**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 (Mark
        one)
 
 [X]
              Quarterly
                  Report pursuant to Section 13 or 15(d) of the Securities Exchange
                  Act of
                  1934 for the quarterly period ended June 30, 2007,
                  or
 
 [   ]
              Transition
                  Report pursuant to Section 13 or 15(d) of the Securities Exchange
                  Act of
                  1934 for the transition period from ______________ to
                  _____________.
 
 Commission
        File No. 0-23862
 **Fonix
        Corporation**
 (Exact
        name of registrant as specified in its charter)
 
 **Delaware**
              **22-2994719**(State
                  or other jurisdiction of incorporation or organization)
              (I.R.S.
                  Employer Identification No.)
 
 **9350
        South 150 East, Suite 700**
 **Sandy,
        Utah 84070**
 (Address
        of principal executive offices with 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] No[ ].
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer.  (Check
        One):
 Larger
        Accelerated Filer __ Accelerated Filer __ Non-Accelerated Filer
 X.
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-25 of the Exchange Act).
 Yes
        __ No
        X
 
 As
        of
        August 15, 2007, there were issued and outstanding 2,510,758,709 shares of
        our
        Class A common stock.
 
 
 
 
  1
  
 **FONIX
        CORPORATION**
 **FORM
        10-Q**
 
 
 **TABLE
        OF CONTENTS**
 
 **Page****PART
                  I - FINANCIAL INFORMATION**Item
                  1.
              Financial
                  Statements (Unaudited)Condensed
                  Consolidated Balance Sheets – As of June 30, 2007, and December 31,
                  2006
              3Condensed
                  Consolidated Statements of Operations and Comprehensive Loss for
                  the Three
                  and Six Months Ended June 30, 2007 and 2006
              4Condensed
                  Consolidated Statements of Cash Flows for the Six Months Ended
                  June 30,
                  2007 and 2006
              5Notes
                  to Condensed Consolidated Financial Statements (Unaudited)
              7Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              18Item
                  3.
              Quantitative
                  and Qualitative Disclosures About Market Risk
              29Item
                  4.
              Controls
                  and Procedures
              29**PART
                  II - OTHER INFORMATION**Item
                  1.
              Legal
                  Proceedings
              30Item
                  1A.
              Risk
                  Factors
              31Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              32Item
                  6.
              Exhibits
              32
 
 
 
 
 
  2
  **Fonix
        Corporation and Subsidiaries**
 **CONDENSED
        CONSOLIDATED BALANCE SHEETS**
 **(Unaudited)**
 
 
 **June
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006****ASSETS****Current
                  assets**Cash
                  and cash equivalents
              
              $
              7,000
              
              
              $
              5,000Funds
                  held in escrow
              
              
              94,000
              
              
              
              -Prepaid
                  expenses and other current assets
              
              
              2,000
              
              
              
              4,000**Total
                  current assets**
              
              
              103,000
              
              
              
              9,000**Property
                  and equipment,** net of accumulated depreciation of $1,286,000 and
                  $1,261,000, respectively
              
              
              23,000
              
              
              
              48,000**Deposits
                  and other assets**
              
              
              117,000
              
              
              
              117,000**Goodwill**
              
              
              2,631,000
              
              
              
              2,631,000**Total
                  assets**
              
              $
              2,874,000
              
              
              $
              2,805,000**LIABILITIES
                  AND STOCKHOLDERS' DEFICIT****Current
                  liabilities**Accrued
                  liabilities
              
              $
              3,281,000
              
              
              $
              2,054,000Accounts
                  payable
              
              
              1,283,000
              
              
              
              1,504,000Net
                  liabilities of discontinued subsidiaries
              
              
              20,819,000
              
              
              
              20,819,000Derivative
                  liability
              
              
              20,274,000
              
              
              
              20,941,000Accrued
                  payroll and other compensation
              
              
              214,000
              
              
              
              214,000Accrued
                  settlement obligation
              
              
              1,530,000
              
              
              
              1,530,000Deferred
                  revenues
              
              
              446,000
              
              
              
              460,000Notes
                  payable - related parties
              
              
              902,000
              
              
              
              800,000Series
                  E debentures
              
              
              1,754,000
              
              
              
              1,754,000Current
                  portion of notes payable
              
              
              3,185,000
              
              
              
              2,883,000Deposits
                  and other
              
              
              7,000
              
              
              
              7,000**Total
                  current liabilities**
              
              
              53,695,000
              
              
              
              52,966,000**Long-term
                  notes payable, net of current portion**
              
              
              3,633,000
              
              
              
              2,988,000**Total
                  liabilities**
              
              
              57,328,000
              
              
              
              55,954,000**Commitments
                  and contingencies****Stockholders'
                  deficit**Preferred
                  stock, $0.0001 par value;  50,000,000 shares
                  authorized;Series
                  A, convertible; 166,667 shares outstanding (aggregate liquidation
                  preference of $6,055,000)
              
              
              500,000
              
              
              
              500,000Common
                  stock, $0.0001 par value; 5,000,000,000 shares authorized;Class
                  A voting, 2,326,143,324 shares and 1,309,965,981 shares outstanding,
                  respectively
              
              
              232,000
              
              
              
              131,000Class
                  B non-voting, none outstanding
              
              
              -
              
              
              
              -Additional
                  paid-in capital
              
              
              238,222,000
              
              
              
              236,936,000Outstanding
                  warrants to purchase Class A common stock
              
              
              474,000
              
              
              
              474,000Cumulative
                  foreign currency translation adjustment
              
              
              10,000
              
              
              
              10,000Accumulated
                  deficit
              
              
              (293,892,000
              )
              
              
              (291,200,000
              )**Total
                  stockholders' deficit**
              
              
              (54,454,000
              )
              
              
              (53,149,000
              )**Total
                  liabilities and stockholders' deficit**
              
              $
              2,874,000
              
              
              $
              2,805,000
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  3
  **Fonix
        Corporation and Subsidiaries**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
        LOSS**
 **(Unaudited)**
 
 **Three
                  Months Ended June 30,**
              
              
              **Six
                  Months Ended June 30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**Revenues
              
              $
              644,000
              
              
              $
              367,000
              
              
              $
              1,004,000
              
              
              $
              639,000Cost
                  of revenues
              
              
              72,000
              
              
              
              1,000
              
              
              
              79,000
              
              
              
              6,000Gross
                  profit
              
              
              572,000
              
              
              
              366,000
              
              
              
              925,000
              
              
              
              633,000Expenses:Selling,
                  general and administrative
              
              
              654,000
              
              
              
              1,253,000
              
              
              
              1,464,000
              
              
              
              2,419,000Product
                  development and research
              
              
              437,000
              
              
              
              590,000
              
              
              
              924,000
              
              
              
              1,160,000Total
                  expenses
              
              
              1,091,000
              
              
              
              1,843,000
              
              
              
              2,388,000
              
              
              
              3,579,000Other
                  income (expense):Interest
                  expense
              
              
              (455,000
              )
              
              
              (374,000
              )
              
              
              (917,000
              )
              
              
              (751,000
              )Gain
                  (loss) on derivative liability
              
              
              (87,000
              )
              
              
              -
              
              
              
              529,000
              
              
              
              -Other
                  income (expense), net
              
              
              (542,000
              )
              
              
              (374,000
              )
              
              
              (388,000
              )
              
              
              (751,000
              )Net
                  loss from continuing operations
              
              
              (1,061,000
              )
              
              
              (1,851,000
              )
              
              
              (1,851,000
              )
              
              
              (3,697,000
              )Net
                  loss from discontinued operations
              
              
              -
              
              
              
              (2,655,000
              )
              
              
              -
              
              
              
              (4,885,000
              )Net
                  loss
              
              
              (1,061,000
              )
              
              
              (4,506,000
              )
              
              
              (1,851,000
              )
              
              
              (8,582,000
              )Preferred
                  stock dividends
              
              
              (431,000
              )
              
              
              (254,000
              )
              
              
              (841,000
              )
              
              
              (2,103,000
              )Loss
                  attributable to common stockholders
              
              $
              (1,492,000
              )
              
              $
              (4,760,000
              )
              
              $
              (2,692,000
              )
              
              $
              (10,685,000
              )Basic
                  and diluted loss per common share from continuing
                  operations
              
              $
              (0.00
              )
              
              $
              (0.00
              )
              
              $
              (0.00
              )
              
              $
              (0.01
              )Basic
                  and diluted loss per common share from discontinued
                  operations
              
              $
              (0.00
              )
              
              $
              (0.01
              )
              
              $
              (0.00
              )
              
              $
              (0.01
              )Net
                  loss
              
              $
              (1,061,000
              )
              
              $
              (4,506,000
              )
              
              $
              (1,851,000
              )
              
              $
              (8,582,000
              )Other
                  comprehensive (loss) income - foreign currency translation
              
              
              -
              
              
              
              7,000
              
              
              
              -
              
              
              
              7,000Comprehensive
                  loss
              
              $
              (1,061,000
              )
              
              $
              (4,499,000
              )
              
              $
              (1,851,000
              )
              
              $
              (8,575,000
              )
 
 
 
 
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  4
  **Fonix
        Corporation and Subsidiaries**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 
 **Six
                  Months Ended June 30,**
              
              **2007**
              
              
              **2006****Cash
                  flows from operating activities**Net
                  loss
              
              $
              (1,851,000
              )
              
              $
              (8,582,000
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Discontinued
                  operations
              
              
              -
              
              
              
              4,885,000Gain
                  (loss) on derivative liability
              
              
              (529,000
              )
              
              
              -Accretion
                  of discount on notes payable
              
              
              494,000
              
              
              
              368,000Accretion
                  of discount on legal settlement
              
              
              -
              
              
              
              82,000Depreciation
              
              
              25,000
              
              
              
              29,000Foreign
                  exchange loss (gain)
              
              
              -
              
              
              
              (7,000
              )Changes
                  in assets and liabilitiesFunds
                  held in escrow
              
              
              (94,000
              )
              
              
              -Prepaid
                  expenses and other current assets
              
              
              2,000
              
              
              
              (46,000
              )Intercompany
                  account
              
              
              -
              
              
              
              (150,000
              )Accounts
                  payable
              
              
              (218,000
              )
              
              
              200,000Accrued
                  payroll and other compensation
              
              
              -
              
              
              
              67,000Other
                  accrued liabilities
              
              
              385,000
              
              
              
              481,000Deferred
                  revenues
              
              
              (14,000
              )
              
              
              25,000Net
                  cash used in operating activities
              
              
              (1,800,000
              )
              
              
              (2,648,000
              )**Cash
                  flows from investing activities**Purchase
                  of property and equipment
              
              
              -
              
              
              
              (12,000
              )Net
                  cash used in investing activities
              
              
              -
              
              
              
              (12,000
              )**Cash
                  flows from financing activities**Proceeds
                  from issuance of Class A common stock, net
              
              
              -
              
              
              
              3,168,000Proceeds
                  from related party note payable
              
              
              102,000
              
              
              
              -Proceeds
                  from  Series B Preferred Stock
              
              
              1,250,000
              
              
              
              -Proceeds
                  from notes payable
              
              
              450,000
              
              
              
              55,000Payments
                  on related party note payable
              
              
              -
              
              
              
              (105,000
              )Payments
                  of accrued settlement obligation
              
              
              -
              
              
              
              (440,000
              )Net
                  cash provided by financing activities
              
              
              1,802,000
              
              
              
              2,678,000**Net
                  increase in cash and cash equivalents**
              
              
              2,000
              
              
              
              18,000**Cash
                  and cash equivalents at beginning of period**
              
              
              5,000
              
              
              
              28,000**Cash
                  and cash equivalents at end of period**
              
              $
              7,000
              
              
              $
              46,000
    See
        accompanying notes to condensed consolidated financial statements.
 
  5
  **Fonix
        Corporation and Subsidiaries**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)**
 **(Unaudited)**
 
 
 **Supplemental
        schedule of noncash investing and financing activities**
 
 **For
        the Six Months Ended June 30, 2007:**
 
 Issued
        1,016,177,343 shares of Class A common stock upon conversion of 115 shares
        of
        Series L Convertible Preferred Stock.
 
 Accrued
        $781,000 of dividends on Series L Preferred Stock Series M Preferred Stock
        and
        Fonix Speech Series B Preferred Stock.
 
 Accrued
        $33,000 of dividends on Series M Preferred Stock.
 
 Accrued
        $27,000 of dividends on Fonix Speech Series B Preferred Stock.
 
 **For
        the Six Months Ended June 30, 2006:**
 
 Issued
        15,028,249 shares of Class A common stock upon conversion of 266 shares of
        Series J Convertible Preferred Stock.
 
 Issued
        109,300,000 shares of Class A common stock upon conversion of 1,093 shares
        of
        Series K Convertible Preferred Stock.
 
 Issued
        2,838,412 shares of Class A common stock as payment of $65,000 of dividends
        on
        Series H Preferred Stock.
 
 Accrued
        $500,000 of dividends on Series H Preferred Stock.
 
 
 
 
 
 
 
 
 
 
 
 
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  6
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 
 **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.  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 2006 Annual Report on Form 10-K.
 
 The
        Company has not consolidated the assets, liabilities or operations related
        to
        its former telecom operations at June 30, 2007, as these assets are under the
        control of the court appointed bankruptcy trustee pursuant to the filing
        for
        protection under Chapter 7 of the Bankruptcy Code by LecStar Telecom, Inc.,
        LecStar DataNet, Inc., LTEL Holdings and Fonix Telecom, Inc., on October
        2,
        2006.  The accompanying footnotes do not include disclosures related
        to the operations of the aforementioned companies and represent solely the
        operations of Fonix Speech, Inc.
 
 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 2006 Annual Report
        on Form 10-K.
 
 Operating
        results for the six months ended June 30, 2007, are not necessarily indicative
        of the results that may be expected for the year ending December 31,
        2007.
 
 ***Nature
        of
        Operations*****–********Fonix
        Corporation (“the Company”) provides value-added speech technologies through its
        subsidiary, Fonix Speech, Inc. (“Fonix Speech”).  The Company offers
        speech-enabling technologies including automated speech recognition (“ASR”) and
        text-to-speech (“TTS”) through Fonix Speech to markets for wireless and mobile
        devices, computer telephony, server solutions and personal software for consumer
        applications.  The Company has received various patents for certain
        elements of our core technologies and have filed applications for other patents
        covering various aspects of its technologies.  The Company seeks 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
        licensing of speech-enabling technologies, maintenance contracts and
        services.
 
 The
        Company previously operated a telecommunications business, the results of
        which
        were included in prior SEC filings.  On October 2, 2006, LecStar
        Telecom Inc., a Georgia corporation (“LecStar Telecom”), LecStar DataNet, Inc.,
        a Georgia corporation (“LecStar DataNet”), LTEL Holdings Corporation (“LTEL
        Holdings”), a Delaware corporation, and Fonix Telecom Inc., a Delaware
        corporation (“Fonix Telecom”), each of which are direct or indirect subsidiaries
        of Fonix, filed for bankruptcy protection in the United States Bankruptcy
        Court
        for the District of Delaware (the “Bankruptcy Court”).  The case
        numbers are as follows:  LTEL Holdings Corporation, 06-11081 (BLS);
        LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083 (BLS);
        Fonix Telecom, Inc., 06-11084 (BLS).)
 
 LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection
        under Chapter 7 of Title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101
        et seq.
        (the “Bankruptcy Code”).  Pursuant to Bankruptcy Code Section 701, on
        October 3, 2006, Alfred Thomas Guliano was appointed the interim trustee
        for
        LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix
        Telecom.  As these subsidiary companies were in Chapter 7 Bankruptcy
        proceedings as of the date of this Report, the results of their operations
        have
        been treated as discontinued operations.
  7
  **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 ***Business
        Condition*****-**For the three months ended June 30,
        2007 and 2006, the company generated revenues of $644,000 and $367,000,
        respectively and incurred net losses of $1,061,000 and $4,506,000,
        respectively.  For the six months ended June 30, 2007 and 2006, the
        company generated revenues of $1,004,000 and $693,000, respectively, incurred
        net losses of $1,851,000 and $8,582,000, respectively, and had negative cash
        flows from operating activities of $1,800,000 and $2,648,000,
        respectively.  As of June 30, 2007, the company had an accumulated
        deficit of $293,892,000; negative working capital of $53,592,000; accrued
        liabilities and accrued settlement liability of $4,811,000; derivative
        liabilities of $20,274,000 related to the issuance of Series L Preferred
        Stock,  Series M Preferred Stock,  Series E Convertible
        Debentures and Series B Preferred Stock of our subsidiary, Fonix Speech;
        net
        liabilities of discontinued subsidiaries of $20,819,000 related to the telecom
        subsidiaries subject to bankruptcy (LecStar Telecom, LecStar DataNet, LTEL
        Holdings and Fonix Telecom); accounts payable of $1,283,000; and current
        portion
        of notes payable of $4,087,000.  The company expects to continue to
        incur significant losses and negative cash flows from operating activities
        at
        least through December 31, 2007, primarily due to expenditure requirements
        associated with continued marketing and development of our speech-enabling
        technologies.
 
 The
        Company’s cash resources, limited to collections from customers, sales of our
        equity and debt securities and loans, have not been sufficient to cover
        operating expenses.  As a result, some payments to vendors have been
        delayed.
 
 These
        factors, as well as the risk factors set out elsewhere in the Annual Report
        on
        Form 10-K,  raise substantial doubt about the Company’s ability to
        continue as a going concern.  The accompanying financial statements do
        not include any adjustments that might result from the outcome of this
        uncertainty.  Management plans to fund further operations of the
        Company from cash flows from future license and royalty arrangements and
        with
        proceeds from additional issuance of debt and equity
        securities.  There can be no assurance that management’s plans will be
        successful.
 
 ***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, 2007 and 2006, there
        were outstanding common stock equivalents to purchase 19,639,705,706 and
        49,919,168  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 table is a reconciliation of the net loss numerator of basic and
        diluted net loss per common share for the three and six months ended June
        30,
        2007 and 2006:
 
 
 **Three
                  Months Ended June 30,****2007**
              
              
              **2006****Per**
              
              
              
              
              
              **Per****Share**
              
              
              
              
              
              **Share****Amount**
              
              
              **Amount**
              
              
              **Amount**
              
              
              **Amount**Net
                  loss from continuing operations
              
              $
              (1,061,000
              )
              
              
              
              
              $
              (1,851,000
              )Net
                  loss from discontinued operations
              
              
              --
              
              
              
              --
              
              
              
              (2,655,000
              )
              
              $
              (0.00
              )Net
                  loss
              
              $
              (1,061,000
              )
              
              
              
              
              
              $
              (4,506,000
              )Preferred
                  stock dividends
              
              
              (431,000
              )
              
              
              
              
              
              
              (254,000
              )Loss
                  attributable to common stockholders
              
              $
              (1,492,000
              )
              
              $
              (0.00
              )
              
              $
              (4,760,000
              )
              
              $
              (0.01
              )Weighted-average
                  common shares outstanding
              
              
              1,960,341,139
              
              
              
              
              
              
              
              705,796,055
 
  8
  **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 **Six
                  Months Ended June 30,****2007**
              
              
              **2006****Per**
              
              
              
              
              
              **Per****Share**
              
              
              
              
              
              **Share****Amount**
              
              
              **Amount**
              
              
              **Amount**
              
              
              **Amount**Net
                  loss from continuing    operations
              
              $
              (1,851,000
              )
              
              
              
              
              $
              (3,697,000
              )Net
                  loss from discontinued operations
              
              
              --
              
              
              
              --
              
              
              
              (4,885,000
              )
              
              $
              (0.01
              )Net
                  loss
              
              $
              (1,851,000
              )
              
              
              
              
              
              $
              (8,582,000
              )Preferred
                  stock dividends
              
              
              (841,000
              )
              
              
              
              
              
              
              (2,103,000
              )Loss
                  attributable to common stockholders
              
              $
              (2,692,000
              )
              
              $
              (0.00
              )
              
              $
              (10,685,000
              )
              
              $
              (0.02
              )Weighted-average
                  common shares outstanding
              
              
              2,036,896,444
              
              
              
              
              
              
              
              686,768,855
 
 
 ***Imputed
        Interest Expense***–******Interest is
        imputed on long-term debt obligations where management has determined that
        the
        contractual interest rates are below the market rate for instruments with
        similar risk characteristics.
 
 ***Comprehensive
        Loss***–******Other comprehensive loss as
        presented in the accompanying condensed consolidated financial statements
        consists of cumulative foreign currency translation adjustments.
 
 ***Revenue
        Recognition***– The Company recognizes 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 reasonably assured.  Revenues are recognized by the
        Company based on the various types of transactions generating the
        revenue.  For software sales, 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.  For telecommunications services,
        revenue is recognized in the period that the service is provided.
 
 For
        Fonix
        Speech, 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.  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 Company’s contracts are typically 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 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.
 
  9
  **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 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 as of June 30, 2007, and December 31, 2006, consisted of the
        following:
 **Description**
                
                **Criteria
                    for Recognition**
                
                **June
                    30, 2007**
                
                **Dec
                    31, 2006**Deferred
                    unit royalties and license fees
                
                Delivery
                    of units to end users or expiration of contract
                
                $
                446,000
                
                $
                460,000
  ***Cost
        of Revenues***– 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.  The cost of
        maintenance and customer support is charged to expense when related revenue
        is
        recognized or when these costs are incurred, whichever occurs
        first.
 
 ***Stock-Based
        Employee Compensation***– Effective January 1, 2006, the Company
        adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based
        Payment” (“FAS 123(R)”), an amendment of SFAS No. 123, “Accounting for
        Stock-Based Compensation” (“SFAS 123”) using the modified prospective transition
        method.  Under this transition method, compensation costs are
        recognized beginning with the effective date: (a) based on the requirements
        of
        FAS 123(R) for all share-based awards granted after the effective date; and
        (b)
        based on the requirements of SFAS 123 for all awards granted to employees
        prior
        to the effective date of FAS 123(R) that remain unvested on the effective
        date.  Accordingly, the Company did not restate the results of prior
        periods.  The most notable change resulting from the adoption of
        FAS123(R) is that compensation expense associated with stock options is now
        recognized in the Company’s Statements of Operations, rather than being
        disclosed in a pro forma footnote to the Company’s financial
        statements.
 
 The
        Company recognized compensation expense related to option grants and the
        vesting
        of previously unvested options for the six months ended June 30, 2007, of
        $0.
 
 There
        were no option grants during the six months ended June 30, 2007.
 
 **2.  GOODWILL**
 
 The
        carrying value of goodwill is assessed for impairment quarterly.  An
        assessment was performed for the six months ended June 30, 2007, which resulted
        in no impairment, and the carrying value of goodwill remained unchanged at
        $2,631,000 at June 30, 2007.
 
 
  10
 **** **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 **3.  NOTES
        PAYABLE**
 
 In
        connection with the acquisition of the capital stock of LTEL Holdings in
        2004,
        the Company issued a 5%, $10,000,000, secured, six-year note (the “Note”)
        payable to McCormack Avenue, Ltd. (“McCormack”).  Under the terms of
        the Note, quarterly interest-only payments were required through January
        15,
        2005, with quarterly principal and interest payments of $319,000 beginning
        April
        2005 and continuing through January 2010.  Interest on the Note is
        payable in cash or, at the Company’s option, in shares of the Company’s Class A
        common stock.  The Note was originally valued at $4,624,000 based on
        an imputed interest rate of 25 percent per annum.
 
 The
        discount on the Note is based on an imputed interest rate of 25%.  The
        carrying amount of the Note of $6,038,000 at June 30, 2007, was net of
        unamortized discount of $2,695,000.  As of the date of this report,
        the Company had not made any scheduled payments for 2006 or 2007.
 
 On
        September 8, 2006, the Company received a default notice (the “Default Notice”)
        from McCormack in respect of the Note.  Under the terms of the Note,
        and a related Security Agreement between the Company and McCormack dated
        February 24, 2004 (the “Security Agreement”), McCormack was entitled to declare
        all liabilities, indebtedness, and obligations of the Company to McCormack
        under
        the Security Agreement and the Note immediately due and owing upon an event
        of
        default.  The Note defines an event of default to include the
        non-payment by the Company of a scheduled payment which is not cured within
        60
        days.
 
 In
        the
        Default Notice, McCormack stated that it intended to exercise its rights,
        including any and all rights set forth in the Note, as amended.
 
 Also
        on
        September 8, 2006, McCormack provided to the Company a Notice of Sale, stating
        McCormack’s intention to sell at public auction all of the collateral referred
        to in the Security Agreement, consisting of the capital stock and assets
        of
        LecStar Telecom, LecStar DataNet, and LTEL Holdings.  As of the date
        of this report, no sale of the assets or capital stock of LecStar Telecom,
        LecStar DataNet nor LTEL Holdings had occurred.
 
 During
        the fourth quarter of 2005, the Company entered into two promissory notes
        with
        an unrelated third party in the aggregate amount of $650,000.  These
        notes accrue interest at 10% annually and were due and payable during May
        and
        June of 2006.  As of the date of this report, the Company had not made
        the scheduled payments on these promissory notes; the holder of the notes
        has
        not declared a default under the notes.
 
 During
        the fourth quarter of 2006, the Company entered into two promissory notes
        with
        an unrelated third party in the aggregate amount of $330,000. These notes
        accrue
        interest at 10% annually and are due and payable during the second quarter
        of
        2007.
 
 During
        the quarter ended March 31, 2007, the Company entered into five promissory
        notes
        with an unrelated third party in the aggregate amount of
        $450,000.  These notes accrue interest at 10% annually and are due and
        payable during the third quarter of 2007.
 
 The
        following schedule summarizes the Company’s current debt obligations and
        respective balances at June 30, 2007, and December 31, 2006:
 
 
  11
  ****Fonix
        Corporation and Subsidiaries**** **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 **Notes
                  Payable**
              
              **June
                  30, 2007**
              
              
              **December
                  31, 2006**5%
                  Note payable to a company, $8,733,000 and $8,733,000 face amount,
                  respectively, due in quarterly installments of $319,000, matures
                  January
                  2010, less unamortized discount based on interest imputed at 25%
                  of $
                  2,695,000 and $3,191,000, respectively
              
              $
              6,038,000
              
              
              $
              5,543,000Note
                  payable to a company, interest at 10%, matured June 2007
              
              
              235,000
              
              
              
              235,000Note
                  payable to a company, interest at 10%, matured June 2007
              
              
              95,000
              
              
              
              95,000Note
                  payable to a company, interest at 10%, matured July 2007
              
              
              450,000
              
              
              
              --Note
                  payable to related parties, interest at 12%, matured September
                  2006,
                  secured by intellectual property rights
              
              
              902,000
              
              
              
              800,000Total
                  notes payable
              
              
              7,720,000
              
              
              
              6,671,000Less
                  current maturities
              
              
              (4,087,000
              )
              
              
              (3,683,000
              )Long-Term
                  Note Payable
              
              $
              3,633,000
              
              
              $
              2,988,000
 
 
 **4.  RELATED-PARTY
        NOTES PAYABLE**
 
 During
        2002, two executive officers of the Company (the “Lenders”) sold shares of the
        Company’s Class A common stock owned by them and advanced the resulting proceeds
        amounting to $333,000 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 12 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.  The
        Company and the Lenders have agreed to postpone the maturity date on several
        occasions.  The note was due September 30, 2006 and no default had
        been declared.  As of the date of this report, the Company had not
        made payment against the outstanding balance due on the note.  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
        at any
        time.  The conversion price was the average closing bid price of the
        shares at the time of the advances.  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 option of $15,000 was recorded as interest expense in connection
        with
        this transaction.  The Lenders may also receive additional
        compensation as determined appropriate by the Board of Directors.
 
 In
        October 2002, the Lenders pledged 30,866 shares of the Company's Class A
        common
        stock to Queen, LLC (the “Equity Line Investor”), in connection with an advance
        of $183,000 to the Company under the Third Equity Line.  The Equity
        Line Investor subsequently sold the pledged shares and applied $82,000 of
        the
        proceeds as a reduction of the advance.  The value of the pledged
        shares of $82,000 was treated as an additional advance from the
        Lenders.
 
 During
        the fourth quarter of 2003, the Company made a principal payment of $26,000
        against the outstanding balance of the promissory note.  During 2004,
        the Company entered into an agreement with the holders of the promissory
        note to
        increase the balance of the note payable by $300,000 in exchange for a release
        of the $1,443,000 of accrued liabilities related to prior indemnity agreements
        between the Company and the note holders.  The Company classified the
        release of $1,143,000 as a capital contribution in the Consolidated Financial
        Statements during the fourth quarter of 2004.  The Company made
        principal payments against the note of $254,000 during the year ended December
        31, 2004.  During the year ended December 31, 2005, the Company
        received an additional advance of $50,000 against the promissory
        note.  The balance due at December 31, 2005, was
        $486,000.  During the year ended December 31, 2006, the Company
        received additional advances of $419,000 and made principal payments to the
        Lenders against the note of $105,000.  During the quarter ended March
        31, 2007, the Company received additional advances of $102,000.  The
        balance due at June 30, 2007, was $902,000.
 
 The
        aggregate advances of $902,000 are secured by the Company’s intellectual
        property rights.  As of June 30, 2007, the Lenders had not converted
        any of the outstanding balance or interest into common stock.
 
  12
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 
 **5.  PREFERRED
        STOCK**
 
 The
        Company’s certificate of incorporation allows for the issuance of preferred
        stock in such series and having such terms and conditions as the Company’s board
        of directors may designate.
 
 ***Series
        A Convertible Preferred Stock***– As of June 30, 2007, there were
        166,667 shares of Series A convertible preferred stock
        outstanding.  Holders of the Series A convertible preferred stock have
        the same voting rights as common stockholders, have the right to elect one
        person to the board of directors and are entitled to receive a one time
        preferential dividend of $2.905 per share of Series A convertible preferred
        stock prior to the payment of any dividend on any class or series of
        stock.  At the option of the holders, each share of Series A
        convertible preferred stock is convertible into one share of Class A common
        stock and in the event that the common stock price has equaled or exceeded
        $10
        per share for a 15 day period, the shares of Series A convertible preferred
        stock will automatically be converted into Class A common stock.  In
        the event of liquidation, the holders are entitled to a liquidating distribution
        of $36.33 per share and a conversion of Series A convertible preferred stock
        at
        an amount equal to .0375 shares of common stock for each share of Series
        A
        convertible preferred stock.
 
 ***Series
        L Convertible Preferred Stock***– On September 7, 2006, the Company
        entered into a Series L 9% Convertible Preferred Stock Exchange Agreement
        (the
        "Exchange Agreement") with McCormack and Kenzie Financial (“Kenzie”), a British
        Virgin Islands company.  Pursuant to the Exchange Agreement, McCormack
        and Kenzie exchanged all of the shares of Series H Preferred Stock that
        they  acquired from sale of LTEL Holdings, for 1,960.8 and 39.2
        shares, respectively,  of the Company's Series L 9% Convertible
        Preferred Stock (the "Series L Preferred Stock").
 
 Because
        the shares of Series L Preferred Stock were issued in exchange for the remaining
        outstanding shares of Series H Preferred Stock, the Company did not receive
        any
        proceeds in connection with the issuance of the Series L Preferred
        Stock.
 
 The
        Series L Preferred Stock entitles McCormack and Kenzie to receive dividends
        in
        an amount equal to 9% of the then-outstanding balance of shares of Series
        L
        Preferred Stock.  The dividends are payable in cash or shares of the
        Company's Class A common stock, at the Company's option.
 
 The
        Series L Preferred Stock is convertible into common stock of the Company
        at the
        option of the holder by using a conversion price which was 80% of the average
        of
        the two lowest closing bid prices for the twenty-day trading period prior
        to the
        conversion date.
 
 Redemption
        of the Series L Preferred Stock, whether at the Company’s option or that of
        McCormack or Kenzie, requires the Company to pay, as a redemption price,
        the
        stated value of the outstanding shares of Series L Preferred Stock to be
        redeemed, together with any accrued but unissued dividends thereon, multiplied
        by one hundred ten percent (110%).
 
 The
        Company accounted for the exchange as redemption of the outstanding Series
        H
        Preferred Stock as the Series H Preferred Stock was not convertible into
        shares
        of common stock of the Company.  The Series L Preferred Stock is
        convertible into shares of common stock of the Company.  The Company
        followed the accounting treatment in SFAS 150 “*Accounting for Certain
        Financial Instruments with Characteristics of Both Liabilities and Equity,”*SFAS 133 “*Accounting for Derivative Instruments and Hedging Activities”*and EITF 00-19 “*Accounting for Derivative Financial Instruments Indexed
        to, and Potentially Settled in, a Company’s Own Stock.”*The Company
        recognized a derivative liability upon the redemption of $30,991,000 due
        to the
        value of the conversion feature of the Series L Preferred Stock.  The
        liability was calculated using the Black-Scholes valuation model with the
        following assumptions: dividend yield of 0%, expected volatility of 140%,
        risk-free rate of 3.75% and expected life of 4 years.  As the value of
        the derivative liability was greater than the face value of the Series L
        Preferred Stock, no value was prescribed to the Series L Preferred
        Stock.  Also in connection with the redemption, the Company recognized
        a preferred stock dividend of $16,000,000, equal to the original discount
        the
        Company had assigned to the Series H Preferred Stock.  At June 30,
        2007 the fair value of the Series L Preferred Stock derivative liability
        was
        $16,812,768.
 
  13
 **** **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 For
        the
        six months ended June 30, 2007, the Company issued 1,016,177,343 shares of
        its
        Class A common stock in conversion of 115 shares of its Series L Preferred
        Stock.  At June 30, 2007, 1,743 shares of Series L Preferred Stock
        remained outstanding.
 
 ***Series
        M Preferred Stock***– On April 4, 2007, the Company entered into a
        Series M 9% Convertible Preferred Stock Exchange Agreement with
        Sovereign.  Pursuant to the exchange agreement, Sovereign exchanged
        150 shares of the Company’s Series L Preferred Stock for 150 shares of the
        Company’s Series M 9% Convertible Preferred Stock (the “Series M Preferred
        Stock”).
 
 The
        Series M Preferred Stock entitles Sovereign or its assignees to receive
        dividends in an amount equal to 9% of the then-outstanding balance of shares
        of
        Series M Preferred Stock.  The dividends are payable in cash or shares
        of the Company’s Class A common stock, at the Company’s option.
 
 The
        Series M Preferred Stock may be converted into common stock of the Company
        at
        the option of the holder by using a conversion price which shall be the lower
        of
        (i) 80% of the average of the two lowest closing bid prices for the twenty-day
        trading period prior to the conversion date, or (ii) $0.004.
 
 Redemption
        of the Series M Preferred Stock, whether at the Company’s option or that of
        Sovereign, requires the Company to pay, as a redemption price, the stated
        value
        of the outstanding shares of Series M Preferred Stock to be redeemed, together
        with any accrued but unissued dividends thereon, multiplied by one hundred
        ten
        percent (110%).
 
 Because
        the shares of Series M were issued in exchange for the outstanding shares
        of
        Series L Preferred Stock, the Company did not receive any proceeds in connection
        with the issuance of the Series M Preferred Stock.
 
 The
        Company followed the accounting treatment in SFAS 150 “*Accounting for
        Certain Financial Instruments with Characteristics of Both Liabilities and
        Equity,”*SFAS 133 “*Accounting for Derivative Instruments and Hedging
        Activities”*and EITF 00-19 “*Accounting for Derivative Financial
        Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”*The Company recognized a derivative liability upon the redemption of
        $1,603,448 due to the value of the conversion feature of the Series M Preferred
        Stock, which was previously recorded as part of the Series L Preferred Stock
        derivative liability.  The liability was calculated using the
        Black-Scholes valuation model with the following assumptions: dividend yield
        of
        0%, expected volatility of 134%, risk-free rate of 5% and expected life of
        4
        years.  As the value of the derivative liability was greater than the
        face value of the Series M Preferred Stock, no value was prescribed to the
        Series M Preferred Stock.  At June 30, 2007 the fair value of the
        Series M Preferred Stock derivative liability was $1,582,507.
 
 ***Fonix
        Speech, Inc. Series B Convertible Preferred Stock***– On April 4,
        2007, the Company entered into a Securities Purchase Agreement by and among
        the
        Company, Fonix Speech, Inc. (“FSI”), and Sovereign Partners, LP
        (“Sovereign”).  FSI is a wholly owned subsidiary of the
        Company.
 
 Pursuant
        to the FSI agreement, FSI sold 125 shares of its Series B 9% Convertible
        Preferred Stock (the “Series B Preferred Stock”) at a per share price of $10,000
        to Sovereign, for gross proceeds of $1,250,000.
 
 The
        shares of Series B Preferred Stock are convertible into shares of the Company’s
        Class A common stock.  The Series B Preferred Stock may be converted
        into common stock of the Company at the option of the holder by using a
        conversion price which shall be the lower of (i) 80% of the average of the
        two
        lowest closing bid prices for the twenty-day trading period prior to the
        conversion date, or (ii) $0.004.
 
 The
        Series B Preferred Stock entitles Sovereign or its assignees to receive
        dividends in an amount equal to 9% of the then-outstanding balance of shares
        of
        Series B Preferred Stock.  The dividends are payable in cash or shares
        of the Company's Class A common stock, at the Company's option
 
 The
        Company followed the accounting treatment in SFAS 150 “*Accounting for
        Certain Financial Instruments with Characteristics of Both Liabilities and
        Equity,”*SFAS 133 “*Accounting for Derivative Instruments and Hedging
        Activities”*and EITF 00-19 “*Accounting for Derivative Financial
        Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”*The Company recognized a derivative liability upon the issuance of
        $1,336,207 due to the value of the conversion feature of the Series B Preferred
        Stock.  The liability was calculated using the Black-Scholes valuation
        model with the following assumptions: dividend yield of 0%, expected volatility
        of 134%, risk-free rate of 5% and expected life of 4 years.  As the
        value of the derivative liability was greater than the face value of the
        Series
        B Preferred Stock, no value was prescribed to the Series B Preferred
        Stock.  At June 30, 2007 the fair value of the Series B Preferred
        Stock derivative liability was
        $1,318,756.             .
 
  14
 **** **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 **6.  CONVERTIBLE
        DEBENTURES**
 
 On
        December 7, 2006, the Company entered into a Securities Purchase Agreement,
        dated as of December 1, 2006 (the “Agreement”), with Southridge relating to the
        purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture
        (the “Debenture”) in the principal amount of $850,000.
 
 Pursuant
        to the Agreement, Southridge paid the purchase price by tendering a prior
        debenture in the aggregate amount (including principal and interest) of
        $641,000, and agreed that an advance to the Company in the amount of $75,000
        made in November 2006 would also constitute part of the purchase
        price.  Southridge agreed to fund the remaining $134,000 upon the
        effectiveness of a registration statement, to be filed by the Company, to
        register the resales of shares issuable to Southridge upon conversion of
        the
        Debenture.
 
 The
        Debenture is convertible into shares of our Class A common stock.  The
        number of shares issuable is determined by dividing the amount of the Debenture
        being converted by the conversion price, which is the average of the two
        lowest
        per share market values for the twenty trading days immediately preceding
        the
        conversion date multiplied by seventy percent. The conversion price is subject
        to adjustment as set forth in the Debenture.  Southridge has agreed
        not to convert the Debenture to the extent that such conversion would cause
        Southridge to beneficially own in excess of 4.999% of the then-outstanding
        shares of Class A common stock of the Company except in the case of a merger
        by
        the Company or other organic change.
 
 The
        Company also entered into a Registration Rights Agreement (the “Registration
        Agreement”) with Southridge pursuant to which the Company agreed to file a
        registration statement to register the resale by Southridge of shares of
        the
        Company’s common stock issuable upon conversion of the Debenture. Under the
        Registration Agreement, the Company agreed to file a registration statement
        to
        register the resale by Southridge of up to 300,000,000 shares of Fonix Class
        A
        common stock
 
 In
        addition to the Debenture issued to Southridge described above, on December
        7,
        2006, the Company entered into a Securities Purchase Agreement, dated as
        of
        December 1, 2006 (the “McCormack Agreement”), with McCormack, relating to the
        purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture
        (the “McCormack Debenture”) in the principal amount of $1,039,000.
 
 Pursuant
        to the McCormack Agreement, McCormack paid the purchase price by tendering
        outstanding promissory notes in the amounts of $300,000 and $350,000, together
        with combined interest thereon of $64,000, and agreed that advances to the
        Company in the amount of $325,000, made in September, October, and November
        2006, would also constitute part of the purchase price.
 
 The
        McCormack Debenture is convertible into shares of the Registrant’s Class A
        common stock. The number of shares issuable is determined by dividing the
        amount
        of the Debenture being converted by the conversion price, which is the average
        of the two lowest per share market values for the twenty trading days
        immediately preceding the conversion date multiplied by seventy percent.
        The
        conversion price is subject to adjustment as set forth in the Debenture.
        McCormack agreed not to convert the Debenture to the extent that such conversion
        would cause McCormack to beneficially own in excess of 4.999% of the
        then-outstanding shares of Class A common stock of the Company except in
        the
        case of a merger by the Company or other organic change.
 
 The
        Company followed the accounting treatment in SFAS 150 “*Accounting for
        Certain Financial Instruments with Characteristics of Both Liabilities and
        Equity,”*SFAS 133 “*Accounting for Derivative Instruments and Hedging
        Activities”*and EITF 00-19 “*Accounting for Derivative Financial
        Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”*The Company recognized a derivative liability upon the issuance of $680,023
        due to the value of the conversion feature of the Debenture.  The
        liability was calculated using the Black-Scholes valuation model with the
        following assumptions: dividend yield of 0%, expected volatility of 139%,
        risk-free rate of 5% and expected life of 4 years.  At June 30, 2007
        the fair value of the Debenture derivative liability was $2,404,266, of which
        $1,754,464 reported as Series E Debenture, $89,916 reported as accrued interest
        and $559,886 reported as derivative liability.
 
  15
 **** **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 The
        Company also entered into a Registration Rights Agreement (the “McCormack
        Registration Agreement”) with McCormack pursuant to which the Company agreed to
        file a registration statement to register the resale by McCormack of shares
        of
        the Company’s common stock issuable upon conversion of the
        Debenture.
 
 The
        Company received no new capital in connection with the issuance and sale
        of the
        Debenture.
 
 **7.  EQUITY
        LINES OF CREDIT**
 
 ***Seventh
        Equity Line of Credit*** - On May 27, 2005, the Company entered into
        a seventh private equity line agreement (the "Seventh Equity Line Agreement")
        with the Equity Line Investor, on terms substantially similar to those of
        the
        Sixth Equity Line between Queen and the Company dated November 15,
        2004.
 
 Under
        the
        Seventh Equity Line Agreement, the Company had the right to draw up to
        $20,000,000 against an equity line of credit (the "Seventh Equity Line")
        from
        the Equity Line Investor.  The Company was entitled under the Seventh
        Equity Line Agreement to draw certain funds and to put to the Equity Line
        Investor shares of the Company's Class A common stock in lieu of repayment
        of
        the draw.  The Company was limited as to the amount of shares it may
        put to the Equity Line Investor in connection with each put; the Company
        could
        not put shares which would cause the Equity Line Investor to own more than
        4.99%
        of its outstanding common stock on the date of the put notice.  The
        number of shares to be issued in connection with each draw was determined
        by
        dividing the amount of the draw by 93% of the average of the two lowest closing
        bid prices of our Class A common stock over the ten trading days after the
        put
        notice is tendered.  The Equity Line Investor was required under the
        Seventh Equity Line Agreement to tender the funds requested by the Company
        within two trading days after the ten-trading-day period used to determine
        the
        market price.
 
 The
        Company granted registration rights to the Equity Line Investor and filed
        three
        registration statements which cover the resales of the shares to be issued
        under
        the Seventh Equity Line.  All of the shares registered by the first
        registration statement had been sold as of October 24, 2005.  The
        second registration statement filed in connection with the Seventh Equity
        Line
        was declared effective by the SEC on February 10, 2006.  All of the
        shares registered by the second registration statement had been sold as of
        July
        26, 2006.  The Company filed a third registration statement on June
        26, 2006, to register additional shares under the Seventh Equity
        Line.  However, that registration statement was not declared
        effective, and no shares were sold under that registration
        statement.
 
 In
        January, 2007, the Company terminated the Seventh Equity Line, and the Company
        has withdrawn the third registration statement related to the Seventh Equity
        Line.  As such, as of the date of this Report, the Company did not
        have an equity line of credit financing available to it.
 
 **8.  COMMON
        STOCK, STOCK OPTIONS AND WARRANTS**
 
 ***Class
        A Common Stock***– During the six months ended June 30, 2007,
        1,016,177,343 shares of Class A common stock were issued upon conversion
        of 115
        shares of Series L Preferred Stock.
 
 ***Stock
        Options –*** As of June 30, 2007, the Company had a total of 526,012
        options to purchase Class A common stock outstanding.  During the six
        months ended June 30, 2007 no options were granted.
 
 ***Warrants***–
        As of June 30, 2007, the Company had warrants to purchase a total of 15,000
        shares of Class A common stock outstanding that expire through
        2010.
 
 
  16
 **** **Fonix
          Corporation and Subsidiaries**
 **Notes
          to Condensed Consolidated Financial Statements**
 **(Unaudited)**
 
 **9.  LITIGATION,
        COMMITMENTS AND CONTINGENCIES**
 
 ***Breckenridge
        Complaint***– On June 6, 2006, Breckenridge filed a complaint against
        the Company in the Supreme Court of the State of New York, County of Nassau
        (the
“Court”), in connection with a settlement agreement between the Company and
        Breckenridge entered into in September 2005. In the Complaint, Breckenridge
        alleged that the Company failed to pay certain amounts due under the settlement
        agreement in the amount of $450,000. The Company denied the allegations of
        Breckenridge’s complaint and has filed a motion for summary
        judgment.  Breckenridge also filed for summary judgment on its
        complaint.
 
 On
        February 2, 2007, the Court granted Breckenridge’s summary judgment motion,
        denied the Company’s summary judgment motion, and directed that a hearing be
        held to determine the amount owed by the Company to Breckenridge.  The
        Company and Breckenridge entered into a stipulation that the Company owed
        Breckenridge $1,530,000 plus interest at a rate of 9% from September 15,
        2006 to
        the date of entry of judgment.
 
 The
        Court’s order, dated as of March 15, 2007, adjudged that the Company owes an
        aggregate of $1,602,000 to Breckenridge.
 
 On
        April
        26, 2007, Breckenridge filed a complaint in the United States District Court
        for
        the District of Utah, entitled “The Breckenridge Fund, LLC v. Fonix
        Corporation, Fonix Speech, Inc., Thomas A. Murdock, and Roger D.
        Dudley.”  In the complaint, and allegations contained in an
        amended complaint,  Breckenridge asserts statutory claims under the
        Uniform Fraudulent Transfers Act and a related equitable claim based on the
        conveyance of intellectual property and other assets made by the Company
        to
        Fonix Speech in February 2006 in connection with the incorporation of Fonix
        Speech as a wholly owned subsidiary of the Company.  The complaint seek a
        judgment against all of the defendants in the amount of $1,601,735.  The
        complaint also seeks to set aside alleged transfers between the Company and
        Dudley or Murdock, and for subordination of any security interest held by
        Dudley
        or Murdock.  Allegations in an amended complaint assert claims against
        the company’s lawyers.
  Concurrent
        with the filing of its complaint, Breckenridge brought a Motion for Prejudgment
        Writ of Attachment seeking to attach certain of the assets of Fonix Speech,
        including its intellectual property and cash, as necessary to satisfy the
        judgment of $1,602,000 that Breckenridge obtained in New York.  In May
        2007, the United States District ordered that Fonix Speech’s remaining $94,000
        of operating capital be frozen immediately.  The court ordered Breckenridge
        to post a bond of $90,000.  Fonix Speech has taken steps to comply with the
        court’s order.  The Company, Fonix Speech and Breckenridge have
        recently conducted discussions concerning settlement of all of Breckenridge’s
        claims
 
 **10.  SUBSEQUENT
        EVENTS**
 
 ***Series
        L Convertible Preferred Stock***– Subsequent to June 30, 2007 the
        Company issued 184,615,385 shares of Class A common stock in conversion of
        12
        shares of the Series L Convertible Preferred Stock.
 
 
 
 
 
  17
  **ITEM
                  2.**
              **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.  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.  Statements relating to the future performance, business
        strategies and implementation, availability of outside financing, financial
        performance, market acceptance of our products, and similar statements may
        also
        include forward looking statements.  Actual results could differ
        materially from the results anticipated by Fonix and 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, 2006.  The Company disclaims
        any obligation or intention to update any forward-looking
        statements.***
 
 **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.**
 
 The
        following Management’s Discussion
        and Analysis of Financial Condition and Results of Operations (“MD&A”) is
        intended to help the reader understand Fonix Corporation, our operations
        and our
        present business environment.  MD&A is provided as a supplement
        to, and should be read in conjunction with, our condensed consolidated financial
        statements and the accompanying notes thereto.  This overview
        summarizes MD&A, which includes the following sections:
 
 ·
              ***Overview***–
                  a general description of our business and the markets in which
                  we operate;
                  our objective; our areas of focus; and challenges and risks of
                  our
                  business.
 
 ·
              ***Significant
                  Accounting Policies*****– a discussion of
                  accounting policies that require critical judgments and
                  estimates.
 
 ·
              ***Results
                  of Operations*****– an analysis of our Company’s
                  consolidated results of operations for the three years presented
                  in our
                  consolidated financial statements.  Except to the extent that
                  differences among our operating segments are material to an understanding
                  of our business as a whole, we present the discussion in the MD&A on a
                  consolidated basis.
 
 ·
              ***Liquidity
                  and Capital Resources*****– an analysis of cash
                  flows; off-balance sheet arrangements and aggregate contractual
                  obligations; the impact of foregoing exchange; an overview of financial
                  position; and the impact of inflation and changing
                  prices.
 
 We
        intend for this discussion to
        provide the reader with information that will assist in understanding our
        financial statements, the changes in certain key items in those financial
        statements from year to year, and the primary factors that accounted for
        those
        changes, as well as how certain accounting principles affect our financial
        statements.  The discussion also provides information about the
        financial results of the various segments of our business to provide a better
        understanding of how those segments and their results affect the financial
        condition and results of operations of the Company as a whole.  This
        discussion should be read in conjunction with our financial statements as
        of
        December 31, 2006, and the year then ended and the notes accompanying those
        financial statements.
 
 ***Overview***
 
 We
        are
        engaged in providing value-added speech technologies through Fonix Speech,
        Inc.
        (“Fonix Speech”).  We offer speech-enabling technologies including
        automated speech recognition (“ASR”) and text-to-speech (“TTS”) through Fonix
        Speech.  We offer our speech-enabling 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
        licensing of speech-enabling technologies, maintenance contracts and
        services.
 
  18
  We
        previously operated a telecommunications business, the results of which were
        included in prior SEC filings.  On October 2, 2006, LecStar Telecom
        Inc., a Georgia corporation (“LecStar Telecom”), LecStar DataNet, Inc., a
        Georgia corporation (“LecStar DataNet”), LTEL Holdings Corporation (“LTEL
        Holdings”), a Delaware corporation, and Fonix Telecom Inc., a Delaware
        corporation (“Fonix Telecom”), each of which are direct or indirect subsidiaries
        of Fonix, filed for bankruptcy protection in the United States Bankruptcy
        Court
        for the District of Delaware (the “Bankruptcy Court”).  The case
        numbers are as follows:  LTEL Holdings Corporation, 06-11081 (BLS);
        LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083 (BLS);
        Fonix Telecom, Inc., 06-11084 (BLS).)
 
 LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection
        under Chapter 7 of Title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101
        et seq.
        (the “Bankruptcy Code”).  Pursuant to Bankruptcy Code Section 701, on
        October 3, 2006, Alfred Thomas Guliano was appointed the interim trustee
        for
        LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix
        Telecom.  As these subsidiary companies were in Chapter 7 Bankruptcy
        proceedings, as of the date of this Report, the results of their operations
        have
        not been included.
 
 For
        the
        three months ended June 30, 2007 and 2006, we generated revenues of $644,000
        and
        $367,000, respectively and incurred net losses of $1,061,000 and $4,506,000,
        respectively.  For the six months ended June 30, 2007 and 2006, we
        generated revenues of $1,004,000 and $639,000, respectively, incurred net
        losses
        of $1,851,000 and $8,582,000, respectively, and had negative cash flows from
        operating activities of $1,800,000 and $2,648,000, respectively.  As
        of June 30, 2007, we had an accumulated deficit of $293,892,000; negative
        working capital of $53,592,000; accrued liabilities and accrued settlement
        liability of $4,811,000; derivative liabilities of $20,274,000 related to
        the
        issuance of Series L Preferred Stock,  Series M Preferred Stock,
        Series E Convertible Debentures and Series B Preferred Stock of our subsidiary,
        Fonix Speech; net liabilities of discontinued subsidiaries of $20,819,000
        related to the telecom subsidiaries subject to bankruptcy (LecStar Telecom,
        LecStar DataNet, LTEL Holdings and Fonix Telecom); accounts payable of
        $1,283,000 and current portion of notes payable of $4,087,000.  We
        expect to continue to incur significant losses and negative cash flows from
        operating activities at least through December 31, 2007, primarily due to
        expenditure requirements associated with continued marketing and development
        of
        our speech-enabling technologies.
 
 We
        are
        continually developing new product offerings in the ASR businesses in an
        effort
        to increase our revenue stream, and we are continuing to work with our existing
        customers to increase sales.  We have also experienced operating
        expense decreases through headcount reductions and overall cost reduction
        measures.  Through the combination of increased recurring revenues and
        the overall operating cost reduction strategies we have implemented, we hope
        to
        achieve positive cash flow from operations in the next 18-24
        months.  However, there can be no assurance that we will be able to
        achieve positive cash flow from operations within this time frame.
 
 Historically,
        our cash resources, limited to collections from customers, draws on equity
        lines
        of credit and loans, have not been sufficient to cover operating
        expenses.  We periodically engage in discussions with various sources
        of financing to facilitate our cash requirements including buyers of both
        debt
        and equity securities.  We rely on first, cash generated from
        operations, and second, cash provided through convertible debt financing
        and
        other financing arrangements.  Except for payment of certain
        liabilities, we will need to generate approximately $1 to $3 million to continue
        operations for the next twelve months.
 
 ***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:
 
  19
  ***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 occurs, we 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 indicate that the carrying value of the long-lived asset will
        not be
        recovered, the carrying value of the long-lived asset, other than software
        technology, is reduced by the estimated excess of the carrying value over
        the
        projected discounted 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.  The testing for
        impairment requires the determination of the fair value of the asset or entity
        to which the goodwill relates (the reporting unit).  The fair value of
        a reporting  unit is determined based upon a weighting of the quoted
        market price of our common stock and present value techniques based upon
        estimated future cash flows of the reporting unit, considering future revenues,
        operating costs, the risk-adjusted discount rate and other
        factors.  Impairment is indicated if the fair value of the reporting
        unit is allocated to the assets and liabilities of that unit, with the excess
        of
        the fair value of the reporting unit over the amounts assigned to its assets
        and
        liabilities assigned to the fair value of goodwill.  The amount of
        impairment of goodwill is measured by the excess of the goodwill’s carrying
        value over its fair value.
 
 ***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
        Fonix
        Speech, 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.  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 our contracts are typically either short-term in duration
        or we
        are 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 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.
 
  20
  Deferred
        revenue as of June 30, 2007, and December 31, 2006, consisted of the
        following:
 **Description**
                
                **Criteria
                    for Recognition**
                
                **June
                    30, 2007**
                
                **Dec
                    31, 2006**Deferred
                    unit royalties and license fees
                
                Delivery
                    of units to end users or expiration of contract
                
                $
                446,000
                
                $
                460,000
  ***Cost
        of
        revenues*****-**  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
        Employee Compensation******-***Effective January
        1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R),
        “Share-Based Payment” (“FAS 123(R)”), an amendment of SFAS No. 123, “Accounting
        for Stock-Based Compensation,” using the modified prospective transition
        method.  Under this transition method, compensation costs are
        recognized beginning with the effective date: (a) based on the requirements
        of
        FAS 123(R) for all share-based awards granted after the effective date and
        (b)
        based on the requirements of FAS 123 for all awards granted to employees
        prior
        to the effective date of FAS 123(R) that remain unvested on the effective
        date.  Accordingly, we did not restate the results of prior
        periods.  The most notable change resulting from the adoption of FAS
        123(R) is that compensation expense associated with stock options is now
        recognized in our Statements of Operations, rather than being disclosed in
        a pro
        forma footnote to our financial statements.
 
 ***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.
 
 ***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.
 
  21
  ***Recently
        Enacted Accounting***Standards In June 2006, the Financial
        Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
        No. 109” (“FIN 48”). FIN 48 clarifies the accounting for
        uncertainty in income taxes recognized in a company’s financial statements and
        prescribes a recognition threshold and measurement attribute for financial
        statement recognition and measurement of a tax position taken or expected
        to be
        taken in a tax return. This Interpretation also provides related guidance
        on
        derecognition, classification, interest and penalties, accounting in interim
        periods and disclosure. FIN 48 is effective for the Company beginning
        January 1, 2007. The Company adopted FIN 48 at the beginning of fiscal year
        2007 with no material impact to the financial condition, results of operations,
        or cash flows.In February 2007, the FASB issued SFAS No. 159, “The Fair Value
        Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This
        Statement provides companies with an option to report selected financial
        assets
        and liabilities at fair value. Generally accepted accounting principles have
        required different measurement attributes for different assets and liabilities
        that can create artificial volatility in earnings. The Statement’s objective is
        to reduce both complexity in accounting for financial instruments and the
        volatility in earnings caused by measuring related assets and liabilities
        differently. SFAS 159 is effective for the Company beginning January 1, 2008.
        The Company is currently evaluating the impact of this standard.
  The
        Company has reviewed all other recently issued, but not yet adopted, accounting
        standards in order to determine their effects, if any, on its consolidated
        results of operation, financial position or cash flows. Based on that review,
        the Company believes that none of these pronouncements will have a significant
        effect on its current or future earnings or operations.
  ***Results
        of Operations (Continuing operations only)***
  **Three
        months ended June 30, 2007, compared with three months ended June 30,
        2006**
  
 During
        the three months ended June 30, 2007, we recorded revenues of $644,000, an
        increase of $277,000 from $367,000 in 2006. The increase was primarily due
        to
        increased royalty revenues of $255,000 and increased licensing revenue of
        $75,000, partially offset by decreased retail product sales of $13,000 and
        decreased non-recurring engineering (“NRE”) speech revenues of
        $40,000.
 
 Selling,
        general and administrative expenses were $654,000 for the three months ended
        June 30, 2007, a decrease of $599,000 from $1,253,000 in 2006. The decrease
        is
        primarily due to decreased salary and wage related expenses of $177,000,
        decreased other expenses of $128,000, decreased consulting expenses $109,000,
        decreased travel expenses of $96,000, decreased investor relations related
        expenses of $52,000, decreased legal and accounting fees of $50,000, decreased
        advertising expenses of $2,000 and decreased depreciation expenses of $1,000
        partially offset by  increased taxes, licenses and permits of $14,000
        and increased occupancy related expenses of $2,000.
 
 We
        incurred research and product development expenses of $437,000 for the three
        months ended June 30, 2007, a decrease of $153,000 from $590,000 in 2006.
        The
        decrease was primarily due to an overall decrease in wage related expenses
        of
        $137,000, reduced occupancy expenses of $22,000, reduced other operating
        expenses of $3,000, reduced depreciation expenses of $2,000, partially offset
        by
        increased  travel expenses of $7,000 and increased consulting expenses
        of $4,000.
 
 Net
        interest and other expense was $542,000 for the three months ended June 30,
        2007, an increase of $168,000 from net other expense of $374,000 in
        2006.  The overall increase was due to an increase in interest expense
        of $81,000 and a loss recognized on the derivative liability of
        $87,000.
 
  **Six
        months ended June 30, 2007, compared with six months ended June 30,
        2006**
  
 During
        the six months ended June 30, 2007, we recorded revenues of $1,004,000, an
        increase of $365,000 from $639,000 in 2006. The increase was primarily due
        to
        increased royalty revenues of $367,000 and increased licensing revenue of
        $95,000 and increased retail product sales of $9,000, partially offset by
        decreased non-recurring engineering (“NRE”) speech revenues of
        $106,000.
 
  22
  Selling,
        general and administrative expenses were $1,464,000 for the six months ended
        June 30, 2007, a decrease of $955,000 from $2,419,000 in 2006. The decrease
        is
        primarily due to decreased salary and wage related expenses of $242,000,
        decreased other expenses of $236,000, decreased travel expenses of $162,000,
        decreased legal and accounting fees of $125,000, decreased consulting expenses
        $105,000, decreased investor relations related expenses of $82,000, decreased
        advertising expenses of $23,000 and decreased depreciation expenses of $2,000,
        partially offset by increased occupancy related expenses of $12,000 and
        increased taxes, licenses and permits of $10,000.
 
 We
        incurred research and product development expenses of $924,000 for the six
        months ended June 30, 2007, a decrease of $236,000 from $1,160,000 in 2006.
        The
        decrease was primarily due to an overall decrease in wage related expenses
        of
        $204,000, reduced occupancy expenses of $27,000, by reduced  travel
        expenses of $3,000  reduced other operating expenses of $2,000,
        reduced depreciation expenses of $2,000, partially offset and increased
        consulting expenses of $2,000.
 
 Net
        interest and other expense was $388,000 for the six months ended June 30,
        2007,
        a decrease of $363,000 from net other expense of $751,000 in
        2006.  The overall decrease was due to a gain recognized on the
        derivative liability of $529,000, partially offset by an increase in interest
        expense of $166,000.
 
 ***Liquidity
        and Capital Resources***
 
 We
        must
        raise additional funds to be able to satisfy our cash requirements during
        the
        next 12 months.  Except for payment of certain liabilities it is
        anticipated that we will need to raise approximately $1 to $3 million over
        the
        next 12 months to meet obligations and continue our product development,
        corporate operations and marketing expenses.  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.  We are working with game developers and other
        potential licensors of our speech product offerings to develop additional
        revenue streams for our speech technologies.  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 of Fonix.
 
 Our
        cash
        resources are limited to collections from customers, proceeds from the issuance
        of preferred stock, and loan proceeds, and are only sufficient to cover current
        operating expenses and payments of current liabilities.  At June 30,
        2007, we had negative working capital of $53,592,000; derivative liabilities
        of
        $20,274,000 related to the issuance of Series L Preferred Stock, of Series
        M
        Preferred Stock, of Series E Convertible Debentures, and of the Series B
        Preferred Stock of our subsidiary, Fonix Speech; net liabilities of discontinued
        subsidiaries of $20,819,000 related to the telecom assets subject to bankruptcy,
        accrued liabilities and accrued settlement obligation of $4,811,000; accounts
        payable of $1,283,000 and current portion of notes payable of
        $4,087,000.
 
 We
        had
        $1,004,000 in revenue and a loss of $1,851,000 for the six months ended June
        30,
        2007.  Net cash used in operating activities of $1,800,000 for the
        quarter ended June 30, 2007, resulted principally from the net loss incurred
        of
        $1,851,000, non-cash gain recognized on the derivative liability of $529,000,
        decreased accounts payable of $218,000, increased funds held in escrow of
        $94,000 and decreased deferred revenues of $14,000  partially offset
        by non-cash accretion of discount on notes payable of $494,000, increased
        accrued liabilities of $385,000, depreciation expense of $25,000 and
        increased prepaid expenses and other current assets of $2,000,.  We
        did not use any cash in investing activities for the quarter ended June 30,
        2007.  Net cash provided by financing activities of $1,802,000
        consisting primarily of proceeds from Series B Preferred Stock of our
        subsidiary, Fonix Speech; the Series B Preferred Stock of $1,250,000, proceeds
        from notes payable of $450,000 and proceeds from the related party note of
        $102,000.
 
 We
        had
        negative working capital of $53,592,000 at June 30, 2007, compared to negative
        working capital of $52,957,000 at December 31, 2006.  Current assets
        increased by $94,000 to $103,000 from $9,000 from December 31, 2006, to June
        30,
        2007.  Current liabilities increased by $729,000 to $ 53,695,000 from
        $52,966,000 during the same period.  The change in working capital
        from December 31, 2006, to June 30, 2007, reflects, in part, increased current
        portion of notes payable of $302,000, increased accrued liabilities of
        $1,227,000 and increased notes payable to related parties of $102,000, partially
        offset by decreased derivative liability of $667,000, decreased accounts
        payable
        of $218,000 and increased cash of $2,000.  Total assets were
        $2,874,000 at June 30, 2007, compared to $2,805,000 at December 31,
        2006.
 
  23
  ***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 12 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 have agreed to postpone the maturity date on several
        occasions.  The note was due September 30, 2006 and no default had
        been declared.  As of August 20, 2007, we had not made payment against
        the outstanding balance due on the note. 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 Fonix at any time.  The conversion price was
        the average closing bid price of the shares at the time of the
        advances.  To the extent the market price of our 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.  The Lenders may also receive additional
        compensation as determined appropriate by the Board of Directors.
 
 In
        October 2002, the Lenders pledged 30,866 shares of our Class A common stock
        to
        Queen, LLC ( the “Equity Line Investor”), in connection with an advance of
        $183,000 to us under the Third Equity Line.  The Equity Line Investor
        subsequently sold the pledged shares and applied $82,000 of the proceeds
        as a
        reduction of the advance.  The value of the pledged shares of $82,000
        was treated as an additional advance from the Lenders.
 
 During
        the fourth quarter of 2003, we made a principal payment of $26,000 against
        the
        outstanding balance of the promissory note.  During 2004, we entered
        into an agreement with the holders of the promissory note to increase the
        balance of the note payable by $300,000 in exchange for a release of the
        $1,443,000 of accrued liabilities related to prior indemnity agreements between
        us and the note holders.  We classified the release of $1,143,000 as a
        capital contribution in the Consolidated Financial Statements during the
        fourth
        quarter of 2004.  We made principal payments against the note of
        $253,000 during the year ended December 31, 2004.  During the year
        ended December 31, 2005, we received an additional advance of $50,000 under
        the
        note from the Lenders.  The balance due the Lenders at December 31,
        2005, was $486,000.  During the year ended December 31, 2006, we
        received additional advances of $419,000 and made principal payments to the
        Lenders against the note of $105,000.  During the quarter ended March
        31, 2007, we received additional advances of $102,000.  The balance
        due at June 30, 2007 was $902,000.
 
 The
        unpaid balance of $902,000 at June 30, 2007, is secured by our assets, including
        our stock of Fonix Speech.  As of March 31, 2007, the Lenders had not
        converted any of the outstanding balance or interest into common
        stock.
 
 ***Notes
        Payable***
 
 In
        connection with the acquisition of the capital stock of LTEL Holdings in
        2004,
        we issued a 5%, $10,000,000, secured, six-year note (the “Note”) payable to
        McCormack Avenue, Ltd. (“McCormack”).  Under the terms of the Note,
        quarterly interest-only payments were required through January 15, 2005,
        with
        quarterly principal and interest payments beginning April 2005 and continuing
        through January 2010.  Interest on the Note is payable in cash or, at
        our option, in shares of our Class A common stock.  The Note was
        valued at $4,624,000 based on an imputed interest rate of 25 percent per
        annum.
 
 The
        discount on the Note is based on an imputed interest rate of 25%.  The
        carrying amount of the Note of $6,038,000 at June 30, 2007, was net of
        unamortized discount of $2,695,000.  As of the date of this Report, we
        had not made any scheduled payments for 2006 or 2007.
 
  24
  On
        September 8, 2006, we received a default notice (the “Default Notice”) from
        McCormack in respect of the Note.  Under the terms of the Note, and a
        related Security Agreement between us and McCormack dated February 24, 2004
        (the
“Security Agreement”), McCormack was entitled to declare all liabilities,
        indebtedness, and obligations of Fonix to McCormack under the Security Agreement
        and the Note immediately due and owing upon an event of default.  The
        Note defines an event of default to include the non-payment by us of a scheduled
        payment which is not cured within 60 days.
 
 In
        the
        Default Notice, McCormack stated that it intended to exercise its rights,
        including any and all rights set forth in the Note as amended.
 
 Also
        on
        September 8, 2006, McCormack provided to us a Notice of Sale, stating
        McCormack’s intention to sell at public auction all of the collateral referred
        to in the Security Agreement, consisting of the capital stock and assets
        of
        LecStar Telecom, LecStar DataNet and LTEL Holdings.  As of the date of
        this report, no sale of the assets or capital stock of LecStar Telecom, LecStar
        DataNet nor LTEL Holdings had occurred.
 
 McCormack
        notified us that notwithstanding the Series L Exchange Agreement between
        us and
        McCormack discussed above, McCormack had not waived any of its rights in
        connection with the Note, the Modification Agreement, the Security Agreement,
        or
        the Supplemental Security Agreement.
 
 During
        the fourth quarter of 2006, we entered into two promissory notes with an
        unrelated third party in the aggregate amount of $330,000. These notes accrue
        interest at 10% annually and are due and payable during the second quarter
        of
        2007.
 
 During
        the six months ended June 30, 2007, we entered into five promissory notes
        with
        an unrelated third party in the aggregate amount of $450,000.  These
        notes accrue interest at 10% annually and are due and payable during the
        third
        quarter of 2007.
 
 
 ***Seventh
        Equity Line of Credit***
 
 On
        May
        27, 2005, we entered into a seventh private equity line agreement (the "Seventh
        Equity Line Agreement") with the Equity Line Investor, on terms substantially
        similar to those of the Sixth Equity Line between Queen and us dated November
        15, 2004.
 
 Under
        the
        Seventh Equity Line Agreement, we had the right to draw up to $20,000,000
        against an equity line of credit (the "Seventh Equity Line") from the Equity
        Line Investor.  We were entitled under the Seventh Equity Line
        Agreement to draw certain funds and to put to the Equity Line Investor shares
        of
        the Company's Class A common stock in lieu of repayment of the
        draw.  We were limited as to the amount of shares we may put to the
        Equity Line Investor in connection with each put; we could not put shares
        which
        would cause the Equity Line Investor to own more than 4.99% of our outstanding
        common stock on the date of the put notice.  The number of shares to
        be issued in connection with each draw was determined by dividing the amount
        of
        the draw by 93% of the average of the two lowest closing bid prices of our
        Class
        A common stock over the ten trading days after the put notice is
        tendered.  The Equity Line Investor was required under the Seventh
        Equity Line Agreement to tender the funds requested by us within two trading
        days after the ten-trading-day period used to determine the market
        price.
 
 We
        granted registration rights to the
        Equity Line Investor and filed three registration statements which cover
        the
        resales of the shares to be issued under the Seventh Equity Line.  All
        of the shares registered by the first registration statement had been sold
        as of
        October 24, 2005.  The second registration statement filed in
        connection with the Seventh Equity Line was declared effective by the SEC
        on
        February 10, 2006.  All of the shares registered by the second
        registration statement had been sold as of July 26, 2006.  We filed a
        third registration statement on June 26, 2006, to register additional shares
        under the Seventh Equity Line.  However, that registration statement
        was not declared effective, and no shares were sold under that registration
        statement.
 
 In
        January 2007, we terminated the
        Seventh Equity Line, and we have withdrawn the third registration statement
        related to the Seventh Equity Line.  As such, as of the date of this
        report, we did not have an equity line of credit financing available to
        us.
 
  25
  ***Series
        A Convertible Preferred Stock***
 
 At
        June 30, 2007, there were 166,667
        shares of Series A convertible preferred stock outstanding.  Holders
        of the Series A convertible preferred stock have the same voting rights as
        common stockholders, have the right to elect one person to the board of
        directors and are entitled to receive a one time preferential dividend of
        $2.905
        per share of Series A convertible preferred stock prior to the payment of
        any
        dividend on any class or series of stock.  At the option of the
        holders, each share of Series A convertible preferred stock is convertible
        into
        one share of Class A common stock and in the event that the common stock
        price
        has equaled or exceeded $10 per share for a 15 day period, the shares of
        Series
        A convertible preferred stock will automatically be converted into Class
        A
        common stock.  In the event of liquidation, the holders are entitled
        to a liquidating distribution of $36.33 per share and a conversion of Series
        A
        convertible preferred stock at an amount equal to .0375 shares of common
        stock
        for each share of Series A convertible preferred stock.
 
 ***Series
        L Convertible Preferred Stock***
 
 On
        September 7, 2006, we entered into a
        Series L 9% Convertible Preferred Stock Exchange Agreement (the "Exchange
        Agreement") with McCormack and Kenzie Financial (“Kenzie”), a British Virgin
        Islands company.  Pursuant to the Exchange Agreement, McCormack and
        Kenzie exchanged all of the shares of Series H Preferred Stock that they
        acquired from sale of LTEL Holdings, for 1,960.8 and 39.2 shares, respectively,
        of our Series L 9% Convertible Preferred Stock (the "Series L Preferred
        Stock").
 
 Because
        the shares of Series L
        Preferred Stock were issued in exchange for the remaining outstanding shares
        of
        Series H Preferred Stock, we did not receive any proceeds in connection with
        the
        issuance of the Series L Preferred Stock.
 
 The
        Series J Preferred Stock entitles McCormack and Kenzie to receive dividends
        in
        an amount equal to 9% of the then-outstanding balance of shares of Series
        L
        Preferred Stock.  The dividends are payable in cash or shares of our
        Class A common stock, at our option.
 
 The
        Series L Preferred Stock is convertible into common stock of Fonix at the
        option
        of the holder by using a conversion price which was 80% of the average of
        the
        two (2) lowest closing bid prices for the twenty-day trading period prior
        to the
        conversion date.
 
 Redemption
        of the Series L Preferred Stock, whether at the Company’s option or that of
        McCormack or Kenzie, requires us to pay, as a redemption price, the stated
        value
        of the outstanding shares of Series L Preferred Stock to be redeemed, together
        with any accrued but unissued dividends thereon, multiplied by one hundred
        ten
        percent (110%).
 
 In
        connection with the issuance of the
        Series L Preferred Stock, we filed with the State of Delaware a Certificate
        of
        Designation and Series L 9% Convertible Stock Terms (the “Series L Terms”),
        which become a part of our Certificate of Incorporation, as
        amended.
 
 We
        accounted for the exchange as
        redemption of the outstanding Series H Preferred Stock as the Series H Preferred
        Stock was not convertible into shares of common stock of Fonix.  The
        Series L Preferred Stock is convertible into shares of common stock of
        Fonix.  We followed the accounting treatment in SFAS 150
“*Accounting for Certain Financial Instruments with Characteristics of
        Both
        Liabilities and Equity,”*SFAS 133 “*Accounting for Derivative
        Instruments and Hedging Activities”*and EITF 00-19 “*Accounting for
        Derivative Financial Instruments Indexed to, and Potentially Settled in,
        a
        Company’s Own Stock.”*We recognized a derivative liability upon the
        redemption of $30,991,000 due to the value of the conversion feature of the
        Series L Preferred Stock.  The liability was calculated using the
        Black-Scholes valuation model.  As the value of the derivative
        liability was greater than the face value of the Series L Preferred Stock,
        no
        value was prescribed to the Series L Preferred Stock.  Also in
        connection with the redemption, the Company recognized a preferred stock
        dividend of $16,000,000, equal to the original discount we had assigned to
        the
        Series H Preferred Stock.
 
 For
        the six months ended June 30, 2007,
        we issued 1,015,229,976 shares of our Class A common stock in conversion
        of 115
        shares of its Series L Preferred Stock.  At June 30, 2007, 1,743
        shares of Series L Preferred Stock remained outstanding.
 
  26
  ***Series
        M Preferred Stock***
 
 On
        April
        4, 2007, we entered into a Series M 9% Convertible Preferred Stock Exchange
        Agreement with Sovereign.  Pursuant to the exchange agreement,
        Sovereign exchanged 150 shares of our Series L Preferred Stock for 150 shares
        of
        our Series M 9% Convertible Preferred Stock (the “Series M Preferred
        Stock”).
 
 The
        Series M Preferred Stock entitles Sovereign or its assignees to receive
        dividends in an amount equal to 9% of the then-outstanding balance of shares
        of
        Series M Preferred Stock.  The dividends are payable in cash or shares
        of our Class A common stock, at our option.
 
 The
        Series M Preferred Stock may be converted into our common stock at the option
        of
        the holder by using a conversion price which shall be the lower of (i) 80%
        of
        the average of the two lowest closing bid prices for the twenty-day trading
        period prior to the conversion date, or (ii) $0.004.
 
 Redemption
        of the Series M Preferred Stock, whether at our option or that of Sovereign,
        requires us to pay, as a redemption price, the stated value of the outstanding
        shares of Series M Preferred Stock to be redeemed, together with any accrued
        but
        unissued dividends thereon, multiplied by one hundred ten percent
        (110%).
 
 Because
        the shares of Series M were issued in exchange for the outstanding shares
        of
        Series L Preferred Stock, we did not receive any proceeds in connection with
        the
        issuance of the Series M Preferred Stock.
 
 ***Fonix
        Speech, Inc. Series B Convertible Preferred Stock***
 
 On
        April 4, 2007, the Company entered
        into a Securities Purchase Agreement by and among the Company, Fonix Speech,
        Inc. (“FSI”), and Sovereign Partners, LP (“Sovereign”).  FSI is a
        wholly owned subsidiary of the Company.
 
 Pursuant
        to the FSI agreement, FSI sold
        125 shares of its Series B 9% Convertible Preferred Stock (the “Series B
        Preferred Stock”) at a per share price of $10,000 to Sovereign.  In
        anticipation of the transaction, Sovereign advanced the gross proceeds of
        $1,250,000 to the Company on March 30, 2007.  The advance has been
        accounted for as a liability in the accompanying financial
        statements.
 
 The
        shares of Series B Preferred Stock
        are convertible into shares of the Company’s Class A common
        stock.  The Series B Preferred Stock may be converted into common
        stock of the Company at the option of the holder by using a conversion price
        which shall be the lower of (i) 80% of the average of the two lowest closing
        bid
        prices for the twenty-day trading period prior to the conversion date, or
        (ii)
        $0.004.
 
 ***Stock
        Options and Warrants***
 
 During
        the six months ended June 30,
        2007, we did not grant any stock options.  As of June 30, 2007, we had
        a total of 526,012 options to purchase Class A common stock
        outstanding.
 
 As
        of June 30, 2007, we had warrants to
        purchase a total of 15,000 shares of Class A common stock outstanding that
        expire through 2010.
 
 **Other**
 
 We
        presently have no plans to purchase
        new research and development or office facilities.
 
 **Corporate
        Outlook**
 
 Fonix’s
        focus on providing competitive and value-added solutions for customers and
        partners requires a broad set of technologies, service offerings and channel
        capabilities.  Management anticipates and expects further development
        of complementary technologies, added product and application developments,
        access to market channels and additional opportunities for strategic alliances
        in other industry segments.
 
  27
  We
        will
        continue to leverage our research and development of speech technologies
        to
        deliver software applications and engines to device manufacturers looking
        to
        incorporate speech interfaces into end-user products.  Fonix Speech’s
        award-wining technologies provide competitive embedded speech solutions for
        mobile/wireless devices, videogames, telephony systems and products for the
        assistive market based on Fonix’s proprietary and patented TTS and ASR
        technologies.
 
 As
        we proceed to implement our strategy
        and to reach our objectives, we anticipate 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 us has significant risks,
        and shareholders and others interested in Fonix and our Class A common stock
        should carefully consider the risks set forth below and under the heading
“Certain Significant Risk Factors” in Item 1, Part I, of our annual report on
        Form 10-K for the year ended December 31, 2006.
 
 As
        noted above, as of June 30, 2007, we
        had an accumulated deficit of $292,892,000 negative working capital of
        $53,592,000, derivative liability of $20,274,000 related to the issuance
        of
        Series L Preferred Stock, Series M Preferred Stock, Fonix Speech Series B
        Preferred Stock  and Series E Convertible Debentures, net liabilities
        of discontinued subsidiaries of $20,819,000 related to the telecom assets
        (LecStar Telecom, LecStar DataNet, LTEL Holdings and Fonix Telecom) subject
        to
        bankruptcy, accrued liabilities and accrued settlement obligation of $4,811,000,
        accounts payable of $1,283,000 and current portion of notes payable of
        $4,087,000.  Sales of products and revenue from licenses based on our
        technologies have not been sufficient to finance ongoing
        operations.  These matters raise substantial doubt about our ability
        to continue as a going concern.  Our continued existence is dependent
        upon several factors, including our success in (1) increasing speech license,
        royalty and services revenues, (2) raising sufficient additional funding,
        and
        (3) minimizing operating costs.  Until sufficient revenues are
        generated from operating activities, we expected to continue to fund our
        operations through debt instruments.  We are currently pursuing
        additional sources of liquidity in the form of traditional commercial credit,
        asset based lending, or additional sales of our equity securities to finance
        our
        ongoing operations.  Additionally, we are pursuing other types of
        commercial and private financing, which could involve sales of our assets
        or
        sales of one or more operating divisions.  Our sales and financial
        condition have been adversely affected by our reduced credit availability
        and
        lack of access to alternate financing because of our significant ongoing
        losses
        and increasing liabilities and payables.  As we have noted in our
        previous annual reports and other public filings, if additional financing
        is not
        obtained in the near future, we will be required to more significantly curtail
        our operations or seek protection under bankruptcy laws.
 
 **Information
        Concerning Forward-Looking Statements**
 
 Certain
        of the statements contained in
        this report (other than the historical financial data and other statements
        of
        historical fact) are forward-looking statements.  These statements
        include, but are not limited to our expectations with respect to the development
        of a diversified revenue base; delivery of our VoiceDial application; the
        market
        volume of educational electronic dictionary devices; our ability to capitalize
        in markets including toys, appliances, and other devices; the market demand
        for
        videogames; our growth strategies and the implementation of our Core
        Technologies and potential results; our payment of dividends on our common
        stock; our ability to meet customer demand for speech technologies and
        solutions; development of complementary technologies, products, marketing,
        and
        strategic alliance opportunities; profitability of language learning tools;
        the
        status of  traditional operator systems; our ability to continue
        operations in the event we do not receive approval to amend our articles
        of
        incorporation; the comparability of our speech-enabled Speech Products to
        other
        products; our intentions with respect to strategic collaborations and marketing
        arrangements; our intentions with respect to use of licenses; our plans with
        respect to development and acquisition of speech solutions; our goals with
        respect to supplying speech solutions for OEMs; our expectations with respect
        to
        continued financial losses; and our intentions with respect to financing
        our
        operations in the future.  Additional forward-looking statements may
        be found in the “Certain Significant Risk Factors” Section of our 10-K for the
        year ended December 31, 2006, together with accompanying explanations of
        the
        potential risks associated with such statements.
 
 Forward-looking
        statements made in this
        report, are made based upon management’s good faith expectations and beliefs
        concerning future developments and their potential effect upon
        Fonix.  There can be no assurance that future developments will be in
        accordance with such expectations, or that the effect of future developments
        on
        Fonix will be those anticipated by management.  Forward-looking
        statements may be identified by the use of words such as “believe,” “expect,”
“plans,” “strategy,” “prospects,” “estimate,” “project,” “anticipate,” “intends”
and other words of similar meaning in connection with a discussion of future
        operating or financial performance.
 
  28
  You
        are cautioned not to place undue
        reliance on these forward looking statements, which are current only as of
        the
        date of this Report.  We disclaim any intention or obligation to
        update or revise any forward-looking statements, whether as a result of new
        information, future events, or otherwise.  Many important factors
        could cause actual results to differ materially from management’s expectations,
        including those listed in the “Certain Significant Risk Factors” Section of our
        10-K for the year ended December 31, 2006, as well as the
        following:
 
 •
              unpredictable
                  difficulties or delays in the development of new products and
                  technologies;
 
 •
              changes
                  in U.S. or international economic conditions, such as inflation,
                  interest
                  rate fluctuations, foreign exchange rate fluctuations or recessions
                  in
                  Fonix's markets;
 
 •
              pricing
                  changes to our supplies or products or those of our competitors,
                  and other
                  competitive pressures on pricing and
                  sales;
 
 •
              difficulties
                  in obtaining or retaining the management, engineering, and other
                  human
                  resource competencies that we need to achieve our business
                  objectives;
 
 •
              the
                  impact on Fonix or a subsidiary from the loss of a significant
                  customer or
                  a significant number of customers;
 
 •
              risks
                  generally relating to our international operations, including
                  governmental, regulatory or political
                  changes;
 
 •
              transactions
                  or other events affecting the need for, timing and extent of our
                  capital
                  expenditures; and
 
 •
              the
                  extent to which we reduce outstanding
                  debt.
 
 **Item
                  3.**
              **Quantitative
                  and Qualitative Disclosures About Market
                  Risk**
 
 **Foreign
        Currency Exposure**
 
 To
        date,
        all of our revenues have been denominated in United States dollars and received
        primarily from customers in the United States.  Our exposure to
        foreign currency exchange rate changes has been insignificant.  We
        expect, 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 we engage in international sales denominated in U.S. dollars, an increase
        in the value of the U.S. dollar relative to foreign currencies could make
        our
        products less competitive in international markets.  Although we will
        continue to monitor our exposure to currency fluctuations, we cannot assure
        that
        exchange rate fluctuations will not adversely affect financial results in
        the
        future.
 
 **Item
                  4.**
              **Controls
                  and Procedures**
 
 Evaluation
        of Disclosure Controls and Procedures.  Our Chief Executive
        Officer and our Chief Financial Officer, after evaluating the effectiveness
        of
        the Company’s “disclosure controls and procedures” (as defined in the Securities
        Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the
        end
        of the period covered by this quarterly report, have concluded that our
        disclosure controls and procedures are effective based on their evaluation
        of
        these controls and procedures required by paragraph (b) of Exchange Act Rules
        13a-15 or 15d-15.
 
 Changes
        in Internal Control Over Financial Reporting. There were no changes in our
        internal control over financial reporting identified in connection with the
        evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15
        that
        occurred during our last fiscal quarter that have materially affected, or
        are
        reasonably likely to materially affect, our internal control over financial
        reporting.
 
  29
  Section
        404 Assessment.  Section 404 of the Sarbanes-Oxley Act of 2002
        requires management’s annual review and evaluation of our internal controls
        beginning with our Form 10-K for the fiscal year ending December 31, 2007,
        and
        an attestation of the effectiveness of these controls by our independent
        registered public accounting firm beginning with our Form 10-K for the fiscal
        year ending on December 31, 2008.  We are dedicating significant
        resources, including management time and effort, and incurring substantial
        costs
        in connection with our ongoing Section 404 assessment.  We are
        currently documenting and testing our internal controls and considering whether
        any improvements are necessary for maintaining an effective control environment
        at our company.  The evaluation of our internal controls is being
        conducted under the direction of our senior management.  In addition,
        our management is regularly discussing the results of our testing and any
        proposed improvements to our control environment with our Audit
        Committee.  We will continue to work to improve our controls and
        procedures, and to educate and train our employees on our existing controls
        and
        procedures in connection with our efforts to maintain an effective controls
        infrastructure at our Company.
 
 Limitations
        on Effectiveness of Controls. A system of controls, however well designed
        and operated, can provide only reasonable, and not absolute, assurance that
        the
        system will meet its objectives. The design of a control system is based,
        in
        part, upon the benefits of the control system relative to its costs. Control
        systems can be circumvented by the individual acts of some persons, by collusion
        of two or more people, or by management override of the control. In addition,
        over time, controls may become inadequate because of changes in conditions,
        or
        the degree of compliance with the policies or procedures may deteriorate.
        In
        addition, the design of any control system is based in part upon assumptions
        about the likelihood of future events.
 
 **PART
        II - OTHER INFORMATION**
 
 **Item
                  1.**
              **Legal
                  Proceedings**
 
 ***Breckenridge
        Complaint***– On June 6, 2006, Breckenridge filed a complaint against
        the Company in the Supreme Court of the State of New York, County of Nassau
        (the
“Court”), in connection with a settlement agreement between the Company and
        Breckenridge entered into in September 2005. In the Complaint, Breckenridge
        alleged that the Company failed to pay certain amounts due under the settlement
        agreement in the amount of $450,000. The Company denied the allegations of
        Breckenridge’s complaint and has filed a motion for summary
        judgment.  Breckenridge also filed for summary judgment on its
        complaint.
 
 On
        February 2, 2007, the Court granted Breckenridge’s summary judgment motion,
        denied the Company’s summary judgment motion, and directed that a hearing be
        held to determine the amount owed by the Company to Breckenridge.  The
        Company and Breckenridge entered into a stipulation that the Company owed
        Breckenridge $1,530,000 plus interest at a rate of 9% from September 15,
        2006 to
        the date of entry of judgment.
 
 The
        Court’s order, dated as of March 15, 2007, adjudged that the Company owes an
        aggregate of $1,602,000 to Breckenridge.
 
 On
        April
        26, 2007, Breckenridge filed a complaint in the United States District Court
        for
        the District of Utah, entitled “The Breckenridge Fund, LLC v. Fonix
        Corporation, Fonix Speech, Inc., Thomas A. Murdock, and Roger D.
        Dudley.”  In the complaint, and allegations contained in an
        amended complaint,  Breckenridge asserts statutory claims under the
        Uniform Fraudulent Transfers Act and a related equitable claim based on the
        conveyance of intellectual property and other assets made by the Company
        to
        Fonix Speech in February 2006 in connection with the incorporation of Fonix
        Speech as a wholly owned subsidiary of the Company.  The complaint seek a
        judgment against all of the defendants in the amount of $1,601,735.  The
        complaint also seeks to set aside alleged transfers between the Company and
        Dudley or Murdock, and for subordination of any security interest held by
        Dudley
        or Murdock.  Allegations in an amended complaint assert claims against
        the company’s lawyers.
  Concurrent
        with the filing of its complaint, Breckenridge brought a Motion for Prejudgment
        Writ of Attachment seeking to attach certain of the assets of Fonix Speech,
        including its intellectual property and cash, as necessary to satisfy the
        judgment of $1,602,000 that Breckenridge obtained in New York.  In May
        2007, the United States District ordered that Fonix Speech’s remaining $94,000
        of operating capital be frozen immediately.  The court ordered Breckenridge
        to post a bond of $90,000.  Fonix Speech has taken steps to comply with the
        court’s order.  The Company, Fonix Speech and Breckenridge have
        recently conducted discussions concerning settlement of all of Breckenridge’s
        claims.
 
  30
  **Item
                  1A.**
              **Risk
                  Factors**
 
 We
        attempt to identify, manage and mitigate the risks and uncertainties associated
        with our business to the extent practical.  However, some level of
        risk and uncertainty will always be present.  The section of our
        Annual Report on Form 10-K for the fiscal year ended December 31, 2006, entitled
        “Certain Significant Risk Factors” describes some of the risks and uncertainties
        associated with our business. These risks and uncertainties have the potential
        to materially affect our business, financial condition, results of operations,
        cash flows, projected results and future prospects. We have revised the
        following risk factors which were previously disclosed in our Annual Report
        on
        Form 10-K for the fiscal year ended December 31, 2006.
 
 **Our
        substantial and continuing losses since inception, coupled with significant
        ongoing operating expenses, raise doubt about our ability to continue as
        a going
        concern.**
 
 Since
        inception, we have sustained
        substantial losses.  Such losses continue due to ongoing operating
        expenses and a lack of revenues sufficient to offset operating
        expenses.  We have raised capital to fund ongoing operations by
        private sales of our securities, some of which sales have been highly dilutive
        and involve considerable expense.  In our present circumstances, there
        is substantial doubt about our ability to continue as a going concern absent
        significant sales of our products and telecommunication services, substantial
        revenues from new licensing or co-development contracts, or continuing large
        sales of our securities.
 
 We
        incurred net losses of $21,943,000,
        $22,631,000 and $15,148,000 for the years ended December 31, 2006, 2005 and
        2004, respectively.  We incurred a net loss of $1,061,000 for the
        three months ended June 30, 2007 and $1,851,000 for the six months ended
        June
        30, 2006.  As of June 30, 2007, we had an accumulated deficit of
        $293,892,000, negative working capital of $53,592,000, derivative liability
        of
        $20,274,000 related to the issuance of Series L Preferred Stock, Series M
        Preferred Stock, Series B Preferred Stock and the Series E Debentures, net
        liabilities of unconsolidated subsidiaries of $20,819,000 related to the
        telecom
        assets subject to bankruptcy, accrued liabilities and accrued settlement
        obligation of $4,811,000 accounts payable of $1,283,000 and current portion
        of
        notes payable of $4,087,000.
 
 We
        expect to continue to spend
        significant amounts to enhance our Speech Products and technologies and fund
        further Product development.  As a result, we will need to generate
        significant additional revenue to achieve profitability.  Even if we
        do achieve profitability, we may not be able to sustain or increase
        profitability on a quarterly or annual basis.  If we do not achieve
        and maintain profitability, the market price for our common stock may further
        decline, perhaps substantially, and we may have to curtail or cease our
        operations.
 
 **Continuing
        debt obligations could impair our ability to continue as a going
        concern.**
 
 As
        of June 30, 2007, we had debt
        obligations of $7,717,000, accrued liabilities and accrued settlement obligation
        of $4,811,000 and vendor accounts payable of approximately
        $1,283,000.  At present, our revenues from existing licensing
        arrangements and Speech Product sales are not sufficient to offset our ongoing
        operating expenses or to pay in full our current debt obligations.
 
 There
        is substantial risk, therefore,
        that the existence and extent of the debt obligations described above could
        adversely affect our business, operations and financial condition, and we
        may be
        forced to curtail our operations, sell part or all of our assets, or seek
        protection under bankruptcy laws.  Additionally, there is substantial
        risk that the current or former employees or our vendors could bring lawsuits
        to
        collect the unpaid amounts.  In the event of lawsuits of this type, if
        we are unable to negotiate settlements or satisfy our obligations, we could
        be
        forced into bankruptcy.
 
 **We
        currently do not have access to the Seventh Equity Line or other equity lines
        of
        credit, which could have a material adverse effect on our ability to continue
        operations.**
 
 Since
        2000, we have relied substantially on equity lines of credit for financing
        our
        operations. Pursuant to these equity lines, we historically have drawn funds
        against the equity line and put shares of our Class A common stock to the
        equity
        line investor in repayment of the draws. In light of current SEC regulations
        and
        interpretations by the SEC, we terminated the Seventh Equity Line and as
        of the
        date of the Report, we did not have access to an equity line of credit or
        similar financing arrangements. Although we are seeking to negotiate additional
        financing sources and reviewing our options, there can be no guarantee that
        we
        will be able to enter into arrangements for financing that will be on terms
        that
        will be satisfactory to us. Any inability to enter into new financing
        arrangements could have a material adverse impact on our ability to continue
        our
        operations, and we may be required to seek protection under the bankruptcy
        laws.
 
  31
  **Item
                  2.**
              **Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds**
 
 During
        the six months ended June 30, 2007, we issued 1,016,177,343 shares of our
        common
        stock in connection with conversions of 115 shares of our Series L Preferred
        Stock for which we received no proceeds.  The shares of common stock
        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.
 
 We
        received no proceeds from the issuance of shares upon conversion of our series
        of preferred stock.
 
 **Item
                  6.**
              **Exhibits**
 
 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
 
 31.1
              Certification
                  of President
 31.2
              Certification
                  of Chief Financial Officer
 32.1
              Certification
                  of President Pursuant to Section 906 of the Sarbanes-Oxley Act
                  of
                  2002
 32.2
              Certification
                  of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley
                  Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  32
  **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:
                  August 20, 2007
              **/s/
                  Roger D.
                  Dudley**Roger
                  D. Dudley, Executive Vice President,Chief
                  Financial Officer(Principal
                  financial officer)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    
 
 33