1, 1999, which is incorporated by reference
from the Company's Current Report on Form 8-K, filed
with the Commission on September 16, 1999 (therein
designated as Exhibit 10(d))
(10)(xxv) License Agreement by and between Fonix/ASI
Corporation and Lernout & Hauspie Speech Products
N.V., dated as of May 19, 1999, which is incorporated
by reference from the Company's Current Report on
Form 8-K, filed with the Commission on September 16,
1999 (therein designated as Exhibit 10(e))
(10)(xxvi) Loan Agreement, dated as of April 22, 1999, which is
incorporated by reference from the Company's Current
Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit
10(f))
(10)(xxvii) Amendment to Loan Agreement, dated as of May 12,
1999, which is incorporated by reference from the
Company's Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein designated
as Exhibit 10(g))
(10)(xxviii) Second Amendment to Loan Agreement, dated as of May
19, 1999, which is incorporated by reference from the
Company's Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein designated
as Exhibit 10(h))
(10)(xxix) Loan Agreement, dated as of May 19, 1999, which is
incorporated by reference from the Company's Current
Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit
10(i))
(10)(xxx) First Amendment to Loan Agreement, dated as of August
12, 1999, which is incorporated by reference from the
Company's Current Report on Form 8-K, filed with the
Commission on September 16, 1999 (therein designated
as Exhibit 10(j))
(10)(xxxi) Agreement, dated as of July 31, 1999, which is
incorporated by reference from the Company's Current
Report on Form 8-K, filed with the Commission on
September 16, 1999 (therein designated as Exhibit
10(k))
(10)(xxxii) Series F Convertible Preferred Stock Purchase Agreement, Among Fonix Corporation,
Sovereign Partners, LP, Dominion Capital Fund, LTD., Dominion Investment Fund, LLC,
Canadian Advantage, L.P., and Queen LLC, dated as of February 1, 2000
(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)
36
(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
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
99.2 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 September 30,
2002:
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.
37
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Fonix Corporation
Date: November 13, 2002 /s/ Roger D. Dudley
--------------------------------------------
Roger D. Dudley, Executive Vice President,
Chief Financial Officer
(Principal financial officer)
38