10-Q/A 1 edq2afull.txt AMENDED QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A Amendment No. 3 [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2002 [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to . --------- ------------ Commission file number 0-23862 Fonix Corporation (Exact name of registrant as specified in its charter) Delaware 22-2994719 (State of Incorporation) (I.R.S. Employer Identification No.) 180 W. Election Road, Suite 200 Draper, UT 84020 (Address of principal executive offices, including zip code) (801) 553-6600 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X or No As of September 13, 2002, 484,475,556 shares of Class A voting common stock, par value $0.0001 per share, were issued and outstanding. FONIX CORPORATION FORM 10-Q EXPLANATORY NOTE The purpose of this amendment to Fonix Corporation's Quarterly Report on Form 10-Q is to reflect the recognition of impairment losses relating to the Company's speech software technology and its investment in Audium Corporation. The unaudited Condensed Consolidated Financial Statements as of June 30, 2002, have been restated as discussed in the notes to the accompanying unaudited Condensed Consolidated Financial Statements. This amendment does not reflect events occurring after the filing of the most recent amendment to this Quarterly Report on September 30, 2002, or modify or update those disclosures as presented in the original or amended Forms 10-Q, except to reflect the restatement as described above, to clarify in Note 1 some of the Company's significant accounting policies, and to describe certain subsequent events in Note 10 to the unaudited Condensed Consolidated Financial Statements. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Page Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - As of June 30, 2002 and December 31, 2001 2 Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months and six months ended June 30, 2002 and 2001 3 Condensed Consolidated Statements of Cash Flows for the three months and six months ended June 30, 2002 and 2001 4 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 PART II - OTHER INFORMATION Item 1. Legal Proceedings 28 Item 2. Changes in Securities 28 Item 3. Quantitative and Qualitative Disclosures About Market Risk 28 Item 4. Submission of Matters to a Vote of Security Holders 29 Item 5. Other Matters - Change in Certifying Public Accountants 29 Item 6. Exhibits and Reports on Form 8-K 30 1 Fonix Corporation CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
ASSETS June 30, December 31, 2002 2001 ---------------- ----------------- Current assets: Cash and cash equivalents $ 38,913 $ 201,401 Subscriptions receivable - 852,970 Accounts receivable, net of allowance for doubtful accounts of $0 70,632 32,210 Other receivables 73,352 25,119 Inventory 28,080 37,154 Prepaid expenses 169,764 120,270 ---------------- ----------------- Total current assets 380,741 1,269,124 Property and equipment, net of accumulated depreciation of $1,491,553 and $1,314,960, respectively 811,490 903,159 Convertible note receivable 1,435,000 630,000 Investment in and note receivable from affiliate, net of unamortized discount of $68,655 1,502,774 1,696,869 Intangible assets, net of accumulated amortization of $222,985 and $145,522, respectively 1,268,057 1,345,520 Goodwill, net of accumulated amortization of $2,295,598, in 2002 and 2001 2,631,304 2,631,304 Other assets 359,199 123,052 ---------------- ----------------- Total assets $ 8,388,565 $ 8,599,028 ================ ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Advance on equity line of credit $ 182,676 $ - Note payable to affiliate, net of unamortized discount of $31,054 968,946 1,484,753 Note payable, net of unamortized discount of $12,102 397,898 1,239,755 Notes payable - related parties 435,933 77,625 Accounts payable 1,664,292 1,085,711 Accrued liabilities 2,622,858 961,299 Accrued liabilities - related parties 1,443,300 1,451,633 Deferred revenues 1,134,792 1,049,849 Other current liabilities 21,881 19,767 ---------------- ----------------- Total current liabilities 8,872,575 7,370,392 ---------------- ----------------- Commitments and contingencies (Notes 1, 3, 5, 6 and 10) Stockholders' equity: Preferred stock, $.0001 par value; 50,000,000 shares authorized; Series A, convertible; 166,667 shares outstanding (aggregate liquidation preference of $6,055,012) 500,000 500,000 Common stock, $.0001 par value; 800,000,000 shares authorized; Class A voting, 484,475,556 and 350,195,641 shares outstanding, respectively 48,448 35,020 Class B non-voting, none outstanding Additional paid-in capital 181,754,780 171,985,508 Outstanding warrants to purchase Class A common stock 2,136,400 2,832,400 Deferred consulting expenses (5,833) (17,777) Cumulative foreign currency translation adjustment (25,396) 2,841 Accumulated deficit (184,892,409) (174,109,356) ---------------- ----------------- Total stockholders' equity (484,010) 1,228,636 ---------------- ----------------- Total liabilities and stockholders' equity $ 8,388,565 $ 8,599,028 ================ =================
See accompanying notes to condensed consolidated financial statements. 2 Fonix Corporation CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ ---------------------------- 2002 2001 2002 2001 -------------- -------------- ------------- ------------- Revenues $ 679,197 $ 107,568 $ 977,981 $ 240,281 Cost of revenues 166,424 468,632 210,528 931,741 -------------- -------------- ------------- ------------- Gross margin 512,773 (361,064) 767,453 (691,460) -------------- -------------- ------------- ------------- Expenses: Selling, general and administrative 3,383,999 3,306,802 6,608,167 5,453,702 Product development and research 2,590,988 2,483,627 4,714,724 4,139,277 Amortization of intangible assets 7,650 151,026 15,300 302,053 -------------- -------------- ------------- ------------- Total expenses 5,982,637 5,941,455 11,338,191 9,895,032 -------------- -------------- ------------- ------------- Loss from operations (5,469,864) (6,302,519) (10,570,738) (10,586,492) -------------- -------------- ------------- ------------- Other income (expense): Interest income 68,386 19,276 96,321 57,524 Interest expense (47,759) (66,096) (105,508) (68,988) -------------- -------------- ------------- ------------- Total other income (expense), net 20,627 (46,820) (9,187) (11,464) -------------- -------------- ------------- ------------- Loss before equity in net loss of affiliate (5,449,237) (6,349,339) (10,579,925) (10,597,956) Equity in net loss of affiliate (89,177) (158,969) (203,129) (158,969) -------------- -------------- ------------- ------------- Net loss (5,538,414) (6,508,308) (10,783,054) (10,756,925) Other comprehensive loss - foreign currency translation (27,365) (2,048) (28,237) (2,048) -------------- -------------- ------------- ------------- Comprehensive loss $ (5,565,779) $ (6,510,356) $ (10,811,291) $ (10,758,973) ============== ============== ============= ============= Basic and diluted net loss per common share $ (0.01) $ (0.03) $ (0.03) $ (0.05) ============== ============== ============= =============
See accompanying notes to condensed consolidated financial statements. 3 Fonix Corporation CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Increase (Decrease) in Cash and Cash Equivalents
Six Months Ended June 30, ------------------------------ 2002 2001 ------------- -------------- Cash flows from operating activities: Net loss $ (10,783,054) $ (10,756,925) Adjustments to reconcile net loss to net cash used in operating activities: Non-cash expense related to issuance of debentures, warrants, preferred and common stock - 62,500 Additional Compensation expense related to issue of stock options and common stock 11,944 - Accretion of discount on note receivable from affiliate (9,036) (3,628) Accretion of discount on note payable from affiliate 34,193 40,690 Accretion of discount on note payable 28,143 - Depreciation and amortization 257,973 1,430,243 Equity in net loss of affiliate 203,129 158,969 Changes in assets and liabilities: Accounts receivable (38,422) 19,372 Inventory 9,074 (24,467) Prepaid expenses and other current assets (97,727) (101,265) Funds held in escrow - 151,006 Other assets (236,147) (18,695) Accounts payable 578,584 291,897 Accrued liabilities 1,661,559 515,054 Accrued liabilities - related party (8,333) (62,500) Other Current Liabilities 21,881 - Deferred revenues 84,943 422,101 Cumulative foreign currency translation adjustment (26,199) (2,048) ------------- -------------- Net cash used in operating activities (8,307,495) (7,877,696) ------------- -------------- Cash flows from investing activities: Purchase of property and equipment (90,880) (507,242) Issuance of notes receivable (805,000) (302,909) Investment in Affiliate - (200,000) Proceeds from sale of Healthcare Solutions Group - 2,000,000 ------------- -------------- Net cash used in investing activities (895,880) 989,849 ------------- -------------- Cash flows from financing activities: Proceeds of note payable to related parties 358,308 - Principal payments on capital lease obligation (19,767) (21,562) Proceeds from sale of Class A common stock, net 10,122,346 6,601,950 Proceeds from exercise of stock options - 9,801 Payments on note payable to affiliate (550,000) (200,000) Payments on note payable (870,000) - ------------- -------------- Net cash provided by financing activities 9,040,887 6,390,189 ------------- -------------- Net increase in cash and cash equivalents (162,488) (497,658) Cash and cash equivalents at beginning of period 201,401 1,413,627 ------------- -------------- Cash and cash equivalents at end of period $ 38,913 $ 915,969 ============= ==============
See accompanying notes to condensed consolidated financial statements. 4 Fonix Corporation CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Six Months Ended June 30, ------------------------------ 2002 2001 -------------- ------------- Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 79,547 $ 43,384
Supplemental Schedule of Non-cash Investing and Financing Activities: For the Six Months Ended June 30, 2002: Warrants for the purchase of 450,000 shares of Class A common stock, valued at $696,000, expired. For the Six Months Ended June 30, 2001: Preferred stock dividends of $9,281 were accrued on Series D and Series F preferred stock. 164,500 shares of Series D preferred stock and related dividends of $320,949 were converted into 13,978,440 shares of Class A common stock. 6,073 shares of Series F preferred stock and related dividends of $6,853 were converted into 519,067 shares of Class A common stock. Warrants for the purchase of 250,000 shares of Class A common stock valued at $62,500 were issued in payment for a perpetual, nonexclusive technology license. A non-interest bearing promissory note was issued in the amount of $2,600,000 to purchase 1,780,818 shares of Series A preferred stock of Audium Corporation. See accompanying notes to condensed consolidated financial statements. 5 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation - The accompanying unaudited condensed consolidated financial statements of Fonix Corporation and subsidiaries (collectively, the "Company" or "Fonix") have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the following disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the financial position and results of operations of the Company for the periods presented. The Company's business strategy is not without risk, and readers of these condensed consolidated financial statements should carefully consider the risks set forth under the heading "Certain Significant Risk Factors" in the Company's 2001 Annual Report on Form 10-K. Operating results for the six months ended June 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. The Company suggests that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's 2001 Annual Report on Form 10-K. Business Conditions - The Company's revenues increased $571,629 for the three months ended June 30, 2001 to $679,197 for the three months ended June 30, 2002, and from $240,281 for the six months ended June 30, 2001 to $977,981 for the six months ended June 30, 2002. However, the Company has incurred significant losses since inception, including a loss of $10,783,055 for the six months ended June 30, 2002. The Company incurred negative cash flows from operating activities of $8,307,495 during the six months ended June 30, 2002. Sales of products and revenue from licenses based on the Company's technologies have not been sufficient to finance ongoing operations. As of June 30, 2002, the Company had negative working capital of $8,491,834 and an accumulated deficit of $184,892,409. The Company has drawn all capital available under its first two equity lines of credit. The Company will not be able to make draws under its third equity line of credit until a registration statement covering the shares of common stock to be issued in connection with that third equity line is declared effective by the SEC. The Company filed the registration statement for the third equity line on June 27, 2002. Accordingly, there is substantial doubt about the Company's ability to continue as a going concern. The Company's continued existence is dependent upon several factors, including the Company's success in (1) increasing license, royalty, product, and services revenues, (2) raising sufficient additional debt or equity funding and (3) minimizing or decreasing operating costs. The accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. Net Loss Per Common Share - Basic and diluted net loss per common share are calculated by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. As of June 30, 2002 and 2001, there were outstanding common stock equivalents to purchase 32,189,576 and 25,177,817 shares of common stock, respectively, that were not included in the computation of diluted net loss per common share as their effect would have been anti-dilutive, thereby decreasing the net loss per common share. The following tables are reconciliations of the net loss numerator of basic and diluted net loss per common share for the three months and six months ended June 30, 2002 and 2001: 6
Three months ended June 30, 2002 2001 --------------------------- ---------------------------- Per Share Per Share Amount Amount Amount Amount Net loss attributable to common stockholders $ (5,538,414) $ (0.01) $ (6,508,308) $ (0.03) ============= ========= ============== ========= Weighted average common shares outstanding 471,938,769 213,416,041 ============== ==============
Six months ended June 30, 2002 2001 ------------------------------ ---------------------------- Per Share Per Share Amount Amount Amount Amount --------------- --------- -------------- ----------- Net loss $ (10,783,054) $(10,756,925) Preferred stock dividends - (9,281) --------------- -------------- Net loss attributable to common stockholders $ (10,783,054) $ (0.03 ) $ (10,766,206) $ (0.05) =============== ========= ============== ========== Weighted average common shares outstanding 431,443,574 207,611,230 ================ ===========
Imputed Interest Expense and Income - Interest is imputed on long-term debt obligations and notes receivable where management has determined that the contractual interest rates are below the market rate for instruments with similar risk characteristics (see Notes 3 and 5). Other Comprehensive Income (Loss) - Other comprehensive income (loss) presented in the accompanying condensed consolidated financial statements consists of cumulative foreign currency translation adjustments. The Company had no items of comprehensive loss prior to April 1, 2001. Recently Enacted Accounting Standards - In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 eliminates the "pooling-of-interests" method of accounting for acquisitions and requires separate accounting for certain intangibles acquired in such transactions. The application of this standard did not have an impact on the Company's financial position and results of operations. SFAS No. 142 changes the accounting for goodwill and intangible assets with indefinite lives from an amortization method to an impairment-only approach. Effective January 1, 2002, the Company adopted the requirements of SFAS No. 142. Accordingly, effective January 1, 2002, amortization of goodwill and intangible assets with indefinite lives was discontinued. Other intangible assets will continue to be amortized over their respective useful lives. During 2002, the Company engaged Houlihan Valuation Advisors, an independent valuation firm, to assess the Company's goodwill and intangible assets with indefinite lives for impairment. The resulting appraisal indicated no impairment and the application of the test for impairment required by SFAS No. 142 had no effect on the Company's 7 financial position or results of operations, except for the change in amortization of goodwill and intangible assets with indefinite lives described in the preceding paragraph. In August 2001, the FASB issued SFAS No. 143 , "Accounting for Asset Retirement Obligations." This statement establishes financial accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company's adoption of this statement on January 1, 2002, did not have a material effect on the Company's financial position or results of operations. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement establishes financial accounting and reporting standards for the impairment or disposal of long-lived assets. The adoption of this statement on January 1, 2002, did not have a material effect on the Company's financial position or results of operations. See Note 2. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Among other provisions, this statement modifies the criteria for classification of gains or losses on debt extinguishments such that they are not required to be classified as extraordinary items if they do not meet the criteria for classification as extraordinary items in APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The Company will be required to apply the provisions of this standard to transactions occurring after December 31, 2002. The adoption of this standard in 2003 is not expected to have a material effect on the Company's financial position or results of operations. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The Company will be required to apply this statement prospectively for any exit or disposal activities initiated after December 31, 2002. The adoption of this standard is not expected to have a material effect on the Company's financial position or results of operations. Revenue Recognition - The Company recognizes revenues in accordance with the provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and related interpretations. The Company generates revenues from licensing the rights to its software products to end users and from royalties. It also generates service revenues from the sale of consulting and development services. Revenues of all types are recognized when contingencies such as conditions of acceptance of functionality, rights of return and price protection are confirmed or can be reasonably estimated, as appropriate. Revenues from development and consulting services are recognized on a completed-contract basis when the services are completed and accepted by the customer. The completed-contract method is used because the contracts are either short-term in duration or the Company is unable to make reasonably dependable estimates of the costs of the contracts. Revenue for hardware units delivered is recognized when delivery is verified and collection assured. Revenue for products distributed through wholesale and retail channels and resellers is recognized upon verification of final sell-through to end users, after consideration of rights of return and price protection. Revenue for these products is recognized when the right of return on such products has expired, typically when the end user purchases the product from the retail outlet. Once the end user opens the package, it is not returnable unless the medium is defective. Price protection is offered to distributors in the event we reduce the price on any specific product. Such price protection is generally offered for a specific time period in which the distributor must make a claim. Resulting revenue recognized reflects the reduced price. Slotting fees paid by the Company for favorable placement in retail outlets are recorded as a reduction in gross revenues. When arrangements to license software products do not require significant production, modification or customization of software, revenues from licenses and royalties are recognized when persuasive evidence of a licensing 8 arrangement exists, delivery of the software has occurred, the fee is fixed or determinable and collectibility is probable. Post-contract obligations, if any, generally consist of one year of support including such services as customer calls, bug fixes, and upgrades. Related revenue is recognized over the period covered by the agreement. Revenues from maintenance and support contracts are also recognized over the term of the related contracts. Revenues applicable to multiple-element fee arrangements are bifurcated among the elements such as license agreements and support and upgrade obligations using vendor-specific objective evidence of fair value. Such evidence consists primarily of pricing of multiple elements as if sold as separate products or arrangements. These elements vary based upon factors such as the type of license, volume of units licensed, and other related factors. Deferred revenue at June 30, 2002, and December 31, 2001, consisted of the following:
June 30, December 31, Description Criteria for Recognition 2002 2002 ----------- ---------------------------------- ---------------------- -------------------- Deferred unit royalties Delivery of units to end users or and licence fees expiration of contract $ 978,063 $ 945,814 Engineering projects not Completion of work and acceptance completed of completed work by customer 125,000 62,500 Deferred customer Expiration of period covered by support support agreement 31,729 41,535 ---------------------- -------------------- Total deferred revenue $ 1,134,792 $ 1,049,849 ====================== ====================
Cost of revenues from license, royalties and maintenance consists of costs to distribute the product (including the cost of the media on which it is delivered), installation and support personnel compensation, amortization of capitalized speech software costs, licensed technology and other related costs. Cost of service revenues consists of personnel compensation and other related costs. Speech software technology development and production costs - All costs incurred to establish the technological feasibility of speech software technology to be sold, leased or otherwise marketed are charged to product development and research expense. Technological feasibility is established when a product design and a working model of the software product have been completed and confirmed by testing. Costs to produce or purchase speech software technology incurred subsequent to establishing technological feasibility are capitalized. Capitalization of speech software costs ceases when the product is available for general release to customers. Costs to perform consulting or development services applications are charged to cost of revenues in the period in which the corresponding revenues are recognized. Cost of maintenance and customer support are charged to expense when related revenue is recognized or when these costs are incurred, whichever occurs first. Capitalized speech software technology costs are amortized on a product-by-product basis. Amortization is recognized from the date the product is available for general release to customers as the greater of (a) the ratio that current gross revenue for a product bears to total current and anticipated future gross revenues for that product or (b) the straight-line method over the remaining estimated economic life of the products. Amortization is charged to cost of revenues. The Company assesses unamortized capitalized speech software costs for possible write down on a quarterly basis based on net realizable value of each related product. Net realizable value is determined based on the estimated future gross revenues from a product reduced by the estimated future cost of completing and disposing of the product, including the cost of performing maintenance and customer support. The amount by which the unamortized capitalized costs of a speech software product exceed the net realizable value of that asset are written off. Reclassifications - Certain reclassifications have been made in the prior period condensed consolidated financial statements to conform with the current period presentation. 9 2. CONVERTIBLE NOTES RECEIVABLE On December 1, 2001, the Company, as the lender, established a revolving line of credit and received a convertible promissory note from Unveil Technologies, Inc. ("Unveil"), that permits Unveil to draw up to $2,000,000 for operations and other purposes. Unveil is a developer of natural language understanding solutions for customer resource management ("CRM") applications. Fonix intends to obtain a license to Unveil's applications when completed and has made the loan to Unveil to facilitate and expedite the development and commercialization of Uneveil's speech-enabled CRM software. Draws on the line of credit bear interest at an annual rate of seven percent, which interest is payable quarterly beginning September 30, 2002. The balance due under the line of credit is secured by Unveil's CRM software and related source code and other assets of Unveil. The Company is a senior creditor to Unveil. The unpaid principal, together with interest accrued thereon, is due and payable on December 31, 2002, and is convertible into common shares of Unveil at the Company's option. Based upon borrowings through June 30, 2002, such conversion at that date would have represented approximately 12 percent of the ownership of Unveil. During the six months ended June 30, 2002, Unveil drew $805,000 on the line of credit, bringing total draws on the line of credit to $1,435,000 as of June 30, 2002. Subsequent to June 30, 2002, Unveil drew an additional $15,000 through September 13, 2002. 3. INVESTMENT IN AFFILIATE In February 2001, the Company entered into a collaboration agreement with Audium Corporation ("Audium") to provide an integrated platform for generating Voice XML solutions for Internet and telephony systems. Audium is a mobile application service provider that builds and operates mobile applications that allow access to Internet information and to complete online transactions using any telephone. The collaboration includes integration of the Company's technologies with Audium's mobile applications development capability. Note Receivable - In connection with the collaboration agreement with Audium, in February and May 2001 the Company advanced an aggregate of $400,000 to Audium as a bridge loan (the "Audium Note"). The loan bears interest at a rate of five percent per year and has a term of four years. The Audium Note is convertible into shares of Audium Series A Convertible Preferred Stock ("Audium Preferred Stock") and is secured by Audium's intellectual property. Management determined that a 12 percent annual interest rate better reflects the risk characteristics of the Audium Note. Accordingly, interest was imputed at 12 percent and the Audium Note was recorded at its original present value of $302,909. For the three months and six months ended June 30, 2002, the Company recorded interest income of $9,519 and $19,038, respectively, including contractual and imputed interest. As of June 30, 2002, the balance of the Audium Note was $331,345, net of the unaccreted discount of $68,655. Investment in Affiliate - In April 2001, the Company entered into a stock purchase agreement with Audium, wherein the Company agreed to purchase up to $2,800,000 of Audium Preferred Stock at a price of $1.46 per share. At closing, the Company paid $200,000 in cash and gave Audium a non-interest bearing note (the "Fonix Note") for the remaining $2,600,000. Each share of Audium Preferred Stock is convertible into one share of Audium's common stock. At closing, Audium issued 14 Audium Preferred Share certificates to Fonix, each certificate for 136,986 shares, and delivered one certificate in exchange for the initial payment of $200,000. The remaining certificates are held by Audium as collateral for the Fonix Note under the terms of a security agreement. For each payment of $200,000 or multiple payments that aggregate $200,000, Audium will release to Fonix one certificate for 136,986 shares of Audium Preferred Stock. The difference between the total purchase price of the Audium Preferred Stock and the Company's portion of Audium's net stockholders' deficit at the time of the purchase was $2,700,727, which was allocated to completed core technology. The excess purchase price allocated to the completed core technology is being amortized on a straight- line basis over a period of eight years. Interest on the Fonix Note was imputed at 12 percent resulting in a present 10 value of $2,370,348. The resulting purchase price of the Audium Preferred Stock was $2,570,348. The investment in Audium does not provide the Company with rights to any technology developed by Audium, but the Company must obtain a license should it choose to do so. The Company does not own an interest sufficient to control Audium, even if it were to convert the Audium Note to Audium Preferred Stock. Accordingly, Fonix does not benefit directly from the research and development being done by Audium. As a result, the Company has determined that it is appropriate to account for its investment, which represents 26.7 percent of Audium's voting stock, under the equity method and not as a research and development arrangement. Accordingly, for the three months and six months ended June 30, 2002, the Company recognized losses consisting of the following:
Three Months Six Months Ended June 30, Ended June 30, 2002 2002 ----------------------- ---------------------- Company share of Audium net loss $ 47,352 $ 119,479 Amortization of difference between purchase price of Audium Preferred Stock and Company's share of Audium's net stockholders' deficit $ 41,825 $ 83,650 ----------------------- ---------------------- Total equity in loss of affiliate $ 89,177 $ 203,129 ======================= ======================
The fair value of this investment is determined based on Audium's estimated future net cash flows considering the status of Audium's product development. The Company evaluates this investment for impairment annually and more frequently if indications of decline in value exist. An impairment loss that is other than temporary is recognized during the period it is determined to exist. An impairment is determined to be other-than-temporary if estimated future net cash flows are less than the carrying value of the investment. If projections indicate that the carrying value of the investment will not be recoverable, the carrying value is reduced by the estimated excess of the carrying value over the estimated discounted cash flows. At December 31, 2001, the Company evaluated the estimated future net cash flows, given the status of Audium's product development. From this evaluation , the Company determined that an impairment loss of $823,275 should be recorded. No subsequent impairment loss has been recorded. Note Payable to Affiliate - The Fonix Note bears no interest unless an event of default occurs, in which case it will bear interest at 12 percent per year. The Company owes Audium $987,500 under the Fonix Note. The Company is currently negotiating a new payment schedule for payment of this amount. If we is are not able to agree on a new payment schedule, then Audium may declare a default under the Fonix Note and exercise its rights under the Fonix Note, including the right to foreclose on approximately 684,930 shares of Audium Preferred Stock held as collateral for the Fonix Note. No events of default have occurred to date. Management determined that a 12 percent annual interest rate reflects the risk characteristics of the Fonix Note. Accordingly, interest has been imputed at 12 percent and the Company recorded a present value of $2,370,348 for the note payable. For the three months and six months ended June 30, 2002, the Company recorded interest expense of $19,426 and $55,428, respectively, related to this note. 4. INTANGIBLE ASSETS The Company adopted the provisions of SFAS No. 142 in its entirety on January 1, 2002. Under the new standard, goodwill and intangible assets deemed to have indefinite lives are no longer amortized, but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their estimated useful lives. The Company has performed the required impairment tests of goodwill and indefinite-lived intangible assets. There was no impairment of goodwill or intangible assets upon adoption of SFAS No. 142. Upon adoption of SFAS No. 142, the Company also reassessed the estimated useful lives of intangible assets subject to amortization. Intangible assets consist of purchased core technology, customer relationships, trademarks, patents and goodwill arising from the purchase of assets from Force Computers, Inc., and the acquisition of AcuVoice, Inc. Also included 11 are direct costs incurred by the Company in applying for patents covering its internally developed technologies. As of June 30, 2002 and December 31, 2001, amortized intangible assets consisted of the following:
June 30, 2002 December 31, 2001 ------------------------------------------ -------------------------------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization --------------------- -------------------- -------------------- --------------------- Purchased core technologies $ 978,582 $ (51,435) $ 978,582 $ - Customer relationships 306,000 (15,300) 306,000 - Patents 164,460 (156,250) 164,460 (145,522) --------------------- -------------------- -------------------- --------------------- Total $ 1,449,042 $ (222,985) $ 1,449,042 $ (145,523) ===================== ==================== ==================== =====================
In addition, the Company has trademarks not subject to amortization, recorded at a carrying value of $42,000 at June 30, 2002 and December 31, 2001. This asset is considered to have an indefinite useful life. Amortization of intangible assets is computed on a straight-line basis over their estimated useful lives, which range from one to ten years. As of January 1, 2002, the weighted-average amortization periods were as follows: total - 4.6 years, purchased core technologies - 4.0 years, customer relationships - 10.0 years, and patents - 0.8 years. Intangible assets subject to amortization will not have any significant residual value at the end of their estimated useful lives. Estimated future amortization expense for intangible assets subject to amortization is as follows: For the Year Ended December 31, Amount -------------------------------- ------ 2002 $ 78,226 2003 134,996 2004 134,996 2005 134,996 2006 124,100 Accumulated amortization of goodwill was $2,295,598 at both June 30, 2002 and December 31, 2001. In accordance with the provisions of SFAS No. 142, the Company no longer amortizes goodwill. The amortization expense for capitalized speech software technology is included in cost of revenues. For the six months ended June 30, 2002 and 2001, th eamortization expense included in cost of revenue was $52,198 and $912,220, respectively. During the three months ended December 31, 2001, the Company recognized an impairment loss on its speech software technology amounting to $5,832,217, and its handwriting recognition technology amounting to $2,056,295, both of which were included in cost of revenues for that period. The carrying values of the Company's long-lived assets is reviewed for impairment whenever events or changes in circumstances indicate that they may not be recoverable. If such an event were to occur, the Company would project undiscounted cash flows to be generated from the use of the asset and its eventual disposition over the remaining life of the asset. If projections were to indicate that the carrying value of the long-lived asset would not be recoverable, the carrying value would be reduced by the estimated excess of the carrying value over the projected discounted cash flows. During 2002, the Company engaged Houlihan Valuation Advisors, an independent valuation firm, to assess its goodwill and intangible assets with indefinite lives for impairment. The resulting appraisal indicated no impairment, and therefore management of the Company did not consider goodwill or other intangible assets to be impaired. However, should the Company's marketing and sales plans not materialize in the near term, the realization of the Company's goodwill and other intangible assets could be severely and negatively impacted. The accompanying condensed consolidated financial statements have been prepared based on management's estimates of realizability, which estimates may change due to factors beyond the control of the Company. Upon initial application of SFAS No. 142, the Company reassessed the useful lives of its intangible assets and determined that no changes to estimated useful lives were necessary as of June 30, 2002. Goodwill amortization expense was $302,053 during the six months ended June 30, 2001 and $1,029,545, 12 $1,029,545 and $1,189,896 during the years ended December 31, 2001, 2000 and 1999, respectively. The effects on loss before extraordinary item, net loss and basic and diluted loss per share of excluding such goodwill amortization from the six months ended June 30, 2002 and 2001 and from the years ended December 31, 2001, 2000 and 1999 is as follows:
For the Six Months Ended For the Years Ended December 31, ------------------------------------ ----------------------------------------------------- June 30, 2002 June 30, 2001 2001 2000 1999 ----------------- ----------------- ----------------- ------------------ --------------- Loss before extraordinary item, as reported $(10,783,054) $(10,756,925) $(31,059,791) $(22,810,677) $(22,136,276) Loss before extraordinary item, excluding goodwill amortization $(10,783,054) $(10,454,872) $(30,455,686) $(22,206,572) $(21,532,171) ================= ================= ================= ================= =============== Net loss, as reported $(10,783,054) $(10,756,925) $(31,059,791) $(22,761,229) $(21,662,419) Add back goodwill amortization - 302,053 604,105 604,105 604,105 ----------------- ----------------- ----------------- ----------------- --------------- Net loss, excluding goodwill amortization $(10,783,054) $(10,454,872) $(30,455,686) $(22,157,124) $(21,058,314) ================= ================= ================= ================= =============== Basic and diluted loss per share: Loss before extraordinary item, as reported $ (0.03) $ (0.05) $ (0.13) $ (0.16) $ (0.32) Loss before extraordinary item, excluding goodwill amortization $ (0.03) $ (0.05) $ (0.13) $ (0.16) $ (0.31) ================= ================= ================= ================= =============== Net loss, as reported $ (0.03) $ (0.05) $ (0.13) $ (0.16) $ (0.31) Net loss, excluding goodwill $ (0.03) $ (0.05) $ (0.13) $ (0.16) $ (0.30) amortization \================= ================= ================= ================= ===============
5. PROMISSORY NOTE In December 2001, the Company entered into an Asset Purchase Agreement with Force Computers, Inc. ("Force"). As part of the purchase price Fonix issued a non-interest bearing promissory note in the amount of $1,280,000 (the "Force Note"). Installment payments under the Force Note are due over the 12 month period following the date of purchase. Management determined that a seven percent annual interest rate reflects the risk characteristics of the Force Note. Accordingly, interest has been imputed at seven percent and the Company recorded a discount of $40,245. For the three months and six months ended June 30, 2002, the Company recorded interest expense of $8,688 and $28,372, respectively, related to the Force Note. As collateral for the Force Note, 7,000,000 shares of the Company's Class A common stock were placed into escrow. To date, all required payments have been made. As of June 30, 2002, payments amounting to $410,000 remained outstanding under the Force Note, including a payment of $160,000 that was due June 12, 2002. Subsequent to June 30, 2002, the June 12 installment payment was made. 6. NOTES PAYABLE - RELATED PARTIES Certain executives officers of the Company (the "Lenders") sold shares of the Company's Class A common stock owned by them and advanced the resulting proceeds amounting to $333,308 to the Company under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in Company operations. The advances bear interest at 10 percent per annum, and are payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, is due and payable on June 10, 2003. Any time after December 11, 2002, all or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company. The conversion price is the average closing bid price of the shares at the time of the advances. If converted, the conversion amount is divided by the conversion price to determine the number of shares to be issued to the Lenders. To the extent the market price of the Company's shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares. A beneficial conversion feature of $14,917 was recorded as interest expense in connection with this transaction. The Lenders 13 may also receive additional compensation as determined appropriate by the Board of Directors. The advances were secured by the Company's intellectual property rights, which security interest was released when the increase in authorized capital of 300,000,000 shares of Class A common stock was approved by the Company's shareholders at the Fonix Annual Shareholder Meeting on July 12, 2002. 7. EQUITY LINES OF CREDIT Equity Line of Credit - On August 8, 2000, the Company entered into a Private Equity Line Agreement (the "Initial Equity Line") with a private investor (the "Equity Line Investor"), which gave the Company the right to draw up to $20,000,000 for Company operations and other purposes through a mechanism of draws and puts of stock. The Company was entitled to draw funds and to "put" to the Equity Line Investor shares of Class A common stock in lieu of repayment of the draw. The number of shares issued was determined by dividing the dollar amount of the draws by 90 percent of the average of the two lowest closing bid prices of Class A common stock over the seven trading- day period following the date the Company tendered the put notice to the Equity Line Investor. The Equity Line Investor funded the amounts requested by the Company within two trading days after the seven trading-day period. On May 8, 2002, the Company and the Equity Line Investor amended the Initial Equity Line to increase the balance available under the Equity Line from $20,000,000 to $22,000,000. Accordingly, as of May 8, 2002, $2,000,000 was available to be drawn under the Equity Line. During the six months ended June 30, 2002, 40,692,920 shares of Class A common stock were issued in connection with draws under the Initial Equity Line of $3,633,817. From inception of the Initial Equity Line through June 30, 2002, 91,083,516 shares of Class A common stock were issued in connection with draws of $20,617,324. As of September 16, 2002, $1,382,676 remains unutilized under the Initial Equity Line, as amended; however, no registered shares remain available to facilitate a draw of this amount. Therefore, this amount is unavailable to the Company at this time. Second Equity Line of Credit - On April 6, 2001, the Company entered into a second equity line agreement (the "Second Equity Line") with the Equity Line Investor. Under the Second Equity Line, the Company has the right to draw up to $20,000,000 under terms substantially identical to the Initial Equity Line. During the six months ended June 30, 2002, 93,586,995 shares of Class A common stock were issued in connection with draws amounting to $5,728,846. From inception of the Second Equity Line through June 30, 2002, 211,600,000 shares of Class A common stock were issued in connection with draws of $19,153,846. As of September 16, 2002, $846,154 remains unutilized under the Second Equity Line; however, no registered shares remain available to facilitate a draw of this amount. Therefore, this amount is unavailable to the Company at this time. Third Equity Line of Credit - On June 27, 2002, the Company entered into a third equity line agreement (the "Third Equity Line") with the Equity Line Investor. Under the Third Equity Line, the Company has the right to draw up to $20,000,000 under terms substantially identical to the Initial Equity Line. On June 27, 2002, the Company filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-2 to register the resale of up to 200,000,000 shares of the Company's Class A common stock by the Equity Line Investor. As of September 16, 2002, the registration statement had not been declared effective by the Commission, and as such, the Company was unable to draw funds under the Third Equity Line as of that date. Prior to June 30, 2002, the Equity Line Investor advanced the Company $182,676 against future draws on the Third Equity Line. As of September 16, 2002, no shares had been issued under the Third Equity Line. Subscriptions Receivable - Proceeds from certain draws on the equity lines prior to December 31, 2001 had not been received by the Company as of those dates. The cash proceeds in the amount of $852,970 were subsequently received in January 2002. 8. COMMON STOCK, STOCK OPTIONS AND WARRANTS 14 Class A Common Stock - During the six months ended June 30, 2002, 134,279,915 shares of Class A common stock were issued in connection with draws on the equity lines (see Note 7). No shares of Class A common stock were issued as a result of the exercise of stock options or warrants during the same period. Stock Options - During the six months ended June 30, 2002, the Company granted options to employees to purchase 5,229,000 shares of Class A common stock and granted options to directors to purchase 1,000,000 shares of Class A common stock. The options have exercise prices ranging from $0.05 to $0.11 per share, which were the quoted fair market price of the stock on the dates of grant. Of the options granted during this six-month period, 5,229,000 vest over the three years following issuance and 1,000,000 vested immediately. These options expire within ten years from the date of grant if not exercised. Using the Black-Scholes pricing model, the weighted average fair value of the employee and director options were $0.08 and $0.04 per share, respectively. As of June 30, 2002, the Company had a total of 29,597,909 options to purchase Class A common shares outstanding. The Company's option plans provide for stock appreciation rights that allow the grantee to receive shares of the Company's Class A common stock equivalent in value to the difference between the designated exercise price and the fair market value of the Company's stock at the date of exercise. As of June 30, 2002, there are options to purchase 33,334 shares of Class A common stock outstanding which provide for stock appreciation rights. These options have an exercise price of $1.00 per share. If not exercised by September 2002, the options with these rights will expire. Warrants - As of September 16, 2002, the Company had warrants to purchase a total of 2,425,000 shares of Class A common stock outstanding that expire beginning in 2002 through 2010. Warrants issued for services were recorded at their fair value determined using the Black-Scholes pricing model. The resulting values were recorded in operating expenses in the periods covered by the services rendered. Warrants for the purchase of 300,000 shares of Class A common stock were issued in January 2000 for consulting services rendered. The warrants were issued at $47,000 using the Black-Scholes pricing model assuming risk-free interest rate of 5.7%, expected exercise life of 5 years, and volatility of 102%. The warrants were issued with exercise prices ranging from $0.28 to $1.25, vested during the year ended December 31, 2000 and expire January 2003. 9. FONIX UK, LTD. On May 30, 2002, the Company established Fonix UK, Ltd., a United Kingdom subsidiary, ("Fonix UK"). Fonix UK will facilitate the Company's development, marketing and investment opportunities in Europe. To date, Fonix UK has no operations. 10. SUBSEQUENT EVENTS On July 12, 2002, the Company held its Annual Meeting of Shareholders in Boston, Massachusetts. The record date for the meeting was May 24, 2002, on which date there were 482,805,888 shares of the Company's Class A common stock outstanding. The first matter voted upon at the meeting was the election of directors. The following directors were elected: SHARES SHARES DIRECTOR VOTED IN FAVOR VOTED AGAINST -------- -------------- ------------- Thomas A. Murdock 399,431,186 11,146,172 Roger D. Dudley 399,361,304 11,216,084 John A. Oberteuffer, Ph.D 404,903,223 5,674,135 William A. Maasberg, Jr. 403,439,549 7,137,809 Mark S. Tanner 403,604,229 6,973,129 15 The second matter voted upon at the meeting was the approval of a proposed amendment to the Company's Certificate of Incorporation to increase the authorized capital stock of the Company to include 800,000,000 shares of Class A Common Stock. The results of the voting were 397,433,216 shares in favor, 11,766,861 shares against, and 1,377,311 shares withheld or abstaining. Convertible Notes Receivable - During 2002, the Company has advanced $920,000 to Unveil under the line of credit. Also during 2002, the Company impaired the full value of the convertible note receivable and interest accrued thereon. Note Payable to Affiliate - The Company made payments of $562,500 on the note payable to Audium Corporation during 2002 through December 10, 2002. Series D Convertible Debentures - On October 11, 2002, the Company entered into a Securities Purchase Agreement with Breckenridge Fund, LLC ("Breckenridge"), an unaffiliated third party, for the sale of the Company's Series D 12% Convertible Debentures (the "Debentures") in the aggregate principal amount of $1,500,000. The outstanding principal amount of the Debentures is convertible at any time at the option of the holder into shares of the Company common stock at a conversion price equal to the average of the two lowest closing bid prices of the Company's Class A common stock for the twenty trading days immediately preceding the conversion date multiplied by 90%. The Debentures are due April 9, 2003. On the earlier of December 20, 2002, or 45 days after the effective date of this registration statement and prospectus (the "Initial Payment Date") and each 30-day anniversary of the Initial Payment Date, the Company is required to make principal payments of $250,000, plus accrued interest. In connection with the sale of the Debentures, the Company issued, as collateral to secure its performance under the Debenture, 83,333,333 shares of Class A common stock (the "Collateral Shares"), which were placed into an escrow pursuant to an escrow agreement. Under the escrow agreement, the Collateral Shares will not be released to Breckenridge unless the Company is delinquent with respect to payments under the Debenture. Additionally, as further consideration for the sale of the Debentures, the Company issued 7,777,778 shares to Breckenridge (the "Additional Shares") which were were valued at $0.052 per share, the market value of the stock on the date of the transaction. In connection with this transaction, in the fourth quarter of 2002, the Company recorded a discount of $404,444 on the Debentures from the allocation of a portion of the proceeds to the Additional Shares and recorded an additional discount of $571,111 from the beneficial conversion option associated with the Debentures, both of which will be amortized as interest expense over the life of the Debentures. In connection with the sale of the Debentures, the Company agreed to register the resale of shares of our Class A common stock underlying the Debentures, the Collateral Shares, and the Additional Shares. The Company will file a registration statement to register those resales. Common Stock - During 2002, the Company has issued 134,279,915 shares of Class A common stock in connection with draws on its equity lines of credit. Stock Options - During the nine months ended September 30, 2002, the Company granted options to employees to purchase 5,239,000 shares of Class A common stock and granted options to directors to purchase 1,000,000 shares of Class A common stock. The options have exercise prices ranging from $0.05 to $0.11 per share, which were the quoted fair market price of the stock on the dates of grant. Of the options granted during this nine-month period, 5,239,000 vest over the three years following issuance and 1,000,000 vested immediately. These options expire within ten years from the date of grant if not exercised. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This quarterly report on Form 10-Q contains, in addition to historical information, forward-looking statements that involve substantial risks and uncertainties. Actual results could differ materially from the results the Company anticipates and which are discussed in the forward-looking statements. Factors that could cause or contribute to such differences are discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. To date the Company has earned only limited revenue from operations and intends to continue to rely primarily on financing through the sale of its equity and debt securities to satisfy future capital requirements. Overview Since inception, Fonix has devoted substantially all of its resources to research, development and acquisition of software technologies that enable intuitive human interaction with computers, consumer electronics, and other intelligent devices. Through June 30, 2002, the Company has incurred significant cumulative losses, and losses are expected to continue until the effects of recent marketing and sales efforts begin to take effect, if ever. The Company incurred negative cash flows from operating activities of $8,307,495 during the six months ended June 30, 2002. Sales and licensing of products based on the Company's technologies have not been sufficient to finance ongoing operations. As of June 30, 2002, the Company had negative working capital of $8,491,835 and an accumulated deficit of $184,892,409. The Company has drawn all capital available under its initial and second equity lines. While a third equity line is in place, it is unavailable to the Company until a registration statement covering the underlying securities is declared effective. The Company's continued existence is dependent upon several factors, including the Company's success in (1) increasing license, royalty, product, and services revenues, (2) raising sufficient additional equity and debt funding and (3) minimizing and reducting operating costs. Until sufficient revenues are generated from operating activities, the Company expects to continue to fund its operations through the sale of its equity and debt securities. The Company continues to emphasize technologies and product delivery and sales while achieving technology upgrades to maintain its perceived competitive advantages. In its current marketing efforts, the Company seeks to form relationships with third parties who can incorporate speech-enabling technologies into new or existing products. Such relationships may be structured in any of a variety of ways including traditional technology licenses, collaboration or joint marketing agreements, co-development relationships through joint ventures or otherwise, and strategic alliances. The third parties with whom Fonix presently has such relationships and with which it may have similar relationships in the future include developers of application software, operating systems, computers, microprocessor chips, consumer electronics, automobiles, telephony and other products. Significant Accounting Policies The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. A complete discussion of significant accounting policies and areas where substantial judgements by management are made is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. Recently Enacted Accounting Standards - In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 eliminates the "pooling-of-interests" method of accounting for acquisitions and requires separate accounting for certain intangibles acquired in such transactions. The application of this standard did not have an impact on the Company's financial position and results of operations. 17 SFAS No. 142 changes the accounting for goodwill and intangible assets with indefinite lives from an amortization method to an impairment-only approach. Accordingly, effective January 1, 2002, amortization of goodwill and intangible assets with indefinite lives was discontinued. Other intangible assets will continue to be amortized over their useful lives. Effective January 1, 2002, the Company adopted the requirements of SFAS No. 142. During 2002, the Company engaged Houlihan Valuation Advisors, an independent valuation firm, to assess its goodwill and intangible assets with indefinite lives for impairment. The resulting appraisal indicated no impairment and the application of the test for impairment required by SFAS No. 142 had no effect on the Company's financial position or results of operations, except for the change in amortization of goodwill and intangible assets with indefinite lives. In August 2001, the FASB issued SFAS No. 143 , "Accounting for Asset Retirement Obligations." This statement establishes financial accounting and reporting standards for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company's adoption of this statement on January 1, 2002, did not have a material effect on the Company's financial position or results of operations. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement establishes financial accounting and reporting standards for the impairment or disposal of long-lived assets. The Company's adoption of this statement on January 1, 2002, did not have a material effect on the Company's financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." Among other provisions, this statement modifies the criteria for classification of gains or losses on debt extinguishments such that they are not required to classified as extraordinary items if they do not meet the criteria for classification as extraordinary items in APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The Company will be required to apply the provisions of this standard to transactions occurring after December 31, 2002. The Company's adoption of this standard in 2003 is not expected to have a material effect on the Company's financial position or results of operations. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The Company will be required to apply this statement prospectively for any exit or disposal activities initiated after December 31, 2002. The Company's adoption of this standard is not expected to have a material effect on the Company's financial position or results of operations. Revenue Recognition - The Company recognizes revenues in accordance with the provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and related interpretations. The Company generates revenues from licensing the rights to its software products to end users and from royalties. It also generate service revenues from the sale of consulting and development services. Revenues of all types are recognized when contingencies such as conditions of acceptance of functionality, rights of return, price protection, etc. are confirmed or can be reasonably estimated, as appropriate. Revenues from development and consulting services are recognized on a completed-contract basis when the services are completed and accepted by the customer. Revenue for hardware units delivered is recognized when delivery is verified and collection assured. Revenue for products distributed through wholesale and retail channels and resellers is recognized upon verification of final sell-through to end users, after consideration of rights of return and price protection. Revenue is recognized when the right of return on such products has expired, typically when the end user 18 purchases the product from the retail outlet. Once the end user opens the package, it is not returnable unless the medium is defective. Price protection is offered to distributors in the event we reduce the price on any specific product. Such price protection is generally offered for a specific time period in which the distributor must make a claim. Resulting revenue recognized reflects the reduced price. Slotting fees paid by the Company for favorable placement in retail outlets are recorded as a reduction in gross revenues. Revenues from licenses and royalties are recognized upon shipment of the software by the Company or by the vendor. Post-contract obligations, if any, generally consist of one year of support including such services as customer calls, bug fixes, upgrades, etc. Related revenue is recognized over the period covered by the agreement. Revenues from maintenance and support contracts are also recognized over the term of the contract. Revenues applicable to multiple-element fee arrangements are bifurcated among the elements such as license agreements, and support and upgrade obligations using vendor-specific objective evidence of fair value. Such evidence consists primarily of pricing of multiple elements as if sold as separate products or arrangements. These elements vary based upon factors such as the type of license, volume of units licensed and other related factors. Deferred revenue at June 30, 2002, and December 31, 2001, consisted of the following:
June 30, December 31, Description Criteria for Recognition 2002 2002 ----------- ---------------------------------- ---------------------- -------------------- Deferred unit royalties Delivery of units to end users or and licence fees expiration of contract $ 978,063 $ 945,814 Engineering projects not Completion of work and acceptance completed of completed work by customer 125,000 62,500 Deferred customer Expiration of period covered by support support agreement 31,729 41,535 ---------------------- -------------------- Total deferred revenue $ 1,134,792 $ 1,049,849 ====================== ====================
Cost of revenues from license, royalties and maintenance consists of costs to distribute the product (including the cost of the media on which it is delivered), installation and support personnel compensation, licensed technology and other related costs. Cost of service revenues consists of personnel compensation, licensed technology and other related costs. Software application development costs - The Company has not capitalized the cost of development of specific software applications due to uncertainty of recovery of such costs. While the Company believes the carrying value of its core technology assets is recoverable, it is uncertain regarding the recoverability of ongoing development costs for specific software applications; therefore, such costs are charged as operating expenses in the period in which they are incurred. Results of Operations Three months ended June 30, 2002, compared with three months ended June 30, 2001 During the three months ended June 30, 2002, the Company recorded revenues of $679,197, reflecting an increase of $571,629 over the same period in the previous year. The increase in revenue is related to the licensing of TTS applications to customers in assistive markets made possible through the acquisition of assets and technology rights in December 2001. Cost of revenues were $166,424 for the three months ended June 30, 2002, a decrease of $302,208, from the corresponding period in 2001. The writedown of the Company's capitalized software costs in 2001 resulted in a 19 $430,001 decrease in amortization in 2002. The decrease was offset by increases in other costs of revenues including the cost of delivering royalties and licenses and the cost of hardware sales. Hardware sales represents the the largest portion of the increase because such sales were new to the Company in 2002, as noted above. Selling, general and administrative expenses were $3,383,999 and $3,306,800 for the three months ended June 30, 2002 and 2001, respectively. The increase of $77,199 includes increases of $142,527 in compensation-related expenses, $87,606 in consultants, outside services and promotional expenses, $33,159 in occupancy charges and $24,277 in other operating expenses, all of which are related to increases in sales, marketing and business development personnel, and efforts related to increased marketing and promotional activities. Administrative expenses were also increased by $54,779 for costs related to the preparation of filings and materials for the annual shareholders meeting that were incurred in the third quarter of 2001. These increases were offset by decreases of $179,220 in legal and accounting fees resulting from fewer regulatory filings completed during the period and $82,468 in travel and entertainment expenses. Product development and research expenses were $2,590,988 and $2,483,627 for the three months ended June 30, 2002 and 2001, respectively, reflecting an increase of $107,361. Increased internal resources and development expertise resulted in an increase of $321,788 in conpensation-related expenses. This internal capacity allowed the Company to reduce its reliance on external service providers in the second quarter resulting in a decrease of $132,308 in consultant and outside service expenses and $72,577 in other operating expenses related to the purchase of software licenses and related services. Amortization of intangible assets was $7,650 and $151,026, for the three months ended June 30, 2002 and 2001, respectively. The decrease of $143,376 is a result of the write down of certain intangible assets in 2001 and the change in accounting for amortization of goodwill dictated by SFAS No. 142. Based on the value of current intangible assets, the Company expects amortization expense to be approximately $68,000, including $53,000 that will be charged to cost of revenues, for the remainder of 2002 and $136,000 per year thereafter, including $104,000 that will be charged to cost of revenues until the underlying assets have been completely amortized. Six months ended June 30, 2002, compared with six months ended June 30, 2001 During the six months ended June 30, 2002, the Company recorded revenues of $977,981, reflecting an increase of $737,700 over the same period in the previous year. The increase in revenue is related to the licensing of TTS applications to customers in assistive markets made possible through the acquisition of assets and technology rights in December 2001. Cost of revenues were $210,528 for the six months ended June 30, 2002, a decrease of $721,213, from the corresponding period in 2001. The writedown of the Company's capitalized software costs in 2001 resulted in a $860,000 decrease in amortization in 2002. The decrease was offset by increases in other costs of revenues including the cost of delivering royalties and licenses and the cost of hardware sales. Hardware sales represents the the largest portion of the increase because such sales were new to the Company in 2002, as noted above. Selling, general and administrative expenses were $6,608,167 and $5,453,702 for the six months ended June 30, 2002 and 2001, respectively. The increase of $1,154,465 includes increases of $447,419 in compensation-related expenses, $193,903 in consultants, outside services and promotional expenses, $73,083 in occupancy charges and $481,293 in other operating expenses that are all related to increases in sales, marketing and business development personnel, and efforts related to increased marketing and promotional activities as well as expansion into assistive markets. Administrative expenses were also increased by $120,000 in consulting fees related to strategic planning and financing efforts and $53,510 for costs related to the preparation of filings and materials for the annual shareholders meeting that were incurred in the third quarter of 2001. These increases were offset by decreases of $154,879 in legal and accounting fees resulting from fewer regulatory filings completed during the period and $99,771 in travel and entertainment expenses. Product development and research expenses were $4,714,724 and $4,139,277 for the six months ended June 30, 2002 and 2001, respectively, reflecting an increase of $575,447. Increases of $669,567 in compensation-related expenses and $45,697 in consultants and outside services reflect the Company's efforts to increase its capacity to 20 develop speech-enabling solutions as well as the cost of additional employees added in connection with the acquisition from Force Computers. These increases were offset by a decrease of $137,138 in occupancy and other operating expenses resulting from reductions in the purchase of software licenses and related services. Amortization of intangible assets was $15,300 and $302,053, for the three months ended June 30, 2002 and 2001, respectively. The decrease of $286,753 is a result of the write down of certain intangible assets in 2001 and the change in accounting for amortization of goodwill dictated by SFAS No. 142. Based on the value of current intangible assets, the Company expects amortization expense to be approximately $68,000, including $53,000 that will be charged to cost of revenues, for the remainder of 2002 and $136,000 per year thereafter, including $104,000 that will be charged to cost of revenues until the underlying assets have been completely amortized. Liquidity and Capital Resources While the Company anticipates that revenues will increase during the next 12 months, it must raise additional funds to be able to satisfy its cash requirements. Research and development, corporate operations and marketing expenses will continue to require additional capital. Because the Company presently has only limited revenue from operations, the Company intends to continue to rely primarily on financing through the sale of its equity and debt securities to satisfy future capital requirements until such time as the Company is able to enter into additional third- party licensing, collaboration or co-marketing arrangements which generate revenues such that it will be able to finance ongoing operations from license, royalty and services revenues. There can be no assurance that the Company will be able to generate substantial revenues from such agreements. Furthermore, the issuance of equity or debt securities which are or may become convertible into equity securities of the Company in connection with such financing could result in substantial additional dilution to the stockholders of the Company and declining market value of the Company's shares may limit the amount available in this manner. The Company currently has drawn all available funds on existing equity lines, but has recently entered into a third equity line with the same investor under which the Company issue up to 200,000,000 shares of Class A common stock when the registration of such shares is declared effective. The Company currently has no alternative plans for funding operations other than issuance of debt and equity securities, but it continues to explore other options for additional funding for its operations. The Company's shareholders recently approved an increase of 300,000,000 common shares in authorized capital in order to facilitate the current funding process. Net cash used in operating activities of $8,307,495 for the six months ended June 30, 2002, resulted principally from the net loss incurred of $10,783,054 offset by non-cash expenses pertaining to depreciation and amortization of $257,973 and equity in net loss of affiliate of $203,131. Payments to vendors and employees have also been delayed since June 2002 resulting in an increase of $2,240,141 in accounts payable and accrued liabilities outstanding. Net cash used in investing activities of $895,880 for the six months ended June 30, 2002 consisted primarily of advances under a convertible note payable of $805,000. Net cash used in operating and investing activities was offset by net cash provided by financing activities of $9,040,887 consisting primarily of the receipt of $10,122,346 in cash related draws under the Company's equity lines of credit offset, in part, by $1,420,000 in payments on notes payable. The Company had negative working capital of $8,491,834 at June 30, 2002, compared to negative working capital of $6,101,268 at December 31, 2001. Current assets decreased by $888,383 to $380,741 from December 31, 2001, to June 30, 2002. Current liabilities increased by $1,502,183 to $8,872,575 during the same period. The change in working capital from December 31, 2001 to June 30, 2002, was primarily attributable to the timing of payments on operating obligations such as accounts payable and accrued liabilities, and receipts of funding under the Company's equity lines of credit. Total assets were $8,388,565 at June 30, 2002, compared to $8,599,028 at December 31, 2001. Convertible Note Receivable and Line of Credit On December 1, 2001, the Company, as the lender, established a revolving line of credit and received a convertible promissory note from Unveil Technologies, Inc. ("Unveil"), that permits Unveil to draw up to $2,000,000 for operations and other purposes. Unveil is a developer of natural language understanding solutions for customer resource management ("CRM") applications. Fonix intends to obtain a license to Unveil's applications when completed and has made the loan to Unveil to facilitate and expedite the development and commercialization of Uneveil's speech-enabled CRM software. Draws on the line of credit bear interest at an annual rate of seven 21 percent, which interest is payable quarterly beginning September 30, 2002. The balance due under the line of credit is secured by Unveil's CRM software and source code therefor and other assets of Unveil. The Company is a senior creditor to Unveil. The unpaid principal, together with interest accrued thereon, is due and payable on December 31, 2002, and is convertible into common shares of Unveil at the Company's option. Based upon borrowings through June 30, 2002, such conversion at that date would have represented approximately 12 percent of the ownership of Unveil. During the six months ended June 30, 2002, Unveil drew $805,000 on the line of credit, bringing total draws on the line of credit to $1,435,000 as of June 30, 2002. Subsequent to June 30, 2002, Unveil drew an additional $15,000. Investment In Audium Corporation In February 2001, the Company entered into a collaboration agreement with Audium Corporation ("Audium") to provide an integrated platform for generating Voice XML solutions for Internet and telephony systems. Audium is a mobile application service provider that builds and operates mobile applications that allow access to Internet information and to complete online transactions using any telephone. The collaboration includes integration of the Company's technologies with Audium's mobile applications development capability. Note Receivable - In connection with the collaboration agreement with Audium, in February and May 2001 the Company advanced an aggregate of $400,000 to Audium as a bridge loan (the "Audium Note"). The loan bears interest at a rate of five percent per year and has a term of four years. The Audium Note is convertible into shares of Audium Series A Convertible Preferred Stock ("Audium Preferred Stock") and is secured by Audium's intellectual property. Management determined that a 12 percent annual interest rate better reflects the risk characteristics of the Audium Note. Accordingly, interest was imputed at 12 percent and the Audium Note was recorded at its original present value of $302,909. For the three months and six months ended June 30, 2002, the Company recorded interest income of $9,519 and $19,038, respectively, including contractual and imputed interest. As of June 30, 2002, the balance of the Audium Note was $331,345, net of the unaccreted discount of $68,655. Investment in Affiliate - In April 2001, the Company entered into a stock purchase agreement with Audium, wherein the Company agreed to purchase up to $2,800,000 of Audium Preferred Stock at a price of $1.46 per share. At closing, the Company paid $200,000 in cash and gave Audium a non-interest bearing note (the "Fonix Note") for the remaining $2,600,000. Each share of Audium Preferred Stock is convertible into one share of Audium's common stock. Interest on the Fonix Note was imputed at 12 percent resulting in a present value of $2,370,348. The resulting purchase price of the Audium Preferred Stock was $2,570,348. At closing, Audium issued 14 Audium Preferred Share certificates to Fonix, each certificate for 136,986 shares, and delivered one certificate in exchange for the initial payment of $200,000. The remaining certificates are held by Audium as collateral for the Fonix Note under the terms of a security agreement. For each payment of $200,000 or multiple payments that aggregate $200,000, Audium will release to Fonix one certificate for 136,986 shares of Audium Preferred Stock. The difference between the total purchase price of the Audium Preferred Stock and the Company's portion of Audium's net stockholders' deficit at the time of the purchase was $2,700,727, which was allocated to completed core technology. The excess purchase price allocated to the completed core technology is being amortized on a straight- line basis over a period of eight years. The investment in Audium does not provide the Company with rights to any technology developed by Audium, but the Company must obtain a license should it choose to do so. The Company does not own an interest sufficient to control Audium, even if it were to convert the Audium Note to Audium Preferred Stock. Accordingly, Fonix does not benefit directly from the research and development being done by Audium. As a result, the Company has determined that it is appropriate to account for its investment, which represents 26.7 percent of Audium's voting stock, under the equity method and not as a research and development arrangement. Accordingly, for the three months and six months ended June 30, 2002, the Company recognized losses consisting of the following: 22
Three Months Six Months Ended June 30, Ended June 30, 2002 2002 ----------------------- ---------------------- Company share of Audium net loss $ 47,352 $ 119,479 Amortization of difference between purchase price of Audium Preferred Stock and Company's share of Audium's net stockholders' deficit $ 41,825 $ 83,650 ----------------------- ---------------------- Total equity in loss of affiliate $ 89,177 $ 203,129 ======================= ======================
The fair value of this investment is determined based on Audium's estimated future net cash flows considering the status of Audium's product development. The Company evaluates this investment for impairment annually and more frequently if indications of decline in value exist. An impairment loss that is other than temporary is recognized during the period it is determined to exist. An impairment is determined to be other-than-temporary if estimated future net cash flows are less than the carrying value of the investment. If projections indicate that the carrying value of the investment will not be recoverable, the carrying value is reduced by the estimated excess of the carrying value over the estimated discounted cash flows. At December 31, 2001, the Company evaluated the estimated future net cash flows, given the status of Audium's product development. From this evaluation , the Company determined that an impairment loss of $823,275 should be recorded. No subsequent impairment loss has been recorded. Note Payable to Affiliate - The Fonix Note bears no interest unless an event of default occurs, in which case it will bear interest at 12 percent per year. The Company owes Audium $987,500 under the Fonix Note. The Company is currently negotiating a new payment schedule for payment of this amount. If we is are not able to agree on a new payment schedule, then Audium may declare a default under the Fonix Note and exercise its rights under the Fonix Note, including the right to foreclose on approximately 684,930 shares of Audium Preferred Stock held as collateral for the Fonix Note. No events of default have occurred to date. Management determined that a 12 percent annual interest rate reflects the risk characteristics of the Fonix Note. Accordingly, interest has been imputed at 12 percent and the Company recorded a present value of $2,370,348 for the note payable. For the three months and six months ended June 30, 2002, the Company recorded interest expense of $19,426 and $55,428, respectively, related to this note. Promissory Note In December 2001, the Company entered into an Asset Purchase Agreement with Force Computers, Inc. ("Force"). As part of the purchase price Fonix issued a non-interest bearing promissory note in the amount of $1,280,000 (the "Force Note"). Installment payments under the Force Note are due over the 12 month period following the date of purchase. Management determined that a seven percent annual interest rate reflects the risk characteristics of the Force Note. Accordingly, interest has been imputed at seven percent and the Company recorded a discount of $40,245. For the three months and six months ended June 30, 2002, the Company recorded interest expense of $8,688 and $28,372, respectively, related to the Force Note. As collateral for the Force Note, 7,000,000 shares of the Company's Class A common stock were placed into escrow. To date, all required payments have been made. As of June 30, 2002, payments amounting to $410,000 remained outstanding under the Force Note, including a payment of $160,000 that was due June 12, 2002. Subsequent to June 30, 2002, the June 12 installment payment was made. Notes Payable - Related Parties Certain executives officers of the Company (the "Lenders") sold shares of the Company's Class A common stock owned by them and advanced the resulting proceeds amounting to $333,308 to the Company under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in Company operations. The 23 advances bear interest at 10 percent per annum, payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, is due and payable on June 10, 2003. Any time after December 11, 2002, all or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company. The conversion price is the average closing bid price of the shares at the time of the advances. If converted, the conversion amount is divided by the conversion price to determine the number of shares to be issued to the Lenders. To the extent the market price of the Company's shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares. A beneficial conversion feature of $14,917 was recorded as interest expense in connection with this transaction. The Lenders may also receive additional compensation as determined appropropriate by the Board of Directors. The advances were secured by the Company's intellectual property rights, which security interest was released when the increase in authorized capital of 300,000,000 shares of Class A common stock was approved by the Company's shareholders at the Fonix Annual Shareholders Meeting on July 12, 2002. The Company also had unsecured demand notes payable to former stockholders of an acquired entity in the aggregate amount of $77,625 outstanding as of June 30, 2002. During 2000, certain holders of these notes made demand for payment. The Company is attempting to negotiate a reduced payoff of these notes. The notes remain unpaid and no additional demands for payment have been received by the Company. Equity Lines of Credit During the six months ended June 30, 2002, 40,692,920 shares of Class A common stock were issued in connection with draws of $3,633,817 against the Initial Equity Line (see Note 7 of the Condensed Consolidated Financial Statements) On May 8, 2002, the Company and the Equity Line Investor amended the Initial Equity Line agreement to increase the balance available under the Initial Equity Line from $20,000,000 to $22,000,000. Accordingly, as of May 8, 2002, an additional $2,000,000 was available to be drawn under the Initial Equity Line. From inception of the Initial Equity Line through June 30, 2002, 91,083,516 shares of Class A common stock have been issued in connection with draws of $20,617,324. As of September 16, 2002, $1,382,676 remains unutilized under the Initial Equity Line, as amended; however, no registered shares remain available to facilitate a draw of this amount. Therefore, this amount is unavailable to the Company at this time. During the six months ended June 30, 2002, 93,586,995 shares of Class A common stock were issued in connection with draws of $5,728,846 against the Second Equity Line (see Note 7 of the Condensed Consolidated Financial Statements). From inception of the Second Equity Line through June 30, 2002, 211,600,000 shares of Class A common stock were issued in connection with draws of $19,153,846. As of September 16, 2002, $846,154 remains unutilized under the Second Equity Line; however, no registered shares remain available to facilitate a draw of this amount. Therefore, this amount is unavailable to the Company at this time. The following table summarizes the transactions completed under the equity lines to date:
Weighted Average Average Number of Total Shares Issued Equity Line Conversion Price Shares Issued Per Draw Under Equity Line ----------- ---------------- ---------------------- ----------------- Initial Equity Line $0.228 4,554,176 91,083,516 Second Equity Line $0.091 11,775,556 211,600,000
On June 27, 2002, the Company entered into a the Third Equity Line Agreement with the Equity Line Investor. Under the Third Equity Line, the Company has the right to draw up to $20,000,000 under terms substantially identical to the previous equity lines. On June 27, 2002, the Company filed with the Commission a registration statement on Form S-2 to register the resale of up to 200,000,000 shares of the Company's Class A common stock by the Equity Line Investor. As of September 16, 2002, the registration statement had not been declared effective by the Commission, and as such, the Company was unable to draw funds under the Third Equity Line as of that date. Prior to June 30, 2002, the Equity Line Investor advanced the Company $182,676 against future draws on the Third Equity Line. As of September 16, 2002, no shares had been issued under the Third Equity Line. 24 Stock Options and Warrants During the six months ended June 30, 2002, the Company granted options to employees to purchase 5,229,000 shares of Class A common stock and granted options to directors to purchase 1,000,000 shares of Class A common stock. The options have exercise prices ranging from $0.05 to $0.11 per share, which were the quoted fair market price of the stock on the dates of grant. Of the options granted during this six-month period, 5,229,000 vest over the three years following issuance and 1,000,000 vested immediately. These options expire within ten years from the date of grant if not exercised. Using the Black-Scholes pricing model, the weighted average fair value of the employee and director options were $0.08 and $0.04 per share, respectively. As of June 30, 2002, the Company had a total of 29,597,909 options to purchase Class A common shares outstanding. The Company's option plans provide for stock appreciation rights that allow the grantee to receive shares of the Company's Class A common stock equivalent in value to the difference between the designated exercise price and the fair market value of the Company's stock at the date of exercise. As of June 30, 2002, there are options to purchase 33,334 shares of Class A common stock outstanding which provide for stock appreciation rights. These options have an exercise price of $1.00 per share. If not exercised by September 2002, the options with these rights will expire. As of September 16, 2002, the Company had warrants to purchase a total of 2,425,000 shares of Class A common stock outstanding that expire beginning in 2002 through 2010. Warrants issued for services were recorded at their fair value determined using the Black-Scholes pricing model. The resulting values were recorded in operating expenses in the periods covered by the services rendered. Warrants for the purchase of 300,000 shares of Class A common stock were issued in January 2000 for consulting services rendered. The warrants were issued at $47,000 using the Black-Scholes pricing model assuming risk-free interest rate of 5.7%, expected exercise life of 5 years, and volatility of 102%. The warrants were issued with exercise prices ranging from $0.28 to $1.25, vested during the year ended December 31, 2000 and expire January 2003. Related-Party Transaction In February 2000, the Company entered into an agreement to purchase from John A. Oberteuffer, an executive officer and director of the Company, all of Dr. Oberteuffer's rights and interests in certain methods and apparatus for integrated voice and pen input for use in computer systems. In payment for Dr. Oberteuffer's technology, the Company granted Dr. Oberteuffer 600,000 warrants to purchase our Class A common stock at an exercise price of $1.00 per share. The warrants were valued using the Black-Scholes method of valuation and resulted in a value of $0.79 per warrant for the 600,000 warrants, or an aggregate value of $474,000. The warrants expire February 10, 2010. Also, the Company granted Dr. Oberteuffer the right to repurchase the technology from the Company at fair market value if the Company subsequently determined not to commercialize the pen/voice technologies or products. In February 2000, the Company was actively pursuing development and licensing opportunities in handwriting recognition ("HWR") and desired to procure the rights to Dr. Oberteuffer's in-process development. However, there was no assurance at the time that the development of the project would result in revenue opportunities when completed, so the cost was charged to in-process research and development at that time. The Company has since determined that there is no substantial benefit to pursuing the market for HWR technology, including the technology acquired from Dr. Oberteuffer and as such, the balance of goodwill from all HWR acquisitions was written off in 2001. The Company's decision to cease efforts to commercialize HWR technologies may trigger Dr. Oberteuffer's right to repurchase the pen/voice technologies acquired from the Company. Other The Company presently has no plans to purchase new research and development or office facilities. Outlook Corporate Objectives and Technology Vision 25 The Company delivers speech solutions that empower people to interact conversationally with information systems and computing devices using natural language. The Company's speech-enabling technologies, which include text-to- speech ("TTS") and neural network-based automated speech recognition ("ASR"), are integrated into products for commercial, industrial and consumer applications. The Company is now delivering standard speech-enabled solutions and applications for specific market segments, namely: mobile and wireless handheld computing devices, automotive solutions, TTS applications for computer telephony, and speech software applications. These solutions and applications are built on the Company's Core Technologies. Management expects to deliver efficient, reusable and scaleable standard solutions to increase revenue margins and leverage the Company's Core Technologies across multiple platforms and operating systems for wireless and mobile computing devices and computer telephony systems. The Fonix Core Technologies are based on proprietary technology that is protected by various patents and trade secrets. Management believes that the Company's speech-enabling technologies and solutions provide superior competitive advantages compared to other speech technologies and products available in the marketplace. Specifically, the Fonix Core Technologies provide the following competitive advantages: o Fonix neural net-based technologies require less memory storage. For example, the combined Fonix ASR & TTS technologies require approximately one megabyte (MB), while the nearest competitor requires approximately three MB for comparable applications. This benefit lowers the cost of the Fonix solution compared to that of our competitors. o Fonix neural net-based technologies require less processing power as measured in MIPS (million instructions per second). Fonix technologies require a less expensive micro-processor (CPU) and allow for more applications to run concurrently on a comparable CPU. o Fonix neural net-based technologies provide a higher recognition accuracy in noisy environments, such as inside of an operating vehicle. o Fonix neural net-based technologies do not require the user to train the system to their individual voice. o Fonix neural net-based architecture provides higher and more robust system reliability. o Fonix neural net-based technologies allow customers (OEMs, VARs, and end users) to modify vocabularies in real-time. o Fonix neural net-based technologies provide a lower porting-cost and require less time to integrate speech- enabling solutions to operating systems ("OS") and CPUs. o To date, Fonix has ported to nine different multiple operating systems and twelve different CPUs, while many competitors support only a limited number of OS and CPU platforms. o Fonix TTS human-like "voices" have very high understandability in noisy environments. In order to accomplish the objective of delivering efficient, resuable and scalable standard solutions to increase revenue margins and leverage our Core Technologies, the Company intends to proceed as follows: Substantially Increase Marketing and Sales Activities. The Company intends to hire additional sales and marketing personnel, both domestically and internationally, who will focus on the automotive embedded and wireless mobile markets, computer telephony and server solution markets and personal software for consumer applications. To address global opportunities, the Company will continue to develop or acquire additional speech-enabling products and technologies for foreign languages and dialects. Fonix will also make significant investments in reseller, co-operative, and market development funded programs in order to build sales and marketing opportunities with software developers, resellers, wholesale distribution channels and corporate partners. Expand Strategic Relationships. The Company has a number of strategic collaboration and marketing arrangements with developers and VARs. The Company intends to expand such relationships and add additional similar relationships, specifically in the mobile communications, PDA, IVR and computer telephony markets. Fonix partners, OEMs, and VARs can accelerate time to market by incorporating Fonix s.Manager, a proprietary dynamic development platform. Further, when the Company is able to identify "first mover" speech-enabling applications in which it can integrate its Core Technologies, the Company intends to investigate investment opportunities in order that the Company can obtain preferred or priority 26 collaboration rights. Continue to Develop and Enhance the Core Technologies. The Company plans to continue to invest significant resources in development of standard solution and products, acquisition of speech-enabling technologies and properties, developer tools and development frameworks to maintain the competitive advantages found in its Core Technologies. The Company has entered into and is seeking to enter into collaboration or joint marketing agreements, co- development relationships, and strategic alliances with well-known technology and consumer product manufacturers, integrators, and value-added resellers ("VARs"). Management believes that the best way to generate material recurring revenues is for the Company to enter into contracts with integrators and VARs who will introduce it to potential end users of products that incorporate our Core Technologies. Typically, these types of agreements require joint marketing and development efforts by both Fonix and the integrators or VARs. The Company spends significant time educating and providing information to both third party integrators and VARs and their prospective customers regarding the use and benefits of Fonix Core Technologies. During this evaluation period, the Company may expend substantial sales, marketing and management resources, all of which is not recoverable unless the prospective customer of the third party integrator or VAR enters into an agreement with the Company or the third party which has integrated Fonix Core Technologies into its products, which agreement ultimately results in the receipt of revenue by the Company. As the Company proceeds to implement its strategy and to reach its objectives, it anticipates further development of complementary technologies, added product and applications development expertise, access to market channels and additional opportunities for strategic alliances in other industry segments. The strategy adopted by the Company has significant risks and shareholders and others interested in the Company and its Class A common stock should carefully consider the risks set forth under the heading "Certain Significant Risk Factors" in the Company's 2001 Annual Report on Form 10-K, Item 1, Part I. Item 3. Quantitative and Qualitative Disclosures About Market Risk To date, all of the Company's revenues have been denominated in United States dollars and received primarily from customers in the United States. The Company's exposure to foreign currency exchange rate changes has been insignificant. The Company expects, however, that future product license and services revenue may also be derived from international markets and may be denominated in the currency of the applicable market. As a result, operating results may become subject to significant fluctuations based upon changes in the exchange rate of certain currencies in relation to the U.S. dollar. Furthermore, to the extent that the Company engages in international sales denominated in U.S. dollars, an increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products less competitive in international markets. Although the Company will continue to monitor its exposure to currency fluctuations, it cannot assure that exchange rate fluctuations will not adversely affect financial results in the future. Item 4. Evaluation of Disclosure Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. The Company's chief executive officer and chief financial officer, after evaluating the effectiveness of the Company's "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934, Rules 13a-14(c) and 15-d-14(c)) as of a date (the "Evaluation Date") within 90 days before the filing date of this quarterly report, have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and designed to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities. (b) Changes in Internal Controls. There were no significant changes in the Company's internal controls, or, to the Company's knowledge, in other factors that could significantly affect these controls subsequent to the Evaluation Date. PART II - OTHER INFORMATION Item 1. Legal Proceedings 27 In November 1998, Fonix filed a suit against John R. Clarke and Perpetual Growth Fund, a company affiliated with Clarke, in Federal District Court for the Central District of Utah seeking a declaratory judgment that it did not owe any money to Clarke and Perpetual Growth relating to certain financing received by the Company during 1998 and thereafter. The case was tried in March 2001, after which the trial court ruled in favor of Fonix and determined that Clarke and Perpetual Growth had no claims for "trailing fees" with regard to the financings which were the subject of the suit. Clarke and Perpetual Growth appealed the decision of the trial court to the United States Court of Appeals for the Tenth Circuit, but the appellate court has not yet rendered a decision. The Company believes that the claims of Clarke and Perpetual Growth are without merit and will continue to vigorously oppose those claims. If the appellate court reverses the decision of the trial court and finds that we owe additional funds to Clarke and/or Perpetual Growth, that ruling could have a material adverse effect on our financial position. The Company is involved in other claims and actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters will not materially affect the consolidated financial position, liquidity or results of operations of the Company. Item 2. Changes in Securities c. Unregistered sales of equity securities during the quarter (other than in reliance on Regulation S). Recent Sales of Unregistered Securities. During the three months ended June 30, 2002, the Company issued equity securities that were not registered under the Securities Act of 1933, as amended (the "1933 Act"), other than unregistered sales in reliance on Regulation S under the Act, as follows: For the three months ended June 30, 2002, the Company received $876,981 in funds drawn under the Initial Equity Line (see Note 7 of the Condensed Consolidated Financial Statements), less commissions and fees of $26,309, and issued 11,505,784 shares of Class A common stock to the Equity Line Investor. The shares were issued without registration under the 1933 Act in reliance on Section 4(2) of the Securities Act of 1933, as amended (the "1933 Act"), and the rules and regulations promulgated thereunder. The resales of the shares were subsequently registered under a registration statement on Form S-2. For the three months ended June 30, 2002, the Company received $1,085,682 in funds drawn under the Second Equity Line (see Note 7 of the Condensed Consolidated Financial Statements), less commissions and fees of $32,570, and issued 9,689,260 shares of Class A common stock to the Equity Line Investor. The shares were issued without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder. The resales of the shares were subsequently registered under a registration statement on Form S-2. Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders On July 12, 2002, the Company held its Annual Meeting of Shareholders in Boston, Massachusetts. The record date for the meeting was May 24, 2002, on which date there were 482,805,888 shares of the Company's Class A common stock outstanding. The first matter voted upon at the meeting was the election of directors. The following directors were elected: 28 SHARES SHARES DIRECTOR VOTED IN FAVOR VOTED AGAINST -------- -------------- ------------- Thomas A. Murdock 399,431,186 11,146,172 Roger D. Dudley 399,361,304 11,216,084 John A. Oberteuffer, Ph.D 404,903,223 5,674,135 William A. Maasberg, Jr. 403,439,549 7,137,809 Mark S. Tanner 403,604,229 6,973,129 The second matter voted upon at the meeting was the approval of a proposed amendment to the Company's Certificate of Incorporation to increase the authorized capital stock of the Company to include 800,000,000 shares of Class A Common Stock. The results of the voting were 397,433,216 shares in favor, 11,766,861 shares against, and 1,377,311 shares withheld or abstaining. Item 5. Other Matters Change in Certifying Public Accountants On July 16, 2002, the Company engaged the accounting firm of Hansen Barnett & Maxwell ("HBM") as the Company's independent public accountants to review the Company's interim financial statements and to audit its financial statements beginning with the fiscal year ending December 31, 2002. The Company terminated its relationship with and dismissed its former independent public accountant, Arthur Andersen LLP ("Andersen"), effective with the appointment of HBM. The dismissal of Andersen and the appointment of HBM as the Company's new independent public accountant were approved by the Company's Audit Committee and Board of Directors on July 12, 2002. During the period from the date of Andersen's engagement as the Company's independent public accountants to July 16, 2002, the Company did not consult with HBM on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. During the most recent fiscal years ended December 31, 2001 and 2000, and the interim period subsequent to December 31, 2001, through the date of dismissal of Andersen, there were no disagreements with Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure that would have caused Andersen to make references in their report to such disagreements. Andersen's report on the financial statements of the Company for the year ended December 31, 2001, contained no adverse opinion or disclaimer of opinion and was not modified as to audit scope or accounting principles, except that Andersen's report dated February 26, 2002, contained an explanatory paragraph regarding the Company's ability to continue as a going concern. Similarly, Andersen's report on the financial statements of the Company for the year ended December 31, 2000, contained no adverse opinion or disclaimer of opinion and was not modified as to audit scope or accounting principles, except that Andersen's report dated March 29, 2001, contained an explanatory paragraph regarding the Company's ability to continue as a going concern. The Company filed with the Commission a current report on Form 8-K on July 17, 2002, disclosing the termination of its engagement with Andersen, its engagement of HBM, and other information required to be disclosed. The Company provided Andersen with a copy of the current report and requested that Andersen furnish a letter addressed to the Commission stating whether Andersen agrees with the above statements. In response, a representative of Andersen advised the Company that Andersen would no longer provide letters relating to its termination as a audit client's independent public accountant, and that Andersen's inability to provide such letters had been discussed with the Staff at the Commission. Resignation of Mark S. Tanner Effective July 27, 2002, Mark S. Tanner resigned as a member of our Board of Directors. Item 6. Exhibits and Reports on Form 8-K 29 a. Exhibits: The following Exhibits are filed with this Form 10-Q pursuant to Item 601(a) of Regulation S-K:
Exhibit No. Description of Exhibit (2)(i) Agreement and Plan of Reorganization among the Company, Fonix Acquisition Corporation and AcuVoice dated as of January 13, 1998, incorporated by reference from the Company's Current Report on Form 8-K, filed March 20, 1998 (2)(ii) Agreement and Plan of Merger among Fonix, Articulate Acquisition Corporation, and Articulate, dated as of July 31, 1998, incorporated by reference from the Company's Current Report on Form 8-K, filed September 17, 1998 (2)(iii) Agreement and Plan of Merger among Fonix, Papyrus Acquisition Corporation, and Papyrus Associates, Inc., dated as of September 10, 1998, incorporated by reference from the Company's Current Report on Form 8-K, filed November 13, 1998 (3)(i) Articles of Incorporation of the Company which are incorporated by reference from the Company's Registration Statement on Form S-18 dated as of September 12, 1989 (3)(ii) Certificate of Amendment of Certificate of Incorporation dated as of March 21, 1994, which is incorporated by reference from the Company's Annual Report for the Fiscal Year Ended December 31, 1994 on Form 10-KSB (3)(iii) Certificate of Amendment of Certificate of Incorporation dated as of May 13, 1994, which is incorporated by reference from the Company's Annual Report for the Fiscal Year Ended December 31, 1994 on Form 10-KSB (3)(iv) Certificate of Amendment of Certificate of Incorporation dated as of September 24, 1997, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (3)(v) The Company's Bylaws, as amended, which are incorporated by reference from the Company's Annual Report for the Fiscal Year Ended December 31, 1994 on Form 10-KSB (4)(i) Description of the Company's common stock and other securities and specimen certificates representing such securities which are incorporated by reference from the Company's Registration Statement on Form S-18 dated as of September 12, 1989, as amended (4)(ii) Certificate of Designation of Rights and Preferences of Series A Preferred Stock, filed with the Secretary of State of Delaware on September 24, 1997, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (4)(iii) Certificate of Designation of Rights and Preferences of Series B Convertible Preferred Stock, filed with the Secretary of State of Delaware on October 27, 1997, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (4)(iv) Certificate of Designation of Rights and Preferences of 5% Series C Convertible Preferred Stock, filed with the Secretary of State of Delaware on October 24, 1997, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 30 (4)(v) Certificate of Designation of Rights and Preferences of Series D 4% Convertible Preferred Stock, filed with the secretary of State of Delaware on August 27, 1998, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998 (4)(vi) Certificate of Designation of Rights and Preferences of Series E 4% Convertible Preferred Stock, filed with the secretary of State of Delaware on October 15, 1998, which is incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998 (9)(i) Voting Trust Agreement dated as of December 10, 1993 by and among Phonic Technologies, Inc., Stephen M. Studdert, Thomas A. Murdock and Roger D. Dudley, which is incorporated by reference from the Company's Current Report on Form 8-K dated as of June 17, 1994 (9)(ii) Amendment of Voting Trust Agreement by and among the Company, Stephen M. Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert Companies Corporation, and Thomas A. Murdock as Trustee, dated as of October 23, 1995, incorporated by reference from the Company's Current Report on Form 8-K dated as of October 23, 1995 (9)(iii) Second Amendment of Voting Trust Agreement by and among the Company, Stephen M. Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert Companies Corporation, and Thomas A. Murdock as Trustee, dated as of July 2, 1996, incorporated by reference from the Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (9)(iv) Third Amendment of Voting Trust Agreement by and among the Company, Stephen M. Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert Companies Corporation, and Thomas A. Murdock as Trustee, dated as of September 20, 1996, incorporated by reference from the Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (9)(v) Fourth Amendment of Voting Trust Agreement by and among the Company, Stephen M. Studdert, Thomas A. Murdock, Roger D. Dudley, Beesmark Investments, L.C., Studdert Companies Corporation, and Thomas A. Murdock as Trustee, dated as of September 20, 1996, incorporated by reference from the Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (10)(i) Product Development and Assignment Agreement dated as of October 16, 1993 between Phonic Technologies, Inc. and Synergetics, Inc., which is incorporated by reference from the Company's Current Report on Form 8-K dated as of June 17, 1994 (10)(ii) Re-Stated Product Development and Assignment Agreement dated as of March 30, 1995, between Fonix Corporation and Synergetics, Inc., which is incorporated by reference from the Company's Annual Report for the Fiscal Year Ended December 31, 1994 on Form 10-KSB (10)(iii) Memorandum of Understanding dated as of March 13, 1997, by and among the Company, Synergetics, Inc. and C. Hal Hansen, which is incorporated by reference from the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (10)(iv) Employment Agreement by and between the Company and Stephen M. Studdert, which is incorporated by reference from the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 31 (10)(v) Employment Agreement by and between the Company and Thomas A. Murdock, which is incorporated by reference from the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (10)(vi) Employment Agreement by and between the Company and Roger D. Dudley, which is incorporated by reference from the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 (10)(vii) Restated Master Agreement for Joint Collaboration between the Company and Siemens, dated November 14, 1997, as revised, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(viii) Restated First Statement of Work and License Agreement between the Company and Siemens, dated February 11, 1998, as revised, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(ix) Master Technology Collaboration Agreement between the Company and OGI, dated October 14, 1997, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(x) Common stock Purchase Agreement among the Company and JNC Opportunity Fund Ltd. and Diversified Strategies Fund, LP, dated as of March 9, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xi) Common stock Purchase Agreement between the Company and Thomson Kernaghan & Co., dated as of March 9, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xii) Royalty Modification Agreement among the Company and Synergetics, dated as of April 6, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xiii) Purchase Agreement with John Oberteuffer and the Company dated April 9, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xiv) Employment Agreement by and between the Company and John A. Oberteuffer, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xv) First Amendment to Master Agreement for Joint Collaboration between the Company and Siemens, dated February 13, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(xvi) Second Amendment to Master Agreement for Joint Collaboration between the Company and Siemens, dated March 13, 1998, which is incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 (10)(vii) Series D Convertible Preferred Stock Purchase Agreement Among Fonix corporation, JNC Opportunity Fund, Ltd., Diversified Strategies Fund, L.P., Dominion Capital Fund, Ltd., Sovereign Partners, LP, Canadian Advantage Limited Partnership and Thomson Kernaghan & Co. (as agent) dated as of August 31, 1998, incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998 32 (10)(xviii) Series E Convertible Preferred Stock Exchange and Purchase Agreement among Fonix corporation, Sovereign Partners, LP and Dominion Capital Fund, Ltd., dated as of September 30, 1998, incorporated by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998 (10)(xix) Securities Purchase Agreement among Fonix Corporation and JNC Strategic Fund, dated December 21, 1998 for 1,801,802 shares of common stock and Repricing Rights, incorporated by reference from Amendment No. 1 to Registration Statement on Form S-3 (File No. 333-67573) (10)(xx) Securities Purchase Agreement among Fonix Corporation and the investors identified therein dated January 29, 1999, as supplemented on March 3, 1999, concerning sales of $6,500,000 principal amount of Series C 5% Convertible Debentures, incorporated by reference from Amendment No. 1 to Registration Statement on Form S-3 (File No. 333- 67573) (10)(xxi) Asset Purchase Agreement - Acquisition of Certain Assets of Fonix Corporation and Fonix/ASI Corporation by Lernout & Hauspie Speech Products N.V., dated as of May 19, 1999, which is incorporated by reference from the Company's Current Report on Form 8- K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(a)) (10)(xxii) Escrow Agreement, dated as of September 1, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(b)) (10)(xxiii) Technology Option Agreement, dated as of May 19, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(c)) (10)(xxiv) Assignment and Assumption Agreement, dated as of September 1, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(d)) (10)(xxv) License Agreement by and between Fonix/ASI Corporation and Lernout & Hauspie Speech Products N.V., dated as of May 19, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(e)) (10)(xxvi) Loan Agreement, dated as of April 22, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(f)) (10)(xxvii) Amendment to Loan Agreement, dated as of May 12, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(g)) (10)(xxviii) Second Amendment to Loan Agreement, dated as of May 19, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(h)) (10)(xxix) Loan Agreement, dated as of May 19, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(i)) 33 (10)(xxx) First Amendment to Loan Agreement, dated as of August 12, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(j)) (10)(xxxi) Agreement, dated as of July 31, 1999, which is incorporated by reference from the Company's Current Report on Form 8-K, filed with the Commission on September 16, 1999 (therein designated as Exhibit 10(k)) (10)(xxxii) Series F Convertible Preferred Stock Purchase Agreement, Among Fonix Corporation, Sovereign Partners, LP, Dominion Capital Fund, LTD., Dominion Investment Fund, LLC, Canadian Advantage, L.P., and Queen LLC, dated as of February 1, 2000 (10) (xxxiii) Amended and Restated Series F Convertible Preferred Stock Purchase Agreement among Fonix Corporation and the investors identified therein dated May 22, 2000, which is incorporated by reference from the Company's Rule 424(b) Registration Statement on Form S-2, filed with the Commission on June 16, 2000 (therein designated as Exhibit 99.3) (10) (xxxiv) Equity Line Agreement between Fonix Corporation and Queen LLC, dated August 8, 2000, which is incorporated by reference from the Company's Registration Statement on Form S-2, filed with the Commission on August 10, 2000 (therein designated as Exhibit 99.4) 10(xxxv) Audium Stock Purchase Agreement between Fonix Corporation and Audium Corporation, dated as of April 5, 2001, filed with the Commission on April 17, 2001 10(xxxvi) Certificate of Designation of Audium Series A Preferred Stock, filed with the Commission on April 17, 2001. 10(xxxvii) Form of Promissory Note from Fonix Corporation to Audium Corporation for $2,600,000, dated as of April 5, 2001, filed with the Commission on April 17, 2001. 10(xxxviii) Security Agreement between Fonix Corporation as the Debtor and Audium Corporation as the Secured Party, dated as of April 5, 2001, filed with the Commission on April 17, 2001. 10(xxxix) Registration Rights Agreement between Fonix Corporation and Audium Corporation, dated as of April 5, 2001, filed with the Commission on April 17, 2001. 10(xl) Security Agreement between Audium Corporation as the Debtor and Fonix Corporation as the Secured Party, dated as of April 5, 2001, filed with the Commission on April 17, 2001. 10(xli) Form of Promissory Note from Audium Corporation to Fonix Corporation for $400,000, filed with the Commission on April 17, 2001. 10(xlii) License Agreement between Fonix Corporation and Audium Corporation, dated as of April 5, 2001, filed with the Commission on April 17, 2001. 10(xliii) Second Private Equity Line Agreement between Fonix Corporation and Queen LLC, dated April 6, 2001, filed with the Commission on April 17, 2001. 10(xliv) Registration Rights Agreement between Fonix Corporation and Queen LLC, dated April 6, 2001, filed with the Commission on April 17, 2001. 34 10(xlv) Amendment to Equity Line Agreement between Fonix Corporation and Queen LLC, dated May 8, 2002, filed with the Commission May 9, 2002. 10(xlvi) Third Private Equity Line Agreement between Fonix Corporation and Queen LLC, dated June 27, 2002, filed with the Commission June 27, 2002. 99.1 Certification of President and Chief Financial Officer 99.2 Certification of President and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(B) Reports filed on Form 8-K during the three-month period ended June 30, 2002: On June 10, 2002, the Company filed a Current Report on Form 8-K to announce a loan and repayment agreement between the Company and Thomas A. Murdock and Roger D. Dudley, two if its executive officers and directors. On July 17, 2002, the Company filed a current report on Form 8-K with the Commission relating to its engagement of Hansen Barnett & Maxwell as its independent public accountants to review the Company's interim financial statements and to audit the Company's financial statements beginning with its fiscal year ending December 31, 2002. The current report also disclosed the termination of the Company's engagement of Arthur Andersen LLP as its independent public accountant, effective upon the engagement of Hansen Barnett & Maxwell. 35 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Fonix Corporation Date: December 13, 2002 /s/ Roger D. Dudley -------------------------------------------- Roger D. Dudley, Executive Vice President, Chief Financial Officer (Principal financial officer) 36 CERTIFICATION I, Thomas A. Murdock certify that: 1. I have reviewed this quarterly report on Form 10-Q of Fonix Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, base on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 13, 2002 /s/ Thomas A. Murdock ------------------------------------- Thomas A. Murdock Chairman and Chief Executive Officer 37 CERTIFICATION I, Roger D. Dudley, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Fonix Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, base on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 13, 2002 /s/ Roger D. Dudley ------------------------------------- Roger D. Dudley Executive Vice President and Chief Financial Officer 38 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Fonix Corporation on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Thomas A. Murdock, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Thomas A. Murdock ------------------------------------------ Thomas A. Murdock Chief Executive Officer 39 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Fonix Corporation on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Roger D. Dudley, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Roger D. Dudley ------------------------------------------ Roger D. Dudley Chief Financial Officer 40