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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1999, or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______________ to
_____________.
Commission File No. 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 87-0380088
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(Address of principal executive offices with zip code)
(801) 328-8700
(Registrant's telephone number, including area code)
Securities registered pursuant to
Section 12(b) of the Act: None
Securities registered pursuant to
Section 12(g) of the Act: Class A Common Stock ($0.0001 par value per
share)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No[ ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $247,408,499 calculated using a closing price of
$1.59 per share on April 10, 2000. For purposes of this calculation, the
registrant has included only the number of shares directly held by its officers
and directors as of April 10, 2000, (and not counting shares beneficially owned
on that date) in determining the shares held by non-affiliates. As of April 10,
2000, there were issued and outstanding 163,994,614 shares of the Company's
Class A common stock.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Page
Item 1. Business............................................................3
Item 2. Properties.........................................................22
Item 3. Legal Proceedings..................................................23
Item 4. Submission of Matters to a Vote of Security Holders................23
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................23
Item 6. Selected Financial Data............................................25
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................26
Item 8. Financial Statements and Supplementary Data........................34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................34
Part III
Item 10. Directors and Executive Officers of the Registrant.................34
Item 11. Executive Compensation.............................................37
Item 12. Security Ownership of Certain Beneficial Owners and Management.....42
Item 13. Certain Relationships and Related Transactions.....................44
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....47
ITEM 1. BUSINESS
General
Fonix Corporation, a Delaware corporation ("Fonix" or the "Company")
is a development stage company engaged in marketing and developing proprietary
human-computer interface ("HCI") technologies and solutions. Specifically, the
Company has developed neural network-based automated speech recognition ("ASR"),
text-to-speech ("TTS"), handwriting recognition ("HWR") and speech compression
technologies that are integrated into products for commercial and industrial
applications and customers. (ASR, TTS, HWR and speech compression technologies
are sometimes collectively referred to as "Core Technologies".) The Company
expects to continue to make commercially available applications and products
utilizing its Core Technologies which enable people to interact with computers
and electronic devices on human terms rather than conforming to the process of a
machine. The Company believes its efficient, intuitive and natural method of HCI
will enhance traditional interaction tools such as the keyboard and mouse in a
broad range of mass market, consumer, industrial, embedded and server-based
applications and products.
Fonix is pursuing revenue opportunities through generation of
non-recurring engineering fees, product and technology license and royalty fees,
product sales and product support maintenance contracts. The Company currently
markets its products and Core Technologies to software developers, consumer
electronics manufacturers, micro-processor manufacturers, third-party product
developers, operating system developers, network and share-ware developers and
Internet and web-related companies. The Company focuses its marketing efforts
toward both embedded systems applications for mobile electronic devices and
consumer products, and server-based solutions for Internet and telephony
voice-activated applications.
Manufacturers of consumer electronics products, software development
and Internet content developers use Fonix Core Technologies to simplify the use
of their products and increase product functionality resulting in broader market
opportunities and significant competitive advantage. Fonix solutions support
multiple platforms, are environment and speaker independent and provide easy
integration within a relatively small memory requirement.
Core Technologies
Fonix Core Technologies have key competitive advantages that
differentiate them from other speech and handwriting technology companies.
ASR. Fonix researchers have developed and patented what the Company
believes to be a fundamentally unique approach to the analysis of human speech
sounds and the contextual recognition of speech. The ASR technologies attempt to
approximate the techniques employed by the human auditory system and language
understanding, based upon the use of a series of neural networks. The Fonix ASR
technologies use information in speech sounds perceptible to humans but not
discernible by other ASR systems. The ASR technologies employ neural network
technologies (artificial intelligence techniques) for identifying speech
components and word sequences contextually. As presently developed, the phonetic
sound recognition engine is comprised of several components, including audio
signal processing, a feature extraction process, a phoneme estimation process,
and a linguistic process based on the neural net technologies. This development
has yielded a proprietary ASR system utilizing a unique method of extracting the
fundamental mathematical elements from the acoustic speech signal, a neural
net-based phoneme (speech sound) identifier, and a neural-net architecture for
modeling the many complex elements of human language. The latter component is
known as MULTCONSTM or multi-level temporal constraint satisfaction network.
These developments have been the subject of two issued patents and 13 pending
patent applications. In addition, the Company has acquired a related patent
covering the front-end recognition process.
The Company believes the reliable recognition of natural, spontaneous
speech spoken by one or more individuals in a variety of common environments by
means of a conveniently placed microphone will significantly improve the
performance, utility and convenience of applications such as computer command
and control, voice activated navigation of the Internet, automotive
applications, data input, text generation, telephony transactions, continuous
dictation, and other applications in both embedded and server based
applications.
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Fonix has pursued the development of these ASR technologies to
produce salable products by overcoming the limitations of currently available
commercial ASR systems and broadening the market acceptance and use of HCI
technologies. Key benefits resulting from Fonix proprietary ASR technologies
which differentiate Fonix ASR products and technologies from other currently
available competitive products include:
1. Significantly reduced computer memory requirements that allows speech
recognition to operate in embedded system environments, or enabling
server-based systems to operate with significantly more simultaneous
users due to lower memory requirements.
2. Significantly reduced power requirements that makes Fonix
technologies available for use in a host of smaller computing
solutions with limited battery/power capacity and enabling more
simultaneous users on server-based systems.
3. Speaker independence that allows various speakers to use the same
system without the system being trained to a particular user's voice
and dialect.
4. Excellent noise cancellation qualities that allows the ASR system to
extract ambient background noise, permitting higher recognition rates
in noisy environments and reduces the need for direct-wired
microphones or headsets.
5. Rapid porting to multiple computer chip platforms and operating
systems that creates broad embedded product demand.
6. Leading edge, visual, integrated development environment using the
Fonix Accelerated Applications Speech Technology (FAAST) software
developer kit ("SDK"), that allows customers to build applications in
a rapid time frame with a high rate of success and few outside
resources, thereby accelerating product time to market.
The Company believes that its ASR technologies offer unique speech
processing techniques that will improve a broad range of computing solutions and
accelerate and enhance integration of HCI technologies into products,
applications, solutions and devices.
The Company expended $6,823,612 in 1999, $12,109,065 in 1998, and
$7,066,294 in 1997 on ASR research and development ("R&D") activities. Since its
inception (October 1, 1993), the Company has spent $36,869,970 on R&D of ASR
technologies. The Company recognized revenue of $2,368,138 in 1998 resulting
from a licensing agreement for ASR technology with an international microchip
manufacturer. Otherwise, no ASR-related revenue has been generated to date and
the Company expects that a substantial part of its capital resources will
continue to be devoted to product development and marketing R&D of ASR
technologies in the future.
TTS. Fonix text-to-speech products include a defined, proprietary
vocabulary-true human-quality synthetic voice with full prosody and an unlimited
vocabulary text-to-speech engine.
The Company's TTS products use actual recordings of "units" of human
speech (i.e., the sound pulsation). Since the unit of speech often consists of
more than one phoneme (sound), Fonix's approach has been called a "large segment
concatenative speech synthesis" approach. Since the early 1960's, other
companies such as DEC and AT&T have used a method called "parametric speech
synthesis." In contrast to these parametric systems, Fonix synthetic speech
products produce a high quality, human sounding voice that includes full voice
inflection, intonation and clarity. Fonix' large vocabulary TTS ("LVTTS") engine
won awards as "best text-to-speech" product at the Computer Technology Expo '97
and '98 and the best of show award at AVIOS '97. Presently LVTTS products are
sold to end-users, systems integrators and OEMs in call centers, Internet
applications, telecommunications, multi-media, educational and assistive
technology markets.
TTS products include the Fonix AV 1700 TTS system for end-user
desktop and laptop system use. The Fonix AV 2001 SDK is a tool for developers of
telephony applications. Run-time software licenses for the AV 2001 are offered
for applications developed with the SDK. The SDK supports major computer
telephony platforms, including Microsoft Windows 95m, Windows 98 and Windows NT,
Solaris Sparc and Solaris X86, and AIX.
During 1999, the Company recognized $397,873 in revenue from
licensing or sale of the TTS technologies and products.
Page 4 of 47
HWR. Fonix handwriting recognition products are marketed under the
Allegro brand name. The Allegro HWR software is a single letter recognition
system like the Graffiti handwriting recognition software for the PalmPilot(R)
PDA. However, Allegro's alphabet is all natural in appearance involving lower
case letter. The Allegro system is easy to use and requires little training.
Allegro is sold by Purple Software, under license from the Company, for the
Psion Series 5(R) hand-held PC. It has also been integrated into NuvoMedia's
Rocketbook(R) for handwriting features in its electronic book program. This
software has also been licensed to Philips for use with its smart cell phones.
Fonix also offers cursive HWR software which recognizes naturally-written whole
words. The cursive HWR technology is only available as a licensed product to OEM
customers. Both the Allegro and the cursive handwriting recognition software are
user independent and require no training on the software.
During 1999, the Company received $41,634 in revenue from the
licensing of the HWR technologies.
Integration of HCI Technologies. During 1999, the Company created
SDK's for developing applications that utilize some or all Core Technologies.
FAAST for Embedded and FAAST for Server allows the rapid development of ASR, TTS
and HWR programs into a single application. One such product development effort
that has been undertaken by the Company is a pen/voice application that permits
simultaneous input and editing of both handwriting and speech for hand-held
devices.
Market Strategy
The world-wide market for HCI technologies and products is emerging.
Currently, only a small portion of prospective applications for HCI technologies
has reached the critical point of commercial viability. Among the largest
current markets developing or employing speech technologies are embedded and
server-based applications in telephony and call centers, automatic desktop
dictation software, personal hand-held communication devices, Internet voice
portals and R&D markets. Historically, development of speech products in an
emerging market has been affected by declining margins, large memory
requirements, non-extendable technology, operating system platform dependence,
lack of integration and non-recurring engineering dependence. Recently, several
market trends have accelerated demand for speech applications including
technology convergence (more speech products companies and proliferation of the
world wide web), explosive growth in mobile personal communications and
organization devices, and legislative concerns for consumer safety and access to
technology by handicapped or disabled individuals.
The Company has strategically sought markets for its Core
Technologies with high margins, broad use, rapid development and market
emergence/presence. Fonix has also strategically avoided markets with low
margins which are commodity driven, subject to continuous price compression and
require costly customer support systems. The Company's current marketing
strategy is governed by the following general principles:
1. Focus on revenues - Pursue specific markets where revenues can be
realized in the short term through a market driven approach and away
from markets focusing on continued R&D. Also pursue opportunities
that represent recurring revenue streams rather than one-time
development or engineering fees.
2. Integration with minimal additional development engineering - Pursue
integration into customer products where Fonix technology is directly
compatible and can go to market as part of existing or new products
with minimal additional development engineering.
3. Existing marketing channels and significant market share - Partner
with customers who have existing marketing channels in place and
leverage product sales through those channels. Also, pursue customers
who enjoy dominant or significant market share in their respective
markets and who display the financial ability and marketing power to
rapidly bring products to market.
4. Second tier customer support - Position Fonix generally as a provider
of second tier customer support, providing training and tools for
Fonix customers who operate excellent front line support systems for
their end-user customers.
Because the Company is pursuing integration into mass market,
industrial, general business and personal electronics products and computing
solutions, lead time to revenue recognition is longer than for retail, commodity
driven software products. The Company's products sold and integrated into
customer applications are subject to both
Page 5 of 47
customer production schedules and customer success in marketing the products and
generating product sales. The Company's revenues are thus subject to delays and
possible cancellation resulting from customer integration delays.
Embedded Markets
Increasingly efficient and powerful computing solutions have rapidly
developed new markets by creating smaller, more convenient devices equipped with
personalized functions. These devices include PDAs (personal digital
assistants), cellular phones, web pads, wireless communications devices, and
other consumer electronics. A significant deterrent to full functionality of
these powerful, yet small computing devices is the current need for a keyboard
and/or a mouse to interface with the device. Recent integration of HWR
technology has helped to increase the demand for natural, intuitive HCI with
these devices and has prepared markets to pay for speech recognition and
synthetic speech in computing solutions. Other product development initiatives
that may drive additional interest in HCI include electronic books, wearable
computers, testing of smart appliances and toys (VCRs, answering machines,
wireless phones, and climate control systems) and command and control
applications (automotive, hands free cellular phones and voice activated
navigation systems).
Historically, micro processors for mobile computing devices did not
contain enough memory or computing power (MIPS) to operate most ASR and TTS
applications. Adding the hardware necessary to boost memory and computing power
increased the price of such devices to unacceptable levels. However, Fonix ASR
and TTS technologies have memory and power requirements that fall well within
tolerances needed to speech enable applications using existing 16 bit and 32 bit
processors. To capitalize on this distinct competitive advantage, Fonix is
pursuing sales and partnership relationships with companies offering embedded
products for mass consumer markets, industrial applications and business
computing solutions. Currently, Fonix has ported its HCI technologies to several
RISC processors including ARM, Epson EOC 33A104 and 204, and the Infineon
TriCore, and to Microsoft Windows CE hardware platforms including Intel
StrongARM, Hitachi SH3 and SH4, and MIPs core.
The Company has addressed these market opportunities by releasing
FAAST 1.0 for Embedded. FAAST for Embedded provides application developers with
a tool enabling rapid development of ASR and TTS applications that can be
quickly and efficiently ported into their product.
Fonix has identified key embedded market segments which it believes
will provide long term, sustainable revenue and earnings flow as follows:
1. Chip Manufacturers. Digital signal processor ("DSP") and micro
processor manufacturers are currently highly focused on technology
innovations which will support and drive sales of chips through
third-party vendors. Fonix ASR and TTS technologies have demonstrated
ability to operate in these environments.
2. Design Developers. Firms designing reference platforms and products
and developing functions operating on those platforms through
contracts with major mass market product suppliers provide a strong
market opportunity for Fonix because they are channels to major
consumer electronics marketers.
3. Software Developers. Software developers in multiple markets
increasingly enable their software products with one or more HCI
technologies, resulting in leveraged product sales and potential
royalty revenue for Fonix.
4. Third-Party Product Developers. Many companies are currently seeking
HCI technologies to integrate into a host of consumer electronics
devices, commercial applications and business solutions. Primary
markets for these applications are in automotive and aviation
telematics, industrial wearable computers, mobile communications
devices and PDAs.
Server-Based Markets
Telephony/call center solutions and shrink-wrap desktop dictation
software sales are two of the most advanced emerging markets for automated
speech. Current industry revenue estimates indicate that customized automated
call centers, virtual operators, packaged call center software, custom vertical
market dictation systems and general desktop dictation systems have led
server-based speech applications into the market. Additionally, new product
areas for automated speech include network systems, telephone company e-mail
reader services, software document readers, Internet navigation and screenless
Internet access, web site text readers and mobile computing solutions.
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The Company has addressed these market opportunities by releasing
FAAST 1.0 for Servers. FAAST for Servers provides application developers with a
tool enabling rapid development of ASR and TTS applications that can be quickly
and efficiently ported into their product.
In addition, the Company is focused on direct product development in
server-based markets in three primary areas:
1. Internet Voice Portals. Speech enabled access to the Internet and web
site navigation is a rapidly emerging need. Fonix is developing and
will soon implement products for voice portals to the Internet which
may be purchased for use by portal companies, web sites and content
providers, Internet service providers and browsers.
2. TTS for Reading Web Sites. Since over 70% of all web content is text,
demand for products allowing web content to be read to the user is
rapidly growing. Fonix has developed a web page reader which can be
added to web sites. This voice solution is targeted toward the
largest web content providers worldwide in media, government,
business and other industries.
3. Network Systems Command and Control and E-mail Reader. Fonix provides
both ASR and TTS which can be seamlessly integrated into network
software to speech-enable software applications.
Fonix Product Development and Delivery Focus
To accelerate the delivery of Fonix technologies, Fonix has
transitioned from an R&D-oriented organization into a product delivery matrix
organization. Company focus and organization consists of product teams led by
product managers who are marketing-oriented and charged with direct profit and
loss responsibilities. These responsibilities begin with market research, and
product definition and specification and end with delivery of quality products
which address needs identified by the marketplace, on schedule and within
budget.
Fonix has organized its product development efforts into the
following product management teams to facilitate delivery of its products to the
embedded and server markets described above:
1. FAAST 1.0 for Embedded Markets includes a Graphical Development
Environment that will allow customers to create and optimize speech
applications and generate the code that will run directly on the
target embedded platform. Fonix is initially delivering this
technology on the Intel StrongArm(R), MIPs Core, Epson EOC 33A104 and
208, Hitachi SH3 and SH4, and Infineon TriCore with standalone and
Microsoft Windows CE versions.
2. FAAST 1.0 for Server Markets is an SDK targeted to tightly integrate
Fonix ASR and TTS technologies on large platforms that will service
hundreds of concurrent users. This technology is primarily targeted
to applications that provide voice in and out for the Internet.
3. TTS Solutions focus on both small and unlimited vocabulary
applications using Fonix AV1700 and AV2001 for the telephony TTS
market.
4. Embedded Command and Control Solutions work directly with
manufacturers of products to integrate HCI into PDA's, cell phones,
automobile command and control and other applications.
5. Internet Voice Portal Solutions utilize the FAAST for Server product
to provide the technology to voice-enable the Internet for devices
which may not have a screen or keyboard, such as PDA's, cell phones,
or automotive applications. A prime market for this product is
providing Internet access to the handicapped.
6. Integrated Pen/Voice Solution provide simultaneous HWR and ASR input
for hand-held, mobile computing devices.
Employees
As of April 10, 2000, the Company employed 89 people. Of this total,
46 were employed in product development and delivery, 15 were employed in sales
and marketing and 28 were employed in strategic development, administration and
support.
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RECENT DEVELOPMENTS
Changes in the Company's Board of Directors and Executive Officers
Stephen M. Studdert resigned as the Company's chief executive officer
on January 26, 1999, as chairman of the board of directors on April 10, 1999 and
as a director on July 31, 1999. In connection with his resignation as chief
executive officer, the Company entered into a separation agreement with Mr.
Studdert pursuant to which Mr. Studdert released the Company from all claims and
obligations under his employment agreement, and the Company agreed to pay Mr.
Studdert $250,000 in 1999, $250,000 in 2000 and $100,000 in 2001.
Joseph Verner Reed, Reginald K. Brack and Rick D. Nydegger resigned
from the board of directors effective September 3, 1999.
William A. Maasberg Jr. became a member of Fonix's board of directors
on September 3, 1999. From December 1997 through February 1999, Mr. Maasberg was
a Vice President and General Manager of the AMS Division of Eyring Corporation.
The AMS Division manufactures multi-media electronic work instruction software
applications. He was also a co-founder and principal in Information Enabling
Technologies, Inc. ("IET"), and LIBRA Corporation ("LIBRA"), two companies
focusing on software application development, and served in several key
executive positions with both IET and LIBRA from May 1976 through November 1997.
Mr. Maasberg worked for IBM Corporation from July 1965 through May 1976 in
various capacities. He received his BS Degree from Stanford University in
Electrical Engineering and his MS in Electrical Engineering from the University
of Southern California. Mr. Maasberg was re-elected to the board of directors at
the Company's 1999 Annual Meeting of Stockholders and became chief operating
officer for the Company on March 21, 2000.
Mark S. Tanner was appointed to Fonix's board of directors on
November 9, 1999. Mr. Tanner is currently the chief financial officer and senior
vice president of finance and administration for Mrs. Fields' Original Cookies,
Inc. Mr. Tanner spent nine years at PepsiCo, where he was chief financial
officer for Pepsi International's operations in Asia, the Middle East, and
Africa. He was vice president of strategic planning for Pepsi North America, as
well as chief financial officer for Pepsi North America's Pepsi East Operations.
Mr. Tanner also spent ten years with United Technologies Corporation in various
capacities, including director of corporate development. Mr. Tanner holds a BA
in economics from Stanford University and an MBA from the University of
California at Los Angeles.
Sale of HealthCare Solutions Group
On September 1, 1999, Fonix completed the sale of the operations and
a significant portion of the assets of its HealthCare Solutions Group to Lernout
& Hauspie Speech Products N.V., an unrelated third party, for up to $28,000,000.
At the closing of this transaction, $21,500,000, less certain credits of
$194,018 was paid, and $2,500,000 was deposited into an 18-month escrow account
in connection with the representations and warranties made by Fonix in the sales
transaction. The remaining $4,000,000 of the sales price is payable as an
earnout contingent on the performance of the HealthCare Solutions Group over the
next two years. Through December 31, 1999, $500,000 had been released from the
escrow. The Company will not record the contingent earnout, if any, until it is
earned. The sale was approved by a majority of Fonix's stockholders. The
proceeds from the sale were used to reduce certain of the Company's liabilities
and to provide working capital to allow Fonix to focus on marketing and
development opportunities.
1999 Annual Meeting of Stockholders
Fonix held its 1999 Annual Meeting of Stockholders on October 29,
1999, at which 59,497,418 shares were represented in person or by proxy. The
stockholders approved amendments to the Company's Certificate of Incorporation
that (1) created a new class of common stock designated as Class B Non-Voting
Common Stock (the "Class B Shares") with 1,985,000 Class B shares authorized;
and (2) redesignated the Company's then-current common stock as Class A Common
Stock and changed each share of then-outstanding
Page 8 of 47
common stock into a share of Class A Common Stock. Additionally, the
stockholders approved an amendment to the Company's Certificate of Incorporation
that increased the number of authorized common shares from 100,000,000 to
300,000,000 and increased the number of authorized preferred shares from
20,000,000 to 50,000,000. The Class B shares were authorized to provide for the
conversion of 1,985,000 common shares issued in connection with the acquisition
of Articulate Systems, Inc. ("Articulate") to a non-voting class of stock as
provided in the Articulate acquisition agreement. The Company does not intend to
register its Class B shares. The stockholders also approved a series of
transactions in which the Company issued its Series D preferred stock and Series
E preferred stock. Finally, the stockholders elected Thomas A. Murdock, Roger D.
Dudley, John A. Oberteuffer, and William A. Maasberg Jr. to Fonix's board of
directors, and approved the board's selection of Arthur Andersen LLP as Fonix's
independent public accountants for the year ended December 31, 1999.
Delisting of the Company's Class A common stock from the Nasdaq SmallCap Market
On June 29, 1999, the Company received a letter from Nasdaq notifying
the Company that unless the minimum bid price for the Company's common stock
returned to $1.00 per share or more for at least ten consecutive trading days
before September 29, 1999, the Company's common stock would be delisted from the
Nasdaq SmallCap Market on October 1, 1999. In September 1999, the Company
appealed the Nasdaq decision to delist the Company's common stock. Nasdaq held a
hearing on the Company's appeal on October 28, 1999. On December 3, 1999, the
Company received notice that its stock had been delisted from the Nasdaq
SmallCap Market as of December 3, 1999. The Company's common stock is currently
trading on the OTC Bulletin Board. See "Risk Factors - Delisting from the Nasdaq
SmallCap Market could have an adverse effect on the liquidity of the Company's
Class A common stock and has triggered certain rights of the holders of the
Company's Debentures and Repurchase Rights."
Financing Activities
Series D and Series E Preferred Stock During 1999, 626,611 shares of
Series D preferred stock and 135,072 shares of Series E preferred stock,
together with related dividends on each, were converted into 47,252,275 shares
and 5,729,156 shares, respectively, of Class A common stock. After the above
conversions, 381,723 shares of Series D preferred stock and no shares of Series
E preferred stock remained outstanding as of December 31, 1999. Subsequent to
December 31, 1999, a total of 217,223 shares of Series D preferred stock,
together with related dividends, were converted into 15,436,378 shares of Class
A common stock. As of April 10, 2000, 164,500 shares of Series D preferred stock
remain outstanding. In connection with the sales of the Series D and Series E
preferred stock, the Company agreed to register the sale of shares received on a
conversion of the Series D and Series E preferred stock. If the number of shares
of the Company's Class A common stock currently issuable upon a hypothetical
conversion of the remaining Series D preferred stock exceeds those authorized
for issuance, the Company would be required to file an additional registration
statement to cover the remaining shares.
December 1998 Private Placement of Common Stock In connection with a
private offering of Class A common stock completed in December 1998 (the "Equity
Offering"), the purchaser of 1,801,802 Class A common shares received an equal
number of Repricing Rights as well as warrants to purchase 200,000 shares of
Class A common stock at an exercise price of $1.665 per share. The Repricing
Rights provide for the issuance of shares of Class A common stock based upon
agreed upon rates that vary depending upon the market price of the stock. Also
included were certain Repurchase Rights that may, upon the occurrence of certain
events, require the Company to repurchase all or a portion of the holder's Class
A common shares or Repricing Rights received in the Equity Offering. A
registration statement covering the shares underlying the Equity Offering was
declared effective February 11, 2000. Subsequently, the Repricing Rights were
exercised, resulting in the issuance of 4,568,569 shares of Class A common stock
on February 14, 2000. The Equity Offering shares and the shares issued upon
exercise of the Repricing Rights were sold, thereby extinguishing the Company's
obligation to repurchase the shares or the Repricing Rights.
Series C Convertible Debentures On January 29, 1999, the Company
entered into a Securities Purchase Agreement with four investors pursuant to
which the Company agreed to issue its Series C convertible debentures in the
aggregate principal amount of $4,000,000. The outstanding principal amount of
the debentures is convertible at
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any time at the option of the holder into shares of Class A common stock at a
conversion price equal to the lesser of $1.25 or the average of the closing bid
price of Class A common stock for the five trading days immediately preceding
the conversion date multiplied by 80%, subject to adjustment. The Company also
issued warrants to purchase 400,000 shares of Class A common stock at an
exercise price of $1.25 per share in connection with this financing. The
warrants have an exercise period of three years. On March 3, 1999, the Company
executed a Supplemental Agreement pursuant to which the Company agreed to sell
another $2,500,000 principal amount of the debentures on the same terms and
conditions as the January 29, 1999 agreement, except no additional warrants were
issued. Interest on the Debentures is payable quarterly in shares of the
Company's Class A common stock or cash, at the Company's option. (The January
and March 1999 offerings of debentures are collectively referred to as the "Debt
Offering.")
In connection with the Debt Offering, two officers and directors and
one former officer and director of the Company (together, the "Guarantors")
pledged 6,000,000 shares of the Company's Class A common stock beneficially
owned by them as collateral security for the Company's obligations under the
debentures. Subsequent to the March 1999 funding, the holders of the debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the pledge and that the holders intended to exercise their
rights to sell some or all of the pledged shares. The holders of the debentures
subsequently informed the Company and the Guarantors that the 6,000,000 pledged
shares were sold, and that proceeds from the sale of the pledged shares were
used to pay penalties attributable to default provisions of the stock pledge
agreement and to reduce the principal balance of the debentures. The aggregate
proceeds from the sale of the pledged shares was $3,278,893. Of this amount,
$406,250 was allocated to penalties attributable to default provisions of the
stock pledge agreement and recorded as interest expense and $343,750 related to
penalty provisions of the Series D preferred stock (held by a related group of
investors) and recorded as preferred stock dividends. Both of these amounts were
recorded by the Company during 1999. The remaining $2,528,893 was applied as a
reduction of the principal balance of the Debentures as of September 30, 1999.
As of April 10, 2000, the remaining principal balance of the debentures of
$3,971,107 plus interest had been converted into 10,385,364 shares of Class A
common stock.
Series F Convertible Preferred Stock Effective February 1, 2000,
Fonix entered into an agreement with four investors whereby Fonix sold to the
investors a total of 290,000 shares of its Series F convertible preferred stock,
in return for cash of $2,750,000. The Series F preferred stock was convertible
into shares of Fonix's Class A common stock during the first 90 days following
the closing of the transaction at a price of $0.75 per share, and thereafter at
a price equal to 85% of the average of the three lowest closing bid prices in
the 20-day trading period prior to the conversion of the Series F preferred
stock. A registration statement describing the Class A common stock to be issued
upon conversion of the Series F preferred stock was declared effective February
11, 2000.
Through April 10, 2000, all 290,000 shares of Series F preferred
stock together with related dividends were converted into 7,764,948 shares of
Class A common stock and the Company recorded a beneficial conversion feature in
the amount of $2,750,000 at the date of issuance.
Registration on Form S-2 In compliance with registration rights
granted in connection with the Equity Offering, Debt Offering and Series F
Preferred Stock transactions described above, Fonix registered 56,864,399 shares
of its Class A common stock. The registration statement filed on Form S-2 became
effective February 11, 2000.
Series G Convertible Preferred Stock Fonix has recently entered into
an agreement with investors whereby Fonix intends to sell up to 250,000 shares
of its Series G 5% convertible preferred stock, in return for cash payments of
up to $5,000,000. Although the terms of the sale have not been finalized, it is
anticipated that the Series G preferred stock will be convertible into shares of
Fonix's Class A common stock at a price of $1.50 per share during the first 90
days following the closing of the transaction, and thereafter at a price equal
to 85% of the average of the three lowest closing bid prices in the twenty-day
trading period prior to the conversion of the Series G preferred stock. The
purchasers of the Series G preferred stock will receive registration rights
which will require Fonix to file a registration statement covering the Class A
common stock underlying the Series G preferred stock. Fonix will also have the
option of redeeming outstanding Series G preferred stock. Through April 10,
2000, Fonix received approximately $1,250,000 as advances in connection with
this financing,
Page 10 of 47
although the securities purchase agreement has not been signed. Accordingly,
final terms may differ from those described above.
Addition of Shares to 1998 Stock Option and Incentive Plan
At a meeting of the board of directors on January 31, 2000, the board
voted to increase the number of shares of Class A common stock subject to the
1998 Stock Option and Incentive Plan (the "Plan") by 10,000,000 shares. The Plan
was adopted on June 1, 1998, and approved by the shareholders of the Company on
July 14, 1998. As initially approved by the shareholders, the Plan contained
10,000,000 shares. Prior to increasing the number of shares available under the
Plan on January 31, 2000, a total of 7,708,782 options had been granted to
employees, directors, and other eligible participants. The additional 10,000,000
shares were registered on Form S-8 effective February 15, 2000.
Grants of Stock Options
During 1999, Fonix granted options to purchase 1,294,000 shares of
Class A common stock as follows:
Grantee Number of Shares Exercise Price
- -------- ---------------- --------------
Directors 400,000 $0.406
Employee 100,000 $3.250
Employee 25,000 $1.531
Employees 25,000 $1.630
Employees 673,000 $1.531
Employees 5,000 $1.781
Employees 50,000 $1.281
Employees 1,500 $0.594
Employees 5,000 $1.375
Unrelated consultants 9,500 $1.531
The term of all of these stock options is ten years from the date of
grant. During 1999, 2,815,882 options expired without exercise. As of December
31, 1999, the Company had a total of 14,355,900 options outstanding, of which
13,484,237 were exercisable on or before December 31, 1999.
The Synergetics Transaction
Prior to March 1997, the Company's scientific research and
development activities were conducted solely by a third party, Synergetics, Inc.
("Synergetics"), pursuant to product development and assignment contracts
(collectively, the "Synergetics Agreement"). Under that arrangement, Synergetics
provided personnel and facilities, and the Company financed the Synergetics
research and development activities on an as-required basis and the Company was
obligated to pay to Synergetics a royalty of 10% (the "Royalty") of net revenues
from sales of products incorporating Synergetics' "VoiceBox" technology as well
as technology derivatives thereof. Synergetics compensated its developers and
others contributing to the development effort, in part, by granting "Project
Shares" to share in a portion of the Royalty received by Synergetics. On April
6, 1998, the Company and Synergetics entered into a Royalty Modification
Agreement whereby the Company agreed to offer an aggregate of 4,800,000
non-transferable common stock purchase warrants to the holders of the Project
Shares in consideration for which Synergetics agreed to cancel any further
obligation on the part of the Company to pay the Royalty. The exercise price of
the warrants was to be $10 per share and the warrants would not be exercisable
until the first to occur of (1) the date that the per share closing bid price of
the Class A common stock was equal to or greater than $37.50 per share for a
period of 15 consecutive trading days, or (2) September 30, 2000.
Effective March 31, 2000, the Company and Synergetics entered into a
Restated Royalty Modification Agreement whereby the Company agreed to pay
Synergetics $28,000 (the "Cancellation Amount") to cancel the obligation of the
Company to pay the Royalty. The Company has paid the Cancellation Amount to
Synergetics and teh Royalty has been canceled. The Company has no further
obligations to Synergetics, including the prior obligation to issue 4,800,000
warrants.
Termination of Financing Relationship
For several years, the Company maintained a relationship with a bank
pursuant to which the Company borrowed against its own funds on deposit with the
bank. Borrowings under this arrangement accrued interest at a
Page 11 of 47
rate approximately 1% greater than the rate of interest earned by the Company on
its funds on deposit with the bank. In order to reduce interest expenses, on
January 8, 1999, the Company applied its deposit account in the amount of
$20,024,109 against the unpaid loan balance of $20,046,776, resulting in an
unpaid loan balance of $22,667, which amount subsequently was paid by the
Company.
CERTAIN SIGNIFICANT RISK FACTORS
The short- and long-term success of the Company is subject to certain risks,
many of which are substantial in nature and outside the control of the Company.
You should consider carefully the following risk factors, in addition to other
information contained herein. All forward-looking statements contained herein
are deemed by the Company to be covered by and to qualify for the safe harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act"). You should understand that several factors govern whether any
forward-looking statement contained herein will or can be achieved. Any one of
those factors could cause actual results to differ materially from those
projected herein. These forward-looking statements include plans and objectives
of management for future operations, including the strategies, plans and
objectives relating to the products and the future economic performance of the
Company and its subsidiaries discussed above. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of any such statement should not be regarded as a representation by
the Company or any other person that the objectives or plans of the Company will
be achieved.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about Fonix's ability to
continue as a going concern.
Since its inception, Fonix has sustained losses. Such losses continue
due to acquisitions made in 1998, ongoing operating expenses, and a lack of
revenues sufficient to offset operating expenses. Fonix had negative working
capital of $4,804,796 at December 31, 1999. Fonix has raised capital to fund
ongoing operations by private sales of its securities, some of which have been
highly dilutive and involve considerable expense. Furthermore, in recent months,
the financial condition of the Company has required the Company to negotiate
with its creditors to reduce the amount or extend the due date of certain
obligations. In its present circumstances, there is substantial doubt about
Fonix's ability to continue as a going concern absent immediate and significant
sales of its existing products, substantial revenues from new licensing or
co-development contracts or a relatively large sale of its securities in the
near term.
Fonix incurred net losses of $21,662,419, $43,118,782 and $22,453,948
for the years ended December 31, 1999, 1998 and 1997, respectively. As of
December 31, 1999, Fonix had an accumulated deficit of $116,706,803 For the year
ended December 31, 1999, Fonix recorded revenues of $439,507. For the years
ended December 31, 1999 and 1998, Fonix recorded combined revenues from the
operations of the TTS and HWR businesses in the amount of $439,507 and $236,586,
respectively. Other than these revenues, Fonix's only revenues to date resulted
from non-refundable license fees totaling $2,368,138 paid in 1998 by an
international microchip manufacturer for the use of certain technologies in
integrated circuits suitable for telecommunications applications, and for which
Fonix has no further obligation whatsoever.
Fonix expects continuing losses from operations until such time as:
o current and additional co-development arrangements with
third parties produce revenues sufficient to offset Fonix's
ongoing operating expenses; and/or
o revenues from the licensing of Core Technologies and
products increase to levels sufficient to exceed Fonix's
operating expenses.
Page 12 of 47
Until that time, the Company must rely on funds raised through debt
and equity placements.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
As of April 10, 2000, Fonix owed trade payables in the aggregate
amount of approximately $789,774, of which $755,454 are more than 90 days
overdue. At present, Fonix's revenues from existing licensing arrangements and
products are not sufficient to offset Fonix's ongoing operating expenses or to
pay Fonix's current debt as described above. There is substantial risk,
therefore, that the existence and extent of the debt obligations described above
could adversely affect Fonix, its operations and financial condition.
If Fonix does not receive additional capital when and in the amounts needed in
the near future, its ability to continue as a going concern is in substantial
doubt.
Fonix anticipates incurring substantial sales and marketing, product
development and research and general operating expenses in the future that will
require substantial amounts of additional capital on an ongoing basis. These
capital needs are in addition to the amounts required to repay the debt
discussed above. Fonix will most likely have to obtain such capital from sales
of its equity, convertible equity and debt securities. Obtaining future
financing may be costly and will likely be dilutive to existing stockholders. If
Fonix is not able to obtain financing when and in the amounts needed, and on
terms that are acceptable to it, Fonix's operations, financial condition and
prospects could be materially and adversely affected, and Fonix could be forced
to curtail its operations or sell part or all of its assets, including its Core
Technologies.
Holders of Fonix Class A common stock are subject to the risk of additional
dilution to their interests as a result of the conversion of presently issued
preferred stock.
Introduction
Page 13 of 47
Fonix currently has two series of preferred stock outstanding: Series
A and Series D. All of Fonix's presently outstanding preferred stock is
convertible into shares of Fonix Class A common stock. The Series A preferred
stock was issued in October 1995 and is convertible, one-for-one into 166,667
shares of Class A common stock at the option of the holder. The Series D
preferred stock is convertible into Class A common stock according to one of
three separate conversion formulas, one of which is based, in part, on the
market price of Fonix Class A common stock during the several week period
leading up to the conversion date. Fonix previously had two other series of
preferred stock outstanding, Series E and Series F preferred stock, with terms
similar to those of the Series D, but all shares of the Series E and Series F
preferred stock have been converted into shares of Class A common stock.
At April 10, 200, the remaining 164,500 shares of Series D preferred
stock would convert into 2,333,333 shares of Class A common stock, representing
1.40% of all shares of Class A common stock then outstanding. However, this
calculation excludes the issuance of shares of Class A common stock as payment
of dividends accrued on the Series D preferred stock at the date of conversion,
as well as shares of Class A common stock issued upon conversion of the Series D
preferred stock prior to April 10, 2000.
The following table describes the number of shares of Class A common
stock that would be issuable as of April 10, 2000, assuming all 164,500 shares
of the Series D preferred stock presently issued and outstanding shares were
converted, and further assuming that the applicable conversion or exercise
prices at the time of such conversion or exercise were the following amounts.
The table excludes the effect of the issuance of shares of Class A common stock
upon payment of accrued dividends and also excludes differences among the
various methods of calculating the applicable conversion or exercise price.
------------------ ------------------------
Shares of Class A
Common Stock
Issuable Upon
Hypothetical Conversion or
Conversion/ Exercise of Series
Exercise Price D Preferred Stock
------------------ ------------------------
$0.25 13,160,000
$0.75 4,386,667
$1.50 2,193,333
$2.25 1,462,222
$3.00 1,096,667
Given the structure of the conversion formulas applicable to the Series D
preferred stock, there effectively
Page 14 of 47
is no limitation on the number of shares of Class A common stock into which such
convertible securities may be converted or exercised. As the market price of the
Class A common stock decreases, the number of shares of Class A common stock
underlying the Series D preferred stock continues to increase.
Overall Dilution to Market Price and Relative Voting Power of
Previously Issued Common Stock
The conversion of the Series D preferred stock may result in
substantial dilution to the equity interests of other holders of Class A common
stock. Specifically, the issuance of a significant amount of additional Class A
common stock would result in a decrease of the relative voting control of Class
A common stock issued and outstanding prior to the conversion of the Series D
preferred stock. Furthermore, public resales of Class A common stock following
the conversion of the Series D preferred stock likely would depress the
prevailing market price of Class A common stock. Even prior to the time of
actual conversions, exercises and public resales, the market "overhang"
resulting from the mere existence of Fonix's obligation to honor such
conversions or exercises could depress the market price of Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common
Stock
The outstanding shares of Series D preferred stock are convertible at
a floating price that may and likely will be below the market price of Class A
common stock prevailing at the time of conversion or exercise. As a result, the
lower the market price of Class A common stock at and around the time the holder
converts or exercises, the more Class A common stock the holder of such
convertible securities receives. Any increase in the number of shares of Class A
common stock issued upon conversion or exercise as a result of decreases in the
prevailing market price would compound the risks of dilution described in the
preceding paragraph of this risk factor.
Increased Potential for Short Sales
Downward pressure on the market price of Fonix Class A common stock
that likely would result from sales of Fonix Class A common stock issued on
conversion of the Series D preferred stock could encourage short sales of Class
A common stock by the holders of the Series D preferred stock or others.
Material amounts of such short selling could place further downward pressure on
the market price of Fonix Class A common stock.
Limited Effect of Restrictions on Extent of Conversions
The holders of the Series D preferred stock are prohibited from
converting their preferred stock into more than 4.999% of the then outstanding
Fonix Class A common stock. This restriction, however, does not prevent such
holders from either waiving such limitation or converting or exercising and
selling some of their convertible security position and thereafter converting or
exercising the rest or another significant portion of their holding. In this
way, individual holders of Series D preferred stock could sell more than 4.999%
of the outstanding Fonix Class A common stock in a relatively short time frame
while never holding more than 4.999% at a time.
Payment of dividends and interest in shares of Class A common stock
may result in further dilution
Under the terms of the Series D preferred stock, the Company has the
option to pay dividends on the preferred stock in shares of the Company's Class
A common stock. Dividends accrue from the date of the purchase of the Series D
preferred stock. As such, a decision by the Company to pay such dividends in
shares of Class A common stock could result in a substantial increase in the
number of shares issued and outstanding and could result in a decrease of the
relative voting control of Fonix Class A common stock issued and outstanding
prior to such payment of dividends.
If Fonix has difficulty capitalizing on acquisitions, its operations and
financial prospects could be adversely affected.
Page 15 of 147
In 1998, Fonix completed the acquisitions of AcuVoice, Inc.,
("AcuVoice") Articulate, and the Papyrus Companies (collectively "Papyrus").
Notwithstanding the sale in 1999 of the HealthCare Solutions Group (consisting
principally of the assets acquired from Articulate), Fonix's acquisitions of
AcuVoice and Papyrus present risks including at least the following:
o Fonix may have difficulty financing ongoing operations of
acquired businesses to the extent such businesses are not
generating positive cash flows;
o Fonix may have difficulty combining or integrating the
technology, operations, management or work force of the
acquired businesses with Fonix's existing operations;
o Fonix may have difficulty retaining the key personnel of the
acquired businesses;
o Fonix may have difficulty maintaining uniform standards,
controls, procedures, and policies across its entire
organization, including the acquired businesses; and
o There may be increased commitment of management resources
and related expenses resulting from efforts to integrate and
manage acquired businesses located at a distance from
Fonix's principal executive offices and research facilities.
Fonix has a limited product offering and many of its key technologies are still
in the product development stage.
There presently are only a limited number of commercially available
applications or products incorporating the Core Technologies. Fonix markets its
HCI technologies and products for embedded applications, and Internet and
telephony applications. However, the marketing of these technologies and
products is in its initial start-up phase with no material funding commitments
or meaningful sales. These product offerings are still relatively limited and
have not generated significant revenues to date. An additional element of
Fonix's business strategy is to achieve revenues through appropriate strategic
alliances, co-development arrangements, and license arrangements with third
parties. In addition to a master collaboration agreement with an international
microchip manufacturer, the Company has recently entered into licensing and
joint-marketing agreements with Intel and Microsoft. These agreements provide
for joint marketing and application development for Intel and Microsoft
end-users or customers. There can be no assurance that these collaboration
agreements will produce license or other agreements which will generate material
revenues for Fonix.
The market for many of Fonix's technologies is largely unproven and may never
develop sufficiently to allow Fonix to capitalize on its technology and
products.
The market for HCI technologies, including ASR technologies, TTS and
HWR, is relatively new. Additionally, Fonix's technologies are new and, in many
instances, represent a significant departure from technologies which already
have found a degree of acceptance in the HCI marketplace. The financial
performance of Fonix will depend, in part, on the future development, growth,
and ultimate size of the market for HCI applications and products generally, and
applications and products incorporating Fonix's technologies and applications.
The applications and products which incorporate Fonix's technologies will be
competing with more conventional means of information processing such as data
entry, access by keyboard or touch-tone telephone, or professional dictation
services. Fonix believes that there is a substantial potential market for
applications and products incorporating advanced HCI technologies including
speech recognition, speech synthesis, speech compression, speaker identification
and verification, handwriting recognition, pen and touch screen input, and
natural language understanding. Nevertheless, such a market for Fonix's
technologies or for products incorporating Fonix's technologies may never
develop to the point that profitable operations can be achieved or sustained.
Competition from other industry participants and rapid technological change
could impede Fonix's ability to achieve profitable operations.
Page 16 of 147
The computer hardware and software industries are highly and
intensely competitive. In particular, the HCI market sector and specifically the
ASR, computer voice and communications industries are characterized by rapid
technological change. Competition in the HCI market is based largely on
marketing ability and resources, distribution channels, technology and product
superiority and product service and support. The development of new technology
or material improvements to existing technologies by Fonix's competitors may
render Fonix's technologies less attractive or even obsolete. Accordingly, the
success of Fonix will depend upon its ability to continually enhance its
technologies and interactive solutions and products to keep pace with or ahead
of technological developments and to address the changing needs of the
marketplace. Some of Fonix's competitors have greater experience in developing,
manufacturing and marketing HCI technologies, applications and products, and
some have far greater financial and other resources than Fonix, or its potential
licensees and co-developers, as well as broader name-recognition,
more-established technology reputations, and mature distribution channels for
their products and technologies. Barriers to entry in the software industry are
low, and as the market for various HCI products expands and matures, Fonix
expects more entrants into this already competitive arena.
Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 1999, 1998 and 1997.
The independent public accountants' reports for Fonix's financial
statements for the years ended December 31, 1999, 1998, and 1997 include an
explanatory paragraph regarding substantial doubt about Fonix's ability to
continue as a going concern. This may have an adverse effect on the Company's
ability to obtain financing.
Delisting from the Nasdaq SmallCap Market could have an adverse effect on the
liquidity of the Company's Class A common stock.
Until recently, the Company's Class A common stock traded on the
Nasdaq SmallCap market. On December 3, 1999, the Company received notice that
its Class A common stock had been delisted from the Nasdaq SmallCap Market. The
Company's Class A common stock is currently trading on the OTC Bulletin Board.
The result of delisting from the Nasdaq SmallCap Market could be a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Class A common stock continues to trade on the OTC Bulletin
Board. Further, delisting could reduce the ability of holders of the Company's
Class A common stock to purchase or sell shares as quickly and as inexpensively
as they have done historically and adversely affect the Company's ability to
attract additional equity financing.
Fonix's operations and financial condition could be adversely affected by
Fonix's failure or inability to protect its intellectual property or if Fonix's
technologies are found to infringe the intellectual property of a third party.
Dependence on proprietary technology
Fonix's success is heavily dependent upon its proprietary technology.
On June 17, 1997, the United States Patent and Trademark Office issued U.S.
Patent No. 5,640,490 entitled "A User Independent, Real-time Speech Recognition
System and Method" (the "'490 Patent"). The 490 patent has a 20-year life
running from the November 4, 1994 filing date, and has been assigned to Fonix.
This patent covers certain elements of the Fonix ASR technologies. Fonix has
acquired two other patents and has filed 13 additional United States and foreign
patent applications. In addition to its patents, Fonix relies on a combination
of copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. Such means of
protecting Fonix's proprietary rights may not be adequate because such laws
provide only limited protection. Despite precautions that Fonix takes, it may be
possible for unauthorized third parties to duplicate aspects of the Fonix
technologies or the current or future products or technologies of its business
units or to obtain and use information that Fonix regards as proprietary.
Additionally, Fonix's competitors may independently develop similar or superior
technology. Policing unauthorized use of proprietary rights is difficult, and
some international laws do not protect proprietary rights to the same extent as
United States laws. Litigation periodically may be necessary to enforce
Page 17 of 47
Fonix's intellectual property rights, to protect its trade secrets or to
determine the validity and scope of the proprietary rights of others.
Risks of infringement by Fonix upon the technology of unrelated
parties or entities
Fonix is not aware and does not believe that any of its technologies
or products infringe the proprietary rights of third parties. Nevertheless,
third parties may claim infringement with respect to its current or future
technologies or products or products manufactured by others and incorporating
Fonix's technologies. Fonix expects that participants in the HCI industry
increasingly will be subject to infringement claims as the number of products
and competitors in the industry grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time consuming, result in costly litigation, cause development delays,
or require Fonix to enter into royalty or licensing agreements. Royalty or
license agreements may not be available on acceptable terms or at all. As a
result, infringement claims could have a material adverse affect on Fonix's
business, operating results, and financial condition.
Fonix is subject to the risk that certain key personnel, including key
scientific employees and independent contractors named below, on whom Fonix
depends, in part, for its operations, will cease to be involved with Fonix.
Fonix is dependent on the knowledge, skill and expertise of several
key scientific employees, including John A. Oberteuffer, Ph.D., Dale Lynn
Shepherd, R. Brian Moncur, Mark Hamilton and Doug Jensen; independent
contractors including C. Hal Hansen, Tony R. Martinez, Ph.D., and Kenneth P.
Hite; and executive officers, including Thomas A. Murdock and Roger D. Dudley.
The loss of any of the key personnel listed above could materially and adversely
affect Fonix's future business efforts. Although Fonix has taken reasonable
steps to protect its intellectual property rights including obtaining
non-competition and non-disclosure agreements from all of its employees and
independent contractors, if one or more of Fonix's key scientific, executive
employees or independent contractors resigns from Fonix to join a competitor, to
the extent not prohibited by such person's non-competition and non-disclosure
agreement, the loss of such personnel and the employment of such personnel by a
competitor could have a material adverse effect on Fonix. Fonix does not
presently have any key man life insurance on any of its employees.
Fonix has no dividend history and no intention to pay dividends in the
foreseeable future.
Fonix has never paid dividends on or in connection with any class of
its common stock and does not intend to pay any dividends to common stockholders
for the foreseeable future.
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the
only ones facing Fonix. Additional risks and uncertainties not presently known
to Fonix or that Fonix currently deems immaterial may also impair its business
operations. If any of the foregoing risks actually occur, Fonix's business,
financial condition, or results of operations could be materially adversely
affected. In such case, the trading price of Fonix Class A common stock could
decline.
ITEM 2. PROPERTIES
The Company owns no real property. Commencing in October 1996, the Company
leased a 25,600 square foot facility in Draper, Utah, from an unaffiliated third
party at which it conducts its principal scientific research, product
development and sales and marketing activities. The Company's lease of that
facility is for a term of 8 years, with a right to terminate after five years,
at the Company's option. Provided that the Company is not in default under the
lease, the Company has the option to extend the lease for 5 additional years.
The average base monthly lease payment over the 8-year life of the lease for
that facility is $28,389. Beginning in May 1999, the Company subleased
approximately 10,240 square feet of this space to an unrelated third party for a
monthly rental of $13,961.
Page 18 of 47
The sublease expires December 2000, but may be renewed for up to two additional
three-month periods at the option of the sublessee.
The Company also leases approximately 10,000 square feet of office space in
Cupertino, California. The lease on this space is for 5 years, with rent of
$24,412 per month. Beginning June, 1999, the Company subleased this space to an
unaffiliated party who assumed the terms and payments under the lease. Two
executive officers of the Company have personally guaranteed payment on this
lease until the assignment is effective.
In addition to the Draper facility, the Company subleases office space at market
rates for its corporate headquarters and administrative operations in Salt Lake
City, Utah, under subleases from Studdert Companies Corporation ("SCC"). SCC is
owned and controlled by three individuals, two of whom are executive officers
and directors of the Company. [See "Certain Relationships and Related
Transactions," and "Security Ownership of Certain Beneficial Owners and
Management"]. The two executive officers and a former executive officer of the
Company have personally guaranteed these leases in favor of SCC's landlord. The
leases expire December 2002 and February 2003 and require monthly rental
payments of $10,369.
The Company leases approximately 1,377 square feet of office space in Lexington,
Massachusetts, where it conducts sales and marketing for its HWR technologies
and product development for pen/voice products. This lease expires November 30,
2002 and requires monthly rental payments of $2,754.
The Company believes that the facilities described above are adequate for its
current needs.
ITEM 3. LEGAL PROCEEDINGS
On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default, demand for mediation, and demand for arbitration with the American
Arbitration Association. In its demand, OGI asserted that the Company was in
default under three separate agreements between the Company and OGI in the total
amount of $175,000. On September 23, 1999, the Company responded to OGI's demand
and denied the existence of a default under the three agreements identified by
OGI. Moreover, the Company asserted a counterclaim before the American
Arbitration Association against OGI in an amount not less than $250,000. Neither
OGI nor the Company have yet undertaken any discovery. However, a hearing date
has been set for August 8, 2000. The Company believes the OGI arbitration claim
is without merit, and management intends to vigorously press its counterclaim
against OGI.
In addition to the proceeding commenced by OGI, the Company is
involved in various lawsuits, claims, and proceedings arising in the ordinary
course of business. Management believes the ultimate disposition of such matters
will not materially affect the consolidated financial position or results of
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 29, 1999, the Company held its 1999 Annual Meeting of Stockholders.
The following matters were submitted to a vote of security holders:
Election of Thomas A. Murdock, Roger D. Dudley, John A Oberteuffer,
and William A. Maasberg Jr. to the Company's Board of Directors,
approved as follows:
Number of Number of Number of
Name of Director Shares For Shares Against Not Voted
----------------- ---------- -------------- ----------
William A. Maasberg Jr. 47,381,620 7,831,673 4,284,125
John A. Oberteuffer 47,411,770 7,783,378 4,302,270
Thomas A. Murdock 47,356,820 8,562,673 3,577,925
Roger D. Dudley 47,045,370 8,579,348 3,872,700
Appointment of Arthur Andersen LLP as the Company's independent public
accountants for the fiscal year ended December 31, 1999, approved by a
vote of 59,101,639 shares for, 298,317 shares against, and 97,462
shares withheld.
Amendment to the Company's certificate of incorporation that created a
new class of common stock designated as Class B Non-Voting Common
Stock (the "Class B Shares") with 1,985,000 Class B Shares authorized;
approved by a vote of 57,192,593 shares for, 1,015,071 shares against,
and 1,289,754 shares withheld. The Class B shares were authorized to
provide for the conversion of 1,985,000 common shares issued in the
acquisition of Articulate to a non-voting class of stock as provided
in the acquisition agreement.
Redesignation of the Company's then-current common stock as Class A
Common Stock and changed each share of then-outstanding common stock
into a share of Class A Common Stock approved by a vote of 57,192,593
shares for, 1,015,071 shares against, and 1,289,754 shares withheld.
Amendment to the Company's certificate of incorporation that increased
the number of Class A common shares authorized to be issued from
100,000,000 to 300,000,000 and increased the number of authorized
preferred shares from 20,000,000 to 50,000,000, approved by a vote of
20,086,173 shares for, 12,969,230 shares against, 1,261,492 shares
abstaining, and 25,180,523 brokler non-votes.
A series of transactions in which the Company issued its Series D 4%
preferred stock and Series E 4% preferred stock, approved by a vote of
20,779,723 shares for, 12,397,825 shares against, 1,139,347 shares
abstaining and 25, 180,523 shares not voted.
Page 19 of 47
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for Class A common stock as quoted on the Nasdaq (until
December 3, 1999) and on the OTC Bulletin Board thereafter for the four quarters
of calendar 1999 and 1998. The quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commissions and may not represent actual
transactions.
Calendar Year 1999 Calendar Year 1998
----------------------- ----------------------
High Low High Low
---- ----- ----- ----
First Quarter $ 3.31 $ 0.69 $ 6.50 $ 3.50
Second Quarter $ 0.94 $ 0.25 $ 6.34 $ 3.00
Third Quarter $ 1.19 $ 0.28 $ 4.00 $ 1.12
Fourth Quarter $1.00 $ 0.27 $ 2.63 $ 0.94
As of April 10, 2000, there were 164,194,614 shares of Fonix Class A
common stock outstanding, held by approximately 564 holders of record and 10,820
beneficial holders. This number of beneficial holders represents an estimate of
the number of actual holders of the Company's stock, including beneficial owners
of shares held in "nominee" or "street" name. The actual number of beneficial
owners is not known to the Company.
The Company has never declared any dividend on its Class A common
stock and it is expected that earnings, if any, in future periods will be
retained to further the development and sale of the Company's HCI technologies
and products. No dividends can be paid on the Class A common stock until such
time as all accrued and unpaid dividends on outstanding preferred stock, if any,
have been paid.
Recent Sales of Unregistered Equity Securities
On January 29, 1999, the Company sold debentures in the aggregate
principal amount of $4,000,000 to four investors. The outstanding principal
amount of the debentures is convertible at any time at the option of the holders
into shares of Class A common stock at a conversion price equal to the lesser of
$1.25 or 80% of the average of the closing bid price of the Class A common stock
for the five trading days immediately preceding the conversion date. The Company
also issued warrants to purchase 400,000 shares of Class A common stock in
connection with this financing. The warrants are exercisable at a price of $1.25
per share and have a three-year term. On March 3, 1999, the Company executed a
Supplemental Agreement with the same four investors, pursuant to which the
Company sold $2,500,000 principal amount of debentures on the same terms and
conditions as the January 29, 1999 agreement, except no additional warrants were
issued. The Company issued all of the debentures without registration under the
Securities Act of 1933, as amended (the "1933 Act"), in reliance on Section 4(2)
or Regulation D. The debentures were issued as restricted securities and the
debentures were stamped with a restrictive legend to prevent any resale without
registration under the 1933 Act or pursuant to an exemption.
On February 1, 2000, the Company issued 290,000 shares of Series F
preferred stock, par value $20 per share, to five investors for $2,750,000. The
Company issued such shares without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder. The shares of Series F preferred stock were issued as restricted
securities and the certificates representing the Series F preferred stock were
stamped with a restrictive legend to prevent any resale without registration
under the 1933 Act or pursuant to an exemption.
The Class A common shares underlying the debentures and the Series F
preferred stock were subsequently registered on Form S-2 that was declared
effective February 11, 2000.
On June 2, 1999, the Company issued 200,000 shares of Class A common
stock to an unrelated individual
Page 20 of 47
in payment for consulting services rendered. The Company issued such shares
without registration under the 1933 Act in reliance on Section 4(2) or
Regulation D. Such shares of Class A common stock were issued as restricted
securities, and the certificates representing such shares were stamped with a
restrictive legend to prevent any resale without registration under the 1933 Act
or pursuant to an exemption.
In two separate transactions, on December 2 and December 29, 1999,
the Company issued 500,000 shares of Class A common stock each to separate
entities not affiliated with the Company in payment for consulting services
rendered. The Company issued such shares without registration under the 1933 Act
in reliance on Section 4(2) or Regulation D. Such shares of Class A common stock
were registered on Form S-8 effective February 14, 2000.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below is derived from the
Company's consolidated balance sheets and statements of operations as of and for
the years ended December 31, 1999, 1998, 1997, 1996 and 1995. The data set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the consolidated financial
statements and related notes thereto included in this Report.
For the Year Ended December 31,
-------------- -------------- ------------ ------------- --------------
1999 1998 1997 1996 1995
-------------- -------------- ------------ ------------- --------------
Statement of Operations Data:
Revenues $ 439,507 $ 2,604,724 $ -- $ -- $ -
General and administrative expenses 9,498,753 8,817,643 12,947,112 3,530,400 3,553,665
Research and development expenses 7,909,228 13,060,604 7,066,294 4,758,012 2,704,165
Purchase of in-process research and -- 9,315,000 -- -- --
development
Amortization of goodwill and purchased 1,712,267
core technology 2,588,896 -- -- --
Other income (expense) (3,698,789) (6,507,245) (1,558,678) 458,904 (88,067)
Loss from continuing operations (19,949,196) (36,843,475) (21,572,084) (7,829,508) (6,345,897)
Loss from discontinued operations (2,187,080) (6,275,307) -- -- --
Gain (loss) on extraordinary items 473,857 -- (881,864) -- 30,548
Net loss (21,662,419) (43,118,782) (22,453,948) (7,829,508) (6,315,349)
Basic and diluted net loss per common share $ (0.31) $ (0.91) $ (0.59) $ (0.21) $ (0.30)
Weighted average number of common shares
outstanding 76,753,709 52,511,185 42,320,188 36,982,610 21,343,349
Page 21 of 47
As of December 31,
---------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ -------------- ------------- ------------- -------------
Balance Sheet Data:
Current assets $ 480,885 $ 20,638,070 $ 21,148,689 $ 23,967,601 $ 7,912,728
Total assets 19,173,147 61,912,791 22,894,566 25,331,270 7,984,306
Current liabilities 5,285,681 35,317,045 20,469,866 19,061,081 6,674,572
Long-term debt, net of current 3,971,107 -- 52,225 -- --
portion
Stockholders' equity 8,086,359 24,765,746 2,372,475 6,270,189 1,309,734
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FACTORS AFFECTING FUTURE OPERATING RESULTS" AND UNDER THE HEADING
"CERTAIN SIGNIFICANT RISK FACTORS" IN ITEM 1 PART I OF THIS REPORT, ABOVE.
The following discussion of the results of operations and financial condition
should be read in conjunction with the consolidated financial statements and
notes thereto included elsewhere in this report.
Overview
Since inception, Fonix has devoted substantially all of its resources
to research, development and acquisition of software technologies that enable
intuitive human interaction with computers, consumer electronics, and other
intelligent devices. Through December 31, 1999, the Company has incurred
cumulative losses amounting to $98,237,110, excluding cumulative losses from
discontinued operations of $8,462,387 and net extraordinary items. Such losses
are expected to continue until the effects of recent marketing and sales efforts
begin to take effect, if ever.
In 1999, Fonix management began to transition its strategic focus
from technology research, development and acquisition into sales and marketing
and product delivery. In 1999, the Company expended $1,125,611 in sales and
marketing efforts. The Company has made this transition while continuing to
achieve technology upgrades to maintain distinct competitive technology
advantages.
In its current marketing efforts, the Company seeks to form
relationships with third parties who can incorporate HCI technologies into new
or existing products. Such relationships may be structured in any of a variety
of ways including traditional technology licenses, co-development relationships
through joint ventures or otherwise, and strategic alliances. The third parties
with whom Fonix presently has such relationships and with which it may have
similar relationships in the future include developers of application software,
operating systems, computers, microprocessor chips, consumer electronics,
automobiles, telephony and other technology products.
Page 22 of 47
In February 1999, in connection with its transition in strategic
focus, the Company undertook an aggressive program of cost reduction emphasized
in four areas of operations:
1. Salaries, wages and related costs - Salaries greater than $50,000
per year were reduced 20 to 30 percent;
2. Third-party consultants - Reliance on third-party consultants was
reduced in the areas of research and development, marketing and
public relations;
3. Occupancy costs - Office space was reduced to accommodate current
operating needs;
4. Asset acquisition - Acquisition of new operating assets was
significantly restricted.
Implementation of these measures has reduced the monthly deficit in
cash flows from operating activities from $3 million in early 1999 to less than
$1 million in December 1999. Additional reductions are expected as these
measures reach full effect, but will be offset by increased expenses in sales
and marketing and ongoing product development.
On May 19, 1999, Fonix signed an agreement to sell the operations and
a significant portion of the assets of its HealthCare Solutions Group ("HSG"),
which consisted primarily of the operations of Articulate Systems, Inc.
("Articulate"), to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated
third party. The sale closed September 1, 1999. The proceeds from the sale were
used to reduce certain of the Company's liabilities and provided working capital
to allow Fonix to focus on marketing and developing technologies and products.
Results of Operations
The results of operations disclosed below give effect to the sale of
the HSG and the classification of its net assets and operating activities as
discontinued operations.
1999 Compared to 1998
During 1999, the Company recorded revenues of $439,507, a decrease of
$2,165,217 from $2,604,724 for 1998. Revenue in 1998 included licensing fees of
$2,368,138 from an international microchip manufacturer for which the Company
had no further obligation, and product sales and licensing fees of $236,586 from
other customers. The 1999 revenues are primarily from licensing fees from TTS
and HWR technologies and products.
Selling, general and administrative expenses were $9,498,753 for 1999
and $8,817,643 for 1998, an increase of $681,110. A one-time charge to
compensation expense in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company more than
offsets reductions achieved in other areas. Absent this charge, selling, general
and administrative expenses decreased by $762,490, due primarily to the cost
reduction measures undertaken by the Company in February 1999. Decreases in
salaries and related costs of $85,613 and in consulting expenses of $61,842 are
direct results of such measures. Also, a reduction in acquisition activity from
1998 to 1999 resulted in a decrease of $213,346 in legal and investor-related
expenses.
The Company incurred product development and research expenses of
$7,909,228 during 1999, a decrease of $5,151,376 from 1998. This decrease was
due primarily to management's cost reduction initiatives implemented in February
1999 and the transition of emphasis from research and development towards sales
and marketing. The Company anticipates further decreases in product development
and research costs as it nears completion of development of certain TTS and ASR
products. During 1999 and 1998, the Company expended a total of approximately
$303,000 and $130,000, respectively, in connection with ongoing development of
the AcuVoice purchased in-process R&D projects. The Company anticipates that its
investment in product development and research will continue at decreased levels
for 2000, assuming availability of working capital.
Amortization of goodwill and purchased Core Technologies was
$2,588,896 for 1999 and $1,712,267 for 1998. The increase of $876,629 results
from amortization for one full year in 1999 compared to amortization for the
portion of 1998 from the respective acquisition dates of AcuVoice and Papyrus to
the end of the year.
Page 23 of 47
Net other expense was $3,698,789 for 1999, a decrease of $2,808,456
from 1998, resulting from changes in several areas. Interest income decreased by
$979,998 primarily due to certificates of deposit that were converted to cash to
retire a bank line of credit in January 1999. Cancellation of certain common
stock reset provisions resulted in an expense of $6,111,577 in 1998 but did not
affect 1999. Finally, interest expense increased by $2,165,778 primarily as a
result of beneficial conversion features recorded on convertible securities
issued in 1999, interest charges incurred on advances from the purchaser of the
HSG and interest charges on the Series C convertible debentures issued in
January and March 1999.
1998 Compared to 1997
During 1998, the Company recorded revenues of $2,604,724, of which
$2,368,138 was a non-refundable license fee from Siemens for which the Company
has no further obligation of any kind. The balance of revenues reflect sales
and licensing fees related to TTS voice synthesis technology.
During 1998, the Company incurred product development and research
expenses of $13,060,604, an increase of $5,994,310 over the $7,066,294
incurred in 1997. This increase was due primarily to the addition of product
development and research personnel, increased use of independent contractors,
equipment, facilities and the operations of AcuVoice and Papyrus.
Additionally, the Company expensed purchased in-process R&D totaling
approximately $9,315,000 during 1998, in connection with the acquisition of
AcuVoice.
Selling, general and administrative expenses were $8,817,643 in 1998
representing a decrease of $4,129,469 from 1997. This decrease resulted
primarily from a reduction in consulting and outside services amounting to
$6,739,461, offset by an increase in salaries, wages and related benefits of
$858,713, due to the increased workforce from the AcuVoice and Papyrus
acquisitions, and an increase in legal fees of $1,169,770, incurred
primarily in connection with acquisitions of AcuVoice, Articulate and Papyrus.
Goodwill and purchased core technology resulting from the
acquisitions of AcuVoice and Papyrus was amortized to operations for the first
time in 1998. An expense of $1,712,267 reflects amortization from the date of
acquisitions to the end of the year.
Net other expense was $6,507,245 for 1998, an increase of $4,948,567
over the previous year. This increase was primarily due to a $6,111,577
expense recorded in connection with the settlement of a reset provision
associated with a private placement of Class A common stock. This increase was
offset in part by a reduction in interest expense of $1,287,599 from 1998,
primarily due to extinguishment of certain debt instruments.
In-Process Research and Development
At the date of acquisition of AcuVoice, management estimated that the
acquired in-process R&D projects of AcuVoice were approximately 75 percent
complete and that an additional $1.0 million would be required to develop
these projects to commercial viability. As of December 31, 1999, the Company
has expended a total of approximately $433,000 in connection with the AcuVoice
acquired in-process research and development projects, and management
estimates that a total of approximately $567,000 will be required to complete
the AcuVoice projects. Management also estimates that the AcuVoice projects
are 88 percent complete as of December 31, 1999, and that the release dates
will be in the second quarter of 2000.
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its
cash requirements during the next 12 months. Research and development,
corporate operations and marketing expenses will continue to require
additional capital. Because the Company presently has only limited revenue
from operations, the Company intends to continue to rely primarily on
financing through the sale of its equity and debt securities to satisfy future
capital requirements until such time as the Company is able to enter into
additional third-party licensing or co-development arrangements such that it
will be able to finance ongoing operations out of license, royalty and sales
revenue. There can be no assurance that the Company will be able to enter into
such agreements.
Page 24 of 47
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 dilution to the stockholders of the
Company.
The Company had negative working capital of $4,804,796 at December
31, 1999, compared to negative working capital of $14,678,975 at December 31,
1998. The current ratio was 0.09:1 at December 31, 1999, compared to 0.58:1 at
December 31, 1998. Current assets decreased by $20,157,185 to $480,885 from
December 31, 1998 to December 31, 1999. Current liabilities decreased by
$30,031,364 to $5,285,681 during the same period. The improvement in working
capital reflects the payoff of the revolving line of credit with the
certificates of deposit that occurred in January 1999, and the reduction in
notes payable to related parties and accounts payable from the proceeds of the
sale of the HSG that was completed on September 1, 1999. Total assets were
$19,173,147 at December 31,1999, compared to $61,912,791 at December 31, 1998.
Delisting of the Company's Common Stock by Nasdaq
Until recently, the Company's Class A common stock traded on the
Nasdaq SmallCap Market. On December 3, 1999, the Company received notice that
its stock had been delisted from the Nasdaq SmallCap Market as of December 3,
1999. Consequently, the Company's Class A common stock is currently trading on
the OTC Bulletin Board.
The delisting from the Nasdaq SmallCap Market could result in a
reduction in the liquidity of any investment in the Company's Class A common
stock, even if the Company's shares continue to trade on the OTC Bulletin Board.
Further, delisting could reduce the ability of holders of the Company's Class A
common stock to purchase or sell shares as quickly and as inexpensively as they
have done historically and inhibit the ability of the Company to attract
additional equity capital.
Sale of the HealthCare Solutions Group
On September 1, 1999, the Company completed the Sale of the
HSG to L&H for up to $28,000,000. Of this sales price, $21,500,000, less certain
credits of $194,018, was paid at closing, $2,500,000 was held in an 18 month
escrow account in connection with the representations and warranties made by the
Company at the time of the Sale. Of the amount originally held in escrow,
$500,000 was released to the Company prior to December 31, 1999. Any remaining
amount up to $4,000,000 is payable as an earnout contingent on the performance
of the HSG over the next two years. The Company will not record the contingent
earnout, if any, until successful completion of the earnout requirements. The
proceeds from the Sale were used to reduce a significant portion of the
Company's liabilities and to provide working capital for the Company's marketing
and distribution opportunities for its HCI technologies. The assets sold
included inventory, property and equipment, certain prepaid expenses, purchased
technology and other assets of the HSG. Additionally, L&H assumed the capital
and operating lease obligations related to the HSG and the obligations related
to certain of the Company's deferred revenues.
Notes Payable
After the Papyrus acquisition closed in October 1998, the Company
investigated the representations and warranties made by Papyrus to induce the
Company to acquire the Papyrus companies. The Company determined that certain of
the representations made by Papyrus and its executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against the former
stockholders of Papyrus alleging misrepresentation and breach of contract. In
March and April 1999, five of the former stockholders of Papyrus filed actions
against the Company alleging default under the terms of the promissory notes
issued to them in connection with the Papyrus acquisition and certain other
claims. Subsequently, the Company entered into agreements with the five former
Papyrus stockholders for dismissal of the actions and cancellation of the
promissory notes upon payment to the former stockholders of $1,217,384 (the
"Settlement Payment") and return of 970,586 shares of restricted common stock
previously issued to the five former stockholders in connection with the
acquisition of
Page 25 of 47
Papyrus. The Company paid the Settlement Payment in September 1999 and the
lawsuits described above have been dismissed. The 970,586 shares were
effectively canceled in September 1999 in connection with the Settlement
Payment. The original fair market value of $1,000,917 associated with the
canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus Associates, Inc. As of December 31, 1999, the Company had
unsecured notes payable to former Papyrus stockholders in the aggregate amount
of $77,625, which notes were issued in connection with the acquisition of
Papyrus. The holders of these notes have not made demand for payment.
During 1999, the Company paid, or otherwise reduced through agreement
notes payable to various related parties totaling $8,482,946, plus accrued
interest. Additionally, the Company paid other notes payable to other parties
aggregating $560,000, plus accrued interest. Additionally, a revolving note
payable in the amount of $50,000 was paid by a former employee and is included
as an account payable. A revolving note payable in the amount of $19,988,193 at
December 31, 1998, plus accrued interest, was paid in full in January 1999 with
the proceeds from a certificate of deposit that secured the note and $22,667 in
cash.
In the fourth quarter of 1999, the Company negotiated reductions of
$526,697 in amounts due various trade vendors. Additionally, the Company
negotiated reductions of $229,055 in accrued interest owed to certain note
holders. These amounts were considered forgiveness of debt and have been
accounted for as extraordinary items in the 1999 consolidated statement of
operations.
December 1998 Equity Offering
In connection with a private offering of Class A common stock
completed in December 1998 (the "Equity Offering"), the purchaser of 1,801,802
Class A common shares received an equal number of Repricing Rights as well as
warrants to purchase 200,000 shares of Class A common stock at an exercise price
of $1.665 per share. The Repricing Rights provide for the issuance of shares of
Class A common stock based upon rates that vary depending upon the market price
of the stock. Also included were certain Repurchase Rights that may, upon the
occurrence of certain events, require the Company to repurchase all or a portion
of the holder's Class A common shares or Repricing Rights received in the Equity
Offering. A registration statement covering the shares underlying the Equity
Offering was declared effective February 11, 2000.
Subsequently, the Repricing Rights were exercised, resulting in the
issuance of 4,568,569 shares of Class A common stock on February 14, 2000. The
Equity Offering shares and the shares issued upon exercise of the Repricing
Rights were sold, thereby extinguishing the Company's obligation to repurchase
the shares or the Repricing Rights.
Series C convertible debentures
On January 29, 1999, the Company entered into a securities purchase
agreement with four investors pursuant to which the Company sold its Series C
convertible debentures in the aggregate principal amount of $4,000,000. The
outstanding principal amount of the debentures was convertible at any time at
the option of the holders into shares of the Company's Class A common stock at a
conversion price equal to the lesser of (1) $1.25 or (2) 80% of the average of
the closing bid price of the Company's Class A common stock for the five trading
days immediately preceding the conversion date. The Company recorded $687,500 as
interest expense upon the issuance of the debentures in connection with the
beneficial conversion feature. The Company also issued 400,000 warrants to
purchase an equal number of the Company's Class A common shares at a strike
Page 26 of 47
price of $1.25 per share in connection with this financing. The warrants are
exercisable for a period of three years from the date of grant. The estimated
fair value of the warrants of $192,000, as computed under the Black-Scholes
pricing model, was recorded as interest expense upon the issuance of the
debentures.
On March 3, 1999, the Company executed a supplemental agreement
pursuant to which the Company agreed to sell another $2,500,000 principal amount
of the debentures on the same terms and conditions as the January 29, 1999
agreement, except no additional warrants were issued. The Company recorded
$1,062,500 as interest expense upon the supplemental issuance in connection with
the beneficial conversion feature.
The obligations of the Company for repayment of the debentures, as
well as its obligation to register the Class A common stock underlying the
potential conversion of the debentures and the exercise of the warrants issued
in these transactions, were personally guaranteed by two officers and directors
and a former officer and director of the Company (the "Guarantors"). The
Guarantors pledged 6,000,000 shares of common stock of the Company beneficially
owned by them as collateral security for their obligations under their
guarantees.
Subsequent to the March 3, 1999 funding, the holders of the debentures
notified the Company and the Guarantors that the Guarantors were in default
under the terms of the guarantee and the stock pledge agreement and that they
had sold the 6,000,000 shares pledged by the Guarantors. The aggregate proceeds
from the sale of the pledged shares were $3,278,893. Of this total, $406,250 was
allocated to penalties attributable to default provisions of the stock pledge
agreement and recorded as interest expense and $343,750 related to penalty
provisions of the Series D preferred stock (held by a related group of
investors) and recorded as preferred stock dividends. The remaining $2,528,893
was applied as a reduction of the principal balance of the debentures as of
September 30, 1999. Under its indemnity agreement with the Guarantors, the
Company agreed to issue 6,000,00 replacement shares to the Guarantors for the
shares sold by the holders of the debentures and reimburse the Guarantors for
any costs incurred as a result of the holders' sales of the Guarnators' shares.
In 1999, the Company estimated and recorded expenses amounting to $1,296,600
pursuant to the indemnity agreement.
As of December 31, 1999, the remaining outstanding balance on the
debentures was $3,971,107. As of April 10, 2000, all remaining principal and
interest due on the debentures have been converted to 10,385,364 shares of the
Company's Class A common stock.
Page 27 of 47
Guarantors
In addition to guaranteeing obligations relating to the debentures,
the Guarantors guaranteed certain other obligations of the Company. As security
for some of the guarantees, the Guarantors pledged shares of the Company's Class
A common stock beneficially owned by them. In March 1999, 143,230 of the shares
previously pledged by the Guarantors to a bank were sold by the bank and the
proceeds were used to pay Company credit card balances and the related accrued
interest in full totaling $244,824. In May 1999, 100,000 of the shares
previously pledged by the Guarantors to another creditor of the Company were
sold by the creditor and the proceeds, totaling $72,335, were used to pay
amounts owed by the Company. In September 1999, the Company paid a note payable
to an unrelated third party in the amount of $560,000 that had previously been
guaranteed by the Guarantors. As of December 31, 1999, guarantees remained
outstanding in respect of certain real property subleases.
Series D and Series E Preferred Stock
During 1999, 626,611 shares of Series D preferred stock and 135,072
shares of Series E preferred stock, together with related dividends on each,
were converted into 47,252,275 shares and 5,729,156 shares, respectively, of the
Company's Class A common stock. After the above conversions, 381,723 shares of
Series D preferred stock and no shares of Series E preferred stock remained
outstanding as of December 31, 1999. Subsequent to December 31, 1999, a total of
217,223 shares of Series D preferred stock, together with related dividends,
were converted into 15,436,378 shares of Class A common stock. As of April 10,
2000, 164,500 shares of Series D preferred stock remained outstanding. In
connection with the sales of the Series D and Series E preferred stock, the
Company entered into registration rights agreements with the holders of the
Series D and Series E preferred stock and agreed to register the sale of shares
received on a conversion of the Series D and Series E preferred stock. If the
number of shares currently issuable upon a hypothetical conversion of the
remaining Series D preferred stock exceeds those authorized for sale, the
Company will be required to file an additional registration statement to cover
the remaining shares.
Class A common stock, stock options, and warrants
On June 2, 1999, the Company issued 200,000 shares of Class A common
stock (having a market value of $100,000 on that date) to an unaffiliated
individual in payment for consulting services rendered.
On December 23, 1999, the Company issued warrants to purchase
1,000,000 shares of the Company's Class A common stock to professional advisors
and consultants. The warrants were valued at $0.26 per share using the
Black-Scholes pricing model and the resulting charge was recorded as a deferred
consulting expense in stockholders' equity to be amortized as general and
administrative expense over the subsequent period of service. Also in December
1999, 1,000,000 shares of Class A common stock were issued to other
advisors and consultants as consideration for services rendered. The shares were
valued at $375,000 based upon the market value of the shares on the date of
issuance and recorded as general and administrative expenses.
During 1999, the Company granted 884,500 stock options to employees
at exercise prices ranging from $0.59 to $3.25 per share. The term of all
options granted during the year was ten years from the date of grant. Of the
stock options granted, 698,000 vested immediately and 186,500 vest over the
subsequent three-year period. As of December 31, 1999, the Company had a total
of 14,355,900 options outstanding.
The Company's option plans provide for stock appreciation rights that
allow the grantee to receive shares of the Company's Class A common stock
equivalent in value to the difference between the designated exercise price and
the fair market value of the Company's stock at the date of exercise. At
December 31, 1999, there were stock appreciation rights related to 400,000
shares outstanding with a weighted average exercise price of $1.18. Subsequent
to December 31, 1999, these stock appreciation rights were exercised at weighted
average exercise price of $1.18
During 1999, the Company granted warrants to L&H in connection with
loans made to the Company in April and May 1999 totaling $6,000,000. These
warrants allow L&H to purchase 850,000 shares of Class A
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common stock of the Company at exercise prices ranging f