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 March 31, 2009,
  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.)





387
South 520 West, Suite 110


Lindon,
Utah 84042


(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 has submitted electronically and posted on
its Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such
files). Yes  ___   No ___





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting
company.  (Check one):


Large
accelerated filer [  ]  Accelerated filer
[  ]  Non-accelerated filer
[  ]  Smaller reporting company [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
June 1, 2009, there were issued and outstanding 11,108,258 shares of our Class A
common stock.





1





FONIX
CORPORATION


FORM
10-Q








TABLE
OF CONTENTS





PART
I - FINANCIAL INFORMATION





PageItem
      1.
                          Financial
      Statements (Unaudited)Condensed
      Consolidated Balance Sheets – As of March 31, 2009, and December 31,
      2008
                          3Condensed
      Consolidated Statements of Operations and Comprehensive Loss for
      theThree
      Months Ended March 31, 2009 and 2008
                          4Condensed
      Consolidated Statements of Cash Flows for theThree
      Months Ended March 31, 2009 and 2008
                          5Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                          8Item
      2.
                          Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                          22Item
      3.
                          Quantitative
      and Qualitative Disclosures About Market Risk
                          36Item
      4.
                          Controls
      and Procedures
                          36PART
      II - OTHER INFORMATIONItem
      1.
                          Legal
      Proceedings
                          36Item
      2.
                          Unregistered
      Sales of Equity Securities and Use of Proceeds
                          37Item
      3.
                          Defaults
      Upon Senior Securities
                          37Item
      4.
                          Submission
      of Matters to a Vote of Security Holders
                          37Item
      5.
                          Other
      Information
                          37Item
      6.
                          Exhibits
                          37














2





Fonix
Corporation and Subsidiaries


CONDENSED
CONSOLIDATED BALANCE SHEETS


(Unaudited)





March 31,
                                                          
                                                          
                                                          December
31,2009
                                                          
                                                          
                                                          2008ASSETSCurrent
    assetsCash and cash
      equivalents
                                                          
                                                          $
                                                          805,000
                                                          
                                                          
                                                          $
                                                          2,000Accounts
      receivable
                                                          
                                                          
                                                          2,600,000
                                                          
                                                          
                                                          
                                                          -Other
      receivables
                                                          
                                                          
                                                          15,000
                                                          
                                                          
                                                          
                                                          -Inventory
                                                          
                                                          
                                                          2,000
                                                          
                                                          
                                                          
                                                          -Total current
      assets
                                                          
                                                          
                                                          3,422,000
                                                          
                                                          
                                                          
                                                          2,000Property and
      equipment,net of
      accumulated depreciation of $1,305,000 and $1,303,000,
      respectively
                                                          
                                                          
                                                          65,000
                                                          
                                                          
                                                          
                                                          26,000Goodwill
                                                          
                                                          
                                                          658,000
                                                          
                                                          
                                                          
                                                          -Deposits and other
      assets
                                                          
                                                          
                                                          12,000
                                                          
                                                          
                                                          
                                                          12,000Total
assets
                                                          
                                                          $
                                                          4,157,000
                                                          
                                                          
                                                          $
                                                          40,000LIABILITIES AND STOCKHOLDERS'
      DEFICITCurrent
      liabilitiesAccrued
      liabilities
                                                          
                                                          $
                                                          7,316,000
                                                          
                                                          
                                                          $
                                                          6,510,000Accounts
      payable
                                                          
                                                          
                                                          2,204,000
                                                          
                                                          
                                                          
                                                          1,801,000Tax payable
                                                          
                                                          
                                                          33,000
                                                          
                                                          
                                                          
                                                          -Derivative
      liability
                                                          
                                                          
                                                          38,310,000
                                                          
                                                          
                                                          
                                                          34,582,000Accrued payroll and other
      compensation
                                                          
                                                          
                                                          501,000
                                                          
                                                          
                                                          
                                                          211,000Deferred
      revenues
                                                          
                                                          
                                                          445,000
                                                          
                                                          
                                                          
                                                          445,000Notes payable - related
      parties
                                                          
                                                          
                                                          918,000
                                                          
                                                          
                                                          
                                                          917,000Deferred tax liabilities assumed,
      net
                                                          
                                                          
                                                          237,000
                                                          
                                                          
                                                          
                                                          -Deposits and
      other
                                                          
                                                          
                                                          7,000
                                                          
                                                          
                                                          
                                                          7,000Total current
      liabilities
                                                          
                                                          
                                                          49,971,000
                                                          
                                                          
                                                          
                                                          44,473,000Long-term notes payable, net of
      current portion
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -Total
      liabilities
                                                          
                                                          
                                                          49,971,000
                                                          
                                                          
                                                          
                                                          44,473,000Commitments and
      contingenciesStockholders'
      deficitPreferred 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
                                                          
                                                          
                                                          
                                                          500,000Series L, convertible; 1,492
      shares and 1,498 shares outstanding , respectively
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -Common stock, $0.0001 par value;
      20,000,000,000 shares authorized;Class A voting, 7,279,371 shares
      and 3,447,501 shares outstanding, respectively
                                                          
                                                          
                                                          1,000
                                                          
                                                          
                                                          
                                                          1,000Class B non-voting, none
      outstanding
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -Additional paid-in
      capital
                                                          
                                                          
                                                          241,096,000
                                                          
                                                          
                                                          
                                                          240,949,000Outstanding warrants to purchase
      Class A common stock
                                                          
                                                          
                                                          474,000
                                                          
                                                          
                                                          
                                                          474,000Cumulative foreign currency
      translation adjustment
                                                          
                                                          
                                                          10,000
                                                          
                                                          
                                                          
                                                          10,000Accumulated
      deficit
                                                          
                                                          
                                                          (287,895,000
                                                          )
                                                          
                                                          
                                                          (286,367,000
                                                          )Total stockholders'
      deficit
                                                          
                                                          
                                                          (45,814,000
                                                          )
                                                          
                                                          
                                                          (44,433,000
                                                          )Total liabilities and
      stockholders' deficit
                                                          
                                                          $
                                                          4,157,000
                                                          
                                                          
                                                          $
                                                          40,000





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 March
      31,2009
                                                                                    
                                                                                    
                                                                                    2008RevenuesSpeech licenses, royalties and
      maintenance
                                                                                    
                                                                                    $
                                                                                    141,000
                                                                                    
                                                                                    
                                                                                    $
                                                                                    286,000Total
    Revenue
                                                                                    
                                                                                    
                                                                                    141,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    286,000Cost of
      revenuesSpeech licenses, royalties and
      maintenance
                                                                                    
                                                                                    
                                                                                    19,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    25,000Total cost of
      revenues
                                                                                    
                                                                                    
                                                                                    19,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    25,000Gross
profit
                                                                                    
                                                                                    
                                                                                    122,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    261,000Operating
      expenses:Selling, general and
      administrative
                                                                                    
                                                                                    
                                                                                    349,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    502,000Impairment of
      goodwill
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -Product development and
      research
                                                                                    
                                                                                    
                                                                                    243,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    218,000Total operating
      expenses
                                                                                    
                                                                                    
                                                                                    592,000
                                                                                    
                                                                                    
                                                                                    
                                                                                    720,000Other income
      (expense):Interest
      expense
                                                                                    
                                                                                    
                                                                                    (27,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (508,000
                                                                                    )Gain (loss) on derivative
      liability
                                                                                    
                                                                                    
                                                                                    (284,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (79,000
                                                                                    )Gain on forgiveness of
      liabilities
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -Other income (expense),
      net
                                                                                    
                                                                                    
                                                                                    (311,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (587,000
                                                                                    )Income (loss) from continuing
      operations
                                                                                    
                                                                                    
                                                                                    (781,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (1,046,000
                                                                                    )Loss from discontinued
      operations
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -Net income
      (loss)
                                                                                    
                                                                                    
                                                                                    (781,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (1,046,000
                                                                                    )Preferred stock
      dividends
                                                                                    
                                                                                    
                                                                                    (747,000
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (578,000
                                                                                    )Loss attributable to common
      stockholders
                                                                                    
                                                                                    $
                                                                                    (1,528,000
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (1,624,000
                                                                                    )Basic and diluted loss per common
      share from continuing operations
                                                                                    
                                                                                    $
                                                                                    (0.16
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (1.08
                                                                                    )Net loss
                                                                                    
                                                                                    $
                                                                                    (781,000
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (1,046,000
                                                                                    )Other comprehensive income -
      foreign currency translation
                                                                                    
                                                                                    
                                                                                    -
                                                                                    
                                                                                    
                                                                                    
                                                                                    -Comprehensive
      loss
                                                                                    
                                                                                    $
                                                                                    (781,000
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    (1,046,000
                                                                                    )





See
accompanying notes to condensed consolidated financial statements.





4




Fonix
Corporation and Subsidiaries


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Three Months Ended March
      31,
                                            
                                            2009
                                            
                                            
                                            2008Cash flows from operating
      activitiesNet loss
                                            
                                            $
                                            (781,000
                                            )
                                            
                                            $
                                            (1,046,000
                                            )Adjustments to reconcile net loss
      to net cash used in operating activities:Gain (loss) on derivative
      liability
                                            
                                            
                                            284,000
                                            
                                            
                                            
                                            79,000Accretion of discount on notes
      payable
                                            
                                            
                                            -
                                            
                                            
                                            
                                            310,000Depreciation
                                            
                                            
                                            2,000
                                            
                                            
                                            
                                            3,000Changes in assets and
      liabilitiesPrepaid expenses and other current
      assets
                                            
                                            
                                            -
                                            
                                            
                                            
                                            61,000Other
assets
                                            
                                            
                                            -
                                            
                                            
                                            
                                            108,000Accounts
      payable
                                            
                                            
                                            84,000
                                            
                                            
                                            
                                            228,000Accrued payroll and other
      compensation
                                            
                                            
                                            290,000
                                            
                                            
                                            
                                            -Other accrued
      liabilities
                                            
                                            
                                            70,000
                                            
                                            
                                            
                                            175,000Net cash used in operating
      activities
                                            
                                            
                                            (51,000
                                            )
                                            
                                            
                                            (82,000
                                            )Cash flows from investing
      activitiesNet cash acquired in
      acquistion
                                            
                                            
                                            796,000
                                            
                                            
                                            
                                            -Net cash used in investing
      activities
                                            
                                            
                                            796,000
                                            
                                            
                                            
                                            -Cash flows from financing
      activitiesProceeds from related party note
      payable
                                            
                                            
                                            58,000
                                            
                                            
                                            
                                            59,000Proceeds from issuance of Series O
      Preferred Stock
                                            
                                            
                                            -
                                            
                                            
                                            
                                            290,000Payments on accrued settlement
      obligation
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (200,000
                                            )Net cash provided by financing
      activities
                                            
                                            
                                            58,000
                                            
                                            
                                            
                                            149,000Net increase (decrease) in cash
      and cash equivalents
                                            
                                            
                                            803,000
                                            
                                            
                                            
                                            67,000Cash and cash equivalents at
      beginning of period
                                            
                                            
                                            2,000
                                            
                                            
                                            
                                            26,000Cash and cash equivalents at end
      of period
                                            
                                            $
                                            805,000
                                            
                                            
                                            $
                                            93,000


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 Three Months Ended March 31, 2009:





Issued
351 shares of Series P Preferred stock for the acquisition of G-Soft Limited.





Issued
2,093,099 shares of Class A common stock upon conversion of 6 shares of Series L
Convertible Preferred Stock.





Issued
196,652 shares of Class A common stock upon conversion of $14,000 in accrued
interest.





Issued
1,080,057 shares of Class A common stock upon conversion of $57,000 in notes
payable.





Accrued
$337,000 of dividends on Series L Preferred Stock.





Accrued
$34,000 of dividends on Series M Preferred Stock.





Accrued
$39,000 of dividends on Series N Preferred Stock.





Accrued
$16,000 of dividends on Series O Preferred Stock.





Accrued
$296,000 of dividends on Series P Preferred Stock.





Accrued
$28,000 of dividends on Fonix Speech Series B Preferred Stock.





The
Company acquired the following balance sheet items as a result of the
acquisition of G-Soft
Limited:


·
            Cash
      - $796,000


·
            Accounts
      receivable - $2,600,000


·
            Other
      receivables - $15,000


·
            Inventory
      - $2,000


·
            Property,
      plant and equipment - $41,000


·
            Goodwill
      - $658,000


·
            Accounts
      payable - $319,000


·
            Accrued
      liabilities - $13,000


·
            Taxes
      payable - $33,000


·
            Deferred
      tax liabilities, assumed - $237,000





For
the Three Months Ended March 31, 2008:





Issued
270,850 shares of Class A common stock upon conversion of 15 shares of Series L
Convertible Preferred Stock.





Issued
12,270 shares of Class A common stock upon conversion of $11,500 in accrued
interest.





Accrued
$481,000 of dividends on Series L Preferred Stock.





Accrued
$34,000 of dividends on Series M Preferred Stock.





Accrued
$31,000 of dividends on Series N Preferred Stock.







See
accompanying notes to condensed consolidated financial
statements.





6











Fonix
Corporation and Subsidiaries


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)


(Unaudited)





Accrued
$3,000 of dividends on Series O Preferred Stock.





Accrued
$28,000 of dividends on Fonix Speech Series B Preferred Stock.







See
accompanying notes to condensed consolidated financial statements.





7





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 ofFonixCorporation 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 2008 Annual Report on Form 10-K.





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 2008 Annual Report
on Form 10-K.





Operating
results for the three months ended March 31, 2009, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2009.





Nature of
Operations–Fonix Corporation(the “Company,” “Fonix,” or
“we”)was
incorporated in Delaware in 1985, and, pursuant to a merger transaction in 1994,
the Company’s name was changed to Fonix Corporation. The Company’s operations
are managed through its two wholly owned subsidiaries, Fonix Speech, Inc. (“Fonix
Speech”)and Fonix GS
Acquisition Co., Inc. (“Fonix GS”).





Fonix
Speech





Fonix Speech providesvalue-addedspeech-enabling technologies, speechinterface development
tools,and speech solutions
and applications,including
automated speech recognition (“ASR”) and text-to-speech (“TTS”, together with ASR,the “Core Technologies”) that empowerconsumersto interact conversationally with
information systems and
devices.Fonix
Speechoffersour speech-enabling technologies to
markets for personal software for consumer applicationsincluding video games, e.Dictionaries
and mobile navigation devices with GPS,wireless and mobile devices, computer
telephony,andserver solutions.Fonix Speech’s Products enhance
user productivity, ease of use and efficiency in a broad range of market
segments, including mobile and wireless devices; videogame consoles; electronic
devices for the assistive and language learning markets, robots, appliances;
automotive telematics, computer telephony and server applications.





Fonix Speechhasreceived various patents for certain elements of our Core
Technologies and have filed
applications for other patents covering various aspects of our technologies.Fonix Speechseeksto 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,unit royalties,maintenance contracts and
services.





Prior to
2002, Fonix Speech focused
on research and development (“R&D”) projects for customized
applications.  R&D and prototype development used the Core
Technologies to develop applications and engines marketed for multiple operating
systems and hardware platforms.  Today, Fonix Speech serves markets
that are adopting speech-enabled interfaces, solutions and
applications.  As memory requirements, noise robustness, speech
recognition accuracy and efficiency of speech interface solutions become
increasingly critical, Fonix Speech anticipates that its Core Technologies and
solutions will meet customer demand for simple, convenient user
interfaces.





8





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




Fonix GS





Fonix GS
was formed on June 27, 2008, to facilitate the acquisition of Shanghai Gaozhi Software Systems Limited
(“GaozhiSoft”).  GaozhiSoft isa Chinese software developer and
solutions provider in 2G (second-generation) and 3G (third-generation)telecommunication operation
support systemsin China
and throughout the Asian Pacific region.Gaozhisoft isaqualified competitor for telecommunication operation
supports systems.


GaozhiSoft’s products are designed to
increase data transferring speed, reduce telecommunications data loss and
provide network management, billing accuracy and improved implementation
techniques to telecom carriers.





GaozhiSoft’s software products are
divided into two main categories: (1)MOSS series and(2)MDtrac series. MOSS products provideservice
providerswith integrated
electronic management platformsfor peer-to-peer business
operation and automatic
management.MDtrac products providedatacollectionsolutions.GaozhiSoft hasreceived variouscopyrights andpatents for certain of its products and
hasfiled applications for
othercopyrights andpatents covering various
aspects ofits
products.





Business
Condition-For
the quarters ended March 31, 2009 and 2008, the company generated revenues of
$141,000 and $286,000, respectively, and incurred net losses of $781,000 and
$1,046,000, respectively; and had negative cash flows from operating activities
of $51,000 and $82,000, respectively.  As of March 31, 2009, we had an
accumulated deficit of $287,895,000; negative working capital of $46,549,000;
derivative liabilities of $38,310,000 related to the issuance of Series P
Preferred Stock, Series L Preferred Stock, Series M Preferred stock, Series N
Preferred Stock, Series O Preferred Stock, Series E Convertible Debentures and
Series B Preferred Stock of our subsidiary; accrued liabilities of $7,316,000;
accounts payable of $2,204,000; deferred revenues of $445,000.  We
expect to continue to incur significant losses and negative cash flows from
operating activities at least through December 31, 2009, 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.  On March 15, 2007, the New York State trial court entered
judgment against the Company and in favor of the Breckenridge Fund in the amount
of $1,602,000.  In February 2008, the Company entered into an amended
settlement agreement with Breckenridge under which the Company agreed to pay
Breckenridge $540,000.  The Company has paid Breckenridge the full
amount.  No further obligations are required by the Company to
Breckenridge.





These
factors, as well as the risk factors set out elsewhere in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008,  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 March 31, 2009 and 2008, there
were outstanding common stock equivalents to purchase or receive
1,114,567,966and
30,758,759 shares of common stock, respectively.  All common stock
equivalents at March 31, 2009 and 2008 were excluded 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 months ended March 31, 2009 and
2008:





Three
      Months Ended March 31,2009
                                                
                                                
                                                2008Per
                                                
                                                
                                                
                                                
                                                
                                                PerShare
                                                
                                                
                                                
                                                
                                                
                                                ShareAmount
                                                
                                                
                                                Amount
                                                
                                                
                                                Amount
                                                
                                                
                                                AmountNet
      loss
                                                
                                                $
                                                (781,000
                                                )
                                                
                                                
                                                
                                                
                                                $
                                                (1,046,000
                                                )Preferred
      stock dividends
                                                
                                                
                                                (747,000
                                                )
                                                
                                                
                                                
                                                
                                                
                                                (578,000
                                                )Loss
      attributable to common stockholders
                                                
                                                $
                                                (1,528,000
                                                )
                                                
                                                $
                                                (0.16
                                                )
                                                
                                                $
                                                (1,624,000
                                                )
                                                
                                                $
                                                (1.08
                                                )Weighted-average
      common shares outstanding
                                                
                                                
                                                4,885,960
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                969,167




9





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




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 collectability
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 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
collectability is probable.  Post-contract obligations, if any,
generally consist of one year of support including such services as customer
calls, bug fixes, and upgrades.  Related revenue is recognized over
the period covered by the agreement.  Revenues from maintenance and
support contracts are also recognized over the term of the related
contracts.





Revenues
applicable to multiple-element fee arrangements are bifurcated among the
elements such as license agreements and support and upgrade obligations using
vendor-specific objective evidence of fair value.  Such evidence
consists primarily of pricing of multiple elements as if sold as separate
products or arrangements.  These elements vary based upon factors such
as the type of license, volume of units licensed, and other related
factors.





Deferred
revenue as of March 31, 2009, and December 31, 2008, consisted of the
following:





Description
                  Criteria
      for Recognition
                  
                  March
      31, 2009
                  
                  
                  December
      31, 2008Deferred
      unit royalties and license fees
                  Delivery
      of units to end users or expiration of contract
                  
                  $
                  445,000
                  
                  
                  $
                  445,000




10





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




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.





Goodwill -In accordance with the provisions of SFAS No. 142, “Goodwill and
Other Intangible Assets,” the Company tests its recorded goodwill for impairment
on an annual basis during the fourth quarter, or more often if indicators of
potential impairment exist, by determining if the carrying value of each
reporting unit exceeds its estimated fair value. Factors that could trigger
impairment include, but are not limited to, underperformance relative to
historical or projected future operating results, significant changes in the
manner of use of the acquired assets or the Company’s overall business and
significant negative industry or economic trends. Future impairment reviews may
require write-downs in the Company’s goodwill and could have a material adverse
impact on the Company’s operating results for the periods in which such
write-downs occur.





Fair
Value of Financial Instruments - The carrying amount of cash and cash
equivalents, receivables, accounts payable and accrued expenses approximates
fair value because of their short maturity.  The carrying value of the
goodwill approximates its fair value.





2.  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 secured by the capital stock and all of
the assets of LTEL Holdings and its subsidiaries.  The Note was
originally valued at $4,624,000 based on an imputed interest rate of 25 percent
per annum.





On
September 8, 2006, the Company received a default notice (the “Default Notice”)
from McCormack in respect of the Note  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.  McCormack has taken no
action to collect amounts due under the Note.





During
the fourth quarter of 2006, the Company entered into two promissory notes with
McCormack Avenue, Ltd., in the aggregate amount of $330,000. These notes accrue
interest at 10% annually and were due and payable during the second quarter of
2007.  These promissory notes were exchanged for shares of the
Company’s Series P Preferred Stock.  See table below.





During
the quarter ended March 31, 2007, the Company entered into five promissory notes
with McCormack Avenue, Ltd. and Sovereign Partners LP., in the aggregate amount
of $450,000.  These notes accrue interest at 10% annually and were due
and payable during the third quarter of 2007.  These promissory notes
were exchanged for shares of the Company’s Series P Preferred
Stock.  See table below.





11





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





On
September 30, 2008, the Company entered into a Series P 9% Convertible Preferred
Stock Exchange Agreement (the “Exchange Agreement”) with McCormack and Sovereign
Partners, LP (“Sovereign”), whereby McCormack exchanged the Note, along with
other promissory notes and the Series E debenture (discussed in Note 6), and
Sovereign exchanged two promissory notes, for shares of the Company’s Series P
9% Convertible Preferred Stock (the Series P Preferred Stock”).  The
obligations exchanged and the number of shares of Series P Preferred Stock
issued is as follows:





Purchaser
                                                                    Nature
      of Obligation Exchanged
                                                                    
                                                                    Amount
      of Obligation
                                                                      Exchanged
                                                                    
                                                                    
                                                                    Number
      of Series P
                                                                      Preferred
      Shares IssuedSovereign
      Partners LP
                                                                    Promissory
      Note, dated February 22, 2007, in the principal amount of $100,000, and
      interest of $16,278
                                                                    
                                                                    $
                                                                    116,278
                                                                    
                                                                    
                                                                    
                                                                    11.6278Sovereign
      Partners LP
                                                                    Promissory
      Note, dated March 13, 2007, in the principal amount of $100,000, and
      interest of $15,750
                                                                    
                                                                    $
                                                                    115,750
                                                                    
                                                                    
                                                                    
                                                                    11.575McCormack
      Avenue, Ltd.
                                                                    Promissory
      Note, dated January 11, 2007, in the principal amount of $50,000, and
      interest of $8,722
                                                                    
                                                                    $
                                                                    58,722
                                                                    
                                                                    
                                                                    
                                                                    5.8722McCormack
      Avenue, Ltd.
                                                                    Promissory
      Note, dated January 19, 2007, in the principal amount of $100,000, and
      interest of $17,222
                                                                    
                                                                    $
                                                                    117,222
                                                                    
                                                                    
                                                                    
                                                                    11.7222McCormack
      Avenue, Ltd.
                                                                    Promissory
      Note, dated January 26, 2007, in the principal amount of $100,000, and
      interest of $17,028
                                                                    
                                                                    $
                                                                    117,028
                                                                    
                                                                    
                                                                    
                                                                    11.7028McCormack
      Avenue, Ltd.
                                                                    Promissory
      Note, dated December 28, 2006, in the principal amount of $95,000, and
      $16,942
                                                                    
                                                                    $
                                                                    111,942
                                                                    
                                                                    
                                                                    
                                                                    11.1942McCormack
      Avenue, Ltd.
                                                                    Promissory
      Note, dated December 15, 2006, in the principal amount of $235,000, and
      interest of $42,701
                                                                    
                                                                    $
                                                                    277,701
                                                                    
                                                                    
                                                                    
                                                                    27.7701McCormack
      Avenue, Ltd.
                                                                    Note
      Payable, dated February, 2004, in the principal amount of $8,732,620, and
      interest of $1,311,105
                                                                    
                                                                    $
                                                                    10,043,725
                                                                    
                                                                    
                                                                    
                                                                    1,004.3725McCormack
      Avenue, Ltd.
                                                                    Series
      E Debenture, dated December 7, 2007, in the principal amount of
      $1,754,464, and interest of $291,763
                                                                    
                                                                    $
                                                                    2,046,227
                                                                    
                                                                    
                                                                    
                                                                    204.6227





3.  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, was 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.  As of June
30, 2008, 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.





12





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





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 and other consideration from the Lenders in
the aggregate amount of $419,000 and made principal payments to the Lenders
against the note of $105,000.  During the year ended December 31,
2007, the Company received additional advances of $102,000.  During
the three months ended March 31, 2009, the Company received additional advances
of $58,000.  The balance due at March 31, 2009, was
$918,000.





The
balance due of $918,000 is secured by the Company’s intellectual property rights
and common stock of Fonix Speech.  For the three months ended March
31, 2009, the Lenders converted $57,000 of the principal balance into 1,080,057
shares common stock, and also converted $14,000 of accrued interest into 196,652
shares of common stock for the benefit of one of the Lenders, Thomas A. Murdock,
a former officer and director of the Company.





4.  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 March 31, 2009, 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 $15 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 .0000075 shares of common
stock for each share of Series A convertible preferred stock.





Series L
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 2,000 shares of Series H Preferred Stock that they acquired from
the 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 (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 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%).





13





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





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 March 31,
2009, the fair value of the Series L Preferred Stock derivative liability was
$15,409,000.





For the
three months ended March 31, 2009, the Company issued 2,093,099 shares of its
Class A common stock in conversion of 6 shares of its Series L Preferred
Stock.  At March 31, 2009, 1,492 shares of Series L Preferred Stock
remained outstanding.  (See Note 9 for discussion of conversions
subsequent to March 31, 2009.)





Series M
Preferred Stock– On April 4, 2007, the Company entered into a Series M
9% Convertible Preferred Stock Exchange Agreement with Sovereign Partners, LP
(“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
$1,603,000 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 March 31, 2009, the fair value of the
Series M Preferred Stock derivative liability was $1,549,000.





As of
March 31, 2009, there were 150 shares of Series M Preferred Stock convertible
preferred stock outstanding.





14





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Series N
Convertible Preferred Stock – On August 24, 2007, the Company entered
into a Securities Purchase Agreement with Trillium Partners, LP and other
unnamed future investors relating to the issuance and sale of the Company’s
Series N 9% Convertible Preferred Stock.





Pursuant
to the agreement, the Company agreed to issue up to 2,400 shares of its Series N
9% Convertible Preferred Stock (the “Series N Preferred Stock”) at a per share
price of $1,000 to Trillium Partners, LP and other unnamed future investors, for
gross proceeds of up to $2,400,000.  As of the date of this report,
the Company had issued 1,755 shares of the Series N Preferred Stock, for cash
proceeds of $1,350,000.





The
Series N Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series N
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 N Preferred Stock is convertible into Class A common stock of the Company
at the option of the holder by using a conversion price equal to 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 N Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series N Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





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
$957,000 due to the value of the conversion feature of the Series N Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 128%, risk-free rate of 5.0% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
N Preferred Stock, no value was prescribed to the Series N Preferred
Stock.  At March 31, 2009, the fair value of the Series N Preferred
Stock derivative liability was $1,812,000.





As of
March 31, 2009, there were 1,755 shares of Series N Preferred Stock convertible
preferred stock outstanding.





Series O
Convertible Preferred Stock – Between January 25, 2008, and September 30,
2008, the Company received advances from three entities in connection with the
purchase agreements related to the Company’s Series O 9% Convertible Preferred
Stock (“Series O Preferred Stock”). On May 20, 2008, the Company entered into
Securities Purchase Agreements with Southridge Partners LP, Southshore Capital
Fund LTD, Sovereign Partners LP (collectively, the “Series O Purchasers”) for
the sale of an aggregate of 730 shares of Series O Preferred Stock for gross
proceeds of $730,000.  The material terms of the purchase agreements
had been agreed upon prior to receipt of the advances.  Therefore, the
Series O Preferred Stock was accounted for as discussed below on the dates cash
proceeds were received by the Company.  The Company also began
accruing dividends upon receiving the advances.





The
Series O Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series O
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 O Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price, equal to 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 O Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series O Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





15





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





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 $290,000 due to the value of the
conversion feature of the Series O Preferred Stock. The liability was calculated
using the Black-Scholes valuation model with the following assumptions: dividend
yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected
life of 4 years. As the value of the derivative liability was greater than the
face value of the Series O Preferred Stock, no value was prescribed to the
Series O Preferred Stock. At March 31, 2009, the fair value of the Series O
Preferred Stock derivative liability was $753,000.





As of
March 31, 2009, there were 730 shares of Series O Preferred Stock convertible
preferred stock outstanding.





Series P
Convertible Preferred Stock – On September 30, 2008, the Company entered
into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange
Agreement”) with Sovereign Partners, LP (“Sovereign”), and McCormack Avenue Ltd.
(“McCormack”).  Pursuant to the Exchange Agreement, Sovereign and
McCormack exchanged certain debt obligations, discussed more fully below, for
shares of the Company’s Series P 9% Convertible Preferred Stock (the “Series P
Preferred Stock”).





The
Series P Preferred Stock entitles the holders to receive dividends in an amount
equal to 9% of the then-outstanding balance of shares of Series P 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 P 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 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 P Preferred Stock, whether at our option or that of the holder,
requires us to pay, as a redemption price, the stated value of the outstanding
shares of Series P 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 P were issued in exchange for certain outstanding debt
obligations, the Company, we did not receive any proceeds in connection with the
issuance of the Series P Preferred Stock to McCormack and
Sovereign.





In
connection with the issuance of the Series P Preferred Stock, on September 26,
2008, the Company filed with the State of Delaware a Certificate of Designation
and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a
part of its Certificate of Incorporation, as amended.





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 $13,,000 due to the value of the
conversion feature of the Series P Preferred Stock. The liability was calculated
using the Black-Scholes valuation model with the following assumptions: dividend
yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected
life of 4 years. As the value of the derivative liability was greater than the
face value of the Series P Preferred Stock, no value was prescribed to the
Series P Preferred Stock. At March 31, 2009, the fair value of the Series P
Preferred Stock derivative liability was $16,621,000.





As of
March 31, 2009, there were 1,651 shares of Series P Preferred Stock convertible
preferred stock outstanding.  During the quarter ended March 31, 2009,
the Company issued the following shares of Series P Preferred
Stock:





16





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Issuance
of Series P 9% Convertible Preferred Stock in G-Soft Transaction





As
disclosed in a Current Report filed with the Commission on March 27, 2009, Fonix
Corporation (the “Company”) issued an aggregate of one hundred and twenty shares
(120) of the Company’s Series P 9% Convertible Preferred Stock (the “Series P
Preferred Stock”) to G-Soft Limited, a Hong Kong corporation (“G-Soft”), which
is the ultimate parent of Shanghai Gaozhi Software Systems Limited
("GaozhiSoft"), and the shareholders of G-Soft (collectively, the
“Sellers”).  The Shares of Series P Preferred Stock were issued
pursuant to an exchange agreement (the “Exchange Agreement”), with Southridge
LLC, a Connecticut limited liability company (“Southridge”), and the
Sellers.  Additionally, subject to the terms of the amended agreement
with the Sellers, the Sellers are entitled to annual earn-out payments equal to
fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in
the form of Series P Preferred Stock (the “Earn-Out Payments”).  The
aggregate of the Earn-Out Payments is limited to three hundred and eighty (380)
shares of Series P Preferred, which were issued into an escrow
account.





The
Series P Preferred Stock entitles the holders to receive dividends in an amount
equal to 9% of the then-outstanding balance of shares of Series P Preferred
Stock.  The dividends are payable in cash or shares of our Class A
common stock, at the Company’s option.





The
Series P Preferred Stock may be converted into the Company’s common stock at the
option of the holder by using a conversion price which shall be 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 P Preferred Stock, whether at the Company’s option or that of the
holder, requires the Company to pay, as a redemption price, the stated value of
the outstanding shares of Series P Preferred Stock to be redeemed, together with
any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





On
September 26, 2008, the Company filed with the State of Delaware a Certificate
of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”),
which become a part of the Company’s Certificate of Incorporation, as
amended.





Under the
G-Soft Agreement and the Series P Terms, the holders of the Series P Preferred
Stock may convert shares of Series P Preferred Stock into shares of the
Company’s common stock.  The Company’s issuances of shares of common
stock upon any conversion of the Series P Preferred Stock will be made without
registration under the Securities Act of 1933 (the “1933 Act”) in reliance on
Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to the Sellers was made without registration under the 1933 Act in
reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder.





Issuance
of Shares of Series P 9% Convertible Preferred Stock to Acquire Remaining 20% of
G-Soft





In
connection with the G-Soft transaction described above, on March 27, 2009, the
Company entered into a Series P Convertible Preferred Stock Purchase Agreement
(the “Preferred Stock Purchase Agreement”), with Southridge Partners LP
(“Southridge”).  Pursuant to the Preferred Stock Purchase Agreement,
the Company issued 189 shares of Series P Preferred Stock in exchange for the
20% of G-Soft shares which Southridge had purchased in the G-Soft Transaction
described above.





The
Series P Preferred Stock issued to Southridge has the same terms as described
above.





Under the
Preferred Stock Purchase Agreement and the Series P Terms, Southridge may
convert shares of Series P Preferred Stock into shares of the Company’s common
stock.  The Company’s issuances of shares of common stock upon any
conversion of the Series P Preferred Stock will be made without registration
under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of
the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to Southridge was made without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.





17





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Issuance
of Shares of Series P 9% Convertible Preferred Stock I n Payment of
Notes





In
connection with the G-Soft transaction described above, Southridge Partners
(“Southridge”) and Southshore Capital Fund (“Southshore”) made a bridge loan to
G-Soft in the amount of $400,000.  Upon the acquisition of G-Soft b y
Fonix GS, Fonix Corporation agreed to repay the bridge loan through the issuance
of shares of Series P Preferred Stock.





In an
agreement dated March 31, 2009, the Company issued an aggregate of 42 shares of
Series P Preferred Stock to Southridge and Southshore as repayment of the bridge
loans described above.





The
Series P Preferred Stock issued to Southridge and Southshore has the same terms
as described above.





Under the
Preferred Stock Purchase Agreement and the Series P Terms, Southridge and
Southshore may convert shares of Series P Preferred Stock into shares of the
Company’s common stock.  The Company’s issuances of shares of common
stock upon any conversion of the Series P Preferred Stock will be made without
registration under the Securities Act of 1933 (the “1933 Act”) in reliance on
Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to Southridge was made without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.





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 purchase 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 March 31, 2009, the fair value of the Series B Preferred
Stock derivative liability was $1,291,000.





As of
March 31, 2009, there were 125 shares of Series B Preferred Stock convertible
preferred stock outstanding.





18





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





5.  CONVERTIBLE
DEBENTURES





On
December 7, 2006, the Company entered into a Securities Purchase Agreement,
dated as of December 1, 2006 (the “Agreement”), with Southridge Partners, LP
(“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 Company received no new capital in connection with the
issuance and sale 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 Class A common stock issuable upon conversion of the
Debenture.   As of the date of this Report, no registration
statement has been filed.





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 Company’s Class A common
stock on the same terms as the Debenture.





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.  As of the date of this Report, no registration statement
had been filed.





This
debenture was exchanged for shares of the Company’s Series P Preferred
Stock.  See Note 2.





6.  COMMON
STOCK, STOCK OPTIONS AND WARRANTS





Class A Common
Stock – In December 2008, the Company implemented a 1-for-5,000 share
reverse stock split.  The share numbers in these notes have been
adjusted to reflect the reverse stock split.  During the three months
ended March 31, 2009, 2,093,099 shares of Class A common stock were issued in
conversion of 6 shares of Series L Preferred Stock, 1,080,057 shares were issued
in conversion of the outstanding balance on the related party note and 196,652
shares were issued in conversion of accrued interest on the related party
note.





Stock Options
– As of March 31, 2009, the Company had a total of 40 options to purchase
Class A common stock outstanding.  During the three months ended March
31, 2009 no options were granted.





Warrants –
As of March 31, 2009, the Company had warrants to purchase a total of 3 shares
of Class A common stock outstanding that expire through 2010.





19





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





7.  LITIGATION,
COMMITMENTS AND CONTINGENCIES





Hite Development Corporation v. Fonix
Corporation,Third District Court, Salt Lake County (Civil No.
070900883).  In January 2007, Hite Development Corporation (“Hite”)
brought a lawsuit against the Company claiming breach of contract and breach of
the covenant of good faith and fair dealing, alleging that the Company failed to
make certain payments under a settlement agreement with Hite dating from March
2005.  The complaint seeks approximately $33,000 plus
interest.  The Company filed its answer in May
2007.   On May 8, 2008, Hite filed a motion for summary judgment,
which the Court granted.





RR Donnelley Receivables Inc. v.
Fonix Corporation,Third District Court, Salt Lake County (Civil No.
070412088).  In July 2007, RR Donnelley Receivables Inc. (“Donnelly”)
brought a lawsuit against the Company for alleged failure to pay for services
provided.  The complaint seeks approximately $21,000 plus
interest.  The Company filed its answer in August 2007, and filed a
motion to dismiss the action in December 2007.  That motion is
currently pending before the court.  If the Company’s motion to
dismiss is denied, the Company intends to defend


against
the claims in the complaint.





Perpetual Storage, Inc. vs. Fonix
Corporation, Third District Court, Salt Lake County (Civil No.
080907080).  Perpetual Storage, Inc. (“PSI”), brought suit, claiming
breach of contract and unjust enrichment, and seeking damages of approximately
$12,300 plus attorneys’ fees and costs.  The Company filed its answer
in July 2008.  In December 2008, PSI moved for summary judgment, which
the Company opposed.  The Court denied the motion at a hearing in
April 2009.  As of the date of this report, the case was in the
discovery phase.





8.  FAIR
VALUE





SFAS No.
157 establishes a fair value hierarchy which requires an entity to maximize the
use of observable inputs and minimize the use of unobservable inputs when
measuring fair value. SFAS No. 157 describes three levels of inputs that the
Company uses to measure fair value:





·
            Level
      1: Quoted prices (unadjusted) for identical assets or liabilities in
      active markets that the entity has the ability to access as of the
      measurement date.





·
            Level
      2: Level 1 inputs for assets or liabilities that are not actively traded.
      Also consists of an observable market price for a similar asset or
      liability. This includes the use of “matrix pricing” used to value debt
      securities absent the exclusive use of quoted
  prices.





·
            Level
      3: Consists of unobservable inputs that are used to measure fair value
      when observable market inputs are not available. This could include the
      use of internally developed models, financial forecasting,
      etc.





Fair
value is defined as the price that would be received to sell an asset or paid to
transfer a liability between market participants at the balance sheet date. When
possible, the Company looks to active and observable markets to price identical
assets or liabilities. When identical assets and liabilities are not traded in
active markets, the Company looks to observable market data for similar assets
and liabilities. However, when certain assets and liabilities are not traded in
observable markets the Company must use other valuation methods to develop a
fair value.





The
following table presents financial assets and liabilities measured on a
recurring basis:





Fair
      Value Measurements at Reporting Date UsingDescription
                                        
                                        Balance
      at
                                          March
      31, 2009
                                        
                                        
                                        Quoted
      Prices in
                                          Active
      Markets for
                                          Identical
      Assets
                                          (Level
      1)
                                        
                                        
                                        Significant
      Other
                                          Observable
                                          Inputs
                                          (Level
      2)
                                        
                                        
                                        Significant/Unobservable
                                          Inputs
                                          (Level
      3)Certificates
      of deposit
                                        
                                        $
                                        225,000
                                        
                                        
                                        $
                                        225,000
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —Goodwill
                                        
                                        $
                                        658,000
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        $
                                        658,000








20





Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





9.  SUBSEQUENT
EVENTS





Subsequent
to March 31, 2009, the Company has issued 2,350,007 shares of its Class A common
stock in conversion of 6 shares of Series L Preferred Stock.





Subsequent
to March 31, 2009, the Company has issued 447,678 shares of its Class A common
stock in payment of interest on the Series L Preferred Stock.





Subsequent
to March 31, 2009, the Company has issued 550,000 shares of its Class A common
stock in payment of principal and interest on related party notes
payable.





Subsequent
to March 31, 2009, the Company has issued 481,202 shares of its Class A common
stock for services performed.

















21





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, 2008.  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, 2008, 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.





22





For the
three months ended March 31, 2009 and 2008, the company generated revenues of
$141,000 and $286,000, respectively, and incurred net losses of $781,000 and
$1,046,000, respectively.  As of March 31, 2009, we had an accumulated
deficit of $287,895,000; negative working capital of $46,549,000; derivative
liabilities of $38,310,000 related to the issuance of Series L Preferred
Stock,  Series M Preferred Stock, Series N Preferred Stock, Series O
Preferred Stock,  Series P Preferred Stock and Series B Preferred
Stock of our subsidiary; accounts payable of $2,204,000; notes payable to
related parties of $918,000; accrued payroll and other compensation of $501,000
and deferred revenues of $445,000.  We expect to continue to incur
significant losses and negative cash flows from operating activities at least
through December 31, 2009, 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.





Fonix GS
was formed on June 27, 2008, to facilitate the acquisition of Shanghai Gaozhi Software Systems Limited
(“GaozhiSoft”).  GaozhiSoft is a leading Chinese software developer
and solutions provider in 2G (second-generation) and 3G (third-generation)
telecommunication operation support systems in China and throughout the Asian
Pacific region.  Gaozhisoft is a qualified competitor for
telecommunication operation supports systems.





GaozhiSoft’s products are designed to
increase data transferring speed, reduce telecommunications data loss and
provide network management, billing accuracy and improved implementation
techniques to telecom carriers.





GaozhiSoft’s software products are
divided into two main categories: (1) MOSS series and (2) MDtrac series. MOSS
products provide service providers with integrated electronic management
platforms for peer-to-peer business operation and automatic
management.  MDtrac products provide data collection
solutions.  GaozhiSoft has received various copyrights and patents for
certain of its products and has filed applications for other copyrights and
patents covering various aspects of its products.





Gaozhisoft has an outstanding management
team with extensive industrial knowledge and experience with system developing,
marketing and sales.  Since completion of the acquisition of
GaozhiSoft, Fonix GS, through its wholly owned foreign entities, has been
working with the management team to transition the business with a focus on
creating synergies among the Company’s existing technologies and GoazhiSoft’s
products.  Upon completion of the transition, we expect GaozhiSoft to
continue its rapid growth and market penetration based on the implementation of
the 3G mobile network service with these professional
partners.





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.  To date, no additional sources of funding
offering terms superior to those available under equity lines have been
implemented, and we rely on first, cash generated from operations, and second,
cash provided through convertible debt financing arrangements.  We
will need to generate approximately $2 to $3 million to continue operations for
the next twelve months.  There can be no assurance that we will be
able to obtain such financing or that, if we can obtain such financing, it will
be on terms favorable to us.





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:





23





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 collectability 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 its 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
collectability 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.





24





Deferred revenue as of March 31, 2009,
and December 31, 2008, consisted of the following:




Description
                              Criteria
      for Recognition
                              
                              March
      31, 2009
                              
                              
                              December
      31, 2008Deferred
      unit royalties and license fees
                              Delivery
      of units to end users or expiration of contract
                              
                              $
                              445,000
                              
                              
                              $
                              445,000





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.





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.





Recently Enacted
Accounting Standards





In
March 2008, the Financial Accounting Standards Board (FASB) issued SFAS
No. 161 (SFAS 161), “Disclosures about Derivative Instruments and Hedging
Activities, an Amendment of FASB Statement No. 133.” SFAS 161 amends and
expands the disclosure requirements of Statement 133 with the intent to provide
users of financial statements with an enhanced understanding of how and why an
entity uses derivative instruments, how derivative instruments and related
hedged items are accounted for under Statement 133 and its related
interpretations, and how derivative instruments and related hedged items affect
an entity’s financial position, financial performance, and cash flows. 
SFAS 161 was effective beginning in the first quarter of fiscal 2009. The
adoption of this accounting pronouncement had no effect on the Company’s
consolidated financial position or results of operations.





25





In
December 2007, the FASB issued SFAS No. 141 (revised 2007)
(SFAS 141R), Business Combinations and SFAS No. 160 (SFAS 160),
Noncontrolling Interests in Consolidated Financial Statements, an amendment of
Accounting Research Bulletin No. 51. SFAS 141R changes how business
acquisitions are accounted for and impacts financial statements both on the
acquisition date and in subsequent periods. SFAS 160 changes the accounting
and reporting for minority interests, which is recharacterized as noncontrolling
interests and classified as a component of equity. SFAS 141R and
SFAS 160 were effective for us beginning in the first quarter of fiscal
2009. The adoption of SFAS 141R and SFAS 160 had no effect on the
Company’s consolidated financial position or results of operations.





In April
2009, the Financial Accounting Standards Board (FASB) issued three FASB Staff
Positions, or FSPs, to address concerns about (1) measuring the fair value
of financial instruments when the markets become inactive and quoted prices may
reflect distressed transactions and (2) recording impairment charges on
investments in debt securities. The FASB also issued a third FSP to require
disclosures of fair values of certain financial instruments in interim financial
statements.





FSP No.
FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the
Asset or Liability Have Significantly Decreased and Identifying Transactions
That Are Not Orderly,” provides additional guidance to highlight and expand on
the factors that should be considered in estimating fair value when there has
been a significant decrease in market activity for a financial asset. This FSP
also requires new disclosures relating to fair value measurement inputs and
valuation techniques (including changes in inputs and valuation
techniques).





FSP No.
FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary
Impairments,” will change (1) the trigger for determining whether an
other-than-temporary impairment exists and (2) the amount of an impairment
charge to be recorded in earnings. To determine whether an other-than-temporary
impairment exists, an entity will be required to assess the likelihood of
selling a security prior to recovering its cost basis. This is a change from the
current requirement for an entity to assess whether it has the intent and
ability to hold a security to recovery or maturity. This FSP also expands and
increases the frequency of existing disclosure about other-than-temporary
impairments and requires new disclosures of the significant inputs used in
determining a credit loss, as well as a rollforward of that amount each
period.





FSP No.
FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial
Instruments,” increases the frequency of fair value disclosures from annual to
quarterly to provide financial statement users with more timely information
about the effects of current market conditions on their financial
instruments.





The
Company is currently evaluating the provisions of these three FSPs which require
adoption effective for the quarter ending June 30, 2009. The Company
believes that the future requirements of these three FSPs will not have a
material impact on its consolidated financial position or results of
operations.





Results
of Operations





Three
months ended March 31, 2009, compared with three months ended March 31,
2008





During
the three months ended March 31, 2009, we recorded revenues of $141,000, a
decrease of $145,000 from $286,000 for the same period in 2008. The decrease was
primarily due to decreased support revenue of $46,000, royalty revenues of
$25,000, and decreased application revenue of $25,000.





Selling,
general and administrative expenses were $349,000 for the three months ended
March 31, 2009, a decrease of $153,000 from $502,000 for the same period in
2008. The decrease is primarily due to decreased occupancy related expenses of
$129,000, decreased other expenses of $41,000 and decreased travel expenses of
$51,000, partially offset by increased wage related expenses of $55,000, and
increased legal and accounting fees of $13,000.





We
incurred research and product development expenses of $243,000 for the three
months ended March 31, 2009, an increase of $25,000 from $218,000 for the same
period in 2008. The increase was primarily due to an overall increase of wage
related expenses of $74,000 offset by decreases in occupancy expenses of
$32,000, decreased other operating expenses of $13,000, decreased travel
expenses of $4,000.








26




Liquidity and Capital
Resources





We must raise additional funds to be
able to satisfy our cash requirements during the next 12
months.It is anticipated that we will need to raise
approximately $2.5 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 not sufficient to cover current operating expenses and
payments of current liabilities.  AtMarch 31, 2009,negative working capital of
$46,549,000; derivative liabilities of $38,310,000 related to the issuance of
Series L Preferred Stock,  Series M Preferred Stock, Series N
Preferred Stock, Series O Preferred Stock,  Series P Preferred Stock
and Series B Preferred Stock of our subsidiary; accrued liabilities of
$7,316,000; accounts payable of $2,204,000;  notes payable to related
parties of $918,000; accrued payroll and other compensation of $501,000 and
deferred revenues of $445,000.





We had $141,000in revenue and a loss of $781,000 for the three months ended March
31, 2009.  Net cash used in operating activities of $51,000 for the
three months ended March 31, 2009, resulted principally from the net loss
incurred of $781,000, increased accrued liabilities of
$290,000,  non-cash loss
recognized on the derivative liability of $284,000, increased accounts payable of
$84,000, and depreciation expense of $2,000.  Net cash used obtained
investing activities of $796,000, for the three months ended March 31, 2009,
consisted of the cash acquired in the acquisition of $796,000.  Net
cash provided by financing activities of $58,000 from the proceeds from the
related party note of $58,000.





Wehad negative working capital of
$46,549,000 at March 31, 2009, compared to
negative working capital of $44,471,000 at December 31, 2008.  Current assets increased by
$3,420,000 to $3,422,000 from $2,000 from December 31, 2008, to March 31,
2009.  Current liabilities
increased by $5,498,000 to $49,971,000 from $44,473,000 during the same
period.  The change in working capital from December 31, 2008, to
March 31, 2009, reflects, in part, increased accrued
liabilities of $806,000, increased accounts payable of
$403,000, increased derivative liability of $3,728,000,increased accrued payroll and other
compensation of $290,000,increased tax payable of $33,000, and increased notes payable to related parties
of $1,000.Total assets were $4,157,000 at March 31, 2009, compared to
$40,000 at December 31, 2008.





Notes
Payable - Related Parties





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, was 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.  As of
March 31, 2009, 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.





27




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 and other consideration from the Lenders in
the aggregate amount of $419,000 and made principal payments to the Lenders
against the note of $105,000.  During the year ended December 31,
2007, the Company received additional advances of $102,000.  During
the three months ended March 31, 2009, the Company received additional advances
of $59,000.  The balance due at March 31, 2009, was
$918,000.





The
balance due of $918,000 is secured by the Company’s intellectual property rights
and common stock of Fonix Speech.  For the three months ended March
31, 2009, one of the Lenders, not a current executive, office r or
director  converted $57,000 of the principal balance into 1,080,057
shares common stock, and also converted $15,000 of accrued interest into 196,652
shares of common stock for the benefit of one of the Lenders, Thomas A. Murdock,
a former officer and director of the Company.





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 was
payable in cash or, at the Company’s option, in shares of the Company’s Class A
common stock.  The Note was secured by the capital stock and all of
the assets of LTEL Holdings and its subsidiaries.  The Note was
originally valued at $4,624,000 based on an imputed interest rate of 25 percent
per annum.





On
September 8, 2006, the Company received a default notice (the “Default Notice”)
from McCormack in respect of the Note.   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.  McCormack has taken no
action to collect amounts due under the Note.





During
the fourth quarter of 2006, the Company entered into two promissory notes (the
“Additional Notes”) with McCormack Avenue, Ltd., in the aggregate amount of
$330,000. These Additional Notes accrue interest at 10% annually and were due
and payable during the second quarter of 2007.  The Additional Notes
were exchanged for shares of the Company’s Series P Preferred
Stock.  See below.





During
the quarter ended March 31, 2007, the Company entered into five promissory notes
with McCormack Avenue, Ltd. and Sovereign Partners LP., in the aggregate amount
of $450,000.  These notes accrue interest at 10% annually and were due
and payable during the third quarter of 2007.  These promissory notes
were exchanged for shares of the Company’s Series P Preferred
Stock.  See below.





On
September 30, 2008, the Company entered into a Series P 9% Convertible Preferred
Stock Exchange Agreement (the “Exchange Agreement”) with McCormack and Sovereign
Partners, LP (“Sovereign”), whereby McCormack exchanged the Note, along with the
Additional Notes and the Series E debenture (discussed in Note 5), and Sovereign
exchanged two promissory notes, for shares of the Company’s Series P 9%
Convertible Preferred Stock (the Series P Preferred Stock”).  A table
listing the obligations exchanged and the number of shares of Series P Preferred
Stock issued was included in the Company’s Annual Report for the year ended
December 31, 2008.





Series A
Convertible Preferred Stock





As of
March 31, 2009, 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 $15
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 .0000075 shares of common stock for each share of Series A
convertible preferred stock.





28




Series L
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 2,000 shares of
Series H Preferred Stock that they  acquired from the 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 (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 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 March 31,
2009, the fair value of the Series L Preferred Stock derivative liability was
$15,409,000.





For the
three months ended March 31, 2009, the Company issued 2,555,160 shares of its
Class A common stock in conversion of 6 shares of its Series L Preferred
Stock.  At March 31, 2009, 1,492 shares of Series L Preferred Stock
remained outstanding.  (See Note 9 for discussion of conversions
subsequent to March 31, 2009.)





Series M
Preferred Stock– On April 4, 2007, the Company entered into a Series M
9% Convertible Preferred Stock Exchange Agreement with Sovereign Partners, LP
(“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.





29




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
$1,603,000 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 March 31, 2009, the fair value of the
Series M Preferred Stock derivative liability was $1,549,000.





As of
March 31, 2009, there were 150 shares of Series M Preferred Stock convertible
preferred stock outstanding.





Series N
Convertible Preferred Stock – On August 24, 2007, the Company entered
into a Securities Purchase Agreement with Trillium Partners, LP and other
unnamed future investors relating to the issuance and sale of the Company’s
Series N 9% Convertible Preferred Stock.





Pursuant
to the agreement, the Company agreed to issue up to 2,400 shares of its Series N
9% Convertible Preferred Stock (the “Series N Preferred Stock”) at a per share
price of $1,000 to Trillium Partners, LP and other unnamed future investors, for
gross proceeds of up to $2,400,000.  As of the date of this report,
the Company had issued 1,755 shares of the Series N Preferred Stock, for cash
proceeds of $1,350,000.





The
Series N Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series N
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 N Preferred Stock is convertible into Class A common stock of the Company
at the option of the holder by using a conversion price equal to 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 N Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series N Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





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
$957,000 due to the value of the conversion feature of the Series N Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 128%, risk-free rate of 5.0% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
N Preferred Stock, no value was prescribed to the Series N Preferred
Stock.  At March 31, 2009, the fair value of the Series N Preferred
Stock derivative liability was $1,812,000.





As of
March 31, 2009, there were 1,755 shares of Series N Preferred Stock convertible
preferred stock outstanding.





30




Series O
Convertible Preferred Stock – Between January 25, 2008, and September 30,
2008, the Company received advances from three entities in connection with the
purchase agreements related to the Company’s Series O 9% Convertible Preferred
Stock (“Series O Preferred Stock”). On May 20, 2008, the Company entered into
Securities Purchase Agreements with Southridge Partners LP, Southshore Capital
Fund LTD, Sovereign Partners LP (collectively, the “Series O Purchasers”) for
the sale of an aggregate of 730 shares of Series O Preferred Stock for gross
proceeds of $730,000.  The material terms of the purchase agreements
had been agreed upon prior to receipt of the advances.  Therefore, the
Series O Preferred Stock was accounted for as discussed below on the dates cash
proceeds were received by the Company.  The Company also began
accruing dividends upon receiving the advances.





The
Series O Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series O
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 O Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price, equal to 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 O Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series O Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





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 $290,000 due to the value of the
conversion feature of the Series O Preferred Stock. The liability was calculated
using the Black-Scholes valuation model with the following assumptions: dividend
yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected
life of 4 years. As the value of the derivative liability was greater than the
face value of the Series O Preferred Stock, no value was prescribed to the
Series O Preferred Stock. At March 31, 2009, the fair value of the Series O
Preferred Stock derivative liability was $753,000.





As of
March 31, 2009, there were 730 shares of Series O Preferred Stock convertible
preferred stock outstanding.





Series P
Convertible Preferred Stock – On September 30, 2008, the Company entered
into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange
Agreement”) with Sovereign Partners, LP (“Sovereign”), and McCormack Avenue Ltd.
(“McCormack”).  Pursuant to the Exchange Agreement, Sovereign and
McCormack exchanged certain debt obligations, discussed more fully below, for
shares of the Company’s Series P 9% Convertible Preferred Stock (the “Series P
Preferred Stock”).





The
Series P Preferred Stock entitles the holders to receive dividends in an amount
equal to 9% of the then-outstanding balance of shares of Series P 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 P 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 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 P Preferred Stock, whether at our option or that of the holder,
requires us to pay, as a redemption price, the stated value of the outstanding
shares of Series P 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 P were issued in exchange for certain outstanding debt
obligations, the Company, we did not receive any proceeds in connection with the
issuance of the Series P Preferred Stock to McCormack and
Sovereign.





31




In
connection with the issuance of the Series P Preferred Stock, on September 26,
2008, the Company filed with the State of Delaware a Certificate of Designation
and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a
part of its Certificate of Incorporation, as amended.





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 $13,,000 due to the value of the
conversion feature of the Series P Preferred Stock. The liability was calculated
using the Black-Scholes valuation model with the following assumptions: dividend
yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected
life of 4 years. As the value of the derivative liability was greater than the
face value of the Series P Preferred Stock, no value was prescribed to the
Series P Preferred Stock. At March 31, 2009, the fair value of the Series P
Preferred Stock derivative liability was $16,621,000.





As of
March 31, 2009, there were 1,651 shares of Series P Preferred Stock convertible
preferred stock outstanding.


During
the quarter ended March 31, 2009, the Company issued the following shares of
Series P Preferred Stock:





Issuance
of Series P 9% Convertible Preferred Stock in G-Soft Transaction





As
disclosed in a Current Report filed with the Commission on March 27, 2009, Fonix
Corporation (the “Company”) issued an aggregate of one hundred and twenty shares
(120) of the Company’s Series P 9% Convertible Preferred Stock (the “Series P
Preferred Stock”) to G-Soft Limited, a Hong Kong corporation (“G-Soft”), which
is the ultimate parent of Shanghai Gaozhi Software Systems Limited
("GaozhiSoft"), and the shareholders of G-Soft (collectively, the
“Sellers”).  The Shares of Series P Preferred Stock were issued
pursuant to an exchange agreement (the “Exchange Agreement”), with Southridge
LLC, a Connecticut limited liability company (“Southridge”), and the
Sellers.  Additionally, subject to the terms of the amended agreement
with the Sellers, the Sellers are entitled to annual earn-out payments equal to
fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in
the form of Series P Preferred Stock (the “Earn-Out Payments”).  The
aggregate of the Earn-Out Payments is limited to three hundred and eighty (380)
shares of Series P Preferred, which were issued into an escrow
account.





The
Series P Preferred Stock entitles the holders to receive dividends in an amount
equal to 9% of the then-outstanding balance of shares of Series P Preferred
Stock.  The dividends are payable in cash or shares of our Class A
common stock, at the Company’s option.





The
Series P Preferred Stock may be converted into the Company’s common stock at the
option of the holder by using a conversion price which shall be 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 P Preferred Stock, whether at the Company’s option or that of the
holder, requires the Company to pay, as a redemption price, the stated value of
the outstanding shares of Series P Preferred Stock to be redeemed, together with
any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





On
September 26, 2008, the Company filed with the State of Delaware a Certificate
of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”),
which become a part of the Company’s Certificate of Incorporation, as
amended.





Under the
G-Soft Agreement and the Series P Terms, the holders of the Series P Preferred
Stock may convert shares of Series P Preferred Stock into shares of the
Company’s common stock.  The Company’s issuances of shares of common
stock upon any conversion of the Series P Preferred Stock will be made without
registration under the Securities Act of 1933 (the “1933 Act”) in reliance on
Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to the Sellers was made without registration under the 1933 Act in
reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder.





32




Issuance
of Shares of Series P 9% Convertible Preferred Stock to Acquire Remaining 20% of
G-Soft





In
connection with the G-Soft transaction described above, on March 27, 2009, the
Company entered into a Series P Convertible Preferred Stock Purchase Agreement
(the “Preferred Stock Purchase Agreement”), with Southridge Partners LP
(“Southridge”).  Pursuant to the Preferred Stock Purchase Agreement,
the Company issued 189 shares of Series P Preferred Stock in exchange for the
20% of G-Soft shares which Southridge had purchased in the G-Soft Transaction
described above.





The
Series P Preferred Stock issued to Southridge has the same terms as described
above.





Under the
Preferred Stock Purchase Agreement and the Series P Terms, Southridge may
convert shares of Series P Preferred Stock into shares of the Company’s common
stock.  The Company’s issuances of shares of common stock upon any
conversion of the Series P Preferred Stock will be made without registration
under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of
the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to Southridge was made without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.





Issuance
of Shares of Series P 9% Convertible Preferred Stock I n Payment of
Notes





In
connection with the G-Soft transaction described above, Southridge Partners
(“Southridge”) and Southshore Capital Fund (“Southshore”) made a bridge loan to
G-Soft in the amount of $400,000.  Upon the acquisition of G-Soft b y
Fonix GS, Fonix Corporation agreed to repay the bridge loan through the issuance
of shares of Series P Preferred Stock.





In an
agreement dated March 31, 2009, the Company issued an aggregate of 42 shares of
Series P Preferred Stock to Southridge and Southshore as repayment of the bridge
loans described above.





The
Series P Preferred Stock issued to Southridge and Southshore has the same terms
as described above.





Under the
Preferred Stock Purchase Agreement and the Series P Terms, Southridge and
Southshore may convert shares of Series P Preferred Stock into shares of the
Company’s common stock.  The Company’s issuances of shares of common
stock upon any conversion of the Series P Preferred Stock will be made without
registration under the Securities Act of 1933 (the “1933 Act”) in reliance on
Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.  The Company’s sale and issuance of the Series P Preferred
Stock to Southridge was made without registration under the 1933 Act in reliance
on Section 4(2) of the 1933 Act and the rules and regulations promulgated
thereunder.





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 purchase 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





33




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 March 31, 2009, the fair value of the Series B Preferred
Stock derivative liability was $1,291,000.





As of
March 31, 2009, there were 125 shares of Series B Preferred Stock convertible
preferred stock outstanding.





Stock Options and
Warrants





During
the three months ended March 31, 2009, we did not grant any stock
options.  As of March 31, 2009, we had a total of 40 options to
purchase Class A common stock outstanding.





As of
March 31, 2009, we had warrants to purchase a total of 3 shares of Class A
common stock outstanding that expire through 2010.





Other


We
presently have no plans to purchase new research and development.





Corporate
Outlook





Company management intends to willfocus on the following strategies:


(i)
            provide
      competitive and value-added speech interface solutions for customers and
      partners through Fonix Speech Inc.
and;


(ii)
              expand
      organic revenue growth through GS in China, and;utilize
      the GS platform for additional China-based
  acquisitions.




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, ofour annual report on Form 10-K for the
year ended December 31, 2008.





As noted above, as of  March
31, 2009,we had an accumulated deficit of $287,895,000; negative working
capital of $46,549,000; derivative liabilities of $38,310,000 related to the
issuance of Series L Preferred Stock,  Series M Preferred Stock,
Series N Preferred Stock, Series O Preferred Stock , Series P Preferred Stock
and Series B Preferred Stock of our subsidiary; accrued liabilities of
$7,316,000; accounts payable of $2,204,000; taxes payable of $33,000; notes
payable to related parties of $918,000; accrued payroll and other compensation
of $501,000 and deferred revenues of $445,000.  Sales of products and revenue from
licenses based on our technologies have notbeen 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.





34




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 ouriSpeakapplicationfor the Apple iPhone; 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 China business
growth  opportunities through existing customers and potential
acquisitions;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 ofour
10-K for the year ended December 31, 2008, 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.





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” Sectionof our 10-K for the year
ended December 31, 2007, 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.


35




Item
3.            Quantitative
and Qualitative Disclosures About Market Risk








Foreign Currency
Exposure





Our
functional currency is the U.S. Dollar (USD).  The functional currency
of our operating subsidiaries in the PRC is RMB.  However, the
accompanying financial statements have been expressed in USD, which is our
functional currency.  The accompanying consolidated balance sheets
have been translated into USD at the exchange rates prevailing at each balance
sheet date.





Fluctuations
in exchange rates may affect our financial results reported in USD terms without
giving effect to any underlying change in our business or results of
operations.





Item
4T.          Controls and
Procedures




Management's
Report on Internal Control Over Financial Reporting




Evaluation of Disclosure
Controls and Procedures.  Our Chief Executive Officer who is
also 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, has concluded that
our disclosure controls and procedures were effective based on his 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.





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





Hite Development Corporation v. Fonix
Corporation,Third District Court, Salt Lake County (Civil No.
070900883).  In January 2007, Hite Development Corporation (“Hite”)
brought a lawsuit against the Company claiming breach of contract and breach of
the covenant of good faith and fair dealing, alleging that the Company failed to
make certain payments under a settlement agreement with Hite dating from March
2005.  The complaint seeks approximately $33,000 plus
interest.  The Company filed its answer in May
2007.   On May 8, 2008, Hite filed a motion for summary judgment,
which the Court granted.





RR Donnelley Receivables Inc. v.
Fonix Corporation,Third District Court, Salt Lake County (Civil No.
070412088).  In July 2007, RR Donnelley Receivables Inc. (“Donnelly”)
brought a lawsuit against the Company for alleged failure to pay for services
provided.  The complaint seeks approximately $21,000 plus
interest.  The Company filed its answer in August 2007, and filed a
motion to dismiss the action in December 2007.  That motion is
currently pending before the court.  If the Company’s motion to
dismiss is denied, the Company intends to defend


against
the claims in the complaint.





Perpetual Storage, Inc. vs. Fonix
Corporation, Third District Court, Salt Lake County (Civil No.
080907080).  Perpetual Storage, Inc. (“PSI”), brought suit, claiming
breach of contract and unjust enrichment, and seeking damages of approximately
$12,300 plus attorneys’ fees and costs.  The Company filed its answer
in July 2008.  In December 2008, PSI moved for summary judgment, which
the Company opposed.  The Court denied the motion at a hearing in
April 2009.  As of the date of this report, the case was in the
discovery phase.





36




Item
2.            Unregistered
Sales of Equity Securities and Use of Proceeds





During
the three months ended March 31, 2009, we issued 2,093,099 shares of our common
stock in connection with conversions of 6 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
3.            Defaults
Upon Senior Securities





None.





Item
4.            Submission
of Matters to a Vote of Security Holders





None.





Item
5.            Other
Information





None.





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
      Exhibit3
                  
                  Amendment
      to Certificate of Incorporation (previously filed as an exhibit to a
      Current Report filed on December 24, 2008, and incorporated herein by
      reference).4
                  
                  Certificate
      of Designation of Rights and Preferences for Series P 9% Convertible
      Preferred Stock (previously filed as an exhibit to a Quarterly Report
      filed on November 19, 2008, and incorporated herein by
      reference).10.1
                  
                  Exchange
      Agreement, dated as of September 30, 2008 (previously filed as an exhibit
      to a Quarterly Report filed on November 19, 2008, and incorporated herein
      by reference).10.2
                  
                  Form
      of First Amendment to the Exchange Agreement, dated as of December 12,
      2008 (previously filed as an exhibit to a Current Report filed on December
      19, 2008, and incorporated herein by reference).10.3
                  
                  Escrow
      Agreement dated of December 12, 2008 (previously filed as an exhibit to a
      Current Report filed on December 19, 2008, and incorporated herein by
      reference).10.4
                  
                  Side
      Letter Agreement dated as of February 18, 2009 (previously filed as an
      exhibit to a Current Report filed on March 27, 2009, and incorporated
      herein by reference).31
                  
                  Certification
      of President and Chief Financial Officer32
                  
                  Certification
      of President and Chief Financial Officer Pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002







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
      CorporationDate:
      June 10, 2009,
                    /s/  Roger
      D.DudleyRoger D.  Dudley, Chief
      Executive Officer, President,Chief Financial Officer, and
      Director(Principal Executive Officer,
      Principal Financial
Officer)









37