**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q/A**


**(Amendment
      No. 1)**





(Mark
      one)





[X]
            Quarterly
                Report pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934 for the quarterly period ended September 30, 2006,
                or





[  
              ]
            Transition
                Report pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934 for the transition period from ____________ to
                ___________.





Commission
      File No. 0-23862


**Fonix
      Corporation**


(Exact
      name of registrant as specified in its charter)





**Delaware**
            **22-2994719**(State
                or other jurisdiction of incorporation or organization)
            (I.R.S.
                Employer Identification No.)





**9350
      South 150 East, Suite 700**


**Sandy,
      Utah 84070**


(Address
      of principal executive offices with zip code)





**(801)
      553-6600**


(Registrant's
      telephone number, including area code)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days: Yes [X] No[ ].





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


Larger
      Accelerated Filer __ Accelerated Filer __ Non-Accelerated Filer X .





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-25 of the Exchange Act). Yes __ No X





As
      of
      December 29, 2006, there were issued and outstanding 1,309,965,981 shares of
      our
      Class A common stock.





The
      purpose of this amendment is to properly account for the discontinued operations
      of the Company’s telecom entities.








1








**FONIX
      CORPORATION**


**FORM
      10-Q**








**TABLE
      OF CONTENTS**





**PART
      I - FINANCIAL INFORMATION**





**Page**Item
                1.
            Financial
                Statements (Unaudited)Condensed
                Consolidated Balance Sheets - As of September 30, 2006, and December
                31,
                2005
            3Condensed
                Consolidated Statements of Operations and Comprehensive Loss for
                the Three
                and Nine Months Ended September 30, 2006 and 2005
            4Condensed
                Consolidated Statements of Cash Flows for the Nine Months Ended September
                30, 2006 and 2005
            5Condensed
                Combined Balance Sheets (Liquidation Basis) - As of September 30,
                2006
            7Condensed
                Combined Statements of Operations and Comprehensive Loss (Liquidation
                Basis) for the Three and Nine Months Ended September 30,
                2006
            8Notes
                to Condensed Consolidated Financial Statements
            9Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            21Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            32Item
                4.
            Controls
                and Procedures
            32**PART
                II - OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            33Item
                1A.
            Risk
                Factors
            33Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            34Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            35Item
                6.
            Exhibits
            35











2


**Fonix
      Corporation and Subsidiaries**


**CONDENSED
        CONSOLIDATED BALANCE SHEETS**
 **(Unaudited)**
 
 **September
                  30,**
              
              **December
                  31,****2006**
              
              **2005****ASSETS****Current
                  assets**Cash
                  and cash equivalents
              
              $
              44,000
              
              $
              168,000Accounts
                  receivable, net of an allowance for doubtful accounts of $0 and
                  $137,000,
                  respectively
              
              
              -
              
              
              1,121,000Prepaid
                  expenses and other current assets
              
              
              186,000
              
              
              176,000**Total
                  current assets**
              
              
              230,000
              
              
              1,465,000**Property
                  and equipment,**net of accumulated depreciation of $1,247,000 and $1,594,000,
                  respectively
              
              
              62,000
              
              
              947,000**Deposits
                  and other assets**
              
              
              119,000
              
              
              1,592,000**Intangible
                  assets**
              
              
              -
              
              
              2,658,000**Goodwill**
              
              
              2,631,000
              
              
              2,631,000**Total
                  assets**
              
              $
              3,042,000
              
              $
              9,293,000**LIABILITIES
                  AND STOCKHOLDERS' DEFICIT****Current
                  liabilities**Accrued
                  liabilities
              
              $
              1,592,000
              
              $
              8,138,000Accounts
                  payable
              
              
              1,403,000
              
              
              6,770,000Net
                  liabilities of unconsolidated subsidiaries
              
              
              20,639,000
              
              
              -Derivative
                  liability
              
              
              21,392,000
              
              
              -Accrued
                  payroll and other compensation
              
              
              214,000
              
              
              223,000Accrued
                  settlement obligation, net of unamortized discount of $35,000 and
                  $118,000, respectively
              
              
              1,511,000
              
              
              1,853,000Deferred
                  revenues
              
              
              476,000
              
              
              923,000Notes
                  payable - related parties
              
              
              706,000
              
              
              486,000Current
                  portion of notes payable
              
              
              3,503,000
              
              
              1,847,000Deposits
                  and other
              
              
              7,000
              
              
              229,000**Total
                  current liabilities**
              
              
              51,443,000
              
              
              20,469,000**Long-term
                  notes payable, net of current portion**
              
              
              3,077,000
              
              
              4,050,000**Total
                  liabilities**
              
              
              54,520,000
              
              
              24,519,000**Commitments
                  and contingencies****Stockholders'
                  deficit**Preferred
                  stock, $0.0001 par value; 50,000,000 shares authorized;Series
                  A, convertible; 166,667 shares outstanding (aggregate liquidation
                  preference of $6,055,000)
              
              
              500,000
              
              
              500,000Series
                  H, nonconvertible; 0 shares and 2,000 shares outstanding
              
              
              -
              
              
              4,000,000Series
                  I, convertible; 0 shares and 0 shares outstanding, respectively
              
              
              -
              
              
              -Series
                  J, convertible; 0 shares and 1,359 shares outstanding, respectively
              
              
              -
              
              
              1,359,000Series
                  K, convertible; 0 shares and 0 shares outstanding, respectively
              
              
              -
              
              
              -Series
                  L, convertible; 1,973 shares and 0 shares outstanding ,
                  respectively
              
              
              -
              
              
              -Common
                  stock, $0.0001 par value; 5,000,000,000 shares authorized;Class
                  A voting, 886,430,512 shares and 392,929,230 shares outstanding,
                  respectively
              
              
              88,000
              
              
              39,000Class
                  B non-voting, none outstanding
              
              
              -
              
              
              -Additional
                  paid-in capital
              
              
              235,519,000
              
              
              228,905,000Outstanding
                  warrants to purchase Class A common stock
              
              
              474,000
              
              
              474,000Cumulative
                  foreign currency translation adjustment
              
              
              10,000
              
              
              18,000Accumulated
                  deficit
              
              
              (288,069,000
              )
              
              (250,521,000
              )**Total
                  stockholders' deficit**
              
              
              (51,478,000
              )
              
              (15,226,000
              )**Total
                  liabilities and stockholders' deficit**
              
              $
              3,042,000
              
              $
              9,293,000
 
 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****September
                  30,**
              
              **Nine
                  Months Ended September 30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Revenues
              
              $
              386,000
              
              $
              258,000
              
              $
              1,024,000
              
              $
              978,000Cost
                  of revenues
              
              
              6,000
              
              
              21,000
              
              
              12,000
              
              
              34,000Gross
                  profit
              
              
              380,000
              
              
              237,000
              
              
              1,012,000
              
              
              944,000Expenses:Selling,
                  general and administrative
              
              
              2,024,000
              
              
              1,410,000
              
              
              4,444,000
              
              
              3,756,000Legal
                  settlement expense
              
              
              -
              
              
              2,080,000
              
              
              -
              
              
              2,080,000Product
                  development and research
              
              
              551,000
              
              
              580,000
              
              
              1,711,000
              
              
              1,628,000Total
                  expenses
              
              
              2,575,000
              
              
              4,070,000
              
              
              6,155,000
              
              
              7,464,000Other
                  income (expense):Interest
                  and other income
              
              
              -
              
              
              106,000
              
              
              -
              
              
              112,000Interest
                  expense
              
              
              (528,000
              )
              
              (283,000
              )
              
              (1,279,000
              )
              
              (931,000
              )Loss
                  on derivative liability
              
              
              (1,763,000
              )
              
              -
              
              
              (1,763,000
              )
              
              -Gain
                  on forgiveness of liabilities
              
              
              -
              
              
              78,000
              
              
              -
              
              
              95,000Other
                  expense, net
              
              
              (2,291,000
              )
              
              (99,000
              )
              
              (3,042,000
              )
              
              (724,000
              )Net
                  loss from continuing operations
              
              
              (4,486,000
              )
              
              (3,932,000
              )
              
              (8,185,000
              )
              
              (7,244,000
              )Net
                  loss from discontinued operations
              
              
              (6,361,000
              )
              
              (2,583,000
              )
              
              (11,247,000
              )
              
              (7,681,000
              )Net
                  loss
              
              
              (10,847,000
              )
              
              (6,515,000
              )
              
              (19,432,000
              )
              
              (14,925,000
              )Preferred
                  stock dividends
              
              
              (16,192,000
              )
              
              (423,000
              )
              
              (18,295,000
              )
              
              (996,000
              )Loss
                  attributable to common stockholders
              
              $
              (27,039,000
              )
              $
              (6,938,000
              )
              $
              (37,727,000
              )
              $
              (15,921,000
              )Basic
                  and diluted loss per common share from continuing
                  operations
              
              $
              (0.03
              )
              $
              (0.01
              )
              $
              (0.03
              )
              $
              (0.01
              )Basic
                  and diluted loss per common share from discontinued
                  operations
              
              $
              (0.01
              )
              $
              (0.01
              )
              $
              (0.01
              )
              $
              (0.01
              )Net
                  loss
              
              $
              (10,847,000
              )
              $
              (6,515,000
              )
              $
              (19,432,000
              )
              $
              (14,925,000
              )Other
                  comprehensive (loss) income - foreign currency translation
              
              
              -
              
              
              (20,000
              )
              
              7,000
              
              
              2,000Comprehensive
                  loss
              
              $
              (10,847,000
              )
              $
              (6,535,000
              )
              $
              (19,425,000
              )
              $
              (14,923,000
              )
 
 
 See
        accompanying notes to condensed consolidated financial statements.
 
 
  4
  **Fonix
        Corporation and Subsidiaries**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 **Nine
                    Months Ended September 30,**
                
                **2006**
                
                **2005****Cash
                    flows from operating activities**Net
                    loss
                
                $
                (19,432,000
                )
                $
                (14,925,000
                )Adjustments
                    to reconcile net loss to net cash used in operating
                    activities:Discontinued
                    operations
                
                
                11,643,000
                
                
                7,681,000Loss
                    on derivative liability
                
                
                1,763,000
                
                
                -Accretion
                    of discount on notes payable
                
                
                603,000
                
                
                558,000Non-cash
                    expense related to the issuance of preferred stock
                
                
                -
                
                
                250,000Stock
                    issued for interest expense on long-term debt
                
                
                -
                
                
                384,000Accretion
                    of discount on legal settlement
                
                
                98,000
                
                
                -Write
                    down of intercompany receivable
                
                
                1,214,000
                
                
                -Legal
                    settlement expense
                
                
                -
                
                
                2,080,000Gain
                    on sale of preferred stock
                
                
                -
                
                
                (104,000
                )Gain
                    on forgiveness of liabilities
                
                
                -
                
                
                (95,000
                )Depreciation
                
                
                44,000
                
                
                45,000Foreign
                    exchange loss (gain)
                
                
                (8,000
                )
                
                2,000Changes
                    in assets and liabilitiesAccounts
                    receivable
                
                
                1,000
                
                
                -Prepaid
                    expenses and other current assets
                
                
                (47,000
                )
                
                (98,000
                )Intercompany
                    account
                
                
                -
                
                
                (1,078,000
                )Other
                    assets
                
                
                (95,000
                )
                
                (33,000
                )Accounts
                    payable
                
                
                448,000
                
                
                (149,000
                )Accrued
                    payroll and other compensation
                
                
                (9,000
                )
                
                (1,421,000
                )Other
                    accrued liabilities
                
                
                582,000
                
                
                131,000Deferred
                    revenues
                
                
                10,000
                
                
                24,000Net
                    cash used in operating activities
                
                
                (3,185,000
                )
                
                (6,748,000
                )**Cash
                    flows from investing activities**Purchase
                    of property and equipment
                
                
                (12,000
                )
                
                (23,000
                )Net
                    cash used in investing activities
                
                
                (12,000
                )
                
                (23,000
                )**Cash
                    flows from financing activities**Proceeds
                    from issuance of Class A common stock, net
                
                
                3,504,000
                
                
                6,521,000Proceeds
                    from related party note payable
                
                
                325,000
                
                
                140,000Proceeds
                    from debentures
                
                
                250,000
                
                
                -Proceeds
                    from credit advance
                
                
                75,000
                
                
                -Payments
                    on related party note payable
                
                
                (105,000
                )
                
                -Payments
                    of accrued settlement obligation
                
                
                (440,000
                )
                
                -Discontinued
                    operations
                
                
                (536,000
                )
                
                -Principal
                    payments on notes payable
                
                
                -
                
                
                (102,000
                )Net
                    cash provided by financing activities
                
                
                3,073,000
                
                
                6,559,000**Net
                    decrease in cash and cash equivalents**
                
                
                (124,000
                )
                
                (212,000
                )**Cash
                    and cash equivalents at beginning of year**
                
                
                168,000
                
                
                309,000**Cash
                    and cash equivalents at end of year**
                
                $
                44,000
                
                $
                97,000
 
 
 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 Nine Months Ended September 30, 2006:**
 
 Issued
        15,028,249 shares of Class A common stock in conversion of 266 shares of
        Series
        J Convertible Preferred Stock.
 
 Issued
        109,300,000 shares of Class A common stock in conversion of 1,093 shares
        of
        Series K Convertible Preferred Stock.
 
 Issued
        2,838,412 shares of Class A common stock as payment of $65,000 of dividends
        on
        Series H Preferred Stock.
 
 Accrued
        $692,000 of dividends on Series H Preferred Stock.
 
 Issued
        2,000 shares of Series L Convertible Preferred Stock with a face value of
        $20,000,000 in exchange for 2,000 shares of Series H Preferred Stock with
        a face
        value of $20,000,000.
 
 Issued
        66,334,622 shares of Class A common stock in conversion of 27 shares of Series
        L
        Preferred Stock.
 
 **For
        the Nine Months Ended September 30, 2005:**
 
 Issued
        18,482,083 shares of Class A common stock in conversion of 1,078 shares of
        Series I Convertible Preferred Stock.
 
 Issued
        12,944,095 shares of Class A common stock as payment of $750,000 of dividends
        on
        Series H Preferred Stock.
 
 Issued
        18,894,034 shares of Class A common stock as payment of $968,000 of principal
        and interest on long-term debt.
 
 Accrued
        $250,000 of dividends on Series H Preferred Stock.
 
 Issued
        1,452 shares of Series J Preferred Stock with a value of $1,452,000 in exchange
        for 1,172 shares of Series I Preferred Stock with a value of $1,172,000,
        a
        placement fee of $250,000 and settlement expense of $30,000.
 
 Issued
        2,277,000 shares of Class A common stock for a legal settlement expense valued
        at $73,000, or $0.03 per share.
 
 
 
 
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  6
  **LecStar
        Telecom, Fonix Telecom & LTEL Holdings**
 **CONDENSED
        COMBINED BALANCE SHEETS (Liquidation Basis)**
 **(Unaudited)**
 
 
 **September
                  30,**
                **2006****ASSETS****Current
                  assets**Cash
                  and cash equivalents
              
              $
              -Accounts
                  receivable
              
              
              -Prepaid
                  expenses and other current assets
              
              
              -**Total
                  current assets**
              
              
              -**Property
                  and equipment,**net of accumulated depreciation of $0 and $391,000,
                  respectively
              
              
              -**Deposits
                  and other assets**
              
              
              -**Intangible
                  assets**
              
              
              -**Total
                  assets**
              
              $
              -**LIABILITIES
                  AND STOCKHOLDERS' DEFICIT****Current
                  liabilities**Accrued
                  liabilities
              
              $
              8,757,000Accounts
                  payable
              
              
              9,847,000Intercompany
                  payable
              
              
              1,214,000Deferred
                  revenues
              
              
              371,000Current
                  portion of notes payable
              
              
              256,000Deposits
                  and other
              
              
              216,000**Total
                  current liabilities**
              
              
              20,661,000**Long-term
                  notes payable, net of current portion**
              
              
              158,000**Total
                  liabilities**
              
              
              20,819,000**Commitments
                  and contingencies****Stockholders'
                  deficit**Additional
                  paid-in capital
              
              
              12,800,000Accumulated
                  deficit
              
              
              (33,619,000
              )**Total
                  stockholders' deficit**
              
              
              (20,819,000
              )**Total
                  liabilities and stockholders' deficit**
              
              $
              -
 
 
 See
        accompanying notes to condensed consolidated financial statements.
 
  7
  
 **LecStar
        Telecom, Fonix Telecom & LTEL Holdings**
 **CONDENSED
        COMBINED STATEMENTS OF OPERATIONS**
 **AND
        COMPREHENSIVE LOSS (Liquidation Basis)**
 **(Unaudited)**
 
 **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2006**
              
              **2006**Revenues
              
              $
              2,622,000
              
              $
              8,424,000Cost
                  of revenues
              
              
              2,145,000
              
              
              6,725,000Gross
                  profit
              
              
              477,000
              
              
              1,699,000Expenses:Selling,
                  general and administrative
              
              
              1,923,000
              
              
              5,412,000Impairment
                  of assets
              
              
              4,611,000
              
              
              5,623,000Amortization
                  of intangible assets
              
              
              -
              
              
              917,000Total
                  expenses
              
              
              6,534,000
              
              
              11,952,000Other
                  income (expense):Interest
                  expense
              
              
              (304,000
              )
              
              (995,000
              )Gain
                  on sale of investments
              
              
              -
              
              
              -Other
                  expense, net
              
              
              (304,000
              )
              
              (995,000
              )Net
                  loss
              
              $
              (6,361,000
              )
              $
              (11,248,000
              )
           
 
 See
        accompanying notes to condensed consolidated financial
        statements.
  8
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 
 **1.
        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
 
 ***Basis
        of Presentation*** - The
        accompanying unaudited condensed consolidated financial statements
        of ** Fonix ** Corporation
        and subsidiaries (collectively, the “Company” or “Fonix”) have been prepared by
        the Company pursuant to the rules and regulations of the Securities and Exchange
        Commission (the “SEC”). Certain information and footnote disclosures normally
        included in financial statements prepared in accordance with accounting
        principles generally accepted in the United States of America have been
        condensed or omitted pursuant to such rules and regulations, although the
        Company believes that the following disclosures are adequate to make the
        information presented not misleading. The Company suggests that these condensed
        consolidated financial statements be read in conjunction with the consolidated
        financial statements and the notes thereto included in the Company’s 2005 Annual
        Report on Form 10-K.
 
 The
        Company has not consolidated the assets, liabilities or operations related
        to
        the assets shown on the liquidation basis financial statements at September
        30,
        2006 as these assets are under the control of the court appointed bankruptcy
        trustee pursuant to the filing for protection under Chapter 7 of the Bankruptcy
        Code by LecStar Telecom, Inc., LecStar DataNet, Inc., LTEL Holdings and Fonix
        Telecom, Inc. on October 2, 2006 (See Note 9). The accompanying footnotes
        do not
        include disclosures related to the operations of the aforementioned companies
        and represent solely the operations of Fonix Speech, Inc. The Company has
        also
        included the financial statements for LecStar Telecom, Fonix Telecom and
        LTEL
        Holdings shown on a combined liquidation basis.
 
 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 2005 Annual Report on Form
        10-K.
 
 Operating
        results for the nine months ended September 30, 2006, are not necessarily
        indicative of the results that may be expected for the year ending December
        31,
        2006.
 
 ***Nature
        of Operations*** **-** ****** Fonix
        Corporation, a technology company based in Salt Lake City, Utah, provides
        value-added speech technologies through Fonix Speech, Inc. (“Fonix Speech”).
 
 Through
        Fonix Speech, the Company delivers speech interface development tools, solutions
        and applications (the “Speech Products”) that empower people to interact
        conversationally with information systems and devices. The Speech Products
        are
        based on the Company’s speech-enabling technologies, which include
        text-to-speech (“TTS”) and proprietary neural network-based automatic speech
        recognition (“ASR”). ASR and TTS technologies are sometimes collectively
        referred to in this report as “Core Technologies.” The Company has received
        various patents for certain elements of its Core Technologies and has filed
        applications for other patents covering various aspects of its technologies.
        The
        Company’s Speech Products enhance user productivity, ease of use and efficiency
        in a broad range of market segments, including mobile and wireless devices;
        entertainment game consoles; electronic devices for assistive, language
        learning, robots and appliances; and computer telephony and server applications.
        Revenues for Fonix Speech are generated through licensing of speech-enabling
        technologies, royalty payments for the use of the Company’s technologies,
        maintenance contracts and services.
 
 On
        October 2, 2006, LecStar Telecom Inc., a Georgia corporation (“LecStar
        Telecom”), LecStar DataNet, Inc., a Georgia corporation (“LecStar DataNet”),
        LTEL Holdings Corporation (“LTEL Holdings”), a Delaware corporation, and Fonix
        Telecom Inc., a Delaware corporation (“Fonix Telecom”), each of which are direct
        or indirect subsidiaries of the Company, filed for bankruptcy protection
        in the
        United States Bankruptcy Court for the District of Delaware (the “Bankruptcy
        Court”). The case numbers are as follows: LTEL Holdings Corporation, 06-11081
        (BLS); LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083
        (BLS); Fonix Telecom, Inc., 06-11084 (BLS).)
 
  9
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection
        under Chapter 7 of title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101
        et seq.
        (the “Bankruptcy Code”). Pursuant to Bankruptcy Code Section 701, on October 3,
        2006, Alfred Thomas Guliano was appointed the interim trustee for LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom.
 
 ***Business
        Condition*** **** -
        For the
        three months ended September 30, 2006 and 2005, the Company generated revenues
        of $386,000 and $258,000, respectively, and incurred net losses of $10,847,000
        and $6,515,000, respectively. For the nine months ended September 30, 2006
        and
        2005, the Company generated revenues of $1,024,000 and $978,000, respectively,
        incurred net losses of $19,432,000 and $14,925,000, respectively, and had
        negative cash flows from operating activities of $3,185,000 and $6,748,000,
        respectively. As of September 30, 2006, the Company had an accumulated deficit
        of $288,069,000, negative working capital of $51,213,000, derivative liability
        of $21,392,000 related to the issuance of Series L Preferred Stock, net
        liabilities of unconsolidated subsidiaries of $20,639,000 related to the
        telecom
        subsidiaries subject to bankruptcy (LecStar, Telecom, LecStar DataNet, LTEL
        Holdings and Fonix Telecom), accrued liabilities and accrued settlement
        obligation of $3,800,000, accounts payable of $1,403,000 and current portion
        of
        notes payable of $4,209,000. The Company expects to continue to incur
        significant losses and negative cash flows from operating activities at least
        through December 31, 2007, primarily due to expenditure requirements associated
        with continued marketing and development of its speech-enabling
        technologies.
 
 The
        Company’s cash resources, limited to collections from customers, draws on the
        Seventh Equity Line and loans, have not been sufficient to cover operating
        expenses. As a result, some payments to vendors have been delayed. The Company
        currently does not have an active registration statement with the SEC and
        cannot
        access funds under the Seventh Equity Line. The Company does not anticipate
        being able to access additional funds under the Seventh Equity
        Line.
 
 These
        factors, as well as the risk factors set forth herein and in the Company’s
        Annual Report on Form 10-K for the year ended December 31, 2005, 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 through 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 September 30, 2006 and
        2005,
        there were outstanding common stock equivalents to purchase 6,192,412,281
        and
        81,965,771 shares of common stock, respectively, that were not included in
        the
        computation of diluted net loss per common share as their effect would have
        been
        anti-dilutive, thereby decreasing the net loss per common share.
 
 The
        following table is a reconciliation of the net loss numerator of basic and
        diluted net loss per common share for the three months and nine months ended
        September 30, 2006 and 2005:
 
 **Three
                  Months Ended September 30,****2006**
              
              **2005****Per**
              
              
              
              **Per****Share**
              
              
              
              **Share****Amount**
              
              **Amount**
              
              **Amount**
              
              **Amount**Net
                  loss from continuing operations
              
              $
              (4,486,000
              )
              
              
              
              $
              (3,932,000
              )Net
                  loss from discontinued operations
              
              
              (6,361,000
              )
              $
              (0.01
              )
              
              (2,583,000
              )
              $
              (0.01
              )Net
                  loss
              
              $
              (10,847,000
              )
              
              
              
              $
              (6,515,000
              )Preferred
                  stock dividends
              
              
              (16,192,000
              )
              
              
              
              
              (423,000
              )Loss
                  attributable to common stockholders
              
              $
              (27,039,000
              )
              $
              (0.03
              )
              $
              (6,938,000
              )
              $
              (0.01
              )Weighted-average
                  common shares outstanding
              
              
              825,819,722
              
              
              
              
              
              294,655,483
 
  10
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 
 **Nine
                  Months Ended September 30,****2006**
              
              **2005****Per**
              
              
              
              **Per****Share**
              
              
              
              **Share****Amount**
              
              **Amount**
              
              **Amount**
              
              **Amount**Net
                  loss from continuing operations
              
              $
              (8,185,000
              )
              
              
              
              $
              (7,244,000
              )Net
                  loss from discontinued operations
              
              
              (11,247,000
              )
              $
              (0.01
              )
              
              (7,681,000
              )
              $
              (0.01
              )Net
                  loss
              
              $
              (19,432,000
              )
              
              
              
              $
              (14,925,000
              )Preferred
                  stock dividends
              
              
              (18,295,000
              )
              
              
              
              
              (996,000
              )Loss
                  attributable to common stockholders
              
              $
              (37,727,000
              )
              $
              (0.03
              )
              $
              (15,921,000
              )
              $
              (0.01
              )Weighted-average
                  common shares outstanding
              
              
              716,417,308
              
              
              
              
              
              221,598,946
 
 
 ***Imputed
        Interest Expense*** - ****** Interest
        is imputed on long-term debt obligations where management has determined
        that
        the contractual interest rates are below the market rate for instruments
        with
        similar risk characteristics.
 
 ***Comprehensive
        Loss*** - ****** Other
        comprehensive loss as presented in the accompanying condensed consolidated
        financial statements consists of cumulative foreign currency translation
        adjustments.
 
 ***Revenue
        Recognition*** -
        The
        Company recognizes revenue when pervasive evidence of an arrangement exists;
        services have been rendered or products have been delivered; the price to
        the
        buyer is fixed and determinable; and collectibility is reasonably assured.
        Revenues are recognized by the Company based on the various types of
        transactions generating the revenue. For software sales, the Company recognizes
        revenues in accordance with the provisions of Statement of Position No. 97-2,
        “Software Revenue Recognition,” and related interpretations *.* The
        Company generates revenues from licensing the rights to its software products
        to
        end users and from royalties.
 
 For
        Fonix
        Speech, revenue of all types is recognized when acceptance of functionality,
        rights of return and price protection are confirmed or can be reasonably
        estimated, as appropriate. Revenues from development and consulting services
        are
        recognized on a completed-contract basis when the services are completed
        and
        accepted by the customer. The completed-contract method is used because the
        Company’s contracts are typically either short-term in duration or the Company
        is unable to make reasonably dependable estimates of the costs of the contracts.
        Revenue for hardware units delivered is recognized when delivery is verified
        and
        collection assured.
 
 Revenue
        for products distributed through wholesale and retail channels and through
        resellers is recognized upon verification of final sell-through to end users,
        after consideration of rights of return and price protection. Typically,
        the
        right of return on such products has expired when the end user purchases
        the
        product from the retail outlet. Once the end user opens the package, it is
        not
        returnable unless the medium is defective.
 
 When
        arrangements to license software products do not require significant production,
        modification or customization of software, revenue from licenses and royalties
        are recognized when persuasive evidence of a licensing arrangement exists,
        delivery of the software has occurred, the fee is fixed or determinable,
        and
        collectibility is probable. Post-contract obligations, if any, generally consist
        of one year of support including such services as customer calls, bug fixes,
        and
        upgrades. Related revenue is recognized over the period covered by the
        agreement. Revenues from maintenance and support contracts are also recognized
        over the term of the related contracts.
 
 Revenues
        applicable to multiple-element fee arrangements are bifurcated among elements
        such as license agreements as well as 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.
 
  11
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 For
        Fonix
        Telecom and LecStar (accounted for as discontinued operations in these
        statements), telecommunications revenue was comprised of two main components:
        (1) fees paid by business and residential subscribers of voice and data
        services; and (2) carrier access fees. Subscriber revenues include monthly
        recurring charges, usage charges and non-recurring charges. Monthly recurring
        charges are flat monthly fees for local phone and data services. Usage charges,
        which primarily include long distance fees, were generally billed on a
        per-minute or per-call basis. Non-recurring charges are generally one-time
        charges for installation or changes to the subscriber’s service. Carrier access
        fees were paid to the Company by other telecommunications carriers as
        compensation for originating and terminating the carriers’ long distance
        traffic. Revenue from monthly recurring charges was recognized ratably over
        the
        period the local phone and data services are provided. Revenue from usage
        charges non-recurring charges and carrier access fees was recognized on the
        date
        the services are provided.
 
 Deferred
        revenue as of September 30, 2006, and December 31, 2005, consisted of the
        following:
 
 **Description**
              **Criteria
                  for Recognition**
              
              **September
                  30, 2****006**
              
              **December
                  31,****2005**Deferred
                  unit royalties and license fees
              Delivery
                  of units to end users or expiration of contract
              
              $
              476,000
              
              $
              466,000Telecom
                  deferred revenue
              Service
                provided for customer
              
              
              --
              
              
              457,000Total
                  deferred revenue
              
              
              $
              476,000
              
              $
              923,000
  ***Cost
          of Revenues*** -Cost
          of
          revenues from license, royalties, and maintenance consists of costs to
          distribute the product, installation and support personnel compensation,
          amortization and impairment of capitalized speech software costs, licensed
          technology, and other related costs. Cost of service revenues consists
          of
          personnel compensation and other related costs.
 
 ***Software
        Technology Development and Production Costs*** **** -
        All
        costs incurred to establish the technological feasibility of speech software
        technology to be sold, leased, or otherwise marketed are charged to product
        development and research expense. Technological feasibility is established
        when
        a product design and a working model of the software product have been completed
        and confirmed by testing. Costs to produce or purchase software technology
        incurred subsequent to establishing technological feasibility are capitalized.
        Capitalization of software costs ceases when the product is available for
        general release to customers. Costs to perform consulting or development
        services are charged to cost of revenues in the period in which the
        corresponding revenues are recognized. The cost of maintenance and customer
        support is charged to expense when related revenue is recognized or when
        these
        costs are incurred, whichever occurs first.
 
 ***Stock-Based
        Employee Compensation*** -
        Effective January 1, 2006, the Company adopted Statement of Financial Accounting
        Standards No. 123(R), “Share-Based Payment” (“FAS 123(R)”), an amendment of SFAS
        No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) using the
        modified prospective transition method. Under this transition method,
        compensation costs are recognized beginning with the effective date: (a)
        based
        on the requirements of FAS 123(R) for all share-based awards granted after
        the
        effective date; and (b) based on the requirements of SFAS 123 for all awards
        granted to employees prior to the effective date of FAS 123(R) that remain
        unvested on the effective date. Accordingly, the Company did not restate
        the
        results of prior periods. The most notable change resulting from the adoption
        of
        FAS123(R) is that compensation expense associated with stock options is now
        recognized in the Company’s Statements of Operations, rather than being
        disclosed in a pro forma footnote to the Company’s financial
        statements.
 
 The
        Company recognized compensation expense related to option grants and the
        vesting
        of previously unvested options for the three months ended September 30, 2006,
        of
        $0. For the nine months ended September 30, 2006, the Company recognized
        compensation expense related to option grants and the vesting of previously
        unvested options of $0.
 
  12
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 Prior
        to
        January 1, 2006, the Company accounted for stock options granted under its
        Stock
        Option Plans under the recognition and measurement provisions of Accounting
        Principles Board Opinion No. 25, *Accounting
        for Stock Issued to Employees* )
        and
        related interpretations, as permitted by SFAS 123. Had the Company determined
        compensation cost based on the fair value at the grant date for its stock
        options under SFAS No. 123, the Company’s net loss would have been increased to
        the pro forma amounts indicated below for the three and nine months ended
        September 30, 2005:
 
 **Three
                  Months Ended September 30,**
              
              **2005**Net
                  loss, as reported
              
              $
              (6,515,000
              )Add
                  back: Total stock-based employee compensation
              
              
              -Deduct:
                  Total stock-based employee compensation determined under fair value
                  based
                  method for all awards
              
              
              (15,000
              )Pro
                  forma net loss
              
              $
              (6,530,000
              )Basic
                  and diluted net loss per common share:As
                  reported
              
              $
              (0.03
              )Pro
                  forma
              
              
              (0.03
              )
 
 
 **Nine
                  Months Ended September 30,**
              
              **2005**Net
                  loss, as reported
              
              $
              (14,925,000
              )Add
                  back: Total stock-based employee compensation
              
              
              -Deduct:
                  Total stock-based employee compensation determined under fair value
                  based
                  method for all awards
              
              
              (37,000
              )Pro
                  forma net loss
              
              $
              (14,962,000
              )Basic
                  and diluted net loss per common share:As
                  reported
              
              $
              (0.07
              )Pro
                  forma
              
              
              (0.07
              )
 
 The
        fair
        value of the options granted during the nine months ended September 30, 2005
        was
        $76,000, or $0.11 per share, and was estimated on the dates granted using
        the
        Black Scholes option pricing model with the following weighted average
        assumptions: dividend yield of 0%, expected volatility of 142%, risk-free
        rate
        of 3.75% and expected life of 5 years .
 
 **2.
        GOODWILL**
 
 The
        carrying value of goodwill is assessed for impairment quarterly. An assessment
        was performed for the nine months ended September 30, 2006, which resulted
        in no
        impairment, and the carrying value of goodwill remained unchanged at $2,631,000
        for the nine months ended September 30, 2006.
 
 **3.
        NOTES PAYABLE**
 
 On
        February 24, 2004, LecStar had an asset securitization facility of $750,000.
        Assets securitized under this facility consist of executory future cash flows
        from LecStar customers in the states of Georgia, Tennessee, Florida, and
        Louisiana. LecStar has pledged to the lender its interest in the special
        purpose
        securitization facility, LecStar Telecom Ventures LLC, a wholly owned subsidiary
        of LTEL, and customer accounts receivable. The note bears an interest rate
        of
        6.5% and is due on February 27, 2007, with 24 equal monthly installments
        which
        began on March 6, 2005. During 2005, the Company made principal payments
        of
        $213,000. During the nine months ended September 30, 2006, the Company made
        principal payments of $124,000.
 
  13
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 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
        is 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.
 
 The
        discount on the N ote
        is
        based on an imputed interest rate of 25%. The carrying amount of the Note
        of
        $5,312,000 at September 30, 2006, was net of unamortized discount of $3,241,000.
        As of December 29, 2006, the Company had not made any scheduled payments
        for
        2006.
 
 On
        September 8, 2006, the Company received a default notice (the “Default Notice”)
        from McCormack in respect of the Note. Under the terms of the Note, and a
        related Security Agreement between the Company and McCormack dated February
        24,
        2004 (the “Security Agreement”), McCormack may declare all liabilities,
        indebtedness, and obligations of the Company to McCormack under the Security
        Agreement and the Note immediately due and owing upon an event of default.
        The
        Note defines an event of default to include the non-payment by the Company
        of a
        scheduled payment which is not cured within 60 days .
 
 In
        the
        Default Notice, McCormack stated that it intended to exercise its rights,
        including any and all rights set forth in the Note, as amended.
 
 Also
        on
        September 8, 2006, McCormack provided to the Company a Notice of Sale, stating
        McCormack’s intention to sell at public auction all of the collateral referred
        to in the Security Agreement, consisting of the capital stock and assets
        of
        LecStar Telecom, LecStar DataNet, and LTEL Holdings. To date, no sale of
        the
        assets or capital stock of LecStar Telecom, LecStar DataNet nor LTEL Holdings
        has occurred.
 
 During
        the fourth quarter of 2005, the Company entered into two promissory notes
        with
        an unrelated third party in the aggregate amount of $650,000. These notes
        accrue
        interest at 10% annually and were due and payable during May and June of
        2006.
        As of December 29, 2006, the Company had not made the scheduled payments
        on
        these promissory notes; the holder of the notes has not declared a default
        under
        the notes.
 
 During
        the third quarter of 2006, the Company entered into a debenture agreement
        with
        an unrelated third party for $619,000. The debenture accrues interest at
        9%
        annually and was due and payable on September 30, 2006. As of December 29,
        2006,
        the Company had not made payment on the debenture; the holder of the debenture
        has not declared a default under the debenture.
 
  14
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 The
        following schedule summarizes the Company’s current debt obligations and
        respective balances at September 30, 2006, and December 31, 2005:
 
 **Notes
                  Payable**
              
              **2006**
              
              **2005**5%
                  Note payable to a company, $8,733,000 and $8,733,000, respectively
                  face
                  amount, due in quarterly installments of $319,000, matures January
                  2010,
                  less unamortized discount based on interest imputed at 25% of $3,421,000
                  and $4,023,000, respectively
              
              $
              5,311,000
              
              $
              4,710,000Note
                  payable to a company, interest at 10%, matured May 2006
              
              
              350,000
              
              
              350,000Note
                  payable to a company, interest at 10%, matured June 2006
              
              
              300,000
              
              
              300,000Note
                  payable to a company, due in monthly installments of $23,000, interest
                  at
                  6.5%, matures January 2008, collateralized by trade accounts
                  receivable
              
              
              --
              
              
              537,000Debenture
                  to a company, interest at 9%, matured September 2006
              
              
              619,000
              
              
              --Note
                  payable to related parties, interest at 12%, matured September
                  2006,
                  secured by intellectual property rights
              
              
              706,000
              
              
              486,000Total
                  notes payable
              
              
              7,286,000
              
              
              6,383,000Less
                  current maturities
              
              
              (4,209,000
              )
              
              (2,338,000
              )Long-Term
                  Note Payable
              
              $
              3,077,000
              
              $
              4,050,000
 
 **4.
        RELATED-PARTY NOTES PAYABLE**
 
 During
        2002, two of the Company’s executive officers (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 the
        Company’s operations. The advances bear interest at 12 percent per annum, which
        interest is payable on a semi-annual basis. The entire principal, along with
        unpaid accrued interest and any other unpaid charges or related fees, were
        originally due and payable on June 10, 2003. Fonix and the Lenders have agreed
        to postpone the maturity date on several occasions. The note was due September
        30, 2006. As of December 29, 2006, 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 Fonix at any time. The conversion price was the average
        closing bid price of the shares at the time of the advances. To the extent
        the
        market price of 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. The
        Lenders may also receive additional compensation as determined appropriate
        by
        the Board of Directors.
 
  15
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 In
        October 2002, the Lenders pledged 30,866 shares of the Company's Class A
        common
        stock to the Equity Line Investor in connection with an advance of $183,000
        to
        the Company under the Third Equity Line. The Equity Line Investor subsequently
        sold the pledged shares and applied $82,000 of the proceeds as a reduction
        of
        the advance. The value of the pledged shares of $82,000 was treated as an
        additional advance from the Lenders.
 
 During
        the fourth quarter of 2003, the Company made a principal payment of $26,000
        against the outstanding balance of the promissory note. During 2004, the
        Company
        entered into an agreement with the holders of the promissory note to increase
        the balance of the note payable by $300,000 in exchange for a release of
        the
        $1,443,000 of accrued liabilities related to prior indemnity agreements between
        the Company and the note holders. The Company classified the release of
        $1,143,000 as a capital contribution in the Consolidated Financial Statements
        during the fourth quarter of 2004. The Company made principal payments against
        the note of $253,000 during the year ended December 31, 2004. During the
        year
        ended December 31, 2005, the Company received an additional advance of $50,000
        under the note from the Lenders. The balance due the Lenders at December
        31,
        2005, was $486,000. During the nine months ended September 30, 2006, the
        Company
        received additional advances of $325,000 and made principal payments to the
        Lenders against the note of $105,000. The balance due at September 30, 2006,
        was
        $706,000.
 
 The
        unpaid balance of $706,000 at September 303, 2006, is secured by the Company’s
        assets, including its stock of Fonix Speech. As of September 30, 2006, the
        Lenders had not converted any of the outstanding balance or interest into
        common
        stock.
 
 **5.
        PREFERRED STOCK**
 
 The
        Company’s certificate of incorporation allows for the issuance of preferred
        stock in such series and having such terms and conditions as the Company’s board
        of directors may designate.
 
 ***Series
        A Convertible Preferred Stock*** - As of
        September 30, 2006, there were 166,667 shares of Series A convertible preferred
        stock outstanding. Holders of the Series A convertible preferred stock have
        the
        same voting rights as common stockholders, have the right to elect one person
        to
        the board of directors and are entitled to receive a one time preferential
        dividend of $2.905 per share of Series A convertible preferred stock prior
        to
        the payment of any dividend on any class or series of stock. At the option
        of
        the holders, each share of Series A convertible preferred stock is convertible
        into one share of Class A common stock and in the event that the common stock
        price has equaled or exceeded $10 per share for a 15 day period, the shares
        of
        Series A convertible preferred stock will automatically be converted into
        Class
        A common stock. In the event of liquidation, the holders are entitled to
        a
        liquidating distribution of $36.33 per share and a conversion of Series A
        convertible preferred stock at an amount equal to .0375 shares of common
        stock
        for each share of Series A convertible preferred stock.
 
 ***Series
        H Preferred Stock*** - The
        Company issued 2,000 shares of 5% Series H nonvoting, nonconvertible Preferred
        Stock on February 24, 2004 in connection with the acquisition of LTEL. Dividends
        on the $20,000,000 stated value of the outstanding Series H Preferred Stock
        were
        payable at the rate of 5% per annum as and when declared by the Board of
        Directors. The annual dividend requirement was $1,000,000. If dividends were
        declared on Fonix's common stock, as a condition of that dividend, Fonix
        was
        required to pay three percent of the aggregate amount of such dividend to
        the
        Series H Preferred Stock. Dividends on the Series H Preferred Stock were
        payable
        in cash or, at the option of Fonix, in shares of Class A common stock. The
        Company has accrued for the March 31, 2006, June 30, 2006 and the period
        from
        July 1, 2006 through September 7, 2006 dividend payments under the Series
        H
        Preferred Stock, but has not paid the dividends to the holders of the Series
        H
        Preferred Stock as of the date of this report.
 
 On
        September 7, 2006, the Company entered into an agreement to exchange the
        2,000
        shares of Series H Preferred Stock for shares of the Company’s Series L
        Preferred Stock. (See discussion below under “Series L Preferred Stock.”) As of
        September 30, 2006, no shares of Series H Preferred Stock remained
        outstanding.
 
 ***Series
        J Preferred Stock*** -
        On
        October 6, 2005, the Company entered into a Series J 5% Convertible Preferred
        Stock Exchange Agreement (the "Exchange Agreement") with Southridge Partners,
        LP
        ("Southridge"), a Delaware limited partnership. Pursuant to the Exchange
        Agreement, Southridge exchanged all of the shares of the Company’s Series I
        Preferred Stock that it acquired from The Breckenridge Fund, LLC, for 1,452
        shares of the Company's Series J 5% Convertible Preferred Stock (the "Series
        J
        Preferred Stock").
 
  16
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 Because
        the shares of Series J Preferred Stock were issued in exchange for the remaining
        outstanding shares of Series I Preferred Stock, the Company did not receive
        any
        proceeds in connection with the issuance of the Series J Preferred Stock.
        The
        Company issued 1,452 shares of Series J Preferred Stock in exchange for 1,172
        shares of Series I Preferred Stock. Of the 280 additional shares that were
        issued to Southridge, 250 were issued as a placement fee and were accounted
        for
        as selling, general and administrative expense. The remaining 30 shares were
        issued as additional litigation expense and were accounted for as legal
        settlement expense.
 
 The
        Series J Preferred Stock entitled Southridge to receive dividends in an amount
        equal to 5% of the then-outstanding balance of shares of Series J Preferred
        Stock. The dividends were payable in cash or shares of the Company's Class
        A
        common stock, at the Company's option.
 
 The
        Series J Preferred Stock was convertible into common stock of the Company
        at the
        option of the holder by using a conversion price which was 90% of the average
        of
        the two (2) lowest closing bid prices for the twenty-day trading period prior
        to
        the conversion date.
 
 For
        the
        year ended December 31, 2005, the Company issued 3,795,918 shares of its
        Class A
        common stock upon conversion of 93 shares of its Series J Preferred Stock.
        For
        the nine months ended September 30, 2006, the Company issued 15,028,249 shares
        of its Class A common stock upon conversion of 266 shares of its Series J
        Preferred Stock. As of September 30, 2006, no shares of Series J Preferred
        Stock
        remained outstanding.
 
 ***Series
        K Preferred Stock*** - On
        February 3, 2006, the Company’s Board of Directors approved the designation and
        issuance of Series K 5% Convertible Preferred Stock (the “Series K Preferred
        Stock”). The Series K Preferred Stock entitled the holder to receive dividends
        in an amount equal to 5% of the stated value of the then-outstanding balance
        of
        shares of Series K Preferred Stock. The dividends were payable in cash or
        shares
        of the Company’s Class A common stock, at the Company’s option.
 
 The
        shares of Series K Preferred Stock were issued pursuant to a Series K 5%
        Convertible Preferred Stock Exchange Agreement (the “Series K Agreement”), in
        connection with which Southridge exchanged 1,093 shares of Series J Convertible
        Preferred Stock for 1,093 shares of Series K Convertible Preferred
        Stock.
 
 The
        Series K Preferred Stock were convertible into common stock of the Company
        at
        the option of the holder by using a conversion price of $0.01 per
        share.
 
 For
        the
        nine months ended September 30, 2006, the Company issued 109,300,000 shares
        of
        its Class A common stock upon conversion of all 1,093 shares of its Series
        K
        Preferred Stock. As of September 30, 2006, no shares of Series K Preferred
        Stock
        remained outstanding.
 
 ***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 of the shares of Series H
        Preferred Stock that they acquired from sale of LTEL Holdings, for 1,960.8
        and
        39.2 shares, respectively, of the Company's Series L 9% Convertible Preferred
        Stock (the "Series L Preferred Stock").
 
 Because
        the shares of Series L Preferred Stock were issued in exchange for the remaining
        outstanding shares of Series H Preferred Stock, the Company did not receive
        any
        proceeds in connection with the issuance of the Series L Preferred Stock.
 
 The
        Series L Preferred Stock entitles McCormack and Kenzie to receive dividends
        in
        an amount equal to 9% of the then-outstanding balance of shares of Series
        L
        Preferred Stock. The dividends are payable in cash or shares of the Company's
        Class A common stock, at the Company's option.
 
 The
        Series L Preferred Stock is convertible into common stock of the Company
        at the
        option of the holder by using a conversion price which was 80% of the average
        of
        the two (2) lowest closing bid prices for the twenty-day trading period prior
        to
        the conversion date.
 
  17
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 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%).
 
 In
        connection with the issuance of the Series L Preferred Stock, the Company
        filed
        with the State of Delaware a Certificate of Designation and Series L 9%
        Convertible Stock Terms (the “Series L Terms”), which become a part of the
        Company’s Certificate of Incorporation, as amended.
 
 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.
 
 For
        the
        nine months ended September 30, 2006, the Company issued 66,334,622 shares
        of
        our Class A common stock in conversion of 27 shares of its Series L Preferred
        Stock. At September 30, 2006, 1,973 shares of Series L Preferred Stock remained
        outstanding. Subsequent to September 30, 2006 and through December 29, 2006,
        the
        Company issued 423,535,469 shares of our Class A common stock in conversion
        of
        114.6 shares of Series L Preferred Stock.
 
 **6.
        EQUITY LINES OF CREDIT**
 
 ***Seventh
        Equity Line of Credit*** - On May
        27, 2005, the Company entered into a seventh private equity line agreement
        (the
“Seventh Equity Line Agreement”) with Queen, LLC (the “Equity Line Investor”).
        Under the Seventh Equity Line Agreement, the Company has the right to draw
        up to
        $20,000,000 against an equity line of credit (“the Seventh Equity Line”) from
        the Equity Line Investor. The Company is entitled under the Seventh Equity
        Line
        Agreement to draw certain funds and to put to the Equity Line Investor shares
        of
        the Company’s Class A common stock in lieu of repayment of the draw. The number
        of shares to be issued is determined by dividing the amount of the draw by
        93%
        of the average of the two lowest closing bid prices of the Company’s Class A
        common stock over the ten trading days after the put notice is tendered.
        The
        Equity Line Investor is required under the Seventh Equity Line Agreement
        to
        tender the funds requested by the Company within two trading days after the
        ten-trading-day period used to determine the market price.
 
 Pursuant
        to the Seventh Equity Line Agreement, the Company granted to the Equity Line
        Investor a right of first refusal (the “Refusal Right”) with respect to
        additional financing transactions. Under the Refusal Right, for a period
        of 180
        days after the effective date of a registration statement filed to register
        resales by the Equity Line Investor, the Company may not offer or sell, with
        certain exceptions, shares of our common stock in a financing transaction
        without first offering that financing transaction to the Equity Line Investor.
        The Equity Line Investor then has the right to choose to offer financing
        to the
        Company on the same terms or to allow the Company to proceed with the financing
        transaction with other investors.
 
 In
        connection with the Seventh Equity Line Agreement, the Company entered into
        an
        agreement with the Equity Line Investor to terminate all previous equity
        lines,
        and cease further draws or issuances of shares in connection with all previous
        equity lines. As such, as of the date of this report, the only active equity
        line of credit was the Seventh Equity Line.
 
  18
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 Also
        in
        connection with the Seventh Equity Line Agreement, the Company granted
        registration rights to the Equity Line Investor and has filed three registration
        statements which cover the resales of the shares to be issued under the Seventh
        Equity Line. All of the shares registered by the first registration statement
        had been sold as of October 24, 2005. The second registration statement filed
        in
        connection with the Seventh Equity Line was declared effective by the SEC
        on
        February 10, 2006. All of the shares registered by the second registration
        statement had been sold as of July 26, 2006. The Company filed a third
        registration statement on June 26, 2006, to register additional shares under
        the
        Seventh Equity Line. However, this registration statement has not been declared
        effective the SEC and, based upon its communication with the SEC, the Company
        currently expects that the SEC will not declare the registration statement
        to be
        effective. Accordingly, the Company does not currently have an active
        registration statement filed with the SEC related to the Seventh Equity Line
        and
        is currently unable to draw on the Seventh Equity Line.
 
 For
        the
        nine months ended September 30, 2006, the Company received $3,378,000 in
        funds
        drawn under the Seventh Equity Line, less commissions and fees of $114,000.
        The
        Company issued 300,000,000 shares of Class A common stock to the Equity Line
        Investor as puts under the Seventh Equity Line totaling $3,378,000.
 
 **7.
        COMMON STOCK, STOCK OPTIONS AND WARRANTS**
 
 ***Class
        A Common Stock*** - During
        the nine months ended September 30, 2006, 300,000,000 shares of Class A common
        stock were issued in connection with draws on the Seventh Equity Line,
        15,028,249 shares were issued in conversion of 266 shares of Series J Preferred
        Stock, 109,300,000 shares were issued in conversion of 1,093 shares of Series
        K
        Preferred Stock, 2,838,412 shares were issued in payment of dividends on
        Series
        H Preferred Stock and 66,334,621 shares were issued in conversion of 27 shares
        of Series L Preferred Stock.
 
 ***Stock
        Options -*** As of
        September 30, 2006, the Company had a total of 916,705 options to purchase
        Class
        A common stock outstanding. During the six months ended September 30, 2006,
        the
        Company granted options to employees to purchase 58,000 shares of Class A
        common
        stock, none of which were to employees participating in the option exchange
        program. The options have exercise prices ranging from $0.01 to $0.02 per
        share,
        which was the quoted fair market value of the stock on the dates of grant.
        The
        options granted vest over the three years following issuance. Options expire
        within ten years from the date of grant if not exercised. Using the
        Black-Scholes pricing model, the weighted average fair value of the employee
        options was $0.01 per share.
 
 ***Warrants*** - As of
        September 30, 2006, the Company had warrants to purchase a total of 15,000
        shares of Class A common stock outstanding that expire through
        2010.
 
 **8.
        LITIGATION, COMMITMENTS AND CONTINGENCIES**
 
 ***Breckenridge
        Complaint*** - On
        June 6, 2006, The Breckenridge Fund, LP (“Breckenridge”) filed a complaint
        against the Company in the Supreme Court of the State of New York, County
        of
        Nassau (Index No. 009050/06), in connection with a settlement agreement between
        the Company and Breckenridge entered into in September 2005. In the Complaint,
        Breckenridge alleges that Fonix failed to pay certain amounts due under the
        settlement agreement in the amount of $450,000. The Company has denied the
        allegations of Breckenridge’s complaint and has filed for a summary judgment
        motion. The Company intends to vigorously defend itself.
 
 **9.
        SUBSEQUENT EVENTS**
 
 Subsequent
        to September 30, 2006, and through December 29, 2006, the Company received
        conversion notices on its Series L Preferred Stock and issued 423,535,469
        shares
        of its Class A common stock in conversion of 114.6 shares of its Series L
        Preferred Stock.
 
 On
        October 2, 2006, LecStar Telecom Inc., a Georgia corporation (“LecStar
        Telecom”), LecStar DataNet, Inc., a Georgia corporation (“LecStar DataNet”),
        LTEL Holdings Corporation (“LTEL Holdings”), a Delaware corporation, and Fonix
        Telecom Inc., a Delaware corporation (“Fonix Telecom”), each of which are direct
        or indirect subsidiaries of the Company, filed for bankruptcy protection
        in the
        United States Bankruptcy Court for the District of Delaware (the “Bankruptcy
        Court”). The case numbers are as follows: LTEL Holdings Corporation, 06-11081
        (BLS); LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083
        (BLS); Fonix Telecom, Inc., 06-11084 (BLS).)
 
  19
  **Fonix
        Corporation and Subsidiaries**
 **Notes
        to Condensed Consolidated Financial Statements**
 
 LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection
        under Chapter 7 of title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101
        et seq.
        (the “Bankruptcy Code”). Pursuant to Bankruptcy Code Section 701, on October 3,
        2006, Alfred Thomas Guliano was appointed the interim trustee for LecStar
        Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom.
 
 On
        December 7, 2006, the Company entered into a Securities Purchase Agreement,
        dated as of December 1, 2006 (the “Agreement”), with Southridge relating to the
        purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture
        (the “Debenture”) in the principal amount of $850,000.
 
 Pursuant
        to the Agreement, Southridge paid the purchase price by tendering a prior
        debenture in the aggregate amount (including principal and interest) of
        $641,000, and agreed that an advance to the Company in the amount of $75,000
        made in November 2006 would also constitute part of the purchase price.
        Southridge agreed to fund the remaining $134,000 upon the effectiveness of
        a
        registration statement, to be filed by the Company, to register the resales
        of
        shares issuable to Southridge upon conversion of the Debenture.
 
 The
        Debenture is convertible into shares of our Class A common stock. The number
        of
        shares issuable is determined by dividing the amount of the Debenture being
        converted by the conversion price, which is the average of the two lowest
        per
        share market values for the twenty trading days immediately preceding the
        conversion date multiplied by seventy percent. The conversion price is subject
        to adjustment as set forth in the Debenture. Southridge has agreed not to
        convert the Debenture to the extent that such conversion would cause Southridge
        to beneficially own in excess of 4.999% of the then-outstanding shares of
        Class
        A common stock of the Company except in the case of a merger by the Company
        or
        other organic change.
 
 The
        Company also entered into a Registration Rights Agreement (the “Registration
        Agreement”) with Southridge pursuant to which the Company agreed to file a
        registration statement to register the resale by Southridge of shares of
        the
        Company’s common stock issuable upon conversion of the Debenture. Under the
        Registration Agreement, the Company agreed to file a registration statement
        to
        register the resale by Southridge of up to 300,000,000 shares of Fonix Class
        A
        common stock
 
 In
        addition to the Debenture issued to Southridge described above, on December
        7,
        2006, the Company entered into a Securities Purchase Agreement, dated as
        of
        December 1, 2006 (the “McCormack Agreement”), with McCormack, relating to the
        purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture
        (the “McCormack Debenture”) in the principal amount of $1,039,000.
 
 Pursuant
        to the McCormack Agreement, McCormack paid the purchase price by tendering
        outstanding promissory notes in the amounts of $300,000 and $350,000, together
        with combined interest thereon of $64,000, and agreed that advances to the
        Company in the amount of $325,000, made in September, October, and November
        2006, would also constitute part of the purchase price.
 
 The
        McCormack Debenture is convertible into shares of the Registrant’s Class A
        common stock. The number of shares issuable is determined by dividing the
        amount
        of the Debenture being converted by the conversion price, which is the average
        of the two lowest per share market values for the twenty trading days
        immediately preceding the conversion date multiplied by seventy percent.
        The
        conversion price is subject to adjustment as set forth in the Debenture.
        McCormack agreed not to convert the Debenture to the extent that such conversion
        would cause McCormack to beneficially own in excess of 4.999% of the
        then-outstanding shares of Class A common stock of the Company except in
        the
        case of a merger by the Company or other organic change.
 
 The
        Company also entered into a Registration Rights Agreement (the “McCormack
        Registration Agreement”) with McCormack pursuant to which the Company agreed to
        file a registration statement to register the resale by McCormack of shares
        of
        the Company’s common stock issuable upon conversion of the Debenture.
 
 The
        Company received no new capital in connection with the issuance and sale
        of the
        Debenture.
   20
  **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. Actual results could
          differ
          materially from the results anticipated by Fonix and discussed in the
          forward-looking statements. When used in this report, words such as “believes,”
“expects,” “intends,” “plans,” “anticipates,” “estimates,” and similar
          expressions are intended to identify forward-looking statements, although
          there
          may be certain forward-looking statements not accompanied by such expressions.
          Factors that could cause or contribute to such differences are discussed
          in the
          Company’s Annual Report on Form 10-K for the year ended December 31, 2005. 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.**
  **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.
 
 We
          previously operated a telecommunications business, the results of which
          were
          included in prior SEC filings. On October 2, 2006, LecStar Telecom Inc.,
          a
          Georgia corporation (“LecStar Telecom”), LecStar DataNet, Inc., a Georgia
          corporation (“LecStar DataNet”), LTEL Holdings Corporation (“LTEL Holdings”), a
          Delaware corporation, and Fonix Telecom Inc., a Delaware corporation (“Fonix
          Telecom”), each of which are direct or indirect subsidiaries of Fonix, filed for
          bankruptcy protection in the United States Bankruptcy Court for the District
          of
          Delaware (the “Bankruptcy Court”). The case numbers are as follows: LTEL
          Holdings Corporation, 06-11081 (BLS); LecStar Telecom, Inc., 06-11082 (BLS);
          LecStar DataNet, Inc., 06-11083 (BLS); Fonix Telecom, Inc., 06-11084 (BLS).)
 
 LecStar
          Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection
          under Chapter 7 of title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101
          et seq.
          (the “Bankruptcy Code”). Pursuant to Bankruptcy Code Section 701, on October 3,
          2006, Alfred Thomas Guliano was appointed the interim trustee for LecStar
          Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom. As these subsidiary
          companies are now in Chapter 7 Bankruptcy proceedings, the results of their
          operations have not been included in this report.
 
 For
          the
          three months ended September 30, 2006 and 2005, the Company generated revenues
          of $386,000 and $258,000, respectively; and incurred net losses of $10,847,000
          and $6,515,000, respectively. For the nine months ended September 30, 2006
          and
          2005, the Company generated revenues of $1,024,000 and $978,000, respectively,
          incurred net losses of $19,432,000 and $14,925,000, respectively, and had
          negative cash flows from operating activities of $3,185,000 and $6,748,000,
          respectively. As of September 30, 2006, we had an accumulated deficit of
          $288,069,000, negative working capital of $51,213,000, derivative liability
          of
          $21,392,000 related to the issuance of Series L Preferred Stock, net liabilities
          of unconsolidated subsidiaries of $20,639,000 related to the telecom
          subsidiaries subject to bankruptcy (LecStar Telecom, LecStar DataNet, LTEL
          Holdings and Fonix Telecom), accrued liabilities and accrued settlement
          obligation of $3,800,000, accounts payable of $1,403,000 and current portion
          of
          notes payable of $4,209,000. We expect to continue to incur significant
          losses
          and negative cash flows from operating activities at least through December
          31,
          2007, primarily due to expenditure requirements associated with continued
          marketing and development of its speech-enabling technologies.
 
  21
  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.
 
 Our
          cash
          resources, limited to collections from customers, draws on the Seventh
          Equity
          Line and loans, have not been sufficient to cover operating expenses. We
          have
          not been declared in default under the terms of any material agreements.
          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 the Seventh
          Equity Line. We will need to generate approximately $6 to $8 million to
          continue
          operations for the next twelve months .
 
 ***Significant
          Accounting Policies***
 
 The
          discussion and analysis of our financial condition and results of operations
          are
          based upon our consolidated financial statements, which have been prepared
          in
          accordance with accounting principles generally accepted in the United
          States.
          The preparation of these financial statements requires management to make
          estimates and assumptions that affect the reported amounts of assets and
          liabilities and disclosure of contingent assets and liabilities at the
          date of
          the financial statements and the reported amounts of sales and expenses
          during
          the reporting period. Significant accounting policies and areas where
          substantial judgments are made by management include:
 
 ***Accounting
          estimates*** **-** The
          preparation of financial statements in conformity with accounting principles
          generally accepted in the United States requires management to make estimates
          and assumptions that affect the reported amounts of assets and liabilities
          and
          the disclosures of contingent assets and liabilities at the date of the
          financial statements, and the reported amounts of revenues and expenses
          during
          the reporting period. Actual results could differ from those
          estimates.
 
 ****** ***Valuation
          of long-lived assets*** - The
          carrying values of our long-lived assets are reviewed for impairment whenever
          events or changes in circumstances indicate that they may not be recoverable.
          When such an event occurred, we would project undiscounted cash flows to
          be
          generated from the use of the asset and its eventual disposition over the
          remaining life of the asset. If projections were to indicate that the carrying
          value of the long-lived asset would not be recovered, the carrying value
          of the
          long-lived asset, other than software technology, would be reduced by the
          estimated excess of the carrying value over the projected discounted cash
          flows.
 
 ***Goodwill*** -
          Goodwill represents the excess of the cost over the fair value of net assets
          of
          acquired businesses. Goodwill is not amortized, but is tested for impairment
          quarterly or when a triggering event occurs. The testing for impairment
          requires
          the determination of the fair value of the asset or entity to which the
          goodwill
          relates (the reporting unit). The fair value of a reporting unit is determined
          based upon a weighting of the quoted market price of our common stock and
          present value techniques based upon estimated future cash flows of the
          reporting
          unit, considering future revenues, operating costs, the risk-adjusted discount
          rate and other factors. Impairment is indicated if the fair value of the
          reporting unit is allocated to the assets and liabilities of that unit,
          with the
          excess of the fair value of the reporting unit over the amounts assigned
          to its
          assets and liabilities assigned to the fair value of goodwill. The amount
          of
          impairment of goodwill is measured by the excess of the goodwill’s carrying
          value over its fair value.
 
 ***Revenue
          recognition -*** We
          recognize revenue when pervasive evidence of an arrangement exists, services
          have been rendered or products have been delivered, the price to the buyer
          is
          fixed and determinable and collectibility is reasonable assured. Revenues
          are
          recognized by us based on the various types of transactions generating
          the
          revenue. For software sales, we recognize revenues in accordance with the
          provisions of Statement of Position No. 97-2, “Software Revenue Recognition” and
          related interpretations *.* We
          generate revenues from licensing the rights to 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.
 
  22
  Revenue
          for products distributed through wholesale and retail channels and through
          resellers is recognized upon verification of final sell-through to end
          users,
          after consideration of rights of return and price protection. Typically,
          the
          right of return on such products has expired when the end user purchases
          the
          product from the retail outlet. Once the end user opens the package, it
          is not
          returnable unless the medium is defective.
 
 When
          arrangements to license software products do not require significant production,
          modification or customization of software, revenue from licenses and royalties
          are recognized when persuasive evidence of a licensing arrangement exists,
          delivery of the software has occurred, the fee is fixed or determinable,
          and
          collectibility is probable. Post-contract obligations, if any, generally
          consist
          of one year of support including such services as customer calls, bug fixes,
          and
          upgrades. Related revenue is recognized over the period covered by the
          agreement. Revenues from maintenance and support contracts are also recognized
          over the term of the related contracts.
 
 Revenues
          applicable to multiple-element fee arrangements are bifurcated among elements
          such as license agreements and support and upgrade obligations using
          vendor-specific objective evidence of fair value. Such evidence consists
          primarily of pricing of multiple elements as if sold as separate products
          or
          arrangements. These elements vary based upon factors such as the type of
          license, volume of units licensed, and other related factors.
 
 For
          Fonix
          Telecom and LecStar (accounted for as discontinued operations in the Condensed
          Consolidated Financial Statements), telecommunications revenue was comprised
          of
          two main components: (1) fees paid by business and residential subscribers
          of
          voice and data services; and (2) carrier access fees. Subscriber revenues
          include monthly recurring charges, usage charges and non-recurring charges.
          Monthly recurring charges were flat monthly fees for local phone and data
          services. Usage charges, which primarily include long distance fees, are
          generally billed on a per-minute or per-call basis. Non-recurring charges
          are
          generally one-time charges for installation or changes to the subscriber’s
          service. Carrier access fees were paid to us by other telecommunications
          carriers as compensation for originating and terminating the carriers’ long
          distance traffic. Revenue from monthly recurring charges was recognized
          ratably
          over the period the local phone and data services are provided. Revenue
          from
          usage charges non-recurring charges and carrier access fees was recognized
          on
          the date the services are provided.
 
 Deferred
          revenue as of September 30, 2006, and December 31, 2005, consisted of the
          following:
 **Description**
                  **Criteria
                      for Recognition**
                  
                  **September
                      30, 2006**
                  
                  **December
                      31, 2005**Deferred
                      unit royalties and license fees
                  Delivery
                      of units to end users or expiration of contract
                  
                  $
                  476,000
                  
                  $
                  466,000Telecom
                      deferred revenue
                  Service
                    provided for customer
                  
                  
                  --
                  
                  
                  457,000Total
                      deferred revenue
                  
                  
                  $
                  476,000
                  
                  $
                  923,000
 ***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.
 
  23
  Capitalized
          software technology costs were amortized on a product-by-product basis.
          Amortization was recognized from the date the product was available for
          general
          release to customers as the greater of (a) the ratio that current gross
          revenue
          for a product bears to total current and anticipated future gross revenues
          for
          that product or (b) the straight-line method over the remaining estimated
          economic life of the products. Amortization was charged to cost of
          revenues.
 
 We
          assessed unamortized capitalized software costs for possible write down
          on a
          quarterly basis based on net realizable value of each related product.
          Net
          realizable value was determined based on the estimated future gross revenues
          from a product reduced by the estimated future cost of completing and disposing
          of the product, including the cost of performing maintenance and customer
          support. The amount by which the unamortized capitalized costs of a software
          product exceeded the net realizable value of that asset was written
          off.
 
 ***Stock-Based
          Employee Compensation***  ***-*** Effective
          January 1, 2006, we adopted Statement of Financial Accounting Standards No.
          123(R), “Share-Based Payment” (“FAS 123(R)”), an amendment of SFAS No. 123,
“Accounting for Stock-Based Compensation,” using the modified prospective
          transition method. Under this transition method, compensation costs are
          recognized beginning with the effective date: (a) based on the requirements
          of
          FAS 123(R) for all share-based awards granted after the effective date
          and (b)
          based on the requirements of FAS 123 for all awards granted to employees
          prior
          to the effective date of FAS 123(R) that remain unvested on the effective
          date.
          Accordingly, we did not restate the results of prior periods. The most
          notable
          change resulting from the adoption of FAS 123(R)is that compensation expense
          associated with stock options is now recognized in our Statements of Operations,
          rather than being disclosed in a pro forma footnote to our financial statements.
          We recognized compensation expense related to option grants and the vesting
          of
          previously unvested options for the three months ended September 30, 2006,
          of
          $0. For the nine months ended September 30, 2006, we recognized compensation
          expense related to option grants and the vesting of previously unvested
          options
          of $0.
 
 Prior
          to
          January 1, 2006, we accounted for stock options granted under our Stock
          Option
          Plans under the recognition and measurement provisions of Accounting Principles
          Board Opinion No. 25, *Accounting
          for Stock Issued to Employees* ,
          and
          related interpretations, as permitted by Statement of Financial Accounting
          Standards No. 123, *Accounting
          for Stock-Based Compensation* .
 
 ***Imputed
          Interest Expense*** -
          Interest is imputed on long-term debt obligations and notes receivable
          where
          management has determined that the contractual interest rates are below
          the
          market rate for instruments with similar risk characteristics.
 
 ***Foreign
          Currency Translation*** **-** The
          functional currency of our Korean subsidiary is the South Korean won.
          Consequently, assets and liabilities of the Korean operations are translated
          into United States dollars using current exchange rates at the end of the
          year.
          All revenue is invoiced in South Korean won and revenues and expenses are
          translated into United States dollars using weighted-average exchange rates
          for
          the year.
 
 ***Comprehensive
          Income*** *-* ****** Other
          comprehensive income presented in the accompanying consolidated financial
          statements consists of cumulative foreign currency translation adjustments.
 
 ***Results
          of Operations (Continuing operations only)***
  **Three
          months ended September 30, 2006, compared with three months ended September
          30,
          2005**
  
 During
          the three months ended September 30, 2006, we recorded revenues of $386,000,
          an
          increase of $128,000 from $258,000 in 2005. The increase was primarily
          due to
          increased licensing revenues of $77,000, increased royalty revenue of $50,000
          and increased retail product sales of $31,000, partially offset by decreased
          non-recurring engineering (“NRE”) speech revenues of $28,000.
 
 Selling,
          general and administrative expenses were $2,024,000 for the three months
          ended
          September 30, 2006, an increase of $614,000 from $1,410,000 in 2005. The
          increase is primarily due to the expense related to fully reserving the
          intercompany receivable we had with our subsidiaries that filed for bankruptcy
          protection of $1,214,000, increased advertising expenses of $8,000 and
          increased
          occupancy expenses of $7,000, partially offset by decreased other expenses
          of
          $235,000, decreased legal and accounting fees of $159,000, decreased consulting
          expenses of $125,000, decreased travel expenses of $37,000 and decreased
          salary
          and wage expenses of $27,000
 
  24
  We
          incurred research and product development expenses of $551,000 for the
          three
          months ended September 30, 2006, a decrease of $29,000 from $580,000 in
          2005.
          The decrease was primarily due to an overall decrease in consulting expenses
          of
          $45,000 and decreased other expenses of $13,000, partially offset by increased
          salaries and wage-related expenses of $12,000, increased occupancy related
          expenses of $6,000 and increased travel expenses of $8,000.
 
 Net
          interest and other expense was $2,291,000 for the three months ended September
          30, 2006, an increase of $2,192,000 from $99,000 in 2005. The overall increase
          was due to the loss recognized on the redemption of the Series H Preferred
          Stock
          of $10,991,000 and an increase in interest expense of $245,000, combined
          with
          decreased interest income of $106,000 and the gain on forgiveness of liabilities
          of $78,000 recognized in the 2005 period, partially offset by a gain recognized
          on the change in the derivative liability associated with the Series L
          Preferred
          Stock of $9,228,000.
 
 **Nine
          months ended September 30, 2006, compared with nine months ended September
          30,
          2005**
 
 During
          the nine months ended September 30, 2006, we recorded revenues of $1,024,000,
          an
          increase of $46,000 from $978,000 in 2005. The increase was primarily due
          to
          increased royalty revenues of $138,000 and increased licensing revenues
          of
          $74,000, partially offset by decreased NRE speech revenues of $146,000
          and
          decreased retail product sales of $23,000.
 
 Selling,
          general and administrative expenses were $4,444,000 for the nine months
          ended
          September 30, 2006, an increase of $688,000 from $3,756,000 in 2005. The
          increase is primarily due to the expense related to fully reserving the
          intercompany receivable we had with our subsidiaries that filed for bankruptcy
          protection of $1,214,000, increased salary and wage expenses of $125,000,
          increased occupancy expenses of $33,000, increased advertising expenses
          of
          $25,000 and increased travel expenses of $6,000, partially offset by decreased
          legal and accounting fees of $363,000, decreased other expenses of $225,000,
          decreased investor relations related expenses of $75,000 and decreased
          other tax
          expenses of $42,000.
 
 We
          incurred research and product development expenses of $1,711,000 for the
          nine
          months ended September 30, 2006, an increase of $83,000 from $1,628,000
          in 2005.
          The increase was primarily due to an overall increase in salaries and
          wage-related expenses of $116,000, increased travel expense of $17,000
          and
          increased occupancy related expenses of $14,000, partially offset by decreased
          other operating expenses of $36,000 and decreased consulting expenses of
          $27,000.
 
 Net
          interest and other expense was $3,042,000 for the nine months ended September
          30, 2006, an increase of $2,319,000 from $724,000 in 2005. The overall
          increase
          was due to the loss recognized on the redemption of the Series H Preferred
          Stock
          of $10,991,000 and an increase in interest expense of $349,000, combined
          with
          decreased interest income of $112,000 and the gain on forgiveness of liabilities
          of $112,000 recognized in the 2005 period, partially offset by a gain recognized
          on the change in the derivative liability associated with the Series L
          Preferred
          Stock of $9,228,000.
 
 ***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 $6 to $8 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.
 
  25
  Our
          cash
          resources are limited to collections from customers, proceeds from the
          issuance
          of preferred stock and loan proceeds, and are only sufficient to cover
          current
          operating expenses and payments of current liabilities. At September 30,
          2006, we
          had
          negative working capital of $51,213,000, derivative liability of $21,392,000
          related to the issuance of Series L Preferred Stock, net liabilities of
          unconsolidated subsidiaries of $20,639,000 related to the telecom assets
          subject
          to bankruptcy, accrued liabilities and accrued settlement obligation of
          $3,317,000, accounts payable of $1,403,000 and current portion of notes
          payable
          of $4,209,000.
 
 We
          had
          $1,024,000 in revenue and a loss of $19,432,000 for the nine months ended
          September 30, 2006. Net cash used in operating activities of $3,185,000
          for the
          nine months ended September 30, 2006, resulted principally from the net
          loss
          incurred of $19,432,000, increased other assets of $95,000, increased prepaid
          expenses of $47,000, and decreased accrued payroll of $9,000, partially
          offset
          by the results of discontinued operations of $11,107,000, the loss on derivative
          liability of $1,763,000, the write-down of intercompany receivables of
          $1,214,000, non-cash accretion of the discount on notes payable of $603,000,
          increased other accrued liabilities of $582,000, increased accounts payable
          of
          $448,000, non-cash accretion of the discount on legal settlement obligation
          of
          $98,000, depreciation expense of $44,000 and increased deferred revenues
          of
          $10,000. Net cash used in investing activities of $12,000 for the nine
          months
          ended September 30, 2006, consisted of the purchase of equipment of $12,000.
          Net
          cash provided by financing activities of $3,609,000 consisting primarily
          of the
          receipt of $3,504,000 in cash related to the sale of shares of Class A
          common
          stock, $325,000 in cash from proceeds from related party notes, proceeds
          from
          debentures of $250,000 and proceeds from a credit advance of $75,000, partially
          offset by payments on accrued settlement obligation of $440,000 and payments
          on
          related party notes of $105,000.
 
 We
          had
          negative working capital of $51,213,000 at September 30, 2006, compared
          to
          negative working capital of $19,004,000 at December 31, 2005. Current assets
          decreased by $1,235,000 to $230,000 from $1,465,000 from December 31, 2005,
          to
          September 30, 2006. Current liabilities increased by $30,974,000 to $51,443,000
          from $20,469,000 during the same period. The change in working capital
          from
          December 31, 2005, to September 30, 2006, reflects, in part, the derivative
          liability recognized in connection with the issuance of Series L Preferred
          Stock
          of $21,392,000, the loss of assets related to discontinued operations,
          the net
          liabilities of unconsolidated subsidiaries of $20,639,000 related to
          discontinued operations and increases in current portion of notes payable,
          accrued liabilities and accounts payable, partially offset by decreases
          in
          accrued settlement obligation due to payments made during the nine months
          ended
          September 30, 2006. Total assets were $3,042,000 at September 30, 2006,
          compared
          to $9,293,000 at December 31, 2005.
 
 ***Notes
          Payable - Related Parties***
 
 During
          2002, two of our executive officers (the “Lenders”) sold shares of our Class A
          common stock owned by them and advanced the resulting proceeds amounting
          to
          $333,000 to us under the terms of a revolving line of credit and related
          promissory note. The funds were advanced for use in our operations. The
          advances
          bear interest at 12 percent per annum, which interest is payable on a
          semi-annual basis. The entire principal, along with unpaid accrued interest
          and
          any other unpaid charges or related fees, were originally due and payable
          on
          June 10, 2003. Fonix and the Lenders have agreed to postpone the maturity
          date
          on several occasions. The note was due September 30, 2006. As of December
          29,
          2006, we had not made payment against the outstanding balance due on the
          note.
          All or part of the outstanding balance and unpaid interest may be converted
          at
          the option of the Lenders into shares of Class A common stock of Fonix
          at any
          time. The conversion price was the average closing bid price of the shares
          at
          the time of the advances. To the extent the market price of our shares
          is below
          the conversion price at the time of conversion, the Lenders are entitled
          to
          receive additional shares equal to the gross dollar value received from
          the
          original sale of the shares. The Lenders may also receive additional
          compensation as determined appropriate by the Board of Directors.
 
 In
          October 2002, the Lenders pledged 30,866 shares of the Company's Class
          A common
          stock to the Equity Line Investor in connection with an advance of $183,000
          to
          us under the Third Equity Line. The Equity Line Investor subsequently sold
          the
          pledged shares and applied $82,000 of the proceeds as a reduction of the
          advance. The value of the pledged shares of $82,000 was treated as an additional
          advance from the Lenders.
 
  26
  During
          the fourth quarter of 2003, we made a principal payment of $26,000 against
          the
          outstanding balance of the promissory note. During 2004, we entered into
          an
          agreement with the holders of the promissory note to increase the balance
          of the
          note payable by $300,000 in exchange for a release of the $1,443,000 of
          accrued
          liabilities related to prior indemnity agreements between us and the note
          holders. We classified the release of $1,143,000 as a capital contribution
          in
          the Consolidated Financial Statements during the fourth quarter of 2004.
          We made
          principal payments against the note of $253,000 during the year ended December
          31, 2004. During the year ended December 31, 2005, we received an additional
          advance of $50,000 under the note from the Lenders. The balance due the
          Lenders
          at December 31, 2005 was $486,000. During the nine months ended September
          30,
          2006 we received additional advances of $325,000 and made principal payments
          to
          the Lenders against the note of $105,000. The balance due at September
          30, 2006
          was $706,000.
 
 The
          unpaid balance of $706,000 at September 30, 2006, is secured by our assets,
          including our stock of Fonix Speech. As of September 30, 2006, the Lenders
          had
          not converted any of the outstanding balance or interest into common
          stock.
 
 ***Notes
          Payable***
 
 On
          February 28, 2004, LecStar had an asset securitization facility which provided
          LecStar with $750,000. Assets securitized under this facility consist of
          executory future cash flows from LecStar customers in the states of Georgia,
          Tennessee, Florida, and Louisiana. LecStar has pledged its interest in
          the
          special purpose securitization facility, LecStar Telecom Ventures LLC,
          and
          customer accounts receivable to the lender. We have recorded the $750,000
          as a
          note payable in our consolidated financial statements. The note bears an
          interest rate of 6.5% and is due on February 27, 2007, with 24 equal monthly
          installments which began on March 6, 2005. During 2005, we made principal
          payments of $215,000. During the nine months ended September 30, 2006,
          we made
          principal payments of $124,000.
 
 In
          connection with the acquisition of the capital stock of LTEL Holdings in
          2004,
          we issued a 5%, $10,000,000, secured, six-year note (the “Note”) payable to
          McCormack Avenue, Ltd. (“McCormack”). Under the terms of the Note, quarterly
          interest only payments were required through January 15, 2005, with quarterly
          principal and interest payments beginning April 2005 and continuing through
          January 2010. Interest on the Note is payable in cash or, at our option,
          in
          shares of our Class A common stock. The Note is secured by the capital
          stock and
          all of the assets of LTEL Holdings and its subsidiaries. The Note was valued
          at
          $4,624,000 based on an imputed interest rate of 25 percent per annum.
 
 The
          discount on the Note is based on an imputed interest rate of 25%. The carrying
          amount of the Note of $5,312,000 at September 30, 2006, was net of unamortized
          discount of $3,421,000. As of December 29, 2006, we had not made any scheduled
          payments for 2006.
 
 On
          September 8, 2006, we received a default notice (the “Default Notice”) from
          McCormack in respect of the Note. Under the terms of the Note, and a related
          Security Agreement between us and McCormack dated February 24, 2004 (the
          “Security Agreement”), McCormack may declare all liabilities, indebtedness, and
          obligations of Fonix to McCormack under the Security Agreement and the
          Note
          immediately due and owing upon an event of default. The Note defines an
          event of
          default to include the non-payment by us of a scheduled payment which is
          not
          cured within 60 days .
 
 In
          the
          Default Notice, McCormack stated that it intended to exercise its rights,
          including any and all rights set forth in the Note as amended.
 
 Also
          on
          September 8, 2006, McCormack provided to us a Notice of Sale, stating
          McCormack’s intention to sell at public auction all of the collateral referred
          to in the Security Agreement, consisting of the capital stock and assets
          of
          LecStar Telecom, LecStar DataNet and LTEL Holdings. To date, no sale of
          the
          assets or capital stock of LecStar Telecom, LecStar DataNet nor LTEL Holdings
          has occurred.
 
 McCormack
          has notified us that notwithstanding the Series L Exchange Agreement between
          us
          and McCormack discussed above, McCormack has not waived any of its rights
          in
          connection with the Note, the Modification Agreement, the Security Agreement,
          or
          the Supplemental Security Agreement.
 
 During
          2005, we entered into two promissory notes with an unrelated third party
          in the
          aggregate amount of $650,000. These notes accrue interest at 10% annually
          and
          were due and payable during May and June of 2006. As of December 29, 2006,
          we
          had not made the scheduled payments on these promissory notes; the holder
          of the
          notes has not declared a default under the notes.
 
  27
  During
          the third quarter of 2006, we entered into a debenture agreement with an
          unrelated third party for $619,000. The debenture accrues interest at 9%
          annually and was due and payable on September 30, 2006. As of December
          29, 2006,
          we had not made payment on the debenture; the holder of the debenture has
          not
          declared a default under the debenture.
 
 ***S*** ***eventh
          Equity Line of Credit***
 
 On
          May
          27, 2005, we entered into a seventh private equity line agreement (the
“Seventh
          Equity Line Agreement”) with Queen, LLC (the “Equity Line Investor”). Under the
          Seventh Equity Line Agreement, we have the right to draw up to $20,000,000
          against an equity line of credit (“the Seventh Equity Line”) from the Equity
          Line Investor. We are entitled under the Seventh Equity Line Agreement
          to draw
          certain funds and to put to the Equity Line Investor shares of our Class
          A
          common stock in lieu of repayment of the draw. The number of shares to
          be issued
          is determined by dividing the amount of the draw by 93% of the average
          of the
          two lowest closing bid prices of our Class A common stock over the ten
          trading
          days after the put notice is tendered. The Equity Line Investor is required
          under the Seventh Equity Line Agreement to tender the funds requested by
          us
          within two trading days after the ten-trading-day period used to determine
          the
          market price.
 
 Pursuant
          to the Seventh Equity Line Agreement, we granted to the Equity Line Investor
          a
          right of first refusal (the “Refusal Right”) with respect to additional
          financing transactions. Under the Refusal Right, for a period of 180 days
          after
          the effective date of a registration statement filed to register resales
          by the
          Equity Line Investor, we may not offer or sell, with certain exceptions,
          shares
          of our common stock in a financing transaction without first offering that
          financing transaction to the Equity Line Investor. The Equity Line Investor
          then
          has the right to choose to offer financing to us on the same terms or to
          allow
          us to proceed with the financing transaction with other investors.
 
 In
          connection with the Seventh Equity Line Agreement, we entered into an agreement
          with the Equity Line Investor to terminate all previous equity lines, and
          cease
          further draws or issuances of shares in connection with all previous equity
          lines. As such, as of the date of this report, the only active equity line
          of
          credit was the Seventh Equity Line.
 
 Also
          in
          connection with the Seventh Equity Line Agreement, we granted registration
          rights to the Equity Line Investor and have filed three registration statements
          which cover the resales of the shares to be issued under the Seventh Equity
          Line. All of the shares registered by the first registration statement
          had been
          sold as of October 24, 2005. The second registration statement filed in
          connection with the Seventh Equity Line was declared effective by the SEC
          on
          February 10, 2006. All of the shares registered by the second registration
          statement had been sold as of July 26, 2006. We filed a third registration
          statement on June 26, 2006, to register additional shares under the Seventh
          Equity Line. However, this registration statement has not been declared
          effective by the SEC and, based upon our communication with the SEC, we
          currently expect that the SEC will not declare the registration statement
          to be
          effective. Accordingly, we do not currently have an active registration
          statement filed with the SEC related to the Seventh Equity Line and we
          are
          currently unable to draw on the Seventh Equity Line.
 
 For
          the
          nine months ended September 30, 2006, we received $3,378,000 in funds drawn
          under the Seventh Equity Line, less commissions and fees of $114,000. We
          issued
          300,000,000 shares of Class A common stock to the Equity Line Investor
          as puts
          under the Seventh Equity Line totaling $3,378,000.
 
 ***Series
          H Preferred Stock***
 
 We
          issued
          2,000 shares of 5% Series H nonvoting, nonconvertible Preferred Stock on
          February 24, 2004 in connection with the acquisition of LTEL. Dividends
          on the
          $20,000,000 stated value of the outstanding Series H Preferred Stock were
          payable at the rate of 5% per annum as and when declared by the Board of
          Directors. The annual dividend requirement was $1,000,000. If dividends
          were
          declared on Fonix's common stock, as a condition of that dividend, Fonix
          was
          required to pay three percent of the aggregate amount of such dividend
          to the
          Series H Preferred Stock. Dividends on the Series H Preferred Stock were
          payable
          in cash or, at the option of Fonix, in shares of Class A common stock.
          We have
          accrued for the March 31, 2006, June 30, 2006 and the period from July
          1, 2006
          through September 7, 2006 dividend payments under the Series H Preferred
          Stock,
          but have not paid the dividends to the holders of the Series H Preferred
          Stock
          as of the date of this report.
 
  28
  On
          September 7, 2006, we entered into an agreement to exchange the 2,000 shares
          of
          Series H Preferred Stock for shares of our Series L Preferred Stock. (See
          discussion below under “Series L Preferred Stock.”) As of September 30, 2006, no
          shares of Series H Preferred Stock remained outstanding.
 
 ***Series
          J Preferred Stock***
 
 On
          October 6, 2005, we entered into a Series J 5% Convertible Preferred Stock
          Exchange Agreement (the "Exchange Agreement") with Southridge Partners,
          LP
          ("Southridge"), a Delaware limited partnership. Pursuant to the Exchange
          Agreement, Southridge exchanged all of the shares of our Series I Preferred
          Stock that it acquired from The Breckenridge Fund, LLC, for 1,452 shares
          of our
          Series J 5% Convertible Preferred Stock (the "Series J Preferred
          Stock").
 
 Because
          the shares of Series J Preferred Stock were issued in exchange for the
          remaining
          outstanding shares of Series I Preferred Stock, we did not receive any
          proceeds
          in connection with the issuance of the Series J Preferred Stock. We issued
          1,452
          shares of Series J Preferred Stock in exchange for 1,172 shares of Series
          I
          Preferred Stock. Of the 280 additional shares that were issued to Southridge,
          250 were issued as a placement fee and were accounted for as selling, general
          and administrative expense. The remaining 30 shares were issued as additional
          litigation expense and were accounted for as legal settlement
          expense.
 
 The
          Series J Preferred Stock entitled Southridge to receive dividends in an
          amount
          equal to 5% of the then-outstanding balance of shares of Series J Preferred
          Stock. The dividends were payable in cash or shares of the Company's Class
          A
          common stock, at our option.
 
 The
          Series J Preferred Stock was convertible into common stock of Fonix at
          the
          option of the holder by using a conversion price which was 90% of the average
          of
          the two (2) lowest closing bid prices for the twenty-day trading period
          prior to
          the conversion date.
 
 For
          the
          year ended December 31, 2005, the Company issued 3,795,918 shares of its
          Class A
          common stock upon conversion of 93 shares of its Series J Preferred Stock.
          For
          the nine months ended September 30, 2006, we issued 15,028,249 shares of
          its
          Class A common stock upon conversion of 266 shares of its Series J Preferred
          Stock. At September 30, 2006, no shares of Series J Preferred Stock remained
          outstanding.
 
 ***Series
          K Preferred Stock***
 
 On
          February 3, 2006, the Company’s Board of Directors approved the designation and
          issuance of Series K 5% Convertible Preferred Stock (the “Series K Preferred
          Stock”). The Series K Preferred Stock entitles the holder to receive dividends
          in an amount equal to 5% of the stated value of the then-outstanding balance
          of
          shares of Series K Preferred Stock. The dividends are payable in cash or
          shares
          of our Class A common stock, at our option.
 
 The
          shares of Series K Preferred Stock were issued pursuant to a Series K 5%
          Convertible Preferred Stock Exchange Agreement (the “Series K Agreement”), in
          connection with which Southridge exchanged 1,093 shares of Series J Convertible
          Preferred Stock for 1,093 shares of Series K Convertible Preferred
          Stock.
 
 The
          Series K Preferred Stock were convertible into shares of our Class A common
          stock at the option of the holder by using a conversion price of $0.01
          per
          share.
 
 For
          the
          nine months ended September 30, 2006, we issued 109,300,000 shares of its
          Class
          A common stock upon conversion of 1,093 shares of our Series K Preferred
          Stock.
          At September 30, 2006, no shares of Series J Preferred Stock remained
          outstanding.
 
 
 ***Series
          L Preferred Stock***
 
 On
          September 7, 2006, we entered into a Series L 9% Convertible Preferred
          Stock
          Exchange Agreement (the "Exchange Agreement") with McCormack and Kenzie
          Financial (“Kenzie”), a British Virgin Islands company. Pursuant to the Exchange
          Agreement, McCormack and Kenzie exchanged all of the shares of Series H
          Preferred Stock that they acquired from sale of LTEL Holdings, for 1,960.8
          and
          39.2 shares, respectively, of our Series L 9% Convertible Preferred Stock
          (the
          "Series L Preferred Stock").
 
  29
  Because
          the shares of Series L Preferred Stock were issued in exchange for the
          remaining
          outstanding shares of Series H Preferred Stock, we did not receive any
          proceeds
          in connection with the issuance of the Series L Preferred Stock.
 
 The
          Series J Preferred Stock entitles McCormack and Kenzie to receive dividends
          in
          an amount equal to 9% of the then-outstanding balance of shares of Series
          L
          Preferred Stock. The dividends are payable in cash or shares of our Class
          A
          common stock, at our option.
 
 The
          Series L Preferred Stock is convertible into common stock of Fonix at the
          option
          of the holder by using a conversion price which was 80% of the average
          of the
          two (2) lowest closing bid prices for the twenty-day trading period prior
          to the
          conversion date.
 
 Redemption
          of the Series L Preferred Stock, whether at the Company’s option or that of
          McCormack or Kenzie, requires us to pay, as a redemption price, the stated
          value
          of the outstanding shares of Series L Preferred Stock to be redeemed, together
          with any accrued but unissued dividends thereon, multiplied by one hundred
          ten
          percent (110%).
 
 In
          connection with the issuance of the Series L Preferred Stock, we filed
          with the
          State of Delaware a Certificate of Designation and Series L 9% Convertible
          Stock
          Terms (the “Series L Terms”), which become a part of our Certificate of
          Incorporation, as amended.
 
 We
          accounted for the exchange as redemption of the outstanding Series H Preferred
          Stock as the Series H Preferred Stock was not convertible into shares of
          common
          stock of Fonix. The Series L Preferred Stock is convertible into shares
          of
          common stock of Fonix. We followed the accounting treatment in SFAS 150
          “ *Accounting
          for Certain Financial Instruments with Characteristics of Both Liabilities
          and
          Equity,”* SFAS
          133
“ *Accounting
          for Derivative Instruments and Hedging Activities”* and
          EITF
          00-19 “ *Accounting
          for Derivative Financial Instruments Indexed to, and Potentially Settled
          in, a
          Company’s Own Stock.”* We
          recognized a derivative liability upon the redemption of $30,991,000 due
          to the
          value of the conversion feature of the Series L Preferred Stock. The liability
          was calculated using the Black-Scholes valuation model. As the value of
          the
          derivative liability was greater than the face value of the Series L Preferred
          Stock, no value was prescribed to the Series L Preferred Stock. Also in
          connection with the redemption, the Company recognized a preferred stock
          dividend of $16,000,000, equal to the original discount we had assigned
          to the
          Series H Preferred Stock.
 
 For
          the
          nine months ended September 30, 2006, we issued 66,334,622 shares of its
          Class A
          common stock in conversion of 27 shares of its Series L Preferred Stock.
          At
          September 30, 2006, 1,973 shares of Series L Preferred Stock remained
          outstanding. Subsequent to September 30, 2006 and through December 29,
          2006, we
          issued 423,535,4469 shares of our Class A common stock in conversion of
          114.6
          shares of our Series L Preferred Stock.
 
 ***Stock
          Options and Warrants*** ****
 
 During
          the nine months ended September 30, 2006, we granted options to employees
          to
          purchase 58,000 shares of Class A common stock. The options have an exercise
          prices ranging from $0.01 to $0.02 per share, which was the quoted fair
          market
          value of the stock on the dates of grant. The options granted vest over
          the
          three years following issuance. Options expire within ten years from the
          date of
          grant if not exercised. Using the Black-Scholes pricing model, the weighted
          average fair value of the employee options was $0.01 per share. As of September
          30, 2006, we had a total of 916,705 options to purchase Class A common
          stock
          outstanding.
 
 As
          of
          September 30, 2006, we had warrants to purchase a total of 15,000 shares
          of
          Class A common stock outstanding that expire through 2010.
 
 **Other**
 
 We
          presently have no plans to purchase new research and development or office
          facilities.
 
  30
 
 **Outlook**
 
 Fonix’s focus
          on
          providing competitive and value-added solutions for customers and partners
          requires a broad set of technologies, service offerings and channel
          capabilities. Management anticipates and expects further development of
          complementary technologies, added product and application developments,
          access
          to market channels and additional opportunities for strategic alliances
          in other
          industry segments.
 
 We
          will
          continue to leverage our research and development of speech technologies
          to
          deliver software applications and engines to device manufacturers looking
          to
          incorporate speech interfaces into end-user products. Fonix Speech’s
          award-wining technologies provide competitive embedded speech solutions
          for
          mobile/wireless devices, videogames, telephony systems and products for
          the
          assistive market based on Fonix’s proprietary and patented TTS and ASR
          technologies.
 
 As
          we
          proceed to implement our strategy and to reach our objectives, we anticipate
          further development of complementary technologies, added product and
          applications development expertise, access to market channels and additional
          opportunities for strategic alliances in other industry segments. The strategy
          adopted by us has significant risks, and shareholders and others interested
          in
          Fonix and our Class A common stock should carefully consider the risks
          set forth
          below and under the heading “Certain Significant Risk Factors” in Item 1, Part
          I, of our Annual Report on Form 10-K for the year ended December 31,
          2005.
 
 As
          noted
          above, as of September 30, 2006, we had an accumulated deficit of $288,069,000,
          negative working capital of $51,213,000 ,
          derivative liability of $21,392,000 related to the issuance of Series L
          Preferred Stock, net liabilities of unconsolidated subsidiaries of $20,639,000
          related to the telecom assets (LecStar Telecom, LecStar DataNet, LTEL Holdings
          and Fonix Telecom) subject to bankruptcy, accrued liabilities and accrued
          settlement obligation of $3,800,000 accounts payable of $1,403,000 and
          current
          portion of notes payable of $4,209,000. Sales of
          products and revenue from licenses based on our technologies have not been
          sufficient to finance ongoing operations. These matters raise substantial
          doubt
          about our ability to continue as a going concern. Our continued existence
          is
          dependent upon several factors, including our success in (1) increasing
          speech
          license, royalty and services revenues, (2) raising sufficient additional
          funding, and (3) minimizing operating costs. Until sufficient revenues
          are
          generated from operating activities, we expected to continue to fund our
          operations through debt instruments. We are currently pursuing additional
          sources of liquidity in the form of traditional commercial credit, asset
          based
          lending, or additional sales of our equity securities to finance our ongoing
          operations. Additionally, we are pursuing other types of commercial and
          private
          financing, which could involve sales of our assets or sales of one or more
          operating divisions. Our sales and financial condition have been adversely
          affected by our reduced credit availability and lack of access to alternate
          financing because of our significant ongoing losses and increasing liabilities
          and payables. As we have noted in our annual report and other public filings,
          if
          additional financing is not obtained in the near future, we will be required
          to
          more significantly curtail our operations or seek protection under bankruptcy
          laws.
 
 **Information
          Concerning Forward-Looking Statements**
 
 Certain
          of the statements contained in this report (other than the historical financial
          data and other statements of historical fact) are forward-looking statements.
          These statements include, but are not limited to our expectations with
          respect
          to the development of a diversified revenue base; delivery of our VoiceDial
          application; the market volume of educational electronic dictionary devices;
          our
          ability to capitalize in markets including toys, appliances, and other
          devices;
          the market demand for videogames; our growth strategies and the implementation
          of our Core Technologies and potential results; our payment of dividends
          on our
          common stock; our ability to meet customer demand for speech technologies
          and
          solutions; development of complementary technologies, products, marketing,
          and
          strategic alliance opportunities; profitability of language learning tools;
          the
          status of traditional operator systems; our ability to continue operations
          in
          the event we do not receive approval to amend our articles of incorporation;
          the
          comparability of our speech-enabled Speech Products to other products;
          our
          intentions with respect to strategic collaborations and marketing arrangements;
          our intentions with respect to use of licenses; our plans with respect
          to
          development and acquisition of speech solutions; our goals with respect
          to
          supplying speech solutions for OEMs; our expectations with respect to continued
          financial losses; and our intentions with respect to financing our operations
          in
          the future. Additional forward-looking statements may be found in the “Certain
          Significant Risk Factors” Section of our Annual Report on Form 10-K for the year
          ended December 31, 2005, together with accompanying explanations of the
          potential risks associated with such statements.
 
  31
  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” Section of our
          2005 Annual Report on Form 10-K, as well as the following:
 
 •
                unpredictable
                    difficulties or delays in the development of new products and
                    technologies;
 
 •
                changes
                    in U.S. or international economic conditions, such as inflation,
                    interest
                    rate fluctuations, foreign exchange rate fluctuations or recessions
                    in
                    Fonix's markets;
 
 •
                pricing
                    changes to our supplies or products or those of our competitors,
                    and other
                    competitive pressures on pricing and
                    sales;
 
 •
                difficulties
                    in obtaining or retaining the management, engineering, and other
                    human
                    resource competencies that we need to achieve our business
                    objectives;
 
 •
                the
                    impact on Fonix or a subsidiary from the loss of a significant
                    customer or
                    a significant number of customers;
 
 •
                risks
                    generally relating to our international operations, including
                    governmental, regulatory or political
                    changes;
 
 •
                transactions
                    or other events affecting the need for, timing and extent of
                    our capital
                    expenditures; and
 
 •
                the
                    extent to which we reduce outstanding
                    debt.
 
 **Item
                    3.**
                **Quantitative
                    and Qualitative Disclosures About Market
                    Risk**
 
 **Foreign
          Currency Exposure**
 
 To
          date,
          all of our revenues have been denominated in United States dollars and
          received
          primarily from customers in the United States. Our exposure to foreign
          currency
          exchange rate changes has been insignificant. We expect, however, that
          future
          product license and services revenue may also be derived from international
          markets and may be denominated in the currency of the applicable market.
          As a
          result, operating results may become subject to significant fluctuations
          based
          upon changes in the exchange rate of certain currencies in relation to
          the U.S.
          dollar. Furthermore, to the extent that we engage in international sales
          denominated in U.S. dollars, an increase in the value of the U.S. dollar
          relative to foreign currencies could make our products less competitive
          in
          international markets. Although we will continue to monitor our exposure
          to
          currency fluctuations, we cannot assure that exchange rate fluctuations
          will not
          adversely affect financial results in the future.
 
 **Item
                    4.**
                **Controls
                    and Procedures**
 
 Evaluation
          of Disclosure Controls and Procedures .
          Our
          Chief Executive Officer and our Chief Financial Officer, after evaluating
          the
          effectiveness of the Company’s “disclosure controls and procedures” (as defined
          in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or
          15d-15(e)) as of the end of the period covered by this quarterly report,
          have
          concluded that our disclosure controls and procedures are effective based
          on
          their evaluation of these controls and procedures required by paragraph
          (b) of
          Exchange Act Rules 13a-15 or 15d-15.
 
  32
  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.
 
 Section
          404 Assessment .
          Section
          404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and
          evaluation of our internal controls, and an attestation of the effectiveness
          of
          these controls by our independent registered public accounting firm beginning
          with our Form 10-K for the fiscal year ending on December 31, 2007. We
          are
          dedicating significant resources, including management time and effort,
          and
          incurring substantial costs in connection with our ongoing Section 404
          assessment. We are currently documenting and testing our internal controls
          and
          considering whether any improvements are necessary for maintaining an effective
          control environment at our company. The evaluation of our internal controls
          is
          being conducted under the direction of our senior management. In addition,
          our
          management is regularly discussing the results of our testing and any proposed
          improvements to our control environment with our Audit Committee. We will
          continue to work to improve our controls and procedures, and to educate
          and
          train our employees on our existing controls and procedures in connection
          with
          our efforts to maintain an effective controls infrastructure at our
          Company.
 
 Limitations
          on Effectiveness of Controls .
          A
          system of controls, however well designed and operated, can provide only
          reasonable, and not absolute, assurance that the system will meet its
          objectives. The design of a control system is based, in part, upon the
          benefits
          of the control system relative to its costs. Control systems can be circumvented
          by the individual acts of some persons, by collusion of two or more people,
          or
          by management override of the control. In addition, over time, controls
          may
          become inadequate because of changes in conditions, or the degree of compliance
          with the policies or procedures may deteriorate. In addition, the design
          of any
          control system is based in part upon assumptions about the likelihood of
          future
          events.
 
 **PART
          II - OTHER INFORMATION**
 
 **Item
          1.**  **Legal
          Proceedings**
 
 ***Breckenridge
          Complaint*** - On
          June 6, 2006, The Breckenridge Fund, LP (“Breckenridge”) filed a complaint
          against the Company in the Supreme Court of the State of New York, County
          of
          Nassau (Index No. 009050/06), in connection with a settlement agreement
          between
          the Company and Breckenridge entered into in September 2005.  In the
          Complaint, Breckenridge alleges that Fonix failed to pay certain amounts
          due
          under the settlement agreement in the amount of $450,000. We have denied
          the
          allegations of Breckenridge’s complaint. We have filed for a motion of summary
          judgment. The Company intends to vigorously defend itself.
 
 **Item
          1A.**  **Risk
          Factors**
 
 We
          attempt to identify, manage and mitigate the risks and uncertainties associated
          with our business to the extent practical. However, some level of risk
          and
          uncertainty will always be present. The section of our Annual Report on
          Form
          10-K for the fiscal year ended December 31, 2005, entitled “Certain Significant
          Risk Factors” describes some of the risks and uncertainties associated with our
          business. These risks and uncertainties have the potential to materially
          affect
          our business, financial condition, results of operations, cash flows, projected
          results and future prospects. We have revised the following risk factors
          which
          were previously disclosed in our Annual Report on Form 10-K for the fiscal
          year
          ended December 31, 2005.
 
 **Our
          substantial and continuing losses since inception, coupled with significant
          ongoing operating expenses, raise doubt about our ability to continue as
          a going
          concern.**
 
 Since
          inception, we have sustained substantial losses. Such losses continue due
          to
          ongoing operating expenses and a lack of revenues sufficient to offset
          operating
          expenses. We have raised capital to fund ongoing operations by private
          sales of
          our securities, some of which sales have been highly dilutive and involve
          considerable expense. In our present circumstances, there is substantial
          doubt
          about our ability to continue as a going concern absent significant sales
          of our
          products and telecommunication services, substantial revenues from new
          licensing
          or co-development contracts, or continuing large sales of our
          securities.
 
  33
  We
          incurred net losses of $22,631,000, $15,148,000 and $13,543,000 for the
          years
          ended December 31, 2005, 2004 and 2003, respectively. We incurred a net
          loss of
          $10,847,000 for the three months ended September 30, 2006 and $19,432,000
          for
          the nine months ended September 30, 2006. As of September 30, 2006, we
          had an
          accumulated deficit of $288,069,000, negative working capital of $51,213,000,
          derivative liability of $21,392,000 related to the issuance of Series L
          Preferred Stock, net liabilities of unconsolidated subsidiaries of $20,639,000
          related to the telecom assets subject to bankruptcy, accrued liabilities
          and
          accrued settlement obligation of $3,800,000, accounts payable of $1,403,000
          and
          current portion of notes payable of $4,209,000.
 
 We
          expect
          to continue to spend significant amounts to enhance our Speech Products
          and
          technologies and fund further Product development. As a result, we will
          need to
          generate significant additional revenue to achieve profitability. Even
          if we do
          achieve profitability, we may not be able to sustain or increase profitability
          on a quarterly or annual basis. If we do not achieve and maintain profitability,
          the market price for our common stock may further decline, perhaps
          substantially, and we may have to curtail or cease our operations.
 
 **Continuing
          debt obligations could impair our ability to continue as a going
          concern.**
 
 As
          of
          September 30, 2006, we had debt obligations of $7,286,000, accrued liabilities
          and accrued settlement obligation of $3,800,000 and vendor accounts payable
          of
          approximately $1,403,000. At present, our revenues from existing licensing
          arrangements and Speech Product sales are not sufficient to offset our
          ongoing
          operating expenses or to pay in full our current debt obligations.
 
 There
          is
          substantial risk, therefore, that the existence and extent of the debt
          obligations described above could adversely affect our business, operations
          and
          financial condition, and we may be forced to curtail our operations, sell
          part
          or all of our assets, or seek protection under bankruptcy laws. Additionally,
          there is substantial risk that the current or former employees or our vendors
          could bring lawsuits to collect the unpaid amounts. In the event of lawsuits
          of
          this type, if we are unable to negotiate settlements or satisfy our obligations,
          we could be forced into bankruptcy.
 
 **We
          currently do not have access to the Seventh Equity Line or other equity
          lines of
          credit, which could have a material adverse effect on our ability to continue
          operations.**
 
 Since
          2000, we have relied substantially on equity lines of credit for financing
          our
          operations. Pursuant to these equity lines, we historically have drawn
          funds
          against the equity line and put shares of our Class A common stock to the
          equity
          line investor in repayment of the draws. Under current SEC regulations
          and
          interpretations by SEC staff members, it appears that we will no longer
          have
          access to the Seventh Equity Line of Credit or similar financing arrangements.
          Although we are seeking to negotiate additional financing sources and reviewing
          our options, there can be no guarantee that we will be able to enter into
          arrangements for financing that will be on terms that will be satisfactory
          to
          us. Any inability to enter into new financing arrangements could have a
          material
          adverse impact on our ability to continue our operations, and we may be
          required
          to seek protection under the bankruptcy laws.
 
 **Item
                    2.**
                **Unregistered
                    Sales of Equity Securities and Use of
                    Proceeds**
 
 During
          the nine months ended September 30, 2006, we issued 300,000,000 shares
          of our
          common stock under the Seventh Equity Line to the Equity Line Investor
          in
          connection with draws of $3,378,000. We issued 15,028,249 shares of our
          common
          stock in connection with conversions of our Series J Preferred Stock for
          which
          we received no proceeds. We issued 109,300,000 shares of our common stock
          in
          connection with conversions of our Series K Preferred Stock for which we
          received no proceeds. We issued 2,838,412 shares of our common stock in
          payment
          of $65,000 in dividends on our Series H Preferred Stock. We issued 66,334,621
          shares of our common stock in connection with conversions of our Series
          L
          Preferred Stock for which we received no proceeds. Subsequent to September
          30,
          2006 and through December 29, 2006, we issued 423,535,469 shares of our
          common
          stock in connection with conversions of 114.6 shares of our Series L Preferred
          Stock. 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.
 
  34
  The
          resales of the shares issued in connection with the Seventh Equity Line
          were
          registered under registration statements on Form S-1 and Form S-2. The
          proceeds
          from the Seventh Equity Line transactions were used for working capital.
          We
          received no proceeds from the issuance of shares upon conversion of our
          series
          of preferred stock.
 
 **Item
                    4.**
                **Submission
                    of Matters to a Vote of Security
                    Holders**
 
 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 Exhibit
 
 31.1
                Certification
                    of President
 31.2
                Certification
                    of Chief Financial Officer
 32.1
                Certification
                    of President Pursuant to Section 906 of the Sarbanes-Oxley Act
                    of
                    2002
 32.2
                Certification
                    of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley
                    Act of 2002.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  35
  **SIGNATURES**
 
 In
          accordance with the requirements of the Exchange Act, the registrant caused
          this
          report to be signed on its behalf by the undersigned, thereunto duly
          authorized.
 
 
 **Fonix
                    Corporation**Date:
                    January 8, 2007
                /s/
                    Roger D.
                    DudleyRoger
                    D. Dudley, Executive Vice President,Chief
                    Financial Officer(Principal
                    financial officer)
 
                          36