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

                                  FORM 10-Q


[X]        Quarterly report pursuant to Section 13 or 15(d) of the Securities
           Exchange Act of 1934 for the quarterly period ended March 31, 1999

[ ]        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) 328-0161
              (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 19,  1999,  70,660,944  shares of common  stock,  par value $.0001 per
share, were issued and outstanding.




<PAGE>
                                   Fonix Corporation
                             [A Development Stage Company]

                          CONDENSED CONSOLIDATED BALANCE SHEETS
                                     (Unaudited)

<TABLE>
<CAPTION>
ASSETS
                                                                                                       March 31,     December 31,
                                                                                                         1999           1998
                                                                                                      -----------   -------------
<S>                                                                                                   <C>           <C>
Current assets:
      Cash and cash equivalents                                                                       $     76,885  $ 20,045,539
      Notes receivable                                                                                           -       245,000
      Accounts receivable, net of allowance for doubtful accounts of $22,526 and $8,115, respectively    1,146,727       219,908
      Prepaid expenses                                                                                     145,924        51,866
      Inventory                                                                                             88,070        77,386
      Interest and other receivables                                                                        33,127         8,276
      Employee advances                                                                                      3,109        67,231
                                                                                                      ------------  ------------
          Total current assets                                                                           1,493,842    20,715,206

Property and equipment, net of accumulated depreciation of $1,430,367 and $1,195,390, respectively       2,166,005     2,328,012

Intangible assets, net of accumulated amortization of $3,895,358 and $2,599,554, respectively           37,471,697    38,816,421

Other assets                                                                                               129,819       130,288
                                                                                                      ------------  ------------
          Total assets                                                                                $ 41,261,363  $ 61,989,927
                                                                                                      ============  ============
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
      Bank overdraft                                                                                  $    167,882     $ 138,034
      Revolving notes payable                                                                               50,000    20,038,193
      Notes payable - related parties                                                                    7,170,410     8,491,880
      Notes payable - other                                                                                560,000       560,000
      Accounts payable                                                                                   3,708,273     3,536,074
      Accrued liabilities                                                                                1,691,058       981,774
      Accrued liabilities - related parties                                                              1,159,139       900,004
      Deferred revenues                                                                                    846,429       695,997
      Capital lease obligation - current portion                                                            44,382        52,225
                                                                                                      ------------  ------------
          Total current liabilities                                                                     15,397,573    35,394,181

Capital lease obligation, net of current portion                                                            28,340             -
Series C 5% Convertible Debentures                                                                       6,500,000             -
                                                                                                      ------------  ------------
          Total liabilities                                                                             21,925,913    35,394,181
                                                                                                      ------------  ------------
Common stock and related repricing rights subject to redemption; 1,801,802 shares and
      repricing rights outstanding (aggregate redemption value of $2,500,000)                            1,830,000     1,830,000
                                                                                                      ------------  ------------
Commitments and contingencies (Notes 5, 6, 7, 9, 12, 13 and 15)

Stockholders' equity:
      Preferred stock, $.0001 par value;  100,000,000 shares authorized;
          Series A, convertible; 166,667 shares outstanding
              (aggregate liquidation preference of $6,055,012)                                             500,000       500,000
          Series D, 4% cumulative convertible; 990,834 shares outstanding in 1999
              (aggregate liquidation preference of $20,293,495)                                         22,902,972    22,200,936
          Series E, 4% cumulative convertible; 90,000 shares outstanding in 1999
              (aggregate liquidation preference of $1,827,249)                                           2,153,357     3,257,886
      Common stock, $.0001 par value; 100,000,000 shares authorized;
          65,837,475 and 64,324,480 shares outstanding, respectively                                         6,584         6,432
      Additional paid-in capital                                                                        91,872,264    88,517,711
      Outstanding warrants                                                                               3,453,147     3,323,258
      Deferred consulting expense                                                                          (26,675)     (106,700)
      Deficit accumulated during the development stage                                                (103,356,199)  (92,933,777)
                                                                                                      ------------  ------------
          Total stockholders' equity                                                                    17,505,450    24,765,746
                                                                                                      ------------  ------------
          Total liabilities and stockholders' equity                                                  $ 41,261,363  $ 61,989,927
                                                                                                      ============  ============
</TABLE>

                   See accompanying note to condensed consolidated
                                 financial statements.


                                        2

<PAGE>
                              Fonix Corporation
                        [A Development Stage Company]

               CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (Unaudited)
<TABLE>
<CAPTION>

                                                                                                                  October 1,
                                                                                                                    1993
                                                                                Three Months Ended              (Inception) to
                                                                                    March 31,                    March 31,
                                                                                ------------------
                                                                            1999                1998                1999
                                                                        -------------      --------------      -------------
<S>                                                                     <C>                <C>                 <C>         
Revenues                                                                $  1,110,332       $   1,295,785       $  4,000,016
Cost of revenues                                                             225,439                   -            301,783
                                                                        -------------      --------------      -------------
      Gross margin                                                           884,893           1,295,785          3,698,233
                                                                        -------------      --------------      -------------
Expenses:
      Selling, general and administrative                                  3,675,561           1,380,080         35,993,093
      Product development and research                                     2,971,279           2,701,203         34,529,320
      Amortization of goodwill and purchased core technology               1,287,581              98,783          3,828,734
      Purchased in-process research and development                                -           9,315,000         13,136,000
                                                                        -------------      --------------      -------------
           Total expenses                                                  7,934,421          13,495,066         87,487,147
                                                                        -------------      --------------      -------------
Loss from operations                                                      (7,049,528)        (12,199,281)       (83,788,914)
                                                                        -------------      --------------      -------------
Other income (expense) 
      Interest income                                                         22,046             271,477          3,689,437
      Interest expense                                                    (2,267,379)           (311,924)        (7,647,028)
      Cancellation of common stock reset provision                                 -                   -         (6,111,577)
                                                                        -------------      --------------      -------------
           Total other income (expense), net                              (2,245,333)            (40,447)       (10,069,168)
                                                                        -------------      --------------      -------------
Loss before extraordinary items                                           (9,294,861)        (12,239,728)       (93,858,082)

Extraordinary items:
      Loss on extinguishment of debt                                               -                  -           (881,864)
      Gain on forgiveness of debt                                                  -                  -             30,548
                                                                        -------------      --------------      -------------
Net loss                                                                $ (9,294,861)      $ (12,239,728)      $(94,709,398)
                                                                        =============      ==============      =============

Basic and diluted net loss per common share                             $      (0.16)      $       (0.27)
                                                                        =============      ==============
</TABLE>

                   See accompanying note to condensed consolidated
                                 financial statements.


                                        3

<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,
                                                                             ------------------------------
                                                                                 1999            1998            1999
                                                                             -------------   --------------   -------------
<S>                                                                          <C>             <C>              <C>
Cash flows from operating activities:
     Net loss                                                                $ (9,294,861)   $ (12,239,728)   $(94,709,398)
     Adjustments to reconcile net loss to net cash
       used in operating activities:
       Issuance of common stock for services                                            -               -       5,487,554
       Issuance of common stock for patent                                              -         100,807         100,807
       Non-cash expense related to issuance of debentures,
         warrants, preferred and common stock                                   1,995,760               -      12,074,674
       Non-cash compensation expense related to issuance
         of stock options                                                          92,565               -       2,588,865
       Non-cash expense related to issuance of notes payable
          and accrued expense for services                                              -               -         857,000
       Non-cash exchange of notes receivable for services                               -               -         150,000
       Non-cash portion of purchased in-process research and development                -       8,814,768      13,136,000
       Write-off of assets received in acquisition                                      -               -           1,281
       Depreciation and amortization                                            1,579,701         235,252       5,355,155
       Extraordinary loss on extinguishment of debt                                     -               -         881,864
       Extraordinary gain on forgiveness of debt                                        -               -         (30,548)
       Changes in assets and liabilities, net of effects of acquisitions:
          Accounts receivable                                                    (926,819)              -      (1,075,317)
          Employee advances                                                        (3,864)              -         (71,095)
          Interest and other receivables                                          (16,851)         19,314         (22,334)
          Inventory                                                               (10,684)              -         (30,905)
          Prepaid assets                                                          (94,058)        (36,517)       (141,524)
          Other assets                                                                469               -        (119,376)
          Accounts payable                                                        417,024         138,642       5,430,760
          Accrued liabilities                                                     709,284         (90,817)      1,351,073
          Accrued liabilities - related party                                     259,135        (238,355)        406,894
          Deferred revenues                                                       150,432               -         231,698
                                                                             -------------   -------------    ------------
       Net cash used in operating activities                                   (5,142,767)     (3,296,634)    (48,146,872)
                                                                             -------------   -------------    ------------
Cash flows from investing activities, net of effects of acquisitions:
     Acquisition of subsidiaries, net of cash acquired                                  -      (7,246,119)    (15,323,173)
     Purchase of property and equipment                                           (38,025)       (255,259)     (3,374,495)
     Investment in intangible assets                                                    -               -        (164,460)
     Issuance of notes receivable                                                       -        (200,000)     (3,228,600)
     Payments received on notes receivable                                        245,000               -       2,128,600
                                                                             -------------   -------------    ------------
       Net cash provided by (used in) investing activities                        206,975  #   (7,701,378)  - (19,962,128)
                                                                             -------------   -------------    ------------
Cash flows from financing activities:
     Bank overdraft                                                                29,848               -         167,882
     Net proceeds (payment) from revolving note payable                       (19,988,193)     (4,504,265)            750
     Net proceeds (payments) from revolving note payable - related parties     (1,506,309)       (514,601)     (1,424,668)
     Proceeds from other notes payable                                                  -               -       2,911,667
     Payments on other notes payable                                                    -               -      (1,779,806)
     Principal payments on capital lease obligation                               (14,448)        (11,687)       (107,154)
     Proceeds from advances                                                             -       1,076,426               -
     Proceeds from issuance of convertible debentures, net                      6,446,240               -       9,631,240
     Proceeds from sale of warrants                                                     -         322,928       1,072,928
     Proceeds from sale of common stock, net                                            -      14,340,000      38,175,700
     Proceeds from sale of preferred stock, net                                         -               -      17,707,346
     Proceeds from sale of common stock and related repricing rights
       subject to redemption, net                                                       -               -       1,830,000
                                                                             -------------   -------------    ------------
       Net cash provided by (used in) financing activities                    (15,032,862)     10,708,801      68,185,885
                                                                             -------------   -------------    ------------
Net (decrease) increase in cash and cash equivalents                          (19,968,654)       (289,211)         76,885

Cash and cash equivalents at beginning of period                               20,045,539      20,501,676               -
                                                                             -------------   -------------    ------------
Cash and cash equivalents at end of period                                       $ 76,885    $ 20,212,465        $ 76,885
                                                                             =============   =============    ============
</TABLE>


                   See accompanying note to condensed consolidated
                                 financial statements.


                                        4
<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,
<S>                                                  <C>          <C>          <C> 
Supplemental disclosure of cash flow information:    1999          1998          1999

       Cash paid during the period for interest      $ 142,701    $ 311,863    $ 3,572,707
</TABLE>

Supplemental Schedule of Non-cash Investing and Financing Activities:

       For the Three Months Ended March 31, 1999:

         The Company entered into a capital lease obligation for equipment in
         the amount of $34,945.

         Advances to employees totaling $59,986 were applied as payments on a
         related-party note payable.

         A total of 143,230 shares previously pledged to a bank by certain
         officers and directors of the Company as collateral for Company credit
         card debt were sold by the bank and the proceeds were used to pay the
         debt and the related accrued interest in full totaling $244,824.

         Preferred stock dividends of $905,090 were recorded related to the
         beneficial conversion features of convertible preferred stock.

         Preferred stock dividends of $222,471 were accrued on convertible
         preferred stock.

         A total of 17,500 shares of Series D convertible preferred stock and
         related dividends of $5,833 were converted into 426,464 shares of
         common stock.

         A total of 45,072 shares of Series E convertible preferred stock and
         related dividends of $12,019 were converted into 1,086,531 shares of
         common stock.

       For the Three Months Ended March 31, 1998:

         Preferred stock 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 quoted
         market value of $16,995,972) in connection with the acquisition of
         AcuVoice, Inc.


                   See accompanying note to condensed consolidated
                                 financial statements.


                                        5
<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  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.

Operating  results for the three months ended March 31, 1999 are not necessarily
indicative of the results that may be expected for the year ending  December 31,
1999.  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, 1998.

Recently Enacted Accounting  Standards - In June 1998, the Financial  Accounting
Standards Board issued Statement of Financial  Accounting Standards ("SFAS") No.
133,  "Accounting  for  Derivative  Instruments  and Hedging  Activities."  This
statement   establishes   accounting  and  reporting  standards  requiring  that
derivative  instruments  be recorded in the balance  sheet as either an asset or
liability  measured at its fair value and that changes in the derivative's  fair
value be  recognized  currently in earnings  unless  specific  hedge  accounting
criteria are met.  SFAS No. 133 is effective  for fiscal years  beginning  after
June 15, 1999. The adoption of this statement is not expected to have a material
effect on the Company's  consolidated  financial  statements as the Company does
not currently hold any derivative or hedging instruments.

Reclassifications - Certain reclassifications have been made in the prior period
consolidated   financial   statements   to  conform  with  the  current   period
presentation.

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, 1999 and 1998, there were outstanding  common stock  equivalents to
purchase  44,358,188 and 13,951,667 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.


                                        6

<PAGE>



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, 1999 and
1998:

<TABLE>
<CAPTION>
                                                                    1999                                  1998
                                                                   ------                                -----
                                                                                Per                                     Per
                                                                               Share                                   Share
                                                           Amount              Amount            Amount                Amount
                                                           ------              ------            ------                ------
<S>                                                        <C>                    <C>            <C>                    <C>
Net loss                                                   $  (9,294,861)                         $(12,239,728)
Preferred stock dividends                                     (1,127,561)                             (131,660)
                                                            -------------                        --------------
Net loss attributable to common
  stockholders                                              $(10,422,422)         $(0.16)         $(12,371,388)         $(0.27)
                                                            =============         =======         =============         =======
Weighted average common shares
  outstanding                                                 64,476,886                             45,740,942
                                                           ==============                        ==============
</TABLE>

2.  ACQUISITIONS

The  Company  acquired  AcuVoice,  Inc.  ("AcuVoice")  in March  1998.  AcuVoice
developed  and marketed TTS  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. In
addition,  the Company  acquired  Papyrus  Associates,  Inc. ("PAI") and Papyrus
Development  Corporation ("PDC") (together with PAI, "Papyrus") in October 1998.
PAI  developed,   marketed  and  supported  printing  and  cursive   handwriting
recognition software for "personal digital  assistants",  pen tablets and mobile
phones under the trademark,  Allegro(TM). PDC was a systems integration provider
with  expertise  and  intellectual  property  in imbedded  systems and  enhanced
Internet  applications.  The products and services formerly provided by AcuVoice
and Papyrus are now provided by the Company's Interactive Technologies Solutions
Group.

The Company also acquired Articulate Systems,  Inc.  ("Articulate") in September
1998.  Articulate was a provider of sophisticated voice recognition  products to
specialized  segments of the health care industry under the PowerScribe(R) trade
name.  These same  products  and  services  are now  provided  by the  Company's
HealthCare Solutions Group.

All three acquisitions were accounted for as purchases.

The following  unaudited pro forma financial statement data for the three months
ended March 31, 1998 present the results of  operations of the Company as if the
acquisitions  of  AcuVoice,  Articulate  and Papyrus had  occurred at January 1,
1998. 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 acquisitions
been made at January 1, 1998 or of future results. Purchased in-process research
and  development  related to the  acquisitions of AcuVoice and ASI of $9,315,000
and $3,821,000,  respectively, were recorded at the date of the acquisitions and
are not presented in the following pro forma financial statement data since they
are non-recurring charges directly attributable to the acquisitions.


                                        7

<PAGE>



<TABLE>
<CAPTION>
                                                                              Pro Forma
                                                                          Three Months Ended
                                                                            March 31, 1998                     
                                                                        ---------------------
<S>                                                                        <C>          
Revenues                                                                   $   1,625,764

Loss before extraordinary items                                               (5,425,339)

Net loss                                                                      (5,425,339)

Basic and diluted net loss
   per common share                                                                (0.11)
</TABLE>


3.  CERTIFICATE OF DEPOSIT

At  December  31,  1998,  the  Company   maintained  a  $20,000,000   short-term
certificate  of  deposit  at  a  bank  which  was  included  in  cash  and  cash
equivalents.  This  certificate  was pledged as collateral  on a revolving  note
payable (see Note 5). On January 8, 1999,  this  certificate of deposit  matured
and was not renewed.  Proceeds from the  certificate  were applied to reduce the
related revolving note payable balance.

4.  INTANGIBLE ASSETS

Intangible   assets  consist  of  purchased  core  technology  and  goodwill  in
connection with the  acquisition of AcuVoice,  Articulate and Papyrus 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
lives  ranging  from five to eight years.  Total  accumulated  amortization  was
$3,895,358 and $2,599,554 at March 31, 1999 and December 31, 1998, respectively.

The  Company  evaluates,   at  each  balance  sheet  date,  whether  events  and
circumstances  have  occurred that  indicate  possible  impairment of long-lived
assets which may require reduction in the book value of such assets. The Company
uses an estimate of future  undiscounted  net cash flows of the related asset or
group of assets  over the  remaining  life in  measuring  whether the assets are
recoverable.  The Company assesses impairment of long-lived assets at the lowest
level for which there are identifiable  cash flows that are independent of other
groups of assets.  As of March 31, 1999, the Company does not believe any of its
long-lived  assets  are  impaired.  However,  the amount of  goodwill  and other
long-lived assets considered  realizable could be reduced in the near term based
on changing  conditions and the Company's  success in funding further  marketing
and development of its products and technologies.

5.  REVOLVING AND OTHER NOTES PAYABLE

At December 31, 1998,  the Company had a revolving note payable to a bank in the
amount of $19,988,193.  This note was due January 8, 1999, bore an interest rate
of 6.00 percent,  and was secured by a  certificate  of deposit in the amount of
$20,000,000  (see  Note  3).  The  Company  paid  this  revolving  note in full,
including  accrued  interest,   on  January  8,  1999  with  proceeds  from  the
certificate of deposit that secured the note and $22,667 in cash.

At March 31, 1999, the Company had an unsecured revolving note payable to a bank
in the amount of $50,000.  Amounts  loaned under the revolving  note payable are
limited to $50,000.  The weighted average  outstanding  balance during the three
months ended March 31, 1999 was $50,000.  The weighted average interest rate was
9.75 percent during this period.  This note is payable on demand,  matures April
1, 2007,  bears interest at the bank's prime rate plus 2.0 percent (9.75 percent
at March 31, 1999) and requires interest to be paid monthly.


                                        8

<PAGE>



At March 31,  1999,  the Company had a note payable to a lender in the amount of
$560,000 which bears interest at 18 percent per year,  which interest is payable
monthly.  The note payable was  originally due January 2, 1999 and is secured by
certain  accounts  receivable  of the Company.  The Company has extended the due
date to May 28, 1999 by agreeing to pay the lender accrued interest plus a fee
of $5,600. The Company  anticipates that it will request  additional  extensions
of the due date.  The note is  personally  guaranteed  by two officers and
directors and a member of the Board of Directors of the Company. The Company
anticipates that it will enter into an indemnity agreement with these three
individuals  relating to this and other guarantees and pledges (see Note 9).

6.  RELATED-PARTY NOTES PAYABLE

At March 31, 1999, the Company had unsecured demand notes payable outstanding to
former Articulate  stockholders in the aggregate amount of $4,658,980 related to
the  acquisition  of Articulate in 1998.  These notes were payable on demand any
time after  November 30, 1998. In December  1998,  the holder of a $407,971 note
demanded payment.  In connection with this demand, the Company paid the holder a
partial  payment of $50,000 in 1998 and the holder  agreed to extend the date on
which demand  could be made to March 15, 1999 and increase the interest  rate to
11 percent  per year.  No  additional  demand has been given for payment of this
note. In 1998, the Company also negotiated extensions of $1,715,775 of the notes
to May 30, 1999 and adjusted the interest rate to 10 percent per year. During 
the three months ended March 31, 1999 and subsequent to March 31, 1999, the
Company made  partial  payments of $50,000 and $175,000 on a $2,535,235 note and
agreed to pay the balance in connection  with a sale of one of its operating
segments (see Note 15).

At March 31, 1999, the Company had unsecured demand notes payable outstanding to
former  Articulate  employees in the aggregate amount of $452,900 and an accrued
liability  of  $404,100  to the same  employees.  Both  amounts  are  related to
incentive  compensation  granted to the employees for continued  employment with
the Company after the  acquisition  of Articulate in 1998. The demand notes bear
interest at an annual rate of 8.5 percent  and were  payable  upon demand  after
November 1, 1998. None of the holders of these notes has demanded  payment.  The
Company  has agreed to pay  interest  on these notes at 9 percent per year after
November 1, 1998.  No demand for  payment has been made for the  $404,100 by the
former Articulate employees.

At March 31, 1999,  the Company had  unsecured  demand  notes  payable to former
Papyrus  stockholders  in the aggregate  amount of $1,710,000,  which notes were
issued in connection  with the  acquisition  of Papyrus in 1998.  The notes were
payable in various  installments  from  February 28, 1999 through  September 30,
1999.  In April,  1999,  the Company  entered into  agreements  with five former
Papyrus shareholders to reduce the aggregate amounts payable to them under these
notes from  $1,632,375 to  $1,188,909,  which amounts will be paid in connection
with a sale of one of the  Company's  operating  segments  (see  Note  15).  The
aggregate   remaining  balance  of  $77,625  of  the  notes  payable  to  former
shareholders  of  Papyrus  will also be paid at the  closing  of the sale of the
operating segment.

At March 31, 1999,  the Company had an unsecured  revolving  note payable in the
amount of $184,839 in principal and $5,929 in accrued interest to SMD, a company
owned by two  individuals  who are  executive  officers  and  directors  and one
individual who is a director of the Company and who each  beneficially  own more
than 10 percent of the Company's  common  stock.  The weighted  average  balance
outstanding  during the three  months  ended  March 31, 1999 was  $53,398.  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 during the
period  ended  March  31,  1999 was  $184,839.  In 1999,  advances  to the three
individuals  in the amount of $59,986 were applied as a partial  payment of this
note.

In December 1998, two individuals  who are executive  officers and directors and
one  individual  who is a  director  of the  Company  ("Guarantors")  guaranteed
certain  obligations  of the Company  (see Note 9). As security  for some of the
guarantees,   the   Guarantors   also  pledged  shares  of  Fonix  common  stock
beneficially  owned by them.  In March  1999,  143,230 of the shares  previously
pledged by the  Guarantors to a bank were sold by the bank and the proceeds were
used to pay Company  credit card  balances and the related  accrued  interest in
full  totaling  $244,824.  These  amounts  are  now  included  in the  unsecured
revolving note payable to SMD described above.

                                        9

<PAGE>




At March 31, 1999,  the Company had an unsecured,  non-interest  bearing  demand
note payable in the amount of $100,000 to Synergetics,  Inc. ("Synergetics"),  a
research and development entity (see Note 11). This note is payable on demand.

At March 31, 1999,  the Company had an  unsecured  note payable to an officer of
the Company in the amount of $20,000,  which bears interest at an annual rate of
10 percent  and was due  December  31,  1998.  The holder of this note agreed to
extend the due date to June 30, 1999.

At March 31, 1999,  the Company had an  unsecured  note payable to an officer of
the Company in the amount of $43,691  which bears  interest at an annual rate of
10 percent and is due on or before July 31, 1999.  Subsequent  to March 31, 1999
this same officer  advanced an  additional  $25,000 to the Company under similar
terms.

The Company believes the terms of the related-party  revolving notes payable are
at least as favorable as the terms that could have been obtained from  unrelated
third parties in similar transactions.

7.  SERIES C 5% CONVERTIBLE DEBENTURES

On January 29, 1999, the Company  entered into a Securities  Purchase  Agreement
with  four  investors  pursuant  to  which  the  Company  sold  its  Series C 5%
Convertible  Debentures in the aggregate  principal  amount of  $4,000,000.  The
outstanding principal amount of the debentures is convertible at any time at the
option of the holders into shares of the Company's  common stock at a conversion
price  equal to the lesser of $1.25 or 80 percent of the  average of the closing
bid price of the  Company's  common stock for the five trading days  immediately
preceding the conversion date. The Company recorded $687,500 as interest expense
upon  the  issuance  of  the  debentures  in  connection  with  this  beneficial
conversion  feature.  The Company  also issued  400,000  warrants to purchase an
equal number of the Company's  common stock at a strike price of $1.25 per share
in connection with this financing.  The warrants are exercisable for a period of
three years from the date of grant.  The estimated fair value of the warrants of
$192,000,  as computed under the  Black-Scholes  pricing model,  was recorded as
interest  expense upon the  issuance of the  debentures.  On March 3, 1999,  the
Company executed a supplemental  agreement  pursuant to which the Company agreed
to  sell  another  $2,500,000  principal  amount  of  Series  C  5%  Convertible
Debentures on the same terms and  conditions as the January 29, 1999  agreement,
except no additional  warrants were issued.  The Company recorded  $1,062,500 as
interest expense upon the issuance of the supplemental  debentures in connection
with its  beneficial  conversion  feature.  The  obligations  of the Company for
repayment of the  debentures,  as well as its  obligation to register the common
stock underlying the potential  conversion of the debentures and the exercise of
the warrants  issued in these  transactions,  are  personally  guaranteed by the
Guarantors  (see Note 9). In  connection  with the  March 3, 1999  funding,  the
Company  agreed to grant a lien on the patent  covering the Company's  Automated
Speech  Recognition  ("ASR")  technologies  as  collateral  for repayment of the
debentures. However, to date no lien on the patent has been granted.

Subsequent to the March 3, 1999 funding,  the holders of the debentures notified
the Company and the  Guarantors  that the  Guarantors  were in default under the
terms of the pledge and that the holders  intended to exercise  their  rights to
sell some or all of the pledged shares of the  Guarantors.  At the present time,
the Company has no knowledge of sales of the Guarantors'  shares by the holders.
However,  if the holders proceed to sell some or all of the Guarantors'  shares,
the Company may be  obligated,  under its  indemnity  agreement  in favor of the
Guarantors, to issue replacement shares to the Guarantors for all shares sold by
the holders and reimburse the  Guarantors  for any costs incurred as a result of
the holder's sales of Guarantors' shares (see Note 9).

8.  STOCKHOLDERS' EQUITY

Series D and E Preferred  Stock - During the three  months ended March 31, 1999,
17,500  shares of Series D  Convertible  Preferred  Stock and  45,072  shares of
Series E Convertible Preferred Stock together with related

                                       10

<PAGE>



dividends on each were  converted  into  426,464  shares and  1,086,531  shares,
respectively, of the Company's common stock.

On February 3, 1999,  certain  holders of Series D and Series E preferred  stock
forwarded  conversion  notices to the Company  converting  (i) 27,500  shares of
Series D preferred  stock and related  dividends  into 315,379  shares of common
stock and (ii) 77,500 shares of Series E preferred  stock and related  dividends
into  1,955,346  shares  of  common  stock.  Due to an error  in the  conversion
calculations and a subsequent delay in receiving further clarifying instructions
from the holders, the common shares  issuable upon such  conversions  were never
issued to the Series D and Series E  holders,  although  the  Company's  records
reflected  that such  shares  had been  issued.  Subsequent  to April 15,  1999,
because the common stock had not been  received,  the Series D and Series E
holders rescinded the February 3 conversions, which the holders were legally
entitled to do under the terms and conditions of the Series D and E preferred
stock agreements.  The effects of this recission have been retroactively
reflected in the accompanying condensed consolidated financial statements and
these Notes.

Common Stock Options - During the three months ended March 31, 1999, the Company
granted  753,000  stock  options to  employees  and 9,500  stock  options to two
consultants at exercise  prices ranging from $1.28 to $1.78 per share.  The term
of all options granted during this three month period is ten years from the date
of grant. Of the stock options issued,  725,834 vested immediately,  18,334 vest
six months after issuance and 18,332 vest one year after issuance.  The weighted
average fair value of the options  granted to employees  during the three months
ended March 31, 1999 was $1.31 per share using the Black-Scholes  pricing model.
Had  compensation   expense on these options  been  recorded in  accordance
with  the  method prescribed  by SFAS No. 123,  "Accounting  for  Stock-Based
Compensation",  the Company's net loss would have been  $11,406,432 or $0.18 per
share.  As of March 31, 1999, the Company had a total of 16,419,282 options
outstanding.

9.  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 10 percent of the Company's  issued and  outstanding  common stock
not  otherwise  disclosed  herein as of and for the three months ended March 31,
1999 and 1998 were as follows:

<TABLE>
<CAPTION>
                                                                               1999             1998
                                                                              ------           -----
<S>                                                                         <C>           <C>
Expenses:
     Base rent                                                              $ 31,104      $     23,130
Liabilities:
     Accrued liabilities                                                           -           222,147
</TABLE>

The Company  rents  office  space  under a  month-to-month  lease from  Studdert
Companies  Corporation  (SCC) and the lease from SCC is  guaranteed by the three
officers,  owners and directors of SCC. The lease requires  monthly  payments of
$10,368.  The Company believes the terms of the related-party lease are at least
as favorable  as the terms that could have been  obtained  from an  unaffiliated
third party in a similar transaction.

Guarantee  of  Company   Obligations  and  Related  Indemnity  Agreement  -  The
Guarantors have guaranteed  certain  obligations of the Company (see Notes 5, 6
and 7). As security for some of the guarantees, the Guarantors have also pledged
shares  of  Fonix  common  stock  beneficially  owned by  them.  The  guaranteed
obligations  and the related  pledged  Fonix  shares as of March 31, 1999 are as
follows:
<TABLE>
<CAPTION>
                                                                  Amount                    Shares
                                                                Guaranteed                  Pledged   
                                                                ----------                  --------
<S>                                                          <C>                           <C>
Series C 5% Convertible Debentures                           $    6,500,000                6,000,000
Note payable                                                        560,000                      -
Accounts payable - legal fees                                       147,000                  100,000
</TABLE>

                                       11

<PAGE>




The Company has agreed to indemnify  the  Guarantors if they are required to pay
any sums for the benefit of the Company under their  guaranty of the Series C 5%
Convertible  Debentures.  The indemnity agreement provides that the Company will
issue shares of the Company's  common stock of sufficient value to reimburse the
Guarantors  in full,  plus  interest  at 10  percent  per  annum,  for all costs
associated  with meeting the  guarantee  commitment,  including any income taxes
resulting  therefrom.  Additionally,  in  consideration  for the pledge of Fonix
common  shares as collateral  for the Series C 5%  Convertible  Debentures,  the
Board of Directors  authorized  the  issuance,  to the  Guarantors of one common
stock purchase  warrant for every three shares pledged.  However,  subsequent to
the Board of Directors'  authorization,  the  Guarantors  declined to accept the
warrants and they were not issued.

The Company  anticipates  that in the future the Guarantors may request that the
Company provide  indemnity  and/or  compensation  for the  guarantees,  advances
and/or pledges by the  Guarantors for the benefit of the Company.  To the extent
such  requests,  if any,  are  reasonable  and of a nature  similar  to what the
Company would grant to unrelated  parties in similar  transactions,  the Company
presently anticipates that it will consider such requests.

At March 31, 1999, the Company had unsecured advances from a bank in the form of
a bank  overdraft in the  approximate  amount of $136,000  that were  personally
guaranteed  by an officer of the  Company.  Subsequent  to March 31,  1999,  the
overdraft was reduced to zero.

10.  STATEMENT OF WORK

On February 11,  1998,  the Company  entered into a First  Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens")  under  which the Company  and  Siemens  are  jointly  pursuing  the
development of Siemens' integrated circuits  incorporating ASR and other related
technologies for use in certain telecommunications applications. On February 20,
1998, the Company received  $2,691,066 in cash from Siemens. Of that amount: (a)
$1,291,712  was paid to the  Company  as a  non-refundable  payment  to  license
certain ASR  technologies for which the Company has no further  obligation;  (b)
$322,928 was paid to purchase warrants to acquire 1,000,000 shares of 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 (c) $1,076,426 was paid
to the  Company  to  acquire,  if Siemens so  elected,  shares of the  Company's
restricted  common  stock or to become a  non-refundable  license  payment.  The
Company recorded  $1,291,712 of the license payments as revenue during the three
months  ended  March  31,  1998.  In June  1998,  Siemens  elected  to apply the
$1,076,426   portion  as  a  non-refundable   payment  to  license  certain  ASR
technologies  for which the Company has no further  obligation.  As of March 31,
1999,  400,000 of the warrants  originally issued had expired and 600,000 of the
warrants remain outstanding at an average exercise price of $25 per share.

11.  PRODUCT DEVELOPMENT AND RESEARCH

Synergetics  - In October  1993,  the Company  entered  into an  agreement  with
Synergetics (the "Synergetics  Agreement"),  a research and development  entity,
whereby Synergetics was to develop certain technologies related to the Company's
ASR  technologies.  Under the terms of the  Synergetics  agreement,  the Company
expended  $186,455 and $435,957 during the three months ended March 31, 1999 and
1998, respectively.

IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2, a research and development  entity, to provide assistance to Fonix in
the continuing  development of specific ASR technologies.  The President of IMC2
is also the President of Synergetics. The professional services agreement is for
a term of 36 months  and  requires  the  Company  to make  monthly  payments  of
$22,000.  Under the terms of the agreement,  the Company expended $66,000 in the
three months  ended March 31,  1999.  The Company did not expend any funds under
this arrangement during the three months ended March 31, 1998.

Adiva-  Beginning in 1998,  the Company  utilized  the research and  development
services of Adiva.  The president of Adiva is also the president of  Synergetics
and IMC2. The Company expended $63,395 during the three months

                                       12

<PAGE>



ended March 31, 1999 for research and development  efforts.  The Company did not
expend any funds under this arrangement  during the three months ended March 31,
1998.

12.  COMMITMENTS AND CONTINGENCIES

Employment  Agreements - In January 1998,  the Company  entered into  employment
contracts  with two employees  which expire in January 2001.  The minimum annual
salary payments  required by these contracts total $405,000.  In connection with
these  agreements,  these  individuals  were granted options to purchase 360,000
shares of the  Company's  common stock at $3.34 per share.  These options have a
ten-year  life and are subject to a  three-year  vesting  schedule,  pursuant to
which one-third of the total number of options granted are vested on the date of
grant and one-third vests each year  thereafter.  In the event that,  during the
contract term, both a change of control 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.  In January  1999,  the
Company  announced  a  major  cost  reduction  program  for the  Company's  1999
operating  year  wherein the two  employees  referred to above agreed that their
compensation would be reduced 30 percent effective February 1999.

Executive Employment  Agreements - On November 1, 1996, the Company entered into
employment  contracts with three executive officers (one of whom is no longer an
executive  officer)  which expire on December  31, 2001.  The annual base salary
pursuant  to the  contracts  with  each  executive  officer  for the year  ended
December 31, 1999 is $425,000.

In January 1999, the Company  announced a major cost  reduction  program for the
Company's  1999  operating  year wherein the two  remaining  executive  officers
agreed that their annual compensation would be reduced to $297,500 commencing
February 1999.  At the same time, Stephen M. Studdert resigned as the  Company's
Chief Executive Officer and entered into a separation  agreement pursuant to
which Mr. Studdert will be paid  $250,000 per year through  January 31, 2001 and
$100,000 for the year ended  January 31,  2002.  Additionally,  his  employment
contract described above was canceled.

Professional  Services  Agreement - Effective May 7, 1998,  the Company  entered
into a one-year  professional  services  agreement with a public relations firm.
The minimum  monthly  retainer  was $15,000 per month.  Subsequent  to March 31,
1999, the Company  negotiated a termination of this agreement for a cash payment
of  approximately  $33,000.  The Company  will  expense the  remaining  deferred
consulting expense in the period the agreement was terminated.

Operating Lease Agreement - In March 1999, the Company entered into an agreement
to lease office space in Cleveland,  Ohio for sales and installation  personnel.
The lease is for three years at a monthly  rate of $4,260 and becomes  effective
May 1, 1999.

Future aggregate minimum obligations under this operating lease are as follows:

<TABLE>
<CAPTION>
Years ending December 31,
-------------------------
<S>                                               <C>
1999                                              $  34,080
2000                                                 51,120
2001                                                 51,120
2002                                                 17,040
                                                   ----------
          Total                                    $153,360
</TABLE>

Capital  Lease  Obligations  - In  January  1999,  the  Company  entered  into a
noncancellable capital lease arrangement for telephone equipment at its facility
in Woburn, Massachusetts.

Future aggregate minimum obligations under this capital lease are as follows:

                                       13

<PAGE>




<TABLE>
<CAPTION>
Years ending December 31,
-------------------------
<S>                                                         <C>
1999                                                          $    8,265
2000                                                               9,016
2001                                                               9,016
2002                                                               9,016
2003                                                               9,016
Thereafter                                                           751  
                                                              -----------
  Total future minimum lease payments                             45,080
   Less amounts representing interest                            (10,135)
                                                              -----------
      Present value of future minimum lease payments          $   34,945  
                                                              ===========
</TABLE>

Royalty  Agreements - The Company has entered into  various  technology  license
agreements.  Generally,  the agreements require the Company to pay royalties at
specified  dollar  amounts in  connection  with each product  sold that utilizes
technologies  licensed by the Company  under these agreements.  The  royalty  
expense  is  accrued  at the  time  product  revenues incorporating the licensed
technologies  are  recognized.  Royalty  expense of $46,877 was incurred  during
the three months ended March 31, 1999 in connection with these agreements. There
were no sales of products incorporating these licensed technologies during the
three months ended March 31, 1998.

13. LITIGATION

Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse  purportedly owns,  commenced an action against Fonix in federal
court  for the  Southern  District  of New York.  Clarke  and  Perpetual  Growth
asserted  claims for breach of  contract  relating  to certain  financing  Fonix
received during 1998. Specifically, Clarke and Perpetual Growth allege that they
entered  into a  contract  with Fonix  under  which  Fonix  agreed to pay them a
commission  of five  percent of all  financing  provided to Fonix by  Southridge
Capital  Management or its affiliates.  Clarke and Perpetual claim that they are
entitled to  commissions  with  respect to  approximately  $3,000,000  of equity
financing  to Fonix in July and August 1998,  and Fonix's  offerings of Series D
and Series E  preferred  stock,  totaling  together  $12,000,000,  in August and
September 1998.

Fonix  believes  that the Clarke  lawsuit is without merit and filed a motion to
dismiss  based upon the court's lack of personal  jurisdiction  over Fonix.  The
court  granted  Fonix's  motion to  dismiss.  Clarke and  Perpetual  Growth have
appealed  the  dismissal.  Fonix has filed a suit against  Clarke and  Perpetual
Growth in federal  court for the Central  District of Utah seeking a declaratory
judgment that it does not owe any money to Clarke and Perpetual Growth. Now that
the action in New York has been  dismissed,  Fonix intends to vigorously  pursue
the Utah action. However, the lawsuit in New York could be reinstated on appeal
and Clarke and Perpetual  Growth could  prevail in that  lawsuit,  in which case
Fonix may be required to pay significant amounts of money damages awarded by the
court.

Papyrus - After the  Papyrus  acquisition  closed in October  1998,  the Company
investigated  some of the  representations  and  warranties  made by  Papyrus to
induce the Company to acquire  Papyrus.  The Company  determined that certain of
the  representations  made by Papyrus and their executive  officers appear to be
false.  At about the same time, the Company began  negotiations  with the former
executive officers of Papyrus. On February 26, 1999, the Company filed an action
against  Papyrus in the United States  District  Court for the District of Utah,
Central  Division,  wherein the Company  alleged  claims for  misrepresentation,
negligent misrepresentation,  breach of contract, breach of the implied covenant
of good faith and fair dealing and rescission.  On March 11, 1999,  three of the
former shareholders of Papyrus filed an action against the Company in the United
States  District  Court for the  District of  Massachusetts,  alleging a default
under the terms of the  promissory  notes issued to them in connection  with the
Papyrus  Acquisition.  On April 2, 1999, the three former  Papyrus  shareholders
filed an amended  complaint  against the  Company  seeking  additional  remedies
including  violation of  Massachusetts  unfair and deceptive  acts and practices
statutes and copyright  infringement.  On April 8, 1999, a fourth former Papyrus
shareholder filed an

                                       14
<PAGE>



action against the Company  alleging a default under the terms of the promissory
notes  issued to him in  connection  with the  Papyrus  acquisition  and seeking
additional  remedies including  violation of Massachusetts  unfair and deceptive
acts and  practices  statutes and copyright  infringement.  On April 13, 1999, a
fifth  former  Papyrus  shareholder  filed a similar  action  in  Massachusetts.
Subsequently,  the  Company  has entered  into  agreements  with the five former
Papyrus  shareholders  for  dismissal  of the  actions and  cancellation  of the
promissory  notes upon payment to the former  shareholders  of  $1,188,909  (the
"Settlement  Payment")  and return for  cancellation  by the  Company of
approximately 970,000 shares of restricted common stock issued to the five
former  shareholders in the acquisition.  The Company must pay the Settlement
Payment on or before July 15, 1999 or the Company and the five former Papyrus
shareholders are free to pursue their respective claims.

Apple Computer,  Inc. - In February 1993, Articulate received a patent (the "303
patent")  for a product  which  would  allow the user of an Apple  MacIntosh  to
create spoken  commands which the computer would  recognize and respond to. Soon
after the 303 patent was issued, Articulate put Apple Computer, Inc.("Apple") on
notice that Apple's  "PlainTalk"  product  infringed the 303 patent.  When Apple
ignored Articulate's notices, Articulate sued Apple. Apple responded to the suit
by suing  Articulate  and Dragon  Systems,  Inc.,  which  suit was  subsequently
dismissed.  The  Company  acquired  Articulate's  claims  against  Apple  in the
Articulate  acquisition.  The  Company  has  completed  discovery  in the action
pending against Apple and is awaiting the scheduling of a trial.

In addition to the above,  the Company is 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.

14.  REPORTABLE SEGMENTS

The Company is  organized  into two  business  segments  based  primarily on the
nature of the  Company's  products and  customers.  Each  segment is  separately
managed  because  its  customers  require  different  technology  solutions  and
marketing strategies.

The  Company's  HealthCare  Solutions  Group ("HSG")  includes the  development,
manufacture,  sale  and  maintenance  of a  voice  recognition  product  to  the
healthcare industry marketed under the PowerScribe(R)  trademark.  The Company's
Interactive  Technologies  Solutions Group ("ITSG")  includes the development of
relationships  with third  parties  which can  incorporate  Fonix  products  and
technologies  into their own  products  or product  development  efforts.  These
products and  technologies  include ASR,  handwriting and  text-to-speech
applications.

The following  tables reflect  certain  financial  information  relating to each
business segment for each of the three months ended March 31, 1999 and 1998, and
as of March 31, 1999, and December 31, 1998:


                                       15

<PAGE>





<TABLE>
<CAPTION>
                                                                     Three Months               Three Months
                                                                    Ended March 31,            Ended March 31,
                                                                          1999                       1998
                                                                   -------------------       --------------------
Revenues:
<S>                                                                <C>                       <C>           
   HSG                                                                  $    1,056,526             $            -
   ITSG                                                                         53,806                  1,295,785
                                                                   -------------------       --------------------
                                                                        $    1,110,332             $    1,295,785
                                                                   ===================       ====================

Gross margin:
   HSG                                                                  $      836,378             $            -
   ITSG                                                                         48,515                  1,295,785
                                                                   -------------------       --------------------
                                                                         $     884,893             $    1,295,785
                                                                   ===================       ====================

Product development and research expenses:
   HSG                                                                   $     458,453             $            -
   ITSG                                                                      2,512,826                  2,701,203
                                                                   -------------------       --------------------
                                                                         $   2,971,279             $    2,701,203
                                                                   ===================       ====================

Selling, general and administrative expenses:
   HSG                                                                   $     930,491             $            -
   ITSG                                                                      2,745,070                  1,380,080
                                                                   -------------------       --------------------
                                                                         $   3,675,561             $    1,380,080
                                                                   ===================       ====================

Amortization of goodwill and purchased core technology:
   HSG                                                                   $     621,664             $            -
   ITSG                                                                        665,917                     98,783
                                                                   -------------------       --------------------
                                                                         $   1,287,581             $       98,783
                                                                   ===================       ====================

Purchased in-process research and development:
   HSG                                                                   $           -             $            -
   ITSG                                                                              -                  9,315,000
                                                                   -------------------       --------------------
                                                                         $           -             $    9,315,000
                                                                   ===================       ====================

Loss from operations:
   HSG                                                                  $    1,174,230             $            -
   ITSG                                                                      5,875,298                 12,199,281
                                                                   -------------------       --------------------
                                                                        $    7,049,528             $   12,199,281
                                                                   ===================       ====================
</TABLE>
<TABLE>
<CAPTION>

                                                                       As of March 31,         As of December 31,
                                                                            1999                      1998
                                                                   -------------------       --------------------  
<S>                                                                <C>                       <C>
Assets:
   HSG                                                                    $ 20,016,726              $  19,760,394
   ITSG                                                                     21,244,637                 42,229,533
                                                                   -------------------       --------------------
                                                                          $ 41,261,363               $ 61,989,927
                                                                   ===================       ====================
</TABLE>

15.  SUBSEQUENT EVENTS

Recent Financing Activities - On April 22, 1999, the Company entered into a loan
agreement with an  unaffiliated  entity  pursuant to which the Company  received
proceeds in the  aggregate  amount of  $1,000,000.  This note is payable in full
including  accrued  interest on  July 28, 1999  and bears  interest at the prime
rate, as published in  The Wall  Street Journal under the heading "Money Rates,"
plus 2.0 percent (9.75 percent at April 22, 1999).  The  loan is  secured by all
the assets of Fonix/Articulate, Inc., a wholly  owned  subsidiary, including its
intellectual property


                                       16
<PAGE>


rights  represented by patents,  copyrights and trademarks.  On May 14, 1999, an
additional $100,000 was advanced under the terms of this note.

Conversion  of Series D and Series E Preferred  Stock - Subsequent  to March 31,
1999, 18,500 shares of Series D Convertible Preferred Stock and 46,500 shares of
Series  E  Convertible  Preferred  Stock  and  related  dividends  on each  were
converted  into 862,015 and  2,159,652  shares of the  Company's  common  stock,
respectively. After the above conversions, 972,334 shares of Series D and 43,500
shares of Series E Convertible Preferred Stock remain outstanding.

Resignation  of  Stephen M . Studdert  as Chairman -  Effective  April 30, 1999,
Stephen  M. Studdert  resigned as  Chairman  of  the  Board of  Directors of the
Company and Thomas A. Murdock, the Chief  Executive  Officer of the Company, was
elected Chairman.  Mr. Studdert continues as a member of the Board of Directors.

Sale  of  an  Operating  Segment  - At  the  present  time  the  Company  is  in
negotiations  regarding the sale of one of its operating segments.  There can be
no assurance  that these  negotiations  will result in any agreement to sell the
related operating segment.

Advance of Funds from  Directors,  Officers and  Employees - Subsequent to March
31, 1999, two directors and an executive officer of the Company advanced $49,779
to pay for certain Company operating  expenses.  These advances have been repaid
by the Company.  Additionally,  subsequent  to March 31, 1999,  another group of
officers and employees of the Company have  advanced  $72,496 to pay for certain
Company  operating  expenses.  The  Company has  verbally  agreed to repay these
advances from the first available cash flow and to pay interest of 8.5 percent 
per year for the period the advances remain unpaid.

Sublease of Office  Facilities - Effective  May 14, 1999 the Company entered
into an agreement to sublease 10,224 square feet of its Draper, Utah facility to
an  unrelated  third party.  The agreement requires the sublessee to pay 40
percent of the Company's obligation under the primary lease agreement through
December 31, 2000.  The  sublessee has the option to extend the term by two
additional  three-month periods.

General Magic Licensing - On May 17, 1999, the Company completed a renegotiation
of its license agreement with General Magic, Inc., to use AcuVoice's
text-to-speech software.  Under the amended agreement, the Company agreed to
license the present version of the AcuVoice text-to-speech software source code
to General Magix, Inc., and reduce the future royalties from General Magic for
sales of its products and services incorporating the text-to-speech software. 
General Magic agreed to pay $250,000 in cash, which payment is to be received
over a five month period, and relinquished its exclusive rights to the software
through September 23, 2000.

                                       17
<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, 1998.

Overview

Fonix is a  development-stage  company  engaged in marketing and  development of
proprietary  automated speech recognition  ("ASR"),  text-to-speech  ("TTS") and
handwriting recognition technologies and products which may be licensed in whole
or in part to third parties.  The Company aims to make commercially  available a
comprehensive package of products and technologies that allow humans to interact
with computer and other electronic  products in a more efficient,  intuitive and
natural way rather than through traditional methods such as the keyboard.
Specifically,  Fonix has developed  proprietary automated speech recognition and
related technologies such as text-to-speech  (speech synthesis),  handwriting
recognition and speech compression.  These  technologies,  as developed to date,
use speech recognition techniques that include the use of a proprietary  neural
network method.  Neural networks  are  computer-based  methods  which  simulate
the way the human brain processes  information.  Fonix licenses its technologies
to and has entered into co-development   relationships  and  strategic alliances
with  third  parties including producers of application  software,  operating
systems,  computers and microprocessor chips.

Automated Speech Recognition

Presently available traditional voice recognition technologies have been used in
a variety of products for industrial, telecommunications,  business and personal
applications.  Speech recognition algorithms in software have been developed and
refined over the past several years.  However,  the increase in processing speed
and  memory  capacity  of  personal  computers  has  accounted  for  much of the
improvement in traditional speech recognition  systems during that period.  This
improvement includes vocabulary size, recognition accuracy and continuous speech
recognition ability. Currently available speech recognition systems for personal
computers include speech command systems for navigating the Windows(R) interface
and inexpensive, discrete word dictation systems offered by Dragon Systems, IBM,
Lernout  &  Hauspie  and  others.  Recently,  general  and  specific  vocabulary
continuous speech dictation  systems also have been introduced by Philips,  IBM,
Dragon Systems and others. In addition,  telephony applications with menu choice
systems and small vocabulary  dialogue systems have been demonstrated by Nuance,
Nortel and others.

Despite the nominal advances in performance of such presently available systems,
there are  significant  limitations  inherent in all of these  systems,  each of
which continues to use traditional  approaches  generally based on Hidden Markov
Models  ("HMM")  technology.  These  traditional  approaches  have not  advanced
appreciably since the late 1980s.  Applications based on such traditional speech
recognition systems for personal computers all require close-talking microphones
in relatively  low noise  environments  and a formal  speaking  style to achieve
acceptable  accuracy.  In so-called  continuous  dictation systems,  significant
adaptation to user speech,  speaking style,  and content area also are required.
These traditional  systems are generally  restricted to speech recognition for a
single  individual  dictating  in  a  quiet  environment;   presently  available
telephony-based systems are even more limited in general functionality.

The present industry standard  methodology,  the HMM, uses a general template or
pattern matching technique based on statistical  language models.  Massachusetts
Institute   of   Technology   researcher   Dr.   Victor   Zue  has  noted   that
speech-recognition systems based on such technology

           "utilize  little or no  specific-speech  knowledge,  but rely instead
           primarily on general-purpose  pattern-recognition  algorithms.  While
           such  techniques  are adequate  for a small class of  wellconstrained
           speech  recognition   problems,   their   extendibility  to  multiple
           speakers,  large  vocabularies,  and/or  continuous  speech is highly
           questionable. In fact, even for the applications

                                       18

<PAGE>



           that these devices are designed to serve, their performance typically
           falls far short of human performance."

HMM's widely recognized weaknesses are many:  (i) it does not meet the needs for
many mass market implementations,  (ii) it has limited input feature types,
(iii) it accounts for only limited  context,  (iv) it has limited  ability to
generalize  acoustic and language  structure,  (v) it  requires  training  data
from  the  end-user  for acceptable  performance,  (vi)  models become extremely
large and  complex as vocabulary  grows,  and (vii)  there is a lack of hardware
parallel  processing capability.

In contrast to HMM, Fonix  researchers  have developed what the Company believes
to be a  fundamentally  new approach to the analysis of human speech  sounds and
the  contextual   recognition  of  speech.   The  core  Fonix  automated  speech
recognition   technologies  (the  "ASRT"  or  "Core  Technologies")  attempt  to
approximate  the techniques  employed by the human auditory  system and language
understanding  centers in the human brain.  The ASRT use  information  in speech
sounds  perceptible to humans but not  discernible by current  automated  speech
recognition  systems.  They also  employ  neural  net  technologies  (artificial
intelligence  techniques) for identifying  speech  components and word sequences
contextually,  similar to the way in which  scientists  believe  information  is
processed by the human brain. As presently developed,  the ASRT are comprised of
several components including a phonetic sound representation recognition engine,
audio signal  processing,  a feature  extraction  process,  a phoneme estimation
process, and a linguistic process consisting of two components,  one of which is
expert-  or  rule-based  and one of which is based  on  proprietary  neural  net
technologies, that are designed to interpret human speech contextually.

Fonix believes the reliable recognition of natural, spontaneous speech spoken by
one or more  individuals  in a  variety  of  common  environments  by means of a
conveniently  placed  microphone,  all  based on its  ASRT,  will  significantly
improve the performance, utility and convenience of applications currently based
on traditional HMM technology such as computer interface navigation, data input,
text  generation,   telephony  transactions,   continuous  dictation  and  other
applications.  Additionally,  the  Company  believes  that  its ASRT  will  make
possible major new speech recognition  applications such as the transcription of
business  meetings  and  conversations,   real-time   speech-to-speech  language
translation,  natural  dialogues  with  computers  for  information  access  and
consumer electronic devices controlled by natural language.

Thus,  the  Company  believes  that its ASRT  offers  unique  speech  processing
techniques that will complement and significantly  enhance  currently  available
speech  recognition  systems.  Through its  Interactive  Technologies  Solutions
Group,  Fonix intends to continue to license its ASRT, to continue to co-develop
the ASRT with  research  and  development  groups in industry  and  academia and
ultimately to market a suite of Fonix-branded  technologies and products. In the
long term, the Company  anticipates  that automated speech  recognition  systems
employing  the  Company's  unique ASRT will set the  industry  standard  for all
automated speech recognition  applications because of its anticipated capacities
to overcome the weaknesses of HMM. In addition, the Company expects that certain
elements of its Core  Technologies  will have  industry-leading  applications in
non-speech  recognition  industries,  market  segments and  disciplines  such as
artificial  intelligence  and data  compression.  Although these plans represent
management's beliefs and expectations based on its current  understanding of the
market and its experience in the industry, there can be no assurance that actual
results will meet these expectations. See "Certain Significant Risk Factors." In
the last two fiscal years,  the Company has expended  $13,620,748 and $7,066,294
on research and development  activities.  Since its inception (October 1, 1993),
the Company has spent  $34,529,320 on research and  development of the ASRT. The
Company expects that a substantial  part of its capital  resources will continue
to be devoted to  research  and  development  of the ASRT and other  proprietary
technologies for the foreseeable future.

HealthCare Solutions Group Products

The three PowerScribe  products now being sold by the HealthCare Solutions Group
are  PowerScribeRAD,  PowerScribeRAD  Software  Development  Kit ("SDK")TM,  and
PowerScribeEM.  PowerScribe  products  use  state-of-the-art  continuous  speech
recognition engines licensed from Dragon Systems,  Inc., which enables a user to
dictate  naturally  and  continuously  without  having to pause  between  words.
PowerScribe   incorporates  customized  medical  language  models  gleaned  from
millions of words  sampled  from  medical  specialty  departments  across  North
America.


                                       19

<PAGE>



PowerScribe  products have been  designed as  mission-critical  applications  to
operate as an open and scalable continuous speech reporting and charting system.
PowerScribe  products utilize core  technologies from Microsoft's Back Office(R)
applications  development  suite  and  rely  on  Windows  NT(R),  Open  Database
Connectivity (ODBC) and SQL Server(R) as the foundation operational elements.

           PowerScribeRAD for Radiology Reporting

PowerScribeRAD  enables the full automation of the radiology  reporting  process
and   replaces   existing   digital   dictation   and   transcription   systems.
PowerScribeRAD  permits the dictation of radiology  reports  directly into text,
with edit, approve, and sign functions  accomplished within a matter of minutes;
thereby significantly  reducing  transcription costs and report turnaround time.
Once reports are  dictated,  they may be  automatically  stored in the Radiology
Information  System  ("RIS"),   the  Hospital   Information  System  ("HIS")  or
PowerScribeRAD's own report repository.

           PowerScribeEM for Emergency Medicine Reporting

PowerScribeEM  is a  completely  integrated  emergency  medicine  dictation  and
transcription system which allows emergency department  professionals to dictate
their reports  directly into text in the first total  solution for capturing and
documenting  emergency  medicine clinical  encounters.  PowerScribeEM  minimizes
training and the need for healthcare  professionals to modify their work styles.
PowerScribe includes post-processing of the text for organization into a typical
structured  emergency  medicine  report.  PowerScribeEM  seamlessly  handles the
overall workflow of an emergency department.  Once reports are dictated, reports
are  either  automatically  stored  in the HIS or in  PowerScribe's  own  report
repository for further analysis at a later date.

           PowerScribe Radiology SDK for User Development Applications

The PowerScribe  Radiology SDK allows users to integrate the full  functionality
of the  PowerScribeRAD  system into the user's own radiology  applications.  For
radiology  environments such as a RIS or Picture Archival  Communication  System
("PACS") the  PowerScribe  SDK allows  users to develop a completely  integrated
dictation and  transcription  system utilizing  continuous  speech  recognition.
Using this SDK, the PowerScribeRAD client functionality can be embedded into the
user's application while also customizing the user interface and report workflow
to meet specific  application  needs. The  PowerScribeRAD  SDK supports multiple
development  environments  including  Microsoft(R)  Visual  Basic,  C++  and the
Microsoft(R)  Internet  Explorer  environment.  The  SDK  includes  an  Active-X
composite control along with sample code and developer documentation.

           Interactive Solutions Group Products

The Interactive  Technologies  Solutions Group offers products and  technologies
which include  automated  speech  recognition,  text-to-speech,  and handwriting
recognition  for a variety of hardware and  software  platforms.  The  marketing
direction  for  the  Interactive   Technologies   Solutions  Group  is  to  form
relationships  with third parties who can incorporate  Fonix  technologies  into
their own products or product  development  efforts.  Such  relationships may be
structured  in  any  of a  variety  of  ways  including  traditional  technology
licenses,  co-development relationships through joint ventures or otherwise, and
strategic  alliances.  The third  parties  with whom  Fonix  presently  has such
relationships  and with which it may have  similar  relationships  in the future
include participants in the application software,  operating systems,  computer,
microprocessor  chips, consumer  electronics,  automobile,  telephony and health
care technology market sectors.  Interactive Technologies Group products include
AcuVoice  AV 1700,  AV 2001  text-to-speech  systems,  and  Allegro  handwriting
recognition.

           Embedded Technologies

Fonix  has  developed  an  application  development  tool,  the  Fonix  Advanced
Application  Speech  Toolkit  (FAAST(TM))  which allows  developers to simulate,
prototype and create code for embedded  applications using Fonix' human computer
interaction   technologies.   This  system   currently   supports  Fonix  speech
recognition   for   command  and  control   applications   and  Fonix   AcuVoice
text-to-speech  engines for both very high quality  limited  vocabulary and high
quality unlimited vocabulary  applications.  The system is designed to support a
number  of  popular   microprocessors   and   operating   systems  for  embedded
applications. Currently, FAAST supports the Siemens

                                       20

<PAGE>



TriCore micro-controller. The beta version of the FAAST system will be available
for  developers in June 1999. An alpha version of the system is currently  being
used  internally  at  Fonix to  support  the  development  of  embedded  systems
applications for several companies  including consumer  electronic,  automotive,
and cell phone devices.

           Core Speech Recognition Technologies

Since 1994 Fonix has pursued the  development  of a "3rd  Generation"  automated
speech recognition technology to overcome the limitations of currently available
commercial  speech   recognition   systems.   This  development  has  yielded  a
proprietary  ASR system  utilizing a unique  front-end  analysis of the acoustic
speech signal,  a neural net based phoneme  identifier,  and a completely  novel
neural net architecture for back-end language modeling.  The latter component is
the MULTCONS or multi-level constraint  satisfaction network. These developments
have been the  subject of two issued  patents.  In  addition,  the  Company  has
acquired a related patent covering portions of this technology. Portions of this
technology are currently being employed in Fonix embedded systems applications.

           Text-to-Speech (Speech Synthesis)

In 1986  AcuVoice  began to develop  and market a new  approach  to  synthesized
speech,  a system using actual  recordings of "units" of human speech (i.e., the
sound  pulsation).  Since the unit of speech  consists  of more than one phoneme
(sound),  AcuVoice's  approach  has been called a "large  segment  concatenative
speech  synthesis"  approach.  Other companies such as DEC and AT&T began in the
early 1960s and continue  until the present to use a system  called  "parametric
speech  synthesis."  Parametric  systems  are  plagued  with  problems of speech
quality, because their unit is not an actual recording, but a computer's version
of what a human voice sounds like.  Poor speech  quality also occurs because the
parametric unit consists,  for the most part, of a single  phoneme,  such as the
"t" in the word "time."

Although as early as 1994 AcuVoice released versatile  prototypes of its system,
it was not until early 1996 that the AcuVoice  Speech  Synthesizer was ready for
sale  into  the  telecommunications,   multi-media,  educational  and  assistive
technology markets.  AcuVoice won awards as "best text-to-speech" product at the
Computer  Technology  Expo '97 and '98 and the best of show  award at AVIOS '97.
Presently AcuVoice products are sold to end-users, systems integrators and OEMs.

Fonix  text-to-speech  products  include  those  developed by AcuVoice and those
developed  by Fonix.  All are sold under the AcuVoice  brand name.  The products
include the AcuVoice AV 1700 TTS system for end-user  desktop and laptop  system
use. The AcuVoice AV 2001 SDK is a software  development  kit for  developers of
telephony  applications.  Run-time software licenses for the AV 2001 are offered
for applications developed with the SDK.
The SDK supports major computer telephony platforms.

           Handwriting Recognition

Prior to the  Papyrus  Acquisition  in October  1998,  PAI  developed  and began
selling  handwriting  recognition  software  including  the Allegro  handwriting
recognition software.  The Allegro handwriting  recognition software is a single
letter  recognition  system like the popular  Graffiti  handwriting  recognition
software for the PalmPilot PDA.  However,  Allegro's  alphabet is all natural in
appearance  as lower  case  letters.  Because  the  letters  are  written in the
standard  way in almost all  instances,  the  Allegro  system is easy to use and
requires practically no learning.  Allegro is sold by Purple Software in England
for the Psion Series 5 hand-held  PC. This  software  has also been  licensed to
Philips for its popular smart cell phone. Allegro is also the subject of a sales
agreement  with Lucent  Technologies  for use in its Inferno  operating  system.
Papyrus  has also  developed  cursive  handwriting  recognition  software  which
recognizes  naturally-written  whole  words.  This  cursive  technology  is only
available  as a licensed  product to OEM  customers.  Both the  Allegro  and the
cursive  handwriting  recognition  software are user  independent and require no
training on the software.

In March 1998,  the Company  expanded  its suite of  human-computer  interaction
technologies  by acquiring the  award-winning  voice  synthesis  technologies of
AcuVoice, Inc.  ("AcuVoice").  The business operations  previously  conducted by
AcuVoice are now part of the Company's Interactive Technologies Solutions Group.
During the three  months  ended  March 31,  1999,  the  Company  received in the
aggregate,   $53,806  in  revenue  from   licensing  or  sale  of  the  AcuVoice
technologies  and  products  compared  to  pro-forma  revenue of $46,735 for the
comparable three

                                       21

<PAGE>



month period of 1998.

In September 1998, the Company acquired Articulate Systems, Inc. ("Articulate"),
a developer of leading voice  recognition  and systems  software for specialized
applications  in the health care industry.  The business  operations  previously
conducted by Articulate are now conducted by the Company's  HealthCare Solutions
Group based in Woburn,  Massachusetts.  During the three  months ended March 31,
1999, the Company received in the aggregate, $1,056,526 in revenue from sales of
the PowerScribe  Radiology  product  marketed by the HealthCare  Solutions Group
compared to pro-forma  revenue of $142,782 for the comparable three month period
of 1998.

In October 1998, the Company  acquired the Papyrus  Companies.  Papyrus develops
and markets printing and cursive handwriting  recognition software for PDAs, pen
tablets and mobile phones.  The Company operates the business  formerly operated
by  Papyrus as part of its  Interactive  Technologies  Solutions  Group from its
facilities  in Woburn,  Massachusetts.  During the three  months ended March 31,
1999,  the Company  received no revenue  from  licensing  or sale of the Papyrus
technologies  compared to pro-forma revenue of $140,462 for the comparable three
month period of 1998.

The Company markets its previously developed ASR technologies, together with TTS
technologies  and products  acquired from AcuVoice and  handwriting  recognition
technologies  and  products   acquired  from  Papyrus  through  its  Interactive
Technologies   Solutions  Group.  The  present   marketing   direction  for  the
Interactive  Technologies  Solutions Group is to form  relationships  with third
parties  which  can  incorporate  the  Company's   technologies  and  the  other
technologies  available to the  Interactive  Technologies  Solutions  Group into
their own products or product  development  efforts.  Such  relationships may be
structured  in  any  of a  variety  of  ways  including  traditional  technology
licenses,  co-development relationships through joint ventures or otherwise, and
strategic alliances.  The third parties with whom the Company presently has such
relationships  and with which it may have  similar  relationships  in the future
include participants in the application software,  operating systems,  computer,
microprocessor  chips, consumer  electronics,  automobile,  telephony and health
care technology industries.

The Company  markets  voice  recognition  and systems  software for  specialized
applications in the health care industry through its HealthCare Solutions Group.
The  HealthCare   Solutions  Group  presently  markets  large  vocabulary  voice
recognition  software for the rapid  capture,  transcription  and  management of
clinical  information dictated by radiologists and emergency medical physicians.
The  products  now  being  sold by the  HealthCare  Solutions  Group,  including
PowerScribe  Radiology and PowerScribeEM, are marketedto major hospitals and
medical centers nationwide.

In addition to the transactions  involving  AcuVoice,  Articulate and Papyrus in
1998,  the Company was also in  negotiations  to acquire  several  other  speech
technology-related  companies.  The  Company  terminated  all  such  acquisition
discussions in late 1998.

Resignation of Chairman of the Board

Effective April 30, 1999, Stephen M.  Studdert resigned as Chairman of the Board
of Directors of the  Company and  Thomas A. Murdock, the Chief Executive Officer
of the Company, was elected Chairman.  Mr. Studdert continues as a member of the
Board of Directors.

Year 2000 Issue

Many computer  systems and software  products are coded to accept only two digit
entries in the date code field.  These date code fields will need to accept four
digit entries to distinguish  21st century dates from 20th century  dates.  As a
result,  many companies'  software and computer systems will need to be upgraded
or  replaced  in order to comply  with such  Year  2000  requirements.  Fonix is
subject to the risk that problems  encountered with Year 2000 issues,  either in
its internal  systems,  technologies and products,  or in external systems could
adversely affect its operations and financial condition.

In the ordinary course of its business, Fonix tests and evaluates its
technologies and software and hardware

                                       22
<PAGE>



products.  Fonix believes that its technologies and products  generally are Year
2000 compliant,  meaning that the use or occurrence of dates on or after January
1, 2000 will not  materially  affect the  performance  of such  technologies  or
products with respect to four digit date  dependent  data or the ability of such
products to correctly create,  store, process, and output information related to
such data. However, Fonix may learn that certain of its technologies or products
do not contain all  necessary  software  routines  and codes  necessary  for the
accurate  calculation,  display,  storage,  and  manipulation  of data involving
dates.  In addition,  Fonix has  warranted or expects to warrant that the use or
occurrence of dates on or after  January 1, 2000 will not  adversely  affect the
performance  of its  technologies  or products  with  respect to four digit date
dependent data or the ability to create,  store, process, and output information
related  to such  data.  If the end  users  of any of  Fonix's  technologies  or
products  experience  Year 2000 problems,  those persons could assert claims for
damages.

Fonix  uses  third-party  equipment  and  software  that  may not be  Year  2000
compliant.  Fonix is presently  conducting a review of key products  provided by
outside vendors to determine if their products are Year 2000 compliant. Although
that process is not yet completed,  Fonix  presently  believes that all software
provided  by  third  parties  that is  critical  to its  business  is Year  2000
compliant. Fonix expects to complete its review of all internal systems for Year
2000 compliance by June 30, 1999. If this third-party equipment or software does
not  operate  properly  with  regard  to the Year  2000  issue,  Fonix may incur
unexpected expenses to remedy any problems.  Such costs may materially adversely
affect  Fonix's  business,   operating  results,  and  financial  condition.  In
addition,  if Fonix's key systems, or a significant number of its systems,  fail
as a result  of Year 2000  problems  Fonix  could  incur  substantial  costs and
disruption of its business.  Fonix may also  experience  delays in  implementing
Year 2000  compliant  software  products.  Any of these  problems may materially
adversely affect Fonix's business, operating results or financial condition.

In addition, the purchasing patterns of Fonix's licensees,  potential licensees,
customers  and  potential  customers  may be affected by Year 2000 issues.  Many
companies are expending  significant resources to correct their current software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to license Fonix  technologies  or to purchase  other Fonix  products.
This may adversely affect Fonix's  business,  operating  results,  and financial
condition.

Results of Operations

Three  months  ended March 31, 1999  compared  with three months ended March 31,
1998

During the three months ended March 31, 1999, the Company  recorded  revenues of
$1,110,332, a decrease of $185,453 over the same period in the previous year. In
the  1998  comparable   period  the  Company  received  its  first  revenues  of
$1,295,785, of which, $1,291,712 was paid by Siemens as a non-refundable license
fee. The 1999  revenues are primarily  from sales and licensing  fees related to
the PowerScribe dictation product and TTS technologies and products.

The Company  incurred  product  development and research  expenses of $2,971,279
during the three months ended March 31, 1999,  an increase of $270,076  over the
same  period in the  previous  year.  This  increase  was due  primarily  to the
addition of product  development and research personnel,  equipment,  facilities
and the operations of the  Interactive  Technologies  and  HealthCare  Solutions
Groups.  The Company  anticipates  similar or increased product  development and
research  costs as it  continues  to develop  and market  the  applications  and
products  offered  by its  HealthCare  Solutions  and  Interactive  Technologies
Solutions Groups.

Selling,  general and  administrative  expenses were $3,675,561 and $1,380,080 ,
respectively,  for the three  months  ended March 31,  1999 and 1998.  Salaries,
wages and related costs were  $2,093,626 and $716,550 for the three months ended
March 31 1999 and 1998, respectively,  an increase of $1,377,076.  This increase
is attributable to increases in personnel costs resulting from the  acquisitions
of AcuVoice,  Articulate and Papyrus.  Legal and accounting  expenses  increased
$238,692,  marketing  expenses  increased  $336,668 and  consulting  and outside
services increased by $94,094.

Amortization  of goodwill and purchased core  technologies  were  $1,287,581 and
$98,783 ,  respectively,  for the three  months  ended  March 31,  1999 and 1998
representing an increase of $1,188,798.  This increase is primarily attributable
to the  amortization  of  intangible  assets  acquired  in  connection  with the
acquisitions of AcuVoice,

                                       23
<PAGE>



Articulate and Papyrus.

The Company incurred losses from operations of $7,049,528 and $12,199,281 during
the three  months ended March 31, 1999 and 1998,  respectively.  The decrease in
losses from operations is due primarily to the $9,315,000  charge for in-process
research  and  development  costs  during the three months ended March 31, 1998,
offset  in  part  by  increases  in  general  and  administrative  expenses  and
amortization  expense.  The Company  anticipates  that its investment in ongoing
scientific  product  development  and  research  will  continue  at  present  or
increased   levels  for  at  least  the  remainder  of  fiscal  1999,   assuming
availability of working capital.

Net other expense was  $2,245,333  for the three months ended March 31, 1999, an
increase of $2,204,886 over the three months ended March 31, 1998. This increase
was due primarily to increased  interest  expense of $1,955,455 due to financing
costs associated with the issuance of the Series C 5% Convertible Debentures.

Liquidity and Capital Resources

The  Company  must  raise  additional  funds  to be able  to  satisfy  its  cash
requirements  during  the  next  twelve  months.  The  scientific  research  and
development,  corporate  operations  and  marketing  expenses  will  continue to
require additional  capital.  In addition,  the Company's recent acquisitions of
AcuVoice,  Articulate,  and Papyrus place further  requirements on the Company's
limited cash resources.  Because the Company  presently has only limited revenue
from operations,  the Company intends to continue to rely primarily on financing
through  the sale of its  equity  and  debt  securities  or  sales  of  existing
technologies  or businesses 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 revenue.  There can be no
assurance  that  the  Company  will be  able  to  enter  into  such  agreements.
Furthermore,  the issuance of equity securities or other securities which are or
may become  convertible into equity securities of the Company in connection with
such financing (or in connection with acquisitions)  would result in dilution to
the stockholders of the Company which could be substantial.

The  Company  had  negative  working  capital of  $13,903,731  at March 31, 1999
compared to negative  working  capital of  $14,678,975 at December 31, 1998. The
current ratio was 0.10 at March 31, 1999, compared to 0.59 at December 31, 1998.
Current assets  decreased by $19,221,364 to $1,493,842 from December 31, 1998 to
March 31, 1999.  Current  liabilities  decreased by  $19,996,608  to $15,397,573
during the same period.  The increase in working  capital from December 31, 1998
to March 31, 1999,  was primarily  attributable  to the payment of notes payable
and other accrued  liabilities  from the proceeds of the Series C 5% Convertible
Debentures.   Total  assets  were  $41,261,363  at  March  31,1999  compared  to
$61,989,927 at December 31, 1998.

During the three months ended March 31, 1999, the Company  granted 753,000 stock
options to various  employees  and 9,500  stock  options to two  consultants  at
exercise  prices ranging from $1.28 to $1.78 per share.  The term of all options
granted  during this three month  period is ten years from date of grant.  As of
March 31, 1999, the Company had a total of 16,419,282 options outstanding.

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.  On January
29, 1999,  the Company  entered into a Securities  Purchase  Agreement with four
investors  pursuant  to  which  the  Company  sold its  Series C 5%  Convertible
Debentures (the  "Debentures") in the aggregate  principal amount of $4,000,000.
The outstanding principal amount of the Debentures is convertible at any time at
the  option  of the  holder  into  shares  of the  Company's  common  stock at a
conversion  price  equal to the  lesser  of $1.25 or 80% of the  average  of the
closing  bid  price of the  Company's  common  stock for the five  trading  days
immediately  preceding  the  conversion  date.  The Company also issued  400,000
warrants in connection with this financing.  The warrants entitle the holders to
purchase up to 400,000  shares of the Company  common stock at an exercise price
of $1.25 per  share.  On March 3, 1999,  the  Company  executed  a  Supplemental
Agreement pursuant to which the Company agreed to sell an additional  $2,500,000
principal  amount of the  Debentures  on the same  terms and  conditions  as the
January 29, 1999  agreement,  except no additional  warrants were issued.  Gross
proceeds to the Company from these two transactions were $6,500,000.

The obligations of the Company for repayment of the  Debentures,  as well as its
obligation to register the common stock  underlying the potential  conversion of
the Debentures and the exercise of the warrants issued in these

                                       24
<PAGE>



transactions,  were personally guaranteed by Thomas A. Murdock,  Roger D. Dudley
(each of whom are  executive  officers and directors of the Company) and Stephen
M. Studdert (director of the Company) (collectively, "Guarantors"). The personal
guarantees of these  Guarantors were secured by a pledge of 6,000,000  shares of
Fonix common stock  beneficially owned by them and held in the name of Thomas A.
Murdock,  Trustee.  In connection with the Supplemental  Agreement,  the Company
agreed to pledge as collateral  for repayment of the  Debentures,  a lien on the
patent covering  certain ASR  technologies.  At the present time the Company has
not  executed a security  agreement  in favor of the  investors  describing  the
patent.  In  connection  with the  guaranty and the pledge of Fonix common stock
given by  Guarantors,  the Company agreed to indemnify and hold them harmless in
the event of a default that results in any payment or other  liability or damage
incurred  by any of them.  In  consideration  for the  guaranty  and  pledge  by
Guarantors,  the Company also agreed to grant each of them common stock purchase
warrants  to  purchase  666,666  shares of common  stock at a price of $1.59 per
share.  However, the Guarantors have declined the grant of these warrants. On or
about April 6, 1999,  the  holders of the  Debentures  notified  the Company and
Guarantors that  Guarantors  were in default under the terms of the pledge,  and
that the holders  intended to exercise  their  rights to sell some or all of the
pledged  shares.  At the present time,  the Company has no knowledge of sales of
Guarantors'  shares by the holders of the  debentures.  However,  if the holders
proceed to sell some or all of Guarantors'  shares, the Company may be obligated
under its  indemnity  agreement  in favor of  Guarantors  to issue shares to the
Guarantors  in  replacement  of all shares sold by the holders and to  reimburse
Guarantors  for any income tax  liability  incurred as a result of the  holders'
sales of Guarantors' shares.

During  the  three  months  ended  March  31,  1999,  17,500  shares of Series D
Convertible  Preferred Stock and 45,072 shares of Series E Convertible Preferred
Stock and related  dividends  were  converted  into 426,464 shares and 1,086,531
shares, respectively, of the Company's common stock.

At December 31, 1998,  the Company had a revolving note payable to a bank in the
amount of $19,988,193.  This note was due January 8, 1999, bore an interest rate
of 6.00 percent,  and was secured by a  certificate  of deposit in the amount of
$20,000,000.  The Company paid this  revolving note in full,  including  accrued
interest,  on January 8, 1999 with proceeds from the certificate of deposit that
secured the note and $22,667 in cash.

At March 31, 1999, the Company had an unsecured revolving note payable to a bank
in the amount of $50,000.  Amounts  loaned under the revolving  note payable are
limited to $50,000.  The weighted average  outstanding  balance during the three
months ended March 31, 1999 was $50,000.  The weighted average interest rate was
9.75 percent during this period.  This note is payable on demand,  matures April
1, 2007, bears interest at a bank's prime rate plus 2.0 percent (9.75 percent at
March 31, 1999) and requires interest to be paid monthly.

At March 31,  1999,  the Company had a note payable to a lender in the amount of
$560,000 which bears interest at 18 percent per annum, which interest is payable
monthly.  The note payable was  originally due January 2, 1999 and is secured by
certain  accounts  receivable of the Company's  HealthCare  Solutions Group. The
Company  has  extended  the due date  through  May 28, 1999 by paying the lender
accrued  interest  plus a fee of $5,600.  The Company  anticipates  that it will
request additional extensions of the due date. The note is personally guaranteed
by two officers and a member of the Board of Directors of the Company.

At March 31, 1999, the Company had unsecured demand notes payable outstanding to
former Articulate  stockholders in the aggregate amount of $4,658,980 related to
the  acquisition  of Articulate in 1998.  These notes were payable on demand any
time after  November 30, 1998. In December  1998,  the holder of a $407,971 note
demanded payment.  In connection with this demand, the Company paid the holder a
partial  payment of $50,000 in 1998 and the holder  agreed to extend the date on
which demand  could be made to March 15, 1999 and increase the interest  rate to
11 percent  per year.  No  additional  demand has been given for payment of this
note. In 1998, the Company also  negotiated  extensions of $986,481 of the notes
to May 30, 1999 and adjusted the  interest  rate to 10 percent per year.  During
the three months  ended March 31, 1999 and  subsequent  to March 31,  1999,  the
Company made partial payments of $50,000 and $175,000 respectively, on a 
$2,535,235 note and agreed to pay the balance in connection with a sale of one
of its operating segments.

At March 31, 1999, the Company had unsecured demand notes payable outstanding to
former  Articulate  employees in the aggregate amount of $452,900 and an accrued
liability  of  $404,100  to the same  employees.  Both  amounts  are  related to
incentive  compensation  granted the employees for continued employment with the
Company  after the  acquisition  of  Articulate  in 1998.  The demand notes bear
interest at an annual rate of 8.5 percent and were payable

                                       25
<PAGE>



upon  demand  after  November  1, 1998.  None of the  holders of these notes has
demanded  payment.  The Company  has agreed to pay  interest on these notes at 9
percent per year after November 1, 1998. No demand for payment has been made for
the $404,100 by the former Articulate employees.

At March 31, 1999,  the Company had  unsecured  demand  notes  payable to former
Papyrus  stockholders  in the aggregate  amount of $1,710,000,  which notes were
issued in connection  with the  acquisition  of Papyrus in 1998.  The notes were
payable in various  installments  from  February 28, 1999 through  September 30,
1999.  In April  1999,  the Company  entered  into  agreements  with five former
Papyrus shareholders to reduce the aggregate amounts payable to them under these
notes from  $1,632,375 to  $1,188,909,  which amounts will be paid in connection
with a sale of one of the Company's operating segments.  The aggregate remaining
balance of $77,625 of the notes payable to former  shareholders  of Papyrus will
also be paid at the closing of the contemplated sale of the operating segment.

At March 31, 1999,  the Company had an unsecured  revolving  note payable in the
amount of $184,839 in principal and $5,929 in accrued interest to SMD, a company
owned by two  individuals  who are  executive  officers  and  directors  and one
individual who is a director of the Company and who each  beneficially  own more
than 10 percent of the Company's  common  stock.  The weighted  average  balance
outstanding  during the three  months  ended  March 31, 1999 was  $53,398.  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 during the
period  ended  March  31,  1999 was  $184,839.  In 1999,  advances  to the three
individuals  in the amount of $59,986 were applied as a partial  payment of this
note.

In December 1998, two individuals  who are executive  officers and directors and
one  individual  who is a  director  of the  Company  ("Guarantors")  guaranteed
certain obligations of the Company. As security for some of the guarantees,  the
Guarantors also pledged shares of Fonix common stock beneficially owned by them.
In March 1999,  143,230 of the shares previously  pledged by the Guarantors to a
bank were sold by the bank and the proceeds were used to pay Company credit card
balances  and the related  accrued  interest in full  totaling  $244,824.  These
amounts  are  now  included  in the  unsecured  revolving  note  payable  to SMD
described above.

At March 31, 1999,  the Company had an unsecured,  non-interest  bearing  demand
note payable in the amount of $100,000 to Synergetics,  Inc. ("Synergetics"),  a
research and development entity. This note is payable on demand.

At March 31, 1999,  the Company had an  unsecured  note payable to an officer of
the Company in the amount of $20,000,  which bears interest at an annual rate of
10 percent  and was due  December  31,  1998.  The holder of this note agreed to
extend the due date to June 30, 1999.

At March 31, 1999,  the Company had an  unsecured  note payable to an officer of
the Company in the amount of $43,691  which bears  interest at an annual rate of
10 percent and is due on or before July 31, 1999.  Subsequent to March 31, 1999,
this same officer  advanced an  additional  $25,000 to the Company under similar
terms.

On  April  22,  1999,  the  Company  entered  into  a  loan  agreement  with  an
unaffiliated  entity  pursuant  to which the  Company  received  proceeds in the
aggregate principal amount of $1,000,000. This note is payable in full including
accrued  interest  on July 28,  1999 and bears  interest  at the  prime  rate as
published in The Wall Street  Journal  under the heading  "Money Rates" plus 2.0
percent (9.75 percent at April 22, 1999).  The loan is secured by all the assets
of Fonix/ASI  Corporation,  a wholly owned subsidiary of the Company,  including
its  intellectual  property  rights  represented  by  patents,   copyrights  and
trademarks. On May 14, 1999, an additional $100,000 was advanced under the terms
of this note. . The Company  anticipates  that it will need to raise  additional
funds to satisfy  its cash  requirements  during the next  twelve  months.  Even
taking  into  account  expected  revenues  from  the  HealthCare  Solutions  and
Interactive  Technologies  Solutions  Groups,  the Company's  ongoing  operating
expenses will remain  higher than revenues from  operations at least through the
first  three  quarters  of  1999.  Accordingly,  the  Company  expects  to incur
significant  losses  until  such  time as it is able to enter  into  substantial
licensing and co-development  agreements and receive  substantial  revenues from
such arrangements or from the operations of its recently acquired  subsidiaries,
of  which  there  can be no  assurance.  Scientific  research  and  development,
corporate  operations and marketing expenses will continue to require additional
capital.  The  Company  therefore  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

                                       26
<PAGE>



is able  to  enter  into  additional  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  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 research and development
or office facilities.

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 ASR, TTS, handwriting  recognition and
other  arenas  related  to  these  technologies.  The  Board  of  Directors  and
management  have  developed a business  strategy that  identifies  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.

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 HMM, 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  as well as  technologies  and  inventions  derived  from the
knowhow,  technologies  and products  obtained with the acquisition of AcuVoice,
Articulate and Papyrus. Management believes this strategy will set the Company's
advanced human computer interaction 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.   Advanced   human-computer   interface
technologies and multi-modal systems include:

           o         speech recognition and synthesis
           o         speaker identification and verification
           o         handwriting recognition
           o         pen and touch screen input
           o         natural language understanding

Anticipated  products  incorporating  such advanced  multi-modal  human computer
interface technology include the following:

           o         PCs and PDAs
           o         cellular phones
           o         automotive and home environment speech controls
           o         automated information and transaction kiosks
           o         telephone systems with natural dialogue and gesture
                     controls
           o         medical transcription and reporting systems, including
                     PowerScribeRAD and PowerScribeEM
           o         smart consumer appliances and electronics
           o         speech and pen-based computers utilizing handwriting and
                     cursive recognition
           o         interactive education and entertainment systems
           o         redesigned appliances
           o         toys and games


                                       27
<PAGE>



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

           o         semiconductors
           o         health care
           o         telecommunications
           o         computers
           o         software
           o         consumer electronics
           o         entertainment
           o         automotive

Fonix is a technology company.  Since its inception,  the Company has focused on
the development of its Core Technologies and related complementary technologies,
including those  technologies  obtained in connection  with the  acquisitions of
AcuVoice,  Articulate  and Papyrus.  The Company will pursue the  development 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 agreements with Oregon Graduate Institute and Brigham Young
University.

As the Company  proceeds to implement its strategy and to reach its  objectives,
it anticipates  that it will continue to realize several benefits for itself and
for its shareholders.  In addition,  the Company expects 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  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, 1998.

                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, 1998.


                     PART II - OTHER INFORMATION


Item 1.  Legal Proceedings

Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's spouse  purportedly owns,  commenced an action against Fonix in federal
court  for the  Southern  District  of New York.  Clarke  and  Perpetual  Growth
asserted  claims for breach of  contract  relating  to certain  financing  Fonix
received during 1998. Specifically, Clarke and Perpetual Growth allege that they
entered  into a  contract  with Fonix  under  which  Fonix  agreed to pay them a
commission  of five  percent of all  financing  provided to Fonix by  Southridge
Capital  Management or its affiliates.  Clarke and Perpetual claim that they are
entitled to  commissions  with  respect to  approximately  $3,000,000  of equity
financing  to Fonix in July and August 1998,  and Fonix's  offerings of Series D
and Series E  preferred  stock,  totaling  together  $12,000,000,  in August and
September 1998.

Fonix  believes  that the Clarke  lawsuit is without merit and filed a motion to
dismiss based upon the court's lack of


                                       28
<PAGE>



personal  jurisdiction  over Fonix. The court granted Fonix's motion to dismiss.
Clarke and Perpetual Growth have appealed the dismissal.  Fonix has filed a suit
against Clarke and Perpetual Growth in federal court for the Central District of
Utah seeking a declaratory judgment that it does not owe any money to Clarke and
Perpetual  Growth.  Now that the  action in New York has been  dismissed,  Fonix
intends to vigorously pursue the Utah action.  However, the lawsuit  in New York
could be reinstated  on appeal and Clarke and Perpetual  Growth could prevail in
that lawsuit,  in which case Fonix may be required to pay significant amounts of
money damages awarded by the court.

Papyrus - After the  Papyrus  acquisition  closed in October  1998,  the Company
investigated  some of the  representations  and  warranties  made by  Papyrus to
induce the Company to acquire  Papyrus.  The Company  determined that certain of
the  representations  made by Papyrus and their executive  officers appear to be
false.  At about the same time, the Company began  negotiations  with the former
executive officers of Papyrus. On February 26, 1999, the Company filed an action
against  Papyrus in the United States  District  Court for the District of Utah,
Central  Division,  wherein the Company  alleged  claims for  misrepresentation,
negligent misrepresentation,  breach of contract, breach of the implied covenant
of good faith and fair dealing and rescission.  On March 11, 1999,  three of the
former shareholders of Papyrus filed an action against the Company in the United
States  District  Court for the  District of  Massachusetts,  alleging a default
under the terms of the  promissory  notes issued to them in connection  with the
Papyrus  Acquisition.  On April 2, 1999, the three former  Papyrus  shareholders
filed an amended  complaint  against the  Company  seeking  additional  remedies
including  violation of  Massachusetts  unfair and deceptive  acts and practices
statutes and copyright  infringement.  On April 8, 1999, a fourth former Papyrus
shareholder  filed an action  against the Company  alleging a default  under the
terms of the  promissory  notes  issued to him in  connection  with the  Papyrus
acquisition and seeking additional remedies including violation of Massachusetts
unfair and deceptive acts and practices statutes and copyright infringement.  On
April 13, 1999, a fifth former  Papyrus  shareholder  filed a similar  action in
Massachusetts.  Subsequently,  the Company has entered into  agreements with the
five former Papyrus  shareholders  for dismissal of the actions and cancellation
of the promissory  notes upon payment to the former  shareholders  of $1,188,909
(the "Settlement Payment") and return for cancellation by the Company of
approximately 970,000 shares of restricted common stock issued to the five
former  shareholders in the acquisition.  The Company must pay the Settlement
Payment on or before July 15, 1999 or the Company and the five former Papyrus
shareholders are free to pursue their respective claims.

Apple Computer,  Inc. - In February 1993, Articulate received a patent (the "303
patent")  for a product  which  would  allow the user of an Apple  MacIntosh  to
create spoken  commands which the computer would  recognize and respond to. Soon
after the 303 patent was issued, Articulate put Apple Computer, Inc.("Apple") on
notice that Apple's  "PlainTalk"  product  infringed the 303 patent.  When Apple
ignored Articulate's notices, Articulate sued Apple. Apple responded to the suit
by suing  Articulate  and Dragon  Systems,  Inc.,  which  suit was  subsequently
dismissed.  The  Company  acquired  Articulate's  claims  against  Apple  in the
Articulate  acquisition.  The  Company  has  completed  discovery  in the action
pending against Apple and is awaiting the scheduling of a trial.

In addition to the above,  the Company is 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.


Item 2.  Changes in Securities

           c. Unregistered  sales of equity securities during the quarter (other
than in reliance on Regulation S).

           Recent Sales of  Unregistered  Securities.  During the quarter  ended
March 31, 1999,  the Company issued equity  securities  that were not registered
under  the  Securities  Act  of  1933,  as  amended  (the  "Act"),   other  than
unregistered sales in reliance on Regulation S under the Act, as follows:

                  During the three months ended March 31, 1999, 17,500 shares
         of Series D Convertible Preferred Stock and 45,072 shares of Series E
         Convertible  Preferred Stock together with related  dividends on each
         were   converted   into   426,464   shares  and   1,086,531   shares,
         respectively, of the Company's common stock.




                                       29
<PAGE>

                  On January  29,  1999,  the  Company  sold  Debentures  in the
         aggregate  principal  amount  of  $4,000,000  to  four  investors.  The
         outstanding  principal  amount of the  Debentures is convertible at any
         time at the option of the holder into shares of Fonix common stock at a
         conversion  price equal to the lesser of $1.25 or 80% of the average of
         the closing bid price of the Fonix  common  stock for the five  trading
         days immediately preceding the conversion date. The Company also issued
         warrants to purchase  400,000 shares of common stock in connection with
         this  financing.  The warrants are  exercisable at a price of $1.25 per
         share  and  have a three  year  term.  On March 3,  1999,  the  Company
         executed  a  Supplemental  Agreement  with  the  same  four  investors,
         pursuant to which the Company sold another $2,500,000  principal amount
         of the  Debentures on the same terms and  conditions as the January 29,
         1999 agreement,  except no additional warrants were issued. The Company
         issued all of the Debentures without registration under the 1933 Act in
         reliance on Section 4(2) or Regulation D. The Debentures were issued as
         restricted   securities  and  the   Debentures   were  stamped  with  a
         restrictive legend to prevent any resale without registration under the
         1933 Act or pursuant to an exemption.

Item 6.  Exhibits and Reports on Form 8-K

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

           (2)                 Agreement and Plan of Reorganization among the
                               Company, fonix Acquisition Corporation and
                               AcuVoice dated as of January 13, 1998,
                               incorporated by reference from the Company's
                               Current Report on Form 8-K, filed March 20, 1998

           (3)(i)              Articles of  Incorporation  of the Company  which
                               are  incorporated by reference from the Company's
                               Registration  Statement  on Form S-18 dated as of
                               September 12, 1989

           (3)(ii)             Certificate   of  Amendment  of   Certificate  of
                               Incorporation  dated as of March 21, 1994,  which
                               is  incorporated  by reference from the Company's
                               Annual Report for the Fiscal Year Ended  December
                               31, 1994 on Form 10-KSB

           (3)(iii)            Certificate of Amendment of Certificate of
                               Incorporation dated as of May 13, 1994, which is
                               incorporated by reference from the Company's
                               Annual Report for the Fiscal Year Ended December
                               31, 1994  on Form 10-KSB

           (3)(iv)             Certificate   of  Amendment  of   Certificate  of
                               Incorporation  dated as of  September  24,  1997,
                               which  is  incorporated  by  reference  from  the
                               Company's  Quarterly  Report on Form 10-Q for the
                               period ended September 30, 1997

           (3)(v)              The Company's Bylaws, as amended, which are
                               incorporated by reference from the Company's
                               Annual Report for the Fiscal Year Ended December
                               31, 1994 on Form 10-KSB

           (4)(i)              Description of the Company's common stock and
                               other securities and specimen certificates
                               representing such securities which are
                               incorporated by reference from the Company's
                               Registration Statement on Form S-18 dated as of
                               September 12, 1989, as amended

           (4)(ii)             Certificate of Designation of Rights and
                               Preferences of Series A Preferred Stock, filed
                               with the Secretary of State of Delaware on
                               September 24, 1997, which is incorporated by
                               reference from the Company's Quarterly Report on
                               Form 10-Q for the period ended September 30, 1997

           (4)(iii)            Certificate   of   Designation   of  Rights   and
                               Preferences  of  Series B  Convertible  Preferred
                               Stock,  filed  with  the  Secretary  of  State of
                               Delaware   on   October   27,   1997,   which  is
                               incorporated  by  reference  from  the  Company's
                               Quarterly  Report  on Form  10-Q  for the  period
                               ended September 30, 1997

           (4)(iv)             Certificate   of   Designation   of  Rights   and
                               Preferences of 5% Series C Convertible  Preferred
                               Stock,  filed  with  the  Secretary  of  State of
                               Delaware   on   October   24,   1997,   which  is
                               incorporated  by  reference  from  the  Company's
                               Quarterly  Report  on Form  10-Q  for the  period
                               ended September 30, 1997

           (10)(i)             Product Development and Assignment Agreement
                               dated as of October 16, 1993 between Phonic
                               Technologies, Inc. and Synergetics, Inc., which
                               is incorporated by reference from the Company's
                               Current Report on Form  8-K dated as of June 17,
                               1994

           (10)(ii)            Re-Stated  Product   Development  and  Assignment
                               Agreement  dated as of March  30,  1995,  between
                               fonix Corporation and Synergetics, Inc., which is
                               incorporated  by  reference  from  the  Company's
                               Annual Report for the Fiscal Year Ended  December
                               31, 1994 on


                                       30
<PAGE>



                               Form 10-KSB

           (10)(iii)           Memorandum of Understanding dated as of March 13,
                               1997, by and among the Company, Synergetics, Inc.
                               and C. Hal Hansen, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-KSB for the fiscal year ended December
                               31, 1996

           (10)(iv)            Employment Agreement by and between the Company
                               and Stephen M. Studdert, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-KSB for the fiscal year ended December
                               31, 1996

           (10)(v)             Employment Agreement by and between the Company
                               and Thomas A. Murdock, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-KSB for the fiscal year ended December
                               31, 1996

           (10)(vi)            Employment Agreement by and between the Company
                               and Roger D. Dudley, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-KSB for the fiscal year ended December
                               31, 1996

           (10)(vii)           Convertible Debenture Purchase Agreement dated as
                               of June 18, 1997 between the Company and
                               Southbrook International Investments, Ltd.,
                               incorporated by reference from Amendment No. 1 to
                               the Quarterly Report on Form 10-Q for the period
                               ended June 30, 1997

           (10)(viii)          Amended and Restated Purchase Agreement effective
                               as of September  30, 1997 and dated as of October
                               24,   1997  by  and   between   the  Company  and
                               Southbrook International Investments, Ltd., which
                               is  incorporated  by reference from the Company's
                               Quarterly  Report  on Form  10-Q  for the  period
                               ended September 30, 1997

           (10)(ix)            Convertible  Preferred  Stock Purchase  Agreement
                               effective as of  September  30, 1997 and dated as
                               of October  24, 1997 by and among the Company and
                               JNC   Opportunity   Fund  Ltd.  and   Diversified
                               Strategies  Fund,  L.P., which is incorporated by
                               reference from the Company's  Quarterly Report on
                               Form 10-Q for the period ended September 30, 1997

           (10)(x)             Restated Master Agreement for Joint Collaboration
                               between the Company and Siemens,  dated  November
                               14, 1997, as revised,  which is  incorporated  by
                               reference  from the  Company's  Annual  Report on
                               Form 10-K for the year ended December 31, 1997

           (10)(xi)            Restated First Statement of Work and License
                               Agreement between the Company and Siemens, dated
                               February 11, 1998, as revised, which is
                               incorporated by reference from the Company's
                               Annual Report on Form 10-K for the year ended
                               December 31, 1997

           (10)(xii)           Master Technology Collaboration Agreement between
                               the Company and OGI, dated October 14, 1997,
                               which is incorporated by reference from the
                               Company's Annual Report on Form 10-K for the year
                               ended December 31, 1997

           (10)(xiii)          Common Stock Purchase Agreement among the Company
                               and JNC Opportunity Fund Ltd. and Diversified
                               Strategies Fund, LP, dated as of March 9, 1998,
                               which is incorporated by reference from the
                               Company's Annual Report on Form 10-K for the year
                               ended December 31, 1997

           (10)(xiv)           Common Stock Purchase Agreement between the
                               Company and Thomson Kernaghan & Co., dated as of 
                               March 9, 1998, which is incorporated by reference
                               from the Company's Annual Report on Form 10-K for
                               the year ended December 31, 1997

           (10)(xv)            Royalty Modification Agreement among the Company
                               and Synergetics, dated as of April


                                       31
<PAGE>



                               6,  1998,  which  is  incorporated  by
                               reference  from the  Company's  Annual
                               Report on Form 10-K for the year ended
                               December 31, 1997

           (10)(xvi)           Purchase Agreement with John Oberteuffer and the
                               Company dated April 9, 1998, which is
                               incorporated by reference from the Company's
                               Annual Report on Form 10-K for the year ended
                               December 31, 1997

           (10)(xvii)          Employment Agreement by and between the Company
                               and John A. Oberteuffer, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-K for the year ended December 31, 1997

           (10)(xviii)         First  Amendment  to Master  Agreement  for Joint
                               Collaboration  between the  Company and  Siemens,
                               dated February 13, 1998, which is incorporated by
                               reference  from the  Company's  Annual  Report on
                               Form 10-K for the year ended December 31, 1997

           (10)(xix)           Second Amendment to Master Agreement for Joint
                               Collaboration between the Company and Siemens,
                               dated March 13, 1998, which is incorporated by
                               reference from the Company's Annual Report on
                               Form 10-K for the year ended December 31, 1997

           (27)                Financial Data Schedule


(B)  Reports  filed on Form 8-K during the three  month  period  ended March 31,
1999:

           On January 7, 1999, the Company filed a Current Report on Form 8-K to
announce the  closing of a private  placement of the Company's restricted common
stock.





                                       32

<PAGE>


                                                              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:          May 19, 1998                              /s/ Douglas L. Rex
     ---------------------------------------             -----------------------
                                                         Douglas L. Rex,
                                                         Chief Financial Officer



                                       33