<PAGE>
 
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                  FORM 10-Q/A
                               (Amendment No. 1)


[X]  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934 for the quarterly period ended March 31, 1998

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

                      Commission file number    0-23862
                                              ------------

                               fonix corporation
             (Exact name of registrant as specified in its charter)

               Delaware                           22-2994719
      ------------------------       -----------------------------------
      (State of Incorporation)       (I.R.S. Employer Identification No.)

                    60 East South Temple Street, Suite 1225
                           Salt Lake City, UT 84111
                 ---------------------------------------------
             (Address of principal executive offices and zip code)

                                (801) 328-8700
                        ------------------------------
             (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 Section 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes   X  or No
                                               -----     -----

As of May 8, 1998, 51,313,739 shares of the issuer's Common Stock, par value
$.0001 per share, were issued and outstanding.
<PAGE>
 
                                 INTRODUCTION

     This Amendment No. 1 to the Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1998, of Fonix Corporation (the "Company") is submitted
to amend the following Items:

Part I - Financial Information
     Item 1.   Financial Statements
     Item 2.   Management's Discussion and Analysis



                        PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

     The interim unaudited condensed consolidated financial statements required
     by Rule 10-01 of Regulation S-X follow immediately.

                                       2
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)
<TABLE> 
<CAPTION> 
<S>                                                                                          <C>             <C> 
                                  
ASSETS
                                                                                                March 31,    December 31,
                                                                                                  1998          1997
                                                                                               ------------  ------------ 
Current assets:
        Cash and cash equivalents                                                              $ 20,212,465  $ 20,501,676
        Notes receivable                                                                            250,000       600,000
        Interest and other receivables                                                                9,332        14,919
        Prepaid assets                                                                               69,411        32,094
                                                                                               ------------  ------------ 

              Total current assets                                                               20,541,208    21,148,689

Property and equipment, net of accumulated depreciation of $612,314 and $464,100, respectively    1,704,194     1,567,279

Intangible assets, net of accumulated amortization of $132,515 and $25,509, respectively         16,056,785       138,951

Other assets                                                                                         39,647        39,647
                                                                                               ------------  ------------ 
                    Total assets                                                               $ 38,341,834  $ 22,894,566
                                                                                               ============  ============ 

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------

Current liabilities:
        Revolving note payable                                                                 $ 14,157,257  $ 18,612,272
        Revolving note payable - related party                                                       36,909       551,510
        Accounts payable                                                                            436,404       291,638
        Accrued liabilities                                                                         431,375       505,619
        Accrued liabilities - related party                                                         221,147       459,502
        Capital lease obligation - current portion                                                   51,191        49,325
                                                                                               ------------  ------------ 
              Total current liabilities                                                          15,334,283    20,469,866

Capital lease obligation, net of current portion                                                     38,672        52,225
Advances (Note 9)                                                                                 1,076,426             -
                                                                                               ------------  ------------ 

                    Total liabilities                                                            16,449,381    20,522,091
                                                                                               ------------  ------------ 

Commitments and contingencies (Note 11)

Stockholders' equity:
        Preferred stock                                                                             500,000     5,812,444
        Common stock                                                                                  5,130         4,358
        Additional paid-in capital                                                               75,517,409    38,637,059
        Outstanding warrants                                                                      3,259,048     2,936,360
        Deficit accumulated during the development stage                                        (57,389,134)  (45,017,746)
                                                                                               ------------  ------------ 
                    Total stockholders' equity                                                   21,892,453     2,372,475
                                                                                               ------------  ------------ 

                    Total liabilities and stockholders' equity                                 $ 38,341,834  $ 22,894,566
                                                                                               ============  ============ 
</TABLE> 



    See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                                                               October 1,
                                                                                Three Months Ended               1993
                                                                                    March 31,                (Inception) to
                                                                         -------------------------------       March 31,
                                                                              1998            1997               1998
                                                                         -------------   ---------------   ----------------
<S>                                                                     <C>              <C>               <C>
Revenues                                                                 $   1,295,785   $             -   $      1,295,785
                                                                         -------------   ---------------   ----------------
Expenses:
      Purchased in-process research and development                          9,315,000                 -          9,315,000
      Research and development                                               2,701,203         1,610,058         20,638,496
      General and administrative                                             1,478,863         1,293,391         23,725,533
                                                                         -------------   ---------------   ----------------

           Total expenses                                                   13,495,066         2,903,449         53,679,029
                                                                         -------------   ---------------   ----------------

Loss from operations                                                       (12,199,281)       (2,903,449)       (52,383,244)
                                                                         -------------   ---------------   ----------------

Other income (expense):
      Interest income                                                          271,477           305,549          2,863,544
      Interest expense                                                        (311,924)         (265,563)        (4,164,467)
                                                                         -------------   ---------------   ----------------
           Total other income (expense), net                                   (40,447)           39,986         (1,300,923)
                                                                         -------------   ---------------   ----------------

Loss before extraordinary items                                            (12,239,728)       (2,863,463)       (53,684,167)

Extraordinary items:
      Loss on extinguishment of debt                                                 -                 -           (881,864)
      Gain on forgiveness of debt                                                    -                 -             30,548
                                                                         -------------   ---------------   ----------------

Net loss                                                                 $ (12,239,728)   $   (2,863,463)   $   (54,535,483)
                                                                         =============   ===============   ================

Basic and diluted net loss per common share                              $       (0.27)   $        (0.07)
                                                                         =============   ===============   ================
</TABLE>

    See accompanying notes to condensed consolidated financial statements.
                                       
                                       4

<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)
               Increase (Decrease) in Cash and Cash Equivalents

<TABLE> 
<CAPTION> 
                                                                                                                   October 1,
                                                                                                                      1993
                                                                                 Three Months Ended              (Inception) to
                                                                                     March 31,                     March 31,
                                                                             ---------------------------------
                                                                               1998               1997                1998
                                                                             -------------- -----------------  -------------------
<S>                                                                          <C>            <C>                 <C>                 
Cash flows from operating activities:
       Net loss                                                              $ (12,239,728)     $ (2,863,463)       $ (54,535,483)
       Adjustments to reconcile net loss to net cash
         used in operating activities:
           Issuance of common stock for services                                         -           331,406            5,437,240
           Issuance of common stock for patent                                     100,807                 -              100,807
           Non-cash expense related to issuance of debentures,
             warrants, preferred and common stock                                        -                 -            3,967,337
           Non-cash compensation expense related to issuance
             of stock options                                                            -                 -            2,282,900
           Non-cash portion of purchased in-process research and development     8,814,768                 -            8,814,768
           Write-off of assets received in acquisition                                   -                 -                1,281
           Depreciation and amortization                                           235,252            66,178              724,861
           Extraordinary loss on extinguishment of debt                                  -                 -              881,864
           Extraordinary gain on forgiveness of debt                                     -                 -              (30,548)
           Changes in assets and liabilities, net of acquisition:
              Interest and other receivables                                        19,314            70,198                4,395
              Prepaid assets                                                       (36,517)          (35,620)             (68,611)
              Other assets                                                               -            (8,735)             (39,647)
              Accounts payable                                                     138,642           (72,525)           2,210,480
              Accrued liabilities - related party                                 (238,355)         (373,129)             221,147
              Accrued liabilities                                                  (90,817)          116,061              542,783
                                                                             -------------- -----------------  -------------------

           Net cash used in operating activities                                (3,296,634)       (2,769,629)         (29,484,426)
                                                                             -------------- -----------------  -------------------

Cash flows from investing activities:
       Acquisition of business                                                  (7,246,119)                -           (7,246,119)
       Purchase of property and equipment, net of acquisition                     (255,259)         (226,140)          (2,286,638)
       Investment in intangible assets, net of acquisition                               -                 -             (164,460)
       Issuance of notes receivable                                               (200,000)         (883,600)          (2,683,600)
       Payments received on notes receivable                                             -                 -            1,883,600
                                                                             -------------- -----------------  -------------------

           Net cash used in investing activities                                (7,701,378)       (1,109,740)         (10,497,217)
                                                                             -------------- -----------------  -------------------

Cash flows from financing activities:
       Net proceeds from (payments on) revolving note payable                   (4,504,265)        1,892,530           14,108,007
       Net proceeds from (payments on) revolving note payable - related party     (514,601)                -               36,909
       Proceeds from other notes payable                                                 -                 -            2,351,667
       Payments on other notes payable                                                   -                 -           (1,779,806)
       Principal payments on capital lease obligation                              (11,687)                -              (55,068)
       Proceeds from advances (Note 8)                                           1,076,426                 -            1,076,426
       Proceeds from issuance of convertible debentures, net                             -                 -            3,185,000
       Proceeds from sale of warrants                                              322,928                 -              922,928
       Proceeds from sale of common stock, net                                  14,340,000           425,000           35,044,545
       Proceeds from sale of Series B and C preferred stock, net                         -                 -            5,303,500
                                                                             -------------- -----------------  -------------------

           Net cash provided by financing activities                            10,708,801         2,317,530           60,194,108
                                                                             -------------- -----------------  -------------------

Net (decrease) increase in cash and cash equivalents                              (289,211)       (1,561,839)          20,212,465

Cash and cash equivalents at beginning of period                                20,501,676        22,805,786                    -
                                                                             -------------- -----------------  -------------------

Cash and cash equivalents at end of period                                    $ 20,212,465      $ 21,243,947         $ 20,212,465
                                                                             ============== =================  ===================
</TABLE> 


     See accompanying notes to condensed consolidated financial statements.

                                       5

<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
          CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
                                  (Unaudited)
<TABLE> 
<CAPTION> 

                                                                                                                      October 1,
                                                                                                                         1993
                                                                                          Three Months Ended        (Inception) to
                                                                                               March 31,               March 31,
                                                                                     ----------------------------
Supplemental disclosure of cash flow information:                                         1998           1997            1998
                                                                                     --------------  ------------  -----------------
<S>                                                                                  <C>             <C>           <C> 
         Cash paid during the period for interest                                    $      311,863  $    247,785   $      2,348,882
</TABLE> 
Supplemental Schedule of Non-cash Investing and Financing Activities:

         For the three months ended March 31, 1998:

         Dividends of $131,660 were recorded related to the beneficial
            conversion features of Series B and Series C Convertible Preferred
            Stock.

         A total of 27,500 shares of Series B Preferred Stock and related
            dividends of $8,531 were converted into 193,582 shares of common
            stock.

         A total of 185,000 shares of Series C Preferred Stock and related
            dividends of $123,129 were converted into 1,295,919 shares of common
            stock.

         The Company issued 2,692,216 shares of common stock (having a market
            value of $16,995,972) in connection with the acquisition of
            AcuVoice, Inc.

         For the three months ended March 31, 1997:

         The Company issued 155,000 shares of common stock to unrelated parties
            for consulting fees valued at $730,975.


    See accompanying notes to condensed consolidated financial statements.

                                       6
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  [Unaudited]



1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements of  fonix corporation and subsidiaries (collectively, the
"Company") have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the following disclosures are adequate to make the information presented
not misleading.

These condensed 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.

Operating results for the three months ended March 31, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998.  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 Annual Report on Form 10-K for the
year ended December 31, 1997.

Recently Enacted Accounting Standards - Effective January 1, 1998, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income".  This Statement establishes standards for reporting and
display of comprehensive income and its components in financial statements.  The
adoption of this statement had no effect on the Company's statements of
operations presentation.

In June 1997, the Financial Standards Board issued SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information."  SFAS No. 131
establishes new standards for public companies to report information about their
operating segments, products and services, geographic areas and major customers.
This statement is effective for financial statements issued for periods
beginning after December 15, 1997.  Accordingly, the Company will adopt SFAS No.
131 beginning with its December 31, 1998 consolidated financial statements.

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.
At March 31, 1998 and 1997, there were outstanding common stock equivalents to
purchase 13,951,667 and 5,417,667 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.   Net loss per common share amounts have been restated for all
periods presented to reflect basic and diluted per share presentations.


                                       7
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  [Unaudited]


The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three months ended March 31, 1998 and
1997:

<TABLE>
<CAPTION>
                                                  1998                         1997
                                       ---------------------------   --------------------------- 
                                                        Per Share                     Per Share
                                            Loss         Amount          Loss          Amount
                                       ------------   ------------   -----------    ------------  
<S>                                    <C>            <C>            <C>             <C>
Net loss                               $(12,239,728)                 $(2,863,463)

Preferred stock dividends                  (131,660)                      -
                                       ------------                  -----------

Net loss attributable to common
 stockholders                          $(12,371,388)        $(0.27)  $(2,863,463)         $(0.07)
                                       ============   ============   ===========    ============

Weighted average common shares
 outstanding                             45,740,942                   41,834,372
                                       ============                  ===========
</TABLE>

2.  ACQUISITION

The Company created a wholly owned subsidiary for the purpose of acquiring
AcuVoice, Inc., a California corporation, in March 1998. After the acquisition,
the subsidiary changed its name to fonix/AcuVoice, Inc. ("fonix AcuVoice").
fonix AcuVoice develops and markets text-to-speech or speech synthesis
technologies and products directly to end-users, systems integrators and
original equipment manufacturers for use in the telecommunications, multi-media,
education and assistive technology markets. The merger was closed on March 13,
1998, in connection with which the Company exchanged 2,692,216 shares of
restricted common stock (having a market value of $16,995,972 on that date) and
a cash payment of approximately $8,000,000 for all of the then outstanding
common shares of AcuVoice, Inc. The AcuVoice acquisition was accounted for as a
purchase.

Purchase price allocations to tangible assets included $253,881 of cash, $13,728
of accounts receivable, $9,902 of fixed assets and $800 of prepaid expense.
Purchase price allocations to liabilities assumed included $22,929 of accounts
payable and accrued expenses and $599,250 of notes payable.

The excess of the purchase price over the estimated fair market value of the
tangible net assets (liabilities) assumed of AcuVoice, Inc. was $25,339,840, of
which $11,192,000 was capitalized as purchased core technology, $4,832,840 was
capitalized as goodwill and $9,315,000 was expensed as purchased in-process
research and development.

The following unaudited pro forma financial statement data for the three months
ended March 31, 1998 and March 31, 1997 present the results of operations of the
Company as if the acquisition of fonix AcuVoice had occurred at the beginning of
each three-month period.  The pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of what would have
occurred had the acquisition been made at the beginning of the applicable period
or of future results.  A $9,315,000 expense related to the purchased in-process
research and development was recorded at the date of acquisition and is not
presented in the following pro forma financial statement data because it is a
non-recurring charge directly attributable to the acquisition.

                                       8
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 [Unaudited] 
 
                                   Three Months Ended March 31,
                                   -----------------------------
                                        1998            1997
                                   -------------   -------------  
 
     Revenues                      $   1,342,520   $      17,249
 
     Loss from operations             (3,445,993)     (3,501,904)
 
     Net loss                         (3,478,674)     (3,461,862)
 
     Basic and diluted net loss
       per common share                    (0.07)          (0.08)
 

3.  CERTIFICATE OF DEPOSIT

At March 31, 1998, the Company had a $20,000,000 short-term certificate of
deposit at a bank which amount is included in cash and cash equivalents.  The
certificate bore interest at 5.50 percent per annum at March 31, 1998.  Interest
is payable monthly.  This certificate is pledged as collateral on a revolving
note payable (see Note 6).

4.  NOTES RECEIVABLE

At March 13, 1998, the Company had a short-term unsecured, non-interest bearing
note receivable from AcuVoice, Inc. in the amount of $550,000.  AcuVoice, Inc.
was merged with a wholly owned subsidiary of the Company effective March 13,
1998.  At March 31, 1998, this note receivable was eliminated in consolidation.

At March 31, 1998, the Company had a short-term, unsecured, demand note
receivable from an unrelated entity in the amount of $250,000 which was issued
in connection with the Company's intended acquisition of that entity.  Interest
begins to accrue at six percent per annum on the date which is 90 days after the
Company demands payment, which the Company may do in the event both parties
agree that the acquisition will not proceed. Subsequent to March 31, 1998, the
Company has advanced an additional $171,139 to the same entity under similar
terms.

5.  INTANGIBLE ASSETS

Intangible assets consist of purchased core technology and goodwill in
connection with the acquisition of AcuVoice, Inc. and direct costs incurred by
the Company in applying for patents covering its technologies.  Amortization is
computed on a straight-line basis over the estimated useful life of five to
eight years.  Total accumulated amortization was $132,515 at March 31, 1998.

6.  REVOLVING NOTES PAYABLE

At March 31, 1998, the Company had a revolving note payable to a bank in the
amount of $14,157,257.  Loaned amounts under the revolving note payable are
limited, in the aggregate at any time, to $20,000,000.  The weighted average
outstanding balance during the three months ended March 31, 1998 was
$17,465,681.  This note was due April 29, 1998, bore an interest rate of 6.50
percent per annum, and was secured by a certificate of deposit in the amount of
$20,000,000 (see Note 3).  This revolving note is renegotiated quarterly and
interest is payable monthly.  Subsequent to March 31, 1998, similar terms were
negotiated to extend the maturity date of the note to August 4, 1998.  The
Company plans to continue renewing the note indefinitely.

The Company has an unsecured revolving note payable to a company owned by three
individuals who are executive officers and directors of the Company and who each
beneficially own more than ten percent of the Company's common stock. At March
31, 1998, $36,909 in principal and $129,004 in accrued interest and loan fees
were outstanding under

                                       9
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  [Unaudited]
 
this revolving note payable. The weighted average balance outstanding during the
three months ended March 31, 1998 was $214,219. This revolving note is payable
on demand and bears interest at an annual rate of 12 percent. The maximum amount
outstanding under this revolving note was $551,510 during the three months ended
March 31, 1998. As of March 31, 1998, no interest or loan fees had been paid
related to the note. Subsequent to March 31, 1998, the outstanding principal,
accrued interest and loan fees were paid in full. The Company believes the terms
of the related-party revolving note payable were at least as favorable as the
terms that could have been obtained from an unrelated third party in a similar
transaction.

7.  STOCKHOLDERS' EQUITY

Common Stock - During the three months ended March 31, 1998, the Company issued
7,719,864 shares of common stock.  Of such shares, 3,333,333 shares were issued
in connection with a private placement (see below), 2,692,216 shares were issued
in connection with the acquisition of AcuVoice, Inc. (see Note 2), 1,489,501
shares were issued upon the conversion of convertible preferred stock and
related dividends, 180,000 shares were issued upon the exercise of previously
granted warrants and 24,814 shares were issued for the purchase of a patent.

Private Placement - On March 12, 1998, the Company completed a private placement
(the "Offering") of up to 6,666,666 shares of its restricted common stock to
seven separate accredited investors.  The total purchase price to be paid by the
investors pursuant to the Offering is $30,000,000.  Of that amount, $15,000,000
was received by the Company on March 12, 1998, in return for which the Company
issued a total of 3,333,333 shares of restricted common stock.  Finders' fees of
$870,000 were paid in connection with the $15,000,000 received.  The remainder
of the purchase price is to be paid by the investors 60 days after the
effectiveness of a registration statement that the Company filed with the
Securities and Exchange Commission on April 16, 1998 (the "Second Funding
Date"), provided that, as of such date, certain conditions are satisfied.
Specifically, as of the Second Funding Date: (i) the registration statement
covering all of the common stock to be issued must be effective, (ii) the
representations and warranties of the Company as set forth in the documents
underlying the Offering shall be correct in all material respects, (iii) the
market price of the Company's common stock shall exceed $4.50 per share, (iv)
the dollar volume of trading in the Company's common stock for the 10-trading
day period preceding such date shall equal or exceed $1,000,000, (v) there shall
be at least 18 market makers for the Company's common stock, and (vi) there
shall be no material adverse change in the Company's business or financial
condition.

Additionally, the investors in the Offering have certain "reset" rights pursuant
to which the investors will receive additional shares of restricted common stock
if the average market price of the Company's common stock for the 60-day periods
following the initial closing date and the Second Funding Date does not equal or
exceed $5.40 per share.  The investors in the Offering also have certain first
rights of refusal and other rights if the Company conducts other offerings in
the near future with other investors and the terms of such other offerings are
more advantageous to such other investors than the terms of the Offering.

Series B Preferred Stock - In January 1998, 27,500 shares of Series B Preferred
Stock and related dividends were converted into 193,582 shares of common stock.
At March 31, 1998, no shares of  Series B Preferred Stock were outstanding.

Series C Preferred Stock - During the three months ended March 31, 1998, 185,000
shares of Series C Preferred Stock and related dividends were converted into
1,295,919 shares of the Company's common stock.  At March 31, 1998, no shares of
Series C Preferred Stock were outstanding.

Common Stock Options - During the three months ended March 31, 1998, the Company
granted 1,225,000 stock options. 450,000 of such options having an exercise
price of $5.16 per share were granted to three individuals who are executive
officers and directors of the Company and who each beneficially own more than 10
percent of the Company's
                        
                                      10
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 [Unaudited] 

common stock. 355,000 and 420,000 of such options were granted to various
employees at exercise prices of $3.34 and $6.50 per share, respectively. The
term of all options granted during such three month period is ten years from the
date of grant. As of March 31, 1998, the Company had a total of 11,790,000
options outstanding.

8.  RELATED-PARTY TRANSACTIONS

Related-party transactions with entities owned by three individuals who are
directors and executive officers of the Company and each of whom beneficially
own more than ten percent of the Company's issued and outstanding common stock
not otherwise disclosed herein for the three months ended March 31, 1998 and
1997 were as follows:

                              1998       1997
                            --------  ----------
Expenses:

     Base rent              $ 23,130  $   19,300

Liabilities:

     Accrued liabilities     221,147   1,388,614

During 1996, disinterested members of the Company's Board of Directors
authorized the Company to reimburse three executive officers for all taxes
payable by them in conjunction with the 1995 exercise of 3,700,000 warrants by a
company owned by them. The total authorized reimbursement was $1,150,000 in 1997
and $1,350,000 in 1996. As of March 31, 1998, the Company had paid $2,407,857 of
the authorized reimbursement. The unpaid balance of the authorized reimbursement
is included in accrued expenses-related party in the accompanying condensed
consolidated balance sheet as of March 31, 1998.

9.  STATEMENTS OF WORK

On February 11, 1998, the Company entered into a Statement of Work agreement
with Siemens Semiconductor Group of Siemens Aktiengesellschaft ("Siemens")
pursuant to which the Company and Siemens will jointly pursue the development of
Siemens' integrated circuits incorporating the Company's technologies for use in
certain telecommunications applications.  During the three months ended March
31, 1998, the Company received $2,691,066 in cash from Siemens.  Of that amount:
(1) $1,291,712 was paid to the Company as a non-refundable payment to license
certain automated speech recognition technologies for which the Company has no
further obligation; (2) $322,928 was paid to purchase warrants to acquire
1,000,000 shares of fonix restricted common stock at an average exercise price
of $20 per share with expiration dates ranging from December 31, 1998 to
December 31, 1999; and (3) $1,076,426 was paid to the Company to acquire, if
Siemens so elects, shares of the Company's restricted common stock (the
"Shares") at any time prior to March 12, 1998, (this exercise period
subsequently was extended to May 31, 1998).   The purchase price of the Shares,
if purchased by Siemens, shall be the closing price of the common stock on the
day preceding the day on which Siemens notifies the Company of its election to
purchase the Shares. If Siemens elects not to acquire all or a part of the
Shares on or prior to May 31, 1998, the $1,076,426 or any portion thereof not
used to purchase all or a portion of the Shares will become a non-refundable
license payment, unless the Company and Siemens mutually agree to extend that
deadline.

10.  RESEARCH AND DEVELOPMENT

In October 1993, the Company entered into an agreement with Synergetics, Inc.
(the "Synergetics Agreement"), a research and development entity, whereby
Synergetics was to develop certain technologies related to the Company's
automated speech recognition ("ASR") technologies. The president of the Company
is one of seven members of the board of directors of Synergetics, and three
executive officers, directors and ten percent beneficial owners of the Company
own less than five percent of the common stock of Synergetics. Under the terms
of the Synergetics

                                      11
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 [Unaudited]

Agreement, as subsequently modified, the Company acquired intellectual property
rights, technologies and technology rights that were developed by Synergetics
and that pertained to the ASR technologies. The Company agreed to provide all
funding necessary for Synergetics to develop commercially viable technologies.
There was no minimum requirement or maximum limit with respect to the amount of
the funding to be provided by the Company. However, under the terms of the
Synergetics Agreement, the Company was obligated to use its best efforts in
raising the necessary funding for the engineering, development and marketing of
the ASR technologies. As part of the Synergetics Agreement, the Company agreed
to pay Synergetics a royalty of ten percent of gross revenues from sales of its
ASR technologies (the "Royalty"). Under the terms of the Synergetics Agreement,
the Company paid to Synergetics $935,957 and $1,361,977 for the three months
ended March 31, 1998 and 1997, respectively, for research and development
efforts.

Until March 1997, Synergetics had compensated its engineers, employees, members
of its development team, and other financial backers (collectively, the
"Developers"), in part, with the issuance of "Project Shares" granting the
holders of such shares the right, within limits, to share pro rata in future
Royalty payments by the Company.  In addition to issuance of Project Shares,
Synergetics had made cash advances to some members of its project team on a non-
recourse basis.  Repayment of those advances was secured by future
disbursements, if any, under the borrower's Project Shares.

On April 6, 1998, the Company and Synergetics entered into a Royalty
Modification Agreement, under which the Company agreed, subject to its
compliance with applicable securities laws, to make an offer to exchange common
stock purchase warrants having an exercise price of $10 per share for the
Project Shares at the rate of one warrant to purchase 800 fonix common shares
for each Project Share.  The warrants, if and when issued, will not be
exercisable until the earlier of (1) the date the Company's common stock has
traded for a period of 15 consecutive trading days at a minimum of  $37.50 per
share or (2) September 30, 2000.  The offer of warrants to holders of Project
Shares cannot be made by the Company until a registration statement covering the
total number of warrants issuable upon the exercise of the warrants has been
declared effective by the Securities and Exchange Commission.  Upon the tender
to the Company of any Project Shares a corresponding percentage of the Royalty
will be canceled.

11.  COMMITMENTS AND CONTINGENCIES

Employment Agreements - In January 1998, the Company entered into employment
contracts with two executives which expire in January 2001.  The minimum annual
salary payments required by these contracts total $405,000.  In connection with
those agreements, the executives were granted options to purchase an aggregate
of 355,000 shares of the Company's common stock at $3.34 per share.  The options
have a ten-year term and are subject to a two-year vesting schedule, pursuant to
which one-third of the total number of options vested on the grant date, and one
third vest on the following two anniversaries of the grant date.  If, during the
contract term, both a change of control of the Company occurs, and within six
months after such change in control occurs, the executive's employment is
terminated by the Company for any reason other than cause, death or retirement,
the executive shall be entitled to receive an amount in cash equal to all base
salary then and thereafter payable within thirty days of termination.

Professional Services Agreement - On February 23, 1998, the Company entered into
a two-year professional services agreement with Meridian Speech Technology, Inc.
("Meridian"), whereby Meridian agreed to provide consulting services in
connection with the research and development of the ASR technologies.  The
minimum monthly fee payable to Meridian is $30,000 per month for the first six
months and $10,000 per month for the remaining eighteen months of the agreement.
The agreement may be terminated by either party if the other party has not
performed any material covenant or has otherwise breached any material term of
the agreement.

Litigation - On March 11, 1998, an action (the "J&L Action") was filed against
the Company in the Supreme Court of the State of New York for the County of New
York by Jesup & Lamont Securities Corporation.  The J&L Action alleges that the
Company must pay a fee in excess of $1,200,000 plus 30,000 shares of the
Company's restricted common stock in connection with the Offering (see Note 7).
An answer has been filed by the Company and limited discovery has taken 

                                       12
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  [Unaudited]
 
place. The Company's Board of Directors and its management believe that the J&L
Action is without merit, and the Company intends to vigorously defend the
action. There can be no assurance that the Company will prevail in the J&L
Action, or that the pendency of the lawsuit will not adversely affect the
Company's operations. As the outcome of this matter cannot be reasonably
determined, the Company has not accrued any reserve to cover potential losses.

In addition to the J&L action, the Company from time to time is or may be
involved in various lawsuits, claims  and actions arising in the ordinary course
of  business.  In the opinion of management, after consultation with legal
counsel, the ultimate disposition of these matters will not materially affect
the consolidated financial position or results of operations of the Company.

License Agreement - On September 23, 1997, AcuVoice, Inc., fonix AcuVoice's
predecessor-in-interest,  entered into a license agreement with General Magic,
Inc. ("General Magic").  Under that agreement, General Magic was granted a
perpetual, irrevocable, worldwide license in a specific field of use to use,
reproduce, publicly display and distribute fonix AcuVoice's text-to-speech
software in connection with General Magic's voice accessed integrated network
service. The license is exclusive for the first three years and non-exclusive
thereafter.  Under the license agreement, the Company is entitled to royalty
payments based upon monthly subscriber revenue from the use of the integrated
network service.  Additionally, AcuVoice, Inc. granted an option to General
Magic to purchase the then-current text-to-speech source code and all source
code documentation for a cash payment of $2,500,000 and $2,500,000 in General
Magic common stock.

                                      13
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS, IN ADDITION TO HISTORICAL
INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE
RESULTS ANTICIPATED BY THE COMPANY AND DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE
DISCUSSED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1997.

Overview
--------

fonix is a development-stage company engaged in scientific research and
development of proprietary automated speech recognition ("ASR") technologies
comprised of components that may be licensed in whole or in part to third
parties. The Company also has developed, and seeks to license, certain other
technologies related to the ASR technologies such as data compression and neural
network design technologies (collectively the ASR technologies and such other
related technologies are referred to in this report as the "Core Technologies").
The Company has completed the Core Technologies such that they are available for
third-party licensing and co-development.

In November 1997, the Company entered into an agreement (the "Siemens
Agreement") with the Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") pursuant to which the Company and Siemens agreed to pursue research
and development of certain technologies related to ASR and the commercialization
of such technologies for the telecommunications industry through a strategic
alliance.  Pursuant to the terms of the Siemens Agreement, the Company and
Siemens entered into the First Statement of Work and License Agreement (see Note
9 to the condensed consolidated financial statements) pursuant to which Siemens
paid the Company a license fee for the development and production of fonix Core
Technologies in integrated circuits suitable for certain telecommunications
applications. The Siemens Agreement calls for the payment to the Company of
additional license fees when the Company and Siemens have entered into further
agreements for the development of specific technologies, although there can be
no assurance that the parties will enter into such additional agreements.

On October 14, 1997, the Company entered into a Master Technology Collaboration
Agreement (the "OGI Agreement") with the Oregon Graduate Institute of Science
and Technology ("OGI") under which the Company and OGI have agreed to pursue
research and development of certain Core Technologies.  In furtherance of the
OGI Agreement, the Company and OGI have entered into the first Statement of
Work, under which the parties are collaborating on advanced ASR applications for
entry in the 1999 DARPA competition.  The OGI Agreement contemplates that the
Company and OGI will enter into other agreements to pursue research and
development of certain technologies related to the Core Technologies, although
there can be no assurance that such additional agreements will be entered into
by the Company and OGI.

Other than the arrangements with Siemens and OGI, the Company has no licensing
or co-development agreements with any third party and, other than the non-
refundable license fee paid by Siemens, the Company has received no revenue to
date.  fonix presently anticipates that any products incorporating the Company's
Core Technologies would be manufactured and marketed by third-party licensees
and co-development and strategic alliance partners such as Siemens and therefore
has no plans to manufacture products incorporating the Core Technologies for the
foreseeable future.  The Company is presently engaged in discussions with
numerous potential licensees and co-developers.  There can be no assurance that
the Company will be able to license its Core Technologies to third parties other
than Siemens or enter into additional co-development or strategic alliance
agreements.

The Company's primary development objective is to further develop, refine and
enhance the main components of its Core Technologies.  The Company's initial
marketing direction is to focus on licensing its Core Technologies to third
parties and co-developers.  These licenses will be made broadly available to
many segments of the computer industry, including application software,
operating systems, computers and microprocessor chips, and research and
development entities worldwide, including academia, government, industry and
commercial speech product developers who may want to take advantage of the
Company's Core Technologies in their existing products.  The Company anticipates
that it will sell or license its Core Technologies on terms advantageous to the
Company, and that run-time product license royalty 

                                      14
<PAGE>
 
rates will vary according to applications, sales volumes, and end-user pricing
of products using the Core Technologies. The Company may reserve exclusive
rights in some fields of use for the internal development of high value end-user
products and applications.

The Company's Board of Directors has determined that the Company's ability to
enter into profitable licensing arrangements with third parties could be
enhanced by the Company's acquisition of other technologies complementary to the
ASR technologies.  The Company believes such acquisitions would allow the
Company to substantially increase the pool of potential licensees of the
Company's technologies by offering a more comprehensive suite of computer voice
recognition, voice synthesis and other advance human computer interface
technology solutions.  Furthermore, because many such complementary technologies
involve research and development challenges similar in nature to those involved
in the development of the Core Technologies, the Company believes that
developmental efficiencies can be achieved by coordinating new development among
a variety of applications (see "Outlook" below).

In furtherance of this strategy, in March 1998, the Company acquired the award-
winning voice synthesis technologies of AcuVoice, Inc.  That acquisition was
accomplished through a merger of AcuVoice, Inc. into a wholly owned subsidiary
of the Company  now known as fonix/AcuVoice, Inc.  AcuVoice, Inc. was
incorporated in 1984 and since that time has been engaged in development of a
software only text-to-human-speech synthesis technology called "concatenative
speech synthesis," now recognized in the speech technology industry as a leading
method of achieving natural sounding speech from a computer.  Beginning in early
1996, AcuVoice, Inc. began selling developer kits based on its technology, and
companies that presently are believed to be developing marketable products based
on the fonix AcuVoice technologies include IBM, General Motors, Kurzweil
Educational Systems, Pratt & Whitney, Octel Communications, Andersen Consulting,
NEC, Dialogic and Bell Atlantic.  Companies that have developed products using
fonix AcuVoice developer kits, and now are selling or using products containing
fonix AcuVoice text-to-speech technologies include AT&T, Motorola, Northern
Telecom, Lucky Goldstar (Korea), Smart Dial, Signet, Concierge, Ultimate
Technology, First Call, XL Vision, Applied Future Technologies and Productivity
Works.

In addition to fonix AcuVoice, the Company is presently considering other
mergers and acquisitions involving additional complementary technologies.  There
can be no assurance that any other acquisitions will be consummated, or that the
AcuVoice merger, or any other acquisition or merger consummated, will result in
increased opportunities for the Company to enter into profitable licensing
arrangements or that such additional technologies can be successfully integrated
with the Core Technologies.  To the extent the Company finances such
acquisitions by issuances of its capital stock, additional, and possibly
substantial dilution will result to existing shareholders.

Acquisition
-----------

During the quarter ended March 31, 1998, the Company acquired AcuVoice, Inc. for
the in-process research and development (IPR&D) of that company.

AcuVoice is a developer of a speech-synthesizing software system that is capable
of translating text into natural sounding speech. Its currently available
products include the AcuVoice Speech Synthesizer AV1700 Text Reader and the
AcuVoice Speech Synthesizer AV2001 Telephony/Multimedia Interface.  These
applications are able to read a variety of input text in an American English
male voice.

At the date of acquisition, AcuVoice IPR&D efforts were focused on the continued
development and evolution of the next generation of these products.
Specifically, the Company is working to expand voice capacity to include both a
male and female voice, and to expand language capacity to include Japanese,
Mandarin Chinese, French, German, and Spanish. In addition to the technological
issues resulting from these efforts, the Company also intends to enhance the
next generation applications with a stronger Text-to-Speech engine, sound bank,
SAPI 4.0, SDK, and user dictionary; and increased VOX file output,
documentation, C++ API and JSAPI.  AcuVoice is also developing an ESL product
for the Windows 95/Windows NT environments that would have a customized
dictionary and sample English sentences, and a highly scalable multi-channel
version for applications that would operate in Windows NT/Solaris environments.

The developmental projects at the time of the acquisition were not
technologically feasible and had no alternative future use. This conclusion was
attributable to the fact that AcuVoice had not completed a working model that
had been tested and proven to work at performance levels which were expected to
be commercially viable, and that the technologies 

                                      15
<PAGE>
 
constituting the projects had no alternative use other than their intended use.
The value is attributable solely to the development efforts completed as of the
acquisition date. The acquired IPR&D was valued at approximately $9.3 million
based on an analysis of forecasted income.

As of the date of acquisition, AcuVoice had invested approximately $3.5 million
in the IPR&D identified above. Development of the acquired in-process technology
into commercially viable products and services required efforts principally
related to the completion of all planning, designing, coding, prototyping,
scalability verification, and testing activities necessary to establish that the
proposed technologies would meet their design specifications, including
functional, technical, and economic performance requirements. Management
estimates that approximately $1.0 million will be required over the next 12
months to develop the aforementioned products to commercial viability.

The Company currently estimates that a redeveloped version of its AcuVoice
applications will be released within range of the development horizon in terms
of date of release and cost to complete anticipated at the date of acquisition.
Management confirms that remaining IPR&D projects are continuing to be developed
as anticipated.

Valuation Methodology

The valuations of the respective acquired IPR&D included, but were not limited
to, an analysis of (1) the market for AcuVoice products; (2) the completion
costs for the projects; (3) the expected cash flows attributable to the in-
process research and development projects; and (4) the risks associated with
achieving such cash flows. The assumptions underlying the cash flow projections
were derived from investment banking reports, independent analyst reports, fonix
and AcuVoice company records, and discussions with the management of both
companies. Primary assumptions such as revenue growth and profitability were
compared to indications of similar companies as well as to indications from
industry analyst reports, to determine the extent to which these assumptions
were supportable. The Company did not assume in its valuation any material
change in its profit margins as a result of the acquisition and did not assume
any material increases in selling, general and administrative expenses as a
result of the acquisition. The Company did not anticipate any expense reductions
or other synergies as a result of the acquisition. The basis of the acquisition
was an attempt to enhance the Company's competitive position by offering a
broader product line, including applications and functionality based upon the
acquired Text-to-Speech technology.

The Company does not break down revenues attributable specifically to AcuVoice-
derived products. As products are offered both as a suite and as individual
applications, fonix license fees are not necessarily application specific.
However, the Company believes that revenues generated to date concur with the
assumptions used in the valuation analysis.

Because the Company does not account for expenses by product, it is not possible
to determine the actual expenses associated with the technology acquired from
AcuVoice.  The Company currently believes that expenses associated with
completing the purchased IPR&D and integrating the technology with the Company's
existing products are approximately consistent with the Company's estimates used
in the analysis and that completion dates for the development projects discussed
above concur with projections used at the time of the acquisition. Research and
development spending with respect to these offerings is expected to continue at
a rate that is consistent with the Company's overall research and development
spending. The Company does not believe that the acquisition resulted in any
material changes in its profit margins or in selling, general and administrative
expenses. The Company does not believe that it achieved any material expense
reductions or synergies as a result of the acquisition.

The rates utilized to discount the net cash flows to their present value were
consistent with the nature of the forecast and the risks associated with the
projected growth, profitability and developmental projects.  Discount rates of
50% and 60% for AcuVoice were deemed appropriate for the business enterprise and
for the acquired IPR&D, respectively. These discount rates were consistent with
the acquired company's stage of development; the uncertainties in the economic
estimates described above; the inherent uncertainty at the time of the
acquisition surrounding the successful development of the purchased in-process
technology; the useful life of such technology; the profitability levels of such
technology; and the inherent uncertainties of the technological advances that
were indeterminable at the time of the acquisition.

The forecasts used in valuing the IPR&D were based upon assumptions the Company
believed to be reasonable but which were inherently uncertain and unpredictable.
For these reasons, actual results may vary from projected results. 

                                      16
<PAGE>
 
The Company currently markets the AcuVoice acquired and subsequently-developed
products. Management intends to continue AcuVoice's development program until
the Company is able to successfully introduce the new suite of products.

Results of Operations
---------------------

Three months ended March 31, 1998 compared with three months ended March 31,
1997

During the three months ended March 31, 1998, the Company recorded its first
revenues of $1,295,785, of which, $1,291,712 was paid by Siemens as a non-
refundable license fee, for which the Company has no further obligation.

Prior to March 1997, the Company conducted its scientific research and
development activities through Synergetics, Inc., a research and development
entity ("Synergetics"), pursuant to product development and assignment contracts
between the Company and Synergetics (collectively, the "Synergetics Agreement").
Under that arrangement, Synergetics provided personnel and facilities and the
Company financed scientific research and development of the ASR technologies on
an as-required basis. There was no minimum requirement or maximum limit with
respect to the amount of funding the Company was obligated to provide to
Synergetics under the Synergetics Agreement, and the Company was obligated to
use its best efforts in raising all of the necessary funding for the development
of the ASR technologies. Synergetics submitted pre-authorized work orders and
budgets, which were then reviewed and approved by the Company. All funds paid to
Synergetics have been accounted for by the Company as research and development
expense. Under the Synergetics Agreement, the Company had also agreed to pay a
royalty to Synergetics equal to ten percent of revenues from sales of the ASR
technologies or products incorporating the ASR technologies (the "Royalty"). On
March 13, 1997, the Company and Synergetics reached an agreement in principle to
modify the Synergetics Agreement with regard to the development and assignment
of the Company's ASR technologies. Most research and development activities
previously conducted by Synergetics were moved in-house to the Company in or
about March 1997. On April 6, 1998, the Company and Synergetics entered into a
Royalty Modification Agreement, under which the Company agreed, subject to its
compliance with applicable securities laws, to make an offer to exchange common
stock purchase warrants having an exercise price of $10 per share for the
Project Shares at the rate of one warrant to purchase 800 fonix common shares
for each Project Share. The warrants, if and when issued, will not be
exercisable until the earlier of (1) the date the Company's common stock has
traded for a period of 15 consecutive trading days at a minimum of $37.50 per
share or (2) September 30, 2000. The offer of warrants to holders of Project
Shares cannot be made by the Company until a registration statement covering the
total number of warrants issuable upon the exercise of the warrants has been
declared effective by the Securities and Exchange Commission. Upon the tender to
the Company of any Project Shares a corresponding percentage of the Royalty will
be canceled. Assignment to the Company of all technology relating to the ASR
technologies is confirmed by the Modification Agreement.

From inception on October 1, 1993 through March 31, 1998, the Company has
invested $20,638,496 in research and development relating to its Core
Technologies.  During the three months ended March 31, 1998, the Company
incurred research and development expenses of $2,701,203, an increase of
$1,091,145 over the same period in the previous year. This increase is due
primarily to the addition of research and development personnel, equipment and
facilities.  The Company anticipates similar or increased research and
development costs as it expands and continues to develop and market its Core
Technologies.  Additionally, the Company purchased in-process research and
development totaling $9,315,000 during the three months ended March 31, 1998 in
connection with the acquisition of AcuVoice, Inc.

General and administrative expenses were $1,478,863 and $1,293,391,
respectively, for the three months ended March 31, 1998 and 1997. This increase
over the previous period was due primarily to increases in salaries. Salaries
were $687,930 and $375,497 for the three months ended March 31, 1998 and 1997,
respectively, an increase of $312,433 over the three months ended March 31,
1997. Additionally, the Company incurred increased expenses in legal, accounting
and travel of $246,271 and a decrease in consulting and outside services of
$421,968.

Due to minimal revenues and significant research and development and general and
administrative expenses, the Company has incurred losses from operations since
inception totaling $52,383,244, of which $12,199,281 and $2,903,449 were
incurred during the three months ended March 31, 1998 and 1997, respectively. At
March 31, 1998, the Company had an accumulated deficit of $57,389,134 and
stockholders' equity of $21,892,453. The Company

                                      17
<PAGE>
 
anticipates that its investment in ongoing scientific research and development
of the Core Technologies will continue at present or increased levels for at
least the remainder of fiscal 1998.

Net other expense was $40,447 for the three months ended March 31, 1998, an
increase in net expense of $80,433 over the three months ended March 31, 1997.
This increase was due to increased interest expense and reduced interest income
from notes receivable.

Liquidity and Capital Resources
-------------------------------

The Company's current assets exceeded its current liabilities by $5,206,925 at
March 31, 1998 compared to $678,823 at December 31, 1997.  The current ratio was
1.34 at March 31, 1998, compared to 1.03 at December 31, 1997.  Current assets
decreased by $607,481 to $20,541,208 from December 31, 1997 to March 31, 1998.
Current liabilities decreased by $5,135,583 to $15,334,283 during the same
period.  The increase in working capital from December 31, 1997 to March 31,
1998 is primarily attributable to a decrease in the Company's revolving note
payable of $4,455,015 due to the sale of common stock.  Total assets were
$38,341,834 at March 31 ,1998 compared to $22,894,566 at December 31, 1997.

From its inception, the Company's principal source of capital has been private
and other exempt sales of the Company's debt and equity securities.  During the
three months ended March 31, 1998, the Company issued 7,719,864 shares of common
stock for net cash proceeds of $14,340,000.  Of such amount, 3,333,333 shares
were issued in connection with a private placement (see below), 2,692,216 shares
were issued in connection with the acquisition of AcuVoice, Inc., 1,489,501
shares were issued upon the conversion of convertible preferred stock and
related dividends, 180,000 shares were issued upon the exercise of previously
granted warrants and 24,814 shares were issued for the purchase of a patent.

On March 12, 1998, the Company completed a private placement (the "Offering") of
up to 6,666,666 shares of its restricted common stock to seven separate
accredited investors.  The total purchase price to be paid by the investors
pursuant to the Offering is $30,000,000.  Of that amount, $15,000,000 was
received by the Company on March 12, 1998, in return for which the Company
issued a total of 3,333,333 shares of restricted common stock.  Finders' fees of
$870,000 were paid in connection with the $15,000,000 received.  The remainder
of the purchase price is to be paid by the investors 60 days after the
effectiveness of a registration statement that the Company filed with the
Securities and Exchange Commission on April 16, 1998 (the "Second Funding
Date"), provided that, as of such date, certain conditions are satisfied.
Specifically, as of the Second Funding Date: (i) the registration statement
covering all of the common stock to be issued must be effective, (ii) the
representations and warranties of the Company as set forth in the documents
underlying the Offering shall be correct in all material respects, (iii) the
market price of the Company's common stock shall exceed $4.50 per share, (iv)
the dollar volume of trading in the Company's common stock for the 10-trading
day period preceding such date shall equal or exceed $1,000,000, (v) there shall
be at least 18 market makers for the Company's common stock, and (vi) there
shall be no material adverse change in the Company's business or financial
condition.

Additionally, the investors in the Offering have certain "reset" rights pursuant
to which the investors will receive additional shares of restricted common stock
if the average market price of the Company's common stock for the 60-day periods
following the initial closing date and the Second Funding Date does not equal or
exceed $5.40 per share.  The number of additional shares that will be issued
pursuant to such reset provisions will be determined by dividing (x), the
product of (A) the amount by which such 60-day average price is less than $5.40
and (B) the number of shares of common stock issued to the investor by, (y) the
60-day average price.  The investors in the Offering also have certain first
rights of refusal and other rights if the Company conducts other offerings in
the near future with other investors and the terms of such other offerings are
more advantageous to such other investors than the terms of the Offering.

In January 1998, 27,500 shares of Series B Preferred Stock and related dividends
were converted into 193,582 shares of common stock.  At March 31, 1998, no
shares of  Series B Preferred Stock were outstanding.

During the three months ended March 31, 1998, 185,000 shares of Series C
Preferred Stock and related dividends were converted into 1,295,919 shares of
the Company's common stock.  At March 31, 1998, no shares of  Series C Preferred
Stock were outstanding.

                                      18
<PAGE>
 
During the three months ended March 31, 1998, the Company granted 1,225,000
stock options. 450,000 of such options having an exercise price of $5.16 per
share, were granted to three individuals who are executive officers and
directors of the Company and who each beneficially own more than ten percent of
the Company's common stock. 355,000 and 420,000 of such options were granted to
various employees at an exercise price per share of $3.34 and $6.50,
respectively. These options have a ten-year term.

Although the Company has signed its first Statement of Work with Siemens and the
Company anticipates that it will enter into additional third-party license or
licenses or co-development agreements for its Core Technologies with Siemens and
other parties during fiscal year 1998, there can be no assurance that this will
occur.  Even with the Siemens Agreement in place and taking into account
expected revenues from the AcuVoice merger, the Company's ongoing operating
expenses remain higher than revenues from operations.  Accordingly, the Company
expects to incur significant losses at least through the end of fiscal year 1998
and until such time as it is able to enter into substantial licensing and co-
development agreements and receive substantial revenues from such arrangements,
of which there can be no assurance.

The Company has established a relationship with a major regional federally
insured financial institution pursuant to which the Company is permitted to
borrow against its own funds on deposit with the institution.  As of March 31,
1998, the Company had funds on deposit of $20,000,000.  As of March 31, 1998,
the Company owed $14,157,257 to the institution, compared with $18,612,272 as of
December 31, 1997.  The weighted average outstanding balance during the three
months ended March 31, 1998 was $17,465,681.  This note was due April 29, 1998
and bore an interest rate of 6.50 percent per annum at March 31, 1998.  This
note has been renewed through August 4, 1998.  This revolving note is
renegotiated quarterly and the Company plans to continue renewing the note
indefinitely.  The net difference between the rate of interest paid by the
institution for the Company's funds on deposit at the institution and the
interest rate paid to the Company by the institution is approximately one
percent.  Interest income and expense is payable monthly and the principal
amount is payable in full at maturity.

The Company anticipates that it will need to raise additional funds to satisfy
its cash requirements during the next twelve months. Scientific research and
development, corporate operations and marketing expenses will continue to
require additional capital.  In addition, the Company has recently acquired
AcuVoice, Inc. and is actively seeking additional complementary acquisition
opportunities.  These transactions will require additional capital resources,
even if the Company uses its securities in payment of all or part of the
purchase price of such acquisitions, because AcuVoice, Inc. and certain
acquisition targets presently do not have monthly income to provide sufficient
revenue to finance such acquisitions.  Because the Company presently has only
limited revenue from operations, the Company intends to continue to rely
primarily on financing through sales of its equity and debt securities to
satisfy future capital requirements until such time as the Company is able to
enter into additional acceptable third-party licensing or co-development
arrangements such that it will be able to finance ongoing operations out of
license, royalty and sales revenues.  There can be no assurance that the Company
will be able to sell its equity and debt securities or enter into such
arrangements, or both such that sufficient operating capital will be available
when and in the amounts needed. Furthermore, the issuance of equity securities
or other securities which are or may become convertible to the equity securities
of the Company in connection with such financing (or in connection with
acquisitions) will result in dilution to the stockholders of the Company which
could be substantial.

The Company presently has no plans to purchase any new plants or office
facilities.  The Company is currently planning to lease a larger office facility
in the San Jose, California area to house a growing fonix AcuVoice staff and
anticipates that it will incur approximately $950,000 in capital expenditures
for equipment Company-wide over the next twelve months.

Outlook
-------

Corporate Objectives, Technology Vision and Acquisition Strategy

The Company has positioned itself as a developer of "next generation" speech and
human-computer interface technologies that will provide multiple product
solutions for business, consumer and service applications. The fonix management
team has assembled leading talents in the speech recognition, speech synthesis
and other arenas related to its Core Technologies. The Board of Directors and
management have developed a business strategy that identifies

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<PAGE>
 
the Company's strengths and objectives, outlines a vision of the next major
market opportunities in the computer, telephony and electronics industries and
articulates a corporate and technology strategy that includes strategic
alliances, collaborative development agreements, strategic acquisitions and,
ultimately, marketing a suite of fonix-branded products.

Management believes the primary strengths of fonix include:

     .    Next generation Core Technologies
     .    Growing suite of complementary advanced speech and human-computer
          interface technologies
     .    Strong Board of Directors and management team with experience in
          industry and finance sectors
     .    Inclusive, open, supportive corporate culture
     .    Depth of technological expertise, including product engineering teams
          in Salt Lake City, Silicon Valley and Boston
     .    Reasoned global market strategy

Management believes that these strengths can be used by the Company to provide
added access to capital markets, facilitate accomplishment of the objectives of
the Company and position the Company as an attractive investment and development
partner.

The Company believes that its Core Technologies will be the platform for the
next generation of automated speech technology and products.  Most speech
recognition products offered by other companies are based on technologies such
as HMMs, that are largely in the public domain and represent nothing
particularly "new" or creative.  The fonix Core Technologies are based on
proprietary, patented technology.  The Company will continue to seek patent
protection of the Core Technologies and will seek to add, including through
acquisitions such as the AcuVoice merger, products and technologies that are
either patented or unique in the marketplace.  Management believes this strategy
will set the Company's advanced speech products apart from the competition.

The Company is determined to become a multi-market, multi-product enterprise
offering advanced speech and human-computer interface technologies for business,
consumer and service applications.  Advance human-computer interface
technologies and multi-modal systems include:

     .    speech recognition
     .    speech synthesis
     .    speaker identification and verification
     .    handwriting recognition
     .    pen and touch screen input
     .    facial and gesture input and output
     .    natural language understanding

Products anticipated to incorporate such advanced multi-modal human computer
interface technologies include, among others, the following:

     .    PC's and cellular phones
     .    automotive and home environment speech controls
     .    automated information and transaction kiosks
     .    telephone systems with natural dialogue and gesture controls
     .    medical reporting systems
     .    smart consumer appliances and electronics
     .    speech and pen-based computers
     .    interactive education and entertainment systems
     .    interactive advertising
     .    real-time translation systems

This next generation technology presents important product and service
opportunities for fonix in a variety of industry segments, including:

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<PAGE>
 
     .    semiconductors
     .    telecommunications
     .    computers
     .    software
     .    consumer electronics
     .    entertainment

fonix is a technology company.  Since its inception, the Company has focused on
the development of its Core Technologies and related complementary technologies.
The Company will pursue the development and acquisition of advanced speech and
computer-interface technologies that will enhance or may be enhanced by its own
Core Technologies.  fonix will pursue this development through strategic
alliances, such as the Siemens agreement in the telecommunications industry, and
through collaborative research arrangements such as its agreement with OGI.

Acquisition targets will (i) have technologies that are complementary to the
Core Technologies, (ii) offer existing products and marketing strengths that
provide immediate revenues to the Company, (iii) open new marketing channels for
existing technologies or products of the Company, (iv) provide new product
vehicles for the Core Technologies and (v) possess vertical market applications
expertise that can be leveraged by the Company in further product development
and marketing opportunities.  The Company has observed that there are numerous
small "boutique" speech technology vendors.  An alliance with or acquisition of
such vendors by the Company can offer these small companies greater access to
human and financial resources which, it is hoped, will lead to greater market
share, improved product development and support, and creation of additional
applications.  The Company believes that the ideal candidates will be involved
in one or more of these categories:

     .    Core speech and language technology, which would include companies
          with speech products or technology involving text-to-speech, multiple
          languages, natural language processing, translation, speaker
          identification, and microphone design.

     .    Speech products and applications, such as interactive natural dialogue
          systems, telephone systems, large vocabulary medical, legal systems,
          compression, and chip-based systems.

     .    Other computer interface technologies, such as pen input and
          handwriting recognition, haptic (manual) input and output, face and
          gesture recognition, pentop and wearable computers.

The strategy described above is not without risk, and shareholders and others
interested in the Company and its common stock should carefully consider the
risks contained the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.

               Special Note Regarding Forward-Looking Statements

Certain statements contained herein under,  "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Outlook,"
including statements concerning (i) the Company's strategy, (ii) the Company's
expansion plans, (iii) the market for and potential applications of the
Company's technologies, (iv) the results of research and development efforts,
and (v) the growth of the Company's business contain certain forward-looking
statements concerning the Company's operations, economic performance and
financial condition.  Because such statements involve risks and uncertainties,
actual results may differ materially from those expressed or implied by such
forward-looking statements.  Factors that could cause such differences include,
but are not necessarily limited to, those discussed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.

 

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<PAGE>
 
                                  SIGNATURES

     In accordance with the requirements of the Exchange Act, the registrant
caused this Amendment No. 1 to be signed on its behalf by the undersigned,
thereunto duly authorized.

                                       fonix corporation



Date:       March 12, 1999               /s/ Douglas L. Rex
      -----------------------------    -------------------------
                                         Douglas L. Rex,
                                         Chief Financial Officer

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