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Form 10-Q for FONIX CORP
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13-May-2005
Quarterly Report
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report on Form 10-Q contains, in addition to historical information, forward-looking statements that involve substantial risks and uncertainties.
All forward-looking statements contained herein are deemed by Fonix to be covered by and to qualify for the safe harbor protection provided by Section 21E of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from the results anticipated by Fonix and discussed in the forward-looking statements. When used in this report, words such as "believes," "expects," "intends," "plans," "anticipates," "estimates," and similar expressions are intended to identify forward-looking statements, although there may be certain forward-looking statements not accompanied by such expressions.
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, 2004.
To date, we have earned only limited revenue from operations and intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements.
Overview
We are engaged in providing integrated telecommunications services through Fonix Telecom, Inc., and LecStar Telecom, Inc., and value-added speech technologies through The Fonix Speech Group. We operate Fonix Telecom, Inc., and LecStar Telecom, Inc., a regional provider of telecommunications services in the Southeastern United States and LecStar DataNet, Inc., a provider of Internet services. (LecStar Telecom, Inc. and LecStar DataNet are collectively referred to in this report as "LecStar.")
We offer our speech-enabling technologies including automated speech recognition ("ASR") and text-to-speech ("TTS") through The Fonix Speech Group. We offer our ASR and TTS technologies to markets for wireless and mobile devices, computer telephony, server solutions and personal software for consumer applications. We have received various patents for certain elements of our core technologies and have filed applications for other patents covering various aspects of our technologies. We seek to develop relationships and strategic alliances with third-party developers and vendors in telecommunications, computers, electronic devices and related industries, including producers of application software, operating systems, computers and microprocessor chips. Revenues are generated through providing telecommunication services, licensing of speech-enabling technologies, maintenance contracts and services.
Fonix Telecom's non-regulated telecommunication services include VoIP, BPL and wireless broadband access. These services are initially available in the southeastern United States and we anticipate that they eventually will be available throughout the United States.
LecStar's telecommunication services include wireline voice, data, long distance and Internet services to business and residential customers. LecStar Telecom, Inc., is certified by the Federal Communications Commission in nine states-Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina and Tennessee-as a competitive local exchange carrier ("CLEC") to provide regulated local, long distance and international telecommunications services. LecStar DataNet, Inc., provides non-regulated telecommunication services including Internet access.
For the three months ended March 31, 2005 and 2004, we generated revenues of $4,223,000 and $1,925,000, respectively; incurred net losses of $4,080,000 and $2,342,000, respectively; and had negative cash flows from operating activities of $2,559,000 and $5,478,000, respectively. As of March 31, 2005, we had an accumulated deficit of $231,002,000, negative working capital of $13,121,000, accrued liabilities of $6,877,000, accounts payable of $5,383,000 and accrued employee wages and other compensation of $1,311,000. We expect to continue to incur significant losses and negative cash flows from operating activities through at least December 31, 2005, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies and further developing our telecommunications services business.
Our cash resources, limited to collections from customers, draws on the Sixth Equity Lines and loans, have not been sufficient to cover operating expenses.
We have not been declared in default under the terms of any material agreements.
Significant Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our 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. Significant accounting policies and areas where substantial judgments are made by management include:
Accounting estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Valuation of long-lived assets - The carrying values of our long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that they may not be recoverable. When such an event occurred, we 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 recovered, the carrying value of the long-lived asset, other than software technology, would be reduced by the estimated excess of the carrying value over the projected discounted cash flows.
Intangible assets - Customer base, contracts and agreements and brand names are amortized over their estimated useful lives unless they are deemed to have indefinite useful lives. For intangible assets subject to amortization, an impairment charge is recognized if the carrying amount is not recoverable and the carrying amount exceeds the fair value of the intangible asset. Intangible assets deemed to have indefinite useful lives, primarily the LecStar brand name are not amortized, are tested for impairment on a quarterly basis and impairment is recognized if the carrying amount is not recoverable or exceeds its fair value. During the year ended December 31, 2004, we recorded an impairment loss on the intangible asset related to the contracts and agreements acquired in connection with the LecStar acquisition (see Note 2 of the Condensed Consolidated Financial Statements) of $738,000 based on estimated future cash flows.
Goodwill - Goodwill represents the excess of the cost over the fair value of net assets of acquired businesses. Goodwill is not amortized, but is tested for impairment quarterly or when a triggering event occurs. If a triggering event occurs, the undiscounted net cash flows of the asset or entity to which the goodwill relates are evaluated. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The amount of the impairment is measured using a discounted-cash-flow model considering future revenues, operating costs, a risk-adjusted discount rate and other factors.
Revenue recognition - We recognize revenue when pervasive evidence of an arrangement exists, services have been rendered or products have been delivered, the price to the buyer is fixed and determinable and collectibility is reasonable assured. Revenues are recognized by us based on the various types of transactions generating the revenue. For software sales, we recognize revenues in accordance with the provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and related interpretations. We generate revenues from licensing the rights to our software products to end users and from royalties.
For telecommunications services, revenue is recognized in the period that the service is provided.
For The Fonix Speech Group, revenue of all types is recognized when acceptance of functionality, rights of return, and price protection are confirmed or can be reasonably estimated, as appropriate. Revenue for hardware units delivered is recognized when delivery is verified and collection assured.
Revenue for products distributed through wholesale and retail channels and through resellers is recognized upon verification of final sell-through to end users, after consideration of rights of return and price protection. Typically, the right of return on such products has expired 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.
When arrangements to license software products do not require significant production, modification or customization of software, revenue from licenses and royalties are recognized when persuasive evidence of a licensing arrangement exists, delivery of the software has occurred, the fee is fixed or determinable, and collectibility is probable. Post-contract obligations, if any, generally consist of one year of support including such services as customer calls, bug fixes, and upgrades. Related revenue is recognized over the period covered by the agreement. Revenues from maintenance and support contracts are also recognized over the term of the related contracts.
Revenues applicable to multiple-element fee arrangements are bifurcated among the elements such as license agreements and support and upgrade obligations using vendor-specific objective evidence of fair value. Such evidence consists primarily of pricing of multiple elements as if sold as separate products or arrangements. These elements vary based upon factors such as the type of license, volume of units licensed, and other related factors.
For Fonix Telecom, Inc., our telecommunications revenue is comprised of two main components: (1) fees paid by business and residential subscribers of voice and data services and (2) carrier access fees. Subscriber revenues include monthly recurring charges, usage charges and non-recurring charges. Monthly recurring charges are flat monthly fees for local phone and data services. Usage charges, which primarily include long distance fees, are generally billed on a per-minute or per-call basis. Non-recurring charges are generally one-time charges for installation or changes to the subscriber's service. Carrier access fees are paid to us by other telecommunications carriers as compensation for originating and terminating the carriers' long distance traffic.
Deferred revenue as of March 31, 2005, and December 31, 2004, consisted of the following:
Criteria for March 31, 2005 December 31, 2004
Description Recognition
Delivery of units to
Deferred unit royalties end users or
and license fees expiration of contract $ 447,000 $ 458,000
Telecom deferred revenue Service provided for 495,000 526,000
customer
Total deferred revenue $ 942,000 $ 984,000
Cost of revenues - Cost of revenues from telecommunications services consists mainly of billings from the incumbent local exchange carriers (" ILECs") for access to the ILECs network. With respect to The Fonix Speech Group, cost of revenues from license, royalties, and maintenance consists of costs to distribute the product, installation and support personnel compensation, amortization and impairment of capitalized speech software costs, licensed technology, and other related costs. Cost of service revenues consists of personnel compensation and other related costs.
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 software technology incurred subsequent to establishing technological feasibility are capitalized. Capitalization of software costs ceases when the product is available for general release to customers. Costs to perform consulting or development services are charged to cost of revenues in the period in which the corresponding revenues are recognized. Costs of maintenance and customer support are charged to expense when related revenue is recognized or when these costs are incurred, whichever occurs first.
Capitalized software technology costs were amortized on a product-by-product basis. Amortization was recognized from the date the product was 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 was charged to cost of revenues.
We assessed unamortized capitalized software costs for possible write down on a quarterly basis based on net realizable value of each related product. Net realizable value was 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 software product exceeded the net realizable value of that asset was written off.
Stock-based Compensation Plans -We account for our stock-based compensation issued to non-employees using the fair value method in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." Under SFAS No. 123, stock-based compensation is determined as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The measurement date for these issuances is the earlier of the date at which a commitment for performance by the recipient to earn the equity instruments is reached or the date at which the recipient's performance is complete.
At March 31, 2005, we had stock-based employee compensation plans. We account for the plans under the recognition method and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and the related Interpretations. Under APB Opinion No. 25, compensation related to stock options, if any, is recorded if an option's exercise price on the measurement date is below the fair value of our common stock, and amortized to expense over the vesting period. Compensation expense for stock awards or purchases, if any, is recognized if the award or purchase price on the measurement date is below the fair value of our common stock, and is recognized on the date of award or purchase.
Imputed Interest Expense - 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.
Foreign Currency Translation - The functional currency of our Korean subsidiary is the South Korean won. Consequently, assets and liabilities of the Korean operations are translated into United States dollars using current exchange rates at the end of the year. All revenue is invoiced in South Korean won and revenues and expenses are translated into United States dollars using weighted-average exchange rates for the year.
Comprehensive Income - Other comprehensive income presented in the accompanying consolidated financial statements consists of cumulative foreign currency translation adjustments.
Recently Enacted Accounting Standards - In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost will be measured based on the fair value of the instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123(R) replaces SFAS No. 123 and supersedes APB Opinion No. 25. As originally issued in 1995, SFAS No. 123 established as preferable the fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. We will be required to apply SFAS No. 123(R) as of the first interim reporting period that begins after June 15, 2005, and we plan to adopt it using the modified-prospective method, effective July 1, 2005.
We are currently evaluating the impact SFAS No. 123(R) will have on us and, based on our preliminarily analysis, we expect that the adoption will not have a material impact on our financial statements.
In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of Non-monetary Assets-an amendment of APB Opinion No. 29." This Statement amends APB Opinion 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The statement will be effective in January 2006. We do not expect that the adoption of SFAS No. 153 will have a material impact on our consolidated financial statements.
Results of Operations
Three months ended March 31, 2005, compared with three months ended March 31, 2004
During the three months ended March 31, 2005, we recorded revenues of $4,223,000, an increase of $2,298,000 from $1,925,000 in 2004. The increase was primarily due to the acquisition of LecStar, accounting for $2,436,000 of the increase, increased non-recurring engineering ("NRE") revenues of $125,000, increase retail revenues of $12,000, partially offset by decreased licenses revenues of $226,000, and decreased DECtalk royalties of $49,000.
Cost of revenues was $2,187,000, an increase of $1,395,000 from $792,000 for the three months ended March 31, 2005. The increase was primarily due to the acquisition of LecStar, contributing $2,180,000 to the increase. These costs represent expenses associated with providing LecStar's services through the leasing of network components from BellSouth and long distance services purchased from inter-exchange carriers.
Selling, general and administrative expenses were $3,415,000 for the three months ended March 31, 2005, a increase of $1,084,000 from $2,331,000 in 2004 The increase is primarily due to the acquisition of LecStar, which contributed $1,477,000 to the increase, and increased investor relations expenses of $45,000, increased occupancy related expenses of $14,000 partially offset by decreased salary and wage expenses of $186,000, decreased legal and accounting fees of $174,000, decreased travel expenses of $33,000 decrease other operating expenses of $24,000 decreased consulting expenses of $16,000 decreased taxes, licenses and permits of $12,000, and decreased depreciation expenses of $7,000.
We incurred research and product development expenses of $520,000 for the three months ended March 31, 2005, a decrease of $279,000 from $799,000 in 2004. The decrease is primarily due to an overall decrease in salaries and wage-related expenses of $214,000, decreased other operating expenses of $39,000, decreased travel expenses of $9,000, decreased consulting expenses of $22,000, due to a decrease in the utilization of external consultants, and decreased depreciation of $9,000 due to the overall decrease in fixed assets, partially offset by increased occupancy of $14,000.
Net interest and other expense was $595,000 for the three months ended March 31, 2005, a decrease of $843,000 from $248,000 for 2004. The overall decrease is due to the gain on forgiveness of liabilities of $481,000, partially offset by increased interest expense of $319,000, the gain on the sale of long-term investments of $134,000 and increased interest income of $13,000.
Three months ended March 31, 2004, compared with three months ended March 31, 2003
During the three months ended March 31, 2004, we recorded revenues of $1,925,000, an increase of $1,335,000 over the same period in the previous year.
The increase was primarily due to the acquisition of LecStar accounting for $1,447,000, partially offset by decreased NRE revenues of $87,000 and a decrease in DECtalk royalties of $25,000.
Cost of revenues was $792,000 for the three months ended March 31, 2004, an increase of $712 000 from $80,000 over the same period in the previous year.
The increase is primarily due to the acquisition of LecStar contributing $775,000 to the increase. These costs represent expenses associated with providing LecStar's services through the leasing of network components from Bellsouth and long distance services purchased from inter-exchange carriers.
This increase was partially offset by decreased expenses related to NRE projects due to the overall decrease in NRE contracts during the quarter.
Selling, general and administrative expenses were $2,924,000 for the three months ended March 31, 2004, representing an increase of $647,000 over the same period in the previous year. The increase is due to increased depreciation expense and increased amortization expense related to intangible assets acquired in the LecStar acquisition of $601,000, increased legal and accounting fees of $219,000 also primarily related to the LecStar acquisition, and increased travel related expenses of $25,000, partially offset by decreased salary and wage related costs of $146,000, decreased taxes and license fees of $65,000, decreased investor relations related expenses of $51,000, decreased occupancy related costs of $21,000 and decreased promotion and advertising expenses of $21,000.
We incurred research and product development expenses of $799,000 for the three months ended March 31, 2004, a decrease of $876,000 over the same period in the previous year. The decrease is primarily due to an overall decrease in salaries and wage related expenses of $770,000, decreased occupancy related costs of $51,000, decreased consulting expenses of $43,000 due to a decrease in the utilization of external consultants and decreased depreciation of $30,000 due to the overall decrease in fixed assets.
Net interest and other expense was $233,000 for the three months ended March 31, 2004, a decrease of $509,000 from the same period in the previous year. The overall decrease is due to the retirement of the Series D Debentures during the fourth quarter of 2003, partially offset by increased interest expense related to debt acquired in connection with the LecStar acquisition.
Liquidity and Capital Resources
We must raise additional funds to be able to satisfy our cash requirements during the next 12 months. Product development, corporate operations, and marketing expenses will continue to require additional capital. Because we presently have only limited revenue from operations, we intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements until such time as we are able to enter into additional third-party licensing, collaboration, or co-marketing arrangements such that we will be able to finance ongoing operations from license, royalty, and sales revenue. There can be no assurance that we will be able to enter into such agreements. Furthermore, the issuance of equity or debt securities which are or may become convertible into equity securities of Fonix in connection with such financing could result in substantial additional dilution to the stockholders Fonix.
As of March 31, 2005, our cash resources were limited to collections from customers, draws on the Sixth Equity Line, proceeds from the issuance of preferred stock and loan proceeds, and were only sufficient to cover current operating expenses and payments of current liabilities. We have entered into certain term payment plans with current and former employees and vendors. As a result of cash flow deficiencies, payments to former employees and vendors not on a payment plan have been delayed. At March 31, 2005, we had accrued liabilities of $6,877,000, accrued wages and other compensation payable to current and former employees amounted to approximately $1,311,000 and vendor accounts payable amounted to approximately $5,383,000. We have not been declared in default under the terms of any material agreements.
Several former employees filed suits against Fonix to collect past due wages or filed complaints with the State of Utah Labor Commission asserting past due wage claims. We have settled several of these suits and are negotiating to settle the remaining suits on terms similar to those offered to current employees who are also owed past due wages.
We had $4,223,000 in revenue and a loss of $4,080,000 for the three months ended March 31, 2005. Net cash used in operating activities of $2,559,000 for the three months ended March 31, 2005, resulted principally from the net loss incurred of $4,080,000 decreased accrued payroll of $455,000, decreased prepaid expenses and other current assets of $155,000, the gain recognized in connection with the sale of long-term assets of $134,000, decreased other assets of $48,000 and decreased deferred revenues of $42,000, partially offset by amortization of intangible assets of $1,586,000, collection of LecStar accounts receivables of $218,000, increased accounts payable and accrued liabilities of $183,000 and depreciation expense of $37,000. Net cash provided by investing activities of $92,000 is due to the sale of long-term investments of $237,000, partially offset by purchases of property and equipment of $145,000. Net cash provided by financing activities of $2,614,000 consisted of the receipt of $2,652,000 in cash related to the sale of shares of Class A common stock, partially offset by principal payments on notes payable of $60,000.
We had negative working capital of $13,121,000 at March 31, 2005, compared to negative working capital of $13,580,000 at December 31, 2003. Current assets increased by $214,000 to $2,344,000 from December 31, 2004, to March 31, 2005.
Current liabilities decreased by $235,000 to $15,464,000 during the same period. The change in working capital from December 31, 2004, to March 31, 2005, reflects, in part, the increases resulting from collection of receivable balances and the overall decrease in the accrued payroll balance due to scheduled payments made during the period. Total assets were $17,557,000 at March 31, 2005, compared to $19,000,000 at December 31, 2004.
Notes Payable - Related Parties
During 2002, two of our executive officers (the "Lenders") sold shares of our Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to us under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in our operations. The advances bear interest at 10 percent per annum, which interest is payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, were originally due and payable on June 10, 2003. Fonix and the Lenders agreed to postpone the maturity date on . . .
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13-May-2005
Quarterly Report
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report on Form 10-Q contains, in addition to historical information, forward-looking statements that involve substantial risks and uncertainties.
All forward-looking statements contained herein are deemed by Fonix to be covered by and to qualify for the safe harbor protection provided by Section 21E of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from the results anticipated by Fonix and discussed in the forward-looking statements. When used in this report, words such as "believes," "expects," "intends," "plans," "anticipates," "estimates," and similar expressions are intended to identify forward-looking statements, although there may be certain forward-looking statements not accompanied by such expressions.
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, 2004.
To date, we have earned only limited revenue from operations and intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements.
Overview
We are engaged in providing integrated telecommunications services through Fonix Telecom, Inc., and LecStar Telecom, Inc., and value-added speech technologies through The Fonix Speech Group. We operate Fonix Telecom, Inc., and LecStar Telecom, Inc., a regional provider of telecommunications services in the Southeastern United States and LecStar DataNet, Inc., a provider of Internet services. (LecStar Telecom, Inc. and LecStar DataNet are collectively referred to in this report as "LecStar.")
We offer our speech-enabling technologies including automated speech recognition ("ASR") and text-to-speech ("TTS") through The Fonix Speech Group. We offer our ASR and TTS technologies to markets for wireless and mobile devices, computer telephony, server solutions and personal software for consumer applications. We have received various patents for certain elements of our core technologies and have filed applications for other patents covering various aspects of our technologies. We seek to develop relationships and strategic alliances with third-party developers and vendors in telecommunications, computers, electronic devices and related industries, including producers of application software, operating systems, computers and microprocessor chips. Revenues are generated through providing telecommunication services, licensing of speech-enabling technologies, maintenance contracts and services.
Fonix Telecom's non-regulated telecommunication services include VoIP, BPL and wireless broadband access. These services are initially available in the southeastern United States and we anticipate that they eventually will be available throughout the United States.
LecStar's telecommunication services include wireline voice, data, long distance and Internet services to business and residential customers. LecStar Telecom, Inc., is certified by the Federal Communications Commission in nine states-Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina and Tennessee-as a competitive local exchange carrier ("CLEC") to provide regulated local, long distance and international telecommunications services. LecStar DataNet, Inc., provides non-regulated telecommunication services including Internet access.
For the three months ended March 31, 2005 and 2004, we generated revenues of $4,223,000 and $1,925,000, respectively; incurred net losses of $4,080,000 and $2,342,000, respectively; and had negative cash flows from operating activities of $2,559,000 and $5,478,000, respectively. As of March 31, 2005, we had an accumulated deficit of $231,002,000, negative working capital of $13,121,000, accrued liabilities of $6,877,000, accounts payable of $5,383,000 and accrued employee wages and other compensation of $1,311,000. We expect to continue to incur significant losses and negative cash flows from operating activities through at least December 31, 2005, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies and further developing our telecommunications services business.
Our cash resources, limited to collections from customers, draws on the Sixth Equity Lines and loans, have not been sufficient to cover operating expenses.
We have not been declared in default under the terms of any material agreements.
Significant Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our 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. Significant accounting policies and areas where substantial judgments are made by management include:
Accounting estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Valuation of long-lived assets - The carrying values of our long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that they may not be recoverable. When such an event occurred, we 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 recovered, the carrying value of the long-lived asset, other than software technology, would be reduced by the estimated excess of the carrying value over the projected discounted cash flows.
Intangible assets - Customer base, contracts and agreements and brand names are amortized over their estimated useful lives unless they are deemed to have indefinite useful lives. For intangible assets subject to amortization, an impairment charge is recognized if the carrying amount is not recoverable and the carrying amount exceeds the fair value of the intangible asset. Intangible assets deemed to have indefinite useful lives, primarily the LecStar brand name are not amortized, are tested for impairment on a quarterly basis and impairment is recognized if the carrying amount is not recoverable or exceeds its fair value. During the year ended December 31, 2004, we recorded an impairment loss on the intangible asset related to the contracts and agreements acquired in connection with the LecStar acquisition (see Note 2 of the Condensed Consolidated Financial Statements) of $738,000 based on estimated future cash flows.
Goodwill - Goodwill represents the excess of the cost over the fair value of net assets of acquired businesses. Goodwill is not amortized, but is tested for impairment quarterly or when a triggering event occurs. If a triggering event occurs, the undiscounted net cash flows of the asset or entity to which the goodwill relates are evaluated. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The amount of the impairment is measured using a discounted-cash-flow model considering future revenues, operating costs, a risk-adjusted discount rate and other factors.
Revenue recognition - We recognize revenue when pervasive evidence of an arrangement exists, services have been rendered or products have been delivered, the price to the buyer is fixed and determinable and collectibility is reasonable assured. Revenues are recognized by us based on the various types of transactions generating the revenue. For software sales, we recognize revenues in accordance with the provisions of Statement of Position No. 97-2, "Software Revenue Recognition" and related interpretations. We generate revenues from licensing the rights to our software products to end users and from royalties.
For telecommunications services, revenue is recognized in the period that the service is provided.
For The Fonix Speech Group, revenue of all types is recognized when acceptance of functionality, rights of return, and price protection are confirmed or can be reasonably estimated, as appropriate. Revenue for hardware units delivered is recognized when delivery is verified and collection assured.
Revenue for products distributed through wholesale and retail channels and through resellers is recognized upon verification of final sell-through to end users, after consideration of rights of return and price protection. Typically, the right of return on such products has expired 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.
When arrangements to license software products do not require significant production, modification or customization of software, revenue from licenses and royalties are recognized when persuasive evidence of a licensing arrangement exists, delivery of the software has occurred, the fee is fixed or determinable, and collectibility is probable. Post-contract obligations, if any, generally consist of one year of support including such services as customer calls, bug fixes, and upgrades. Related revenue is recognized over the period covered by the agreement. Revenues from maintenance and support contracts are also recognized over the term of the related contracts.
Revenues applicable to multiple-element fee arrangements are bifurcated among the elements such as license agreements and support and upgrade obligations using vendor-specific objective evidence of fair value. Such evidence consists primarily of pricing of multiple elements as if sold as separate products or arrangements. These elements vary based upon factors such as the type of license, volume of units licensed, and other related factors.
For Fonix Telecom, Inc., our telecommunications revenue is comprised of two main components: (1) fees paid by business and residential subscribers of voice and data services and (2) carrier access fees. Subscriber revenues include monthly recurring charges, usage charges and non-recurring charges. Monthly recurring charges are flat monthly fees for local phone and data services. Usage charges, which primarily include long distance fees, are generally billed on a per-minute or per-call basis. Non-recurring charges are generally one-time charges for installation or changes to the subscriber's service. Carrier access fees are paid to us by other telecommunications carriers as compensation for originating and terminating the carriers' long distance traffic.
Deferred revenue as of March 31, 2005, and December 31, 2004, consisted of the following:
Criteria for March 31, 2005 December 31, 2004
Description Recognition
Delivery of units to
Deferred unit royalties end users or
and license fees expiration of contract $ 447,000 $ 458,000
Telecom deferred revenue Service provided for 495,000 526,000
customer
Total deferred revenue $ 942,000 $ 984,000
Cost of revenues - Cost of revenues from telecommunications services consists mainly of billings from the incumbent local exchange carriers (" ILECs") for access to the ILECs network. With respect to The Fonix Speech Group, cost of revenues from license, royalties, and maintenance consists of costs to distribute the product, installation and support personnel compensation, amortization and impairment of capitalized speech software costs, licensed technology, and other related costs. Cost of service revenues consists of personnel compensation and other related costs.
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 software technology incurred subsequent to establishing technological feasibility are capitalized. Capitalization of software costs ceases when the product is available for general release to customers. Costs to perform consulting or development services are charged to cost of revenues in the period in which the corresponding revenues are recognized. Costs of maintenance and customer support are charged to expense when related revenue is recognized or when these costs are incurred, whichever occurs first.
Capitalized software technology costs were amortized on a product-by-product basis. Amortization was recognized from the date the product was 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 was charged to cost of revenues.
We assessed unamortized capitalized software costs for possible write down on a quarterly basis based on net realizable value of each related product. Net realizable value was 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 software product exceeded the net realizable value of that asset was written off.
Stock-based Compensation Plans -We account for our stock-based compensation issued to non-employees using the fair value method in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." Under SFAS No. 123, stock-based compensation is determined as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The measurement date for these issuances is the earlier of the date at which a commitment for performance by the recipient to earn the equity instruments is reached or the date at which the recipient's performance is complete.
At March 31, 2005, we had stock-based employee compensation plans. We account for the plans under the recognition method and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and the related Interpretations. Under APB Opinion No. 25, compensation related to stock options, if any, is recorded if an option's exercise price on the measurement date is below the fair value of our common stock, and amortized to expense over the vesting period. Compensation expense for stock awards or purchases, if any, is recognized if the award or purchase price on the measurement date is below the fair value of our common stock, and is recognized on the date of award or purchase.
Imputed Interest Expense - 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.
Foreign Currency Translation - The functional currency of our Korean subsidiary is the South Korean won. Consequently, assets and liabilities of the Korean operations are translated into United States dollars using current exchange rates at the end of the year. All revenue is invoiced in South Korean won and revenues and expenses are translated into United States dollars using weighted-average exchange rates for the year.
Comprehensive Income - Other comprehensive income presented in the accompanying consolidated financial statements consists of cumulative foreign currency translation adjustments.
Recently Enacted Accounting Standards - In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost will be measured based on the fair value of the instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123(R) replaces SFAS No. 123 and supersedes APB Opinion No. 25. As originally issued in 1995, SFAS No. 123 established as preferable the fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. We will be required to apply SFAS No. 123(R) as of the first interim reporting period that begins after June 15, 2005, and we plan to adopt it using the modified-prospective method, effective July 1, 2005.
We are currently evaluating the impact SFAS No. 123(R) will have on us and, based on our preliminarily analysis, we expect that the adoption will not have a material impact on our financial statements.
In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of Non-monetary Assets-an amendment of APB Opinion No. 29." This Statement amends APB Opinion 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The statement will be effective in January 2006. We do not expect that the adoption of SFAS No. 153 will have a material impact on our consolidated financial statements.
Results of Operations
Three months ended March 31, 2005, compared with three months ended March 31, 2004
During the three months ended March 31, 2005, we recorded revenues of $4,223,000, an increase of $2,298,000 from $1,925,000 in 2004. The increase was primarily due to the acquisition of LecStar, accounting for $2,436,000 of the increase, increased non-recurring engineering ("NRE") revenues of $125,000, increase retail revenues of $12,000, partially offset by decreased licenses revenues of $226,000, and decreased DECtalk royalties of $49,000.
Cost of revenues was $2,187,000, an increase of $1,395,000 from $792,000 for the three months ended March 31, 2005. The increase was primarily due to the acquisition of LecStar, contributing $2,180,000 to the increase. These costs represent expenses associated with providing LecStar's services through the leasing of network components from BellSouth and long distance services purchased from inter-exchange carriers.
Selling, general and administrative expenses were $3,415,000 for the three months ended March 31, 2005, a increase of $1,084,000 from $2,331,000 in 2004 The increase is primarily due to the acquisition of LecStar, which contributed $1,477,000 to the increase, and increased investor relations expenses of $45,000, increased occupancy related expenses of $14,000 partially offset by decreased salary and wage expenses of $186,000, decreased legal and accounting fees of $174,000, decreased travel expenses of $33,000 decrease other operating expenses of $24,000 decreased consulting expenses of $16,000 decreased taxes, licenses and permits of $12,000, and decreased depreciation expenses of $7,000.
We incurred research and product development expenses of $520,000 for the three months ended March 31, 2005, a decrease of $279,000 from $799,000 in 2004. The decrease is primarily due to an overall decrease in salaries and wage-related expenses of $214,000, decreased other operating expenses of $39,000, decreased travel expenses of $9,000, decreased consulting expenses of $22,000, due to a decrease in the utilization of external consultants, and decreased depreciation of $9,000 due to the overall decrease in fixed assets, partially offset by increased occupancy of $14,000.
Net interest and other expense was $595,000 for the three months ended March 31, 2005, a decrease of $843,000 from $248,000 for 2004. The overall decrease is due to the gain on forgiveness of liabilities of $481,000, partially offset by increased interest expense of $319,000, the gain on the sale of long-term investments of $134,000 and increased interest income of $13,000.
Three months ended March 31, 2004, compared with three months ended March 31, 2003
During the three months ended March 31, 2004, we recorded revenues of $1,925,000, an increase of $1,335,000 over the same period in the previous year.
The increase was primarily due to the acquisition of LecStar accounting for $1,447,000, partially offset by decreased NRE revenues of $87,000 and a decrease in DECtalk royalties of $25,000.
Cost of revenues was $792,000 for the three months ended March 31, 2004, an increase of $712 000 from $80,000 over the same period in the previous year.
The increase is primarily due to the acquisition of LecStar contributing $775,000 to the increase. These costs represent expenses associated with providing LecStar's services through the leasing of network components from Bellsouth and long distance services purchased from inter-exchange carriers.
This increase was partially offset by decreased expenses related to NRE projects due to the overall decrease in NRE contracts during the quarter.
Selling, general and administrative expenses were $2,924,000 for the three months ended March 31, 2004, representing an increase of $647,000 over the same period in the previous year. The increase is due to increased depreciation expense and increased amortization expense related to intangible assets acquired in the LecStar acquisition of $601,000, increased legal and accounting fees of $219,000 also primarily related to the LecStar acquisition, and increased travel related expenses of $25,000, partially offset by decreased salary and wage related costs of $146,000, decreased taxes and license fees of $65,000, decreased investor relations related expenses of $51,000, decreased occupancy related costs of $21,000 and decreased promotion and advertising expenses of $21,000.
We incurred research and product development expenses of $799,000 for the three months ended March 31, 2004, a decrease of $876,000 over the same period in the previous year. The decrease is primarily due to an overall decrease in salaries and wage related expenses of $770,000, decreased occupancy related costs of $51,000, decreased consulting expenses of $43,000 due to a decrease in the utilization of external consultants and decreased depreciation of $30,000 due to the overall decrease in fixed assets.
Net interest and other expense was $233,000 for the three months ended March 31, 2004, a decrease of $509,000 from the same period in the previous year. The overall decrease is due to the retirement of the Series D Debentures during the fourth quarter of 2003, partially offset by increased interest expense related to debt acquired in connection with the LecStar acquisition.
Liquidity and Capital Resources
We must raise additional funds to be able to satisfy our cash requirements during the next 12 months. Product development, corporate operations, and marketing expenses will continue to require additional capital. Because we presently have only limited revenue from operations, we intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements until such time as we are able to enter into additional third-party licensing, collaboration, or co-marketing arrangements such that we will be able to finance ongoing operations from license, royalty, and sales revenue. There can be no assurance that we will be able to enter into such agreements. Furthermore, the issuance of equity or debt securities which are or may become convertible into equity securities of Fonix in connection with such financing could result in substantial additional dilution to the stockholders Fonix.
As of March 31, 2005, our cash resources were limited to collections from customers, draws on the Sixth Equity Line, proceeds from the issuance of preferred stock and loan proceeds, and were only sufficient to cover current operating expenses and payments of current liabilities. We have entered into certain term payment plans with current and former employees and vendors. As a result of cash flow deficiencies, payments to former employees and vendors not on a payment plan have been delayed. At March 31, 2005, we had accrued liabilities of $6,877,000, accrued wages and other compensation payable to current and former employees amounted to approximately $1,311,000 and vendor accounts payable amounted to approximately $5,383,000. We have not been declared in default under the terms of any material agreements.
Several former employees filed suits against Fonix to collect past due wages or filed complaints with the State of Utah Labor Commission asserting past due wage claims. We have settled several of these suits and are negotiating to settle the remaining suits on terms similar to those offered to current employees who are also owed past due wages.
We had $4,223,000 in revenue and a loss of $4,080,000 for the three months ended March 31, 2005. Net cash used in operating activities of $2,559,000 for the three months ended March 31, 2005, resulted principally from the net loss incurred of $4,080,000 decreased accrued payroll of $455,000, decreased prepaid expenses and other current assets of $155,000, the gain recognized in connection with the sale of long-term assets of $134,000, decreased other assets of $48,000 and decreased deferred revenues of $42,000, partially offset by amortization of intangible assets of $1,586,000, collection of LecStar accounts receivables of $218,000, increased accounts payable and accrued liabilities of $183,000 and depreciation expense of $37,000. Net cash provided by investing activities of $92,000 is due to the sale of long-term investments of $237,000, partially offset by purchases of property and equipment of $145,000. Net cash provided by financing activities of $2,614,000 consisted of the receipt of $2,652,000 in cash related to the sale of shares of Class A common stock, partially offset by principal payments on notes payable of $60,000.
We had negative working capital of $13,121,000 at March 31, 2005, compared to negative working capital of $13,580,000 at December 31, 2003. Current assets increased by $214,000 to $2,344,000 from December 31, 2004, to March 31, 2005.
Current liabilities decreased by $235,000 to $15,464,000 during the same period. The change in working capital from December 31, 2004, to March 31, 2005, reflects, in part, the increases resulting from collection of receivable balances and the overall decrease in the accrued payroll balance due to scheduled payments made during the period. Total assets were $17,557,000 at March 31, 2005, compared to $19,000,000 at December 31, 2004.
Notes Payable - Related Parties
During 2002, two of our executive officers (the "Lenders") sold shares of our Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to us under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in our operations. The advances bear interest at 10 percent per annum, which interest is payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, were originally due and payable on June 10, 2003. Fonix and the Lenders agreed to postpone the maturity date on . . .
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Fonix Reports First-Quarter 2005 Highlights and Results
SALT LAKE CITY, UT (May 13, 2005) Fonix Corporation (OTC BB: FNIX), an integrated communications carrier providing telecommunications services and value-added speech technologies, announces financial results for the quarter ended March 31, 2005.
First quarter company highlights include:
Fonix Corp. realigns its business segments into three revenue-centric operating groups: Fonix Speech (providing value-added speech interface technologies), Fonix Telecom (providing facilities-based, VoIP and BPL telephone services) and LecStar Telecom (a re-seller of traditional local/long distance telephone services).
Fonix Telecom offers telecom voice and broadband service to enterprise and corporate customers ranging from single offices to multi-office, multi-state installations via its Fonix FoneSM VoIP solution.
Fonix Speech sees the launch of Casio handheld electronic dictionaries in Japan, which feature the Fonix Language Learning Speech Solution, designed to teach users correct pronunciation of foreign words in U.S. and U.K English, French, German and Spanish using Fonix DECtalk™ text-to-speech technology.
Fonix Speech’s award-winning Fonix VoiceDial™ solution, which allows hands-free access to mobile phone contacts, is upgraded to include Italian speech recognition.
Fonix Speech sees the first NovaLogic videogame titles to ship with Fonix voice technology. NovaLogic, Inc. releases the Xbox® and PlayStation®2 versions of Delta Force® - Black Hawk Down®, which feature Fonix VoiceIn® for speech-enabled command and control in videogames.
“Fonix’s financial results for the first quarter reflect the merit of realigning our business operations,” says Thomas A. Murdock, Fonix Chairman and CEO. “We expect further improvement in revenue and cost management as we leverage the operating advantages of LecStar Telecom, Fonix Telecom and The Fonix Speech Group.”
Fonix revenues were $4,223,000 for the quarter ended March 31, 2005, an increase of $2,298,000 compared to $1,925,000 for the same period in 2004. Operating expenses, exclusive of non-cash amortization of $1,586,000, decreased by $805,000 from $3,935,000 in the first quarter of 2004 to $3,130,000 in the first quarter of 2005. Net loss was $4,080,000 ($0.03 per common share) for the first quarter in 2005 compared to $2,342,000 ($0.08 per common share) for the same period in 2004. During the quarter ended March 31, 2005, the company reduced accrued payroll and other compensation-related expenses by $445,000. First quarter results reflect a full quarter of operations for LecStar Telecom and a partial quarter for Fonix Telecom.
“We are encouraged by the results of the restructuring and redirection of our business,” says Roger D. Dudley, Fonix Executive VP and CFO. “We have reduced combined operating expenses, less non-cash amortization, by 20 percent, and we believe Fonix will continue to improve its operating margin and increase revenue as we implement aggressive sales and marketing plans, on both the telecom and speech sides of the business.”
SALT LAKE CITY, UT (May 13, 2005) Fonix Corporation (OTC BB: FNIX), an integrated communications carrier providing telecommunications services and value-added speech technologies, announces financial results for the quarter ended March 31, 2005.
First quarter company highlights include:
Fonix Corp. realigns its business segments into three revenue-centric operating groups: Fonix Speech (providing value-added speech interface technologies), Fonix Telecom (providing facilities-based, VoIP and BPL telephone services) and LecStar Telecom (a re-seller of traditional local/long distance telephone services).
Fonix Telecom offers telecom voice and broadband service to enterprise and corporate customers ranging from single offices to multi-office, multi-state installations via its Fonix FoneSM VoIP solution.
Fonix Speech sees the launch of Casio handheld electronic dictionaries in Japan, which feature the Fonix Language Learning Speech Solution, designed to teach users correct pronunciation of foreign words in U.S. and U.K English, French, German and Spanish using Fonix DECtalk™ text-to-speech technology.
Fonix Speech’s award-winning Fonix VoiceDial™ solution, which allows hands-free access to mobile phone contacts, is upgraded to include Italian speech recognition.
Fonix Speech sees the first NovaLogic videogame titles to ship with Fonix voice technology. NovaLogic, Inc. releases the Xbox® and PlayStation®2 versions of Delta Force® - Black Hawk Down®, which feature Fonix VoiceIn® for speech-enabled command and control in videogames.
“Fonix’s financial results for the first quarter reflect the merit of realigning our business operations,” says Thomas A. Murdock, Fonix Chairman and CEO. “We expect further improvement in revenue and cost management as we leverage the operating advantages of LecStar Telecom, Fonix Telecom and The Fonix Speech Group.”
Fonix revenues were $4,223,000 for the quarter ended March 31, 2005, an increase of $2,298,000 compared to $1,925,000 for the same period in 2004. Operating expenses, exclusive of non-cash amortization of $1,586,000, decreased by $805,000 from $3,935,000 in the first quarter of 2004 to $3,130,000 in the first quarter of 2005. Net loss was $4,080,000 ($0.03 per common share) for the first quarter in 2005 compared to $2,342,000 ($0.08 per common share) for the same period in 2004. During the quarter ended March 31, 2005, the company reduced accrued payroll and other compensation-related expenses by $445,000. First quarter results reflect a full quarter of operations for LecStar Telecom and a partial quarter for Fonix Telecom.
“We are encouraged by the results of the restructuring and redirection of our business,” says Roger D. Dudley, Fonix Executive VP and CFO. “We have reduced combined operating expenses, less non-cash amortization, by 20 percent, and we believe Fonix will continue to improve its operating margin and increase revenue as we implement aggressive sales and marketing plans, on both the telecom and speech sides of the business.”