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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2000, or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
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Commission File No. 0-23862
Fonix Corporation
(Exact name of registrant as specified in its charter)
Delaware 87-0380088
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
60 East South Temple, Suite 1225
Salt Lake City, Utah 84111
(Address of principal executive offices with zip code)
(801) 328-8700
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock
($0.0001 par value
per share)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No[ ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $92,208,533. calculated using a closing price of
$0.45 per share on March 20, 2001. For purposes of this calculation, the
registrant has included only the number of shares directly held by its officers
and directors as of March 20, 2001, (and not counting shares beneficially owned
on that date) in determining the shares held by non-affiliates. As of March 20,
2001, there were issued and outstanding 210,827,463 shares of the Company's
Class A common stock.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Fonix Corporation
2000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Part I
Page
Item 1. Business............................................................3
Item 2. Properties.........................................................19
Item 3. Legal Proceedings..................................................20
Item 4. Submission of Matters to a Vote of Security Holders................21
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................21
Item 6. Selected Financial Data............................................23
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................24
Item 8. Financial Statements and Supplementary Data........................31
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................31
Part III
Item 10. Directors and Executive Officers of the Registrant.................32
Item 11. Executive Compensation.............................................35
Item 12. Security Ownership of Certain
Beneficial Owners and Management...................................42
Item 13. Certain Relationships and Related Transactions.....................44
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................45
PART I
ITEM 1. BUSINESS
THIS ANNUAL REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FORWARD-LOOKING STATEMENTS" AND ELSEWHERE IN THIS ANNUAL REPORT. THE
FOLLOWING DISCUSSION SHOULD BE READ TOGETHER WITH OUR FINANCIAL STATEMENTS AND
RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT.
General
Fonix Corporation, a Delaware corporation ("Fonix" or the "Company"),
engages in marketing and developing proprietary technologies for natural user
interface ("NUI") technologies, applications and solutions. The Company's NUI
technologies, which include text-to-speech ("TTS"), neural network-based
automated speech recognition ("ASR"), speech compression and handwriting
recognition ("HWR"), are integrated into products for commercial and industrial
applications. ASR, TTS, HWR and speech compression technologies are sometimes
collectively referred to as "Core Technologies". The Company develops
commercially available applications and solutions utilizing its Core
Technologies that enable people to interact more easily with computers and
electronic devices in multiple mass-market implementations. The Company believes
its efficient and intuitive method of NUI enhances user productivity and
efficiency in a broad range of markets in server-based and embedded applications
and products.
The Company currently markets its Core Technologies solutions and
applications to software developers, consumer electronics manufacturers,
micro-processor manufacturers, third-party product developers, operating system
developers, network developers and Internet-related companies. The Company
focuses its marketing efforts toward both embedded systems applications for
mobile electronic devices and consumer products, and server-based solutions for
Internet and telephony voice-activated applications. The Company pursues revenue
opportunities through generation of royalty fees, product and technology
licenses, product sales, non-recurring engineering fees, and support agreements.
Manufacturers of consumer electronics products, software developers
and Internet content developers use Fonix Core Technologies to simplify the use
and increase the functionality of their products and services resulting in
broader market opportunities and significant competitive advantage. Fonix
solutions support multiple hardware and software platforms, are environment and
speaker independent, optimize cost and power efficiencies and provide easy
integration within a relatively small memory requirement as well as scalability
for high density capacity.
After initial introductions to the market in the fall of 1999 of ASR
and TTS in software packages geared toward application developers, Fonix
transitioned from a research and product development focus to a market-driven
focus. The operations of the Company, including sales, marketing, engineering,
product development and testing, and business development, have been
restructured to deliver on customer needs and acceptance of NUI applications and
solutions in multiple server-based and embedded products.
In the research report "Wireless Data: Speaking Up" (February 1,
2001), the investment banking firm Robertson Stephens states, "In our opinion,
voice is the next killer application, poised at the start of a major new
technology investment cycle." Fonix is well positioned to serve markets that are
rapidly adopting speech-enabled applications. As footprint size, noise
robustness, recognition accuracy and efficiency of speech technologies becomes
increasingly critical, Fonix expects to provide compelling solutions to meet
highly competitive customer demands.
Page 3 of 51
Fonix Accelerated Application Solutions Technologies (FAAST)
As the worldwide market for NUI technologies and products has
expanded, consumer products manufacturers, software developers and Internet
content developers have demanded decreased development time for NUI solutions
and increased quality of user interface technologies. Fonix has responded to
this demand with the development and release of FAAST, a proprietary development
framework. FAAST provides developers with a speech application framework that
enables rapid development of NUI applications that can be integrated quickly and
efficiently into products. FAAST has been released in versions for both the
server-based and embedded markets.
The FAAST development framework is quickly becoming recognized by
customers as a key ingredient to the successful launch of speech solutions. By
implementing FAAST, developers are provided a dynamic development environment to
integrate best-of-breed NUI technologies with minimal effort. Specifically,
FAAST allows a developer to integrate into products a highly scalable framework
that includes a broad range of key features necessary to create NUI
functionality, such as speech. The FAAST framework includes support for multiple
processors and operating system, highly flexible audio input drivers (i.e.
microphone, HTML, XML, Web, MP3, telephony), output drivers (i.e. speaker, MP3,
file, telephone, buffer), speech APIs (including SAPI and JSAPI), the Fonix
graphical application builder, and the ability to plug-and-play multiple ASR and
TTS engines. Furthermore, the FAAST development framework permits developers to
employ Fonix TTS and ASR or speech components from other sources of their own
choosing, as the needs of their total solution may dictate. Further benefits to
the customer may include a single-source NUI solution, a clear product upgrade
path, reduced integration time for NUI vendor upgrades and maximum product
flexibility.
Marketing and Product Delivery Initiatives
In the second quarter of 2001, Fonix intends to announce a strategic
marketing program designed to assist its channel partners to adopt and integrate
FAAST and Fonix NUI technologies. A Partner Program entitled "Powered by Fonix"
will offer distinct advantages to developers, resellers, and corporate partners.
Developer Partners - Designed to provide developers with a central
location for accessing a wide array of developer tools produced by
Fonix to help them successfully develop, deploy, and manage voice
applications. The Company's primary objective is to provide access to
multiple tools, such as FAAST, that help developers do their job.
Some tools will offer enhanced capabilities, others will offer
increased efficiency, and still others will provide unique
capabilities that Fonix believes might interest developers. While
some tools will be offered in full versions, others will be offered
in evaluation versions so that developers can conveniently try them
before purchasing.
Reseller Partners - Designed to establish and strengthen
relationships with the reseller community, the "Powered by Fonix
Channel Partner Program" will offer benefits designed to strengthen
relationships and promote the sale of Fonix technologies. With
benefits like sales leads, marketing collateral, training, TTS
hosting services, premium support and a secure reseller web site,
Fonix will provide its partners with the tools they need to
successfully implement the Fonix line of NUI solutions.
Corporate Partner - Designed to address the needs of the Company's
corporate customers, the Corporate Partner Program will focus on
service, support and high level relationships directed at maintaining
and recruiting key accounts and strategic partners.
Because the Company is pursuing third party integration of Fonix NUI
technology into mass market, industrial, general business and personal
electronics products and computing solutions, lead time to revenue recognition
will be longer than software products released directly into consumer channels.
The Company's products sold and integrated into customer applications are
subject to both customer production schedules and customer success in marketing
the products and generating product sales.
Page 4 of 51
Marketing and Sales Focus
Fonix has organized marketing and sales groups to address the needs
of emerging market opportunities and to ensure timely delivery of appropriate
applications and solutions.
Marketing. Headed by a vice president, the marketing group is
responsible for corporate communications, public relations and information,
direct product marketing, website operations, sales collateral and product
specification descriptions, corporate and sales presentations, product research
and management, product support, and trade show activity.
Within the marketing group, industries and products receive specific
attention:
Industry market segments - Industry Marketing Directors guide Fonix
product development in each industry, including market trend and
development research, competitive analysis, industry developments,
and technical requirements for required functions and features, and
sales support.
Product Management - Product Managers focus production efforts on
time and specification requirements, product quality assurance,
market introduction and product launch, competitive assurance,
engineering coordination, product upgrade coordination, and sales
support.
Additionally, the marketing group develops direct channel sales
opportunities for fully developed Fonix consumer applications. This includes the
establishment of channel sales partners, products and supporting marketing
processes.
Sales. Headed by a vice president, the sales group is responsible to
develop sales partners, opportunities, and relationships. The sales group is
responsible to develop original equipment manufacturers ("OEM") application
development projects, value-added resellers ("VAR") and other resellers,
enterprise (large corporate) sales, cross-selling opportunities to the Company's
existing customer base, and sales development for both server-based and embedded
markets. Key customer relationships, specifically with existing corporate
partnerships and relationships, are assigned to account representatives who are
responsible to pursue revenue opportunities by meeting customer needs through
product delivery.
Fonix focuses its primary sales efforts on customers and markets with
high margins, broad use, rapid development and market presence. Current sales
strategy is governed by the following general principles:
Focus on revenues - Pursue specific markets where revenues can be
rapidly realized without significant continued research and
development. Pursue opportunities that represent recurring revenue.
Application replication - Focus on specific applications that can be
developed and sold to multiple customers. Pursue integration where
Fonix technologies are directly compatible and can be integrated as
part of existing or new OEM products with minimal additional effort.
Existing marketing channels and significant market share - Partner
with customers who have existing marketing channels and leverage
product sales through those channels. Pursue customers with dominant
or significant market share and who are able to rapidly bring
products to market.
Second-tier customer support - Position Fonix as a provider of
second-tier customer support, providing training and tools for Fonix
customers who operate front line support systems for their end-user
customers.
Market Strategy: Server-Based and Embedded Environments
Page 5 of 51
Fonix products and solutions are sold into two markets based on
processor size and speed, and memory and power capacity. They include
server-based solutions (scaling from desktop/laptop applications to connected
server applications and even to full distributed solutions) and embedded
solutions (smaller processors with limited memory and power capacity).
Server-Based Markets - Interactive voice response solutions and voice
web portal development are two of the most advanced markets for automated
speech, and sales are increasing each year. Current industry revenue estimates
indicate that customized automated call centers, virtual operators, packaged
call center software, custom vertical market dictation systems and general
desktop dictation systems have led server-based speech applications into the
market. Additionally, new product areas for automated speech include network
systems, telephone company email reader services, software document readers,
Internet navigation and screenless access, website text readers and mobile
computing solutions. Currently, server-based markets are trending toward the
convergence of wireless data transmission and connectivity between mobile
computing and fixed-server databases.
The FAAST framework, including Fonix TTS and ASR engines, is marketed
primarily to solution integrators, including OEMs and VARs, who bring together
various applications and products to provide a complete solution to their
end-user customers. Fonix has entered into agreements with several key solution
providers such as Nortel Networks, Nuance Communications, Envox, and Motorola
Mobile Internet Exchange for one or both of these engines.
Fonix continues to focus on product enhancement and application
delivery in the following server-based markets:
Interactive voice response ("IVR") - Telephony applications for
corporate call centers, short messaging services and information
retrieval from server databases are already common. FAAST facilitates
upgrades and shortens development time required for new systems.
Internet Voice Portals - Speech-enabled access to the Internet and
website navigation are rapidly emerging needs. Fonix is developing
and anticipates marketing products for voice portals to the Internet
that may be purchased for use by portal companies, website and
content providers, Internet service providers and browsers.
Website readers - Because over 70% of all web content is text, demand
for products allowing web content to be read to the user is quickly
growing. Fonix has developed a web page reader that can be added to
websites. This voice solution is targeted toward the largest web
content providers worldwide in media, government, business and other
industries.
Network systems command and control and email reader - Fonix provides
TTS which can be seamlessly integrated into network software to
speech-enable software applications.
Embedded Markets - Increasingly efficient and powerful computing
solutions have resulted in the development of new markets by creating smaller,
more convenient devices and applications equipped with personalized functions.
These applications include personal digital assistants (PDAs), cellular phones,
web pads, wireless communication devices, automotive telematics and other
consumer electronics. A significant deterrent to full functionality of these
powerful and small computing devices is the current need for a keyboard, touch
screen and/or a mouse to interface with the device. Recent integration of HWR
technology has helped to increase the demand for these devices and has prepared
markets to pay for ASR and TTS in computing solutions. Other product development
initiatives that may drive additional interest in NUI technologies include
electronic books, wearable computers, smart toys and appliances such as VCRs,
answering machines, wireless climate control systems, and command-and-control
applications.
Fonix ASR and TTS technologies have memory and power requirements
that fall well within tolerances needed to speech-enable applications using
existing 16-bit and 32-bit processors. To capitalize on this distinct
competitive advantage, Fonix is pursuing sales and partnership relationships
with companies offering embedded
Page 6 of 51
products for mass consumer markets, industrial applications, and business
computing solutions. Currently, Fonix has ported its NUI technologies to several
RISC processors including ARM, Epson EOC 33A104 and 208, the Infineon TriCore,
and to Microsoft Windows CE hardware platforms including Intel StrongArm(R),
Hitachi SH3 and SH4, and MIPS core.
Fonix focuses on product development and application delivery in the
following embedded markets:
PDAs such as handheld computers requiring a developed operating
system with multiple functionality for both consumer and enterprise
markets.
Consumer electronics characterized by common processor usage and
typically no formal operating system.
Automotive telematics which require command-and-control speech
applications for common in-car functions and entertainment systems.
Cellular phones which require command-and-control speech applications
for both current market phone functions and future smart phone
applications.
Fonix has identified channel and direct sales opportunities for ASR,
TTS, and HWR technologies in embedded markets.
Chip Manufacturers - Digital signal processor, microprocessor, and
controller manufacturers are highly focused on technology innovations
that will support and drive sales of chips via third-party vendors.
Fonix has ported ASR and TTS to multiple platforms and is leveraging
sales through the third-party software networks. Partners in this
area include Motorola, Intel, Epson and Infineon.
Design and Operating System Developers - Reference platform and
product designers provide opportunity for design-in speech technology
sales. These companies are channels to major consumer electronics
marketers. Current design partners include Doctor Design (Wind River)
and Accelent.
Software Developers and Resellers - Software developers in multiple
markets, including operating systems, increasingly enable their
software products with one or more NUI technologies, resulting in
leveraged product sales and potential royalty revenue opportunities.
Current partners include PurpleSoft, Microsoft and QNX.
Product Developers and Manufacturers - Many companies are seeking NUI
technologies to integrate into a host of consumer electronics
devices, commercial applications, and business solutions. Primary
markets for these applications are in automotive and aviation
telematics, industrial wearable computers, mobile communications
devices and PDAs in both consumer and vertical markets. Current OEM
customers include Panasonic and Thomson Consumer Electronics.
Direct Sales of Embedded Applications - Fonix has developed and sold,
through website and reseller channels, complete software applications
directly to consumers and expects to continue this effort with new
products. Current products include TimeTalk and iSpeak.
Core Technologies and Product Applications
The Company expended $5,871,414 in 2000, $7,909,228 in 1999 and
$13,060,604 in 1998 on product development and research of its NUI technologies.
During 2000, 1999 and 1998, the Company received $656,853, $439,507 and
$236,586, respectively, in revenue from the licensing of NUI technologies. In
addition to these revenues, Fonix received non-refundable license fees totaling
$2,368,138 paid in 1998 by an international microchip manufacturer.
Page 7 of 51
ASR. Fonix researchers have developed and patented what the Company
believes to be a fundamentally unique approach to the analysis of human speech
sounds and the contextual recognition of speech. Fonix ASR technologies attempt
to approximate the techniques employed by the human auditory system and language
understanding, based upon the use of a series of neural networks. The Fonix ASR
technologies use information in speech sound features perceptible to humans but
not discernible by other ASR systems. As presently developed, the phonetic sound
recognition engine is comprised of several components, including audio signal
processing, a feature extraction process, a phoneme estimation process and a
linguistic process based on the neural net technologies. This development has
yielded a proprietary ASR system utilizing a unique method of extracting the
fundamental mathematical elements from the acoustic speech signal, a neural
net-based phoneme (speech sound) identifier, and neural-net architecture for
modeling the many complex elements of human language. The latter component is
known as MULTCONSTM or multi-level temporal constraint satisfaction network.
These developments are the subject of issued and allowed patents as well as
other patent applications that are pending.
The Company believes the reliable recognition of natural, spontaneous
speech spoken by one or more individuals in a variety of common environments by
means of a conveniently placed microphone will significantly improve the
performance, utility and convenience of applications. Such applications include
computer command-and-control, voice-activated navigation of the Internet,
automotive telematics, data input, text generation, telephony transactions,
continuous dictation and others in both embedded and server-based environments.
Fonix has pursued the development of its ASR technologies to produce
practical applications and products by overcoming the limitations of currently
available commercial speech recognition systems and broadening the market
acceptance and use of NUI technologies. Key benefits that help differentiate
Fonix ASR technologies from other currently available competitive products
include:
Significantly reduced computer memory requirements - allow speech
recognition to operate in embedded system environments, or enable
server-based systems to operate with lower memory requirements that
permit significantly more simultaneous users.
Significantly reduced power requirements - make ASR available for use
in smaller computing solutions with limited battery/power capacity
and enable more simultaneous users on server-based systems.
Speaker independence - allows various speakers to use the same system
without training the system to a particular user's voice and dialect.
Noise immunity quality - allows the ASR system to extract ambient
background noise, permitting higher recognition rates in noisy
environments and reduces the need for direct-wired microphones or
headsets.
Rapid porting to multiple computer chip platforms and operating
systems - creates broad product demand in embedded system
environments.
FAAST graphical application software developer kit ("SDK") - uses a
visual, integrated development environment that allows customers to
build applications rapidly with high success rate and few outside
resources, thereby accelerating product time-to-market.
Fonix products currently employing ASR technologies include FAAST
Embedded and FAAST Embedded for Windows CE development frameworks that utilize a
visual interface and graphical representation of elements to facilitate creation
of speech-enabled applications in embedded environments.
TTS. Fonix has developed two TTS engines, one for use with a large or
unlimited vocabulary and the other for use with a customized, smaller
vocabulary. Both engines utilize phonetic splicing to create words, are
exceptionally high quality in their respective domains and have specific market
focus.
The unlimited vocabulary synthetic voice engine can "speak" text of
any length and verbiage. The engine is deployed in both male and female voices
and in multiple languages including American English, U.K. English,
Page 8 of 51
French, German, Spanish, Italian, Dutch, Swedish, Finnish, Icelandic, and
Norwegian for uses which include email reading, web content reading and
streaming and document reading. A key competitive advantage of the unlimited
vocabulary engine is the ability to scale to a very broad range of applications.
Fonix TTS engines are able to deploy over eight times the channel density of the
nearest competitor, thus allowing significant hardware cost savings for
customers. Additionally, this unlimited TTS technology has been compressed to
levels well under five megabytes in memory size to allow use in many embedded
devices.
Custom or limited domain TTS is human quality synthetic speech and
can be deployed for vocabularies of up to 2,000 word blocks. Because the
dictionary for the custom engine is defined, connecting polysyllables or
elements of words that are larger than phonemes creates the application.
Applications for this technology include prompts and confirmation for
command-and-control systems, weather reports, traffic reports, etc. This engine
enjoys a memory size well under one megabyte and very low power requirements and
therefore is ideal for use in embedded, mobile and wireless applications.
Fonix synthetic speech products produce a high-quality,
human-sounding voice that includes full voice inflection, intonation, and
clarity. In addition to the human-like quality of the Fonix TTS, the technology
employed for processing the speech synthesis is significantly more efficient
than other competing technologies allowing Fonix TTS to operate in single-user
embedded environments as well as providing more simultaneous speech channels on
server-based applications.
Fonix products currently employing TTS technologies include:
FAAST TTS 5.1 - A software development framework that delivers TTS to
telephony, voice portal and Internet applications.
FAAST Embedded 1.1 - A software development framework that delivers
TTS and ASR to embedded applications.
iSpeak - A personal text reader for desktop and laptop systems that
reads to the user from any text file out loud in a natural,
human-sounding voice.
TimeTalk - A small software utility program for Pocket PC that reads
time out loud in a pleasant, human-quality voice.
Speak@Me - A TTS converter for audio playback across the Internet
that gives web content providers the ability to deliver audio content
to customers using a Real Audio player plug-in.
HWR. The Fonix HWR system converts natural handwriting into text that
can be read by electronic devices. It recognizes conventional cursive writing,
printing, and a natural, single-stroke alphabet. The single-stroke alphabet is
marketed under the "Allegro" brand name. Because it recognizes natural
handwriting styles as well as predefined high definition characters, the Allegro
system is quicker and requires less training than other similar applications.
In addition to currently available Allegro products, the Company is
also developing applications that will allow HWR to be used as a natural
handwriting interface with many handheld and tablet PC applications. Such
applications are designed to provide character recognition using any graphic pen
or stylus and computer tablet and forwards the characters to whatever
application the user is currently working in.
Employees
As of March 20, 2001, the Company employed 115 people. Of this total,
61 were employed in product development and delivery, 33 were employed in sales
and marketing, and 21 were employed in strategic development, administration and
support.
Page 9 of 51
RECENT DEVELOPMENTS
2000 Annual Meeting of Stockholders
Fonix held its 2000 Annual Meeting of Stockholders on September 28,
2000, at which 130,262,281 shares were represented in person or by proxy. The
stockholders elected Thomas A. Murdock, Roger D. Dudley, John A. Oberteuffer,
William A. Maasberg Jr. and Mark S. Tanner to The Company's board of directors,
and approved the board's selection of Arthur Andersen LLP as the Company's
independent public accountants for the year ended December 31, 2000.
Expansion Activities
Advocast - In 1997 and 1998, Fonix purchased 60,200 shares of Series
A 6% Convertible Preferred Stock (the "Advocast Preferred Stock") of Advocast,
Inc. ("Advocast") for $1,521,755. Subsequent to 1998, Advocast obtained an
additional $1,000,000 in financing from third parties, and continued developing
its technology to the point where it is ready for integration with speech
technologies, such as those available from Fonix.
On February 26, 2001, Fonix agreed to provide an additional $100,000
of financing under the terms of a 6% convertible debenture. The debenture is due
February 26, 2002, and is secured by the intellectual property and operating
assets of Advocast. The debenture is convertible into shares of Advocast common
stock at a rate of $8.62 per share at the option of Fonix. Furthermore, Fonix
has the right to convert its Advocast Preferred Stock into additional principal
under the debenture at a rate of $25 per share of Preferred Stock. If converted,
the resulting balance due under the debenture is subject to the same terms of
conversion into Advocast common stock or becomes due and payable six months
following the original due date of the convertible debenture. Fonix has not yet
advanced any amounts under the debentures.
Advocast and Fonix also entered into an agreement whereby Advocast
will provide consulting services to Fonix for development of Internet
applications of the Company's NUI technologies. The term of the agreement is
three months and may be renewed at the Company's option for an additional three
months. Fonix will pay Advocast $10,000 per month for these consulting services.
To date, Fonix has paid $30,000 to Advocast pursuant to the consulting
agreement.
Audium - In February 2001, the Company and Phone2Networks, Inc. dba
Audium ("Audium") entered into a collaboration agreement to provide an
integrated platform for generating Voice XML solutions for Internet and
telephony systems. Audium is a mobile application service provider that builds
and operates mobile applications that allow access to Internet information and
complete online transactions using any telephone. The collaboration will include
integration of FAAST with Audium's mobile applications development capability.
In connection with the collaboration agreement, in February 2001, the
Company advanced $200,000 to Audium as a bridge loan. The loan bears interest at
a rate of 12 percent per year, is due on or before February 28, 2003 and is
convertible into shares of Audium Series A Convertible Preferred Stock.
Telia - Telia Promotor AB ("Telia"), a wholly owned subsidiary of
Telia AB, a Swedish telecommunications company, has developed multiple language
capability for integration into TTS applications. In October 2000, the Company
entered into a revenue sharing arrangement with Telia that provides that Fonix
will pay a percentage of revenue to Telia for Fonix licenses of TTS technology
that include languages other than American English provided by Telia.
Korea Sales Office - In March 2001, the Company opened an office in
Seoul, Korea, to sell and market Fonix products and solutions in the embedded
and server markets to Korean manufacturers of microprocessor chips and consumer
electronics, and through VARs for retail distribution.
Page 10 of 51
Financing Activities
Convertible Promissory Note and Private Equity Lines of Credit On
June 20, 2000, the Company executed a convertible promissory note (the "2000
Note") with a private investor in the amount of $7,500,000 and was permitted to
draw funds as they were required for operations. During 2000, the Company drew
the entire amount available and recorded $106,348 as interest and financing
expense. Principal and interest were converted into 11,544,775 shares of Class A
common stock. The Company also recorded a beneficial conversion feature in the
amount of $3,447,623 related to borrowings under the promissory note.
On August 8, 2000, the Company entered into a Private Equity Line
Agreement ("Equity Line") with the same investor (the "Equity Line Investor"),
which gives the Company the right to draw down a maximum of $20,000,000 for
operations and other purposes. The initial $7,500,000 was obtained as part of
the convertible promissory note described above. The balance remaining under the
Equity Line is available to the Company through a mechanism of draws and puts of
stock. The Company is entitled to draw funds and to "put" to the Equity Line
Investor shares of Class A common stock in lieu of repayment of the draw. The
number of shares issued is determined by dividing the dollar amount of the draw
by 90 percent of the average of the two lowest closing bid prices of Class A
common stock over the seven trading-day period following the date the Company
tenders the put notice. The Equity Line Investor funds the amounts requested by
the Company within two trading days after the seven trading-day period.
During 2000, draws taken under the Equity Line amounted to $3,973,508
and were converted to 12,492,680 shares of Class A common stock. Subsequent to
December 31, 2000, additional draws amounting to $3,010,000 were converted into
6,770,945 shares of Class A common stock. As of March 20, 2001, $5,516,492 of
credit remains available to be drawn on the Equity Line.
Series F Convertible Preferred Stock In February 2000, Fonix entered
into an agreement with five investors whereby Fonix sold to the investors a
total of 290,000 shares of its Series F convertible preferred stock, in return
for cash of $2,750,000. In May 2000, the Series F investors and the Company
agreed to amend the Series F Stock Purchase Agreement adding a sixth investor
and increasing the number of Series F preferred shares issued by 26,036 shares,
bringing the total to 316,036 shares of Series F convertible preferred stock
issued. The Series F preferred stock was convertible into shares of Fonix's
Class A common stock during the first 90 days following the closing of the
transaction at a price of $0.75 per share, and thereafter at a price equal to
85% of the average of the three lowest closing bid prices in the 20-day trading
period prior to the conversion of the Series F preferred stock. A registration
statement describing the Class A common stock to be issued upon conversion of
the Series F preferred stock was declared effective February 11, 2000. In 2000,
309,963 shares of Series F preferred stock and related dividends were converted
into 8,342,820 shares of Class A common stock and the Company recorded a
beneficial conversion feature in the amount of $2,750,000 at the date of
issuance. Subsequent to December 31, 2000, the remaining 6,073 shares of Series
F convertible preferred stock and related dividends were converted into 519,067
shares of Class A common stock.
Series D Convertible Preferred Stock During 2000, 217,223 shares of
Series D preferred stock together with related dividends, were converted into
15,436,378 shares of Class A common stock. After the above conversions, 164,500
shares of Series D preferred stock remained outstanding as of December 31, 2000.
Subsequent to December 31, 2000, the remaining shares of Series D preferred
stock and related dividends, were converted into 13,978,440 shares of Class A
common stock.
Registrations on Form S-2 In compliance with registration rights
granted in connection with the Series F Convertible Preferred Stock and certain
aspects of previous convertible preferred stock and debenture transactions,
Fonix registered 56,864,399 shares of its Class A common stock. The registration
statement filed on Form S-2 became effective February 11, 2000, and was later
amended and declared effective December 4, 2000.
In compliance with registration rights granted in connection with the
Equity Line transaction described above, Fonix registered 53,185,889 shares of
its Class A common stock. The registration statement filed on Form
Page 11 of 51
S-2 became effective September 5, 2000, and was later amended and declared
effective December 4, 2000.
Grants of Stock Options
During 2000, Fonix granted options to purchase 7,116,067 shares of
Class A common stock as follows:
Grantee Number of Shares Exercise Prices
- -------------- ---------------- ----------------
Directors and Executive Officers 4,800,000 $0.28 - $1.01
Employees 2,052,400 $0.28 - $1.50
Consultants 263,667 $0.28 - $1.00
The term of all of these stock options is ten years from the date of
grant. During 2000, 675,570 options expired without exercise. As of December 31,
2000, the Company had a total of 19,857,700 options outstanding, of which
18,923,001 were exercisable at a weighted average exercise price of $3.07.
Page 12 of 51
CERTAIN SIGNIFICANT RISK FACTORS
The short- and long-term success of the Company is subject to certain risks,
many of which are substantial in nature and outside the control of the Company.
You should consider carefully the following risk factors, in addition to other
information contained herein. All forward-looking statements contained herein
are deemed by the Company to be covered by and to qualify for the safe harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act"). You should understand that several factors govern whether any
forward-looking statement contained herein will or can be achieved. Any one of
those factors could cause actual results to differ materially from those
projected herein. These forward-looking statements include plans and objectives
of management for future operations, including the strategies, plans and
objectives relating to the products and the future economic performance of the
Company and its subsidiaries discussed above. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of any such statement should not be regarded as a representation by
the Company or any other person that the objectives or plans of the Company will
be achieved.
Fonix's substantial and continuing losses since inception, coupled with
significant ongoing operating expenses, raise doubt about Fonix's ability to
continue as a going concern.
Since its inception, Fonix has sustained losses. Such losses continue
due to ongoing operating expenses and a lack of revenues sufficient to offset
operating expenses. Fonix had limited working capital of $180,356 at December
31, 2000. Fonix has raised capital to fund ongoing operations by private sales
of its securities, some of which have been highly dilutive and involve
considerable expense. In its present circumstances, there is substantial doubt
about Fonix's ability to continue as a going concern absent significant sales of
its existing products, substantial revenues from new licensing or co-development
contracts or continuing large sales of its securities.
Fonix incurred net losses of $22,761,229, $21,662,419, and
$43,118,782 for the years ended December 31, 2000, 1999 and 1998, respectively.
As of December 31, 2000, Fonix had an accumulated deficit of $143,040,284. As of
December 31, 2000, Fonix owed trade payables of approximately $655,352, of which
$224,436 are more than 60 days past due.
The Company expects to spend significant amounts to enhance its
products and technologies, expand domestic and international sales and
operations and fund research and development. As a result, the Company will need
to generate significant additional revenue to achieve profitability. Even if the
Company does achieve profitability, it may not be able to sustain or increase
profitability on a quarterly or annual basis. If the Company does not achieve
and maintain profitability, the market price for its common stock may further
decline, perhaps substantially.
If Fonix does not receive additional capital when and in the amounts needed in
the near future, its ability to continue as a going concern is in substantial
doubt.
Fonix anticipates incurring substantial sales and marketing, product
development and research and general operating expenses in the future that will
require substantial amounts of additional capital on an ongoing basis. Fonix
will most likely have to obtain such capital from sales of its equity,
convertible equity and/or debt securities. Obtaining future financing may be
costly and will likely be dilutive to existing stockholders. If Fonix is not
able to obtain financing when and in the amounts needed, and on terms that are
acceptable to it, Fonix's operations, financial condition and prospects could be
materially and adversely affected, and Fonix could be forced to curtail its
operations or sell part or all of its assets, including its Core Technologies.
Continuing debt obligations could impair Fonix's ability to continue as a going
concern.
At present, Fonix's revenues from existing licensing arrangements and
products are not sufficient to offset Fonix's ongoing operating expenses or to
pay in full the Company's current debt obligations. There is substantial
Page 13 of 51
risk, therefore, that the existence and extent of the debt obligations described
above could adversely affect Fonix, its operations and financial condition.
Holders of Fonix Class A common stock are subject to the risk of additional and
substantial dilution to their interests as a result of the issuances of Class A
common stock in connection with the Equity Line:
Introduction
The following table describes the number of shares of Class A common
stock that would be issuable as of March 20, 2001, assuming that the full amount
of the Equity Line had been put to the Equity Line Investor, and further
assuming that the applicable conversion or exercise prices at the time of such
conversion or exercise were the following amounts.
Equity Line - Shares
Hypothetical Conversion/ issuable upon put of
Exercise Price remaining $5,516,492
- ------------------------------ -----------------------
$0.25 22,065,968
$0.75 7,355,323
$1.50 3,677,661
$2.25 2,451,774
$3.00 1,838,831
Given the formulas for calculating the shares to be issued under the
Equity Line, there effectively is no limitation on the number of shares of Class
A common stock which may be issued in connection with a put under the Equity
Line. If the market price of the Class A common stock decreases, the number of
shares of Class A common stock issuable in connection with the Equity Line will
increase.
Overall Dilution to Market Price and Relative Voting Power of
Previously Issued Common Stock
The issuance of Class A common stock in connection with the Equity
Line may result in substantial dilution to the equity interests of other holders
of the Company's Class A common stock. Specifically, the issuance of a
significant amount of additional Class A common stock would result in a decrease
of the relative voting control of the Company's Class A common stock issued and
outstanding prior to the issuance of Class A common stock in connection with the
Equity Line. Furthermore, public resales of the Company's Class A common stock
following the issuance of Class A common stock in connection with the Equity
Line likely would depress the prevailing market price of the Company's Class A
common stock. Even prior to the time of actual conversions, exercises and public
resales, the market "overhang" resulting from the mere existence of the
Company's obligation to honor such conversions or exercises could depress the
market price of the Company's Class A common stock.
Increased Dilution With Decreases in Market Price of Class A Common
Stock
The formulas for determining the number of shares of Class A common
stock under the Equity are based, in part, on the market price of the Class A
common stock and likely will include a discount from the market price. As a
result, the lower the market price of the Company's Class A common stock at and
around the time the Company puts shares under the Equity Line, the more Class A
common stock the Equity Line Investor receives. Any increase in the number of
shares of the Company's Class A common stock issued upon conversion or put of
shares as a result of decreases in the prevailing market price would compound
the risks of dilution described in the preceding paragraph of this risk factor.
Increased Potential for Short Sales
Downward pressure on the market price of the Company's Class A common
stock that likely would result from sales of the Company's Class A common stock
issued in connection with a put under the Equity Line could encourage short
sales of Class A common stock by the Equity Line Investor. Material amounts of
such short selling
Page 14 of 51
could place further downward pressure on the market price of the Company's Class
A common stock.
Limited Effect of Restrictions on Extent of Conversions
Fonix is prohibited from putting shares to the Equity Line Investor
under the Equity Line if such put would result in that investor holding more
than 4.999% of the then outstanding Class A common stock. These restrictions,
however, do not prevent the Equity Line Investor from selling shares of Class A
common stock received in connection with a put, and then receiving additional
shares of Class A common stock in connection with a subsequent put. In this way,
the Equity Line Investor could sell more than 4.999% of the outstanding the
Company's Class A common stock in a relatively short time frame while never
holding more than 4.999% at one time.
Fonix has a limited product offering and many of its key technologies are still
in the product development stage.
Presently, there are a limited number of commercially available
applications or products incorporating the Company's Core Technologies. For the
Company to be ultimately successful, sales from these product offerings must be
substantially greater. An additional element of Fonix's business strategy is to
achieve revenues through appropriate strategic alliances, co-development
arrangements, and license arrangements with third parties. The Company has
recently entered into licensing and joint-marketing agreements with Intel and
Microsoft. These agreements provide for joint marketing and application
development for Intel and Microsoft end-users or customers. There can be no
assurance that these collaboration agreements will produce license or other
agreements which will generate material revenues for Fonix.
The market for many of Fonix's technologies and products is largely unproven and
may never develop sufficiently to allow Fonix to capitalize on its technology
and products.
The market for NUI technologies is relatively new and rapidly
evolving. Additionally, Fonix's technologies are new and, in many instances,
represent a significant departure from technologies which already have found a
degree of acceptance in the NUI marketplace. The financial performance of Fonix
will depend, in part, on the future development, growth, and ultimate size of
the market for NUI applications and products generally, and applications and
products incorporating Fonix's technologies and applications. Accordingly, in
order to achieve commercial acceptance of the Core Technologies, Fonix will have
to educate prospective customers, including large, established
telecommunications companies, about the uses and benefits of NUI software in
general and its products in particular. If these efforts fail, or if NUI
software platforms do not achieve commercial acceptance, the Company's business
could be harmed.
The applications and products which incorporate the Fonix Core
Technologies will be competing with more conventional means of information
processing such as data entry, access by keyboard or touch-tone telephone, or
professional dictation services. Fonix believes that there is a substantial
potential market for applications and products incorporating advanced NUI
technologies including ASR, TTS, HWR, speech compression, speaker identification
and verification, pen and touch screen input, and natural language
understanding. Nevertheless, such a market for Fonix's technologies or for
products incorporating Fonix's technologies may never develop to the point that
profitable operations can be achieved or sustained.
The application and delivery of the Company's Core Technolgies to end users is
dependent upon third party integration and may be subject to delays and
cancellations that are beyond the Company's control.
Because the Company is pursuing third party integration of Fonix NUI
technologies into mass market, industrial, general business and personal
electronics products, and computing solutions, lead time to revenue recognition
will be longer than software products directly released into consumer channels.
Purchase of the Company's products often require a significant expenditure by a
customer. Accordingly, the decision to purchase the Company's products typically
requires significant pre-purchase evaluation. The Company may spend significant
time educating and providing information to prospective customers regarding the
use and benefits of its products and technologies. During this evaluation
period, the Company may expend substantial sale, marketing and management
resources.
Page 15 of 51
Further, the Company's products and technologies sold and integrated
into customer applications are subject to both customer production schedules and
customer success in marketing the products and generating product sales. The
Company's revenues are thus subject to delays and possible cancellation
resulting from customer integration risks and delays.
In cases where the Company's contract with its customers specifies
milestones or acceptance criteria, the Company may not be able to recognize
license or services revenue until these conditions are met. The Company has in
the past and may in the future experience unexpected delays in recognizing
revenue. Consequently, the length of the Company's sales and implementation
cycles and the varying order amounts for its products make it difficult to
predict the quarter in which revenue recognition may occur and may cause license
and services revenue and operating results to vary significantly from period to
period. These factors could cause the Company's stock price to be volatile or to
decline.
Competition from other industry participants and rapid technological change
could impede Fonix's ability to achieve profitable operations.
The computer hardware and software industries are highly and
intensely competitive. In particular, the NUI market sector and, specifically,
the ASR, computer voice and communications industries are characterized by rapid
technological change. Competition in the NUI market is based largely on
marketing ability and resources, distribution channels, technology and product
superiority and product service and support. The development of new technology
or material improvements to existing technologies by Fonix's competitors may
render Fonix's technologies less attractive or even obsolete. Accordingly, the
success of Fonix will depend upon its ability to continually enhance its
technologies and interactive solutions and products to keep pace with or ahead
of technological developments and to address the changing needs of the
marketplace. Some of Fonix's competitors have greater experience in developing,
manufacturing and marketing NUI technologies, applications and products, and
some have far greater financial and other resources than Fonix, or its potential
licensees and co-developers, as well as broader name-recognition,
more-established technology reputations, and mature distribution channels for
their products and technologies. Barriers to entry in the software industry are
low, and as the market for various NUI products expands and matures, Fonix
expects more entrants into this already competitive arena.
Fonix's failure to respond to rapid change in the NUI market could cause the
Company to lose revenue and harm its business.
The NUI industry is relatively new and rapidly evolving. Fonix's
success will depend substantially upon its ability to enhance its existing
technologies and products and to develop and introduce, on a timely and
cost-effective basis, new technologies, products and features that meeting
changing end-user requirements and incorporate technological advancements. If
the Company is unable to develop new products and enhanced functionalities or
technologies to adapt to these changes, or if the Company cannot offset a
decline in revenue from existing technologies and products with sales of new
products, the Company's business would suffer.
Commercial acceptance of the Company's products and technologies will
depend, among other things, on:
o the ability of the Company's products and technologies to meet
and adapt to the needs of its target markets;
o the performance and price of the Company's products and its
competitors' products; and
o the Company's ability to deliver customer services directly and
through its resellers.
Any software defects in the Company's products could harm its business and
result in litigation.
Complex software products such as the Company's may contain errors,
defects and bugs. With the planned release of any product, Fonix may discover
these errors, defects and bugs and, as a result, its products may
Page 16 of 51
take longer than expected to develop. In addition, Fonix may discover that
remedies for errors or bugs may be technologically unfeasible. Delivery of
products with undetected production defects or reliability, quality, or
compatibility problems could damage its reputation. Errors, defects or bugs
could also cause interruptions, delays or a cessation of sales to the Company's
customers. Fonix could be required to expend significant capital and other
resources to remedy these problems. In addition, customers whose businesses are
disrupted by these errors, defects and bugs could bring claims against Fonix
which, even if unsuccessful, would likely be time-consuming and could result in
costly litigation and payment of damages.
In order to increase the Company's international sales, the Company must develop
localized versions of its products. If the Company is unable to do so, it may be
unable to grow its revenue and execute its business strategy.
Fonix intends to expand its international sales, which requires it to
invest significant resources to create and refine different language models for
each particular language or dialect. These language models are required to
create versions of Fonix's products that allow end users to speak the local
language or dialect and be understood. If Fonix fails to develop localized
versions of its products, Fonix's ability to address international market
opportunities and to grow its business will be limited.
Fonix may encounter difficulties in managing its growth, which could prevent it
from executing its business strategy.
Fonix's growth has placed, and continues to place, a significant
strain on its resources. To accommodate this growth, the Company must continue
to upgrade a variety of operational and financial systems, procedures and
controls and hire additional employees to support increased business and product
development activity. This has resulted in increased responsibilities for
Fonix's management. Fonix's systems, procedures and controls may not be adequate
to support its operations. If the Company fails to improve its operational,
financial and management information systems, or to hire, train, motivate or
manage its employees, the Company's business could be harmed.
If the Company is unable to hire and retain technical, sales and marketing and
operational employees, its business could be harmed.
The Company intends to hire additional employees, including software
engineers, sales and marketing employees and operational employees. Competition
for hiring these individuals is intense, especially in the Salt Lake City area
where the Company is headquartered, and it may not be able to attract,
assimilate, or retain additional highly qualified employees in the future. The
failure to attract, integrate, motivate and retain these employees could harm
Fonix's business.
The Company's stock price is volatile, and an investor may not be able to resell
its shares at or above the purchase price.
In recent years, the stock market in general, and the OTC Bulletin
Board and the securities of technology companies in particular, has experienced
extreme price and trading volume fluctuations. These fluctuations have often
been unrelated or disproportionate to the operating performance of individual
companies. These broad market fluctuations may materially adversely affect the
Company's stock price, regardless of its operating results.
Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 2000, 1999 and 1998.
The independent public accountants' reports for Fonix's financial
statements for the years ended December 31, 2000, 1999 and 1998 include an
explanatory paragraph regarding substantial doubt about Fonix's ability to
continue as a going concern. This may have an adverse effect on the Company's
ability to obtain financing to further develop and market its products.
Page 17 of 51
Fonix's operations and financial condition could be adversely affected by
Fonix's failure or inability to protect its intellectual property or if Fonix's
technologies are found to infringe the intellectual property of a third party.
Dependence on proprietary technology
Fonix's success is heavily dependent upon its proprietary technology.
Certain elements of the Company's Core Technologies are the subject of six
patents issued and allowed by the United States Patent and Trademark Office and
13 other patent applications are pending. In addition to its patents, Fonix
relies on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect its proprietary
rights. Such means of protecting Fonix's proprietary rights may not be adequate
because such laws provide only limited protection. Despite precautions that
Fonix takes, it may be possible for unauthorized third parties to duplicate
aspects of the Fonix technologies or the current or future products or
technologies of its business units or to obtain and use information that Fonix
regards as proprietary. Additionally, Fonix's competitors may independently
develop similar or superior technology. Policing unauthorized use of proprietary
rights is difficult, and some international laws do not protect proprietary
rights to the same extent as United States laws. Litigation periodically may be
necessary to enforce Fonix's intellectual property rights, to protect its trade
secrets or to determine the validity and scope of the proprietary rights of
others.
Risks of infringement by Fonix upon the technology of unrelated
parties or entities
Fonix is not aware and does not believe that any of its technologies
or products infringe the proprietary rights of third parties. Nevertheless,
third parties may claim infringement with respect to its current or future
technologies or products or products manufactured by others and incorporating
Fonix's technologies. Fonix expects that developers of NUI technologies
increasingly will be subject to infringement claims as the number of products
and competitors in the industry grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit,
could be time consuming, result in costly litigation, cause development delays,
or require Fonix to enter into royalty or licensing agreements. Royalty or
license agreements may not be available on acceptable terms or at all. As a
result, infringement claims could have a material adverse affect on Fonix's
business, operating results, and financial condition.
Fonix is subject to the risk that certain key personnel, including key
scientific employees and independent contractors named below, on whom Fonix
depends, in part, for its operations, will cease to be involved with Fonix.
Fonix is dependent on the knowledge, skill and expertise of several
key scientific employees, including John A. Oberteuffer, Ph.D., Dale Lynn
Shepherd, Mark Hamilton, R. Brian Moncur, and Doug Jensen; independent
contractors including C. Hal Hansen, Tony R. Martinez, Ph.D., and Kenneth P.
Hite; and executive officers, including Thomas A. Murdock, Roger D. Dudley and
William A. Maasberg, Jr. The loss of any of the key personnel listed above could
materially and adversely affect Fonix's future business efforts. Although Fonix
has taken reasonable steps to protect its intellectual property rights including
obtaining non-competition and non-disclosure agreements from all of its
employees and independent contractors, if one or more of Fonix's key scientific
employees, executive employees or independent contractors resigns from Fonix to
join a competitor, to the extent not prohibited by such person's non-competition
and non-disclosure agreement, the loss of such personnel and the employment of
such personnel by a competitor could have a material adverse effect on Fonix.
Fonix does not presently have any key man life insurance on any of its
employees.
Fonix's charter and bylaws and Delaware law contain provisions which may delay
or prevent a change of control of the Company.
Provisions of the Company's charter and bylaws may make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, control of Fonix. These provisions could limit the price
that investors might be willing to pay in the future for shares of Class A
common stock. These provisions include:
Page 18 of 51
o procedures for advance notification of stockholder nominations
and proposals; and
o the ability of the board of directors to alter the Company's our
bylaws without stockholder approval.
In addition, the board of directors has the authority to issue up to
50,000,000 shares of preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The board
utilized this right when approving and issuing the Series A through Series F
preferred stock. The issuance of preferred stock, while providing flexibility in
connection with financings or acquisitions or other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of Fonix's outstanding voting stock.
Fonix may incur a variety of costs to engage in future acquisitions of
companies, products or technologies, and the anticipated benefits of those
acquisitions may never be realized.
The Company may make acquisitions of, or significant investments in,
complementary companies, products or technologies. Any future acquisitions would
be accompanied by risks such as:
o difficulties in assimilating the operations and employees of
acquired companies;
o diversion of management's attention from ongoing business
concerns;
o potential inability to maximize the Company's financial and
strategic position through the successful incorporation of
acquired technology and rights into its products and services;
o additional expense associated with amortization of acquired
assets;
o maintenance of uniform standards, controls, procedures and
policies; and
o impairment of existing relationships with employees, suppliers
and customers as a result of the integration of new management
employees.
Fonix cannot guarantee that it will be able to successfully integrate
any business, products, technologies or employees that it might acquire in the
future, and its failure to do so could harm its business.
Fonix has no dividend history and no intention to pay dividends in the
foreseeable future.
Fonix has never paid dividends on or in connection with any class of
its common stock and does not intend to pay any dividends to common stockholders
for the foreseeable future.
There may be additional unknown risks which could have a negative effect on
Fonix.
The risks and uncertainties described in this section are not the
only ones facing Fonix. Additional risks and uncertainties not presently known
to Fonix or that Fonix currently deems immaterial may also impair its business
operations. If any of the foregoing risks actually occur, Fonix's business,
financial condition, or results of operations could be materially adversely
affected. In such case, the trading price of Fonix Class A common stock could
decline.
Page 19 of 51
ITEM 2. PROPERTIES
The Company owns no real property. Commencing in October 1996, the
Company leased a 25,600 square foot facility in Draper, Utah, from an
unaffiliated third party at which it conducts its principal scientific research,
product development and sales and marketing activities. The Company's lease of
that facility is for a term of eight years, with a right to terminate after five
years, at the Company's option. Provided that the Company is not in default
under the lease, the Company has the option to extend the lease for five
additional years. The average base monthly lease payment over the eight-year
life of the lease for that facility is $28,389. Beginning in May 1999, the
Company subleased approximately 10,224 square feet of this space to an unrelated
third party for a monthly rental of $13,961. The sublease expired December 2000.
In addition to the Draper facility, the Company subleases office
space on a month-to-month basis at market rates for its corporate headquarters
and administrative operations in Salt Lake City, Utah, under subleases from SCC
Asset Management, Inc., formerly Studdert Companies Corporation ("SCC"). SCC is
owned and controlled by three individuals, two of whom are executive officers
and directors of the Company. (See "Certain Relationships and Related
Transactions," and "Security Ownership of Certain Beneficial Owners and
Management"). The two executive officers and a former executive officer of the
Company have personally guaranteed these leases in favor of SCC's landlord. The
leases expire December 2002 and February 2003 and require monthly rental
payments of $10,368.
The Company leases approximately 1,377 square feet of office space in
Lexington, Massachusetts, where it conducts sales and marketing for its Core
Technologies and product development for pen/voice products and other
applications. This lease expires November 30, 2002 and requires monthly rental
payments of $2,754.
Effective May 25, 1999, the Company entered into an agreement to
sublease its Cupertino, California facility to an unrelated third party. The
agreement requires the sublessee to pay $35,432 per month through May 31, 2003.
The Company believes that the facilities described above are adequate
for its current needs.
ITEM 3. LEGAL PROCEEDINGS
OGI - On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default, demand for mediation and demand for arbitration with the American
Arbitration Association. In its demand, OGI asserted that the Company was in
default under three separate agreements between the Company and OGI in the total
amount of $175,000. On September 23, 1999, the Company responded to OGI's demand
and denied the existence of a default under the three agreements identified by
OGI. Moreover, the Company asserted a counterclaim before the American
Arbitration Association against OGI in an amount not less than $250,000. In
December 2000, a settlement was reached that required the Company to pay $27,500
in cash and issue 260,145 shares of Class A common stock, valued at $81,295 at
the date of settlement, and required that OGI return equipment loaned to them by
Fonix under the terms of their original agreements.
Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
affiliated with Clarke, commenced an action against Fonix in federal court for
the Southern District of New York. Clarke and Perpetual Growth asserted claims
for breach of contract relating to certain financing Fonix received during 1998
and thereafter. Fonix filed a motion to dismiss based upon the court's lack of
personal jurisdiction over Fonix. The court granted Fonix's motion to dismiss.
Clarke and Perpetual Growth thereafter appealed the decision of the New York
court to the United States Court of Appeals for the Second Circuit. The Court of
Appeals affirmed the decision of the trial court. In the interim, Fonix filed a
suit against Clarke and Perpetual Growth in federal court for the Central
District of Utah seeking a declaratory judgment that it did not owe any money to
Clarke and Perpetual Growth. The case was tried to the Utah court in March 2001,
after which the Utah court ruled in favor of Fonix and determined that Clarke
and Perpetual Growth had no claims for "trailing fees" with regard to the
financings which
Page 20 of 51
were the subject of the suit. Clarke and Perpetual Growth have appealed the
decision of the Utah court to the United States Court of Appeals for the Tenth
Circuit. The Company believes that the claims of Clarke and Perpetual Growth are
without merit and will continue to vigorously oppose those claims.
The Company is involved in other lawsuits, claims and actions arising
in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters will
not materially affect the consolidated financial position or results of
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 28, 2000, the Company held its 2000 Annual Meeting of
Stockholders. The following matters were submitted to a vote of security
holders:
Election of Thomas A. Murdock, Roger D. Dudley, John A. Oberteuffer,
William A. Maasberg Jr. and Mark S. Tanner to the Company's board of
directors, approved as follows:
Shares Shares
Name of Director Voted For Voted Against
---------------- --------- -------------
Thomas A. Murdock 129,445,118 726,163
Roger D. Dudley 129,319,052 852,229
John A. Oberteuffer 129,492,751 678,530
William A. Maasberg, Jr. 129,625,436 545,581
Mark S. Tanner 129,656,436 514,845
Appointment of Arthur Andersen LLP as the Company's independent
public accountants for the fiscal year ended December 31, 2000,
approved by a vote of 129,784,384 shares for and 315,764 shares
against.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Fonix Class A common stock is listed on the OTC Bulletin Board under
the trading symbol FONX. The following table shows the range of high and low
sales price information for Class A common stock as quoted on the Nasdaq
SmallCap Market (until December 3, 1999) and on the OTC Bulletin Board
thereafter for the four quarters of calendar 2000 and 1999. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commissions
and may not represent actual transactions.
Calendar Year 2000 Calendar Year 1999
----------------------- ----------------------
High Low High Low
---- ----- ----- ----
First Quarter $ 2.50 $ 0.25 $ 3.31 $ 0.69
Second Quarter $ 1.81 $ 1.00 $ 0.94 $ 0.25
Third Quarter $ 1.39 $ 0.50 $ 1.19 $ 0.28
Fourth Quarter $ 0.94 $ 0.28 $ 1.00 $ 0.27
As of March 20, 2001, there were 210,827,463 shares of Fonix Class A
common stock outstanding, held by approximately 664 holders of record and 46,550
beneficial holders. This number of beneficial holders represents an estimate of
the number of actual holders of the Company's stock, including beneficial owners
of shares held in "nominee" or "street" name. The actual number of beneficial
owners is not known to the Company.
Page 21 of 51
The Company has never declared any dividend on its Class A common
stock and it is expected that earnings, if any, in future periods will be
retained to further the development and sale of the Company's NUI technologies
and products. No dividends can be paid on the Class A common stock until such
time as all accrued and unpaid dividends on outstanding preferred stock, if any,
have been paid.
Recent Sales of Unregistered Equity Securities
During 2000, the Company issued 316,036 shares of Series F preferred
stock, par value $20 per share, to five investors for $2,750,000. The Company
issued such shares without registration under the Securities Act of 1933 (the
"1933 Act) in reliance on Section 4(2) of the 1933 Act and the rules and
regulations promulgated thereunder. The shares of Series F preferred stock were
issued as restricted securities and the certificates representing the Series F
preferred stock were stamped with a restricted legend to prevent any resale
without registration under the 1933 Act or pursuant to an exemption.
The resales of the Class A common shares underlying the Series F
preferred stock were subsequently registered on a Form S-2 that was initially
declared effective February 11, 2000, and amended and declared effective
December 4, 2000.
On May 25, 2000, the Company issued 250,000 shares of Class A common
stock to a consultant for services rendered in connection with certain financing
transactions. The Company issued such shares without registration under the 1933
Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder. The shares were subsequently registered on a Form S-2
that was declared effective September 5, 2000, and amended and declared
effective December 4, 2000.
On June 30, 2000, the Company issued 612,069 shares of Class A common
stock to a consultant for services rendered in connection with certain financing
transactions. The Company issued such shares without registration under the 1933
Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder. The shares were subsequently registered on a Form S-2
that was declared effective September 5, 2000, and amended and declared
effective December 4, 2000.
Between August 8, 2000 and December 31, 2000, in connection with the
Equity Line Agreement, the Company received $11,473,508 in funds drawn under the
2000 Note and the Equity Line Agreement and issued 24,037,455 shares of Class A
common stock to the Equity Line Investor. The shares were issued without
registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and
the rules and regulations promulgated thereunder.
The resales of the shares were subsequently registered under a
registration statement on Form S-2 which was declared effective September 5,
2000 and amended and declared effective December 4, 2000.
Page 22 of 51
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below is derived from the
Company's consolidated balance sheets and statements of operations as of and for
the years ended December 31, 2000, 1999, 1998, 1997, and 1996. The data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and related notes thereto included in this Report.
For the Year Ended December 31,
2000 1999 1998 1997
----------------- ---------------- ----------------- ----------------
Statement of Operations Data:
Revenues $ 656,853 $ 439,507 $ 2,604,724 $ --
General and administrative expenses 10,722,313 9,498,753 8,817,643 12,947,112
Product development and research 5,871,414 7,909,228 13,060,604 7,066,294
Purchase of in-process research and development 474,000 -- 9,315,000 --
Amortization of intangible assets 2,457,829 2,588,896 1,712,267 --
Other income (expense) (3,991,348) (3,698,789) (6,507,245) (1,558,678)
Loss from continuing operations (22,810,677) (19,949,196) (36,843,475) (21,572,084)
Loss from discontinued operations -- (2,187,080) (6,275,307) --
Gain (loss) on extraordinary items 49,448 473,857 -- (881,864)
Net loss (22,761,229) (21,662,419) (43,118,782) (22,453,948)
Basic and diluted net loss per common share $ (0.16) $ (0.31) $ (0.91) $ (0.59)
Weighted average number of common shares
outstanding 162,684,298 76,753,709 52,511,185 42,320,188
1996
-----------------
Statement of Operations Data:
Revenues $ --
General and administrative expenses 3,530,400
Product development and research 4,758,012
Purchase of in-process research and development --
Amortization of intangible assets --
Other income (expense) 458,904
Loss from continuing operations (7,829,508)
Loss from discontinued operations --
Gain (loss) on extraordinary items --
Net loss (7,829,508)
Basic and diluted net loss per common share $ (0.21)
Weighted average number of common shares
outstanding 36,982,610
As of December 31,
-------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------- ---------------- ----------------- ---------------- -----------------
Balance Sheet Data:
Current assets $ 3,752,210 $ 480,885 $ 20,638,070 $ 21,148,689 $ 23,967,601
Total assets 17,517,373 19,173,147 61,912,791 22,894,566 25,331,270
Current liabilities 3,571,854 5,285,681 35,317,045 20,469,866 19,061,081
Long-term debt, net
of current portion 19,767 3,971,107 -- 52,225 --
Stockholders' equity 13,925,752 8,086,359 24,765,746 2,372,475 6,270,189
Page 23 of 51
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY
THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION
ENTITLED "FACTORS AFFECTING FUTURE OPERATING RESULTS" AND UNDER THE HEADING
"CERTAIN SIGNIFICANT RISK FACTORS" IN ITEM 1 PART I OF THIS REPORT, ABOVE.
The following discussion of the results of operations and financial condition
should be read in conjunction with the consolidated financial statements and
notes thereto included elsewhere in this report.
Overview
Since inception, Fonix has devoted substantially all of its resources
to research, development and acquisition of software technologies that enable
intuitive human interaction with computers, consumer electronics, and other
intelligent devices. Through December 31, 2000, the Company has incurred
cumulative losses amounting to $121,047,787, excluding cumulative losses from
discontinued operations of $8,462,387 and net extraordinary items. Such losses
are expected to continue until the effects of recent marketing and sales efforts
begin to take effect, if ever.
In 2000, Fonix management continued to transition its strategic focus
from technology research, development and acquisition into sales and marketing
and product delivery. The Company expended approximately $1,954,752 in 2000 and
$1,125,611 in 1999 in sales and marketing efforts. The Company has made this
transition while continuing to achieve technology upgrades to maintain distinct
competitive technology advantages.
In its current marketing efforts, the Company seeks to form
relationships with third parties who can incorporate NUI technologies into new
or existing products. Such relationships may be structured in any of a variety
of ways including traditional technology licenses, collaboration or joint
marketing agreements co-development relationships through joint ventures or
otherwise, and strategic alliances. The third parties with whom Fonix presently
has such relationships and with which it may have similar relationships in the
future include developers of application software, operating systems, computers,
microprocessor chips, consumer electronics, automobiles, telephony and other
products.
Results of Operations
The results of operations disclosed below give effect to the sale of
the Healthcare Solutions Group ("HSG") in September 1999 and the classification
of its net assets and operating activities as discontinued operations.
2000 Compared to 1999
During 2000, the Company recorded revenues of $656,853, an increase
of $217,346 from $439,507 for 1999. The increase in 2000 results primarily from
increased activity in licensing of TTS channels in telephony applications.
Selling, general and administrative expenses were $10,722,313 for
2000 and $9,498,753 for 1999, an increase of $1,223,560. Excluding a
compensation charge in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company, the increase
from 1999 is actually $2,666,860. The increase is due to consulting expense of
$2,294,756 resulting from compensation paid in shares of Class A
Page 24 of 51
common stock for services rendered to the Company by outside consultants. Also
contributing to the increase is other compensation expense in the amount of
$628,000 incurred as a result of the exercise of stock appreciation rights.
Other changes resulting from sales and marketing activity undertaken by the
Company as indicated by the marketing strategy described above were not
significant in 2000, but will impact future periods.
The Company incurred product development and research expenses of
$5,871,414 during 2000, a decrease of $2,037,814 from 1999. This decrease was
due to the ongoing effects of management's cost reduction initiatives
implemented in 1999 and the transition of emphasis from research and development
towards sales and marketing. The Company also experienced decreases in product
development and research costs as it completed development of certain TTS and
ASR products. Ongoing development efforts will be focused on product
applications and solutions utilizing the NUI technologies developed to date.
Net other expense was $3,991,348 for 2000, an increase of $292,559
from 1999. Interest income increased by $44,260 from earnings on the funds held
in escrow in connection with the sale of the HSG. Interest and related finance
charges increased by $367,644 as a result of financing activities undertaken
related to the 2000 Note. Included in interest expense are charges resulting
from beneficial conversion features incurred in connection with the convertible
promissory note in the amount of $3,447,623 in 2000 and the Series C convertible
debentures in the amount of $1,750,000 in 1999.
1999 Compared to 1998
During 1999, the Company recorded revenues of $439,507, a decrease of
$2,165,217 from $2,604,724 for 1998. Revenue in 1998 included licensing fees of
$2,368,138 from an international microchip manufacturer for which the Company
had no further obligation, and product sales and licensing fees of $236,586 from
other customers. The 1999 revenues are primarily from licensing fees from TTS
and HWR technologies and products.
Selling, general and administrative expenses were $9,498,753 for 1999
and $8,817,643 for 1998, an increase of $681,110. A one-time charge to
compensation expense in 1999 in the amount of $1,443,300 for obligations to
certain executives for expenses incurred on behalf of the Company more than
offset reductions achieved in other areas. Absent this charge, selling, general
and administrative expenses decreased by $762,190, due primarily to the cost
reduction measures undertaken by the Company in February 1999. Decreases in
salaries and related costs of $85,613 and in consulting expenses of $61,842 are
direct results of such measures. Also, a reduction in acquisition activity from
1998 to 1999 resulted in a decrease of $213,346 in legal and investor-related
expenses.
The Company incurred product development and research expenses of
$7,909,228 during 1999, a decrease of $5,151,376 from 1998. This decrease was
due primarily to management's cost reduction initiatives implemented in February
1999 and the transition of emphasis from research and development towards sales
and marketing. The Company anticipates further decreases in product development
and research costs as it nears completion of development of certain TTS and ASR
products. During 1999 and 1998, the Company expended a total of approximately
$303,000 and $130,000, respectively, in connection with ongoing development of
the AcuVoice-related research and development projects.
Amortization of goodwill and purchased Core Technologies was
$2,588,896 for 1999 and $1,712,267 for 1998. The increase of $876,629 results
from amortization for one full year in 1999 compared to amortization for the
portion of 1998 subsequent to the respective acquisition dates of AcuVoice, Inc.
and Papyrus Associates, Inc.
Net other expense was $3,698,789 for 1999, a decrease of $2,808,456
from 1998, resulting from changes in several areas. Interest income decreased by
$979,998 primarily due to certificates of deposit that were converted to cash to
retire a bank line of credit in January 1999. Cancellation of certain common
stock reset provisions resulted in an expense of $6,111,577 in 1998 but did not
affect 1999. Finally, interest expense increased by $2,165,778 primarily as a
result of beneficial conversion features recorded on convertible securities
issued in 1999, interest charges incurred on advances from the purchaser of the
HSG and interest charges on the Series C 5%
Page 25 of 51
convertible debentures issued in January and March 1999.
Selected Quarterly Reports of Operations
The following tables set forth selected unaudited statement of
operations data for each of the quarters in the years ended December 31, 2000
and 1999. This data has been derived from our unaudited financial statements
that have been prepared on the same basis as the audited financial statements
and in the opinion of our management, include all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of the
information when read in connection with the financial statements and the
related notes. Our quarterly operating results have varied substantially in the
past and may vary substantially in the future. You should not draw any
conclusions about our future results for any period from the selected unaudited
statement of operations data for any particular quarter.
For the Quarter Ended
------------------------------------------------------------------------
March 31, September December
2000 June 30, 2000 30, 2000 31, 2000
----------------- ---------------- ----------------- ----------------
(Unaudited)
Net sales $ 56,447 $ 143,825 $ 172,222 $ 284,359
Loss before extraordinary item (5,819,130) (4,778,159) (8,451,438) (3,761,950)
Net loss (5,787,153) (4,731,272) (8,451,438) (3,791,366)
Basic and diluted loss before extraordinary item
per common share $ (0.06) $ (0.03) $ (0.05) $ (0.02)
Basic and diluted loss per common share (0.06) (0.03) (0.05) (0.02)
For the Quarter Ended
------------------------------------------------------------------------
March 31, June 30, 1999 September December
1999 30, 1999 31, 1999
----------------- ---------------- ----------------- ----------------
(Unaudited)
Net sales $ 53,806 $ 231,571 $ 65,707 $ 88,423
Loss before extraordinary item (9,294,861) (6,517,785) (3,395,845) (2,927,785)
Net loss (9,294,861) (6,517,785) (3,023,784) (2,825,989)
Basic and diluted loss before extraordinary item
per common share $ (0.16) $ (0.10) $ (0.06) $ (0.02)
Basic and diluted loss per common share (0.16) (0.10) (0.05) (0.02)
Liquidity and Capital Resources
The Company must raise additional funds to be able to satisfy its
cash requirements during the next 12 months. Research and development,
corporate operations and marketing expenses will continue to require
additional capital. Because the Company presently has only limited revenue
from operations, the Company intends to continue to rely primarily on
financing through the sale of its equity and debt securities to satisfy future
capital requirements until such time as the Company is able to enter into
additional third-party licensing , collaboration or co-marketing arrangements
such that it will be able to finance ongoing operations from license, royalty
and sales revenue. There can be no assurance that the Company will be able to
enter into such agreements. Furthermore, the issuance of equity or debt
securities which are or may become convertible into equity securities
Page 26 of 51
of the Company in connection with such financing could result in substantial
dilution to the stockholders of the Company.
The Company had minimal working capital of $180,356 at December 31,
2000, compared to negative working capital of $4,804,796 at December 31, 1999.
The current ratio was 1.05:1 at December 31, 2000, compared to 0.09:1 at
December 31, 1999. Current assets increased by $3,271,325 to $3,750,210 from
December 31, 1999 to December 31, 2000. Current liabilities decreased by
$1,713,827 to $3,571,854 during the same period. The improvement in working
capital reflects the reclassification of funds held in escrow that were
released in March 2001 as well as reductions in accounts payable and other
liabilities made possible through the private equity line financing. Total
assets were $17,517,373 at December 31, 2000, compared to $19,173,147 at
December 31, 1999, the decrease resulting primarily from amortization of
intangible assets.
Convertible Promissory Note and Private Equity Line of Credit
On June 20, 2000, the Company executed a convertible promissory note
(the "2000 Note") with a private investor in the amount of $7,500,000, which
permitted the Company to draw funds as needed for operating purposes. The note
bore interest at six percent annually, compounded monthly, and was due September
30, 2001. Principal drawn under the terms of the promissory note was designated
as the "Initial Investment Amount" under the Private Equity Line described
below. The investor had the right to convert, at its option, all or any portion
of the outstanding principal and interest into shares of Class A common stock at
the lesser of $0.75 or 85 percent of the average of the three lowest closing bid
prices of Class A common stock in the 20-day trading period prior to the date of
conversion. During 2000, the Company drew the entire amount available and
recorded $106,348 as interest and financing expense. Principal and interest were
converted into 11,544,775 shares of Class A common stock. The Company also
recorded a beneficial conversion feature in the amount of $3,447,623 related to
borrowings under the promissory note.
On August 8, 2000, the Company entered into a Private Equity Line
Agreement ("Equity Line") with the same investor("Equity Line Investor"), which
gives the Company the right to draw down a maximum of $20,000,000 for operations
and other purposes. The initial $7,500,000 was drawn as part of the convertible
promissory note described above. The balance remaining under the Equity Line is
available to the Company through a mechanism of draws and puts of stock. The
Company is entitled to draw funds and to "put" to the Equity Line Investor
shares of Class A common stock in lieu of repayment of the draw. The number of
shares issued is determined by dividing the dollar amount of the draw by 90
percent of the average of the two lowest closing bid prices of Class A common
stock over the seven trading-day period following the date the Company tenders
the put notice. The Equity Line Investor funds the amounts requested by the
Company within two trading days after the seven trading-day period.
During 2000, draws taken under the Equity Line, excluding the 2000
Note, amounted to $3,973,508 were converted to 12,492,680 shares of Class A
common stock. Subsequent to December 31, 2000, additional draws amounting to
$3,010,000 were converted into 6,770,945 shares of Class A common stock. As of
March 20, 2001, $5,516,492 credit remains available to be drawn on the Equity
Line.
Series F Convertible Preferred Stock
Effective February 1, 2000, the Company entered into an agreement
with five investors whereby it sold a total of 290,000 shares of its Series F
convertible preferred stock in return for payment of $2,750,000. On May 22,
2000, the Series F investors and the Company agreed to amend the Series F Stock
Purchase Agreement adding a sixth investor and increasing the number of Series F
preferred shares issued by 26,036 shares, bringing the total to 316,036 shares
of Series F convertible preferred stock issued. Dividends accrued on the stated
value ($20 per share) of Series F convertible preferred stock at a rate of six
percent per year, were payable annually or upon conversion, in cash or common
stock, at the option of the Company, and were convertible into shares of Class A
common stock at any time at the holders' option. The Series F convertible
preferred stock was convertible into shares of Class A common stock at a price
of $0.75 per share during the first 90 days following the close of the
transaction, and
Page 27 of 51
thereafter at a price equal to 85 percent of the average of the three lowest
closing bid prices in the 20-day trading period prior to the conversion of the
Series F convertible preferred stock.
In 2000, 309,963 shares of Series F convertible preferred stock,
together with related dividends accrued thereon, were converted into 8,342,820
shares of Class A common stock. Using the conversion terms most beneficial to
the holders, the Company recorded a preferred stock dividend of $2,750,000 for
the beneficial conversion feature related to these shares on the date the Series
F convertible preferred stock was issued. Subsequent to December 31, 2000, the
remaining 6,073 shares of Series F convertible preferred stock, together with
related dividends accrued thereon, were converted into 519,067 shares of Class A
common stock.
Notes Payable
After the Papyrus acquisition closed in October 1998, the Company
investigated the representations and warranties made by Papyrus to induce the
Company to acquire the Papyrus companies. The Company determined that certain of
the representations made by Papyrus and its executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against the former
stockholders of Papyrus alleging misrepresentation and breach of contract. In
March and April 1999, five of the former stockholders of Papyrus filed actions
against the Company alleging default under the terms of the promissory notes
issued to them in connection with the Papyrus acquisition and certain other
claims. Subsequently, the Company entered into agreements with the five former
Papyrus stockholders for dismissal of the actions and cancellation of the
promissory notes upon payment to the former stockholders of $1,217,384 (the
"Settlement Payment") and return of 970,586 shares of restricted common stock
previously issued to the five former stockholders in connection with the
acquisition of Papyrus. The Company paid the Settlement Payment in September
1999 and the lawsuits described above have been dismissed. The 970,586 shares
were effectively canceled in September 1999 in connection with the Settlement
Payment. The original fair market value of $1,000,917 associated with the
canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus. As of December 31, 2000, the Company had unsecured notes
payable to former Papyrus stockholders in the aggregate amount of $77,625, which
notes were issued in connection with the acquisition of Papyrus. Some holders of
these notes made demand for payment in September 2000 and the Company made a
counter offer to settle the balances. No final settlement has been reached at
this time.
During 1999, the Company paid, or otherwise reduced through
agreement, notes payable to various parties totaling $8,482,946, plus accrued
interest. Additionally, the Company paid other notes payable to other parties
aggregating $560,000, plus accrued interest. Additionally, a revolving note
payable in the amount of $50,000 was paid by a former employee and is included
as an account payable. A revolving note payable in the amount of $19,988,193 at
December 31, 1999, plus accrued interest, was paid in full in January 1999 with
the proceeds from a certificate of deposit that secured the note and $22,667 in
cash.
In the fourth quarter of 1999, the Company negotiated reductions of
$526,697 in amounts due various trade vendors. Additionally, the Company
negotiated reductions of $229,055 in accrued interest owed to certain note
holders. These amounts were considered forgiveness of debt and have been
accounted for as extraordinary items in the 1999 consolidated statement of
operations.
Class A common stock, warrants and stock options
In July 2000, the Company issued 1,000,000 shares of Class A common
stock (having a market value of $1,015,600 on that date) to unaffiliated
consultants in payment for services rendered. The resulting charge was recorded
as a deferred consulting expense in stockholders' equity and amortized as
general and administrative expense over the subsequent period of service in
2000.
In May 2000, the Company issued 250,000 shares of Class A common
stock (having a market value of $312,500 on that date) to an unaffiliated
consultant in payment for services rendered in connection with financing
transactions. The resulting charge was recorded as general and administrative
expense.
Page 28 of 51
In January 2000, warrants for the purchase of 300,000 shares of Class
A common stock were issued to unaffiliated consultants for services rendered.
The warrants were valued at $45,000 per share using the Black-Scholes pricing
model and the resulting charge was recorded as a deferred consulting expense in
stockholders' equity and amortized as general and administrative expense over
the subsequent period of service in 2000.
In December 1999, the Company issued warrants to purchase 1,000,000
shares of the Company's Class A common stock to professional advisors and
consultants. The warrants were valued at $0.26 per share using the Black-Scholes
pricing model and the resulting charge was recorded as a deferred consulting
expense in stockholders' equity to be amortized as general and administrative
expense over the subsequent period of service. Also in December 1999, 1,000,000
shares of Class A common stock were issued to other advisors and consultants as
consideration for services rendered. The shares were valued at $375,000 based
upon the market value of the shares on the date of issuance and recorded as
general and administrative expenses.
As of December 31, 2000, the Company had a total of 3,470,000
warrants outstanding.
During 2000, the Company granted 6,552,400 stock options to employees
at exercise prices ranging from $0.28 to $1.50 per share. The term of all
options granted during the year was ten years from the date of grant. Of the
stock options granted, 5,621,000 vested during 2000 and 931,400 vest over the
subsequent three-year period. As of December 31, 2000, the Company had a total
of 19,857,700 options outstanding, of which 18,923,001 were exercisable.
The Company's option plans provide for stock appreciation rights that
allow the grantee to receive shares of the Company's Class A common stock
equivalent in value to the difference between the designated exercise price and
the fair market value of the Company's stock at the date of exercise. During
February 2000, these stock appreciation rights were exercised at weighted
average exercise price of There are options to purchase 516,339 shares of Class
A common stock outstanding which provide for stock appreciation rights. Of these
options, 126,669 have an exercise price of $6.50 per share, 13,000 have an
exercise price of $3.66 per share and 376,671 have an exercise price of $1.00
per share.
Outlook
Corporate Objectives and Technology Vision
The Company's objective is that its Core Technologies become the
platform for the next generation of NUI applications and products. Most speech
recognition products offered by other companies are based on technologies that
are largely in the public domain and represent nothing particularly "new" or
creative. The Fonix Core Technologies are based on proprietary, patented
technology. Management believes the Company's NUI technologies provide a
superior competitive advantage compared to other technologies available in the
marketplace. In order to accomplish this objective, the Company intends to
proceed as follows:
Substantially Increase Marketing and Sales Activities. The Company
intends to hire additional sales and marketing personnel, both
domestically and internationally, who will focus on the server-based
and embedded markets. To address global opportunities, the Company
will continue to develop or acquire additional NUI products and
technologies for foreign languages and dialects. Fonix will also make
a significant investment in the "Powered by Fonix" Partner Program in
order to build sales and marketing opportunities with software
developers, resellers and corporate partners.
Expand Strategic Relationships. The Company has a number of strategic
collaboration and marketing arrangements with developers and VARs. The
Company intends to expand such relationships and add additional
similar relationships, specifically in the mobile communications, PDA,
IVR and Internet portal markets. Because FAAST is increasingly
recognized as a dynamic development platform, Fonix expects FAAST to
be the product around which many of these relationships are